The Delaware Court of Chancery’s recent opinion in Carsanaro v. Bloodhound Technologies is a wake-up call to venture capital firms. In a nearly 40 page opinion, Vice Chancellor Laster held that VCs are not necessarily immune to private litigation from shareholders who claim unfair dilution from down round financing transactions, even when the VCs are not controlling shareholders. Under Bloodhound, early investors have standing to pursue direct litigation to challenge dilutive stock issuances when the transaction is not approved by a majority of disinterested and independent directors.
Prior to Bloodhound, unless a controlling shareholder stood on both sides of the stock issuance, shareholders could pursue only derivative litigation to challenge a dilutive stock transaction — the lawsuit would be brought on behalf of the company and only if the shareholder could establish demand futility. As a practical matter, the absence of a direct financial incentive to pursue litigation and the procedural hurdles associated with derivative litigation made lawsuits arising out of dilutive stock transactions relatively rare. But Bloodhound opens the door to direct lawsuits by early investors when a majority of directors who approve the dilutive transaction are beholden to participating investors — which is not unusual in venture capital financing transactions.
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