Preferred Stockholder Consent Rights: Fletcher International, Ltd. v. ION Geophysical Corp.

May 3, 2010

Publication| Corporate Transactions| Corporate & Chancery Litigation

In Fletcher International, Ltd. v. ION Geophysical Corp., C.A. No. 5109-VCP (Del. Ch. Mar. 24, 2010), the Court of Chancery held that a company’s issuance of a promissory note convertible into common stock likely violated a contractual right of the company’s preferred stockholder to consent to the issuance of “any security,” but declined to issue a preliminary injunction based on the balance of hardships.

Fletcher International, Ltd. (“Fletcher”) was the owner of preferred stock of ION Geophysical Corp. (“ION”). Under the terms of the preferred stock, Fletcher retained the right to consent to the issuance of “any security” by any subsidiary of ION. As part of an impending transaction with a third party, a wholly owned subsidiary of ION issued a convertible promissory note (the “Note”) without Fletcher’s consent.

Fletcher alleged in its complaint breaches of contract and fiduciary duty in connection with the issuance of the Note without Fletcher’s consent. As part of its motion for partial summary judgment, Fletcher asked the Court to invalidate the issuance of the Note and require that ION repay any funds borrowed under the Note. Due to ION’s imminent transaction with a third party that involved the Note (scheduled to close the day after the ruling was issued), the Court addressed only Fletcher’s request for injunctive relief.

The Court analyzed Fletcher’s injunctive relief request under the well-known preliminary injunction standard, requiring the movant to demonstrate: “(1) a reasonable probability of success on the merits at a final hearing, (2) an imminent threat of irreparable injury, and (3) a balance of the equities that tips in favor of issuance of the requested relief.” While declining to make a final ruling on the issue of whether the Note is a “security,” the Court found that Fletcher had demonstrated a reasonable probability of success on the merits of its claim that ION violated Fletcher’s rights by issuing a security through its subsidiary without first obtaining Fletcher’s consent. The Court reached this conclusion by reasoning that an instrument convertible into a security is itself considered to be a security. The Court also found that Fletcher made a weak showing that it may suffer irreparable injury if its request for injunctive relief were not granted, because although an award of monetary damages may prove difficult for the Court to determine, it was not beyond the Court’s ability.

The Court, however, refused to grant a preliminary injunction based largely on the third and final factor: balance of the equities. The Court found that if ION were required to pay back the funds borrowed under the Note, ION would be required to pay down indebtedness under an existing credit facility that would cause significant liquidity problems that may lead to default and even bankruptcy. Furthermore, the Court determined that, based on statements made in ION’s recent Form 10-K, requiring ION to repay the funds borrowed under the Note could prevent ION from closing its impending third party transaction, which may, consequently, cause ION to suffer significant adverse financial consequences. Because ION would be exposed to significant potential harm if the injunctive relief were granted, and because Fletcher faced little potential harm if an injunction were not issued, the Court found that the balance of equities strongly favored denial of the requested injunctive relief.

Accordingly, the Court denied Fletcher’s motion for partial summary judgment to the extent it sought to require ION’s immediate repayment of funds under the Note or otherwise block the closing of ION’s third-party transaction based on the asserted invalidity of the Note.

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