By Tom Hals
WILMINGTON, Delaware (Reuters) - Delaware is poised to adopt changes to its widely used corporate law that critics argue could weaken U.S. boards of directors in favor of influential investors such as private-equity firms.
State lawmakers last week approved a bill that gives a corporation the authority to enter into contracts with one or more shareholders that give the investors power over key board decisions.
The approval followed an unusually contentious debate that included warnings from state judges and academics, who said legislators were rushing ahead without understanding the potential impact.
"This is a radical change in Delaware law," Usha Rodrigues, a law professor from the University of Georgia, one of more than a dozen opponents who spoke at a senate hearing on June 11.
Governor John Carney has said he will sign Senate Bill 313, which addresses three recent rulings by the Delaware Court of Chancery. It will become law Aug. 1.
The court plays a key role in interpreting the state's corporate law. Most U.S. public companies are chartered in the state and related fees provide around one-third of Delaware's general budget revenue.
The bill comes at a difficult moment for the court, which has been criticized repeatedly by Tesla (NASDAQ:TSLA) CEO Elon Musk for voiding his compensation and by political conservatives for allegedly emphasizing social issues above investment returns.
The bill enshrines a common practice known as stockholder agreements that a court ruling called into question.
In February, Travis Laster, a Court of Chancery judge, invalidated a stockholder agreement that gave Ken Moelis veto power over nearly every significant decision by the board of Moelis & Co, an investment bank he founded.
"The directors only manage the company to the extent (Ken)Moelis gives them permission to do so," Laster wrote in his 133-page opinion.
Laster said the agreement violated a bedrock principle of Delaware law that directors manage the business using their best judgment for the benefit of all investors.
The ruling can be appealed and the bill excludes pending cases.
Laster's ruling cast doubt on thousands of stockholder agreements struck by venture capital and private-equity investors and touched off a scramble in Delaware to amend the law.
"Investors have invested millions of dollars in corporations and they don't know if the rights they have are valid," Srinivas Raju, a Delaware corporate lawyer who helped draft the bill, told lawmakers.
The agreements are common among private companies and around 20% of corporations that have gone public in recent years have done so subject to a stockholder agreement, Gabriel Rauterberg, a law professor at the University of Michigan, told Reuters.
Critics argue the agreements can be adopted without public shareholder approval or consent.
Supporters said shareholders in public companies are on notice because such agreements are disclosed in securities filings and annual reports.
In addition, similar arrangements can be achieved by including them in a certificate of incorporation or through preferred stock.
The court's chief judge, Chancellor Kathaleen McCormick (NYSE:MKC), who wrote two of the rulings that prompted the bill, and Laster have both spoken against the rush to pass the legislation, in an unusual break with tradition.
In response, William Chandler, a former chancellor on the court and now with the Wilson Sonsini law firm, urged Delaware House members to ignore academics and judges and follow the state bar, which drafted the bill.
"At the moment the corporate market is not feeling too good about Delaware because of the uncertainty and unpredictability of a few decisions by just two judges," Chandler told lawmakers on June 20. "Judges don't need to intrude upon the process of making law."