Meaning
Failures to follow required statutory or charter rules when executing corporate actions can invalidate board resolutions or equity issuances. This administrative failure, termed a procedural corporate defect, occurs when a company issues stock or approves an action without obtaining the correct board or stockholder approvals. It typically remains unnoticed until the company undergoes rigorous due diligence during a major transaction.
The boundary of the issue lies in whether the action can be retroactively cured under state law.
Validation Process
Correcting these errors historically required complex court proceedings, but modern corporate statutes provide a streamlined path for rectification. A procedural corporate defect can now be cured through a formal ratification process under sections of corporate law like Section 204 of the Delaware General Corporation Law. This involves the board of directors adopting resolutions to approve the defective action, followed by stockholder approval if necessary.
Once approved, the company files a certificate of validation with the state, which retroactively validates the action from its original date.
Commercial Impact
Unresolved corporate errors can block acquisitions or venture rounds by creating uncertainty about who owns the company’s equity. If a major stock issuance is defective, the holder might not legally own the shares, which prevents them from voting or selling. This can freeze the company’s ability to close transactions and force expensive, time consuming audits of all historical corporate records.
Corporate Correction
Startups must maintain tidy minute books from inception to avoid these issues. An audit of corporate history before a sale is the best prevention.
