Mistakes Were Made: Corporate Cleanups Under DGCL § 204

Founders and entrepreneurs wear many hats in a startup, one of which is Chief Paperwork Officer. Although that is a glorious position, in the fast-paced environment of a startup, attention to proper corporate governance and legal paperwork can understandably lag behind the demands of building the business.

Luckily, in 2014, Delaware enacted Section 204 of the General Corporation Law (8 Del. C. § 204) to help corporations (big and small, public and private) fix prior defective corporate acts. Prior to 2014, Delaware law provided no clear mechanism for corporations to remedy defective corporate acts – actions that, while within the corporation’s power, were void or voidable due to a failure to comply with DGCL, the certificate of incorporation, bylaws, or other governing documents. Delaware courts strictly enforce these requirements, and technical missteps could render actions irreparably void. Section 204 is critical for early-stage and growth companies, which frequently discover technical defects in their corporate records during due diligence for financings or acquisitions.

Section 204 is essentially a playbook for a company's board of directors and stockholders, showing them how to fix prior defective corporate acts that would otherwise be void or voidable under Delaware law. For example, if a CEO issues shares to a new employee without proper approval from the board of directors, the board of directors can retroactively ratify that issuance. In addition, Section 204 can ratify the appointment of a director who was not properly appointed and can ratify the proper actions that the unauthorized director made.
However, Section 204 cannot be used to change history. If the CEO had not originally issued shares, the board of directors cannot go back in time and issue the shares to that employee at a prior date. In addition, Section 204 cannot be used to ratify a corporate act that was rejected by a previous iteration of the board of directors or stockholders.

Simply put, to invoke Section 204 to cleanse the past, the company must ensure the following actions are properly completed.

1. The current board of directors will need to approve and adopt resolutions that clearly identify the defective corporate act(s), specify the date(s) of the act(s), describe the nature of the failure of authorization, and state that the board approves the ratification. The quorum and voting requirements for these resolutions are those that would have applied to the original act, unless a higher threshold was required at the time.
2. If the defective corporate act required stockholder approval at the time it was taken or at the time of ratification, the company's current stockholders must approve the ratification. The applicable quorum and voting requirements are those that would have applied to the original act, unless a higher standard was required at the time.
3. The company must provide notice of the ratification to all current stockholders and former stockholders (unless their identities or addresses cannot be determined from the records), who were holders of valid stock or putative stock at the time of such act. The notice must include a copy of the board resolutions or the required information, and must inform recipients that any challenge to the ratification must be brought in the Delaware Court of Chancery within 120 days of the “validation effective time” or the date notice is given, whichever is later.
4. If the defective act required a filing with the State of Delaware, then the company will need to file a certificate of validation. Notably, this filing cannot be expedited, and the process of preparing and filing the certificate, as well as providing the required notices, can be time-consuming and costly.

Cleaning up defective corporate acts is often triggered by the due diligence process in a financing or acquisition, but waiting until such a critical juncture can result in costly delays and increased expenses. For example, the filing fee (which does not include lawyers' fees) for the certificate of validation is approximately $2,500. The process of identifying all affected parties, providing proper notice, and resolving any disputes can take weeks or months. Therefore, it is prudent for companies to address defects as soon as they are discovered, rather than waiting for a transaction to force the issue.

It is best not to wait for a financing or acquisition to clean up the past; when you have identified a defect, clean it up right away. Section 204 is one of the many tools that we can use to help companies move past missteps by the Chief Paperwork Officer and move ahead to the next milestone.