SB21: Delaware Responds In The DExit Battle

The annual DGCL amendments this year carry a little more urgency than before. SB21 was rushed through to the Delaware Senate in mid-February, bypassing the normal process that involves recommendation by the Council of the Corporation Law Section of the Delaware State Bar Association (the “CLC”).  At the legislature’s request, the CLC is weighing in with recommended changes to SB21, and that version is the current front runner to get approved by the legislature and adopted this year, and is the version (as currently available) described below. Delaware’s hurried process can be seen as a response to a gathering movement by corporations to reincorporate in other jurisdictions, dubbed “DExit”, which threatens Delaware’s mantle as the undisputed leader in state corporate law, and a material revenue source for the State. The movement seems to have at least two underlying causes. One is cyclical. Delaware’s judge made law periodically either swings too far in the pro-plaintiff direction, or otherwise produces controversial decisions, alienating companies incorporated in Delaware. This is followed by a course correction, sometimes judicial and sometimes legislative. A second cause is jurisprudence around the level of judicial scrutiny applied to actions taken by controllers, with particularly pronounced criticism coming from companies with “rockstar” CEOs and founders.[1]

There were several decisions in 2023 that provoked backlash, including Moelis,[2] which invalidated a controller’s stockholder agreement in a decision that was sharply at odds with prevailing M&A practice, and Activision,[3] some aspects of which were unusually formalistic and ran contrary to common M&A practices. Both decisions were legislatively overturned in the 2024 DGCL amendments. Another decision, Palkon v. Maffei,[4] applied the entire fairness standard of review to a reincorporation transaction, eliciting the ire of controllers given the speculative nature of the purported controller benefit. That decision was overturned by the Delaware Supreme Court this year. But perhaps the biggest judicial catalyst for DExit is Tornetta v. Musk[5], where in 2024 the Court of Chancery invalidated Elon Musk’s performance award at Tesla, despite its having received board and minority stockholder approval. The value of the award ($56 billion at the time of litigation), the size of the fee award to plaintiff’s counsel ($345 million), and the profile of the company and its CEO, guaranteed that the judicial decisions emanating from the dispute would receive a lot of attention, particularly from other large founder-led tech companies.[6]

SB21 seeks to recalibrate through expanding DGCL Section 144, which regulates the voidability of contracts and transactions in which officers and directors are interested, to also regulate challenges to controlling stockholder contracts and transactions, and to expand applicability of the rule to fiduciary duty challenges. SB21 also seeks to recalibrate through tightening up DGCL Section 220, the rule governing inspection of books and records, which has been a vehicle for a significant increase in litigation in the last few years. In tandem with SB21, the Delaware Senate introduced Senate Concurrent Resolution 17 (“SCR17”), requesting that the CLC prepare a report with recommendations for legislative action relating to excessive awards of attorney’s fees in certain corporate litigation cases.

Amendments to DGCL Section 144

Current paragraph (a) of Section 144 protects against the voidability of contracts and transactions due to the interest of one or more officers or directors, where the contract or transaction is authorized in good faith by the board or a board committee by a majority of the disinterested directors, is approved by the stockholders (in each case with knowledge of the material facts) or is fair to the corporation. As amended, paragraph (a) would protect against equitable relief or damages awards. It thus would expand from a narrow focus on validity to serve as a broad shield against fiduciary duty challenges. Approval by the board requires a majority of disinterested directors, and if a majority of board members are not disinterested, approval of a committee of two or more members, all of whom are independent.

New paragraphs (b) and (c) would for the first time bring controlling stockholders within the ambit of Section 144. One of the criticisms of current case law is that to avoid an entire fairness standard of review and obtain the shielding effect of the business judgment standard of review, controllers must comply with the narrow strictures of In re MFW[7] and its progeny,[8] including obtaining approval of both (i) a special committee composed of disinterested and independent directors, and (ii) disinterested stockholders. Paragraph (b) significantly relaxes the procedural hurdles for controllers to obtain the liability shield outside of going private transactions. Under paragraph (b), for a controlling stockholder transaction to be protected against equitable relief or damages awards, either (i) or (ii) is required, but not both. As for paragraph (a), the special committee must have two or more members, all of whom are independent. The approval of disinterested stockholders must be by a majority of votes cast, in contrast to the majority of shares held by disinterested stockholders currently required under MFW.

For public companies, the amendments provide that a director is presumed to be disinterested with respect to a transaction to which the director isn’t a party, if the board has determined that the director satisfies the criteria for determining independence from the corporation and, if applicable, the controlling stockholder, under stock exchange rules. The presumption is “heightened and may only be rebutted by substantial and particularized facts that such director has a material interest in such act or transaction or has a material relationship with a person with a material interest in such act or transaction.”  Moreover, being the nominee of someone with a material interest does not, by itself, show that a director is not disinterested. This new test addresses scope creep that occurred through a series of Delaware cases, where the test has expanded in recent years to include social ties.[9]

Under new paragraph (c), for going private transactions, approval of both a special committee and disinterested stockholders is required. But, given the liberalization of the stockholder approval requirement described above, the test is easier to meet than under existing case law. Moreover, paragraph (c) does not incorporate the “ab initio” requirement under MFW, but merely provides that the transaction “is conditioned on a vote of the disinterested stockholders at or prior to the time it is submitted to stockholders for their approval or ratification.” For public companies, a “going private transaction” is a “Rule 13e-3 transaction” as defined under the Securities Exchange Act of 1934. For non-public corporations, it is, generally stated, an M&A transaction pursuant to which all or substantially all of the shares of capital stock held by disinterested stockholders are cancelled or acquired.

Another criticism of existing case law is the expanding definition of who can be deemed to be a controlling stockholder. This is also addressed in the amendments, through introduction of a specific definition of a “controlling stockholder” as a person that, together with affiliates and associates, either (i) owns or controls a majority in voting power of outstanding voting stock of the corporation entitled to vote in the election of directors, (ii) has the contractual or other right to cause the election of nominees constituting a majority of members of the board, or (iii) has the power functionally equivalent to such a majority owner, and holds at least one-third in voting power of outstanding voting stock of the corporation. The one-third threshold is an important bright line that is likely to lead to a reduction in litigation against controllers.

The amendments also override recent case law holding that controlling stockholders owe a fiduciary duty of care to the corporation,[10] by introducing the functional equivalent of exculpation under DGCL Section 102(b)(7), but without the need to opt in. The amendments provide that controlling stockholders are not liable in that capacity to the corporation or to its stockholders for monetary damages for breach of fiduciary duty, other than for breach of the duty of loyalty, acts or missions not in good faith, or derivation of an improper personal benefit.

The amendments to Sections 144 and 220 apply to all acts and transactions (including book and records demands) before, on or after the date the Governor signs them into law, but do not apply to any judicial proceeding that is completed or pending on or before February 17, 2025. The synopsis states that this lack of retroactivity “shall not in any way affect the ability of a court, by reference to existing case law, to reach an outcome consistent with one that would be dictated by this Act.”[11]  

Amendments to DGCL Section 220

Amendments to Section 220 delineate, through a “books and records” definition, the documents that stockholders can obtain, including items such as a charter and bylaws (and instruments incorporated by reference), minutes of meetings of stockholders, emails to stockholders within the last 3 years, minutes of meetings of the board and board committees and information packages for those meetings, agreements under DGCL 122(18), annual financial statements, and D&O independence questionnaires.  Importantly, this does not include emails or text messages among directors, officers, or managers, access to which has allowed plaintiff’s attorneys to engage in sometimes expansive fishing expeditions. The amendments limit a court’s ability to order the production of a broader set of books and records, but they do provide that a court can require production of additional records if the corporation does not have minutes of meetings of stockholders, boards or board committees, or annual financial statements. This underscores the importance for corporations of maintaining good minutes in order to limit the scope of document productions in books and records actions.  

The amendments also limit the time period for which a shareholder can inspect books and records (that is, only books and records within three years of the date of the demand) and impose conditions on a stockholder’s ability to inspect and copy the books and records themselves. A stockholder’s demand must be “made in good faith and for a proper purpose” and describe “with reasonable particularity the stockholder’s purpose and the books and records the stockholder seeks to inspect.” The books and records sought must be “specifically related to the stockholder’s purpose.” This change appears to replace the currently low standard requiring only a “credible basis,” but the CLC’s recommended changes to the amendments in SB 21 permit shareholders to request a broader set of documents in the event that the shareholder can show a “compelling need for an inspection of such records to further the stockholder’s proper purpose” and the shareholder has shown “by clear and convincing evidence that such specific records are necessary and essential to further such purpose.” Whether this change to the amendments is incorporated into the final bill remains to be seen.

The amendments permit the corporation to impose reasonable restrictions on the “confidentiality, use, or distribution” of the books and records, to redact unrelated material, and to require that the stockholder incorporate by reference the books and records into any complaint the stockholder files. This change codifies what has been Delaware courts’ current practice.

SCR 17

SCR 17 focuses on the trade-off between preventing excessive attorney’s fees in stockholder litigation, and appropriately incentivizing law firms to bring actions on a contingent fee basis that protect stockholder rights. The Resolution requests the Council of the Corporation Law Section of the Delaware State Bar Association to:

prepare, on or before March 31, 2025, a report with recommendations for legislative action that might help the Delaware Judiciary ensure that awards of attorney’s fees provide incentives for litigation appropriately protective of stockholders but not so excessive as to act as a counterproductive toll on Delaware companies and their stockholders that threatens to make the overall “benefit-to-cost” ratio of corporate litigation negative.

The Resolution specifically requests the Council to consider the utility of fee caps. Foley & Lardner LLP will continue monitoring the progress of SB 21 and SCR 17 as they progress. Both are moving quickly. The Senate Judiciary Committee has scheduled a hearing on the proposed amendments on March 12, 2025.

[1] To the extent that rockstar founders/CEOs seek the same level of autonomy controlling corporations as they could have managing limited liability companies, that is not the focus of the proposed amendments, and it is difficult seeing the Delaware legislature granting their wish. It would undermine Delaware’s goal of navigating between being a business-friendly jurisdiction and protecting the rights of stockholders, and would undermine one of its competitive advantages, which is the sophistication of its judiciary. The CLC recommendations appear to dial back some of the loosening of procedural constraints under SB21.

[2] W. Palm Beach Firefighters’ Pension Fund v. Moelis & Co., 311 A.3d 809 (Del. Ch. 2024).

[3]Sjunde AP-Fonden v. Activision Blizzard, Inc., 2024 WL 863290 (Del. Ch. 2024).

[4] Palkon v. Maffei, 311 A.3d 255 (Del. Ch. 2024), rev’d, 2025 WL 384054 (Del. 2025).

[5] See, e.g. Tornetta v. Musk, 310 A.3d 430 (Del. Ch. 2024).

[6] For example, Tesla, SpaceEx and The Trade Desk have reincorporated out of Delaware. Meta and DropBox are both reportedly considering reincorporating out of Delaware. There are also several very large tech companies that are likely to go public in the near future.   

[7] In re MFW S’holders Litig., 67 A.3d 496 (Del. Ch. 2013), aff’d, 88 A.3d 635 (Del. 2014)

[8] In re Match Grp., Inc. Deriv. Litig., 315 A.3d 446 (Del. 2024) (holding that where a controlling stockholder stands on both sides of a transaction with its controlled corporation, the standard of review does not change to business judgment unless both of MFW’s procedural devices – that is, using a special committee and a majority-of-the-minority vote – are used).

[9] See, e.g. In re Dell Technologies Inc. Class V S’holders Litig., 2020 WL 3096748 (Del. Ch. 2020)

[10] See In re Sears Hometown and Outlet Stores, Inc. S’holder Litig., 309 A.3d 474 (Del. Ch. 2024).

[11] Some legal commentators have viewed this as paving the way for the Tornetta decision to be overturned on appeal.