The Delaware Court of Chancery in Manti Holdings LLC v. Authentix Acquisition Company recently confirmed that a stockholder agreement may contractually restrict the exercise of statutory appraisal rights. Although the court has previously ruled on the enforceability of waivers of preferred stockholders’ appraisal right, this marks the first time that a Delaware court has ruled on the enforceability of contractual restriction of appraisal rights for common stockholders. The decision provides guidance for negotiating and drafting investment-related documents to properly address effective waiver of appraisal rights when a triggering event occurs.
The plaintiffs were among a group of stockholders who had purchased common stock in the Company. The plaintiffs’ investment was governed by a stockholder agreement that included investment in the Company by a group of investors who purchased preferred stock, representing a majority of the outstanding capital stock of the Company. As is customary in many such transactions, the stockholder agreement included a provision for drag-along rights obligating the plaintiffs to consent to a sale of the Company if approved by at least 50% of the Company’s stock. The stockholder agreement also obligated the common stockholders to refrain from exercising any appraisal rights with respect to any such sale of the Company.
By written consent, a majority of the Company’s stockholders resolved to sell the Company, which was accomplished via merger. The cash consideration available for distribution to stockholders as a result of the merger left little or nothing for the common stockholders of the Company. After the sale closed, the plaintiffs sought to exercise their appraisal rights under Section 262 of the Delaware General Corporation Law (DGCL), despite the prohibitive language in the stockholder agreement. The plaintiffs argued first that the stockholder agreement only required them to refrain from exercising appraisal rights prior to closing on the sale of the Company, but did not waive appraisal rights entirely. They relied on the fact that the stockholders agreement provided that it terminated upon the consummation of a Company sale. The court quickly dispensed with plaintiffs’ linguistic gymnastics, citing that plaintiffs’ interpretation of the stockholder agreement was unreasonable given that appraisal rights would not accrue until the transaction closed and that rights that vested before termination are not extinguished by such a provision. Although it would have been preferable to use the term “waiver,” the court held that “refrain” unambiguously evidenced the elimination of appraisal rights under the circumstances.
The plaintiffs’ fallback argument was that the elimination of appraisal rights in conjunction with the drag-along provision violated Section 151(a) of the DGCL. Section 151(a) requires that limitations on classes of stock appear in or derive from the Company’s certificate of incorporation. The court disagreed that a waiver of appraisal rights in the stockholder agreement is the equivalent of imposing restrictions on a class of stock. The court recognized that stockholders may, and in this instance did, take on contractual obligations in a stockholder agreement to which they will be bound. Such contractual obligations do not violate Section 151(a) in the court’s view.
Another interesting claim raised by the plaintiffs was that if the transaction had been structured as a transfer of equity, their obligations under the drag-along provisions of the stockholder agreement would have been triggered and only required that they refrain from seeking appraisal rights if they received the same price per share as the preferred investors. The plaintiffs tried to extend this to any sale of the Company. Since the preferred and common shares did not receive the same value in the distribution of the merger proceeds due to the liquidation preferences of the preferred stock, the plaintiffs argued that the price paid to the common stockholders and the investors was not the same and thus their duties were never triggered. The court found the plaintiffs’ reading doubtful but did not directly address their contention because it found the provision inapplicable. It found that even if they were reading the provision correctly, it was inapplicable in this case as the stockholders’ agreement did not impose the same condition on a Company sale structured as a merger as it did in a transfer of equity. Since the sale was accomplished by a merger approved by the board of directors of the Company, and the merger agreement did not address distribution, the distribution of proceeds was governed by the waterfall in the Company charter. The court found that the stockholders’ agreement differentiated between Company sale by merger (which provides certain fiduciary protections), in which case the stockholders must consent and raise no objections to the sale, and a Company sale by transfer of equity securities which imposed an additional affirmative duty on stockholders to take actions in furtherance of the sale only so long as the price per share is the same.
Private equity and venture capital investors may rely upon this decision as authority for the enforceability of contractual waivers of statutory appraisal rights. As with any contract, agreement to the terms of the stockholder agreement must be voluntary and for consideration. Investment in the company is sufficient consideration. Care must also be taken to properly construct the waiver provision. To avoid ambiguity, drag-along provisions should clearly state not only that stockholders refrain from exercise of such rights but also that such rights are waived effective upon approval of the applicable sale transaction. Parties should also be clear as to whether obligations relating to any sale transaction apply to any and all forms of sale transaction (whether accomplished through merger, consolidation, divisive merger, sale of equity, sale of assets or otherwise). Further, conditions to the drag-along provision should clearly delineate any permitted differential treatment between and among different classes and series of stock to allow for compliance with the waterfall provisions of the company’s governing documents relating to liquidation preferences and ensure that such provisions apply regardless of the structure of the sale transaction.