Section 204 of the Delaware General Companies Act

Did your corporation sell any shares before you authorized a sufficient number of shares under its certificate of incorporation? The DGCL requires that the authorized capital be increased before the sale is consumed because the Company must create the stock that it is going to sell. Without the creation of the share, there is nothing to sell to investors and failure to increase the authorized capital could consider the sale and issue null or void due to the Company’s failure to comply with technical details. of the DGCL. Before 2014, there was no mechanism to retroactively fix the issue of equity with an insufficient number of authorized capital or any other type of transaction requiring certain technical requirements of the DGCL. These types of mistakes led to potentially embarrassing conversations with a company’s investors, but in 2014 that all changed.

In 2014, article 204 was added to the DGCL to provide companies with a mechanism to retroactively ratify defective corporate acts. The ratification process with respect to issuing shares with an insufficient number of authorized shares will be the focus of this article, but section 204 can be used to ratify many other flawed corporate acts such as l ‘election of directors without the good vote of the shareholders or the authorization of certain operations as defined by the DGCL. The ratification process is not an easy one, but once completed, the error is corrected retroactively.

What must a company do to ratify a faulty corporate act such as issuing shares without a sufficient number of authorized capital under section 204?

In order for a company to ratify an equity issue when there was an insufficient number of authorized shares, the company must first seek approval from the board of directors. The board of directors must clearly identify the defective corporate deed, the date of this deed, approve and confirm the ratification of this defective issue by filing a certificate of validation with the State of Delaware and recommend this ratification to the shareholders of the company.

Once the approval of the board of directors is obtained, the company must seek the approval of its shareholders. In the event that, at the time of consummation of the defective corporate deed, a certain group of shareholders held rights which required their consent, the consent of these shareholders must be obtained even if they no longer have such rights. . For example, if the preferred Series A holders of a corporation were to consent to the amendment of the certificate of incorporation that should have been filed at the time of the defective corporate deed, then this approval must be obtained for the ratification of the deed. defective corporate act in addition to any other consent requirement currently in effect.

Upon receipt of the required consent of the board of directors and shareholders, the company must then file a validation certificate that describes the defective corporate act, confirms the approval of the board of directors and shareholders of the company, included as an exhibit the certificate of incorporation or an amendment to that certificate which provides for the correct number of shares to cover the defective issuance of shares and provides for the date on which the certificate of incorporation or the amendment should be deemed to come into force. The state of Delaware filing fee for the validation certificate is at least $ 2,579, but could be higher depending on the authorized capital of the company. The fees do not include legal fees or any other third party fees, so repairing a faulty business deed does not come cheap. Accepting the validation certificate is also not a quick process as it can take two to four weeks to be accepted by the Delaware Secretary of State and there is no expedited option.

Corporations must also send a notice in paper form (not just by email) to all of their unwilling shareholders, as well as to any former shareholders who held shares as a result of one of the defective corporate acts that have been ratified. The notice must include a statement alerting shareholders that any claim that the share issuances are void or voidable due to failed authorization, or any claim that the Delaware State Court of Chancery should declare at its discretion that ratification will not be effective or be effective only under certain conditions, must be submitted within 120 days of the date of the notice. Once the time limit has elapsed, the Company has completed the process and the defective issue of shares is deemed to be ratified on the date of the sale of the shares.

Article 204 of the DGCL is a useful tool when companies find themselves in a situation that could call into question the validity of their transactions; however, this is a long and expensive process and should only be used when absolutely necessary.