It’s always incredibly exciting when you have worked for months – and sometimes years – to grow a business to a place where you can secure funding from outside third-party investors. It is often a long and arduous process and documentation of the investment always feels like it takes significant time and energy. As part of those investment transaction documents, there are a litany of agreements, including certificates of incorporation, voting agreements, investors’ rights agreements, right of first refusal and co-sale agreements, opinions and a series of consents and approvals that new investors and existing shareholders agree to enter into and be bound by. Within those documents, investors are often granted rights to elect certain parties to the board of directors or make certain decisions in writing that are binding on the company.
For quite some time, the standard course of drafting practice in investment rounds has been to loop post-closing consent items (i.e., appointing new board members or officers) into the closing consents. While all parties executing those documents clearly see the efficiency in papering closing and post-closing items collectively, non-participating minority shareholders may not necessarily appreciate their lack of voting say in the process and may even argue for a deviation from the governing documents—and now, thanks to Bäcker, et al. v. Palisades Growth Cap. II, L.P., they would be correct. While a majority of new and existing shareholders may appreciate executing documents once to get past the funding round, recent shareholder litigation in Delaware indicates the courts will rebut them as a matter of equity where corporate formalities, documentation or statutes are ignored for the sake of convenience.
Litigation Backdrop
In Bäcker, et al. v. Palisades Growth Capital II, L.P., the Delaware Chancery Court issued an opinion (Del. Supr. Jan. 15, 2021) adhering to the principle of needing consent to effectuate specific actions, including approving new board members. This case began its journey in 2009 with Appellant Alex Bäcker co-founding QLess, Inc., a privately held Delaware corporation. As the majority owner of the company's common stock, Bäcker controlled two board seats (one of which he held himself) and was CEO. The company’s certificate of incorporation permitted Palisades Growth Capital II, L.P. (Palisades) and Altos Hybrid 2 L.P. (Altos), each majority stockholders of their respective investment share classes, to appoint one director to the board. Palisades’ designee was Jeff Anderson and Altos’ designee was Hodong Nam. According to the company’s voting agreement, a fifth board seat was occupied by an independent director, Ivan Markman. The voting agreement also required the board to create a new CEO director seat to be filled by Bäcker’s replacement in the event of Bäcker’s termination.
In early 2019, employees began alleging to the board that Bäcker was creating a toxic work environment. Over the following months, the situation got worse, with Anderson and Nam ultimately concluding that the board should remove Bäcker as CEO and with Nam telling Bäcker that he should resign. Bäcker was not willing to resign, and as part of his efforts to retain his position as CEO, Bäcker fired the other common stock board director, Michael Bell, and replaced him with his father. This action led to a standoff – the two preferred stock directors (Anderson and Nam) wanted Bäcker removed as CEO, the two common stock directors (Alex Bäcker and his father) opposed the removal, and the independent director (Markman) was undecided.
As employees continued to allege complaints regarding Bäcker, the board voted to form a special committee consisting of Anderson, Nam and Markman, which hired a law firm to investigate employees’ complaints. The law firm substantiated many of the complaints against Bäcker and provided a report to the special committee upon completion of its investigation. As a result, the special committee recommended that the full board terminate Bäcker.
In June 2019, the board voted to remove Bäcker as CEO, which triggered the provision in the voting agreement stating that if Bäcker were terminated as CEO, the stockholders would vote to expand the board to six seats and appoint the replacement CEO to the board. The board then conducted a CEO search and hired Kevin Grauman as QLess’ new CEO. Soon after, Nam resigned his position on the board, and Altos decided that Paul D’Addario, a partner at Palisades, would replace Nam as Altos’ designee. Subsequently, Altos’ counsel erroneously advised them that board action would be required to fill the vacancy created by Nam’s resignation, even though QLess’ certificate of incorporation gave Altos the exclusive right to fill its Series A-1 director seat by vote or written consent in place of a meeting. Relying on this bad advice and contrary to the governing documents, Altos took no further action to elect D’Addario, waiting instead for the next board meeting. Bäcker requested that the board convene a meeting in November 2019 to finalize the votes for the new CEO. However, one day before the board meeting, Markman unexpectedly resigned his position as an independent director. Seeing that he now held a 2-1 board majority with himself and his father versus Anderson, Bäcker started executing a plan to be reinstated as CEO and lock in control of QLess.
Anderson and the company’s outside counsel were concerned that Bäcker would attempt to take advantage of the board situation, but they concluded that Bäcker and his father were compelled by the voting agreement to vote in favor of D'Addario’s appointment, which would be the first item on the board meeting agenda. After that, they believed Bäcker would be unable to take any unwanted actions as Anderson and D'Addario would be there to object.
Hours before the board meeting, the outside counsel emailed Bäcker and his father about the previously circulated board resolutions for the meeting, stating that they had not electronically signed a board consent adopting the resolutions, including resolutions to confirm Grauman’s employment as CEO and board appointment as well as D'Addario’s appointment to the board. The outside counsel noted that his understanding was that executing the consent was a prerequisite for the meeting and that without the executed consent, Anderson would not attend the meeting, leaving the board without a quorum. Bäcker and his father decided not to sign the consent and despite not hearing back from the Bäckers, Anderson decided to attend the board meeting.
Later that evening, Bäcker called the board meeting to order and, with his father, executed his agenda, which included, among other things, firing Grauman as CEO, hiring himself as CEO and CFO, appointing himself to the newly created CEO-director seat, and appointing a consultant friendly with Bäcker to his vacated director seat. Anderson and D'Addario objected to each board action, to no avail.
Days after the board meeting, Palisades filed a complaint in the Court of Chancery challenging the Bäckers’ actions at the meeting. It argued that the email from Altos’ general counsel that requested QLess take action to facilitate stockholder consent of D’Addario’s appointment constituted a “vote” to place D’Addario on the board, and if the court held that the email was not a vote, it was a written consent. The complaint also alleged a breach of the voting agreement for failure to confirm Grauman to the CEO director seat.
First, the Chancery Court held (and was subsequently affirmed by the Delaware Supreme Court) that the email Altos’ general counsel sent did not constitute a stockholder vote under the certificate of incorporation or under applicable law. The court explained that the Delaware General Corporation Law (DGCL) is clear that stockholders vote at meetings. The court further held that Altos’ general counsel’s email was not a written consent because the email requested that QLess draft the stockholder consent and because, under 8 Del. C. § 228, electronic transmissions “still must [set] forth the action so taken by the stockholder giving the consent.” Altos’ general counsel’s email did not comply with those formalities because it did not set forth action taken; it merely requested that a particular action be taken. Second, the court recognized that most of the board believed Grauman had been appointed before the meeting. Still, the court also acknowledged that under QLess’ bylaws, a formal executed unanimous written consent would have been required for a valid appointment. Ultimately though, the court held that all the actions taken at the November board meeting were void as a matter of equity: “Relying on the evidence discussed above, the court found that “Anderson’s presence at the meeting was secured under deliberately false pretenses.” “If Anderson had known of [the Bäckers’] change of plans, he would have refused to participate in the meeting, defeating a quorum and thwarting the coup.”” Bäcker v. Palisades Growth Capital II, L.P., 246 A.3d 81, 94 (Del. 2021).
So Why Should Companies Care?
Looking to consents following the Bäcker decision, there may be an increase in formalities during the normal course of business, as well as after transactions, to ensure compliance with corporate documents and to ensure speed does not trump adherence to governing documents and corporate law. The Bäcker opinion is significant because the court found that it may void action by a board of directors – even where the action is not otherwise in violation of the corporate charter or the DGCL – when equity so requires. If Altos and Grauman had relied on a formal executed unanimous written consent, the need for litigation would have been alleviated. Ultimately, the decision in Bäcker is a reminder that “notwithstanding board members’ adherence to the procedural requirements associated with conducting board business – as codified in statues, bylaws, and articles of incorporation – directors may still be held liable for breaching fiduciary duties if these procedures are deceptively employed (emphasis added).”
As a result, to ensure that the Bäcker case is not used in a manner to invalidate appointments of new board members or other corporate actions, strict adherence to corporate procedures, including obtaining consents in writing, and to statutory requirements is strongly advised for all clients impacted by Delaware law. In turn, this means that we now see a litany of written approvals at all intervals of the corporate life cycle to ensure that Bäcker’s reach cannot be used to invalidate board appointments, decisions, or transactions in total. So, when you think you have closed your transactions and the money is in the bank, remember: There is more to do thanks to the Bäcker decision and many more consents to execute after you think you have moved beyond the deal. Email alone is generally insufficient and the rules of equity, fairness and adherence to corporate formalities are principles that the Delaware courts are keeping a close eye on.
Anthony Long II (The Ohio State University Moritz College of Law, ’23) contributed significantly to this article as a Thompson Hine summer associate; he is not admitted to the practice of law. Please contact Julia Zerman to learn more about our summer program.
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