On April 21, 2010, in Crown Emak Partners, LLC v. Kurz, the Delaware Supreme Court issued a wide-ranging opinion providing guidance regarding buying votes from stockholders, contractual restrictions on the transfer of stock, removal of directors and who is a record holder entitled to vote and deliver consents in respect of shares. The opinion is of interest to general counsels, corporate secretaries, participants in control contests and those involved in arrangements that may separate the voting and economic rights of an equity security.
The case grew out of a battle for control of EMAK Worldwide, Inc. Donald Kurz, an EMAK director and former CEO of the company, led an insurgent attempt to gain control of the board. EMAK’s management together with Crown Capital, a holder of EMAK preferred stock, attempted to stave off Kurz. The two groups launched competing consent solicitations. The Kurz group sought to remove two directors from the board of seven and elect three new directors. The Crown and management group proposed to amend EMAK’s bylaws to reduce the size of the board to three directors and require that, once the board was reduced, a special meeting of shareholders be held to elect one director as successor to all directors whose seats were eliminated. Given that Crown’s preferred stock entitled it to elect two EMAK directors as a class, the bylaw amendments would give Crown control.
With its own and management’s votes, Crown easily obtained sufficient consents to approve its bylaw proposals. Kurz on the other hand struggled to obtain the required consents. Shortly before the solicitation deadline, Kurz agreed to acquire shares owned by Peter Boutros, a former EMAK employee. Because Mr. Boutros’s restricted stock grant prohibited transfer of the shares before March 2011, the Kurz/Boutros purchase agreement delayed the actual transfer of title until after the expiration of the transfer restriction. The purchase agreement, however, provided for an immediately effective proxy to vote the shares and an executed consent card in favor of the Kurz group. The votes associated with the Boutros shares were sufficient to give the Kurz group the necessary majority.
The court thus confronted two contradictory and ostensibly successful consent solicitations. The court’s most significant holdings are as follows.
- Vote Buying. Because the agreement between Boutros and Kurz resulted in transfer of the “swing votes” in the Kurz group’s consent solicitation, the court determined it was subject to judicial review. In the course of its review, the court noted that the foundation of the corporate decision-making scheme is the presumption that shareholders will act to maximize their shared, economic interest in the corporation. As a result, when reviewing a vote-buying transaction a Delaware court will focus on whether the transaction maintained the alignment between the economic and voting rights inherent in the shares. The court concluded there was no improper vote buying in the Kurz/Boutros transaction because the economic and voting rights in the shares were transferred together. Any party considering a transaction that would result in the separation of the voting and economic interests in shares should consult the Crown Emak.
- Contractual Transfer Restrictions. Although it passed muster under a vote buying analysis, the court invalidated the Kurz/Boutros sale on contractual grounds. The subject shares were restricted under a grant that prohibited transfer until March 2011 but did not explicitly address agreements to transfer. Kurz and Boutros attempted to contract around the restriction by providing for immediate grant of a proxy and delivery of a consent, but delaying delivery of title to the shares until the expiration of the restricted period. The cash consideration for the shares was due on execution of the purchase agreement, and except for expiration of the restriction, the subsequent transfer of title was otherwise unconditional. The court concluded that the transaction violated the transfer restriction because the economic risk and voting interests – “the functional equivalent of ‘full ownership'” – effectively were transferred upon signing, despite the fact that “bare legal title” was retained by Boutros and notwithstanding the absence of an explicit prohibition on agreements to transfer.
- Director Removal. Crown’s preferred shares had the right to elect two directors separately as a class and were entitled to vote on an as-converted basis with the common stock on most matters, but did not participate in the election or removal of the other five directors. As a result, management and Crown decided not to pursue a more typical strategy of first removing directors and only then reducing the size of the board. Instead, they secured the requiste consents in favor of by-law amendments that would (i) reduce the board from seven to three directors and (ii) require that, once the board was reduced, a special meeting of shareholders be held to elect one director as successor to all directors whose seats were eliminated. The bylaw amendments were invalidated by the court on the grounds that reducing the size of the board below the number of sitting directors violates Delaware law. The court held that, under the Delaware statutory scheme, directors must first be removed by the shareholders before their seats are eliminated.
- Record Holders. An interesting twist in the case arose because the Kurz group failed to obtain an omnibus proxy from the Depository Trust Company. An omnibus proxy is used in all public company elections and consent solicitations to transfer the right to vote “street name” shares from DTC, the record holder, back to the beneficial owners. Without the street name shares, the Kurz group would not have had the necessary consents to pass its proposals. In sustaining the Kurz group proposals, the lower court held that the DTC proxy was unnecessary because although only record holders – that is, the holders listed in the corporation’s stock ledger – have the right to vote or grant consents, the definition of a corporation’s stock ledger should be expanded beyond the corporation’s own records to include DTC’s official breakdown of the owners of the shares held through DTC. Having invalidated the share purchase transaction, thereby depriving the Kurz group of the consents necessary to pass its proposals, the Supreme Court did not need to decide the impact of the failure by the Kurz group to obtain the omnibus proxy. However, the court stressed that the lower court’s groundbreaking holding that the stock ledger includes the DTC breakdown for purposes of determining record holders entitled to vote is “without precedential effect” and that a legislative solution to the question would be preferable.