In a recent M&A transaction, a nuanced issue regarding the exculpation of directors under the Delaware General Corporation Law (DGCL) arose in the context of a potentially conflicted director serving on the board of a company considering a sale transaction. The company was an early-stage Delaware corporation that had completed multiple rounds of equity financing, the most recent of which was led by a strategic investor in the same industry as the company. At the time of its investment, the strategic investor negotiated for the right to designate one director to the company’s board. Due to the strategic investor’s potential interest in acquiring the company, when the company began considering acquisition offers, the strategic investor’s designated director had at least the appearance of a conflict of interest. In considering the potentially conflicted director’s obligations in the context of the board’s deliberations, counsel for the strategic investor incorrectly assumed that the exculpation language in the company’s certificate of incorporation, which is explicitly permitted (and limited) by Section 102(b)(7) of the DGCL1, amounted to a waiver of all fiduciary duties by the company.2
As Section 102(b)(7) makes clear, however, no such provision may exculpate a director for any breach of the duty of loyalty. Under the counsel’s mistaken interpretation, the director would have been free to share information he received in his capacity as a director with the strategic investor for whom he worked, potentially to the detriment of the company. As noted in prior Delaware case law, while it is possible to cleanse an interested party transaction under Delaware law, a director cannot disclose information to the appointing stockholder when such director is wearing two hats, i.e., if the disclosure could cause harm to the company to which such director owes a duty of loyalty.3 This is definitely a conundrum for directors appointed by private equity firms or other purely financial investors in many situations, but can be even more of a challenge for directors designated by strategic investors, who often have interests that are not solely focused on maximizing the economic value of their investment in a manner that is aligned with other stockholders.
While the duty of loyalty issue was ultimately resolved between counsel, the scenario highlighted an interesting secondary issue: whether Delaware law would have required the same outcome if the target company had been a Delaware LLC. As practitioners know, while a corporation is a creature of statute, LLCs are generally creatures of contract. There are also important differences between the DGCL and the Delaware Limited Liability Company Act, particularly with respect to fiduciary duties. As the Delaware Court of Chancery noted in the recent Manti case4, and as is well established in Delaware law: “Waiver of fiduciary duty is a permitted feature of the LLC form.”
The DGCL allows corporations to eliminate director liability for breaches of the duty of care, as described in Section 102(b)(7), and to renounce corporate opportunities, but the DGCL does not expressly authorize a contractual waiver of fiduciary duties or of claims to enforce such duties. By contrast, the Delaware Limited Liability Company Act has broad enabling provisions that allow for private ordering, including the modification or elimination of all fiduciary duties. The Manti case hinged on a purported contractual waiver of corporate directors’ fiduciary duties, but due to the court’s rejection of the waiver interpretation, the court did not ultimately rule on whether such a contractual waiver would be permissible in the corporate context.
Exculpation from financial liability under Delaware corporate law has express limits and does not amount to the type of broad waiver that can be contracted for in LLCs. While there are many reasons that venture capital investors, in particular, prefer the use of Delaware corporations for their investments, when structuring investments generally, in addition to tax and other factors, consideration should be given to whether a corporation or LLC is the best vehicle in light of potential conflicts of interest that may arise in connection with exits and future financing arrangements. From the company’s perspective, these types of conflicts should be given serious consideration when deciding upon the composition of the board of directors, especially as it relates to strategic investors’ access to all of the information that would normally be shared with a board.
Relatedly, as previously noted in Business Vantage Point, recently enacted amendments to the DGCL will likewise extend the right of a corporation to exculpate officers in certain situations, but it is clear that this expansion relates solely to the duty of care, as the prior version of the statute was also so limited with respect to directors. The expanded exculpation right does not apply to the duty of loyalty implicated in most conflict of interest cases involving a director appointed by, and in many cases employed as an officer or manager of, a stockholder who may be interested in a sale or other significant transaction.
1 DGCL Section 102(b)(7):
Section 102: Contents of certificate of incorporation.
(b) In addition to the matters required to be set forth in the certificate of incorporation by subsection (a) of this section, the certificate of incorporation may also contain any or all of the following matters:
(7) A provision eliminating or limiting the personal liability of a director or officer to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director or officer, provided that such provision shall not eliminate or limit the liability of:
(i) A director or officer for any breach of the director’s or officer’s duty of loyalty to the corporation or its stockholders;
(ii) A director or officer for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law;
(iii) A director under § 174 of this title;
(iv) A director or officer for any transaction from which the director or officer derived an improper personal benefit; or
(v) An officer in any action by or in the right of the corporation.
No such provision shall eliminate or limit the liability of a director or officer for any act or omission occurring prior to the date when such provision becomes effective.
An amendment, repeal or elimination of such a provision shall not affect its application with respect to an act or omission by a director or officer occurring before such amendment, repeal or elimination unless the provision provides otherwise at the time of such act or omission.
All references in this paragraph (b)(7) to a director shall also be deemed to refer to such other person or persons, if any, who, pursuant to a provision of the certificate of incorporation in accordance with § 141(a) of this title, exercise or perform any of the powers or duties otherwise conferred or imposed upon the board of directors by this title.
All references in this paragraph (b)(7) to an officer shall mean only a person who at the time of an act or omission as to which liability is asserted is deemed to have consented to service by the delivery of process to the registered agent of the corporation pursuant to § 3114(b) of Title 10 (for purposes of this sentence only, treating residents of this State as if they were nonresidents to apply § 3114(b) of Title 10 to this sentence).
2 The language in question originated from the National Venture Capital Association’s model Certificate of Incorporation, Article Ninth, which is available here.
3 Also worth noting is that the strategic investor had contractual information rights, as is typical for major investors in venture capital equity rounds. Information provided by the company to the investor pursuant to these contractual rights would not be subject to the same limitations based on fiduciary duties, although it would remain subject to applicable contractual confidentiality obligations. Further, all stockholders of Delaware corporations have the right to demand certain books and records pursuant to Section 220 of the DGCL, and other recent Delaware caselaw suggests that nonpublic company information furnished pursuant to a Section 220 request may not always be protected by confidentiality obligations.
4 Manti Holdings, LLC v. The Carlyle Group Inc., C.A. No. 2020-0657-SG (Del. Ch. Feb. 14, 2022).