In its seminal decision in Blasius Industries, Inc. v. Atlas Corp., the Delaware Court of Chancery characterized the stockholder franchise as the "ideological underpinning upon which the legitimacy of directorial power rests" (564 A.2d 651, 659 (Del. Ch. 1988)). Based on this principle, the Blasius court held that if the board acts with the primary purpose of interfering with the stockholders' fundamental right to elect directors, the board must show it had a compelling justification for doing so.

But while Delaware law emphasizes the protection of stockholder voting rights, the stockholder franchise coincides with the fundamental principle of Delaware corporate law, enshrined in Section 141(a) of the DGCL, that the directors of the corporation, not the stockholders, manage the business and affairs of the corporation. The principle of director primacy takes precedence even when the stockholders vote directly on a given issue, if that issue concerns the management of the business.

The coexistence of director primacy with the protection of the stockholder franchise is illustrated in two recent decisions of the Delaware Court of Chancery.

The case of Gorman v. Salamone involves an ongoing dispute between two stockholder factions ( (Del. Ch. Jul. 31, 2015)). The plaintiff, John Gorman, is Westech Capital Corp.'s majority stockholder and a board member. On July 7, 2014, Gorman acted by stockholder written consent to amend Westech's by-laws to allow stockholders to remove and replace corporate officers. Having approved the by-law, Gorman immediately sought to implement it by removing defendant Gary Salamone as CEO and appointing himself to that role.

The Delaware Court of Chancery held that the by-law, though passed by a majority of the stockholder votes, was invalid and of no effect. The court reasoned that the by-law would have interfered with the directors' ability to manage the corporation by preventing them from discharging one of their most important functions: appointing officers.

As the court explained, Section 141(a) establishes that the business and affairs of every Delaware corporation are managed by or under the direction of the board (unless the corporation provides otherwise in its certificate of incorporation). The court has previously held that although the stockholders have a general right to amend the by-laws, that right is "limited by the board's management prerogatives under Section 141(a)" (CA, Inc. v. AFSCME Emps. Pension Plan, 953 A.2d 227, 232 (Del. 2008)).

At issue in Gorman was whether the removal of an individual from corporate office constitutes the kind of business decision that is reserved to the board under Section 141(a). The court's "reflexive answer" was that it does. As the court put it, it is "difficult to conceive" how a board can establish a long-term corporate strategy without having the power to control who serves as the CEO of the corporation.

Gorman attempted to find statutory support for a stockholder right to appoint officers in Section 142(b) of the DGCL. Section 142(b) states that officers are to be chosen in the manner prescribed in the by-laws. Gorman argued that if stockholders can amend the by-laws, then by implication they can choose the officers under Section 142(b). However, the court rejected this reading of Section 142(b) out of hand, explaining that the statute only allows the by-laws to establish a method for selecting officers, but does not speak to how officers can be removed. (Later in the decision, the court footnoted that the analysis leaves open the question of whether a by-law can grant stockholders the right to appoint officers to vacant positions.)

Like Gorman v. Salamone, the facts of Kerbawy v. McDonnell involve a dispute between two sets of stockholders ( (Del. Ch. Aug. 18, 2015)). However, in Kerbawy, the majority of shares were voted in favor of a new board of directors. This implicates the stockholder franchise that is protected under Delaware law.

The plaintiff, Kyle Kerbawy, is a 5% stockholder in ACell, Inc., a privately held corporation with about 150 stockholders. An investigation by the DOJ of ACell caused a fissure among ACell's directors and largest stockholders. James DeFranseco, a director and the company's former CEO and controller of about 24 percent of the company's stock, was dismissed as CEO by the board in October 2014. He and the company's former COO, Rodney Bosley, a 3% stockholder, aligned with Kerbawy, who orchestrated a consent solicitation to replace the company's board of directors. The solicitation was ultimately successful, with Kerbawy securing written consents representing roughly 53.3% of the issued and outstanding voting shares of ACell in favor of Kerbawy's slate of new directors. Kerbawy brought an action under Section 225 of the DGCL for the Court of Chancery to declare that six of the company's seven incumbent directors had been removed and replaced by Kerbawy's slate of five directors, one of whom was DeFranseco.

The incumbent directors did not dispute the validity of the consents on any technical grounds, which made them presumptively valid. The directors instead argued that the consents should be set aside on equitable grounds, contending that they had been procured by Kerbawy's inappropriate use of company confidential information provided to him by DeFranseco and by his allegedly misleading disclosures. In particular, the directors claimed that DeFranseco and Bosley's involvement in Kerbawy's process and Kerbawy's plans to involve them in the company's future strategic planning were material facts that should have been disclosed to the stockholders, and that the failure to disclose those facts rendered the stockholders' consent uninformed.

Consents cannot be procured through fraud or misrepresentation, but it is the stockholders who have been misled who have standing to bring a claim to set aside the consents on those grounds. For the directors to set aside the consents, however, they must establish that the misstatements were tantamount to a breach of fiduciary duty and that that breach "inequitably tainted the election process" (Portnoy v. Cryo-Cell Int'l, Inc., 940 A.2d 43, 72 (Del. Ch. 2008)). In search for such a fiduciary duty, the incumbent directors offered two arguments:

The court rejected both theories. Kerbawy was not a director of the company and therefore did not owe the stockholders a duty of disclosure—a duty that itself is derived from the traditional duties of care and loyalty (Pfeffer v. Redstone, 965 A.2d 676, 684 (Del. 2009)). In addition, the incumbent directors did not argue that Kerbawy was a controlling stockholder or a member of a control group. Kerbawy therefore did not owe fiduciary duties by any conventional means, and the court refused to conjure a new duty of disclosure to apply against him.

The court agreed that DeFranseco would have owed a duty of disclosure had he made disclosures directly to the stockholders, but stated that it was reluctant to hold that that duty should be imputed to Kerbawy. The court did not discuss the imputation theory at length, however, instead relying on its subsequent findings that the missing disclosures were not material enough to significantly alter the total mix of information made available to the stockholders. In so holding, the court distinguished its ruling in Flaa v. Montano, a case in which the court held invalid a stockholder consent to remove a director because of the failure to disclose the terms of a vote-buying agreement ( (Del. Ch. May 29, 2014)).

As the court explained, Flaa involved an agreement to appoint a director that was unknown to the stockholders and found material and inequitable. That lack of disclosure rose to the level of inequitably tainting the process under Portnoy. In this case, by contrast, the failure to disclose the full extent of DeFranseco and Bosely's roles did not meet that "heavy burden." The court added that the incumbent directors' own disclosures had been equally, if not more, misleading, which weighed on the balance of equities in a ruling on equitable grounds.

Under Gorman v. Salamone, Delaware law is clear that stockholders cannot remove officers of the company, even by way of amending the by-laws to give them that right. In the context of removing and replacing directors, however, Delaware courts are inclined to defer to stockholder wishes as expressed through the stockholder franchise, as long as the vote was informed. The question of whether the disclosures to the stockholders were inadequate or misleading is a factual matter, but the duty of disclosure can only be ascribed to directors and controlling stockholders. Minority stockholders do not automatically owe a fiduciary duty of disclosure by virtue of the solicitation of written consents.