Key Takeaways

  • DGCL 203 is Delaware’s anti-takeover statute that restricts “interested stockholders” (those owning 15% or more) from engaging in certain business combinations for three years unless specific exceptions apply.
  • Exceptions include prior board approval, post-acquisition supermajority shareholder approval, or acquisition of at least 85% of shares in a single transaction (excluding insider-owned shares).
  • Companies can opt out of DGCL 203 through provisions in their certificate of incorporation or bylaws, often done at formation or within a statutory time frame.
  • Violations of DGCL 203 can lead to litigation, with courts scrutinizing whether statutory exemptions were properly applied.
  • “Business combination” is broadly defined to include mergers, asset sales, leases, significant securities issuances, and other substantial transactions with the interested stockholder.

What Is Section 203 of the Delaware General Corporation Law?

Section 203 of the Delaware General Corporation Law, or DGCL, is a Delaware statute that prevents shareholders (along with their affiliates and associates) from engaging in a tender or exchange offer for a period of three years after buying more than 15 percent of the company’s stock unless certain criteria are met.

In simpler terms, if a shareholder purchases greater than 15 percent, but less than 85 percent, of the company’s stock, he or she is considered an interested shareholder. This type of stockholder cannot engage in certain business combinations with the corporation for three years after having been deemed an interested shareholder unless three criteria are met.

If, however, less than 15 percent of the company’s shares are purchased, this statute would not apply. Furthermore, this statute only applies to those Delaware corporations that haven’t opted out of coverage. Therefore, if the company waives Section 203, then the shareholders will be permitted to engage in any type of exchange offer without a three-year holding period.

Legislative Purpose and Policy of DGCL 203

DGCL 203 was enacted in 1988 as part of Delaware’s broader effort to balance the interests of corporate boards, shareholders, and potential acquirers. Its primary policy goal is to deter hostile takeovers that might pressure boards into unfavorable deals without adequate time for evaluation. By imposing a three-year moratorium on certain transactions between a corporation and an interested stockholder, the statute gives directors leverage to negotiate more favorable terms or to consider alternative bids.

The law reflects Delaware’s commitment to director primacy in corporate governance, ensuring that large shareholders cannot quickly force structural changes that could disadvantage minority shareholders. However, it is not an absolute bar to transactions—its built-in exceptions recognize situations where shareholder approval or rapid acquisitions demonstrate sufficient market support to justify proceeding sooner.

Stock Transfer Rule Exceptions

As previously noted, all interested shareholders will be prevented from engaging in certain business combinations with the company for a period of three years after being categorized as an interested shareholder unless the following can be met. If, prior to the date when the shareholder purchased the shares, any of the below are met, then the shareholder will not be considered an interested shareholder and can engage in any combination of business transactions with the corporation:

  • The board of directors approves the business combination.
  • The transaction that resulted in the shareholder becoming an interested stockholder of the company was previously approved by the board.
  • The business combination is approved by the board, and the shareholders cast an affirmative vote where at least 66 2/3 percent of the outstanding voting stock isn’t owned by the interested shareholder.

If the board previously approves the business combination or the transaction that resulted in the interested shareholder categorization, then the shareholder will not be required to the three-year holding period before engaging in other business combinations. Moreover, if the board approves the business combination and also engages in an affirmative vote that identifies that at least 66 2/3 percent of the outstanding voting stock does not belong to the shareholder, then the statute will not apply.

Additional Statutory Exceptions and Safe Harbors

In addition to the primary exceptions, DGCL 203 offers nuanced safe harbors:

  • 85% Ownership Exception – If the acquiring stockholder, in a single transaction, obtains at least 85% of the outstanding voting stock, they may bypass the three-year restriction. Shares owned by directors, officers, and certain insiders at the time of the transaction are excluded from the 85% calculation.
  • Subsidiary Mergers – Certain mergers involving wholly owned subsidiaries of the interested stockholder can proceed without triggering the restriction, provided they meet statutory conditions.
  • Non-Voting Stock – Ownership thresholds are based on voting stock, meaning acquisitions of non-voting shares do not, by themselves, create “interested stockholder” status.

These provisions are designed to allow flexibility in corporate transactions where overwhelming shareholder support or special structures mitigate the takeover concerns DGCL 203 was meant to address.

Sample Clauses

There are Section 203 clauses that should be identified both in the Delaware Corporation’s bylaws and shareholder agreement if the corporation wishes to opt out of the statutory protection. Some sample clauses include the following:

  • As of today’s date, shareholders nor their affiliates are deemed to be interested shareholders as defined in Section 203 of the DGCL.
  • This company has elected not to be governed by Section 203 of the DGCL.
  • This company expressly elects not to participate in Section 203 of the DGCL.

So long as the corporate bylaws, shareholder agreements, and articles of incorporation expressly indicate that the corporation is not being governed by the statute and it can be reasonably understood that none of the shareholders of the company are deemed interested shareholders, then all current and future shareholders will be on notice that the statute doesn’t apply.

How Else Can a Business Waive Statutory Rights

Section 203, entitled business combinations with interested stockholders, clearly identifies the abovementioned restrictions. While certain exceptions do in fact exist, there are other ways in which a company, particularly those that have been in existence for decades, can waive protection under the law. For example, if the corporation doesn’t have voting stock that is listed on a national securities exchange, then the statute wouldn’t apply.

Furthermore, a corporation’s board of directors could have adopted an amendment of its corporate bylaws within 90 days after February 2, 1988, expressly indicating that it chooses to opt out of Section 203. If, after this point, the corporation failed to amend its bylaws within the 90-day timeframe, the company and its shareholders can only rely on the aforementioned exceptions in order to opt out.

Judicial Interpretation and Enforcement of DGCL 203

Delaware courts have actively interpreted DGCL 203 in disputes over mergers and acquisitions. A notable case, Arkansas Teacher Retirement System v. Alon USA Energy, Inc., involved allegations that a controlling shareholder’s acquisition violated the statute because the exemption they relied upon was improperly applied. The Court of Chancery emphasized that compliance with each statutory element is essential, and technical missteps can leave transactions vulnerable to challenge.

Courts will examine:

  • Whether the board granted approval before the stockholder crossed the 15% threshold.
  • The accuracy of calculating ownership percentages, especially when insider holdings are excluded.
  • Whether supermajority shareholder approval was truly independent of the interested stockholder’s influence.

Enforcement actions are typically brought by stockholders, but boards also have fiduciary duties to ensure transactions comply with the law to avoid later invalidation.

What Is a Business Combination?

A business combination refers to any merger or consolidation of the company’s assets, which can include a sale, lease, exchange, mortgage, or transfer of assets with the company. For example, let’s say you own a company and use your company’s assets to purchase 20% of ABC Inc. shares. Assuming that ABC Inc. hasn’t opted out of the statute, you and your company are now considered interested shareholders. Therefore, for a period of three years, you and your company cannot engage in any type of business transaction with ABC Inc., as this might give you a greater advantage to a potential increase in the company’s shares.

Practical Implications for Corporate Planning

For corporations incorporated in Delaware, DGCL 203 has significant implications when structuring equity investments, strategic alliances, and acquisitions. Corporate counsel should:

  1. Monitor Ownership Levels – Maintain up-to-date records of voting stock ownership to avoid unintentionally triggering “interested stockholder” status.
  2. Consider Pre-Approval Strategies – Boards anticipating large investments can approve transactions in advance to preserve flexibility.
  3. Draft Clear Opt-Out Provisions – If the company chooses to opt out of DGCL 203, the language in governing documents should be explicit and unambiguous.
  4. Evaluate Deal Timing – For transactions involving potential interested stockholders, consider the three-year restriction early in deal planning to avoid costly restructuring.

These measures help avoid litigation risks and maintain strategic agility during significant corporate events.

Frequently Asked Questions

  1. What is the main purpose of DGCL 203?
    DGCL 203 aims to prevent hostile takeovers by restricting certain transactions with large shareholders for three years unless specific conditions are met.
  2. Who is considered an “interested stockholder” under DGCL 203?
    An interested stockholder is a person or entity that owns 15% or more of a corporation’s voting stock.
  3. How can a company opt out of DGCL 203?
    A company can opt out through provisions in its certificate of incorporation or bylaws, typically adopted at formation or within the statutory timeframe.
  4. What qualifies as a “business combination” under DGCL 203?
    Business combinations include mergers, asset sales, significant stock issuances, or other substantial transactions between the corporation and the interested stockholder.
  5. What happens if DGCL 203 is violated?
    Violations can lead to shareholder lawsuits, and courts may invalidate the transaction if statutory requirements were not strictly followed.

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