Continuing the long line of precedent confirming the primacy of the board of directors in the governance of a Delaware corporation, the Delaware Court of Chancery recently invalidated a stockholder-adopted bylaw that attempted to grant stockholders the right to remove and replace corporate officers, even in situations where the corporation’s board of directors objected to such removal.  In a brief 25-page opinion,[1] Vice Chancellor Noble held that, although stockholders generally have the broad power to adopt and amend bylaws, that right is not unlimited and the bylaw at issue would “unduly interfere with directors’ management prerogatives under Section 141(a)” of the Delaware General Corporation Law (the “DGCL”).

Gorman arose out of a series of disputes over the proper composition of the board of Westech Capital Corporation (the “Company”), a Texas-based financial services holding company, between John Gorman, the Company’s controlling shareholder (“Gorman”), and members of the Company’s board of directors (the “Board”).  The initial disputes centered around the interpretation of a voting agreement, which set forth how the Company’s directors were to be selected.

After having won in part and lost in part a prior Court of Chancery decision regarding the interpretation of the voting agreement,[2] Gorman attempted to act by stockholder written consent to amend the bylaws of the Company, which amendment provided that:

“[a]ny officer may be removed, with or without cause, at any time by the Board or by the stockholders acting at an annual or special meeting or acting by written consent … .  The board shall, if necessary, immediately implement any such removal of any officer by the stockholders.”[3]

Thereafter, Gorman immediately took action to remove Gary Salamone (“Salamone”) from his position as chief executive officer, which if valid would also have required the Board to remove him as a director pursuant to the terms of the voting agreement.  In the same action, Gorman elected himself to fill the resulting vacancy.  When Salamone and the rest of the Board refused to recognize the validity of the amended bylaw and the actions taken by Gorman to remove Salamone, Gorman filed suit in the Court of Chancery seeking confirmation that the actions he took in amending the bylaw and in reliance on the amended bylaw were valid.

Gorman’s main argument relied on Section 142(b) of the DGCL, which states:

“Officers shall be chosen in such a manner and shall hold their offices for such term as are prescribed by the bylaws or determined by the board of directors or other governing body. Each officer shall hold office until such officer’s successor is elected and qualified or until such officer’s earlier resignation or removal. Any offer may resign at any time upon written notice to the corporation.”[4]

In support of his argument, Gorman also pointed to Section 109 of the DGCL, which states that shareholders can adopt and amend bylaws “relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.”[5]

In his ruling, Vice Chancellor Noble reasoned that, although Section 109 permits shareholders to adopt bylaws to establish a mechanism for selecting officers and filling vacancies, the provision does not “speak to how corporate officers may be removed, never mind grant stockholders such a power.”[6]  In his view, “valid bylaws focus on process” and in considering whether a bylaw is more than procedural and intrudes upon the board’s authority, it has to be read in light of its context and purpose.  Here, the underlying facts related to Gorman’s previous attempts at control no doubt influenced the result.  According to the Vice Chancellor, the bylaw at issue “was apparently intended to take an important managerial function from the board.”[7]

Confirming the “bedrock statutory principle of director primacy”,[8] the Vice Chancellor held that bylaws cannot mandate how the board should make specific substantive decisions – “[s]tockholders’ ability to amend bylaws is ‘not coextensive with the board’s concurrent power and is limited by the board’s management prerogatives under Section 141(a).’”[9]  In his view, the subject bylaw would “unduly constrain the Board’s ability to manage the Company” [10] and could require the Board to take action in conflict with the directors’ fiduciary duties.[11]  As a result, the Vice Chancellor invalidated the bylaw.

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Although arising in connection with a majority stockholder, Gorman is a good reminder for transactional lawyers to consider actions taken by insurgents or other activists in the context of Section 141(a) of the DGCL and the corresponding Delaware jurisprudence.  Actions invading the zone of authority normally reserved to a corporation’s board of directors may be subject to greater challenge (or risk depending on one’s perspective), given the long history of Delaware caselaw in this area and the interests that Delaware courts have in maintaining the primacy of the board in the governance of the corporation.

[1] Gorman v. Salamone  C.A. No. 10183-VCN (Del. Ch. July 31, 2015)

[2] See In re Westech Capital Corp. 2014 WL 2211612 (Del. Ch. May 29, 2014)

[3] A. No. 10183-VCN, at *5

[4] DGCL § 142(b)

[5] DGCL § 109

[6] A. No. 10183-VCN, at *10

[7] Id at *15

[8] Id at *12 (quoting Klaassen v. Allegro Dev. Corp., 2013 WL 5967028, at *9 (Del. Ch. Nov. 7, 2013)).

[9] Id at *11 (quoting CA, Inc. v. AFSCME Emps. Pension Plan, 953 A.2d 227, 232 (Del. 2008)).

[10] Id. at *15

[11] Id. at *15