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SV Investment Partners, LLC v. ThoughtWorks, Inc.: Delaware Supreme Court Affirms Court of Chancery Decision Without Addressing Whether "Funds Legally Available" Is Equivalent to "Surplus"

March 2, 2012

In SV Investment Partners, LLC v. ThoughtWorks, Inc., No. 107, 2011 (Del. Nov. 15, 2011), the Delaware Supreme Court affirmed the Court of Chancery’s holding that SV Investment Partners, LLC (“SVIP”) failed to prove that ThoughtWorks, Inc. (“ThoughtWorks”) had “funds legally available” to satisfy SVIP’s redemption demand, even assuming that SVIP was correct in arguing that the phrase “funds legally available,” as used in ThoughtWorks’ certificate of incorporation, was equivalent to the term “surplus,” as used in 8 Del. C. § 160. Thus, the Supreme Court determined that it did not need to address the Court of Chancery’s other holding that “funds legally available” was not equivalent to “surplus.”

In 2000, SVIP invested $26.6 million in ThoughtWorks in exchange for Series A Preferred Stock that was redeemable at the option of the holder after five years, subject to the funds being legally available (the “Redemption Provision”). Specifically, the Redemption Provision provided that “each holder of Preferred Stock shall be entitled to require the Corporation to redeem for cash out of any funds legally available therefor.”

In 2005, SVIP demanded redemption of the Preferred Stock. In response, the ThoughtWorks board of directors convened a special meeting to consider the extent to which ThoughtWorks had the “funds legally available” to redeem the stock. Determining that ThoughtWorks had $500,000 in funds legally available for redemption, the board redeemed shares of Preferred Stock up to that amount. In each of the 16 successive quarters, the board evaluated the financial state of ThoughtWorks, consulting with its financial advisers as to the amount of funds legally available to redeem the Preferred Stock. During this period, ThoughtWorks redeemed a total of $4.1 million of Preferred Stock. Nevertheless, SVIP claimed that more Preferred Stock should have been redeemed, and sought a declaratory judgment in the Court of Chancery as to the meaning of “funds legally available” and a monetary judgment for the full amount of the funds legally available for redemption, which it argued was equivalent to statutory “surplus.”

The Court of Chancery rejected SVIP’s contention that “funds legally available” meant statutory “surplus” and held that “funds legally available therefor” meant “cash funds on hand that can be legally disbursed for redemption without violating 8 Del. C. § 160 or any other statutory or common law.” Alternatively, the Court of Chancery held that, assuming “funds legally available” did mean statutory “surplus,” SVIP failed to prove that ThoughtWorks had “funds legally available” to redeem the Preferred Stock. The Court of Chancery premised this aspect of its decision, in part, on the insufficiency of SVIP’s expert witness testimony at trial. In particular, the Court of Chancery noted that the expert did not consider the amount of funds ThoughtWorks could use to redeem the stock while still operating as a going concern. Thus, while the expert’s testimony was “defensible as a theoretical exercise,” it did not reflect “real economic value or bear any relationship to what ThoughtWorks might borrow or its creditors recover.” Further, because the board had made determinations as to the amount of funds legally available for redemptions, SVIP was required to prove that the board had acted in bad faith, had relied on methods and data that were unreliable, or had made a determination so far off the mark as to constitute actual or constructive fraud. Because the expert testimony did not offer any evidence that went to those issues, the Court of Chancery held that SVIP failed to carry its burden in proving that ThoughtWorks had the “funds legally available” to redeem the Preferred Stock, even assuming that “funds legally available” was equivalent to statutory “surplus.”

The Delaware Supreme Court affirmed the Court of Chancery’s decision solely on the ground that SVIP failed to carry its burden of proof to establish that ThoughtWorks had “funds legally available” to redeem the Preferred Stock, regardless of the construction of the term “funds legally available.” Thus, the Supreme Court did not address whether SVIP’s definition of “funds legally available” as statutory surplus was legally correct. Rather, the Supreme Court noted that “a factual finding based on a weighing of expert opinion may be overturned only if arbitrary or lacking any evidential support” and concluded that the Court of Chancery had explained a logical rationale for rejecting the testimony of SVIP’s expert witness. Accordingly, because the Court of Chancery’s finding that SVIP had failed to carry its burden of proving that ThoughtWorks had the funds legally available did not constitute reversible error, the Supreme Court affirmed.