Reassessing a Defused “Time Bomb”: A Fresh Look at Corporate Foot Faults and the Benefits Conferred by their Discovery
2024
Publication| Corporate & Chancery Litigation| Corporate Governance| Corporate Transactions| Mergers & Acquisitions| Special Committees & Investigations
In early 2023, the Delaware Court of Chancery was inundated with petitions under Section 205 of the DGCL filed by former SPACs seeking to have their capital structures validated after the Court. The petitions followed a ruling granting a fee award in Garfield v. Boxed, Inc., in which the Court found a challenge to the authorization of a SPAC’s business combination—followed by countless other SPACs—meritorious when filed. Beginning in In re Lordstown Motors Corp., and throughout the scores of Section 205 proceedings that followed, the Court of Chancery allowed equity to prevail and expeditiously restored the expectations of all interested constituents. Although the episode showcased the Court of Chancery’s agility and attentiveness to the legitimate needs of corporate constituents, it was not without cost to the Delaware courts, affected corporations, and public stockholders. These costs, as well as those arising from the growing number of challenges to inadvertent technical defects in recent years, have followed a series of rulings in cases such as Boxed in which corporations have been ordered to pay sizeable attorneys’ fee awards approaching—or even exceeding—seven figures to those who identified technical defects in corporate action.
In finding support for these awards, the Delaware courts have attributed significant benefits to the revelation of technical missteps, looking to the drastic consequences that have historically accompanied corporate defects (such as incurable voidness), even characterizing them as a “ticking time bomb.” But as Lordstown and other similar cases illustrate, the adoption of Sections 204 and 205 of the DGCL, which eliminated the specter of incurable voidness for technical defects from the corporate universe, defused this time bomb, with inadvertent defects no longer presenting an existential threat to a corporation’s foundation. The practical effect of these statutes, in our view, has not yet been formally taken into account in rulings on fee awards to compensate those who identify technical defects. Instead, it appears that fee awards have continued to follow precedent developed in the pre-ratification and validation era. The precedent, in turn, has built upon itself and led, in our view, to fee awards that, in a post-204 and 205 era, are disproportionate to the benefits actually conferred on the corporations ordered to pay them.
Far from advancing the corporate benefit doctrine’s foundational principles of equity, disproportionately high fee awards of this nature erode stockholder value. While the Court has in some prior rulings cited the noble goal of incenting statutory compliance as support for fee awards, the equitable foundations of the corporate benefit doctrine, as well as the restrictions on the Court’s ability to award punitive damage, tend to undercut this rationale for outsized fee awards. For the corporate benefit doctrine to carry out the benefit it was designed to achieve, we believe its application to inadvertent corporate defects must be recalibrated to reflect the limited real-world effect, following the enactment of Sections 204 and 205, of claims that highlight technical defects. In our view, this refined approach should look to the actual benefits, if any, conferred on a corporation from the discovery of technical defects, taking into account various equitable factors, including those set forth in Section 205(d) of the DGCL, the “Sugarland factors”, and—where appropriate —the size of the corporation or transaction at issue.
John Mark Zeberkiewicz & Robert B. Greco, Reassessing a Defused “Time Bomb”: A Fresh Look at Corporate Foot Faults and the Benefits Conferred by Their Discovery, 49 Del. J. Corp. L. 1 (2024).