Move to Change Delaware Law After Musk Attacks Called Knee-Jerk

Calls for Delaware’s legislature to overturn a landmark court decision are dividing the state’s corporate bar over whether a statutory fix would be an overcorrection.

An influential committee is urging the legislature act to restore the status quo after a judge upended a popular corporate strategy in February. The proposal aims to put stockholder agreements—a key tool for boards defusing proxy fights and venture capital firms leading public listings—back on the right side of the law.

The move to directly override a court ruling looks uncomfortably like a concession to Elon Musk, who has publicly threatened to move Tesla Inc. to another state after a Delaware judge invalidated his $55 billion pay package, said Stephen Ram, a partner at Stradling Yocca Carlson & Rauth LLP.

“If something happens to your team, you might want to see big changes right away because you’re in the moment,” he said. “Then you take a step back and think, ‘Maybe we don’t need to fire the coach. Maybe we can just tinker with the lineup a little.’”

An initial version of the state bar committee’s proposal drew widespread criticism for language that arguably created more uncertainty than it resolved. Although the committee tweaked the amendments a few weeks later, the rush to rewrite the statute without hashing out all the implications—or allowing time for an appeal—is still giving short shrift to “the coherence of the law,” according to Tulane University law professor Ann Lipton.

The push reflects “excess anxiety around Delaware’s status that is plausibly related to Musk,” said University of Michigan law professor Gabriel Rauterberg.

The main court decision targeted by the proposal invalidated stockholder agreement clauses that hand the corporate reins to founders, preferred backers, or activist investors. The ruling by Vice Chancellor J. Travis Laster struck down extensive veto rights in a pact between Moelis & Co. and its billionaire founder, along with sections pledging the investment bank’s support for his future board nominees. Constrained by those provisions, “the board is not really a board,” Laster said.

Rick Alexander, a member of the Corporation Law Council—the body proposing the changes—said the proposed amendments would restore faith in Delaware among venture-backed companies that prize flexibility. Regardless of Musk’s broadsides, the state has always sought to strike a balance between the rights of investors and the needs of management, according to Alexander, CEO of the nonprofit Shareholder Commons.

With states like Nevada and Texas competing for corporate charters, a race to the bottom “would be bad for American capitalism,” he said. “If we break the deal by all of a sudden calling into question thousands of these existing contracts—applying a rule no one was aware of—there’s a real risk people will say, ‘Why choose Delaware?’”

Activist Agreements

The amendments take aim at recent Delaware Chancery Court rulings that got an anxious reception, particularly the Feb. 23 decision on shareholder agreements by Laster, who said the “irresistible force of market practice” must yield to the “immovable object of statutory law.” The court’s chief judge, Chancellor Kathaleen St. J. McCormick, echoed Laster’s language a week later when she issued a ruling that could threaten the way companies typically negotiate mergers and acquisitions.

Corporate boards and their attorneys have complained that the novel decisions raised more questions than answers, a departure for a judiciary that usually bends over backward to offer clear guidance even on emerging issues.

Read More: Novel Corporate Rulings Fuel Charged Debate on Delaware’s Role

About a month after those rulings, the council—a 26-member subcommittee tasked with keeping Delaware’s corporate laws state-of-the-art—began circulating the proposed amendments. Delaware-based law firms, meanwhile, started publishing client alerts about their potential impact, along with others doubling down on doubts about the state’s role in the corporate world. The legislature hasn’t yet formally taken up the proposal.

At the same time, a wave of litigation has targeted accords thrown into legal limbo by the Moelis decision. Several of the lawsuits concern cooperation agreements between companies and activists such as Elliott Investment Management LP, a major hedge fund. Others, including one against private equity giant Apollo Global Management Inc., involve similar pacts with corporate founders.

The disputes underscore “how useful and widespread these things are,” said University of Iowa law professor Robert Miller, who supports the proposal. Companies “are settling with activists every day,” reaching agreements that often represent the only way to avoid a protracted conflict, according to Miller.

“In the great long history of the world, this is something that should be done now,” he said.

Secret Sauce

Neither the Moelis decision nor McCormick’s ruling—in a case challenging the $69 billion merger between Microsoft Corp. and Activision Blizzard Inc.—has reached the Delaware Supreme Court yet. If the legislature effectively overturns the results in those cases, it would rob the state’s justices of the chance to alleviate the confusion, according to Lipton.

Read More: Crackdown on Corporate Insiders Collides With New Era of Control

The council revised its proposal in early May to make clear the changes would only let companies use stockholder agreements to establish otherwise legal corporate structures—rather than create an end run around mandatory limits. Rauterberg called the new version “a major improvement,” but said it’s still a mistake to short-circuit any potential appeal.

Although the council’s work is “widely admired,” the state’s courts are “way more admired,” according to Rauterberg. “When people think, ‘What’s Delaware’s secret sauce?,’' they think, ‘The Delaware Chancery Court is the leading adjudicative forum for corporate law.’”

Miller, speaking in favor of the proposal, stressed the urgency created by the Moelis decision, particularly for proxy fights. Usually, “the Delaware court says what the law is and the market adjusts,” he said. But Moelis reined in the main mechanism driving those adjustments: private contractual arrangements circumventing default rules.

Although the courts would likely find their way to some sort of equilibrium, “I wouldn’t wait for the Delaware Supremes to do it,” Miller said. “Yes, this is Delaware, and we litigate quickly, but it could still take a year.”

Red Herring

Rauterberg called those arguments off-base, saying the types of agreements needed to resolve activism campaigns remain legal. The Moelis ruling only invalidated longer-term promises to back unknown future board nominees, he said, not pledges to support specific candidates.

The amendments seem geared more toward founders and venture firms trying to creatively engineer bespoke capital structures that let them exercise longer-term corporate control after they begin taking money from the public, according to Ram.

The proposal “gives the board and those types of shareholders a lot more flexibility to do what they want in perpetuity,” Ram said.

Shareholder agreements reflect a legitimate way for companies to order their affairs “as long as you’re doing them for the right reasons,” said Alexander, who stressed that the amendments would only overturn portions of the Moelis decision declaring common provisions outright illegal. Judges hearing fiduciary breach claims would still have a chance to ensure the pacts aren’t abused, according to Alexander.

“There were a lot of settled expectations, and then all of a sudden, thousands of financings are at risk,” he said.

Rauterberg said he sympathizes with the clamor for more clarity. “But if you’re doing something in tension with basic, longstanding principles of corporate law, sometimes you don’t get to have immediate certainty,” he said.