Delaware Court Of Chancery Invalidates Stockholder Agreement Provisions That Deprive Board Of Key Decision-Making Powers
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  • Delaware Court Of Chancery Invalidates Stockholder Agreement Provisions That Deprive Board Of Key Decision-Making Powers
    03/26/2024

    On February 23, 2024, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery invalidated a number of significant provisions in a stockholder agreement between a financial institution (the “Company”) and its founder and controlling stockholder. West Palm Beach Firefighters Pension Fund v. Moelis & Co., No. 2023-0309-JTL (Del. Ch. Feb. 23, 2024). The Court found that a number of the provisions impermissibly delegated to the controller authority over governance activities that, under Delaware General Corporation Law, are within the exclusive providence of the board, in violation of Section 141(a) and, as to a provision governing committee composition, Section 141(c). The Court so concluded notwithstanding that many of the provisions are commonly included in controller stockholder agreements.

    Plaintiff stockholders alleged that the stockholder agreement gave the controller, who is also chairman and CEO, substantial power to manage the affairs of the business and to control board composition in violation of Delaware law. In particular, the agreement required controller consent for the board to take eighteen different categories of action—or as the Court described it, “virtually everything the Board can do,” including incur certain debt, issue securities, enter new lines of business and certain contracts, hire or fire officers, and issue dividends (the “Pre-Approval Requirements”). Plaintiffs also objected to the provisions that permitted the controller to dictate the size and composition of the board and committees (the “Board Composition Requirements”).

    The Court undertook a two-step analysis to evaluate the validity of the provisions, first considering whether the provisions concerned “an internal governance arrangement” and, if so, then weighing the degree of encroachment on the directors’ use of independent judgment in managing the company’s affairs under the Abercrombie test. The Court rejected defendants’ argument that many of the provisions are widely accepted “market practice,” noting that even widespread use of prohibited provisions cannot supersede statutory requirements.

    The Court invalidated all of the Pre-Approval Requirements, finding them facially invalid because the Board could not “freely exercise its powers” and, consequently, was “not really a board.” The Court also rejected four of the Board Composition Provisions: (i) a “Recommendation Requirement,” which compelled the Board to recommend the controller’s designees for election; (ii) a “Vacancy Requirement,” which required the Board to replace a departing designee director with another designee; (iii) a “Size Requirement,” which prevented the Board from increasing the number of board seats beyond eleven; and (iv) a “Committee Composition Provision,” which required any board committee to comprise a number of controller designees proportionate to the number of controller designees on the board. However, the Court upheld rights that merely allowed the controller to identify preferred candidates without binding the Board to a course of action.

    Abercrombie v. Davies, 123 A.2d 893 (Del. Ch. 1956), rev’d on other grounds, 130 A.2d 338 (Del. 1957).

    CATEGORIES: Charters & Bylaws, Fiduciary Duties

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