Proposed Amendments Would Clarify Delaware Statutory Requirements, to Align with M&A Market Practice, Following the Moelis, Activision, and Crispo Decisions

The Delaware Court of Chancery's recent decisions in Moelis, Activision and Crispo surprised many practitioners by calling into question the validity of some long-standing, common corporate practices, based on seemingly technical readings of Delaware statutory law (in Moelis and Activision) and standard merger agreement provisions (in Crispo). In response to these decisions, the Council of the Corporation Law Section of the Delaware State Bar Association has proposed certain amendments (the "Amendments") to the Delaware General Corporation Law that would establish the validity of the practices the court found problematic in these cases. The Court of Chancery itself suggested in both Moelis and Activision that the Delaware legislature might want to consider amendments of the DGCL to that end.

The Amendments, if adopted (as is expected), would clarify the DGCL to align its requirements with market practice, in connection with (i) the granting of governance rights in stockholders agreements (the issue in Moelis), (ii) the process for board approval of a merger agreement (the issue in Activision), and (iii) the enforceability of so-called Con Ed provisions in merger agreements (the issue in Crispo).

Notably, the Amendments would be retroactive, covering agreements that a corporation entered into, or its board approved, on or before the effective date of the Amendments (the "Effective Date"). However, the Amendments would not retroactively apply to or affect any litigation or proceeding completed or pending on or before the Effective Date. With respect to any such litigation, the law predating the Amendments would apply. Thus, for existing stockholder agreements granting governance rights and merger agreements effected in the past, which were not the subject of litigation prior to the Effective Date, the agreements would not be invalid based on the court's rulings in Moelis and Activision.

Key Points

• Governance rights in stockholder agreements (Moelis). The Amendments would provide that a corporation can grant governance and control rights not only in the corporation's charter but also in stockholder agreements. The Amendments apply only to stockholder agreements with stockholders in their capacity as such. Accordingly, some uncertainty remains with respect to non-stockholder agreements in connection with the "line-drawing" issue the court noted in Moelis as to when Section 141(a) would apply to agreements containing both "internal governance" and "external commercial" arrangements (such as, for example, activist settlement agreements).

• Merger agreement approval process (Activision). The Amendments would provide that a board can approve a draft agreement that is in "substantially final form"-meaning that all of the material terms are set forth in the draft or are otherwise known to the board. Also, the Amendments would provide that disclosure schedules to a merger agreement would not be deemed to be part of the merger agreement for purposes of the DGCL; the charter of the surviving corporation need not be included in the merger agreement for a cash-out merger; and the proxy notice can incorporate by reference the description of the merger agreement in the proxy statement. The Amendments also would confirm that past mergers approved under the procedures the court found problematic in Activision would not be invalid, subject to the exception for the non-retroactivity of the Amendments in connection with litigation and proceedings that are pending or have been completed at the Effective Date. The Amendments provide no guidance as to what terms may be considered to be "material" for purposes of determining whether a draft agreement is in substantially final form; nor guidance as to whether a side letter extending a merger agreement drop-dead date may (as the court in Activision suggested) constitute an amendment of the agreement (which, if so, would be invalid if occurring after stockholder approval of the agreement).

• Enforcement of lost merger premium damages provisions (Crispo). The Amendments would provide that Con Ed provisions-which provide that, in the event of the termination of a merger agreement, the damages the target can recover would include any lost merger premium-are enforceable. They state that the stockholders' right to lost merger premium damages could be enforced through the appointment of a stockholders' representative at the time the target stockholders approve the merger agreement. The Amendments do not indicate whether the target company itself could be appointed as the stockholders' representative, nor do they provide guidance as to issues that may arise in connection with appointment of a stockholders' representative in the public company context.

• The significance of Moelis, Activision and Crispo. Although the proposed Amendments would validate the practices the court found problematic, this trio of decisions underscores that the court generally may be inclined to apply strict interpretations, and require strict adherence, to DGCL requirements and merger agreement provisions, especially in the context of mergers and potentially also in other areas of corporate practice.

Discussion

The proposed Amendments are not yet-but are likely to become-effective. The Council's recommendations carry significant weight and typically are ultimately approved. To become effective, they will now have to be approved by the Corporation Law Section of the Delaware State Bar Association (and a meeting for this vote has been scheduled for April 8, 2024); then by the Delaware State Bar Association's Executive Committee; and then by the Delaware General Assembly. The Amendments state that, if approved, they will become effective on August 1, 2024, and will apply to all agreements entered into or approved by a board before or after that date. However, as noted above, they will not apply to or affect any litigation or proceedings completed or pending on or before that date (and the law predating the Amendments will apply thereto).

In response to Moelis, the proposed Amendments provide that governance rights can be granted in stockholder agreements. In West Palm Beach Firefighters Pension Fund v. Moelis & Co. (Feb. 24, 2024), the Court of Chancery held that significant governance rights granted by corporations in stockholder agreements may be facially invalid given DGCL Section 141(a)'s mandate that it is the board of directors that must manage the corporation's business except to the extent otherwise set forth in the company's charter. The decision thus appeared to invalidate governance rights commonly provided to founders, controllers or other key stockholders in stockholder agreements. While the court noted that such rights could validly be provided in a corporation's charter, the court did not address that, for example in the context of an already pubic company with an existing stockholders agreement granting governance rights, any replication of such rights through amendment of the charter would be subject to the directors' fiduciary duties (requiring justification for the re-granting of such rights at a time when the stockholder may not be making new or continued contributions to the corporation) and to stockholder approval (which would likely be unobtainable in most cases as practical matter). See Fried Frank's Delaware Dispatch column in Law360 (Mar. 2024), "How Moelis Upends Stockholder Agreements."

The proposed Amendments in response to Moelis:

• Governance rights in stockholders agreements. The Amendments add a new subsection (18) to DGCL Section 122. The new subsection provides that, whether or not specified in the corporation's charter, a corporation can enter into agreements with any current or prospective stockholders, and that a grant of governance rights therein (including, for example, stockholder consent or veto rights, and requirements that the board recommend the stockholder's director designees) will not be facially invalid. The Council's Synopsis of the Amendments (the "Synopsis") states: "New § 122(18) provides bright-line authorization for these contractual provisions, and therefore would reach a different result from a holding in Moelis with respect to the validity of a contract with a stockholder."

• Fiduciary duties. Importantly, as the Council notes in the Synopsis, the Amendments do not alter the fiduciary duties of directors, officers or stockholders in connection with decisions to enter into, perform or breach a stockholders agreement; do not affect the judicial standard of review that may be applicable to challenge of any such agreement; and do not affect equitable remedies that may be available (such as setting aside the agreement if the stockholder party is found to have aided and abetted directors' breach of fiduciary duties in entering into the agreement). The Synopsis states that the Amendments "are intended to promote a policy granting [judicial] relief based on equitable principles relating to fiduciary duties, as applied to specific facts and circumstances, rather than on the grounds that the contract is facially invalid under [the DGCL]." Accordingly, it appears that, under the new subsection, governance rights, even if extensive, granted in stockholders agreements to stockholders in their capacity as such, would not violate Section 141(a)-however, depending on the specific facts and circumstances, the granting of over-extensive rights could be subject to challenge as a breach of fiduciary duties (such as, for example, where the rights granted are extensive but the stockholder's contributions to the company are or expected to be minimal).

• Non-stockholder agreements. The Amendments address only the granting of governance rights to stockholders, in their capacity as such, in stockholder agreements. The Synopsis confirms that contracts of other types (such as with persons other than stockholders, or with stockholders in their other capacities) can be entered into under existing DGCL Section 122(13) (and, we note, apparently, such agreements would still have to be compliant with Section 141(a)).

• Default rights. With respect to corporate powers authorized by DGCL Section 122 (including, but not limited to, under the new subsection (18), the Amendments authorize a corporation to take the actions authorized whether or not the actions are specified in the corporation's charter. Thus, the Amendments clarify that, except to the extent the charter expressly excludes the powers specified in Section 122, the corporation has such powers.

Remaining issues in connection with the Amendments in response to Moelis:

• Line-drawing issue. In Moelis, the court noted a "line-drawing issue" as to which types of agreements are subject to Section 141(a). The court held that "internal governance documents" are subject to Section 141(a), but "external commercial arrangements" are not subject to Section 141(a). The Amendments would establish that agreements with stockholders, in their capacity as such, are not subject to Section 141(a). However, what the court called a "line-drawing issue" may remain with respect to other agreements and arrangements. In Moelis, the court offered the guidance that the key consideration in making such a determination is whether the provision's or agreement's "point is governance" or the point is "to protect the underlying commercial arrangement." We expect some uncertainty relating to such line-drawing, however, given the many types of agreements that may be considered to be equally focused on both governance and a commercial arrangement, and the flexibility of financial instruments such that the lines between debt and equity may be blurred.

• Activist settlement agreements. In Moelis, the court noted that activist settlement agreements are hybrid arrangements, with both governance and commercial features, giving rise to the line-drawing issue. The court expressly declined to state whether activist settlement agreements would be subject to Section 141(a) or not; and, as discussed, the Amendments do not address the potential applicability of Section 141(a) outside the context of stockholder agreements. We note that, since Moelis, the court in resolving motions in two cases to expedite litigation involving activist settlement agreements, has suggested that Section 141(a) considerations may be applicable in this context. (See Taylor v. L3 Harris Tech's (Mar. 13, 2024), and Miller v. Bartolo (Mar. 8, 2024), in both of which the court appeared to treat as an open issue whether provisions requiring the company to recommend board nominees to be designated by the activist would violate Section 141(a)).

In response to Activision, the proposed Amendments provide that a board can approve a merger agreement that is in "substantially final form," and that disclosure schedules need not be included for an agreement to be in substantially final form. In Ap-Fonden v. Activision (Feb. 29, 2024), first, the Court of Chancery held that a merger may be invalid, and subject to post-closing claims of unlawful conversion, if the merger agreement that the board approved was not "essentially complete." The court found it likely that the draft agreement approved by the buyer's board in Activision was not essentially complete-as it used a code name for the target company; left a blank for the merger consideration; did not include the surviving corporation's charter (as required by the DGCL); did not include the disclosure schedules; and did not address a "key" remaining open issue about the company's dividend policy pending closing. The decision thus appeared to invalidate the commonly used procedure of having a board, in the hours leading up to finalization of the agreement, approve a most-recent draft of the merger agreement (without disclosure schedules), so that the agreement can be announced immediately after execution rather than having a delay at that point for the board to consider and approve the final agreement.

Second, the court held that it was likely that the proxy notice provided to stockholders was not valid. The DGCL requires either that (a) a brief description of the merger be included in the proxy notice or (b) the merger agreement be provided with the proxy notice. The court found it likely that (a) was not satisfied because the description of the merger was not in the proxy notice itself (but instead in the proxy statement included with the proxy notice); and (b) was not satisfied because the merger agreement attached, although the executed draft, was not "essentially complete" because it did not contain the surviving corporation's charter (as required by the DGCL) and (possibly) because it did not include the disclosure schedules. Third, the decision led to concerns as to the possible invalidity of past mergers that were approved in the manner the court found problematic in this case. See Fried Frank's article in the New York Law Journal (Mar. 21, 2024), "Key Delaware Decision in Activision Upends Standard Board Practices for Approving Mergers."

The proposed Amendments in response to Activision:

• Approval of a draft agreement in "substantially final form." The Amendments would create a new DGCL Section 147. The new section would provide that, when the DGCL expressly requires board approval of an agreement, the agreement may be approved in "final form or substantially final form." The Amendments do not define "substantially final form"; however, the Synopsis states that the new section "is intended to enable a board of directors to approve an agreement…if, at the time of board approval, all of the material terms are either set forth in the agreement…or are determinable through other information or materials presented to or known by the board." The Synopsis states that the new Section does not alter directors' fiduciary duties in connection with approving an agreement and does not exclude any equitable remedies.

• Ratification. To the extent there may be uncertainty as to whether the agreement draft approved by the board was in substantially final form, the Amendments provide for a board to adopt a resolution ratifying its prior approval. Under the Amendments, any such ratification will be deemed effective as of the time of the original approval; and will not require the notice to stockholders that would be required if ratification were effected instead under DGCL Section 204.

• Surviving corporation charter. The Amendments provide that, when stockholders are not receiving stock in the surviving corporation (e.g., in a cash-out merger), there will no longer be a requirement that the surviving corporation's charter be included in the merger agreement.

• Disclosure schedules. The Amendments provide disclosure schedules will not be deemed to be part of a merger agreement for purposes of the DGCL (thus they can be prepared and finalized at the direction of the board, without a statutory requirement for formal board approval, and they need not be included in the agreement attached to the proxy statement.

• Validity of past mergers. The Amendments eliminate the uncertainty that Activision created as to whether past mergers approved under the procedures the court found problematic in Activision might be invalid and subject to conversion claims. The Amendments state that they will apply to all merger agreements entered into or approved by a corporation, including before the effectiveness of the Amendments. (Again, however, as noted above, any litigation or proceedings pending or completed prior to the Effective Date would be decided without reference to the Amendments.)

• Proxy notice. In Activision, the court also held that the proxy notice provided to stockholders in that case may have been invalid. DGCL Section 251 requires a corporation to include either a copy of the merger agreement, or a brief summary thereof, in the proxy notice. In this case, the corporation purported to provide a copy of the merger agreement, which was referenced in the proxy notice and attached to the proxy statement-but which was not in "essentially complete" form in the court's view. The court rejected the argument that in any event a brief summary was provided in the attached merger agreement. The court reasoned that the statute required the brief summary to be included in the proxy notice itself (not in the proxy statement). The Amendments would enact a new DGCL Section 232(g), which would provide that a notice given to stockholders would be deemed to include any document enclosed with or annexed to the notice (such as a proxy statement provided along with a notice of a stockholder agreement to approve a merger agreement).

Remaining issues in connection with the proposed Amendments in response to Activision:

• Material terms. No guidance is provided as to what terms may be considered to be "material" for purposes of determining in this context whether a draft agreement is in substantially final form. We note that, in Activision, the Court of Chancery stated that the open issue as to the company's dividend policy during the period between signing and closing, which was left blank in the draft merger agreement approved by the board, was a "key issue" given that the parties expected the period to be lengthy due to regulatory approval issues.
• Side letter extending drop-dead date. In Activision, the court suggested that a side letter extending the outside termination date may effectively be an amendment of the agreement (and therefore would be invalid if it occurred after stockholder approval of the agreement and adversely affected the stockholders). The Amendments provide no guidance on this issue.

In response to Crispo, the proposed Amendments provide that lost merger premium damages ("Con Ed") provisions are enforceable. In Crispo v. Musk (Oct. 31, 2023), the Court of Chancery held that merger agreement provisions that provide for recovery of damages including a lost merger premium, in the event the agreement is terminated, may be unenforceable by either the target company (as it is not the company but its stockholders who would have received the merger premium) or by the target company's stockholders (as they are neither parties to, nor third party beneficiaries of, the merger agreement). The decision thus called into question whether Con Ed provisions, commonly used in merger agreements for decades, are enforceable at all.See Fried Frank's Delaware Dispatch column in Law360 (Nov. 2023), "Refining M&A Terms After Twitter Investor Suit."

The proposed Amendments in response to Crispo:

• Enforceability. The Amendments specify that corporations would be able to contract for remedies in the event of a terminated merger agreement, whether due to a contractual breach or otherwise, including damages based on the lost merger premium. The Amendments state that corporations could appoint a stockholder representative to enforce the stockholders' rights under the agreement (a mechanism that has been commonly used in private company transactions to enforce stockholders' rights post-closing).
• Stockholders' representative. The Amendments provide that appointment of a stockholders' representative would be effective as of the time the agreement is approved by the stockholders, and could be made irrevocable and binding on all the stockholders. Further, they state that a stockholder representative can be delegated full, exclusive authority to enforce Con Ed provisions. The Synopsis notes that the Amendments do allow for merger agreement provisions empowering a stockholders' representative to exercise powers beyond those related to enforcement of the rights of stockholders under the merger agreement-for example, to waive appraisal rights or consent to non-compete provisions (although the Amendments do not restrict any sockholder(s) from granting a stockholders' representative such or other delegable powers, such as through execution of a joinder to the merger agreement or a consent or support agreement).
• Fiduciary duties. The Amendments do not alter directors' fiduciary duties in determining whether to approve, perform or enforce lost merger premium provisions. Thus, for example, a board's decision to enter into an agreement providing for a termination fee in the event of a change in recommendation or approval of a superior offer would remain subject to existing case law on fiduciary duties.
• Retention of payment. The Amendments provide that the corporation receiving lost merger premium damages can retain the payment (i.e., need not distribute it to its stockholders).

Practice Points

• Strict adherence to statutory requirements. Practitioners should keep in mind the court's approach in Moelis and Activision of strictly interpreting, and requiring strict adherence with, DGCL provisions. Where appropriate, a board may wish to review actions taken in areas other than those discussed in these cases and the Amendments to confirm that all technical statutory requirements with respect to such actions were met.
• Addressing remaining stockholders agreement issues arising out of Moelis:
  • Line-drawing issues. Parties to merger agreements, activist settlement agreements, and other corporate arrangements under which governance rights are granted should consider the possible applicability of Section 141(a) to provisions in the agreement. To address the line-drawing issue (discussed above), the parties should consider providing supplemental language in the agreement in an effort to clarify, with respect to any governance provisions, that the parties' intention is not primarily governance-related but primarily to protect the underlying commercial arrangement. Further, parties should consider crafting an arrangement to provide greater clarity that Section 141(a) does not apply-such as by clarifying that the arrangement is a stockholders agreement (for example, adding, or increasing, an equity element and labeling the arrangement a stockholders agreement) or by clarifying that it is an external commercial agreement (for example, adding, or increasing, the commercial arrangements).
  • Fiduciary issues. In the context of a corporation going public and granting governance rights in a stockholders agreement, consideration should be given to whether including all or certain of such rights also in the charter may reduce any fiduciary issues with respect to the grant. (It appears that such rights could be incorporated into the charter by reference to the agreement-athough, at least arguably, the agreement then would have to be publicly available.) Also, where appropriate, a board could consider the use of a special committee to negotiate, evaluate and recommend a stockholders agreement granting governance rights.
• Addressing remaining merger agreement approval issues arising out of Activision:
  • "Material terms."To ensure that a draft agreement approved by the board is in "substantially final form," all material terms should be set forth in the agreement or otherwise provided to the board-and it should be documented (for example, in board minutes) that the information was provided to the board. Consideration should be given to what terms may be considered by the court to be material in this context. Existing caselaw with respect to materiality for purposes of adequate disclosure to stockholders would presumably be the guidepost. Based on the court's discussion in Activision, special consideration should be given to whether an open issue regarding the company's dividend policy during the interim period (which affects the value of the surviving corporation) might be deemed material (such as if the amount involved is significant and the interim period is expected to be lengthy). The Amendments do not make clear, but appear to suggest, that providing the board with a summary of the material terms of the agreement would be sufficient, without providing the draft of the agreement. For the sake of certainty, in the case of board approval of a non-final draft or summary of material terms, post-execution ratification may be advisable.
  • Ratification. To the extent a board approves an agreement of merger that could be deemed not to have been in substantially final form (including, for example, because one or more issues were still being resolved which potentially could be considered as material), the board should consider whether, for the sake of extra certainty of compliance with statutory requirements, it should ratify the merger agreement after it is fully finalized and executed. To facilitate a board's ratification of already-approved agreements, the board could amend the corporation's bylaws to provide a lower quorum requirement for these purposes.
  • Surviving corporation charter.In the context of a merger involving stock consideration, the charter of the surviving corporation should be included in the merger agreement.
  • Extension of drop-dead date.To address the possibility of an extension of the final termination date of an agreement after stockholder approval being considered a material amendment of the agreement requiring reapproval by the stockholders, the agreement should authorize the board to agree to change or extend the date from time to time (and consider providing supplemental language stating that such actions would not constitute amendment of the agreement).
  • Checklists. Practitioners' checklists for a merger agreement approval process should be updated based on the Amendments if they are adopted (or based on the Activision and Crispo decisions if the Amendments are not adopted), and should be carefully followed.

• Addressing enforcement of Con Ed provisions based on Crispo. Merger parties including standard Con Ed provisions in their agreement should also include provisions for appointment of a stockholders' representative with full and exclusive authority to enforce such provisions post-closing. The provisions should state that the appointment will be irrevocable and binding on all stockholders. As noted, the Amendments do not address whether the target company itself could be the appointed stockholders' representative.

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