Time to Take the Plunge? Officer Exculpation Under Delaware Law

For corporate officers, exposure to potential liability is part of the job. Two of the primary protections available to corporate officers come in the form of a tailored D&O insurance program and a favorable indemnification agreement. Relatively recently, the Delaware legislature gifted corporations the ability to extend an additional layer of protection for certain officers by amending their certificates of incorporation to provide for officer exculpation. While some Delaware corporations successfully went through the process of amending their certificates of incorporation to provide for this new protection, more took a wait-and-see approach. This article is for those that might be considering taking the plunge in 2024.

This article will:

• Provide a refresher on officer exculpation under Delaware law
• Share encouraging data from the 2023 proxy season
• Suggest next steps and considerations

Officer Exculpation: A Quick Refresher

We previously discussed officer exculpation under Delaware law shortly after the Delaware legislature amended Section 102(b)(7) of the Delaware General Corporation Law in 2022 to expand exculpation to certain senior officers. As a reminder, before this amendment, which dates back to the mid-’80s, Section 102(b)(7) only allowed Delaware corporations to eliminate or limit (i.e., exculpate) the personal liability of a corporation’s director or its stockholders for monetary damages for breaches of those directors’ fiduciary duties of care. Director exculpation provisions are commonplace, and it’s common for Delaware corporations to include director exculpation provisions in their certificates of incorporation.

The plaintiffs’ bar has exploited the fact that officers haven’t been extended the same level of protection as directors. Realizing that officers of a corporation have the same fiduciary duties as directors and knowing Section 102(b)(7) didn’t protect them, it has more frequently pursued a strategy of bringing duty of care claims against officers.

The amendment to Section 102(b)(7) effectively allows Delaware corporations to include in their certificates of incorporation a provision that greatly reduces the possibility of certain officers facing financial monetary liability for breaches of their fiduciary duty of care.

The Delaware legislature limited officer exculpation to the following officers, as described in Section 3114(b) of Title 10 of the Delaware Code:

• Chief executive officer
• President
• Chief operating officer
• Chief financial officer
• Chief legal officer
• Controller
• Treasurer
• Chief accounting officer
• The most highly compensated executive officers as identified by public filings with the SEC
• People who consent to be identified as an officer

Additionally, and more importantly, Delaware corporations must take the affirmative step of putting officer exculpation provisions in their certificates of incorporation. For corporations that are just being formed, this should be a relatively easy exercise. Private corporations will need to ask their stockholders to vote to approve officer exculpation provisions after their boards meet and confirm they want to make such an amendment to their certificates of incorporation. This is not likely that heavy of a lift here either.

Public companies may face more of a challenge. They also need to put this to a stockholder vote, which requires a proposal in their proxy statement. For public companies, putting anything non-routine up to a stockholder vote is generally met with some hesitation. Officer exculpation is no different. Some of the questions that companies were asking themselves in advance of the 2023 proxy season when it came to this issue included:

• What are the benefits to the company?
• Do our officers really care about this?
• How will our stockholders react to this proposal?
• Will our proposal be met with resistance from proxy advisory firms?
• Should we wait to see what other companies do this year and revisit next year?

Almost a year later and with the results from the 2023 proxy season in hand, companies that chose the wait-and-see approach have some data they can use to draw insights as they consider the issues.

By the Numbers: Public Company Stockholders Were Largely Supportive in 2023

Sullivan & Cromwell reported on the results for annual meetings through the first half of 2023 that included an officer exculpation provision proposal. Here are a few of the notable data points:

• 269 US public companies put an officer exculpation proposal up to a vote, including 31 companies in the S&P 500.
• 84% of those proposals met the applicable threshold for charter amendments under the company’s organizational documents (typically a majority or supermajority of the company’s outstanding shares).
• A determining factor for failed proposals was a low percentage of voted shares (high broker non-votes).
• While proxy advisory firm Glass Lewis generally recommended against these provisions, ISS recommended against only 19% of them; the recommendations did not impact voting results.

Glass Lewis’ and ISS’ positions in 2023 were generally that they would closely evaluate officer exculpation proposals on a case by-case basis. Notably, Glass Lewis indicated it would recommend voting against these proposals, unless the board provided a compelling rationale for the adoption and the provisions were reasonable.

Looking to the 2024 annual meeting season, voting policies for Glass Lewis and ISS regarding officer exculpation haven’t changed, so we should expect similar recommendations from these proxy advisory firms. While proxy advisory firm views on this topic are an important data point, the voting results noted above strongly indicate that stockholders are generally supportive of these proposals despite the concerns expressed by proxy advisory services.

Officer Exculpation: Next Steps and Considerations

For Delaware corporations, particularly those that are public, the prospects of a “yes” vote for an officer exculpation provision proposal this upcoming proxy season are generally good. However, before plotting a course whose destination is officer exculpation, here are a few suggested next steps and considerations:

1. Secure Internal Alignment About the Rationale for the Proposal

As previously discussed, good practice for both public and private boards will be to take the time to discuss and record, in official board meeting minutes, the reasons for adopting officer exculpation provisions. This is especially important since this position will need to be detailed in the board’s recommendation for the proposal in the proxy statement. The form of board recommendation last proxy season relating to officer exculpation didn’t vary much across companies.

In case you are looking for inspiration when it comes to determining the rationale for your corporation’s own proposal, here are links to a few company proxy statements that were successful in securing stockholder approval: Fox, SWK Holding Corporation, Guidewire Software, and Skillsoft.

2. Build the Proposal Into Your Proxy Statement Timeline

It takes time to ensure an understanding of the required procedures to adopt an officer exculpation provision under your governance documents, Delaware law, exchange listing standards, and Securities & Exchange Commission (SEC) rules. Take the SEC rules, for example: An officer exculpation proposal would require the filing of a preliminary proxy statement since it would, if approved, result in the amendment of the certificate of incorporation. There is also the matter of the voting standards that attach to non-routine matters like this one, and the related discussion that would need to be included in the proxy statement.

All this to say that companies would be wise to take the time to build the proposal into their proxy statement timeline early in the process.

3. Gauge Stockholder Sentiment and Consider Proactive Outreach

There are a few ways to gain insight into how your own proposal may fare, as well as to how to best ensure a favorable voter turnout. Out of the gate, general voting results on these proposals from last proxy season should provide some comfort in the chances of your proposal getting approved.

To gain a better insight into your situation, consider your largest institutional holders and companies where they hold significant equity positions. If any of those companies put an exculpation provision proposal up for a vote last year and it was approved, it would be a good idea to review how those companies teed up the proposal in their proxy statements.

Another way is to look at how your peers fared in the case that they offered up the proposal.

Additionally, for those companies that proactively conduct institutional stockholder outreach ahead of their annual meeting, it may be worthwhile to include officer exculpation as a topic of discussion and mention that the company is considering adopting it.

Lastly, as noted earlier, the determining factor for failed votes was a low percentage of voted shares, which is why it may make sense to engage a proxy solicitor to help in, among other things, providing an accurate analysis of your stockholder base and garnering a high vote participation.

4. Multi-Class Companies, You Can Breathe a Sigh of Relief

Plaintiff stockholders brought lawsuits against Fox and Snap, both multi-class companies, for the way they structured their officer exculpation proposals. The argument in those cases was effectively that the companies put the proposals up for vote to stockholders together as a single class, as opposed to seeking votes from each separate class. This created a significant amount of angst for similarly situated companies and uncertainty for multi-class companies that were considering including an exculpation provision proposal in their next proxy statement. Vice Chancellor Laster ruled in favor of Fox and Snap by granting summary judgment in March 2023. The plaintiffs filed a notice to appeal with the Delaware Supreme Court, which affirmed the decision on January 17, 2024. Translation: Delaware General Corporation Law doesn’t require multi-class companies to seek separate approval from each class to amend their certificates of incorporation to provide for officer exculpation. For more information, see this post from Wilson Sonsini.

Ultimately, for those companies with multiple classes of stock that are looking to put one of these proposals on the ballot, the recent Delaware Supreme Court decision should make the process much easier and less fraught with uncertainty.

5. Officer Exculpation Isn’t a Free Pass

It’s worth noting that officer exculpation isn’t a free pass for officers in terms of their fiduciary duties. It wouldn’t protect officers from being held personally liable for breaches of their duty of loyalty and good faith, intentional misconduct or knowing violations of law, transactions involving improper personal benefits, and any actions or claims brought derivatively or by the board. This is a point that several companies have made in their proposals. Relatedly, it may be a good idea to conduct a fiduciary responsibility refresher training for your directors and officers as part of this general exercise. 

6. D&O Insurance Considerations

Here is a common question that has been asked: Would adding an officer exculpation provision to our certificate of incorporation result in lower D&O premiums? Unlikely. What’s more likely is that this issue will become a point of discussion on future D&O insurance program renewal calls. If a company hasn’t added officer exculpation, insurers may factor that into how they profile that company’s risk in the context of the potential defense and settlement costs associated with stockholder suits brought against officers. So, if your company has successfully adopted an officer exculpation provision, be sure that it's highlighted in connection with your next D&O insurance program renewal. 

Parting Thoughts: A Good Option for Most Companies

For most Delaware corporations, extending exculpation to officers, like federal choice of forum and state choice of forum provisions, should generally be viewed as low hanging fruit when thinking of how best to reduce the corporation’s risk profile, lessen frivolous litigation, and protect its directors and officers. While we continue to recommend that Delaware corporations consider extending exculpation to its officers, each corporation will need to take the time to discuss whether adding officer exculpation makes sense for them. The key will be to ensure that the discussion occurs early enough in the annual meeting and proxy season so that if the decision is to put this proposal in the proxy statement, there is ample time to best position the proposal for approval.