United States: Court Of Chancery Holds That Stockholder Was Not Bound By Stock Transfer Restrictions

Last Updated: August 1 2017
Article by Eric E. Freedman and H. Corinne Smith

Court Of Chancery Holds That Stockholder Was Not Bound By Stock Transfer Restrictions That Were Not Noted On Stock Certificates, Because Stockholder Did Not Have Actual Knowledge Of Such Restrictions When He Acquired The Stock And Did Not Affirmatively Assent To Such Restrictions Thereafter

In Henry v. Phixios Holdings, Inc., C.A. No. 12504-VCMR (Del. Ch. July 10, 2017), the Court of Chancery, interpreting Section 202 of the Delaware General Corporation Law, found that a stockholder had not forfeited his shares by engaging in activities prohibited by stock transfer restrictions contained in a company stockholder agreement, because the restrictions were not printed on the stock certificate and the stockholder did not have actual knowledge of the restrictions at the time that he acquired the stock, and did not agree to the restrictions thereafter. The Court of Chancery therefore rejected the company's assertions that the individual was a former stockholder rather than a current stockholder, and ordered the company to produce books and records requested by the individual in his capacity as a stockholder.

The plaintiff, Jon Henry, became an employee and stockholder of Phixios Holdings, Inc. (the "Company") in March 2015. A Company Stockholder Agreement in effect at the time provided that if a stockholder engaged in activities that were determined to be "damaging" to the Company, including "[w]orking for a competitor," the stockholder's shares could, by a majority vote of all voting stockholders, be revoked in return for payment to the stockholder of the par value of the stock. However, these restrictions were not printed on the Company stock certificates.

Henry and his wife subsequently set up an account enabling Henry's wife's consulting company, RSH Business Consulting Services ("RSH"), to pursue federal government contracting opportunities for woman-owned small businesses. After opening the account, RSH received requests for proposals and quotations for federal contracting opportunities. Henry shared information regarding various of these opportunities with the Company's Chief Information Officer (the "CIO"), while advising that the Company did not qualify as a woman-owned small business or under any of the other categories that would entitle a business to preferential treatment in pursuing federal government contracting opportunities. Despite the lack of such qualification, the Company considered pursuing some of these opportunities, but ultimately did not do so.

Henry was fired in May 2016. Shortly thereafter, Henry received a cease-and-desist letter from the Company alleging that he was conspiring with the CIO to defraud the Company and misappropriate Company assets by pursuing opportunities on behalf of RSH that were in competition with the Company. Henry and the CIO responded by making a written demands for books and records of the Company that, among other things, might support their suspicions that the Company's Chief Operating Officer (the "COO") had misused Company funds. The Company then removed the CIO as a director, and purported, on the basis of the transfer restrictions of the Stockholder Agreement, to revoke all of the shares of stock held by Henry and the CIO.

The Court of Chancery held that, under Section 202 of the Delaware General Corporation Law, an existing restriction on the transfer of a security is enforceable against a subsequent purchaser of the security if the restriction is noted conspicuously on the stock certificate, or if the person against whom enforcement is sought had actual knowledge of the restriction at the time of acquiring the security. If the restriction is not noted on the stock certificate, or if the stockholder did not have actual knowledge of the restriction at the time of acquiring the stock, the stockholder may be bound by the restriction only if the stockholder affirmatively consents to the restriction. Because the restriction on Henry's stock was not printed on the stock certificate, the restriction was binding on Henry only if he either had actual knowledge of the restriction or assented to the stock transfer restrictions after acquiring the shares.

The COO testified that she had disclosed the stock transfer restrictions to Henry at the time that he acquired his shares, but Henry testified that he and the COO had not discussed any provisions of the Stockholder Agreement, including the transfer restrictions. The Court found that the COO's testimony was contradictory and unpersuasive, and the Company could not produce any written evidence to support the COO's claims that Henry had been advised of the transfer restrictions contained in the Stockholder Agreement. The Court therefore held that Henry did not have actual knowledge of the restrictions at the time that he acquired the stock.

The Court also held that Henry did not assent to the stock transfer restrictions subsequent to his acquisition of the shares. After Henry received his stock, the COO emailed the Stockholder Agreement to multiple Company stockholders, including Henry. At that time, Henry thanked the COO for supplying the Stockholder Agreement "for [his] records," but he did not look at the Stockholder Agreement. Henry testified that he did not open the email attachment containing the Stockholder Agreement because he thought the document was perfunctory and had been given no reason to believe otherwise. The Court found that Henry had not affirmatively assented to the transfer restrictions, and therefore was not bound by them and remained a stockholder of the Company.

Turning to the books and records claim, the Court rejected the Company's claims that Henry should not be entitled to receive copies of the documents that he had requested. Henry sought access to Company books and records for three reasons: (i) to communicate with other stockholders concerning an upcoming special meeting; (ii) to value his shares; and (iii) to investigate mismanagement and wrongdoing at the Company. The Court explained that under Section 220 of the Delaware General Corporation Law, a stockholder must have a proper purpose to inspect books and records. A stockholder alleging Company wrongdoing as the basis for such inspection must state a credible basis for the allegations. The Court found that Henry's suspicions that the COO had been using Company funds for personal expenses were based on credible evidence and constituted appropriate grounds for pursuing an investigation of wrongdoing. The Court found that the purposes for Henry's request were all proper, and required that the Company produce the books and records that he had requested.

Jon Henry v. Phixios Holdings, Inc.

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