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In Energy Founders Fund v. Daskevich, (Tex. Bus.; 5/26), the Texas Business Court rejected a minority investor’s claim that drag-along rights contained in Energy Founders Funds’ (EFF) LLC agreement were not triggered by the controller’s sale of its interests to a third party.

The drag-along provision did not apply to transactions with an affiliate of EFF, and the plaintiff claimed that the substantial contractual control rights that EFF would acquire with respect to the buyer following the sale made the buyer an “Affiliate” of EFF. The agreement used the following common formulation to define the term “Affiliate”:

“Affiliate” means, when used with reference to a specified Person, any other Person that directly, or indirectly through one or more intermediaries, controls, is controlled by or is under common control with the Person specified. For purposes of the foregoing, “control,” “controlled by” and “under common control with” with respect to any Person shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person . . . whether through the ownership of voting securities, partnership interests or other equity interests, or by contract or otherwise.

Analyzing this language, Judge Brian Stanger pointed to three factors that led to the conclusion that the buyer should not be regarded as an Affiliate prior to the closing.  First, he observed that the definition speaks in the present tense. In order to be an Affiliate, the entity must “control”, be “controlled by” or be “under common control with” the specified person. In order to for such control to exist under the agreement, Judge Stanger concluded that the party must presently have “possession” of the power to direct management and policies. In the Judge’s view, the term “possession” means “current, existing authority, not a future or contingent entitlement to it.”

The second factor Judge Stanger identified was that the definition focused on actual operational governance, and that the relevant inquiry was “therefore straightforward: before closing, who could actually run [the buyer],” and that under the terms of the contract, it was clear that any rights EFF had with respect to the buyer’s business did not arise until after the closing.

Finally, the Judge noted that the plaintiff placed significant weight on the language indicating that the control necessary to be regarded as an Affiliate could exist “by contract or otherwise.” While he agreed that this kind of catch-all language was intended to prevent parties from concealing affiliate relationships “behind clever labels or corporate subterfuge,” it did not override the need for the specified person to current have control. Such a conclusion would have the result of reading the term “possession” out of the definition entirely.

Accordingly, Judge Stanger granted the defendant’s motion for summary judgment and dismissed the plaintiff’s claims.

– John Jenkins