Delaware Supreme Court Rejects Board’s Decision To Apply 10% Voting Limitation in Proxy Contest


A familiar corporate charter provision for many companies and, in particular, the stock holding company formed in the charter of newly converted mutual savings institution, is a limitation on voting shares beneficially owned by a person, directly or indirectly, to the extent the shares are in excess of ten percent of outstanding shares.  The provision typically defines “person” broadly to include shares held by members of a group acting in concert, and the voting limitation is then applied to all shares held by the group in excess of ten percent of outstanding shares.  This provision is often accompanied by language that makes the board’s determination under the voting limitation rule “conclusive and binding” on all stockholders.  While these provisions only rarely come into play at shareholder meetings, a recent Delaware Supreme Court decision is a cautionary tale of how invoking the provision can backfire.

In a case decided on July 19, 2023, CCSB Financial Corp. v. Totta, the Delaware Supreme Court found that an incumbent board breached its duty of loyalty to stockholders when it directed the inspector of elections to disregard the voting of shares held by a purported shareholder group in excess of the ten percent voting limitation.  Specifically, the Court held that, absent express statutory authorization, a charter provision that empowered the board to make a “conclusive and binding” determination that the voting limitation was triggered could not be relied upon to exculpate the directors from a breach of the duty of loyalty.  Moreover, the Court concluded that there was no equitable basis to give effect to the board’s decision to exclude the votes.

The case arose out of a proxy contest involving a major shareholder who proposed a slate of three directors at the company’s 2021 annual meeting.  Based on limited anecdotal information, the board applied the voting limitation and directed the inspector of elections to disregard some 37,000 shares held by members of the purported shareholder group.  The board had never applied the voting limitation since undergoing a mutual-to-stock conversion in 2003 and, in the Delaware Chancery Court, the board advanced the somewhat dubious argument that the outcome of prior elections was not affected by the apparent voting of shares in excess of the limitation.  For the 2021 annual meeting vote, the board conducted no investigation regarding whether any other stockholder or stockholder group were acting in concert despite the fact that the bank’s president was known to hold over ten percent of the outstanding shares and, in the past, had failed to include stock held by his daughter in his beneficial ownership totals.  There was further evidence that the president had been actively monitoring the proxy vote and encouraging votes for the incumbent board members.  The inspector of elections, who was also the company’s general counsel, conducted no independent inquiry into the board’s determination, and shareholders were never informed that the voting limitation had been applied to shares that had been voted for the dissident slate.  The record showed that the dissident slate would have been successful if the excluded votes had been counted.

On appeal, the company argued that the “conclusive and binding” language in the charter provision eliminated the need to inquire into whether the board’s decision was a breach of fiduciary duty.  The company advanced the argument that the only issue before the Court was whether the business judgment rule protected the board’s decision.  However, the Court found that the Delaware General Corporation Law bars any charter provision that directly or indirectly limits director liability for a breach of the duty of loyalty and that the “conclusive and binding” language impermissibly insulated the directors from an inquiry into whether they breached their duty of loyalty.  This line of analysis, the Court concluded, would restrict the Court to a business judgment rule review even where, under existing precedent, the Court’s standard of review would consider the entire fairness of the transaction to determine whether the directors breached their duty of loyalty.

The Court next turned to consideration of whether the board properly determined that the holders of the disputed shares were “acting in concert”, a phrase not defined in the charter’s voting limitation provision.  The company argued that the definition of “acting in concert” under the federal Change in Bank Control Act (the “CIBCA”) should apply, an argument that the Court rejected since it was not argued in the Chancery Court below.  Interestingly, in a sidebar discussion, the Court noted that a finding under the CIBCA that shareholders were acting in concert could inform a finding under the charter’s voting limitation, but absent at least a “mention” of the CIBCA in the charter, the finding would not be dispositive of the outcome.  Ultimately, the Court accepted the Chancery Court’s view that, under Delaware law, the phrase should be interpreted in a manner consistent with its plain meaning, i.e., that persons act in concern when they have an agreement, arrangement or understanding regarding the voting or disposition of shares.  Applying this definition, the Chancery Court had found that testimony from members of the purported “group” credibly undermined the company’s contention that they were acting in concert and, therefore, the board’s instruction to the inspector of elections was invalid.  The Court affirmed these findings and, therefore, did not reach the issue of whether board’s instructions would have survived an enhanced scrutiny review.

In light of the CCSB decision, corporate boards should be wary of any casual application of a voting limitation in their charter.  The threshold issue is to understand exactly what the charter provision covers and what facts will allow the board to invoke the limitation.  Next, the board should consider whether the limitation has been applied in the past and, if not, whether it should have been applied and whether the failure to apply the rule would have altered the results of prior vote.  Inconsistent or targeted application of the limitation in the past could have later implications for the board’s current decision to apply the limitation.  Next, the board should be careful to validate all facts that suggest that the shareholders whose votes will not be counted are in fact acting in concert or otherwise have ties that suggest indirect ownership.  The mere impression that shareholders have business or family ties or evidence that one shareholder in a purported group has sold shares to another shareholder in the group in the past may not support a finding that the shareholders are acting in concert or share beneficial ownership.  Finally, after the CCSB decision, the board should act with the knowledge that their determination may be subject to judicial review even if the charter provision vests “conclusive and binding” authority in the board to apply the voting limitation.

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