Fletcher Int'l., Ltd. v. ION Geophysical Corp., C.A. No. 5109-CS (Del. Ch. Dec. 4, 2013) (Strine, C.)
In this opinion, the Court of Chancery calculated the extent of damages owed to an investor for violation of its consent rights. In arriving at that calculation, the Court was required to go back in time and recreate the hypothetical negotiation that would have occurred between the relevant parties to determine how much a company would have paid its investor in exchange for that investor’s consent to a bridge financing transaction.
The events giving rise to this case trace back to 2005, when Fletcher International, Limited (“Fletcher”), a hedge fund organized in Bermuda, entered into an investment agreement with ION Geophysical Corporation (“ION”), a Delaware corporation that provided technology-focused services and equipment to the global energy industry. As part of the agreement, Fletcher purchased a total of 70,000 shares of ION Cumulative Convertible Preferred Stock. The Preferred Stock was governed by a Certificate of Rights and Preferences that included a provision conferring upon Fletcher the right to consent to the issuance of any security by a wholly-owned subsidiary of ION. By the end of 2009, Fletcher had staked its future on ION, investing nearly two-thirds of its assets in the company.
In 2008, ION and ION International S.àr.l. (“ION S.àr.l.”), a wholly-owned subsidiary, entered into a new $100 million credit facility (the “Credit Facility”) through which they would borrow money on a revolving basis from a consortium of banks (the “Existing Lenders”). ION’s credit agreement with the Existing Lenders contained a number of restrictive covenants which, if violated by ION, authorized the Existing Lenders to declare a default, resulting in the entire amount of the loans outstanding under the Credit Facility becoming immediately due. The Existing Lenders’ power to declare a default granted them substantial influence over ION.
ION began experiencing financial problems in 2008 and, by 2009, ION was aggressively searching for a long-term solution to its financial woes. In mid-2009, ION began negotiating a joint venture with BGP Inc. (“BGP”), a Chinese-state owned enterprise that was backed by the state-owned Bank of China. Eventually, ION and BGP reached an agreement in which BGP would hold the majority interest in the joint venture, gain a substantial ownership stake in ION, and receive anti-dilution protection subject to Fletcher’s right to convert its already existing Preferred Stock into ION common stock. Although the joint venture heralded a long-term solution to ION’s liquidity issues, both parties feared that ION lacked the necessary cash to meet its obligations during the ensuing months in which the parties would have to garner the requisite regulatory approvals. BGP and ION agreed that the Credit Facility would be amended so that the Bank of China could be added as a lender and provide a $40 million bridge financing loan to ION. Realizing that the BGP transaction presented the best chance that they had of being repaid, the Existing Lenders unanimously approved the amendment to the Credit Facility and, in exchange for their approval, the Existing Lenders received a consent fee of 25 basis points over the amount of the loan outstanding.
On October 23, 2009, ION announced the joint venture with BGP and issued the Convertible Promissory Notes evidencing the bridge loan from the Bank of China. Under the Convertible Promissory Notes, ION borrowed $30 million and its subsidiary, ION S.àr.l., borrowed $10 million, for a total of $40 million in bridge loans. The announcement of the joint venture ushered in an immediate positive impact on ION’s stock price and, accordingly, on Fletcher’s investment in ION. Fletcher noted in an internal email that ION’s stock price jumped as much as 47% following the announcement. Fletcher even began purchasing more ION stock after the announcement.
About one month later, on November 25, 2009, Fletcher initiated an action against ION in the Court of Chancery, seeking a declaration that its right to consent to any issuance of a security by ION S.àr.l. had been violated, an injunction of the BGP transaction, and an award of damages. In a sharp turn from its earlier statements, Fletcher asserted in its complaint that ION’s transaction with BGP was “unfavorable” and “disastrous.” Fletcher then moved for partial summary judgment, asking the Court for a declaration that Fletcher’s consent rights had been violated. To the extent that the motion could be construed as a provisional request for a preliminary injunction of the transaction, the Court denied it, but reserved ruling on the remaining portions of the motion. Accordingly, the BGP transaction closed on March 25, 2010, enabling ION to repay all of its outstanding loans under the Credit Facility and to reduce its overall debt from $240 million to only $106 million. The stock market reacted favorably to the closing as ION’s stock price rose from its pre-BGP transaction low of $0.83 in March 2009 to over $8.00 by the end of 2010.
In May 2010, the Court issued an opinion resolving the outstanding issues on Fletcher’s summary judgment motion. The Court determined that Fletcher’s consent right was violated when the ION S.àr.l. note (the note qualified as a security because the note was convertible) was issued without Fletcher’s consent. The Court resolved the remaining issue of damages by conducting a trial at which the parties presented competing versions of a hypothetical negotiation regarding Fletcher’s asserted right to consent to the ION S.àr.l. note before it issued. In its version of the hypothetical negotiation, Fletcher portrayed itself as an inflexible bargainer who would not have consented to the ION S.àr.l. note issuance unless it received a consent fee in the amount of $78 million, almost double the value of the bridge loan. Essentially, Fletcher attempted to persuade the Court that it would have been willing to blow up the entire deal, force ION into bankruptcy, and devastate more than half of its own investment portfolio if it did not receive its $78 million consent fee. However, Fletcher’s version of the hypothetical negotiation assumed that Fletcher and ION would have been the only parties to the negotiation and that ION would have simply rolled over and timidly surrendered to Fletcher’s demands. Fletcher ignored that both BGP and the Existing Lenders would have participated with significant leverage in the hypothetical negotiation and that ION would have had viable alternatives to the deal that would not have implicated Fletcher’s consent right. Although Fletcher later retreated somewhat in a post-trial brief from its view of the hypothetical negotiation, Fletcher still pressed on in its belief that ION had no other options but to pay the ransom that Fletcher sought to exact in exchange for Fletcher’s consent. ION presented a version of the hypothetical negotiation in which, after hearing Fletcher’s outrageous demands, ION, BGP, and the Existing Lenders restructured the bridge loan in a way that did not implicate Fletcher’s consent right.
After considering the parties’ polarized versions of the hypothetical negotiation, the Court noted that consent rights are commonly viewed as protective devices to shield the holder of the right against being harmed by a new transaction that would be adverse to its interests. Here, the BGP transaction benefitted Fletcher, meaning that, in actuality, Fletcher suffered no damage as a result of the consummation of the BGP transaction. However, although it was also true that the bridge financing could have been restructured in a way that did not implicate Fletcher’s consent right, the fact of the matter was that Fletcher’s consent right was violated in this case. Hence, the Court proceeded to quantify Fletcher’s damages, based on its reasonable expectations at the time of the hypothetical negotiation that would have occurred before the announcement of the BGP transaction. The Court noted that BGP and the Existing Lenders had much less to lose than Fletcher from simply walking away from the BGP transaction. And, although ION by itself wielded little leverage over Fletcher, BGP and the Existing Lenders were in ION’s corner. Hence, BGP, the Existing Lenders, and ION reasonably would have balked at Fletcher’s outrageous demands and endeavored to restructure the transaction in a way that divorced Fletcher from the deal. For this reason, assuming (as the Court did) that Fletcher would have been reasonable in balancing its zeal with reality, the Court hypothesized that Fletcher would have demanded 75 basis points, or three times what the Existing Lenders received for their consent to the amendment to the Credit Facility. The Court determined that, although aggressive, Fletcher’s demand was sufficiently tempered such that the other parties would have assented to it. Hence, the Court imposed a monetary damage award of $300,000 (.75% X $40,000,000).