Client alert: Implications of decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co.
April 9, 2024
The Delaware Court of Chancery recently handed down a decision that will significantly impact how investors and corporations approach investors’ blocking rights over certain actions of the corporation. Such blocking rights are a key component to many investments.
In West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., the plaintiff, a stockholder of Moelis & Company (the “Company”), challenged the validity of certain provisions in a Stockholder Agreement between the Company and its CEO, Ken Moelis. Pursuant to the stockholder agreement, Moelis had a number of blocking rights over key actions of the company, including stock issuances, incurrence of debt over a certain threshold, removal or appointment of certain officers of the company, approval of annual budgets, and entering into material contracts. These types of blocking rights are very common in venture capital investment.
The plaintiff argued that these provisions violated Section 141(a) of the Delaware General Corporation Law (DGCL), which mandates that the business and affairs of a corporation be managed by or under the direction of a board of directors, except as otherwise provided in the DGCL or in the corporation’s certificate of incorporation.
The court found that these provisions effectively transferred the management of the corporation to Moelis, contrary to Section 141(a). However, the court also found that certain provisions were not invalid on their face. Because the Court did not undertake a line-by-line review of the blocking rights, we do not know whether a subset of the blocking rights, or any one of them standing on their own, would have passed muster. The Delaware Supreme Court may address this decision, providing additional guidance in the future.
Key takeaways:
- The statute applies regardless of past practice. Widespread market practice will not be viewed as a defense to activities that the courts view as contrary to Delaware law. Nor will longstanding acceptance by the corporation and its stockholders. The Court made clear that “[w]hen market practice meets a statute, the statute prevails.”
- Only corporations are impacted. The impact of this decision applies only to corporations and does not extend to partnerships, limited liability companies, or other entities organized under Delaware law.
- Both publicly traded and private corporations are impacted. The case did not differentiate between publicly traded and private companies. The risk profile may be different for private companies, in particular where all stockholders are party to a stockholder agreement containing the relevant governance rights (e.g., many venture capital-backed companies).
In response to the Moelis decision, legislation proposing to amend the DGCL has been approved by the Council of the Corporation Law Section of the Delaware State Bar Association and is expected to be introduced to the Delaware General Assembly for consideration during its 2024 regular session. If enacted, the amendments would eliminate potential facial invalidity claims regarding certain provisions in stockholder agreements arising out of the Moelis decision. These amendments would become effective on August 1, 2024, and apply to all contracts made by a corporation, or agreements or documents approved by the board, made or approved before or after August 1, 2024. The text of the proposed amendments may be accessed here.
Recommended next steps for Delaware corporations negotiating blocking rights over company decisions:
- Include blocking rights in the corporation’s charter. This can be done either directly, or by cross-referencing the relevant stockholder agreement, side letter, or other applicable agreement. The decision of whether to place rights directly in the corporation’s charter will be fact-specific. It is easier to amend any such rights if they are contained in a separate cross-referenced agreement. Cross-referencing also protects the confidentiality of the investor, since the charter is publicly filed.
- Consider adding “fiduciary-out” language in key documents. To mitigate risk, corporations should consider adding “fiduciary-out” language directly in specific documents (e.g. side letter, stockholder agreement, etc.) allowing the board to not comply with a specific covenant if doing so would violate its fiduciary duties.
- Consult with counsel to ensure compliance.
In addition, the National Venture Capital Association may issue a suggested approach.
Croke Fairchild Duarte & Beres attorneys will be monitoring these developments closely and keep our clients informed of all new information.