Moelis, Novelty, And Hyperbole

The Moelis decision was the first Delaware case to address a new wave of agreements.[1] Although nominally called stockholder agreements, they are not traditional agreements among stockholders about how to exercise their stockholder rights. Instead, they are governance agreements that confer rights on the stockholder counterparty and obligations on the corporation. They are also not tied to a commercial transaction. They operate purely to address the internal allocation of control among corporate actors.

The Moelis case involved an extreme version of a governance agreement. It contained two sets of provisions. The first comprised eighteen pre-approval requirements that collectively gave the stockholder counterparty the ability to control virtually everything the board might address (the “Pre-Approval Requirements”). The second comprised a series of covenants that bound the corporation to ensure that the board was comprised as the stockholder counterparty wanted, including a covenant that mandated that the directors recommend candidates for election regardless of the directors’ views (the “Covenants”). The court held that both sets of provisions were subject to Section 141(a), invalidated the Pre-Approval Requirements in their entirety, and invalidated three of the six Covenants.

A recent news article quotes a distinguished Delaware practitioner telling a reporter that the Moelis decision put “thousands of financings are at risk.”[2] That smacks of hyperbole.

The Moelis decision took pains to distinguish between governance agreements and commercial agreements. The news story doesn’t say what types of financings the practitioner was envisioning, but they would likely fall on the commercial side and would not be threatened.

Take debt financings. The Moelis decision repeatedly identified credit agreements as falling on the commercial side of the line.[3] A non-alarmist reading of Moelis would not think debt financings were at risk.

On the equity side, we can distinguish between financings that have yet to close and those that already have closed. For those that have yet to close, practitioners can implement the equity financing in a manner that complies with Section 141(a). The controller of a pre-IPO corporation can put whatever governance provisions it wants in its charter. If the controller wants perpetual control, it can be created using dual-class stock. If the controller wants control that sunsets after a period of time or once equity ownership falls below a particular percentage, that can be built into the high-vote shares. Simply make them redeemable for a grand total of $1 once the trigger is hit. For private companies contemplating IPOs, Moelis has no effect at all.

The same is true for post-IPO financings that have not yet closed. Rather than baking control provisions into a governance agreement, they can appear in the certificate of designations for a preferred stock. Preferred shares can carry veto rights under Section 151 and board-representation rights under Section 141(d). The right to appoint directors can be set to expire upon the occurrence of ascertainable facts, such as if the holder’s ownership stake drops below a floor. The only counterargument I have heard to this is the suggestion that not all companies may have charters that authorize blank-check preferred, I would like to see that assertion backed up with some numbers. Every charter I see authorizes it.

Now let’s move to completed financings. If a corporation has completed its IPO and the contractual counterparty continues to control a majority of the corporation’s voting power, then the controller can implement its preferred governance scheme by charter amendment.

That leaves one unique circumstance: A corporation that has completed its IPO, then the controller later sold down below majority control (and possibly below working control). That subset of corporations and their counterparties could be at risk. But that’s not thousands.

The threshold policy question we should ask is whether Delaware law should facilitate the ability of small minority holder to perpetuate their control by contract. It’s not clear to me why, as a policy matter, we would do that.[4] IBut assuming Delaware did want to help out small minority controllers, the board can restore the counterparty’s rights through a preferred stock. Admittedly, fiduciary duties will come into play, but the statutory path is open.

It thus seems dubious that Moelis put thousands of financings at risk. The only financings potentially at risk involve small dollar controllers, where the policy case for perpetuating control is contestable. But that doesn’t make for a good quote. Hyperbole does.

[1] W. Palm Beach Firefighters' Pension Fund v. Moelis & Co., 311 A.3d 809 (Del. Ch. 2024).

[2] Mike Leonard, Move to Change Delaware Law After Musk Attacks Called Knee-Jerk (May 15, 2024).

[3] Moelis, 311 A.3d at 819 (“Under a credit agreement, for example, declaring a dividend or buying back stock can be events of default. Both are board level decisions, so those provisions limit the board's freedom of action. Yet both are legitimate protections for a lender to demand.”); id. at 820 (“No one would mistake the Stockholder Agreement for a supply agreement, credit agreement, or some other external commercial contract.”); Id. at 859 (“[U]nlike a commercial contract, a governance agreement does not readily reveal an underlying commercial exchange. In a services agreement, supply agreement, or credit agreement, the contract reflects a clear exchange of consideration.”); Id. (“Credit agreements often contain negative covenants geared towards protecting the lender's right to be repaid. Transaction agreements often contain interim operating covenants to ensure that the buyer gets what it contracted to buy. In a commercial agreement, the bargain is the point and the governance rights protect the bargain. In a governance arrangement, the governance rights are the point.”); id. at 858 (rejecting defendant’s argument that credit agreements are “doctrinally indistinguishable” from governance agreements); id. at 878 n.339 (distinguishing cases that involved credit agreements”).

[4] See generally Lucian A. Bebchuk & Kobi Kastiel, The Perils of Small-Minority Controllers, 107 Geo. L.J. 1453 (2019)