Opinion
Civil Action No. 5798.
Submitted: March 5, 1979.
Decided: March 8, 1979.
Edward B. Maxwell, II, Esquire, Jack B. Jacobs, Esquire, and David C. McBride, Esquire, of Young, Conaway, Stargatt Taylor, Wilmington, for Plaintiff.
Steven J. Rothschild, Esquire, David B. Ripsom, Esquire, and Edward P. Welch, Esquire, of Prickett, Ward, Burt Sanders, Wilmington, for Defendants.
(MEMORANDUM OPINION)
At the present stage of this proceeding the plaintiff, Telvest, Inc. ("Telvest") seeks a preliminary injunction against the defendant, Outdoor Sports Industries, Inc. ("OSI") and its board of directors. Telvest is currently the owner of 20 per cent of the outstanding common stock of OSI. It has acquired its 20 per cent holdings through the gradual market purchases of OSI stock commencing during 1978. OSI has concluded that Telvest is acquiring stock with a view toward bringing about a merger, liquidation or sale of assets of OSI.
Telvest is said to be the instrument of one Clyde Engle and others who are referred to by OSI as "the Engle group." OSI has evaluated other recent corporate acquisitions by the Engle group, and it does not like that which it sees. OSI has concluded that in the other transactions the Engle group has gradually got itself into a position through market purchases wherein it was able to take control of the target corporations, with the accompanying result being that the acquired companies were looted and the public stockholders eliminated on less than favorable terms. In OSI's view (disputed by Telvest), the Engle group, through Telvest, is in the process of now attempting a similar quiet raid on OSI.
OSI has been engaging in certain defensive tactics to counteract this supposed take-over attempt by Telvest since the fall of 1978. It has initiated Federal litigation in Chicago in an effort to divest Telvest of its OSI holdings and also to prevent Telvest from voting its OSI stock in the interim. To date, it has been unsuccessful in this attempt, although the federal litigation is ongoing.
In January OSI gave indication that it would call a February meeting of stockholders to consider proposed amendments to OSI's certificate of incorporation. These amendments were designed to create supermajority voting requirements for the approval of mergers, a liquidation, a sale of assets and the like. Under OSI's present certificate of incorporation, and in conformity with the various minimum requirements of the applicable Delaware statutes, these transactions are subject to approval by a simple majority vote of all outstanding voting shares.
Telvest then sought a list of stockholders from OSI with regard to the proposed February meeting of stockholders. Whether for this reason or for others, OSI thereafter elected to forego the stockholders meeting. At the same time, its board of directors proceeded to meet and to adopt a resolution which created a series of stock, designated as preferred stock, which carried with it, in certain situations, the right to vote on mergers, consolidations, sales of assets, etc. The voting rights created by this so-called preferred stock provide for a supermajority vote of 80 per cent in order to approve any business combination or transaction with any party who, at the time, is the owner of 20 per cent or more of the outstanding voting stock of OSI.
Telvest views this as action directed solely at Telvest since it is the only owner of 20 per cent of OSI's stock. OSI does not dispute this, but rather defends this action as being necessary to insure the survival of the corporation and to protect its shareholders other than Telvest from the "scorched earth" policy which OSI feels the Engle group has exhibited in its recent acquisition victories.
Telvest has filed this action, both individually and derivatively, to enjoin the distribution of the preferred stock. It contends that the action by OSI's board of directors is self-serving and improperly motivated, and that in addition the attempt to impose supermajority voting requirements through the issuance of preferred stock by means of a resolution of the board of directors is in violation of the Delaware Corporation Law, and therefore illegal. Telvest contends that if the preferred stock is permitted to be distributed, and thus turned loose in the market place, it will constitute irreparable injury to OSI. In order to understand the problem, it is first necessary to briefly consider the action taken by OSI's board and the obviously-intended ramifications thereof.
By its resolution, the board of directors, acting "pursuant to the authority of the Restated Amended Certificate of Incorporation" has purported to create a series of 145,000 shares of "Series Preferred Stock" at a par value of $1.00 per share. The issuance of such shares has been declared as a stock dividend to be delivered to those persons who were the holders of record of the common stock of OSI as of February 15, 1979 "at a rate of one share of First Series Preferred for each ten shares of Common Stock held of record by such date (with each such holder to receive the next highest whole number of shares)." The resolution further calls for a transfer from surplus to the capital account of the corporation of an amount equal to the aggregate par value of the First Series Preferred declared as the dividend.
The preferences attributed to the First Series Preferred by the director's resolution may be summarized as follows. (1) Prior to declaring any dividends on the common stock, the board of directors must first declare a dividend on the First Series Preferred "which on a per share basis is the same on that to be declared on the Common Stock." (2) No dividends on the common stock can be paid until their identical dividend has either been paid, or provision for payment has been made, with regard to the First Series Preferred. (3) In the event of a liquidation, dissolution or winding up of the corporation, the holders of the First Series Preferred must receive payment for their shares prior to payment to the holders of the common stock, although the amount to be received for the First Series Preferred in such event will be "an amount equal to the amount of (remaining) net assets multiplied by a fraction the numerator of which is one and the denominator of which is the sum of the number of outstanding shares of Common Stock and First Series Preferred." Beyond this, the First Series Preferred has no other dividend rights, no rights of redemption and no rights of conversion.
The other purported preferences stem from the following voting rights. It is these supermajority voting rights that form the basis for this suit. The resolution provides that although they shall be entitled to no vote on any other matter, the holders of the First Series Preferred shall be entitled to vote as a class on, among other things, any merger or consolidation of the corporation with or into a "Related Person;" upon any sale, lease, exchange, transfer or other disposition of all or substantially all assets either to or from a "Related Person;" upon the issuance of any securities of the corporation, or any subsidiary, to a "Related Person;" and upon the acquisition by the corporation, or any subsidiary, of securities from a "Related Person."
The term "Related Person" is defined as any individual, corporation, partnership or other entity, and each member of any "person" as the term as defined in Section 13 (d) (3) of the Securities Exchange Act of 1934 which, together with affiliates and associates "is the Beneficial Owner of in the aggregate 20% or more of the outstanding shares of voting stock of the corporation."
Furthermore, in any such proposed transaction involving a Related Person wherein the holders of the First Series Preferred become entitled to vote as a class, it is provided that "the affirmative vote of the holders of not less than 80% of the outstanding First Series Preferred . . . which shall include the affirmative vote of at least 50% of the outstanding shares of First Series Preferred held by stockholders other than a Related Person" shall be required for the approval or authorization of any business combination previously set forth herein in which the Related Person is involved.
Finally, the resolution provides nonetheless that the aforesaid voting requirements for 80 per cent approval by the holders of the First Series Preferred shall not be applicable if the board of directors of the corporation, by two-thirds vote, has (1) "given prior approval to the acquisition by the Related Person involved . . . of the shares which increase his ownership to more than 20% of the outstanding shares of the voting stock" or has (2) "approved the Business Combination prior to the Related Person in-volved in the Business Combination having become a Related Person." Additionally, approval by the vote of the First Series Preferred holders is not necessary (i.e., they have no vote) if the Related Person "acquired pursuant to a tender offer for all the Corporation's outstanding Voting Stock at least 75% of the shares of Voting Stock held by persons other than such Related Person."
While the foregoing compilations by no means lists all the events which would either trigger the required vote of the holders of this First Series Preferred or abrogate their right to vote on a transaction involving a Related Person, it is sufficient for the purpose of this decision to highlight the area of dispute. Reduced to simpler terms, what has the action of the board of directors purported to accomplish through the authorization and arguable issuance of the First Series Preferred stock?
As I see it, through the declaration of a purported stock dividend, OSI's board has attempted to convert the voting rights of those same stockholders who would have had the power to approve or disapprove certain business combinations by majority vote — i.e., the holders of the common stock — into the power, in certain situations, to permit less than a majority of the present common stockholders to vote down a merger, sale of assets, etc. when it is being proposed by the owner of 20 per cent or more of the outstanding common stock. The board, by resolution, has attempted to set up a check valve in a situation wherein, without the prior blessing of the board, and without having first acquired 75 per cent or more of all outstanding common shares not owned by such person or corporation through a tender offer for all such other shares, a person or corporation has nonetheless acquired 20 per cent or more of OSI's outstanding common stock through other means. In such a situation, wherein the holder of 20 per cent or more of the common stock seeks to bring about some transaction or combination with OSI which the board opposes on behalf of the corporation, the board seeks to confine stockholder approval of the transaction to a majority of the voting stockholders other than the stockholder owing 20 per cent or more of the common stock and, in addition, to require that the total vote of the remaining stockholders, when coupled with the vote of the 20 per cent or more stockholder, amount to at least 80 per cent of all outstanding shares having the right to vote on the matter. I say that, in effect, this brings about an alteration of the voting powers of the common stock because the First Series Preferred, being issued in piggy-back fashion as a common stock dividend at a one for ten ratio to the common, reflects a proportionate voting power almost identical to that previously held by the owners of the common stock. The difference is that the voting power of a 20 per cent or more stockholder who is opposed by OSI's board will not be as strong as it would have been prior to the proportionate issuance of the First Series Preferred as a stock dividend, while the voting powers of the remaining stockholders will become stronger, at least insofar as merger, consolidation, etc. are concerned.
OSI suggests that this procedure assures the shareholders other than a 20 per cent or more shareholder of the independent ability to determine whether a proposed combination with the 20 per cent shareholder, which is opposed by OSI's board, is in their best interests as shareholders. However, the interests of the shareholders is not so easily divided into two groups. This is true because the same supermajority requirements which will prevent a 20 per cent or more shareholder from benefiting from a simple majority vote will also prevent other shareholders, who might also favor the proposed merger or other transaction, from benefiting from the former requirement of only a majority vote.
Thus, I think it clear that the action taken by the board in creating the First Series Preferred and declaring it as a common stock dividend will, if permitted to stand, alter the previously existing voting rights granted to OSI's common shareholders by OSI's certificate of incorporation. Telvest concedes that under the Delaware Corporation Law the voting rights of the common stock can be altered in this fashion by means of an amendment to the certificate of incorporation. The question here is whether this same change can be accomplished by resolution of the board of directors in the absence of shareholder approval.
OSI justifies its action in issuing the Series Preferred Stock in the following manner. At Paragraph 4F of OSI's certificate of incorporation it is provided as follows:
"[T]he Board of Directors of the corporation is hereby expressly granted authority to fix, by resolution duly adopted prior to the issuance of any shares of a particular series of preferred stock so designated by the Board of Directors, the voting powers of such stock of such series, if any, and the designations, preferences and relative, participating, optional and other special rights. . . ." (Emphasis added.)
This said to mirror the authority extended by 8 Del.C. § 151(a) which, among other things, permits a corporation to issue one or more series of stock which "may have such voting powers, full or limited . . . and such designations, preferences and relative, participating, optional and other special rights . . . as shall be stated and expressed in the certificate of incorporation or of any amendment thereto, or in the resolution or resolutions providing for the issue of such stock adopted by the board of directors pursuant to authority expressly vested in it by the provisions of its certificate of incorporation."
Thereafter § 151(g) provides that if a corporation desires to issue any shares of any series of stock, the voting powers and preferences of which have not been set forth in the certificate of incorporation but which shall have been established in a resolution adopted by the board of directors pursuant to authority expressly given by the certificate of incorporation, a certificate setting forth such resolution can be executed, acknowledged, filed, recorded and shall become effective pursuant to 8 Del.C. § 103.
Turning next to 8 Del.C. § 104, that section defines the term "certificate of incorporation," as used in Title 8, unless the context requires otherwise, as including:
". . . not only the original certificate of incorporation filed to create a corporation but also all other certificates . . . or other instruments, howsoever designated, which are filed pursuant to . . . [§] 151 . . . of this title, and which have the effect of amending or supplementing in some respect a corporation's original certificate of incorporation."
Finally, OSI points to 8 Del.C. § 245 which authorizes a corporation to integrate into a restated certificate of incorporation of the company, "all provisions of its certificate of incorporation which are then in effect and operative as a result of there having been theretofore filed with the Secretary of State 1 or more certificates or instrument; pursuant to any of the sections referred to in § 104 of this title."
In summary, OSI is arguing that § 151(a) authorizes a board of directors, by resolution, to issue preferred stock and to set voting rights and preferences thereon as it sees fit as long as the certificate of incorporation permits the board to do so by resolution; that the certificate of incorporation of OSI permits its board to do so; that pursuant to § 151(g) this resolution can be certified and filed; that when so filed it falls within the definition of "certificate of incorporation" in § 104; and that as a consequence, by acquiring a restated certificate of incorporation under § 245, the resolution becomes a part of OSI's certificate of incorporation.
I am not persuaded by this reasoning at this point. In the first place, OSI's certificate of incorporation allows its directors, by resolution, to fix voting rights and preferences as to preferred stock only. There is some question as to whether the First Series Preferred is really preferred stock. It is entitled to a dividend only when the common stock is entitled to a dividend. The amount of its dividend must be the same as the common stock dividend. On dissolution, it receives only that amount received by the common stock. The only difference is that in either event the First Series Preferred is entitled to be paid this identical sum first. As to the dividend aspect, a corporation cannot validly declare a dividend without setting aside sufficient funds to pay all dividands so declared.Wilmington Trust Co. v. Wilmington Trust Co., Del.Ch., 15 A.2d 665 (1940). As to dissolution rights, the funds to pay the First Series Preferred will have to be available by virtue of the fact that the amount per share is determined by dividing remaining net assets by the total number of First Series Preferred plus common shares. Thus any supposed preference as to dividends or liquidation rights seems illusory at best. If any preference is created, it would seem to lie almost entirely in the voting rights. In this regard, Starring v. American Hair Felt Co., Del.Ch., 191 A. 887 (1937) casts some doubt on the proposition that a stock can be classified as "special" or "preferred" under § 151 solely because it is given a favored voting position.
In the second place, OSI offers no authority in support of its unique interpretation of the foregoing statutes. Reduced to the simplest of terms, OSI is saying that where the certificate of incorporation gives the board of directors the same general powers given by § 151, then § 151 is transformed into the statutory means whereby the board of directors can amend the certificate of incorporation by resolution so as to require a greater than majority vote by the shareholders to approve a merger. This logic, while not being persuasive on its face, _s further weakened by the language of § 104 which includes within the definition of "certificate of incorporation" a certified copy of a resolution filed pursuant to § 151 provided it "have the effect of amending or supplementing in some respect a corporation's original certificate of incorporation." Thus OSI is arguing that the directors resolution here amends and becomes part of the certificate of incorporation by virtue of § 104 when, in reality, § 104 holds that a certificate filed pursuant to § 151 is considered as part of the certificate of incorporation only if it amends or supplements the original certificate. This, to me, constitutes a gap in OSI's reasoning.
On the present record I am convinced that Telvest has demonstrated a likelihood that it will prevail on the merits on this point. It seems more logical to conclude that where the holders of the common stock are given the right to approve certain transactions by only the majority vote required by the various applicable statutes, that right cannot be changed short of an amendment to the certificate of incorporation approved by the stockholders pursuant to 8 Del.C. § 242. I am aware of no policy evident in the Delaware Corporation Law, and I have been referred to none, which would empower a board of directors to alter existing voting rights of shareholders for the supposed good of the shareholders without permitting the shareholders to be heard on the matter.
In addition, Telvest argues that the issuance of the Series Preferred Stock as a common stock dividend is illegal because it will not be distributed on a pro rata basis. This stems from the fact that those who hold shares other than in multiples of ten will receive the First Series Preferred on the basis of "the next highest whole number of shares." Generally, a dividend must always be pro rata, equal, and without discrimination or preference. 11 Fletcher, Cyclopedia Corporations § 5352. OSI does not dispute the fact that some uneveness will result in the distribution of the stock dividend hare. The explanations offered for this, i.e., that it is a matter for the business judgment of the board and that any increase in voting rights is slight, orde minimus, are also not persuasive at this point.
Finally, to the extent that OSI relies on the decisions inKors v. Carey, Del.Ch. 158 A.2d 136 (1960); Cheff v. Mathes, Del.Supr., 199 A.2d 548 (1964); and Kaplan v. Goldsamt, Del.Ch., 380 A.2d 556 (1977), I agree with Telvest that such reliance is misplaced. Those cases dealt with the alleged waste of corporate funds used in purchasing the stock of a dissident faction so as to avoid that justifiably appeared to be a threat to the well-being of the corporation. Those cases do not purport to authorize management, without putting the matter to the shareholders, to superimpose new strictures on existing shareholder voting power on the theory that such action is needed to curtail a threat to corporate existence presented by a large concentration of stock in one shareholder.
If anything, and even assuming arguendo that it is legally proper for OSI's board to have taken the action challenged here, it would seem that such action would fall within the type of conduct deplored in Schnell v. Chris-Craft Industries, Inc., Del.Supr., 258 A.2d 437 (1971); Condec Corporation v. Lunkenheimer Company, Del.Ch., 230 A.2d 769 (1967); and Canada Southern Oils v. Manabi Explcration Co., Inc., Del.Ch., 96 A.2d 810 (1953). At least it would so appear on the present record.
Thus, I conclude that a preliminary injunction should issue enjoining the distribution of the Series Preferred Stock pending further order of the Court. The suggestion in West v. Sirian Lamp Co., Del.Ch., 42 A.2d 883 (1945) that all holders of illegally distributed stock would be necessary parties to an action to cancel it, when coupled with the recent decision ofShaffer v. Heitner, 433 U.S. 86(1977), convinces me that the immediate distribution proposed by OSI's board constitutes a real threat of irreparable injury to OSI. The suggestion that any harm could be avoided by printing a legend on the share certificates, stating that the legality of the First Series Preferred is currently in litigation and that the stock might later be held invalid, is a solution to which this Court should certainly give no sanction. I would hope that the reason is obvious.
The preliminary injunction will issue. Counsel for Telvest is directed to present a form of order. If counsel desire to be heard on the amount of the bond, they should so advise.