By Steven Bartz Esq., Rahul Patel Esq. and R. Samuel Snider
Esq.
Introduction
When a conflict of interests exists between preferred stockholders and common
stockholders, to whom does the board owe duties and what duties does it owe?
Under Delaware law, the basic rights of common stockholders are set forth in
the Delaware General Corporation Law, and Delaware case law clearly defines the
contours of the duties that directors owe common stockholders. The rights of
preferred stockholders, on the other hand, are a hybrid of contractual,
equitable, and other legal rights. As stated in Appraisal of Metromedia
Int'l Group, Inc., "[a] preferred shareholder's rights are defined in
either the corporation's certificate of incorporation or in the certificate of
designation, which acts as an amendment to a certificate of
incorporation," but the rights of preferred stockholders are, for example,
also "interwoven with a stockholder's statutory right of appraisal." 1
Recent decisions indicate that Delaware courts will honor preferred stock terms
as written in their underlying governing documents and will not interpret them
more broadly when the terms addressing a particular situation are clear and
unambiguous. In the absence of clearly negotiated contract provisions
addressing a particular situation, directors must act to protect the interests
of both preferred stockholders and common stockholders when their interests are
aligned. But when the interests of preferred and common stockholders are not
aligned, directors must generally prefer the interests of the common
stockholders.
In negotiating and approving a merger, it is possible for directors to breach
their fiduciary duties by improperly favoring the interests of preferred
stockholders when their interests are opposed to those of the common
stockholders. Delaware courts are inclined to treat preferred stockholders as
sophisticated investors and will honor the contractual bargain that they
struck. Consequently, investors in, and issuers of, preferred stock should
carefully negotiate the terms of their investments and should address as many
potential situations as possible in their contracts.
Issuers and their directors can minimize the likelihood that their decisions
regarding a merger will end in litigation by precisely describing the rights
that preferred stockholders do and do not have. Preferred stockholders should
understand that Delaware courts will not rescue them from a bad result if the
contractual terms for which they negotiated do not dictate the desired outcome.
As such, asserting a breach of duty claim against the board of the issuer will
not likely save a preferred stockholder from a bad result in a merger.
Investors in, and issuers of, preferred stock can avoid potential lawsuits by
taking time to carefully negotiate the terms of the investment, and they should
be prepared to live with the terms of the deal that they negotiate.
II. Overview of Developments
The scenario in which a board is most likely to encounter conflicts of interest
between the selling corporation's preferred and common stockholders is during ...
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ABOUT THE AUTHOR(S):
Sam Snider is Vice President and Lead Acquisition Counsel for
LexisNexis, a division of Reed Elsevier Inc. He is responsible for all aspects
of LexisNexis global mergers, acquisitions, divestitures and restructuring
activities, including numerous acquisitions in the United States, Europe and
Asia. In addition, he leads the Outsourcing and Offshoring and U.S. Legal
Compliance teams within the LexisNexis legal department. He is a frequent
writer and speaker on corporate law and M&A matters and was named a Georgia
Rising Star by Atlanta Magazine and Georgia Super Lawyers-Rising Star
Edition.
Rahul Patel is a partner in King & Spalding LLP's Corporate Practice
Group, where his practice focuses on mergers and acquisitions and strategic
corporate transactions. A significant portion of his practice involves cross-border
transactions, particularly transactions involving Indian companies. He is the
President of the University of Florida College of Law Alumni Council, serves on
the University of Florida Alumni Association Board of Directors, and was
recently one of three University of Florida Law School alumni given the
inaugural Outstanding Young Alumnus Award. He has also been named a Georgia
Rising Star by Atlanta Magazine and Georgia Super Lawyers-Rising Star
Edition.
Steven Bartz is an associate in the Atlanta office of King &
Spalding and a member of the firm's Corporate Practice.