Corporate lawyers ask General Assembly to change law after legal defeat

Proposed changes to Delaware’s General Corporation Law would upend more than a century of corporate fiduciary law.

 · April 12, 2024
Legislators working on the floor of the Delaware General Assembly

Lawyers representing the most powerful corporate interests in the country are on the cusp of sending a draft bill to the General Assembly asking it to change Delaware’s corporate code after a legal defeat in the Court of Chancery left a single investor unable to wield near-total control over a public corporation.

The proposed amendment to Delaware’s General Corporation Law (DGCL), which was recently approved by a special committee within the Delaware State Bar Association (DSBA), has drawn criticism from legal experts who are questioning not only the timing of the amendment, which some see as a direct challenge to the Court of Chancery, but also the bill’s substance, which could potentially upend more than a century of corporate law in the United States. At stake is nothing less than corporate democracy itself — the ability of shareholders and boards of directors to decide important corporate issues.

So what happened?

Last month, the Court of Chancery issued a narrow opinion in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co. that invalidated provisions of a stockholder agreement between Moelis & Co. and its founder and chief executive officer that required his personal approval for nearly all consequential corporate decisions, including who should sit on the board of directors. In the Court’s opinion for Moelis, Vice Chancellor J. Travis Laster found that the broad terms of Moelis’ contract, which was entered into before the stock went public and gave a single shareholder veto power over decisions usually left to a board of directors, wrongly disempowered the directors and therefore violated Section 141(a) of the Delaware corporate code, which requires boards to act in the best interest of the companies they oversee, for the benefit of the shareholders, whom they represent as fiduciaries.

In other words, certain types of shareholder agreements that purport to tell boards of directors what they can or can’t do in the future are therefore invalid under the Moelis ruling. Shareholders vote for the directors and have a right to expect that it is the directors who will be in charge of the corporation. 

There are well-established ways around this rule. Because the certificate of incorporation sets out the basic ground rules of corporate law and is a public document anyone can view, if the corporation wants to put limits on the board’s power, it is free to do so in the certificate. But Moelis didn’t do that – instead using a private stockholder agreement, which was struck down by the Court.

However, just weeks after the Court of Chancery invalidated sections of the Moelis contract, the DSBA Corporation Law Council proposed amendments to Delaware’s corporate code that will change the rules in favor of powerful investors, allowing the very kinds of contracts the court just invalidated, “whether or not so provided in the certificate of incorporation,” according to language included the original draft bill.

“The Amendments may be well-intentioned, but regardless of one’s view of Moelis, they are not well-suited to their purpose,” law professors Sarath Sanga and Gabriel Rauterberg wrote in an article recently published in the Harvard Law School Forum on Corporate Governance. “On its face, the Amendment seemingly authorizes corporations to enter any contract changing any aspect of corporate governance. But that cannot be its intended effect.”

Among the questions they have of the new law:

  • Do the Amendments intend, for example, to empower a corporation to promise its directors that it will never sue them, even for an intentional tort or bad faith act?
  • Do the Amendments intend to empower a board to cede 100 percent of its decision making power to a single person?

“The answers to these questions,” wrote Sanga and Rauterberg, “cannot be yes” because that would directly contradict the most fundamental principles underpinning corporate accountability under Delaware law.

How does all this complicated legal jargon work in the real world? In an interview with Delaware Call, Sanga and Rauterberg expanded on their critique. For example, according to Delaware corporate law, only natural persons can serve on boards of directors.

“This is as old as Delaware corporate law itself,” said Sanga. “But the amendment seems to enable a board to cede, or a corporation to cede, 100 percent of its powers to an entity. This is something that has never been contemplated.”

“It’s really a bit of a dramatic expansion of what you can do by a contract between a corporation and a given stockholder,” Rauterberg added. “Changes to the DGCL are usually explicitly and finely targeted at a problem. And I think what is causing consternation in this proposed amendment is it’s taking a sledge hammer to hit a nail, tackling something in one unpopular opinion by purporting to legalize virtually anything by contract.”

After approval from the Corporation Law Council, the Corporation Law Section (within which the Council sits) approved the proposed amendments by majority vote on Monday. The Executive Committee of the DSBA is likely to hold a final vote on the proposal next week, after which the draft bill will be sent to friendly members of the state Senate, who are likely to sponsor the bill and begin the legislative process. And given that nearly 1.9 million corporations now call Delaware their legal home — including two-thirds of Fortune 500 companies like Amazon, Coca-Cola, Comcast, and Google’s parent Alphabet — this amendment to a small state’s corporate code will have profound national ramifications.

What makes the draft bill doubly concerning is the timing. It’s not unusual for the DSBA to propose changes to the corporate code in response to Chancery Court rulings, but generally these changes come months or years after final judgment. Among Delaware’s state and local leaders, the corporate lawyers of the DSBA are looked to as experts on business matters, and amendments to the corporate code are usually treated as routine and noncontroversial. However, amendments are rarely — if ever — offered within weeks of a disappointing court ruling, particularly when the Delaware Supreme Court has not yet had the opportunity to weigh in, and the matter has not yet reached a final, nonappealable judgment. 

The DSBA already sent its proposed amendments to other sections of the corporate code to the General Assembly back in January, and as Delaware Call reported, there were no changes to the DGCL proposed at that time. That the DSBA is now rushing amendments to the DGCL suggests the Moelis ruling was something of an unwelcome surprise.

“You could completely overturn Moelis and still have a cabining provision that doesn’t invite endless uncertainty,” Rauterberg said. “The current phrasing invites the question: Is there anything you can’t do by contract now? Can you just alter the entirety of corporate law, and do things you otherwise cannot do at all, by entering an appropriately phrased contract with your shareholder? And the idea that the answer to that question is yes — that you could do anything — is so implausible, but therein lies the problem with the amendment.”

Last year, when Delaware state Rep. Madinah Wilson-Anton proposed a rare amendment to DGCL changes that had been offered by the Corporation Law Council, the now-chair of the Council reportedly promised legislators (at 4:10:09 pm) that future bills would be provided earlier in the legislative session to allow important corporate issues to be addressed more thoroughly, including in public committee meetings open for debate. In a follow-up with legislators, the Council reiterated its commitment “to file amendments of the annual updates to the Corporation Law and the Alternative Entity bills earlier in the year to give legislators ample opportunity to review and discuss the substance of the updates.” 

READ MORE: Special interests pull back on Delaware corporate law changes after Wilson-Anton amendment

Although this did occur with the alternative entity proposals that were made earlier this year, these new, late additions to the DGCL will arrive at Legislative Hall with little time remaining for robust analysis or debate over the complex legal issues at stake in this bill.

The DSBA did not respond to a request for comment as of publication.

If the bill passes the General Assembly, Sanga and Rauterberg suggest the proposed amendments “would only exacerbate uncertainty” in Delaware corporate law. “The question of how corporations should be able to alter corporate governance to optimize their affairs is a really profound one that deserves the systematic attention of the Council of the Delaware State Bar Association and the state legislature,” Rauterberg concludes. “They should just pull back on proposing this amendment this year and take a much more systematic path for next year. This is a great topic for legislative involvement, but it can’t be done in this overly broad way.”

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Read more from Jordan Howell.