Action by Written Consent Challenged by Court

Lawyers often say that bad facts make bad law. Until the recent passage of the corporate statute for Massachusetts under Chapter 156D, corporate lawyers in Massachusetts would often shy away from incorporating in Massachusetts because of the various statutory limitations and the lack of case law to help interpret corporate conduct. One key issue, one seemingly resolved in the new 156D, was the requirement in the old law that all stockholders must sign a written consent. With clients and investors spread around the world, and often traveling, this requirement delayed many a closing and created other issues. The new statute provides an opt-in procedure for a charter provision to permit the majority to act by written consent in lieu of a meeting. While most practitioners still see this format as being inferior to that in Delaware - where this is the default from which you need to opt out – it is still a major improvement.

A recent decision by a Massachusetts Superior Court involving a renewable energy start-up called Current to Current Corporation (C2C) places this provision in doubt and creates ambiguity around the process of removing directors by written consent.

In Peak Ventures, Inc. v. Manfred Kuehnle et al, Mass. Sup. CV 07-3772 (Gants, J., Aug. 24, 2007), the controlling stockholder group (including the company’s founder, CEO and chairman) sought to remove independent directors from the Board after they accused the CEO, Mr. Kuehnle, of self-dealing and sought to remove him from the Board. The complaint alleges that he failed to disclose the company’s grave financial position to the Board and excluded them from the fundraising process, driving the company into insolvency and into deep debts. The plaintiffs (the other board members who were also minority investors and option holders) upon learning of the alleged wrongdoing, noticed a meeting to remove the CEO from office and to take other emergency action. The CEO asked to delay the meeting, while taking action by written consent to amend the bylaws to give the stockholders additional control over key corporate decisions and to remove the independent directors from the Board and appoint two new directors that plaintiffs claimed to be “loyal” to the CEO. The bylaws for the company followed the 156D statutory language to allow actions by less than unanimous written consent and expressly provided that a “[c]onsent signed under this Section has the effect of a vote at a meeting.”

With the action to take effect on seven days from the notice, the plaintiffs sought a TRO to prevent the effect of the consent action to restructure the Board. The Court agreed with them in part, ruling that removal of directors without a meeting is a special circumstance that requires a live stockholder meeting. Say what? The order does not cite any case law in support of this decision, nor is there any in the plaintiffs motion for TRO. The court held that the specific requirement for a meeting before a director is removed “overrides the more general authorization in 156D, s 7.04 for shareholder actions to be conducted without a meeting." The court reasoned that “this exception reflects the Legislature’s recognition that, when a director is to be removed, the reasons for such removal should be aired at a meeting, which may not occur if the majority of shareholders are permitted to act without such a meeting through a Consent.”

This decision is troubling for many reasons. Getting entrepreneurs to think about corporate governance issues and to bring on independent directors at an early stage is difficult enough. Decisions like Peak Ventures are only likely to scare founders away from bringing others into their decision-making process, leaving young companies without an experienced sounding board for their decisions. Considering that many venture investors will seek board representation and will ask to add industry experts as independents to the board, founding stockholders would be well-advised to increase the board size to still retain majority of the board. Here the board consisted of 5 directors; now it would seem that 7 or 9 may be the right number – making meetings harder to schedule and conduct.

For practitioners, this decision poses an interesting opinion issue. Since most startups don’t hold formal shareholder meetings and make most, if not all, decisions by written consent, the election of directors on which one relies for providing a corporate authorization representation and opinion could now be placed in doubt. In light of this decision, diligencing for opinion may now include a closer examination of written consents vs. meeting minutes.

When is consent unreasonably withheld?

Consent provisions in contracts and leases become hot issues in the context of an acquisition. Landlords and licensors don't always have to play nice and a badly drafted consent provision in a key contract could kill an entire deal.

In negotiating these provisions, lawyers often try to soften the impact by requiring that the consenting party (such as a landlord, bank, licensor, etc.) does not "unreasonably withhold consent". What does this clause really mean?

A couple of recent decisions help interpret what protection this clause may actually provide to the party seeking consent in the future. They also provide guidance as to the type of information that a consenting party may reasonably request in order to evaluate whether or not to grant its consent.

A recent Massachusetts Supreme Judicial Court decision, Chapman v. Katz, 448 Mass. 519, 862 N.E.2d 735 (Mass. Mar 16, 2007) restates the law in Massachusetts on when it is reasonable to withhold consent in the context of a commercial lease.

• In a commercial context, only factors which relate to a landlord's interest in preserving the property or in having the terms of the prime lease performed should be considered. Among the factors properly considered are the financial responsibility of the subtenant, the legality and suitability of the proposed use, and the nature of the occupancy. A landlord's personal taste and convenience, on the other hand, are not factors properly considered. . . .
• [I]t is unreasonable for a landlord to withhold consent to a sublease solely to extract an economic concession or to improve its economic position.

Another decision comes out of California from the auto franchise context . Fladeboe v. American Isuzu Motors Inc., 2007 WL 1191135 (Cal.App. 4 Dist. Apr 23, 2007). Here the court provided as follows:

• [W]ithholding consent to assignment of an automobile franchise is reasonable under California Vehicle Code section 11713.3(e) if it is supported by substantial evidence showing that the proposed assignee is materially deficient with respect to one or more appropriate, performance-related criteria. This test is more exacting than whether the manufacturer subjectively made the decision in good faith after considering appropriate criteria. It is an objective test that requires that the decision be supported by evidence. The test is less exacting than one which requires that the manufacturer demonstrate by a preponderance of the evidence that the proposed assignee is deficient.
• The relevant criteria include, without limitation: (1) whether the proposed dealer has adequate working capital; (2) the extent of prior experience of the proposed dealer; (3) whether the proposed dealer has been profitable in the past; (4) the location of the proposed dealer; (5) the prior sales performance of the proposed dealer; (6) the business acumen of the proposed dealer; (7) the suitability of combining the franchise in question with other franchises at the same location; (8) whether the proposed dealer provides the manufacturer sufficient information regarding its qualifications; and (9) the dealer's honesty and good faith in relations with the manufacturer.
• The initial burden of explaining the basis for the decision is on the manufacturer, but the ultimate burden of persuasion is on the assigning dealer to demonstrate that the manufacturer's refusal to consent is unreasonable.”