Delaware Law Updates
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PDF, Inc. v. Hoffman, et al., C.A. No. 22390-VCN (Del. Ch. June 30, 2009)

June 30, 2009

The Court of Chancery granted defendants’ motion to dismiss a complaint for failure to state a claim after rejecting an argument that directors breached fiduciary duties owed to a preferred stockholder when they agreed to issue stock to a third party at a price above market value. The Court held that such a transaction did not result in a breach of either fiduciary duties or the implied covenant of good faith and fair dealing., Inc. (“Amazon”) held preferred stock of Basis Technology Corporation (“Basis”). Amazon’s preferred stock terms included an anti-dilution feature, which provided that if Basis issued any new stock at a price (or conversion equivalent) less than Amazon’s conversion rate of $1.36 per share, such conversion rate would be adjusted in Amazon’s favor. In two transactions, Basis issued shares of a new series of preferred stock at a price of $1.39 per share, three cents above Amazon’s anti-dilution trigger. Amazon brought suit and argued that the Basis directors breached the fiduciary duties of loyalty and care, and the implied covenant of good faith and fair dealing, by setting the price of the transactions purposely to avoid Amazon’s anti-dilution protection.

The Court held that Amazon arguably stated a claim for breach of the duty of care by demonstrating that the Basis directors did not make a real effort to determine an accurate and appropriate issuance price, but the Basis charter’s Section 102(b)(7) exculpatory provision precluded the pursuit of a due care claim. With respect to the duty of loyalty claim, the Court found that Amazon failed to state such a claim because Amazon did not demonstrate how a director who authorized the sale of stock for a price greater than its fair value acted disloyally. In rejecting Amazon’s challenge to the independence of two of the four directors, the Court found that one director arguably was beholden to another director (the CEO and controlling stockholder), but Amazon failed to show that the CEO was interested in, or received a benefit separate and distinct from his status as a common stockholder as a result of, the transactions.

Amazon also alleged that the CEO was motivated by his position as a common stockholder to treat Amazon, a preferred stockholder, inequitably, but the Court disagreed. The Court held that, even if it did not consider Delaware authority holding that preferred stockholders have no fiduciary duty claims against directors that are not also fiduciary duty claims of common stockholders, the Basis directors did not breach any fiduciary duty owed to Amazon as a preferred stockholder because Amazon’s stock purchase agreement with Basis defined the relationship between Amazon and Basis. Since Basis did not issue shares below the minimum price specified in the stock purchase agreement, the transactions did not implicate the anti-dilution provision, and the Basis directors did not breach the duty of loyalty.

The Court also denied Amazon’s claim that the transactions breached the implied covenant of good faith and fair dealing implicit in the stock purchase agreement and the Basis charter because the stock purchase agreement was not silent with respect to the anti-dilution threshold, which was specifically negotiated. Therefore, the scope of the contract was defined, and this case did not involve a situation where the parties’ expectations were so fundamental that they did not feel a need to negotiate the issue. The Court characterized Amazon’s claim that the Basis directors acted to circumvent the stock purchase agreement’s anti-dilution provision as a “creative” attempt to blend Amazon’s contractual rights with any fiduciary protections. The Court resisted Amazon’s attempt to create a right more powerful than rights based on independent contractual and fiduciary duties because such an approach “would run the risk of altering the carefully honed relationship among preferred stockholders and common stockholders.”

The full opinion is available here