Controversy notwithstanding, the proposed amendments to the Delaware General Corporation Law in Senate Bill 313 have reportedly “sailed through” the Delaware Senate and are scheduled to move to the Delaware House this week. (See, e.g., this article in Bloomberg.) The proposed amendments were largely designed to address the outcome of the decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, which invalidated portions of a stockholder agreement relinquishing to a founding stockholder control over certain corporate governance matters, a decision that many practitioners viewed as inconsistent with current market practice. But, as discussed in this PubCo post, those proposed amendments have turned out to be highly contentious: a number of academics and jurists, including Delaware Chancellor Kathaleen McCormick in a seven-page letter to the Delaware State Bar Committee, raised objections to the haste and timing (prior to adjudication of an appeal by the Delaware Supreme Court) of the legislation. Adding even more fuel to the fire was a letter submitted to the Delaware legislature, posted on the Harvard Law School Forum on Corporate Governance, by a group of over 50 law professors in opposition to the amendments, along with these separate posts by noted academics on the HLS Forum and on the CLS Blue Sky blog, with this lonely post in favor. (See this PubCo post.)
Background. 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 turned out to be highly contentious. As an example of the pushback, the letter from the law professors referenced above said that 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 [regarding forum selection provisions], 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 the legislature. According to the Delaware Business Times, in a two-hour hearing last week before the Delaware Senate Judiciary Committee, the Chair of the Delaware State Bar’s Corporation Law Council told the committee that “‘[c]orporations have received millions of dollars from investors and they don’t know if their rights are valid, the corporations don’t know if they have potential rescission claims on their hands from an investor….The proposed amendment addresses those issues relating to such contracts strictly from a power and authority perspective.’” As reported by Law360, the Chair testified that the Council “‘believe[s] there are thousands of contracts that may be called into question’” by the recent Delaware court decisions, creating uncertainty about many contracts that are “‘relatively straightforward commercial arrangements done for decades.’” To the extent that these agreements apply to public companies, he added, they must be disclosed. In any event, he said that Delaware corporations currently have a comparable right by issuing blank check preferred stock that gives special rights to holders of that preferred. Moreover, he added, given that fiduciary duties would still apply, the courts would usually have the opportunity to address issues that arise: “‘This is technical. It’s not a foot fault. It’s not a gotcha. You have to comply with fiduciary duties….Circumstances always give courts the leeway to police any situation where boards should have acted’” differently.
However, the Delaware Business Times reported, “more than half a dozen legal experts testified on the bill, voicing their concerns that the amendments [in] SB 313 came from a rushed process and would make this section toothless.” According to the article, some of the academics testified that the bill would undermine the interests of minority stockholders and lead to unintended consequences harmful to the Delaware franchise. One professor testified that “‘[t]his has been justified as a market change, as we need to maintain the franchise to keep it current….If you want to do that, you need to spend more time with [the amendments] than what has been spent so far.’” Another cautioned that “‘Delaware law offers corporate participants incredible flexibility, but flexibility without guardrails can be catastrophic….There are certain fundamental features of a corporation that are essential to that entity’s identity and cannot be waived. As drafted, this would allow those mandatory features to be eliminated by private contract.’”
Another professor, Law360 reported, argued that the bill “‘does not advance the goal of contractual flexibility,’ but rather for Delaware corporations, ‘it subverts it….For contractual governance to work, two things are needed….All affected parties have to know about the contract governance and have to consent to the terms in a meaningful way.’ He added that ‘disfavored’ stockholders in some cases cannot learn about deals, ‘particularly the vast majority of Delaware corporations that are not publicly traded.’”
Law360 suggests concerns that might perhaps be underlying the rush to move forward with the legislation: “recent corporate saber-rattling over the court rulings that critics said could spur greater interest in corporate charter relocation from Delaware, where the DGCL governs the functioning of more than a million Delaware-incorporated business entities, including two-thirds of the Fortune 500. Those entities account—through corporate franchise taxes—for 28.3% of state general fund revenue as of May, second only to the 40.3% generated by personal income taxes.”
The Delaware Business Times reports that, after the hearing, the Delaware Senate Judiciary Committee voted in favor of SB 313. The bill was then sent on to the Delaware Senate. According to Law360, the Senators received only a 15-minute briefing from the Chair of the State Bar’s Corporation Law Council before the vote, where he told the Senators that the “‘certainty that these amendments would provide [is] urgently needed.’” He advised that the Council “‘spent a lot of time thinking through these amendments. It was done in a compressed time frame. They were all done in response to recent court decisions….All of the guardrails, all the fiduciary duties, all the protections remain fundamentally in place….These amendments have only dealt with power and authority. The fact that you have power to do an agreement doesn’t mean someone can’t challenge it.’” He also rejected the “characterization of the measures as a ‘major change,’ [arguing instead that] ‘the legislation codifies the practice we thought was the law. This is not, from our perspective, a major change.’” A professor opposing the legislation said that “the broadly written legislation will authorize virtually any provision in a stockholder agreement unless specifically prohibited elsewhere in the statute. She added that the changes ‘threaten to supplement the board-centric model that is fundamental to Delaware corporate law,’ ceding fundamental decision-making authority to activists or any other stockholder who is able to exert sufficient leverage.”
According to Law360, the bill then “sailed through” the Delaware Senate “without debate or an opposing vote, with a House vote expected as early as next week.”
