September 21, 2022

Voting Agreements: Watch Out for Dual-Class Transfer Restrictions

Voting agreements from major shareholders are often a critical component of a merger agreement requiring shareholder approval. But this Cooley blog says that companies with dual-class structures need to ensure that their charter documents contain appropriate language permitting the holders of high-vote stock to enter into those agreements without inadvertently converting into low-vote shares.  It even cites this cautionary tale:

In October 2021, stockholders of Inovalon brought suit in the Delaware Court of Chancery claiming that, by executing the voting agreement, the founder’s high-vote shares automatically converted to low-vote shares, an event that was not described in the company’s proxy statement. The plaintiffs sought a declaration that the shares had been converted and an injunction enjoining the stockholder vote until an accurate proxy statement could be issued. In order to avoid having to delay Inovalon’s special meeting to approve the transaction to litigate the plaintiffs’ claims, the parties agreed with the plaintiffs that, unless the transaction was approved by holders of Inovalon shares sufficient to approve the transaction – assuming that the auto-conversion had in fact occurred – Inovalon would not close the transaction until the Delaware Court of Chancery had ruled on the plaintiffs’ complaint.

In other words, Inovalon and the acquirer were forced to agree to act as though the voting agreement had not been entered into. While Inovalon’s stockholders ultimately approved the transaction in sufficient numbers to satisfy this requirement, if they had not, the consummation of the transaction would have been subject to the resolution of the plaintiffs’ claims in the merits, which could have significantly delayed, or even prevented, closing. Ultimately, the plaintiffs’ firms were awarded $1.9 million in fees and expenses in connection with the disposition of the action, meaningfully in excess of the typical “mootness” fee for public M&A transactions, which one paper estimated as usually in the range of $50,000 to $300,000.

The blog says the best way to avoid this situation is to ensure that an appropriate carve-out is included in the restrictions on transfer of high-vote stock laid out in the certificate of incorporation.  It includes some suggested language and points out that although most modern dual-class charters contain carve-outs that address these concerns, the charters of dual-class companies that went public prior to 2017 may not.

If obtaining shareholder approval for a charter amendment isn’t a viable option, the blog suggests alternative strategies that the company may employ to provide some kind of commitment from a major shareholder that doesn’t run afoul of these restrictions.

John Jenkins