Seavit v. N-able, Inc., C.A. No. 2023-0326-JTL (Del. Ch. July 25, 2024) (Laster, V.C.)

In this decision, the Court of Chancery held that several provisions in a stockholders agreement—similar to the provisions the Court held invalid in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, C.A. No. 2023-0309-JTL (Del. Ch. Feb. 23, 2024)—were facially invalid because they impermissibly restricted the board’s ability to exercise its authority consistent with the requirements of Delaware law.  In response to the Moelis decision, the Delaware General Assembly recently enacted legislation (“Market Practice Amendments”) that, among other things, authorizes private governance agreements notwithstanding Section 141(a) of the General Corporation Law of the State of Delaware (the “DGCL”).  The Market Practice Amendments expressly apply retroactively except for proceedings that were pending on or before August 1, 2024.  Accordingly, the Court’s decision did not present an opportunity to apply the Market Practice Amendments and is consistent with the Court’s pre-amendment reasoning in Moelis.

Plaintiff in this dispute challenged several provisions in a stockholders agreement (the “Agreement”) that was entered into by entities affiliated with two private equity firms, Silver Lake Group, LLC and Thoma Bravo, LLC (together, the “Lead Investors”), and N-able, Inc. (the “Company”), prior to the spinoff of the Company that resulted in the Company becoming a publicly traded corporation.  Specifically, the Agreement (i) required that the Board receive the Lead Investors prior written consent before undertaking specified categories of corporate actions, such as entering into or effecting a change of control, causing the Company to enter into certain transactions over a specified dollar value, causing the Company to enter into a joint venture, initiating voluntary liquidation or insolvency proceedings, terminating the CEO, incurring debt, and increasing or decreasing the size of the Board (the “Pre-Approval Requirements”); (ii) provided the Lead Investors with the ability to determine the composition of the Board, including by requiring the Board to maintain its size unless otherwise requested by the Lead Investors, providing the Lead Investors rights to nominate directors that the Company must include in its proxy (the “Nomination Covenant”), requiring the Board to recommend the Lead Investors’ nominees for election and force the Company to include the nominees on its slate and requiring the Company to undertake reasonable best efforts to ensure that the Lead Investors nominees are elected (collectively, the “Efforts Covenant”), giving the Lead Investors rights to veto nominees for any Board seat, and ensuring that the Lead Investors have representation on certain Board committees (the “Committee Composition Requirements”); and (iii) purported to authorize the Lead Investors to remove a director without cause, even if the Lead Investors are not holders of the majority of shares then entitled to vote in the election of directors (the “Removal Provision”).  Plaintiff argued that the Pre-Approval Requirements and Board Composition Requirements were facially invalid and unenforceable under Section 141(a) of the DGCL (pre-Market Practice Amendments), the Board Compositions Requirements were also facially invalid and unenforceable under Section 141(c)(2) of the DGCL and that the Removal Provision was facially invalid and unenforceable under Section 141(k) of the DGCL.  The Company argued that because certain provisions in its certificate of incorporation were expressly made “subject to” the Agreement, that the terms of the agreement were incorporated by reference and therefore compliant with Section 141 of the DGCL.

On cross-motions for summary judgment, the Court implemented the two-step test it developed in Moelis that applies when a Delaware court evaluates whether a contractual provision or arrangement impermissibly restricts the Board’s ability to exercise its authority in accordance with Delaware law.  Under this framework, a Delaware court must first consider whether a challenged contractual provision “constitutes part of the corporation’s internal governance arrangement.”  If not, the Court’s inquiry ceases.  If it does, Section 141(a) of the DGCL is implicated and the Court then applies the test set forth in Abercrombie v. Davies, where the provision will be deemed invalid if it has “the effect of removing from directors in a very substantial way their duty to use their own best judgment on management matters” or “tends to limit in a substantial way the freedom of director decisions on matters of management policy[.]”

After considering the seven factors articulated in Moelis for applying part one of the test, the Court held that the Agreement “is another prototypical governance agreement that has all of the hallmarks of an effort to regulate the internal affairs of the Company” that implicates Section 141(a) of the DGCL and triggers further review.  The Court then determined that the Pre-Approval Requirements, each individually and as a whole, were direct, board-level restrictions in violation of Section 141(a) of the DGCL and were facially invalid.  The Court also held that, with the exception of the Nomination Covenant and certain parts of the Efforts Covenant, the other challenged provisions were facially invalid under Sections 141(a) of the DGCL for the reasons stated in Moelis. It is also worth noting that the Court found that the Pre-Approval Requirements relating to change of control transactions (in particular, mergers, consolidations, and sales of all or substantially all of the assets of the Company) also violated the Sections of the DGCL applicable to such transactions because the provision upended the statutory mechanisms for approving such transactions and removed the ability of the board to act as the gatekeeper for such transactions. 

Further, the Court determined that the Committee Composition Requirements were invalid under both Sections 141(a) and 141(c)(2) of the DGCL.  The Court explained that the Company’s certificate of incorporation did not deviate from the default standard in Section 141(c)(2) of the DGCL that empowers the board of directors to create committees and select the members and the Committee Composition Requirements contravene Section 141(c)(2) by requiring the board to include certain designees on certain committees.  Finally, the Court held that the Removal Provision was facially invalid under Section 141(k) of the DGCL because it purported to permit the Lead Investors to remove directors with less than a majority vote and it purported to permit removal of a director on a classified board without cause.

In its analysis of the Board Composition Requirements, the Court rejected the Company’s argument that certain provisions of the Agreement may be incorporated by reference into the certificate of incorporation and/or bylaws of the Company.  The Court explained that the DGCL does not permit certificate of incorporation to include “provisions ascertainable” outside the certificate of incorporation, only “facts ascertainable.”  The Court noted that there is “a self-evident difference between ‘facts’ and ‘provisions.’”  The Court further grounded its reasoning in: (i) the fact that certificates of incorporation must be filed publicly and the purpose of publicly filing certificates of incorporation is to provide basic information to investors and third parties, which purpose would be frustrated by incorporating provisions from another agreement; (ii) a public interest in promoting certainty and stability of the company’s foundational document, which would be frustrated if a certificate of incorporation could effectively be amended by privately amending an agreement that is incorporated by reference (without complying with the provision of Section 242 of the DGCL); (iv) the fact that the DGCL establishes a step-by-step process for amending a certificate of incorporation; and (v) the General Assembly’s inability to delegate its legislative authority because the act of creating a corporate body remains a sovereign exercise of state power akin to enacting a statute.

Despite the Court’s admonition that the decision exists within “a stub timeline where courts must apply the old law,” the Market Practice Amendments do not impact the Court’s holding that the incorporation by reference of a private agreement into a certificate of incorporation is invalid or that certain provisions of the Agreement are invalid because they violate statutory provisions other than Section 141(a) of the DGCL.  Therefore, parties drafting looking to incorporate provisions of agreements into a certificate of incorporation (or other agreements where the DGCL permits the terms of such other agreement to be dependent on “facts ascertainable”) should consider this decision for guidance on how to effectively incorporate the provision by reference, even in light of the Market Practice Amendments.  Further, parties drafting stockholders agreements should be mindful of potential violations of DGCL provisions other than Section 141(a), which are not immune to challenge under the Market Practice Amendments.

About Potter Anderson

Potter Anderson & Corroon LLP is one of the largest and most highly regarded Delaware law firms, providing legal services to regional, national, and international clients. With more than 100 attorneys, the firm’s practice is centered on corporate law, corporate litigation, intellectual property, commercial litigation, bankruptcy, labor and employment, and real estate.