Differential Voting Rights for Directors of a Delaware Corporation Must Be Set Forth in the Certificate of Incorporation

By William Axtman and Dotun Obadina

In addressing a request for a preliminary injunction seeking the invalidity of a resolution adopted by the defendant directors through the exercise of disproportionate voting rights, the Delaware court reaffirmed that differential voting rights for directors of a Delaware corporation must be set forth in the certificate of incorporation.

In Sinchareonkul v. Fahnemann, the plaintiff, a director of Sempermed USA, Inc. (the “Company”), brought suit against two other directors of the Company, seeking declaratory judgments invalidating bylaw provisions that conferred disproportionate voting power on the defendants who are also directors of the Company.  Semperit Technische Produkte Gesellschaft m. b. H. (“Semperit”), Sri Trang Agro-Industry Public Co., Ltd. (“Sri Trang”), and Siam Sempermed Corporation Ltd. (“Siam Sempermed”) agreed to form the Company in 1998 for the purposes of manufacturing latex surgical gloves and then distributing and selling them in the United States market.

To document their business relationship, Semperit, Sri Tang, and Siam Sempermed entered into a Joint Venture Agreement (the “JV Agreement”), which contemplated that the Company would have an eight-member board of directors, evenly split between nominees of Semperit and Sri Trang.  In an effort to avoid deadlock, the JV Agreement provided that the chairman of the board would be elected by the four Semperit directors and would be provided with an additional vote in the event of a deadlock between the eight directors.  The JV Agreement acknowledged that the Company would have a certificate of incorporation and bylaws, but provided that in the event of any discrepancy between the certificate of incorporation or the JV Agreement, the provisions of the JV Agreement would control and the certificate of incorporation would be promptly amended accordingly.  The bylaws of the Company, and not the Company’s certificate of incorporation, provided for the designation of a chairman of the board and granted the chairman the additional voting rights in the event of a deadlock.

At a board meeting on January 13, 2015, the directors were deadlocked on a vote related to a resolution regarding an increase of royalty payments owed by the Company to Semperit—the Semperit directors voted to approve the resolution and the Sri Trang directors voted against the resolution.  The chairman, a Semperit director, broke the deadlock by voting in favor of the resolution.  Plaintiff, a Sri Tang director, then brought suit against the Semperit directors, seeking a declaratory judgment that the bylaws designating a chairman of the board and conferring upon that chairman additional voting rights in the event of a deadlock and the resolution related to the increase of royalty payments were void.  After the filing of the lawsuit, the Semperit directors noticed a meeting of the board, occurring on February 10, 2015, to consider an amendment to the Company’s certificate of incorporation to incorporate the terms of the JV Agreement related to the designation of a chairman of the board and conferring upon that chairman additional voting rights in the event of a deadlock.  The resolution adopting the proposed amendment also called for a meeting of stockholders so that the Company’s stockholders could vote on the proposed amendment.  The plaintiff, then, moved to schedule an expedited hearing on an application for a preliminary injunction, which would occur prior to the board meeting.

Under Delaware law, an expedited hearing on an application for a preliminary injunction will be scheduled only if the plaintiff has (1) articulated a sufficiently colorable claim and (2) shown a sufficient possibility of a threatened irreparable injury, as would justify imposing on the defendants and the public the extra costs of an expedited preliminary injunction proceeding.

The court first addressed whether the plaintiff had articulated a sufficiently colorable claim.  In doing so, the court highlighted and reaffirmed the following:

(a)    Under Section 141(d) of the Delaware General Corporation Law (the “DGCL”), if one category or group of directors is given differential voting rights not shared by the other directors, the differential voting rights must be set forth in the certificate of incorporation;

(b)   The DGCL and a company’s governing documents form a hierarchy comprising from top to bottom: the DGCL, the certificate of incorporation, and the bylaws, and each of the lower components of the contractual hierarchy must conform to the higher components; and

(c)    Section 109(b) of the DGCL provides that a bylaw that conflicts with the certificate of incorporation or law (including the DGCL) is void.

Applying these principles to the facts of this case, the court found that the plaintiff articulated a sufficiently colorable claim because (1) the rights of the Semperit directors  to designate a chairman and the additional voting rights conferred upon the chairman in the event of a deadlock were provided in the bylaws and not the certificate of incorporation and (2) the additional voting rights provided in the bylaws conflicted with the DGCL and the Company’s certificate of incorporation and, under Section 109(b) of the DGCL, are therefore void.

As to the second requirement, the court held that there was not a sufficient threat of irreparable harm to warrant scheduling a preliminary injunction because the potential harm that could result was either unlikely or could be remedied by money damages.  Because the second requirement for an expedited preliminary hearing was not met, the court denied the plaintiff’s motion for an expedited hearing for an application for a preliminary injunction.  Instead, the court found that good cause existed for a “speedy hearing” in the form of a two-day trial on the merits, to be scheduled in approximately 90-120 days from the date of the decision.

Sinchareonkul v. Fahnemann, et al. (January 22, 2015) (Laster, V.C.)

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