May 01, 2019

Shareholders' Agreements: Recent Lessons From The Delaware Courts

By Marla H. Norton


With the new 21% flat tax for C corporations enacted by the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, business owners are reassessing the use of corporations rather than pass-through entities. In considering the corporate form for a closely held business, a shareholders’ agreement is an important planning tool. Agreements among stockholders are common in venture capital and other funding transactions. Since Delaware is a popular choice for capital formation, it should come as no surprise that the Delaware court have issued multiple decisions over the past five years involving shareholders’ agreements.


Several themes have emerged from recent Delaware precedent. First, courts have recognized that stockholders may contractually waive rights granted to them by the Delaware General Corporation Law (the “DGCL”) and the certificate of incorporation. But Delaware courts will not enforce a shareholders’ agreement that usurps the authority of the board of directors or that is inconsistent with due process. Finally, with the freedom to relinquish statutory rights comes a responsibility to draft clearly and consistently. The following principles emerge from recent Delaware cases:

1. A shareholders’ agreement may curtail the rights of the parties to elect and remove directors. Klaassen v. Allegro Development Corp., C.A. No. 8626-VCL (Del. Ch. Oct. 11, 2013).

Allegro’s certificate of incorporation established a seven-person board, with three directors elected by the preferred stockholders (the “Investors”), one elected by the common stockholders, and the remaining three elected by all stockholders voting as a combined class (controlled by the founder). The bylaws prohibited removal of directors without cause, except in accordance with the shareholders’ agreement. The shareholders’ agreement dedicated one of the at-large seats to the Chief Executive Officer (“CEO”), who was empowered to designate two independent, outside directors, with the Investors’ approval, to fill the other two. As CEO, the founder served on the board and chose the two outside directors. After the board terminated the CEO and named one of the outside directors to succeed him, the founder attempted to remove and replace the outside directors.

Vice Chancellor Laster held that because Section 141(k) of the DGCL empowers the stockholders to remove directors without cause (with specified exceptions), conflicting restrictions in the shareholders’ agreement were binding only on the parties. As a signatory, the founder had relinquished his right to appoint and remove without cause non-class directors, except as provided therein. Because the shareholders’ agreement permitted removal of the CEO’s board appointees following a CEO change, he could remove but not replace outside directors. But because the successor CEO was entitled to a board seat, his removal was invalid.

Since the founder had neither resigned nor been removed as a director, he remained a board member. Had the charter assigned a board seat to the CEO, his firing would have terminated his directorship. But an entitlement contained in the bylaws or a shareholders’ agreement does not result in automatic forfeiture of a board seat upon termination of employment.

2. A shareholders’ agreement cannot deprive the board of its statutory authority to manage corporate affairs and appoint officers. Schroeder v. Buhannic, C.A. No. 2017-0746-JTL (Del. Ch., January 10, 2018).

The shareholders’ agreement in Schroeder contained a board composition provision obligating all stockholders to elect three designees of the common stockholders, one of whom was the CEO of the company. The majority common stockholders advanced the novel interpretation that this provision entitled them to select the company’s CEO. The plaintiffs’ reading was that the common stockholders must elect the person serving as CEO as one of their three Board designees.

The majority stockholders attempted to remove and replace the CEO as both an officer and director. In the resulting litigation, on a motion for judgment on the pleadings, Vice Chancellor Laster found the defendants’ construction inconsistent with DGCL Section 142(b), which states that corporate officers are chosen as provided in the bylaws or by board action, and the company’s bylaws, under which the board appointed officers annually, following the annual meeting of stockholders, and could remove officers without cause. If the provision did authorize stockholders to appoint or terminate the CEO, it improperly usurped board authority. As the shareholders’ agreement entitled the CEO to a board appointment, stockholders could not remove the CEO as a director.

3. Common stockholders may agree in a shareholders’ agreement to waive their statutory appraisal rights. Manti Holdings, LLC. V. Authentix Acquisition Co., C.A. No 2017-0887-VCSG (Del. Ch, October 12, 2018)

In this shareholders’ agreement, the common stockholders agreed to “refrain from exercising” appraisal rights in connection with a sale of the company approved by the holders of a majority of the corporation’s voting stock. A separate drag-along provision obligated the common stockholders to participate in a sale only if they received equivalent consideration to the preferred stockholders. The plaintiffs (common stockholders) nonetheless sought appraisal following a merger approved by the preferred stockholders as majority holders.

Vice Chancellor Montgomery-Reeves rejected the plaintiffs’ semantic argument that their negative covenant applied only at consummation of a sale transaction but not afterwards. Because appraisal rights are perfected post-merger, this construction rendered the covenant meaningless. While the term “waiver” would have been optimal, “refrain” was held sufficient to extinguish appraisal rights. Finally, the equivalent consideration requirement of the drag-along provision was inapplicable to the provision governing the merger transaction. This holding reinforces that stockholders may contractually waive rights conferred on them by the DGCL and also highlights the importance of drafting with precision.

4. Stockholders may in a shareholders’ agreement to waive their right to litigate internal affairs issues in Delaware courts. Bonanno v. VTB Holdings, Inc., C.A. No. 10681-VCN (Del. Ch. Feb. 8, 2016)

Section 115 of the DGCL, effective August 1, 2015, authorizes a certificate of incorporation or bylaws to mandate litigation of internal corporate claims in Delaware and prohibits a waiver in the certificate or bylaws of the right to litigate such claims in Delaware. Prior to Section 115’s enactment, the Delaware Court of Chancery found no Delaware public policy forbade stockholders from consenting to exclusive foreign jurisdiction over a matter involving the internal affairs of a Delaware corporation. See Baker v. Impact Holding, Inc. , C.A. No. 1144-VCP, 2010 WL 1931032, at *2-3.(Del. Ch. May 13, 2010).

In Bonanno, the plaintiff was party to numerous documents, including a shareholders’ agreement, containing New York choice of law and exclusive forum selection clauses. After the plaintiff sued in Delaware seeking redemption of his stock, the corporation argued that the parties had agreed to litigate all claims in New York. The Court of Chancery ruled that Section 115 did not alter Delaware’s public policy, citing language in the bill synopsis confirming that the legislature did not intend “to prevent the application of [a] provision in a stockholders agreement or other writing signed by the stockholder against whom the provision is to be enforced.” The court noted that such a waiver must be "strikingly clear." Accordingly, an exclusive forum selection clause in a shareholders’ agreement for a Delaware corporation should be clear and sufficiently broad.

5. The Delaware Court of Chancery will enforce a provision in a shareholders’ agreement stating that shares issued in breach of the agreement are void. Southpaw Credit Opportunity Master Fund, LP v. Roma Restaurant Holdings Inc., C.A. 2017-0059-TMR (Del. Ch. Feb. 1, 2018)

Here, the shareholders’ agreement prohibited the issuance of new shares to a third party unless, prior to the issuance, the prospective stockholder executed a joinder substantially in the form attached as an exhibit. Noncompliance with the joinder requirement rendered the issuance null and void.

The plaintiff agreed to purchase stock from a former officer, which would give its control group a bare majority. Upon learning of the sale, the board hastily convened a telephonic meeting approving a new compensation plan authorizing dilutive stock awards. The corporation issued the shares without obtaining stockholder approval and without executed joinders by the grantees.

The defendants claimed that the grantee award agreements were substantially equivalent to the required joinder. But the joinder form acknowledged that the signatory had reviewed the shareholders’ agreement and had an opportunity to consult with counsel, while the award agreements merely mentioned the shareholders’ agreement and obligated the grantees to execute joinders if necessary. Vice Chancellor Montgomery-Reeves found that this language was inadequate and characterized the actions of the defendants as defensively motivated and fraught with gamesmanship. Because the shares were void rather than voidable, they could be ratified only under DGCL Section 204 or 205.

6. Carefully consider the triggers for a buy-sell agreement to ensure that they clearly address the parties’ concerns. Badii v. Metropolitan Hospice, Inc., C.A. No. 6192-VCP (March 12, 2012)

This case examined an ambiguity between different sections of a shareholders’ agreement. One stated that the shares of a deceased stockholder were converted to a non-voting economic interest. The second, a deadlock-breaking provision, required approval by the “Majority Interest Holders” of a “major decision” approved by a less-than-unanimous board vote. The agreement defined “Majority Interest Holders” as “holders of a majority interest” without mentioning voting rights. After the majority stockholder’s death, the board adopted a restructuring proposal proposed by a minority stockholder with majority voting power. The executor of the estate opposed the plan as self-dealing, unfair and prejudicial to the estate. In an action for the appointment of a receiver, the Court of Chancery avoided resolving the ambiguity by granting the petition. But this case underscores the need to scriven carefully.

7. Delaware law does not require a corporation to repurchase the shares of a minority stockholder or impose a duty on its board of directors to negotiate a discretionary repurchase in good faith or accept a reasonable proposal. Blaustein v. Lord Baltimore Capital Corp., C.A. No. 272 (Del. Supr. Jan 21, 2014).

The corporation’s shareholders’ agreement imposed transfer restrictions and contained a discretionary repurchase right on mutually acceptable terms and conditions. After the plaintiff sought repurchase of her large minority stake, the company offered her a 52% discount to net asset value and refused to negotiate price. She sued, alleging that the Board was interested. After she attempted to add additional counts for breach of fiduciary duty and violation of the implied covenant of good faith and fair dealing, the Chancery Court denied her motion.

On appeal, the Delaware Supreme Court confirmed that the board of a closely-held corporation has no fiduciary duty to repurchase a stockholder’s shares or to negotiate a reasonable price. Accordingly, the plaintiff had no right to consideration by a disinterested majority or independent committee. Finally, the Supreme Court found no gap to be filled by the implied covenant – the parties considered repurchase rights and agreed to an optional repurchase at a price to be negotiated.

8. Execution of a shareholders’ agreement with Delaware governing law is not sufficient to confer personal jurisdiction over a nonresident stockholder. EBP Lifestyle Brands Holdings Inc. v. Boulbain, C.A. No. 2017-0269 -VCS (Del. Ch. Aug. 4, 2017)

An executive based in California received options to acquire stock of his employer’s holding company. Upon his termination, the Delaware parent allowed the executive to exercise his options if he executed the company’s shareholders’ agreement. The agreement included noncompetition and non-solicitation provisions and a Delaware governing law clause.

After the ex-employee accepted new employment, the corporation sued in Delaware seeking specific performance and injunctive relief. The corporation invoked long-arm jurisdiction based upon the defendant’s execution of the shareholders’ agreement and transactions undertaken in Delaware by his employers. The Court of Chancery found that the executive had done nothing to avail himself of Delaware law. He signed a boilerplate shareholders’ agreement to obtain his shares. Actions taken as a corporate employee did not subject him to personal jurisdiction. Imposing personal jurisdiction on a non-resident based solely on these facts would violate due process. Had the shareholders agreement contained a choice of forum clause and a consent to personal jurisdiction and service of process, the outcome might have been different.

These recent corporate decisions indicate that stockholders in a closely-held Delaware corporations can contract away their rights pursuant to a shareholders’ agreement, subject to notions of due process. However, fundamental corporate law principles will constrain the power of stockholders, by contract, to infringe on the authority of the board of directors. As with unincorporated entities, the freedom to contractually alter the default rules is tempered by the need to engage in clear and thoughtful drafting.

Note: Marla Norton chairs the ABA Model Shareholders Agreement Task Force, which is developing a form of Shareholders Agreement for use by a group of stockholders actively involved in the company’s business. This Task Force is seeking input from business lawyers across the U.S. who can help add commentary regarding state-law specific guidance, alternate provisions or approaches, and address relevant tax issues. Please contact Marla Norton at if you are interested in assisting this Task Force.

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