West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., 311 A.3d 809, 816 (Del. Ch. 2024)
In this seminal opinion resolving the parties’ cross-motions for summary judgment, issued by the Delaware Court of Chancery on February 23, 2024, the Court considered whether a stockholder agreement containing various provisions and requirements of Moelis’s board of directors violated Sections 141(a) and 141(c) of the Delaware General Corporation Law (DGCL). The Court concluded that several of the provisions in the stockholder agreement violated Section 141(a) and that a separate provision violated Section 141(c).
The Court’s ruling prompted multiple amendments to Section 141(a) of the DGCL, which are discussed below.
The opinion is currently on appeal to the Delaware Supreme Court.
Case Background
Moelis & Company (the Company), a well-known investment bank, was founded in 2007 by Ken Moelis. After several years of successful operations, Moelis restructured the Company and he, along with three affiliates and the Company itself, entered into a stockholder agreement (the Stockholder Agreement). The Stockholder Agreement is what the Court termed a “new wave” agreement, meaning that it did not involve “stockholders contracting among themselves to address how they will exercise their stockholder-level rights.” Rather, the Court described these types of agreements as “contain[ing] extensive veto rights and other restrictions on corporate action.”
In particular, under the Stockholder Agreement, the Company’s board had to obtain Moelis’s prior written consent before taking different actions, which covered almost everything the board could do (the Pre-Approval Requirements).
There were various other features of the Stockholder Agreement, including provisions (i) requiring the board to ensure that Moelis could select a majority of its members (the Board Composition Provisions), (ii) requiring that the board maintain a size of not more than 11 seats (the Size Requirement), (iii) entitling Moelis to name a number of designees equal to a majority of the board seats (the Designation Right), (iv) requiring that the board nominate Moelis’s designees as candidates for election (the Nomination Requirement), (v) requiring that the board recommend that stockholders vote in favor of Moelis’s designees (the Recommendation Requirement), (vi) requiring that the Company use reasonable efforts to allow Moelis’s designees to be elected and continue to serve (the Efforts Requirement), and (vii) requiring that the board fill any vacancy in any seat occupied by a Moelis designee with a new Moelis designee (the Vacancy Requirement).
Another provision in the Stockholder Agreement required that the board populate any committee with a number of Moelis’s designees proportionate to the number of designees on the full board (the Committee Composition Provision; collectively with the Pre-Approval Requirements and the Board Composition Provisions, the Challenged Provisions). Accordingly, the board was unable to create an independent committee with no Moelis designees unless Moelis consented.
Plaintiff, a stockholder of the Company, initiated litigation claiming that the Challenged Provisions violated Section 141(a) of the DGCL and that the Committee Composition Provision violated Section 141(c). Plaintiff argued that under Abercrombie v. Davies, 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 judgment on management matters” or “limit in a substantial way the freedom of director decisions on matters of management policy….” The Company countered that Delaware corporations have the power to contract, which necessarily constrains a board’s freedom to act. Or as the Court put it, “[a] contract is a contract is a contract.”
Analysis
The Court explained that Plaintiff had to show that the Challenged Provisions could not operate lawfully in the face of Section 141(a) “under any circumstances.” This inquiry involves two elements: (i) the Court must determine whether the challenged provision is part of an internal governance arrangement, and if so, (ii) the Court applies the Abercrombie test to determine whether the provision imposes a restriction that violates Section 141(a). On the other hand, if the provision is not part of any internal governance arrangement, the Court’s inquiry ends.
In assessing the first step, the Court noted the distinction between external commercial agreements and agreements that seek to govern a corporation’s internal affairs. The Court identified several factors to consider that differentiate external contracts from governance arrangements—all of which the Court found applicable to the Stockholder Agreement. Those differentiating factors include: (i) governance agreements frequently have a statutory grounding in a section of the DGCL (the Stockholder Agreement was grounded in Section 218 of the DGCL); (ii) the corporation’s counterparties in a governance agreement hold roles as intra-corporate actors (all of the Stockholder Agreement’s counterparties were intra-corporate actors—the Company, Moelis, and three of Moelis’s affiliates); (iii) the challenged provisions seek to specify the terms on which intra-corporate actors can authorize the corporation’s exercise of its corporate power (the Challenged Provisions attempted to govern how internal corporate actors authorize the exercise of corporate power); (iv) unlike a commercial contract, a governance agreement does not readily reveal an underlying commercial exchange (“there is no evident underlying deal that led the Company to grant Moelis the extensive rights he received”); (v) the relationship between the contractual restrictions and a commercial purpose (the governance features in the Stockholder Agreement are not tied to any underlying commercial arrangement, and instead the Challenged Provisions “establish a web of governance rights and constraints”); (vi) the presumptive remedy for a breach, meaning that in a commercial agreement, the remedy will likely be damages tied to the commercial bargain, whereas governance arrangements typically generate equitable remedies (any action that succeeded in enforcing the Challenged Provisions would result in an injunction either forcing the board to act or not act and would make it difficult to award damages to remedy a breach); and (vii) a commercial agreement is more likely to be terminable or to have a limited duration, whereas a governance arrangement is more likely to be potentially indefinite (the board also lacked any ability to terminate the Stockholder Agreement).
After analyzing the Challenged Provisions, the Court concluded that the Challenged Provisions were part of an internal governance arrangement as opposed to an external commercial agreement. The Court also noted that the purpose of the Challenged Provisions was “obvious…to preserve Moelis’[s] control, even if he sold enough shares that his voting power dropped below a mathematical majority….”
Because the Challenged Provisions were part of the Company’s internal governance arrangement, they were subject to the Abercrombie test. Under Abercrombie, 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 judgment on management matters” or “limit in a substantial way the freedom of director decisions on matters of management policy….”
The Court concluded that the Pre-Approval Requirements were direct limitations on the board’s ability to take action as “direct, board-level constraints.” While the Company argued that the Pre-Approval Requirements were “consent rights,” the Court rejected this characterization, noting that these requirements were clearly expressed as prohibitions: “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.” Accordingly, the Court held that the Pre-Approval Requirements were facially invalid under the Abercrombie test.
Plaintiff also asserted a facial challenge to the Board Composition Provisions, which sought to constrain the size and composition of the board (and thus, were part of a governance arrangement to which Section 141(a) applied). The Court found that three of the six provisions were facially invalid because they were part of a governance arrangement, violated the Abercrombie test, and could not operate legitimately. The Court found that the other three provisions could operate legitimately and were therefore not facially invalid.
Finally, the Court evaluated the Committee Composition Provision and held that it was invalid under Sections 141(a) and 141(c)(2). Specifically, the Court explained that this provision violated the Abercrombie test “by removing from the directors in a very substantial way their duty to use their own best judgment on a management matter” (i.e., who should serve on a committee). “By requiring that the [b]oard include a proportionate number of Moelis designees on each committee, the Committee Composition Provision forces the [b]oard to exercise its discretion in a particular way.”
In sum, the Court granted Plaintiff’s motion for summary judgment as to the facial invalidity of the Pre-Approval Requirements, the Recommendation Requirement, the Vacancy Requirement, and the Size Requirement. The Court granted the Company’s cross-motion for summary judgment as to the facial validity of the Designation Right, the Nomination Requirement, and the Efforts Requirement.
On August 16, 2024, the Company filed a Notice of Appeal, appealing the Court’s decision (among other orders and rulings issued by the Court) to the Delaware Supreme Court.
DGCL Amendments Following Moelis
Following the issuance of this opinion, legislation proposing to amend the DGCL was approved by the Council of the Corporation Law Section of the Delaware State Bar Association in March 2024. The amendments were later approved by a special committee within the bar association in April and were introduced to the Delaware General Assembly as Delaware Senate Bill 313 (S.B. 313) on May 23. The assembly passed S.B. 313 on June 20 and the bill was signed into law by Governor Carney on July 17. The amendments to the DGCL became effective on August 1.
Of particular relevance to the Court’s decision in this case is an amendment to Section 122 of the DGCL designed to get around—or essentially overturn—the Court’s ruling in Moelis. This amendment adds a new paragraph (18) to Section 122 providing that, notwithstanding Section 141(a) of the DGCL, corporations may enter into stockholder agreements “in exchange for such minimum consideration determined by the board of directors” as long as the agreement does not violate the company’s charter and would not violate Delaware law if included in the charter.
In particular, this newly added subsection of Section 122 clarifies that the types of permitted agreements include those that (i) “restrict or prohibit [the corporation] from taking actions specified in the contract,” (ii) “require the approval or consent of one or more persons or bodies before the corporation may take actions specified in the contract,” and (iii) “covenant that the corporation or one or more persons or bodies will take, or refrain from taking, actions specified in the contract.”
The new DGCL amendments also include amendments adding a new DGCL Section 147, a new paragraph (g) to Section 232, new DGCL Sections 268(a) and (b), and new DGCL Sections 261(a)(1) and 261(a)(2).
Takeaways
As reflected in Moelis, Delaware law has historically empowered and deferred to the power of boards of directors in exercising their independent business judgment. But the landscape could shift with the Delaware General Assembly’s reaction to Moelis and the resulting amendments to the DGCL. The business community and practitioners should monitor the law as it develops—including any rulings from the Delaware Supreme Court in the pending appeal—to determine how to best navigate and protect their interests and the interests of their clients.