Moelis case in Delaware highlights the core element of a corporate structure
In my experience, it is rare that a corporate law case raises three basic philosophical questions, but the Delaware Court of Chancery's decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co. delivers that rare treat while underscoring a core element of corporate structure.
The case involved a shareholder’s challenge of the validity of provisions in a shareholder agreement between a publicly traded company (Moelis & Co.) and its principal shareholder (which shareholder was controlled by the company’s eponymous founder, Ken Moelis. The shareholder agreement required the board to obtain the shareholder’s consent before taking a broad list of actions, obligated the board to maintain its size and to nominate and support a majority of the board comprised of the shareholder’s nominees, and further compelled the board to populate any committee with a majority of the shareholder’s representatives.
Agreements like the Moelis shareholder agreement are not uncommon. For example, they’re used to provide for principal shareholder continuing control – as in Moelis’ case – and they’re also frequently utilized to settle proxy fights (where activist shareholders bargain for board representation rights and similar).
The Delaware court described these types of agreements as part of the “irresistible force of market practice” and the case more generally as one where that market practice clashes head-on with the “immovable object of statutory law,” the latter being the board of directors’ statutory duty to manage and direct the corporation's business and affairs.
The first philosophical puzzle is the soritical paradox. This is the classic question of where to draw a line. A typical expression involves a heap of sand: if removing a single grain doesn’t cause the heap to become a non-heap, how can it be that when only a single grain remains,, there is evidently no longer a heap?
In context, if directors are empowered to manage the corporation and can cause the corporation to enter agreements that endure beyond the directors’ tenure, how can this type of shareholder agreement not be valid?
The Delaware court leapt this hurdle, noting that this paradox bedevils logicians but not humans. The court drew a line, determining that governance agreements that substantially remove directors’ authority are invalid; they cause the directors’ heap to no longer be a heap.
The second brain teaser is simpler. Moelis argued that the impugned provisions were not problematic because they operate validly as long as the shareholder and the board agree. This argument failed because when everyone is in agreement, the shareholder agreement provisions are not really operating at all.
The third and last one is the mother lode, a conundrum that corporate lawyers frequently encounter. The commercial objectives of the Moelis shareholder agreement could have been accomplished by other, completely legitimate and valid, means.
For example, the Delaware court observed that Moelis had a class of “blank cheque” preferred shares in its capital structure into which all of the governance rights provided to the shareholder could have been incorporated. The corporation had a dual class capital structure that gave the principal shareholder voting power disproportionate to its equity, and the public company itself had only a minority stake in the operating business controlled by the management team.
But putting all that aside, the company could have done the very thing being challenged differently, and that would have been fine. The Delaware court confronted this point but dispensed with it comfortably because this is precisely what is contemplated by “the doctrine of independent legal significance.”
Notably, after the Moelis decision, the Delaware political wheels were put in motion, and steps are underway to introduce legislation that will essentially overturn the Moelis case and expressly empower corporations to enter into governance agreements.
Whatever the outcome, the decision is important in its clear emphasis on directors’ duties and encouraging for corporate lawyers, more generally, who are entertained by philosophical challenges and/or who have a new “doctrine of independent legal significance” label for their daily creative deal-structuring endeavors.
