In Related Actions, Chancery Court Orders Advancement of Expenses and Confirms that New DGCL Section 205 Provides Limited Authority for the Court to Invalidate Corporate Acts

By Lisa Stark and John Sun

In In re Genelux Corp., C.A. Nos. 10612, 10042-VCP (Del. Ch. Oct. 22, 2015), the Delaware Court of Chancery held that Dr. Aladar Szalay, a former director and officer of Genelux Corporation (“Genelux”), was entitled to advancement of his fees and expenses incurred as an intervenor in an action brought by Genelux to invalidate Szalay’s Genelux stock and the election of two Genelux directors (the “Section 205/225 Action”).  The Court also awarded Szalay his fees in prosecuting the advancement action.  In the Section 205/225 Action, the Court held that new Section 205 of the Delaware General Corporation Law (the “DGCL”) does not authorize the Court of Chancery to invalidate any defective corporate act, including putative stock, other than defective corporate acts ratified pursuant to Section 204 of the DGCL.  The Court also held that Szalay’s election of two Genelux directors based on the disputed stockholdings to be valid under Section 225 of the DGCL.

  1. Advancement Action

This advancement action arose after Genelux declined to advance Szalay his attorney fees and costs incurred in intervening in the Section 205/225 Action.  Szalay sought advancement under Genelux’s bylaws which provided, in pertinent part:

Each person who was or is made a party or is threatened to be made a party or is involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative (hereinafter a “proceeding”), by reason of the fact that he or she, or a person of whom he or she is the legal representative, is or was a director or officer, of the Corporation . . . whether the basis of such proceeding is alleged action in an official capacity as a director, officer, employee or agent or in any other capacity while, serving as a director, officer, employee or agent, shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Delaware General Corporation Law…. provided, however, that, except as provided in paragraph (b) hereof, the Corporation shall indemnify any such person seeking indemnification in connection with a proceeding (or part thereof) initiated by such person only if such proceeding (or part thereof) was authorized by the Board of Directors of the Corporation.

Szalay also sought advancement pursuant to his indemnification agreement with Genelux, which provided for mandatory advancement of expenses incurred in connection with any proceeding by reason of Szalay’s “Corporate Status”.  The indemnification agreement defined “Corporate Status” to include “the status of a person who is or was a director….”  Similar to the advancement provisions in Genelux’s bylaws, the indemnification agreement prohibited advancement “in connection with any Proceeding (or any part of any Proceeding) initiated by Indemnitee,” without the consent of Genelux’s board of directors.

Genelux argued, inter alia, that Szalay was not entitled to advancement under either Genelux’s bylaws or the indemnification agreement because: (1) Szalay intervened in the Section 205/225 Action for personal reasons unrelated to his status as a former Genelux director and officer; (2) Szalay “initiated” his involvement in the Section 205/225 Action without obtaining board approval as required by Genelux’s bylaws and the indemnification agreement; and (3) Genelux’s insurer had agreed to pay Szalay’s legal fees.

The Court determined that Szalay had a corporate interest in intervening in the Section 205/225 Action because the proceeding sought to invalidate actions taken by Szalay in his capacity as a Genelux director (namely, the issuance of the disputed shares).  The Court also rejected Genelux’s contention that Szalay could not seek advancement given his failure to obtain board approval for his intervention in the 205/225 Action.  According to the Court, Szalay’s intervention was defensive in nature because he would be barred on collateral estoppel grounds from subsequently arguing that he had acted properly as a director of Genelux in connection with the disputed stock issuances had he not intervened in the 205/225 Action.  The Court also found that it would be inequitable to deny Szalay’s claim for advancement where the underlying proceeding threatened Szalay’s interests more than the interests of the named defendants.  Finally, because Szalay was not seeking to recover fees paid by an insurer, the Court found that he was entitled to advancement of any reasonable fees and expenses, not covered by an insurer.

  1. Section 205/225 Action.

In the Section 205/225 Action, the Court of Chancery held that Section 205 of the DGCL does not authorize the Court to invalidate any defective corporate act, including putative stock, other than defective corporate acts ratified pursuant to Section 204 of the DGCL.  This action arose after Szalay elected two directors to Genelux’s board of directors at Genelux’s 2014 annual meeting of stockholders.  Genelux sought to invalidate: (1) issuances of Genelux stock to Szalay in 2005 and 2009 (the “Disputed Stock”) under Section 205 of the DGCL, and (2) Salazay’s election of the two directors at the 2014 annual meeting under Section 225 of the DGCL.  Section 205 of the DGCL, which was adopted by the Delaware legislature in 2013, provides that the Court of Chancery may: “[d]etermine the validity of any corporate act or transaction and any stock, rights or options to acquire stock.”  8 Del. C. 205(a)(4).  Plaintiffs argued that inherent within Section 205’s grant of power to the Court of Chancery to determine the validity of any stock was the authority to invalidate stock.

The Court found that the language of new Section 205 of the DGCL was ambiguous on the issue of whether the Court of Chancery had the authority to invalidate corporate acts.  After reviewing extrinsic evidence of the drafters’ intent, the Court held that Section 205 could be used to cure defective corporate acts, but not to invalidate corporate acts, except acts ratified under new Section 204 of the DGCL.  Because the Disputed Stock was valid, the Court found that Szalay had properly elected the defendants as directors of Genelux.

In re Genelux – Advancement Opinion

In re Genelux – Section 205 Opinion

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