A new 133-page opinion by the Delaware Court of Chancery highlights risks to the enforceability of agreements between Delaware corporations and one or more shareholders where the agreements focus on internal affairs and governance. The primary risk is that these agreements may infringe on the broad rights reserved for boards of directors under the Delaware General Corporation Law.
The Court held that a number of provisions in the shareholders agreement in question, including pre-approval (veto) rights of the shareholder and rights of the shareholder over the composition of the board and committees, were unenforceable. This opinion has implications for many common scenarios including:
- Arrangements by founders, strategic investors, financial sponsors, venture investors, and others to ensure they have minority protections, negative control, or exclusive control when investing in Delaware corporations. Clients often enter into these arrangements pre-IPO, at the IPO, or as part of PIPE investments after the IPO.
- Settlement agreements with activists that are conditioned on undertakings by the corporation to ensure the activist that its designee(s) will occupy one or more board seats for a specified period.
- Efforts by corporations to reject stockholder proposals (including those made pursuant to SEC Rule 14a-8) on the grounds that they envision changes that would conflict with Delaware corporate law’s board-centric approach as detailed extensively in this new opinion.
The decision may be appealed, and new legislation may be adopted by the Delaware General Assembly at some point to address this outcome. Thus, it is worth consulting with us on this issue early and often.
In the meantime, consideration should be given to:
- using alternative entities, such as LLCs and LPs, which will not suffer from these constraints if the LLC and partnership documentation are drafted properly; and
- enshrining governance and internal affairs provisions appropriately in certificates of incorporation and certificates of designations of preferred stock where practical – taking into account that there are limits to the ability to use these avenues and that creative approaches to drafting, structuring and implementation may be necessary.
In short, a thoughtful approach to shareholder governance arrangements is merited going forward.