Ratification of Defective Corporate Acts: An Overview

At a Glance

• This guide provides a high-level summary of the circumstances, under Sections 204 and 205 of the Delaware General Corporation Law (DGCL), where a corporation, its shareholders and/or the Court of Chancery can ratify or validate defective corporate acts that would be void or voidable due to a failure of authorization.¹ 
• Defective Corporate Acts are acts or transactions that are within the corporation’s powers to effect but are “defective” because management failed to obtain proper authorization, such as:
  1. An over issuance of company stock
  2. An election or appointment of directors done without proper authorization
• Failure of Authorization refers to corporate management’s failure to correctly effect an act or transaction in compliance with:
  1. The provisions under Sections 204 and 205
  2. The certificate of incorporation, bylaws or other organizational documents of the corporation
  3. Any plan or agreement the corporation is party to, or the disclosure set forth in any proxy or consent solicitation statement
  4. The failure of the board of directors or any officer of the corporation to authorize or approve any act or transaction taken by or on behalf of the corporation that would have required for its due authorization the approval of the board of directors or such officer.

What Steps Does a Board Need to Take to Ratify a Defective Corporate Act?

1. Draft a Resolution. For each act that needs ratification, the resolution must include: (a) the defective act, (b) the date the act occurred, (c) the nature of the failed authorization and (d) a statement that the board approves the ratification.
1. Note, if the defective act involves the issuance of putative stock, the resolution must also include the (i) type of stock, (ii) number of shares and (iii) date of issuance.
2. Multiple defective acts can be ratified through one resolution, as long as the resolution has correct information for each defective corporate act.
2. Submit the Resolution for Stockholder Approval.
   1. A company will not need stockholder approval if:
   1. No provision in the corporation’s organizational documents, plans or agreements requires stockholder approval for the defective act at issue.
   2. The defective act is not the result of the corporation’s failure to abide by the rules governing business combinations with interested stockholders. DGCL Section 203.
   3. No valid stock is outstanding and entitled to vote on the ratification when the board adopts the resolution used to ratify the defective act.
   2. Procedural Considerations
      The following procedural issues are important for a board to keep in mind in connection with a stockholders’ ratification vote.
      • At least 20 days before the meeting where the vote is to take place, stockholders holding valid stock need to be given notice of that meeting (date, time, place and, if applicable, purpose).
      • The quorum and voting requirements for ratification are identical to the requirements to affect the corporate act in the first instance.
      • If the defective act involves the corporation’s failure to abide by the rules governing business combinations with interested stockholders, a stockholder meeting will always be required.

The next two steps may be optional for a corporation depending on the defective act being ratified among other factors outlined below.

3. File a Certificate of Validation.
   1. This step is required only in circumstances where the operative section of the DGCL requires a filing with the Secretary of State, but in carrying out the defective act, that filing (1) never happened or (2) was made but needs to be amended to give effect to the corporate act.
   2. The certificate of validation should state that (1) the company has ratified one or more defective acts that require the filing of a certificate under a provision of the DGC; and (2) each act has been ratified under Section 204 of the DGCL.
   3. If the corporation has previously filed a certificate under Section 103 and that certificate needs to be amended to give effect to the defective corporate act, the certificate of validation should include: (1) the name, title and filing date of the certificate that needs to be changed; (2) an exhibit containing a copy of that certificate; and (3) the effective date of the certificate that was amended through the ratification process.
   4. If the corporation has not filed a certificate under Section 103, but should have in connection with the defective act, the certificate of validation should: (1) state that it attaches a certificate with all the information required under a specific provision of the DGCL to give effect to the defective act; and (2) include the effective date of the attached certificate.
4. Send Notice of Ratification. The board should inform holders of both voting and nonvoting stock of the defective corporate act and the date of ratification, along with a copy of the ratifying resolution, within 60 days of said ratification. The notice should include:
   1. a. A copy of the board resolution or the information required for such resolutions
   2. A statement that any claim meant to challenge the ratification of the defective corporate act must be brought within 120 days of the effective date of the ratification or the date on which notice is given; whichever is later
   3. Any notice required under Section 228(e), if the defective act was ratified by the written consent of stockholders.
   Notice is not required when:
   1. No stockholder approval was required for ratification.
   2. The corporation has a class of stock listed on a national securities exchange and has publicly filed a document with the ratification information.

What Role Does the Court of Chancery Play in the Ratification Process?

The Court of Chancery (the court) has exclusive power to determine all actions brought under DGCL Section 204 and 205. Section 205 gives the court the power to make determinations and provide relief.

You may be wondering…

Who Can Bring an Action?

Such actions may be brought by a successor entity to the corporation, a member of the board, or any record or beneficial holder of valid stock or putative stock. These classifications are determined as of the time of the defective act at issue.

I Have an Issue With How the Defective Act Was Ratified. Can the Court Help?

Yes. Within 120 days of the ratified act’s effective date, one may bring claims that the ratification of the defective act is (a) not effective, (b) only effective under certain circumstances, or (c) lacking proper authorization. Within that time frame, the court can determine the validity and effectiveness of both the defective act that has been ratified and the process of its ratification.

What Does the Court Consider When Evaluating the Lawfulness or Completion of a Ratification Process?

• Did the corporation think it had ratified the act initially?
• Have the corporation and its board been behaving as if the act was properly ratified? Have they engaged in conduct based on a reliance that the act had been properly ratified?
• Has anyone, or will anyone, be harmed because of the ratification process the corporation undertook?
  
  • Note: If an alleged harm would have occurred if the act was ratified correctly in the first place, the court will not consider the harm in its analysis. 
• If the court does not ratify the defective act, will someone be harmed?
• As a catchall, the court can also consider any other factors they deem fair. 

What Else Does the Court Have the Power To Do?

The court can modify the ratification process or waive it altogether. The court also can determine the validity of any corporate act, transaction, stock issuances and their corresponding rights, or the corporation’s options to acquire stock.