A recent decision by the Delaware Chancery Court has shaken up the existing state of the governance and management of Delaware corporations. In West Palm Beach Firefighters Pension Fund v. Moelis & Co., the court sided with the plaintiff, a stockholder of Moelis & Company (the "Company"), who challenged the facial validity of several provisions in a stockholders' agreement (the "Stockholders Agreement") between the Company and Ken Moelis, the founder, CEO, and chair of the Company. The provisions at issue in the Stockholders Agreement granted Moelis sweeping, valuable rights with respect to the governance and management of the Company. Given that such rights are common in stockholders agreements, the Moelis decision has compelled various stakeholders to reconsider established governance arrangements and contemplate methods for structuring such agreements in the future.
In Moelis, the court analyzed the three categories of expansive rights – Pre-Approval, Board Composition, and Committee Composition – and decided that each was facially invalid under Section 141 of the Delaware General Corporate Law (DGCL). Section 141(a) of the DGCL provides 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." The plaintiff's claim was grounded in Delaware precedent that held that a governance restriction in an agreement (not inclusive of the corporation's certificate of incorporation) is prohibited when it, either directly or indirectly, has "the effect of removing from 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."
The Pre-Approval requirements were taken under consideration collectively and specify that the board could not approve, without Moelis' prior consent, a variety of actions (in the court's words, "virtually everything the board can do."). The actions included removing or appointing executives, paying dividends, bringing lawsuits, entering new lines of business, adopting annual budgets and business plans, issuing stock, executing material contracts, incurring debt, and changing the company's name. The court reasoned that, in combination, such provisions violate Section 141(a) of the DGCL because all meaningful action of the board is subject to Moelis' consent, depriving the board of "a significant portion of their authority" over management activities.
Moelis had similarly broad rights with respect to the composition of the board and committees under the Stockholders Agreement. The Stockholders Agreement: (1) entitled Moelis to designate nominees for a majority of the seats (the "Designation Right"), (2) required the board to nominate Moelis' designees (the "Nomination Requirement"), (3) required the board to recommend that the stockholders vote in favor of Moelis' designees (the "Recommendation Requirement"), (4) required the Company to use reasonable efforts to enable the election of Moelis' designees (the "Efforts Requirement"), (5) required the size of the board to consist of no more than 11 directors (the "Size Requirement"), (6) required the board to fill any vacancy in a seat occupied by a Moelis designee to be filled with another individual designated by Moelis (the "Vacancy Requirement"), and (7) required the board to fill any committee with a number of Moelis' designees proportionate to the number of his designees on the full board (the "Committee Composition Provision"). Of the seven foregoing rights, the court decided that the Recommendation Requirement, the Vacancy Requirement, the Size Requirement, and the Committee Composition Provision were impermissible under Section 141(a) of the DGCL. In the court's view, the limits the Stockholders Agreement placed on the authority of the board to make recommendations, fill vacancies, and determine the size of the board and composition of committees, functionally meant that the board could "manage the Company only to the extent Moelis gives them permission to do so." This arrangement, again, deprived the directors of a material part of their authority to act as a board, precluding them from exercising their independent judgment in the management of the Company as required by Section 141(a) of the DGCL. The other three requirements (the Designation Right, the Nomination Requirement, and the Efforts Requirement) were held to be permissible under Section 141 of the DGCL; such requirements did not force the board to take any specific actions and were, therefore, legitimate stockholder rights.
As previously noted, it's common for stockholders agreements to contain rights similarly favorable to those that Moelis enjoyed under the Stockholders Agreement. The court acknowledged that "[c]orporate planners now regularly implement internal governance arrangements through stockholder agreements providing favored stockholders with extensive veto rights and other restrictions on corporate action." So, recognizing that the Moelis decision could be potentially "highly disruptive" to market practice, the court provided a couple of valid alternatives for giving a stockholder like Moelis substantially the same expansive rights without violating the DGCL. For example, the court stated that the "vast majority" of the Moelis governance rights could have been validly set forth (i) in an amendment of the Company's charter or (ii) through issuance of a golden preferred share (i.e., a share of preferred stock that carries governance rights but no economic interest; the certificate of designations for the preferred stock by law would become part of the charter). The court reflected, "Although some might find it counterintuitive that the DGCL would prohibit one means of accomplishing a goal while allowing another, that is what the doctrine of independent legal significance contemplates." Therefore, building specific protective provisions in the charter may provide more robust protection for stockholders as compared to specifying the same rights in a stockholders agreement (note, however, that this may be complicated by fiduciary implications).
Although the Moelis decision has shaken up the existing state of the governance and management of Delaware corporations, stakeholders will hopefully get some clarity in the near future. The court noted that the "expansive use of stockholder agreements suggests that greater statutory guidance may be beneficial" and that it "would welcome additional statutory guidance." To that end, the Council of the Corporation Law Section of the Delaware State Bar Association approved legislation proposing to amend the DGCL to provide guidance on what governance restrictions are permitted. The legislation is expected to advance to the Delaware General Assembly for consideration during its 2024 regular session. If enacted, the 2024 amendments will provide explicit authorization for the types of provisions that the court found to be overbroad and statutorily impermissible in theMoelisStockholders Agreement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.