Court of Chancery Construes Stockholders Agreement and Proxy Agreement to Determine Constituency of Board in Section 225 Case
In this 50-page post-trial decision, the Court of Chancery in TR Investors, LLC v. Genger, C.A. No. 3994-VCS (July 23, 2010), read opinion here, held that: (1) defendant Arie Genger (“Genger”), the founder and former majority owner of Trans-Resources, Inc. (“Trans-Resources”) violated a Stockholders’ Agreement by a transfer of shares; (2) the transfer was not later ratified; (3) Genger had failed to procure an irrevocable proxy giving him voting control of the transferred shares; and (iv) the Trans-Resources board no longer consisted of Genger’s designees. The Court’s decision presents in great detail the Court’s findings of facts after trial.
Kevin Brady of the Connolly Bove firm prepared this synopsis.
Formation of Trans-Resources and Subsequent Stockholders’ Agreement
In 1985, Genger formed Trans-Resources and his majority interest was held through TPR Investment Associates, Inc. (“TPR”). By 2001, however, Trans-Resources was nearly insolvent. Genger’s close friends, Jules and Eddie Trump, through two entities, TR Investors, LLC (“TR”) and Glencova Investment Co. (“Glencova”) (collectively, the “Trump Group”), approached Genger with an offer to purchase nearly all of Trans-Resources’ bonds. Shortly after buying the bonds, the debt was converted into equity under an Exchange Agreement, giving TR Investors and Glencova a collective 47.15% stake in Trans-Resources.
The parties also entered into a Stockholders Agreement which essentially precluded the transfer of shares to anyone other than a limited number of permitted transferees including Genger, one of his entities, or – for estate planning purposes only – Genger’s family members. At this period in time, Genger was involved in a bitter family dispute so the purpose of the Stockholders Agreement was to make certain that the Trump Group would be dealing only with Genger or one of the entities he controlled. An attempt to transfer shares to someone else triggered a right of first refusal for the other party to the Stockholders Agreement. If a transfer was made in violation of the Stockholders Agreement, the transfer could be deemed void. Alternatively, the Trump Group could purchase TPR’s shares in Trans-Resources if Genger had either made an impermissible transfer or effectuated a change of control in TPR.
Genger Transfers Shares in 2004; Trump Group Not Notified Until 2008
In 2004, as part of a drawn-out and contentious marital settlement, Genger agreed to transfer his equity interest in TPR to his ex-wife and to two trusts for his children (the “Orly Trust” and the “Sagi Trust”). Genger did not notify TR Investors or Glencova as required by the Stockholders Agreement. However, Genger alleged that he orally informed Jules Trump, despite the latter’s disagreement as to that representation.
By 2008, Trans-Resources was back in financial trouble so Genger again turned the Trumps for help. The Trumps were able to negotiate a reduction of Trans-Resources’ debt and helped craft a Funding Agreement which would provide for a capital infusion into Trans-Resources. During the negotiations, to the surprise of Eddie Trump, Genger acknowledged that TPR was no longer a stockholder of Trans-Resources. Genger later admitted that he did not provide the requisite notice of the transfer, but claimed he had essentially complied with the Stockholders Agreement by controlling the shares through irrevocable lifetime proxies in favor of Genger.
Subsequently, the Trans-Resources board approved the Funding Agreement which provided that the Trumps would invest an additional $57.5 million in exchange for 50% of Trans-Resources’ outstanding stock which would give the Trumps voting control of the company. Genger initially agreed to the terms of the Funding Agreement, but after he secured an alternative source of funding he backed away from the agreement.
Genger then alleged for the first time that he had orally notified Jules Trump of the transfers in 2004 and threatened litigation if the transfers were challenged. The Trumps then indicated that Glencova was exercising its right under the Stockholders Agreement to purchase all of the shares that were subject to the 2004 transfer. Glencova then filed an action in the Southern District of New York to enforce the Funding Agreement and its rights under the Stockholders Agreement. The Trumps then purchased the shares of Trans-Resources transferred to the Sagi Trust. Because Sagi Genger had separately acquired control of TPR, the Purchase Agreement for the Sagi Trust shares included provisions stating that the transfer was void, that TPR still owed the shares, and that TPR had to sell them to the Trump Group at 2004 prices.
Trump Group Reconstitutes Board; Files Section 225 Action
With its newly acquired majority position in Trans-Resources, the Trump Group executed a written consent removing Genger from the board and adding four pro-Trump personnel. Genger rejected the written consent and so the Trump Group filed an action pursuant to Section 225 to determine the composition of the Trans-Resources board. The Trump Group alleged that the 2004 transfers were in violation of the Stockholders Agreement and that they had a right to purchase all of TPR’s shares pursuant to that agreement. Genger counterclaimed that the transfers were appropriate because he had provided notice to Jules Trump in 2004. Moreover, Genger claimed that the 2008 purchase of the Sagi Trust’s shares ratified the 2004 transfers and, as a result, Genger controlled the board. The parties settled the action with a stipulated final judgment that the Trump Group’s board designees constituted a majority.
However, two weeks later, the Trump Group moved to reopen the action after having learned that Genger had destroyed information relevant to the Section 225 action in violation of a status quo order. In a separate decision, Genger was found to be in contempt. As a sanction, the Court, among other things, raised his evidentiary burden by one level (for example, from preponderance of the evidence to clear and convincing evidence). With the action re-opened, Genger again argued that the transfers were properly effectuated either through oral notice or ratification. In the alternative, Genger alleged that nonetheless, the Trump Group took the Sagi Trust’s shares subject to the proxies issued in his favor.
Court Finds Stockholders Agreement Violated; No Subsequent Ratification
The Court found that Genger did not notify the Trump Group of the 2004 Transfer until the June 13, 2008 meeting with Jules Trump and as a result, Genger failed to comply with the notice requirement of the Stockholders Agreement. In addition, the Court found that Genger did not meet his “clear and convincing” burden to show that the Trump Group ratified the 2004 transfers. The Court noted that on numerous occasions starting on June 13, 2008, the Trump Group stated that the transfers violated the Stockholders Agreement. Moreover, Genger failed to show that there was a benefit to the Trump Group. Instead, it was Genger who ultimately walked away from the Funding Agreement, which would have served as a compromise for Genger’s violations by giving the Trump Group voting control of Trans-Resources. Because the Trump Group was only trying to obtain what it was owed under the Stockholders Agreement — control of Trans-Resources — the Court found that its actions did not ratify the transfer.
The Court also held that even if the Trump Group had ratified the transfers, it would still have voting control over Trans-Resources because the Trump Group did not take the Sagi Trust shares subject to the Proxy. The language of the proxy did not suggest that it would run with the shares if they were sold or that there was a reservation of voting powers to Genger after such a sale. The Court noted that because Genger’s interpretation would result in empty voting – a disfavored situation where voting and economic interest are decoupled – public policy required strict construction of the policy. Moreover, where there is an ambiguity, the ambiguity must be construed in favor of not restricting the right to vote.
The Court also found that the proxy failed to satisfy the terms of the governing New York statute which mandates that for a proxy to be irrevocable it must be held by either a pledge, creditor, contract officer or purchaser of the shares, or if there is an agreement between two or more shareholders. None of those requirements were satisfied. As a result, the proxy was not irrevocable under New York law. Since it was irrevocable, it was revoked by the sale of the Sagi Trust shares to the Trump Group.