In Klaassen v. Allegro Development Corporation, et al., the Delaware Court of Chancery described the difference between actions that are void or voidable when taken by a board in violation of the by-laws (No. 8626-VCL (Del. Ch. Oct. 11, 2013)). In a case involving notice requirements for board meetings, Allegro Development Corporation's CEO and majority common stockholder Eldon Klaassen challenged his removal as CEO by the board of directors of the company. Klaassen, who was also a board member, alleged that his removal was void under the by-laws of the corporation because he had not received notice of the board's plan to fire him before the board meeting at which he was removed. At trial, the outside directors explained their concern that Klaassen may have taken action to harm the company had he known of the board's plans ahead of time. The board therefore decided not to give Klaassen notice of their plan to replace him until they had control over the corporation's bank accounts, intellectual property and other key assets.

In the immediate aftermath of his removal as CEO, Klaassen stayed on as a director and consultant to the company, and did not claim that his termination as CEO was invalid. Seven months later, however, he took the position by letter to the board that he was still CEO of the company. On the same day, he filed an action under Section 225 of the DGCL, claiming that his removal was void on grounds that three of the five board members who had voted to replace him had breached their duty of loyalty and good faith. Klaassen also argued a novel theory that the board had an equitable notice requirement owed to him as an officer and director who could have exercised a right to potentially change the board's composition to pre-empt the board's action.

The court did not address the equitable-notice theory squarely, although it did note its skepticism in a footnote. Instead, the court rejected it by balancing the equities of the board's actions against Klaassen's own. In so doing, the court noted the distinction between an action that is void because of a breach of the by-law's requirements, and an action that is voidable because of a breach arising in equity. An action that is void cannot be corrected except under the amended Section 204 of the DGCL, effective April 1, 2014 (see Legal Update, Proposed Changes to Delaware Law: No More Top-up Options and Default Fiduciary Duties for LLC Managers). In contrast, a voidable action can be upheld by the court based on countervailing equitable principles. Because Klaassen's claims rested in equity, rather than on a violation of a mandatory by-law, the court dismissed Klaassen's claim on the basis of the equitable doctrines of laches and acquiescence (acting in a way that amounts to recognition of the complained act).

The Allegro decision highlights that the nature of the board's wrongful act, and whether it is a violation of an explicit by-law or a breach of fiduciary duties, will alter the court's analysis. Board members must therefore exercise particular caution that their actions comply with the letter of the by-laws, including on technical issues like notice.

The decision also demonstrates that even majority stockholders must pay attention to the wording of the company's organizational documents. It can be tempting to assume that a majority stockholder's power to replace the board before it takes action that the stockholder disapproves renders the organizational documents somewhat less significant. Yet in Allegro, because the board did not directly violate the by-laws, the majority stockholder could only raise a complaint against the board's action on a basis of equity. This opened the door for the court to engage in a balancing act of other equitable principles and ultimately affirm the board's actions.

Update: On December 20, 2013, the Delaware Supreme Court affirmed the Court of Chancery's October 11th opinion (No. 583, 2013 (Del. Dec. 20, 2013)).

For example language for notice requirements for board meetings, see Standard Document, Private Company By-laws (Delaware Corporation): Section 3.09. For a discussion of best practices in maintaining by-laws for privately held corporations, see Practice Note, Best Practices in Corporate Subsidiary Management.

The Delaware Court of Chancery addressed the validity of an officer's action in light of an organizational document similar to a corporation's by-laws in Flaa v. Montano, et al., No. 8632-VCG, (Del. Ch. Oct. 4, 2013). In Montano, the plaintiff, a director of CardioVascular BioTherapeutics, Inc. (Cardio), sought confirmation that the removal of certain of Cardio's other board members by written stockholder consent was valid. The consent in question was delivered by Vizier Investment Capital Limited (Vizier), a Bahamian investment vehicle created by Cardio's founder and CEO, Daniel Montano, solely to hold Cardio stock shared by Daniel and his wife, Vicki Montano. The Montanos later divorced.

The removal of Cardio's directors became necessary as part of a plan by a stockholder of Cardio to rescue the company from insolvency. After Cardio defaulted on several loans, the lender proposed a financing arrangement to Cardio's board that was conditioned on the immediate resignation of Daniel Montano as CEO and of almost all other Cardio board members. Cardio's board rejected the proposal. The lender then initiated a written stockholder consent seeking to remove Daniel and the other directors. The action could only be ratified with the consent of the Vizier shares, and as vice president of Vizier, Vicki voted those shares in favor of the proposal. The defendant directors, who were removed by virtue of the stockholder consents, challenged the consents voted by Vizier, arguing that Vicki did not have authority to execute a stockholder consent in her role as vice president. (Although Bahamian law controlled the issue of authority to execute the Vizier consents, the parties agreed that the analysis under Bahamian law was the same as under Delaware law.)

The court accepted the defendant directors' argument. In so doing, the court recited the Restatement (Third) of Agency, which states, "the office of vice president by itself does not carry actual or apparent authority to bind the corporation" (§ 3.02 cmt. 4). Rather, any powers must be explicitly granted in the organizational documents that create the role. The court therefore looked to Vizier's Articles of Association, which provided that the president, Daniel, would manage the day-to-day affairs of Vizier and the vice president, Vicki, would act in the absence of the president. Having found that Daniel was not absent, and with no explicit signing authority granted under the Articles of Association to the office of vice president, the court ruled that Vicki did not have the authority to execute the consents, and invalidated the stockholder consent.

The Montano decision is a reminder that important-sounding titles do not necessarily carry commensurate powers, if those powers are not spelled out in either the by-laws or by board resolution (see Section 142(a) of the DGCL). This can undermine actions both large (as in this case) and small if an officer takes action on the company's behalf for which he is not authorized.

For an example of language for Delaware by-laws that both creates the office of vice president and grants signing power to vice presidents of a corporation, see Standard Document, Private Company By-laws (Delaware Corporation): Drafting Note, Execution Authority.

The third recent development involving Delaware by-laws stems not from a court decision, but a voluntary withdrawal of an appeal. On June 25, 2013, the Delaware Court of Chancery held in Boilermakers Local 154 Ret. Fund, et al. v. Chevron Corp., et al. that the forum selection by-laws unilaterally adopted by the boards of directors of Chevron and FedEx were valid under Delaware law and contractually valid and enforceable as forum-selection clauses (73 A.3d 934 (Del. Ch. 2013)). For a discussion of that decision, see Legal Update, Delaware Court of Chancery Upholds Boards' Unilaterally Adopted Forum Selection By-laws. On October 15, the plaintiffs in the case dropped their appeal to the Delaware Supreme Court, leaving the Court of Chancery's ruling as the final word on the issue for now.

The Court of Chancery's decision emphasizes that the board acted under the authority granted to it and that it may unilaterally adopt by-laws establishing the exclusive venue for claims relating to the internal affairs of the corporation. These types of by-laws are within the scope of Section 109(b) of the DGCL.

For a sample by-law to establish Delaware as the exclusive jurisdiction for internal disputes, see Standard Clause, By-laws or Certificate of Incorporation: Delaware Forum Selection.