Moelis, Pension Fund Get Split Ruling in Corporate Control Bout

Moelis & Co. partially lost its latest bid to end litigation challenging a web of contract clauses that give its billionaire founder control over its choice of CEO and other key decisions.

A Delaware judge, Vice Chancellor J. Travis Laster, in a split ruling on Friday granted summary judgment in favor of an institutional investor challenging a raft of items for which the company’s board must obtain chairman Ken Moelis‘s prior written approval before taking action, as well as other corporate stockholder agreement provisions relating to board size and the filling of vacancies.

“When market practice meets a statute, the statute prevails,” the judge said near the end of his 132-page ruling. “Market participants must conform their conduct to legal requirements, not the other way around.”

At the same time, Laster granted summary judgment in favor of Moelis & Co., and against the West Palm Beach Firefighters’ Pension Fund, rejecting its challenges to clauses related to designation rights, and nomination and efforts requirements, finding those to be facially valid.

The decision comes less than two weeks after the chancery judge denied Moelis’ earlier effort to end the litigation. The parties have 10 days to tell the court how they wish to proceed in the wake of the rulings, Laster said for the Delaware Court of Chancery.

The fund’s proposed class action is part of a wave of investor suits challenging similar pacts. It takes aim at provisions of the stockholder agreement giving entities affiliated with Moelis a veto over the financial firm’s leadership, litigation strategy, budgets, business plans, and charter so long as he owns at least a roughly 7% stake. The affiliates can also allegedly veto stock issuances and dividend payments.

The court’s ruling confronted an issue never before resolved by a Delaware judge: the extent to which the state’s laws permit a corporation to delegate board authority to a stockholder through private contracts in ways that couldn’t be legally accomplished through its charter or bylaws.

At the heart of the matter is section 141(a) of the Delaware General Corporation Law, which states that the business and affairs of every corporation organized under that chapter “shall be managed by or under the direction of a board of directors, except as may otherwise be provided” in the chapter or the certificate of incorporation.

A 1957 chancery court ruling, Abercrombie v. Davies, held that governance restrictions violate that section when they effectively remove from directors “in a very substantial way” their duty to use their own best judgment on matters of management, Laster noted.

Abercrombie Applied

“The question then becomes whether the challenged provisions violate the Abercrombie test,” he said. The preapproval requirements do, facially violating §141(a) Laster said. So too does the vacancy requirement.

The judge sided with Moelis on the fund’s challenge to his right to specify individuals as potential candidates for director.

“The Designation Right, standing alone, only gives Moelis the ability to propose a specific number of designees,” but doesn’t force the board or company to do anything with them, Laster said. “Viewed in isolation, the Designation Right does not impose any restriction on the Board that could violate Section 141(a). It is not invalid.”

He also upheld a so-called “efforts” requirement, one obligating the company to take “all reasonable actions” within its control to cause Moelis’ designees to be elected, or maintained, on the board.

But Laster struck down a committee composition provision as violating two different GCL statutes.

That provision “violates the Abercrombie test by removing from the directors in a very substantial way their duty to use their own best judgment on a management matter, viz., who should serve on a committee,” the judge said.

Ripple Effects

The ruling will likely ripple across the other ongoing disputes that echo the Moelis litigation. They include a trio of lawsuits targeting General Atlantic LP, which allegedly has broad contractual veto rights affecting several businesses it invests in: payments firm EngageSmart Inc., medical logistics business Alignment Healthcare Inc., and HireRight Holdings Corp., an employment-related background check company.

Some of the other cases have involved Petco Health & Wellness Co.—backed by the Canada Pension Investment Board and a Luxembourg-based private equity firm—and IT services company N-able Inc., which has a parallel deal with Silver Lake Group LLC and Thoma Bravo LP. One similar suit, filed in December, concerns a pact between Driven Brands Holding Co. and Roark Capital Group Inc.

Ascension Health Alliance and TowerBrook Capital Partners LP, meanwhile, agreed last year to shoulder nearly $40 million of a roughly $46 million settlement resolving shareholder litigation over an allegedly lopsided financing round at R1 RCM Inc. that gave them certain parallel veto rights.

Laster’s prior decision, issued Feb. 12, denied the company’s initial bid to end the case. In that ruling, the judge rejected the argument that the pension fund should have either challenged the stockholder agreement soon after it was adopted or waited until the company actually wields it unfairly.

“The plaintiff has not sued too late,” he said Feb. 12. “Nor has the plaintiff sued too early.”

West Palm Beach Firefighters’ Pension Fund is represented by Saxena White PA. The company is represented by Morris, Nichols, Arsht & Tunnell LLP and Wachtell, Lipton, Rosen & Katz.

The case is W. Palm Beach Firefighters’ Pension Fund v. Moelis & Co., Del. Ch., No. 2023-0309, 2/26/24.