July 02, 2008
Classified Boards in Transition
Posted by Gordon Smith

Steve Davidoff and Matt Bodie are blogging about a nasty issue of statutory interpretation emanating from the takeover dispute between InBev and Anheuser-Busch. Matt describes the problem:

In most cases, the determination of whether shareholders can remove directors is straightforward: if the board is classified, they need cause; if not classified, there is no need for cause.  The A-B board, however, is in a period of transition.  In 2007, the Board and shareholders amended the A-B charter to declassify the board.  Thus, beginning with the 2007 shareholders meeting, directors would be changed over from classified three-year terms to annual elections.

As of now, eight of the thirteen directors have been changed over from classified to annually elected.  The remaining five will be elected to one-year terms at the 2009 shareholders meeting.  However, as of now they are serving out their last classified term of three years.  So -- are they still classified or not?

Obviously, this situation is unlikely to arise often, and both Steve and Matt contend that the Delaware statute does not address this situation expressly. Let's think about this ...

Consider first Section 141(k): "Any director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors, except ... in the case of a corporation whose board is classified as provided in subsection (d) of this section."

Note that the board is classified, not the directors.

But then look at Section 141(d):

The directors of any corporation organized under this chapter may, by the certificate of incorporation or by an initial bylaw, or by a bylaw adopted by a vote of the stockholders, be divided into 1, 2 or 3 classes; the term of office of those of the first class to expire at the first annual meeting held after such classification becomes effective; of the second class 1 year thereafter; of the third class 2 years thereafter; and at each annual election held after such classification becomes effective, directors shall be chosen for a full term, as the case may be, to succeed those whose terms expire.

Hmm. Can we reconcile these provisions? Beyond the problem of whether the board or the directors are classified, by a literal reading, these sections are nonsensical: if the board of directors is "divided" into "1 class," as allowed by Section 141(d), then the directors on that board would not be removeable, except for cause pursuant to Section 141(k). Of course, most boards of directors have only one class, and every board must have "1, 2 or 3 classes," so did the drafters of this statute intend to prohibit removal except for cause in all circumstances? Nonsense!

The only reasonable reading of the statute would hold that a "classified board" is one with at least two and no more than three classes. Using this as a starting point, A-B could argue that it's current board has two classes: directors to be elected in 2008 and directors to be elected in 2009. That's a pretty straightforward argument that all of the directors are subject to removal only for cause. But would it work? I think there is a strong argument that it would not. Two points ...

First, both Steve and Matt, apparently taking their cues from A-B, imagine an argument in which five of the A-B directors are "classified" while the remaining eight directors "have been changed over from classified to annually elected." I do not see how this is possible under the terms of the Delaware statute. Whether you are talking about a "classified board" or "classified directors," it seems clear that all of the directors have to be involved in the classification scheme. In other words, a company cannot have a mix of classified and unclassified directors.

Second, as suggested above, in this case, A-B could argue for two classes that would become one at the end of 2009. This would take care of the problem in the foregoing paragraph, but it seems to me that Section 141(d) would foreclose such an argument because the argument rests on the premise that one set of directors could be elected for multi-year terms while another set would be elected annually. Section 141(d) plainly contemplates terms of equal length for each class of directors. Thus, the A-B transition scheme seems to violate the terms of the statute.


UPDATE: The implication of my analysis is that a declassification of the board of directors would permit the immediate removal of all directors with or without cause prior to the expiration of the full terms to which directors were elected. This is why John Coates wrote in 2001: "To be effective, a staggered board must be specified in the charter, or, if in the bylaws, the shareholders must not be able to amend by the bylaws without a supermajority vote." John C. Coates IV, Explaining Variation in Takeover Defenses: Blame the Lawyers,  89 Cal. L. Rev. 1301, 1411 (2001).

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