One of the fundamental issues that companies preparing for an IPO must consider is the type of corporate governance mechanisms to put in place after their IPO. Under Delaware law, public companies can have a classified board, with directors elected in a series of classes over several years. Classified boards make it harder for a hostile acquirer or activist investor to wage a proxy contest and remove the entire board in one fell swoop. In response to pushback from proxy advisor firms, such as Glass-Lewis and ISS, as well as shareholder rights activists, many pre-IPO companies are going public, or considering going public, without a classified board.
Under Delaware law, an important ancillary benefit of a classified board is that directors can only be removed by the shareholders for cause. To address this point, close to 200 public companies with non-classified boards have implemented charter or by-law provisions that prohibit shareholders from removing directors without cause. In the recent Vaalco Energy case, Chancellor Laster held that such provisions are invalid under Delaware law and cited DCGL §141(k) which states the default rule that shareholders may remove directors of non-classified boards with or without cause.
In light of this ruling, pre-IPO companies that are considering a non-classified board structure should realize that they can no longer limit removal of directors to cause in their charter or by-law provisions. One compromise approach is to simply have a less classified board. Most companies implement a classified board that is divided into three classes that are elected over three years. However, Delaware law does not require that there specifically be three classes. Accordingly, companies can implement a board with only two classes and give shareholders the ability to effect change over a shorter time frame, while still maintaining the benefits of limiting removal of directors to cause.
Mark T. BettencourtPartnerManaging Partner, Goodwin
John J. Egan IIIPartnerCo-Chair, Technology
Joseph C. Theis Jr.Partner