The Delaware General Assembly to the Rescue: Proposed Legislative Fixes to Uncertainty Created by Three Significant Delaware Chancery Court Decisions

Summary

On March 28, 2024 the Council of the Corporation Law Section of the Delaware State Bar Association released a set of proposed amendments to the Delaware General Corporation Law (the "DGCL"). The proposed amendments, which are expected to be introduced to the Delaware General Assembly for approval this year, are intended to resolve uncertainty created by three significant decisions of the Delaware Court of Chancery over the last several months.¹ Specifically:

• One set of proposed amendments provides that a merger or similar agreement can provide for the damages and other consequences of a breach of the agreement, including recovery by a corporation of damages reflecting the loss of the premium or the "benefit of the bargain" its stockholders would have received if a merger had been consummated ("lost premium damages"). These amendments also provide that a merger agreement can include a provision appointing one or more persons as agent on behalf of the stockholders to enforce the rights of stockholders and enter into settlements on their behalf. These amendments are intended to address the longstanding uncertainty regarding whether and how Delaware corporations and/or their stockholders could collect lost premium damages from a breaching acquirer, which issue was addressed but left unresolved by the Chancery Court's decision in Crispo v. Musk.²
• A second set of proposed amendments provides that Delaware corporations can enter into governance arrangements with one or more current or prospective stockholders (or one or more beneficial owners of stock) that limit what the corporation can do without the approval of one or more persons or bodies (which may include the board of directors or one or more current or future directors, stockholders or beneficial owners of stock). These amendments are intended to address the uncertainty created by the Chancery Court's decision in West Palm Beach Firefighter's Pension Fund v. Moelis & Co.,³ which invalidated provisions of a stockholder agreement between Moelis & Co., an investment bank, and its eponymous founder Ken Moelis as violative of DGCL Section 141(a), which provides that the business and affairs of a corporation will be managed by its board of directors, except as may otherwise be provided in the DGCL or the corporation's charter.
• A third set of proposed amendments provides, among other things, that it is sufficient for the board of directors of a Delaware corporation to approve an agreement in "substantially final" form, i.e., the agreement does not need to be in final form, and that a board can ratify any agreement or instrument required to be filed with the Delaware Secretary of State after it has approved the document but before it is filed with the Secretary of State. These amendments are intended to address uncertainty regarding the board approval process created by the Chancery Court's decision in Sjunde AP-Fonden v. Activision Blizzard, Inc.,⁴ regarding board approval of agreements, instruments and documents that are in less-than-final form.

While each of these sets of amendments are important, two of them – those relating to external governance arrangements and those relating to board approval of merger and similar agreements – to a large extent codify long-standing market practice and thus are not likely to have a significant impact on Delaware practice. The third set of amendments, those relating to the recovery of lost premium damages, is likely to have a meaningful impact on merger negotiations and the related allocation of risk in the event of an acquirer breach.

If enacted, the proposed amendments will become effective as of August 1, 2024. The amendments will apply to all agreements, instruments and documents approved by a board of directors, and all agreements of merger and consolidation entered into by a corporation, in each case whether approved or made on or after August 1, 2024. However, the amendments would not affect civil actions or proceedings completed or pending on or before such date.

The proposed amendments would, if enacted, alleviate a great deal of the uncertainty in Delaware corporate law created by the three Chancery Court decisions. Alleviating this uncertainty may counteract the nascent view that Delaware has become an unpredictable (and consequently potentially problematic) state in which to be incorporated, and thus help to quiet the voices that had begun to suggest companies should consider incorporating elsewhere.

The below summary identifies and discusses the principal provisions of the proposed amendments and the Delaware Chancery Court decisions that gave rise to them. This is not intended to be a comprehensive or exhaustive review of the amendments, related case law and their likely consequences, and is subject in all respects to the text of the proposed amendments and the decisions.

Recovery of Lost Premium Damages

Ever since the decision by the US Court of Appeals for the Second Circuit in Consolidated Edison v. Northeast Utilities in 2005, the issue of whether a jilted public company target and/or its stockholders can recover lost premium damages from a breaching acquirer has been the subject of much discussion among practitioners and a principal issue in merger agreement negotiations. In that decision, commonly known as Con Ed, the Second Circuit held that stockholders could not recover lost premium damages from a breaching acquirer where the merger agreement expressly disclaimed the rights of third-party beneficiaries, which would include stockholders.

Corporate practitioners responded (or declined to respond) to the Con Ed decision in various ways, including the following:

1. ignoring the issue, which was the most common response;
2. including a provision in the merger agreement that the target company's damages include lost premium damages (a "lost premium damages provision");
3. including a provision in the merger agreement appointing the target company the agent of its stockholders to recover lost premium damages on their behalf; or
4. including a provision in the merger agreement that the target's stockholders are third-party beneficiaries of the agreement.

In the Crispo decision the Chancery Court addressed the Con Ed issue in an unusual context – an action by stockholder Crispo to recover a mootness fee for his role in forcing (or persuading) Elon Musk and his affiliates to close their acquisition of Twitter Inc., which turned on whether Crispo had standing to sue for breach of the merger agreement as a third-party beneficiary of the agreement at the time he filed his motion. The merger agreement contained both a lost premium damages provision, as well as an express disclaimer of all third-party beneficiaries except in limited circumstances not directly relevant to the case.

The Court denied plaintiff Crispo's motion for a mootness fee, holding that he did not have any third-party beneficiary rights at the time he filed his motion. In reaching this conclusion, the Court found that although there were "two objectively reasonable interpretations" of the merger agreement, under either interpretation any third-party beneficiary rights Crispo may have had would not have vested by that time.

Under one interpretation, the merger agreement's disclaimer of third-party beneficiary rights precluded any rights of a stockholder to sue to enforce the agreement or to collect lost premium damages. Under a second interpretation, which reflected the Court's attempt to give effect to both the disclaimer of third-party beneficiary rights and the lost premium damages provision, Crispo may have had third-party beneficiary rights in the "exceptionally narrow circumstances and for the limited purpose of seeking lost-premium damages" where the agreement had been terminated and the target company was no longer seeking specific performance.

The Court also found that a lost premium damages provision that provides for recovery by the target company of lost premium damages would be unenforceable because it is the stockholders, not the company, who are entitled to these damages. In dicta, the Court further observed that:

1. granting stockholders third-party beneficiary rights to enforce a merger agreement is inconsistent with Delaware's board-centric model of corporate governance and creates the possibility of concurrent and conflicting enforcement actions against a breaching acquirer by the target company, on the one hand, and various stockholders, on the other hand; and
2. provisions in a merger agreement appointing the target company as the agent of its stockholders to collect lost premium damages are of suspect enforceability without a mechanism for the stockholders to actually appoint the target as their agent for this purpose.

The proposed amendments would revise Section 261 of the DGCL to, among other things, provide that parties to an agreement of merger or consolidation (a "merger agreement") can expressly provide:

1. that a party that breaches the agreement prior to the time the transaction becomes effective, or otherwise fails to consummate the transaction in accordance with the agreement's terms, can be liable for such penalties and consequences as are provided for in the agreement, which can include damages based on the amount of any premium the stockholders would have received if the transaction had been consummated. Under the proposed amendments, a target company could retain (and not turn over to its stockholders) any lost premium damages it might recover. The penalties and consequences (including lost premium damages) are in addition to any other remedies available at law or in equity; and
2. for the appointment, at or after the time that the merger agreement is approved by a party's stockholders, of one or more persons to serve as representatives of that party's stockholders (a "stockholders' representative"), including stockholders whose shares will be canceled, exchanged or converted into merger consideration in the transaction, and the delegation to the stockholders' representative of the authority to take action on behalf of the stockholders, including enforcing the rights of the stockholders under the agreement and entering into settlements on their behalf. Once a stockholders' representative is appointed at or following the stockholders' adoption of the merger agreement, such appointment will be binding on all stockholders.

Key takeaways and practice pointers:

• The amendments would largely resolve the Con Ed issue in Delaware by permitting parties to a merger agreement to include in the agreement (a) a lost premium damages provision under which a party could recover and retain lost premium damages and/or (b) a provision providing for a stockholders' representative who has the authority to enforce the rights of the stockholders under the agreement.
• With respect to a lost premium damages provision, it remains to be seen whether a target company that recovers what are effectively lost premium damages to which its stockholders were entitled will have a fiduciary duty to pay out those damages to its stockholders on a pro rata basis rather than retaining the amounts.
• With respect to a stockholders' representative provision, the merger agreement will presumably need to provide (in addition to the appointment of the representative) that the target company's stockholders are third-party beneficiaries of the agreement in order for the stockholders' representative to have the right to recover lost premium damages on their behalf.
• Although the proposed amendments do not delineate any limitations on the right of a stockholders' representative to agree to revised transaction terms on behalf of the stockholders, presumably a stockholders' representative could not agree to fundamentally different terms (such as a material change in the amount or form of consideration) without having to obtain stockholder approval of the new terms.
• The proposed amendments, just as the Crispo decision did, will undoubtedly bring a great deal of focus on merger agreement provisions intended to address these issues.
• Parties negotiating merger agreements between now and when the proposed amendments are scheduled to become effective on August 1, 2024 could take various approaches:
  • remain silent on the Con Ed issue, as the majority of parties have done since the decision was issued by the Second Circuit in 2005;
  • assume the amendments will become effective as proposed on August 1, 2024, negotiate remedies based on that assumption, and assume (or hope) that any challenge to the enforceability of these remedies' provisions will be resolved after August 1, 2024; or
  • if the parties conceptually agree that a breaching acquirer should be liable for lost premium damages, adopt the approach suggested by the Crispo Court and include in the merger agreement both a lost premium damages provision and a provision that gives the target company's stockholders third-party beneficiary rights to recover lost premium damages after the agreement has been terminated and the remedy of specific performance is no longer available.

Third-party Governance Arrangements

Delaware law practitioners had long assumed that Delaware corporations could enter into stockholder agreements granting stockholders various governance rights and/or limiting or prohibiting the ability of their boards to take certain actions without the approval of a stockholder. Consequently, the Chancery Court's decision in the Moelis case came as a significant surprise to these practitioners, as well the corporations and stockholders party to these agreements.

Moelis & Co., an investment bank, had entered into a stockholder agreement with its founder Ken Moelis that provided Mr. Moelis with various governance rights, including the right to approve 18 corporate actions and rights to nominate persons for election as directors and to fill vacancies on the board. The agreement also imposed on the board the obligation to recommend Mr. Moelis's nominees for election to the board and required the corporation to use reasonable best efforts to get the nominees elected as directors.

A stockholder challenged the enforceability of the stockholder agreement on the ground that it violates Section 141(a) of the DGCL, which provides that the "business and affairs of every [Delaware] corporation . . . shall be managed by or under the direction of a board of directors, except as may otherwise be provided in this chapter or in the certificate of incorporation." The Court held that "internal governance arrangements" included in agreements with third parties (such as stockholder agreements) are invalid if they substantially remove the ability of directors to exercise their own judgment, or limit in a substantial way their freedom to make decisions, with respect to management matters.

The proposed amendments would revise Section 122 of the DGCL to provide that in exchange for minimum consideration approved by the board, a Delaware corporation can enter into an agreement with a current or prospective stockholder (or beneficial owner of its stock):

1. that restricts or prohibits future corporate actions specified in the agreement;
2. that requires the approval of one or more persons or bodies (including the board or current or future directors, officers, stockholders or beneficial owners) before the corporation can take certain specified actions; and
3. under which the corporation agrees that it or any of these persons or entities will take, or refrain from taking, specified actions.

The proposed amendments to Section 122 would clarify that the ability of boards to delegate to corporate officers or agents duties that reside with the board will remain subject to Section 141(a) and the common law limiting excessive delegation of those duties. The amendments would not alter a director's fiduciary duties as they apply to the decision to enter into an agreement that grants a stockholder governance rights, as well as a decision to comply with or breach the agreement.

Key takeaways and practice pointers:

• The amendments would codify long-standing market practice that a Delaware corporation can enter into agreements with its stockholders and beneficial owners to (a) grant various corporate governance rights (including veto rights over corporate actions) to the stockholder or beneficial owner and/or (b) limit or prohibit the corporation from taking action, or from refraining to act, without the approval of the stockholder or beneficial owner.
• The agreement must be supported by minimal consideration for the corporation in exchange for granting the governance rights.
• The fiduciary duties of the directors of the corporation will apply to any decision to enter into such an agreement and to comply with, or breach the terms of, the agreement.
  • Although the proposed amendments do not create any new law regarding the fiduciary duties of directors and officers, they will likely lead to greater scrutiny regarding the application of these duties to stockholder agreements.
    • For example, would directors breach their duty of care if they authorized a corporation to enter into an agreement with a stockholder which gave the stockholder a veto right over any sale of the corporation, and the stockholder vetoed a transaction that would have maximized stockholder value (or in sale of the corporation for cash, offered stockholders the best price reasonably available for their shares)?
• Parties negotiating stockholder agreements between now and when the proposed amendments are scheduled to become effective on August 1, 2024 could take various approaches:
  • assume the amendments will become effective as proposed on August 1, 2024, and assume (or hope) that any challenge to the enforceability of the agreement will be resolved after August 1, 2024; or
  • if the corporation has authorized but unissued blank check preferred stock, take the approach suggested by the Moelis Court as a possible way to grant a stockholder many of the governance rights Mr. Moelis had without running afoul of Section 141(a) of the DGCL, i.e., issue the stockholder one so-called "golden share" of preferred stock that sets forth all the governance rights that the corporation is willing to grant to the stockholder.
    • The corporation may wish to provide that the golden share would be redeemable under certain circumstances, including following the effectiveness of the proposed amendments and the execution of a stockholder agreement setting forth the governance terms previously embodied in the golden share.
    • A corporation's directors considering this course of action should keep in mind that their decision to issue to a stockholder a golden share embodying governance terms will be subject to their fiduciary duties of care and loyalty.

Board Approval and Stockholder Notice Regarding Merger Agreements

It had long been assumed among most Delaware practitioners that to satisfy the DGCL section requiring a constituent corporation to a merger to approve the merger agreement (DGCL Section 251(b)) it was sufficient for the board to approve a substantially final draft of the agreement as opposed to the final, execution version. In fact, these practitioners probably viewed this as a concession to the reality that most board meetings to approve a merger are held before the merger agreement has been finalized.

Accordingly, it came as a surprise when the Delaware Chancery Court in Sjunde AP-Fonden v. Activision Blizzard, ruling on a motion to dismiss, refused to dismiss a claim that the merger agreement was not properly approved by the Activision Blizzard board because the board had not approved the final form of the agreement. In reaching this conclusion the Court determined that the merger agreement was not even in substantially final form because it was missing key provisions, including the purchase price, disclosure schedules and the surviving corporation's certificate of incorporation.

The Court also refused to dismiss the plaintiff's claims that (a) the Activision board had improperly delegated to a board committee responsibility for negotiating a merger agreement provision relating to the ability of the company to pay dividends between signing and closing, and (b) the notice of the stockholder meeting to approve the merger did not satisfy the requirements of the relevant section of the DGCL (Section 251(c)) because it failed to include a copy of the merger agreement or a summary thereof.

The proposed amendments would amend the DGCL:

1. to add a new Section 147 that provides that:
   1. when the DGCL requires the board of directors to approve or take other action with respect to any agreement or instrument, the document can be in final form or substantially final form. The official synopsis of the proposed amendments makes clear that in order to be in substantially final form the material terms and conditions of the document need not be set forth in the document itself, but can be presented to the board in a separate presentation or separate materials; and
   2. if the board has acted to approve or take other action with respect to any agreement or instrument that is required to be filed with the Delaware Secretary of State, the board can, after taking the action but before the document is filed with the Secretary of State, ratify the document, and the time of ratification will relate back to the time the approval or other action was taken;
2. to amend Section 232, which addresses notices to stockholders, to provide that any materials included with or attached to a notice to stockholders will be deemed to be part of the notice for purposes of the DGCL; and
3. to add a new Section 268 that provides that:
   1. in connection with the adoption of a merger agreement that provides that all the shares of a constituent corporation are being cashed out or exchanged for property, rights or securities (other than stock of the surviving corporation), (a) the certificate of incorporation of the surviving corporation does not need to be referenced in or attached to the agreement, and (b) any amendment to the certificate of incorporation of the surviving corporation can be approved by the board of the constituent corporation (or if the shares or other equity interests of a constituent entity are being converted into all the shares of the surviving corporation, the board of directors or other governing body of such constituent entity), or another person acting at its direction (Section 268(a)); and
   2. disclosure schedules and similar documents and instruments delivered in connection with a merger agreement that modify, qualify or make exceptions to representations, warranties, covenants and conditions in the agreement are not considered part of the agreement for purposes of approval of the agreement under the DGCL.

Key takeaways and practice pointers:

• The amendments would codify longstanding market practice regarding board approval of merger agreements and notices to stockholders of meetings to approve merger agreements. Accordingly, they should not have a significant impact on market practice.
• While it is not entirely clear what constitutes "substantially final form," for a merger agreement, it likely includes, in addition to the purchase price and form of consideration, other material terms and conditions such as the mechanism for determining the exchange ratio in stock-for-stock deals, termination rights, termination fees and reverse termination fees, significant interim operating covenants (for a target company), regulatory efforts covenants and key closing conditions.
• The proposed amendments do not address one issue raised in the Sjunde AP-Fonden decision, i.e., the ability of boards to delegate the right to approve a merger agreement to a committee thereof, which by negative implication means the agreement needs to be approved by the full board.

^{1 The text of the proposed amendments, as well as the official synopsis thereto, can be found here.
2 304 A.3d 567 (Del. Ch. 2023).
3 – A.3d – , 2024 WL 747180 (Del. Ch. Feb. 23, 2024).
4 2024 WL 863290 (Del. Ch. Feb. 29, 2024).}

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