Novel Corporate Rulings Fuel Charged Debate on Delaware’s Role

A landmark court ruling that upended a popular corporate governance strategy without offering companies a clear path forward is amplifying concerns—spurred by Elon Musk—about Delaware’s place as America’s corporate capital.

It’s rare for judges on the state’s elite business court to strike down the status quo without signing off on a replacement. But “the seemingly irresistible force of market practice” must yield to “the traditionally immovable object of statutory law,” Vice Chancellor J. Travis Laster said in the ruling last month.

Laster, writing for Delaware’s Chancery Court, stopped short of drawing the types of bright lines the state’s corporations have come to expect. The agreement between Moelis & Co. and its billionaire founder clearly went too far, which is all a judge needed to decide, he said.

Read More: Moelis Ruling Sharpens Focus on Private Equity Veto Agreements

The Feb. 23 ruling is one of several recent decisions—including one in January striking down Musk’s $55 billion pay package at Tesla Inc.—that have arguably offered more questions than answers about the court’s approach to emerging issues with broad ramifications.

“They’re basically saying, ‘We don’t know what you can do, but you can’t do that,’” said Carliss Chatman, a Southern Methodist University law professor. “They’re just deciding the issues that are in front of them, without making grand pronouncements, and we’re left to piece together the patterns.”

The decisions have gotten an anxious greeting from court watchers “spoiled” by judges who go out of their way to stay ahead of major corporate trends, according to Chatman. Delaware’s forceful oversight liability doctrine, for instance, came from a decision on settlement fees, she said.

If the state’s judges are going to keep issuing rulings that resolve cases as narrowly as possible, “then the question becomes: ‘Why Delaware?’” Chatman said.

Three new lawsuits challenging shareholder pacts followed the Moelis decision. They involve L3Harris Technologies Inc., which reached a cooperation agreement with billionaire activist David Shaw; Crown Castle Inc., which has a similar agreement with Elliott Investment Management LP; and Apollo Global Management Inc., which struck a deal pledging support for board nominees proposed by its founders. That’s in addition to a wave of similar litigation already pending.

Uncertain Uncertainty

Laster has sought to downplay the doomsaying. Many of the critics “want to hold the sword of Damocles of asserted uncertainty over the heads of Delaware decision makers, and ideally Delaware judges, so that they can potentially be motivated to do whatever the fearmongers want,” he said at a March 13 hearing in the L3Harris case.

A range of disputes unrelated to shareholder agreements—including the Musk compensation case—have also injected uncertainty. They include litigation involving Match Group Inc. that could overhaul court review of insider deal conflicts and a shareholder challenge to the $69 billion merger between Microsoft Corp. and Activision Blizzard Inc.

The Activision deal decision—by the Chancery Court’s chief judge, Chancellor Kathaleen St. J. McCormick—quoted Laster’s language about unstoppable forces and immovable objects. The sentiment fits with public remarks by several Delaware judges who spoke at a corporate law conference in early March, according to Jacob Kirkham, a partner at Kobre & Kim LLP.

“Look, Delaware is going to follow the law,” Kirkham said. “It doesn’t matter how much political, social, media, or other pressure is coming in.”

Laster also ruled in a case involving TripAdvisor Inc. that the travel company can move to Nevada, though its leaders may face damages claims. The decision was widely seen as a road map for Musk, who has been threatening to relocate the world’s most valuable automaker. Laster said in a subsequent ruling that the legal framework “does not invite a trial court to consider the level of media attention” a case has received.

“A lot of it is media hype,” according to Renee Zaytsev, a partner at Boies Schiller Flexner LLP. Concerns about the demise of Delaware’s primacy are part of a lengthy hand-wringing tradition, and the reports have always proven premature, she said. Though it’s unusual for the state’s judges to hand down so much confusion at once, that reflects a coincidence rather than a “concerted effort” to change the way corporate law is practiced, according to Zaytsev.

“There’s no doubt the Delaware Supreme Court is aware of the criticisms,” she said. “I think the talk is going to die down pretty soon.”

‘Superstar’ Ire

Much of the controversy has been driven by Musk, who has publicly assailed the compensation ruling.

The decision—stressing his outsize influence over the company—put “superstar CEOs” on notice. But McCormick didn’t lay down a concrete legal test for identifying who fits that description.

“People are constantly tempted to overestimate how settled corporate law is,” according to Gabriel Rauterberg, a University of Michigan law professor. “There can’t always be a crisp rule” for novel situations raising “genuinely difficult” questions, Rauterberg said. “Sometimes you just have to have vague standards and trust the people applying them.”

SMU’s Chatman struck a similar note. “Maybe the reason the judges are going case by case, or what feels like case by case, is they’re saying, ‘You’re not a special case,’” she said. “Maybe we’re panicking more than they are.”

Members of Delaware’s judiciary try to offer “as much guidance as they can,” but trial-level judges are limited to ruling on the controversies that land in front of them, according to Kirkham. The state supreme court, however, can wait for all the related issues to percolate before handing down a broader ruling that delivers more certainty, he said.

Open Questions

At least nine other parallel cases have hit the court’s docket, including those involving Petco Health & Wellness Co., N-able Inc., and HireRight Holdings Corp.

Most of the issues raised in those disputes were left open by the Moelis ruling. Perhaps the most immediate question follows from sections of the decision suggesting many of the pact’s provisions would likely be less problematic in a corporate charter, rather than a stockholder side deal. The case didn’t call for Laster to make a firm decision on that approach.

But it’s the focus of a letter he sent recently in the N-able case. Laster asked if the company could legally cross-reference a shareholder agreement in its charter, then effectively amend the charter just by changing the shareholder agreement.

That’s a key issue, according to Tulane University law professor Ann Lipton. “He’s asking what it means to be in the charter,” she said. “I can’t think of a single reason why you couldn’t just say, ‘We wrote the charter on multiple pieces of paper.’ The question in N-able is: Did they?”

The Crown Castle and L3Harris disputes have surfaced a different wrinkle: whether it’s enough for boards to tinker with shareholder agreements by adding a “fiduciary out” that gives them leeway to waive their provisions in the company’s best interest.

“I’m not in a position today to make a fully informed determination,” Laster said at the L3Harris hearing. But he agreed to fast-track the case, saying it’s urgent “to try to get some type of clarity.”

The judge also expressed concerns about letting companies facing proxy fights exploit litigation-related delays long enough to enforce illegal contract terms at the next shareholder meeting. That could amount to “a free pass,” he said.

Other businesses will likely take the hint about amending their charters, a move that would force judges to squarely decide how much authority a corporate board can validly surrender by any means.

The issue is “foundational,” Chatman said. “Are directors actually in control? That’s the whole point of a corporation.”