South-Western Legal Studies in Business

Board Packing Plan Violates Shareholders' Rights
Description The Delaware high court held that a board of directors improperly impeded the rights of shareholders when the board voted to expand from five to seven members. Two existing board members were voted out by shareholders who were unhappy with the board's performance.
Topic Business Organization
Key Words Corporations; Board of Directors; Board-Packing; Shareholder Democracy
C A S E   S U M M A R Y
Facts The board of Liquid Audio (LA) voted to expand from five to seven members. That action was taken when it was clear that candidates for the LA board proposed by MM Companies were going to be elected to two of the five existing positions. Existing board members did not want the MM candidates elected. MM challenged the action as a violation of the principles of Delaware corporation law. The Court of Chancery held that the expansion of the board did not violate Delaware law. MM appealed.
Decision

Reversed. When the primary purpose of a board of directors' defensive measure is to interfere with or impede the effective exercise of the shareholder franchise in a contested election for directors, the board must first demonstrate a compelling justification for such action as a condition for any judicial consideration of reasonableness. The purpose of the board expansion here was to impede and interfere with the efforts of the shareholders' power to effectively exercise their voting rights in a contested election for directors. That action compromised the essential role of corporate democracy in maintaining the proper allocation of power between the shareholders and the board.

Citation MM Companies v. Liquid Audio, Inc., --- A.2d --- (2003 WL 58969, Sup. Ct., Del., 2003)

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