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Fletcher Int’l, Ltd. v. ION Geophysical Corp., C.A. No. 5109-VCP (Del. Ch. May 28, 2010) (Parsons, V.C.)

May 28, 2010

This decision involves a breach of contract claim and breach of fiduciary duty claim stemming from the issuance of a promissory note (the “Note”) by ION International S.àr.l. (“ION S.àr.l.”), a wholly-owned subsidiary of ION Geophysical Corporation (“ION”). Plaintiff, Fletcher International, Ltd. (“Fletcher”) is the beneficial owner of all of the outstanding shares of Series D-1, D-2, and D-3 Preferred Stock of ION (collectively, the “Series D Preferred Stock”). According to the Certificates of Rights and Preferences of the Series D Preferred Stock (the “Certificates”), the consent of Fletcher, as the holder of all outstanding shares of Series D Preferred Stock, is required to “permit any Subsidiary of [ION] to issue or sell, or obligate itself to issue or sell, except to [ION] or any wholly owned Subsidiary, any security of such Subsidiaries.” (emphasis added). In connection with a joint venture between ION and BGP, Inc. (“BGP”), ION caused ION S.àr.l. to issue the Note to BGP without Fletcher’s consent. Fletcher asserted several claims, including breach of contract and breach of fiduciary duty against ION, ION S.àr.l., and the members of ION’s board.

With respect to the breach of contract claim, the Court determined that ION breached the provision in the Certificates granting Fletcher the right to vote on the issuance of “any security” by an ION subsidiary. The Court interpreted the term “any security” under the objective theory of contracts, which requires the Court to interpret the language as it “would be understood by an objective, reasonable third party.” The Certificates contained the defined term “Other Securities,” which included “any stock . . . and other securities of ION,” reflecting an understanding that the term securities included something beyond stock. Citing standard rules of contract interpretation and noting in particular that the Court ordinarily allows the plain meaning of a contract to control unless it is ambiguous, the Court concluded that the term “security” in the Certificates is not ambiguous and must be afforded its ordinary meaning. The Court continued by concluding that the Note was a “security,” namely because the Note could convert at any time into common stock of ION. To further evidence that the Note is a security, the Court applied the “family resemblance” test from Reves v. Ernst & Young, 494 U.S. 56 (1990), even though, the Court noted, the convertibility feature of the Note eliminated the need to examine the Note under this test. The Court concluded that because the Note is most naturally understood as an investment in ION, is freely assignable and transferable, is convertible into common shares of a public company, and is subject to an investment risk, the Note is a “security” under Reves.

Finally, the Court dismissed Fletcher’s breach of fiduciary duty claim against the ION directors, which claim was based upon the directors’ failure to obtain Fletcher’s approval of the issuance of the Note and their failure to disclose to Fletcher all material information in the board’s control regarding the issuance of the Note. Fletcher’s right to vote on an ION subsidiary’s issuance of securities is contractual in nature and Fletcher could remedy a violation of that right through its breach of contract claim. Thus, it had no need to assert a fiduciary duty claim based on those same contractual rights or a claim based on a breach of the duty of disclosure, which was premised on there actually being a vote.

The full opinion is available here