When preferred and common collide: a recent Delaware case gives directors appointed by preferred stockholders a reminder of their foremost obligation.

• Author: Raymond, Doug
• Position: Case overview

IT IS COMMON KNOWLEDGE that directors should act in the best interests of their corporation; however, where the interests of the corporation's different stakeholders are not aligned, directors can face complicated decisions. The board must often choose which constituency's interest will dominate. While in the sale of a company, this issue is relatively clear--directors obligations are to seek the best price reasonably available for the stockholders, issues can nonetheless arise when the interests of common stockholders conflict with those of preferred stockholders. A recent Delaware case deals with this situation, and reminds us of the primacy of the common stockholders.

In re Trados Incorporated Shareholder Litigation involved the sale of Trados Inc. to another company. Trados had issued preferred stock to various investors who also appointed four of Trados's seven directors. The preferred holders pushed for a sale of the company; ultimately, a deal was signed with a purchase price that would pay out the bulk (but not all) of the preferred stockholders' liquidation preference and provide Trados's management, which included two directors, with significant bonuses. The common stockholders, on the other hand, would receive nothing from the sale. Not surprisingly, some of the common stockholders sued the directors, alleging that they had negotiated and approved the sale without considering the common stockholders' interests and, instead, were only looking out for their own and the preferred stockholders' interests.

The Chancery Court denied the directors' motion to dismiss the common stockholders' suit, and in the process illustrated two important lessons.

First, the court found that six of Trados's seven directors had a conflict of interest or otherwise lacked independence, so their actions were subject to the exacting scrutiny of the entire fairness doctrine. The two directors who received management sale bonuses were "interested" because each received "a personal financial benefit [...] not equally shared by the stockholders ... that made it improbable such director could perform his fiduciary duties without being influenced by [his] overriding personal interest." The other four directors also were found to be not independent, not because they had been appointed by the preferred stockholders, but because a substantial part of their livelihood depended on the preferred stockholders (they were all employees, directors, and/or owners of the...