Clarity for M&A Practitioners: Proposed DGCL Amendments Bridge the Gap between Recent Delaware Chancery Court Decisions and Market Practice

• Reaffirm prevailing market practice of having boards approve merger agreements in “substantially final form” whereby all of the material terms are set forth therein or otherwise determinable through information or materials presented or known to the board and authorizing officers to approve incremental non-material changes (see proposed DGCL Section 147).
• Specifically authorize corporations to enter into stockholder agreements with current or prospective stockholders that contain governance rights over the corporation, such as covenants, consent rights and veto rights (see proposed DGCL Section 122(18)).
• Validate the enforceability of damages provisions in merger agreements in the event of a terminated transaction, including lost-premium damages and reverse termination fees (see proposed DGCL Section 261(a)).

The proposed Amendments are in response to recent case law decisions in Activision, Moelis and Crispo that uprooted well-established market practice and called into question the enforceability of the merger agreement approval process (see Activision), the granting of governance rights in stockholder agreements (see Moelis), and the usage of lost-premium damages provisions in merger agreements (see Crispo). The proposed Amendments would align the statutory requirements under the DGCL with market practice and would retroactively apply to all agreements, subject to limited exceptions. To become effective, the proposed Amendments would need to be enacted by the Delaware General Assembly and signed into law by the governor of Delaware.  It is currently contemplated that the proposed Amendments will be introduced to the Delaware General Assembly later this year.

Below we discuss how each of the decisions in Activision, Moelis and Crispo have been addressed by the proposed Amendments to the DGCL. Finally, we conclude with several practice tips for M&A advisors to consider in light of these important Delaware law updates.

Proposed Amendments in Response to Activision
In Sjunde AP-Fonden v. Activision Blizzard, Inc., C.A. No. 2022-1001-KSJM (Del. Ch. Feb. 29, 2024), the Delaware Court of Chancery held, in relevant part, as follows:

• Section 251(b) of the DGCL requires a board to approve an “essentially complete” version of the merger agreement. The Delaware Court of Chancery denied the defendants’ motion to dismiss the Section 251(b) claim as it was reasonably conceivable that the board did not approve an essentially complete version of the merger agreement when such merger agreement omitted the target company’s name, the consideration, the company disclosure letter, the disclosure schedules, the surviving company’s charter and the amount of dividends that could be paid during the interim operating period.
• Section 251(c) of the DGCL requires that the proxy notice to stockholders contain the “essentially complete” version of the merger agreement or a brief summary thereof. The Delaware Court of Chancery denied the defendants’ motion to dismiss the Section 251(c) claim, as the proxy notice neither contained an essentially complete version of the merger agreement (due to the exclusion of the surviving company’s charter) nor a brief summary of the merger agreement (due to the summary being incorporated in the proxy statement attached to the proxy notice, rather than the proxy notice itself).

The Activision decision challenges well-established market practice that provides the flexibility necessary to negotiate and finalize merger agreements, disclosure schedules and other transaction documents in an efficient and expeditious manner. It has long been customary for boards to approve a substantially final version of the merger agreement and delegate authority to authorized officers to approve any changes or modifications to such approved form of merger agreement and negotiate the disclosure schedules, which are oftentimes negotiated right up until signing, and other transaction documents. This provides the board time to review and evaluate the material provisions of the merger agreement while allowing teams to concurrently wordsmith non-material provisions and negotiate the disclosure schedules and other transaction documents, allowing for the merger agreement to be executed immediately upon finalization of all transaction documents without the added delay of convening another board meeting.

The proposed Amendments in response to the decision in Activision include the following:

• Boards may approve agreements in “substantially final form.” The proposed Amendments would amend the DGCL to add a new Section 147 that would, among other things, enable boards to approve agreements in “substantially final form.” Although the proposed Amendments do not define what constitutes “substantially final form,” the synopsis of the proposed Amendments clarifies that the new Section 147 is intended to enable board approval of agreements if, at the time of approval, all of the material terms are set forth therein or otherwise determinable through other information or materials presented or known to the board.
• Boards may ratify agreements. New Section 147 further provides that a board may ratify any approval or action taken with respect to an agreement required to be filed with the Delaware Secretary of State or referenced in any certificate so filed (such as a certificate of merger) so long as ratification occurs prior to the effectiveness of such filing. Any such ratification will be deemed to be effective as of the time of the original approval or action taken. The synopsis of the proposed Amendments notes that such ratification is available to provide greater certainty when there may be a question as to whether an agreement was in “substantially final form” when it was approved by the board. Any such ratification would be an alternative to Section 204 of the DGCL and thus would not require notice to stockholders.
• Surviving company charter does not need to be approved by the board in all-cash deals. The proposed Amendments would amend the DGCL to add a new Section 268(a) that would, among other things, clarify that in deals where the company stockholders are not receiving stock in the surviving company, the merger agreement need not contain a copy of the surviving company charter to be deemed to be in “substantially final form,” any amendment to the surviving company charter can be adopted by the board or any person acting at the board’s direction, and no change to the surviving company charter shall be deemed to constitute an amendment to the merger agreement. This will allow for greater flexibility in reverse triangular mergers where the company becomes a wholly-owned subsidiary of the buyer and the surviving company charter is less relevant to the company’s stockholders.
• Disclosure schedules do not need to be approved by the board or stockholders. The proposed Amendments would amend the DGCL to add a new Section 268(b) clarifying that disclosure schedules are not considered to be a part of the merger agreement for the purposes of the provisions of the DGCL. This permits disclosure schedules to be finalized independently of the merger agreement at the direction of the board (and without the need for formal board approval thereof) and obviates the need to submit the disclosure schedules for approval by the stockholders.
• Proxy notice includes all attachments. The proposed Amendments would amend the DGCL to add a new Section 232(g) clarifying that each document enclosed, annexed or appended to any proxy notice would be deemed to be a part of such proxy notice for the purpose of determining whether notice was duly given. Accordingly, any proxy statement appended to a proxy notice for the purposes of approving a merger agreement could be used to satisfy the notice requirements under Section 251(c) of the DGCL.
• Proposed Amendments would retroactively apply to agreements. If approved, the proposed Amendments would become effective on August 1, 2024, and retroactively apply to all contracts made by a corporation, agreements approved by the board and merger agreements entered into by a corporation, except to the extent that any civil action is completed or pending on or before such date (in which case the DGCL, without the benefit of such proposed Amendments, would be referenced for the purposes of any such civil action).

Proposed Amendments in Response to Moelis
In West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, C.A. No. 2023-0309-JTL (Del. Ch. Feb. 23, 2024), the Delaware Court of Chancery held, in relevant part, as follows:

• Stockholder agreements with expansive consent rights afforded to a stockholder may be deemed to violate Section 141(a) of the DGCL. The Delaware Court of Chancery granted the plaintiff’s motion for summary judgment as to the facial invalidity of a collective set of 18 different categories of action requiring stockholder approval prior to the board being able to take any such actions. Stockholder agreements that require the board to obtain a stockholder’s prior written consent before taking virtually any meaningful action will be deemed to improperly constrain the board’s authority in violation of Section 141(a) of the DGCL.
• Provisions requiring the board to (i) maintain its size at a certain number of seats, (ii) recommend that stockholders vote in favor of a stockholder designee, (iii) fill vacancies previously occupied by a stockholder designee with a new stockholder designee, or (iv) populate any committee with a specific number of stockholder designees violate Section 141(a) of the DGCL (and committee composition provisions also violate Section 141(c) of the DGCL). The Delaware Court of Chancery granted the plaintiff’s motion for summary judgment as to the facial invalidity of the foregoing size requirement, recommendation requirement, vacancy requirement and committee composition provisions, which removes the ability of the directors to use their best judgment and improperly compels them to take action that is within their exclusive authority.
• Provisions requiring the board to (i) name a number of designees equal to a majority of the seats, (ii) nominate stockholder designees, or (iii) use reasonable efforts to enable stockholder designees to be elected and continue to serve are permissible under Section 141(a) of the DGCL. The Delaware Court of Chancery granted the company’s motion for summary judgment as to the facial validity of the foregoing designation right, nomination requirement and efforts requirement, as such rights do not infringe upon powers exclusively held by the board and are ministerial in nature.

The Moelis decision invalidates customary market practice of providing certain governance rights to key stockholders in stockholder agreements. Rather, the Delaware Court of Chancery advises that such governance rights would be more appropriately implemented through a company’s certificate of incorporation (such as through the issuance of preferred stock). Notably, the Delaware Court of Chancery does not address the practicality of amending the certificate of incorporation of a public company, which could be a costly and time-consuming process given the dispersed shareholder base and the likely requirement to obtain shareholder approval.

In reaching its decision in Moelis, the Delaware Court of Chancery applied a two-step test. First, it determined whether the challenged provision was part of the corporation’s internal governance arrangement (in which case Section 141(a) of the DGCL applies) or an external commercial contract (in which case the inquiry ends). Second, if Section 141(a) of the DGCL is applicable, the Abercrombie test must be applied to determine whether the challenged provision imposes a restriction in violation of Section 141(a) of the DGCL (i.e., whether the challenged provisions have the effect of removing from directors in a very substantial way their duty to use their own best judgment on management matters). Although the Delaware Court of Chancery asserts that the line-drawing exercise can be applied using legal reasoning, this line of inquiry will invariably introduce uncertainty and ambiguity into determinations as to whether agreements contain provisions that constitute impermissible governance arrangements or acceptable commercial contracts.

The proposed Amendments in response to the decision in Moelis include the following:

• Stockholder agreements may provide for governance rights. The proposed Amendments would amend the DGCL to add a new subsection (18) to Section 122 that would, whether or not authorized in the corporate charter, permit a corporation to enter into contracts with its current or prospective stockholders that (i) require, restrict or prohibit certain corporate actions and (ii) otherwise afford consent or veto rights with respect to certain corporate actions to one or more parties (provided that any such contract is supported by such minimum consideration as approved by the board). Any limitations on the ability of the corporation to enter into such contracts would need to be incorporated into the certificate of incorporation. The synopsis of the proposed Amendments specifically notes that the intent of this new subsection (18) to Section 122 would result in a different holding under Moelis.
• Proposed Amendments do not alter existing case law with respect to the ability of the board to delegate authority. The proposed Amendments would amend the DGCL to modify subsection (5) to Section 122 to clarify that any contract or arrangement that empowers an officer or agent of the corporation to act on its behalf remains subject to Section 141(a) of the DGCL and established limits with respect to the delegation of authority.
• Proposed Amendments do not relieve directors of their fiduciary duties or require directors to take on additional liability. The synopsis of the proposed Amendments clarifies that the addition of a new subsection (18) to Section 122 does not relieve directors, officers or stockholders of any fiduciary duties owed to the corporation or its stockholders (including with respect to decisions to enter into, perform, or breach stockholder agreements). In addition, the new subsection (18) to Section 122 does not authorize a corporation to enter into agreements that (i) impose consequences against directors (as opposed to the corporation) for taking, or failing to take, certain actions or (ii) remove the need for director or stockholder approval if otherwise required under the DGCL.
• Corporations may continue to rely on subsection (13) to Section 122 of the DGCL to enter into contracts with non-stockholder parties. The proposed Amendments only address the granting of governance rights to current or prospective stockholders in their capacity as stockholders (and do not address contracts entered into with non-stockholder parties or stockholders acting in different capacities).

Proposed Amendments in Response to Crispo
In Luigi Crispo v. Elon R. Musk, C.A. No 2022-0666-KSJM (Del. Ch. Oct. 31, 2023), the Delaware Court of Chancery held, in relevant part, as follows:

• Merger agreement provisions that entitle target company stockholders to seek lost-premium damages, in the event that the merger agreement is terminated, may be unenforceable. In denying the plaintiff’s petition for mootness fees for lack of a meritorious claim, the Delaware Court of Chancery maintained that lost-premium damages provisions may be unenforceable by the target company stockholders, absent explicit language in the merger agreement conferring third-party beneficiary status. Specifically, the Delaware Court of Chancery stated that the lost-premium provision was unenforceable by the target company stockholders because (a) the merger agreement did not “expressly” confer third-party beneficiary status on stockholders and (b) the stockholders lacked standing to seek such damages while the target company was pursuing a claim for specific performance since those rights had not yet vested.
• Target companies are not entitled to recover lost-premium damages in the event the merger agreement is terminated. The Delaware Court of Chancery suggested that lost-premium damages provisions would be unenforceable by the target company whether (i) the target company acted as an agent for recovering damages on behalf of its stockholders (as there is no legal basis for allowing a contracting party to appoint itself as an agent for a non-party for the purpose of controlling such non-party’s rights) or (ii) the definition of damages is broad enough to capture lost premia (as the target company has no right or expectation to receive merger consideration that is paid directly to stockholders).

The Crispo decision challenges well-established market practice to provide for the enforceability of lost-premium damages provisions via contract drafting. This practice resulted from the Second Circuit’s opinion in Consolidated Edison, Inc. v. Northeast Utilities, 426 F. 3d 524 (2d Cir. 2005), in which the Second Circuit held that a merger agreement’s blanket prohibition on third-party beneficiary rights deprived target company stockholders of standing to sue the buyer for the lost share premium where a deal fails due to buyer breach. Following this decision, concern grew regarding the ability of target companies to deter buyers from backing out of a deal and as a result, the following three different variations of “Con Ed provisions” emerged to hold buyers liable for lost stockholder premiums resulting from buy-side merger agreement breaches: (i) conferring the target company stockholders with third-party beneficiary status, (ii) appointing the target company as an agent to recover damages on behalf of stockholders, and (iii) expanding the definition of damages to include lost premia. The Crispo decision calls into question the enforceability of these Con Ed provisions.

The proposed Amendments in response to the decision in Crispo include the following:

• Parties to merger agreements would be able to negotiate and enforce provisions for penalties or consequences in the event a merger agreement is terminated, including lost-premium damages provisions and reverse termination fees. The proposed Amendments would amend the DGCL to add a new Section 261(a)(1) that clarifies that parties to a merger agreement may, through an express provision in the merger agreement, specify the penalties or consequences of a party that does not comply with the terms and conditions of the agreement. The target company is allowed to contractually provide in the merger agreement that it is entitled to seek damages, such as lost-premium damages and reverse termination fees, for the buyer’s failure to perform pre-closing obligations or failure to consummate the merger under the merger agreement. Consistent with the DGCL, the new Section 261(a)(1) confirms that corporations have latitude to allocate the risk of non-performance through the express provisions of the agreement. The proposed Amendment also provides that the target company is allowed to keep such payments and that it does not have to distribute the proceeds to its stockholders. This new Section 261(a)(1) does not exclude any remedies that are otherwise available to any party at law or in equity and it does not alter the fiduciary duties of directors.
• Appointment of stockholders’ representatives. The proposed Amendments would amend the DGCL to add a new Section 261(a)(2), which expressly confirms that the merger agreement may include provisions that appoint a stockholders’ representative to enforce the rights of stockholders in connection with any merger agreement. Under this new Section 261(a)(2), the stockholder’s representative would only be authorized to enforce the rights of stockholders under the agreement but could not, without the express authority of the stockholder, consent to any restrictive covenants, or waive, compromise or settle any rights to appraisal or assert any direct claim for breach of fiduciary duty. The synopsis of the proposed Amendments further clarifies that any such appointment of a stockholders’ representative would only be effective as of, or any time following the approval of, the merger agreement in accordance with the requirements set forth in the DGCL.

Practice Considerations
In light of the decisions in Activision, Moelis and Crispo, legal advisors should consider the following proactive measures in connection with their practice until we receive further guidance on the future of the proposed Amendments from the Delaware General Assembly:

• Refresh requirements. The Delaware Court of Chancery has demonstrated a reluctance to give way to market practice in favor of a strict interpretation of the provisions of the DGCL. Legal advisors should take care to refresh their knowledge and understanding of the nuances and technical requirements governing Delaware corporations and the merger and acquisition process generally.
• Monitor developments and revise deal processes accordingly. Legal advisors should remain vigilant about any further developments or clarifications to the DGCL in response to recent case law. Internal checklists, processes and procedures should be updated to reflect the proposed Amendments (if they are adopted) or recent case law (if they are not adopted).
• Manage the board’s expectations. The logistics of scheduling board meetings can often become even more challenging in the often time-compressed lead up to signing. The board approval process should be factored into transaction timelines and socialized early on in the process so that board members understand the importance of being available to review any potential last-minute changes to the merger agreement and any potential scheduling conflicts can be proactively addressed.
• Appropriately document board approval. Given that the proposed Amendments do not provide guidance on what changes would be “material” to final approval, even if the proposed Amendments are approved and become effective on August 1, 2024, M&A counsel should take a conservative view in determining the materiality of last-minute changes. To the extent that there are subsequent changes to a form of merger agreement that has been previously approved by the board, it would be prudent to have all board members review and approve such subsequent changes prior to execution. In the event that reconvening the board to approve any last-minute substantive changes prior to signing is not possible, then the board should consider ratifying the executed merger agreement.
• Migrate governance rights to charters. Consider whether certain governance rights would be more appropriately addressed in the corporate charter as opposed to in stockholder agreements (noting that the corporate charter will be publicly available).
• Appoint a stockholder’s representative. If parties to a merger agreement plan to rely on any of the Con Ed provisions, they should also expressly appoint a stockholder representative with the full and exclusive authority to enforce the provisions of the merger agreement and to state that such provisions are binding.
• When in doubt, communicate. Given the number and complexity of recent Delaware law developments, both in-house counsel and external counsel would be well advised to keep the lines of communication open with each other. Not only is timely communication critical for assessing the materiality of last-minute changes to a merger agreement, but it is also important to ensure that the necessary subject matter experts are on hand to help analyze any last-minute changes that may occur during the often-frenzied time around signing. For example, is the target company’s controller available to confirm the capitalization figures in the merger agreement? Is the target company’s management available to provide feedback on last-minute changes to certain representations and warranties in the merger agreement? Best practice is to pick up the phone and keep each other abreast of any developments as they occur.