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E-MailNeil McCarthy is Co-Founder and Chief Product Officer, G. Michael Weiksner is Co-Founder and Chief Technology Officer, and James Palmiter is CEO and Co-Founder at DragonGC. This post is based on a DragonGC memorandum by Mr. McCarthy, Mr. Weiksner, Mr. Palmiter, Jennifer Carberry, Natalie Richardson, and Evan Quille, and is part of the Delaware law series; links to other posts in the series are available here.
Delaware amended Section 102(b)(7) of its General Corporation Law (DGCL) in 2022 to allow exculpation of certain senior officers from personal liability for monetary damages for breaches of their fiduciary duty of care (“Officer Exculpation”). Before it was amended DGCL §102(b)(7) only allowed exculpation for directors. To take advantage, Delaware companies need to include a provision in the certificate of incorporation, which typically will require a stockholder vote to implement for companies that are already public.
Since the law changed, DragonGC has been tracking trends in adoption of Officer Exculpation by Delaware companies. In this report, we examine the adoption of Officer Exculpation to date, with an emphasis on Fortune 1000 companies.
Background
In 1985 the Delaware Supreme Court rocked corporate America with its decision in Smith v. Van Gorkom finding that the board of Trans Union had violated its duty of care by accepting an acquisition offer for the company. While the offer was at a significant premium to the company’s trading price, the Court held that the directors were “grossly negligent in approving the ‘sale’ of the Company upon two hours’ consideration; therefore, the business judgment rule provides no protection.”
After the Court’s decision, the directors agreed to pay $23.5 million in damages, of which $10 million was covered by insurance. The balance was paid by Jay Pritzker, the controlling shareholder of the buyer, even though he was not a party to the lawsuit.
In response, in 1986 the Delaware legislature adopted DGCL §102(b)(7) which allows for charter provisions that exculpate directors, but which did not include officers. The Van Gorkom decision also made widespread the practice of using investment bank fairness opinions in public company M&A transactions. Nevada later adopted an exculpation provision to its law which included all corporate officers. Delaware followed suit by amending DGCL §102(b)(7), effective August 1, 2022, to allow for exculpation of certain officers.
Since the Amendment in August 2022
Following the DGCL amendment, Delaware companies began to add Officer Exculpation proposals to their agendas for their Annual Meeting.
- From August 1, 2022 through June 30, 2023, 325 Delaware public companies put adoption of Officer Exculpation to a vote. Of these, 61 are in the current Fortune 1000 (19%).
- From July 1, 2023 through June 30, 2024, 420 Delaware public companies put adoption of Office Exculpation to a vote. Of these, 116 are in the current Fortune 1000 (28% ).Thus, there are about 460 public companies in the Fortune 1000 that remain eligible to adopt §102(b)(7) Officer Exculpation.
Which officers can be exculpated?
- President, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer, and chief accounting officer
- Named executive officer, as defined per SEC rules
- Identified as an officer for purposes of service of process in Delaware
What can be exculpated?
- Only claims that do not involve breaches of the duty of loyalty, acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, or any transaction in which the officer derived an improper personal benefit
- Also, statutory exculpation does not extend to derivative claims brought by or in the right of the company
- We note that some companies use language that would extend their exculpation to include any future extensions included in the DGCL
Should a company adopt officer exculpation?
Typical arguments for adoption include:
- By reducing their legal exposure companies will be better positioned to attract and retain executive talent
- With less legal exposure to exploit, plaintiff law firms will be less inclined to include these officers as defendants in shareholder litigation
- Reduced legal exposure should reduce the costs of D&O insurance premiums Typical reasons to “wait and see” include:
- Reluctance by management to be an early adopter of what might be called a self-serving reduction in their legal exposure for malfeasance
- The current voting policies of ISS, Glass Lewis and certain large institutional investors
- The adverse optics of having a failed vote
- The incremental costs of including Officer Exculpation as an agenda item at the annual meeting
DragonGC Data Insights
We applied our AI-enabled DragonFind research tools to public sources to derive the data set forth at the end of this report. Here’s a summary:
- We focused on the Fortune 1000. Until now, as a group these companies have lagged in adopting which we attribute to their being more deliberate. When they have acted, they have had high approval rates as shown in the following table.
- Vote percentages are “For / Shares Outstanding.” A majority of outstanding is required by the DGCL. Some companies have heightened requirements per their charter (e.g., 2/3rds). We note that companies with high retail ownership can be challenged to meet these requirements.
We took a deeper look at the failed votes:
- MGM Resorts International needed 50% but only got 48.6%, as 29.7% of its outstanding shares were unvoted broker non-votes which in effect were AGAINST votes
- The Williams Companies, Inc. needed 75% to approve but only got 69.3%
- Owens Corning needed 75% to approve but only got 71.1%
- JetBlue Airways Corporation needed 50% but only got 48.7%, as 24.1% of its outstanding shares were unvoted broker non-votes which in effect were AGAINST votes
- AMC Entertainment Holdings, Inc. needed 50% but only got 13.3%. 31.7% of its outstanding shares were unvoted broker non-votes and the company has underperformed financially in recent periods
- Vishay Intertechnology, Inc. has dual class shares and, although it got 87.5% approval of the total voting power, it failed to get approval from common shares voting as a separate class.
ISS / Glass Lewis Voting Guidelines
Both ISS and Glass Lewis updated their voting guidelines in response to the DGCL amendment. According to its published policy, ISS will vote case-by-case on exculpation proposals, considering the stated rationale for the proposed change considering a list of factors.
Compared to ISS, Glass Lewis is less supportive of Officer Exculpation: “However, given the differences in the roles of directors and officers, we have adopted a more cautious stance when providing recommendations on the adoption of such provisions for officers. We believe that the officers of public companies are well-compensated for the risk of litigation they take on and identify this factor as an important contrast between the roles of corporate officers and their director counterparts. Shareholders should be reluctant to relinquish their rights to pursue claims for breaches of duty of care against corporate officers without some clear demonstration of the benefit to the company and its shareholders of adopting such provisions.”
Newly public companies
We reviewed the final prospectuses for the 70 Initial Public Offerings by Delaware corporations which closed from January 1, 2024 through July 31, 2024. Each of these companies included a charter provision to indemnify officers “to the fullest extent possible under the DGCL” or equivalent language.
Should companies continue to “wait and see”?
This decision is of course a prerogative of the board, but DragonGC believes the data we’ve analyzed provides insight:
- Concerns with being an early adopter should be less now that many other companies have adopted Officer Exculpation with strong voting support from institutional investors, including 177 of the approximately 650 Delaware companies in the Fortune 1000.
- Whether ISS / Glass Lewis recommended against doesn’t explain failed votes as much as the need for some companies to obtain supermajority approval and/or deal with the challenges of soliciting a shareholder base with significant retail ownership.
- Companies without a supermajority voting requirement that have significant institutional ownership are likely to obtain the necessary shareholder vote. Others may need the help of a targeted solicitation campaign.
- Adopting Officer Exculpation requires the filing of a preliminary proxy statement which can add incremental expense and complicate a company’s timetable. As shown in the schedules below, 93 of the 177 in the Fortune 1000 that have adopted had no other agenda item requiring the preliminary; 84 had other items such as authorizing new shares which would independently require the filing of a preliminary.
Link to the full report can be found here.
