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Court of Chancery Clarifies Directors Duties in Common/Preferred Stock Conflict

Posted In Fiduciary Duty

In re Trados Incorporated Shareholder Litigation, C.A. 1512-CC (July 24, 2009).

Directors sometimes face a conflict between what is best for the common stockholders compared to what is best for the preferred stockholders. While it is generally recognized that preferred stockholder rights are largely contractual and not based on fiduciary duties, that does not resolve all conflicts with common stockholders. The certificate of incorporation just cannot deal with every possible conflict. Here the Court  held that common stock is to be favored in any conflict with the preferred that is not resolved by the terms of the certificate of incorporation. That will not solve all the problems, of course, and in this case, the Court held that a full trial might be needed to reach a final decision on how the preferred/common conflict should be resolved.

Where then does that leave a board of directors faced with such a conflict in the interests of the common and preferred stockholders? The answer probably lies in the case law dealing with what to do when a company is insolvent and the creditors are the residual risk holders. In that instance, the stockholders want the board to use every last dollar to reverse the company's fortunes, while the creditors want asset preservation and liquidation to get what they can. The Delaware Courts have held in that circumstance, the board is charged with making a business judgment over what is the best course for the entity to follow. That is easier said than done but may boil down to a risk/benefit analysis somewhat like a card player makes when deciding if it is time to fold his hand. So long as the board acts in good faith, its decision should be upheld.

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