Background
For over three decades, the MBCA has authorized corporations to include a provision in their articles of incorporation that limits or eliminates, with certain exceptions, the monetary liability of directors to the corporation and its shareholders. Commonly referred to as an exculpatory provision, this provision has protected directors from personal liability for monetary damages for breaches of the duty of care. Today, all states provide for some form of director exculpation in their corporate code. These statutes follow three different approaches—charter option statutes, self-executing statutes, and cap on money damages statutes—or some combination thereof. Section 2.02(b)(4) of the MBCA is a charter option statute, which permits corporations to adopt a charter provision that now provides for the exculpation of both directors and designated officers.
At the time director exculpation statutes were initially being adopted, limiting the liability of directors was viewed as vital to addressing a perceived director shortage resulting from the D&O insurance crisis and the Delaware Supreme Court’s groundbreaking decision in Smith v. Van Gorkom. Similar protection for officers, on the other hand, was generally viewed as unnecessary, and their inclusion in exculpation amendments was ultimately rejected in most states. Until recently, the topic of officer exculpation has remained largely dormant. Several recent developments surrounding officer liability, however, have led to renewed interest in exculpating senior management in a manner similar to that which exists for directors. First, Delaware amended its long-arm statute in 2003 to cover senior executive officers of Delaware corporations. Second, the Delaware Supreme Court, in its 2009 Gantler v. Stephens decision, held that officers owe the same fiduciary duties as directors. Finally, in response to several opinions from the Delaware courts clarifying the ability of shareholders to challenge merger transactions, officers are being named as defendants in M&A litigation with increasing frequency. Due to the lack of exculpatory protection, disclosure claims against officers in these lawsuits were allowed to survive while those same claims against corporate directors were dismissed based on exculpation provisions in the charter. In response to those developments, the Delaware legislature amended its corporate code in 2022 to permit exculpation of certain senior executive officers. Under the amendments, exculpated officers largely enjoy the same protection as directors with the exception that officers cannot be exculpated from derivative claims or claims brought by the corporation.
As was the case with the adoption of director exculpation, the Corporate Laws Committee watched these developments and considered whether, and how, to amend the MBCA to provide for officer exculpation. Earlier this year, the Committee adopted amendments to Section 2.02 permitting the articles of incorporation to include a provision exculpating certain officers.
The MBCA Amendments
As amended, Section 2.02(b)(4) authorizes a provision to be included in the articles of incorporation that limits or eliminates monetary liability for specified officers. In general, the protection afforded to officers under a Section 2.02 exculpation provision is similar to that which the MBCA already allows for directors. Like directors, officers may not be relieved of personal liability for (i) financial benefits received to which the officer is not entitled; (ii) any act or omission that intentionally inflicts harm on the corporation or its shareholders; or (iii) any act or omission that is an intentional violation of criminal law. In addition to these carve-outs, officers (but not directors) may not be exculpated for any claim by or in the right of the corporation (e.g., derivative proceedings). Essentially, under the amendments, a provision in the articles of incorporation may exculpate certain officers for breaches of the duty of care in direct claims brought by shareholders (which includes class actions), but not for claims brought by the corporation or in a shareholder derivative proceeding.
In connection with the exculpation amendments, a new subsection (f) was added to Section 2.02 that defines “officer.” This new definition applies only to the use of “officer” in Section 2.02(b)(4)’s exculpation and not to the use of “officer” elsewhere in the MBCA. The definition has three components to it. First, subsection (f) provides a statutory list of executive officers who are covered by default in an exculpatory provision: chief executive officer, president, chief operating officer, chief financial officer, chief legal officer, secretary, controller, treasurer, and chief accounting officer. Second, consistent with freedom of contract principles, subsection (f) allows the articles of incorporation to expand or contract the default list of enumerated officers or specify a procedure for doing so. Third, unless otherwise provided in the articles of incorporation, the board of directors may, by way of resolution, exculpate other officers beyond those listed in the articles. The board may not, however, alter the exculpatory protection provided to the officers listed in the articles without amending that document. Thus, the MBCA allows a board of directors to tailor the definition of “officers” for exculpatory purposes to the specific needs of the corporation as they may vary from time to time, unlike the Delaware statute which defines the term “officer” in the statute itself.
Comparison to Delaware
The MBCA and Delaware’s General Corporation Law serve as the two principal blueprints for state corporate codes. In the case of officer exculpation, Delaware amended its statute two years prior to the final adoption of the MBCA’s amendments. Overall, Delaware and the MBCA provide similar exculpation protection to officers. One particular area of divergence, however, is the exact language used for the carve-outs for nonexculpable liability. Identical to the carve-outs for director exculpation, the MBCA’s language provides greater clarity than that of the Delaware statute through its use of more concrete and narrower exclusions. For example, contrary to Delaware’s statute, the MBCA’s exclusions avoid references to the “duty of loyalty” and “good faith” as bases for exclusion from exculpation, instead excluding “intentional infliction[s] of harm on the corporation or the shareholders” and “intentional violation[s] of criminal law.” Likewise, the MBCA carves out a narrower set of “financial benefits” to which a director or officer is not entitled, as opposed to Delaware’s “improper personal benefit.”
Another difference in the two statutes relates to the definition of the “officers” who can be exculpated. Delaware’s statute relies upon the definition of “officer” found in its long-arm statute while the MBCA has its own definition in the statute. Both Delaware and the MBCA identify the same list of executive officers to be included in the definition of “officer.” After the initial enumerated list of executive officers, Delaware looks to Securities and Exchange Commission filings and an individual’s consent to jurisdiction as the criteria for determining who is an “officer.” The MBCA, on the other hand, provides corporations with more flexibility to individually tailor inclusion in the “officer” definition through specific enumeration in the articles of incorporation or, alternatively, by a board resolution. By authorizing officer exculpation by a board resolution, the MBCA’s definition allows a board to be nimble in addressing officer exculpation on a case-by-case basis, when and if the need arises, without having to pursue the formal process of amending the corporation’s articles.
Officer Exculpation Trends
Corporate Charter Amendment Trends
Under both the MBCA and the Delaware amendments, an exculpation provision for officers must be set forth in the corporation’s charter. For existing corporations this means amending the charter through a statutorily required process that includes approval of the amendment by the board and the shareholders. For publicly traded corporations this also means satisfying federal securities laws requirements such as disclosures in a proxy statement. While the MBCA’s amendments are too new to have been adopted in more than one MBCA jurisdiction and thus there are no statistics for corporate adoptions in those states, there is a growing body of data on adoption rates by Delaware corporations.
Since Delaware’s adoption of its officer exculpation amendments, there has been a modest, but continually growing, number of public companies that have amended their charters. Overall, commentators have observed that these amendments are being approved by shareholders, with only a handful of proposed officer exculpation amendments failing due to shareholder turnout and a two-thirds supermajority vote standard for approval. To date, most of the officer exculpation amendments have been proposed at small-cap companies (under $2 billion market cap) and mid-cap companies ($2–$10 billion market cap). Commentators predict an increase in the number of large-cap companies (over $10 billion market cap) and dual class companies proposing officer exculpation amendments to their charters moving forward in light of three developments: (i) the clarification by Delaware courts that such amendments do not require a separate class vote of nonvoting shares for approval; (ii) the relative success in approving these amendments at smaller companies; and (iii) the limited impact that negative proxy advisor recommendations have had on the approval of such amendments.
State Statute Adoption Trends
Prior to Delaware’s amendment of its corporate code to provide for officer exculpation, only seven states had such a statutory provision. Around the same time that Delaware adopted its amendments, Pennsylvania amended its corporate statute to limit officer liability. Since that time, a number of additional states have amended or are considering amending their corporate codes to provide for officer exculpation. Both Oklahoma and Alabama have recently adopted officer exculpation amendments. The Oklahoma amendments are nearly identical to the language in Delaware’s statute while Alabama, which is an MBCA state, has adopted an amendment that is based on the MBCA language. As of the writing of this article, it remains to be seen how quickly other states will amend their corporate statutes to provide for officer exculpation as well as whether the MBCA’s or Delaware’s statutory language will serve as the prevailing model. Nevertheless, the adoption of the MBCA amendments as well as the increasing frequency and success of Delaware corporations in adopting officer exculpation charter amendments will likely spur calls for more jurisdictions to consider such changes.
