New Delaware Case Regarding "Stockholders of Record"

By Cydney Posner

Kurz v. Holbrook is an important new Delaware case that reinterprets Delaware law with respect to the definition of "stockholders of record" entitled to vote.  A copy of the case can be found online. (In 80 pages, it will also tell you more than you ever wanted to know about proxy plumbing and the multi-layered world of depositories, brokers and their agents.) While the court did "not foresee any headaches" arising out of the case, it also acknowledged that "it will require future cases to work through particular issues." As a result, the full implications of the case with regard to other provisions of Delaware law remain to be seen. We await the appeal.

The case involved competing consent solicitations in a contest for control of the board. The insurgent group sought, and, after it purchased some additional shares, ultimately provided sufficient consents, to remove and replace several directors to seat a majority. The incumbent group sought, and submitted sufficient consents, to amend the company's bylaws to reduce the size of the board to eliminate unwanted directors and leave it with a majority (since it had the right to appoint a specified number of directors who would then constitute a majority). Because it was a public company, a large proportion of the company's shares were held in street name. While the incumbents obtained direct signatures from DTC for the few banks and brokers they needed, no one obtained the DTC "omnibus proxy" for the consents of all of the shares of the banks and brokers held of record by DTC (in the nominee name of "Cede &Co."). (Remember that DTC is the depository that is the stockholder of record for all of the participating banks and brokers.) As a result, the transfer agent viewed many of the consents submitted by the insurgents to be invalid.

Among many other charges and counter-charges, the insurgents claimed that the bylaw amendment was invalid, and the incumbents claimed that (i) the absence of the omnibus proxy from DTC made a number of the consents submitted by the insurgents invalid and (ii) the insurgents had improperly engaged in vote buying. Deciding in favor of the insurgents, the court held the following:

• Failure to obtain an omnibus proxy from DTC was not fatal with regard to written consents obtained for the shares held in street name. The court found no legal authority addressing how an omnibus proxy is obtained or who has the responsibility to obtain it. In the court's view, the omnibus proxy was really just a formality, and, if the DTC omnibus proxy were not obtained, as in this case, insisting on the need for the omnibus proxy would have the effect of disenfranchising stockholders, contrary to public policy.

• Banks and brokers who appeared on the Cede breakdown list of participants had the power to vote as record holders at a meeting of stockholders or for purposes of taking action by written consent. In most cases involving shares held in street, the Delaware courts have viewed the record holder (i.e., DTC) as the stockholder that can exercise voting and other rights. However, in cases regarding requests for stocklists under Section 220, the Delaware courts have not held that the depository was the stockholder of record, but rather that the Cede breakdown (the list of bank and broker DTC participants) was part of the stock ledger for purposes of Section 220. In addition, under some aspects of federal securities law, the banks and brokers are viewed as the record holders of the shares held by the depositories. Although the court "hew[ed] to prior precedent holding that only a stockholder of record can execute a written consent," the court concluded that, as is the case under Section 220, the Cede breakdown was part of the stock ledger for purposes of Section 219(c) and, accordingly, DTC participant banks and brokers who appeared on the Cede breakdown were considered stockholders of record on the company's stock ledger for purposes of determining stockholders entitled to vote. The court emphasized that its ruling "does not alter the traditional distinction between record and beneficial ownership," and that its holding applies only to DTC in its role as a federally registered clearing agency.

• A bylaw that purports to shrink the size of the board below the number of sitting directors was invalid. Apparently, there is no reference in the Delaware code to eliminating directors through "shrinkage," and the issue was one of first impression. (The court acknowledged that there is likewise no reference to ending the tenure of directors through death either; however, "[b]arring a major breakthrough in séance technology, death remains an insurmountable barrier to board service. But death is … not [a] procedural means by which a director's term can be brought to a close under a corporation's constitutive documents and the DGCL. To impose death on a director is not a legitimate method of effecting board change. It is a felony.") The proposed bylaw could not, under Delaware law, eliminate the "excess" sitting directors or create holdover directors. In addition, if "a bylaw amendment reducing the size of a board could eliminate sitting directors, then directors suddenly would have the power to remove other directors." Accordingly, the proposed bylaw amendment to reduce the size of the board conflicted with Delaware law and was invalid.

• The insurgents did not engage in improper vote buying largely because they acquired both the voting and economic interest in the shares. The court acknowledged that the concept of vote buying was broad enough to encompass the "shadowy aspects of the voting process and techniques by which voting rights can be manipulated…. When they prove deleterious to stockholder voting, this Court can and should provide a remedy." The court concluded that the share purchase had the potential to be disenfranchising because it provided one party with the votes needed to prevail and, therefore, should be subjected to a vote-buying analysis. However, the court found that, because, among other things, the purchase agreement transferred the full economic risk associated with the purchased shares and the voting rights appropriately followed the economic interest, the voting of the shares did not constitute a "legal wrong. " Even though the insurgents "primarily wanted the voting rights carried by the shares, not the shares themselves," the court did "not perceive anything illicit in that fact given the nature of the transaction as a whole."

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