Recently, the Delaware Court of Chancery upheld a waiver of fiduciary duty by stockholders of a Delaware corporation. There, in New Enterprise Associates 14 v. Rich, the court found that a fiduciary waiver in a stockholders’ agreement will be upheld if sophisticated stockholders make an informed and unforced decision to do so.
The Rich plaintiffs, a group of investment funds managed by venture capital firms, invested in a private company called Fugue, Inc. The funds were seeking liquidity and did not want to increase their funding but could not find a buyer. Fugue management told its investors that a group led by defendant Rich could make an equity investment on the condition that all existing preferred stock became common stock, that the Rich Group received new preferred stock, and that the funds signed a voting agreement. The voting agreement included a drag-along provision by which all parties agreed to sell their shares in a transaction satisfying a list of conditions set out in the voting agreement. The drag-along provision included a covenant by the plaintiffs not to sue the Rich Group over a drag-along sale, including for a breach of fiduciary duty covenant.
Later, after Rich gained control of the Fugue board, the company agreed to be sold and the defendants circulated notice of the drag along. The plaintiffs asked the defendants to confirm that they had no communications with the buyer before the Rich investment, and they demurred. The plaintiffs then filed suit for breach of fiduciary duty.
The defendants argued that the plaintiffs’ covenant not to sue foreclosed the plaintiffs from bringing any claims for breach of fiduciary duty. The plaintiffs argued that the provision containing the covenant not to sue was invalid and should not be enforced.
The court enforced the provision, confirming that it would enforce covenants not to sue for breach of fiduciary duty if they are narrowly tailored and reasonable under the circumstances. The provision was narrowly tailored, according to the court, because it only applied to the signatories of the covenant and not all investors, and only in connection with sales transactions that met the specified requirements to be considered a drag-along sale. The court said the provision was reasonable under the circumstances because it was part of an agreement made between sophisticated parties who were familiar with provisions such as this one, and because similar outcomes are permitted under agency law, trust law and Delaware common law. The court also noted that waivers of fiduciary duty are permitted in a corporate charter, which requires stricter scrutiny than stockholder-level agreements.
The court found that the language was not an outright waiver of fiduciary duty, but a tailoring of fiduciary duty according to terms agreed upon by the parties. Liability for breach of fiduciary duty of a Delaware corporation cannot be eliminated or modified, but it can be tailored, the court held. The court stated, however, that liability for bad faith or intentional wrongdoing cannot be waived by contract. The court reiterated Delaware’s emphasis on contractual freedom and emphasized that the defendants were sophisticated parties that were free to agree to allow the company to take action which would otherwise be considered a breach of fiduciary duty. Lastly, the court said that a different result might be appropriate if different factors were present, such as if the signatories were retail investors or were not free to negotiate the terms of the agreement, or if the agreement purported to waive liability for intentional wrongdoing or bad faith.
It seems fitting that the Rich case involved venture capital investors. While Rich involves waiver of fiduciary duty in a Delaware corporation, institutional investors in private investment funds (including venture, private equity and hedge funds) organized under Delaware limited partnership law or its LLC law are accustomed to fiduciary duty waivers. Indeed, in Rich, the court favorably cited Dieckman v. Regency GP LP, a 2016 Chancery Court decision affirming that a limited partnership may waive fiduciary duties.1
In sum, Rich can be seen as an affirmation that institutional investors will face an uphill battle to invalidate a waiver of fiduciary duty in a Delaware legal entity ‒ and not just in limited partnerships and LLCs but corporations as well.
- 2016 WL 1223348, at *8 (Del. Ch. Mar. 29, 2016), rev’d on other grounds, 155 A.3d 358 (Del. 2017)
Client Alert 2023-168
