Pell v. Kill

Delaware Court of Chancery · Corporations

Corporationsstockholder voting rightsboard reductionproxy contestenhanced scrutinyDelawarefiduciary dutyenhanced scrutiny

Facts

Cogentix had an eight-member staggered board with three Class I seats up for election at the 2016 annual meeting. After Pell publicly disclosed his intention to seek changes in management and board composition and potentially wage a proxy contest, Kill and allied directors developed a plan to reduce the board from eight seats to five and reduce Class I seats from three to one. The board approved an immediate reduction from eight to seven seats and a further reduction to five effective at the annual meeting. The court found the plan was intended to preserve the incumbents’ control and neutralize Pell’s proxy challenge by ensuring stockholders could not change board-level control through the election.

Issue

Whether directors breach their fiduciary duties by reducing the size of the board and the number of seats up for election in the face of an anticipated proxy contest so as to prevent stockholders from changing board control. Also, whether a preliminary injunction should issue to stop implementation of that plan before the annual meeting.

Rule

When directors take action affecting an election of directors or touching matters of corporate control, enhanced scrutiny applies. In the voting context, directors must prove their motives were proper and not selfish, that their action did not preclude stockholders from exercising their voting rights or coerce their vote, and that the action was reasonable in relation to a legitimate objective; when the action affects director elections or corporate control, the justification must be compelling in the sense of a close fit between means and ends. Directors cannot justify such interference by claiming they know better than stockholders who should serve on the board.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

Redwood Surgical Devices, Inc., a Delaware corporation based in Cleveland, has a nine-member classified board. After stockholder Maya Torres publicly announces in a Schedule 13D amendment that she may run a slate for the three Class II seats up at the next annual meeting, the board votes to reduce Class II from three seats to one effective at that meeting.

If Maya challenges the reduction, which standard of review is most likely to apply under Delaware law as described here?

Explanation. Enhanced scrutiny applies when directors take action affecting an election of directors or touching matters of corporate control. Reducing the number of seats up for election in response to an announced proxy effort directly intrudes on the stockholder franchise, so the board must justify the action under enhanced scrutiny rather than receive ordinary business-judgment deference.