Section 203 of The Delaware General Corporation Law: Everything You Need to Know
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. 4 min read
2. Stock Transfer Rule Exceptions
3. Sample Clauses
4. How Else Can a Business Waive Statutory Rights
5. What Is a Business Combination?
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.
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.
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.
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.
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