DealLawyers.com Blog

The list of unanswered questions about Delaware’s statutory Moelis fix – new Section 122(18) of the DGCL – isn’t getting any shorter.  A recent post on the Harvard Governance Blog by Stanford Law School lecturer Jim An says that parties to the kind of governance agreements enabled by Section 122(18) may find themselves unable to obtain specific performance – and perhaps unable to obtain monetary damages as well.

The blog lays out a hypothetical under which a party has a contractual right to veto the appointment of a new CEO, but the company appoints that CEO over the party’s objections. The blog notes that this an equitable remedy like specific performance to compel the CEO’s removal would be the preferred remedy in this situation, but this excerpt suggests that might not work:

A problem arises, however, if the remedy of specific performance is put up against the legislative purpose of § 122(18). As a reminder, § 122(18)’s sponsors repeatedly represented to Delaware’s legislators that, at least in the § 122(18) context, “fiduciary duties trump contracts, always.”

To elaborate on the above CEO-veto example, suppose that the directors of the corporation have made a good-faith determination that Candidate A is the best choice for CEO, and that it would violate their fiduciary duties to allow the side-letter counterparty to veto that choice. Accordingly, the directors cause the corporation to breach the terms of the side letter and appoint Candidate A anyway, as the directors must to fulfill their fiduciary duties.

If, however, a court subsequently enforces the veto right at the behest of the counterparty, it will have rendered the clear intent of § 122(18)’s drafters and proponents a nullity—the contract would have trumped the board’s fiduciary duties, and no “efficient breach” would be possible in any meaningful way. The only way for a court to give meaning to the purpose of § 122(18) is to hold that specific performance is unavailable for § 122(18)-enabled contracts where a corporation can show that it breached the contract as a result of its directors’ fiduciary obligations under the relevant standard of review (which would be the deferential business judgment rule in most cases). Moreover, if a board intentionally avoids such a breach to escape, say, public harassment from the counterparty, the board may be engaging in self-dealing conduct and exposing itself to a fiduciary duty suit from other shareholders subject to enhanced scrutiny.

The blog goes on to say that an alternative like a liquidated damages provision with teeth might also preclude a board from engaging in an efficient breach, and in the absence of such a provision, economic damages may be very difficult to prove – thus leaving the party with a contract right that’s essentially illusory.

I do think the Chancery Court is going to spend an inordinate amount of time over the next several years sorting out the fiduciary duties v. contract rights thicket created by these amendments, but I guess I’m as skeptical about this addition to the parade of horribles supposedly associated with this statute as I am about the suggestion that dead hand pills are now undead. It seems to me that the unfortunate phrase “fiduciary duties always trump contracts” is being used as a straw man here, and I doubt that the Chancery Court is going to see these issues in black and white terms.

Fortunately, you don’t have to rely on my half-baked thoughts on the DGCL amendments, because we’ve assembled a panel of experts for our upcoming webcast – “2024 DGCL Amendments: Implications & Unanswered Questions” – to help you navigate Section 122(18) and the other recent changes to the DGCL.

– John Jenkins