As we mentioned in this post earlier this month, the Delaware Court of Chancery has issued its decision in the matter of In re Trados Incorporated Shareholder Litigation, C.A. No. 1512-VC (August 16, 2013), in which it addresses extensively a variety of issues that directors and investors will want to consider in similar circumstances. In the opinion, by Vice Chancellor J. Travis Laster, the court found that although the preferred stockholders received all of the merger consideration in an end-stage transaction and the common stockholders received nothing, and although the Trados directors failed to demonstrate that they had followed a fair process, the transaction was still “entirely fair” to the common stockholders because the common stock had no monetary value before the merger. You can read our detailed alert here by DLA Piper partners John J. Gilluly III and John Reed, which provides background for the case and includes additional detail regarding the four key takeaways from the opinion listed below.
Four Key Takeaways from the Trados Opinion
Take into account that director independence is no automatic safe harbor for non-employee directors. Directors are not automatically independent if they do not work for a venture capital firm directly and companies should consider relationships of directors with the venture capital investors when appointing a director believed to be independent or relying on his or her independence in connection with corporate action.
Understand the nature of directors’ fiduciary obligations to preferred shareholders. The court held that directors do not owe fiduciary duties to preferred stockholders when considering an action that might violate or circumvent the preferred shares’ contractual rights (including the preferential rights set forth in a company’s certificate of incorporation). Directors must act in good faith and on an informed basis to maximize the value of the corporation for the benefit of residual claimants (that is, common stockholders and preferred stockholders not relying on a liquidation preference or some other preference). The board owes fiduciary duties to preferred stockholders only when such holders are relying on a right shared equally with common stockholders.
Companies may wish to revisit their management bonuses in change-in-control plans. Directors may violate their duty of loyalty if they improperly structure a change-in-control bonus plan to favor preferred stockholders over common stockholders or to incentivize management to take action for the benefit of the preferred stockholders.
Remember that courts place great weight on contemporaneous written communications of management, directors and investors (including internal reports and communications solely within the venture firms). The court repeatedly references reports made by the board designees of the venture firms to the designees’ partners inside the firms. When considering corporate action that may be challenged later, involved persons should take extra care to ensure that their written communications are accurate and consistent with their fiduciary obligations.