Supermajority Requirement Inapplicable in the Context of a Reincorporation to Nevada

In Gunderson v. The Trade Desk, Inc. (Nov. 7, 2024), the Delaware Court of Chancery held that only a majority stockholder vote will be required to approve the proposed reincorporation of The Trade Desk, Inc. (the “Company”) from Delaware to Nevada through a corporate conversion (the “Conversion”). The court held that, although Article X of the Company’s charter (the “Charter”) requires a supermajority vote for amendment or repeal of the Charter, and although the Conversion as a substantive matter would will result in amendment or repeal of the Charter, Article X is inapplicable because the language as drafted does not state that the Supermajority Vote requirement applies to amendment or repeal of the Charter as a result of a conversion.

Key Points

• Critical drafting point for charter amendment provisions. The decision reiterates the precise guidance provided in previous cases for corporate drafters when they seek to extend a protective supermajority (or other special) vote requirement for amendment or repeal of a charter that is effected through a corporate transaction such as a merger, consolidation, or conversion. For the vote requirement to extend to charter amendment or repeal in such cases, the charter amendment provision must explicitly state that the vote requirement applies to amendment or repeal of the charter whether by merger, consolidation, conversion or otherwise. (We note that the decision bodes well for Tesla, Inc. in the pending litigation challenging its majority stockholder vote on its reincorporation to Texas pursuant to a conversion, as Tesla’s amendment charter provision was similar to Trade Desk’s.)
• Potency of the doctrine of independent legal significance. The court’s result was based on the doctrine of independent legal significance—which holds that legal action authorized under one section of the DGCL is not invalid because it causes a result that would not be achievable if pursued through other action under other provisions of the statute. While over the years there has been some uncertainty among practitioners as to the continued force of the doctrine, the court emphasized in Gunderson that it is “a bedrock of Delaware corporate law and should not easily be displaced.”
• Narrow opinion, however. The court addressed in this opinion only the question whether the Conversion will be legally authorized if approved by a majority rather than a supermajority vote. Noting that director action is “twice-tested, first for legal authorization, and second by equity,” the court reaffirmed that the doctrine of independent legal significance cannot bar fiduciary or equitable claims. The court indicated that the Plaintiff’s equitable claims challenging the substantive fairness of the Conversion may be addressed at a subsequent stage of the litigation.
• Continued judicial emphasis on technical formalities. We note that the decision is consistent with the trend of the court in recent years toward an emphasis on technical formalities in a variety of contexts. The court focused on the formal transaction structure the board utilized (a conversion) rather than the transaction’s substantive effect (repeal of the Charter); the technical requirements under the Delaware statute applicable to the transaction; and the precise language of the Charter.
• Few reincorporations from Delaware. Due to certain controversial decisions issued by the Delaware courts in the past couple of years (including Crispo, Moelis, Activision, Tornetta, and Match Group), there has been much discussion about the possibility of Delaware corporations deciding to reincorporate to states that impose lower fiduciary standards for corporate directors. Our research indicates, however, that, since 2021, only eight Delaware corporations have reincorporated to other states—and each of them was a controlled company. We note, further, that the decision in the appeal of TripAdvisor (Feb. 2024) is expected imminently. In TripAdvisor, the Court of Chancery held at the pleading stage of the litigation that a reincorporation from Delaware to Nevada was subject to entire fairness review (Delaware’s strictest standard). If TripAdvisor is overturned, it is possible there would be some increase in interest in reincorporation from Delaware.

Background. The Company is a Delaware corporation with a dual class stock structure. The Company’s founder, Jeff Green, is a controlling stockholder. In September 2024, the board of directors approved a resolution to reincorporate the Company as a Nevada corporation, through a conversion to be effected pursuant to DGCL Section 266. A special meeting for stockholder approval of the Conversion is scheduled for November 14, 2024. In the proxy statement, the Company told stockholders that, under Section 266, a majority vote is required to approve the Conversion. The stockholder-Plaintiff brought suit, claiming that a supermajority vote is required because Article X of the Company’s Charter requires a supermajority vote for amendment or repeal of the Charter and the Conversion will result in amendment or repeal of the Charter. Vice Chancellor Fioravanti held that only a majority vote is required and granted summary judgment in favor of the Company, Green and the director-Defendants.

Discussion

The doctrine of independent legal significance. This doctrine has been described by the Delaware Supreme Court as providing that “action taken under one section of [Delaware law] is legally independent, and its validity is not dependent upon, nor to be tested by the requirements of[,] other unrelated sections under which the same final result might be attained by different means.” The doctrine provides certainty to corporate planners—as a transaction structured to comply with a section of the DGCL will not be invalidated for its failure to comply with a different section of the DGCL. The paradigm application of the doctrine is where a corporate action is taken pursuant to a specific statute and there is an alternative statute with which the corporation could have complied to accomplish the same result.

Application of the doctrine to amendment or repeal of a charter. The Conversion will have the substantive effect of amending or repealing the Company’s Charter. DGCL Section 266 requires a majority vote for approval of a conversion. DGCL Section 242 (which provides general authorization for amendment or repeal of corporate charters) requires a majority vote for amendment or repeal of a charter unless the charter provides for a greater vote. Article X of the Charter requires a 66 2/3% vote for amendment or repeal of the Charter. In addressing whether the Conversion requires a majority vote under Section 266 or, instead, a supermajority vote under Section 242 in light of Article X, the Plaintiff urged the court to focus on the substantive effect of the Conversion (i.e., amendment or repeal of the Charter) rather than on the formality as to the specific type of transaction pursuant to which that result will be obtained (i.e., a conversion). The court rejected this argument, writing: “[T]he entire field of corporation law has largely to do with formality.” And such formality, the court stated, “has significant utility for business planners and investors.” The court concluded that, under the doctrine of independent legal significance, and based on a longstanding line of precedential decisions, a majority vote is required for the Conversion, as Article X does not expressly and clearly provide that it applies to amendments or repeal of the Charter that are effected through a corporate transaction such as a conversion. In the absence of such explicit language extending the reach of Article X, the court concluded, Article X applies only when the Company takes action to amend or repeal the Charter pursuant to DGCL Section 242 and not when the Charter is amended or repealed through corporate transactions (such as mergers or conversions) authorized under sections of the DGCL other than Section 242).

Clear guidance under precedential cases. The critical consideration for the court in Gunderson, in not applying a substantive analysis to determine the intent of the drafters of Article X, was that there is a long line of precedential cases—Warner Communications v. Chris-Craft (Del. 1989) and Elliott Associates v. Avatex (Del. 1998), and their progeny—that has provided “clear guidance to practitioners” with respect to drafting special vote requirements for charter amendments such that they would extend to amendments effected as a result of corporate transactions. In Warner, the Court of Chancery held that a merger could proceed under DGCL Section 251 without a class vote of the company’s preferred stock even though the merger could have an adverse effect on the preferred stock that would have triggered a class vote under DGCL Section 242. In Avatex, the Delaware Supreme Court held that preferred stockholders had a vote on a merger that would have adversely affected their rights set forth in the company’s charter because—in contrast to the charter provision in Warner—the Avatex charter granted the preferred stockholders a vote on amendment or repeal of the charter “whether by merger, consolidation or otherwise. The court emphasized in Gunderson that, given the decades-long precedent containing explicit guidance to drafters, if the language endorsed by the court is absent then “the court will infer that [its] absence…is intentional” on the part of the drafters.

Potential viability of equitable claims notwithstanding the doctrine of independent legal significance. Even when the doctrine of independent legal significance applies, it cannot preclude equitable review, under which the court could determine to recharacterize a transaction even if the parties have complied with the applicable statutes. The court confirmed that, notwithstanding application of the doctrine of independent legal significance, “a substantive analysis [(i.e., looking through a transaction’s form to its substantive effect)] may prove necessary” when evaluating equitable claims, for example “to determine drafters’ intent in adopting a particular provision.” The court indicated that the Plaintiff’s claims challenging the substantive fairness of the Conversion—which the Plaintiff added to the Complaint during the parties’ briefing of the Plaintiff’s motion to expedite hearing of the parties’ summary judgment cross-motions—may be considered at a subsequent stage of the litigation. This opinion, narrowly, considered only the legal question relating to the required stockholder vote necessary for the Conversion.

Reincorporation from Delaware. An appendix to the Company’s proxy statement provides a table of proxy filings by Delaware corporations that have recently proposed reincorporations to other states. The table, prepared by Professor Stephen Solomon Davidoff, indicates that, from January 1, 2021 to August 19, 2024, 18 Delaware corporations proposed to reincorporate to other states—of those, 14 were proposals for reincorporation to Nevada; 2 (one of which is Tesla) for reincorporation to Texas; 1 for reincorporation to Colorado; and 1 for reincorporation to Maryland. Our research indicates that only 8 of the 18 Delaware corporations that proposed to reincorporate to other states have actually reincorporated (6 to Nevada and 2 to Texas)—and all of these companies appear to have a controlling stockholder. (We note that the Appendix also reflects that there were 18 corporations during that period that proposed to reincorporate to Delaware—2 of which were Nevada corporations and 1 of which was a Texas corporation.)

TripAdvisor appeal. The appeal of the Court of Chancery’s TripAdvisor (Palkon v. Maffei, Feb. 2024) decision was heard by the Delaware Supreme Court on October 30, 2024 and a decision is expected imminently. In TripAdvisor, the Court of Chancery held that reincorporation from Delaware to a state imposing lesser fiduciary standards on directors offers a non-ratable benefit to directors (namely, more protection against personal liability) and so will be subject to entire fairness review if challenged. The decision indicated that, while a Delaware corporation is free to reincorporate to a lower-fiduciary-standard state, a board’s fiduciary duties may require that the stockholders be compensated in some way (potentially in the form of monetary damages) for the diminishment of their “litigation rights” as a result of the reincorporation. Notably, in TripAdvisor, the company asserted that Nevada law provides for lower fiduciary standards than Delaware—allegedly, without carefully examining the Nevada statute; and there was, allegedly, substantial evidence that obtaining the benefit for directors of lower fiduciary standards was the primary reason for the company’s proposing the reincorporation. If the Supreme Court overturns TripAdvisor, this may stimulate more interest in reincorporation from Delaware. If TripAdvisor is upheld, the Supreme Court’s decision may provide needed guidance on open issues, such as whether compensation would not be owing to stockholders if the board seeks reincorporation for reasons that provide benefit to the corporation and its stockholders as a whole rather than to provide directors with lesser exposure to fiduciary claims.

Practice Points

• Consider whether to include “Avatex language” in charter provision requiring a supermajority (or class or other special) vote for charter amendments. The court-endorsed language—which is protective of stockholders—would state that the supermajority (or class or other special) vote requirement applies to any amendment or repeal of the charter “whether effected through a merger, consolidation, conversion, or otherwise.” We note that this issue arises not only in the context of conversions and mergers, but often in the context of the issuance of preferred stock and a charter provision requiring a class vote of the holders for charter amendments that would adversely affect the rights and preferences of the preferred stock.
• Monitor Delaware decisions for court-endorsed language in other contexts. It should be kept in mind that, where the court has clearly and over a long period endorsed specific language to be used in a specific context to effect a certain result, the absence of such (or similar) language may be interpreted by the court as being intentional, indicating that the drafter did not intend to effect such result.
• Reincorporation from Delaware. Pending and subject to any guidance that may be offered in the upcoming decision in the appeal of TripAdvisor, corporations considering reincorporation from Delaware should:
  • Examine carefully the statutes and policies of the proposed new state to determine if they provide lower fiduciary standards for corporate directors, officers or controllers—rather than simply assuming as much;
  • Keep in mind that entire fairness review may be applicable; that the stockholders may be owed compensation for a decrease in their “litigation rights” if the fiduciary standards are lower in the new state than in Delaware; and that it is unclear what form that compensation can take and, if monetary damages, how they would be calculated; and
  • Establish a record reflecting that the reasons for proposing the reincorporation are based on benefits to the corporation and its stockholders as a whole—for example, lower franchise fees. (We note that, as one example, Gaxos.ai Inc. disclosed in its proxy statement relating to its reincorporation that, based on its current capital structure, it would pay franchise taxes of $200,000 in Delaware for 2024, while in Nevada it would pay only $675.) Other potential reasons for reincorporation that would redound to the benefit of the corporation and its stockholders as a whole include, for example: greater ability to attract and retain management and employees in the new state; lower exposure to product liability claims under the new state’s legal regime; a political climate in the new state that better aligns with the corporation’s culture and values; and being located in the state where the corporation’s primary facilities or operations are located.

Of course, companies considering reincorporation from Delaware should keep in mind the potentially significant disadvantages—including less predictability on legal matters due to more limited case law in the new state; and potential investor unease to the extent the law and policies in the new state are viewed as being less developed, less understood, and/or less protective of stockholder rights than Delaware’s laws and policies.