Sujeet Indap in New York JUNE 21 2024

Companies incorporated in Delaware would be able to bypass their own boards and cut deals more easily with significant shareholders under a controversial law passed this week in the state that is home to some of the biggest US companies.

The changes, approved by the Delaware House of Representatives on Thursday night and the Delaware state senate last week, now go to the governor, who is expected to sign the bill into law.

Supporters of the bill say it keeps up with market trends and will cement Delaware as the leading domicile for big businesses. But its critics told lawmakers that the amendments to the state’s corporate code will fundamentally alter the bedrock relationship between directors and shareholders.

The amendments were drafted in response to three different decisions made by one of the country’s pre-eminent business courts, the Delaware Court of Chancery, in recent months that some corporate lawyers believed had improperly hamstrung boards of directors.

The most controversial ruling, which was handed down in February, invalidated an agreement the investment bank Moelis & Co had struck with its founder Ken Moelis, which gave him the power to unilaterally make important company decisions, shunting aside the board’s prerogatives.

In the Moelis decision, the chancery court held that Delaware corporations, even those with a single large shareholder, could not contract away fundamental legal powers that belong to a company’s board. The legislation passed by Delaware lawmakers would allow companies to more easily strike such shareholder agreements.

The three amendments to the Delaware General Corporation Law, which were proposed in late March, were formulated by corporate lawyers who are part of a committee of the state’s bar association panel that suggests statutory changes to the legislature.

Lawyers supporting the changes said that unless they were enacted, plaintiffs lawyers would spark a frenzy of nuisance lawsuits over existing shareholder agreements that are common for public companies that have private equity or venture capital backers.

“The uncertainties exposed by the Moelis decision are too widespread to be left to case-by-case evaluation, and too disruptive to fester for a year or more without legislative guidance, ”wrote Larry Hamermesh, a professor of law at Widener University, in a letter to Delaware lawmakers.

But a group of critics including two Delaware judges faulted lawmakers for bringing the legislation before a higher court had weighed in on the Moelis decision on appeal. Some corporate law firms as well as dozens of other law professors said that the updated corporate code would upset what they described as the basic principle of corporations: that boards were empowered to make independent decisions on behalf of all shareholders.

“The more entity governance moves out of the corporate charter and into personal contracts, the more Delaware risks losing its grip over corporate governance,” said Ann Lipton a professor at Tulane University.

Delaware Senate majority leader Bryan Townsend, who sponsored the bill, said in a statement to the FT on Friday: “One of the key reasons Delaware is the preferred jurisdiction for corporations and alternative entities is the General Assembly’s commitment to being responsive to market and legal developments and ensuring clarity in the Delaware Code.”

The vast majority of large US public companies are incorporated in Delaware, which is widely recognised for its sophisticated legal community and deep corporate law. But recent months have proved tense in the small mid-Atlantic state. Elon Musk has been fighting a recent decision that invalidated a $56bn pay award and has successfully lobbied Tesla shareholders to move its domicile to Texas. In the process he has derided Delaware and its courts, and moved two of his private companies from Delaware to other states.

Shareholders and companies had historically favoured Delaware for its even-handedness. Some now worry that the balance has been tilted to the company side.

Charles Elson, a legal scholar regarded as the dean of the Delaware legal community and who testified before the state legislature opposing the corporate code amendments, told the FT: “The changes will have a negative impact on the investment community’s view of Delaware as a neutral protector of investor capital.”

Copyright The Financial Times Limited 2024. All rights reserved.