Corporate Governance

Kurz v. Holbrook: Shareholder Voting, Omnibus Proxies, and the Role of DTC: Invalidating Director Resignation Bylaws

By J Robert Brown Jr.

VC Laster, in invalidating a bylaw that would reduce the size of the board and remove incumbent directors, concluded that Section 141 (which gives shareholders the right to remove directors) was the exclusive method of removing directors under Delaware law.  As we noted, the import of this conclusion is to invalidate bylaws that provide for mandatory removal upon a director becoming disabled.  This is not the only type of bylaw arguably invalidated by the court's reasoning. 

VC Laster concluded that a director meeting board qualifications at the time of election could not be removed if, after the election, he/she ceases to meet those qualifications.   

• For similar reasons, my reading of Section 141(b) is not affected by the possibility that a corporation might establish qualifications for directorship and provide that a director who ceased to meet them could no longer serve. This Court has upheld a limited example of such a provision that appeared in the certificate of incorporation.   In light of the three procedural means for ending a director's term in Section 141(b), I do not believe a bylaw could impose a requirement that would disqualify a director and terminate his service.  Section 141(b)'s  recognition of the bylaws as a locus for director qualifications instead contemplates reasonable qualifications to be applied at the front end, before a director's term commences, when the director is "elected and qualified." 8 Del. C. 141(b). The concept of a bylaw that would end a director's service through disqualification thus lends no support to a bylaw that would accomplish the same thing through board shrinkage. Neither is valid under Section 141(b) (citations omitted)

In fact, however, bylaws are commonly written to require directors to submit a letter of resignation in the event that they cease, after election, to continue to meet certain specified qualifications necessary to be elected in the first place.  This bylaw from Sachs Inc. is an example:  

• Mandatory Resignation. Directors who are also officers of the Corporation shall submit a letter of resignation as such to the Board of Directors upon any termination of employment as an officer of the Corporation, and directors who are not officers of the Corporation shall likewise submit a letter of resignation upon any change in that directors principal business or other activity in which the director was engaged at the time of his or her election.

Similarly, the bylaws of Harley Davidson provide:  

• Retirement . Notwithstanding that directors are elected for a three year term, a director shall automatically cease to be a director of the corporation effective upon the commencement of the Annual Meeting immediately following such director's seventy-second (72 nd ) birthday. Each director, other than a director who is serving or has served as the Chief Executive Officer of the corporation, whose position of principal employment, occupation or affiliation changes substantially, and each director who develops a conflict of interest with the corporation as a result of changes in the business of the corporation, such director's personal interests or such director's principal employer, after his or her most recent election to the Board of Directors shall submit his or her resignation as a director of the corporation promptly following such change, and the Board of Directors (without such director present if the Board of Directors so chooses) shall consider whether to accept such resignation in the interests of the corporation.

Presumably under VC Laster's analysis, these types of bylaws are invalid.  They essentially extend to the board the authority to remove directors who fail to meet specified qualifications during their term. 

This could be a significant problem where, for example, a director of an exchange traded company ceases to be independent and, as a result, the board violates the listing requirements.  Perhaps the director could be induced to resign or the board expanded and additional independent directors appointed.  Nonetheless, in at least some cases, directors may refuse to resign and the company may find itself in violation of the listing requirements.

This portion of the opinion was dicta and unnecessary.  Even assuming Section 141 contains the exclusive method of removing directors, mandatory resignation for failing to meet mandatory qualifications is not removal, at least not in the way contemplated by Section 141.  Section 141 contemplates volitional acts by shareholders.  No longer meeting qualifications seems more like death, a form of removal not influenced by directors or other groups.  Nonetheless, the dicta in the case throws these types of bylaws into doubt.

The opinion and a number of primary materials are posted at the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on March 11, 2010 (boomark / email).