When a dissatisfied stockholder petitions the Court of Chancery for an appraisal of shares extinguished in a merger, the petitioner will have the burden of persuading the court of the fair value of those shares. When the holder owns preferred stock, valuation issues arise that do not pertain to the holders of common stock. That is because, unlike for common stockholders, preferred stockholders’ rights, including to redemption and sometimes to valuation in the event of a merger, are spelled out contractually.
If a merger is consummated prior to the date of a mandated redemption, a question arises of whether a court can take the redemption right into consideration in an appraisal action where, by statute, the court is to value the shares "exclusive of any element of value arising from the accomplishment or expectation of the merger." The Court of Chancery answers this question in the affirmative in Shiftan v. Morgan Joseph Holdings Inc., and in the process provides useful guidance to counsel for issuers and holders of preferred stock.
One lesson of Shiftan is a reminder that the Court of Chancery will apply principles of contract construction to determine the rights of holders of preferred stock. Here, the court noted a tension between the principle that a Delaware court should not presume or imply rights for holders of preferred stock — such rights instead must be clearly set forth in a certificate of incorporation — and the doctrine of contra proferentem, which in the corporate context has been applied to mean that any ambiguities are construed against the drafter and in favor of the reasonable expectations of the investor.
What happens, the court asked, if the court agrees that the relevant provision is ambiguous and there is no parol evidence available?: "Do the preferred stockholders win because of contra proferentem? Or does the corporation win because preferences of preferred stock ‘will not be presumed’ unless they are clearly expressed in the certificate?"
The court did not have to answer that question because parol evidence was available, but practitioners should be aware of the premium on careful drafting and the uncertainties that result when language is unclear.
At issue in Shiftan was whether certain redemption rights at $100 per share that became available on July 1, 2011, were optional or mandatory. The court reviewed the relevant provisions and concluded that the right to an automatic redemption was not subject to any excess cash requirement and, therefore, that the redemption right was mandatory. Buttressing that conclusion was parol evidence in the form of informational material Morgan Joseph had used to market the securities. The court found that such information reflected the reasonable expectations of the investors at the time of purchase. That informational material made no mention that automatic redemptions were subject to excess cash requirements. Thus, because the parol evidence resolved any ambiguity in favor of the preferred stockholders, their interpretation prevailed that the redemption right was mandatory.
Morgan Joseph nonetheless argued that the redemption right should not be admissible in the appraisal action because, as of the date of the merger, the automatic redemption right had not been triggered. The court held that while that was true, nonetheless, the automatic redemption as of July 1 was mandatory and unconditional, thus distinguishing the holders of preferred from those in In re Appraisal of Metromedia International Group Inc. The court explained that in that case, the petitioners asked the court to award an appraisal value that was based on "what preferred holders would have been entitled to had their stock been redeemed or had there been a liquidation event," arguing that the redemption of the preferred shares would occur in three to five years because the private equity buyer of Metromedia would probably seek to exit its investment within that time frame.
The court found that while the "untriggered" redemption right in Metromedia offered no nonspeculative basis on which the court could rely in an appraisal action, for the preferred stockholders of Morgan Joseph, there was no conditionality to the automatic redemption right due to occur a mere six months after the merger date. Therefore, the court concluded that it would consider at the appraisal trial evidence of the value of the automatic redemption right as of the date of the merger in appraising the fair value of the preferred shares.
In so holding, the court applied well-settled principles that the value of preferred stock is determined solely from the contract rights reflected in the certificate of designation. The court stated in dicta that the certificate of designations may pre-empt entirely the rights of preferred stockholders to appraisal, citing to In re Appraisal of Ford Holdings Inc. Preferred Stock. Whether a holder of preferred stock has a right to appraisal and how to value that holder’s preferred shares will depend on the language in the certificate of designation. Scriveners beware.