Fiduciary Duties of Directors and Rights of Preferred Stockholders
This should be of particular concern to directors appointed by holders of preferred stock.
At the recent NVCA document group meeting there was a lot of discussion around a recent Delaware case (Trados) that pushes the law of fiduciary duty owed by directors generally in the direction of common stockholders. Jeffrey Wolters of the well known Delaware firm Morris, Nichols, Arsht & Tunnell LLP, recently sent around an email to the group noting another recent Delaware decision (QuadraMed) that is consistent with the Trados case.
This is not going to be a lawyer's discussion of the case and the fact and the holding. We may prepare a client alert separately (and I am happy to discuss it with anyone who wants to).
The larger point is that the way Delaware law is trending is that the directors owe their fiduciary duties to the holders of common stock and the holders of preferred stock will have whatever rights they bargained for and that is that.
While those of you who “represent” the holders of preferred stock may not like this result, it does lend conceptual clarity to fiduciary the obligations of directors. Companies enter into contracts (and preferred stock is a contract albeit one among three parties the company that issues the stock, the purchaser/holder of the preferred stock and the State of Delaware whose corporation laws define certain rights limits etc of the preferred stock), and companies have a legal obligation to meet their contractual obligations.
If companies fail to meet their obligations, bad things happen: They get sued for breach. But companies are not obligated to do more than is required under a contract. You fulfill the contract and that is the end of the obligation.
Once the company has fulfilled its contractual obligations, the board owes a duty to the common stock to run the company with the interest of the common stock in mind.
While this seeming conceptual clarification leaves a lot of questions to be decided and worked out, at least it starts to get us away from a world in which directors could, potentially, have conflicting duties to holders of preferred and common.
Comments (1)
Read through and enter the discussion by using the form at the endMike Feinstein - March 17, 2010 10:36 AM
Unfortunately, preferred directors still have a conflict even if the courts say that they should represent the interest of the common shareholders. VC partners are investors in their venture funds and are compensated with a portion of the profits (carried interest). Therefore, a preferred director has a personal financial incentive to protect the interests of the preferred stock where their compensation is tied.
You could argue that it might be in a company's interest to give each preferred director some common options to keep them focused on the common shareholder's interests. But, most venture firms are required to share this compensation with their investors, so it wouldn't have as strong of an effect.
This issue of a preferred director's split loyalties between the preferred and common is very significant, particularly if a company hits tough times, needs to get a difficult financing done, etc. I don't have a recommended solution, but I don't think that some court decisions will make a difference when personal motivation comes into play.