Preferred vs. Common -- Who Is Commonly Preferred In Mergers?

Preferred vs. Common -- Who Is Commonly Preferred In Mergers?

By Steven Bartz Esq., Rahul Patel Esq. and R. Samuel Snider Esq.


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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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.