Salamone v. Gorman, C.A. No. 8845 (Del. Dec. 9, 2014)

In this en banc decision, the Delaware Supreme Court affirmed in part and reversed in part the Court of Chancery’s decision interpreting a Voting Agreement governing the designation and removal of directors by preferred stockholders.  Specifically, the Supreme Court affirmed the Court of Chancery’s decision that certain directors are designated on a per share basis while other directors are designated on a per capita basis, reversed the Court of Chancery’s decision that the directors elected on a per capita basis could be removed on a per share basis, and affirmed the Court of Chancery’s ruling that the per capita designation scheme in the Voting Agreement did not violate the “one share/one vote” principle of 8 Del. C. § 212(a).

The decision arose from a dispute between two sets of stockholders regarding the validity of their appointment of directors to the board of Westech Capital Corporation (“Westech”).  Each set of stockholders believed that it had validly designated directors pursuant to a Voting Agreement between purchasers of Westech Series A Preferred Stock (“Preferred Stock”).  The stockholders brought multiple actions under 8 Del. C. § 225, asking the Court of Chancery to determine which directors were validly elected.

The dispute centered on the interpretation of the Voting Agreement.  Section 1.2 of the Voting Agreement governed the composition and designation of directors on Westech’s board, providing the process for appointing designees for particular factions of holders of Preferred Stock.  Specifically, Section 1.2(b) provided for the designation of an independent director “by the majority of the holders of the Series A Preferred Stock.”  Section 1.2(c) provided for a designee “elected by the Key Holders, who shall initially be John J. Gorman IV [“Gorman”] and Robert W. Halder [“Halder”].”  Further, Section 1.4 governed the removal of directors, preventing removal unless “such removal is directed or approved by the affirmative vote of the Person, or of the holders of more than fifty percent (50%) of the then outstanding Shares entitled under Section 1.2 to designate that director.”

Gorman, representing one faction of the stockholders, argued that Sections 1.2(b), 1.2(c), and 1.4 of the Voting Agreement provided for a per share scheme for designating and removing directors.  Gorman held nearly 54% of the voting power of stock outstanding, and thus his designation of directors over other the stockholders’ objection would be valid under a per share scheme.  Gary Salamone, Mike Dura, and Halder (collectively the “Management Group”), on the other hand, contended that the Voting Agreement provided for a per capita scheme for designating and removing directors.

The Court of Chancery held that Section 1.2(b) provided for designation based on a per share scheme, Section 1.2(c) provided for designation on a per capita scheme, and Section 1.4 provided for removal of directors on a per share scheme.  In reaching these decisions, the Court of Chancery determined Section 1.2(b) to be ambiguous due to inconsistent implications within the Voting Agreement and accordingly allowed the parties to present extrinsic evidence regarding the parties’ intent.  The Court of Chancery, however, found the negotiation history of the Voting Agreement “not particularly illuminating” because the Voting Agreement was mostly copied from a form agreement on a website.  The Court of Chancery thus relied on the presumption under Delaware law against disenfranchisement of a majority stockholder’s power to elect directors and found insufficient evidence to overcome the presumption.  The Court of Chancery accordingly found that Section 1.2(b) provided for designation on a per share basis.  The Court of Chancery also held that Section 1.2(c) unambiguously provided for designation on a per capita basis because such interpretation was the only way to reconcile the parties’ intent, as indicated elsewhere in the Voting Agreement, for the director designated pursuant to Section 1.2(c) to represent all of the Key Holders.  Finally, the Court of Chancery held that Section 1.4 provided for removal of directors on a per share basis because the section explicitly permitted “the holders of more than fifty percent of the then outstanding shares” who were entitled to designate a director under Section 1.2 to remove that director. 

The parties cross-appealed.  The Management Group challenged the Court of Chancery’s ruling regarding Sections 1.2(b) and 1.4, and Gorman challenged the Court of Chancery’s ruling regarding Section 1.2(c).  Gorman also argued that the Court of Chancery’s determination that directors were to be designated on a per capita basis violated 8 Del. C. § 212(a) because any departure from Section 212(a)’s default “one share/one vote” rule must be within the certificate of incorporation to be valid.

The Delaware Supreme Court affirmed in part and reversed in part.  First, the Supreme Court held that Section 1.2(b) provided for designation on a per share basis, largely following the reasoning of the Court of Chancery.  Like the Court of Chancery, the Supreme Court found Section 1.2(b) to be ambiguous.  The Supreme Court acknowledged some extrinsic evidence suggesting a per capita scheme, but accepted the Court of Chancery’s conclusion that the evidence against per share scheme was not “clear and convincing” and did not rebut the presumption against disenfranchisement of a majority stockholder’s power to elect directors.  Thus, the Supreme Court found that Section 1.2(b) provided for designation on a per share basis.

Second, the Supreme Court agreed with the Court of Chancery that Section 1.2(c) unambiguously required per capita designation of the Key Holder directors.  The Supreme Court noted that the alternative interpretation would read other provisions of the Voting Agreement “out of existence,” particularly the Voting Agreement’s implications that all the Key Holders would together designate directors pursuant to Section 1.2(c).  Because the Key Holders included Gorman, the majority stockholder, a per share scheme would negate the involvement of other Key Holders because Gorman’s vote would override their input under a per share scheme.  Thus, to preserve the contract’s intent to designate the Section 1.2(c) directors on behalf of all Key Holders rather than just Gorman, the Supreme Court held that Section 1.2(c) followed a per capita scheme. 

Third, the Supreme Court held that the director removal provisions of Section 1.4 were unambiguously intended to be symmetrical with the designation provisions of Section 1.2 and accordingly reversed the portion of the Court of Chancery’s decision to the contrary.  Unlike the Court of Chancery, the Supreme Court held that the two parts of Section 1.4 were intended to provide for removal of directors on the same basis as the directors were appointed.  The first portion thus provided for removal on a per capita basis to align with Section 1.2(c), and the second portion provided for removal of directors on a per share basis to align with Section 1.2(b).

Finally, the Supreme Court held that the per capita designation of directors under Section 1.2(c) did not violate the one share/one vote principle of 8 Del. C. § 212(a).  The Supreme Court explained that while modification of the one share/one vote default rule must be made in a certificate of incorporation, Section 218(c) permits stockholders to agree to vote in a particular manner.  The Voting Agreement provided for designation of nominees in a particular fashion as permitted by Section 218(c) then provided for election in a manner consistent with 212(a).  The Supreme Court rejected Gorman’s argument that the nomination process violated Section 212(a), holding that although the directors were designated based on a per capita scheme, the directors were elected in accordance with the one share/one vote principle in compliance with Section 212(a).

About Potter Anderson

Potter Anderson & Corroon LLP is one of the largest and most highly regarded Delaware law firms, providing legal services to regional, national, and international clients. With more than 100 attorneys, the firm’s practice is centered on corporate law, corporate litigation, intellectual property, commercial litigation, bankruptcy, labor and employment, and real estate.