In LC Capital Master Fund Ltd. v. James et al., C.A. No. 5214-VCS (March 8, 2010), read opinion here,  the Court of Chancery denied a request by plaintiff LC Capital Master Fund, Ltd., a preferred stockholder of QuadraMed Corporation, to enjoin the acquisition of QuadraMed by defendant Francisco Partners II, LP, on the grounds that the defendants breached their fiduciary duties of care and loyalty. LC Capital argued that the consideration it was scheduled to receive allegedly did not exceed the "as if converted" value the preferred stockholders were contractually entitled to demand in the event of a merger.

Kevin Brady, a Delaware litigator, prepared this synopsis.

Background

Under the terms of the challenged merger agreement, defendant Francisco Partners offered to acquire QuadraMed at a price of $8.50 per share of common stock. The preferred stockholders were to receive $13.7097 in cash in exchange for each share of preferred stock. The “’as if converted’ value was based on a formula in the certificate of designation governing the preferred stock, and gave the preferred the bottom line right to convert into common at a specified ratio and then receive the same consideration as the common in the Merger.”

Arguments of Parties

The preferred stockholders argued that: (i) the “QuadraMed board had the duty to make a ‘fair’ allocation of the Merger consideration between the common and preferred stockholders”; (ii) the Board should have “set up some form of negotiating agent, with the duty and discretion to exert leverage on behalf of the preferred stockholders in the allocation process” because the directors of QuadraMed (including every member of the Special Committee) owned common stock but did not own preferred stock; and (iii) the Certificate included a mandatory conversion right that allowed QuadraMed to force the preferred stockholders to convert into common shares when the company’s common stock hit a price of $25 per share. Interestingly, the preferred stockholders did not argue that the Board breached any fiduciary duty owed to all stockholders, just the preferred. The preferred stockholders claimed that their stock had “a strong liquidation preference and certain non-mandatory rights to dividends that the Board failed to accord adequate value, and that as a result of these contractual rights, the QuadraMed Board owed the preferred a fiduciary duty to accord it more than it was contractually entitled to receive by right in a merger.”

The defendants argued that: (i) the QuadraMed Board discharged its fiduciary obligations by: (a) “fulfilling its Revlon obligations to all equity holders, including the preferred, to seek the highest reasonably available price for the corporation;” and (b) “allocating to the preferred the percentage of value equal to their bottom line right, in the event of a merger, to convert and receive the same consideration as the common;” (ii) “[since] the preferred stockholders had no contractual right to impede, vote upon, or receive consideration higher than the common stockholders in the Merger…the Board’s decision to accord them the value that the preferred were entitled to contractually demand in the event of a merger cannot be seen as unfair;” and (iii) the Board honored all of the contractual rights belonging to the preferred, and thus the Board had no duty to go further.

Analysis

The Court found that the preferred stockholders had not established a likelihood of success on their claim that the defendants breached their duty of care. The Court noted that “the record reveals that the Board complied with its Revlon duties by actively seeking the best value and considered whether the preferred should get more than the contractual bottom line. Finding no special reason for better treatment, the Board allocated the preferred stockholders their share of the Merger proceeds in accord with those bottom line rights. The preferred stockholders may not like that decision, but it was made on a thoughtful basis informed by advice of counsel, and there is no hint of any lapse in care.”

The Court also noted that while a board “may have a gap-filling duty in the event that there is no objective basis to allocate consideration between the common and preferred stockholders in a merger.…when a certificate of designation does not provide the preferred with any right to vote upon a merger, does not afford the preferred a right to claim a liquidation preference in a merger, but does provide the preferred with a contractual right to certain treatment in a merger…the board of directors that allocates consideration in a manner fully consistent with the bottom-line contractual rights of the preferred need not, as an ordinary matter, do more.”