Chancery Court Provides Guidance On 'Void' vs. 'Voidable' Stock Issuances
The Delaware Court of Chancery in a recent decision held that stock Roma Restaurant Holdings Inc. issued in 2016 in an effort to dilute a shareholder group’s ownership is void and cannot be counted in a vote to determine the composition of the Roma board. The ruling provides guidance on the difference between “void” and “voidable” stock issuances under Delaware common law.
Roma, the parent company of restaurant chains Tony Roma’s and TR Fire Grill, filed for bankruptcy in 2005. The court-approved reorganization process bound all stockholders to an agreement that barred Roma from issuing stock or stock equivalents to any person that was not a party to the stockholder agreement, unless that person agreed, in writing, to be bound to the agreement. Failure to properly execute joinders to the agreement made any issuance of shares or stock equivalents null and void.
In 2006, Roma adopted an incentive plan to compensate key employees as part of the reorganization. This plan, which empowered the board to issue options and restricted stock for a period of ten years, expired in early 2016.
In November 2016, a stockholder group negotiated the purchase of enough shares to brings it ownership stake to 51.4 percent. The next day, Roma’s board approved a new plan that did not require stockholder approval before the issuance of the restricted stock. The plan also authorized the issuance of a total of 48,500 shares of restricted stock, which was enough to dilute the shareholder group’s ownership of Roma from 51.4 percent to 46.9 percent.
Litigation and Decision
The shareholder group filed a lawsuit in January 2017, arguing the restricted stock issuance under the 2016 Plan was invalid and void because it violated the stockholders’ agreement and Delaware law. The defendants argued the stock issuance was voidable, but not void.
The distinction was key: if the restricted stock issuance was simply voidable, Roma’s board could potentially fix the flaws with later actions.
Following a trial, Vice Chancellor Tamika Montgomery-Reeves on Feb. 1 sided with the shareholder group and ruled the stock issuance was void for failure to comply with the joinder requirement in the stockholders’ agreement. As such, the stock issued under the 2016 Plan cannot be counted in a vote to determine the composition of the Roma board.
Vice Chancellor Montgomery-Reeves noted the defendants did not contest that the recipients of restricted stock under the 2016 Plan did not agree to be bound by joinders at the time of issuance. Rather, the defendants argued the award agreements under contained language “substantially in the form” of the joinder required. But the court said there were certain key differences.
Among other things, the agreement does not acknowledge that the recipient had the opportunity to read the stockholders’ agreement and consult with counsel, the court wrote. “Moreover, the joinder requirement must be satisfied before issuance of the restricted stock, which the Company failed to do.”
Vice Chancellor Montgomery-Reeves also rejected the defendants’ argument that a finding that the restricted stock issuance to be void was an inequitable outcome because the breach of the stockholders’ agreement was on “technical ground.”
“[A]s discussed above, the award agreement substantively failed to comply with numerous elements of the joinder provision, including the timing under which the joinders must be completed as well as the requirements that the recipient acknowledge that they had ample time to read and consult with counsel on the Stockholders’ Agreement,” the court wrote. “Defendants’ failure to satisfy the joinder provision was more than a mere technical deficiency; it was a failure to substantially perform the required actions.”