In the recent In re Trados Incorporated Shareholders Litigation case, there was a reiteration of a principle by Vice Chancellor Laster that bears repeating. In several pages of his 114-page opinion, Vice Chancellor Laster reminds us as practitioners and investors that no special duty is owed by a board of directors of a Delaware corporation to the holders of preferred stock. Rather, the board of directors owes a duty to the residual claimants of a corporation (i.e., common stockholders).
As is often the case, preferred stockholders are provided with a number of preferential rights, including liquidation preferences, special voting rights, rights to board seats and registration rights. However, as Vice Chancellor Laster notes, these rights are contractually established and do not necessitate a fiduciary duty level of protection. Accordingly, these rights will be interpreted in a manner consistent with customary contractual interpretation. Vice Chancellor Laster notes further, “a board does not owe fiduciary duties to preferred stockholders when considering whether or not to take corporate action that might trigger or circumvent the preferred stockholders’ contractual rights.” In re Trados Incorporated. Preferred stockholders are owed fiduciary duties only when they do not involve their special contractual rights and rely on a right shared equally with the common stock.
Thus, when directors are in a position to evaluate a liquidity event for a corporation in which preferred stockholders are present, it is incumbent on the directors to build a record of maximizing value for the common stockholders as well as the preferred stockholders. To be even clearer, the Delaware Court notes, “generally it will be the duty of the board, where discretionary judgment is to be exercised, to prefer the interests of the common stock . . . to the interests, special rights, preferences, etc. . . . of preferred stock.” In Re Trados Incorporated quoting Equity-Linked 705 A.2d. 1042.
This analysis argues for boards of directors to be cautious when considering the relative rights of common and preferred stockholders. Moreover, it is important to consider whether special committee structures should be implemented when representatives of preferred stockholders have significant membership on a board or meaningful influence over board outcomes.