In the Court of Chancery of the State of Delaware
Key Facts: Trados Incorporated agreed to sell the entire company for $60M, of which approximately $52M was paid to preferred stockholders in connection with a liquidation preference of the preferred stock and approximately $8M was paid to management in connection with a management incentive plan (MIP). The common stockholders received nothing in the sale. In April of 2004, the Board began to discuss the potential sale of the Company. A couple of months later a turnaround CEO was hired. At that time the Company was losing money and had little cash to fund operations. However, under the direction of the new CEO, the Company improved its performance, was able to borrow money, and it no longer had a need for cash. In February 2005 following the improved performance of the Company, the CEO was instructed to initiate merger discussions. The Board consisted of seven Directors, four of which represented preferred stockholders, two of which were management who would participate in the MIP, and one independent director.
Complaint: The former common stockholders of Trados Incorporated initiated a class action, claiming breach of the Directors’ fiduciary duties in connection with the sale of the Company.
Delaware Court of Chancery Findings: In response to the Directors Motion to Dismiss the Complaint, the Court found that the plaintiffs alleged sufficient claims to allow the case to proceed as to the Directors breaching their fiduciary duties. The court focused on the fact that a majority of the Board was not disinterested and found nothing to indicate that the Board considered the interests of the common stockholders. Since the preferred stockholders received financial benefits that were not shared equally by all of the stockholders, the Court found six of the seven Directors to have a conflict of interest. The financial benefits were found by the Court to be of a sufficiently material importance to have made it improbable that the conflicted Directors would not be influenced by their personal interests. The Court indicated that it was reasonable to infer that the common stockholders would receive some consideration for their stock at some point in the future had the sale been deferred. The Board’s fiduciary duties were owed to the common stockholders as well as the preferred stockholders where there is no preference. However, the Court held that it will be the duty of the Directors to prefer the interests of the common stockholders where there is a conflict.
Practical Pointers: Having a majority of the Board represented by disinterested Directors or establishing a disinterested Committee of the Board to address matters involving conflicts of interest can be beneficial and result in lower levels of scrutiny upon Court review. Further, the interests of the common stockholders needs to be addressed (and possibly preferred over the interests of the preferred stockholders), and a record of addressing the rights and interests of the common stockholders should be established in the Board minutes.
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