LC Capital Master Fund, Ltd. v. James
2010 WL 772306, 990 A.2d 435, 2010 Del. Ch. LEXIS 50 (2010)
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Rule of Law:
When a certificate of designation contractually defines the rights of preferred stockholders in a merger, a board of directors satisfies its fiduciary duties by honoring those specific contractual rights. The board is not obligated to allocate additional merger consideration to the preferred stock at the expense of the common stock.
Facts:
- QuadraMed Corporation's capital structure included common stock and preferred stock, with the rights of the preferred governed by a certificate of designation (the 'Certificate').
- The Certificate specified that in a merger, preferred stockholders did not have voting rights, and a merger would not trigger their liquidation preference.
- The Certificate did, however, grant preferred stockholders a right to convert their shares into common stock at a specified ratio (the 'Conversion Formula') and receive the same consideration as common stockholders.
- QuadraMed explored a potential sale for several years, receiving interest from multiple bidders, including Francisco Partners II, L.P.
- During negotiations, preferred stockholders demanded a price based on their $25 per share liquidation preference, a right not triggered by the merger under the Certificate.
- Francisco Partners made a final offer to acquire QuadraMed, proposing to pay common stockholders $8.50 per share and to cash out the preferred stock on an 'as-if converted' basis using the Conversion Formula, resulting in $13.7097 per preferred share.
- QuadraMed's Board of Directors, advised by a special committee whose members owned common stock but no preferred stock, approved the merger agreement with Francisco Partners, allocating the consideration according to the Conversion Formula.
Procedural Posture:
- Plaintiff LC Capital Master Fund, Ltd., a preferred stockholder of QuadraMed Corporation, filed a lawsuit in the Delaware Court of Chancery against the QuadraMed board and acquirer Francisco Partners II, L.P.
- The plaintiff sought a preliminary injunction to prevent the consummation of the proposed merger between QuadraMed and Francisco Partners.
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Issue:
Does a board of directors breach its fiduciary duty to preferred stockholders by allocating merger consideration based on a contractually defined conversion formula specified in the certificate of designation, rather than allocating a greater amount based on other non-merger contractual rights like liquidation preferences?
Opinions:
Majority - Strine, Vice Chancellor
No, the board of directors did not breach its fiduciary duty. When a certificate of designation provides an objective, contractual basis for allocating merger consideration, a board that honors those bottom-line contractual rights has satisfied its duty to the preferred stockholders. The rights of preferred stock are primarily contractual. Fiduciary duties act as a 'gap-filler' only when a contract is silent or ambiguous. Here, the Certificate was not silent; it explicitly provided the Conversion Formula as the preferred stock's key right in a merger. The Board was correct to honor this bargained-for right. After satisfying its contractual obligations to the preferred, the Board's duty was to act in the best interests of the common stockholders. To have allocated extra value to the preferred stockholders, beyond their contractual entitlement, would have been a breach of duty to the common stockholders.
Analysis:
This decision significantly clarifies the scope of fiduciary duties owed to preferred stockholders in merger transactions, reinforcing the primacy of contract law. It establishes that when a certificate of designation specifically addresses the treatment of preferred stock in a merger, courts will defer to those contractual terms. This ruling provides a clear and predictable framework for corporate boards, allowing them to rely on negotiated contracts when allocating merger consideration, thereby reducing the risk of fiduciary litigation from preferred stockholders seeking more than their bargained-for rights. The case limits the use of 'fiduciary duty' claims as a tool for preferred stockholders to renegotiate their contractual position after a deal is struck.
