PWP Xerion Holdings III LLC v. Red Leaf Resources, Inc., C.A. No. 2017-0235-JTL (Del. Ch. Oct. 23, 2019) (Laster, V.C.)
In this memorandum opinion, the Court of Chancery granted a stockholder’s (“Plaintiff”) motion for summary judgment, holding that Red Leaf Resources, Inc. (the “Company”) breached Plaintiff’s right to consent to certain matters as the holder of a majority of the shares of the Company’s Series A preferred stock. Applying principles of contract interpretation, the Court determined that the Company had breached Plaintiff’s consent rights by authorizing and effecting a settlement agreement with Total E&P USA Oil Shale, LLC (“Total Sub”) without Plaintiff’s consent.
This dispute arose out of Total Sub’s desire to exit a joint venture with the Company. In connection with its efforts to exit the joint venture, Total Sub proposed a settlement, pursuant to which it would pay the Company $85 million and return its equity interests in the Company. As part of a previous investment in the Company, however, Plaintiff had bargained for certain consent rights in the certificate of designations governing the Series A preferred stock, including the right to consent to the following matters: (i) any transaction with or for the benefit of any director or officer (or their respective affiliates), (ii) any material alteration to, or change of, the business or business plan of the Company or any of its subsidiaries, and (iii) any purchase or redemption of, or payment of any dividend or other distribution on, any capital stock or any other equity interest in the Company. The Company and Total Sub initially sought Plaintiff’s consent for the proposed settlement. After Plaintiff declined to consent, the Company and Total Sub went forward with a modified settlement, restructured in an effort to avoid the need for Plaintiff’s consent.
Following execution of the settlement agreement, Plaintiff brought an action claiming that the Company, in authorizing and effecting the settlement agreement, breached Plaintiff’s consent rights because the transaction (i) would benefit an affiliate of a director of the Company, (ii) would cause a material change in the Company’s business plan and (iii) would result in the purchase or redemption of an equity interest in the Company.
The Court first analyzed whether authorizing and effecting the settlement agreement violated Plaintiff’s right to consent to a transaction benefitting an affiliate of a director of the Company. As part of its investment in a joint venture with the Company, Total Sub had the right to designate a member of the Company’s board of directors. At the time the Company approved the settlement, the Total Sub director on the Company’s board of directors also served as an officer of Total Sub and a director of Total E&P USA, Inc., an affiliate of Total Sub. Referencing a “control-based” definition of “affiliate” under Section 203 of the General Corporation Law of the State of Delaware and under Rule 144 of the Securities Act of 1933, as well as the plain meaning of “affiliate,” the Court found that the director was affiliated with Total Sub and thus the Company’s approval of the settlement agreement breached Plaintiff’s consent right.
The Court next analyzed whether authorizing and effecting the settlement agreement violated Plaintiff’s right to consent to a transaction that resulted in a material change of the Company’s business plan. The Court noted that, at the time that the Company and Total Sub entered into the joint venture, the Company had developed a series of specific steps that it would take, in conjunction with support from Total Sub and its affiliates, to execute a business plan focused on “pursuing a pilot project in Seep Ridge, Utah, for the extraction of oil from shale by heating it inside a single-use earthenware capsule.” Because of the emphasis placed on such plan, the Court determined that the settlement agreement and the exit of Total Sub and its affiliates from the joint venture represented a material change in the Company’s business plan. Accordingly, the Company violated Plaintiff’s consent rights by not seeking its approval for that change. In support of such a finding, the Court noted that, after entering into the settlement agreement, senior management and a committee of the Company’s board of directors discussed business plan options and ultimately adopted a new plan for the Company. The Court rejected the Company’s argument that it had not changed its business plan because it “was and continues to be to develop, commercialize, and license its oil shale technology,” finding that the Company’s general characterization confused the difference between the company’s “business” and its “business plan.”
The Court then analyzed whether authorizing and effecting the settlement agreement violated Plaintiff’s right to consent to a transaction that would result in the purchase or redemption by the Company of its capital stock. Given that the settlement agreement was structured to avoid “effecting” the redemption of Total Sub’s interest until Plaintiff provided its consent to the settlement agreement, the Court analyzed whether the Company had authorized the redemption. After examining the plain meaning of “authorization” and the terms of the settlement agreement, the Court concluded that the Company had not authorized the redemption, because such redemption was contingent upon seeking Plaintiff’s approval, which the Company had not received. In reaching its decision, the Court rejected Plaintiff’s argument that the Company had collapsed the steps of “authorizing” and “effecting,” rendering the former a nullity. The Court noted that the settlement agreement, as drafted, conditioned the Company’s “authority” to effect the redemption upon Plaintiff’s consent. The Court also rejected Plaintiff’s attempt to utilize the step transaction doctrine, finding instead that the step transaction doctrine was “inapposite” because the settlement agreement represented one transaction and the question at issue was whether the “final aspect” of such transaction was authorized.
Lastly, the Court considered certain additional points made by the Company. The Company pointed to prior instances where Plaintiff had not asserted its consent rights, despite those rights being available to it. The Court found that the consent rights were clear and unambiguous and that the Company had not argued that such consent rights had been waived by course of dealing or otherwise. The Company also argued that the board of directors of the Company acted in accordance with its fiduciary duties and in good faith in approving the settlement agreement. The Court dismissed that argument, noting that Plaintiff asserted a breach of contract by the Company in connection with the settlement agreement and not a breach of fiduciary duty.