DealLawyers.com Blog

In January, Vice Chancellor Laster issued a post-trial opinion in In Re Dura Medic Holdings, Inc. (Del. Ch.; 1/25) addressing fiduciary duty claims by a target company’s co-founder related to post-acquisition financing from its controlling stockholder. The court found that the financings were not entirely fair. Notably, as a remedy, it applied equitable subordination — treating the parent-level, unsecured subordinated promissory note issued as part of the merger consideration as if the target company had issued it, giving it priority over the challenged financings. Here are the facts involved, from this Sidley Enhanced Scrutiny blog:

In May 2018, Comvest took a controlling stake in Dura Medic, a durable medical equipment supplier. Under the agreement, the selling stockholders, including the co-founder, received $18 million in cash consideration, and a $12 million Seller Note . . . Dura Medic needed cash while new management sought to right the ship, so Comvest, which was then the controlling stockholder of the Company, injected additional funds over four financings. Two of the financings were structured as debt, and two were structured as preferred equity.

The financings provided for a 15% interest rate and, notably, were structurally senior in priority to the co-founder’s Seller Note: the financings were at the operating company level whereas the Seller Note was a debt of the operating company’s parent entity. The Court observed that no outreach to third party sources of financing was conducted, and no market analysis of the terms of the financings was performed before the financings closed. The co-founder challenged the Comvest financings as a breach of Comvest’s fiduciary duty to the Company. The Court of Chancery applied the exacting entire fairness standard of review because Comvest was the controlling shareholder, and Dura Medic’s board lacked an independent and disinterested majority.

VC Laster found that no indicia of fair process or substance were present and rejected the argument that the participation offer to minority stockholders evidenced fairness. Consequently:

To remedy the breach, the Court of Chancery equitably subordinated the challenged financings to be junior to the Seller Note. Equitable subordination, while not a common remedy, may be ordered where a creditor’s inequitable conduct has a detrimental effect on other creditors. It can be a powerful remedy in a distressed entity where subordinated claims may have a greater risk of going unpaid.

In re Dura Medic Holdings, Inc. is a reminder that both publicly traded and privately held companies are best served to consider best practices—substantive and procedural—in related-party transactions. When parties fail to do so, unique equitable remedies may result.

– Meredith Ervine