In determining that preferred stockholders not entitled to liquidation preference, Court declines to integrate conversion of preferred stock with subsequent merger
Applying well-established principles of contract interpretation, the Delaware Supreme Court, in Alta Berkeley VI C.V., et al v. Omneon, Inc.,1 recently declined to require payment of a liquidation preference to preferred stockholders that was not clearly mandated by the "plain meaning" of the governing instrument. In affirming a lower court ruling, the Court concluded that a pre-merger conversion of the preferred stock into common stock was not the first in a "series of related transactions" so as to require integration with the subsequent merger and thereby trigger a liquidation event. This decision underscores the reluctance of Delaware courts to give contracting parties rights that they failed to bargain for when negotiating their arrangements.
Omneon, Inc., a "privately-held technology company" headquartered in California, was acquired on September 15, 2010 via merger by Harmonic, Inc., a NASDAQ-traded technology company. Pursuant to the merger agreement, Omneon's common stock was converted into "roughly $190 million in cash plus $120 million in Harmonic stock." The merger was conditioned on Omneon's preferred stockholders (other than the holders of the Series A-2.2 preferred stock) approving, by majority vote, an "automatic" conversion of their preferred shares into common stock before the merger. Holders of the Series A-2.2 preferred stock were permitted by Omneon's charter to "opt out" of the conversion and receive their liquidation preference of approximately $1.5 million.
Although both the conversion and merger were approved by the requisite votes of Omneon's preferred and common stockholders, the holders of Omneon's Series C-1 preferred stock claimed that they, too, were entitled to their liquidation preference (which exceeded their share of the merger consideration) and asked the Delaware Superior Court to award "damages equal to the difference between their liquidation preference and the merger consideration they received following the conversion and merger." Under Omneon's certificate of incorporation, which set forth the preferred stock terms, a "Liquidation Event" includes "the acquisition of the Company by any person or entity by means of any transaction or series of related transactions ...." The Series C-1 preferred stockholders argued that the conversion – although occurring before the merger – was related and integral to the merger and, therefore, triggered a "Liquidation Event."
The Superior Court granted summary judgment in favor of Omneon. The Series C-1 preferred stockholders appealed to the Delaware Supreme Court, which affirmed the lower court ruling on the basis that "because the conversion validly converted the Series C-1 preferred into common shares before the Liquidation Event (the merger), the Series C-1 shareholders were no longer entitled to any liquidation preference at the time the merger took place."
The Court's Analysis
The Court began by noting the "undisputed" fact that the merger itself was a "Liquidating Event that would entitle every Series of preferred to its respective liquidation preference." The key question, therefore, was whether the "antecedent conversion" was related and integral to the merger and, as a result, a part of a "Liquidation Event." If not, then the Series C-1 preferred stock was validly converted into common stock before the merger and entitled only to its share of the merger consideration paid to the common stockholders.
To address this question, the Court utilized well-established rules of contract interpretation providing that, "[u]nless there is ambiguity, Delaware courts interpret contract terms according to their plain, ordinary meaning." Certificates of incorporation, such as the Omneon charter, "are regarded as contracts between the shareholders and the corporation" and, as a result, courts "must give effect to all terms of the instrument, must read the instrument as a whole, and, if possible, reconcile all the provisions of the instrument." Further, a contract "is not ambiguous merely because the parties dispute what it means." Rather, "[t]o be ambiguous, a disputed contract term must be fairly or reasonably susceptible to more than one meaning."
The Court found that "the plain meaning of Omneon's unambiguous charter language" supported the lower court's ruling. The Court reached this result by focusing on three factors:
- Per Omneon's charter, a Liquidation Event contemplates "'transactions' that involve an acquirer that gains some incremental 'voting power' or stock in each component transaction, and that eventually obtains ... majority voting power at the completion of the 'series.'" The Court noted, however, that "Harmonic, did not acquire Omneon or any part of its stock ..., let alone majority voting power, in the conversion." Under such circumstances, "Courts will not torture contractual terms to impart ambiguity where ordinary meaning leaves no room for uncertainty."
- The conversion should not be viewed as part of a "series of related transactions" with the merger because "[t]o do so would transmute the preferred shareholders' performance of an antecedent condition of the merger (the conversion) into a Liquidation Event transaction where Harmonic acquired Omneon (the merger itself)." While the two events may have been "'related' sequentially and factually, they cannot be fused together so as to become 'related' legally, and thereby made part of the same Liquidation Event 'series.'"2
- The fact that the holders of the Series A-2.2 Preferred Stock were expressly authorized by the charter to "opt out" of any "automatic" conversion that is "conditioned upon ... consummation of a Liquidation Event" supported the lower court's grant of summary judgment to Omneon. To allow the Series C-1 preferred stockholders to avoid the automatic conversion in order to obtain their liquidation preference would, in the Court's view, render the right bargained for by the Series A-2.2 preferred stockholders – but not by the Series C-1 preferred stockholders – "superfluous." The Court was not prepared to permit the Series C-1 preferred stockholders to "now obtain from the courts a right that they failed to achieve at the bargaining table."
The Omneon Court relied on fundamental principles of contract interpretation to read Omneon's charter through a plain language lens. Absent any ambiguity in the relevant provision, the Court refused to circumvent the plain text to make "superfluous" one provision at the expense of another. As Omneon makes clear, courts will not "do violence to the plain language" of a contract, or rely on so-called "anti-circumvention" provisions, in order to grant rights to parties which they failed to obtain at the negotiating table.
1. C.A. No. N10C-11-102 (Del. Sup. Ct. March 5, 2012).
2. In this connection, the Court cited Bank of New York Mellon Trust Co. v. Liberty Media Corp., 29 A.3d 225 (Del. 2011), for the proposition that the "series of related transactions" formulation is "anti-circumvention language, intended to prevent Omneon and Harmonic from evading the Liquidation Event definition ... such as by a 'creeping acquisition.'" The Court did not view the forced conversion of the Series C-1 preferred stock before the merger as an anti-circumvention event. For a discussion of the LibertyMedia decision, please see our Client Alert entitled "Delaware Supreme Court Provides Guidance on Interpretation of 'Boilerplate' Indenture Provisions," dated November 2, 2011.
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