A recent decision by the Delaware Court of Chancery, W. Palm Beach Firefighters’ Pension Fund v. Moelis & Co. (“Moelis”), held corporate shareholder agreements are invalid if they impose certain restrictions on the Company’s Board. In response, the Delaware Senate added further uncertainty on the power structures of corporations under Delaware law. Introduced on May 23, 2024, Delaware Senate Bill 313 (“S.B. 313”) amends Section 122 of the Delaware General Corporation Law (“DGCL”) and “authorizes a corporation to enter into contracts with one or more of its stockholders or beneficial owners of its stock” to:
- restrict or prohibit future corporate actions specified in the contract;
- require the approval or consent of one or more shareholders before the corporation act; and
- covenant that the corporation will take, or refrain from taking, future actions specified in the contract.
Critics claim that the Bill has the potential to “functionally redefine what it means to be a corporation.”
THE MOELIS DECISION
On February 23, 2024, Travis Laster, Vice Chancellor of the Delaware Court of Chancery held in Moelis that a company’s stockholder agreement violates Section 141(a) of the DGCL where it is part of an internal governance arrangement of the company that grants stockholders pre-approval requirements over the board. Addressing the expansion of restrictive stock agreements, the Moelis court stated “What happens when the seemingly irresistible force of market practice meets the traditionally immovable object of statutory law? A court must uphold the law, so the statute prevails.” Citing Abercrombie v. Davies, the Moelis court adopted the plaintiff’s argument that “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.’”
In an extensive 133-page opinion, the Moelis court put forth a two-part test:
- “The court must determine whether the challenged provision is part of an internal governance arrangement. If not, then the inquiry ends. If so, then the court must apply the Abercrombie test to determine whether the provision imposes a restriction that violates Section 141(a).
- Second, “does The Challenged Provision Improperly Restrict The Board?” Where step one has been met, “the court must assess whether the provision has the effect of removing from the directors in a very substantial way their duty to use their own best judgment on management matters or tends to limit in a substantial way the freedom of director decisions on matters of management policy.”
If the challenged provision meets both parts of the test, then Section 141(a) is violated.
Although the Moelis court held that “the statute prevails” over market practices, it acknowledged that its interpretation of the “immovable object” of the law comes at the expense of the “new-wave agreements” of stockholders which typically “contain extensive veto rights and other restrictions on corporate action.” The court further noted that “the General Assembly could enact a provision stating what stockholder agreements can do,” and it appears that the Delaware Senate has quickly responded to the Moelis court’s signal.
S.B. 313
The proposed Bill adds a new subsection to Section 122 of the DGCL that gives companies the power to enter into contracts with current or prospective stockholders that include rights like those given to the founder in Moelis, including certain veto rights*. This amendment would reverse Moelis, but has already been identified as “potentially handing over the board’s power to powerful shareholders.” This would “hollow out” Section 141(a) of the DGCL,” which empowers the board of directors to manage the affairs of a corporation. Other opinions have urged caution to the proposed amendment and encouraged the Delaware Senate to take more time to consider the “critical issues” raised by the proposed legislation, and the potential effect on the rights of all investors in a corporation.
As it stands, S.B. 313 has about a month to pass under the current Senate’s term, which adjourns June 30. While this may leave limited time to passage, the Bill was sponsored by eighteen of the twenty-one members of the Delaware Senate. This in effect means that there will be little time for any opponents to the Bill to organize debate against certain passage if the Delaware Senate acts. The Delaware House of Representatives also adjourn on June 30, meaning any passage in the Senate must leave time for re-introduction and passage in the Lower House, which is on break until June 11, 2024. If enacted, S.B. 313 would be effective August 1, 2024.
While the passage and signing of S.B. 313 is not certain, any shareholders of companies organized in Delaware should carefully monitor the Bill’s progress. Even without the new statute, the full implications of the Moelis decision have not been resolved.
*Although Moelis delt with Section 141(a), S.B. 313 addresses Section 122 because this is the section of the DGCL that control contracts between a corporation and current or prospective shareholders.
