The terms of the preferred stock issued to PE & VC investors typically include a tightly drawn mandatory redemption obligation that kicks in after a period of time or upon the occurrence of certain events. In Continental Investment Fund v. Tradingscreen, (Del. Ch.; 7/21), the Chancery Court was confronted with a claim by preferred stockholders that a company that lacked sufficient funds to fully satisfy its mandatory redemption obligations violated the terms of the preferred stock.
As a result of the alleged default, the plaintiffs contended that they were entitled to interest from the date of the breach in 2013 through the date in 2020 when the company finally satisfied those obligations. Vice Chancellor Laster disagreed, holding that the company did not violate the terms of the preferred due to its inability to fully redeem the preferred. A Morris James blog summarizes the Vice Chancellor’s decision:
The Court concluded that the company met its redemption obligations in 2013 by redeeming all of the shares that it could. A special committee aided by a financial advisor evaluated the number of funds available for redemptions, including whether the company could obtain debt financing to pay more, and the amount of cash the company needed to continue to operate as a going concern and remain solvent for the foreseeable future. Ultimately, the committee determined that the company could use $7.2 million for redemptions and that the company should keep $20 million cash, an amount the committee thought was needed to retain and attract business in the company’s industry (i.e., providing electronic trading solutions to institutional investors around the world).
In reaching its conclusion, the Court observed that the Committee’s determination was “a judgment-laden exercise entitled to deference” absent a showing of bad faith, unreliable methods or data, or fraud. The defendants did not have the burden to show that paying more would have rendered the company insolvent. Rather, the preferred stockholder had the burden to prove the existence of additional funds legally available to redeem its shares. The Court also rejected the argument that the committee erred by reserving funds for two years of operation, rather than one, reasoning that directors have the discretion to evaluate the appropriate time horizon and resources required for their particular corporation to continue as a going concern.
-John Jenkins, DealLawyers.com October 1, 2021