Delaware Proposes Dramatic Corporate Law Amendments in Response to Moelis Decision
In response to a recent landmark decision by the Delaware Court of Chancery, Delaware’s legislature may be poised to pass sweeping amendments to Delaware’s General Corporation Law (the “DGCL”). These amendments could potentially hand over power from a board to a corporation’s largest shareholders, which would affect the rights of all the corporation’s investors.
The DGCL governs the fiduciary duties of the officers and directors of most publicly traded companies in the United States. As such, the Delaware Court of Chancery is widely recognized as the nation’s preeminent forum for the determination of disputes involving the DGCL, including stockholder class and derivative lawsuits alleging breaches of fiduciary duty.
These proposed amendments to the DGCL, released on March 28, 2024 by the Council of the Corporation Law Section of the Delaware State Bar Association, are expected to be introduced to the Delaware General Assembly for approval this year.
They are an attempt to legislatively overrule the Delaware Court of Chancery’s February 23, 2024 decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., which primarily concerned DGCL Section 141(a). That provision states that “the business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.” Among other things, Section 141(a) polices external agreements entered into by a board of directors, prohibiting a board from contracting away its duties in private agreements with third parties.
The Moelis case concerns just such agreements. The day before shares of Moelis & Company (Moelis & Co.”), a global investment bank, began publicly trading following its IPO, the company’s board of directors (“Board”) entered into agreements directly with the company’s Chairman, Chief Executive Officer and Founder Ken Moelis, requiring Mr. Moelis’ prior written consent before the Board could take 18 categories of actions (the “Pre-Approval Requirements”). The Court of Chancery characterized the Pre-Approval Requirements as broad and encompassing “virtually everything the Board can do.” In addition to the Pre-Approval Requirements, the Board also entered into a number of other agreements with Mr. Moelis, giving him the right to, among other things, nominate a set number of Board members. Mr. Moelis was also given the right to include at least one of his nominees on all Board committees, effectively ensuring that no Board committees would be entirely independent from Mr. Moelis unless he waived his right to include his Board nominee on the committee.
A company stockholder filed suit in the Delaware Court of Chancery, alleging that the various agreements entered into between Mr. Moelis and the Board violated, among other things, Section 141(a). Ultimately, the Moelis court found that the Pre-Approval Requirements “mean that [Mr.] Moelis determines what action the Board can take. The directors cannot exercise their own judgment. They must check with Moelis first and can only proceed with his approval.” Accordingly, the Board required pre-approval from Mr. Moelis before taking virtually any meaningful action, effectively giving Mr. Moelis control over the Board. The court found that, with the Pre-Approval Requirements in place, the Board was not really a Board. The directors only manage the company to the extent Moelis gives them permission to do so.
The court was unpersuaded by the Board’s defense that the agreements with Mr. Moelis represented a private contract between the Board and a stockholder. The court drew distinctions between contracts that companies necessarily enter into in the ordinary course of business, and the governance-related agreements entered into by the Moelis & Co. Board. The court also noted that the agreements with Mr. Moelis were entered into directly with the Board, as opposed to typical agreements entered into with a corporation.
In addition to striking down the Pre-Approval Requirements, the court also found that the agreements requiring a nominee of Mr. Moelis to appear on Board committee was unenforceable and violated Section 141. The court found that determining the composition of board committees falls within the Board’s authority. A stockholder cannot determine who comprises a committee.
Not all of the agreements with Mr. Moelis were found to violate Delaware law. The court found that it was permissible for the Board to allow Mr. Moelis to nominate designees for the Board. However, the court conditioned this right by noting that “what the Board or the Company does with those candidates is what matters.” Mr. Moelis could nominate his designees at a stockholder meeting, and the company can agree to facilitate that process, so long as the Board is not compelled to recommend Mr. Moelis’ designees for election.
The court also struck down other agreements regarding the size and composition of the Board. By way of example, the court found that the Board could not enter into an agreement with Mr. Moelis to fill a vacancy created by a departing Mr. Moelis designee with another Mr. Moelis designee. The court also found that it was improper for the Board to agree that it would not increase the number of Board seats beyond eleven, an agreement meant to prevent the Board from diluting the control of Mr. Moelis’ nominees to the Board.
The court made it clear that alternative avenues exist for the Moelis & Co, Board and other boards seeking to enter into similar agreements with significant stockholders, noting that many of the invalidated agreements would have been valid if they were found in the Certificate of Incorporation as opposed to private agreements. The court also noted that revising a Certificate of Incorporation need not be an onerous process. The Moelis & Co. Board could, in theory, use its blank check authority to issue Mr. Moelis “a single golden share” and grant that preferred stock a set of voting rights and director appointment rights. The certificate of designations for the new preferred stock would become part of the Certificate of Incorporation as a matter of law, resolving many of the court’s concerns regarding the agreements. The court acknowledged that some might find it “bizarre” that the DGCL would prohibit one means of accomplishing a goal while allowing another.
The court also appeared to anticipate the potential for its decision to create upheaval, acknowledging that many other Delaware corporations had entered into agreements that were similar to the agreements that it struck down in the Moelis opinion. The court acknowledged that “[c]orporate planners now regularly implement internal governance arrangements through stockholder agreements,” and that such agreements “contain extensive veto rights and other restrictions on corporate action.” However, the court was constrained by the mandates of Section 141(a), noting that “a court must uphold the law, so the statute prevails [over the private agreements].”
The uncertainty created by Moelis boiled over on May 24, 2024, when proposed amendments to Delaware’s corporate code were introduced that threaten to upend Section 141(a) and alter the relationship between stockholders and Delaware corporations. The proposed amendments, which were assigned to the Delaware Senate Judiciary Committee, would effectively reverse the Moelis decision by giving Delaware boards greater ability to enter into similar agreement to those that were struck down in Moelis. The proposed amendments would permit a board to enter into agreements with current or prospective stockholders similar to those that were rejected in Moelis, provided that the amendments do not otherwise violate Delaware law. Specifically, the amendments state that the corporation may agree in a contract with a stockholder to: (a) restrict or prohibit itself from taking actions specified in the contract, (b) require the approval or consent of one or more persons or bodies before the corporation may take actions specified in the contract (which persons or bodies may include the board of directors or one or more current or future directors, stockholders or beneficial owners of stock of the corporation), and (c) covenant that the corporation or one or more persons or bodies will take, or refrain from taking, actions specified in the contract (which persons or bodies may include the board of directors or one or more current or future directors, stockholders or beneficial owners of stock of the corporation). Unless amended, the proposed amendments will allow Delaware corporations to more easily contract away traditional corporate powers to large stockholders.