What’s Next After 2024 “Market Practice” DGCL Amendments – Moelis and Stockholder Agreement Amendments
Effective August 1, 2024, amendments to the Delaware General Corporation Law (DGCL) took effect that codify the right of corporations to enter into agreements granting stockholders specific control rights that would otherwise intrude upon the board of director’s scope of authority under Delaware law. The amendments were specifically in response to the 2024 Delaware Court of Chancery ruling in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company (Moelis or the “Opinion”).
In the Opinion, Delaware Vice Chancellor Travis Laster invalidated provisions of a Stockholders’ Agreement that granted Ken Moelis, the CEO and Chairman of the Board of Moelis, certain approval rights in his capacity as a shareholder that gave him an essential veto right over all the actions that would ordinarily be in the Board’s discretion to approve as well as a right to ensure his designees controlled the Board. The plaintiff shareholder argued that the pre-approval requirements and board composition provisions, among others, violated Section 141(a) of the DGCL. Section 141(a) is a fundamental underpinning of Delaware corporate law under which the business and affairs of every Delaware corporation “shall be managed by or under the direction of a board of directors, except as may be otherwise provided in [the DGCL] or in [the corporation’s] certificate of incorporation.” The Court of Chancery reasoned that under the Stockholders’ Agreement the business and affairs of the Company were being managed under the direction of Moelis, rendering the Board a mere advisory body. Calling stockholder agreements “fertile ground” for violations of Section 141(a), the Court stated that such agreements are subordinate to the DGCL, Company charter and bylaws in the corporate hierarchy. Thus, the Court noted that the corporation could have achieved a similar corporate governance arrangement without violating Section 141(a) through its charter, preferred stock designations or bylaws. Even if it has been market practice in “new-wave agreements” to impose governance limitations on a board, Moelis held that the statute prevails over common market practice unless and until the General Assembly could enact a provision stating that stockholder agreements can do more.
The General Assembly did just that, enacting into law new DGCL Section 122(18) (the “Amendments”) which authorizes a corporation’s board to enter into agreements with one or more current or prospective stockholders that allow stockholders’ consent rights similar to those at issue in Moelis in exchange for minimum consideration (as determined by the board). The Amendments effectively allow for privately negotiated governance terms between a corporation and its investors, including prospective investors, notwithstanding Section 141(a) of the DGCL. The Amendments apply retroactively to stockholder agreements entered into prior to the law’s enactment (but not to any civil actions or proceedings completed or pending prior to August 1, 2024). Now that Delaware companies are statutorily entitled to enter into such agreements without amending their charters, controlling stockholders and prospective investors are likely to negotiate for significant governance rights under such agreements.
A stockholder agreement may not, however, include provisions that would be unenforceable if included in the corporation’s charter (except for governing law and forum selection clauses). No provision of a stockholder agreement would be valid to the extent inconsistent with the corporation’s charter or the DGCL. Corporations that have or plan to enter into such shareholder agreements should carefully analyze them in relation to the DGCL and charter to ensure there is no such inconsistency. Conversely, if a corporation wishes to limit the impact of Section 122(18), it could do so in the corporation’s charter (for example, by expressly limiting the shareholder veto rights allowable under a separately negotiated shareholders’ agreement).
New Section 122(18) also does not relieve any directors, officers or stockholders of the fiduciary duties they owe to the corporation or its stockholders, including with respect to entering into, performing under or breaching a stockholder agreement. Even if negotiated control rights are permissible under such agreements, the new law also implies that the board would have a fiduciary out if a breach of such agreement would in the best interests of the corporation and its shareholders.
Going forward, corporations and boards entering into contractual arrangements that afford broad control rights to specific shareholders should consider and carefully weigh any expanded approval rights in light of the company’s governing documents, the DGCL and the fiduciary duties applicable to the specific matter in question, for example in the context of approving a change of control transaction or determining whether the actions of a controlling shareholder are fair to the corporation.
