Delaware amends laws related to interested directors and officers, controlling stockholders, and books and records demands

This spring, the State of Delaware adopted significant amendments (the Amendments) to the Delaware General Corporation Law (DGCL), which aim to provide a clear path to approving take-privates and other related party transactions for Delaware corporations, as well as limit stockholders’ rights to obtain certain corporate records from Delaware corporations.

What you need to know

• The Amendments provide procedural “safe harbors” for approving take-private transactions with controlling stockholders and other related party transactions between Delaware corporations and their directors, officers and controlling stockholders. These safe harbors, if complied with, are expected to significantly raise the bar for stockholder litigation challenging take-privates and other related party transactions. 
• The Amendments also generally limit the scope of books and records that stockholders may obtain from Delaware corporations. Absent a “compelling need”, informal records such as emails, text messages and the like will not be available for inspection—a change which will protect Delaware corporations and their directors and officers against wide-ranging stockholder information requests that have become increasingly common.

Director and officer conflicts

Under current Delaware law, directors and officers of a corporation with an interest in an act or transaction with the corporation face personal liability if the conflict of interest breaches their duty of loyalty. The Amendments provide a safe harbor to shield conflicted directors and officers from personal liability if the act or transaction is:

1. approved by an informed majority of the disinterested directors of the board or applicable board committee;
2. approved by the informed and uncoerced majority of the votes cast by disinterested stockholders; or
3. fair as to the corporation and its stockholders.

Notably, prong 2 above only requires the affirmative vote of a majority of the votes cast (as opposed to requiring a majority of the total voting power, which was the prior requirement). The Amendments also clarify that the mere nomination or election of a director to the board by a person with a material interest in an act or transaction to which the director is not a party will not, in and of itself, be evidence that that director is interested in that transaction.

Controlling stockholder transactions

Transactions other than going private transactions

For transactions other than “going private” transactions, the Amendments insulate directors, officers, controlling stockholders and any members of a control group from liability arising from a claim asserting breach of fiduciary duty if the transaction is:

1. approved or recommended in good faith by an informed board committee that has been expressly delegated the authority to negotiate (or oversee negotiations) and reject the transaction, so long as (a) the committee does not include the controlling stockholder and (b) a majority of its members approving the transaction are disinterested;
2. approved by an informed and uncoerced majority of the votes cast by disinterested stockholders; or
3. fair as to the corporation and its stockholders.

Going private transactions

By contrast, for “going private” transactions, the safe harbor will still require both procedural protections outlined in prongs 1 and 2 above, or that the transaction is “fair as to the corporation and the corporation’s stockholders”.

The Amendments represent a major departure from the so-called “MFW doctrine”. The MFW doctrine effectively required both  procedural protections outlined in prongs 1 and 2 above to be implemented at the outset of a transaction (the ab initio requirement) in order to benefit from “business judgment rule” scrutiny (as opposed to the stricter “entire fairness” standard). The Amendments now provide that transactions other than “going private” transactions will receive the safe harbor protection so long as one of these two protections is present (with no ab initio requirement) or the transaction is “fair as to the corporation and the corporation’s stockholders”.

Controlling stockholder definition

The Amendments also provide, for the first time, a statutory definition of “controlling stockholder”, which is defined as any person that, together with their affiliates and associates:

1. owns or controls stock in the corporation sufficient to elect directors with a majority of the voting power of all directors on the board;
2. has the right, by contract or otherwise, to cause the election of nominee directors who have a majority of the voting power of all directors on the board; or
3. has the power functionally equivalent to a person described in prong 1 by virtue of (a) owning or controlling at least one-third of the voting power of the corporation’s stock entitled to elect directors and (b) having the power to exercise managerial authority over the corporation.

These changes provide clarity as to when a stockholder will be deemed a “controlling stockholder” (in particular, via the minimum ownership floor defined in prong 3). Recent Delaware case law (including In Re Oracle Corporation Derivative Litigation) established that this determination must be fact specific.

Public companies

Amendments to Section 144 of the DGCL also establish a presumption of independence for a director of a publicly traded corporation who is not party to an act or transaction if the board determines the director satisfies the relevant criteria for determining director independence under the applicable stock exchange rules. This presumption can only be rebutted by “substantial and particularized facts” that show that the director has a material interest in the act or transaction, or has a material relationship with a person having a material interest in the act or transaction.

Books and records amendments

Amendments to Section 220 of the DGCL address Delaware corporations’ concerns with the increasing number of “books and records” demands (and subsequent litigation) by stockholders in recent years, which have placed significant costs on Delaware corporations. Under the Section 220 amendments, stockholders are generally only allowed to inspect a limited set of formal corporate documents, such as organizational documents, board and stockholder meeting minutes, records relating to corporate actions and financial statements. Inspection of informal corporate documents, such as internal emails, text messages, or informal board communications, is only permitted if the stockholder demonstrates a “compelling need” for the request. To protect such information, a corporation may impose reasonable confidentiality, use and distribution restrictions and may redact information in the books and records that are not specifically related to the purpose asserted by the requesting stockholder.