Debt Download
March 29, 2024

Debt Download

Welcome to Debt Download, Goodwin’s monthly newsletter covering what you need to know in the leveraged finance market. Spring is here, and Debt Download is getting you ready for warmer temperatures, cherry blossoms and higher-for-longer interest rates. 

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In the News

Goodwin Insights – Delaware Court of Chancery Invalidates Governance Rights in Stockholder Agreement

For this edition of Debt Download, Goodwin partners Jordan D. Weiss, Michael J. Kendall, Jennifer L. Chunias and Joseph P. Rockers and associate Dylan Schweers examine a recent case in the Delaware court of chancery that threatens to upend fairly common control provisions in stockholder agreements.

On February 23, 2024, the Delaware Court of Chancery issued a decision in a class action lawsuit (West Palm Beach Firefighters’ Pension v. Moelis & Co.) that concluded most of the control provisions in a stockholder agreement in favor of a stockholder were facially invalid under Delaware’s General Corporation Law (“DGCL”) because they were not in the Charter.

Key Takeaways:

  • Most or all of the invalidated governance provisions would be valid if included in a company’s certificate of incorporation, rather than a stockholders’ agreement
  • Stockholder agreement provisions could also be incorporated by reference into certificates of incorporation to make amending those provisions easier
  • Existing arrangements that may be subject to challenge on the same basis as Moelis can be amended to be compliant, subject to fiduciary considerations
  • This ruling does not impact similar governance provisions for limited liability companies (LLCs) or limited partnerships (LPs)

At the center of the case is a 2014 stockholder agreement (the “Stockholder Agreement”) that provides Moelis & Co.’s (the “Company”) founder, CEO, and Chairman, Ken Moelis, certain negative covenants, or “blocking rights,” with respect to eighteen of the Company’s key decisions, including stock issues, financing, contracts, litigation decisions, dividend payments, and senior officer selections (the “Pre-Approval Requirements”). In addition, under the Stockholder Agreement, the Company’s board of directors (the “Board”) was required to ensure that Moelis can select a majority of its members (the “Board Composition Provisions”).

In its motion for summary judgment, plaintiff stockholder alleged that the Pre-Approval Requirements and the Board Composition Provisions are invalid on their face because they violate the “bedrock” principles of director decision making under Delaware law. More specifically, plaintiff argued that the challenged provisions in the Stockholder Agreement violate Delaware law because they effectively remove from directors “in a very substantial way” their duty to use their own best judgment on matters of management. Meanwhile, the Company argued that Delaware corporations possess the power to contract, including contracts that may constrain a board’s freedom of action, and the Stockholder Agreement should not be treated any differently.

After a painstaking analysis of applicable Delaware cases, the court found that several of the Board Composition Provisions, and all of the Pre-Approval Requirements, were facially invalid under Delaware law. The court decided that each of the Pre-Approval Requirements went “too far” because they forced the Board to obtain Moelis’s prior written consent before taking “virtually any meaningful action” and, thus, “the Board is not really a board.” Potentially worth noting, the court decided only to address the Pre-Approval Requirements together, rather than individually, leaving open the possibility that some of them, standing alone, could be valid. It is not clear whether that choice was meant to convey legal significance, but at a minimum it leaves open the question for future litigation of how any particular blocking right might have been viewed when analyzed through the multi-prong test laid out in the opinion.

Offering some counsel to market participants, the court makes the point that the provisions it invalidated could have been accomplished consistent with Delaware law if they had been included in the Company’s certificate of incorporation, rather than in a stockholder agreement. The court also posited that, even now, the Board could implement many of the challenged provisions by using its blank check authority to issue Moelis a single “golden share” of preferred stock carrying a set of voting rights and director appointment rights.

Additionally, because this decision arises out of the DGCL, it does not apply to other corporate forms such as LLCs or LPs.

The Opinion will likely have a ripple effect on cases already pending in the Chancery Court that involve similar “new wave” stockholder agreements. Beyond those matters, in this Firm’s view and based on our experience, the most likely practical impact is that the next time that a target’s counsel argues against including one or more stockholder rights in the target’s certification of incorporation—perhaps based on the efficiency of leaving certain matters to the Board, instead of requiring stockholder votes—the potential investor will win that negotiation.

Our team will continue to monitor the Moelis & Co. case, including with respect to any appeals, and will continue to give thought to the decision’s impact. Please contact Jordan Weiss, Mike Kendall, Jennifer Chunias, Joe Rockers or Dylan Schweers with any questions. 

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For inquiries regarding Goodwin’s Debt Download or our Debt Finance practice, please contact Dylan S. Brown, Nikolaus J. Caro, and Robert J. Stein.

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This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.