It's pretty rare to read a unanimous opinion totally outside my areas of interest with which I strongly disagree.
To even state the question, in my mind, is to answer it: Can a corporation with articles of incorporation that limit the number of shares to X nonetheless grant shares in excess of X and then allow those excess shares to vote to approve retroactively the increase in shares?
No. No way. Yet the Court of Appeal holds that it can.
I get the motivation. Pacific Capital Bank (in Santa Barbara) was failing. Like so many others during the credit crunch. It's failing so bad that the Federal Reserve Bank and the Office of the Comptroller of the Currence give it until a certain date to increase its capital condition or be taken over and liquidated.
The Bank's articles of incorporation only authorize 100 million shares, and it needs a lot more than this to give to potential investors in return for capital. So the Board issues a proxy statement and asks shareholders to increase the number to 500 million. The shareholders agree. Whew.
But the credit crunch only gets worse. The deadline's approaching, the Bank has a potential investor, but the investor wants more than even the 500 million shares the shareholders have authorized. It wants over 2.5 billion shares. It also has the Bank over a barrel. This is the best deal the Bank can find, and it doesn't want to be liquidated. So it says, essentially: "Fine."
Except, again, it doesn't have 2.5 billion shares. It's under time pressure. So it -- and its lawyers, of course -- do something "creative". It gives the investor 225 million shares, which it can do since it only makes 500 million total (which the shareholders approve). It also gives the investor 455,000 "preferred" shares. That it can do too, since preferreds are okay under the articles of incorporation.
But it also allows those preferred shares to be converted into 2.275 billion shares of common stock. That it can't do -- not without shareholder approval, anyway. How do we make sure that the shareholders approve it? By letting those 2.275 billion shares vote in deciding whether to approve the increase in shares. A vote the outcome of which is certain because the 2.275 billion shares are 80 to 90% of the shares, and they'll all vote "Yes."
A shareholder objects, and files suit. But both the trial court and Court of Appeal say, nope, that's all fine. A company can increase the number of shares in excess of an express limit of the articles of incorporation and let those same shares vote retroactively to authorize the deal.
I disagree. Strongly. The whole point of share limits is to stop stuff like this. Companies put limits like these in their articles because we want (and need) shareholders to rely upon them. To know that if they have 500 shares, they own at least one-one-millionth of the corporation, since there are only 500 million authorized shares, and that without shareholder approval, that won't change. To give a majority of the existing holders security in their ownership of the corporation, and to expressly prevent its dilution.
All that's undercut -- egregiously -- by the Court of Appeal's holding. Because what's good for Pacific Bank in the credit crunch is equally good for Qualcomm (or anyone else) on a sunny day. Bad facts make bad law. And, in my opinion, this is really, really bad law. Contrary to the central and express point of both the articles of incorporation and California law.
But the Court of Appeal's holding is not only wrong as a matter of first principles and public policy, but is also a terrible interpretation of the underlying statute. There's a law about this, and it's Section 405(a) of the Corporations Code. Which says that the shareholders have to authorize the shares first.
But the Court of Appeals says: "Ah, but the statute says "[i]f at the time of granting option or conversion rights or at any later time," which means that you can authorize the excess shares later. But the former's true -- those are the words of the statute -- but not the latter. Because the statute says: "If at the time of granting option or conversion rights or at any later time the corporation is not authorized by articles to issue all the shares required for the satisfaction of the rights, if and when exercised, the additional number of shares required to be issued upon the exercise of such option or conversation rights shall be authorized by an amendment to the articles." Which means that the phrase "or at any later time" modifies "at the time of granting [the] option or conversion rights," not the latter part of the statute that discusses when the share authorization amendment is required. Section 405(a) is just saying that if the shares are excess at any time -- either at the outset or thereafter (due to a decrease in the number of authorized shares), you've got to get shareholder approval to increase the number. It doesn't say that approval can come later, and certainly doesn't say that the excess shares that you granted without the required shareholder approval get to vote on the validity of their issuance. Because that'd be terrible, precisely for the reasons I mentioned above.
So, again, I get why the Court of Appeal comes out this way. It's a crisis, and they feel bad for the Bank. But that doesn't make it the right law.
Particularly since it's unnecessary. Part I of the opinion notes that the transaction already closed, and that courts generally don't unwind mergers. Which means the appeal of the preliminary injunction is moot, and the Court of Appeal expressly so holds. Plus, as the Court of Appeal also notes, even if it did set aside the transaction, that'd require -- at a minimum -- a return of the $500 million investment. Which the Bank does not have, so we can't unwind it anyway. Making the appeal get again totally moot.
Notwithstanding all of this, the Court of Appeal goes on to decide the merits "in the interest of judicial economy." I might be on board for that if it was essential, or if the law that was developed was right, or at least beneficial. But it's not. Far from it. It's affirmatively bad.
So this is a case where bad facts unnecessarily make bad law. Which is even worse than usual.
In short, I'm not on board for this one.