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E-MailSarath Sanga is a Professor of Law and Co-Director of the Center for the Study of Corporate Law at Yale Law School and Gabriel Rauterberg is a Professor of Law at the University of Michigan Law School. Related research from the Program on Corporate Governance includes Letting Shareholders Set the Rules by Lucian A. Bebchuk.
A new frontier of corporate law jurisprudence has emerged. At issue are the limits of corporate contractual freedom and stockholders’ power to change the rules of Delaware corporate law. Recent key cases include the Delaware Supreme Court’s decision in Manti v. Authentix (on waiving appraisal rights) and last year’s decision in New Enterprise Associates v. Rich (on waiving the right to sue for breach of fiduciary duty). Both decisions affirmed stockholders’ power to contract around the rules of corporate law.
But this year saw an exception. In Moelis, Vice Chancellor Laster issued a narrow ruling invalidating a small number of provisions in an unusually extreme stockholder agreement. The Moelis stockholder agreement gave an entity controlled by Kenneth Moelis, the founder and CEO of Moelis & Co., veto rights over almost every corporate decision of consequence, including over whom to recommend to stockholders for election to the board. Vice Chancellor Laster held that, while many of the rights may individually be lawful and even commonplace, collectively they went too far. A corporation cannot cede that much governance power without running afoul of a centerpiece of Delaware’s corporate law statute: DGCL Section 141(a), which famously enshrines Delaware’s board-centric model of corporate governance.
In response, last week the Council of the Corporation Law Section of the Delaware State Bar Association released a draft of proposed amendments to the DGCL (“Amendments”) designed to overturn Moelis. One of the Amendments would give corporations power to:
Make contracts with one or more current or prospective stockholders . . . , [in which] the corporation may agree to:
(a) restrict or prohibit itself from taking actions specified in the contract, . . . (b) require the approval or consent of one or more persons or bodies before the corporation may take actions specified in the contract . . ., and (c) covenant that the corporation or one or more persons or bodies will take, or refrain from taking, actions specified in the contract . . . .
Simply put, the Amendment would empower a corporation to agree to (a) not do something, (b) do something only with permission, and (c) make sure something is done (or not done).
The Amendments may be well-intentioned, but regardless of one’s view of Moelis, they are not well-suited to their purpose. They would not resolve the deep legal uncertainties inherent in stockholder agreements such as the one at issue in Moelis. Instead, they would replace a century of nuanced if imperfect Delaware jurisprudence with an open-ended statement that enables too much to be taken at face value.
On its face, the Amendment seemingly authorizes corporations to enter any contract changing any aspect of corporate governance. But that cannot be its intended effect. Do the Amendments intend, for example, to empower a corporation to promise its directors that it will never sue them, even for an intentional tort or bad faith act? Do the Amendments intend to empower a board to cede 100 percent of its decisionmaking power to a single person? The answers to these questions cannot be yes.
The Amendments would also conflict with other parts of the statute. DGCL 141(b) provides that only natural persons can serve on a board, but the Amendments would enable a corporation to contractually cede one or more seats to an outside entity. Is this an intended consequence? If so, then far more is at stake than the agreement rejected in Moelis.
So what should be done? Take a lesson from the DGCL itself and consider Section 102(b)(7), which allows corporations to adopt a charter provision eliminating directors and officers’ liability for breach of the duty of care. Like the proposed Amendment, Section 102(b)(7) also overturned a judicial opinion unpopular with the corporate bar. But it did so in a clear and well-targeted fashion that precisely articulated not just what the corporation could do, but how it could go about doing it.
The harder question here is not so much whether a corporation should be able to contract around a given statutory or common law rule—but how. That is, the challenge lies not in deciding that a corporation should be able to contract around many of the statutory rules, but rather in fashioning the right recipe that a corporation should follow to contract around a rule. The focus needs to be on designing the right altering rule for changing a default, one that enables value-creating innovation while limiting opportunities for abuse. Altering rules are the basic building blocks of private ordering. Yet Delaware’s approach to altering rules is uncharacteristically unsystematic, especially when compared to its typically thoughtful and systematic approach to most everything else in corporate law.
At the present, the law of stockholder contracting is fraught with legal uncertainty. Corporations need guidance, and both the Delaware legislature and the Council of the Corporation Law Section are the right institutions to provide it. The question is not whether corporations can form contracts to alter governance—we know they can. The Amendments, which restate that fact without qualification, would only exacerbate the uncertainty.
