Moelis Decision Ushers in Uncertainty for Enforcement of Shareholder Agreements

The Delaware Court of Chancery ushered in uncertainty for early-stage companies and their investors with its recent decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company (Moelis)[1]. Following the decision, issuers and investors have been grappling with whether and to what extent typical agreements entered into between investors and issuers are enforceable (and if not, the downstream consequences of such unenforceability).

On March 28, 2024, the Council of the Corporation Law Section of the Delaware State Bar Association (the council) released proposed amendments to the Delaware General Corporation Law (DGCL) to address the fallout from Moelis, but companies and investors should proceed cautiously for now.

The Moelis Decision

DGCL Section 141(a) provides that, generally, unless otherwise set forth in a company’s certificate of incorporation “[t]he business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors.”

In Moelis, the court considered the enforceability of Moelis & Company’s (the company) shareholders agreement, entered into by Ken Moelis, founder of the company (the founder), immediately before the company’s 2007 initial public offering. The shareholders agreement gave the founder veto rights over certain company actions, including issuing company stock, incurring debt over certain thresholds, declaring or paying dividends, liquidating the company, and amending the company’s governing documents.

The founder also was given the right to designate a majority of the company’s board of directors and the board was required to populate each board committee with a proportionate number of directors designated by the founder.

The court determined that the shareholders agreement was an internal affairs document and, applying the Abercrombie test, determined that certain provisions of the shareholders agreement violated DGCL Section 141(a) on their face by usurping the board’s power to manage the company. The court found that the provisions were facially invalid (and that others might be invalid as applied) because they “have the effect of removing from directors in a very substantial way their duty to use their own best judgment on management matters” and tended “to limit in a substantial way the freedom of director decisions on matters of management policy.”[2]

Amendments to the DGCL

On March 28, 2024, the council released proposed amendments (the amendments) to the DGCL that are designed to address the unexpected result of Moelis and bring existing law in line with market practices. The amendments would include a new subsection to Section 122 of the DGCL that would give companies the power to enter into contracts with current or prospective stockholders that include rights like those given to the founder in Moelis, and even include a list of provisions permitted to be included in a contract between an issuer company and prospective/current shareholders.

Note, however, that directors’ fiduciary duties will continue to apply to decisions to enter into such contracts, which we believe may result in increased scrutiny of directors that authorize a company to enter into an agreement that gives stockholders veto rights over decisions that according to the court in Moelis should belong to the board itself.

Although the final amendments may be adopted as early as June 30, 2024, they likely would not become effective until August or September; but once adopted, the amendments would apply to all contracts made or entered into by a corporation, regardless of whether such contracts are entered into before the effective date of the amendments. Any litigation completed or pending prior to the effective time of the amendments, however, will be decided pursuant to the law predating the amendments. For that reason, early-stage companies and investors must take precautions until the amendments become effective, if ever.

Protection in the Interim

Brown Rudnick is guiding early-stage companies and investors as they grapple with how to navigate internal governance documents that grant stockholders rights post-Moelis that the court ruled should be reserved for the board.

The most conservative approaches corporations are using include: (i) refraining from giving stockholders powers that usurp governing powers from the board (which may have limited effectiveness given investors’ penchant for restrictive covenants, (ii) including such stockholder rights directly in the company’s certificate of incorporation, or (iii) expressly waiving compliance with the provisions of existing shareholder agreements found by Moelis to be in violation of the DGCL. Because it is unclear that incorporation by reference to a shareholders agreement in the charter is effective, we are aware that some corporations have considered attaching shareholder agreements with otherwise potentially impermissible stockholder rights as exhibits to the company’s certificate of incorporation.

More aggressive approaches include continuing to negotiate for bespoke veto and consent rights assuming that the amendments will go into effect in the next couple months and the uncertainty ushered in by Moelis will be resolved. Whether or not the amendments being considered are effectuated (in current or some modified form), the well-established fiduciary duties of directors of Delaware corporations will not be altered. As such, corporations should carefully consider incorporating express fiduciary exclusions to the rights granted to stockholders in shareholder agreements.

Brown Rudnick will continue to monitor any new guidance related to the Moelis case and its downstream effects on companies and investors. In the meantime, we would be pleased to assist you in your analysis of best practices.

[1] 2024 WL 747180 (Del. Ch. Feb. 23, 2024). 

[2] Id.