Not Without Consent: Protecting Consent Rights Against Deliberate Breach
Karen A. Chesley
Under Delaware law, corporate officers and directors are bound by two distinct obligations: fiduciary duties to stockholders as a whole, and contractual obligations entered into on behalf of the corporation. One species of contractual obligation is “consent rights,” or limitations on what the corporation can do without approval from a specified party. Such rights are commonly granted by corporations in contracts governing loans, joint ventures, and the issuance of preferred stock.
When a consent rightsholder invokes its ability to block corporate conduct that management may otherwise believe is in the best interest of the corporation, management may face a conflict between its obligation to act in the best interests of stockholders and its obligation to respect the contractual rights to which the corporation voluntarily agreed. Are there any circumstances, for example, under which a joint venturer should abandon its contractual obligations and take action that its fellow partner has unreasonably refused to approve? At the extreme end of the spectrum, if the partner is blocking action indisputably in the best interests of the joint venture, does that justify breaching the partner’s consent rights—and if so, how should courts address such a breach? And does it matter if the partner is clearly using its consent rights to harm the company, thereby holding the company hostage until it pays an unjustifiably high ransom?
Recent Delaware decisions have suggested that the doctrine of “efficient breach” may resolve this conflict. Under this theory, a corporation may breach a party’s consent rights where doing so is in the best interest of stockholders, with the caveat—recently emphasized by the Delaware Supreme Court—that the corporation must pay damages to the consent rightsholder to fully compensate for its loss. The invocation of this doctrine, however, raises several problems, not the least of which is how those damages should be calculated. Although Delaware recognizes that rights may be valued based on a “hypothetical negotiation” for the rightsholders’ consent, there is not a single Delaware case in which a court awarded a substantial sum of money for the breach of a consent right, despite the high value that rightsholders tend to attach to these provisions during contract negotiations. Equally troubling is the difficulty in determining whether a breach is truly “efficient,” given the reputational harm that may befall a corporation that breaches its promises to key contractual counterparties like lenders, partners, and investors.
Like most matters of contract enforcement, these issues are best left to the bargaining table at the time of contracting—or, failing that, ex post negotiations between the parties once a dispute has arisen (fostered, if necessary, through injunctive relief). Absent a negotiated solution, there will continue to be a conflict between satisfying Delaware’s well-established policy of enforcing contracts as they are written and the need to prevent a rogue consent rightsholder from inflicting harm through the misuse of its contractual privileges. In general, courts should not attempt to resolve this conflict by protecting companies that breach a consent rightsholder’s interests under the “efficient breach” doctrine, as the difficulty of assessing damages ex post creates a substantial danger that any monetary remedy would be insufficient to satisfy the rightsholder’s reasonable expectations that the protections it negotiated would be strictly enforced under Delaware law. Instead, courts should more readily look to equitable remedies to force the parties back to the bargaining table.