What Do You See In Section 122(18)?

This week I thought a case both raised my first Section 122(18) issue and would result in that statute fulfilling its goal of providing some certainty. No dice on either count. But thinking about the issue did suggest to me that Section 122(18) may have opened the door to broad new contractual limitations on stockholder counterparties. Where once I only saw a rabbit, I now also see a duck.

Simplified facts: Three stockholders in a closely held corporation entered into an agreement to which the corporation was a party. Because Section 122(18) applies retrospectively (except for the donut hole), the new statute governs this agreement.

The agreement contained a provision under which one of the three--a 15% stockholder--purported to waive statutory information rights. Was such a provision previously valid under Delaware law? No clear answer. See Juul Labs, Inc. v. Grove, 238 A.3d 904, 919 (Del. Ch. 2020) (“This decision does not address whether a stockholder can waive inspection rights under Delaware law.”) (collecting authorities).

But Section 122(18) generally provides that if a provision cannot appear in the charter, then it cannot appear in a governance agreement. We know that a charter provision cannot eliminate inspection rights. State v. Penn-Beaver Oil Co., 34 Del. 81, 143 A. 257, 260 (1926) (“[T]he provision in defendant's charter which permits the directors to deny any examination of the company's records by a stockholder is unauthorized and ineffective.”).

Did Section 122(18) give us clarity by invalidating information-right waivers in governance agreements? Nope. Section 122(18) provides that “no provision of such contract shall be enforceable against the corporation to the extent such contract provision is contrary to the certificate of incorporation or would be contrary to the laws of this State (other than § 115 of this title) if included in the certificate of incorporation.” (Emphasis added). The charter-based floor only applies to provisions binding the corporation, not counterparties. The information-rights waiver would be enforced against the counterparty, not the corporation.

But does Section 122(18) work the other way to authorize information-rights waivers? Call me na?ve, but that was a new perspective. I have been focused on Section 122(18)’s authorization of provisions binding the corporation, resulting in the new statute authorizing covenants that compel board action notwithstanding Section 141(a). The statute’s language on covenants, however, is quite broad. It says that “[w]ithout limiting the provisions that may be included in any such contracts, the corporation may agree to … covenant that … one or more persons or bodies will … refrain from taking actions specified in the contract, (which persons … may include … one or more current … stockholders or beneficial owners of stock of the corporation.”

For the information-rights waiver, that language seems both applicable and weird.

First, applicable: With a contractual information-rights waiver in a governance agreement, a stockholder [check] is covenanting [check] to refrain from taking [check] an action specified in the contract [check], namely exercising Section 220 information rights.

Second, weird: Section 122(18) literally says that the corporation can covenant on behalf of its stockholders to have them take or refrain from taking actions, suggesting that the corporation could bind stockholders to a covenant even if the stockholders were not parties to the agreement. I would have thought that a stockholder would have to be a party to a governance agreement to be constrained by the governance agreement, but when I close my eyes and reopen them, that statutory language is still there.

In most cases, the stockholder that is covenanting to act will be a counterparty to the governance agreement. Think about an option grant. The counterparty is a prospective stockholder, and there is consideration, so we fall under Section 122(18). There’s lots of things companies would like to include in those agreements as “covenants … that one or more persons … will take, or refrain from taking, actions specified in the contract" where the persons are "one or more current or future … stockholders or beneficial owners of stock of the corporation,” namely the person receiving the option.

I, for example, have long been worried about option agreements and similar internal affairs documents being used to impose restrictive covenants or otherwise affect an employment relationship governed by the law of a sister state. It did not seem like good policy to me for Delaware to be sticking its nose into those areas. https://www.dhirubhai.net/posts/travis-laster-397079216_thanks-to-a-now-widespread-legal-technology-activity-7134205475025252354-_JIW?utm_source=share&utm_medium=member_desktop

Could it be that Section 122(18) statutorily validated all that and more while we were all focused on its effect on Section 141(a)?

I don’t know. But I’m looking at the statute in a new way,