BNA’s Corporate Counsel Weekly™

Reproduced with permission from Corporate Counsel Weekly Newsletter, 27 CCW 384, 12/12/2012. Copyright ஽ 2012 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com BNA Insights Mergers and Acquisitions ‘SEPTA v. Volgenau’ and the ‘Ultra Vires’ Doctrine

BY FRANK AQUILA AND poration’s certificate of incorpora- power to enter into a particular tion and therefore was invalid, the transaction. SARAH PAYNE plaintiff could proceed with a n a recent letter opinion, South- breach of fiduciary duty claim DGCL Section 124 eastern Pennsylvania Transpor- against the corporation’s directors I In particular, Section 124 pro- tation Authority (‘‘SEPTA’’) v. Vol- who allegedly caused the corpora- vides three limited instances in genau,1 the Delaware Chancery tion to violate the certificate of in- which a claimant may assert lack of Court interpreted Section 124 of the corporation. corporate capacity or power: 3 Delaware General Corporation Law Section 124 of the DGCL, which s in a proceeding by a stock- (‘‘DGCL’’), a provision that limits was adopted in 1967 and codified holder against the corporation to the instances in which a claimant existing law,2 provides certain pro- enjoin the doing of any act by the may challenge a corporate action as tections for corporations and their corporation; ultra vires. counterparties against ultra vires s in a proceeding by the corpo- The court found that although claims, or claims asserting that the ration, whether directly or, among Section 124 precluded the plaintiff corporation lacked the capacity or stockholder from claiming that a other things, in a stockholder de- rivative lawsuit, against an officer completed merger violated the cor- 2 1R.FRANKLIN BALOTTI &JESSE A. or director, for damages due to such FINKELSTEIN,DELAWARE LAW OF CORPO- 1 individual’s unauthorized act; C.A. No. 6354-VCN, 2012 BL 225637 RATIONS AND BUSINESS ORGANIZATIONS s (Del. Ch. Aug. 31, 2012). § 2.3 (3d ed. 2011). in a proceeding by the Attor- ney General of the State of Dela- ware to dissolve the corporation, or to enjoin the corporation from the Frank Aquila ([email protected]) is co-head of Sullivan & Crom- transaction of unauthorized busi- well LLP’s global corporate practice. Mr. Aquila has a broad multi- ness. disciplinary practice that includes extensive experience in negotiated The SEPTA case involved the ac- and unsolicited mergers and acquisitions, complex cross-border quisition of SRA International, Inc. transactions, global joint ventures, private equity transactions, and by affiliates of private equity firm corporate governance matters. Providence Equity Partners. SRA Sarah Payne ([email protected]) is a partner in the Sullivan & had two classes of stock, and as part Cromwell LLP Mergers & Acquisitions and Securities Groups, resi- of the merger Volgenau, an alleged dent in the firm’s Palo Alto office. Ms. Payne has a broad-based cor- controlling stockholder, rolled over porate practice advising clients on corporate governance and regula- a portion of his Class B stake in SRA tory compliance issues, as well as on a wide range of transactions, including public and private securities offerings, acquisitions of public 3 Section 124 provides: ‘‘No act of a and private companies, and takeover defenses. corporation . . . shall be invalid by rea- The views expressed in this article are their own and do not necessar- son of the fact that the corporation was ily reflect the views of Sullivan & Cromwell LLP or its clients. The without capacity or power to do such act or to make or receive such conveyance authors wish to thank Zachary Bohlender for his assistance with this or transfer, but such lack of capacity or article. power may be asserted . . .’’ in the three types of proceedings described above.

COPYRIGHT ஽ 2012 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 0886-0475 2 (No. 48) into equity of the surviving company. and the concept of ultra vires apply to conclusion had the plaintiff’s com- The Class A stockholders were corporate actions that are outside of plaint not used the term ‘‘invalid.’’ 7 cashed out in the merger. The SRA the corporation’s inherent corporate certificate of incorporation provided purpose and power, rather than ac- Breach of Fiduciary Duty? that the holders of the two classes of tions that can occur, provided that stock would be entitled to equal per the proper approvals are obtained or Addressing the plaintiff’s breach share payments in any merger. the proper procedures are followed. of fiduciary duty claim, the court con- The plaintiff brought a variety of cluded that Section 124 would not In its decision, the court wrote that preclude claims against those who claims in connection with the merger. ‘‘[Section 124] provides that certain At the time of the court’s decision, caused the ultra vires act. The court acts may not be set aside because in particular noted that although the the merger had been completed and 4 they are ultra vires.’’ The court stockholders may not assert that SRA accordingly, the plaintiff’s claims for found that the contractual breach injunctive relief to prevent closing of lacked capacity to undertake the claim was only a claim to set aside merger, stockholders may bring a di- the merger had been abandoned. the transaction and therefore was Two of the plaintiff’s claims were at rect claim against directors for precluded by Section 124, as direct breach of fiduciary duty for causing issue in the court’s decision on a mo- claims by stockholders attacking the tion for judgment on the pleadings the corporation to breach the charter. validity of a transaction may only be The court acknowledged that there is under Rule 12(c). brought for injunctive relief. The First, the plaintiff alleged that Vol- a fine line between ‘‘a corporation’s court interpreted the language in the invalid acts and the conduct of direc- genau’s receipt of different consider- complaint attacking the validity of ation constituted a breach of the cor- tors in causing the corporation to un- the merger as a demand ‘‘to make the dertake those acts.’’ 8 poration’s certificate of incorpora- action void’’ and ‘‘a claim that the act tion, rendering the merger invalid. could not occur.’’ 5 The court also acknowledged the Second, the complaint alleged that by potential for success of the breach of approving the invalid merger, the de- The court noted that its decision fiduciary duty claim, noting that a fendant directors breached their fidu- would not preclude all direct claims breach of the corporation’s charter ciary duties. by stockholders for breach of the cer- seems analogous to a claim that a di- tificate of incorporation, citing Blue rector caused the corporation to com- Invalid Under the Charter? Chip Capital Fund II Limited Partner- mit an illegal act, ‘‘which is typically ship v. Tubergen,6 which permitted a The defendants argued that under viewed as a breach of the duty of stockholder breach of contract claim 9 Section 124, claims that the merger loyalty.’’ for alleged violations of the certificate was invalid under the corporation’s On the other hand, the court ac- of incorporation. charter as well as claims that in ap- knowledged that its decision is un- proving an invalid merger, the direc- It is not clear, however, whether likely to reach beyond the sale con- tors breached their fiduciary duties the court intends that all such breach text, because in most instances where are ultra vires claims and cannot of charter claims are inherently ultra a stockholder is challenging the di- form the basis for a non-injunctive di- vires claims that must either fit within rectors’ actions vis-a-vis ongoing op- rect claim against any of the defen- Section 124 or be brought as breach erations of the business, the claim is dants. The court appeared to inter- of fiduciary duty claims (as discussed likely to be a derivative, rather than pret the defendants’ arguments to the below) or alternatively, whether the direct, claim. effect that because both of the plain- court would have reached a different tiff’s claims asserted lack of corpo- 7 The language in the complaint simply rate power and capacity, they were 4 Volgenau, 2012 BL 225637, at *3. provided ‘‘[t]hat [the merger contemplat- limited by Section 124. 5 The opinion states that ‘‘[a] challenge ing an unequal merger consideration On the other hand, the plaintiff ap- to the validity of an action or to the corpo- allocation] renders the Merger invalid un- peared to argue that the contractual ration’s capacity to undertake that action der the Company’s Certificate of Incorpo- and fiduciary duty breaches, not lack seeks to make the action void. It is a claim ration.’’ Volgenau, 2012 BL 225637, at *1. that the act could not occur. That is what The court implied that the plaintiff was of corporate capacity issues, ren- [Section 124] speaks to: it says that the trying to expand the language and mean- dered the merger voidable and in- corporate actions will not be set aside and ing of this aspect of its complaint in its valid and therefore, Section 124 did that capacity can only be challenged in briefing papers. not apply to limit the claims. The three instances.’’ Id. 8 Volgenau, 2012 BL 225637, at *3 n.13. plaintiffs also argued that Section 124 6 906 A.2d 827, 834 (Del. Ch. 2006). 9 Id. at *3 n.16.

12-12-12 COPYRIGHT ஽ 2012 BY THE BUREAU OF NATIONAL AFFAIRS, INC. CCW ISSN 0886-0475