On February 23, 2024, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery issued a decision concluding that some provisions of a stockholder agreement purporting to give a large stockholder various governance rights—here, in the public company and investment bank Moelis—violated the Delaware statute by infringing upon the authority of the board of directors and were therefore invalid.1 The decision will receive attention going forward, with regard to both preexisting governance arrangements that involve similar issues and structuring such arrangements in the future.
The relevant facts are as follows. In 2014, in preparation for its initial public offering, the company and its founder and controlling stockholder entered into an agreement that included various governance-related rights in favor of the founder. Specifically, the agreement required i) the company’s board to obtain the founder’s prior consent before taking 18 different categories of action, ii) the board to maintain the board size at not more than 11 directors, iii) the board to allow the founder to name designees equal to a majority of those seats, to nominate those designees for election and to fill vacancies in those seats with new founder designees, iv) the board to recommend that the company’s stockholders vote in favor of the founder’s designees, v) the company to use reasonable efforts for the founder’s designees to be elected and continue to serve as directors and vi) the board to include a certain number of the founder’s designees on each board committee. Nine years after the IPO, in 2023, a stockholder filed suit, challenging these provisions as violating the Delaware General Corporation Law (the DGCL). In an earlier decision issued on February 12, 2024, the court concluded that the stockholder’s complaint was not time-barred given, among other things, the technical nature of the claims.2
In its 133-page decision resolving cross-motions for summary judgment, the court largely sided with the plaintiff and determined that most of those rights—the consent rights, the board size requirement, the obligation of the board to recommend the founder’s nominees and fill vacancies with such nominees, and the board committee requirement—violated the DGCL. The heart of the court’s determination was that the stockholder agreement was an internal governance arrangement, but that under Section 141(a) of the DGCL, the business and affairs of the corporation must be managed by or under the direction of the board of directors unless otherwise provided by the certificate of incorporation or another provision of the DGCL. The court described Section 141(a) as the “source of Delaware’s board-centric model of corporate governance” and cited prior case law describing Section 141(a) as the “bedrock” of Delaware law and a “cardinal precept.”
Reviewing Delaware case law on board authority dating back to the early twentieth century, the court determined that the offending provisions—set forth in a stockholder agreement and not in the certificate of incorporation—operated as an improper constraint on board authority in violation of Section 141(a) and interfered with the board’s authority to use its best judgment on management matters and policy. As to the board committee requirement, the court also concluded that Section 141(c) vests the board with the authority to populate board committees. The court contrasted the stockholder agreement at issue—consisting of “governance arrangements”—with external commercial contracts, which can validly limit a board’s range of authority and provide third parties with consent rights and the like.
At the same time, the court concluded that some of the rights in question—particularly, the requirement to nominate the founder’s nominees for election and to use reasonable efforts for such nominees to be elected and to continue to serve as directors—were not facially invalid because they could operate legitimately under Delaware law. In particular, the court noted that stockholders have a fundamental right to nominate directors and that the corporation could appropriately take efforts, such as including the nominees in its proxy materials and on its proxy card, to cause the founder’s nominees to be elected and to serve on the board.
It is important to note what the decision did not invalidate or call into question. The court noted that there may have been other structural pathways to designing a corporate structure that worked similarly to the arrangement in question, such as by incorporating certain of these stockholder rights into the certificate of incorporation. The case did not appear to address agreements with express “fiduciary outs” that make the provisions of the agreement explicitly subject to the board’s fiduciary duties. The case also does not invalidate stockholder agreements in general. Indeed, Section 218 of the DGCL permits stockholder agreements, and the opinion expressly recognizes that when stockholders “are bargaining over their private property” in the form of a stockholder agreement, they may have relatively broad flexibility to make their own determinations. The court noted that this means that stockholders can agree, among other things, how to vote their shares and when and how to sell their shares.
In assessing the impact of this case on current and future governance arrangements involving contracts outside of the certificate of incorporation, the details of the arrangements will matter—including the specific governance rights and obligations in question, whether they are referenced in the company’s certificate of incorporation, and potentially whether contractual provisions have fiduciary outs. There are several other cases pending in the Court of Chancery involving challenges to similar provisions in stockholder agreements of other companies. We will monitor future developments in these matters and any appeal activity in the case.
[1] West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., C.A. No. 2023-0309-JTL (Del. Ch. Feb. 22, 2024).
[2] West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., C.A. No. 2023-0309-JTL (Del. Ch. Feb. 12, 2024).
