Delaware Supreme Court Affirms Decision as to Valuation of Preferred Stock Converted Before Merger

Delaware Supreme Court Affirms Decision as to Valuation of Preferred Stock Converted Before Merger

Holders of preferred stock ("Series C-1 preferred shareholders") appealed a decision from the Superior Court which found that the Series C-1 preferred shareholders were not entitled to a liquidation preference payout (estimated to be approximately $28.78 per share) because those shares had been automatically and validly converted into common stock immediately prior to the Omneon-Orinda merger.  The value of the cash and stock merger consideration was estimated to be $11.10 per share.  In addition, under the plain language of the Omneon certificate of incorporation, only one series of preferred shares, the Series A-2.2, was legally entitled to a liquidation preference payout.  In Berkeley v. Omneon, Inc., No. 442, 2011 (March 5, 2012), the Delaware Supreme Court affirmed the Superior Court's decision. 

Background

Omneon and Harmonic entered into a merger agreement under which Harmonic would acquire Omneon in a triangular merger involving a Harmonic-controlled entity, Orinda.  The merger agreement provided that, among other things: (i) the Series A-2.2 preferred would receive its approximately $1.5 million liquidation preference as Omneon's charter required; and (ii) the merger would not be consummated until after the remaining preferred shareholders approved, by majority vote, an "automatic" conversion of their preferred shares into common stock (and by agreeing to the conversion, the preferred shareholders would forego their contractual right to any liquidation preference payout that would otherwise be triggered by the merger).  On September 15, 2010, the conversion took place immediately prior to the merger being consummated.  On November 10, 2010, the Series C-1 preferred shareholders filed suit in Superior Court seeking damages equal to the difference between their liquidation preference and the merger consideration they received following the conversion and merger.  The Series C-1 preferred shareholders claimed that they were entitled to their liquidation preference payout, because the conversion was a part of a "Liquidation Event" as defined in the Omneon certificate of incorporation.  Omneon moved for summary judgment and the Superior Court ruled that only the merger was a Liquidation Event, not the conversion involving the Series C-1 preferred shareholders, and because the conversion preceded the merger, the Series C-1 shareholders were common stockholders at the time of the Liquidation Event (the merger), and as such were not entitled to a liquidation preference payment.

Series C-1 Preferred Shareholders Appeal

The issue on appeal was whether the conversion that occurred immediately prior to the consummation of the merger constituted, or was a part of, a "Liquidation Event" as defined by Omneon's charter.  Under the charter, a "Liquidation Event" must occur to trigger the right of the Series C-1 preferred to a liquidation preference payment and the charter specifies that a "Liquidation Event" includes, without limitation, any "reorganization, merger, or consolidation" that transfers a control bloc from Omneon's shareholders to the acquirer.  The Series C-1 preferred shareholders argued that the Superior Court erred in holding that the conversion was not a part of a "Liquidation Event" that would trigger their contractual entitlement to a liquidation preference payment because the conversion was one of a "series of related transactions" that constituted that "event" and as a result, the conversion fell within the Omneon charter's Liquidation Event definition.   Omneon argued that: (i) the conversion was not part of a "series of related transactions" that constituted a Liquidation Event; (ii) only the merger constituted a Liquidation Event and because the conversion took place before the merger, at the time of the merger the Series C-1 preferred shareholders held only common stock that had no "liquidation preference" rights; and (iii) there is a separate charter provision (Article 4(B)(3)(b)) which authorizes, by majority vote of the preferred shareholders, an "automatic" conversion of all preferred shares into common stock. 

 Supreme Court Affirms the Superior Court's Decision

 In finding that the conversion was not a Liquidation Event "transaction," the Supreme Court concluded that under the plain meaning of Omneon's charter language, the Superior Court was correct in finding that: (i) the "automatic" (i.e., forced) conversion was not a part of a Liquidation Event because the conversion was not a transaction in which Harmonic, or a related entity or Harmonic shareholders acquired voting power in Omneon; and (ii) the merger was the only transaction constituting a Liquidation Event and as a result, the Series C-1 preferred shareholders were common stockholders at the time of the Liquidation Event, and as such were no longer entitled to any liquidation preference payment.  The Court noted that under Article 4(B)(2)(b) of the Omneon certificate, a Liquidation Event is "deemed" to occur upon: (1) an "acquisition" in which the acquirer obtains majority voting power "by means of any transaction or series of related transactions" [subsection (b)(i)]; or (2) the closing of the transfer of a majority of voting stock to an acquirer "in one transaction or a series of related transactions" [subsection (b)(ii)]. However, both charter provisions (Article 4(B)(2)(b)(i) and (b)(ii) refer only to "transactions" that involve an acquirer that gains some incremental "voting power" or stock in each component transaction, and that eventually obtains majority voting power at the completion of the "series."  Here, the Court found that the acquirer, Harmonic, did not acquire Omneon or any part of its stock or voting power (let alone majority voting power), in the conversion.  The Court also noted that "[a]lthough those two events were "related" sequentially and factually, they cannot be fused together so as to become "related" legally, and thereby made part of the same Liquidation Event "series."  Any such construction would do violence to the plain language and the underlying intent of clauses b(i) and b(ii), both of which envision aggregating only transactions that transfer voting power from Omneon's shareholders to a third party.  Harmonic played no role, and it received no voting power, in the conversion."

Read more Delaware business litigation case summaries and commentary on Delaware Corporate and Commercial Litigation Blog.

For more information about LexisNexis products and solutions connect with us through our corporate site.

 

Comments

Anonymous
Anonymous
  • 08-03-2012

I would like to say that preferred stock is the ownership stake an investor in a corporation is issued to provide evidence of their preferential rights.