Correcting Corporate Oversights: A Guide for Delaware Corporations
Entrepreneurs are primarily concerned with running a successful company. On a daily basis, they make myriad decisions and face constant pressure related to the operation of the company.
Often, particularly early on in a company’s existence, taking formal steps to document and track corporate actions and decisions is an afterthought, given the pace at which decisions are made and actions are taken.
Drafting corporate resolutions, recording meeting minutes and tracking stock available for issuance is sometimes seen as a distraction from the company’s primary focus of pursuing its business plan and achieving its goals.
Such a mindset, however, can ultimately prove damaging to a business’s growth and future. Mistakes or failures to monitor corporate actions can come back to haunt a company at the most inopportune times, such as when it is looking to bring aboard investors.
Take, for example, a company that has issued stock to its founders and employees without documenting these grants through corporate resolutions, only to find that it has issued more shares than permitted under the company’s Certificate of Incorporation.
Such an issue is a red flag for both investors and lenders, both of whom view adherence to formalities as a sign of a company’s overall commitment to detail.
All is not lost, however, because under Section 204 of the Delaware General Corporation Law, a company can retroactively ratify mistakes through action that, prior to the adoption of Section 204 of the Delaware General Corporate Law in 2013, would have been deemed invalid as well as a financial and logistical mess to correct.
Elaborating on our example, assume that a company is authorized to issue 2 million shares of stock under its Certificate of Incorporation but has inadvertently issued 2.1 million shares.
What would Section 204 require as a corrective action for the issuance of these 100,000 shares of unauthorized stock that was issued to the shareholders?
- Board Resolution: The Board of Directors must adopt a resolution providing details about the invalid shares, and then ratify and approve the shares.
- Potential Vote: If the invalid shares would have required a shareholder vote (which, in our example, would be the case, as a stock amendment of the Certificate of Incorporation would be required), then the company traditionally would submit the ratifying corporate resolution to a vote of the current shareholders as well as the shareholders at the time of the defective action.
- Potential Notice: If the invalid shares would not have required a shareholder vote, then notice of the ratifying resolution is typically sent to all current shareholders as well as those persons who were shareholders at the time of the defective action.
- Corrective Filing: If the invalid shares would have required a filing to be made (an amended Certificate of Incorporation in our example), the company would traditionally file a certificate of validation with the state of Delaware describing the defective action and making the required filing after the fact.
If the above actions are done in compliance with Section 204, the defective action is approved by the state of Delaware and, in our example, the 100,000 formerly invalid shares would be deemed valid stock and the amended Certificate of Incorporation would govern.
Section 204 is not the only means by which a Delaware company can give authorization to correct prior mistakes, but it is a formal means with which to deal with serious problems, such as the breach of a company’s Certificate of Incorporation, per our example.
This is unique to the state of Delaware and yet another example of how Delaware keeps the Delaware corporate law structure on the cutting edge.
A company reviewing its past or current compliance with corporate formalities should seek the assistance of counsel to ensure that any corporate clean-up is documented appropriately.
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.