This article describes recent Delaware decisions that are relevant to the Model Business Corporation Act (the “MBCA”). These include several decisions addressing (i) the validity of governance provisions in agreements and (ii) the requirements for board of directors and stockholder approvals of merger agreements. In addition, this article describes legislation recently enacted in Delaware dealing with a number of the issues raised by these decisions.
Validity of Governance Provisions in Agreements
Delaware Decisions
Moelis Decision
In West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, 311 A.3d 809 (Del. Ch. 2024),[1] the Delaware Court of Chancery held that certain pre-approval rights and board and committee composition provisions in a stockholder agreement entered into by the corporation with its controlling stockholder in anticipation of an initial public offering (“IPO”) by the corporation were facially invalid under Section 141(a) of the Delaware General Corporation Law (the “DGCL”), which provides that the “business and affairs of every corporation . . . shall be managed by or under the direction of the board of directors, except as may be otherwise provided in [the DGCL] or the certificate of incorporation.” The Court held that those provisions infringed on the power of the board to manage the corporation’s affairs under the DGCL’s board-centric model of corporate governance.
The challenged stockholder agreement required the corporation to obtain the stockholder’s approval before taking various corporate actions and granted the stockholder extensive rights designed to ensure that he could elect a majority of the directors and that the composition of board committees would be proportionate to the number of the stockholder’s designees on the board. While the Court characterized the agreement as a “new-wave” stockholder agreement, rights of this kind are often found in agreements entered into in connection with debt and equity financings (including venture capital and private equity investments) and other commercial arrangements, as well as in settlement agreements with activists. The Moelis decision raises significant questions regarding the validity of these provisions when they are included in this kind of agreement. Because the decision is likely to be appealed, it may not be the last word from the Delaware courts on these issues.
The Court held that the pre-approval requirements in the Moelis agreement, viewed collectively, and some of the stockholder’s rights involving the composition of the board and its committees were facially invalid under Section 141(a). In addition, the Court held that the provisions related to the composition of board committees were also invalid under Section 141(c)(2), which vests the board with the authority to designate committees. The Court noted that most of the invalidated provisions (but not those relating to the composition of board committees or that are inconsistent with a mandatory feature of the DGCL) would have been valid if they had been included in the certificate of incorporation. This could have been accomplished by either (i) including them expressly in the certificate or by incorporating them by reference to an agreement as permitted by Section 102(d) regarding reference to extrinsic facts, or (ii) if the board is authorized to create new classes or series of stock (“blank check” authority), including them in a certificate of designation and issuing a single “golden” preferred share. An amendment of the certificate of incorporation would, of course, require stockholder approval, but a new class or series of stock could be created by the board alone if it has blank check authority.
The Court noted that, although Delaware is a contractarian state that favors private ordering, the ability to do so is subject to the limitations of the DGCL. The Court emphasized the need to differentiate between an agreement creating an internal governance arrangement and an external commercial contract that constrains board actions, like a credit agreement with restrictive covenants or an exclusive supply contract, while it also recognized the challenge in differentiating between the two. The Court identified several factors that indicate that an agreement creates an “internal governance” arrangement, including whether it arose out of an obvious commercial exchange and whether the purpose of the restrictions was to allocate governance rights. However, the Court did not specify how those factors should be weighted, other than that all of them are matters of degree and none are essential. It then indicated that once a contractual provision appears to be part of the corporation’s internal governance arrangements, a court must assess whether the provision prevents or limits in a substantial way the ability of the directors to use their own best judgment and make decisions in managing the corporation’s affairs. Applying these standards, the Court had no problem concluding that the Moelis stockholder agreement involved an internal governance arrangement that was not tied to any underlying commercial transaction and finding that most of its provisions violated Section 141 and were invalid. The Court found, however, that several provisions in the agreement that related to the rights of the stockholder to nominate board members and for the corporation to use its best efforts to cause them to be elected were valid.
Wagner Decision
Following the Moelis decision, the Court of Chancery, in Wagner v. BRP Group, Inc., 2024 WL 2741191 (Del. Ch. May 28, 2024), found invalid provisions in another pre-IPO stockholder agreement, as it was initially executed, that required pre-approval by the controlling stockholder of (i) any significant decision regarding a senior officer because it contravened Section 141(a) and Sections 142(b) and (e), (ii) any charter amendment because it contravened Sections 141(a) and 242, and (iii) certain significant transactions, most involving the corporation’s sole operating subsidiary, because it violated Section 141(a). Wagner differed from Moelis, however, because following the filing of the lawsuit, the parties modified the challenged stockholder agreement to provide that the stockholder would approve any action that a committee of the independent directors unanimously determined in good faith was in the best interest of the corporation. The Court considered the effect of the modification on the validity of the governance provisions. Although it recognized that the unanimity requirement permitted any one committee member to block a determination, since the DGCL permits bylaws to establish procedural limitations, like high vote and even unanimity requirements for a corporate action,[2] the Court held that the committee mechanism was sufficient to overcome the invalidity under Section 141(a), but not the invalidity of the senior officer provision under Section 142 or the pre-approval requirement for charter amendments under Section 242.
N-able Decision
After the legislation described below was enacted and before it became effective, the Court of Chancery decided Seavitt v. N-able, Inc., 2024 WL 3534476 (Del. Ch. July 25, 2024), which involved similar issues to those in Moelis and Wagner regarding the validity of a pre-IPO stockholder agreement with controlling stockholders that contained pre-approval covenants and board and committee composition and director removal provisions. Like Moelis and Wagner, the Court found many of the provisions facially invalid in violation of the DGCL, an issue that was not resolved by the legislation because agreements subject to litigation at the legislation’s effective date were excluded from coverage under the legislation. As a harbinger of issues that can arise under the new legislation, the Court suggested that provisions in a stockholder agreement modifying the requirement for stockholder approval under the DGCL or permitting identified stockholders to remove directors might not be valid under the legislation because those provisions would not have been permissible in the certificate of incorporation.
Unlike in Moelis and Wagner, some of the provisions in the N-able certificate of incorporation stated that they were “subject to” the stockholder agreement. That raised the issue whether (as characterized by the Court) “this laconic prepositional phrase” effectively incorporates the stockholder agreement into the charter by reference under Section 102(d) of the DGCL. Not surprisingly in view of this characterization, the Court held that the reference was not sufficient to incorporate the agreement into the charter and, moreover, indicated that a private agreement cannot be incorporated into a charter, which is a foundational public document, noting that the statute only authorizes incorporation of “facts ascertainable” outside the charter.[3]
Delaware Legislation
In response to the uncertainties created by the Moelis decision, legislation has been enacted in Delaware to add a new clause (18) to Section 122 of the DGCL to give corporations the power, notwithstanding Section 141(a), to enter into governance agreements—like the ones in Moelis, Wagner, and N-able—that include approval rights and board composition provisions that otherwise could be included in the certificate of incorporation.[4] The legislation, which encountered some criticism, principally from academics and some in the Delaware judiciary, became effective on August 1, 2024, and applies retroactively except to litigation begun before that date. Section 122(18) eliminates some of the uncertainties for Delaware corporations arising from the Moelis, Wagner, and N-able decisions, but interpretive issues in applying the new provision, such as the scope of agreements authorized under it and how those agreements mesh with fiduciary duties, will need to be considered.
Relevance for the MBCA
Although the Moelis, Wagner, and N-able decisions apply to Delaware corporations, their reasoning could be applied to business corporations formed in other jurisdictions that have provisions similar to Section 141, such as Section 8.01 of the MBCA. Whether other states will follow the reasoning in the Moelis, Wagner, and N-able decisions is not certain. Unlike Delaware, many state corporation statutes, such as those based on the MBCA, expressly permit stockholder agreements, in addition to provisions in the charter, to vary the director management norm. Typically, however, the stockholder agreements authorized by a statute like Section 7.32(b) of the MBCA require that all stockholders be a party to the agreement.[5] Some jurisdictions, including Delaware, have close corporation provisions that permit stockholder agreements. A court might read these provisions to exclude stockholder agreements among less than all of the stockholders as permitted vehicles for varying the director management norm, and if so, the issues raised by Moelis, Wagner, and N-able could be even more difficult in those jurisdictions. On the other hand, a court could preferably read these provisions as nonexclusive for these purposes. The ABA Corporate Laws Committee is currently considering how, if at all, to respond to the Moelis, Wagner, and N-able decisions and the recent Delaware legislation.
In deciding whether governance provisions that do not have the benefit of the Delaware legislation may be validly included in an agreement, practitioners should consider whether the provisions limit the authority and exercise of discretion by the board of directors. In the case of an agreement with these limitations, practitioners should then determine whether those provisions are external commercial contractual arrangements or are internal governance arrangements to be tested against the statutory provisions like Section 141 of the DGCL and Section 8.01 of the MBCA and other provisions of the applicable corporation statute. The Court of Chancery distinguished traditional commercial contracts from the agreements in Moelis, Wagner, and N-able, which were not tied to any underlying commercial transaction and were designed to address corporate governance in an extensive way, thus constituting an “internal governance” arrangement. Accordingly, traditional commercial credit agreements with institutional lenders and securities purchase agreements with equity investors that contain customary restrictive covenants associated with protecting the credit or the investment should not be viewed as an internal governance arrangement. The dividing line is not clear between these customary agreements and agreements with extensive protective and governance provisions that fall between these two.
Analyzing provisions implicated by the Moelis, Wagner, and N-able decisions and giving legal opinions on the validity of those provisions, especially outside of Delaware, may be problematic, and the need to do so should be weighed in the context of the specific transaction. If practitioners are concerned about the validity of provisions in an agreement, they could redraft the provisions, for example by including a fiduciary duty out[6] or similar exception, or they could include some or all of the provisions in the charter, either through an amendment or, if authorized, in a certificate of designation creating a new class or series of stock that becomes part of the charter. Section 102(d) of the DGCL permits certain provisions of the certificate of incorporation to “be made dependent upon facts ascertainable outside such instrument, provided that the manner in which such facts shall operate upon such provision is clearly and explicitly set forth therein,” and Section 2.02(d) of the MBCA permits such provisions to be “made dependent upon facts objectively ascertainable outside the articles of incorporation” if the requirements of Section 1.20(k) of the MBCA are met, one of which authorizes reference to terms of an agreement to which the corporation is a party.[7] Even when governance provisions are included in a corporation’s charter, however, they still should be analyzed to ensure that they are of a type permitted to be included in the charter. For example, as noted above, limitations on the board’s authority to designate committees under Section 141(c) can raise issues, as can provisions that are inconsistent with a mandatory feature of the DGCL.
Actions to Approve Mergers and Other Fundamental Changes
Delaware Decision
In Sjunde AP-fonden v. Activision Blizzard, Inc., 2024 WL 863290 (Del. Ch. Feb. 29, 2024) (corrected Mar. 19, 2024), the Delaware Court of Chancery declined to grant a motion to dismiss a complaint challenging the approval of a merger, which serves as reminder to practitioners of the importance of strictly following the requirements to approve a merger under Section 251 of the DGCL. These requirements relate to the need for a sufficiently final merger agreement to be approved by the board of directors and to the contents of the notice that must be sent to the stockholders when soliciting their approval of the merger.
In Delaware an essentially final merger agreement must first be approved by the board. The key question addressed by the Court in Activision was what “essentially final” means. The plaintiff argued for the execution version to be approved, while the defendants asked the Court to recognize the market practice of submitting a draft or near-final form to the board for approval. The Court held that, at least for purposes of dealing with the motion to dismiss, in order to comply with Section 251(b) of the DGCL, the board had to approve an essentially complete version of the merger agreement. It then went on to conclude that the plaintiff adequately pled that the merger agreement approved by the board was not essentially complete because it omitted the name of the company being acquired, the merger consideration, a disclosure letter that qualified a number of provisions of the agreement, the disclosure schedules called for by the agreement, and the surviving corporation’s charter[8] and because the board delegated a decision on the amount of the dividends that the acquired company may pay prior to closing to an ad hoc committee of the board. The defendants may be able to establish at trial that the board had before it some of the omitted information, such as the name of the company to be acquired and the merger consideration. The Court recognized as an open issue whether the disclosure schedules were essential, but the Court’s decision indicates that a merger agreement that the board approves, to be essentially complete, must be close to being the execution version.
The Court then examined whether the information required under Section 251(c) to be included in the notice of the stockholder meeting was satisfied. It acknowledged that the notice purported to provide a copy of the merger agreement by referring to the exhibit to the accompanying proxy statement, but the Court determined that the merger agreement provided with the notice did not satisfy Section 251(b) because, among other things, it omitted the surviving corporation’s charter.[9] The Court also ruled that the notice did not satisfy the alternative permitted under Section 251(c) of containing a brief summary of the merger agreement because, although the proxy statement sent with the notice contained a summary of the merger agreement, the proxy statement was not part of the notice.[10]
Finally, the Court ruled that the board’s delegation to a committee to finalize the provision of the merger agreement permitting the payment of certain pre-closing dividends by the target was invalid because under Section 141(c) a committee cannot approve on its own matters for which stockholder approval is required under the DGCL, such as approval of a merger agreement.[11]
Delaware Legislation
The recently enacted Delaware legislation[12] includes provisions to address the issues identified by the Activision decision. It adds a new Section 147 to the DGCL to recognize that the board of directors can approve a merger agreement and other agreements requiring board approval in substantially final form, not necessarily the final form, and can ratify a previously approved agreement before a filing is made with the Secretary of State. Also, Section 232 dealing with notices to stockholders is amended to provide that any materials included with, or attached to, a notice to stockholders, like a proxy statement, is considered to be part of the notice. In addition, (i) a new Section 268(a) is added to eliminate the need for the certificate of incorporation of the surviving corporation to be attached to the merger agreement or approved by stockholders of the target where those stockholders will not become stockholders of the surviving corporation, as is the case for an all cash reverse triangular merger, and (ii) a new Section 268(b) is added to make clear that disclosure letters and schedules are not part of the merger agreement and therefore, as a statutory matter, do not need to be approved by the board.[13]
Relevance for the MBCA
The Activision decision highlights the importance of strict compliance with notice and approval requirements, even after enactment of the Delaware legislation, under both Delaware law and the law of other relevant jurisdictions. Those requirements, which are not limited to mergers, differ among jurisdictions, and thus the particular jurisdiction’s law needs to be carefully reviewed. For example, under Section 11.04 of the MBCA a “plan of merger” meeting the requirements of Section 11.02(d) must first be adopted by the board and then, with certain exceptions, approved by the stockholders; if approval is to be sought at a meeting, the notice of the meeting shall “contain or be accompanied by a copy or summary of the plan,” in some cases with a copy or summary of the surviving entity’s governing documents.[14] It is common, at least in states outside of Delaware, to structure mergers using both a transactional agreement, usually called a merger agreement or acquisition agreement that describes the transaction and contains representations, covenants, conditions to closing and other provisions, and a separate plan of merger that is typically attached as an exhibit to the transactional agreement. The plan of merger is typically a relatively short document that contains only the terms and conditions of the merger as required by the corporation statute, which in MBCA jurisdictions are those set forth in Section 11.02(d). Only the plan of merger needs to be submitted to stockholders for adoption in those jurisdictions. The statutory pattern in Delaware is somewhat different, and that difference may account for a difference in practice and the Court’s rulings in Activision. Section 251(b) of the DGCL requires that the board approve an agreement of merger and declare its advisability and that the agreement of merger be executed by the corporation and submitted to the stockholders for approval. Under the MBCA, the plan of merger need not be executed by the corporation, and as long as there is a plan of merger approved by the board and the stockholders, the transactional agreement signed by the parties to the merger need not be submitted to or approved the stockholders.
This piece originally appeared in the Summer 2024 issue of the MBCA Newsletter, the newsletter of the ABA Business Law Section’s Corporate Laws Committee. Read the full issue and previous issues, including previous articles in the Recent Decisions Relevant to the MBCA series, at the Corporate Laws Committee’s Model Business Corporation Act Resource Center.
The views expressed in this article are solely those of the author and not his law firm or clients. No legal advice is being given in this article.
In a prior decision, West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, 310 A.3d 985 (Del. Ch. 2024), the Court held that laches and ripeness did not apply where there is an alleged violation of a statute. ↑
See Section 141(c)(4) of the DGCL. ↑
The Court distinguished Colon v. Bumble, Inc., 305 A.3d 352 (Del. Ch. 2023), which upheld super-voting power granted to stockholders identified in a stockholder agreement on the grounds that the identified stockholders were ascertainable facts outside of the charter as permitted by Section 151(a). See Stanley Keller, Delaware Court of Chancery Approves Differential Voting Within Same Class, In Our Op. (ABA Bus. Law Section Legal Ops. Comm.), Fall 2023 (Vol. 23, No. 1), at 17–18. ↑
S.B. 313, 152nd Gen. Assemb., An Act to Amend Title 8 of the Delaware Code Relating to the General Corporation Law, 84 Del. Laws ch. 309 (enacted on July 17, 2024). ↑
The MBCA uses the term “shareholders,” but for consistency this article follows the DGCL usage of “stockholders.” ↑
The question of whether a fiduciary out alone will validate certain governance provisions in a stockholder agreement could be an issue in Dollens v. Goosehead Ins., Inc., C.A. No. 2022-1018-JTL (Del. Ch. Nov. 10, 2022), in which the plaintiffs challenged a stockholder agreement as being in violation of Section 141(a). A proposed settlement involving amendments to the stockholder agreement has been agreed to by the parties to the litigation and is pending approval. The amendments narrow the governance provisions and add fiduciary outs for the board. The notice of the proposed settlement is available from plaintiff’s counsel. ↑
As noted above, the question of whether and the extent to which the terms of an agreement may be incorporated by reference in a certificate of incorporation pursuant to Section 102(d) of the DGCL is addressed in N-able. ↑
The Court’s reference to Section 251(b) requiring the surviving corporation’s charter to be included in the merger agreement does not appear to be apt because the requirement of Section 251(b)(4) applies only to a consolidation. For a merger, Section 251(b)(3) requires only a statement that the surviving corporation’s charter shall be its charter, unless it is to be amended or restated, in which event that shall be stated. ↑
Id. ↑
The Court noted that Section 251 did not contain the amendments to Sections 228 on stockholder consents and 242 on certificate of incorporation amendments that permit notice of internet availability of proxy material to satisfy the merger agreement notice requirement. An alternative that could have satisfied Section 251 would have been for the notice to have referred to the summary of the merger agreement in the proxy statement instead of referring just to the merger agreement attached as an exhibit to the proxy statement. ↑
An application has been filed with the Court of Chancery to validate the merger at issue in the Activision decision under Section 205 of the DGCL. The MBCA has similar provisions to validate defective corporate acts and stock issuances in Subchapter E of Chapter 1 (Sections 1.45–1.52). ↑
Supra note 4. ↑
The Delaware legislation also adds a new Section 261 to address the holding in Crispo v. Musk, 304 A.3d 567 (Del. Ch. 2023), regarding remedies for breaches of a merger agreement by recognizing a provision in the agreement that allows a target company to seek damages, including lost stockholder premium, for a breach by the acquirer and, if so provided, to retain such damages. It also allows the stockholders, by approving the merger agreement, to appoint a stockholder representative to enforce their rights under the merger agreement. ↑
If appraisal rights under Chapter 13 of the MBCA are available, additional information is required. ↑
