Stockholder Agreements, Dexit and Contractarianism – Could There Have Been a Better Delaware Response to Moelis?

In my forthcoming paper with Professor Brian R. Cheffins, we discuss the case of West Palm Beach v. Moelis and its aftermath, making comparisons to a UK case from nearly 35 years ago to propose an alternative approach that Delaware could have taken in light of the original Moelis decision.

Moelis was one of the most controversial decisions of Delaware’s Court of Chancery in recent years.  The case involved a contractual stockholder agreement between NYSE-listed Moelis and Company, and its founder, CEO and chair.  The stockholder agreement inured certain governance rights on the founder, including board nomination, committee composition, and board decision veto rights. In an opinion by Vice-Chancellor Laster, some of those rights, including the veto rights, were held to be void on the basis that they infringed section 141(a) of the Delaware General Corporation Law (DGCL) which provides that the business and affairs of a corporation shall be managed by, or at the direction of, the board unless otherwise specified in the charter.  Even though such stockholder agreements were commonplace in the private equity and venture capital world (particularly in private companies), Laster maintained that “When market practice meets a statute, the statute prevails.”

Perhaps unsurprisingly the Moelis decision created consternation in the business community.  As one commentator put it, “With a stroke of the pen, the [Court] invalidated commonplace provisions in scores of stockholder agreements relating to public corporations and likely many more relating to private corporations.”  By way of private ordering, veto rights play a crucial part in private equity and venture capital strategy, ingraining majority and minority shareholder protections in private companies to respect the business arrangements which all the parties have agreed to pursue.  For reasons of confidentiality and control over revisions, such rights are often included in a contractual stockholder agreement rather than in the company’s constitutional documents.  In response to such concerns, the Delaware legislature introduced, with remarkable haste, Senate Bill 313 (SB 313), later becoming section 122(18) of the DGCL, which essentially reversed the decision in Moelis.  Fears over a loss of incorporations and transfers of existing companies from Delaware to other states (euphemistically known as “DExit”) partly drove the response.  For its part, SB 313 caused uproar in the academic and judicial community, with assertions that it had been rushed through without adequate consultation, and had undermined a well-reasoned judicial decision before the appeal had even been heard in the Delaware Supreme Court.  As notable academic Charles Elson contended, SB 313 constituted “the self- destruction of its [Delaware’s] corporate role”.

Clearly, there were strong views on both sides of the aisle, but we’ve seen this movie before.  In the early-90s, the UK had its own “Moelis-moment” in the case of Russell v. Northern Bank Development Corporation.  The House of Lords found that a veto right in a stockholder agreement between a (private) company and its stockholders was void due to it fettering the company’s mandatory statutory right to amend its constitution.  The case was again a manifestation of statutory primacy. Similar to Moelis, the Russell decision was explosive, being described as a “jurisprudential time bomb detonated in the heart of…the City of London”.  Unlike Moelis, however, there was no statutory response to Russell. Why?

The reasons are manyfold as investigated in our paper, but critically Russell had little meaningful impact on business practice.  For a start, most law firms eventually interpreted Russellnarrowly such that it impugned only a handful of statutory company rights that could simply be drafted around.  Moreover, even with a broader interpretation (as some commentators have invoked) that Russell is precedent for contractual veto rights generally being void if they undermine board authority, the UK common law “Re Duomatic principle” rescues such contractual agreements provided that all the stockholders are parties to the agreement, which is often the case in private companies.

What about stockholder agreements to which not all the stockholders are parties, such as in publicly-listed companies – could the broader interpretation (debatable but plausible) compromise the enforceability of such agreements?  For companies listed on the London Stock Exchange, though, until recently, Moelis-style stockholder agreements were in any event prohibited on the exchange by virtue of listing rules.  The Russell decision therefore had little consequence for market practice.

We argue that the Delaware legislature could have avoided controversy by mimicking the post-Russell UK position.  SB 313 could have been narrower, only saving stockholder agreements to which all the stockholders are parties, thereby permitting contractual veto rights in private companies but effectively preserving the Moelis decision extant for public companies.  It is, after all, in public companies where such stockholder agreements are more egregious – they are challenging to price-in at IPO, and could even be entered into after IPO.  We also observe that taking such a narrower SB 313 approach would still have assuaged DExit concerns, since such a position would not be out-of-line with other states, including the Model Business Corporation Act, and Texas and Nevada, two states often held-up as Delaware competitors.  In any case, it seems that Moelis-style stockholder agreements are rare in public companies.  Business practice could have been maintained in private companies with less of the furore surrounding SB 313.  Is it time for Delaware to partially reverse course on SB 313?  Possibly yes, but practically unlikely.  The global trend is toward de-regulation.  SB 313 is, for better or worse, here to stay.

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Bobby V. Reddy is the Professor of Corporate Law and Governance at the University of Cambridge Faculty of Law, and an ECGI Research Member.

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This blog is based on a paper presented at the 5th conference on The Law and Finance of Private Equity and Venture Capital, held at Goethe University Frankfurt. The conference was convened by Bocconi University, the DFG LawFin Center at Goethe University Frankfurt, LSE Law School, the Faculty of Law of the University of Oxford, and the Institute for Law & Economics at the University of Pennsylvania, together with ECGI., Visit the event page to explore more conference-related blogs.

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