September 21, 2018

Delaware Chancery Says Merger Doesn’t Extinguish Exercised Put Rights

In QC Holdings v. Allconnect, Vice Chancellor Laster held that obligations to investors who had exercised a put right prior to a merger were not extinguished by that transaction – despite the fact that, prior to the deal, the selling corporation did not have funds legally available to repurchase the shares under Delaware law.  This Morris James blog summarizes the case. Here’s an excerpt:

Briefly, the stockholder in this case had exercised its put rights, but the payment date was tolled according to the contract’s terms and based on the company’s then-present financial circumstances. Before the company could satisfy the put, it was acquired. The acquirer declined to respect the put. The stockholder sued and the Court ruled in its favor.

In doing so, the Court first rejected the acquirer’s argument that the put rights were a one-time exercise opportunity, rather than an ongoing obligation if funds were not available at exercise. According to the Court, the acquirer’s position would result in a commercially irrational forfeiture without the necessary clear language requiring a forfeiture. The Court also rejected the stockholder’s argument that the merger consideration constituted legally available funds of the company to satisfy the put.

The Court further found that, had the stockholder continued to hold its stock, its rights may have been limited to accepting its share of the merger consideration. But the Court ultimately ruled in the stockholder’s favor because it had transferred the put shares to the company at the time of its exercise, making it a contractual creditor, no longer a stockholder. The payment obligation of the company became the obligation of the acquirer under Section 259 of the DGCL and was due and owing.

There’s an important drafting note in the Vice Chancellor’s opinion. He suggests that the decision was a closer call than might otherwise have been the case if the contract had included language regarding the ongoing nature of the redemption obligation – language that was included in the terms of other securities issued by the company:

When sophisticated parties negotiate redemption rights, they frequently include language specifying that the obligation to redeem the shares will be ongoing. The redemption rights addressed in other cases illustrate this point. Closer to home, the redemption right enjoyed by the holders of the Series F Preferred established an ongoing redemption obligation, stating:

“At any time and from time to time thereafter when additional funds of the Corporation are legally available for redemption of shares of Preferred Stock, such funds immediately will be used to redeem the balance of the shares of Preferred Stock which the Corporation has become obligated to redeem on any Redemption Date but which it has not redeemed.”

Vice Chancellor Laster pointed out that no analogous provision appeared in the put agreement, thus allowing the company to make a “linguistically plausible” argument that its obligations terminated when the merger closed.

John Jenkins