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The Delaware Court of Chancery, held in one of three courts in the state, including the Leonard L. Williams Justice Center, is the premier arena for corporate disputes in the country. A proposed bill would make major changes to corporation law. | DBT FILE PHOTO[/caption]
DOVER — A bill that would amend Delaware’s corporate code to dramatically change how boards of directors oversee companies as fiduciaries in the nation’s incorporation epicenter is now working its way through the state legislature.
Changes to the Delaware General Corporation Law typically go through the General Assembly as routine updates which are proposed by the Corporation Law Council of the Delaware State Bar Association (DSBA). But this year, the bill contains dramatic changes to stockholder agreements that have caught the eye of corporate America and legal experts around the country.
Senate Bill 313, proposed by Sen. Bryan Townsend (D-Newark) creates a new subsection of the state corporation law that would grant companies the power to enter into contracts with one or more stockholders, greatly expanding what corporations can do without the full approval of the board of directors. Several legal experts testified on Wednesday before the Senate Judiciary Committee that these agreements would put dramatic limits on the board’s independent authority.
Under section 141 of Delaware corporate law, the business “and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.”
In a two hour hearing on Tuesday, more than half a dozen legal experts testified on the bill, voicing their concerns that the amendments SB 313 came from a rushed process and would make this section toothless.
Brian Quinn, a professor at Boston College Law School who has extensively written on legal reform, wrote the Senate Judiciary Committee a letter that said it was “strange that the legislature would consider such an ignoble end” to section’s 141’s position by “endorsing outsourcing of internal governance” to stockholder contracts.
“In most states, like my own Massachusetts, the corporation law is subject to interest group politics,” Quinn wrote on May 29. “Small, organized, groups with vested interests can benefit from specific changes to the law and use political power to work changes that benefit their narrow interest while no one is looking out for the whole.”
Quinn also testified on Tuesday, with much of his testimony echoed from his letter.
“...Amendments to the Corporation Law should be guided by an understanding of the public good, incorporating market practices where appropriate without being dictated by them,” he continued in his letter.
What’s at stake
Delaware is one of the most-well known spaces for business incorporation with its corporate laws written so sophisticatedly that countries like Israel have spent years setting up a court that mirrors the Delaware Court of Chancery. That court is where judges, who spent years in law school and crafting arguments in the top business law arenas, settle matters for 1.9 million businesses that incorporate in the First State.
According to the Delaware Department of State, about 68% of Fortune 500 companies are incorporated in Delaware. Fiscal Year 2022 saw another 16.8% added to the state’s coffers. To add to the corporate flair, the Delaware State Bar boasts a membership of more than 5,600 attorneys, judges and academics that focus on laws that impact corporations and alternative business entities.
The bill, SB 313, has the potential to shape corporate law for years to come, as well as shift how corporate lawyers do business in the boardroom and the courtroom for millions of businesses. Delaware legal analysts have long noted that the state has historically prided itself on its laws that grant power to the board of directors for the benefit of all stockholders, rather than the select few.
Outside the two-hour hearing on the bill, roughly 50 academics and lawyers drafted a brief letter to Delaware lawmakers to reconsider. Two Chancery Court Judges, including Vice Chancellor J. Travis Laster and Chancellor Kathaleen McCormick, have written publicly and to the state bar regarding their concerns about the new amendment. Many other lawyers have written detailed memos and briefs on their concerns, as well.
On Tuesday, the Senate Judiciary Committee voted in favor of SB 313. It now waits to be heard on the Senate floor with eight days left in the legislative session.
Chancery Court’s opinion
SB 313 was drafted in part to respond to the Chancery Court’s recent decision in the case West Palm Beach Firefighter's Pension Fund v. Moelis & Co. The bill cites the case in its analysis.
The Court issued an opinion in February for that case, nullifing provisions of an agreement between global investment bank Moelis & Co. and its chief executive officer and requiring the CEO to sign off on any major corporate decisions. It also granted the executive veto power, potentially setting up a situation where a single shareholder can override a board of directors.
The Chancery Court opinion, written by Laster, upheld that the statute prevails over market practices, even though in recent years “new wave” stockholder agreements have become more aggressive —granting veto powers and other restrictions to executives, which can restrict the board’s authority.
“Crashing into this traditionally immovable object is the seemingly irresistible force of market practice. Corporate planners now regularly implement internal governance arrangements through stockholder agreements,” Laster wrote. “What happens when the seemingly irresistible force of market practice meets the traditionally immovable object of statutory law? The court must uphold the law.”
However, Laster also wrote that the General Assembly could respond to this matter by enacting a provision defining what stockholder agreements can do. However, he has suggested on social media that the proposal outlined in SB 313 was not the solution.
The 27 members of the DSBA Corporation Law Council proposed the amendment to address this on March 28. It was later approved by the association on May 16. SB 313 was filed on May 23.
The debate
DSBA Corporation Law Council Chair Srinivas Raju testified on Wednesday before the Senate Judiciary Committee that there was more feedback on the amendment, including additional meetings with law professors that were facilitated by former Vice Chancellor Joe Slights, over the course of five weeks.
Raju said that the Moelis case raised many questions, and the DSBA Corporation Law Council weighed its impacts heavily on future contract law. That council believed that thousands of contracts may have been called into question as a result of the case.
“Corporations have received millions of dollars from investors and they don’t know if their rights are valid, the corporations don't know if they have potential rescission claims on their hands from an investor,” he said during a Senate Judiciary Committee hearing on Tuesday. “The proposed amendment addresses those issues relating to such contracts strictly from a power and authority perspective.”
However, many legal experts testified that the proposal would set a new precedent and undermine minority stockholder interests. Boston College Law School professor Brian Quinn testified that he feared SB 313 would cause unintended consequences to harm the stability of Delaware’s franchise.
He also argued that the amendments contradict another provision that allows outsourcing governance to a single stockholder and that they allow contract disputes to be decided by arbitration outside the state.
"That could quickly become a source of erosion of Delaware’s market positions,” Quinn said.
Georgetown University Law School faculty member Robert Thompson testified that he and many other academics have preached that Delaware is the first state in corporate law, and many of their have gone on to practice in its borders. He shared concerns that the process was rushed and not enough input from those who rely on these laws.
“This has been justified as a market change, as we need to maintain the franchise to keep it current,” Thompson said. “If you want to do that, you need to spend more time with [the amendments] than what has been spent so far.”
University of Pennsylvania Law School professor Jill Fisch, who has taught corporate law for 35 years, urged the Senate to practice caution when handling the amendments outlined in SB 313.
“Delaware law offers corporate participants incredible flexibility, but flexibility without guardrails can be catastrophic,” she said. “There are certain fundamental features of a corporation that are essential to that entity's identity and cannot be waived. As drafted, this would allow those mandatory features to be eliminated by private contract.”
