On September 13, 2021, over a rare dissent, the Delaware Supreme Court affirmed the Court of Chancery’s dismissal of a petition for appraisal filed by minority stockholders (the “Petitioners”) of Delaware corporation Authentix Acquisition Company, Inc. (“Authentix”). The high court agreed that the Petitioners could waive the statutory right to an appraisal through provisions in a stockholder agreement (the “Stockholders Agreement”). Significantly, this ruling may open the door for corporations to contractually waive other permissions portions of the Delaware General Corporation Law (“DGCL”).
Nearly fifteen years ago, Petitioners became minority investors in Authentix after an acquisition by a private equity firm; as part of that transaction, the Petitioners entered into a Stockholders Agreement and agreed to refrain from invoking their appraisal rights in the event of a future merger. The court referred to this obligation as the “Refrain Obligation.”
Nearly ten years later, in 2017, Authentix merged with a “third-party entity.” After application of the consideration and a waterfall provision, common stockholders were left with “little to no consideration” for their canceled stock. They, therefore, sent timely appraisal demands and then petitioned in Chancery Court to exercise their statutory appraisal rights under DGCL § 262.
On October 1, 2018, the Court of Chancery granted Authentix’s motion for summary judgment, holding that the Petitioners had waived their appraisal rights under the Stockholders Agreement. Following the Chancery Court’s final memorandum opinion on August 11, 2020, the Petitioners appealed this result to the Delaware Supreme Court.
The Supreme Court’s Decision
The majority identified two main issues regarding the Petitioners’ request for appraisal: (1) whether the Petitioners clearly waived their appraisal rights with respect to the 2017 merger; and (2) whether a Delaware corporation “can enforce a waiver of appraisal rights against its own stockholders.” The court answered each in the affirmative and affirmed the Court of Chancery in full.
- Whether the Petitioners clearly waived their appraisal rights regarding the 2017 merger.
The Petitioners offered three reasons why the Refrain Obligation did not waive their appraisal rights: (1) the Refrain Obligation was never triggered because the private equity firm’s stock was not acquired on the same “Terms and Conditions” as the Petitioners’ common stock; (2) the Refrain Obligation did not clearly survive the termination of the Stockholders Agreement after the merger; and (3) Authentix could not “enforce the Stockholders Agreement because it was not an intended beneficiary.” The court did not agree with any of these contentions.
First, the court rejected the Petitioners’ argument that the Refrain Obligation was never triggered. Under the Stockholders Agreement, if a Company Sale was “structured as a sale of Equity Securities,” the private equity firm could exercise certain drag-along rights provided the company acquired the stock of holders like the Petitioners’ “on the Same Terms and Conditions” as the private equity firm’s stock. Although the private equity firm received substantially more compensation for its preferred stock, the court reasoned that the 2017 merger still triggered the Refrain Obligation because the merger was not structured as a sale of securities. The “Same-Terms Requirement” did not even apply because the merger canceled all outstanding stock. In that regard, Authentix treated all outstanding stock equally.
Second, the court dispatched the Petitioners’ argument that the Refrain Obligation could not apply because the Stockholders Agreement terminated after the merger. Such an interpretation was “commercially unreasonable,” according to the court, because each party understood that appraisal rights only arise after mergers.
Third, the Petitioners argued that, because Authentix’s ownership completely changed after the 2017 merger, post-merger Authentix was not a party to the Stockholders Agreement and could not enforce its provisions. Citing the “fundamental principle of Delaware law” that a corporation possesses an identity separate from its stockholders, the court reasoned that any changes to Authentix’s ownership did not alter its status as a party to the Stockholders Agreement. As the surviving entity post-merger, it was entitled to enforce the agreement. But in the alternative, Authentix would nonetheless qualify as a third-party beneficiary because “the parties must have recognized when they formed the Stockholders Agreement that the Refrain Obligation was intended to benefit Authentix” — the surviving corporation “that would be liable for paying” fair value for its canceled stock.
Accordingly, the court held that the Petitioners had waived their right to appraisal by the terms of the Stockholders Agreement.
- Whether Delaware corporations can enforce the contractual waiver of appraisal rights against their own stockholders.
Having held that the Petitioners had waived their right to seek appraisal, the court then considered whether a Delaware corporation could enforce such a waiver against its own stockholders. The Petitioners argued that three provisions of the DGCL prevented Authentix from enforcing any waiver: (1) the Refrain Obligation amounted to a stock restriction required to be included in the corporation’s charter under § 151(a); (2) § 262 prohibits ex ante waiver of appraisal rights under a stockholders agreement; and (3) Delaware corporations cannot enforce a stockholders agreement with their own stockholders pursuant to § 218. Again, the court rejected each of the Petitioners’ assertions.
First, the court affirmed the holding of the Chancery Court that the Refrain Obligation was not a stock restriction. The fact that the Stockholders Agreement imposed personal commitments on the stockholders — rather than encumbrances on the property rights of their stock — suggested the obligation did not function as a stock restriction. Further, the Refrain Obligation did not implicate the “notice-giving public policy concern” belying § 151. Authentix only sought to enforce the obligation in this case against sophisticated parties that negotiated and signed the Stockholders Agreement with the advice of counsel. The court made clear that corporations would still need to make proper disclosures to issue stock with restrictions. In this case, the court merely refused to hold that “any performance duty imposed under a bilateral agreement binding all of a corporation’s stockholders is a stock restriction.”
Second, while recognizing that “there are certain fundamental features of a corporation that are essential to that entity’s identity and cannot be waived,” the Court asserted that appraisal rights under § 262 are not such an indispensable right. Instead, sophisticated and informed stockholders may agree to waive their appraisal rights in exchange for valuable consideration. Holding otherwise would supposedly frustrate the DGCL’s purpose of providing businesses broad freedom to contract as they see fit. Further, the court did not read § 262’s provision that certain stockholders “shall be entitled to an appraisal” as creating an unwaivable right. The Court cited Graham v. State Farm Mutual Automobile Insurance and Baio v. Commercial Union Insurance for the proposition that parties can indeed agree to waive mandatory rights. While the Delaware General Assembly can prohibit parties from altering certain mandatory DGCL provisions — as it has proscribed corporations from adopting charters or bylaws that deny access of internal corporate claims to Delaware courts under § 115 — the court pointed out that the Assembly has chosen not to do so for § 262. Finally, the court again accorded great weight to the fact that the Petitioners “were sophisticated and informed investors, represented by counsel, that used their bargaining power to negotiate for funding . . . in exchange for waiving their appraisal rights.” This status alleviated any concerns of inequity or rational apathy on the part of widely disaggregated shareholders.
Before addressing § 218, the court eschewed the notion that public policy concerns outweighed the freedom of sophisticated and informed stockholders to waive appraisal rights in exchange for valuable consideration. The petitioners provided two main public policy reasons to prevent enforcement of the Refrain Obligation: (1) a stockholder cannot knowingly waive its appraisal rights without knowing the details of a transaction; and (2) allowing enforcement would “dilute the corporate ‘brand’ and allow corporations to use stockholders agreements to change all other provisions of the DGCL.” The court rejected the Petitioners’ first argument on the grounds that as sophisticated investors with the benefit of counsel, they were not ignorant of the Refrain Obligation when they signed the Stockholders Agreement. Invocation of the Refrain Obligation for such parties would be “easy . . . to predict.” Additionally, the court maintained that the Petitioners’ framing of the invalidity of ex ante waivers would invalidate all arbitration clauses. Addressing the Petitioners’ second contention, the court did not agree that all DGCL provisions are mandatory unless otherwise stated. Such an interpretation would render inoperable portions of the DGCL granting broad discretion in drafting charters and bylaws.
Finally, the court reasoned that nothing in the language of § 218 prohibits corporations from entering into and enforcing a stockholders agreement. On the contrary, the language of § 218 specifically authorizes multiple stockholders to form agreements without “any limitations on the number or percentage” of stock that may be party to the agreement. According to the court, this interpretation vindicates the “core corporate power” of forming contracts. And in light of Delaware’s public policy in favor of private ordering, the Petitioners could not provide any reason to narrowly construe § 218. Accordingly, the Court held that Delaware corporations can enforce stockholders agreements against their own stockholders.
Justice Valihura dissented from the majority, averring that appraisal rights under § 262 are fundamental features of corporate governance, modification of which should be permitted only in the corporate charter. While Justice Valihura acknowledged that it is a “close call,” she would classify appraisal rights as mandatory and invite the General Assembly to clarify in the event that it disagrees.
Possibility for Broader Application
The Delaware Supreme Court’s opinion in Manti Holdings leaves the door open for what other portions of the DGCL may be waived through a contractual stockholder’s agreement.
While the court recognized that there are some provisions of the DGCL that are so fundamental that they are essential to a corporation’s identity and cannot be waived, the court did not clarify what makes such a provision fundamental. Thus, the Manti Holdings decision leaves unanswered which provisions of the DGCL corporate entities may waive by agreement.