Opinion
Civil Action No. 711-N.
Date Submitted: November 2, 2004.
Date Decided: November 4, 2004.
R. Judson Scaggs, Jr. and Samuel Taylor Hirzel, II, of MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware; OF COUNSEL: James A. DiBoise, David J. Berger and Tracy Tosh Lane of WILSON SONSINI GOODRICH ROSATI, Palo Alto, California, Attorneys for Plaintiff and Counterclaim Defendant WatchMark Corp., Third-Party Defendant WatchMark Acquisition Corp., and Third-Party Director Defendants John Hansen, Gerald Poch, Ralph Faison, and T. Mark Maybell.
Kurt M. Heyman, Peter B. Ladig, and Patricia L. Enerio, of THE BAYARD FIRM, Wilmington, Delaware; OF COUNSEL: Barry B. White, Brandon F. White, Joshua A. McGuire and Kalun Lee, of FOLEY HOAG LLP, Boston, Massachusetts, Attorneys for Defendants/Counterclaim and Third-Party Claim Plaintiffs.
MEMORANDUM OPINION
Plaintiff WatchMark Corporation ("WatchMark") brought this action pursuant to 10 Del. C. § 6501, 8 Del. C. § 111, and Court of Chancery Rule 57 seeking a declaratory judgment regarding the right of certain Series B preferred stockholders to vote as a series on a proposed merger between WatchMark and its subsidiary, WatchMark Acquisition Corporation, ("WAC"). A decision in favor of WatchMark necessarily affirms its right to enter into the merger and the subsequent financing transaction described below. Defendants GSM Capital Limited Partnership and ARGC II, LLC are venture capital firms and are managed by defendant ARGO Global Capital, LLC (collectively "ARGO").
ARGO has answered WatchMark's complaint and has asserted a counterclaim against WatchMark, WAC, and four members of WatchMark's six-member board. ARGO's counterclaim alleges that the proposed merger and subsequent financing is in violation of WatchMark's charter and that WatchMark's directors breached their fiduciary duties by approving these transactions. ARGO has moved for a preliminary injunction seeking to enjoin WatchMark from consummating these transactions. After expedited discovery, both parties have moved for summary judgment, and oral argument was held late in the afternoon on October 28. For the reasons set forth below, I deny ARGO's request for the preliminary injunction that would preclude WatchMark's merger with WAC and subsequent financing. In addition, I conclude, as a matter of law, that the Series B preferred stockholders are not entitled to a separate series vote on the WAC merger. Finally, I conclude that WatchMark's board has not breached any fiduciary duty.
The other two directors represent ARGO and another stockholder that is not participating in the financing at issue.
I. BACKGROUND
A. The Metrica Merger
WatchMark is a privately-held Delaware corporation based in Bellevue, Washington. Its board of directors consists of six members; five are designees of the various venture capital funds that provide the lions' share of WatchMark's capital. ARGO is one of those five funds, and is a firm whose focus is investing in the Internet and wireless communication industries.
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Throughout the spring and summer of 2004, WatchMark engaged in due diligence and numerous negotiations in its effort to acquire Metrica.
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During the ensuing months, WatchMark's board actively deliberated the ongoing updates provided by management, engaged in active and lengthy negotiations with ADC over price, and considered appropriate strategies for consummating the deal. On October 22, 2004, WatchMark's board approved the merger for $35 million in cash and other layout provisions. B. The Necessary Financing
It remains uncontested that Ms. Bradin, ARGO's delegate to WatchMark's board, does not dispute the benefit the Metrica merger will have on WatchMark. See Deposition of Bernice Bradin at 20, 21-22.
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With the Metrica merger pending, the WatchMark board began negotiations regarding the terms of a new series of preferred stock, Series F, as a means to raise the necessary capital. All company investors were invited to participate in the negotiations. The board's active negotiations, at which ARGO's board representative (Ms. Bradin) was involved, were buttressed by multiple financial analyses showing the various returns available depending on the structure of the financing. During the Series F negotiations, all board members were informed of the transaction's details. By August 10, 2004, WatchMark's various investors reached an agreement concerning the key elements of the proposed, new Series F financing. By the end of August, all directors were asked to indicate how much their respective firms would invest in the new series, at which point ARGO informed WatchMark it would not participate in the financing. C. The Relevant WatchMark Certificate of Incorporation Provisions
The principal terms of the new series allowed Series F investors to receive a liquidation preference equal to twice their particular buy-in; all existing investors holding outstanding preferred who do not participate in the new series would be converted to common stock at the designated conversion ratio; and other incentives intended to encourage investors to "pay-to-play." WatchMark has alleged that ARGO's principal motivation behind their threatened block was that ARGO was willing to participate in the Series F financing if WatchMark was willing to sweeten the deal. Such claims weaken ARGO's position that the proposed Series F and the accompanying pay-to-play provisions are discriminatory and belie ARGO's attempt to rely on Section 2(i) of the charter, as it certainly is the case that ARGO has a corresponding obligation of negotiating in good faith.
Other WatchMark investors have indicated that they will not participate in the Series F financing and yet do not challenge the conversion of their preferred shares to common stock. See Deposition of Gerald A. Poch at 79-80. Because ARGO owns approximately 40 percent of WatchMark's Series B preferred, they can effectively block any transaction submitted to the Series pursuant to Section 3(c) of WatchMark's charter. See Compl. ¶ 3.
WatchMark's certificate of incorporation contains three provisions that take on particular import here. The first, Section 3(a), requires the vote of 70 percent of the then outstanding preferred stock, voting together as a class, to approve any merger. The second, Section 3(c), requires with respect to the Series B stockholders the vote of 80 percent of the Series B stockholders, voting as a single series, whenever WatchMark endeavors to:
Section 3(a)(i)(B) states in relevant part:
At any time when shares of Preferred Stock are outstanding, except where the vote of the holders of a greater number of shares of the Corporation is required by law or by this Restated Certificate of Incorporation, and in addition to any other vote or written consent of the holders of at least seventy percent (70%) of the then outstanding shares of Preferred Stock, voting as a separate class . . . this corporation will not: enter into or authorize . . . any consolidation or merger. . . .
alter the preferences, rights, privileges or powers of, or the restrictions provided for the benefit of, the Series B Preferred Stock so as to adversely affect the Series B Preferred Stock. . . .
Section 3(c) refers specifically to the Series B Preferred. There are respective sections for each Series created under the charter. Section 3(c) reads in its entirety as follows:
At any time when shares of Series B Preferred Stock are outstanding, except where the vote of the holders of a greater number of shares of the Corporation is required by law or by this Restated Certificate of Incorporation, without first obtaining the affirmative vote or written consent of the holders of at least eighty percent (80%) of the then outstanding shares of Series B Preferred Stock, voting as a single class the Corporation will not alter the preferences, rights, privileges or powers of, or the restrictions provided for the benefit of, the Series B Preferred Stock so as to adversely affect the Series B Preferred Stock; increase or decrease the number of shares of Series B Preferred Stock; or adopt any amendment to the Restated Certificate of Incorporation or Bylaws of the Corporation that otherwise adversely affects the Series B Preferred Stock in a manner different from other Preferred Stock.
The final provision, Section 2(i), provides that WatchMark shall seek the consent of the preferred stockholders as "required under Section 3" whenever WatchMark endeavors to undertake several transactions among which include: mergers; transfer of assets; amendments to the certificate of incorporation; and the issuance or sale of securities. Section 2(i) also provides that all transactions entered into by WatchMark shall be entered into in good faith, and not for the purpose of avoiding the observance or performance of any terms to be observed or performed under WatchMark's charter. D. The WatchMark WAC Merger
Section 2(i) reads in its entirety as follows:
Without the consent of the holders of the then outstanding preferred as required under Section 3, the Corporation shall not, by amendment of its Restated Certificate of Incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Corporation but shall at all times in good faith assist in the carrying out of all the provisions for this Section 2 and in taking of all such action as may be necessary or appropriate in order to protect the Conversion Rights of the holders of Preferred Stock against dilution or other impairment.
Faced with ARGO's threatened veto, WatchMark's board decided to undertake another transaction whereby its wholly-owned subsidiary, WAC, would merge with WatchMark and adopt a nearly identical charter. The only material change to the charter would be the removal of the 80 percent voting requirement as it applies to all of WatchMark's preferred stockholders. The resulting charter would require a vote of 70 percent of all preferred stockholders, voting together as a single class, to effect an alteration of the preferred's rights.
If the merger is successfully ratified, the board intends to present the Series F financing proposal to all of the preferred stockholders, who will then be entitled to vote on the issuance. If ratified by the newly adopted 70 percent supermajority requirement, all preferred stockholders would be entitled, and indeed encouraged, to participate in the financing. No conversion to common stock can occur unless a preferred shareholder voluntarily opts out of the proposed Series F financing.
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II. ANALYSIS
A. Standard for Injunctive ReliefThis Court will issue a preliminary injunction only where a party demonstrates: (1) a reasonable probability of success on the merits at a final hearing; (2) that the failure to issue a preliminary injunction will result in immediate and irreparable harm; and (3) that the harm to the moving party if relief is denied will outweigh the harm to the opposing party if relief is granted. This extraordinary remedy is granted sparingly and only upon a persuasive showing that it is urgently necessary, that it will result in comparatively less harm to the adverse party, and that, in the end, it is unlikely to be shown to have been issued improvidently. I discuss only the first prong of this standard, as ARGO has not shown a reasonable probability of success on the merits.
Next Level Communs., Inc. v. Motorola, 834 A.2d 828, 845 (Del.Ch. 2003).
This Court begins its analysis by reciting the admonition given by our Supreme Court in Elliott Assocs., L.P. v. Avatex Corp., in which "the path for . . . drafters to follow in articulating class vote provisions . . . [was made] clear. When a certificate . . . grants only the right to vote on an amendment, alteration or repeal, the preferred have no class vote in a merger." This reasoned warning is predicated on the fact that the rights that flow to the preferred stockholders emanate from the contractual provisions creating those rights. As such, the Court will "first determine if the intent of the parties can be ascertained from the words chosen by the parties; unless the contract is ambiguous, extrinsic evidence may not be considered; and the document should be construed `as a whole' to reconcile, if possible, all of its provisions."
715 A.2d 843 (Del. 1998).
Id. at 855.
Benchmark Capital Partners IV, L.P. v. Vague, 2002 Del. Ch. LEXIS 90, at *25 (Del.Ch. July 15, 2002) ("[A court's function in ascertaining the rights of preferred stockholders] is essentially one of contract interpretation."), aff'd sub nom. Benchmark Capital Partners IV, L.P. v. Juniper Fin. Corp., 822 A.2d 396 (Del. 2003).
Id. at *26.
Section 3(c), the lynchpin of ARGO's argument, provides in clear and unambiguous terms the instances when an 80 percent vote of the Series B preferred stock is required. Those instances impose no restriction on WatchMark's ability to merge with another company. When faced with the clear and unambiguous language of Section 3(c), I conclude that the drafters of Section 3(c) intended to incorporate the protections afforded by 8 Del. C. § 242. Clearly, however, § 242 protections do not apply to mergers, even if such a reading would deny the protective provision's "apparent purpose of assuring a class vote if adverse consequences flow from a merger."
Section 3(c) goes on to list other transactions that require the 80 percent vote, but does not specifically incorporate mergers into the provision.
WatchMark's charter was adopted after the Avatex decision. Despite the fact that Section 3(c) does not track § 242 exactly, "[g]iven the well established case law construing the provisions of certificates of incorporation and the voting rights of classes of preferred stockholders," it is appropriate to impute this construction upon those whom, I am sure, were sophisticated contract draftsmen hired by sophisticated financiers. Accord Benchmark, 2002 Del. Ch. LEXIS, 90 at *33.
Id. at *30.
Because of the consequences, which accrue when protective provisions omit mergers, ARGO points to WatchMark's "no impairment" provision of Section 2(i) as providing a blanket incorporation by reference of Section 3(c)'s voting requirements whenever a merger would have the ultimate effect of avoiding the obligations provided for under WatchMark's charter. A plain reading of Section 2(i) provides that WatchMark's board must, in good faith, and when approving certain transactions, seek the vote of the preferred stockholders in the manner prescribed in "Section 3." Under traditional principles of contract interpretation, the charter must be looked to as a whole when reconciling its provisions. From that perspective, I conclude that no independent right springs from Section 2(i). Instead, Section 2(i) provides that when WatchMark undertakes a particular transaction, it must act in good faith, and in accordance with the relevant provision of Section 3 regarding the appropriate voting standard. The only place the voting requirement for mergers is mentioned is in Section 3(a), and that Section requires a 70 percent vote of all the outstanding preferred, voting together as a single class. Contrary to ARGO's arguments, the preferences, rights and privileges clause provided in Section 3(c) does not by its express terms incorporate or refer to mergers. Accordingly, WatchMark's merger with WAC may be consummated if ratified by the vote required under Section 3(a), or 70 percent of all of the outstanding preferred stock.
See id. at 26.
If the WAC merger is successful, the new company's board will undertake the issuance of the Series F preferred stock. At the point when the transaction is presented to the new company's stockholders, the only provision relating to its approval will be a 70 percent voting requirement, with all preferred stockholders voting together as a single class. This transaction is independent of the merger and will not invoke the protections once provided under WatchMark's the removed Section 3(c). Because ARGO will be in a position no different than all of the other preferred shareholders, it may petition the other preferred stockholders to oppose the financing. The preferred stockholders, of their own volition, may choose to participate or not, according to their own economic interests. Therefore, alteration of ARGO's Series B rights will be a function of ARGO's own economic interests, a decision of its own making. The same is true for all of the five series of preferred stockholders.
The common stockholders and the preferred will also need to approve the transaction by a 50 percent vote with the common and preferred voting as a single class. See Compl. ¶ 5.
"[A]ction taken under one section of . . . law [ i.e., 8 Del. C. § 251] is legally independent, and its validity is not dependent upon, nor to be tested by the requirements of other unrelated sections [ i.e., Del. C. § 242] under which the same final result might be attained by different means." See, e.g., Rothschild International Corp. v. Liggett Group, Inc., 474 A.2d 133, 136 (Del. 1984).
B. Fiduciary Duties
Duties owed to preferred stockholders are "primarily . . . contractual in nature," involving the "rights and obligations created contractually by the certificate of designation." If fiduciary duties are owed to preferred stockholders, it is only in limited circumstances. Whether a given claim asserted by preferred stockholders is governed by contractual or fiduciary duty principles, then, depends on whether the dispute arises from rights and obligations created by contract or from "a right or obligation that is not by virtue of a preference but is shared equally with the common."
HB Korenvaes Investments, L.P. v. Marriott Corp., 1993 Del. Ch. LEXIS 90, at *14 (Del.Ch. June 9, 1993).
Id.
Moore Business Forms, Inc. v. Cordant Holdings Corp., 1995 Del. Ch. LEXIS 134, at *16 (Del.Ch. Nov. 2, 1995).
To the extent any actionable claim arises from the effect the WAC merger and the Series F financing have on the Series B preferred's rights, those rights spring from the contract between the preferred stockholders and the corporation. For the reasons already stated, I have disposed of those claims. That then leaves this Court to consider the process by which the WAC merger was adopted by WatchMark's board. ARGO urges this Court to apply the exacting entire fairness standard and require WatchMark's board to demonstrate the entire fairness of the Series F Financing. I decline to do so, because ARGO has not met the burden necessary to rebut the business judgment rule.
No dispute exists as to the independence of the WatchMark board to enter into and to approve the Metrica merger.
"The business judgment rule, as a standard of judicial review, is a commonlaw recognition of the statutory authority to manage a corporation that is vested in the board of directors." "The . . . rule is a presumption that in making a business decision the directors of a corporation act on an informed basis, in good faith and in the honest belief that the action taken is in the best interests of the company." "An application of the traditional business judgment rule places the burden on the party challenging the board's decision to establish facts rebutting the presumption." "The effect of a proper invocation of the business judgment rule, as a standard of judicial review, is powerful because it operates deferentially." Unless the procedural presumption of the business judgment rule is rebutted, a court will not substitute its judgment for that of the board if the board's decision can be attributed to any rational business purpose. ARGO has failed to rebut this strong presumption.
MM Cos. v. Liquid Audio, 813 A.2d 1118, 1127-1128 (Del. 2003).
Id. (quoting Unitrin, Inc. v. American Gen. Corp., 651 A.2d 1361, 1373; Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984)).
Id.
Id.
Id.
WatchMark's board is comprised of six members, five of whom represent the five respective venture capital firms that constitute the primary WatchMark investors. For this Court to accept ARGO's position, ARGO must show that the other investors, through the acts of their director-representatives, obtain a benefit from the WAC merger and the Series F financing to the exclusion or to the detriment of ARGO. As described above, the WatchMark merger does one thing. It removes the 80 percent supermajority-voting requirement as it applies to all preferred stockholders. Once the merger is complete, any transaction that affects the rights of the then outstanding preferred stockholders must be approved by a 70 percent supermajority voting requirement, with all preferred stockholders voting together as a single class. This, of course, will apply to the Series F financing transaction and its corresponding pay-to-play provisions. Again, all preferred stockholders have an equal opportunity to participate. Only if a preferred stockholder chooses, of its own volition, not to participate in the new Series F issuance will its shares be converted to common. Any disparate treatment between the preferred stockholders is therefore a self-imposed consequence and not the result of any self-dealing. Based on the undisputed facts, I therefore conclude that the WAC merger and Series F financing are rational business decisions, approved by an informed board and on a good faith basis.
See, e.g., In re Budget Rent-A-Car Corp. S'holders Litig., 1991 Del. Ch. LEXIS 29, *10-*11 (Del.Ch. Mar. 15, 1991) (drawing on principles enunciated in Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971)).
Preferred shares will be converted to common only to the pro-rata extent of their non-participation.
Again, it is important to point out that no one has disputed that the Metrica merger is in the best interests of WatchMark. Furthermore, nothing said in the briefing or at oral argument belies the fact that WatchMark's board undertook an informed and deliberate process of recommending the WAC merger as a necessary and sufficient condition precedent to the much needed Series F financing.
C. WatchMark's Petition for Declaratory Judgment
This action was initiated by WatchMark's complaint seeking a declaration concerning the right of the Series B Preferred to vote as a series on the WAC merger. In order for this Court to exercise its declaratory judgment jurisdiction there must be an actual controversy:
(1) it must be a controversy involving the rights or other legal relations of the party seeking declaratory relief; (2) it must be a controversy in which the claim of right or other legal interest is asserted against one who has an interest in contesting the claim; (3) the controversy must be between parties whose interests are real and adverse; and (4) the issue involved in the controversy must be ripe for judicial determination.36
There is no question that the requirements set forth in Gannett are met here.37 Moreover, WatchMark has moved for summary judgment on its petition. Court of Chancery Rule 56(c) entitles a party to summary judgment "if the pleadings, depositions, answers to interrogatories and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law."38 In this case, there are no disputed issues of material facts, although each party has presented their own unique interpretive twist on those facts. Rather, the questions now before this Court are questions of law. The first question is whether the Series B Preferred stockholders are entitled to a series vote on the WAC merger. The second question is whether WatchMark's directors complied with their fiduciary duties in recommending the WAC merger and the subsequent Series F financing. For the reasons set forth above, I conclude that the Series B preferred stockholders are not entitled to a series vote on the proposed merger and that WatchMark's board has not breached any fiduciary duty in connection with the decision to recommend the merger and the Series F financing proposal — to the extent such duties exist given WatchMark's charter provisions.
III. CONCLUSION
For all the reasons stated above, ARGO has not demonstrated a reasonable probability of success on the merits at a final hearing. I therefore deny its motion for a preliminary injunction. ARGO, as a holder of the Series B preferred, is not entitled to a series vote on the WAC merger, and WatchMark's board has complied with its fiduciary duties, to the extent those duties exist. I therefore deny ARGO's motion for summary judgment and grant WatchMark's motion for summary judgment.
IT IS SO ORDERED.