Texas Pacific: Following Trial, Delaware Court Rules Investors Violated Stockholders Agreement

Hogan Lovells

Hogan Lovells

In Texas Pacific Land Corporation v. Horizon Kinetics LLC, the Delaware Court of Chancery ruled in a post-trial opinion that investors violated a stockholders agreement by failing to vote in favor of a board proposal to increase the number of authorized shares of Texas Pacific Land Corporation (the Company). The defendant investor group argued that certain exceptions to a “Voting Commitment” allowed the group not to vote in favor of the board’s proposal. After finding that the exceptions to the Voting Commitment were ambiguous—and that the stockholder agreement’s prohibition on considering negotiation and drafting of the agreement as extrinsic evidence was enforceable—the court considered other extrinsic evidence and concluded that the provisions did not exempt the investors from complying with the Voting Commitment. The court also held that the Company’s disclosure failures in the proxy statement did not constitute “unclean hands” and the Company was entitled to judgment in its favor.

Texas Pacific Land Corporation (the Company) is one of the largest landowners in Texas and was originally constituted as a trust that issued a fixed number of trust certificates. In January 2021, the Company converted from a trust to a corporation. In connection with that change, a group of investors seeking board seats entered into a stockholders agreement pursuant to which the investors were required to vote in favor of board proposals, subject to exceptions for major transactions and environmental, social, and governance matters (the Voting Commitment). A material issue during the conversion process was whether the Company could authorize or issue additional equity, given that the Company’s equity previously had been fixed. The issue was tabled and never resolved. After failing to consummate two potential acquisitions due to the Company’s inflexible equity structure, the Company’s board proposed to increase the number of authorized shares (the Proposal). Two of the signatories to the stockholders agreement (the Investor Group) voted against the Proposal.

The Company filed suit against the Investor Group under Section 225 of the Delaware General Corporation Law. The Investor Group argued that:  (i) the share issuance fell under the exceptions in the stockholders agreement to the Voting Commitment; and (ii) the Company’s disclosure deficiencies in the proxy statement obviated the Investor Group’s obligation to comply with the Voting Commitment under the doctrine of unclean hands.

The court disagreed, holding that: (i) extrinsic evidence of the Investor Group’s subjective beliefs about the terms of the Voting Commitment resolved ambiguous terms in the Company’s favor; and (ii) the disclosure failures did not constitute unclean hands in the context of the voting commitment. The court therefore deemed the shares issued.

A corporation seeking to limit stockholders’ voting rights must first prove the existence of such a limitation. Here, however, the Voting Commitment was an unambiguous limitation on the Investor Group’s voting rights. As a result, the Investor Group bore the burden of proving that an exception the Voting Commitment applied. These exceptions included matters “related to” mergers, acquisitions, and recapitalizations, along with ESG matters. The court held that each party offered reasonable interpretations of the exceptions to the Voting Commitment, rendering the exceptions ambiguous. After determining that none of the exceptions was, on its face, applicable to the share issuance, the court turned to extrinsic evidence to interpret the meaning of the exceptions. 

Importantly, the court held that a provision of the stockholders agreement, prohibiting the use of drafting history in interpreting the agreement, was enforceable, and that expert testimony on trade usage was non‑dispositive. Therefore, the court considered other extrinsic evidence indicating the parties’ course of performance, including correspondence and contemporaneous notes of conversations between members of the Investor Group and third parties. Based on that evidence, the court found that the Investor Group believed in advance of the vote on the Proposal that the Voting Commitment would obligate them to vote in favor of the Proposal. The court thus concluded that the Investor Group failed to prove that any exception to the Voting Commitment applied.

Finally, the court held that the doctrine of unclean hands, based on one misrepresentation and one omission in the proxy statement, would not bar the Company’s success on the merits. The court first cited precedent holding that the duty of disclosure does not apply in connection with a contractual obligation, such as the Voting Commitment. The court then noted that the doctrine of unclean hands is unavailable when the party claiming the doctrine had itself acted inequitably. The Investor Group had violated the standstill provision in the stockholders agreement by actively campaigning against the Proposal in communications with other stockholders, foreclosing the possibility that the disclosure violations, even if material, would render the doctrine of unclean hands unavailable to the Company.

This case provides a helpful analysis on the enforceability of contractual provisions designed to prevent courts from considering evidence of the parties’ negotiations. However, central to the court’s holding was its finding that the restriction did not unduly limit the court’s ability to consider the extrinsic evidence needed to interpret the ambiguous provisions. It remains unclear whether a contractual provision foreclosing consideration of all extrinsic evidence would be enforceable.

Authored by Allison M. Wuertz, Christopher T. Pickens, Jordan Teti, and Sean MacDonald

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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