/>iOn March 25, Delaware governor, Matt Meyer, signed into law Substitute 1 to Senate Bill 21 (SB 21), following its rapid approval by the Delaware state legislature. This legislative measure aims to counter the current trend of companies relocating their headquarters out of Delaware, following a January 2024 Delaware Chancery Court ruling that overturned a $56 billion compensation package for a high-profile tech CEO.
SB 21 and the changes to the Delaware General Corporation Law (DGCL) it contains could potentially lower litigation risks for Delaware-based corporations, including their directors, officers, and majority shareholders.
This strategic move to refine corporate governance in Delaware will most significantly impact how interested director and interested stockholder transactions are handled. These amendments introduce new safe harbor provisions and redefine key terms, which greatly enhance the protections for interested directors, interested officers, and majority shareholders. As Delaware aims to retain its status as the renowned hub for corporations, often leading the way in corporate law, these changes promise to provide a more predictable and favorable legal environment for corporations.
The amendments took effect immediately following the Governor’s signature and, in most cases, are applied retroactively. Regarding SB 21’s retroactive application, these amendments cover all acts or transactions, regardless of whether they occurred before, on, or after the date of enactment. However, they do not apply to any actions, proceedings, or requests to inspect books or records that were initiated or made on or before February 17, which is when the initial draft of the amendments was first made public.
Interested Director, Officer, and Stockholder Transactions
Prior to the amendments, DGCL §144(a) provided a safe harbor for transactions involving interested directors, ensuring they were not automatically void or voidable due to conflicts of interest, provided that all relevant facts about the director’s or officer’s conflict, including their involvement in the transaction, were fully disclosed. The transaction then had to be approved by (1) a majority of disinterested directors on the board or a board committee, even if they did not constitute a quorum, and (2) a majority of informed, disinterested, and uncoerced stockholders.
If these conditions went unmet, the transaction had to be “fair to the corporation and its stockholders” to qualify for the safe harbor, necessitating compliance with the “entire fairness” doctrine. Entire fairness is historically the highest standard of review in corporate law, requiring boards to demonstrate both fair pricing and fair procedures in transactions with conflicts of interest.
In a recent case, the Delaware Supreme Court demonstrated that transactions could be deemed entirely fair, despite flaws, emphasizing factors like independent negotiation, expert advisory involvement, and informed stockholder approval. The court emphasized that fair dealing and fair pricing can be established through comprehensive vetting, appropriate timing, and market validation, even when certain procedural safeguards are not employed. Although DGCL §144(a) previously ensured that such transactions were not void or voidable solely due to director interest, directors and officers could still face litigation for breaches of fiduciary duties, if they failed to demonstrate entire fairness in the transaction or both of the aforementioned requirements.
The amendments from SB 21 broaden the scope of protection under the safe harbor provisions, now preventing any claims for equitable relief or monetary damages if there is either, (1) approval by a well-informed and functioning special committee with at least two disinterested directors or (2) an informed, uncoerced vote by disinterested stockholders. This significantly lessens the stress on interested parties and corporations, allowing them to transact without the same fear of legal repercussions. However, under SB 21, as discussed below, in a going private transaction where there is a controlling shareholder, both mechanisms, designed to protect minority shareholders from conflicted transactions, must still be used in order to take advantage of the safe harbor.
Controlling Stockholder Transactions
SB 21 amends the DGCL to introduce a more structured framework for transactions involving controlling stockholders. These amendments, particularly to DGCL §144, aim to streamline the approval process for such transactions, excluding “going private” deals, and provide a clearer path to avoid legal challenges if specific conditions are met.
The amendments to DGCL §144(b) establish a safe harbor for transactions involving controlling stockholders. This safe harbor is designed to protect these transactions from actions seeking equitable relief and damages, provided they meet certain criteria. The transaction must be approved, in good faith, by a special committee that has the express authority to negotiate and reject the transaction. The committee must consist of a majority of disinterested directors and must exclude the controlling stockholders. This ensures that the decision-making process is unbiased and focused on the best interests of the corporation and its minority shareholders.
Alternatively, the safe harbor can be applied if the transaction is approved or ratified by a majority of informed, disinterested, and uncoerced stockholders, provided that all material facts regarding the transaction are disclosed to them. This dual pathway for approval offers flexibility, while maintaining rigorous standards for transparency and fairness.
For “going private” transactions, the amendments introduce a new subsection, DGCL §144(c), which outlines a more stringent dual requirement for safe harbor protection. This provision mandates that the transaction must be approved by both a special committee and a majority of disinterested stockholders, with all material facts disclosed to both parties. This is essentially invoking the DGCL’s entire fairness standard of review.
These amendments effectively roll back previous expansions of the MFW Doctrine, which was established in the landmark case of Kahn v. M&F Worldwide Corp. The Delaware Supreme Court had previously ruled that controlling stockholder transactions could be reviewed under the business judgment rule, rather than the “entire fairness” standard, only if such transactions were conditioned on approval by both an independent special committee and a majority of disinterested stockholders.
SB 21 confirms that the full scope of the MFW Doctrine is now limited to going private transactions. For other controlling stockholder transactions, compliance with either of the MFW procedural mechanisms (i.e., approval by an independent special committee or a majority of disinterested stockholders) allows under the business judgment rule. This simplification could potentially reduce litigation risks and provide a more predictable legal framework for corporate transactions involving controlling shareholders.
These amendments reflect a strategic shift in Delaware’s corporate law, aiming to balance the interests of minority shareholders, with those of controlling stockholders. By providing a more predictable and streamlined process for approving transactions, the amendments could encourage more efficient dealmaking.
Now, following SB 21, it is paramount for companies to ensure that all material facts are thoroughly disclosed and that the decision-making process is free from coercion of informed, disinterested, and uncoerced stockholders.
Controlling Stockholder Classification
SB 21 also introduced DGCL §144(e), a subsection that sharpens the focus on corporate governance by clearly defining key terms related to stockholder and director roles. The new definitions are pivotal under the DGCL, especially the term “controlling stockholder,” which now refers to an entity or individual with significant influence, either by owning a majority of voting power, having the contractual right to elect a majority of directors, or wielding equivalent power through substantial voting shares and managerial control. This clarity helps pinpoint who holds sway in corporate affairs, promoting more transparent governance.
In tandem, SB 21 outlines what makes a “disinterested director.” Such a director is uninvolved in the transaction, free from material interests, and lacks significant ties to interested parties. This definition is crucial for ensuring directors act impartially, safeguarding the corporation’s and shareholders’ interests. SB 21 also presumes independence for directors meeting these criteria, a presumption that can only be overturned with detailed evidence, bolstering directors’ defenses against potential shareholder lawsuits. The enhanced protection allows directors to act more freely and confidently, knowing that their independence is presumed and safeguarded against unwarranted challenges. This assurance can make Delaware a more attractive jurisdiction for companies, as it reduces the risk of litigation over director decisions and reinforces the state’s reputation for strong, clear corporate governance standards, potentially discouraging companies from considering relocation.
The amendments further introduce safe harbor provisions for transactions involving conflicted directors or officers. These provisions shield such transactions from legal challenges if they receive approval from an independent board committee with at least two directors or are ratified by a majority of disinterested stockholders. This process ensures that even potentially conflicted transactions are handled with transparency and fairness. The final amendments in SB 21 refine a pre-existing safe harbor provision for disinterested directors, mandating that disinterested director approvals occur within an independent committee context.
Redefining Stockholder Inspection Rights
SB 21 amends DGCL §220, making significant changes to the rights of stockholders and directors in inspecting the books and records of Delaware corporations. Historically, Section 220 allowed stockholders to inspect corporate records for a “proper purpose,” which courts have interpreted to include a variety of reasons such as investigating potential misconduct, engaging in proxy contests, and assessing stock value. Once a proper purpose was established, stockholders were entitled to access records deemed “necessary and essential” to their purpose. However, the scope of what constituted “necessary and essential” had broadened over time, extending beyond traditional board materials to include electronic communications like emails and texts.
The amendments aim to curtail this expansion by clearly defining “books and records” as core materials, such as board minutes from the past three years, board presentations, director independence questionnaires, and communications with stockholders. While stockholders can still request additional materials, they must now demonstrate a “compelling need” and provide “clear and convincing evidence” that these materials are essential to their purpose.
Furthermore, the amendments provide corporations with greater certainty and protection, by allowing them to impose reasonable confidentiality restrictions on the use and distribution of inspected records. Corporations can also redact information that is not directly related to the stockholder’s purpose. These changes address previous challenges where courts sometimes denied confidentiality protections, depending on the circumstances.
Overall, the amendments to Section 220 establish a structured framework for record inspection, aiming to balance the rights of stockholders with the need to protect corporate confidentiality and limit the scope of inspection to truly essential materials.
