Almost as a reflex, when we are asked to form a corporation, a limited partnership or a limited liability company, we recommend forming the entity in Delaware. Almost just as often, clients ask us quizzically, “Why?” We answer that, in Delaware, those who form the entity have the greatest freedom to set the terms and conditions for the structure of the business. Moreover, we say, the Delaware business courts are sophisticated and generally uphold the choices made by those who form the entities.
On September 13, 2021, the Delaware Supreme Court issued its opinion in the case of Manti Holdings, LLC vs. Authentix Acquisition Company, Inc., which supports our views about Delaware entity law. This opinion is a comprehensive statement of the freedom of contract philosophy that underlies the law’s various business statutes. The opinion, by Justice Tamika Montgomery-Reeves, also includes a vigorous, exceptionally detailed and thoughtful riposte in the form of a dissent by Justice Karen Valihura. The dialectic that the majority opinion and the dissent create gives a full exposition of the purposes of the entity statutes.
The specific facts involve Authentix Acquisition Company, Inc., a Delaware corporation. Authentix merged with a third-party entity in 2017 in a transaction in which Authentix’s common stockholders did not receive advance notice of the merger, nor were they allowed to vote on the transaction. A group of these stockholders subsequently filed a petition to exercise their appraisal rights under Section 262 of the Delaware General Corporation Law (“DGCL”). Section 262 states that stockholders of Delaware corporations are—in the case of a merger that they did not vote on—entitled to “an appraisal by the Court of Chancery of the fair value of [their] shares.”
In this case, however, Authentix argued that its shareholders had waived their appraisal rights in a stockholders agreement to which they had previously become parties. The petitioners argued that appraisal rights are a fundamental feature of a corporate entity and that Section 262 of the DGCL prohibited a waiver of those rights through a stockholders agreement.
The opinion and dissent reached opposing conclusions in two important respects:
OPINION: Yes, the DGCL is meant to be a “broad and enabling statute” allowing corporations to adopt their own contractual terms. Additionally, the DGCL does not include language prohibiting stockholders agreements from overriding its provisions. What is not prohibited is permitted.
DISSENT: No, only the corporation’s charter can modify fundamental features of corporate governance, such as appraisal rights. A private stockholders agreement should not operate as a de facto charter that supersedes the public document.
OPINION: Just because a right is “mandatory” does not mean that the parties who are authorized to assert it cannot voluntarily waive that right. In this case, the petitioners were “sophisticated and informed investors, represented by counsel, that used their bargaining power to negotiate for funding.” Those parties may waive appraisal rights.
DISSENT: The appraisal rights provision is mandatory because it was originally created as a check to balance the power between stockholders and officers/directors of a corporation. In addition, the absence of appraisal rights in the enabling statutes for other Delaware business entities suggests that the provision’s inclusion in the DGCL indicates that it is an essential right.
The majority opinion held that:
“As a matter of public policy, there are certain fundamental features of a corporation that are essential to that entity’s identity and cannot be waived. Nonetheless, it is the Court’s view that the individual right of a stockholder to seek a judicial appraisal is not among those fundamental features that cannot be waived. Accordingly, we hold that Section 262 does not prohibit sophisticated and informed stockholders, who were represented by counsel and had bargaining power, from voluntarily agreeing to waive their appraisal rights in exchange for valuable consideration.”
The case and both arguments serve as a primer on the philosophy and structure of Delaware corporate law and how it is intended to operate and balance the rights of the constituencies involved. The case also poses some key questions regarding what many may consider a standard and settled element of contracts that set forth the rights and obligations of stockholders.
If you have any questions regarding corporate governance, shareholder agreements or commercial litigation, please contact William A. Newman.