SV Investment Partners, LLC v. ThoughtWorks, Inc.: Court of Chancery Interprets Redemption Rights of Preferred Stockholder
February 1, 2011
Following trial in SV Investment Partners, LLC v. ThoughtWorks, Inc., 7 A.3d 973 (Del. Ch. 2010), the Court of Chancery rejected a preferred stockholder’s argument that the phrase “funds legally available” is equivalent to “surplus” in the context of redemption rights and entered judgment against the preferred stockholder.
The underlying dispute in the case arose in connection with the terms of a preferred stock investment by SV Investment Partners, LLC (“SVIP”) in ThoughtWorks, Inc. (“ThoughtWorks”). In 2000, SVIP purchased over 94% of ThoughtWorks’ Series A Preferred Stock (“Preferred Stock”) for $26.6 million and, pursuant to a provision in ThoughtWorks’ certificate of incorporation, was granted the right to have all of its shares of Preferred Stock redeemed for cash “out of funds legally available therefor” beginning five years after the issuance of the Preferred Stock. The redemption provision further provided that the redemption requirements were to be “continuous” such that in the event funds legally available for redemption were insufficient to redeem all of the Preferred Stock at the time of the redemption, any funds becoming available thereafter were required to be applied until the Preferred Stock was fully redeemed.
SVIP first exercised its redemption right in 2005. In response, the ThoughtWorks’ board of directors held a special meeting to analyze the extent to which the Company had “funds legally available” to make a redemption payment, determined that ThoughtWorks had $500,000 of funds legally available and redeemed Preferred Stock in that amount. Because ThoughtWorks did not have sufficient cash to redeem all of the Preferred Stock, in each successive quarter, the ThoughtWorks’ board of directors evaluated: (i) whether ThoughtWorks had surplus from which a redemption could be made; (ii) whether ThoughtWorks could readily obtain cash for a redemption; and (iii) whether a redemption would endanger ThoughtWorks’ ability to continue as a going concern. Over sixteen quarters, ThoughtWorks redeemed a total of $4.1 million of SVIP’s Preferred Stock that had an aggregate redemption price of $66.9 million. SVIP objected to this periodic approach and sought declaratory judgment as to the meaning of the phrase “funds legally available” and a monetary judgment for the aggregate redemption price.
SVIP argued that because ThoughtWorks had sufficient “surplus,” as determined in accordance with Section 160 of the General Corporation Law of the State of Delaware, ThoughtWorks had funds legally available for the redemption of all of the Preferred Stock. SVIP maintained that “funds legally available” is synonymous with “surplus.” The Court of Chancery rejected SVIP’s argument as a matter of law and held that the phrase “funds legally available” is not equivalent to “surplus.” The Court determined that “funds legally available” “contemplates ‘funds’ (in the sense of cash) that are ‘available’ (in the sense of on hand or readily accessible through sales or borrowing) and can be deployed ‘legally’ for redemptions without violating Section 160 or other statutory or common law restrictions, including the requirement that the corporation be able to continue as a going concern and not be rendered insolvent by the distribution.” Thus, a Delaware corporation could have “funds” that are not “legally available” for payment in a redemption, or it could have “surplus” for a redemption, but no “funds” for the payment thereof. The Court concluded that even if ThoughtWorks had sufficient “surplus” to effect the redemption, it did not have “funds legally available” to effect the redemption and, therefore, ThoughtWorks was not obligated to redeem the Preferred Stock.
The Court gave considerable deference to the ThoughtWorks’ board of directors in its assessment of whether ThoughtWorks had funds legally available to effect the redemption. The Court noted that a plaintiff seeking to challenge such a determination must prove that “in determining the amount of funds legally available, the board acted in bad faith, relied on methods and data that were unreliable, or made a determination so far off the mark as to constitute actual or constructive fraud.” In its post-trial opinion, the Court found that that the ThoughtWorks board “actively tested the market to determine what level of ‘funds’ ThoughtWorks could obtain.” The Court concluded that the board “acted responsibly to fulfill its contractual commitment to the holders of Preferred Stock despite other compelling business uses for [ThoughtWorks’] cash” and its process was “impeccable.”