Since 1986, Section 102(b)(7) of the Delaware General Corporation Law (“DGCL”) has allowed corporations to include an exculpation provision in their certificate of incorporation that eliminates or limits the personal liability of their directors. Section 102(b)(7) was recently amended to allow corporations to extend similar exculpation rights to certain senior officers.
What the Amendment to Section 102(b)(7) Permits
As amended, Section 102(b)(7) allows corporations to exculpate certain senior officers, in addition to directors, from personal liability. However, unlike directors, officer exculpation provisions will only shield officers from personal liability arising from direct claims brought by stockholders, which commonly arise in the context of mergers and acquisitions. Officers can still face personal liability in the context of derivative claims, which are claims brought by or in the right of the corporation. As is the case for directors, officers also cannot be exculpated for breaches of the duty of loyalty, self-dealing, and acts or omissions not in good faith or involving intentional misconduct or knowing violation of law.
Only certain senior officers are eligible for exculpation under the newly amended Section 102(b)(7), including the president, chief executive officer, chief financial officer, chief operating officer, chief legal officer, controller, treasurer, chief accounting officer, and others named as executives in SEC filings.
Delaware Court of Chancery’s Recent Clarification on Charter Amendments for Officer Exculpation
While exculpating directors and certain officers from personal liability is allowed under Section 102(b)(7), such rights are not automatically extended. A provision for director or officer exculpation must be included in the certificate of incorporation to be enforced. Thus, existing corporations wishing to take advantage of the amendment to Section 102(b)(7) and extend exculpation to senior officers must amend their certificates of incorporation, which requires approval by both the board of directors and stockholders under Section 242 of the DGCL. Newly formed corporations may include an exculpation provision in their initial certificates of incorporation.
Several Delaware corporations have amended their certificates of incorporation to provide for officer exculpation under the newly amended Section 102(b)(7). In some cases, stockholders have challenged the charter amendments as void for failure to obtain a separate class vote. The Delaware Court of Chancery recently issued an important ruling on this issue, clarifying that companies with multiple classes of stock are not required to obtain approval of each class under Section 242(b) in order to amend their certificates of incorporation to provide for officer exculpation.1
In the recent cases where the stockholders challenged the charter amendments, the corporations each had at least one class of voting stock and one class of non-voting stock outstanding, but they adopted the charter amendments based only on the approval of the voting stock, without a class vote of the non-voting stock. The corporations’ stockholders filed separate lawsuits alleging that the respective charter amendments were void because they violated Section 242(b)(2) of the DGCL, which provides that, if a corporation has more than one class of stock outstanding and a charter amendment would “alter or change the powers, preferences, or special rights” of the shares of a class of stock in an adverse manner, then the class must separately approve the charter amendment.2 The stockholders argued that the charter amendments adversely affected the non-voting stockholders’ power to sue under Section 242(b)(2), thus triggering a mandatory class vote.
In a bench ruling, the Court of Chancery rejected the stockholders’ arguments and dismissed the actions. The Court of Chancery explained that the each of the officer exculpation charter amendments at issue did not require a vote of the non-voting stock because the proposed amendments did not affect a power, preference, or special right that appeared expressly in the corporations’ respective charters. The corporations could instead rely on a majority of the outstanding voting stock to adopt the officer exculpation charter amendments. While many Delaware corporations have adopted similar majority voting standards for charter amendments, which is the default rule under Section 242 of the DGCL, some have adopted higher standards, such as 2/3 or 75% of the outstanding stock.
The stockholders in the above-mentioned actions filed a notice of appeal with the Delaware Supreme Court from the Court of Chancery’s ruling. As of the date of this article, a decision from the Delaware Supreme Court on the appeal has not been issued.
With the recent amendment to Section 102(b)(7) (among other amendments) and the Court of Chancery’s decision rejecting dual-class votes on officer exculpation provisions, now is a great time for existing corporations to review their certificates of incorporation and determine whether amendments, such as adding an officer exculpation provision, may be beneficial. An exculpation provision is not retroactive and only protects officers from personal liability for acts or omissions that occur after the provision is adopted (whether as an amendment to or in the initial certificate of incorporation), so the sooner this change is made, the sooner corporate officers receive its benefit.
Extending personal liability protections to officers in addition to directors may, among other benefits: (i) reduce the volume and scope of lawsuits against corporate officers for breach of fiduciary duty, and in turn reduce corporate litigation costs or insurance obligations that arise out of obligations to indemnify officers; (ii) encourage talented individuals to serve as senior officers and help corporations retain such talented individuals; (iii) alleviate the discrepancy between director and officer liability where individuals served as both directors and officers, which often led to an individual being exempt from personal liability in his or her director capacity, yet still liable in his or her officer capacity; and (iv) reduce negative publicity for corporations, especially public corporations, that are often embroiled in fiduciary duty lawsuits involving their corporate officers.
When considering whether to adopt an officer exculpation charter amendment, corporations should review their governing documents and Delaware law to confirm the procedures for adopting such amendment, including board and stockholder voting requirements. Delaware corporations should also consider performing a broader review of their governing documents and whether other changes may be beneficial.
1 The Court of Chancery’s ruling relates to multiple actions that were brought by stockholders of each Fox Corporation and Snap, Inc. The Court of Chancery consolidated two actions that were filed against Snap, Inc. by two different stockholders, Sbroglio v. Snap Inc., C.A. No. 2022-1032-JTL (Del. Ch.) and Dembrowski v. Snap Inc., C.A. No. 2022-1042-JTL (Del. Ch.), into one action with the caption In re Snap Inc. Section 242 Litigation, 2022-1032-JTL (Del. Ch.). In re Snap Inc. Section 242 Litigation, 2022-1032-JTL (Del. Ch.) was then coordinated with Electrical Workers Pension Fund, Local 103, IBEW v. Fox Corp., C.A. No. 2022-1007-JTL (Del. Ch.) for the purposes of resolving the parties’ cross-motions for summary judgment.
2 Section 242(b)(2) similarly provides for series-level votes, where a class is divided into series, for the series affected by the amendment.