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Shiftan v. Morgan Joseph Holdings, Inc.: Court of Chancery Finds that Non-Speculative Future Redemption Right of Preferred Stockholders Must Be Taken into Account in an Appraisal

March 2, 2012

In Shiftan v. Morgan Joseph Holdings, Inc., C.A. No. 6424-CS (Del. Ch. Jan. 13, 2012), the Court of Chancery concluded on summary judgment that a specific, non-speculative future redemption right of preferred stockholders must be taken into account when determining the fair value of their shares in an appraisal under 8 Del. C. § 262(h).

In December 2010, Morgan Joseph Holdings, Inc. (“Morgan Joseph”) merged with another investment bank, Tri-Artisan Capital Partners, LLC. Instead of exchanging their Series A preferred stock for new Series A preferred stock, petitioners demanded appraisal. Under the terms of Morgan Joseph’s certificate of incorporation, an “Automatic Redemption” would have been triggered on July 1, 2011, entitling the Series A preferred stockholders to $100 per share. The petitioners argued that because the Automatic Redemption triggered an unconditional obligation to redeem their shares on July 1, 2011 for $100, the $100 per share redemption value should be given effect in the Court’s determination of fair value. Morgan Joseph responded with two separate arguments: first, the Automatic Redemption clause was subject to an Excess Cash requirement; second, the Court should disregard the Automatic Redemption because it was not triggered by the merger and had not occurred as of the merger. The Court sided with petitioners on both issues.

Applying Delaware’s traditional contract interpretation principles, the Court found that the Automatic Redemption provision’s unambiguous terms did not support a reading that the provision was subject to an Excess Cash requirement, and that the clause clearly created an unconditional obligation to redeem the shares on July 1, 2011 at the $100 redemption value. The Court did not address, and thus implicitly rejected, a related argument made by Morgan Joseph based on the Chancery Court’s recent opinion in SV Investment Partners, LLC v. ThoughtWorks, Inc. that the Company’s redemption obligation was not fixed because of uncertainty over whether the Company would have “lawful funds” on the mandatory redemption date. While the Court noted that under Section 160 of the DGCL a company must have “lawful funds” to redeem its stock, it did not suggest that Section 160 required anything other than that the company have statutory surplus therefor.

Despite finding that the terms of Morgan Joseph’s certificate of incorporation were unambiguous, the Court nonetheless took the opportunity to address a doctrinal tension that emerges when contractual ambiguity in the preferred stock context does exist. Delaware courts generally adhere to the doctrine of contra proferentem—that a contract should be interpreted against the drafter—in order to resolve ambiguity in governing instruments of business entities in favor of investors. However, the principle of contra proferentem is in tension with another well-settled principle of Delaware contract law requiring strict construction of preferences claimed by preferred stockholders. Thus, a Delaware court will not imply or presume a preference of a preferred stockholder unless it is clearly set forth in the certificate. In dicta, the Court concluded that while the strict construction principle does not preclude considering parol evidence where ambiguity exists, “unless the parol evidence resolves the ambiguity with clarity in favor of the preferred stock, the preferred stockholders should lose.”

Finally, the Court explained that because the Series A preferred stockholders would have been entitled to an Automatic Redemption six months after the merger, this specific, non-speculative contractual right must be taken into account in the appraisal analysis. The Court distinguished In re Appraisal of Metromedia International Group, Inc., 971 A.2d 893, 905 (Del. Ch. 2009), a case relied upon by Morgan Joseph in arguing that the Automatic Redemption cannot be considered in an appraisal, because the rights claimed by the preferred stockholders in that case were based on future events that were not certain to occur.