In a recent opinion in New Enterprise Associates 14, L.P. v. Rich, (Del. Ch.; 5/23), Vice Chancellor Laster found a stockholder covenant not to sue for breach of the duty of loyalty — in the context of a sale of the company that triggered the drag-along provision in a stockholders’ agreement — partially enforceable. Here’s an excerpt from a recent Duane Morris blog discussing the opinion:
Conducting a deep-dive into the history and philosophical underpinnings of fiduciary law, the Court reasoned that specific, limited, and reasonable covenants not to sue are valid, but that Delaware abhors pre-dispute waivers of suit for intentional harms. The Court laid out a two-part test, sure to join the corporate practitioner’s lexicon of eponymous capital-t Tests swiftly:
“First, the provision must be narrowly tailored to address a specific transaction that otherwise would constitute a breach of fiduciary duty. The level of specificity must compare favorably with what would pass muster for advance authorization in a trust or agency agreement, advance renunciation of a corporate opportunity under Section 122(17), or advance ratification of an interested transaction like self-interested director compensation. If the provision is not sufficiently specific, then it is facially invalid.
. . . Next, the provision must survive close scrutiny for reasonableness. In this case, many of the non-exclusive factors suggested in Manti point to the provision being reasonable. Those factors include (i) a written contract formed through actual consent, (ii) a clear provision, (iii) knowledgeable stockholders who understood the provision’s implications, (iv) the Funds’ ability to reject the provision, and (v) the presence of bargained-for consideration.”
Emphasizing the placement of the convent in a stockholder-level agreement (versus the charter or bylaws) and that it only applied to a drag-along sale, which had to meet a list of eight criteria, VC Laster found the covenant to be enforceable, except to the extent it would relieve defendants of tort liability for intentional harm, which would be contrary to Delaware public policy. To make a successful public policy argument, the plaintiff must show bad faith.
This is neither here nor there, but the blog’s reference to VC Laster’s over 1,200-word footnote reminded me of Infinite Jest, the endnotes of which (fun fact!) have their own audio file on audible.com.
– Meredith Ervine, DealLawyers.com, May 8, 2023