Last month, this PubCo post discussed the recent controversy over proposed amendments to the Delaware General Corporation Law. As noted in the post, the Council of the Corporation Law Section of the Delaware State Bar Association proposes amendments annually, but some of the amendments proposed this year, submitted as Senate Bill 313 to the Delaware General Assembly, have elicited a substantial amount of pushback. The controversy has revolved largely around proposed amendments designed to address the outcome of the decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, which many practitioners viewed as inconsistent with current market practice. Then, a letter on this topic, dated April 12, surfaced (hat tip to Law 360) from Delaware Chancellor Kathaleen McCormick to the Delaware State Bar Committee. Adding even more fuel to the fire is a letter submitted to the Delaware legislature, just posted on the Harvard Law School Forum on Corporate Governance, by a group of over 50 law professors in opposition to the amendments.
As described by the court, in Moelis, the founder and CEO had entered into a stockholder agreement with the company, consistent with current market practice of implementing “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, under the 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.” But did the agreement violate 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).”
The proposed amendments add a new subsection (18) to Section 122 of the DGCL to allow corporations to enter into the types of stockholder contracts at issue in Moelis, even if the provisions are not set forth in a certificate of incorporation. But, as discussed in this PubCo post, that proposal has turned out to be highly contentious—concerning enough to elicit a seven-page letter from McCormick. McCormick, writing on her own behalf, was motivated to write because, as the author of two of the three decisions at which some of the legislation is directed, she acknowledges that she had “flagged the possibility of legislative review” in those opinions. (The two opinions she authored both related to market practices in connection with acquisition agreements—a requirement that boards approve “essentially complete” versions of merger agreements and a decision limiting the availability of “lost-premium” damages in the event of a busted deal.) But, she protests, she had envisioned quite a different type of legislative intervention—such as the considered and measured approaches, over months and years, that led to the enactment of Section 102(b)(7) of the DGCL in response to the Delaware Supreme Court’s 1985 decision, Smith v. Van Gorkom, or the enactment of amendments to the DGCL in response to the Enron and WorldCom scandals. That legislation proceeded slowly over years: “These moments in history also illustrate that the rare instances of legislative intervention have involved a cautious and highly deliberative process that allowed time for countervailing views to inform the policy discussion. The resulting legislation was targeted and, by the time of adoption, uncontroversial.”
Moreover, she continued, it is rare for the Council to take action in response to a judicial decision and, unprecedented to take action prior to “a final decision, that is, [before] the Delaware or United States Supreme Courts have weighed in. The Council has never taken aim at a Chancery decision, much less one in a case that is pending before the trial court.”
These “hallmarks of reasoned legislative intervention in Delaware corporate law,” she continued, are “integrity-enhancing and insulate the process from the whims, pressure, and politics of private interests[,] prevent collateral attacks on the rule of law[,] serve as important roadblocks preventing a race to the bottom[, and] ensure Delaware’s continued credibility and preeminence in the field of corporate law.” But the proposal, she contends, reflects “[n]one of the hallmarks of Delaware’s tradition…. The Proposal was not the product of a cautious and deliberative process. The Proposal is not targeted in scope or uncontroversial. The Proposal does not address Delaware Supreme Court decisions. Quite the opposite. The Proposal was the product of a rushed reaction, prepared mere weeks after Moelis and Activision were issued…. The Proposal has moved forward at a pace that forecloses meaningful deliberation and input from diverse viewpoints.”
The rush, she observes, has been explained as a reaction to decisions that run contrary to market practice. That, she contends, “is a legitimate concern, but one that lacks normative force. The fact that ‘everyone is doing it’ is not a reason to do something. The question is whether everyone is doing the right thing: Is the market acting in a manner that is good for corporate law?” Alternatively, the speed may be a result of the “Council’s concern that the decisions at issue render Delaware corporation law unpredictable. Reasonable minds can dispute that premise. More importantly, reasonable minds can dispute whether the Proposal achieves the intended purpose of predictability or the opposite.” In McCormick’s view, “reasonable minds should be given the opportunity to debate the normative qualities of market practice and whether the Proposal solves the purported lack of predictability in our law. Optimally, that opportunity would occur before the Executive Committee is forced to vote on the Proposal…. Slowing down [this] process would allow for people to study (or at least read!) the lengthy Proposal and potentially propose alternative solutions.”
As reported by Law 360, Vice Chancellor Laster, who authored Moelis, posted that, “[t]his is not the annual tweaking of the DGCL. That’s a cosmetic procedure by comparison. This is major surgery.” In addition, he posted that “[w]herever this ends up, it seems likely that a generation of corporate law professors will be able to get tenure based on research agendas tied to the legislation….The amendments raise deep questions about corporate theory and legal doctrine. They invite updated assessments of Delaware’s political economy and the mechanisms used to update the DGCL.”
In their letter, the law professors write that they “routinely disagree over corporate law issues,” but not on this topic. On this issue, they
“are unanimous in our belief that the appropriate response to the Moelis decision is to allow the appellate process to proceed to the Delaware Supreme Court. The issues at stake warrant careful judicial review, not hasty legislative action. The Proposal would do more than simply overturn Moelis. It would allow corporate boards to unilaterally contract away their powers without any shareholder input. It would also exempt such contracts from Section 115, thereby creating a separate class of internal corporate claims—including claims of breach of fiduciary duty—that could be arbitrated and decided under non-Delaware law. These would be the most consequential changes to Delaware corporate law of the 21st century, and they should not be made hastily—if at all.”
In addition, contrary to views of the proponents of the legislation, who maintain that the contract at issue in Moelis was “common practice” before the decision, these academics maintain that the contract in Moelis was “far from typical, especially for public corporations,” and that the Moelis decision did not invalidate all of the provisions of the agreement, but rather required only that some be adopted in a charter following a shareholder vote.
Rather than acting through this legislation, they argue, the Delaware Supreme Court should be given the opportunity to express its view and provide guidance: “The Delaware Supreme Court may ultimately agree with or tweak the Moelis decision, or even undo it entirely. But it will do so only after careful consideration of the complex interplay between Delaware’s commitment to contractual freedom—a commitment we wholeheartedly support—and its equal commitment to protecting shareholders through an empowered and accountable board of directors. Delaware’s unique ability to uphold both commitments is what gives the public confidence to invest in Delaware corporations, and what makes Delaware the leading jurisdiction for corporate law.”
According to Law 360, the amendments are scheduled for the first legislative debate tomorrow.
