DGCL Amendments Authorizing Governance Rights in Stockholders Agreements Will Become Effective August 1st—What You Need to Know

On July 17, 2024, the Governor of Delaware signed into law a series of amendments to the Delaware General Corporation Law. This Briefing describes the amendments (the "Amendments") enacted in response to the Court of Chancery's holding in Moelis that rights granted in stockholder agreements, rather than the corporate charter, violate DGCL Section 141(a)'s mandate that the affairs of a corporation be managed by its board of directors except to the extent otherwise set forth in the charter.

The Amendments bring the statute more in line with what practitioners have asserted is common market practice in the granting of governance rights in stockholders agreements. Although the Amendments provide a significant degree of clarity with respect to these matters, we expect some continued uncertainty as the courts interpret the Amendments, expand on Section 141(a) jurisprudence generally, and amplify the requirements of other sections of the DGCL that may relate to governance rights granted in stockholders agreements.

Effective date. The Amendmentsbecome effective as of August 1, 2024. The Amendments are retroactive, covering agreements that a corporation entered into, or its board approved, on or before August 1, 2024. However, the Amendments are not retroactive with respect to and do not affect any agreements subject to any litigation or proceeding completed or pending on or before August 1, 2024 (and the law predating the Amendments applies in such cases). Thus, for existing stockholders agreements granting governance rights, and for merger agreements effected in the past-in both cases which were not the subject of litigation prior to August 1, 2024-the agreements are valid notwithstanding the court's rulings in Moelis.

Moelis decision. In Moelis (issued Feb. 23, 2024), the Court of Chancery held that governance rights granted in a stockholders agreement (rather than in a corporation's charter) may be facially invalid under DGCL Section 141(a), which requires that a corporation's affairs be managed by its board of directors (i.e., not by a stockholder) except to the extent set forth otherwise in the charter. The decision was at odds with what practitioners believe is a common market practice of including governance rights in stockholders agreements in various situations, including, for example, in the context of granting special governance rights to a founder or other significant stockholder, or granting such rights in connection with the settlement of stockholder activist situations. (See here our Law360 Del. Dispatch column, How Moelis Upends Stockholder Agreements.)

Express authorization of governance rights in stockholders agreements. The Amendments add a new subsection (18) to DGCL Section 122. The new subsection provides that, notwithstanding Section 141(a), a corporation can enter into agreements, with one or more current or prospective stockholders (or beneficial owners of its stock), in their capacity as such, that grants them governance rights. The new subsection expressly permits corporations to agree to take, or not to take, actions that are specified in such a stockholders agreement; and to grant other persons or entities (such as one or more specified stockholders and/or directors) veto or consent rights over actions specified in the agreement. Such provisions would be facially valid under the statute, notwithstanding Section 141(a), so long as they do not violate requirements for corporate action specified in other sections of the DGCL or in the company's charter. For example, as Section 242(b)(1) requires board and then stockholder approval to adopt a charter amendment, a stockholders agreement could not eliminate those requirements-but it could agree with a stockholder that the corporation would not amend the charter without also obtaining the stockholder's (or its designated director's) consent. Notably, as the new subsection expressly authorizes granting approval or veto rights to one or more specified directors, it overrides the prior requirement generally applicable under Section 141(a) that differential voting rights granted to one or more directors had to be provided for in the corporate charter.

Does not affect governance arrangements entered into without consideration (such as bylaws or stockholder rights plans). New Section 122(18) addresses governance arrangements entered into with stockholders in exchange for consideration-specifically, a "minimum amount of consideration" as determined by the board of directors. The Amendments specifically provide that such consideration may include inducing the stockholder grantee to take or refrain from taking one or more actions, and that these could include facilitating an IPO or not pursuing an activist proxy contest. As the Amendments apply only to governance rights for which consideration is obtained, they would not affect existing law regarding the facial validity of governance arrangements entered into without consideration, such as bylaws or stockholder rights plans (poison pills).

Does not affect officer over-delegation cases or cases involving other contractual parties. New Section 122(18) addresses agreements with current or prospective stockholders or beneficial owners in their capacity as such. It does not address contracts entered into with stockholders in any other capacity (such as a creditor). A clarifying amendment to DGCL Section 122 (5) provides that Section 141(a), and existing law interpreting it, still applies in the case of management agreements or other agreements empowering officers or agents to act on behalf of the corporation. Thus, agreements with officers delegating authority to them, or with stockholders in their non-stockholder capacities, remain subject to Section 141(a). However, the Synopsis to the Amendments confirms that agreements entered into with parties in such other capacities may be entered into under DGCL Section 122(13).

Remedies available for breach of such agreements. The Amendments state that, in the event of breach of a stockholders agreement granting governance rights, the corporation will be subject to the remedies available to the agreement counterparty under applicable law. Therefore, if for example the agreement required action by other persons, such as one or more individual directors or stockholders, and those individuals did not perform as required under the agreement, the counterparty would have a breach of contract remedy against the corporation (and not against the individual directors or stockholders who did not perform). As clarified in the Synopsis, if a counterparty seeks a remedy of specific performance (such as, say, effecting an agreed merger), which involves an action that under other sections of the DGCL requires approval by the stockholders, specific performance would not be available if the statutorily required approval by stockholders had not been obtained.

Fiduciary challenges. The Amendments establish only that governance provisions in stockholders agreements are not facially invalid. Any such agreement still is subject to challenge on the basis that the board, officers, and/or a controlling stockholder breached their fiduciary duties by entering into, performing, or exercising their rights under, any such agreement.

Statutory challenges. Governance provisions in stockholders agreements are still subject to challenge on the basis that, Section 141(a) aside, the rights granted violate other sections of the DGCL. Notably, in Wagner v. BRP Group, Inc. (issued May 28, 2024-before, but in anticipation of, enactment of the Amendments), the Court of Chancery held that, when governance rights are granted in stockholders agreements, even if the Section 141(a) problem is resolved (as occurred in Wagner via the parties' agreement to a governance mechanism that the court viewed as returning a sufficient degree of authority to the board), the grant of rights may violate other sections of the DGCL. See here our article, Practice Points on Stockholder Rights After Moelis and Wagner, in the July 2024 Fried Frank M&A/PE Quarterly.) Accordingly, notwithstanding the Amendments solving the Section 141(a) problem for governance rights granted in stockholder agreements, the court may still view such rights as facially invalid if they violate other sections of the DGCL.

In Wagner, for example, the stockholders agreement at issue granted a stockholder pre-approval rights over (i) actions regarding senior officers (including hiring and firing them, as well as filling vacancies) (the "Officer Pre-Approval Requirement"); (ii) charter amendments (the "Charter Pre-Approval Requirement"); and (iii) a list of eleven types of significant transactions (the "Transaction Pre-Approval Requirement"). First, the court held that the Officer Pre-Approval Requirement violated DGCL Sections 142(b) and (e), which require that officers be chosen, and vacancies filled, as prescribed by the bylaws or determined by the board. In this case, the court stressed, the bylaws did not provide for a stockholder to be able to take actions with respect to senior officers. Second, the court held that the Charter Pre-Approval Requirement violated DGCL Section 242, which provides that, to effectuate a charter amendment, the board must adopt a resolution declaring the advisability of the amendment and calling for a stockholder vote, and then a majority of the outstanding stock entitled to vote must vote in favor. Those two events "must occur in precise sequence for the amendment to be effective," the court stated. Third, the court held that the Transaction Pre-Approval Requirement may well have violated DGCL Section 252 if the restriction on mergers had been drafted to apply at the corporate level, although in this case the provision was drafted to apply only at the LLC level so Section 252 did not apply.

Exclusive forum and arbitration provisions. The Amendments provide an exception to the requirement that governance rights in stockholders agreements not contravene Delaware law. The exception states that such agreements need not comply with Section 115. New Section 122(18) includes a proviso confirming that no provision of an agreement will be enforceable against the corporation to the extent it is contrary to the company's charter or Delaware law (other than DGCL Section 115) if included in the charter. The Synopsis states that "[t]he proviso excludes § 115 so that corporations that may enter into contracts under § 122(18) with exclusive forum and arbitration provisions that do not select the courts of [Delaware] to adjudicate claims under the agreements."

Default application; and incorporation by reference. New introductory language to Section 122 clarifies that a corporation has the powers set forth in the Section unless they are expressly limited in the company's charter. The Synopsis states that a corporation can limit its powers under Section 122 "if a limitation is provided for, or referenced as a fact ascertainable in," the company's charter as permitted by Section 102. Thus, such agreements and arrangements can be incorporated by reference into the charter.

Practice Points:

• Continued uncertainty is to be expected.Notwithstanding the Amendments, based on (i) Wagner, (ii) some arguably ambiguous drafting in the Amendments, and (iii) possible fiduciary issues, we expect some amount of continued uncertainty as to the validity of governance rights granted in stockholders agreements. Thus, a board still should consider granting any significant governance rights in the charter, or in a "golden share" of preferred stock (if blank-check preferred shares are authorized), to the extent possible.This should be readily accomplished in the context of a company about to go public. Amendment of the charter of an already public company to provide such rights, however, presents logistical issues in terms of obtaining the necessary stockholder approval; fiduciary duty issues in terms of justifying the grant of rights in a post-IPO context; and the need to obtain stockholder approval to amend the charter if changes are later desired.
  
  
• Consider a tailored approach. As, notwithstanding the Amendments, governance rights granted in stockholders agreements still will be facially invalid if they violate DGCL Sections other than Section 141(a), any grant of such rights, and the exercise of such rights in existing agreements, must be approached with care. The corporation, together with legal counsel, should identify all potentially applicable sections of the DGCL that may be applicable to each of such rights; and then should consider how best to ensure that the rights, the agreement, the bylaws, and/or other documents may be tailored so that the rights do not violate any section of the statute. Tailoring rights granted to stockholders, to seek to ensure compliance with the DGCL, should be an ongoing process that takes into account the Amendments, Wagner, any further judicial or legislative developments in this area, as well as developing market practices and norms.
  
  
• Consent rights over actions subject to statutory voting rights. In Wagner, the court held that a stockholder's pre-approval right for charter amendments violated DGCL Section 242, which requires that charter amendments be approved by the board and then the stockholders. The court stated that this right would not have violated Section 242 if it had been structured as an "additional vote" coming after the statutorily required board and stockholder votes, rather than as a pre-approval right that "introduced a threshold requirement before the statutory mechanism can proceed." Thus, with respect to consent rights granted to a stockholder over actions that are subject to statutory voting requirements, consideration should be given to structuring the right as a post-approval (not a pre-approval) right. We expect it should be permissible in this situation, and it would be practical, to provide in the stockholders agreement that the stockholder, if requested, at the outset of the process will provide an indication as to whether it would intend, absent changed circumstances, to provide its consent after the board and stockholder approvals are obtained.

• Consent rights over actions that the statute provides can be taken as prescribed in the bylaws. In Wagner, the court held that a stockholder's pre-approval right for actions affecting senior corporate officers violated DGCL Section 142, which provides that certain key actions relating to officers (such as their hiring and firing) can be taken as set forth in the company's bylaws or as determined by the board. The court emphasized that the Company's bylaws did not authorize a contractual counterparty to control the hiring and firing of the company's senior officers. Thus, with respect to any governance rights as to which the DGCL permits actions to be taken "as prescribed by the bylaws or determined by the board," a board should consider providing in the bylaws that such actions can be taken as set forth in any stockholders agreement the company has and/or may enter into. (We note, however, that, in Wagner, the court injected an element of doubt with respect to this approach, stating that the court was not addressing whether "the Charter or the Bylaws could empower a contractual counterparty to control [such matters relating to senior officers], because nothing in the [Company's] Charter or Bylaws [even] purport[ed] to allow it" (emphasis added).

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