If enacted, the market practice amendments of 2024 will create uncertainty about the law governing board recommendations, including the extent to which a contract can require a board to recommend a merger under Section 251 of the DGCL. I’ve pondered the language of the bill, and I’m not sure how it works.[1]

Let’s envision a standard reverse triangle merger in which the target will merge with and into the acquisition subsidiary, emerging as a wholly owned subsidiary of parent buyer. Assume the buyer demanded and secured a provision in the merger agreement stating that the board would not change or withdraw its recommendation in favor of the deal.

Historically, that provision would have been a problem, because under case law dating back to Van Gorkom,[2] a board must both provide stockholders with a true and correct merger recommendation and update its recommendation if it changes.[3] Distinguished practitioners have been unanimous on this point.[4]

Now enter Section 122(18). If the parent buyer is a party to the merger agreement, then we have an agreement “with one or more … prospective stockholders of the corporation,” so the merger agreement falls within the scope of Section 122(18).

Once we are in the world of Section 122(18), three aspects of that provision seem pertinent. First, by its terms, Section 122(18) authorizes a corporation to “covenant that the corporation or one or more persons or bodies will take, or refrain from taking, actions specified in the contract (which persons or bodies may include the board of directors or one or more current or future directors, stockholders or beneficial owners of stock of the corporation).” Standing alone, that would seem to permit a buyer to bind the target board to maintain an affirmative merger recommendation.

But that’s only one aspect of Section 122(18) The proposed statute also states that “no provision of such contract shall be enforceable against the corporation to the extent such contract provision is contrary to the certificate of incorporation or would be contrary to the laws of this State (other than § 115 of this title) if included in the certificate of incorporation.” The question therefore becomes whether a charter provision could override the obligation to issue a current and accurate merger agreement.

I would not have thought so. Before Section 122(18), I would have viewed a charter provision that attempted to restrict the board’s ability to change its recommendation as an impermissible infringement on the Board’s authority. In reaching that conclusion, I would have relied on the board’s gatekeeper role under Section 251.

But that gets us to the third aspect of Section 122(18), which qualifies the operation of the proviso. It states: “Solely for purposes of applying the proviso in the first sentence of this subsection, restriction, prohibition or covenant in any such contract that relates to any specified action shall not be deemed contrary to the laws of this State or the certificate of incorporation by reason of a provision of this title or the certificate of incorporation that authorizes or empowers the board of directors (or any one or more directors) to take such action.”

The basis for holding the recommendation limitation invalid would be that Section 251 “authorizes or empowers the board of directors (or any one or more directors) to take such action.” Section 122(18) states that a court can’t consider that aspect of the DGCL in determining whether the constraint on board action is statutorily infirm.

How does one escape this statutory mobius strip? The magic of Section 122(18) seems to have unmoored the analysis of the merger recommendation from the merger statute.

Without other statutory hooks, I would attempt to resolve the confusion by looking to Section 102(b)(1), which authorizes charter provisions that are “not contrary to the laws of this State.” The Delaware Supreme Court has interpreted that section to permit a broad range of provisions, except those that “transgress a statutory enactment or a public policy settled by the common law or implicit in the General Corporation Law itself.”[5]

To determine Delaware’s public policy on this issue, I would have looked to the content and structure of the DGCL. But that content and structure include Section 122(18), which takes us back to square one.

All that is left is for a court, and ultimately the Delaware Supreme Court, to issue a pronouncement on whether a governance agreement under Section 122(18) can override the merger recommendation. It’s not clear what authority they would rely on to determine Delaware’s public policy, because Section 122(18) takes the strongest indicators off the table.

Perhaps the proponents of the market practice amendments believe there is an obvious answer. And perhaps if a dispute arises, they will be able to explain it convincingly. For present purposes, I find myself wishing that a set of amendments supposedly designed to remove uncertainty weren’t going to create so much of it.

Endnotes

1As with my other posts, I offer the comments in this post in my personal capacity. Canon 4 of the Delaware Judges’ Code of Judicial Conduct permits a judge to engage in “activities to improve the law, the legal system, and the administration of justice.” That canon says that “[a] judge may speak, write, lecture, teach, and participate in other activities concerning the law, the legal system, and the administration of justice (including projects directed to the drafting of legislation).” By writing this post, I am attempting to “write” on an issue concerning “the law, the legal system, and the administration of justice.”(go back)

2Smith v. Van Gorkom, 488 A.2d 858, 888 (Del. 1985) (subsequent history omitted).(go back)

3See Frontier Oil Corp. v. Holly Corp., 2005 WL 1039027, at 28 (Del. Ch. Apr. 29, 2005) (“Revisiting the commitment to recommend the Merger was not merely something that the Merger Agreement allowed the [Target] Board to do; it was the duty of the [Target] Board to review the transaction to confirm that a favorable recommendation would continue to be consistent with its fiduciary duties.”); see also In re Berkshire Realty Co., Inc., 2002 WL 31888345, at *4 (Del. Ch. Dec. 18, 2002) (“[I]f the board, in the exercise of its business judgment, determined that liquidation was not in the best interests of . . . its stockholders, it could not have recommended a liquidation without violating its fiduciary duty to the stockholders.”).(go back)

4See Steven M. Haas, Limiting Change of Merger Recommendations to “Intervening Events,” 13 No. 8 M&A Law. 15, 20 n.1 (Sept. 2009); R. Franklin Balotti & A. Gilchrist Sparks, III, Deal-Protection Measures and the Merger Recommendation, 96 Nw. U. L. Rev. 467, 476 (2002); John F. Johnston, A Rubeophobic Delaware Counsel Marks Up Fiduciary–Out Forms: Part II, 14 Insights: The Corp. & Sec. L. Advisor, No. 2, 16, 19 (Feb. 2000).; John F. Johnston, A Rubeophobic Delaware Counsel Marks Up Fiduciary-Out Forms: Part I, 13 Insights: The Corp. & Sec. L. Advisor, No. 10, 2, 5 (Nov. 1999).(go back)

5Salzberg v. Schiabacucchi, 227 A.3d 102, 113 (Del. 2020).(go back)