CHANCERY COURT ISSUES DECLARATORY JUDGMENT REGARDING BOARD AND MEMBER ACTIONS TAKEN IN CONTRAVENTION OF CORPORATION’S BYLAWS

By: Susan A. Apel & Rachel Cheasty Sanders

In Rainbow Mountain, Inc. v. Terry Begeman, C.A. No. 10221-VCMR (Del. Ch. March 23, 2017), the Delaware Court of Chancery issued a declaratory judgment on cross-motions for summary judgment regarding whether pro se defendant, Terry Begeman, was properly removed as a director, member, and officer of plaintiff nonstock corporation Rainbow Mountain, Inc. (“Rainbow Mountain” or the “corporation”).  Based on uncontroverted facts, the Court determined that Terry[1] had been properly removed as Secretary, but retained his position as Senior Vice-President, director and member.  Under the bylaws, as a “Regular Member” of Rainbow Mountain, Terry had the right to occupy the corporation’s land.

Rainbow Mountain, a Delaware nonstock corporation formed by Terry’s parents, owns approximately 97 acres of land in Virginia. The original members of the corporation were Terry, his mother, Barbara and father, Sheridan, and his five siblings, Mark, Cindy, Laurie, Jeffrey, and Todd.  Originally, the corporation had no written bylaws, but following the parents’ deaths, four of the six children signed a written consent dated July 7, 2005 electing new directors and adopting bylaws.  On September 21, 2005, the directors that were elected in the July 7, 2005 written consent signed a unanimous written consent terminating Mark and Cindy’s memberships in Rainbow Mountain without cause and adding Susan, Jason, Melanie, Bonnie, and Justin as Regular Members.[2]

In its decision, the Court considered the validity of a vote of members on November 15, 2008 pursuant to which Laurie, Jeffrey, Susan, Jason, and Melanie removed Terry from the Board; a vote of the same persons on April 29, 209 to elect Melanie’s husband, Eric, to fill the vacancy on the Board caused by Terry’s removal; a second vote on April 29, 2009 pursuant to which Susan, Jeffrey, Laurie, Jason, Melanie, and Eric purported to, as directors, remove Terry as a member of Rainbow Mountain without cause; and a vote by the same six directors to appoint Laurie as the new Secretary of Rainbow Mountain, a position that had been held by Terry.

As an initial matter, the Court determined that the bylaws dated 2003, rather than the bylaws dated 2005, were operative. Pursuant to the 2003 bylaws, only Regular Members are entitled to vote and to live on Rainbow Mountain’s property with their respective families, and Regular Members “may be terminated for cause . . . only by a vote of expulsion by 2/3 or more of the Full Board of Directors.”  The 2003 bylaws define “cause” by enumerating seven circumstances that constitute “cause.”  Directors, on the other hand, “may be removed with or without cause, at any time, by the majority vote of the Regular Members” and the Board has the power to appoint and remove officers by majority vote.  Furthermore, the 2003 bylaws establish a quorum by stating that “[m]embers holding more than 50% of the votes that may be cast at any meeting shall constitute a quorum at a meeting of Members.”

Before the Court could decide whether Terry’s positions in the corporation had been properly terminated, the Court had to determine the status of Mark and Cindy’s membership, which the Board had terminated without cause in 2005 by unanimous written consent. The Court found that the 2005 written consent misquoted the 2003 bylaws by stating “membership … may be terminated by the Board of Directors at any time without cause” and that because Mark and Cindy could be removed as Regular Members only with cause, their removal was not properly effective.

The Court then turned to the plaintiff’s assertion of equitable estoppel. Because Terry signed the written consent which purported to terminate their membership without cause, the plaintiffs asserted that Terry was estopped from using the ineffectiveness of their termination to his advantage.  The Court explained, however, that estoppel is unavailable in matters where the corporate action in question is void, rather than voidable.  The Court, citing to prior Delaware case law and noting that it has not always been consistent, found that board action in contravention of bylaws is properly treated as void.

The Court went on to find that because the memberships of Mark and Cindy were not properly terminated, they were still members of the corporation, and that the removal of Terry as a director was therefore ineffective because only five of the members were present at the November 15, 2008 meeting, and a quorum of more than 50% was thus not obtained. Further, because Terry was not properly removed as a director, Eric could not be appointed to the “vacant” director’s seat as the seat was not vacant (and because a quorum of members was not present).  If Eric was not a director at the time Terry was voted off the Board, only five of nine directors voted to terminate Terry’s membership, which did not satisfy the requirement in the 2003 bylaws that members may only be removed by 2/3 vote of the full Board.

Next, the Court turned to Terry’s officer positions. Pursuant to the 2003 bylaws, Terry’s term as an officer of Rainbow Mountain terminated if and when a successor was appointed and qualified.  Thus, when the board appointed Laurie to Secretary, Terry was replaced and his term as Secretary ended.  Because only a majority of directors was needed to appoint officers pursuant to the 2003 bylaws, five of the nine directors who appointed Laurie constituted a quorum effectuating Terry’s replacement.  However, because no successor was appointed to Terry’s position as Senior Vice-President of Rainbow Mountain, he remained in that position.

Finally, the Court discussed the matter of Terry’s right to occupy Rainbow Mountain property. According to the 2003 bylaws, as a Regular Member, Terry could “live on the grounds of Rainbow Mountain Incorporated with [his] spouse and children.”  Because the termination of Terry’s membership was ineffective, Terry still retains his right to live on Rainbow Mountain property.

[1] The Court’s opinion referred to the parties by their first names “because many of them share the same last names.”

[2] While the record is clear that Barbara and Sheridan’s six children were Regular Members, the Court assumed that Susan, Bonnie, Melanie, Jason, and Justin were also Regular Members for the purposes of the decision.

Rainbow Mountain, Inc. v. Begeman C.A. No. 10221-VCMR (Del. Ch. Mar. 23, 2017)