Delaware Legislature Expeditiously Codifies Stockholder Agreements' Market Practice After Court of Chancery Ruling
On July 17, 2024, the Delaware Governor signed into law Bill SB313 (available here), introducing certain amendments (the “Amendments”) to the Delaware General Corporation Law (“DGCL”), effective August 1, 2024.
The Amendments, proposed by the Corporation Law Council of the Delaware State Bar Association, aim to address the legal uncertainty surrounding governance-related agreements between corporations and their stockholders stemming from the Court of Chancery’s opinion in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company (the “Opinion”), discussed in this Client Alert.[i] The Amendments were introduced and enacted a mere four months after the Opinion was rendered and before the Delaware Supreme Court had an opportunity to rule on the expected appeal to the Opinion. The Amendments will apply to all contracts within their scope, whether entered into before or after August 1, 2024, but will not affect any completed or pending litigation.
Responding to the Opinion, new DGCL Section 122(18) expressly authorizes Delaware corporations to enter into contracts with one or more current or prospective stockholders that may contain, among other terms not contrary to Delaware law or the corporation’s certificate of incorporation, provisions that:
- restrict or prohibit the corporation from taking actions specified in the contract;
- 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); or
- include a 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),
(such contracts, “Stockholder Agreements”).
Under Section 122(18), the Stockholder Agreements will be valid and enforceable notwithstanding Section 141(a) of the DGCL, under which the business and affairs of a corporation shall be managed by, or under the direction of a board of directors, and which formed the basis for invalidation of such agreements in the Opinion.
As such, Section 122(18) provides a legal basis for governance-related agreements between a corporation and one or more equity investors, including in the context of new public companies (in which the pre-IPO stockholders wish to retain some degree of control post-IPO, and which was at issue in the Opinion), additional equity investments and activist settlements.
The Amendments provide several advantages to parties to Stockholder Agreements, key of which are:
- Broad authorization. The statutory language of Section 122(18) does not restrict what actions a corporation may be required to take or prohibited from taking (either absolutely or without the consent of specified persons) under a Stockholder Agreement.
- Private negotiation. Unlike amendments to a charter, Stockholder Agreements do not require approval of stockholders not party to them (unless such approval is required by the charter, law or another Stockholder Agreement) and are privately negotiated between the corporation and relevant stockholder.
- Confidentiality. Stockholder Agreements do not need to be included or referenced in the charter, and, with respect to private companies, do not need to be publicly filed. Public companies, however, will, in most cases, need to publicly disclose them.
- Prospective Stockholders Can Be Parties. Stockholder Agreements can be entered into with both current and prospective stockholders, potentially assisting companies with their fundraising efforts.
- Minimum consideration sufficient. It is sufficient for a Stockholder Agreement to be supported by “such minimum consideration as approved by the board of directors”. Examples of agreements that fail this test, according to the Synopsis provided by the Amendments’ proponents, include amendments to bylaws and shareholder rights plans in which no new consideration is received by the corporation; the Amendments, however, do not require that the consideration takes a particular form or introduce an adequacy test for such consideration, leaving its determination to the board of directors.
- Choice of law. Subject to the general choice of law principles (including the internal affairs doctrine)[ii], the Stockholder Agreements may be subject to law other than Delaware.
- Choice of forum. The Stockholder Agreements may be submitted to jurisdiction of courts outside of Delaware or arbitration.
Despite the broad enabling language of Section 122(18), the ability of the parties to enter into Stockholder Agreements and to have them enforced in accordance with their terms will be subject to several constraints, the precise operation of which is left to be clarified in case law in and outside of Delaware, including the following:
- Fiduciary Duties. The Amendments do not alter the fiduciary duties of directors, officers and controlling stockholders that may apply during the entry into, performance, and decision not to perform a Stockholder Agreement. It is possible that Stockholder Agreements, while no longer facially invalid as infringing on the board’s authority, would generate substantial scrutiny and litigation on fiduciary duty and/or public policy grounds and consequent development of fiduciary duties and public policy law.[iii]
It is also worth noting that stockholders parties to Stockholder Agreements face a risk of being deemed controlling stockholders by virtue of the rights granted to them under the agreements, and therefore subject to fiduciary duty liability in connection with the agreements themselves and exercise of their powers.
- Mandatory Rules of Delaware Law. A Stockholder Agreement may not include provisions that would be unenforceable if included in the charter, except for governing law and forum selection clauses discussed above.[iv] Thus, a provision in a Stockholder Agreement purporting to eliminate annual election of directors[v] or their removal without cause (except in the cases of a classified board)[vi], or of stockholder approval of a merger (subject to statutory exceptions)[vii], or to exculpate or indemnify directors and officers for breaches of a duty of loyalty[viii], will be unenforceable.
- Certificates of Incorporation. Similar to the mandatory law exceptions, no provision of a Stockholder Agreement would be enforceable against a corporation to the extent it is contrary to its charter. In addition to a careful review of the existing charter, it would be advisable that a Stockholder Agreement establishes a veto right over charter amendments — at a minimum, over those that would put the Stockholder Agreement itself at risk.[ix]
As a corollary, corporate planners may consider adopting charter provisions aimed at restricting potential future Stockholder Agreements with third parties that would upend the desired balance of power within a corporation.
[i] In addition to authorizing agreements between corporations and their stockholders at issue in the Opinion, the Amendments also address (i) the procedure for approval and adoption of merger agreements, in response to the Court of Chancery’s decision in Sjunde AP-Fonden v. Activision Blizzard, Inc., No. 2022-1001-KSJM, 2024 WL 863325 (Del. Ch. Feb. 29, 2024); and (ii) the damages recoverable by the target corporation for breach of a merger agreement, in response to the Court of Chancery’s decision in Crispo v. Musk, 304 A.3d 567 (Del. Ch. 2023).
[ii] Under the internal affairs doctrine, the law applicable to “matters peculiar to corporations, that is, those activities concerning the relationships inter se of the corporation, its directors, officers and shareholders” is the law of the state of incorporation. See McDermott Inc. v. Lewis, 531 A.2d 206, 215 (Del. 1987)); Edgar v. MITE Corp., 457 U.S. 624, 645 (1982). We expect that subsequent case law will clarify the boundaries of the internal affairs doctrine in the context of Stockholder Agreements.
[iii] In particular, the extensive debate and commentary within the academic and professional legal community, including a letter from more than 50 law professors opposing the Amendments (available here) and statements by Chancellor McCormick (available here) and Vice Chancellor Laster, the author of the Opinion (available here, among other statements) may contribute to evolution of case law defining the limits of Stockholder Agreements.
[iv] Corporate planners should, however, carefully consider the implications of choosing non-Delaware governing law and forum for a Stockholder Agreement involving a Delaware corporation, including the risk of judgments, arbitral awards or equitable remedies with respect to such Stockholder Agreement that conflict with decisions by Delaware courts in parallel stockholder proceedings with respect to the same Stockholder Agreement.
[v] DGCL, Section 211(b); Rohe v. Reliance Training Network, Inc., No. CIV. A. 17992, 2000 WL 1038190, at *11 (Del. Ch. July 21, 2000) (“Rohe”).
[vi] DGCL Section 141(k); Rohe, ibid.
[vii] DGCL Section 251.
[viii] DGCL Section 102(b)(7).
[ix] See, however, Jones Apparel Grp., Inc. v. Maxwell Shoe Co., 883 A.2d 837, 852 (Del. Ch. 2004), suggesting that a provision divesting the board of the power to approve amendments to a charter or a merger may not be permitted even in the charter.
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