Delaware Gov. John Carney, whose state is home to almost two million corporations and almost 70% of Fortune 500 companies, will soon receive a bill for his signature that allows a founder or other big shareholder to enter into an agreement with the company to exercise authority over key management decisions.
The bill effectively codifies into law an increasingly common use of agreements to shift authority from boards to powerful shareholders — often after a company goes public — over critical matters like mergers, consolidation, recapitalization, board size or committee composition.
The bill is a response to recent decisions by the state’s closely watched Chancery Court that critics contend interfere with contractual matters between companies and their shareholders.
In a February decision, for example, Chancery Court Vice Chancellor Travis Laster shot down parts of an agreement between Ken Moelis and the investment firm he took public in 2014, Moelis & Co. The agreement gave him, post-IPO, pre-approval rights on major business decisions and rights to approve a majority of directors and the composition of committees.
Critics say the decision ignores that such agreements have become commonplace. In the ruling, Judge Laster said Delaware law is clear that the kind of authority at stake in the case resides with boards, statutorily, and that the proper place for handing significant authority over to a shareholder is in an amendment to the company’s charter or through issuance of preferred stock, which are open to public scrutiny, not in a private contractual agreement.
“He [Moelis] could have accomplished the vast majority of what he wanted through the Company’s certificate of incorporation (the ‘Charter’),” the judge said in the ruling. “Even now, the Board could implement many of the Challenged Provisions by using its blank check authority to issue Moelis preferred stock carrying a set of voting rights.”
It’s because Delaware places a premium on keeping the balance of interests between the board and shareholders properly weighed that the state has become the default choice for incorporations, Joel Fleming of the law firm Equity Litigation Group told The Wall Street Journal.
“The reason Delaware has been successful is because it’s perceived as neutral and balanced between management and public investors,” Fleming said.
Critics say decisions like Moelis run roughshod over contractual matters that parties enter into freely with one another.
“It appears that many stockholder agreements with Delaware corporations (public or private) that provide governance rights to stockholders ... may be invalid,” attorneys at Fried, Frank say in an analysis.
That raises an issue for any type of agreement, possibly even commercial agreements, to the extent they have governance provisions in them, the analysis says. There could be “an issue” with “certain other corporate agreements that provide for such rights,” the analysis says.
Laster says this concern is overblown. “No one would mistake the Stockholder Agreement for a supply agreement, credit agreement, or some other external commercial contract,” which isn’t subject to Delaware’s board governance requirement, the judge said in the ruling.
Regardless of which side of the issue one is on, the bill isn’t the way to go, a group of almost 60 corporate law scholars say in an open letter to the state legislature.
The better approach is to let the plaintiffs in the case, who represent investors, appeal and have the matter sorted out by the state’s top court.
“The issues at stake warrant careful judicial review, not hasty legislative action,” the group says.
Among their concerns is that the bill, once signed, will let companies present one governance structure to the public — and investors will make due diligence decisions based on that — only to change that later in a non-public agreement, effectively creating two classes of investors.
“A company will be able to go public with a single-class capital structure and then, after the company is already public, confer comprehensive control rights by contract on a powerful founder without any stockholder vote,” the law scholars say in an analysis of the bill.
The bill would exempt these shareholder contracts from Delaware’s main board governance provision, creating a separate class of internal corporate claims — including claims of breach of fiduciary duty — that could be arbitrated and decided under non-Delaware law.
“These would be the most consequential changes to Delaware corporate law of the 21st century, and they should not be made hastily — if at all,” the scholars say.
The bill, should it be signed, could take effect as early as August 1, according to The Wall Street Journal report. The publication reports that the governor intends to sign it.
