Posts in Corporate Charters

Court Of Chancery Again Explains Preferred Stock Rights

Fletcher International LTD v. Ion Geophysical Corp., C.A. 5109-VCS (March 29, 2011)

This is another in the line of decisions that stress that preferred stockholder rights are what is set out in the certificate of incorporation and nothing more.  Thus, if the preferred stockholders bargain for the right to consent to the sale of stock by any subsidiary, then they do not also have the right to vote on the sale of subsidiary stock by the parent.

To be fair, this brief description does not do justice to the Court's careful reasoning and simplifies the charter provisions at issue.  However, best to state the principle starkly to avoid any misunderstanding.

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Court Of Chancery Explains Charter Interpretation Rules

KFC National Council and Advertising Cooperative Inc v. KFC Corporation, C.A. 5191-VCS (January 31, 2011)

When a certificate of incorporation is ambiguous, the Court must decide what it means.  This decision explains how a court will do that job.

At least in the case of a publicly traded corporation, the Court is less inclined to use parol evidence and more inclined to fall back on rules of construction.  One such rule is that it is presumed that stockholders retain the power to decide matters that are usually reserved for stockholder decision.  Hence, if a stockholder or the board claim unusual powers, they had better spell those out clearly or lose the dispute.

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Court Of Chancery Upholds Limits On Redemption Right

SV Investment Partners, LLC v. Thoughtworks, Inc., C.A. 2724-VCL (November 10, 2010)

Private equity investors often want to use preferred stock to invest in a company.  In doing so the investors expect to be cashed out at some defined point.  They frequently provide for that by having the certificate of incorporation require mandatory redemption of the preferred stock.  One customary limit on those redemption rights is that only "funds legally available" be used for the redemption. Investors may assume that means that if the company's assets exceed its liabilities that redemption is required at least to the extent of the excess.

Well if they think that they are wrong. This decision holds that the "funds" available refers to the company's cash and that cash may only be used if to do so will not impair the company's ability to pay its creditors in due course. As a result,  what seemed like mandatory redemption may instead be put off indefinitely.

This is not just a simple matter to cure by drafting, however.  While it is true, as the decision points out, that all sorts of investment vehicles exist to permit an investor to demand and get back its investment, those may not always be appropriate.  Preferred stock has the advantage of being treated as equity on a balance sheet. Other investment vehicles may not have that advantage.

The real issue is who calls the shots once the mandatory redemption deadline passes without redemption.  If the investors want to do so, then they need to bargain for that power when they make their investment.

This decision was affirmed by the Supreme Court on November 15, 2011.

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Court Of Chancery Explains Conversion Cap

ION Geophysical Corporation v. Fletcher International Ltd., C.A. No. 5050-VCP (November 5, 2010)

This decision explains how a  'conversion cap' works to prevent the holders of convertible securities from converting those securities to common stock.  These provisions thereby avoid running afoul of the SEC rules on registering ownership of stock.

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Court Of Chancery Addresses "Blank Check Company" Agreement

Ruffalo v. TransTech Service Partners Inc., C.A. 5039-VCP (August 23, 2010)

This decision addresses the rights of investors in a so-called "blank check company" where a pool of money is raised to invest in some to-be determined business.  Not surprisingly,  the investors' rights are determined by what the certificate of incorporation provides. That may not be an easy matter to determine, as such "contracts' are, as here, complicated and not always clear.

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Court Of Chancery Limits Remedy For Charter Breach

Fletcher International Inc. v. ION Geophysical Corp.,  C.A. 5109-VCP (March 24, 2010)

When a provision in a certificate of incorporation is violated, the question that often arises is what is the remedy. Often the Court  will enjoin the violation, but not always. Here the preferred stock had approval rights for certain corporate transactions. Those rights were violated. Finding that an injunction would cause more harm than was merited, the Court denied the injunction and remitted  a damages remedy to the plaintiff.

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Court of Chancery Approves "Continuing Directors"

San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals Inc., C.A. 4446-VCL (May 12, 2009)

One defense against a hostile takeover is a provision that permits only "continuing directors" to approve certain important corporate acts.  In general, to be a "continuing director" you need to be "approved" by the existing board.  Hence, if you are elected in a proxy contest that marks the beginning of a takeover battle, you may not be an approved "continuing director."  That would be a bad thing for your client.

In this decision, the Court upheld the power of the board to approve even candidates from an opposition slate of directors to be "continuing directors."  This unusual circumstance was the result of a bond debenture provision that would have triggered a default if there were too many non-continuing directors on the board.  To avoid a default, it was decided to approve even the enemy.

That, in turn, lead the Court to be concerned about whether the board had acted in the stockholders' best interests.  The Court cautioned that the approval must be a considered act and that the adoption of such continuing director provisions needs to be carefully reviewed by the board in the future if they are to be upheld.

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Court of Chancery Divides Settlement Among Shareholders In Class Action Suit

The plan of allocation approved in Ginsburg v. Philadelphia Stock Exchange et. al., C.A. No. 2202-CC is a landmark decision for those in the business of litigation arbitrage, buying shares of a company that is involved in a class action that may lead to substantial settlement proceeds. More ›

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Supreme Court Upholds Preferred Stock Provision

Hildreth v. Castle Dental Centers, Inc., Del. Sup. C.A. No. 195, 2007 (November 15, 2007).

A tricky issue arises when a defective certificate of incorporation causes stock to be void. Here, the preferred stock was validly authorized but there was not enough common stock to fulfill the conversion rights of the preferred. The Supreme Court held that the defect was with the common stock, not with the preferred. Hence, one defect in the "contract" will not invalidate the whole contract.

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Court of Chancery Interprets Change of Control Provision

Law Debenture  Trust Company of New York v. Petrohawk Energy Corp., C.A. No. 2422-VCS (August 1, 2007).

Change of control provisions are common in employment contracts and other contexts. Here the provision was in a debenture. While primarily focusing on the specific language involved, this opinion is useful to others to see how to avoid triggering a change in control provision while at the same time implementing a merger.

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Court of Chancery Interprets No Shop Clause

Energy Partners Ltd. v. Stone Energy Corporation, C.A. No. 2402-N (Del. Ch. October 11, 2006). The Court of Chancery may be called upon to decide the scope of a board of director's duties in appropriate cases. Here, the Court interpreted a common merger agreement provision that limited the board's options in considering third party bids while the merger was pending. The Court held the provision permitted contact with the new bidder. More › Share

Court of Chancery Holds Dividends May Not Be Forced

Superior Vision Services, Inc. v. Reliastar Life Insurance Company, C.A. No. 1668-N (Del. Ch. August 25, 2006). This decision answers the question of when a minority shareholder may block a dividend payment pursuant to the authority to do so in the company's certificate of incorporation. The Superior Vision charter provided that a dividend could not be paid absent the consent of 2/3 of the shareholders. As a 44% owner, the defendant refused to consent to the dividend. The company sued alleging that the defendant had violated a fiduciary duty to consent to the dividend and its duty of good faith and fair dealing. The Court first held that absent actual control over the board of directors, a minority shareholder would not be deemed to be in control of the board just because it can block a board decision to pay a dividend. As a result, the Court concluded that the defendant did not owe a fiduciary duty to the company or its shareholders. In addition, the Court held that when, as here, the certificate of incorporation confers a power to veto a transaction and does not condition the exercise of that right, then there is no duty to act reasonably in that regard. Hence, the duty of good faith and fair dealing was not implicated and the Court dismissed the complaint. More › Share

Delaware Supreme Court Affirms Chancery Court Ruling that Preferred Stock Was Properly Issued

Benihana of Tokyo, Inc. v. Benihana, Inc., No. 36, 2006, 2006 WL 2465412 (Del. Aug. 24, 2006). The Delaware Supreme Court affirmed post-trial ruling by Court of Chancery that $20 million issuance of preferred stock to a third-party holding company was authorized by the corporate charter and that the directors acted properly in approving that transaction. More › Share

Court of Chancery Interprets Charter For Preferred Stock

Blue Chip Capital Fund II Limited Partnership v. Tuberger, C.A. No. 1611-N (Del. Ch. August 22, 2006). The Court of Chancery frequently is called upon to interpret a corporate certificate of incorporation. In this decision, the Court held that a certificate provision permitting a corporation to withhold a reserve for contingent liabilities in connection with calculating the liquidation preference for preferred shareholders did not automatically authorize the board to hold back the highest possible amount, even if doing so was unreasonable based on objective factors. The Court also held that the authority granted by 8 Del C. §281 to hold back a reserve for continent liabilities did not authorize the board to do so under the charter. Instead, the terms of the certificate need be interpreted on its own terms. More › Share

Court of Chancery Enforces Rights of Preferred Stock

Thoughtworks, Inc. v. SV Investment Partners, LLC, C.A. No. 1695-N, 2006 WL 1903127 (Del. Ch. June 30, 2006). It is often said that preferred stock has only the rights granted to it in the certificate of incorporation. This case illustrates that the Court of Chancery will not, however, hesitate to enforce those rights when the certificate of incorporation is clear. Here, the certificate stated that the preferred was entitled to be redeemed and to consent to an extension of the company line of credit. The Court enforced those rights. Share