Proposed Delaware Amendments Would Supersede Moelis Decision
In West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., No. 2023-0309, 2024 WL 747180 (Del. Ch. Feb. 23, 2024) (“Moelis”), the Delaware Court of Chancery held that several provisions in a stockholder agreement were inconsistent with Delaware’s General Corporation Law (“DGCL”) and thus facially invalid. Specifically, Moelis concerned whether a stockholders’ agreement between Moelis (“Company”) and its founding stockholder (“Founder”) unduly constrained the authority of the Board of Directors to manage the affairs of the corporation in its best judgment. The decision has now spurred legislative proposals that, if adopted by the Delaware General Assembly, would supersede the decision by enacting certain reforms.
I. The Moelis Decision
In Moelis, Vice Chancellor Laster invalidated numerous provisions in a stockholder agreement that provided Moelis’s Founder with certain governance rights that circumscribed the power of the Board of Directors. These provisions fell into three general categories:
(1) Pre-Approval Provisions, which required the prior written consent of the Founder before the Board could take any of eighteen different types of actions, including issuing securities, adopting budgets, and incurring indebtedness;
(2) Board-Composition Provisions, which, among other things, limited the size of the Board, required the Board to recommend that other stockholders vote in favor of the stockholder’s designees for Board elections, and required the Board to fill any vacancy in a seat occupied by one of the stockholder’s designees with a new designee picked by the stockholder; and
(3) a Committee Composition Provision, which required the Board to place on any committee a number of Founder designees proportionate to the number of Founder designees on the full board.
The plaintiff, a Moelis stockholder, alleged that these provisions violated Sections 141(a) and (c) of the DGCL by constraining the Board’s authority to manage the business and affairs of the company in its best judgment.
In addressing the question, the Court applied a two-step framework to the analysis, asking (1) whether the challenged provision was part of an internal governance arrangement, as opposed to an external commercial arrangement; and (2) whether the provision substantially limited the directors’ judgment on management matters or restricted their decision-making under the test articulated in Abercrombie v. Davies.[1] If the answer to both questions is “yes,” then the provisions violate Section 141.
In applying the two-step framework, the Court first held that the provisions were part of an internal governance arrangement. The Court then applied the second question, concluding that the Pre-Approval Provisions collectively stripped the Board of the power to manage the Company without the Founder’s permission. The Court further concluded that three of the Board Composition Provisions violated Section 141(a): a provision requiring the Board to recommend the Founder’s designees for election; a vacancy provision requiring the Board to fill a vacancy created by a departing Founder designee with another Founder designee, and a provision preventing the Board from increasing its size. Meanwhile, the Court concluded that the remaining three Board Composition Provisions did not facially violate the statute: the Founder’s right to identify a majority of the candidates for the Board; the provision facilitating the Founder’s nomination of his designees; and an efforts clause requiring the Company to use reasonable efforts to enable the Founder’s designees to be elected and continue to serve. Finally, the Court concluded that the Committee Composition Provision violated both Section 141(a) and (c) by giving the Founder the ability to determine who serves on a committee.
In so holding, however, the Court noted that the Founder and Company could have accomplished the vast majority of what they wanted, without running afoul of Section 141, if the Company had incorporated the same provisions into its certificate of incorporation rather than the stockholder’s agreement, or by “using its blank check authority to issue Moelis preferred stock carrying a set of voting rights and director appointment rights.” (Opinion at 6.)
Notably, in addressing the issue of other stockholder agreements that contained similar provisions, the Court reasoned that “when the seemingly irresistible force of market practice meets the traditionally immovable object of statutory law . . .[a] court must uphold the law, so the statute prevails.” (Opinion at 1.) But importantly, the Court also noted that “[t]he expansive use of stockholder agreements suggests that greater statutory guidance may be beneficial.” (Opinion at 92 n.272.)
II. The Proposed Amendments
Following the decision, the Council of the Corporation Law Section of the Delaware State Bar Association has now proposed several amendments intended to further reconcile Delaware law with market practice. One group of proposals would add a new Section 122(18) to the DGCL designed specifically to override key portions of the Moelis decision.
New Section 122(18) would amend the DGCL by expressly allowing corporations to enter into agreements with current or prospective stockholders (or beneficial owners of stock), “whether or not” the terms of those agreements are “so provided in the certificate of incorporation,” thus removing the distinction that once existed in the law between stockholder’s agreements and certificates of incorporation that Moelis identified. In addition, New Section 122(18) provides a non-exhaustive list of provisions that could lawfully be included in such contracts. The list allows corporations to adopt provisions that (1) “restrict or prohibit” a company from taking specified actions, (2) “require the approval or consent of one or more persons or bodies before the corporation” could take specified actions, and (3) “covenant that the corporation … will take, or refrain from taking,” specified actions. Thus, many provisions that would violate the DGCL under Moelis’s reasoning will be spared that fate if New Section 122(18) is enacted into law.
Other notable aspects of New Section 122(18) include the following:
Consideration necessary: Under New Section 122(18), stockholder agreements would need to be supported by “minimum consideration.” New §122(18). Such consideration would be “determined by the board of directors” and could encompass the stockholder promising to “take, or refrain from taking, one or more actions.” Id. The consideration requirement distinguishes between bargained-for stockholder agreements, like the kind at issue in Moelis, and other governance agreements, such as rights plans or bylaws adopted by stockholders.
Remedies against the corporation, not directors: New Section 122(18) provides that for any breaches under the stockholder agreement, the stockholder’s remedy would be against the corporation. By contrast, nothing in the proposed statute authorizes stockholder agreements that purport to bind and impose remedies against the board of directors or individual directors. See New§ 122(18); see also Synopsis to New § 122(18). But a stockholder’s potential remedies even against a corporation would be limited to some degree. Consider a situation where the corporation covenants to take a certain action that requires stockholder approval under the DGCL. The lack of such approval “would render specific performance of the covenant unavailable.” Synopsis to New §122(18). The synopsis to New Section 122(18) further notes that “even the enforceability of a claim for money damages for breach of the covenant” could “be subject to equitable review if the making or performance” of the covenant “constitute[d] a breach of fiduciary duty.” Id.
Fiduciary duties unaffected: New Section 122(18) notably “does not relieve any directors, officers or stockholders of any fiduciary duties they owe to the corporation or its stockholders.” Synopsis to New §122(18). Those individuals continue to owe fiduciary duties, including when “deciding to cause the corporation to enter into a contract with a stockholder” and “with respect to deciding whether to cause the corporation to perform, or to breach, the contract.” Id. Nor does New Section 122(18) “affect the case law empowering a court to grant equitable relief” regarding the contract, such as the power to “set aside” an agreement when its counterparties “have aided and abetted a breach of fiduciary duty or when a court reviews director actions under an enhanced form of judicial scrutiny.” Id. In other words, even where the amendments remove the DGCL as a barrier for ensuring the legal validity of stockholder agreements, equitable relief may still be available. But such equitable review would proceed as it typically does—on the “specific facts and circumstances, rather than on the grounds that the contract is facially invalid under” the DGCL. Id.
Over-delegation caselaw unaffected: The synopsis further notes “that management contracts and other arrangements appointing or delegating authority to an officer or agent to act on behalf of the corporation continue to be subject to section 141(a) and the related common law addressing” a board’s “over-delegation of duties and authority.” Synopsis to New § 122(18).
III. Next Steps
Before the proposed amendments can become law, they still must be approved by the Delaware State Bar Association’s Executive Committee, enacted by Delaware’s General Assembly, and signed by the Delaware Governor. If the amendments complete those steps, they will take effect on August 1, 2024. Notably, they would generally apply both prospectively to all future stockholder agreements and retrospectively to all stockholder agreements existing before the effective date. But for now, there’s at least one caveat. The amendments would not apply to any stockholder agreements that are the subject of “any civil action or proceeding completed or pending on or before” the effective date. New § 122(18).
[1] 123 A.2d 893, 899 (Del. Ch. 1956), rev’d on other grounds, 130 A.2d 338 (Del. 1957)
