How to Assess and Correct Defective Corporate Acts

In April 2014, Delaware became the first state to enact amendments to address issues related to “defective” corporate actions that initially weren’t properly approved. Since then, the number of Certificate of Validation filings has increased to over 740, and several states have followed Delaware’s lead and amended their corporate statutes to include provisions to cure defective corporate acts.

In “Ratifying Defective Corporate Acts in Delaware: Part 1 & Part 2”, we provided an overview of Delaware’s defective act statutes. Now we’ve put together a checklist of items to consider and steps you can take if you identify that your corporation has been deficient in required corporate actions:

1. Determine if there was a defective corporate act.
   1. Per 8 Del. C. § 204(h)(1), a “defective corporate act" means “an overissue, an election or appointment of directors that is void or voidable due to a failure of authorization, or any act or transaction purportedly taken by or on behalf of the corporation that is, and at the time such act or transaction was purportedly taken would have been, within the power of a corporation … but is void or voidable due to a failure of authorization”. For example, not properly electing directors or officers at a meeting of stockholders and/or directors, or not properly approving an increase in authorized shares to cover shares issued to stockholder.
2. Determine if the domestic jurisdiction of the corporation has enacted statutes to allow for validation of such defective corporate acts.
   1. Connecticut, Delaware, Kansas, Nevada, Oklahoma, Texas and Washington have amended their corporate statutes to include defective act provisions.
   2. Amendments addressing defective corporate acts are pending in North Carolina.
3. If yes, identify the requirements to “validate” such defective acts which may include:
   1. Ratification by the stockholders and Board of Directors.
      1. All states that have amended their statues allow ratification by written consent.
   2. Sending a notice to stockholders if the ratification of the defective act doesn’t require stockholder approval.
   3. Submission of a Certificate of Validation, or its equivalent, for review by the Secretary of State’s “Validation Filing Team”.
      1. Note that the Secretary of State will conduct a thorough review and may request additional information.
      2. Based on the facts presented, the timing of the review by each state will vary. Your registered agent can assist you in identifying the timing and fees that will be charged, including any past franchise taxes that may be due because of shares that may not have been properly authorized.
      3. The review will include assessing if the defective act is merely a “failure of authorization” or if there was a “rejection by stockholders” or other parties authorized to vote on the matter.
      4. If the latter, based on the decision in Nguyen v. View, Inc., C.A. No. 11138-VCS (Del. Ch. June 6, 2017), by the Delaware Court of Chancery, the attempt to ratify the corporate act that was expressly rejected by the stockholders will be denied.
   4. Filing of a Certificate of Validation, or its equivalent, with the Secretary of State, in the domestic state of the corporation to update the public record..
      
      1. Typically, the effectiveness, once the actions taken to “cure” the defects are taken, is deemed to be valid as of the time that the corporate action was taken, including “fixing” the overissuance of shares.
      2. It’s important to note that in all states that permit the ratification of defective acts and require the filing of a Certificate of Validation that this certificate will become part of the corporation’s charter document on the public record.

So, whether you’re a startup that wasn’t aware of some of the statutory corporate governance requirements, or if your company has been transacting business for a while and you’re just discovering that some of the basic administrative actions weren’t taken, don’t worry! There’s an increasing number of states following Delaware’s lead in providing statutory remedies to correct what amount to be administrative errors. We’ll continue to monitor this provision in corporate statutes and will provide periodic updates.

This article is provided for informational purposes only and should not be considered, or relied upon, as legal advice.