June 16, 2017
Preferred Stock: Tips for Investors & Boards
Last month, I blogged about the Chancery Court’s decision in Hsu Living Trust v. ODN Holding (Del. Ch.; 5/17) – the latest Delaware decision to limit the rights of preferred stockholders & the board’s obligations to them. In the wake of that decision, this Cleary blog provides tips to preferred investors on how to protect their interests – and to directors, on how to enhance their position in the event of a fiduciary challenge.
The blog notes that the ability of preferred stockholders to elect a majority of the board in the event of default may not adequately protect their interests after ODN Holding. Here’s an excerpt with some alternative protections:
Investors should consider other protections—such as a penalty interest rate following a failure to effect a redemption or stockholder consent rights over company cash expenditures—to safeguard the benefits of the redemption right. In addition, a preferred stock investor might seek to obtain a right —enforceable by specific performance—to foreclose on company assets or unilaterally cause a sale or liquidation of the company following the company’s failure to comply with a demand for redemption, which would eliminate board discretion and make a fiduciary challenge less likely.
The blog also suggests that an alternative process may have put the board in a better position:
The decision also highlights the Delaware courts’ recent emphasis on the stockholder franchise. Under the procedure set forth in the MFW shareholder litigation, the ODN board’s decision-making likely would have benefited from more deferential business judgment review had an uncoerced and informed majority-of-the-minority stockholder vote on the divestitures been combined with ODN’s use of a special board committee (assuming that committee was independent and adequately-empowered)
The biggest takeaway from the case for directors may be that the board’s compliance with its duties in authorizing a contract “does not mean that a company’s subsequent performance of the obligations in that contract will automatically pass fiduciary muster.”
– John Jenkins