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In re Vaalco Energy, Inc. Stockholder Litigation: Court of Chancery Finds that Certificate and Bylaw Provisions Providing that Directors May Be Removed for Cause Only Are Invalid Unless Board Is Classified or Corporation Has Cumulative Voting

February 25, 2016

In In re Vaalco Energy, Inc. Stockholder Litigation, C.A. No. 11775-VCL (Dec. 21, 2015) (TRANSCRIPT), the Court of Chancery granted the plaintiffs’ motion for summary judgment and invalidated certain provisions of Vaalco’s certificate of incorporation and bylaws, which provided that members of its board of directors could only be removed for cause. The Court held that the default rule under Section 141(k) of the Delaware General Corporation Law (the “DGCL”) that directors “may be removed, with or without cause” may be limited to removal only for cause solely in corporations that either (i) have a board classified pursuant to Section 141(d) of the DGCL (i.e., a staggered board), or (ii) provide for cumulative voting pursuant to Section 214 of the DGCL.

Before its 2010 annual meeting, Vaalco had a staggered board and provisions in its certificate of incorporation and bylaws mandating that directors could be removed only for cause. In 2010, Vaalco de-staggered its board, but failed to remove the provisions of its certificate and bylaws providing for removal of directors for cause only. After a group of dissident stockholders announced its intention to remove certain members of Vaalco’s board in late 2015, Vaalco asserted that these provisions prohibited such action without cause. In response, the group of stockholders brought an action seeking a declaratory judgment that Vaalco’s certificate of incorporation and bylaw provisions permitting only for-cause removal of directors were void under Section 141(k).

Section 141(k) provides that “[a]ny director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors” except in the case of a corporation with either (i) a staggered board, or (ii) cumulative voting. The defendants advanced several arguments in favor of the validity of the Vaalco certificate of incorporation and bylaw provisions, including the alleged fact that approximately 175 public Delaware corporations had similar provisions in their governing documents regarding director removal despite lacking a staggered board or cumulative voting. Of these, the Court found most persuasive the defendants’ argument that Section 141(d) permits a classified board to “be divided into 1, 2 or 3 classes,” and thus allows for a board to be classified into a single class. Accordingly, the defendants argued that a single-class board would be classified for the purposes of Section 141(k), and could properly be subject to removal for cause only.

The Court, however, rejected this argument, which, in its view, would create a “somewhat oxymoronic concept of a single-class classified board.” In so holding, the Court relied upon commentary on the 1974 amendments to the DGCL, which explained that the language in Section 141(d) permitting a board to be “divided into 1, 2 or 3 classes” was intended to clarify that the right of any class or series of stock to elect one or more directors would not create an additional class of directors and did not support the notion of a single-class classified board. Additionally, while Vaalco advanced its interpretation of Section 141(d), it never actually established that its board was classified. Thus, the Court alternatively held that, even if Section 141(d) permitted a single-class classified board, Vaalco did not have such a board.

Following the ruling described above, the plaintiffs’ bar began sending demand letters to the 175 companies identified by the defendant in Vaalco. Suits have been filed against several of those companies. For companies that have de-staggered their boards within the last several years, it may be worthwhile to determine whether similar issues exist before the plaintiffs’ bar initiates contact.