Equity-Linked Investors, L.P. v Adams
705 A.2d 1040. (Del.Ch. 1997)
FACTS
-Genta was a biotech start up firm that was not making any profits.
-Genta kept losing money, but was working on new technologies that looked promising.
-Unfortunately, Genta was near bankruptcy.
-As Genta searched for additional investors, the preferred stockholders were getting ready to cut their losses and liquidate the company.
-The preferred stockholders had a liquidation preference, meaning that if the company went under (or was delisted from the stock exchange), the assets would be sold off and used to pay back the preferred stockholders. The common stockholders would get nothing.
-Genta was able to secure some additional capital to stay in business. The preferred stockholders (led by Equity-Linked) sued the Board for making such a bad business decision.
-Preferred stockholders (P) argued that the more loans Genta took to stay in business, the less they would get if the company was liquidated.
-P argued that Genta was violating their duty to the preferred stockholders by taking out more loans.
-Stockholders were pretty sure that Genta was going to go bankrupt eventually, so asked: "why not do it now instead of waiting until they were deeper in debt?"
-Genta argued: protecting the interests of the common stockholders by doing everything possible to stay in business.
PROCEDURAL HISTORY
Trial Court: Genta.
The Trial Court found that the imposition of additional economic risks on the preferred stockholders for the benefit of the common stockholders did not constitute a breach of duty.
ANALYSIS
-Court found that it is the duty of the directors, where discretionary judgment is exercised, to prefer the interests of the common stock to the interests created by the special rights of preferred stock, where there is a conflict.
RULES
-The Court noted that whether a company liquidates or not is a business judgment, and the courts should apply the Business Judgment Rule.
-Common stock owners are residual owners. They get what's left after all the debt is paid off. Common stock owners are the ones taking the most risk, and are therefore the most sensitive to fluctuations in the company. Makes the most sense for directors to think of common stock owners first.
CONCLUSION
The court concludes that, "In the circumstances disclosed by the balance of credible evidence, the Genta board concluded in good faith that the corporation's interests were best served by a transaction that it thought would maximize potential long-run wealth creation and that in the circumstances, including potential insolvency of the company and presence of a $30 million liquidation preference, the board acted reasonably in pursuit of the highest achievable present value of Genta common stock, by proceeding as it did."
Held: For Genta.
705 A.2d 1040. (Del.Ch. 1997)
FACTS
-Genta was a biotech start up firm that was not making any profits.
-Genta kept losing money, but was working on new technologies that looked promising.
-Unfortunately, Genta was near bankruptcy.
-As Genta searched for additional investors, the preferred stockholders were getting ready to cut their losses and liquidate the company.
-The preferred stockholders had a liquidation preference, meaning that if the company went under (or was delisted from the stock exchange), the assets would be sold off and used to pay back the preferred stockholders. The common stockholders would get nothing.
-Genta was able to secure some additional capital to stay in business. The preferred stockholders (led by Equity-Linked) sued the Board for making such a bad business decision.
-Preferred stockholders (P) argued that the more loans Genta took to stay in business, the less they would get if the company was liquidated.
-P argued that Genta was violating their duty to the preferred stockholders by taking out more loans.
-Stockholders were pretty sure that Genta was going to go bankrupt eventually, so asked: "why not do it now instead of waiting until they were deeper in debt?"
-Genta argued: protecting the interests of the common stockholders by doing everything possible to stay in business.
PROCEDURAL HISTORY
Trial Court: Genta.
The Trial Court found that the imposition of additional economic risks on the preferred stockholders for the benefit of the common stockholders did not constitute a breach of duty.
ANALYSIS
-Court found that it is the duty of the directors, where discretionary judgment is exercised, to prefer the interests of the common stock to the interests created by the special rights of preferred stock, where there is a conflict.
RULES
-The Court noted that whether a company liquidates or not is a business judgment, and the courts should apply the Business Judgment Rule.
-Common stock owners are residual owners. They get what's left after all the debt is paid off. Common stock owners are the ones taking the most risk, and are therefore the most sensitive to fluctuations in the company. Makes the most sense for directors to think of common stock owners first.
CONCLUSION
The court concludes that, "In the circumstances disclosed by the balance of credible evidence, the Genta board concluded in good faith that the corporation's interests were best served by a transaction that it thought would maximize potential long-run wealth creation and that in the circumstances, including potential insolvency of the company and presence of a $30 million liquidation preference, the board acted reasonably in pursuit of the highest achievable present value of Genta common stock, by proceeding as it did."
Held: For Genta.
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