DGCL Amendment Merits Amending Charters and Engagement with Institutional Shareholders

Ethan Klingsberg is partner and Oliver Board is counsel at Freshfields Bruckhaus Deringer LLP. This post is based on their Freshfields memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

Amendments to the charters of Delaware corporations are advisable as a result of a new amendment, effective August 1, 2022, to the Delaware General Corporation Law (the DGCL) that permits the extension of exculpation rights to executive officers.

Delaware law has long permitted a corporation to include a provision in its certificate of incorporation that eliminates or limits the personal liability of directors for monetary damages arising from their breaches of fiduciary duty, subject to basic exceptions. Delaware has now amended Section 102(b)(7) to expand this exculpation right to be available to cover executive officers as well.

This amendment to the DGCL is a response to the increasing frequency of shareholder suits where the plaintiffs name executive officers, including general counsels, as defendants. Often these suits follow the closing of a sale of the corporation. It is not uncommon for such suits to include a claim that the general counsel breached his or her duty of disclosure in connection with the preparation of the merger proxy statement or Schedule 14D-9. Others have alleged that the general counsel engaged in conduct that impeded the fulfillment of the Revlon duty to seek the best price reasonably available when selling control of the corporation. In some of these cases, the courts have dismissed claims against some of the pre-closing directors, because they were exculpated under the corporation’s charter, but allowed claims to proceed against the pre-closing officers, because, prior to this amendment to Section 102(b)(7), they could not be exculpated from personal liability in a similar manner.

The amendment to Section 102(b)(7) allows a corporation to protect against this perverse outcome by amending its charter to expand the exculpation provision (already contained in the charters of virtually every IPO-pipeline company and publicly traded company) to cover officers. Adoption of this charter amendment will require board and shareholder approvals.

For most corporations, the drafting of the amendment will be simple. All that is needed is insertion of a reference to “officers” in the existing exculpatory provision that covers directors. An illustrative form of this provision is as follows:

To the fullest extent permitted by the DGCL, no director or officer of the Corporation shall be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director or officer, as applicable. No amendment or repeal of this provision shall adversely affect any right or protection of a director or officer of the Corporation hereunder in respect of any act or omission occurring prior to such amendment or repeal.

However, even with this change to Delaware’s exculpation regime, officers will continue to have exposure in one circumstance where directors will remain protected. Officers will remain vulnerable to liability for “any action by or in the right of the corporation.” In other words, the board (including in response to a shareholder demand) may still elect to sue officers and recover damages. Importantly, the ultimate determination of whether to bring such suits against officers will lie with the corporation’s directors (and not the shareholders) so long as disabling conflicts do not taint all the directors.

The other standard exceptions to exculpation will apply equally to both directors and officers: for breaches of the duty of loyalty (i.e., where the director or officer acts for personal benefit rather than the good of the corporation), actions or omissions in bad faith, knowing violations of law, unlawful dividends and stock repurchases, and transactions from which the director or officers derives improper personal benefit.

The amendment to Section 102(b)(7) fixes a troubling imbalance in the DGCL that plaintiffs’ lawyers have been exploiting to increase settlement value of suits that have little or no benefit to the corporation or its shareholders. Adoption of a simple charter amendment to take advantage of this fix will now allow officers to avoid liability to shareholder plaintiffs when acting in good faith, while preserving (1) the ability of shareholders to impose personal liability on directors and officers for breaches of the duty of loyalty and (2) the ability of boards, where appropriate (including following a shareholder demand in a derivative litigation), to bring damages claims against officers for misdeeds even if they were the result of good faith actions.

One open question is how institutional shareholders and proxy advisory firms will react to proposals to amend the charter in this manner. The answer, in the case of listed companies, may depend on:

  • the other elements of the corporation’s governance profile and the extent to which there may already be tension with shareholders over governance;
  • the extent to which the corporation otherwise engages in best practices relating to its executive officers, including their compensation, diversity, and skillsets;
  • the relationship between management and the shareholders, including the extent of shareholders’ confidence in management’s stand-alone plan and their assessment of recent performance;
  • management’s approach to shareholder engagement and its ability to articulate effectively in off-cycle meetings with shareholders in the coming months the rationale for putting forward this proposed charter amendment at the next annual meeting; and
  • the effectiveness of the articulation of the rationale for this charter amendment in the proxy statement for the meeting at which the amendment will be voted on and in related solicitation conversations.

We believe that it would be sensible for institutional shareholders and proxy advisory firms to support these charter amendments at all companies due to their strong policy rationale and the meaningful limitations on exculpation of officers embedded in the amended statute. But we recognize that assuring that sensible minds will prevail may take some thoughtful and deliberate efforts on the part of corporations in their engagement with shareholders.

In sum, this new amendment to the DGCL is good news and presents an opportunity that all Delaware corporations ought to take advantage of by amending their charters by no later than their next annual shareholders meetings; but, while the drafting and rationale for these charter amendments is straightforward, there may be some additional work to do to assure that institutional shareholders and proxy advisory firms are on board.

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One Comment

  1. kiers
    Posted Sunday, September 4, 2022 at 10:52 am | Permalink

    “over there” xi jinping amends their corporate charter, “over here” delaware amends our corporate charter.