Moelis and its Aftermath: Recent Case Law and Statutory Developments Addressing the Ability of Stockholders to Manage Corporations through Stockholder Agreements
Delaware has long maintained its status as the mecca for U.S. corporations, with over 50% of all publicly listed corporations incorporated there. Devoted exclusively to the adjudication of business disputes and known for having developed a widely cited and extensive body of case law on corporate governance matters, decisions of the Delaware Court of Chancery are given great deference by the corporate bar and the Delaware legislature alike. It is the rare case where either the Court of Chancery or, on appeal, the Delaware Supreme Court has handed down a decision in the area of corporate governance so momentous and controversial that the Delaware legislature was moved to promptly countermand the court’s holding by legislative action.[1] The Court of Chancery’s recent decision in West Palm Beach Firefighters Pension Fund v. Moelis & Co., C.A. No. 2023-0309-JTL (Del. Ch. Feb. 23, 2024) is one such case, and as such the decision and its progeny and the legislative reversal it provoked bear careful consideration.
In Moelis, Vice Chancellor J. Travis Laster, writing for the Delaware Court of Chancery, ruled that certain rights granted to a founding stockholder in a stockholders' agreement[2] were facially invalid as they impermissibly constrained the board of directors' authority. These rights included certain pre-approval requirements (the “Pre-Approval Rights”),[3] board composition rights (the “Board Composition Provisions”),[4] and a committee composition right (the “Committee Composition Provision”)[5]
The court held that the Pre-Approval Rights violated Section 141(a) of the Delaware General Corporation Law (“DGCL”) because they effectively constrained “in a very substantial way” the directors' ability to manage the corporation, and Section 141(a) of the DGCL provides that the business and affairs of a corporation must be managed by or under the direction of the board of directors unless otherwise specified in the DGCL or the corporation's certificate of incorporation. The court also held that three of the six Board Composition Provisions[6] violated Section 141(a) and the entire Committee Composition Provision violated Section 141(a) and Section 141(c). The Vice Chancellor also noted that the other three Board Composition Provisions (specifically, the designation right, recommendation requirement, and nomination requirement), while not facially invalid, could in the future be the subject of “as applied” challenges.
The court noted that Moelis could have achieved control over the vast majority of the listed actions via an amendment to the certificate of incorporation or issuance of a “golden share” conferring specific governance control rights but no economic rights on the holder. The court also suggested that “greater statutory guidance may be beneficial,” acknowledging the common use of such stockholder agreements to afford approval rights to founding and other large stockholders.
In response, less than a month after the Court of Chancery’s decision, Senate Bill 313 was proposed to amend Section 122 of the DGCL. On July 17, 2024, Delaware Governor John Carney signed into law amendments to the DGCL from Senate Bill 313 that had sparked considerable controversy within the corporate law and governance community. These amendments were principally intended to reverse three recent decisions of the Delaware Court of Chancery[7] and to provide more predictability to certain corporate practices. The amendments became effective August 1, 2024, and apply retroactively to contracts and agreements made by a Delaware corporation.
New Section 122(18) of the DGCL authorizes Delaware corporations to enter into agreements with stockholders and prospective stockholders, even if such agreements constrain the board's managerial discretion, so long as such agreements do not violate the DGCL (other than Section 115 of the DGCL regarding forum selection) or the corporation's certificate of incorporation. These agreements may:
Restrict corporate actions under specified circumstances;
Require specific approvals before the board can take corporate action; and
Provide that the corporation, and its directors and stockholders, will take, or refrain from taking, particular actions.
Section 122(18) does not, however, eliminate fiduciary duties owed by directors, officers or controlling stockholders to the corporation.
Section 122(5) of the DGCL was also amended to reaffirm that a board cannot delegate fundamental board-level functions to officers or agents unless authorized under the corporation's certificate of incorporation, thereby maintaining the board's central role in corporate governance.
The amendments to Section 122 of the DGCL attracted considerable controversy. Critics of the amendments have argued, among other things, that they were hastily enacted while Moelis was still pending appeal to the Delaware Supreme Court and run counter to Delaware's long history of relying on its courts rather than the legislature to shape its corporate law. Ultimately, the amendments passed and have now been signed into law by Governor Carney.
A second opinion authored by Vice Chancellor Laster, issued following Moelis but before effectiveness of the legislative amendments, Wagner v. BRP Grp., Inc., C.A. No. 2023-0150-JTL (Del. Ch. May. 28, 2024), involved the placing by the board of certain guardrails on a founder’s pre-approval requirements whereby the founder bound himself to consent to any action that required his pre-approval if the members of an independent board committee unanimously determined that the action was in the best interests of the corporation. Although the court’s holding suggests such a procedural guardrail is curative of certain types of stockholders agreements in which the corporation confers control rights on a founder, the court found it insufficient to validate the founder’s pre-approval rights regarding (i) hiring or firing of the corporation’s officers (invalidated by the court because it contravenes DGCL 142(a) and (e)) or (ii) amending the charter, which the court held likewise contravenes Section 141(a) and Section 242 of the DGCL.
In a third significant case[8] to address limits on the power of stockholders to contract for governance controls under DGCL 141(a), Vice Chancellor Laster noted that upon the effectiveness of the amendments to the DGCL, there should be no further need for the procedural guardrails on stockholder pre-approval agreements of the sort approved in Wagner for at least a subset of such agreements (specifically, those not contrary to the certificate of incorporation or Delaware law).
However, such guardrails may (although there has yet to be an explicit case-based stress-testing of this postulate) have continuing viability as evidence of procedural fairness to help protect certain stockholder pre-approval agreements under an “as applied” analysis in the context of change-of-control transactions involving a conflicted controller that otherwise could successfully be challenged as a breach of the controller’s fiduciary duties under an entire fairness analysis.
Key Takeaways
The new Section 122(18) of the DGCL permits corporations to enter into stockholder agreements that may constrain the discretion of a board of directors under Delaware law, regardless of whether such agreements are expressly permitted in the corporation's certificate of incorporation, as long as they do not violate the express provisions of the certificate of incorporation and the DGCL.
Delaware courts may now be more willing to characterize a stockholder who has entered into such agreements as a controller, regardless of the stockholder’s percentage ownership of outstanding voting stock.
Founding stockholders, or those otherwise at risk for being deemed a controller, may still want to consider adopting the procedural guardrails used in Wagner to support a potential defense in the event of stockholder conflicted-controller litigation. This would allow them to argue that the retained powers of the board over the stockholder’s pre-approval rights demonstrates that they are not controllers.
Expect to see more cases involving conflicts between the board’s fiduciary duties and the contractual pre-approval rights of stockholders like those in Marmon[9] (stockholder agreements could not limit the board’s obligations to disclose material information to stockholders) and Schroeder[10] (agreement enabling common stockholders to select CEO invalid where bylaws called for board to select CEO).
Jim Rosenbluth is Co-Chair of Pierson Ferdinand’s Private Equity and Venture Capital practice group. Contact Jim at james.rosenbluth@pierferd.com.
Carl Neff is a Litigation Partner in Pierson Ferdinand’s Wilmington, Delaware office. Contact Carl at carl.neff@pierferd.com.
This publication and/or any linked publications herein do not constitute legal, accounting, or other professional advice or opinions on specific facts or matters and, accordingly, the author(s) and PierFerd assume no liability whatsoever in connection with its use. Pursuant to applicable rules of professional conduct, this publication may constitute Attorney Advertising. © 2024 Pierson Ferdinand LLP.
[1] Examples of such cases include: (i) Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), in which the Delaware Supreme Court held that the directors of Trans Union Corporation breached their fiduciary duty of care by approving a merger without adequate information, in response to which the Delaware legislature enacted Section 102(b)(7) of the DGCL, allowing corporations to include provisions in their charters that eliminate or limit the personal liability of directors for breaches of fiduciary duty, except in cases of bad faith, intentional misconduct, or knowing violations of law, and (ii) Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003), in which the court ruled that a merger agreement with “lock-up” provisions was invalid because it precluded the board from exercising its fiduciary duties; the legislature did not directly reverse this decision, but amended DGCL Section 251(h) in 2013 to enable two-step mergers without requiring a stockholder vote, if certain conditions are met.
[2] The opinion included an extended analysis of the application of Section 141(a) to various forms of arrangements purporting to limit the authority of the Board to manage the corporation, including (i) stockholder and director agreements, (ii) stockholder rights plans, (iii) CEO employment agreements, (iv) improper delegations of board power, (v) termination of merger agreements, and (vi) Bylaws. This article focuses solely on the court’s treatment of stockholder agreements like the one in question in Moelis.
[3] The Pre-Approval Rights included 18 categories of actions that required pre-approval of Moelis, including:
Incurring debt over $20 million.
Issuing equity over a specified threshold.
Issuing any preferred stock.
Entering a debt or equity commitment to invest more than $20 million.
Entering into any new business that requires more than $20 million in investment.
Adopting a stockholder rights plan.
Removing or appointing any Section 16 officer.
Amending the charter or bylaws.
Amending the partnership agreement of the holding company limited partnership.
Renaming the company.
Adopting the company’s annual budget and business plan and making any material amendments to them.
Declaring a dividend.
Entering into a merger, recapitalization, or sale.
Liquidating or winding up the company, including through bankruptcy.
Entering into or amening any material contract.
Entering into a related party transaction.
Initiating or settling a material action.
Changing the company’s taxable or fiscal year.
[4] The Board Composition Provisions ensured that Moelis could select a majority of its members by (i) limiting the size of the board, (ii) entitling Moelis to name a number of designees equal to a majority of those seats, and(iii) obligating the Board to (a) nominate Moelis’ designees as candidates for election, (b) recommend that stockholders vote in favor of Moelis’ designees, (c) use reasonable effort to enable Moelis’ designees to be elected and continue to serve, and (d) fill any vacancy in a seat occupied by a Moelis designee with a new Moelis designee.
[5] The Committee Composition Provision required the board to populate any committee with a number of Moelis’ designees proportionate to the number of designees on the full board. The board could not create an independent committee without any Moelis designees, unless Moelis consented.
[6] The Board Composition Provisions determined to be invalid included the recommendation requirement (improperly compels the board to recommend Moelis’ designees for election), vacancy requirement (improperly compels the board to fill a vacancy created by a departing Moelis designee with another Moelis designee), and size requirement (improperly enables Moelis to prevent the number of board seats beyond eleven).
[7] The other two cases are Crispo v. Musk, 304 A.3d 567 (Del. Ch. 2023) (Senate Bill 313 introduced new paragraph (a)(1) to DGCL §261, providing that parties to a merger or consolidation agreement may provide for the penalties or consequences of a failure to perform prior to the effective time of the transaction, or a failure to consummate the transaction) and Sjunde Ap-Fonden v. Activision Blizzard, 2024 WL 863290 (Del. Ch. Feb. 29, 2024) (corrected March 19, 2024) (Senate Bill 313 introduced new section 147 permitting boards to approve agreements that may not contain all of the material terms as long as those terms have been presented to, or are known by, the board, thereby dispensing with the complexities surrounding board approval of merger agreements addressed by Sjunde AP-Fonden).
[8] Seavitt v. N-Able, Inc., No. 2023-0326-JTL, 2024 Del. Ch. LEXIS 263 (Del. Ch. July 25, 2024). In Seavitt, the Delaware Court of Chancery (in an opinion by Vice Chancellor Laster) held that the charter of a Delaware corporation cannot incorporate by reference the substantive terms of a stockholders or other private agreement.
[9] Marmon v. Arbinet-Thexchange, Inc., 2004 WL 936512 (Del. Ch. Apr. 28, 2004).
[10] Schroeder v. Buhannic, 2018 WL 11264517 (Del. Ch. Jan. 10, 2018).
