Gorman v. Salamone: Court of Chancery Invalidates Bylaw Granting Stockholders the Power to Remove and Replace Officers

August 6, 2015

Publication| Corporate Transactions| Corporate & Chancery Litigation

In Gorman v. Salamone, C.A. No. 10183-VCN (Del. Ch. July 31, 2015), the Delaware Court of Chancery held that a stockholder-adopted bylaw amendment that purported to grant stockholders the authority to remove corporate officers over the objection of the corporation’s board of directors was invalid under Delaware law. In so holding, the Court found that the amended bylaw, which permitted stockholders to remove and replace officers without cause, would allow stockholders to “make substantive business decisions” for the corporation and thereby “unduly interfere with directors’ management prerogatives” under Section 141(a) of the General Corporation Law of the State of Delaware (the “DGCL”).

The Court of Chancery’s opinion in Gorman is the most recent installment in an ongoing dispute over the composition of the board of directors of Westech Capital Corp. (the “Company” or “Westech”). See In re Westech Capital Corp., 2014 WL 2211612 (Del. Ch. May 29, 2014) (designating a four-member board and determining the composition thereof), aff’d in part, rev’d in part sub. nom. Salamone v. Gorman, 106 A.3d 354 (Del. 2014) (designating a five-member board and determining the composition thereof). Critical to both the Court of Chancery’s earlier post-trial opinion (the “Chancery Post-Trial Opinion”) and the Delaware Supreme Court’s opinion on appeal was the operation of a voting agreement that required the stockholders party thereto to vote, or cause to be voted, their shares of stock to elect as directors the individuals designated in the manner provided in the agreement. In this respect, the voting agreement provided, among other things, for the election of the Company’s chief executive officer as a director, provided that if for any reason the chief executive officer were to cease to serve as the chief executive officer, the stockholders party to the agreement were required to vote their shares to remove the chief executive officer from the board and to elect the new chief executive officer to the board.

Following the Chancery Post-Trial Opinion, John Gorman, as the Company’s majority stockholder, acted by written consent to amend the bylaws of the Company to provide, among other things, that “[a]ny officer may be removed, with or without cause, at any time by the Board or by the stockholders acting at an annual or special meeting or acting by written consent pursuant to Section 2.8 of these Bylaws. The Board shall, if necessary, immediately implement any such removal of an officer by the stockholders.” C.A. No. 10183-VCN, at *5. In reliance on the amended bylaw, Gorman then removed Gary Salamone as the Company’s chief executive officer and elected himself to fill the resulting vacancy. Following his appointment as chief executive officer, Gorman sought to appoint a new director to serve in his newly vacant director seat. Thereafter, Gorman filed suit in the Court of Chancery seeking confirmation that, among other things, Salamone was no longer the chief executive officer or a director of the Company.

The Court of Chancery held that the amended bylaw was invalid, stating that “Delaware law does not allow stockholders to remove directly corporate officers through authority purportedly conferred by a bylaw.” Id. at * 9. The Court of Chancery rejected Gorman’s argument that Section 142(b) of the DGCL (providing that “[o]fficers shall be chosen in such manner . . . as [is] prescribed by the bylaws or determined by the board of directors”) and Section 142(e) of the DGCL (providing that “[a]ny vacancy occurring in any office . . . shall be filled as the bylaws provide”) permitted the adoption of a bylaw that would allow stockholders to remove and replace officers. In this regard, the Court explained that neither Section 142(b) nor Section 142(e) expressly provided guidance on how officers may be removed, but only on the manner in which officers could be selected and the manner in which any vacancy in an office could be filled. Thus, the Court found that the amended bylaw was not authorized by Section 142 of the DGCL.1

Turning to the argument that stockholders generally have the power under Section 109 of the DGCL to adopt and amend bylaws “relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees,” the Court nonetheless held that the amended bylaw was outside the scope of bylaws permitted by Section 109. In particular, the Court noted that the amended bylaw required the board to “immediately implement any such removal of an officer by the stockholders,” thereby allowing the stockholders to remove an officer over the objection of the board. Explaining that such a directive, if enforceable, “could compel board action, potentially in conflict with its members’ fiduciary duties,” the Court held that the “stockholders’ right to remove officers for any (or no) reason would unduly constrain the board’s ability to manage the Company.” Id. at *15. As a result of such undue constraint, the Court held that the amended bylaw was invalid and that any actions taken in reliance thereon, including the removal of Salamone as chief executive officer, were of no effect.

Notably, the amended bylaw also provided that “[a]ny vacancy occurring in any elected office of the Corporation may be filled by the Board except that any such vacancy occurring as a result of the removal of an officer by the stockholders shall be filled by the stockholders.” The Court of Chancery expressly declined to address the validity of this provision, stating that “[t]he Court need not (and does not) analyze [the vacancy-filling] aspect of the Amended Bylaw because its validity is irrelevant to the matter at hand.” Id. at *10, n.20. The Court noted, however, that “[p]ermitting stockholders to set the mode for officer replacement would allow them to dictate a procedure, and would not necessarily step unduly on management’s toes.” Id. at *16, n.36.

1In reaching this conclusion, the Court noted that, prior to its 1967 revision, the DGCL explicitly authorized directors or stockholders to elect corporate officers, and notes that Professor Earnest Folk, in the first edition of his treatise on the DGCL, commented that the 1967 revision intended no substantive change.  That commentary stated that, while the phrase “by directors or officers” was deleted and the phrase “in the manner provided by the bylaws” was added, the changes were not intended to effect any substantive change as to who may choose the officers.  

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