In August 2024, Delaware enacted what are widely considered the most significant and controversial amendments to the state’s corporate statute in at least a generation. Principally, those amendments exalt freedom of contract over what was, in the words of the Delaware Supreme Court, a “cardinal precept” of corporate law: that the business and affairs of every corporation are managed by its board of directors.
In a forthcoming article, I chronicle the legislative history of the 2024 DGCL amendments, which overturned the Delaware Chancery Court’s holding in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company. The article details the remarkably rushed and contentious process by which the amendments were drafted, redrafted, and enacted. It examines the arguments made by the legislation’s proponents, namely the Delaware Corporate Law Council (the “Council”), as well as the vocal objections raised by investors, practitioners, and academics. Most notably, the article highlights the opposition of Delaware’s own judges, including Vice Chancellor J. Travis Laster, the author of Moelis, who led an unprecedented social media campaign against the proposed legislation.
In Moelis, Laster ruled that a private agreement between a corporation and one of its shareholders may not contractually alter DGCL Section 141(a), which statutorily vests the board of directors with managerial power over the corporation. In doing so, Moelis vindicated Delaware law’s longstanding model of board-centric corporate governance over a recently emergent alternative model of contractual governance.
The drafters of the 2024 DGCL amendments made a different calculation. The amendments introduced a new DGCL Section 122(18), which authorizes a corporation to contractually divest its board’s managerial power, “notwithstanding §141(a),” giving it instead to a founder, activist, or other key investor. The effect of this new provision is to render board-centric corporate governance into a mere default rule. In its place, Section 122(18) introduces a new cardinal precept: freedom of contract.
A striking aspect of the legislative debate over DGCL Section 122(18) was the two sides’ diametrically opposed views of the new section’s consequences. While opponents warned that Section 122(18) would fundamentally alter the basic fabric of Delaware corporate law, proponents assured that the amendment would merely restore the status quo before Moelis.
Looking ahead, the answers to three looming questions will determine which side is correct. First, will DGCL Section 122(18) open the door to forced arbitration of shareholder claims? Second, how will the contractual obligations authorized by the new statute interact with the fiduciary duties of corporate directors? Finally, to what degree does Section 122(18) undo earlier Delaware precedents limiting contractual freedom in corporate law?
Forced Arbitration and Derivative Claims
A central criticism of Section 122(18) was that it would open the door to forced arbitration of shareholder claims, including fiduciary duty claims against directors, officers, and controllers.
During the drafting process, the Council revised the bill’s language to explicitly authorize governance agreements containing a mandatory arbitration provision, notwithstanding DGCL Section 115’s bar against such a provision in a corporation’s charter or bylaws. The Council chair underplayed this facet of the statute, arguing that a mandatory arbitration provision would bind only the signatories to a governance agreement.
The Council chair, however, never explained how that logic would apply in the context of derivative claims. If the corporation is bound by a Section 122(18) governance agreement to arbitrate fiduciary claims against a director, officer, or controller, then any shareholder seeking to bring that same claim derivatively would also be forced to arbitrate.
The widespread use of Section 122(18) governance agreements to force derivative claims into arbitration would diminish Delaware courts’ regulatory oversight of the nation’s public corporations and retard the development of Delaware corporate law. For this reason, arbitration has been described as an “existential threat” to Delaware.
To be sure, Delaware might seek to avoid this threat. But the enforceability of an arbitration clause will ultimately be governed by the Federal Arbitration Act, not Delaware law. Thus, even if Delaware sought to exempt derivative claims from arbitration under new Section 122(18), federal courts, unconcerned with Delaware’s parochial interests, will decide the answer.
Fiduciary Duties versus Contract Obligations
Perhaps the most contested question raised by the enactment of Section 122(18) is how agreements authorized by the new statute will interact with the fiduciary duties of corporate directors. The official synopsis states that the new statute “does not relieve any directors, officers, or stockholders of any fiduciary duties they owe … including with respect to deciding to cause the corporation to enter into [or] perform” obligations under a Section 122(18) governance agreement. Going further, the synopsis asserts that “the enforceability [of such agreements] may be subject to equitable review” if the performance of a governance agreement constitutes a fiduciary breach.
But after Laster convincingly pushed back on this latter assertion, the Council appeared to retreat from it. During his legislative testimony, the Council chair never once suggested that a court could limit the enforceability of an otherwise validly made Section 122(18) governance agreement based on equitable grounds. Instead, the chair repeatedly stated that the new section would have “no effect whatsoever on fiduciary duty or equity-based principles.”
That statement is technically accurate but elides a key point: Once a corporation enters into a Section 122(18) agreement, neither fiduciary duties nor equitable principles can protect the corporation or its shareholders from the consequences of that agreement. Under established Delaware precedent, unless the board breached its fiduciary duty in initially entering the agreement, the agreement will be enforceable – even if its performance later proves contrary to the corporation’s best interest. As Laster wrote in a decision issued while the legislation was pending before the Delaware General Assembly, “the fiduciary status of directors does not give them Houdini-like powers to escape from valid contracts.” Directors may decide that the corporation should breach a Section 122(18) governance agreement. But “[t]he breach is still a breach, and the counterparty still has its full panoply of remedies.”
Undoing Precedent, Redefining Governance
More broadly, the contractual limitations imposed on boards by Moelis-class agreements will fundamentally alter the balance of power in corporate governance away from corporate boards – the fiduciary of all shareholders – and toward the most powerful shareholders.
That shift invites reconsideration of earlier Delaware precedents. Until now, Delaware courts upheld private ordering in corporate law when it empowered the board at the expense of shareholders. But the Moelis-class agreements authorized by new Section 122(18) do the opposite. They disempower boards in favor of contractual counterparties unbound by fiduciary duty. The result may be to relegate the role of Delaware courts to simply enforcing private agreements come what may.
In short, while new Section 122(18) expands private ordering in corporate governance, it does so by empowering parties who may owe no fiduciary obligation to public shareholders – and by stripping power from those who do.
Whether this framework is sustainable, or whether it undermines the normative foundations of Delaware corporate law, remains to be seen.
This post comes to us from Professor Mohsen Manesh at the University of Oregon School of Law. It is based on his recent article, “A New Cardinal Precept in Corporate Law,” available here.