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My Name’s on the Door: Founder Supremacy in Delaware After Moelis
Priya Cherian Huskins, Esq.
Aug 13, 2024
Founding a successful company is enormously difficult. An oft-cited statistic is that 75% of venture-backed start-ups fail, a percentage that is probably both understated and fails to consider all the companies that never even raise a first round of venture capital funding.
Growing a company usually requires capital. While capital providers will want certain rights in exchange for providing this capital, it should be no surprise that founders likely want to retain as much control for themselves as possible.
This is the sort of thing that is ripe for negotiation, and indeed, Delaware law has historically been regarded as friendly to this sort of private ordering.
A good example of this is the many Delaware-incorporated companies with dual-class voting, which tech IPOs have been increasingly fond of adopting in recent years. Note, however, that dual-class voting exists as a function of a company’s certificate of incorporation.
More recently, however, the Delaware Chancery Court struck a founder-controlling shareholder agreement as an invalid restriction on a board of directors, only to have the Delaware legislature take corrective measures swiftly.
This article will describe what happened in the Chancery Court, how the Delaware legislature reacted, and what this means for directors and officers of founder-controlled companies.
The Moelis Decision
Moelis & Company is a well-regarded publicly traded investment bank. Ken Moelis, the current chair and CEO, founded the company in 2007 and took it public on the New York Stock Exchange in 2014 as a dual-class stock company. Class A shares have one vote per share and are publicly traded. Class B shares, held by Mr. Moelis, carry 10 shares per vote.
Shareholders sued the company in 2023 in West Palm Beach Firefighters Pension Fund v. Moelis & Co. At issue was a stockholder agreement that shareholders said violated Section 141(a) of Delaware General Corporation Law (DGCL), which says in relevant part:
The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.
Mr. Moelis had entered into a stockholder agreement the day before the company’s IPO (notice was given to shareholders). The agreement provided him with expansive power to veto and otherwise constrain the board.
There were 18 specific categories of action that required the pre-approval of Mr. Moelis. The list is really quite remarkable in terms of demonstrating that Mr. Moelis had no plans to let anyone run the company other than himself:
- Incurring debt over $20 million
- Issuing equity over a specified (low) threshold
- Issuing any preferred stock
- Entering a debt or equity commitment to invest more than $20 million
- Entering into any new business that requires more than $20 million in investment
- Adopting a stockholder rights plan
- Removing or appointing any Section 16 officer
- Amending the certificate of incorporation or the bylaws
- Amending the partnership agreement
- Renaming the company
- Adopting the company’s annual budget and business plan and making any material amendments
- Declaring a dividend
- Entering into a merger, recapitalization, or sale
- Liquidating or winding up the company, including through bankruptcy
- Entering into or amending any material contract
- Entering into a related party transaction
- Initiating or settling a material action
- Changing the company’s taxable or fiscal year
In addition, the board’s composition had to include a majority of members picked by Mr. Moelis. Any board committee had to include a number of Mr. Moelis’ designees in the same proportion as was serving on the full board.
Vice Chancellor Travis Laster issued his opinion in favor of the suing shareholders in February 2024, shocking corporate law practitioners who have become used to drafting broad shareholder agreements.
The Vice Chancellor’s 133-page decision boiled down to the following: The shareholder agreement is an internal governance arrangement that violates Section 141(a) because it strips decision-making power from directors to such an extent that they are no longer managing the company.
Moelis appealed the decision—but before the appeal could be heard, the Delaware legislature stepped in.
Delaware Legislature Reverses
The Delaware legislature is keenly focused on preserving the franchise Delaware enjoys as the state of incorporation of choice. For example, 70% of Fortune 500 companies are incorporated in Delaware.
In the face of corporate consternation that many shareholder agreements were not valid in light of the Moelis decision, the Delaware legislature acted quickly.
Not everyone was happy about the efficiency of the Delaware legislature. See, for example, Letter in Opposition to the Proposed Amendment to the DGCL, in which nearly 60 corporate law professors urged the Delaware legislature to refrain from acting in haste.
The Delaware legislature ignored them.
The central thesis of the Moelis decision is that a board cannot enter into a contract about internal governance if provisions of the contract conflict with the board’s duty to manage the corporation.
However, the Delaware legislature’s response effectively reversed Moelis.
Whether or not it was a good idea, new subsection (18) of Section 122 of DGCL became effective on August 1, 2024.
In exchange for some form of consideration deemed appropriate by a board, corporations now have clear authority to enter into contracts that the Moelis decision had invalidated.
| The Fox Rothschild law firm summarized the non-exclusive provisions of items corporations may now include in contracts as follows: |
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What Does This Mean for Founders?
With the addition of Section 122(18) to the DGCL, we should expect that more founders will be further empowered to make the kind of aggressive, long-term control arrangements that were at issue in Moelis.
| But is it really a change? Vice Chancellor Laster himself had noted in his opinion that Mr. Moelis could have accomplished many of his goals with appropriate provisions in the certificate of incorporation: |
| He could have accomplished the vast majority of what he wanted through the Company’s certificate of incorporation (the “Charter”). Even now, the Board could implement many of the Challenged Provisions by using its blank check authority to issue Moelis preferred stock carrying a set of voting rights and director appointment rights. A new class of preferred stock need not upset the Company’s equity allocation; it could consist of a single golden share. The certificate of designations for the new preferred stock would become part of the Charter as a matter of law. At that point, because the provisions would appear in the Charter, they would comply with Section 141(a). |
Of course, the “vast majority of what he wanted” is not everything. Also, it is so much easier for a founder to enter into a contract with other friendly shareholders than it is to jump through all the hoops required to amend a company’s certificate of incorporation.
Founders with marketplace power will naturally assert this power.
What Does This Mean for Directors?
Directors will want to be aware of what they are getting into when they agreed to serve on the board of a founder-led company in which the founder has a Moelis-level of control over the board.
Everything might be fine, but more realistically, there will be circumstances in which directors’ decisions will be challenged by shareholders, most likely in court.
Given that this is the case, directors will want to be thoughtful about the process and documentation in any decision of importance, such as the sale of a company or a large CEO pay package. Demonstrating independence will still be important.
Directors will also want to be prepared to settle in for long-haul litigation, including by having robust indemnification agreements and D&O insurance in place.
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