Delaware Corporation Law Insights with Sandra Feldman
TRANSCRIPTION:
Greg Corombos: Hi, I’m Greg Corombos. So our guest in this edition of Expert Insights is Sandra Feldman, publications attorney at CT Corporation. Sandra is here to discuss an important change in Delaware law that allows companies to protect senior officials from liability for breaches of duty. And why are we talking about this? This is because it impacts many businesses, and many are officially registered in Delaware. And Sandra, thank you so much for being with us.
Sandra Felman: Well, thank you, Greg. On August 1, an amendment to Delaware Corporations Act Section 102(b)(7) went into effect, allowing corporations to have a provision in their certificate of incorporation that eliminates personal liability for officers for breach of their fiduciary duties, subject to a number of important exceptions and limitations. And we call this kind of Charter provision an exculpation clause. And given the exceptions and restrictions, this new officer exoneration clause has a rather narrow application.
It applies primarily to direct lawsuits by shareholders alleging that certain directors have breached the duty of care. Nevertheless, it still allows corporations to provide more liability protection to their executives than they previously could. And I think it’s important that directors, officers, shareholders, and attorneys of all Delaware corporations be aware of the changes to section 102(b)(7) because they may soon be considering with their corporation a adopt an exculpation clause for directors.
So, I’ll take a closer look at what section 102(b)(7) as amended actually says, and then I’ll discuss what a company must do if it wants to enact an executive exculpation clause.
CG: Well, Sandra, maybe there are listeners who are not familiar with what we are talking about here. And before they’re mentally buried in 102(b)(7), let’s let them know where we are right now. So before we get into the details of this amended section of the Companies Act, give us a bit of background on where we were at.
SF: Sure, seems like a good idea. Well, the first thing you need to know is that directors and officers of Delaware corporations owe the corporation and its shareholders a fiduciary duty of loyalty and a fiduciary duty of care. And the duty of loyalty essentially means that they must place the interests of the company and its shareholders above any personal interest. And duty of care basically requires them to make informed decisions. And the company or its shareholders can sue directors and officers if they believe they have breached these fiduciary duties.
In 1985, the Delaware Supreme Court issued a decision in which directors were held liable for millions of dollars in damages for breach of duty of care. And Greg, that decision sent shockwaves through the Delaware business community. They worried that corporations would not be able to obtain liability insurance for directors and officers, or find qualified people willing to serve as directors. The Delaware Legislature therefore responded to these concerns in 1986 by enacting Section 102(b)(7), which essentially allows corporations to have a provision in their certificate of incorporation exonerating directors for breaches of their duty to diligence. In section 102(b)(7), as enacted in 1986, applied only to directors, not officers, and it remained that way for 36 years.
But now we can look forward to August 1, 2022, and we will see that has changed.
CG: So how did this change happen?
FS: On July 27, the Governor of Delaware signed Senate Bill 273, which amended Section 102(b)(7) to allow an exculpation clause for officers. However, as I mentioned earlier, there are also important exceptions.
CG: And what are these exceptions?
FS: Well, for starters, Section 102(b)(7) provides that the clause cannot limit or eliminate an agent’s personal liability for breach of duty of loyalty for acts or omissions in bad faith , which involves willful misconduct or a knowing violation of the law, or for any transaction from which the officer has derived an improper personal advantage. And if you’re wondering what’s left, the clause may limit or eliminate liability for breach of duty of care.
CG: Sandra, you mentioned earlier that this does not apply to all officers. So which officers does this apply to?
SF: We’re going to have to go back to the text of section 102(b)(7) and it tells us to look at the definition of officer which is found in title 10, section 3114 B of the Delaware code. And these two sections combined tell us that this liability protection is only available to the President, Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Chief Legal Officer, Controller, Treasurer, or Chief Accounting Officer. , a person identified in the company’s SEC. being among the highest paid executives, or someone who has agreed to be identified as an executive for the purposes of 31 14 D. So basically, as you can see, we’re talking about executives and managers.
CG: Are there any other restrictions that we and other business owners should be aware of?
SF: Yes, very important. Section 102(b)(7) states that a company cannot eliminate or limit liability in a suit brought by or on behalf of the company. So if it’s the corporation suing the officer or the shareholders suing as a consequence, the exculpation clause will not provide a defence. However, if the shareholder sues directly, or class action shareholder, the clause may apply.
And what is important to remember is that this is the main difference between a directors’ exoneration clause and an officers’ exoneration clause, because section 102 (b) (7) n t prohibit a corporation from eliminating the liability of a director in suits brought by, are within the law of the corporation.
And finally, these clauses only apply to actions for pecuniary damages. Thus, if a shareholder seeks non-monetary damages, such as an injunction or termination of an agreement, the exculpation clause would not constitute a defence.
CG: We speak with Sandra Feldman, publications attorney at CT Corporation and Sandra, do we know why the legislator decided to extend protection to agents 36 years after the passage of this law?
SF: I can only speculate on that. But it may have something to do with a recent rise in the number of shareholder class action lawsuits alleging the offices failed in their duty of care. And again, companies are having difficulty obtaining liability insurance for directors and officers. I think there may also be a feeling that it is unfair to dismiss claims against directors but not officers, when they are accused of the same conduct.
CG: Could be. Could be. What does a company need to do now if it wants to provide its executives with this liability protection?
SF: A company incorporated on or after August 1 may include an exoneration clause for directors in the certificate of incorporation of the company’s formation records. A company existing before August 1st, will have to amend the certificate of incorporation as a clause. And keep in mind that if the company already has a 102(b)(7) clause with directors, and many do, it won’t automatically be extended to officers. The company will still have to modify this certificate of incorporation if it also wants to exculpate the directors.
CG: This is also an important clarification. What is the procedure for amending the certificate of incorporation?
SF: Amending a certificate of incorporation requires compliance with Delaware corporate law. And in particular, section 242. In general, an amendment is affected by the adoption by the board of directors of a resolution setting out the proposed amendment and declaring its expediency. This resolution must then be approved by the shareholders. And generally, it is by the vote of a majority of outstanding shares.
And this is followed by the filing of a Certificate of Amendments with the Delaware Secretary of State. And the amendment becomes effective on the date of filing, unless a future effective date is specified on the certificate of amendment. And it’s important to remember that the officer’s exculpation clause cannot eliminate or limit an officer’s liability for any act or omission that occurred before the clause came into effect.
CG: Lots of good information here and important to let everyone know about this law change. Any final thoughts you want to make sure people here know about?
SF: Yeah, I think it’s going to be interesting to see how many existing Delaware corporations choose to amend their certificate of incorporation to add this officer exoneration clause, and also how many new corporations decide to include it in the certificate of incorporation. constitution, a file from the constitution.
And I would be remiss if I did not end by reminding listeners that CT Corporation can help file Certificates of Amendment and Certificates of Incorporation, as well as provide many other services and solutions to Delaware corporations.
CG: Sandra, there are always many things to follow. It’s great to know that CT Corporation is here to help. Thank you very much for your time today. We always appreciate it.
FS: Thanks, Greg.
CG: Sandra Feldman is a publications attorney for CT Corporation. I’m Greg Corombos and I report for Expert Insights. For more information on this topic, please call CTE at 844-787-7782.
