Exculpation

Delaware recently amended its General Corporation Law to permit corporations to adopt charter provisions that would exculpate top officers, as well as directors, from damages liability associated with care violations.

The catch is, unlike with directors, officer liability can only be eliminated for direct shareholder claims – not claims brought by the corporation, including derivative claims.  In other words, the amendments aren’t there to prevent officer liability; they’re there to prevent officer liability as dictated by shareholders.  When directors decide officers should be liable – or shareholders can show directors are incapable of deciding – then officer liability may follow.

So this is a little different than the theory behind director exculpation.  Director exculpation is a protection against the threat of frivolous lawsuits, to some extent, but it also functions so directors can substantively do their jobs without fear that they will be subject to ruinous liability for well meaning mistakes.  That fear, it was posited, would deter people from wanting to be directors in the first place.

Officers, though, they aren’t exactly being protected from ruinous liability over their mistakes – the corporation/directors can still sue them for those.  Which means there’s a lot less concern that officers won’t take the job if they can be held liable.

What are these amendments doing, then?

The protections being offered are only for direct claims.  And, most of the time, direct claims only arise in one context: sale of the company.

Sure, shareholders can sometimes sue directly even for going concerns – oh look, here’s an example from Snap – but those claims are relatively rare, and even rarer still when officers would be potentially liable, and rarer still when monetary damages rather than an injunction would be on the table.  So, most of the time, and in general, the proposed amendments serve one purpose: to exculpate officers for negligence in connection with the sale of the company.

And it goes further.  Because if shareholders vote in favor of the deal, that by itself waives any fiduciary claims – except when disclosures are inadequate.

So this amendment is intended to address one specific scenario: one where officers are arguably negligent in the context of a sale of the company, and where disclosures were inadequate, in a manner that may have been relevant to voting shareholders. 

And these claims will apparently be blocked both when they are frivolous, and when they are meritorious. 

Of course, in order to get this protection, corporations will have to amend their charters.  Relatively easy to do pre-IPO, but requiring the assent of public shareholders post-IPO.  Leading to the question: Will they?

Why would shareholders care about this situation specifically?  As above, it’s hard to imagine they’re worried about qualified officers refusing to serve, as was the case for the original 102(b)(7) protections.  The sale of the company is an unusual event, and one where officers often have golden parachutes that offset any risk – so fear of this precise situation is unlikely to deter many officers from accepting the job in the first place.

Another possible concern is straight up litigation costs – litigation itself is expensive, sucks up the time of top management, and if we’re worried about frivolous suits or even nonfrivolous ones that won’t result in significant penalties, that might be a reason for shareholders to say the game is not worth the candle.  That, too, was likely some of the motivation for 102(b)(7) as originally drafted.

But in a sale scenario, those costs are all borne ultimately by the acquiring company.  In a cash sale, they won’t be borne by shareholders at all; in a stock sale, they’ll be borne somewhat, but even those expenses are attenuated.  And sure, you can imagine maybe the buyer will pay less if the prospect of lawsuits is out there, or insurance costs will be higher – but those possibilities are so speculative that I genuinely wonder whether shareholders would benefit from exculpation, rather than prefer to have the option of bringing nonfrivolous claims for negligently-conducted mergers (where that negligence was concealed from them in advance), knowing that litigation costs will be paid by the acquirer.

That’s particularly true when you consider that a sale of company is a final period scenario – one where corporate officers know they will no longer be subject to shareholder discipline, and therefore are most at risk of abandoning their responsibilities.

Plus, keep in mind that sometimes, cases make it past pleading on narrow theories, but discovery provides grounds for more robust ones.  Suppose keeping the negligence window open allows shareholders to sue over mergers that have a whiff of unfairness, which functionally allows further probing for more problems, which could reveal more serious defects that permit greater damages to selling shareholders?  That, too, might be valuable for shareholders of the selling company.

All of which is to say, it’s not obvious to me that the same cost-benefit analysis that applies to Original Flavor 102(b)(7) would apply to the revised version.  The specific scenarios where protections for officers are proposed are also scenarios that offer the greatest threat to shareholders, and where shareholders bear the least risk of frivolous litigation costs.  And so it’s not obvious that shareholders of publicly traded companies would be wise to approve charter amendments that exculpate officers.

What about publicly traded companies with dual-class stock?  Technically, they don’t need the assent of public shareholders to amend their charters, so they could just adopt officer-exculpation of their own accord, but (1) the public shareholders might then sue, on the grounds that this was an interested transaction intended to protect current insider/officers, and (2) dual-class companies may not be terribly worried about sale scenarios in the first place, and so have less interest in adopting these provisions.

Which leaves the IPO question: can companies simply go public with these provisions in their charters?

I mean, they can, surely, but the real question is will they pay a monetary price for doing so.  If you think IPO markets are efficient, you’d assume that if public shareholders have no use for this change mid-stream, they’d extract some kind of price for it in IPO markets, which might dissuade the adoption altogether.  I, personally, am less sanguine about the efficiency of IPO markets, however.  That said, so many companies now go public with dual-class stock, they once again may not feel they need these protections.

All of which is to say: I’m really curious to see if public companies manage to amend their charters to exculpate officers, if IPO companies adopt officer exculpation, and if there’s an obvious divergence between the two.  And, if we do see different companies adopting these things, I look forward to a financial analysis of whether they seem to affect pricing in a subsequent sale to an acquirer (who would be expected to bear the costs of shareholder litigation).