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Chancery Invalidates Provisions of Stockholder Agreement Under Section 141 of the DGCL, Finding Agreement Impermissibly Granted Board-Level Decision-Making to Founder

West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., C.A. No. 2023-0309-JTL (Del. Ch. Feb. 23, 2024)
One day before a company’s shares began trading publicly, the founder and three affiliates entered into a stockholder agreement with the company. The agreement required the board to obtain pre-approval from the founder for eighteen categories of board action, to take various steps to ensure the founder could select a majority of the board even if he held less than a majority of the company’s outstanding voting power, and to form committees only if they contained designees of the founder proportionate to the number of his designees on the board.

A stockholder challenged the provisions of the agreement as violative of Sections 141(a) and 141(c) of the Delaware General Corporation Law because they removed the directors’ duty to use their best judgment on management matters or substantially limited their freedom on matters of management policy.  The company argued that Delaware law permitted a board to enter into contracts even if the contracts constrained the directors’ freedom of action.

The Court of Chancery determined that, collectively, the agreement’s pre-approval requirements rendered the board not actually a board and had the effect of the directors managing the company only to the extent the founder gave them permission.  The Court reasoned that the pre-approval framework constituted ultimate decision-making by the founder, not the board, which facially violated Section 141(a) of the DGCL.  The board and committee composition provisions were a mixed bag as to facial challenges; the Court invalidated some provisions for improperly compelling or constraining board action, but sustained others regarding certain founder actions or board efforts that were not facially invalid although could be susceptible to as-applied challenges.  The Court noted that the DGCL may permit much of the overall governance framework if made part of the company’s charter, including as a preferred stockholder arrangement, but not as part of a stockholder agreement independent of the charter.

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