Chancery Court Applies Contract Terms to Clarify Difference Between Void and Voidable Stock Issuances

By Jessica Pearlman and Jonathan Miner

Southpaw Credit Opportunity Master Fund, L.P. v. Roma Restaurant Holdings, Inc., C.A. No. 2017-0059-TMR (Del. Ch. Feb. 1, 2018) came before the Delaware Court of Chancery as a dispute over control of the board of directors of Roma Restaurant Holdings, Inc. (“Roma” or the “Company”). Plaintiffs were a stockholder group that had taken a majority position in Roma’s common stock. After learning of Plaintiffs’ majority position, the Roma board adopted a new equity compensation plan and issued sufficient shares of restricted stock to Roma employees to dilute Plaintiffs below a majority ownership position. Plaintiffs considered the dilutive restricted stock issuances as invalid for a number of reasons, including the Company’s failure to obtain contractually mandated stockholder agreement joinder documents from each recipient before issuance, and presented Roma with a written consent that removed two of Roma’s current directors (the “Defendant Directors”) and replaced them with Plaintiffs’ nominees. Roma contested the validity of Plaintiffs’ written consent and the case came before the Court under Section 225 of the Delaware General Corporation Law (DGCL) to determine the proper composition of Roma’s board of directors. Vice Chancellor Montgomery-Reeves found that the disputed restricted stock issuances were void and could not be counted toward a stockholder vote.

In 2006 Roma underwent a court-approved bankruptcy reorganization. The reorganization process bound all stockholders of Roma to a stockholders’ agreement (the “Stockholders’ Agreement”) that barred Roma from issuing stock or stock equivalents to any person not a party to the Stockholders’ Agreement unless such person first agreed in writing to be bound by the Stockholders’ Agreement and that required such person acknowledge having had ample time to read, and consult with counsel on, the Stockholders’ Agreement. The Stockholders’ Agreement also provided that failure to execute proper joinders to the Stockholders’ Agreement before an issuance would make such issuance “null and void ab initio.” At the time of the contested issuance of restricted stock grants, Roma’s prior stock plan had expired. On December 1, 2016 the board authorized a new plan (the “2016 Plan”), which by its terms did not require stockholder approval before the issuance of restricted stock. On the same day the 2016 Plan was approved, the Roma board authorized the issuance of a total of 48,500 shares of restricted stock, sufficient to dilute Plaintiffs’ ownership of Roma from 51.4% to 46.9% and sent emails to the recipients notifying them of their awards. The award agreements provided that the recipients agree to execute all required instruments and that the stock would be “subject” to the Stockholders’ Agreement; however, the recipients never executed the required joinders.

At trial, the Director Defendants did not contest that the Company failed to obtain executed joinder agreements to the Stockholders’ Agreement from the restricted stock recipients but argued “that the restricted stock issued pursuant to the 2016 Plan is voidable because of Director Defendants’ own actions, but not void.” The Director Defendants further argued that finding the stock issuance to be void would result in an inequitable outcome to the recipients and that the requirements of the Stockholder’s Agreement had been substantially performed. If the restricted stock issuances were voidable, instead of void, the flawed issuances could be cured by subsequent action of the Roma board. Plaintiffs argued that the restricted stock issuances were void under the clear provisions of the Stockholders’ Agreement, and thus not capable of cure.

The Court found that the restricted stock issuances were void for failure to comply with the joinder requirement of the Stockholders’ Agreement and could not be counted in a vote to determine the composition of the Roma board. To arrive at its decision the Court analyzed the express language of the Stockholders’ Agreement, citing case law that Delaware adheres to the objective theory of contracts and will give priority to the parties’ intentions as reflected in the four corners of the agreement. Roma’s Stockholder’s Agreement governed almost all important aspects of Roma’s activities, including stock issuances, stock transfers, elections, and meetings. The clear terms of the Stockholders’ Agreement required execution of a joinder agreement before issuance of stock, and further provided that issuances failing to comply with its requirements were null and void. The Court concluded that its finding was also equitable, as the Director Defendants’ failure to comply with the joinder requirements was more than a technical deficiency and was “a failure to substantially perform the required actions.” The Court also noted that the Director Defendants’ actions in adopting the 2016 Plan indicated entrenchment motives, and a party “seeking the aide of equity’s extraordinary remedies do so to the maxim that he who seeks equity must do equity.”

Southpaw Credit Opportunity Master Fund, L.P., v. Roma Restaurant Holdings, Inc., et al., memorandum opinion 180102


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