Chancery Court Rules Inequitable Conduct May Be Considered Within the Scope of a Section 225 Review
By: Claire S. White and Will Smith
In Robert G. Brown v. Lorrence T. Kellar et. al, Civil Action No. 2018-0687-MTZ (Del. Ch. December 21, 2018), the Delaware Court of Chancery granted in part and denied in part a motion for summary judgment by the plaintiff-stockholder, Robert G. Brown (“Brown”), to determine the composition of the board of directors (the “Board”) of SPAR Group, Inc. (“SGRP”), pursuant to 8 Del. C. § 225 (the “225 Action”). Denying Brown’s motion in part, the Court held that the 225 Action should survive summary judgment and continue to trial because the defendant-directors, the incumbent Board members of SGRP (the “Director Defendants”), asserted inequitable conduct by Brown bearing on the Board’s composition. Upholding Brown’s motion in part, the Court held that certain disputed written stockholder consents were effective on delivery under 8 Del. C. § 228(e), even though the Board had not taken action to deliver prompt notice of such written consents to SGRP’s stockholders as required pursuant to Section 228(e).
This case arose from a larger dispute among SGRP, Brown, and William H. Bartels (“Bartels”), another stockholder. SGRP is a Delaware company specializing in merchandising and marketing services based out of New York and Michigan. Brown and Bartels are current and retired executives of SRGP, respectively, and together are SRGP’s controlling stockholders. SRGP initially brought suit against Brown and Bartels as SRGP’s majority stockholders in a separate action for declaratory judgement, conspiracy, and breach of fiduciary duties (the “Bylaw Action”). Brown countered with the 225 Action at issue in this case, seeking a determination of the Board’s true composition pursuant to certain written consents executed by Brown and Bartels in June and July of 2018 (collectively, the “Director Consents”). Section 225 permits a stockholder, director, or officer to contest the validity of any election, appointment, removal, or resignation of a director or officer of a corporation, and the right of any person to hold or continue to hold such office. Executed and delivered in July 2018, the Director Consents purported to remove incumbent director Lorrence T. Kellar and replace him with Jeffrey Mayer. On the same day in July 2018, the Board purported to adopt changes to SGRP’s bylaws, which would have limited Brown and Bartels’s control over Board composition. Later in July 2018, SGRP filed a preliminary statement with the SEC disclosing the Director Consents. However, Brown and Bartels filed a conflicting statement with the SEC in August 2018, which among other things described their continued control of SGRP and the composition of the Board.
Brown moved for summary judgment on the grounds that the Directors Consents were technically valid and effective, and therefore, Mr. Mayer should have replaced Mr. Kellar before the Board’s purported changes to SGRP’s bylaws in July 2018. Brown argued that the Director Consents were valid and effective on delivery. Brown also argued that, as a matter of law, the Court could not consider alleged inequitable conduct to void the Director Consents within the scope of the 225 Action. The Director Defendants opposed summary judgment on the grounds that their affirmative defense to the 225 Action relied on alleged inequitable conduct by Brown and Bartels. The Director Defendants also argued that the Director Consents were not effective on delivery because SGRP did not send prompt notice to the non-consenting stockholders as required by 8 Del. C. § 228(e) and Rule 14c-2 of the Securities Exchange Act of 1934 (the “Exchange Act”).
The Court denied Brown’s motion in part, ruling that the 225 Action should proceed to trial because the Director Defendants asserted cognizable claims bearing on the proper composition of Board. In siding with the Director Defendants, the Court read Schnell v. Chris-Craft Industries, Inc. 285 A.2d 437 (Del. 1971) to provide an “equitable gloss” on Section 225. The Court ruled that Section 225 permits the adjudication of inequitable conduct so long as the cognizable allegations are germane to determining the composition of the Board. The Court held, as a matter of law, that it must review issues that could affect the composition of a company’s de jure directors and officers under Section 225, notwithstanding formal compliance with the technical procedures for filing those offices. The Court concluded that the Defendant Directors should be permitted to develop their defense that Brown’s alleged breaches of fiduciary duty nullified the Director Consents and affected the Board’s composition at trial.
The Court granted Brown’s motion in part, ruling that the Director Consents were effective upon delivery even though SGRP failed to deliver prompt notice under Section 228(e). The Court ruled that Section 228(e) does not require notice to minority stockholders as a condition precedent to an effective written consent. The Court held that SGRP could not nullify otherwise effective written consents by unilaterally withholding notice of those acts. The Court also rejected the Defendant Directors’ argument that SRGP could withhold notice because of a conflict between Delaware law and Rule 14c-2 of the Exchange Act. The Court concluded that because the written consents were technically effective under Section 228 upon delivery, SGRP could not defeat compliance with Delaware law by appeal to the SEC’s rules.