A recent and unique court decision involving investment bank Moelis & Co has posed a potential threat to the increasingly common corporate practice of granting significant authority to a company’s financial backers, via contractual arrangements, over fundamental managerial decisions.
The ruling by a Delaware judge invalidated most of an agreement between the company and its billionaire founder, Kenneth Moelis. This decision marks a turning point as it represents the first in dealing with a surge of shareholder agreements that provide expansive veto rights to early investors. Several other companies, including Alignment Healthcare Inc, EngageSmart Inc, and Petco Health & Wellness Co, have encountered similar legal obstacles.
The contracts are under legal scrutiny for the first time due to structural changes in the US economy, even though companies have adopted similar agreements for many years. This shift has been attributed to the growth of private markets, which allows venture-backed businesses to delay their initial public offerings by several years, according toStephen Ram, a partner at Stradling Yocca Carlson & Rauth LLP.
The core of the matter lies in how firms are increasingly determining the way they employ their investments. This becomes especially pronounced when they are investing capital during crucial moments where they possess more bargaining power. This shift in power dynamics has subsequently made this issue more pertinent for discussion.
Vice Chancellor J. Travis Laster on February 23 rejected a series of approval rights held by Moelis, with the latter previously having the final say over leadership, litigation strategy, budget, business plans, and charter. Moreover, this is in addition to the approximately 40% voting power that comes with his 6.5% stake in the company.
Such robust veto provisions rendered the board ineffectual, according to the judge. Nonetheless, he upheld certain sections of the agreement, highlighting a distinction yet to be scrutinized in shareholder agreements – the extent to which they may conflict with the concept that the corporation should fundamentally be managed by its board of directors.
These areas of critique are vital in understanding Delaware law and its limitations. The key question is: how can these shareholder agreements be modified while still preserving the spirit and intention of Delaware law?
Looking ahead, the legal fraternity will no doubt be keenly watching this brewing storm in the corporate sphere as recent rulings from Delaware courts send mixed signals about the allowable scope and pratice of shareholder agreements, as well as the inherent risks associated with such practices.