July 31, 2024
On July 17, Gov. Carney, a Democrat, signed Senate Bill 313 (S.B. 313), which sailed through the Delaware State Assembly in June despite concerns raised by dozens of academics, shareholder rights’ advocates, and two judges.
Critics said the state’s bar association and lawmakers too hastily drafted the law, contending that it allows side agreements whereby a company’s board of directors can cede its rights to a few powerful stockholders. The law was conceived as a response to several high[1]profile court rulings by the Delaware Court of Chancery that were perceived as anti-business, one of which is still under appeal.
The Senate passed S.B. 313, unopposed and without debate on June 13, just three weeks after it was introduced; a week later, on June 20, the House voted 34 to 7 to approve the measure. Now law, the measure amends the Delaware General Corporation Law (DGCL), which directly affects the governance of millions of companies incorporated in the First State and serves as a model nationwide.
Background
The DGCL includes important investor protection privileges, which are typically refined over time through a steady stream of decisions by the highly specialized and well-respected Delaware Court of Chancery. But recently a debate has unfolded over whether the Court has given shareholders too much say over how companies are run, rather than deferring to the business judgment of corporate directors. Delaware is home to more than half of all U.S. publicly traded corporations and more than two-thirds of the Fortune 500, and some leaders fear that any perceived bias could lead to an exodus.
DGCL Section 141(a) says the “business and affairs” of Delaware corporations “shall be managed by or under the direction of a board of directors,” as long as the directors act loyally and carefully as required by their fiduciary duty to the corporation and its stockholders. The “business judgment rule,” as it’s known, is an important element of the DGCL and has been a key to the state’s popularity among businesses— along with low startup costs, ease of incorporation, and the promise that legal disputes will be adjudicated by the Chancellors, as the seasoned and sophisticated Chancery Court judges are known.
Since 2023, several companies citing increased litigation risk have left Delaware, including TripAdvisor and Fidelity National Financial. Most famously, in June, Tesla CEO Elon Musk sought and received shareholder approval to reincorporate in Texas after Chancellor Kathaleen St. Jude McCormack rejected his 2018 pay package, originally worth $56 billion. In her January opinion, Chancellor McCormick sided with investors who said Tesla’s Board of Directors was beholden to Musk and breached its fiduciary duty by approving the mammoth pay package after sham negotiations.
Moelis
In the interest of brevity, today’s article will deal with only one of the three rulings addressed by the new law: the February 23, 2024 decision by Vice Chancellor J. Travis Laster in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co. (Moelis).
Moelis & Co is a global investment bank founded by Ken Moelis, who ran the bank for years as a private entity before deciding to raise capital by taking the company public in 2014. In order to do so, he reorganized Moelis under a new holding company incorporated in Delaware with himself as CEO and Chairman of the Board.
In Moelis, Vice Chancellor Laster granted summary judgment in favor of a pension fund that objected to a stockholder agreement between Mr. Moelis and the company, reached a day before the IPO, that required the Board of Directors to get written pre-approval from Mr. Moelis over important business decisions and the composition of the board itself. As summarized by Vice Chancellor Laster: “The Pre-Approval Requirements encompass virtually everything the Board can do. Because of the Pre[1]Approval Requirements, the Board can only act if [Mr.] Moelis signs off in advance.”
Citing the standard established in Court’s landmark 1957 decision, Abercrombie v. Davies, Vice Chancellor said some of the challenged provisions facially violated Section 141(a) because they “have the effect of removing from directors in a very substantial way their duty to use their own best judgment on management matters” or “tend[] to limit in a substantial way the freedom of director decisions on matters of management policy. . .”
Moreover, Vice Chancellor Laster wrote, Mr. Moelis “could have accomplished the vast majority of what he wanted” by changing the company charter or having the company issue him new preferred stock with outsized voting and director appointment rights. Instead, he created a situation where “the business and affairs of the Company are managed under the direction of [Mr.] Moelis, not the Board,” as required by Section 141(a).
Opposition to S.B. 313
Into this climate of uncertainty strode the Council of the Corporate Law Section of the Delaware State Bar Association, which quickly drew up S.B. 313 and obtained Bar Association backing. Introduced on May 23 by Delaware Senate Majority Leader Bryan Townsend, a corporate attorney with Morris James LLP, the measure allows the type of stockholder agreements invalidated in Moelis, even if their provisions are not specified in a certificate of incorporation.
The bill drew fire even before its introduction—including from Chancellor McCormick, the author of the two other opinions that prompted the creation of S.B. 313. In an April 12 letter that became public at the end of May, Chancellor McCormick wrote the Delaware State Bar Association that “there is no justification for the rushed nature of the proposal. . .” which, she said had “moved forward at a pace that forecloses meaningful deliberation and input from diverse viewpoints.” The Chancellor also took issue with the fact that the Delaware Supreme Court had not yet ruled on an appeal to the decision. “So why the rush?” she asked.
On June 7, after S.B. 313 had been introduced, a group of more than 50 law professors opposed the bill in a letter to the members of the Delaware Legislature. In the letter, posted on the Harvard Law School Forum on Corporate Governance, the professors wrote that, beyond overturning Moelis, the proposal “would allow corporate boards to unilaterally contract away their powers without any shareholder input.”
“We are professors of corporate law, and we routinely disagree over corporate law issues. Yet we are unanimous in our belief that the appropriate response to the Moelis decision is to allow the appellate process to proceed to the Delaware Supreme Court,” the letter said. “The issues at stake warrant careful judicial review, not hasty legislative action.”
Also in June, Vice Chancellor Laster, in a LinkedIn post he said was made outside his official capacity, called out S.B. 313 as “not the annual tweaking of the DGCL. That’s a cosmetic procedure by comparison. This is major surgery.”
Finally, on July 10, the Council of Institutional Investors asked Gov. Carney to veto the bill, saying that lawmakers’ “unprecedented action” to “overturn[] a trial court ruling that is not yet final” constituted a “legislative rush to judgment. . .”
“A hallmark of Delaware General Corporation Law is the careful and deliberate nature in which it is adopted and enforced, as well as the ways in which Delaware law balances boards’ decision-making with accountability to shareholders,” CII Jeffrey Mahoney wrote. “That reputation could be seriously impaired by a perception that influential actors can easily change the law whenever the Delaware Court of Chancery has the temerity to rule against them.”
The speed with which the measure was created, approved, and enacted appears to swing the pendulum in Delaware away from the Court of Chancery and advocates of a more deliberative approach to changes in Delaware’s board-centric corporate governance model.