Nonvoting Common Stock: A Legal Overview

Dual-class stock structures have recently been the subject of significant commentary. Much criticism has been levied at companies with high-vote/low-vote stock structures, but the conversation seemingly reached a boiling point after Snap Inc.’s recent initial public offering of nonvoting common shares. Without taking a position on the merits of dual-class stock structures, this post provides an overview of the legal issues associated with nonvoting common stock of Delaware corporations.

Limited Right to Vote

The general rule in Delaware is that each share of capital stock is entitled to one vote, but the certificate of incorporation can provide that one or more classes or series of stock shall have limited or no voting rights. It is not uncommon for companies to issue preferred stock with limited or no voting rights, but nonvoting common stock is rare.

Unlike holders of voting shares, holders of nonvoting shares cannot vote on:

• the election or removal of directors;
• the approval of extraordinary transactions, such as mergers, significant asset sales, or dissolution, but holders of nonvoting shares are entitled to vote on conversions and transfers, domestications, or continuances;
• amendments to the certificate of incorporation, which is the legal document setting forth the terms of each class of stock, except that holders of nonvoting shares are entitled to vote on amendments that would (i) unless otherwise provided in the certificate of incorporation, “increase or decrease the aggregate number of authorized shares,” (ii) “increase or decrease the par value of the shares,” or (iii) adversely “alter or change the powers, preferences, or special rights of the shares;”
• converting the corporation into a public benefit corporation, whether through an amendment of its certificate of incorporation, merger, or consolidation; and
• other corporate governance matters, including say-on-pay votes and bylaw amendments put to a stockholder vote.

No Notice of Stockholders Meetings

Nonvoting stockholders are not entitled to notice of stockholders meetings, including annual meetings to elect directors, unless they are entitled to vote on at least one matter brought before the meeting (e.g., a conversion). The limited exceptions to this rule are that notice is required if the meeting is being held to vote on a merger or to obtain stockholder ratification of a defective corporate act.

Other Annual Meeting Issues

The Corporation May Refuse to Permit Nonvoting Stockholders to Attend Annual Meetings

If nonvoting shares are not entitled to notice of or to vote at a stockholders meeting, then their presence is not counted in determining whether a quorum is present. Moreover, it would seem that those nonvoting stockholders also are not legally entitled to attend the meeting, although the Delaware Code does not address this issue specifically.

The Corporation May Choose Not to Hold Annual Meetings

Some corporations with nonvoting shares may be able to avoid holding annual meetings altogether. While Delaware law gives stockholders and directors the right to petition the Court of Chancery to order an annual meeting if one has not been held within the last 13 months, no annual meeting is required if the directors are elected by unanimous written consent. Thus, a dual-class corporation with concentrated voting power whose voting stockholders elect directors by unanimous written consent is not required to hold annual meetings under Delaware law. Stock exchange rules, however, may require the corporation to hold an annual meeting.

The Corporation May Choose Not to Distribute Proxy or Information Statements

Federal securities laws require corporations to distribute proxy or information statements prior to soliciting votes from their stockholders. If a corporation has registered only nonvoting shares, however, federal law would not require that corporation to distribute a proxy or information statement. As a result, the corporation could avoid making various disclosures typically required of public companies. The corporation, however, would have to include certain information in its Form 10-K that most public companies report in their proxy statement under Schedule 14A. In addition, stock exchange rules may require that any proxy statements or other communications sent to voting stockholders also be sent to nonvoting stockholders.

No Notice of Action Taken by Written Consent

Nonvoting stockholders are not entitled to notice that stockholder action has been taken by written consent in lieu of a stockholders meeting. Instead, Delaware law only requires that the notice be sent to non-consenting stockholders who would have been entitled to vote if the action had been taken at a meeting.

Notice of Ratification of Defective Acts

As noted above, nonvoting stockholders are entitled to notice of a stockholders meeting at which stockholders are requested to ratify a defective act, even if they are not entitled to vote on the ratification. Notice also is required to be given to nonvoting stockholders if the board of directors ratifies an act that does not require stockholder approval or if stockholders ratify a defective act by written consent.

Inspection Rights

Voting and nonvoting stockholders have the same statutory right to inspect a corporation’s books and records “for any proper purpose.” In addition, all stockholders have a statutory right to inspect the list of stockholders entitled to vote at a stockholders meeting “for any purpose germane to the meeting.” The statutes do not limit the inspection rights to voting stockholders. Depending on the circumstances, however, a corporation might argue that a nonvoting stockholder does not have an inspection purpose that is “germane to the meeting.”

Fiduciary Duties; Approval of Interested Transactions

Directors owe fiduciary duties to the corporation and its stockholders as a whole. Thus, directors owe the same fiduciary duties to voting and nonvoting stockholders, and nonvoting stockholders have standing to bring direct and derivative actions against directors and officers to the same extent as voting stockholders.

Under Delaware’s interested directors statute, a contract or transaction with a director is not voidable solely due to the director’s conflict of interest if there is proper disclosure “to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders.” Although it could be drafted with greater clarity, the statute appears to provide that the only stockholders who can cleanse an interested transaction under the safe harbor are the voting stockholders.

Another interesting question is whether conditioning an interested transaction on, among other things, the approval of a majority of the outstanding nonvoting shares would cause a court to invoke the business judgment rule. Although the holders of nonvoting shares would not be entitled to vote under state law, conditioning the transaction on their approval at the outset would help facilitate arms-length bargaining and provide for disinterested approval of the transaction.

No Right to Submit Stockholder Proposals

Under Rule 14a-8 of the Securities Exchange Act of 1934, stockholders may submit proposals for inclusion in a corporation’s proxy statement. But Rule 14a-8 requires a stockholder to have owned at least $2,000 in market value, or 1 percent, of a corporation’s securities “entitled to be voted on the proposal at the meeting” for at least one year prior to submitting the proposal. Thus, nonvoting stockholders cannot submit proposals under Rule 14a-8.

We are not aware of Delaware case law addressing whether a nonvoting stockholder can submit a proposal or nomination under state law if the stockholder is ineligible to vote on the matter. But given that nonvoting stockholders are not entitled to notice of or to vote at, and likely do not have an enforceable right to attend, a stockholders meeting, it seems unlikely that a court would find that nonvoting stockholders have an inherent right to present proposals at meetings. Of note, most public company bylaws specifically require that a stockholder must be eligible to vote at the meeting in order to submit a proposal or director nomination.

Excluded in Determining Whether Short-Form Mergers are Permitted

Under Delaware law, a stockholder who owns at least 90 percent of a corporation’s voting shares can effect a “short-form” merger without prior action by the board of directors. Because the short-form merger statutes are based on the percentage ownership of voting shares, nonvoting shares are irrelevant in determining whether a holder of voting shares can satisfy the 90 percent threshold even if nonvoting shares constitute a majority of a corporation’s outstanding equity interests. At first glance, this may seem unremarkable because stockholders holding sufficient voting shares will always have the power to approve a merger. There are potentially significant implications, however, because Delaware courts have held that there is no duty to pay a “fair price” in a short-form merger, and, absent a disclosure violation, a minority stockholder’s sole remedy is to seek appraisal of its shares.

Appraisal Rights

Nonvoting stockholders are entitled to appraisal rights in a merger to the same extent as voting stockholders.

Conclusion

As described above, there are significant differences between the rights of voting and nonvoting stockholders. As their name implies, nonvoting shares do not play a role in the voting process, except for a limited number of corporate actions that can fundamentally affect the shares. Nonvoting stockholders, however, are not entirely without governance rights. Outside of the voting process, they share several rights with voting stockholders, including certain notice rights and appraisal rights. There are also several areas of legal uncertainty as to nonvoting stockholders’ ability to participate in corporate governance. In addition, stock exchange regulations may grant nonvoting stockholders of listed companies certain rights they would not otherwise have under state or federal law, such as requiring the corporation to hold annual meetings and distribute its proxy or information statement to all stockholders and not just voting stockholders. If more companies begin issuing nonvoting shares, we may see the Delaware corporation law, federal securities laws, and stock exchange rules and regulations adapt to provide greater clarity or perhaps expand the rights of nonvoting stockholders.

The complete publication, including footnotes and tables, is available here.