Stockholders of Delaware corporations for many years have had the right to examine stock ledgers, stockholder lists and “books and records” for a “proper purpose” under Section 220 of the Delaware General Corporation Law. Until recently, however, the concepts of “books and records” and “proper purpose” were not specifically defined in the DGCL.
Over time
The board of directors of any Delaware corporation proposing to merge is required under Delaware law to adopt a resolution approving the merger agreement. In the real world of M&A practice, however, the version of the merger agreement presented to and approved by the board is typically still in draft or nearly-final draft form but not yet final. Does this practice violate Delaware law?
A recent amendment to the Delaware General Corporation Law (“DGCL”) provides that any agreement that must be approved by the board under Delaware law must be in “final or substantially final” form when approved. The DGCL amendment was adopted in reaction to an earlier Delaware Chancery Court ruling in favor of a stockholder that claimed that the board violated Delaware law when it approved only a draft version of the merger agreement. These developments underscore the need for boards to consider whether a merger agreement draft submitted for approval is substantially final before approving it.Continue Reading “Draft Dodging”: Approving “Nearly Final” Merger Agreement Becomes Dangerous in Delaware
There are generally two ways you can control a corporation. One is by owning a majority of the stock, in which case you control the board of directors. The other is to secure control contractually, through agreements and charter provisions that provide protections such as board representation or vetos over major transactions. But what happens when those contractual and charter provisions interfere with the statutory authority of a board of directors to manage a company’s affairs as mandated by state corporate law? A recent Delaware Chancery Court decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co. invalidated provisions of a stockholders agreement because they constituted an impermissible delegation of the board’s managerial authority in contravention of Delaware law. The decision throws into question the enforceability of corporate governance provisions routinely included in stockholder agreements, investor rights agreements and voting agreements.
Statutory Authority of Board of Directors
Section 141(a) of the Delaware General Corporation Law (the “DGCL”) provides that:
“the business and affairs of every [Delaware] corporation … shall be managed by or under the direction of a board of directors, except as may be otherwise provided [under the DGCL] or in its certificate of incorporation.”
Section 141(c)(2) empowers the board to designate one or more committees and to determine the composition of those committees.Continue Reading Stay in Your Lane! Delaware Court Invalidates Stockholder Agreement Provisions that Encroach on Board Authority
Process still matters. That’s the main takeaway from the Delaware Court of Chancery’s 200-page opinion striking down Tesla’s 2018 incentive package awarded to Elon Musk. The court rescinded the incentive package mainly because Musk was found to control Tesla and the process, the directors authorizing the package were not independent and the stockholder vote approving it was not properly informed. The ruling is a stark reminder of the importance of both director independence and an informed stockholder vote when transacting with a control stockholder.
The 2018 Stock Option Grant
In 2018, the Tesla board approved a new stock option package for Elon Musk and then submitted the proposal for stockholder approval. At a special meeting of stockholders, 81% of the shares voted in favor (or 73% without counting Musk’s and his brother’s shares). If exercised in full, the option package would have allowed Musk to purchase a number of shares constituting 12% of Tesla’s outstanding stock, subject to both milestone and leadership-based vesting. The options vested in 12 tranches, with each tranche vesting on Tesla achieving one capitalization milestone and one operational milestone, and only if Musk continued serving as either CEO or both executive chairman and chief product officer at each vesting juncture. In the most optimistic case, if Tesla’s capitalization grew from $59 billion at the time of the grant in 2018 to $650 billion by 2028 (the option expiration), all the options would vest and be worth approximately $56 billion. As things turned out, Tesla’s market cap did hit $650 billion by the end of 2020 and all the options vested in full.
Was Musk a Controlling Stockholder?
Normally, corporate boards may compensate their executives however lavishly as they wish because Delaware courts will show tremendous deference to board decisions under the business judgment rule and not second guess them. The exception to the general rule is when the compensation is being paid to a controlling stockholder, in which case the compensation or transaction is evaluated under the stricter entire fairness standard which demands a fair price and fair process. The threshold issue then is whether Elon Musk was a controlling stockholder at the time of the 2018 grant.
Control can be established either through mathematical voting control or effective operational control. On the surface, Musk’s 22% ownership stake at the time of the 2018 grant did not constitute mathematical voting control. But perhaps it did when combined with Tesla’s supermajority vote requirement for any amendment to its bylaws governing stockholder meetings, directors, indemnification rights and the supermajority vote requirement itself. The court’s main focus, however, was on Musk’s “outsized influence” over Tesla’s business affairs in general and over the compensation package in particular.
As to general control, the court found Musk exerted significant influence over Tesla’s board, and that as founder, CEO and chairman he “occupied the most powerful trifecta of roles”. Musk also frequently exercised managerial authority over all aspects of Tesla, in many cases ignoring the Board’s authority such as when he appointed himself Tesla’s “Technoking”, disclosed in a Form 8-K, without consulting the Board. The Court was also swayed by Musk’s “Superstar CEO” status, which it said resulted in shifting the balance of power toward himself and away from the board, which was supposed to exercise authority over him.
The court also found Musk exerted transaction-specific control. He almost unilaterally controlled the timing of the grant. There was no negotiation between Musk and the Board over the size of the grant, and no meaningful negotiation over the other terms. Neither the compensation committee nor the board engaged in any benchmarking analysis. Directors testified at the trial that they viewed the process as “cooperation”, not a negotiation.
Musk’s controlling stockholder status meant that the applicable standard of review would be the entire fairness standard. As a procedural matter, the defendants have the burden of proving fair price and fair process. But defendants (in this case, Musk, the other directors and Tesla) can shift the burden to the plaintiff if the transaction was approved by either a well-functioning committee of independent directors, or an informed vote of the majority of the minority stockholders. As a practical matter, burden of proof in these cases is determinative; the party with the burden almost always loses.Continue Reading Out of Control! What the Elon Musk Compensation Case Reminds Us about Transactions with Controlling Stockholders
In the world of venture capital, there are certain investor rights that ensure the smooth execution of exit transactions. The primary such mechanism is the drag-along provision, under which one group of stockholders agrees in advance to sell or vote their shares in a sale of the company approved by another group of stockholders and/or by the board. Drag-along provisions often include a covenant by the drag-along shareholders not to sue over a drag-along sale, often including waivers of claims for breach of fiduciary duties. But are fiduciary duties of directors too important to allow them to be waived by stockholders? A recent Delaware Chancery Court decision puts guard rails on such waivers.Continue Reading Too Big to Waive? Enforceability of Drag-Along Covenants Not-to-Sue
Should a buyer be allowed to walk away from an acquisition if an extraordinary event occurs between signing and closing that forces the target company to take emergency remedial measures outside its ordinary course, even if consistent with industry practice under the circumstances? This became a pressing issue during the early months of the COVID-19
Lately I’ve been approached by clients and potential clients about series LLCs, so I thought it would be worth blogging about. Basically, a series LLC is an LLC that may create one or more series, each generally having separate assets and liabilities, similar to having separate entities except without the expense and administrative burden of
Dual or multi-class capitalization structures generally allow companies to sell large amounts of shares to the public while maintaining control in the hands of the founders and early investors. Popularized by the Google IPO in 2004, weighted voting rights have since been featured in the high profile IPOs of LinkedIn, Groupon, Zynga, Facebook, Fitbit and
A recent Delaware Chancery Court decision provides important guidance on what types of defective corporate acts may be ratified under Section 204 of the Delaware General Corporation Law (the “DGCL”), and what types may not. Paul Nguyen v. View, Inc. also underscores the importance of focusing on whether to opt out of the class vote
On August 1, 2017, Delaware became the first state to allow corporations to 
record issuances, transfers and ownership of stock using blockchain technology. Amendments to the Delaware General Corporation Law authorizing blockchain stock ledgers were passed by the Delaware State Senate and House of Representatives in June, signed by Governor John C. Carney Jr. in