The Apotheosis Of A Footnote

A distinguished Delaware practitioner objects that the Moelis decision “appl[ied] a rule no one was aware of.”[1] In response, the practitioner and his fellow members of the Corporate Council have proposed the market practice amendments of 2024. Those amendments include a rule that I had never heard of: the concept of determining whether Section 141(a) applies to an instrument based on whether the instrument is supported by consideration. I initially thought that rule was newly minted, but with a bit of luck, I happened upon its progenitor. A version of the same rule appears in footnote 48 of an article that the practitioner and a colleague wrote in 2008.[2] The article has been cited twenty times, but never for the test that footnote 48 proposed. No court has ever used that test. But if the market practice amendments pass, footnote 48 will become law.

Is the practitioner correct that the Moelis decision apply a rule no one had ever heard of? To be sure, the Moelis decision marked the first time that a plaintiff advanced a statutory challenge to a new-wave governance agreement that sought to lockup the board with pre-approval requirements and covenants. As the first decision to address that type of agreement, the Moelis decision necessarily trod new ground. But that new ground involved determining how to distinguish between internal governance arrangements that are subject to Section 141(a) and external commercial contracts that are not. That is the same issue that the practitioner and his colleague addressed in footnote 48. They just drew the line at a different place.

To interpret Section 141(a), the Moelis decision surveyed and integrated precedents dating back to Chancellor Seitz’s landmark decision in Abercrombie v. Davies.[3] The Delaware Supreme Court has repeatedly endorsed the Abercrombie test,[4] and this court has repeatedly applied it.[5]

Those precedents and the associated principles were not a new rule that no one had ever heard of. In fact, the practitioners’ 2008 article deployed the same concepts when explaining how Section 141(a) placed limits on board-constraining bylaws.[6] Many of their observations could have appeared in the Moelis decision, particularly if you substitute “contractual obligations” for “bylaws.” For example:

• “Delaware's existing statutory and common law suggest that the corporate form's underlying structure is inconsistent with the use of mandatory bylaws to control corporate activity and curtail board authority.”[7]
• “A bylaw that effectively allows stockholders to make decisions as to the management of corporate assets … likely violates the Delaware statutory or common law.”[8]
• “Despite the wide latitude for private ordering, it is also important to note that the list of items that may appear in the bylaws does not cover substantive decisions about corporate management. …. [T]he DGCL stops short of authorizing bylaws that place restrictions on the actual decisions that a board can make.”[9]
• “A plain reading of [section 141(a)] would suggest that the bylaws cannot impose limits on the board's power to manage the corporation because section 141(a) permits variation from that rule in the charter, but not the bylaws.”[10]
• “[S]tockholders cannot adopt bylaws that limit or interfere with the board's managerial power: the stockholders cannot impose substantive limits on board decisions and cannot use the bylaws to make decisions for the board, because the stockholders do not generally owe the corporation and their fellow stockholders fiduciary duties.”[11]
• “Delaware's corporate law provides for the management of pooled assets, and requires that fiduciaries manage the corporation in the best interests of the enterprise and its stockholders, and not simply take a direction from a stockholder majority.”[12]
• “Because stockholders do not bear the fiduciary duties to act in the best interests of all stockholders, vesting them with the power of directors to manage corporate assets would constitute a radical redistribution in managerial power under Delaware common and statutory law.”[13]

Far from supporting the assertion that Moelis created a new rule, those passages reveal broad agreement with Moelis about what Section 141(a) provides.

The debatable issue was the extent to which Section 141(a) would apply to a contract with a nominal third party that nevertheless sought to allocate governance rights within the corporation. The possibility that Abercrombie and its progeny could apply to that type of agreement should not have come as a surprise. The Abercrombie decision itself invalided an agreement among stockholders in which they agreed as stockholders to remove any of their nominees who did not vote as agreed.[14] Later decisions applied Section 141(a) to third-party contracts, supported by consideration, including CEO employment agreements, merger agreements, and management agreements.[15] The first law professor to examine a governance agreement between a corporation and a favored stockholder identified the potential statutory risk.[16]

After surveying all of the contemporary Section 141(a) authorities, the Moelis decision used a multi-factor test to distinguish commercial contracts from governance agreements. The decision identified the Moelis agreement as a prototypical governance agreement, then applied Section 141(a) in the same manner that the practitioners described in their article.  

Like the Moelis decision, the practitioners also tried to draw a line between instruments where Section 141(a) would apply and places where it wouldn’t. They thought that concept merited only a single footnote. Footnote 48 stated:

"Of course, we do not believe this authority means that a board cannot limit the exercise of its fiduciary duties to the extent it enters into binding contracts, in which the board contractually limits its range of actions in exchange for bargained for consideration. Such a contract can be entered into with a stranger to the corporation, or even with a stockholder, if the agreement involves a bargained for exchange of benefits. … 

"In our view, such commercial contracts differ from bylaw provisions that do not involve bargained-for consideration but instead are intended solely to alter the statutorily-mandated allocation of authority between current and future boards and between a board and the stockholders."[17]

In support of that interpretation, the practitioners cited two decisions that discussed the obvious and trivial reality that corporations limit their future flexibility when they enter into commercial agreements.[18] Commercial agreements are not governance agreements. Except for a reference to Sample v. Morgan, the practitioners did not cite, much less address, any of the decisions in which Delaware courts had applied Section 141(a) to nominally third party agreements.

The practitioners thus put bylaws on one side of the line and every other conceivable type of arrangement on the other side. The Moelis decision put “commercial contracts” on one side of the line, then put bylaws and agreements “intended solely to alter the statutorily-mandated allocation of authority between current and future boards and between a board and the stockholders” on the other side of the line.

Which is the new rule? Footnote 48 offered a new rule that the practitioners thought explained the cases. No court ever adopted that rule, and no one has ever cited the article for the rule proposed in footnote 48. To the extent the Moelis dividing line reflected something new, so does the line that the practitioners sought to draw and now seek to implement through Section 122(18).

More importantly, which is the better line? Footnote 48 reflects what I think of as “the clarity of the client.” A litigator representing a client knows what the authorities are supposed to say. If your client has been sued, the authorities support dismissal. If your client faces a motion, the cases support its denial. Adverse cases are always distinguishable.

Clients regularly ask Delaware lawyers to opine on the enforceability of agreements. Clients also regularly ask Delaware lawyers to opine that stockholder-adopted bylaws would be contrary to Delaware law and hence can be excluded from a corporation’s proxy statement.

The client’s question provides clarity. For an agreement, the client wants to hear that the agreement is enforceable. For a stockholder-adopted bylaw, the client wants to hear that the bylaw is invalid and can be excluded. But if the same Section 141(a) principles apply equally to both, then matters become complex. Some provisions in stockholders agreements would pass muster, but others would not. Lawyers would confront uncomfortable calls. Sometimes, they might have to tell a client that they could not render the opinion.

Footnote 48 solves the practitioner problem nicely. A proverbial peppercorn suffices for contractual consideration, so using consideration as a dividing line conveniently takes all governance agreements outside the scope of Section 141(a). That statute is no longer an impediment to rendering the enforceability opinions that clients wants, while that statute continues to provide a basis to render the invalidity opinions that clients also want. Clever.

Unfortunately, that line results in governance agreements achieving the same dignity as the charter. It thus collapses the corporate hierarchy of documents, in which the DGCL sits on the top, then the charter, then bylaws, then other agreements. The practitioners' line also erases the distinction between internal affairs and external affairs, because an external agreement will be able control the internal to the same degree as the charter. And the practitioners' line fails to explain the cases that have applied Section 141(a) principles to nominally third-party agreements.[19]

The market practice amendments will elevate footnote 48 to the status of controlling law, but that doesn’t make it a good test. The consideration test from footnote 48 didn’t explain the extant authorities in 2008, and using the consideration test in Section 122(18) doesn’t explain the extant authorities now. But it does make it easy for practitioners to give clients and forwarding counsel the answers they want. And from the standpoint of transactional lawyers, that is a beautiful thing.

Disclaimer: I offer the comments in this post in my personal capacity. Canon 4 of the Delaware Judges’ Code of Judicial Conduct permits a judge to engage in “activities to improve the law, the legal system, and the administration of justice.” That canon says that “[a] judge may speak, write, lecture, teach, and participate in other activities concerning the law, the legal system, and the administration of justice (including projects directed to the drafting of legislation).” By writing this post, I am attempting to “write” on an issue concerning “the law, the legal system, and the administration of justice.” I sometimes forget to include this disclaimer, but it's always there--just like the countdown in 3 Body Problem.

[1] Mike Leonard, Move to Change Delaware Law After Musk Attacks Called Knee-Jerk (May 15, 2024).

[2] Frederick H. Alexander & James D. Honaker, Power To The Franchise Or The Fiduciaries? An Analysis of the Limits of Stockholder Activist Bylaws, 33 Del. J. Corp. L. 749 (2008).

[3] Abercrombie v. Davies, 123 A.2d 893, 899 (Del. Ch. 1956), rev’d on other grounds, 130 A.2d 338 (Del. 1957).

[4] Quickturn Design Sys., Inc. v. Shapiro (Quickturn II), 721 A.2d 1281, 1292 (Del. 1998); Grimes v. Donald (Grimes II), 673 A.2d 1207, 1214 (Del. 1996); see Mayer v. Adams, 141 A.2d 458, 461 (Del. 1958) (citing Abercrombie with approval); Adams v. Clearance Corp., 121 A.2d 302, 305 (Del. 1956) (endorsing Abercrombie’s analysis). More recent cases often cite decisions that relied on Abercrombie, such as Quickturn II and Grimes II. E.g., CA, Inc. v. AFSCME Empls. Pension Plan (AFSCME), 953 A.2d 227, 238 (Del. 2008) (relying on Quickturn II; concluding that bylaw violated Section 141(a)); McMullin v. Beran, 765 A.2d 910, 924–25 & n.66 (Del. 2000) (relying on Grimes II; holding that complaint stated a claim that corporation improperly delegated to its controlling stockholder the task of initiating, negotiating, and approving a sale of the company to a third party).

[5] E.g., In re Bally’s Grand Deriv. Litig., 1997 WL 305803, at *5–6 (Del. Ch. June 4, 1997) (applying test and finding pleading-stage violation); Grimes v. Donald (Grimes I), 1995 WL 54441, at 9 (Del. Ch. Jan. 11, 1995) (Allen, C.) (applying test and finding no pleading-stage violation), aff’d, 673 A.2d 1207 (Del. 1996); Rosenblatt v. Getty Oil Co, 1983 WL 8936, at 18 (Del. Ch. Sept. 19, 1983) (applying test and finding no post-trial violation), aff’d, 493 A.2d 929 (Del. 1985); Chapin v. Benwood Found., Inc., 402 A.2d 1205, 1210–11 (Del. Ch. 1979) (applying rule on summary judgment and finding a violation), aff’d sub nom. Harrison v. Chapin, 415 A.2d 1068 (Del. 1980). More recent cases often cite decisions that relied on Abercrombie. E.g., Unisuper Ltd. v. News Corp., 2005 WL 3529317, at 7 (Del. Ch. Dec. 20, 2005) (relying on Quickturn II; finding no pleading-stage violation); ACE Ltd. v. Cap. Re Corp., 747 A.2d 95, 107 (Del. Ch. 1999) (relying on Quickturn II and rejecting injunction-stage interpretation of merger agreement that would result in Section 141(a) violation); Carmody v. Toll Bros., 723 A.2d 1180, 1190 & n.27 (Del. Ch. 1998) (relying on Grimes I and Abercrombie; finding pleading-stage violation).

[6] Alexander & Honaker, supra.

[7] Id. at 749-50.

[8] Id. at 750.

[9] Id. at 753.

[10] Id.

[11] Id. at 755.

[12] Id. at 755-56.

[13] Id. at 769.

[14] The Abercrombie decision also invalidated a portion of the agreement in which one of the stockholders, who was also a director, bound himself as a director to vote as agreed. Id. at 894–95 & n.1. That seems to be the only part of the decision that some Delaware practitioners choose to remember. But the other signatories bound themselves as stockholders, by contract, and Chancellor Seitz held it was invalid under Section 141(a). Id. at 899. That is a step further removed from Moelis, where the agreement bound the corporation.

[15] See Grimes v. Donald (Grimes II), 673 A.2d 1207 (Del. 1996)(employment agreement with CEO); Politan Cap. Mgmt. LP v. Masimo Corp., C.A. No. 2022-0948-NAC, at 173–91 (Del. Ch. Feb. 3, 2023) (TRANSCRIPT) (employment agreement with CEO) Schroeder v. Buhannic, 2018 WL 11264517, at 2, 4 (Del. Ch. Jan. 10, 2018) (ORDER) (stockholder agreement); Marmon v. Arbinet-Thexchange, Inc., 2004 WL 936512 (Del. Ch. Apr. 28, 2004) (stockholder agreement); Nagy v. Bistricer, 770 A.2d 43 (Del. Ch. 2000). (merger agreement); ACE Ltd. v. Cap. Re. Corp., 747 A.2d 95, 106 (Del. Ch. 1999) (merger agreement); In re Bally’s Grand Deriv. Litig., 1997 WL 305803, at 5–6 (Del. Ch. June 4, 1997) (management agreement); Jackson v. Turnbull, 1994 WL 174668 (Del. Ch. Feb. 8, 1994), aff’d, 653 A.2d 306 (Del. 1994) (merger agreement).

[16] See Gabriel Rauterberg, The Separation of Voting and Control: The Role of Contract in Corporate Governance, 38 Yale J. Reg. 1124, 1148–54 (2021).

[17] Alexander & Honaker, supra, at 763 n.48.

[18] Id. (citing In re infoUSA, Inc. S'holders Litig., 953 A.2d 963, 999 (Del. Ch. 2007); Sample v. Morgan, 914 A.2d 647, 671-72 (Del. Ch. 2007)).

[19] The practitioners' line even fails to explain while threatening to override the rights plan decisions. See Quickturn Design Sys., Inc. v. Shapiro, 721 A.2d 1281 (Del. 1998); Carmody v. Toll Bros., 723 A.2d 1180 (Del. Ch. 1998). Although sometimes we may think of a rights plan as something a board adopts unilaterally, the plan actually takes the form of a third-party contract. The corporation enters into a rights agreement with a rights agent and pays the rights agent for providing its services. Give the rights agent a share and you come within Section 122(18).