How New Delaware Amendments Impact Stockholder, Merger Agreements

Over the summer, Delaware enacted a number of amendments to the General Corporation Law of the State of Delaware (the “DGCL”). The amendments were largely crafted in response to several recent decisions by the Delaware Chancery Court (the “Court”) that the transactional bar had concerns over.

Stockholder Agreements

The Moelis Decision

In February 2024, the Court issued its decision in the West Palm Beach Firefighters’ Pension Fund v. Moelis & Company C.A. No. 2023-0309-JTL (Del. Ch. Feb. 23, 2024)  (“Moelis”). At issue in Moelis was a stockholder agreement, agreed to and authorized by the company’s Board of Directors, which effectively delegated certain decision-making powers to the company’s founder and chairman. The stockholder agreement in question, in basic terms, granted the founder and chairman near complete control over the Board and the decisions they were allowed to make. One stockholder brought suit, arguing that the stockholder agreement improperly interfered with, and effectively eliminated the Board’s ability to run the company under Section 141(a) of the DGCL.

The Court found that the stockholder agreement met the requirement of an internal governance document and then applied the longstanding Abercrombie test, which states that “…governance restrictions violate Section 141(a) when they have the effect of removing from directors, in a very substantial way, their duty to use their own best judgement on management matters or tend to limit, in a substantial way, the freedom of director decisions on matters of management policy.”

The Court found that these arrangements did, in fact, violate Section 141(a), noting that “The pre-approval requirements impose a flat ban on these categories of actions unless Moelis allows them. They make Moelis the gatekeeper to board action.” Moelis at 104. Interestingly, the Court made a point to gently endorse the terms of the stockholder agreement by reminding the parties that had these provisions been included in the company’s certificate of incorporation (“Charter”) as negotiated stockholder rights, they would have been in compliance with Section 141(a).

The Backlash

Corporate practitioners were quick to criticize the decision as being out of touch with the realities of corporate practices, and that by endorsing the validity of the provisions in one document vs. another, the Court was simply focusing on form vs. substance. On the other hand, the Court all but invited legislative involvement, writing that “When considering statutory compliance, formality matters.” Moelis at 131.

The Legislature’s Response

The Delaware legislature was quick to respond, adopting proposed changes which were signed into law and effective as of August 1, 2024. The changes to the DGCL were as follows:

• Section 122(5) was amended to clarify that a Board cannot delegate authority unless the delegation complies with Section 141(a) – meaning such delegation must be permitted within the company’s Charter

• A new Section 122(18) was added which directly related to Moelis. The full text of Section 122(18) is below[1] but effectively, the addition allows for the types of contractual arrangements that were present in Moelis, with certain restrictions and requirements (such as being authorized by the Charter).

Transaction Approval

Also in February, 2024, the Court heard arguments in Sjunde AP-Fonden v. Activision Blizzard, Inc., 2024 WL 863290 (Del. Ch. Feb. 29, 2024) (corrected March 19, 2024) (“Activision”) related to the validity of Board approval of a merger agreement. In summary, the stockholder argued that since the merger agreement was not in final form at the time of Board approval, the approval was invalid.

The Court in Activision discussed Section 251(b) at great length, treating favorably plaintiff’s “execution-version” interpretation that the version that should be approved by the Board is the one which should be signed. Ultimately, however, the Court took the company’s position of the practical impact on corporate transactions, which often have changes to disclosure schedules up until the final moments of the closing, as a reason not to apply the “execution-version” interpretation. Instead, the Court applied the “essentially complete” interpretation.

The Court found that the public policy arguments related to transactional practice did not excuse the merger agreement in Activision from omitting “…the consideration, the Disclosure Letter, the Disclosure Schedules, the Survivor’s Charter and the Dividend Provision”.  Regardless of each individual item, the totality of missing information rendered the agreement not “essentially complete”.

The Legislature’s Response

Those of us in transactional practice are familiar with Board approval of documents in “substantially final” form. The new amendments to Section 147 of the DGCL provide additional clarity and codification of this requirement.

Specifically, Section 147 now states that a Board may approve an agreement in final form or substantially final form. While the statute itself does not define what “substantially final form” means, it also importantly allows for Boards to ratify a previously approved agreement at any time prior to that agreement taking effect. Essentially, if there were concerns raised about a merger agreement (or other agreement) being in substantially final form at the time of initial approval, the Board could simply approve it again in its ultimate form.

Interestingly, the synopsis to the legislation states as follows: “New § 147 is intended to enable a board of directors to approve an agreement, instrument or document if, at the time of board approval, all of the material terms are either set forth in the agreement, instrument or document or are determinable through other information or materials presented to or known by the board.”

While this comports with most thorough corporate practices, it is interesting that this language was not included in the final updates to the DGCL.  Since the source of these disputes comes from stockholder challenges, it will be interesting to see future decisions interpreting what “other information or materials presented to or know by the board” means and how that will impact transactions going forward.

The legislature also amended two other sections of the DGCL in connection with the Activision decision.

• Section 232(g) (notice to stockholders) was amended to state that every document enclosed with the notice or annexed or appended to the notice given pursuant to Sections 232(a)(1) or 232(a)(2) (the most common notice methods by mail, courier or email, essentially) shall be deemed part of the notice solely for purposes of determining whether notice was duly given. Essentially, proxy statements and other similar materials provided to stockholders in connection with certain transactions do not need to be summarized in the notice itself, they can simply be attached to the notice and remain in compliance with the DGCL.
• Section 268(b) was created which states that disclosure schedules, or other similar instruments drafted in connection with a merger agreement’s reps and warranties or covenants and conditions will not be considered part of the merger agreement unless expressly stated in the agreement. This effectively eliminates one of the stockholder objections in Activision with respect to the merger agreement being in substantially final form without the disclosure schedules being finalized at the time of Board approval.

Merger Agreements

The recent amendments also included changes to Section 261(a) as a direct result of the Crispo v. Musk et. al C.A. No. 2022-0666-KSJM (Del Ch. Oct. 31, 2023)  decision (“Crispo). Crispo was brought by a shareholder of Twitter who sued the defendant (Elon Musk) for specific performance and mootness fees as a result of Musk’s attempt to terminate the agreement. As we all know, Musk eventually purchased Twitter, rendering the specific performance claims moot but the shareholder still pursued his claim for premium damages as a third-party beneficiary under the merger agreement. After the Court ruled in favor of Musk, the legislature adopted a few changes to Section 261(a) to clarify when such damages are appropriate for corporations, as well as clarifying the process for appointing stockholder representatives in merger agreements.

The Legislature’s Response

The legislature’s synopsis of the amendment to Section 261(a)(1) states that liquidated damages, including premiums owed to stockholders, can be specified in a merger agreement and that the non-breaching party may enforce such provisions.[2] The legislature also clarified that this is not exclusive of, or in lieu of, any other damages available at law or equity.

Section 261(a)(2) was also amended to codify a longstanding practice of appointing a stockholder representative to negotiate certain terms, and represent the interest of stockholders in connection with a merger agreement. The amendment was carefully crafted to allow the stockholder representative “to take action on behalf of such stockholders pursuant to such agreement, including taking such actions as the representative determines to enforce (including by entering into settlements with respect to) the rights of such stockholders under the agreement of merger or consolidation” but not to give the stockholder broad authority over all stockholder rights available under the DGCL.

As noted in the synopsis, the amendment does not give the stockholder representative the power  to waive appraisal rights or claims for breach of fiduciary duty, but only those rights that the stockholders are entitled to under the merger agreement itself.  The shareholder in Crispo may well have had standing for their claim under this new Section 261(a)(2) had it been in effect at the time.

Impact

For many seasoned transactional attorneys, these amendments largely reflect a codification and clarification of common practices. These amendments provide additional latitude for parties to freely contract for very specific deal terms, but technical compliance with the DGCL is important in order to survive a challenge. There are several primary takeaways from these amendments.

• In the case of the stockholder agreement amendments, companies and counsel should carefully review their existing stockholder agreements and charter to ensure that the rights intended to limit Board decision-making are properly documented.
• In the case of Board approvals, companies and counsel should make every effort to button up the details of their proposed agreements and the details shared with the Board and stockholders in approving such agreements. With the timing requirements for stockholder notices and the fast pace of many deals, approval of an incomplete agreement could have consequences.
• In the case of merger agreement penalties, companies and counsel should continue to carefully tailor their liquidated damages provisions (including whether such damages may be owed to stockholders) in the event of a breach.

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[1] (18) Notwithstanding § 141(a) of this title, make contracts with one or more current or prospective stockholders (or one or more beneficial owners of stock), in its or their capacity as such, in exchange for such minimum consideration as determined by the board of directors (which may include inducing stockholders or beneficial owners of stock to take, or refrain from taking, one or more actions); provided that no provision of such contract shall be enforceable against the corporation to the extent such contract provision is contrary to the certificate of incorporation or would be contrary to the laws of this State (other than § 115 of this title) if included in the certificate of incorporation. Without limiting the provisions that may be included in any such contracts, the corporation may agree to: (a) restrict or prohibit itself from taking actions specified in the contract, (b) require the approval or consent of one or more persons or bodies before the corporation may take actions specified in the contract (which persons or bodies may include the board of directors or one or more current or future directors, stockholders or beneficial owners of stock of the corporation), and (c) covenant that the corporation or one or more persons or bodies will take, or refrain from taking, actions specified in the contract (which persons or bodies may include the board of directors or one or more current or future directors, stockholders or beneficial owners of stock of the corporation). Solely for purposes of applying the proviso in the first sentence of this subsection, a restriction, prohibition or covenant in any such contract that relates to any specified action shall not be deemed contrary to the laws of this State or the certificate of incorporation by reason of a provision of this title or the certificate of incorporation that authorizes or empowers the board of directors (or any one or more directors) to take such action. With respect to all contracts made under this paragraph (18), the corporation shall be subject to the remedies available under the law governing the contract, including for any failure to perform or comply with its agreements under such contract.

[2] “New § 261(a)(1) clarifies that parties to an agreement of merger or consolidation may, through express provision in the agreement, specify the penalties or consequences of a party’s failure to perform its obligations under, or comply with the terms and conditions of, such agreement before the effective time of the merger, or to consummate the merger or consolidation contemplated by such agreement. Such penalties or consequences may include an obligation to make payments to the other party if the merger or consolidation is not consummated, including damages based on the lost premium that stockholders of a constituent corporation would be entitled to receive if the merger becomes effective in accordance with the terms of the agreement and reverse termination fees.”