Chancery Court Invalidates Supermajority Director Removal Bylaw
By: Lisa R. Stark and Taylor B. Bartholomew
In Frechter v. Zier, C.A. No. 12038-VCG (Del. Ch. Jan. 24, 2017), the Delaware Court of Chancery held that a corporation’s bylaw, which purported to require 66 2/3% of the voting power of all of the corporation’s outstanding stock to remove directors, was inconsistent with Section 141(k) of the General Corporation Law of the State of Delaware (the “DGCL”). Section 141(k) of the DGCL provides that, except with respect to corporations having a staggered board or cumulative voting, “[a]ny director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors . . . .” Unlike some other provisions of the DGCL, Section 141(k) does not expressly provide for a default rule that applies “unless otherwise provided in the certificate of incorporation or bylaws.”
On January 7, 2016, Nutrisystem, Inc. (“Nutrisystem”) announced that its board had approved an amendment to Nutrisystem’s bylaws which removed a previous requirement that directors could only be removed for cause. The amendment, however, did not remove the portion of the bylaw requiring the vote of 66 2/3% of the voting power of all of Nutrisystem’s outstanding stock to remove directors (the “Removal Provision”).
Less than two months later, plaintiff, a stockholder of Nutrisystem, filed a complaint alleging that Nutrisystem’s board of directors had breached their fiduciary duties by adopting an unlawful bylaw to entrench themselves in office (“Count I”). The plaintiff also sought a declaratory judgment that the Removal Provision was inconsistent with 141(k) of the DGCL (“Count II”). Defendants moved to dismiss the plaintiff’s complaint. Plaintiff moved for partial summary judgment as to Count II, stipulating that if the Court found in favor of plaintiff on Count II, plaintiff would withdraw Count I.
As support for their argument that the Removal Provision was valid, defendants cited Section 216 of the DGCL, which allows corporations to adopt bylaws that provide the required vote for the transaction of business “[s]ubject to this chapter in respect of the vote that shall be required for a specified action . . . .” Defendants contended that Section 141(k) merely “sets the rules [] for the circumstances under which stockholders may remove directors without cause, and does not address the percentage of the vote that is required to remove directors.” Effectively, defendants argued that Section 216 of the DGCL allows for the Removal Provision’s supermajority voting requirement because Section 141(k) is permissive, providing only that a majority of stockholders may remove directors, which, according to the defendants, is subject to any greater or lesser voting requirement to be set by the corporation in accordance with Section 216.
The Court rejected defendants’ argument and held that the Removal Provision was inconsistent with Section 141(k) of the DGCL because Section 141(k) explicitly provides for a majority stockholder vote for the removal of directors. In so holding, the Court explained that Section 141(k) is only permissive in the sense that stockholders may choose to remove directors, but they are not required to do so. “Under the Removal Provision, however, a simple majority of Nutrisystem stockholders may not exercise such power; the bylaw is, unambiguously, inconsistent with the statute. Defendants’ construction of Section 141(k), that a majority may—but only if the corporation’s bylaws so permit—remove directors, renders the ‘majority’ provision essentially meaningless, and leaves the statutory provision an effective nullity.” Accordingly, the Court denied defendants’ motion to dismiss and granted plaintiff’s motion for partial summary judgment on Count II of his complaint. As stipulated, plaintiff withdrew Count I.
Frechter v. Zier, C.A. No. 12038-VCG (Del. Ch. Jan. 24, 2017)