Delaware Court Of Chancery Invalidates Certain Rights In Stockholder Agreement Sidelining Board Of Directors

• Published date: 26 March 2024
• Subject Matter: Corporate/Commercial Law, Corporate and Company Law, Directors and Officers
• Law Firm: Foley Hoag LLP
• Author: Carmen DeMatteis, Alexander McGrath and Adrian Maraziti

Key Takeaways:

• The Delaware Court of Chancery (the "Court"), through its decision in Moelis¹, has invalidated certain stockholder agreement provisions that circumvent the role of the board of directors (the "Board") and its ability to exercise control pursuant to Section 141(a)² of the Delaware General Corporation Law (the "DGCL").
• Existing stockholder agreements limiting the powers of the board could be held invalid pursuant to Section 141(a) of the DGCL to the extent that such agreements limit the control and powers of the board.
• The ruling in Moelis implies that certain negative covenants related to boards of directors should appear in the company's certificate of incorporation instead of in stockholder agreements to be enforceable.
• The Court's decision only applies to corporations and does not extend to limited liability companies and limited partnerships.

On February 23, 2024, the Court issued an opinion³ invalidating certain provisions of a stockholder agreement, which, in part, contractually constrain the Board's discretion to exercise control over the business and affairs of the company. In its analysis, the Court used a test formulated in Abercrombie⁴ to determine the legality of a stockholder agreement's provision. Accordingly, to determine the validity of a provision, one must first evaluate whether a subject provision falls into the realm of an internal governance arrangement as contemplated in Section 141(a) of the DGCL. Second, if the provision is part of an internal governance arrangement, the Court must determine whether the challenged provision effectively removes the board in a "very substantial way from their duties to use their best judgement on corporate matters."⁵

Drawing off the facts of the case, the Court specifically stated that certain provisions of a stockholder agreement were facially invalid. Such provisions relate to "Pre-Approval Requirements," "Board Composition Provisions," and "Committee Representation Provisions," which are described in more detail below. In Moelis, the Court reasoned as follows:

• "Pre-Approval Requirements" - Under the terms of the company's stockholder agreement, the Board required prior written consent from the stockholder before taking certain actions, which among other matters, included the issuance of equity, removal and appointment of officers, and incurrence of debt. The Court did not consider "whether some lesser combination of rights might pass muster" because these stockholder pre-approval...