May 16, 2019

Not So Efficient Breach: Consent Right Breach Carries $126mm Price Tag

This Fox Rothschild blog reviews the Delaware Supreme Court’s recent decision in Leaf Invenergy Co. v. Invenergy Renewables, LLC, in which it reversed the Chancery Court’s decision to award only nominal damages in connection with a company’s breach of an investor’s consent right. Instead, the Court determined that the plaintiff was entitled to $126 million in damages!  This excerpt summarizes the Court’s reasoning:

The High Court found that Leaf had previously negotiated consent rights when investing $30 million into Invenergy, which required the investor’s permission in advance of any material sale.  Per the opinion, the relevant contract provision reflected each side’s intention to either move forward with a such a sale only with Leaf’s consent, or to require Invenergy to buy out Leaf if it did not consent to the transaction.  When the Court of Chancery determined that those rights had been breached, it should have upheld contractual provisions calling for a damages multiplier, per the Supreme Court.

Instead, Vice Chancellor Laster held that an “efficient breach” had occurred, because even though Invenergy did not seek Leaf’s consent prior to the sale, the trial court found that Leaf received more in the sale than it would have under the contract terms.  Vice Chancellor Laster thus decided on the $1 nominal damages award because he determined that Leaf was left no worse off despite the breaches, in light of the efficient breach doctrine.

When assessing damages, the High Court found that the Court of Chancery erred by limiting its focus on the harm to Leaf in the context of the results of the sale, rather than considering the full effect of Invenergy’s contractual breach in failing to seek Leaf’s consent and then failing to pay the target multiple.  The Supreme Court stated held the trial court should have taken a broader approach that “considered the combination of [all aspects of the contractual breaches] when assessing what injury Leaf suffered from Invenergy’s breach and thus what amount of damages would return Leaf to the position it would have been in had Invenergy not breached [the contract]”.

This decision may turn out to be good news for holders of preferred stock generally. That’s because recent Delaware precedent suggested that directors’ fiduciary duties to common holders might require them to use the “efficient breach” concept in order to avoid complying with preferred stock’s contract rights.

For example, in Hsu Living Trust v. ODN Holding, (Del. Ch.; 5/17), Vice Chancellor Laster held that a board’s fiduciary duty to common shareholders may obligate it to breach contractual obligations to preferred shareholders if it could do so through an “efficient breach.”  The Supreme Court’s approach in Invenergy complicates the efficient breach analysis, and may increase the leverage of preferred holders when attempting to exercise or enforce those rights.

John Jenkins