Duly and Validly Issued, Fully Paid and Nonassessable: Importance of Statutory Formalities for ...

From the outset of a new company’s existence, the founders should be aware of all statutory requirements for issuing stock and should follow all required formalities when doing so.  Without the proper authorizations, stock issued may be deemed void and could have an adverse effect on the company’s control and governance.

The Delaware courts generally will not recognize stock that has not been properly approved and issued pursuant to the applicable statutory or corporate formalities. The case law in Delaware suggests that  while some defects in stock issuances can be cured by later board ratifications, the circumstances are unclear as to when this is acceptable and, more often than not, the Delaware courts find that the defect is incurable and the stock issuance is void.

The holders of a company’s stock appoint the board and have voting authority over certain corporate actions. Accordingly, defective stock issuances may result in invalidation of company actions that were improperly approved by holders of void stock or approved by directors that were appointed by holders of void stock, and can create uncertainty as to the proper owners of the company and create challenges in completing a future sale or initial public offering of the company.

To avoid these potential pitfalls, it’s crucial to understand the requirements for issuing stock under the law of the state in which the company is incorporated. For Delaware corporations, the critical requirements are set forth in the Delaware General Corporation Law (the “DGCL”), and are summarized as follows:

  • The company’s certificate of incorporation must state the number of authorized shares the company is allowed to issue and the company may not issue more than the number of shares authorized (Section 151 of the DGCL).
  • Any increase in the number of authorized stock requires an amendment to the certificate of incorporation, which must be approved by the Board of Directors and the stockholders of the Company, and properly filed with the Secretary of State of Delaware (Section 242 of the DGCL).
  • The Board of Directors of a company must approve and authorize all grants of stock (Section 141 of the DGCL).
  • The stock must be fully paid by the holder, in an amount set by the Board of Directors and not less than the par value of the stock (Sections 152 and 153 of the DGCL).  This means each stockholder must pay an amount equal to at least the par value of the stock for the stock to be validly issued.

This preceding is not intended to be an exhaustive list of all steps a company must take to ensure that its stock has been properly issued; rather, the DGCL sections referenced above provide the basic, fundamental statutory requirements that companies operating under Delaware law must follow. Companies should consult their legal counsel before issuing stock.

For a more in-depth analysis of relevant case law in Delaware, C. Stephen Bigler and Seth Barrett Tillman’s article provides additional insight into the pitfalls companies should avoid when issuing new shares of stock.

This post on Capitalization Issues and Start-up Legal Issues was authored by Nina Chen.

 
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