Last week, the Delaware General Assembly passed S.B. 313, overturning West Palm Beach Firefighters’ Pension Fund v. Moelis. Upon Governor Carney’s signature, S.B. 313 will amend the DGCL by adding § 122(18) and enable corporations to enter so-called shareholder agreements, colloquially called side letters, even to the extent that such agreements grant counterparties contractual rights that intrude on the board’s duty to manage the corporation under DGCL § 141(a).

In the debate over § 122(18), its drafters and proponents sought to assuage concerns that § 122(18) may reduce shareholder protections by effectively overriding a board’s fiduciary obligations. Section 122(18)’s proponents repeatedly asserted that the Moelis-style agreements it enables have “no effect whatsoever on fiduciary duties or equitable principles.” Section 122(18)’s proponents also suggested that boards not only could—but would be obligated to—breach contracts under the concept of efficient breach if adherence to the contract would cause the board to breach its fiduciary duties.

In turn, these representations by § 122(18)’s proponents necessarily suggest that courts must re-evaluate their usual approach to remedies in breach-of-contract cases involving Moelis-style agreements.

Specific Performance May Be Unavailable for Breach of § 122(18)-Enabled Contracts

Given that the types of contracts enabled by § 122(18) concern governance rights rather than remunerative rights, specific performance may ordinarily be a reasonable remedy for redressing a breach of such a contract. For instance, suppose a side letter gives a counterparty the right to veto the appointment of a CEO, but the corporation installs a CEO anyway over the counterparty’s objection. Absent a fiduciary duty defense, a court may choose to enjoin the corporation to remove the CEO at issue rather than award damages. Such an equitable remedy may be particularly advisable with regard to governance provisions as they may be quite difficult to assign a monetary value to.

A problem arises, however, if the remedy of specific performance is put up against the legislative purpose of § 122(18). As a reminder, § 122(18)’s sponsors repeatedly represented to Delaware’s legislators that, at least in the § 122(18) context, “fiduciary duties trump contracts, always.”

To elaborate on the above CEO-veto example, suppose that the directors of the corporation have made a good-faith determination that Candidate A is the best choice for CEO, and that it would violate their fiduciary duties to allow the side-letter counterparty to veto that choice. Accordingly, the directors cause the corporation to breach the terms of the side letter and appoint Candidate A anyway, as the directors must to fulfill their fiduciary duties.

If, however, a court subsequently enforces the veto right at the behest of the counterparty, it will have rendered the clear intent of § 122(18)’s drafters and proponents a nullity—the contract would have trumped the board’s fiduciary duties, and no “efficient breach” would be possible in any meaningful way. The only way for a court to give meaning to the purpose of § 122(18) is to hold that specific performance is unavailable for § 122(18)-enabled contracts where a corporation can show that it breached the contract as a result of its directors’ fiduciary obligations under the relevant standard of review (which would be the deferential business judgment rule in most cases). Moreover, if a board intentionally avoids such a breach to escape, say, public harassment from the counterparty, the board may be engaging in self-dealing conduct and exposing itself to a fiduciary duty suit from other shareholders subject to enhanced scrutiny.

Note that even arbitration and forum selection clauses under § 122(18) may be unenforceable over a fiduciary determination that an alternative venue is superior. In particular, although the Federal Arbitration Act requires courts to enforce arbitration agreements, such enforcement requires the presence of a valid agreement to arbitrate, as determined by state law. Insofar as the intent of § 122(18) is to have fiduciary duties trump contract, any arbitration clause under § 122(18)-enabled contracts should be interpreted to constitute an agreement to arbitrate a dispute only if no fiduciary determination has been made that arbitration would be inferior to another dispute resolution mechanism or venue.

Damages (Liquidated or Otherwise) May Be Unavailable for Breach of § 122(18)-Enabled Contracts

In Leaf Invenergy v. Invenergy, the Delaware Supreme Court restated the black-letter law for damages in cases of so-called “efficient breach”: the breaching party is obligated to pay full contractual damages, including when such damages are specified under a liquidated damages provision. The question of ultimate efficiency—and its answer—is irrelevant to the court’s determination of damages. Rather, whether the breach is “efficient,” i.e., whether the benefits of breach outweigh the costs of breach (including damages), is a question to be decided by the would-be breaching party, not the court.

Once again, however, a problem arises insofar if we are to enforce the clear intent of § 122(18) to keep contractual obligations subservient to fiduciary obligations. Recall that that courts may be unable to order specific performance in § 122(18) cases not because specific performance would be unduly burdensome for the breaching party, but rather because specific performance would eliminate the possibility of efficient breach.

It would thus make a caricature of the express legislative intent of § 122(18) if courts were to substitute specific performance orders with impositions of onerous liquidated damages that, even if not punitive per se, put efficient breaches out of the realm of meaningful economic rationality. Returning to the CEO veto example above, the lack of a specific performance remedy may be effectively meaningless if an enforceable liquidated damages provision can make a breach economically infeasible notwithstanding the board’s good-faith determination that its choice for CEO is superior to any alternative. Thus, liquidated damages provisions should be viewed with severe prejudice in § 122(18) litigation.

Absent clear, contractually specified liquidated damages, courts must make a more complex determination of damages. But the usual contractual approach that looks to the harm suffered by the counterparty is unwieldy given the nature of some of these rights (what’s the economic loss from being denied a veto over a corporate bylaw?).

But even assuming that some of these rights can be practically valued, such valuations are highly problematic as damages considering the legislative intent of § 122(18). Returning again to the CEO veto example, suppose the counterparty argues that the deprivation of their veto power has caused them economic damages because the board’s chosen CEO is unenthusiastic about promoting further business ties between the corporation and the counterparty’s other business ventures. The counterparty claims damages based on the lost profits from those forgone business ties.

If awarded, such damages would of course affect what a rational and dutiful board would have understood to be the best course of action for the corporation in evaluating whether to permit the exercise of the veto right. However, as § 122(18)’s proponents represented before the Delaware legislature, § 122(18) makes Moelis-style contracts “technically valid” but has “no effect whatsoever” on a board’s obligations under their fiduciary duties, presumably including their decisionmaking on whether to perform under Moelis-style side letter. Put differently, whether or not a Moelis agreement is “technically valid” should have no effect on board’s fiduciary evaluation of whether to comply with its terms. However, in making that evaluation with regard to a “technically invalid” agreement, a corporation or its board of course would of course have no fear of damages from breach. And given the statements of the proponents of § 122(18), the board’s fiduciary calculations should be identical when evaluating whether to breach a “technically valid” agreement.

Thus, looking to the legislative intent of § 122(18), directors should not be encumbered by fear of corporate damages from § 122(18)-enabled agreements in carrying out their fiduciary duties. To avoid any such encumbrance, only nominal damages are appropriate for a breach of a provision in a § 122(18)-enabled contract where the breach was prompted by fiduciary duties. The drafters and proponents of § 122(18) had a choice between effective contractual remedies and fiduciary duties, and they loudly and unabashedly chose fiduciary duties.

Finally, note that the issues discussed here must be considered regardless of what law nominally applies to the contract under say, a choice-of-law clause, as § 122(18) gives corporations the power to enter into otherwise-invalid contracts only if such contracts are subservient to fiduciary duties. Put differently, a side letter may be ultra vires—even with § 122(18)—if the letter purports to make expansive remedies available that would enable it to effectively override the board’s fiduciary duties.

The Intent of § 122(18)’s Drafters Should Be Cabined to § 122(18)

In contexts outside of § 122(18), however, we should continue to assume that, in the interest of the stability of corporate and contract law, contracts can validly influence the board’s conduct and the practical meaning and effect of fiduciary duties.

For instance, suppose a corporation enters into a routine money-for-goods contract with a supplier. Ordinarily (at least before § 122(18)), a breach of this contract by the corporation would entitle the counterparty for contractual damages—namely, lost profits from the sale. It would, of course, be a radical upending of not only corporate law, but also contract law, for the corporation be able to avoid damages for a breach simply by claiming that the board’s fiduciary duties obligated it to do so. In such cases, damages should continue to be governed by the standard rule as expressed in Leaf Invenergy, and we should understand the otherwise-unambiguous intent of § 122(18)’s drafters to be limited to contracts that would be unlawful absent § 122(18).