Keyser v. Curtis: Sole Director’s Issuance of Super-Voting Preferred Stock to Himself Fails Entire Fairness Review
September 5, 2012
In a summary proceeding under Section 225 of the Delaware General Corporation Law, the Court of Chancery in Keyser v. Curtis, 2012 WL 3115453 (Del. Ch. July 31, 2012), applied the entire fairness test to a sole director’s effort to prevent stockholders from electing a new board by issuing a new series of preferred stock with powerful voting rights to himself for one cent per share, held that the issuance was not entirely fair, and determined that the newly issued stock could not be counted in determining whether the plaintiff-stockholders had delivered sufficient written consents to elect a new board.
Plaintiffs Robert D. Keyser, Jr., Frank Salvatore and Scott Schalk sued for a determination that they had been elected as the new board of directors of Ark Financial Services, Inc. (“Ark”) by stockholder written consent. Ark contended that one of the plaintiffs, Robert Keyser, was required under a prior settlement agreement to transfer approximately seven million shares of common stock back to Ark, and that Keyser therefore could not give written consents to elect a new board as to those shares. Although the Court determined that Keyser had breached the settlement agreement, the Court declined to order specific performance on the ground that Keyser also had breached an obligation under the same agreement to pay Keyser $50,000. Consequently, the Court held that Keyser was entitled to execute written consents as to the shares, and that the written consents delivered to Ark represented a majority of the outstanding common stock.
Ark also contended that the written consents were insufficient to elect a new board because, approximately a year before the consents were delivered, Albert Poliak, then the CEO and sole director of Ark, had authorized and issued to himself 25,000 shares of a newly created, super-voting Series B preferred stock. Poliak paid $0.01 per share for the Series B stock, but acquired both the right to redeem the stock on demand for $1.00 per share and overwhelming voting power over any matter subject to a vote of Ark’s stockholders.
The Court noted that Poliak admitted that the purpose of the Series B issuance was to prevent the election of a new board, which purpose arguably triggered review under the standard set forth in Blasius Industries Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988). However, the Court explained that, unlike the directors in Blasius, Poliak engaged in a self-dealing transaction. Under Delaware law, self-dealing transactions are subject to review under the more burdensome entire fairness standard.
The defendants argued that because Ark was insolvent at the time of the Series B stock issuance, the shares Poliak received were worthless and thus the penny per share price was fair. The Court rejected this argument, stating that “even if Ark had absolutely no money, it was self-dealing for Poliak to pay $250 for an option to demand $25,000 from Ark in the event it became solvent.” The Court continued that “[c]ontrol of an insolvent corporation is worth something because there is always a chance it will become solvent.” The Court determined that the issuance was not entirely fair and hence that it was invalid.
Accordingly, the Court affirmed that the plaintiffs constituted Ark’s board of directors. The Court declined to award attorneys’ fees to the plaintiffs. The Court’s decision clarified uncertainty around the composition of Ark’s board of directors and the validity of the Series B preferred stock, and thus provided a corporate benefit that could justify awarding the plaintiffs their costs and fees. However, the Court concluded that in bringing the action, Keyser was principally motivated by a desire to benefit himself rather than a desire to benefit Ark.