Recently, the Council of the Corporation Law Section of the Delaware State Bar Association proposed some amendments to the Delaware General Corporation Law, as they do with some regularity. (See this Alert from the Delaware firm, Morris Nichols Arsht & Tunnell.) As the Alert indicated, some of the proposed new amendments were designed to address the effects of recent Delaware cases highlighting “that the legal requirements identified in the cases were not necessarily in line with market practice. The Amendments are designed to bring existing law in line with such practice.” According to Law 360 (here and here), the proposed amendments have just been submitted as Senate Bill 313 to the Delaware General Assembly for its consideration and approval. There’s not usually much controversy surrounding these proposed amendments. Not so this time. This year, there has been a surprising amount of pushback on these proposed amendments—or at least on one of them.
Among the proposed amendments is a change designed to address the outcome of the decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company. As framed by the Delaware Chancery Court, the question in that case was “[w]hat happens 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.” The irresistible market practice at issue was a trend toward implementation of “internal governance arrangements through stockholder agreements. The new wave of stockholder agreements does not involve stockholders contracting among themselves to address how they will exercise their stockholder-level rights. The new-wave agreements contain extensive veto rights and other restrictions on corporate action.” For example, in Moelis, under a stockholder agreement, Moelis’ prior written consent was required before the board could take “eighteen different categories of action…encompass[ing] virtually everything the Board can do.” Other provisions compelled the board to “ensure that Moelis can select a majority of its members,” and to “populate any committee with a number of Moelis’ designees proportionate to the number of designees on the full Board.”
The immovable statutory object that the court upheld was Section 141(a) of the DGCL. Under Delaware precedent, “governance restrictions violate Section 141(a) when they ‘have the effect of removing from directors in a very substantial way their duty to use their own best judgment on management matters’ or ‘tend[] to limit in a substantial way the freedom of director decisions on matters of management policy . . . .’” The provisions in the Moelis agreement, the court reasoned, did not create commercial relationships but rather formed an internal governance arrangement. Accordingly, in Moelis, the court held that, while some provisions could pass muster, many of the governance-related provisions were facially invalid under Section 141(a). For example, as a result of the various pre-approval requirements, the court concluded, “the business and affairs of the Company are managed under the direction of Moelis, not the Board.” As the court concluded, “[i]nternal corporate governance arrangements that do not appear in the charter and deprive boards of a significant portion of their authority contravene Section 141(a).”
It’s the immovable Section 141(a) that is now slated to be moved by this proposed legislation. The proposed amendments “add a new subsection (18) to Section 122 of the DGCL to provide that, whether or not set forth in a certificate of incorporation, a corporation has the power to enter into contracts with current or prospective stockholders that contain the consent rights and other provisions addressed in Moelis.”
But that provision turns out to be highly contentious. Among those jumping into the fray is the Council of Institutional Investors, which has submitted a letter to the Delaware State Bar Association President expressing concern about the proposed amendments designed to address the Moelis opinion—or at least the “legislative rush to judgment” to address the effects of the opinion. The letter suggested that the legislature should “pause the process to permit a more complete consideration of the critical issues raised by the proposed legislation and their potential impact on long-term institutional investors…. There is no need for an immediate legislative ‘fix,’ particularly when there appears to be no consensus that there is a ‘problem’ that needs fixing.” Moreover, the opinion “is subject to review by the Delaware Supreme Court, which may or may not agree with the Opinion.”
CII contended that a more deliberative approach to the opinion is required. Although the opinion declared facially invalid certain provisions that required the board to obtain the founder’s approval before taking more than a dozen specific actions,
“[w]hat has been overlooked in the discussion of the proposed legislation is what the Opinion did not do. The Opinion concluded that certain other provisions were not facially invalid, i.e., provisions requiring the board to allow the founder to nominate enough board candidates sufficient to create a majority, to nominate the founder’s designees, and to make reasonable efforts to elect the founder’s designees. In other words, the Opinion did what judges of the Court of Chancery have been doing for many years: examine the challenged practice under the applicable statute and provide a careful, fully explained statement of the court’s reasons for the ruling providing guidance to corporations and to investors alike, with additional guidance in future cases.”
A more deliberative approach is necessary “because the Opinion raises important questions that lie at the intersection of the board’s ability to run the corporation and the right of shareholders to have a voice in the company they own.” Further, the “need for a more deliberative approach in this case is underscored by the fact that the proposed legislation appears to contain no limit in terms of how far a shareholder agreement can go in changing a company’s corporate governance.”
Citing a letter to the Committee from Gabriel Rauterberg, a University of Michigan law professor, CII reiterates two questions about the operation of the proposed new legislation regarding actions that are not currently permitted: “May a company enter into a contract with a controlling stockholder never to sue that shareholder for a breach of its fiduciary duties? May a company enter a contract never to take any material action without prior approval from a legal entity, such as an investment fund?” On this issue, CII “strongly believe[s] that permitting stockholder agreements to contain the provisions at issue in the Moelis case would disadvantage long-term investors.” Currently, to confer control rights, provisions must be included in a certificate of incorporation for a multi-class structure. But under the proposed legislation, CII writes, a company could have only a single class and “confer comprehensive control rights by contract without any shareholder vote.” That, the letter continued, would be “troubling” for many CII members. Yet there has not been much public debate over these issues. CII states that it is aware that the opinion is inconsistent with certain market practices and that some companies have begun to discuss reincorporating in “friendlier” states, but CII found that rationale unpersuasive.
And CII was not alone in its criticism. Law 360 quotes a Tulane Law School professor Ann Lipton, who contended that the legislation “would functionally redefine what it means to be a corporation….This is happening really fast with unclear implications.” Similarly, two NYU Law School professors, Edward B. Rock and Marcel Kahan, asserted that the “proposed changes could ‘hollow out’ Section 141(a) of the DGCL, which holds that the affairs of a corporation ‘shall be managed by or under the direction of a board of directors.’….If the Delaware Legislature adopts the proposed changes, Section 141(a) ‘will no longer impose meaningful limits on a board’s ability to delegate key governance functions and responsibilities,’ they wrote.” And Charles M. Elson, founding director of the University of Delaware’s Weinberg Center for Corporate Governance, referring to the controversy over the proposed new legislation, argued that the opinion “was carefully thought out….Simply because you didn’t like the result, to try through the Legislature to overrule it is not a good idea. These judges are very careful.”
On the other hand, this article by Widener University Delaware Law School Professor Emeritus Lawrence Hamermesh observes that the “proposed amendments to the DGCL respond to the Moelis opinion’s sweeping questioning of such market practice, which includes governance agreements that have been the basis for long-standing investments in both public and private companies.” As the opinion advised, legislative action would be helpful to clarify the use of these agreements, and that, he suggests, is “exactly what should happen: The proposed amendments to Section 122 are vastly superior in predictability and clarity compared to the state of affairs prevailing under the current statute, as interpreted by the Chancery. The uncertainties exposed by the Moelis decision are too widespread to be left to case-by-case evaluation, and too disruptive to fester for a year or more without legislative guidance.” The criticism, he argues, that it is the board “that manages the business and affairs of the corporation…misses an essential point: The amendments simply allow Delaware corporations to enter into shareholder agreements that include governance arrangements that unquestionably can be included in the corporation’s certificate of incorporation.” And, he notes, the governance arrangements could have been adopted by the board without stockholder approval just by issuing blank check stock. “The proposed amendments,” he contends, “would simply enable the corporation to grant such rights in an agreement with one or more stockholders, instead of amending the certificate of incorporation or issuing blank check stock containing those rights.”
The CII letter points out that the Delaware legislature is scheduled to adjourn next month. Time will tell whether the proposed legislation goes forward this session—or at all.
