Since enacted, Title 8, Section 102(b)(7) of Delaware's Corporate Code has allowed Delaware corporations to exculpate their directors from personal liability to monetary damages due to any breaches of their fiduciary duties by including an exculpation provision in their Articles of Incorporation. However, this protection has never been extended to officers of a corporation, such as its President, Treasurer, or Secretary. This all changed August 1st, 2022, when Delaware amended 102(b)(7) to now extend its protection and allow corporations to exculpate their officers for the same breaches of fiduciary duties. As a result, Delaware corporations can now insulate both their directors and officers from monetary damages that arise from breaches of their fiduciary duties, subject to a few caveats.
Key Differences Between Officer and Director Exculpation Protection.
Despite this new level of protection, exculpation under 102(b)(7) does not provide identical protections to corporate officers as it does to directors. First, exculpation is only available to high-ranking senior officers, such as a President or Chief Financial Officer. Also, corporations still may not eliminate or limit the personal liability of officers for (1) claims for which exculpation of corporate directors is not permissible, or (2) claims brought by or on behalf of the corporation, including shareholder derivative actions. In contrast to this, corporations are able to exculpate directors for breaches of the duty of care however those claims are asserted, whether directly or derivatively. This means that corporate boards still retain their authority to assert their company’s claims against officers who breach their duty of loyalty, act in bad faith, or receive an improper benefit from a transaction. Furthermore, if the board is unable to assert the claim, a shareholder may assert it derivatively on behalf of the corporation. This effectively ensures that the traditional checks on corporate officers’ actions remain in effect, which many view as key to being able to obtain shareholder approval and support to extend exculpation to officers.
Implementation of Officer Exculpation via Article Amendments.
This change does not have a meaningful effect on companies not yet incorporated. A company looking to incorporate in Delaware can exculpate its officers by simply including an exculpation provision in its Articles of Incorporation when it files to incorporate. This is no different than under the prior version of 102(b)(7) for exculpating directors. However, for those already incorporated in Delaware, the process is more complicated. In order to implement officer exculpation this typically will require (1) an amendment to the corporation’s Articles of Incorporation, (2) approval by the board of directors, and (3) adoption by shareholders at a meeting or by written consent.
Shareholders Generally Accept Exculpating Officers.
In order to amend a corporation's Articles of Incorporation, Delaware traditionally requires a vote by the majority of outstanding shares unless a corporation’s Articles state otherwise. In order to gain this requisite approval, public companies generally must solicit their shareholders’ approval by way of Proxy Statements. These Statements provide shareholders with information on the measures the board is seeking to implement and ask for shareholders to vote in support of the actions. The statements also must be filed with the SEC no later than the date the statements are first sent to shareholders.
The 2023 Proxy Statements filed for public companies are the first true look into the trends on officer exculpation proposals. Overall, they show that the majority of shareholders are accepting and approving officer exculpation amendments. This year, 260 Article amendment proposals including the exculpation provision were submitted for approval by public Delaware corporations and only sixteen have not passed. This results in an overall 85% acceptance rate of the amendment. Of the sixteen that did not pass, most failed due to technicalities, not outright shareholder rejection of the measures. More than half of those companies required a supermajority shareholder approval to amend their Articles, unlike the lower standard of a majority of outstanding shares. Also, the remaining companies that did not pass the amendment failed due not having enough shareholder participation in the meetings for voting on the amendments. These higher standards and insufficient shareholder participation are likely what led to the amendments not being approved rather than shareholders actually rejecting the substance of exculpating corporate officers.
Furthermore, the amendments are being approved well above the minimum majority of outstanding shares, with an average of a 71% shareholder approval rating in the actual votes on the amendment. This shows that the majority of shareholders overwhelmingly support exculpating corporate officers from monetary damages. At first glance, this level of shareholder support is somewhat surprising, given that the natural assumption is shareholders would be opposed to relieving corporate officers from monetary damages when they breach their fiduciary duties. However, this is likely explained by the fact that even with the amendment, officers still cannot be immunized from claims brought by or on behalf of the corporation. Shareholders’ own interests in the corporation are still protected by being able to seek the corporation’s board to bring a claim on behalf of the corporation for breaches by an officer, or alternatively, by shareholders bringing a derivative action themselves against an officer. This protection explains the level of support despite the initial appearance of officer exculpation being contrary to shareholders’ own interests.
All Challenges to Officer Exculpation by Shareholders Have Failed.
Despite this general acceptance by corporate shareholders, there have been at least three lawsuits filed against corporations seeking to invalidate the amendments exculpating officers; however, all have failed. Two of these suits, Electrical Workers Pension Fund, Local 103, I.B.E.W. v. Fox Corp., and Sbroglio v. Snap, Inc., involved corporations with two different classes of stock, voting and non-voting. Both of the corporations’ Articles only required approval from their voting classes of stock in order to amend the Articles. The voting-class shareholders approved the amendments, which led to the non-voting shareholders filing suit on the grounds that the amendment’s approval was void because it violated Section 242(b)(2) of Delaware’s Code, which relates to separate class voting requirements.
Under 242(b)(2), if a corporation has more than one class of stock outstanding and a proposed Article amendment would “alter or change the powers, preferences, or special rights” of a class of stock in an adverse way, then the amendment must be adopted by a majority of that outstanding class of stock that’s adversely-affected. This challenge was expressly rejected by the Delaware Chancery Court in both cases, holding that the officer exculpation amendments did not affect any of the non-voting shareholders’ powers or preferences that were “expressly set out” in the corporations’ Articles. Therefore, only approval from a majority of the voting-class shareholders, not non-voting, was needed, and the amendment’s implementation was valid in both cases.
However, up to this point there has not been a challenge to the actual substance of amendments exculpating officers. This means that there may be later shareholder challenges that argue the amendment itself is invalid, even if its implementation is proper under Delaware’s Corporate Code.
Officer Exculpation Will Likely Become the Norm Under 102(b)(7).
In the near future, it is highly likely that there will be substantially more Delaware corporations beginning to implement officer exculpation provisions through amendments to their Articles for a variety of reasons. First, it is to a corporation’s benefit to exculpate its officers in order to attract better talent to its corporate governance. A main factor that dissuades individuals from serving as corporate directors and officers is the risk of being subject to personal liability for damages due to their actions. Although corporations currently can provide indemnification to officers as a way to limit their exposure to financial liability, by shielding officers from liability fully, similar to its directors, corporations can even better incentivize highly-qualified individuals to serve as their officers. This would ultimately lead to corporations being able to produce better products and services overall due to attracting and retaining higher-quality individuals in their governance structure.
Next, aside from the benefits of officer exculpation, corporations now have quantifiable data which supports that they will be able to easily implement the Article amendment without fear it will later be invalidated. With overwhelming shareholder support for the amendment, as shown by the 2023 Proxy Statement data, Delaware corporations can safely assume that so long as they effectively solicit their shareholders through Proxy Statements, they will generally be able to gain the requisite shareholder support needed to implement officer exculpation through an Article amendment. Additionally, the recent rulings by the Delaware Chancery Court, striking down all shareholder challenges to the amendment, provide further support for this action. This precedent establishes a strong backstop that corporations can safely rely on the court to uphold their amendments that implement officer exculpation despite any shareholder challenges after the fact.
Overall, as a result of this change to 102(b)(7), there is strong support that soon both corporate officers and directors will be fully exculpated from personal liability for breaches of their fiduciary duties due to the benefits corporations can derive from officer exculpation as well as the overall acceptance by corporate shareholders for the measure.
*The views expressed in this article do not represent the views of Santa Clara University.