LASTER, Vice Chancellor.
The plaintiffs are a group of affiliated investment funds and their advisor, SV Investment Partners, LLC (collectively, "SVIP"). In 2000, they purchased over 94% of the Series A Preferred Stock (the "Preferred Stock") issued by the defendant ThoughtWorks, Inc. ("ThoughtWorks" or the "Company"). The amended and restated certificate of incorporation of ThoughtWorks dated April 5, 2000 (the "Charter") granted the holders of the Preferred Stock the right to have their stock redeemed "for cash out of any funds legally available therefor" beginning five years after issuance. SVIP first exercised its redemption right in 2005.
ThoughtWorks does not have and cannot obtain the cash to redeem the Preferred Stock in full. Instead, each quarter, its board of directors (the "Board") carefully evaluates the Company's finances to determine (i) whether ThoughtWorks has surplus from which a redemption could be made, (ii) whether ThoughtWorks has or could readily obtain cash for a redemption, and (iii) whether a redemption would endanger the Company's ability to continue as a going concern. Over sixteen quarters, the Board has redeemed Preferred Stock on eight separate occasions. A total of 222,802 shares have been redeemed with a total value of $4.1 million.
SVIP objects to the Board's periodic approach. According to SVIP, the term "funds legally available" simply means "surplus." SVIP presented an expert at trial who opined that ThoughtWorks has surplus of $68-$137 million. SVIP argues that while ThoughtWorks may not have cash or the ability to get it, it nevertheless has "funds legally available" and must redeem the Preferred Stock. Because ThoughtWorks has failed to do so, SVIP believes itself entitled to a judgment for the aggregate redemption price. As of April 5, 2010, that amount was $66,906,539.
SVIP's theory breaks down because the phrase "funds legally available" is not equivalent to "surplus." A corporation can have "funds" and lack "surplus," or have "surplus" and lack "funds." The binding constraint on ThoughtWorks' ability to redeem the Preferred Stock is a lack of funds and the concomitant risk that a significant redemption will render the Company insolvent. An unbroken line of decisional authority dating back to the late nineteenth century prohibits a corporation from redeeming shares when the payment would render the corporation insolvent. Even assuming that SVIP were correct and ThoughtWorks could be deemed to have "surplus," SVIP has not shown that ThoughtWorks has "funds legally available." Judgment is therefore entered in favor of ThoughtWorks and against SVIP.
The following factual findings have been made after a two-day trial. I also have relied on the factual findings made in a prior decision involving the parties, which are res judicata. See ThoughtWorks, Inc. v. SV Inv. P'rs, LLC, 902 A.2d 745 (Del.
Roy Singham founded ThoughtWorks in 1993. The Company describes itself as an information technology professional services firm that develops and delivers custom business software applications and provides related consulting services. Headquartered in Chicago, ThoughtWorks provides services to clients throughout the United States and, through subsidiaries, in various parts of the world. Singham owns approximately 94% of ThoughtWorks' common stock.
Singham created ThoughtWorks to establish "a prestige brand of outstanding talent" in the software consulting industry. To achieve this goal, he fostered a "secret sauce culture" that would appeal to the very best software developers, who, in his estimation, are ten to twenty times more productive than average software developers. ThoughtWorks places tremendous emphasis on recruiting elite professionals and providing them with challenging and intellectually stimulating work. The Company's employees, known as "ThoughtWorkers," are its most valuable asset.
The nature of ThoughtWorks' business makes for volatile cash flows. ThoughtWorks' engagements are typically short-term. Although some clients have engaged ThoughtWorks on multiple occasions over the years, each engagement typically lasts three to six months, does not automatically renew, and is subject to cancellation on as little as fifteen-days' notice. ThoughtWorkers arrive at the scene, solve the problem, and move on. As a result, ThoughtWorks' ability to forecast cash flows accurately is limited, and ThoughtWorks consistently failed to meet its forecasts every year through 2008.
Additionally, ThoughtWorks' business tends to be hyper-cyclical. In a downturn, clients terminate ThoughtWorks' contracts before laying off their own employees. In an upturn, clients engage ThoughtWorks before committing to new permanent hires. The business is also seasonal, largely due to ThoughtWorkers and clients taking holiday vacations. ThoughtWorks' slow period runs from November to January, causing the first calendar quarter to be a low point for cash flow.
Because of the volatility in its business, ThoughtWorks' management historically has tried to maintain a cash cushion that will enable the firm to ride out unexpected revenue shortfalls and seasonal lows. This is not to suggest that management has sought (much less been able) to amass a war chest. Rather, management prudently tries to keep some funds on hand so that checks don't bounce during a dry spell.
In 1999, ThoughtWorks began to consider an initial public offering. ThoughtWorks retained an investment bank, S.G. Cowen Securities Corporation, for advice. Having an existing venture capital investor was thought to enhance a new issuer's credibility. ThoughtWorks and S.G. Cowen therefore prepared a confidential offering memorandum for a $25 million private equity investment.
SVIP received the offering memorandum and liked the ThoughtWorks opportunity. In contrast to the stereotypical dot-com concept, ThoughtWorks had a seven-year track record of revenue growth and profitability, and its customers consisted primarily of blue-chip, Fortune 1000 firms. While SVIP recognized that it was "paying a full valuation for the business," the firm believed that the deal could "provide attractive returns on reasonably (and comparatively) conservative exit assumptions."
When negotiating the terms of SVIP's investment, both SVIP and ThoughtWorks anticipated an IPO within a year or two. They also discussed redemption rights for SVIP in case no IPO materialized. The ThoughtWorks offering memorandum proposed a redemption right after seven years, with the payments made in twelve quarterly installments. SVIP countered with a redemption right after four years, then softened that demand to redemption after five years. ThoughtWorks proposed a two-year payout period. SVIP rejected that term. The parties compromised on a redemption right after five years, subject both to the legal availability of funds and to a one-year working capital carve-out.
On April 5, 2000, SVIP invested $26.6 million in ThoughtWorks in exchange for 2,970,917 shares of the Preferred Stock. Another 167,037 shares were purchased by eighteen individuals who are not parties to this action.
The holders of the Preferred Stock are entitled to receive cumulative cash dividends at a rate of 9% per annum, compounded semi-annually and accruing semiannually in arrears. In any liquidation, dissolution, or winding up of the Company, the Preferred Stock is entitled to a liquidation preference equal to the initial purchase price of $8.95 per share (adjusted for any stock dividends, splits, recapitalizations, or consolidations) plus all accrued and unpaid dividends, plus an amount equal to what the Preferred Stock would receive in liquidation assuming it were converted into common stock and shared ratably with the common.
Critically for the current case, Article IV(B), Section 4(a) of the Charter sets out the Preferred Stock's redemption right. It states:
Charter art. IV(B), § 4(a) (the "Redemption Provision"). The Redemption Provision contains two limitations on the Company's obligation "to redeem for cash." First, the redemption can only be "out of any funds legally available therefor." Second, the provision excludes funds "designated by the Board of Directors as necessary to fund the working capital requirements of the Corporation for the fiscal year of the Redemption Date."
Article IV also addresses what happens if "funds of the Corporation legally and otherwise available for redemption pursuant to Section 4(a)" are "insufficient to redeem all the Preferred Stock required to be redeemed." In that event,
Charter art. IV(B), § 4(d). The same provision states that "[f]or the purpose of determining whether funds are legally available for redemption . . ., the Corporation shall value its assets at the highest amount permissible under applicable law" (the "Valuation Provision"). Id.
On March 10, 2000, the NASDAQ peaked at 5132.52 in intraday trading, having more than doubled in the preceding year. A year later, on March 9, 2001, the NASDAQ closed at 2,052.78, down 59.3%. Three years later, on March 10, 2003, the NASDAQ closed at 1,278.37. It rapidly became clear to everyone that an IPO was no longer a realistic possibility for ThoughtWorks in the near term.
In 2003, ThoughtWorks began considering internally how it might redeem the Preferred Stock. After an extensive analysis, ThoughtWorks general counsel Daniel Goodwin and CFO Eric Loughmiller concluded that ThoughtWorks likely could not pay approximately $43 million to redeem the Preferred Stock in April 2005. In October and November 2003, Singham presented the "Solving The Put Program" to the Global Operating Committee and the Board, identifying the redemption as one of ThoughtWorks' top three priorities.
ThoughtWorks informed SVIP in the summer of 2003 that it would not be able to meet the redemption obligation. During late 2003 and 2004, ThoughtWorks and SVIP discussed possible resolutions. In January 2005, ThoughtWorks engaged an investment bank, William Blair and Company, to seek debt financing to redeem the Preferred Stock. In the hope that financing could be obtained, SVIP agreed to postpone the earliest date the redemption payment would be due until July 5, 2005.
William Blair prepared a confidential information memorandum and distributed it to forty-five potential lenders. In April 2005, William Blair presented the lending proposals from potential lenders in a joint meeting with ThoughtWorks and SVIP. The results were disappointing. ThoughtWorks had hoped to secure at least $30 million in debt financing, but the largest proposal was for $20 million. With no ability to pay $43 million, ThoughtWorks formally offered to redeem all of the Preferred Stock for $12.8 million. SVIP rejected the offer.
Meanwhile, by demand letters sent by the various SVIP entities on May 19 and 20, 2005, SVIP exercised its redemption rights and requested immediate and full redemption effective July 5, 2005.
On July 1, 2005, the ThoughtWorks Board held a special meeting to consider the SVIP redemption demand. The Board focused on the working capital restriction and concluded that "funds required to fund the working capital requirements of the Company [were] an amount in excess of available cash on July 5, 2005." Because of the resulting lack of usable cash, the
After SVIP disagreed with ThoughtWorks' position, the Company filed a declaratory judgment action in this Court to obtain a determination that "it has the right, ongoing from year to year, to exclude necessary working capital from the funds available to pay the redemption obligation." Working Capital Decision, 902 A.2d at 752. This Court concluded that "the working capital set-aside applied only in fiscal year 2005, and, thus, ThoughtWorks must now redeem SVIP's preferred stock to the extent funds are legally available therefor." Id. at 754 (emphasis added). The Court noted that "[t]he question whether ThoughtWorks has legally available funds under Delaware law to apply to its redemption obligation was not at issue in this action." Id. at 754 n. 36. A final order was entered July 25, 2006.
Shortly after this Court issued its final order, SVIP again exercised its redemption right. On August 3, 2006, SVIP demanded that ThoughtWorks redeem its Preferred Stock for $45 million, representing the aggregate redemption price at the time.
In response, at a meeting on August 24, 2006, the Board analyzed the extent to which the Company had "funds legally available" to make a redemption payment. The Board obtained legal advice from Freeborn & Peters LLP and financial advice from AlixPartners LLC. A Freeborn memorandum set out the process for the Board to follow:
At the August 24 meeting, the Board determined that ThoughtWorks had $500,000 of funds legally available and redeemed Preferred Stock in that amount.
In each of the subsequent sixteen quarters, the Board has followed the same process to determine the extent to which funds are legally available for redemptions. In each case, the Board has considered current financial information about the Company and consulted with its advisors. For example, in March 2010, AlixPartners advised the Board that ThoughtWorks' "net asset value" was in the range of $6.2 to $22.3 million, and its "cash availability" — net of the previously declared but still unpaid redemptions — ranged from approximately $1 million (in the worse of two downside cases) to approximately $3 million (in the base case). After deliberating, the Board determined that the Company had no funds legally available and "declare[d] a redemption of Series A Preferred Stock in the amount of $0.00." The
To date, through this quarterly process, ThoughtWorks has redeemed a total of $4.1 million of Preferred Stock. That equates to 222,802 shares, of which 214,484 are held by SVIP. SVIP has declined to submit its stock certificates for payment.
On February 8, 2007, SVIP filed this action. SVIP seeks a declaratory judgment as to the meaning of the phrase "funds legally available" and a monetary judgment for the lesser of (i) the full amount of ThoughtWorks' redemption obligation and (ii) the full amount of ThoughtWorks' "funds legally available." The parties spent summer 2007 in settlement negotiations, including a day-long mediation in August 2007. They resumed discovery for the first half of 2008, then agreed to a series of standstills while settlement negotiations resumed. In February 2009, settlement talks broke down.
Beginning in August 2009, Thought-Works sought third-party financing for a potential redemption. AlixPartners prepared an information memorandum that was sent to seventy financing sources. The seventeen who expressed interest and signed confidentiality agreements received additional information. Three sources provided nonbinding commitment letters. After due diligence, two lenders provided definitive term sheets.
The first binding term sheet was from an asset-based lender that focused on ThoughtWorks' tangible collateral. Given the intangible nature of ThoughtWorks' assets, the amount of financing from this source was limited. It also was contingent on all of the Preferred Stock being redeemed in return for the loan proceeds, which would have been significantly less than full redemption price.
The second binding term sheet was from the debt financing arm of a private equity firm and focused on ThoughtWorks' ability to generate cash flow. On March 25, 2010, ThoughtWorks signed a commitment letter providing total debt financing of $30 million, including a $5 million revolving line of credit and $25 million (less expenses) to redeem the Preferred Stock. The commitment letter was conditioned on holders tendering all of the Preferred Stock. SVIP declined, and the commitment expired.
Section 160 of the Delaware General Corporation Law (the "DGCL") authorizes a Delaware corporation to redeem its shares, subject to statutory restrictions. It provides, in pertinent part:
8 Del. C. § 160(a)(1). "A repurchase impairs capital if the funds used in the repurchase exceed the amount of the corporation's `surplus,' defined by 8 Del. C. § 154 to mean the excess of net assets over the par value of the corporation's issued stock." Klang v. Smith's Food & Drug Ctrs., Inc., 702 A.2d 150, 153 (Del.1997). "Net assets means the amount by which total assets exceed total liabilities." 8 Del. C. § 154. Under Section 160(a)(1), therefore, unless a corporation redeems shares and will retire them and reduce its capital, "a corporation may use only its surplus for the purchase of shares of its own capital stock." In re Int'l Radiator Co., 92 A. 255, 256 (Del.Ch.1914).
Section 160's restrictions on redemptions are intended to protect creditors. See, e.g., Propp v. Sadacca, 175 A.2d 33, 38 (Del.Ch.1961), aff'd in part, rev'd in part sub nom. Bennett v. Propp, 187 A.2d 405 (Del.1962). The statute seeks to accomplish this goal by prohibiting transactions that would redistribute to stockholders assets that were part of what nineteenth and early twentieth century common law jurists deemed a permanent base of financing upon which creditors were presumed to rely when extending credit. See, e.g., In re Tichenor-Grand Co., 203 F. 720, 721 (S.D.N.Y.1913) (Hand, J.) (describing a redemption from capital as taking from the creditors "[t]he fund which they have the right to rely upon"); see generally Bayless Manning & James J. Hanks, Jr., Legal Capital ch. 2 (3d ed. 1990) [hereinafter "Legal Capital"] (describing the development and theoretical underpinnings of "legal capital" as protection for creditors); id. at ch. 4 (describing the regulation of distributions to shareholders under the "legal capital" scheme). As a practical matter, the test operates roughly to prohibit distributions to stockholders that would render the company balance-sheet insolvent, but instead of using insolvency as the cut-off, the line is drawn at the amount of the corporation's capital.
Section 160(a) permits a Delaware corporation to redeem shares of stock. For ThoughtWorks, the Redemption Provision converts that authority into a mandatory obligation by granting SVIP the power "to require [ThoughtWorks] to redeem for cash out of any funds legally available therefor ... not less than 100% of the Preferred Stock."
ThoughtWorks does not have and cannot raise sufficient funds to redeem "100% of the Preferred Stock." SVIP contends that under the circumstances, it is entitled to a judgment against ThoughtWorks for the full amount of the redemption price. SVIP argues that:
Pl.'s Opening Br. at 1-3.
Equating "funds legally available" with "surplus" performs all of the work in SVIP's argument. With that move, SVIP converts a provision contemplating payment "for cash" into a formula based on an incorporeal legalism. This is a fallacy:
Legal Capital, supra, at 37-38. Rather than examining ThoughtWorks' assets to determine whether it has "funds" that are "available" and can be used "legally" for redemptions, SVIP seeks a judgment based on an accounting convention.
The plain meaning of "funds legally available" has more practical content. "A certificate of incorporation is viewed as a contract among shareholders, and general rules of contract interpretation apply to its terms." Waggoner v. Laster, 581 A.2d 1127, 1134 (Del.1990). "Contracts are to be interpreted as written, and effect must be given to their clear and unambiguous terms." Willie Gary LLC v. James & Jackson LLC, 2006 WL 75309, at *5 (Del. Ch. Jan. 10, 2006), aff'd, 906 A.2d 76 (Del. 2006). "Contract terms themselves will be controlling when they establish the parties' common meaning so that a reasonable person in the position of either party would have no expectations inconsistent with the contract language." Eagle Indus., Inc. v. DeVilbiss Health Care, Inc., 702 A.2d 1228, 1232 (Del.1997). "When a contract is clear on its face, the court should rely solely on the clear, literal meaning of the words contained in the contract." Liquor Exch., Inc. v. Tsaganos, 2004 WL 2694912, at *2 (Del.Ch. Nov. 16, 2004).
Because the existence of surplus under Section 160 most commonly constrains a corporation's ability to pay dividends or redeem stock, "funds legally available" is colloquially treated as if synonymous with "surplus." The two concepts, however, are not equivalent. Black's Law Dictionary defines "funds" as follows:
Black's Law Dictionary 673 (6th ed. 1990) (internal citations omitted). Non-legal dictionaries define funds (plural) as "available pecuniary resources," Webster's New Collegiate Dictionary 461 (1979), or "[a]vailable money; ready cash," American Heritage College Dictionary 551 (1993). Each of these definitions focuses on cash, cashequivalents, and other relatively liquid assets that could readily be used as a source of cash.
Black's Law Dictionary defines "available" as "[s]uitable; useable; accessible; obtainable; present or ready for immediate use." Id. at 135. Non-legal definitions of "available" include "present or ready for immediate use," Webster's, supra, at 77, and "[p]resent and ready for use; at hand; accessible," or "[c]apable of being gotten; obtainable," American Heritage, supra, at 94.
Black's Law Dictionary defines "legal" as "[c]onforming to the law; according to law; required or permitted by law; not forbidden or discountenanced by law; ... lawful." Id. at 892. Other definitions of "legal" include "conforming to or permitted by law or established rules," Webster's, supra, at 650, and "[i]n conformity with or permitted by law," American Heritage, supra, at 774.
The phrase "funds legally available" therefore contemplates initially that there are "funds," in the sense of a readily available source of cash. The funds must both be "available" in the general sense of accessible, obtainable, and present or ready for immediate use, and "legally" so, in the additional sense of accessible in conformity with and as permitted by law. The Redemption Provision renders this usage of "funds" all the more clear by speaking in terms of redemption "for cash out of funds legally available therefor." The Redemption Provision thus directly links "funds" to the concept of "cash."
A corporation easily could have "funds" and yet find that they were not "legally available." See Klang, 702 A.2d at 154 (noting that balance sheet showed negative net worth, which prevented distribution of cash via self-tender prior to revaluation of assets); Morris v. Standard Gas & Elec. Co., 63 A.2d 577, 580-81 (Del.Ch.1949) (noting that balance sheet showed surplus of $25 million, which was insufficient for dividend of $88 million without revaluation of assets). A corporation also could lack "funds," yet have the legal capacity to pay dividends or make redemptions because it had a large surplus. Under those circumstances, a corporation could still redeem shares in exchange for other corporate property. See Alcott v. Hyman, 208 A.2d 501, 508 (Del.1965) (explaining that Section 160 authorizes "a corporation to use its property for the purchase of its own capital stock if such use will not impair its capital"). As an insightful monograph on legal capital explains,
Legal Capital, supra, at 38 (footnotes omitted); see Donald Kehl, Corporate Dividends 170-74 (1941) (providing examples of non-cash distributions).
Even within the narrow confines of the DGCL, the terms are not co-extensive. Section 160 authorizes shares to be redeemed
Outside the DGCL, a wide range of statutes and legal doctrines could restrict a corporation's ability to use funds, rendering them not "legally available." The Bank Holding Company Act of 1956, 12 U.S.C. § 1841, et seq., requires bank holding companies to maintain certain capital requirements, and a subject company would need to take those restrictions into account. Federal employment taxes collected from employees are held in trust for the federal government,
Most significantly for the current case, the common law has long restricted a corporation from redeeming its shares when the corporation is insolvent or would be rendered insolvent by the redemption.
Id. § 5297 (footnotes omitted). Learned commentators similarly explain that the redemption right of a preferred stockholder cannot impair the rights of creditors and therefore cannot be exercised when the corporation is insolvent or would be rendered insolvent by the payment.
A corporation may be insolvent under Delaware law either when its liabilities exceed its assets, or when it is unable to pay its debts as they come due. See, e.g., N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 2006 WL 2588971, at *10 (Del.Ch. Sept. 1, 2006), aff'd, 930 A.2d 92 (Del.2007); Prod. Res. Gp., L.L.C. v. NCT Gp., Inc., 863 A.2d 772, 782 (Del.Ch.2004). Although a corporation cannot be balance-sheet insolvent and meet the requirements of Section 160, a corporation can nominally have surplus from which redemptions theoretically could be made and yet be unable to pay its debts as they come due. The common law prohibition on redemptions when a corporation is or would be rendered insolvent restricts a corporation's ability to redeem shares under those circumstances, giving rise to yet another situation in which "funds legally available" differs from "surplus." See In re Color Tile, Inc., 2000 WL 152129, at *5 (D.Del. Feb. 9, 2000) (holding that complaint alleging a Delaware corporation had incurred "debts beyond its ability to pay" validly pled that the corporation "lacked legally available funds at the time of the dividend declaration").
The Valuation Provision does not override these distinctions. It simply requires that when determining whether funds are legally available, ThoughtWorks must "value its assets at the highest amount permissible under applicable law." The provision recognizes that there could be situations, as in Klang and Morris, when Thought-Works could have "funds" on hand and yet could not satisfy applicable legal requirements, most obviously Section 160 of the DGCL. Under those circumstances, the Valuation Provision requires that Thought-Works re-value its assets "at the highest amount permissible under applicable law" in order to free "funds" for redemptions to the maximal extent permitted by law. The Valuation Provision does not create an obligation to redeem shares when no "funds" exist. Nor can the Valuation Provision trump other legal impediments to the use of funds for redemption, such as cash-flow
SVIP's claim depends on "funds legally available" being equivalent to "surplus." Because the two concepts differ, SVIP's claim fails as a matter of law. SVIP's claim also fails because it supposes that the existence of "surplus" is sufficient to establish conclusively a corporation's obligation to redeem shares, regardless of whether the corporation actually has funds from which the redemption can be made. "Funds legally available" means something different. It 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.
The Redemption Provision obligates ThoughtWorks to redeem the Preferred Stock only to the extent it has funds legally available. If ThoughtWorks lacks sufficient funds to redeem 100% of the Preferred Stock, then "funds to the extent so available shall be used for such purpose and [ThoughtWorks] shall effect such redemption pro rata according to the number of shares held by each holder of Preferred Stock." Charter art. IV(B), § 4(d). The Charter further provides that "[t]he redemption requirements provided hereby shall be continuous, so that if at any time after the Redemption Date such requirements shall not be fully discharged, without further action by any holder of Preferred Stock, funds available pursuant to Section 4(a) shall be applied therefor until such requirements are fully discharged." Id.
Under Delaware law, when directors have engaged deliberatively in the judgment-laden exercise of determining whether funds are legally available, a dispute over that issue does not devolve into a mini-appraisal. Rather, the plaintiff 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. Klang, 702 A.2d at 156; accord Morris, 63 A.2d at 584-85.
The Valuation Provision requires that ThoughtWorks "value its assets at the highest amount permissible under applicable law." This language does not eliminate the need for judgment when determining "funds legally available." Judgment is inherently part of the valuation process, particularly when the necessary decisions encompass the corporation's ability to continue as a going concern. Nor does the Valuation Provision require this Court to mark ThoughtWorks' assets at the highest number a valuation expert can put on the Company while keeping a straight face. In Klang, the Delaware Supreme Court held that a corporation has the power to revalue its assets, rather than relying on book value, to show surplus for the purpose of making stock redemptions. 702 A.2d at 154. The Delaware Supreme Court did not invite practitioners of the valuation arts to calculate speculative figures. The Court rather stated: "Regardless of what a balance sheet that has not been updated may show, an actual, though unrealized, appreciation reflects real economic value that the corporation may borrow against or that creditors may claim or
SVIP failed to prove at trial that the Board ever (i) acted in bad faith in determining whether ThoughtWorks had legally available funds, (ii) relied on methods and data that were unreliable, or (iii) made determinations so far off the mark as to constitute actual or constructive fraud. Rather than litigate these issues, SVIP instructed its expert, Laura B. Stamm, to value ThoughtWorks, and she did so utilizing the discounted cash flow, comparable companies, and comparable transaction methodologies. Based on these analyses, she valued ThoughtWorks' equity in the range of $68-$137 million. SVIP's counsel instructed Stamm that in light of the Valuation Provision, her valuation was equivalent to "funds legally available." She therefore opined that ThoughtWorks had sufficient "funds legally available" to redeem SVIP's Preferred Stock.
Stamm concededly did not consider the amount of funds ThoughtWorks could use for redemptions while still continuing as a going concern. She never considered how making an eight-figure redemption payment would affect ThoughtWorks' ability to operate and achieve the projections on which her analyses relied. She had no thoughts on how ThoughtWorks might raise the funds for such a redemption payment. Although defensible as a theoretical exercise, her opinion does not credibly address the issue of "funds legally available." It does not reflect "real economic value" or bear any relationship to what ThoughtWorks might borrow or its creditors recover. It offers no assistance in determining whether the Board acted in bad faith, relied on methods and data that were unreliable, or made determinations so far off the mark as to constitute actual or constructive fraud.
The factual record demonstrates that the Board has acted in the utmost good faith and relied on detailed analyses developed by well-qualified experts. For sixteen straight quarters, the Board has undertaken a thorough investigation of the amount of funds legally available for redemption, and it has redeemed Preferred Stock accordingly. On each occasion, the Board has consulted with financial and legal advisors, received current information about the state of the Company's business, and deliberated over the extent to which funds could be used to redeem the Preferred Stock without threatening the Company's ability to continue as a going concern. The Board's process has been impeccable, and the Board has acted responsibly to fulfill its contractual commitment to the holders of the Preferred Stock despite other compelling business uses for the Company's cash. This is not a case where the Board has had ample cash available for redemptions and simply chose to pursue a contrary course. Cf. Mueller v. Kraeuter & Co., 131 N.J. Eq. 475, 25 A.2d 874, 877 (N.J.Ch.1942) (compelling corporation to take steps to redeem preferred stock where directors in prior years deployed funds exceeding amount of redemption obligation for purposes of expansion).
Most notably, the Board actively tested the market to determine what level of "funds" ThoughtWorks could obtain. A thorough canvass that included contacts with seventy potential funding sources generated a term sheet that would enable ThoughtWorks to borrow funds netting $23 million for redemptions, if and only if the "funds" were used to satisfy the entire obligation to the Preferred Stock. This proposal is the most credible evidence of
SVIP's plight is nothing new. The phrase "funds legally available" is not unique to the Charter. Those words or substantively identical variants customarily appear in charter provisions addressing dividends and redemptions.
Most obviously, in lieu of preferred stock, investors can purchase convertible debt or straight debt with warrant coverage. Either combination provides the same potential equity upside as preferred stock, but carries the downside protection of a debt instrument's right to payment at a specified time, irrespective of the company's financial condition. See 1 Joseph W. Bartlett, Equity Finance: Venture Capital, Buyouts, Restructurings and Reorganizations § 13.5, at 300 (2d ed. 1995) (explaining that a debenture with warrants "gets the holder to the same place as a convertible preferred"). SVIP's representative, Nicholas E. Somers, was aware of the differences between debt and equity and recognized that he could have invested using debt.
Although debt offers an alternative, there are many reasons why investors and issuers might want to structure a position as equity. See generally George G. Triantis, Financial Contract Design in the World of Venture Capital, 68 U. Chi. L.Rev. 305, 311-19 (2001) (comparing venture capital preference for convertible securities, principally preferred stock, with bank paradigm of short-term secured debt). Investors who take equity stakes often insist on additional protections, such as a springing right to board control. See 8 Del. C. §§ 141(d), 151(a); Vogtman, 178 A. 99 (Del.Ch.1935); Petroleum Rights Corp. v. Midland Royalty Corp., 167 A. 835 (Del.Ch.1933). The National Venture Capital Association pointedly explains the rationale for such a provision in terms that apply to the current case:
NVCA Model Term Sheet, supra, at 6 n. 14.
Another alternative, common in stockholders' agreements, allows a preferred stockholder to sell its security and "drag along" the remaining stockholders. "Drag along" rights, which effectively allow a preferred stockholder to sell the entire company to a third party without
The existence of these and other widely utilized alternatives demonstrates at least two things. First, sophisticated investors understand that mandatory redemption rights provide limited protection and function imperfectly, particularly when a corporation is struggling financially. If a standard mandatory redemption provision offered a clear path to a large monetary judgment and concomitant creditor remedies, then so many alternatives likely would not have evolved. My interpretation of "funds legally available" thus fulfills the settled expectations of investors and issuers as evidenced by established commercial practice.
Second, SVIP easily could have protected its investment and avoided its current fate through any number of means. SVIP decided not to, and that choice was rational at the time. SVIP bought the Preferred Stock at the height of the dot-com mania from a technology firm with an established track record, real revenues, and actual earnings — all of which compared favorably with many issuers then embarking on over-subscribed and first-day-popping IPOs. Everyone involved anticipated that ThoughtWorks soon would go public at a multi-billion dollar valuation. Instead, the bubble burst. Now, with hindsight, SVIP understandably wishes it had additional rights, but "it is not the proper role of a court to rewrite or supply omitted provisions to a written agreement." Cincinnati SMSA Ltd. P'ship v. Cincinnati Bell Cellular Sys. Co., 708 A.2d 989, 992 (Del.1998).
Judgment is entered in favor of ThoughtWorks and against SVIP. ThoughtWorks will present a final order upon notice.
