GARY SALAMONE, MIKE DURA, and ROBERT W. HALDER, Defendants Below, Appellants/Cross-Appellees,
JOHN J. GORMAN, IV, Plaintiff Below, Appellee/Cross-Appellant
Submitted: October 8, 2014.
Case Closed December 29, 2014.
[Copyrighted Material Omitted]
Court Below: The Court of Chancery of the State of Delaware. Consol. C. A. No. 8845-VCN.
Michael J. Maimone, Esquire (argued), Gregory E. Stuhlman, Esquire, and E. Chaney Hall, Esquire, Greenberg Traurig, LLP, Wilmington, Delaware, for Appellants/Cross-Appellees.
Stephen B. Brauerman, Esquire (argued), Neil B. Glassman, Esquire, Vanessa R. Tiradentes, Esquire, and Sara E. Bussiere, Esquire, Bayard, P.A., Wilmington, Delaware, for Appellee/Cross-Appellant.
Before STRINE, Chief Justice, HOLLAND, RIDGELY and VALIHURA, Justices, JOHNSTON, Judge,[*] constituting the Court en Banc.
Defendants Below, Appellants/Cross-Appellees Gary Salamone (" Salamone" ), Mike Dura (" Dura" ) and Robert W. Halder (" Halder," and together with Salamone and Dura, the " Management Group" ) appeal from a Court of Chancery Memorandum Opinion dated May 29, 2014, and Order and Final Judgment dated June 24, 2014.
This case involves a dispute between two competing sets of stockholders and directors about the composition of the board of Westech Capital Corporation (" Westech" ), a financial services holding company headquartered in Austin, Texas. Both parties brought actions in the Court of Chancery pursuant to 8 Del. C. § 225 (the " § 225 actions" ), each contending that their respective slates of directors constitute the valid board. The crux of the case for both sides is the interpretation of a Voting Agreement signed by the purchasers of Westech Series A Preferred stock (the " Series A Preferred Stock" ) in September 2011. According to John J. Gorman, IV (" Gorman" ), the founder of the company and its majority stockholder, the Voting Agreement provides for a per share scheme and entitles him to remove and designate new directors, as he purported to do in 2013.
According to the Management Group, all of whom were employees and directors of Westech at the time of the trial, the Voting Agreement provides for a per capita, not a per share, scheme. Because Gorman's attempt to remove and replace directors was not approved by a majority of the (individual) holders of the preferred stock (as opposed to the holders of a majority of shares), they argue that Gorman's attempts to change the board composition were invalid.
On August 27, 2013, both parties filed § 225 actions in the Court of Chancery. The two cases were consolidated, with Gorman as plaintiff and the Management Group as defendants. The Court of Chancery's Memorandum Opinion, issued on May 29, 2014, held that one clause of the Voting Agreement set forth a per capita scheme to designate directors, but another contested provision set forth a per share scheme to designate directors. Thus, the Court of Chancery determined that Gorman's actions were only partially valid, and that the Westech board consisted of two members of the Gorman slate and two members of the Management slate, with three vacant seats. Both parties appealed to this Court, arguing that the Court of Chancery's decision was partially incorrect.
The Management Group raises three issues on appeal relating to the interpretation of the Voting Agreement. They assert that: (1) the trial court erred in holding that the director candidates are designated under Section 1.2(b) by the vote of a majority of " shares" rather than the individual " holders" of Series A Preferred Stock; (2) the trial court correctly held that the director candidates are designated under Section 1.2(c) by a majority vote of the individual Key Holders, but erred in holding that the directors who are Key Holder Designees may be removed by a majority vote of the Series A Preferred Stock controlled by the Key Holders; and (3) the trial court erred in holding that Section 7.17 did not mandate the aggregation of stock transferred by a Series A Preferred stockholder to " Affiliates" for purposes of the per capita scheme.
In his cross-appeal, Gorman contends that the Court of Chancery erred in holding that the Key Holder Designees are designated on a per capita basis. He further contends that the Court of Chancery erred in holding that a per capita scheme
would not violate Section 212(a) of the Delaware General Corporation Law (" DGCL" ).
We affirm in part and reverse in part.
I. FACTUAL AND PROCEDURAL HISTORY
A. The Company and the Parties
Westech, which was founded in 1994 and became a public company in 2001, is a holding company with one primary operating subsidy, a broker-dealer named Tejas Securities Group, Inc. (" Tejas" ). Gorman was one of seven founding members of Westech, and served as the chairman of Westech's Board from 1999 through August 2013. He was also the majority stockholder of Westech common stock and of the total voting shares at all relevant times. Westech has two classes of stock authorized and outstanding: 4,031,722 shares of common stock, and 338 shares of Series A Preferred Stock. The Series A Preferred Stock votes together with the common stock on an as-converted basis, and each share of Series A Preferred Stock is entitled to cast 25,000 votes. According to the parties' pre-trial stipulation, Gorman owns, directly or indirectly, approximately 2.4 million shares of common stock (or nearly 60% of Westech's common stock outstanding), and approximately 173 shares of Series A Preferred Stock (or 51% of the 338 shares outstanding). Because Westech's Series A Preferred stockholders have 25,000 votes for every one share of Series A Preferred Stock, Gorman holds nearly 54% of Westech's total voting power.
Neither Dura nor Salamone has ever owned Westech stock. Dura, who served as interim Chief Executive Officer (" CEO" ) before Salamone, was elected to the board in late 2012. Salamone became CEO of Westech sometime in early 2013, and has served on the board since that time. Halder has been involved with the company since 2002. He has served as President and acting Chief Operating Officer (" COO" ) of Westech, and interim COO of Tejas. He was also elected to Westech's board in or around 2009. He owns, directly or indirectly, nine shares of Series A Preferred Stock in the company. Halder resigned as a Westech employee in June 2014.
B. The Series A Preferred Stock Transaction
According to the Management Group, Gorman's mismanagement and profligate spending caused Westech to experience severe financial distress from 2005 to 2011, particularly a rapid decline in net capital in 2011. Because of the nature of Westech's business, the crisis could have been fatal: the company was required to maintain minimum capital levels by its counterparties, clearing houses, and its regulator, the Financial Industry Regulatory Authority (" FINRA" ). As a result, the company needed an infusion of capital.
Gorman disputes this account of events. He alleges that Westech raised capital in 2011, not because of financial distress, but instead because of his desire to expand the sales base of the business and to acquire other broker-dealers. Nonetheless, the parties do not dispute that the company issued a new series of Series A Preferred stock and Series A Convertible Notes in the fall of 2011. Four primary groups of investors bought these shares: (1) James J. Pallotta (" Pallotta" ), a friend and long-time client of Gorman's; (2) James B. Fellus (" Fellus" ), who had been a consultant to Westech but became CEO after the transaction, and members of Fellus' family; (3) a group of Westech employees, including Halder; and (4) Gorman himself.
80 (preferred only)
600,000 cash $1M note
64 (preferred and notes)
81 (preferred and notes)
72 (preferred and notes)
C. The Voting Agreement
As part of the Series A Preferred Stock transaction, the parties executed a Voting Agreement on September 23, 2011. The Voting Agreement was signed by Halder, Gorman (including as custodian for other accounts), Pallotta, Fellus, and approximately 25 other investors, most of whom were employees who purchased only one or two shares. There are only a few independent holders of Westech common
stock who are not bound by the Voting Agreement. According to the Voting Agreement itself, its purpose was to ensure that the new investors would be represented on the board: " in connection with [the Series A Preferred Stock Purchase Agreement] the parties desire to provide the Investors with the right, among other rights, to designate the election of certain members of the board of directors of the Company. . . ." 
Before the Series A Preferred Stock issuance, Westech's board consisted of Gorman, Gorman's uncle (Charles Mayer), and Halder. Under Section 1.2 of the Voting Agreement, the Board expanded to seven members with the members to be determined as follows:
1.2 Board Composition. Each Stockholder agrees to vote, or cause to be voted, all Shares owned by such Stockholder, or over which such Stockholder has voting control, from time to time and at all times, in whatever manner as shall be necessary to ensure that at each annual or special meeting of stockholders at which an election of directors is held or pursuant to any written consent of the stockholders, the following persons shall be elected to the Board:
(a) One person designated by Mr. James J. Pallotta (" Pallotta" ) (the " Pallota [ sic ] Designee" ), for so long as Pallotta or his Affiliates continue to own beneficially at least ten percent (10%) of the shares of Series A Preferred Stock issued as of the Initial Closing (as defined in the Purchase Agreement);
(b) One person who is an Independent Director and is designated by the majority of the holders of the Series A Preferred Stock (together with the Pallotta Designee, the " Series A Designees" );
(c) Two persons elected by the Key Holders, who shall initially be John J. Gorman IV and Robert W. Halder (the " Key Holder Designees" );
(d) The Company's Chief Executive Officer, who shall initially be James Benjamin Fellus (the " CEO Director" ), provided that if for any reason the CEO Director shall cease to serve as the Chief Executive Officer of the Company, each of the Stockholders shall promptly vote their respective Shares (i) to remove the former Chief Executive Officer from the Board if such person has not resigned as a member of the Board and (ii) to elect such person's replacement as Chief Executive Officer of the Company as the new CEO Director; and
(e) Two individuals with applicable industry experience not otherwise an Affiliate (defined below) of the Company or of any Investor and who are Independent Directors mutually acceptable to the Series A Designees and the Key Holder Designees of the Board.
To the extent that any of clauses (a) through (e) above shall not be applicable, any member of the Board who would otherwise have been designated in accordance with the terms thereof shall instead be voted upon by all of the stockholders of the Company entitled to vote thereon in accordance with, and pursuant to, the Company's Restated Certificate of Incorporation, including the Series A Preferred Stock Certificate of Designation.
For purposes of this Agreement, an individual, firm, corporation, partnership, association, limited liability company, trust or any other entity (collectively, a " Person" ) shall be deemed an " Affiliate" of another Person who directly or indirectly, controls, is controlled by or is under common control with such Person,
including, without limitation, any spouse or child of such Person, or trust or similar entity which controls, is controlled by or is under common control with such Person or any general partner, managing member, officer or director of such Person or any venture capital fund now or hereafter existing that is controlled by one or more general partners or managing members of, or shares in the same management company with, such Person. For purposes of this Agreement, " Independent Director" has the meaning set forth in Nasdaq Rule 5605(a)(2).
The parties also based their arguments on other provisions of the Voting Agreement, including Section 1.4 which addresses the removal of Board members as follows:
1.4 Removal of Board Members. Each Stockholder also agrees to vote, or cause to be voted, all Shares owned by such Stockholder, or over which such Stockholder has voting control, from time to time and at all times, in whatever manner as shall be necessary to ensure that:
(a) no director elected pursuant to Sections 1.2 or 1.3 of this Agreement may be removed from office unless (i) such removal is directed or approved by the affirmative vote of the Person, or of the holders of more than fifty percent (50%) of the then outstanding Shares entitled under Section 1.2 to designate that director or (ii) the Person(s) originally entitled to designate or approve such director or occupy such Board seat pursuant to Section 1.2 is no longer entitled to designate or approve such director or occupy such Board seat;
(b) any vacancies created by the resignation, removal or death of a director elected pursuant to Sections 1.2 or 1.3 shall be filled pursuant to the provisions of this Section 1; and
(c) upon the request of any party entitled to designate a director as provided in Section 1.2(a), 1.2(b) or 1.2(c) to remove such director, such director shall be removed.
If permitted by applicable law, the Board shall execute any written consents required to remove a director or to fill a vacancy created by resignation, removal or death pursuant this Agreement, and, if required by applicable law, all Stockholders agree to execute any written consents required to remove a director or to fill a vacancy created by resignation, removal or death pursuant this Agreement, and the Company agrees at the request of any party entitled to designate directors to call a special meeting of stockholders for the purpose of electing directors if such a special meeting of stockholders is required by applicable law.
The meaning and importance of Section 7.17 was also disputed during the trial. That provision provides:
7.17 Aggregation of Stock. All Shares held or acquired by an Investor and/or its Affiliates shall be aggregated together for the purpose of determining the availability of any rights under this Agreement, and such Affiliated persons may apportion such rights as among themselves in any manner they deem appropriate.
The parties presented sharply different versions of the negotiating history that led
to the Voting Agreement. Gorman claimed that the new board structure was meant to appease his friend, Pallotta, by providing him with a designated board seat and to ensure that together, they would " own a majority of the fully diluted shares."  By contrast, the Management Group contended that the Voting Agreement was intended to limit Gorman's control over the board by bringing in other constituents, namely: Westech employees, represented by Halder; management, represented by the CEO; and the other major investor, Pallotta. Before the Series A Preferred Stock issuance, Gorman owned the majority of common shares, and by all accounts dominated Westech's board. Various members of the Management Group testified that the purpose of the Agreement was to replace Gorman's one-man rule with a " triumvirate" of Halder, Fellus, and Gorman, which would reportedly encourage compromise.
D. Gorman's Attempt to Regain Board Control
By 2013, when the events leading to this case occurred, Salamone had replaced Fellus as the CEO, and therefore as the designated CEO Board member. Pallotta eventually designated his employee, Anthony Peter Monaco, Jr. (" Monaco" ), to fill the Pallotta Designee seat under Section 1.2(a) of the Voting Agreement. Pallotta did not designate Monaco, who had negotiated the Voting Agreement with Westech on Pallotta's behalf, until March 2012, five months after the Series A Preferred Stock offering closed. According to Monaco's deposition testimony, the delay was caused by Pallotta's fear of over-committing Monaco, and Pallotta's apparent belief that he did not need immediate representation on Westech's board because he trusted Westech's management. Only after Pallotta's attorney resigned and " there was no one to advise him against it" did Pallotta designate his preferred director. As specified in Section 1.2(c) of the Voting Agreement, Gorman and Halder held the two Key Holder director seats. Finally, Dura held a Board seat as one of the independent directors referenced in Section 1.2(e). The remaining two seats ( i.e., the other Series A designee under Section 1.2(b) and the other Independent Director under Section 1.2(e)) were vacant.
Gorman resigned from the board effective August 7, 2013. Both sides engaged in finger-pointing. The Management Group asserted at trial that Gorman was unhappy as he could no longer use Westech as his " personal piggy-bank."  Gorman testified that he left because he disagreed with Halder and Salamone's leadership. One week after resigning, Gorman sent a letter to Westech attempting to remove Halder from the Board and elect Greg Woodby in his place. The letter stated that Gorman was acting as the
holder of more than fifty percent of the issued and outstanding Westech voting stock held by the Key Holders. He also purported to elect Barry Williamson to fill the Key Holder seat vacancy. Gorman's letter cited Sections 1.2 and 1.4 of the Voting Agreement as his authority to elect or remove Key Holder Designees as the majority stockholder.
On August 21, 2013, Gorman entered into a Stock Purchase Agreement with Pallotta in which Gorman obtained control over Pallotta's 80 shares of Series A Preferred stock. Pallotta's designee, Monaco, later resigned from the Board. While the sale was pending, Pallotta issued to Gorman a proxy to vote his shares. At the same time, Gorman attempted to elect himself to the Board as the Pallotta Designee, and to designate Barry A. Sanditen to the other Series A Designee seat, by written consents signed by Gorman and four other stockholders.
Two days later, the purported new directors (Gorman, Sanditen, Woodby, and Williamson) attempted to call a board meeting for August 26, 2013. Dura and Salamone, the remaining undisputed directors, were given notice of the meeting, but did not attend. At that meeting, the purported Board voted to remove Dura and elect Daniel Olsen and T.J. Ford to serve as the Section 1.2(e) independent directors.
Westech's Annual Meeting took place as scheduled on September 17, 2013. The two competing sets of directors presented different slates for election by the stockholders:
(a) Pallotta designee
(b) Other Series A designee
(c) Key Holder designee (1)
(c) Key Holder designee (2)
(d) Westech CEO
(e) Independent director (1)
(e) Independent director (2)
Gorman's slate garnered the majority of votes with 5,969,288 votes cast in favor of the Gorman slate and 3,375,000 votes cast in ...