Addressing the Harm to Common Stockholders in Trados and Nine Systems
23 Pages Posted: 26 Apr 2018
Date Written: April 3, 2018
According to the recent opinions in In re Trados (Trados) and In re Nine Systems (Nine Systems), both cases involved the peculiar corporate law equivalent of a burglary in which nothing was stolen. In Trados, the board of directors–––composed mostly of representatives from venture capital (VC) firms holding preferred stock–––voted in favor of a $60 million merger in which preferred stockholders received $52.2 million, management (pursuant to an incentive plan designed to encourage a near-term sale) received $7.8 million, and common stockholders received exactly “nothing.” In Nine Systems, a similarly conflicted and VC-dominated board effected a largely covert recapitalization whereby common stockholder equity was sharply diluted from around 26% to around 2%. The Nine Systems recapitalization ultimately entitled preferred VC stockholders to receive around $150 million in connection with a sale of the company while common stockholders received in total around $3 million. In both Trados and Nine Systems, the courts determined the boards of directors faced clear conflicts that manifested in grossly unfair processes favoring the VC preferred stockholders. And yet, both courts also found common stockholders failed to demonstrate any damage from the challenged transactions and were thus not entitled to recovery beyond possible shifting of attorneys’ fees.
Some have defended, or at least accepted, the reasoning in Trados and Nine Systems; others have focused on the practical implications of these cases for counsel advising preferred-appointed directors; still others have ambitiously argued that the doctrinal framework governing VC-held preferred stock is conceptually unstable and in need of reimagining–––this Comment opts for a more modest approach. Rather than posit a procedural strategy to satisfy the Delaware courts or question the overarching doctrine, this Comment argues that Trados and Nine Systems overlooked the damage incurred upon common stockholders. In other words, Trados and Nine Systems were not victimless breaches: Something was taken from common stockholders.
Specifically, this Comment asserts that the Delaware courts in Trados and Nine Systems failed to recognize that the controlling preferred VC stockholders deprived common stockholders of the option to continue operating the firm in the hopes of performance improving. Far from a nebulous species of damage, this Comment observes that “underwater” options akin to those seized from common stockholders in Trados and Nine Systems can be, and routinely are, valued by financiers and economists. The question of which group–––the VC-held preferred or common stockholders–––has the right to capture the value of this option is one of policy and has been obscured by Trados and Nine Systems. This Comment fills a gap by drawing the policy tension into the light and squarely asking which party should have the contractual burden of specifying the right to capture the value of the option.
Keywords: corporate law, preferred stock, Trados, Nine Systems, venture capital, corporate governance
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