Delaware Now Authorizes Exculpation Of Officers, But On What Basis?

Effective August 1, 2022, Delaware amended Section 102(b)(7) of its General Corporation Law to allow a Delaware corporation to include in its certificate of incorporation a provision exculpating certain of its officers.  Notably and unlike the preexisting authority to exculpate directors, officers may not be exculpated in any action by or in the right of the corporation.  The Delaware legislature did not explain why it believed it had the authority to allow corporations to eliminate the personal liability of officers for monetary damages. 

The Delaware Supreme Court has described the certificate of incorporation as "a contract among shareholders".    Waggoner v. Laster,  581 A.2d 1127, 1134 (Del. 1990).  See also STAAR Surgical Co. v. Waggoner, 588 A. 2d 1130, 1136 (Del. 1991) ("The charter is also a contract among the shareholders themselves.") and Schultz v. Ginsburg, 965 A. 2d 661, 668 (Del. 2009) ("PHLX's Certificate of Incorporation is a contract between the stockholders and the corporation." (citing STAAR Surgical)).  The Supreme Court in STAAR Surgical also found that the certificate of incorporation is also a contract (i) between the state and the corporation; and (ii) the corporation and its stockholders. 

These cases do not hold, however, that the certificate is a contract between the stockholders and the officers.  If the certificate is not a contract between the officers and the shareholders, the inclusion of an exculpation clause cannot be understood as a contract on the part of the shareholders not to advance direct claims.  Similarly, an amendment of the certificate to exculpate officers in direct actions by stockholders cannot be explained as a contractual amendment.  If there is no contract, then there is nothing to amend.  

An exculpation provision might be explained in terms of the officers being third party beneficiaries of either the contract among the shareholders and/or the contract between the shareholders and the corporation.  However, this would require a court to conclude that the officers met the tripartite test for third party beneficiary status:

To adequately allege standing as a third-party beneficiary under Delaware law, Plaintiff must plead that (i) the contracting parties intended that the third-party beneficiary benefit from the contract, (ii) the benefit was intended as a gift or in satisfaction of a preexisting obligation to that person, and (iii) the intent to benefit the third party was a material part of the parties’ purpose in entering into the contract.

Crispo v. Musk, 2022 WL 6693660, at *3 (Del. Ch. Oct. 11, 2022).  Do stockholders really confer exculpation as a "gift" and if not, what preexisting obligation is owed by the stockholders to the officers?
An exculpation provision might also be explained as a waiver on the part of the stockholders.  In general, a waiver require proof that a person (i) had knowledge of all material facts relating to his rights and (ii) intended to relinquish such rights voluntarily.  Prizm Grp., Inc. v. Anderson, 2010 WL 1850792, at *6 (Del. Ch. May 10, 2010).  
Finally, what about choice of law?  Delaware will likely fall back on its fealty to the internal affairs doctrine.  Note, however, that California has codified the internal affairs doctrine only in respect of directors.  Cal. Corp. Code § 2116 ("The directors of a foreign corporation transacting intrastate business are liable to the corporation, its shareholders, creditors, receiver, liquidator or trustee in bankruptcy for the making of unauthorized dividends, purchase of shares or distribution of assets or false certificates, reports or public notices or other violation of official duty according to any applicable laws of the state or place of incorporation or organization, whether committed or done in this state or elsewhere. Such liability may be enforced in the courts of this state.").   Officers, unlike directors, are agents of the corporation.  Under Section 291 of the Restatement (Second) Conflict of Laws, the rights and duties of a principal and agent toward each other are determined by the local law of the state which, with respect to the particular issue, has the most significant relationship to the parties and the transaction under the principles stated in Section 6 of the Restatement.  In many cases, moreover, the corporation and the officer may have specified a choice of law in an employment agreement, equity award agreement or plan, severance agreement, or other employment agreement.
Annual Corporate and LLC Law Update
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