Delaware Supreme Court Reverses Kurz v. Holbrook (In Part); Chancery's Stock Ledger Analysis is "Without Precedential Effect"

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On April 21, 2010, the Delaware Supreme Court issued an
opinion with substantial significance for corporate practitioners.  In Crown EMAK Partners, LLC v. Kurz,
No. 64, 2010 (Apr. 21, 2010), the Supreme Court affirmed in part and
reversed in part the Court of Chancery’s holding in Kurz v. Holbrook, 989 A.2d 140 (Del.
Ch. Feb. 9, 2010).  The Supreme Court upheld the Court of Chancery’s
analysis concerning what is, and what is not, impermissible vote-buying
under Delaware law, and concerning the impermissibility of bylaw
amendments reducing the size of a board of directors to a number less
than the number of sitting directors between annual meetings without
first removing directors.  The Delaware Supreme Court, however,
disagreed with the Court of Chancery’s analysis of whether a restricted
stock agreement was violated by a purchase agreement relating to the
shares subject to the restricted stock agreement, invalidating the votes
attributable to the purchase agreement on account of the purchase
agreement violating the restricted stock agreement.  Given its ruling
invalidating these votes, the Supreme Court declined to rule on, but
labeled as “obiter dictum and
without precedential effect,” the Court of Chancery’s much-discussed
determination that the Cede breakdown is part of the stock ledger for
purposes of 8 Del. C. § 219(c).

The dispute involved competing
consent solicitations relating to control of the board of directors of
EMAK Worldwide, Inc. (“EMAK”), which had seven authorized directorships,
two of which were vacant at the relevant times.  An insurgent group of
common stockholders, Take Back EMAK, LLC (“TBE”), sought to remove two
directors and fill three of the four vacancies with TBE nominees. 
Because one incumbent director, Donald Kurz, was a member of TBE, the
TBE solicitation, if successful, would give TBE majority control of the
EMAK board.  A competing solicitation was launched by Crown EMAK
Partners, LLC (“Crown”), a large preferred stockholder.  Crown’s
preferred stock had a contractual right to elect two directors and a
right to vote together with the common stock on all matters other than
the election of the other directors.  Crown sought to amend EMAK’s
bylaws to reduce the number of authorized directorships from seven to
three and, in the event the number of directors in office exceeded the
authorized three, to require the calling of a special meeting of common
stockholders at which the common stockholders would elect one director
as the lone successor to all the incumbents other than the two appointed
by Crown’s preferred stock.  However, Crown did not solicit consents to
remove any of the directors pursuant to 8 Del. C. § 141(k). 

Crown
secured and delivered consents in favor of its bylaw amendments from
the holders of a majority of the outstanding voting power (with the
preferred stock and common stock voting together).  TBE obtained
consents from the holders of a majority of the common stock (i.e., of the shares entitled to vote
in an election of directors other than those appointed by Crown), but
the inspector of election invalidated consents representing over a
million shares that were held in “street name” (i.e., held of record by Cede & Co., the nominee of
Depository Trust Company) on the ground that TBE had not obtained and
submitted an omnibus proxy executed by Cede, authorizing Cede’s
participants to vote the shares that Cede held on their behalf.  Crown
additionally challenged the validity of the consents as to 150,000
common shares signed by Kurz as proxy for Peter Boutros, the record
owner of the shares and a former EMAK employee, who had signed a
Restricted Stock Grant Agreement that prohibited him from selling or
transferring the shares before March 2011.  Shortly before TBE delivered
its consents, Kurz and Boutros had signed a Purchase Agreement under
which Kurz paid Boutros a price in excess of the trading price, and
Boutros gave Kurz all the shares Boutros owned and was then permitted to
sell, plus all rights to receive all other shares that Boutros might
later be permitted to sell, plus an irrevocable proxy to vote all the
shares. 

After trial, the Court of Chancery found in favor of
TBE.  The Court held that the transaction between Kurz and Boutros was
not an invalid vote-buying transaction and did not violate the
Restricted Stock Grant Agreement.  The Court rejected the Crown bylaw
amendments as impermissible under the Delaware General Corporation Law. 
Most notably, the Court reversed the inspector’s rejection of the
consents delivered by TBE on behalf of the shares held in street name,
on the ground that the consents delivered -- which evidenced authority
from the participating banks and brokers who appeared on the Cede
participant listing, but omitted the omnibus proxy from Cede -- had
validly effected corporate action.  The Court’s ruling on this point
depended on its holding that the Cede breakdown was part of the stock
ledger for purposes of 8 Del. C. § 219(c), just as it is part of the
stock ledger for purposes of 8 Del. C. 220(b).  Consequently, the Court
of Chancery determined that the TBE slate had been elected and
controlled the EMAK board.  An expedited appeal followed. 

On
appeal, the Supreme Court affirmed the Court of Chancery’s analysis of
the vote-buying issue and its determination that Kurz had not engaged in
improper vote-buying.  The Court of Chancery had found no evidence of
fraud in the transaction between Kurz and Boutros, and further found
that Kurz’s voting interests and his economic interests in the Boutros
shares were aligned.  The Supreme Court agreed on the ground that “the
economic interests and the voting interests of the [Boutros] shares
remained aligned since both sets of interests were transferred from
Boutros to Kurz by the Purchase Agreement.” 

However, the
Supreme Court reversed the Court of Chancery’s determination that
Boutros and Kurz had successfully contracted around the sale and
transfer restrictions imposed by the Restricted Stock Grant Agreement. 
The Court of Chancery had noted that the Restricted Stock Grant
Agreement prohibited sales and transfers of Boutros’s shares, but did
not prohibit agreements to sell or transfer the shares in the future. 
The Supreme Court held, however, that because Boutros conveyed both (i)
all economic interest in the shares, and (ii) the right to vote the
shares (via an irrevocable proxy), Boutros had “immediately conferred upon Kurz the functional
equivalent of ‘full ownership.’…  There was nothing for Boutros to
transfer to Kurz in the future, other than bare legal title.”  The
Supreme Court concluded that this transaction violated the Restricted
Stock Grant Agreement, and consequently held that the transaction “did
not operate as a legally valid sale or transfer of Boutros’ shares, and
that Kurz was not entitled to vote those shares.” 

Because the
Supreme Court held that Kurz lacked the right to vote the Boutros
shares, the TBE consent solicitation failed to garner the support of the
requisite majority of common shares, regardless of whether the shares
held in street name (as to which no omnibus proxy executed by Cede had
been submitted) were properly counted in TBE’s favor.  The Supreme Court
therefore expressly declined to review the Court of Chancery’s holding
that the Cede breakdown constituted part of the stock ledger for
purposes of 8 Del. C. § 219(c).  The Supreme Court wrote that a
“gratuitous statutory interpretation resolving this difficult issue”
would not be “prudent,” and indicated that a legislative cure by the
Delaware General Assembly to resolve the question was preferable.  The
Supreme Court concluded with the statement that “the Court of Chancery’s
interpretation of stock ledger in section 219 is obiter dictum and without
precedential effect.” 

Finally, the Supreme Court affirmed the
Court of Chancery’s holding that the Crown bylaw amendments conflicted
with the Delaware General Corporation Law and were void.  The Court of
Chancery had held, and the Supreme Court agreed, that stockholders
cannot end an incumbent director’s term between annual meetings by
purporting to eliminate the director’s seat or by purporting to elect
the director’s successor, without in either case first removing the
incumbent director. 

The Supreme Court remanded the case to the
Court of Chancery for further proceedings in accordance with the
opinion.
 

• Download the EMAK Opinion