Interesting reeding ...
IT IS COMMON KNOWLEDGE that directors should act in the best interests of their corporation; however, where the interests of the corporation's different stakeholders are not aligned, directors can face complicated decisions. The board must often choose which constituency'sinterest will dominate. While in the sale of a company, this issue is relatively clear--directors obligations are to seek the best price reasonably available for the stockholders, issues can nonetheless arise when the interests of common stockholders conflict with those of preferred stockholders. A recent Delaware case deals with this situation, and reminds us of the primacy of the common stockholders.
In re Trados Incorporated Shareholder Litigation involved the saleof Trados Inc. to another company. Trados had issued preferred stock to various investors who also appointed four of Trados's seven directors. The preferred holders pushed for a sale of the company; ultimately, a deal was signed with a purchase price that would pay out the bulk (but not all) of the preferred stockholders' liquidation preference and provide Trados's management, which included two directors, with significant bonuses. The common stockholders, on the other hand, would receive nothing from the sale. Not surprisingly, some of the common stockholders sued the directors, alleging that they had negotiatedand approved the sale without considering the common stockholders' interests and, instead, were only looking out for their own and the preferred stockholders' interests.
The Chancery Court denied the directors' motion to dismiss the common stockholders' suit, and in the process illustrated two important lessons.
First, the court found that six of Trados's seven directors had a conflict of interest or otherwise lacked independence, so their actions were subject to the exacting scrutiny of the entire fairness doctrine. The two directors who received management sale bonuses were "interested" because each received "a personal financial benefit [...] not equally shared by the stockholders ... that made it improbable suchdirector could perform his fiduciary duties without being influencedby [his] overriding personal interest." The other four directors also were found to be not independent, not because they had been appointed by the preferred stockholders, but because a substantial part of their livelihood depended on the preferred stockholders (they were allemployees, directors, and/or owners of the preferred stockholders). The plaintiff stockholders therefore satisfied their burden of establishing a lack of independence by showing that such directors were "beholden to a controlling person or so under [the controlling person's]influence that their discretion would be sterilized." And, as often is the case, this conclusion lead to the result that the directors lost their motion to dismiss and will have to proceed to trial (or a more expensive settlement).
The second lesson learned from In re Trados is that when the interests of the preferred and common stockholders conflict, directors' fiduciary duties run to the common stockholders. While the preferred stockholders in In re Trados asserted that their interests were in "obvious alignment" with those of the common stockholders in obtaining the highest price possible in the sale, the court was persuaded by the plaintiffs that the real question could instead be whether the interests were aligned regarding whether to pursue a sale of the company atall or, instead, to continue to operate the company. Reframed this way, the interests of the common stockholders would not have been aligned with those of the preferred holders because selling Trados left the common stockholders with absolutely nothing.
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