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Chancery Enforces Preferred Stock Consent Rights, and Reasons that Designee of a Corporate Stockholder Is an “Affiliate” of that Stockholder for Purposes of an “Interested Party” Clause

Posted In Preferred Stock

PWP Xerion Holdings III LLC v. Red Leaf Resources Inc., C.A. No. 2017-0235-JTL (Del. Ch. Oct. 23, 2019).

Preferred stockholders frequently obtain the right to veto specific types of transactions.  Here, plaintiff PWP Xerion Holdings III LLC (“Xerion”), a hedge fund that acquired Series A Preferred Stock in Red Leaf Resources Inc. (the “Company”), obtained consent rights for certain events, including (i) any transaction “with or for the benefit of any director or officer (or their respective affiliates)”; and (ii) any change of “the business or business plan” of the Company.  In this decision, the Court of Chancery grants partial summary judgment on Xerion’s claims that the Company violated these consent rights.   

Before the dispute arose, the Company had participated in a joint venture agreement with a major oil company aimed at developing certain technology to extract oil from shale (the “JV”).  The major oil company became a stockholder of the Company and obtained the right to designate a board member.  When the JV did not work out, the board of the Company voted to exit the JV, and the director designated by the major oil company voted for that exit.  The end of the JV also required the Company to refocus its business plan to extraction in a different location and using different technology.

Xerion declined to approve the exit from the JV and the change of business plan, and sued for breach of its consent rights.  The Court of Chancery agreed with Xerion that the director appointed by the major oil company who also was an officer of that company was an “affiliate” of it, citing dictionary definitions of that term and usage under corporate and securities law statutes.  Accordingly, Xerion’s consent was required to exit the JV.  Likewise, refocusing the business from one technology in Utah to a similar but not identical technology in Jordan required Xerion’s consent, as such a change required material alterations to the business plan.  Company witnesses uniformly asserted in depositions that the business plan broadly was “to develop, commercialize, and license its oil shale technology,” but the Court noted that was its business, not its business plan.  While the former remained constant, the latter had changed, and so Xerion’s approval was required.