On February 17, Delaware State Senator Bryan Townsend introduced a bill, SB 21, to the state legislature. SB 21 proposes to make significant changes to a number of sections of the Delaware General Corporation Law (DGCL). The DGCL is the statute which provides for the creation of Delaware corporations, and governs their internal affairs. As such, it is the governing law for about two-thirds of the Fortune 500.
Historically, amendments to the DGCL have started as proposals in the Delaware State Bar Association (DSBA)’s Corporation Law Section. The DSBA is a professional organization of attorneys in Delaware, and the Section consists of corporate law specialists, including a broad spectrum of practitioners and academics. The Delaware Constitution requires amendments to the DGCL to be enacted by 2/3 supermajorities of both chambers of the state legislature. In practice, the DSBA and Corporation Law Section proposals have usually commanded unanimous support within the Section and DSBA, after which they have been enacted by unanimous or near-unanimous bipartisan majorities in the legislature. While SB 21 is being sponsored by the entire bipartisan leadership of both chambers of the state legislature, as noted it was not proposed by the DSBA or the Corporation Law Section at all. Over the past year, several companies have made headlines with their proposal to move out of Delaware citing concerns resulting from recent Delaware Court of Chancery Decisions. If enacted, these amendments would significantly impact the analysis of such a decision and we would urge companies to strongly consider these amendments as part of its risk-benefit analysis if deciding whether to leave the state or stay put.
The amendments make significant changes to two sections of the DGCL, Section 144, and Section 220.
First, the proposed amendments would significantly reduce judicial review of transactions affected by conflicts of interest. Except for freeze-out mergers, a transaction with a corporate controller or other fiduciary would be immunized from judicial review if the transaction is approved by either a committee of the board of directors with an unconflicted majority or a vote of the unconflicted stockholders legislatively overturning last April’s In re Match Group Inc Derivative Litigation (which we covered on the blog), in which one of the parties argued that these provisions were already a part of Delaware law – an argument the Delaware Supreme Court rejected. Under current law, to cleanse a transaction with a controller requires use of both mechanisms, and the committee must be composed entirely of unconflicted directors.
Second, the statute would codify a definition of a “controlling” stockholder or control group. The statutory definition generally tracks existing Delaware case law on corporate controllers, except that it includes a minimum threshold of one-third of the voting stock. Below that threshold, the proposed amendment declares that a stockholder or group is per se not a controller. While Delaware courts are wary about finding control in a stockholder with less than 50% of the voting power, last year’s high-profile Tornetta v. Musk (which we also discussed on the blog) found the CEO to be a controller with slightly under a quarter of the company’s voting stock.
Third, for publicly traded companies on national exchanges, the proposed amendments would heighten the presumption of independence for directors who are classified as independent by the stock exchange. A heightened presumption of independence would make it harder for a stockholder to challenge a committee’s independence.
Fourth, for two-step tender offer mergers under Section 251(h) of the DGCL, the proposed amendment ‘deems’ tendering stockholders to be votes in favor of the transaction. Because two-step tender offer mergers do not have a stockholder vote, this provision appears crafted to take advantage of the proposed statutory cleansing mechanisms in these types of mergers.
Fifth, the proposed amendment would modify Section 220 to greatly narrow the documents available to stockholders on a ‘books and records’ inspection. Stockholders would generally be limited to corporate governance documents, minutes and materials of board meetings, and three years of financial statements.
The proposed amendments have elicited a range of responses. In combination, from the perspective of corporate directors and controllers, the proposed amendments would greatly reduce litigation risk if enacted. From the perspective of a stockholder, the proposed amendments greatly limit the rights of minority investors. We will continue to monitor as the proposed legislation works its way through the legislature but if anything companies who are considering moving out of Delaware, or incorporating elsewhere should strongly consider the potential benefits of the proposed amendments to the DGCL.