Kurz v. Holbrook: Shareholder Voting, Omnibus Proxies, and the Role of DTC: The Authority of the Board to Remove Directors

We are discussing Kurz v. Holbrook, 2010 Del. Ch. LEXIS 24 (Del. Ch. Feb. 9, 2010).

One of the reasons given for striking down the bylaw that reduced the size of the board was that it amounted to a removal of incumbent directors.  Because directors had the same bylaw authority as shareholders, it potentially allowed directors to remove other directors by shrinking the size of the board.  This in turn conflicted with the proposition that directors cannot remove other directors.  As the court noted:

• If a bylaw amendment reducing the size of a board could eliminate sitting directors, then directors suddenly would have the power to remove other directors. For 89 years, Delaware law has barred directors from removing other directors. Bruch v. Nat’l Guar. Credit. Corp., 116 A. 738, 741 (Del. Ch. 1922); accord Robert Pennington, Pennington on Delaware Corporations 117 (1925) (“A director being an officer chosen by the stockholders cannot be removed by his fellow directors.”). In 1974, when the stockholders’ power to remove directors was confirmed and addressed through the adoption of Section 141(k), two leading authorities on the DGCL wrote that “by negative implication intended by the draftsmen, directors do not have the authority to remove other directors.” S. Samuel Arsht & Lewis S. Black, The 1974 Amendments To The Delaware Corporation Law 378 (1974). I do not believe the DGCL contemplates a bylaw amendment could overturn this rule.

In general, the prohibition on directors removing directors amounts to black letter law.  To do so would essentially allow directors to undo the will of shareholders.  Yet in fact, matters are not so clear.

First, some states expressly allow it, at least if for cause.  See Mass. Gen. Laws ch. 156B §51(c) ("any director, and any officer elected by the stockholders, may be removed from his office for cause by vote of a majority of the directors then in office.  A director or officer may be removed for cause only after a reasonable notice and opportunity to be heard before the body proposing to remove him.").  Some permit the removal of directors who were appointed by the board.  See Minn. Stat. § 301A.223(2)(permitting removal by directors, with or without cause, where the director was appointed by the board to fill a vacancy, "the shareholders have not elected directors in the interval between the time of the appointment to fill a vacancy and the time of the removal" and removal is approved by a majority of the remaining directors).  See also ND Cent. Code § 10-19.1-41(2)(same language). 

Others allow for the authority if in the articles or a shareholder adopted bylaws.  See NY Bus. Corp. Law § 706 ("The certificate of incorporation or the specific provisions of a by-law adopted by the shareholders may provide for such removal by action of the board, except in the case of any director elected by cumulative voting, or by the holders of the shares of any class or series, or holders of bonds, voting as a class, when so entitled by the provisions of the certificate of incorporation."). 

Second, Delaware has no statutory prohibition on directors removing other directors.  The law in this area traced back to Bruch v. National Guarantee Credit Corp., 13 Del. Ch. 180 (Del. Ch. April 10, 1922).  As the court in that case concluded:

• But I am of the opinion that directors of an industrial corporation, such as is the defendant, cannot be removed by his fellow members. A director is an officer chosen by the stockholders. His title to the office is as good as the title of his fellows. His right to the office is quite different from that of those officers of the corporation who are selected not by stockholders but by the directors themselves. If the power of amotion of a director exists, it is reasonable to hold that it shall be exercised by the power that elected him, viz., by the stockholders. To allow directors to frame charges against one of their fellows and then to try and expel him, would open the door to possibilities of fraud which designing men might use to wrest control of corporate affairs from the stockholders, or their sympathetic representatives on the board, and transfer it to those who might seek to grasp the corporation for their own ends.

This is a surprisingly thin reed to draw conclusions about the right of directors to remove directors.  First it is only a Chancery Court decision.  Second, it is premised on the idea that directors are elected by shareholders.  Yet this is not true for directors elected by the board, suggesting that a different rule might be applicable.  Third, the court did not deal with circumstances involving removal neither by directors nor shareholders.  Thus, if directors were required to leave the board because of disability or the failure to meet board qualifications, the act of removal would be automatic and based upon criteria set forth at the time of election.

Finally, the court left often the possibility that such authority could be inserted into the articles.  As the opinion stated:  "Whether under the law of this state the certificate of incorporation may confer such power on directors is, of course, not a question involved in this case."

The usual rule that directors cannot remove directors is a sound one.  But without a statutory basis, it is not quite as clear as VC Laster suggests.  Moreover, the Delaware courts have shown a tendency to abandon black letter law when it is not in the statute and abandonment suits management.  Examples?  Vote buying and discrimination among shareholders of the same class of shares.

The opinion and a number of primary materials are posted at the DU Corporate Governance web site.