Fletcher International, Ltd. v. ION Geophysical Corp.: Court of Chancery Interprets Consent Right of Preferred Stockholder
April 28, 2011
The efforts of Fletcher International, Ltd. (“Fletcher”) to block a joint venture between ION Geophysical Corp. (“ION”) and China National Petroleum Corporation (“China National”) have resulted in multiple opinions interpreting Fletcher’s rights as a preferred stockholder of ION. In the latest opinion, Fletcher International, Ltd. v. ION Geophysical Corp., C.A. No. 5109-VCS (Del. Ch. Mar. 29, 2011), the Court of Chancery reaffirmed the primacy of contract principles when interpreting the rights of preferred stockholders under Delaware law and refused to expand the rights of Fletcher beyond the clear and unambiguous terms of ION’s certificate of incorporation.
The preferred stock provision at issue provided that the prior consent of a majority of the holders of ION’s Series D preferred stock (in this case, Fletcher) was necessary to “permit any Subsidiary of [ION] to issue or sell, or obligate itself to issue or sell, except to [ION] or any wholly owned Subsidiary, any security of such Subsidiaries.” In two of the Court’s previous opinions, Fletcher successfully argued that this provision required ION to obtain Fletcher’s consent before a different ION subsidiary could issue a convertible note in connection with the joint venture. Fletcher failed to persuade the Court, however, to enjoin the overall transaction, which was completed on March 24, 2010 when ION transferred 51% of the stock of INOVA Geophysical Equipment Limited (“INOVA”), a wholly owned subsidiary of ION, to China National pursuant to a term sheet and share purchase agreement. After the joint venture transaction had been completed, Fletcher amended its complaint alleging that (i) ION had breached its contractual rights as a preferred stockholder by permitting INOVA to sell or issue securities to China National without Fletcher’s prior consent and (ii) INOVA had tortiously interfered with these same rights. ION and INOVA moved to dismiss both claims, arguing that the preferred stock provision did not give Fletcher a consent right with respect to ION’s sale of INOVA stock.
Fletcher’s primary argument in support of its claims was that ION had violated Fletcher’s consent rights when it entered into the term sheet and the share purchase agreement with China National because ION essentially “permit[ed] INOVA to ‘sell and obligate itself to sell securities equaling 51% of its equity to [China National]’ without first obtaining Fletcher’s consent.” Alternatively, Fletcher asserted that, while formally speaking, the sale of INOVA stock was from ION to China National, the economic substance of the entire joint venture transaction was a sale by INOVA of INOVA stock to China National. Fletcher urged the Court to look beyond the form of the transaction and treat ION’s transfer of 51% of its INOVA stock to China National as an issuance by INOVA of those shares directly to China National.
The Court rejected both arguments, finding them to be “meandering in the sense that [they are] selectively formal and deconstructive in [their] logical approach.” On the one hand, Fletcher argued that the term sheet bound INOVA to transfer its own shares of stock to China National while admitting that under the plain terms of the term sheet, ION would be the one doing the selling of the to-be-formed subsidiary’s stock. On the other, if the Court accepted the argument that INOVA was, from its creation, intended to be an entity owned 51% by China National and only 49% owned by ION, then INOVA was never an ION subsidiary under the terms of the preferred stock provision and thus not subject to Fletcher’s consent right.
Ultimately, the Court held that the rights that Fletcher had bargained for as set forth in the ION certificate of incorporation were clear and unambiguous and did not provide Fletcher with a consent right under any of the scenarios advanced by Fletcher. The Court reiterated the principles that a preferred stockholder’s rights are contractual in nature, are to be strictly construed and must be expressly set forth in the relevant governing document. Applying these principles, the Court concluded that in the transaction at issue the plain language of the preferred stock provisions did not give Fletcher a consent right and that the Court was not empowered to rewrite an unambiguous contract in order to meet Fletcher’s current business interests. Further, the Court noted that it was immaterial whether ION, in structuring the transaction, purposefully chose a structure that did not trigger Fletcher’s consent rights. In the Court’s view, Fletcher was a sophisticated contracting party that could have bargained for the right to consent to ION’s sale of its subsidiary’s stock, but failed to do so. Accordingly, both Fletcher’s breach of contract claim and the dependent tortious interference claim were dismissed.