The Delaware Court of Chancery invalidates terms of a stockholder agreement and sheds light on how joint ventures and governance should be structured8 April 2024

The Corporation maintained that corporations under DGCL have the authority to enter into contracts, including contracts that constrain board freedom of action, and that stockholder agreements fall under this authority.

Legal Analysis

The court laid out a multi-prong test to first assess whether Section 141(a) claims pertain to the challenged provisions. In the ruling, the court determined that Section 141(a) applies if the challenged provision comprises part of the corporation’s internal governance arrangement.³

Upon finding that the provision regulates a corporation’s internal affairs, the court would then apply the “Abercrombie test”⁴ which establishes 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 judgment on management matters” or “tend[] to limit in a substantial way the freedom of director decisions on matters of management policy.”⁵

The court found that many, but not all, of the challenged provisions failed the Abercrombie test and therefore determined that numerous provisions, including the pre-approval requirements, were facially invalid under DGCL. The court declared these provisions impermissibility constrained the board’s ability to manage business and affairs of the Corporation, therefore deteriorated the foundation of the corporate form of independent authority of the board of directors. The court emphasized that the statute does not allow the board to delegate through contractual arrangements with stockholders.

As a result of those findings, the court invalidated the pre-approval requirements because, taken together, they forced the board of directors to obtain Moelis’ prior written consent before taking almost any meaningful corporate action, and therefore Moelis controlled what the board could do. The court did not hold that individual pre-approval requirements are, by themselves, invalid, but it did not go so far as to state that such requirements were permissible; the court stated that the pre-approval requirements in the stockholder agreement at hand went “too far.”⁶

The court highlighted that the “vast majority”⁷ of the provisions invalidated by its decision would have been valid under Delaware law if they had been included in the Corporation’s certificate of incorporation, instead of the stockholder agreement. Furthermore, the court stated that the Corporation could have implemented several of the provisions by using its “blank check authority” to issue Moelis a single “golden share” of preferred stock carrying a set of voting rights and director appointment rights.⁸ Furthermore, because the decision derives from the DGCL, the analysis does not apply to other entity forms such as limited liability companies or limited partnerships.

Applicability to Marshall Islands and Liberian Corporations

Both Marshall Islands and Liberian corporation laws are based, in part, on the DGCL, and each regime generally adopts Delaware case law as its own. This case and its implications should therefore be evaluated by parties considering contractual provisions within Delaware, the Marshall Islands and Liberia. In addition, those with existing stockholder agreements relating to Delaware, Marshall Islands or Liberian corporations should review their provisions in light of this court decision.

footnotes

[1] West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., C.A. No. 2023-0309-JTL (Del. Ch. Feb. 23, 2024).
[2] 8 Del. C. § 141(a).
[3] Moelis, C.A. No. 2023-0309-JTL at 12.
[4] Id. at 5.
[5] Id.
[6] Id. at 9.
[7] Id. at 12.
[8] Id. at 6.