Among the perennial hot topics in Delaware law is the intersection between freedom of contract and internal corporate governance law—two fields in which Delaware’s courts have national and even international renown. While the Delaware General Corporate Law (DGCL) is a broadly enabling statute, a number of recent decisions have found limits to parties’ ability to renegotiate internal corporate governance by “private ordering” outside of the corporate charter and bylaws. These decisions have prompted a flurry of legislative activity—including a pending bill to introduce a new Section 122(18) to the DGCL, granting legislative sanction to some of these stockholders’ agreements. The latest case to address this field of controversy is Wagner v. BRP Group, C.A. 2023-0150-JTL, which once again finds some governance provisions of a pre-IPO stockholders’ agreement facially invalid for transgressing the DGCL.
In Wagner, the company’s owners (founders) entered into a stockholder’s agreement (agreement) with the nascent corporation (corporation) formed to take the company public via an IPO. The agreement, which was disclosed pre-IPO, required the company to obtain the founders’ pre-approval to take any of a host of corporate acts so long as the founders retained at least 10% equity ownership. The challengers contested the validity of the pre-approval rules as they pertained to decision-making on corporate officers, amendments to the corporate charter, and entering into major transactions. After the suit was filed, the founders and the corporation entered into a modification of the agreement (consent agreement) under which the founders would grant pre-approval if a committee of the corporation’s independent directors unanimously recommended the corporate act in question.
The court found all three challenged pre-approval categories violate DGCL Section 141(a), under which a corporation’s board of directors controls corporate management. The court also found that pre-approval requirements relating to corporate officers, and to amending the corporate charter, violated the corresponding sections of the DGCL, Sections 142 and 242, respectively. Because the court additionally held that the consent agreement cured the Section 141(a) problem, but not the Section 142 and 242 violations, the court granted a split decision, allowing the founders to retain their pre-approval power as to major transactions, subject to a unanimous recommendation from the independent directors, but negating their pre-approval authority as to charter amendments and corporate officers.
As the court explained, Delaware courts have long held that it is impermissible to “give legal sanction to agreements which have the effect of removing from directors in a very substantial way their duty to use their own best judgment on management matters,” a principle the court considered in another pre-IPO governance contract in West Palm Beach Firefighters Pension Fund v. Moelis & Co., under which it formulated a two-part test. First, the court looks at whether the agreement is an internal governance arrangement or an external commercial contract, and second whether the internal governance arrangement substantially limits the discretion of a board of directors to exercise their best judgment on management matters.
The court found that the agreement is plainly one of internal corporate governance. It is a stockholder’s agreement with provisions that resemble in both structure and substance the sort of content as might appear in a corporate charter (such as for a class or series of stock), while lacking anything resembling a commercial relationship outside of those governance changes. As a result, the court held it was a “paradigmatic” governance agreement. For the second step, because the founders’ pre-approval authority effectively negated the board’s authority, and because the three challenged provisions addressed key loci of fundamental corporate power— the employment of corporate officers, the consideration of amendments to the corporate charter, and the undertaking of material corporate transactions—the board’s managerial authority was substantially, and thus impermissibly, limited. Thus, the provisions were invalid under Section 141(a).
But, examining the consent agreement, the court found that it gave the independent directors effectively untrammeled discretion to compel the founders’ pre-approval, without any meaningful contractual constraint. As a result, it served to cure the Section 141(a) problem at the second step of the test. Requiring complete unanimity among the independent directors made the board’s exercise of power procedurally more difficult, but procedural limitations are treated differently than substantive ones. The independent directors could compel the founders’ pre-approval; in other words, the agreement as modified by the consent agreement only complicated the board’s exercise of discretion, without actually limiting that discretion, curing the Section 141(a) defect.
However, while the court found the distinction between procedural obstacles and substantive limitations was meaningful for Section 141(a) analysis, the same could not be said for Sections 142 or 242. An additional procedural step of requiring an independent director committee’s unanimous recommendation to overcome the founders’ disapproval, appearing in neither the corporate charter nor its bylaws, was “beyond the statutory pale” for Section 142, and a “Rube Goldberg device” for Section 242.
For Section 142, the DGCL allows the corporate charter and bylaws to include procedures and rules for the selection and employment of corporate officers. By expressly enumerating the charter and bylaws as permissible locations for those procedures and rules, the Court views the DGCL as excluding stockholder agreements. Since the corporation’s charter and bylaws did not authorize the agreement, it was flawed under Section 142 in a manner not saved by the consent agreement.
For Section 242, the court deferred to the Delaware Supreme Court’s 1996 decision in Williams v. Geier, in which it put great weight on the “precise sequence” of “two discrete corporate events” for charter amendments, i.e. board approval followed by stockholder approval. With Williams putting so much emphasis on the timing and order of those procedural steps, the court reasoned that the agreement, even with the consent agreement, was untenable and remained contrary to statute and void.
Taken all together, the court’s reasoning is that a contractual arrangement under which the board’s authority is substantively retained but procedurally snarled survives statutory analysis as a general matter. But when the DGCL already contemplates specific mechanisms and procedures for specific key corporate powers, or particular places where those mechanisms and procedures are to be found, those mechanisms and places must be respected to survive analysis under the DGCL.
Among the guiding stars of Delaware law is the simple precept that parties should get what they bargained for. Thus, Delaware enforces freely entered agreements as written, while reading those agreements with a commercially sophisticated eye. At the same time, Delaware’s fiduciary law is one of the jewels in its jurisprudential crown. Its body of law on the duties owed by those who control the corporate machinery to those who stand to benefit from the corporation’s prosperity is world leading. The acumen of Delaware courts in handling complex cases along those two threads of law have made it a world-leading forum for managing complex disputes. Edge cases on the border between these fields create some of the most difficult-to-resolve conflicts, making the enforceability of stockholder agreements on internal corporate governance matters an acutely hot topic. As the decision in Wagner appears to dispose of all pending claims, it may be the first to reach a final, appealable judgment, even as the General Assembly considers statutory changes to the DGCL with the potential to greatly alter the legal landscape under which these stockholder agreements are considered.
Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.
