August 3, 2010
In Fletcher Int’l, Ltd. v. ION Geophysical Corp., C.A. No. 5109-VCP (Del. Ch. May 28, 2010), the Court of Chancery reaffirmed the primarily contractual nature of the duties owed to, and the rights of, preferred stockholders under Delaware law. Although the Court recognized that preferred stockholders may be owed fiduciary duties under some circumstances, it made clear that unless fiduciary duty claims are based on duties and rights not provided for by contract, a preferred stockholder may not maintain both contractual and fiduciary duty claims arising from the same alleged wrongdoing.
The central issue in Fletcher was whether Fletcher International, Ltd. (“Fletcher”), the beneficial owner of preferred stock of ION Geophysical Corporation (“ION”), was contractually entitled to consent to the issuance of a convertible promissory note by an ION subsidiary. The certificates of designations (the “Certificates”) governing Fletcher’s preferred stock provided Fletcher with the right to give prior consent in the event that an ION subsidiary issued “any security.” The ION subsidiary, however, issued the note without first seeking Fletcher’s consent. Fletcher argued that the note met the definition of “security” under both Delaware and federal law, but the defendants argued that the note was, in reality, nothing more than a commercial bank loan. The Court agreed with Fletcher, finding the term “security” to be unambiguous and determining that the note—a debt instrument convertible into equity securities of ION—qualified as a “security” of the subsidiary under both Delaware and federal law. Because ION did not seek Fletcher’s consent prior to its subsidiary’s issuance of the note, the Court held that ION breached its contractual obligations to Fletcher.
The Court then turned to Fletcher’s claims against ION’s directors for breach of fiduciary duty, which were based on the directors’ unilateral issuance of the note and their failure to disclose to Fletcher information regarding the note. The Court rejected Fletcher’s fiduciary duty claims, finding them to be “superfluous” in light of the contractual nature of Fletcher’s preferred stock and the fact that the conduct at issue was explicitly addressed by the Certificates. The Court recognized that directors generally owe fiduciary duties to preferred stockholders if the facts at issue do not implicate the preferred stockholders’ contractual rights. In such a case, the Court noted that the stockholders would be left “exposed and vulnerable vis-à-vis the board of directors.” Fletcher’s claims, however, did not fall within that scenario, as the same facts underlying its claim for breach of the Certificates provided the basis for its breach of fiduciary duty claims. As such, the Court found that contract rights, and not fiduciary duty principles, provided the proper basis for Fletcher’s claims.