LEGAL ASPECTS OF

CORPORATE FINANCE
LexisNexis Law School Publishing
Advisory Board

William Araiza
Professor of Law
Brooklyn Law School

Ruth Colker
Distinguished University Professor & Heck-Faust Memorial Chair in Constitutional Law
Ohio State University Moritz College of Law

Olympia Duhart
Associate Professor of Law
Nova Southeastern University Shepard Broad Law School

Samuel Estreicher
Dwight D. Opperman Professor of Law
Director, Center for Labor and Employment Law
NYU School of Law

David Gamage
Assistant Professor of Law
UC Berkeley School of Law

Joan Heminway
College of Law Distinguished Professor of Law
University of Tennessee College of Law

Edward Imwinkelried
Edward L. Barrett, Jr. Professor of Law
UC Davis School of Law

Paul Marcus
Haynes Professor of Law
William and Mary Law School

Melissa Weresh
Director of Legal Writing and Professor of Law
Drake University Law School
 LEGAL ASPECTS OF
CORPORATE FINANCE

FOURTH EDITION

2012 Supplement

Richard T. McDermott
Adjunct Professor of aw
Fordham University School of Law
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 TABLE OF CONTENTS

Chapter 1 CORPORATE FINANCE AND THE PROCESS OF CAPITAL

FORMATION ........................................................................................................................... 1

§ 1.01 CORPORATE FINANCE—GENERAL OBSERVATIONS .......................................... 1

§ 1.02 DEBT AND EQUITY SECURITIES .............................................................................. 2

§ 1.06 INVESTMENT BANKING ............................................................................................. 2

§ 1.07 THE CREDIT CRISES OF 2007–08 .............................................................................. 3

§ 1.08 PERTINENT STATUTORY MATERIAL ........................................................................ 6

Chapter 3 DEBT SECURITIES ............................................................................................ 8

§ 3.02 LEGAL AUTHORITY FOR ISSUANCE ....................................................................... 8

§ 3.03 DEBENTURE FORM ..................................................................................................... 8

§ 3.04 THE INDENTURE ......................................................................................................... 9

§ 3.06 “NO ACTION” CLAUSES AND THE INDENTURE TRUSTEE ................................. 16

§ 3.07 THE MEANING OF THE TERM “ALL OR SUBSTANTIALLY ALL” OF THE

ASSETS OF A BUSINESS CORPORATION IN THE CONTEXT OF TRUST
INDENTURES AND OTHER ASPECTS OF CORPORATE FINANCE .................. 17

§ 3.09 THE SUPPLEMENTAL INDENTURE ....................................................................... 20

§ 3.10 SUBORDINATED DEBT SECURITIES .................................................................... 26

Chapter 4 PREFFERED STOCK ....................................................................................... 29

§ 4.01 INTRODUCTION ........................................................................................................... 29

§ 4.03 EXCERPTS FROM A CERTIFICATE OF INCORPORATION AUTHORIZING

THE ISSUANCE OF PREFFERED STOCK .............................................................. 29

§ 4.04 CORPORATE RESOLUTIONS CREATING A SERIES OF PREFERRED

STOCK ........................................................................................................................... 29
§ 4.05 THE MEANING AND EFFECT OF CUMULATIVE DIVIDENDS ......................... 33

§ 4.07 THE LIQUIDATION PREFERENCE ........................................................................... 35

§ 4.08 INTERPRETATION AND EFFECT OF CLASS VOTING PROVISIONS .................. 43

§ 4.09 REDEMPTION PROVISIONS .................................................................................... 58

§ 4.10 NEW YORK STOCK EXCHANGE LISTING REQUIREMENTS REGARDING

PREFERRED STOCK ................................................................................................... 59

Chapter 5 CONVERTIBLE SECURITIES ....................................................................... 64

§ 5.05 THE CONVERSION PREMIUM ................................................................................ 64

§ 5.07 INTERPRETATION AND EFFECT OF ANTI-DILUTION PROVISIONS ............. 64

§ 5.08 EFFECT OF REDEMPTION UPON THE CONVERSION RIGHT ............................ 65

§ 5.12 POISON PILL PROVISIONS ........................................................................................ 70

Chapter 1

CORPORATE FINANCE AND THE PROCESS OF CAPITAL FORMATION

§ 1.01 CORPORATE FINANCE — GENERAL OBSERVATIONS

Page 3, insert the following before § 1.02.

One other observation regarding the securities markets: they are dependent upon the legal
underpinnings of the various instruments representing the securities being traded. As Delaware Vice
Chancellor Jacobs has stated:
Corporate securities are a species of property right that represent not only a firm’s
fundamental source for raising capital, but also now a publicly traded commodity that is a
critical component for creating both institutional and individual wealth that may affect
the economic well-being of entire societies. Given the fundamental importance of such
securities to our economic system, it is critical that the validity of those securities,
especially those that are widely traded, not be easily or capriciously called into question.
Otherwise, the resulting economic uncertainty to investors and institutions that relied
upon the integrity of those securities would be destabilizing. Accordingly, our statutory
scheme, elucidated by case law, has developed a clear and easily followed legal roadmap
for creating these valuable instruments that represent claims upon an enterprise’s capital.
Under that model, if that roadmap is followed, the investment community will be assured
that the corporate securities created by that process will not be vulnerable to legal attack.
If, on the other hand, it is not followed, then the securities will become subject to possible
invalidation.
Kalageogri v. Victor Kamkin, Inc., 750 A.2d 531, 538 (Del. Ch. 1999), aff’d, 748 A.2d 913 (Del. 2000).
Students should not, however, be lulled into complacency by the phrase "easily followed legal
roadmap." The importance of first class lawyering in corporate matters has been described by Sullivan &
Cromwell partner, Benjamin F. Stapleton, as follows: "The educational experience my first three or four
years was just staggering. I learned more about rigorous thinking, about people depending upon you to
get it right and how serious it was if you didn’t get it right." Julie Connelly, He Handles the Big Ones,
THE DAILY DEAL, Feb. 19, 2000.
The results of a failure to adhere to the standards articulated by Mr. Stapleton are illustrated by
the slipshod manner in which many of the pre 2008 Credit Crises mortgage backed securities were put
together. As stated by Judge Cordy of the Supreme Judicial Court of Massachusetts in a decision voiding
a foreclosure by the trustee for such a security:
I concur fully in the opinion of the court, and write separately only to underscore that
what is surprising about these [securitization] cases is not the statement of principles
articulated by the court regarding title law and the law of foreclosure . . . but rather the
utter carelessness with which the plaintiff banks documented the titles to their assets . . .
the holder of an assigned mortgage needs to take care to ensure that his legal paperwork
is in order. . . .
U. S. Bank Nat’l Ass’n v. Antonio, 458 Mass. 637, 655-56 (2011) (emphasis added).
Finally, it should be borne in mind that: "Investor confidence in our Markets depends, in part, on
the certainty and predictability of corporate finance instruments and transactions." Joan MacLeod

1
Heminway, Federal Interventions In Private Enterprise In The United States: Their Genesis In and
Effects On Corporate Finance Instruments And Transactions, 40 SETON HALL L. REV. 1487, 1518
(2010).

§ 1.02 DEBT AND EQUITY SECURITIES

Page 3, insert the following after the second sentence.

The Credit Crises of 2008, which is discussed in § 1.07 infra, was caused in substantial part by
the use (and abuse) of toxic "IOUs," including mortgage-backed securities, collaterized debt obligations
and credit default swaps.

§ 1.06 INVESTMENT BANKING

Page 14, insert the following after the first sentence.

In many investment banking firms, however, advisory business came to be overshadowed by
another source of revenue, proprietary trading. Since substantially more capital was needed to support
those operations than could be raised from the partners of those partnerships, the firms were converted
into publicly traded corporations through stock offerings which raised the necessary capital, and also
made the partners multi-millionaires based on the market value of their ownership of the shares of those
newly minted public corporations. The transformation from partnership to corporation was possible
because, in the aftermath of the 1960s back office crises on Wall Street (which financially decimated a
number of venerable brokerage firms and their partners) the Rules of the New York Stock Exchange
(until then an unincorporated association) were changed to allow member firms to be corporations.
Consequently, it was no longer the case that "partners had personal liability for the [financial] exposure of
the firm, right down to their homes and cars." Peter Weinberg, Wall Street Needs More Skin in the Game,
WALL ST. J., Oct. 1, 2009, at A23. The investment banks’ business model of advisory service and trading
profits became so successful that the large commercial banks decided to enter those same lines of
business; however, they faced a significant legal obstacle.
Page 18, insert the following after the quotation ending with the word "bank."
With further reference to the repeal of Glass-Steagall, a leading contemporary commentator on
the subject has observed that:
Ironically, just as [the questionable activities of the securities business affiliate
of] City Bank had created the final impetus for Glass-Steagall, its successor created the
final impetus for its repeal more than six decades later. Separation of commercial and
investment banking officially remained in place until 1999, when President Clinton
signed the law repealing those provisions of Glass-Steagall. Unofficially, strict
separation had already slowly begun to erode in the 1980's and 1990s. The financial
industry and a chorus of academic critics attacked it an ill-conceived, anachronistic, and
unnecessary restriction standing in the way of financial institutions trying to diversify
their businesses and compete on the global stage. In response, federal banking regulators
and the courts slowly began to permit commercial banks to engage in securities-related
activities and then allowed bank holding companies to acquire investment banking
subsidiaries.

2
 Those trends culminated in the 1998 merger of Citibank, as it was then known,
and the Travelers Group. Citigroup was immediately the world's largest financial
services company, a full-service firm that combined consumer, commercial, and
investment banking with insurance and investment management.
MICHAEL PERINO, THE HELLHOUND OF WALL STREET 290 (2010).
Page 18, insert the following immediately above current § 1.07, and change current § 1.07 to § 1.08

§ 1.07 THE CREDIT CRISES OF 2008

Capital formation in the United States came to an abrupt halt as a result of the Credit Crises of
2008. Banks stopped lending (particularly to other financial institutions) because many such borrowers
lacked the apparent ability to repay. By this time, their "assets" consisted in large part of mortgage
backed securities and their even more complex cousin, collateralized debt obligations, both of which
suddenly had an actual value substantially less than that reflected on their financial statements; many of
the underlying mortgages had been granted to home owners who were unable to repay the mortgage loan.
It soon became apparent that the true value of the assets of a number of financial institutions was less than
their liabilities. Such entities were thus insolvent, or at least required additional capital. As Felix
Rohatyn, of Lazard Freres & Co. prophetically stated more than 20 years before, "The word ‘credit’
derives from the Latin credere to believe. The belief in the integrity of our securities market is a national
asset that we should not dissipate carelessly." Junk Bonds and Other Securities Swill, WALL ST. J., Apr.
18, 1985.
Two other principal culprits of the credit fiasco were (i) a peculiar sounding financial instrument
called a credit default swap (an IOU type contractual obligation to make a payment to the holder of the
1
"swap" in case a particular debtor fails to perform its own financial obligation) and (ii) credit ratings (a
prediction by a purported expert of the likelihood of a party being able to perform a specified financial
obligation). Such ratings play an important role in the determination of the market value of debt
securities. The crises could not have occurred to the extent it did without both of these devices being
essentially free of legal oversight. Federal legislation had been enacted which made the use (and abuse)
of swaps and the dissemination of credit ratings generally free of regulatory constraints. In the case of
credit default swaps, the US Congress enacted and President Clinton signed an innocent sounding law
called the Commodity Futures Modernization Act of 2000. That law added amendments to the Securities
Act of 1933 and the Securities Exchange Act of 1934 which exempted swaps from their regulatory
coverage and literally prohibited the SEC from regulating credit default swaps, thus paving the way for
their unbridled and irresponsible use. In describing the enactment of this so-called "Modernization" law,
Professor Frank Partnoy of the University of San Diego School of Law observed:
Anyone who imagined that members of Congress, or their staffs, drafted laws regarding
derivatives would have been surprised to peek inside the offices of the House Agriculture
Committee during the time Congress was considering the [law]. Instead of seeing
members of Congress at work, you would have seen [a] lobbyist . . . writing important
pieces of the legislation . . . the role of Congress was simply to look over the shoulders of
the finance lobby and nod.

FRANK PARTNOY, INFECTIOUS GREED 295 (2003).

In addition to being debt securities under any common sense definition of the term, swaps can be
viewed either as (i) an insurance policy against the possibility of a payment default or (ii) enabling a
                                                            
1
Many non-securities based swap transactions serve a valid business purpose by providing protection against fluctuations in the
value of certain assets, commodities, currencies and interest rates.

3
wager on the likelihood of such a default. To avoid state insurance regulation, in 2000, the financial
industry obtained a ruling by the New York Insurance Department that was understood to exempt all
swaps from such regulation. (Testimony of Eric Dinallo, Superintendent, New York Insurance
Department to the United States House of Representatives on Nov. 20, 2008 [testifying as to the action of
a prior Insurance Department administration]). State gaming regulation of credit default swaps was
precluded by the Modernization Act itself.
By 2006 it was becoming apparent that in many cases the work product of the credit rating
agencies was often unreliable, if not worthless. In a purported response to calls for regulation, the
euphemistically named Credit Agency Reform Act of 2006, which became Section 15E of the Securities
Exchange Act, was enacted. Although the law requires the major credit rating agencies to register with
the SEC, it prohibits the SEC (and any state) from regulating "the substance of credit ratings or the
procedures and methodologies" used by them. Yet the preamble of the law recites that "credit rating
agencies are of national importance" and that the SEC "needs statutory authority to oversee the credit
rating industry."
The Credit Crises was thus preceded by the: (i) conversion of investment banks from
conservatively managed private partnerships to well capitalized publicly held corporations and (ii)
emergence of "invest to play" competition from the large, publicly traded commercial banks recently
freed from the restraints of Glass-Steagall. This, in turn, led the publicly held investment banks, which
historically were allowed to do business with less oversight than the commercial banks, to engage in (i)
proprietary trading as well as (temporarily) highly profitable, risk intensive, real estate securitizations (not
only allegedly "risk free" owing to their credit ratings, but also purportedly "insured" by credit default
swaps) as well as (ii) traditional investment banking activities. Because this strategy seemed to work so
well, the newly minted "universal" commercial banks quickly followed suit. Disaster was not far behind.
See GRETCHIN MORGENSON & JOSHUA ROSNER, RECKLES$ ENDANGERMENT 109 (2011).
The legislative response to the Credit Crises, which can be viewed as closing the barn door after
the horses have run out, was the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-
Frank") which became law on July 21, 2010. The law was touted as the most comprehensive set of
securities market reforms since those enacted in the 1930s. Dodd-Frank, however, is, to put it generously,
not self executing. Instead, it requires the SEC to issue more than one hundred regulations and conduct a
number of studies. Similar obligations are imposed by Dodd-Frank on other federal agencies. (One can
easily imagine the type of lobbyists referred to above by Professor Partnoy working overtime.) Fourteen
months after the passage of Dodd-Frank less than ten percent of the approximately four hundred required
administrative regulations had been adopted. Moreover, political objections to many Dodd-Frank
provisions prompted legislators to propose rolling back portions of the law.
The law consists of sixteen Titles, three of which are particularly relevant to the matters discussed
herein.
Title VI, Improvements to Regulation of Bank and Saving Association Holding Companies and
Depositary Institutions, contains, in Section 619 of Dodd-Frank (now part of the Bank Holding Company
Act of 1956), the Volcker Rule (named after former Federal Reserve Chairman Paul Volcker) which
2
prohibits proprietary trading by commercial banks. Section 619 does not, however, prohibit market
making and risk management hedging. Those two last-mentioned activities, which resemble proprietary
trading, are not defined in the statute; instead, the SEC and other federal regulatory agencies are required
to issue regulations defining those terms. As would be expected, the commercial banking interests are
urging the adoption of definitions of market making and risk management hedging so broad that they
would nearly emasculate the statutory proprietary trading prohibition.

                                                            
2 Section 619 does not apply to investment banks that are not also commercial banks.

4
 To supplement the Volker Rule and further "mitigate the risks derivatives pose to the
[commercial] banking industry," the Swaps Push-Out Rule was a last minute addition to Section 619.
That Rule in effect "forces [commercial] banks to spin off their derivative trading desks into separately
capitalized affiliates." Kristine Aritoja, The Dodd- Frank Act’s One-Year Anniversary: Evaluating the
Volcker Rule and the Swaps Push-Out Rule, 15 N.Y. BUS. L. J. 7, 8 (2011).

Title VII, Wall Street Transparency and Accountability, provides, inter alia, for the regulation of
the credit default swaps market. Like the rest of Dodd-Frank, Title VII is conceptual in nature; it is
dependent upon SEC regulations to provide substance for its legislative gloss. Dodd-Frank grants to the
SEC sole authority over securities based credit default swaps. Title VII amends Sections 2A and 3A of
the ‘33 and ‘34 Acts discussed above which since 2000 had excluded credit default swaps from the
definition of a "security" and also had prohibited the SEC from regulating them. Dodd-Frank repealed
those excluding provisions of the Commodity Futures Modernization Act of 2000 by (i) amending
Sections 2(a) and 3(a) of the Securities Act and the Exchange Act, respectively, to include "security-based
swaps" within the definition of a "security" and (ii) by adding Section 3(a)(78) to the Exchange Act which
changes the definition of the ‘33 and ‘34 Acts exempt "security based swap agreement" to exclude "any
security based swap."3 Two weeks before those provisions would have become effective in July 2011, in
order to avoid the legal uncertainty that will exist at least until Dodd-Frank is fully implemented by
administrative action, the SEC adopted:
Interim final rules providing [conditional] exemptions under the Securities Act of
1933, the Securities Exchange Act of 1934 and the Trust Indenture Act of 1939 for those
securities-based swaps that under [pre Dodd-Frank] law [were statutorily exempt]
security-based swap agreements [but] will be defined as securities under the Securities
Act and the Exchange Act due solely to the provisions of Title VII of the Dodd-Frank
[Act]. Exemptions for Security-Based Swaps, Securities Act Relief No. 9231, Exchange
Act Relief No. 64, 794, Trust Indenture Act No. 2475, 76 Fed. Reg. 40, 605 (July 11,
2011).
Sub Title C of Title IX of Dodd-Frank, Improvements to the Regulation of Credit Rating
Agencies, amends Section 15E of the Exchange Act by adding subsection (r) thereto; it directs the SEC to
prescribe rules to ensure that credit ratings are determined using procedures adopted by the board of the
organization issuing the rating and that they comply with the issuing organization’s policies and
procedures. Untouched by Dodd-Frank, however, is the prohibition in Exchange Act Section 15E (c) (2)
against SEC regulation of "the substance of credit ratings or the procedures and methodologies" used in
determining them.
Among the casualties of the Credit Crises was the US commercial paper market. During the
nadir of the Crises in the autumn of 2008, the per share net asset value of the Reserve Primary Fund, a
money market mutual fund, fell below $1.00 and became only the second such fund to thus "break the
buck." The reason for that diminution in value was that the Reserve Fund’s holdings of $64 billion in
commercial paper included $785 million issued by Lehman Brothers Holdings Inc. which filed for
bankruptcy in September 2008. This caused the Fund’s investors to seek to recover their investment by
exercising their right to redeem their shares, thus prompting "a run in the bank." Because the amount of
redemptions exceeded the Fund’s ability to make the required cash payments, only eighty percent of the
Fund’s shares had been redeemed as late as a year after the Lehman bankruptcy. It is expected that the
shareholders will eventually receive approximately ninety-nine percent of the value of their investment.
Money market funds, such as the Reserve Fund, are significant purchasers of commercial paper
and, as those funds and other investors stopped purchasing commercial paper as a result of the Reserve
                                                            
3
Section 17 of the ’33 Act, however, prohibits fraudulent trading of "any securities (including security based swaps) or any
security based swap agreement as defined in section 3(a)(78) of the [Exchange Act]."

5
Fund experience, the short term credit needs of US businesses could not be met. It was for this reason
that in October 2008 the Federal Reserve Bank of New York, acting pursuant to its emergency powers
under Section 13 of the Federal Reserve Act, established a Commercial Funding Facility which created a
purchaser of last resort for commercial paper issuers. The purchases were made through a special
purpose vehicle funded by a loan from the New York Fed, thus providing a market for commercial paper
and enabling US businesses to satisfy their short term credit needs. In addition, in September 2008 the
US Treasury guaranteed for one year the shareholder balances of money market funds.

§ 1.08 PERTINENT STATUTORY MATERIAL

Page 29, delete Section 510(b) and add the following.

(b) Dividends may be declared or paid and other distributions may be made either (1) out of
surplus, so that the net assets of the corporation remaining after such declaration, payment or distribution
shall at least equal the amount of its stated capital, or (2) in case there shall be no such surplus, out of its
net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. If the
capital of the corporation shall have been diminished by depreciation in the value of its property or by
losses or otherwise to an amount less than the aggregate amount of the stated capital represented by the
issued and outstanding shares of all classes having a preference upon the distribution of assets, the
directors of such corporation shall not declare and pay out of such net profits any dividends upon any
shares until the deficiency in the amount of stated capital represented by the issued and outstanding
shares of all classes having a preference upon the distribution of assets shall have been repaired. A
corporation engaged in the exploitation of natural resources or other wasting assets, including patents, or
formed primarily for the liquidation of specific assets, may declare and pay dividends or make other
distributions in excess of its surplus, computed after taking due account of depletion and amortization, to
the extent that the cost of the wasting or specific assets has been recovered by depletion reserves,
amortization or sale, if the net assets remaining after such dividends or distributions are sufficient to cover
the liquidation preferences of shares having such preferences in involuntary liquidation.

Page 86, insert the following before § 103 Certificates; corrections.

§ 271 Sale, lease or exchange of assets; consideration; procedure.

(a) Every corporation may at any meeting of its board of directors or governing body sell,
lease or exchange all or substantially all of its property and assets, including its goodwill and its corporate
franchises, upon such terms and conditions and for such consideration, which may consist in whole or in
part of money or other property, including shares of stock in, and/or other securities of, any other
corporation or corporations, as its board of directors or governing body deems expedient and for the best
interests of the corporation, when and as authorized by a resolution adopted by the holders of a majority
of the outstanding stock of the corporation entitled to vote thereon or, if the corporation is a nonstock
corporation, by a majority of the members having the right to vote for the election of the members of the
governing body and any other members entitled to vote thereon under the certificate of incorporation or
the bylaws of such corporation, at a meeting duly called upon at least 20 days’ notice. The notice of the
meeting shall state that such a resolution will be considered.
(b) Notwithstanding authorization or consent to a proposed sale, lease or exchange of a
corporation’s property and assets by the stockholders or members, the board of directors or governing
body may abandon such proposed sale, lease or exchange without further action by the stockholders or
members, subject to the rights, if any, of third parties under any contract relating thereto.
(c) For purposes of this section only, the property and assets of the corporation include the
property and assets of any subsidiary of the corporation. As used in this subsection, "subsidiary" means

6
any entity wholly-owned and controlled, directly or indirectly, by the corporation and includes, without
limitation, corporations, partnerships, limited partnerships, limited liability partnerships, limited liability
companies, and/or statutory trusts. Notwithstanding subsection (a) of this section, except to the extent the
certificate of incorporation otherwise provides, no resolution by stockholders or members shall be
required for a sale, lease or exchange of property and assets of the corporation to a subsidiary.

7
Chapter 3

DEBT SECURITIES

§ 3.02 LEGAL AUTHORITY FOR ISSUANCE

Page 134, add the following to the paragraph in the middle of the page ending with "2004" after
changing the period in the present last line thereof to a comma.
Special Report of the TriBar Opinion, Duly Authorized Opinions on Preferred Stock, 63 BUS.
LAW. 921, 925 (2008); see also Richard T. McDermott, Legal Opinions on Corporate Matters in LEGAL
OPINION LETTERS Ch. 3 (M. John Sterba ed., 3d ed. 2009).
The opinion is addressed to the underwriter of Bissell’s public offering in order to permit the
underwriter to assert, in the event of a claimed legal infirmity of the debentures or the registration
statement, the due diligence defense provided by Section 11(b) (3) of the Securities Act of 1933 which
states that an underwriter shall not be liable for a misstatement or omission in a registration statement if
the underwriter is able to establish that it had "reasonable ground to believe and did believe" that the
statements in question were true. Section 11(c) provides, in turn, that "in determining, for the purposes of
paragraph (3) of subsection (b) of this section, what constitutes reasonable investigation and reasonable
ground for belief, the standard of reasonableness shall be that required of a prudent man in the
management of his own property." Obtaining a legal opinion along the lines of the one set forth above
contributes to compliance with that standard. See generally ABA Section of Business Law, Report of the
Subcommittee on Securities Law Opinions Committee on Federal Regulation of Securities, Negative
Assurances in Securities Offerings, 64 BUS. LAW. 395 (2009).
It is to be observed that the last sentence of paragraph 7 of the above opinion states that the
Underwriting Agreement has been duly executed and delivered but, unlike the Debentures and the
Indenture, no opinion is expressed as to the enforceability of that Agreement. The reason for this
distinction is that there is a legal question as to whether provisions in an agreement purporting to
indemnify an underwriter for liabilities relating to the accuracy of a registration statement are contrary to
public policy and thus unenforceable. See THOMAS LEE HAZEN, THE LAW OF SECURITIES REGULATION
390 (4th ed. 2002).

§ 3.03 DEBENTURE FORM

Page 141, add the following after N.Y. Gen. Ob. L. § 5-1401.
Although a student law note, Barry W. Rashkover, Title 14, New York Choice of Law Rule for
Contractual Disputes: Avoiding The Unreasonable Results, 71 CORNELL L. REV. 227 (1985), asserts that
the New York statue may be constitutionally infirm because in certain instances it might require a New
York Court to decline to apply the law of another state, and thus deprive that other state’s law of the "full
faith and credit" to which it is entitled by Article IV, Section 1 of the U.S. Constitution, such an assertion
would appear to have no applicability to a commercial transaction involving the delivery of legal
opinions. A choice of law by a state court is violative of the full faith and credit clause when it is
"arbitrary" or "fundamentally unfair." See Allstate Ins. Co. v. Hague, 449 U.S. 302, 308 (1981). It is
difficult to imagine a court making such a finding where the parties were represented by counsel and legal
opinions were delivered. But cf. Lehman Bros. v. Minmetals International Non Ferrous Trading Co., 179
F. Supp. 118, 137 (S.D.N.Y. 2000) (dictum).

8
Page 147, add the following to the last paragraph of Note (1).
The "coupon" or "contractual" rate of interest is to be distinguished from the "yield" of a debt instrument.
The distinction between "yield" and "coupon rate" is illustrated by the following example:
Corporation XYZ issues a ten year $1,000 Debenture that according to its terms pays
interest annually at the rate of ten percent (the coupon rate), or $100 per year. Ten
percent is also the market rate of interest for that type of instrument at the time it is
issued. Thereafter, such market rate of interest declines to nine percent. The holder of
the Debenture will not sell the Debenture at par ($1,000) because the purchaser would be
entitled to receive interest in excess of the then market rate. Instead, the Holder will sell
the Debenture for $1100 which, given the contractual annual interest payment of $100,
will yield nine percent to the purchaser. Likewise, if market interest rates increase to
eleven percent, a purchaser will pay only $900 for the Debenture which, again given the
$ 100 contractual annual interest rate, will produce a yield of 11 percent.

§ 3.04 THE INDENTURE

Page 153, add the following immediately above the NOTES.

CONCORD REAL ESTATE CDO 2006-1, LTD. v. BANK OF AMERICA N.A.

Delaware Chancery Court
996 A.2d 324 (2010), aff’d 15A.3d 216 (Del. 2011)

LASTER, VICE CHANCELLOR.

***
The Common Law Rule That Governs Absent A Controlling Provision In The Indenture

The Indenture [in this case] does not explicitly address the surrender of Notes for no
consideration with an instruction that they be canceled. No provision expressly allows it. No provision
expressly prohibits it. Unable to cite a provision directly on point, the parties have joined issue over two
boilerplate provisions that speak indirectly to cancellation in general. I therefore first determine the
common law rule that will apply to the surrender of the Subject Notes absent a governing contractual
provision. I look to the common law because this body of jurisprudence provides a backdrop of standard
default rules that supplement negotiated agreements and fill gaps when a contract is incomplete, whether
by inadvertence or design. Parties can contract around virtually all common law rules. In a lengthy and
sophisticated agreement like the Indenture, the terms of the agreement and not the common law will
control many issues. But unless contradicted or altered by the parties' agreement, the common law rules
form an implied part of every contract.

***

9
 [A] Express Covenants

Page 173, Insert the following immediately before [B] Implied Covenants.

[Insert (1) before the “As” immediately under the word Note and change Note to Notes.]
(2) Very long term corporate debt instruments, such as those in Rievman have not gone
completely out of style. In 2010, Norfolk Southern Corp. issued $250 million of 100 year debentures, and
Goldman Sachs Group Inc issued $250 million of 50 year debentures. Unlike the Rievman bonds,
however, these debt instruments were not secured and were redeemable.

AFFILIATED COMPUTER SERVICES, INC. v. WILMINGTON TRUST COMPANY

United States District Court, Northern District of Texas
2008 U.S. Dist. LEXIS 10190 (Feb. 12, 2008)

SIDNEY A. FITZWATER, CHIEF JUDGE.

This lawsuit requires the court to interpret a provision of an indenture agreement that obligates
the issuer of notes to timely file certain reports with the indenture trustee. The court must decide whether
the provision requires the issuer to timely file the reports with the Securities and Exchange Commission
("SEC") or merely obligates the issuer to timely file with the indenture trustee the reports that it files with
the SEC, even if the SEC filings are themselves untimely. For the reasons that follow, the court agrees
with the plaintiff issuer’s interpretation: the provision merely requires the issuer to timely file with the
indenture trustee the reports that the issuer has filed with the SEC.

Plaintiff-counterdefendant Affiliated Computer Services, Inc. ("ACS") sues defendant-

counterplaintiff Wilmington Trust Company ("Wilmington") in Wilmington’s capacity as indenture
trustee ("Trustee") of two series of senior notes issued by ACS. ACS asks the court to declare that ACS
is not in default under an indenture agreement ("Indenture") entered into between ACS and the Bank of
New York Trust Company ("Bank of New York"). Wilmington is Bank of New York’s successor as
Trustee. Wilmington counterclaims for a declaratory judgment that ACS breached the Indenture by
failing to timely file a Form 10-K with the SEC and by failing to furnish a Form 10-K to Wilmington as
Trustee, and that ACS breached its covenant of good faith and fair dealing. Wilmington also
counterclaims alleging that ACS violated § 314(a) of the Trust Indenture Act of 1939 ("TIA").
The parties essentially agree on the relevant facts. In 2005 ACS conducted a public offering of
two series of senior notes ("the Notes") under the Indenture: (1) $250 million in 4.70% notes, due 2010
(the "4.70% notes"), and (2) $250 million in 5.20% notes, due 2015 (the "5.20% notes"). The Notes
added two supplement agreements to the Indenture.
ACS was later investigated for backdating stock options. In response to an inquiry from the SEC
and a subpoena from the Department of Justice, ACS announced in May 2006 through an SEC Form 8-K
that it was initiating an internal investigation of its stock option practices. In September 2006 ACS
announced through an SEC Form 12b-25 that, due to the ongoing internal investigation, it would not be
timely filing its Form 10-K with the SEC for the fiscal year ending June 30, 2006. The Form 10-K was
due the day before ACS made this announcement.
In response, Cede Company ("Cede"), the registered holder of record of the 5.20% notes, notified
ACS and Bank of New York, the Trustee, that ACS was in default under the Indenture due to its failure to

10
timely file the Form 10-K with the SEC. The notice of default cited § 4.03 of the Indenture as the basis
for ACS’s affirmative contractual duty to make timely filings with the SEC according to §§ 13 and 15(d)
of the Securities Exchange Act of 1934 ("Exchange Act"). Section 4.03(a) of the Indenture provides:
The Company shall file with the Trustee, within 15 days after it files the same with the
SEC, copies of the annual reports and the information, documents and other reports (or
copies of those portions of any of the foregoing as the SEC may by rules and regulations
prescribe) that the Company is required to file with the SEC pursuant to Section 13 or
15(d) of the Exchange Act. The Company shall also comply with the provisions of the
TIA 314(a).
D. App. 33. The notice of default also cited § 6.01 of the Indenture, which makes the failure to comply
with certain Indenture covenants or agreements an "Event of Default." Id. at 36 (Indenture § 6.01(3)).
Section 6.01 also provides, however:
A Default under clause (3) of this Section 6.01 is not an Event of Default until the
Trustee notifies the Company, or the Holders of at least 25% in principal amount of the
then outstanding Securities of the series affected by that Default, or, if outstanding
Securities of other series are affected by that Default, then at least 25% in principal
amount of the then outstanding Securities so affected, notify the Company and the
Trustee, of the Default, and the Company fails to cure the Default within the period of
days specified in the applicable indenture supplement after receipt of the notice. The
notice must specify the Default, demand that it be remedied and state that the notice is a
"Notice of Default."
Id. at 37–38. The parties agree that although the Indenture contemplates a cure period to be spelled out in
the indenture supplements, the two indenture supplements are silent on a cure period for this type of
breach. Once the cure period elapses, and the breach of the Indenture under § 6.03(3) ripens into an
"Event of Default," the Indenture permits the Trustee or the holders of notes who have a right to give
notice of default under § 6.01 to accelerate the Notes upon proper notice. Indenture § 6.02. Cede’s notice
satisfied the Indenture’s notice of default provision.
ACS, in turn, filed suit against Bank of New York as Indenture Trustee seeking a declaratory
judgment that ACS is not in default under the Indenture. Bank of New York, in a notice similar to
Cede’s, also notified ACS that it was in default on the 5.20% notes. Then Cede, and later Bank of New
York, invoked § 6.02 of the Indenture and demanded from ACS acceleration of the 5.20% notes.
Thereafter, the holders of 25% of the 4.70% notes sent ACS and Bank of New York notices of
default alleging the same ground of default as had been asserted regarding the 5.20% notes. These
notices complied with the Indenture’s requirements for notices of default. Cede followed by delivering to
ACS letters demanding acceleration of the 4.70% notes in conjunction with the earlier notices of default.
After completing a lengthy internal investigation, in January 2007 ACS finally filed its Form 10-
K with the SEC for the fiscal year ending June 30, 2006. ACS also filed its belated Form 10-Q with the
SEC for the first quarter of the following fiscal year ending September 30, 2006. On January 25, 2007
ACS delivered both SEC filings to the Trustee.
Wilmington moves for summary judgment dismissing ASC’s declaratory judgment action and
establishing its right to recover on its counterclaims. ACS moves for summary judgment on its request
for declaratory relief and for dismissal of Wilmington’s counterclaims.4

                                                            
4
[1] In its summary judgment response, Wilmington moves to strike the declarations of William Jacobs. In its reply, ACS moves
to strike the declarations of Robert Lamb. Because in deciding these motions the court has not relied on the testimony in these
declarations, the court denies the motions to strike as moot.

11
 II

The Indenture’s choice-of-law provision specifies that New York law controls this contract
dispute. . . .

III

Section 4.03(a) of the Indenture unambiguously requires ACS to file with the Trustee copies of its
SEC reports within 15 days of filing them with the SEC. The question is whether § 4.03(a) itself imposed
on ACS the obligation to file such reports with the SEC.
The court finds persuasive the analysis of Cyberonics, Inc. v. Wells Fargo Bank Nat’l Ass’n, 2007
WL 1729977 (S.D. Tex. June 13, 2007). Cyberonics involved a declaratory judgment action focusing on
an almost-identical indenture provision as is contained in § 4.03(a) of the Indenture. The provision read:
Reports. The Company shall deliver to the Trustee within 15 days after it files them with
the SEC copies of the annual reports and of the information, documents and other reports
(or copies of such portions of any foregoing as the SEC may by rules and regulations
prescribe) which the Company is required to file with the SEC pursuant to Section 13 or
15(d) of the Exchange Act. . . . The Company shall also comply with the other
provisions of Section 314(a) of the TIA.
Id. at 1.5 Just as Wilmington argues that § 4.03 of the Indenture creates an independent covenant to make
timely filings with the SEC, the indenture trustee in Cyberonics argued that the "Reports" covenant
affirmatively obligated the issuing company, Cyberonics, Inc. ("Cyberonics"), to file with the SEC the
reports required by §§ 13 and 15(d) of the Exchange Act. Id. at 4. Because Cyberonics filed its Form 10-
K report with the SEC late, the indenture trustee maintained that Cyberonics was in default under the
"Reports" covenant. Id. at 3–4. The court disagreed, holding that the "Reports" covenant unambiguously
required only that Cyberonics deliver copies of the annual reports and other documents to the indenture
trustee within 15 days after filing them with the SEC. Id. at 4. Therefore, unless Cyberonics filed
documents with the SEC, it was not obligated to deliver any SEC-related documents to the indenture
trustee. Although the provision referred to "reports and of the information . . . which the Company is
required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act," the court noted that
the phrase "which the Company is required" merely identified the types of reports that Cyberonics was
required to deliver to the indenture trustee, and did not independently obligate Cyberonics to make any
SEC filings. Id. The court concluded that had the parties intended to impose a filing, rather than a
delivery, obligation, they could easily have done so. Id.
The court finds further support for the reasoning of Cyberonics from the Indenture’s treatment of
covenants generally. Section 4.03 is found in Article IV of the Indenture, which focuses on the covenants
of ACS, the issuing company. Article IV clearly designates its other covenants by beginning an
independent clause with language such as, "[t]he Company shall" (used nine times), "[t]he Company will"
(used five times), and "[t]he Company covenants" (used two times). Consistent with this approach,
§ 4.03(a) begins, "[t]he Company shall file with the Trustee[.]" Considering Article IV’s other covenant
language, there is no reasonable basis to conclude that the parties intended § 4.03’s modifying phrase—
"that the Company is required to file with the SEC"—to affirmatively obligate ACS to timely file with the
SEC those reports and documents that it is already statutorily obligated to file under § 13 or § 15(d) of the
Exchange Act. If the parties had intended that the Indenture obligates ACS to timely file reports with the
                                                            
5
[2] The only differences between the "Reports" provision in Cyberonics and § 4.03(a) of the Indenture are the use of "deliver to"
instead of "file with," "them" instead of "the same," and "which" instead of "that."

12
SEC, it would have done so with the same clear language employed by the balance of Article IV’s
covenants.
Instead, properly interpreted, § 4.03(a) simply obligates ACS to file with the Trustee copies of the
reports that ACS in fact files with the SEC, and to do so within 15 days of filing.

Wilmington maintains that ACS’s construction of the Indenture cannot be correct, because ACS
would then be able to escape its duty to provide financial information to the Trustee by not filing anything
with the SEC at all. ACS is statutorily obligated, however, to file continuing reports with the SEC under
the Exchange Act. Although ACS’s failure to file with the SEC may not subject it to penalties under the
Indenture, a late filing exposes ACS to other potential sanctions that are surely adequate to prevent ACS
from attempting to take advantage of the note holders. Accordingly, the court’s interpretation of § 4.03(a)
does little to encourage ACS or other indenture obligors to attempt to skirt their statutory and contractual
filing obligations.

Wilmington insists that the court follow Bank of New York v. Bearingpoint, Inc., 824 N.Y.S.2d
752 (N.Y. Sup. Ct. 2006) (unpublished table decision). In Bank of New York a New York County trial
court interpreted an Indenture provision substantially similar to § 4.03 as requiring the indenture obligor
to timely file periodic reports with the SEC. Bank of N.Y., 2006 WL 2670143, at 7. But Bank of New
York is an unpublished decision of a trial court that is not binding on this court.
In order to determine state law, federal courts look to final decisions of the highest court
of the state. When there is no ruling by the state’s highest court, it is the duty of the
federal court to determine as best it can, what the highest court of the state would decide.
Transcon. Gas Pipeline Corp. v. Transp. Ins. Co., 953 F.2d 985, 988 (5th Cir.1992) (citing Comm’r of
Internal Revenue v. Estate of Bosch, 387 U.S. 456, 464–65, 87 S. Ct. 1776, 18 L.Ed.2d 886 (1967)); see
also O’Neill v. City of Auburn, 23 F.3d 685, 689–90 (2d Cir.1994) ("Our task is to predict how the state’s
highest court would rule on this issue"). The court finds Bank of New York unpersuasive. First, the court
held that the indenture provision equivalent to § 4.03(a) incorporated the Exchange Act, thus making § 13
of the Exchange Act a part of the indenture contract. Bank of N.Y., 2006 WL 2670143, at 3. The court
also held that § 314(a)(1) of the TIA and the indenture provision largely restating § 314(a)(1) obligated
the indenture issuer to timely file with the SEC. Id. For the reasons set forth above, the court respectfully
disagrees with both of these conclusions.
Under § 4.03(a) of the Indenture, ACS was not obligated to file timely reports with the SEC
according to §§ 13 and 15(d) of the Exchange Act. Because ACS filed its belated Forms 10-K and 10-Q
with Wilmington within 15 days after filing them with the SEC, ACS is entitled to judgment declaring
that it is not in breach of § 4.03(a) of the Indenture.6 The court therefore grants ACS’s May 7, 2007
summary judgment motion, denies Wilmington’s March 27, 2007 motion, and today files a judgment in
ACS’s favor.

                                                            
6
[5] Because ACS is not in default under § 4.03(a) of the Indenture, the court need not address the parties’ arguments as to the
cure period and the acceleration of the Notes.

13
 RACEPOINT PARTNERS v. JPMORGAN CHASE BANK NA
New York Court of Appeals
14 N.Y 3d 419, 902 N.Y.S.2d 14, 928 N.E.2d 396 (2010)

PIGOTT, J.

On February 7, 2001, the energy company Enron executed an indenture agreement with Chase
Manhattan Bank (Chase), naming Chase as the indenture trustee for the holders of certain Enron notes.
The agreement contained, in section 4.02, a standard provision setting forth a covenant by Enron
"[to] file with the Trustee [i.e. Chase], within 15 days after it files the same with the SEC
[Securities and Exchange Commission], copies of its annual reports and of the
information, documents and other reports . . . which the Company [i.e. Enron] is required
to file with the SEC pursuant to Section 13 or 15(d) of the [Securities] Exchange Act.
Delivery of such reports, information and documents to the Trustee is for informational
purposes only and the Trustee's receipt of such shall not constitute constructive notice of
any information contained therein or determinable from information contained therein,
including the Issuer's compliance with any of its covenants hereunder (as to which the
Trustee is entitled to rely exclusively on Officers' Certificates). The Issuer also shall
comply with any other provisions of Trust Indenture Act Section 314(a)."
The agreement also set forth various circumstances or events that would constitute default by
either party, including failure by Enron to comply with this provision, if not corrected within 60 days of
notification by Chase.
In December 2001, in the wake of the major accounting fraud scandal with which it has become
synonymous, Enron filed for bankruptcy. Thereafter, plaintiffs Racepoint Partners, LLC, and Willow
Capital–II, L.L.C., bought approximately $1 billion of the notes from their holders. Plaintiffs, which, as
secondary holders of the notes, are vested with the claims and demands of the sellers, then brought this
common-law action against Chase alleging, among other things, breach of contract. Plaintiffs claim, first,
that Enron defaulted under the indenture agreement and, second, that Chase had actual knowledge of this
default and that its failure to notify Enron and the noteholders of the default constituted breach of the
agreement.7 The issue in this appeal is the allegation of contractual default by Enron in filing reports that
were false.
Plaintiffs point to the fact that Enron agreed in section 4.02 to file with Chase copies of all reports
that it was "required to file with the SEC pursuant to Section 13 or 15(d) of the [Securities] Exchange
Act." Section 13 of the Act requires publicly traded companies to keep records accurately reflecting their
transactions and assets, and to file annual and quarterly reports with the Securities and Exchange
Commission (see 15 USC § 78m). Plaintiffs argue that because the financial reports filed by Enron with
Chase were inaccurate and did not comply with federal securities law, they were not the reports Enron
was "required to file with the SEC." Plaintiffs posit that, by filing these same fraudulent reports with
Chase, Enron failed to satisfy its section 4.02 covenant, and thus defaulted.
Chase moved to dismiss the complaint under CPLR 3211. Supreme Court denied Chase's
motion. The Appellate Division reversed, granting the motion. . . . We granted leave to appeal . . . and
now affirm.
Section 4.02 of the indenture agreement is a mandated provision based on the requirements of
section 314(a)(1) of the Trust Indenture Act of 1939:

                                                            
7
[*] On a similar theory, plaintiffs also allege that Chase breached its fiduciary duty to the noteholders. Plaintiffs concede that
the dismissal of their breach of contract cause of action is fatal to the breach of fiduciary duty cause of action.

14
 “Each person who, as set forth in the registration statement or application, is or is to be an
obligor upon the indenture securities covered thereby shall . . .
“file with the indenture trustee copies of the annual reports and of the
information, documents, and other reports (or copies of such portions of any of
the foregoing as the [Securities and Exchange] Commission may by rules and
regulations prescribe) which such obligor is required to file with the Commission
pursuant to section 13 or section 15(d) of the Securities Exchange Act of 1934
[15 USC § 78m or § 78o (d)]; or, if the obligor is not required to file information,
documents, or reports pursuant to either of such sections, then to file with the
indenture trustee and the [Securities and Exchange] Commission, in accordance
with rules and regulations prescribed by the Commission, such of the
supplementary and periodic information, documents, and reports which may be
required pursuant to section 13 of the Securities Exchange Act of 1934 [15 USC
§ 78m], in respect of a security listed and registered on a national securities
exchange as may be prescribed in such rules and regulations" (codified at 15
USC § 77nnn [a][1]).
Plaintiffs concede that the parties' intent in section 4.02 may be equated with congressional intent
with respect to section 314(a) of the Trust Indenture Act of 1939. In drafting the Trust Indenture Act,
Congress intended simply to ensure that an indenture trustee was provided with up-to-date reports on a
company's financial status, by requiring the company to send the trustee a copy of filed financial reports.
In the 1930s, when section 314(a) was drafted, computer-based technologies, whereby copies of SEC
reports can now be obtained, did not exist.
The legislative history of section 314(a) suggests that Congress intended to create a delivery
requirement and no more. The 1939 House Report highlighted the legislators' concern that trustees and
bondholders at the time did not receive periodic reports from companies issuing bonds.
"In a substantial portion of the indentures . . . the issuer was under no obligation to file an
annual report with the indenture trustee. None of the indentures . . . required the
transmission to the bondholders of periodic reports, such as stockholders customarily
receive. None of them established machinery for the transmission of such reports. . . ."
(HR Rep. 1016, 76th Cong., 1st Sess., at 35 [1939].)
It is apparent that section 314(a) was designed to mandate such a mechanism of delivery of
reports to indenture trustees. The same House Report, observing that in many cases a company "will
already be required to file periodic reports with the [Securities and Exchange] Commission under section
13 or section 15(d)," stated that the bill under consideration "merely requires that copies of such reports
. . . be filed with the indenture trustee" (HR Rep. 1016, 76th Cong., 1st Sess., at 35).
As federal courts have observed, when considering indenture agreement provisions very similar
to the one at issue here,
"the provision merely requires the company to transmit to the trustee copies of whatever
reports it actually files with the SEC . . .
"[A]ny duty actually to file the reports is imposed ‘pursuant to Section 13 or 15(d) of the
Exchange Act’ and not pursuant to the indenture itself. The provision does not
incorporate the Exchange Act, it merely refers to it in order to establish which reports
must be forwarded.
"[It] impose[s] nothing more than the ministerial duty to forward copies
of certain reports, identified by reference to the Exchange Act, within
fifteen days of actually filing the reports with the SEC" (UnitedHealth

15
 Group Inc. v. Wilmington Trust Co., 548 F.3d 1124, 1128–1130 [8th Cir.
2008]; see also e.g. Affiliated Computer Servs., Inc. v. Wilmington Trust
Co., 565 F.3d 924, 930–931 [5th Cir. 2009] . . . .
It is clear therefore that indenture agreements containing the required delivery provisions
pursuant to section 314(a) refer to the Securities Exchange Act only to identify the types of report that
should be forwarded to indenture trustees. They do not create contractual duties on the part of the trustee
to assure that the information contained in any report filed is true and accurate. That is simply not the
mission or purpose of the trustee or the contract under which it undertakes its duties.
Of course, companies have a duty to file accurate reports with the SEC. That obligation,
however, derives from the Securities Exchange Act, not from indenture agreements.
Our holding that section 4.02 of the indenture agreement simply embodies a delivery
requirement, and does not imply a duty on the part of the trustee to assure the filing of accurate reports or
risk default, is consistent with the limited, "ministerial" functions of indenture trustees (AG Capital
Funding Partners, L.P. v. State St. Bank & Trust Co., 11 N.Y.3d 146, 157, 866 N.Y.S.2d 578, 896 N.E.2d
61 [2008]), and with the plain language of section 4.02, which states that "[d]elivery of such reports,
information and documents [filed with the SEC] to the Trustee is for informational purposes only."
Plaintiffs' proposed interpretation, on the other hand, would require indenture trustees to review the
substance of SEC filings, so as to reduce the risk of liability, greatly expanding indenture trustees'
recognized administrative duties far beyond anything found in the contract.

[B] Implied Covenants

Page 197, add the following new Note immediately after Note (1) and change current Note (2) to
Note (3).
(2) As the court notes in the text preceding footnote 17 of its opinion, the rating agencies’
evaluation of the RJR Nabisco bonds largely determined the market value thereof.
Page 198, add the following new Note before § 3.05.
(4) Another form of contractual protection against a ratings downgrade is the "Step-Up
Coupon," which provides in effect that if the credit rating of a particular debt instrument deteriorates, the
contractual (or coupon) interest rate automatically increases.

§ 3.06 "NO ACTION" CLAUSES AND THE INDENTURE TRUSTEE

Page 236, add the following new Note at the end of § 3.06.

NOTE
No-action clauses also found their way into the Pooling and Servicing Agreements utilized in the
administration of mortgage-backed securities, and have been held to be enforceable in that context as
well. See Greenwich Financial Services Distressed Mortgage Fund 3, LLC v. Countrywide Financial
Corp., No. 650474/08, slip op., Oct. 13, 2010.

16
§ 3.07 THE MEANING OF THE TERM "ALL OR SUBSTANTIALLY ALL" OF THE ASSETS
OF A BUSINESS CORPORATION IN THE CONTEXT OF TRUST INDENTURES AND OTHER
ASPECTS OF CORPORATE FINANCE

Page 240, insert the following immediately before Katz v. Bregman.

The Government’s antitrust challenge to Kennecott Copper Corporation’s 1968 acquisition of
Peabody Coal Company was based on the strict scrutiny of business acquisitions espoused in such cases
as United States v. Von’s Grocery, 384 U.S. 270 (1966). See generally G. EDWARD WHITE, EARL
WARREN: A PUBLIC LIFE 294–301 (1982). That doctrine in effect required acquiring companies to
purchase business segments unrelated to their "core" businesses and thus become "conglomerate"
corporations owning a variety of businesses. That structure also theoretically provides some immunity
from the vicissitudes of the business cycle. The existence of these diversified corporations gave rise to
the leveraged buyouts of the 1980s because certain business segments of an acquired corporation could
thereafter be sold to repay some of the acquisition indebtedness without disrupting its other operations.
This is what Felix Royaton was referring to when he complained about corporations being torn apart like
artichokes. See § 3.04, Note (1), supra. Since the 1960s, there have been various cycles in antitrust
enforcement. Indeed, at one point, enforcement was relaxed to the point where in 2006 Whirlpool and
Maytag were allowed to combine their washing machine and dryer businesses, a far cry from disallowing
the combination of copper and coal mining.
Page 243, add the following immediately before § 3.08 THE TRUST INDENTURE ACT OF 1939.
EBITDA, an important method of measuring the value of a business enterprise, refers to: earnings
before interest, taxes, depreciation and amortization. The difference between it and another valuation
measurement, earnings per share, has been described as follows:
The issue then becomes what benchmark to use in examining changes in the results of
business operations post-signing of the merger agreement—EBITDA or earnings per
share. In the context of a cash acquisition, the use of earnings per share is problematic.
Earnings per share is very much a function of the capital structure of a company,
reflecting the effects of leverage. An acquirer for cash is replacing the capital structure of
the target company with one of its own choosing. While possible capital structures will
be constrained by the nature of the acquired business, where, as here, both the debt and
equity of the target company must be acquired, the capital structure of the target prior to
the merger is largely irrelevant. What matters is the results of operation of the business.
Because EBITDA is independent of capital structure, it is a better measure of the
operational results of the business. . . .
Hexion Specialty Chems., Inc. v. Huntsman Corp., 965 A. 715, 749 (Del. Ch. 2008).
EBITDA is to be distinguished from such business valuation measurements as gross profit
(receipts from all sources less cost of goods sold, i.e. materials, labor and allocated overhead) or gross
revenue (receipts generated less cost of goods sold). An EBITDA calculation produces a smaller figure
than does gross profit or gross revenue because the "earnings" component takes into account all of the
direct operating costs of business, such as research and development, legal and accounting costs and
general administrative expenses. EBITDA is not without its critics. Because assets wear out and
EBITDA nevertheless excludes depreciation of capital expenses, Warren Buffet has reportedly asked,
"Does management think the tooth fairy pays for capital expenditures?"

17
Page 262, insert new subsection [E] immediately above § 3.09.

[E] Filing Requirements of the Trust Indenture Act

AFFILIATED COMPUTER SERVICES, INC. v. WILMINGTON TRUST COMPANY

United States District Court, Northern District of Texas
2008 U.S. Dist. LEXIS 10190 (Feb. 12, 2008)

SIDNEY A. FITZWATER, CHIEF JUDGE

Wilmington contends that even if § 4.03(a) [of the Indenture] does not obligate ACS to make
timely SEC filings, § 314(a) of the [Trust Indenture Act the "TIA"] does. Because the Notes are
registered, the Indenture is "qualified" within the meaning of 15 U.S.C. § 77ccc(9). Accordingly, § 314
of the TIA must form a part of the Indenture. See 15 U.S.C. § 77rrr(c). Moreover, the parties agree that
§ 4.03 explicitly incorporates § 314(a) of the TIA. Section 314(a) provides, in pertinent part:
Each person who, as set forth in the registration statement or application, is or is to be an
obligor upon the indenture securities covered thereby shall —
(1) file with the indenture trustee copies of the annual reports and of
the information, documents, and other reports (or copies of such portions
of any of the foregoing as the [SEC] may by rules and regulations
prescribe) which such obligor is required to file with the [SEC][.]
15 U.S.C. § 77nnn(a).
As in § 4.03 of the Indenture, the phrase "is required to file with the [SEC]" modifies the types of
reports and documents that are included in the universe of those that ACS must file with the Trustee.
Thus § 314 of the TIA obligates ACS to file with Wilmington copies of the reports and documents that
ACS files with the SEC, but § 314 does not require that ACS file anything with the SEC. In Cyberonics
the court concluded that § 314(a) of the TIA "is actually less stringent than the ["Reports" covenant]
because it does not specify the time by which Cyberonics must provide [the indenture trustee] with copies
of information filed with the SEC." Cyberonics, 2007 WL 1729977, at 4.
Wilmington argues that SEC Rule 19a-1 reflects the agency’s interpretation of § 314(a)(1) to
require that "eligible indenture obligors" such as ACS file timely reports with the SEC:
An "eligible indenture obligor" that files with the indenture trustee those Exchange Act
reports filed with the Commission . . . has met its duty under Section 314(a)(1) of the Act
(15 U.S.C. 77nn[n] (a)(1)) to "file with the indenture trustee all reports required to be
filed with the Commission pursuant to Section 13 or Section 15(d) of the Securities
Exchange Act of 1934."
17 C.F.R. § 260.19a-1(c). Under Rule 19a-1, ACS satisfies its obligations under § 314(a)(1) by filing
with the Trustee "those Exchange Act reports filed with the Commission." Id. (emphasis added). This
SEC rule is completely consistent with the court’s construction of § 314(a): the indenture obligor need
only file with the Trustee the reports and documents that it has in fact filed with the SEC. SEC Rule 19a-
1 does not affirmatively require the indenture obligor to file original documents and reports with the SEC.
Wilmington also contends that the policies of the TIA support its interpretation of § 314(a).
Section 302 of the TIA enumerates some practices that adversely affect the public.

18
 [I]t is hereby declared that the national public interest and the interest of investors in
notes, bonds, debentures, evidences of indebtedness, and certificates of interest or
participation therein, which are offered to the public, are adversely affected —. . .
(4) when the obligor is not obligated to furnish to the trustee under
the indenture and to such investors adequate current information as to its
financial condition, and as to the performance of its obligations with
respect to the securities outstanding under such indenture[.]
15 U.S.C. § 77bbb(a). The Indenture’s requirement that ACS deliver to the Trustee a copy of all of
ACS’s required SEC filings within 15 days of filing them with the SEC meets this policy concern. It
ensures that the note holders through the Trustee possess the same financial information concerning the
issuing company that the rest of the investment public has. Moreover, Wilmington cannot argue that it
was without any current financial information on ACS from September 13, 2006, the day ACS’s Form
10-K was due, until January 25, 2006, the day Wilmington received ACS’s 10-K and 10-Q reports.
During this four-month period, ACS did apprise the Trustee and investors of the company’s financial
situation and developments in its internal investigation through SEC Form 8-Ks and other public
announcements.8 Thus Wilmington’s contention that its note holders were deprived of material financial
information necessary to make informed judgments has little merit. Although Wilmington would have
been better protected had the Indenture affirmatively obligated ACS to timely file its Exchange Act
reports directly with the SEC, the court will not rewrite the clear language of § 4.03(a) of the Indenture
and § 314(a)(1) of the TIA on this basis. The court notes that, while urging the court to adopt a policy-
based interpretation of the Indenture, when it suits Wilmington’s purposes concerning other issues in
dispute, it maintains that "Public bondholders must have assurance that indentures will be enforced
according to their terms." D. Reply 20 (emphasis added).

Wilmington’s attempt to distinguish Cyberonics on the basis that the indenture in that case was
not a qualified indenture is misplaced. Although the indenture in Cyberonics was not qualified and thus
did not statutorily incorporate § 314 of the TIA, the Cyberonics court assumed that the indenture
agreement incorporated § 314(a). Cyberonics, 2007 WL 1729977, at 4. But even if Cyberonics could be
distinguished on the basis of the applicability of § 314(a) of the TIA, based on the above discussion, the
court holds that § 314(a) does not provide an independent obligation for the indenture obligor to timely
file reports with the SEC according to §§ 13 and 15(d) of the Exchange Act.
Wilmington argues that reducing § 4.03(a) to a delivery obligation ensuring simultaneous access
of information between shareholders and bondholders renders this provision surplusage in an age of
electronic filing of SEC reports. Because all public SEC filings are accessible to the public via the
Internet on the EDGAR system, Wilmington urges that it would make little sense to have a specific
provision in the Indenture solely dealing with the delivery of these SEC filings to the Trustee.
The court acknowledges that the value of a pure delivery obligation in the post-EDGAR world is
considerably less than before it. But when the TIA was enacted in 1939, a delivery requirement would
have been important, because quick access to SEC filings was not possible through other means. Thus
                                                            
8
[3] ACS filed a Form 8-K on November 1, 2006 that included its preliminary financial information for the first quarter of the
new fiscal year ending September 30, 2006, a notice that it would not timely file a Form 10-Q for that quarter on account of its
ongoing internal investigation, as well as updates on the progress of the internal investigation. Later that month, in a Form 12b-
25, ACS stated that it would not timely file a Form 10-Q for the first quarter ending September 30, 2006 and that it expected to
complete its internal investigation before the end of the year. A few weeks later in a press release, ACS announced the
completion of its internal investigation and estimated that the company’s backdating practices would cost it approximately $51
million, plus tax-related expenses. ACS’s Form 10-K for the fiscal year ending June 30, 2006 confirmed the accuracy of the press
release’s estimates.

19
Wilmington’s argument does not apply to the court’s interpretation of § 314(a) of the TIA. Moreover,
because § 4.03(a) of the Indenture largely mirrors the language of § 314(a), there is no reason to believe
that the parties intended it to require anything more than what § 314(a) requires, except for the addition of
a 15-day delivery limit. While the parties negotiated the Indenture in 2005, the fact that § 4.03(a) largely
restates § 314(a)(1) helps explain why the parties might have included a pure delivery requirement in an
era of publicly-available Internet filings. But even with electronic access, a delivery requirement is not
meaningless. With a delivery requirement the Trustee knows when the Indenture obligor has filed
something with the SEC and is spared the time and expense of printing the documents and reports.
Nevertheless, the court’s construction of § 4.03(a) does not depend on speculation as to why the parties
might have written § 4.03(a) as they did, but rather on § 4.03(a)’s clear language and the context of the
Indenture as whole.9
Page 257, insert the following above [D] Acceleration Provisions and Section 316 of the Trust
Indenture Act.

NOTE
An Indenture Trustee can be held liable for the negligent performance of its Section 315 pre-
default duties. See AG Capital Funding Partners v. State Street Bank & Trust Co., 11 N.Y.3d 146, 866
N.Y.S.2d 578, 896 N.E.2d 61 (2008).
Page 262, insert new § 3.09 and renumber current § 3.09 as § 3.10.

§ 3.09 THE SUPPLEMENTAL INDENTURE

BANK OF NEW YORK v. TYCO INTERNATIONAL GROUP, S.A.

United States District Court, Southern District of New York
545 F. Supp. 2d 312 (2008)

SHIRA A. SCHEINDLIN, DISTRICT JUDGE.

[In 1998, and 2003, respectively, a wholly owned subsidiary ("TIGSA") of the publicly traded
Tyco International, LTD. ("Tyco") issued several series of Notes pursuant to Indentures under which
Bank of New York ("BNY") was the Trustee. Tyco was the guarantor of the Notes. TIGSA was the
owner of four business segments which constituted substantially all of TIGSA’s (and thus Tyco’s) assets.
The Indentures permitted the transfer by TIGSA of substantially all of its assets, only if the transferee
expressly assumed, in a Supplemental Indenture between it and the Trustee, the obligations of TIGSA
under the Notes. In 2007, two of the business segments, medical devices and electronics, were transferred
to Tyco and then spun off to the public stockholders of Tyco; the two other businesses, security systems
and engineered products and services, were transferred to and retained by Tyco, through TIFSA, a
holding company. A proposed Supplemental Indenture provided that Tyco and TIFSA assumed primary
                                                            
9
[4] As the Cyberonics court noted:
[The indenture trustee] contends that because it can already obtain documents and reports filed with the SEC
from the EDGAR system, [the "Reports" covenant] is meaningless if read as only requiring copies of
documents already filed with the SEC and not as an obligation to actually file with the SEC. Again, [the
indenture trustee’s] argument overlooks the plain language of the provision. It also overlooks another crucial
fact that had the parties intended to require filing of the documents, [the "Reports" covenant] could easily
have been written to do just that. If, as [the indenture trustee] contends, the objective of the ["Reports"
covenant] was to insure filings consistent with SEC requirements and guidelines, the parties could have
simply declared so. Instead, the parties agreed that Cyberonics would deliver to [the indenture trustee] copies
of reports after it had filed them with the SEC. The agreement should be enforced as it is clearly and
unambiguously written, and not read as [the indenture trustee] now asserts that it should be.
Cyberonics, 2007 WL 1729977, at 4 (citations omitted).

20
liability for the Notes, as distinguished from Tyco’s former contingent liability as guarantor thereof. The
Trustee refused to sign the Supplemental Indenture because of its contention that Tyco did not become the
continuing owner of substantially all the assets of TIGSA and thus was not a permissible transferee under
the Indenture.]

III. APPLICABLE LAW

B. Sharon Steel

1. Facts

In Sharon Steel, the Second Circuit held that the validity of a transfer of assets in the course of a
liquidation must be evaluated in the context of the overall plan of liquidation.10 During 1977 and 1978,
the obligor on certain notes, UV Industries, Inc. ("UV"), maintained three lines of business: electrical
equipment, operated through Federal Pacific Electric Company ("Federal"); metal fabrication, operated
through Mueller Brass; and metals mining.11 Federal provided sixty percent of UV’s operating revenue
and constituted forty-four percent of the book value of UV’s assets.12
As part of a plan of liquidation, UV first sold Federal and certain other assets to unrelated
purchasers.13 UV then sold its remaining assets to Sharon Steel Corp. ("Sharon Steel"), which agreed to
assume UV’s outstanding notes.14 UV did not obtain noteholder approval before transferring the notes to
Sharon Steel, relying instead on the terms of the successor obligor clause. The assets transferred to
Sharon Steel represented fifty-one percent of the assets that UV held before it began the liquidation.15 To
formalize its position as obligor, Sharon Steel delivered supplemental indentures to the indenture trustees,
who refused to execute them and instead issued notices of default.16 The indenture trustees then sued
claiming that the transfer of assets to Sharon Steel was a breach of the indentures.

2. Proceedings

After a jury trial, the district court directed a verdict for the indenture trustees.17 On appeal, the
Second Circuit first noted that successor obligor clauses are boilerplate and "‘[s]ince there is seldom any
difference in the intended meaning [boilerplate] provisions are susceptible of standardized
expression. . . .’"18 Because of the importance of uniformity to the efficient functioning of capital markets,
the Second Circuit held that the interpretation of boilerplate provisions is a matter of law and should not
be submitted to a jury.19
The Circuit then turned its attention to the application of the successor obligor clauses. Sharon
Steel argued that because it purchased all of the assets UV had at the time of the purchase, the transfer fell
within the literal language and terms of the successor obligor clauses. The Circuit rejected this

                                                            
10
[47] See 691 F.2d at 1042, 1044.
11
[48] See id. at 1045.
12
[49] See id.
13
[50] See id.
14
[51] See id. at 1046.
15
[52] See id. at 1051.
16
[53] See id. at 1046–47.
17
[54] See id. at 1047.
18
[55] Id. at 1048 (quoting American Bar Foundation, Commentaries on Indentures (1971)) (hereinafter Commentaries).
19
[56] See id. The Circuit also held that the district court did not err in rejecting evidence of custom, usage, and practical
construction in interpreting the clauses. See id. at 1048–49.

21
mechanical interpretation of the clauses, instead analyzing them in terms of the interests they were
intended to protect.20
The Circuit found that successor obligor clauses protect both the borrower, by permitting it to
merge, liquidate, or sell its assets, and the lender, by assuring some degree of continuity of assets.21 In
light of these interests, the Circuit held that "boilerplate successor obligor clauses do not permit
assignment of the public debt to another party in the course of a liquidation unless ‘all or substantially all’
of the assets of the company at the time the plan of liquidation is determined upon are transferred to a
single purchaser."22 Thus, the court looked to UV’s assets when the company first decided to liquidate —
i.e., prior to the sale of Federal. Because the assets purchased by Sharon Steel, not including proceeds
from the intermediate sales, constituted only fifty-one percent of UV’s pre-transaction assets — and fifty-
one percent was "[i]n no sense" substantially all — the court held that the transfer of the notes to Sharon
Steel was not effective under the successor obligor clauses and UV remained liable on the Notes.23

IV. DISCUSSION

A. Validity of the Tyco Transaction

The Transaction comprised two transfers of assets. First, TIGSA transferred all of its assets to
Tyco and used the successor obligor clauses to make Tyco the obligor on the Notes. Second, Tyco
transferred Tyco Electronics and Covidien to its shareholders. Tyco maintains that the second transfer did
not violate the successor obligor clauses because it was not a transfer of substantially all of Tyco’s assets.
BNY disagrees, arguing that substantially all of Tyco’s assets were transferred. BNY further contends
that the Transaction as a whole violates the rule of Sharon Steel. These two arguments are addressed
separately.

1. Distribution of Tyco Electronics and Covidien

The successor obligor clauses prohibit Tyco from transferring substantially all of its assets unless
the transferee assumes liability for the Notes. Therefore, if Tyco’s transfer of Tyco Electronics and
Covidien to its shareholders was in fact a transfer of substantially all of Tyco’s assets, the Transaction
breached the Indentures.
I cannot determine on this record whether Tyco Electronics and Covidien constituted
substantially all of Tyco’s assets. However, while BNY contends that factual disputes will require a trial
on issues of valuation,24 the parties may be able to stipulate to a sufficiently narrow valuation range to
permit the Court to resolve the issue on summary judgment. At this time, however, defendants’ motion is
denied without prejudice.

                                                            
20
[57] See id. at 1049–50.
21
[58] See id. at 1050 ("We hold, therefore, that protection for borrowers as well as for lenders may be fairly inferred from the
nature of successor obligor clauses.").
22
[59] Id. at 1051 (emphasis added).
23
[60] Id. at 1051–52.
24
[61] See 10/2/07 Transcript at 27:15–22 ("Gerard E. Harper, Attorney for Intervener Plaintiffs: [I]f your Honor were to decide
that Sharon Steel [does not apply], then I have the right to assert . . . that the spin-off of Covidien and Tyco Electronics was itself
a transfer of all or substantially all of Tyco’s assets and, therefore, trigger[ed] the successor obligor clause-a different analytical
argument and one that would require an analysis and a trial on the valuation of what was spun off and what was left behind.").
Harper entered an appearance as co-counsel for BNY on the same day that certain noteholders, who had intervened as plaintiffs,
voluntarily dismissed their claims. See 10/17/07 Notice of Appearance.

22
 2. Applicability of Sharon Steel

Even if the spin-off of Tyco Electronics and Covidien did not constitute a transfer of substantially
all of Tyco’s assets, the Transaction would still violate the successor obligor clauses if Sharon Steel
applies. In Sharon Steel, the Second Circuit held that a transfer of assets pursuant to a plan of liquidation
had to be evaluated "at the time the plan of liquidation is determined. . . ."25 If Sharon Steel applies here,
the transfer is invalid because Tyco clearly does not hold substantially all of the assets originally held by
TIGSA.
Before the Transaction, Tyco was a public corporation that maintained four lines of business
through a single holding company, TIGSA. TIGSA was the only obligor on the Notes, and Tyco was a
guarantor. After the Transaction, Tyco is a public corporation that maintains two lines of business
through a single holding company, TIFSA. Tyco and TIFSA are co-obligors on the Notes. The
noteholders remain lenders to Tyco, but Tyco divested itself of two lines of business. In essence, Tyco
spun off two of its businesses.
Sharon Steel does not apply to these facts. The transaction in Sharon Steel resulted in Sharon
Steel, a company unrelated to UV, holding only one of UV’s three lines of business and all of UV’s debt.
The transactions were consummated in the course of the liquidation of UV. Here, Tyco spun off two of
its businesses and retained the remainder. Neither the debt nor the engineered products and fire systems
businesses left the conglomerate. Tyco was restructured, not liquidated, with TIFSA replacing TIGSA as
the holding company and Tyco changing from a guarantor on the Notes to an obligor.26 There is no
indication that successor obligor clauses were intended to require consent from the noteholders for such
internal restructuring, even when coupled with a spin-off of some of the obligor’s assets.
In Sharon Steel, the Circuit distinguished a "decision to sell off some properties . . . made in the
regular course of business" from a "plan of piecemeal liquidation. . . ."27 In the former situation, the sale
is "undertaken because the directors expect the sale to strengthen the corporation as a going concern."28
In the latter, the sale "may be undertaken solely because of the financial needs and opportunities or the tax
status of the major shareholders."29 Tyco divided its businesses into three entities after its directors
determined that separating into three independent companies is the best approach to enable these
businesses to achieve their full potential. [Covidien], [Tyco] Electronics and [TIFSA] will be able to
move faster and more aggressively—and ultimately create more value for our shareholders—by pursuing
their own growth strategies as independent companies.30
The Transaction clearly resulted from a decision to sell off some properties made in the regular
course of business. The only liquidation involved in the Transaction was that of TIGSA, a holding
company with minimal assets other than Tyco’s operating businesses, and TIGSA was replaced by
TIFSA, also a holding company with minimal assets other than Tyco’s operating businesses.
BNY argues that Sharon Steel applies because of the liquidation of TIGSA. But the operative
entity with respect to the Notes is Tyco, not TIGSA. TIGSA was simply a holding company, and it has
been replaced by another holding company. While UV’s noteholders found themselves expecting
repayment from an entirely new entity, here the noteholders still look to Tyco for repayment.
                                                            
25
[62] Sharon Steel, 691 F.2d at 1051.
26
[63] Defendants correctly observe that "[t]he real party backing the Notes was always Tyco," and that TIGSA was at all
relevant times merely a holding company. Defendants’ Reply Memorandum of Law in Further Support of Their Cross-Motion for
Summary Judgment at 2. In support of this assertion, Tyco indicates that the offering documents for the Notes included
"substantial information" about Tyco but "only the barest information concerning TIGSA," and that the Indentures required
TIGSA to provide the Indenture Trustee with Tyco’s annual reports and SEC filings. Id.
27
[64] Sharon Steel, 691 F.2d at 1050.
28
[65] Id.
29
[66] Id.
30
[67] 1/13/06 Press Release.

23
 BNY does not argue that Sharon Steel would apply if TIGSA had spun off Tyco Electronics and
Covidien but retained the remaining businesses.31 Similarly, BNY does not dispute that TIGSA could
have transferred the Notes to Tyco without violating the successor obligor clauses at the time that TIGSA
distributed its assets to Tyco, had Tyco not then spun off Tyco Electronics and Covidien. Thus, the crux
of BNY’s position is that the combination of spin-off and transfer violated Sharon Steel. But the transfer
of TIGSA’s assets to Tyco was essentially a nullity because it merely substituted Tyco as obligor for
Tyco as guarantor. Notwithstanding the transfer from TIGSA to Tyco, the Transaction is a spin-off,
rather than a liquidation, and Sharon Steel does not apply.

3. Successor Obligor Clauses and Spin-Off Transactions

BNY’s complaint is essentially that the Notes have lost the protection of Tyco’s healthcare and
electronics businesses.32 BNY is correct. However, successor obligor clauses are not intended to protect
this interest. Successor obligor provisions have two purposes: "to leave the borrower free to merge,
liquidate or to sell its assets in order to enter a wholly new business free of public debt" and to assure the
lender "a degree of continuity of assets."33 Assuming that Tyco Electronics and Covidien did not
represent substantially all of TIGSA’s assets, the lenders have maintained the requisite degree of
continuity of assets. The successor obligor clauses require nothing more.
The Indentures could provide for protection for the noteholders in the event that the obligor
disposed of less than substantially all of its assets, but they do not.34 In the absence of such a provision,
the Court will not impose one.35

B. BNY’s Failure to Execute the Supplemental Indentures

BNY also argues that Tyco could not substitute itself or TIFSA for TIGSA as obligors on the
Notes without BNY’s consent. BNY refused to execute the Supplemental Indentures that would have
permitted such a substitution on the ground that it was unsure whether the Transaction violated the
successor obligor clauses. If the Transaction did violate the clauses, BNY was within its rights in
refusing to execute the Supplemental Indentures.
BNY further maintains that it had the authority to refuse to execute the Supplemental Indentures
whether or not the Transaction was permitted by the successor obligor clauses. BNY suggests that
                                                            
31
[68] Apparently TIGSA did not simply spin off these two businesses because it would have incurred substantial tax liability in
Luxembourg. See Def. 56.1 ¶¶ 62, 64 (noting that dividends of a Luxembourg company are subject to a fifteen percent
withholding tax, while liquidating distributions are not); 12/4/07 Declaration of Marc Seimetz, Attorney at Court ("Avocat à la
Cour") and Member of the Luxembourg Bar Association, Ex. M to Gordon Decl. (same).
32
[69] See Memorandum of Law in Support of Plaintiff’s Motion for Summary Judgment ("Pl. Mem.") at 4–5 ("Noteholders that
made loans (some of which, here, for thirty years) to a $60 billion conglomerate boasting of how its diversity could allocate risk
over this decades long period now find themselves the unwilling creditors of a new company concededly confined to limited
business valued, at best, at a third of the Company to which the Noteholders lent their money."). See also Memorandum of Law
in Further Support of Plaintiff’s Motion for Summary Judgment and in Opposition to Defendants’ Cross-Motion for Summary
Judgment ("Pl. Rep.") at 8 ("What troubled the Second Circuit in Sharon Steel was the notion that a company could, in effect,
cheat its public creditors by taking their money and then liquidating its assets. . . .").
33
[70] Sharon Steel, 691 F.2d at 1050.
34
[71] See F. John Stark, III, et al, "Marriot Risk": A New Model Covenant to Restrict Transfers of Wealth from Bondholders to
Stockholders, 1994 Colum. Bus. L. Rev. 503, 546 ("An expanded or separate covenant limiting dispositions of less than
substantially all of the borrower’s assets or specified assets outside of the ordinary course of business would address issues raised
by transactions such as a spin-off.") (citation omitted); Commentaries 423 (discussing covenants that limit the issuer’s ability to
sell less than substantially all of its assets).
35
[72] See Lui v. Park Ridge at Terryville Assn., 196 A.D.2d 579, 601 N.Y.S.2d 496, 498 (2d Dep’t 1993) ("A court should not,
under the guise of contract interpretation, ‘imply a term which the parties themselves failed to insert’ or otherwise rewrite the
contract.") (quoting Mitchell v. Mitchell, 82 A.D.2d 849, 440 N.Y.S.2d 54, 55 (2d Dep’t 1981)).

24
regardless of why it chose not to execute the Supplemental Indentures, its decision not to do so prevented
Tyco from consummating the Transaction.
The Indentures have different language, but they evince the same intent. Article Seven of the
1998 Indenture provides that
[TIGSA], Tyco, . . . and the Trustee may from time to time and at any time enter into an
indenture or indentures supplemental hereto for one or more of the following purposes
. . . (b) to evidence the succession of another corporation . . . and the assumption by the
successor Person of the covenants, agreements and obligations of the Issuer pursuant to
Article Eight. . . . The Trustee is hereby authorized to join with [TIGSA and] Tyco . . . in
the execution of any such supplemental indenture . . . but the Trustee shall not be
obligated to enter into any such supplemental indenture which affects the Trustee’s own
rights, duties or immunities under this Indenture or otherwise.
Article Eight provides that TIGSA can convey substantially all of its assets to an entity only if
"the successor entity . . . shall expressly assume the due and punctual payment of the principal of and
interest on all the [Notes] . . . by supplemental indenture satisfactory to the Trustee, executed and
delivered to the Trustee by such corporation. . . . ."
Because Article Seven states that the trustee is not obligated to execute a supplemental indenture
that affects its "rights, duties or immunities" under the Indenture, it implies that the trustee is otherwise
obligated to execute supplemental indentures that comply with the Indenture. The requirement in Article
Eight that the supplemental indenture be "satisfactory to the Trustee" in the event of a transfer of assets is
no different. BNY argues that the Indentures give the trustee discretionary authority to halt an otherwise
valid transfer of TIGSA’s assets pursuant to the successor obligor clauses. This is implausible. One of
the purposes of a successor obligor clause is to give the borrower freedom to transfer substantially all of
its assets without the consent of the lenders, provided that the borrower also transfers the obligation on the
notes. Requiring the consent of the noteholders’ representative would be directly contrary to that
purpose.36
The Indentures are best read to permit the Indenture Trustee to decline to execute supplemental
indentures only if it has a good-faith basis to conclude that the proposed transfers violate the successor
obligor clauses. The trustee’s role under the Indentures is simply to review the supplemental indentures
to ensure that they and the transfer in question comply with the Indentures. If they do so, and if the
supplemental indentures do not alter the "rights, duties or immunities" of the trustee, then the trustee must
execute them.37
If a trustee has a good-faith basis for declining to execute a supplemental indenture (because the
trustee reasonably believes that it violates a successor obligor clause), but the transfer is ultimately
determined not to violate the clause, the fact that the trustee did not approve is insufficient to prevent the

                                                            
36
[78] In Sharon Steel, the trustee declined to execute the supplemental indentures. See 691 F.2d at 1046–47. The Second Circuit
only addressed the successor obligor clause, and did not address whether the transaction would have been invalid even had it
complied with the clause because of the trustee’s failure to execute the supplemental indentures.
37
[79] Cf. Restatement (Third) of the Law of Trusts § 76(1) ("The trustee has a duty to administer the trust, diligently and in
good faith, in accordance with the terms of the trust and applicable law."); id. cmt. b ("[A] trustee may commit a breach of trust
by improperly failing to act, as well [as] by improperly exercising the powers of the trusteeship."). I note that "[u]nlike the
ordinary trustee, who has historic common-law duties imposed beyond those in the trust agreement, an indenture trustee is more
like a stakeholder whose duties and obligations are exclusively defined by the terms of the indenture agreement." Meckel v.
Continental Res. Co., 758 F.2d 811, 816 (2d Cir.1985) (citing Hazzard v. Chase Nat’l Bank, 159 Misc. 57, 287 N.Y.S. 541
(Sup.Ct.N.Y.Co.1936), aff’d, 257 A.D. 950, 14 N.Y.S.2d 147 (1st Dep’t 1939), aff’d, 282 N.Y. 652, 26 N.E.2d 801 (1940)).

25
transaction from proceeding.38 If the Supplemental Indentures did not otherwise breach the Indentures,
BNY cannot argue that they are invalid for want of BNY’s execution.39

V. CONCLUSION

For the reasons stated above, the parties’ motions are denied. The Clerk of the Court is directed
to close these motions (documents no. 34 and 49 on the docket sheet). A status conference is scheduled
for March 25, 2008, at 4:30.

§ 3.10 SUBORDINATED DEBT SECURITIES [former § 3.09]

Page 267, move heading "The ‘X’ Clause" to immediately above the paragraph beginning
"§ 3.02(b) of the subordination provisions . . . " and insert the following after the first paragraph on
the page.
The definition of Senior Indebtedness, which is extremely broad, nevertheless contains an
exception for obligations to make payments to equity holders arising out of their ownership of such
securities. The reason for that exception is that, when a dividend is declared, a debtor-creditor
relationship is established between the corporation and the holder of the security with respect to which the
dividend is payable. See Costa Brava Partnership III, L.P. v. Telos Corp., 2006 Md. Cir. Ct. LEXIS 21,
at 5 (Mar. 30, 2006). Accordingly, even a fully subordinated debt instrument ordinarily has priority over
a declared dividend indebtedness.
Page 271, renumber current § 3.10 as § 3.11 and insert the following immediately before new § 3.11.
Chief Judge Posner’s conclusion that "the term ‘payment of’ is used in the parenthetical X-Clause
as a synonym for ‘receipt of’ or ‘entitlement to’" provides a Rosetta stone for interpreting the provision
and a logical basis for concluding that a priority based pro rata distribution of the same class (e.g.,
common stock) of security to senior and junior creditors, respectively, can achieve the practical result
mandated by the X-Clause. This eliminates any need to provide the seniors with a class of security
ranking prior to the one distributed to the juniors. As Judge Posner also points out "one doesn’t ‘pay’
stock, neither does one ‘pay’ securities." But see American Bar Foundation’s Commentaries on Ad Hoc
Committee for Revision of the 1983 Model Simplified Indenture, Revised Model Simplified Indenture, 55
Bus. Law. 1115, 1221 (2000) ("If Senior Debt were to receive preferred stock and the subordinated debt
were to receive common stock, for example, where the preferred stock precluded distributions to common
stockholders until the preferred stock was redeemed, the X-Clause would permit that distribution."),
quoted with approval in In re Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005).

                                                            
38
[80] A trustee that refused to execute the supplemental indenture without a good-faith basis for doing so might face liability
for this refusal, and certainly would not be able to delay the transaction.
39
[81] BNY argues that "the issue is not whether the Trustee was obligated to sign, but whether defendants breached the
Indentures by going ahead with their transaction without obtaining the Trustee’s signature." Pl. Rep. at 16 n. 4. But "it has been
established for over a century that ‘a party may not insist upon performance of a condition precedent when its non-performance
has been caused by the party [if]self.’ " Lomaglio Assocs. v. LBK Marketing Corp., 892 F. Supp. 89, 93 (S.D.N.Y.1995) (quoting
Ellenberger Morgan Corp. v. Hard Rock Cafe, 116 A.D.2d 266, 500 N.Y.S.2d 696, 699 (1st Dep’t 1986)). BNY cannot assert
that Tyco should have obtained an executed supplemental indenture before performing the Transaction while demurring on
whether it had an obligation to execute the Supplemental Indentures.

26
Page 272, delete the material on pages 272-74 (to Certain Restructuring and Issues Reorganization)
and add the following.

703.06 Debt Securities Offerings Listing Process

(A) Listing Policy
The Exchange has set minimum numerical criteria for the listing of debt securities in Section 1.
The Exchange has also set certain numerical delisting criteria.
The Exchange will delist a debt security if the aggregate market value or principal amount that is
publicly-held is less than $1,000,000.
(B) Description of Issue
The description of the issue should indicate the following information:

 The interest rate or if the interest rate varies, e.g., "floating" rate securities, the basis for
the interest variation.
 The seniority of the security in relation to other issues.
 Whether the issue is convertible.
 Whether the issue is one series of a class of debt securities.

(C) Denomination
The standard unit of trading for debt securities listed on the Exchange is $1,000 original principal
amount.
Securities in denominations of $500 and in large denominations that are multiples of $1,000 are
permissible if they are exchangeable without charge for $1,000 denominations.
Units of trading of other than $1,000 may be designated by the Exchange for specific issues of
bonds denominated in U.S. dollars or foreign currencies.
(D) Indenture Provisions
Deposited Funds to be Impressed with a Trust—
Any indenture which permits the deposit of funds with Trustee, Depository or Paying Agent for
the purpose of paying the principal amount or redemption price of debt securities, or releasing a lien or
collateral, or satisfying the indenture, must contain provisions which clearly establish that such funds are
to be impressed with a trust for the holders of debt securities entitled to the benefits of such payment, lien,
collateral or indenture.
(E) Charge for Registration-Transfer-Exchange
There must not be any charge to holders of debt securities for registration, transfer, discharge
from registration, or exchange for other denominations, except for stamp taxes or governmental charges.
Where a single market is to be established in debt securities issued in both coupon and
registration form, the securities must be interchangeable without charge and facilities for transfer and
interchange must be provided to meet normal settlement procedures.
Where only coupon bonds are traded in the regular market, it is recommended that no charge be
made for exchanges between coupon and registered form.

27
(F) Debt Securities Listing Application Supporting Documents
The debt listing application format is that used for subsequent listings as presented in Para.
903.02.
The following documents or notifications must be provided in support of the listing application.
For new issues:

 Timetable (if requested)—including proposed date of effectiveness under the Securities

Act of 1933 and closing date. Such information may be referenced in a cover letter
which accompanies the application.
 For debt securities that have been issued within the past 30 days, notification of
availability of eligible securities for trading.

For all issues:

 Copies of opinions of counsel filed in connection with recent public offerings or, if no
opinions of counsel exist, a certificate of good standing from the company's jurisdiction
of incorporation.
 Specimen certificates—if requested—(except for globally certificated bonds).
 Prospectus—For issues that have been issued during the previous 12 months, but whose
prospectus has not been made publicly available over a disclosure service satisfactory to
the Exchange, 4 copies of the final prospectus; for issues that have been outstanding for
more than 12 months or in respect of which the prospectus has been made publicly
available over a disclosure service satisfactory to the Exchange, 1 copy of either the final
prospectus or an issue term sheet.
 Mortgage or Indenture—1 final copy, unless the document has been made publicly
available over a disclosure service satisfactory to the Exchange. For applications
involving more than one issue, Company may submit a copy of the master indenture and
the separate indenture provisions specific to each issue.
 Signed registration statement under Securities Exchange Act of 1934. In lieu of signed
copy, Company may submit registration statement as filed via EDGAR. Include a
statement to the effect that the registration statement, as submitted, is a true and complete
copy of that which has been filed with the Securities and Exchange Commission.

Page 274, renumber current § 3.11 as § 3.12.

28
Chapter 4

PREFFERED STOCK

§ 4.01 INTRODUCTION

Page 299 insert the following immediately above § 4.02

"When properly authorized and implemented, leaving aside tax considerations (which often play
a strong role in the debt-versus-equity debate), preferred stock -- especially convertible preferred stock [
covered in Chapter 5, infra] — may be an optimal instrument of corporate finance in certain corporate
finance contexts. Both equity-oriented and debt-like terms can be combined in the same instrument — an
instrument well grounded in both statutory law and the corporate charter. Issuer and investor interests can
be delicately balanced, and seemingly infinite possibilities for combinations of provisions exist." Joan
MacLeod Heminway, Federal Interventions in Private Enterprise in the United States: Their Genesis in
and Effects on Corporate Finance Instruments and Transactions, 40 SETON HALL L. REV. 1487, 1499
(2010).

§ 4.03 EXCERPTS FROM A CERTIFICATE OF INCORPORATION AUTHORIZING THE

ISSUANCE OF PREFFERED STOCK

Page 301, insert the following after the last sentence on the page.
It was this type of "blank check" authority that enabled each of the nation’s largest banks in
October 2008 to create and issue, on very short notice, a series of preferred stock to the United States
Department of the Treasury under the Troubled Assets Relief Program (which came to be known as
TARP) pursuant to the Emergency Economic Stabilization Act of 2008. See generally ANDREW ROSS
SORKIN, TOO BIG TO FAIL 519-28 (2009). See, e.g., J.P. Morgan Chase & Co., Rep. on Form 8K, filed
Oct. 31, 2008 (reporting the private placement issuance, in exchange for $25,000,000,000, of "2,500,000
shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series F, par value $1 and
liquidation preference $10,000 per share" and common stock purchase warrants). See Generally, Joan
MacLeod Heminway, Federal Interventions in Private Enterprise in the United States: Their Genesis in
and Effects on Corporate Finance Instruments and Transactions, 40 SETON HALL L. REV. 1487 (2010).

§ 4.04 CORPORATE RESOLUTIONS CREATING A SERIES OF PREFERRED STOCK

Page 325, insert the following after the last paragraph on the page.
STAAR SURGICAL COMPANY v. WAGGONER
Delaware Supreme Court
588 A.2d 1130 (1991)

MOORE, JUSTICE.

In this latest dispute between the parties we determine the validity of two million shares of
STAAR Surgical Company ("STAAR") common stock issued to STAAR's former President and CEO,
Thomas R. Waggoner and his wife, Patricia Waggoner ("Waggoner" or "Waggoners"). This is a
continuation of the controversy between Waggoner and STAAR. We have already ruled that a provision

29
of the preferred stock STAAR issued to Waggoner, purportedly giving him super-majority voting control
of the company, was invalid. See Waggoner v. Laster, Del. Supr. [page 314 supra] ("Waggoner I"). In
Waggoner I, we did not otherwise decide the validity of the Waggoners' preferred and common shares.
In this action, the Court of Chancery assumed that the Waggoners' preferred shares were
technically invalid because STAAR failed to issue them in conformity with 8 Del. C. § 151. See
Waggoner v. STAAR Surgical Co., Del.Ch., C.A. No. 11185, Jacobs, V.C., slip op. at 14 n. 7, 1990 WL
28979 (March 15, 1990) ("Waggoner II"). The trial court nonetheless determined that the Waggoners
were equitably entitled to ownership and voting control of their common shares. Id. at 15-16.
We find that the Court of Chancery erroneously granted equitable relief. The Waggoners
received their common stock through the exercise of their conversion options attached to the preferred
shares. Since the preferred shares were invalid, the trial court had no basis to ignore established
principles of Delaware corporate law and should not have invoked equitable remedies to resuscitate
plainly void stock. Accordingly, we reverse.

***
II.

The Court of Chancery specifically assumed that the preferred shares "were invalidly issued"
because the board failed to formally adopt both the December 17 resolution and the certificate of
designation as required by 8 Del. C. § 151. See Waggoner II, slip op. at 14 n. 7. Nonetheless, the trial
court found that the Waggoners were entitled to an order "akin to specific performance" authorizing the
issuance of the common shares and declaring them eligible to vote. Id. at 9. The court reasoned that
Waggoner was equitably entitled to receive the two million shares of common stock as consideration for
his personal guarantee of STAAR's debts. Id. at 9-10.

A.

The question of the validity of the Waggoners' common shares presents a mixed issue of law and
fact. This Court, however, exercises plenary review of the trial court's determination of purely legal
conclusions including the proper legal standard to judge the validity of shares in a 8 Del. C. § 227 action.
See Triplex Shoe Co. v. Rice & Hutchins, Inc., Del. Supr., 152 A. 342, 346 (1930).

***
[W]e find that it was error to award any type of equitable relief after the trial court essentially
concluded that the preferred shares were invalid. Waggoner obtained his common shares only after
converting one share of his preferred stock into the common. If the preferred shares were void, it follows
a fortiori that the common shares, which purportedly derived from the preferred, also were invalid.

B.

We start with basic and clearly applicable provisions of the Delaware General Corporation Law.
A corporation can issue more than one class of stock, including preferred shares with a conversion
feature. See, e.g., 8 Del. C. §§ 151(a), (e) & (g). The powers, preferences, rights and other characteristics
of such shares must be fixed in either the certificate of incorporation or through a board resolution
adopted pursuant to an explicit grant of authority in the certificate of incorporation. See 8 Del. C.

30
§§ 102(a)(4), 151(a). There is no dispute that the STAAR certificate of incorporation authorized the
board to issue, by resolution, "blank check" preferred stock with such terms and conditions, including:
[T]he rights, if any, of holders of the shares of the particular series to convert the same
into shares of any other series or class or other securities of the corporation. . . .
The Delaware General Corporation Law mandates adoption of a board resolution, when such new
shares of so-called "blank check" preferred, are issued. Section 151(a) of the General Corporation Law
requires, in part, that all new stock voting powers, designations, preferences and other special rights must
either be in the certificate of incorporation or:
[I]n the resolution or resolutions providing for the issue of such stock adopted by the
board of directors pursuant to authority expressly vested in it by the provisions of its
certificate of incorporation. 8 Del. C. § 151(a) (emphasis added).
Section 151(e), which specifically authorizes a company to issue convertible securities, requires,
in part, that the corporation issue the new shares:
[A]t such price or prices or at such rate or rates of exchange and with such adjustments as
shall be stated in the certificate of incorporation or in the resolution or resolutions
providing for the issue of such stock adopted by the board of directors as hereinabove
provided. 8 Del. C. § 151(e) (emphasis added).
Finally, Section 151(g) requires a corporation to file a certificate of designation when the
certificate of incorporation permits the board to issue new securities through a resolution "adopted by the
board." The statute provides:
When any corporation desires to issue any shares of stock of any class or of any series of
any class of which the powers, designations, preferences and relative, participating,
optional or other rights, if any, or the qualifications, limitations or restrictions thereof, if
any, shall not have been set forth in the certificate of incorporation or in any amendment
thereto but shall be provided for in a resolution or resolutions adopted by the board of
directors pursuant to authority expressly vested in it by the certificate of incorporation or
any amendment thereto, a certificate of designations setting forth a copy of such
resolution or resolutions and the number of shares of stock of such class or series as to
which the resolution or resolutions apply shall be executed, acknowledged, filed,
recorded and shall become effective, in accordance with § 103 of this title. . . . 8 Del. C.
§ 151(g) (emphasis added).
Waggoner concedes that the STAAR board never formally adopted either the board resolution on
December 17, 1987, or the certificate of designation. Finally, the trial court found in Laster that the
certificate of designation did not "set forth" a copy of the December 17, 1987 resolution. Slip op. at 11-
12. Indeed, the court ruled that the certificate of designation contained materially different language from
that in the resolution. Id. at 11 n. 5.

C.

The parties' arguments seem to pass like two ships in the night. STAAR contends that the board's
failure to adopt the resolution or the certificate of designation rendered the preferred shares void, thus
invalidating the common stock. STAAR relies on Triplex Shoe Co. v. Rice Hutchins, Inc., Del. Supr., 152
A. 342 (1930), for the proposition that illegally issued stock is void and, regardless of the equities, cannot
be transferred or voted. The Waggoners, in contrast, focus on the common stock and not the preferred
shares. They assert that even if the board failed to technically conform to the clear corporate law, the
STAAR directors all agreed at the December 17, 1987 board meeting to issue Waggoner two million
shares of common stock as compensation for his guarantee of the BONY loans. Therefore, Waggoner

31
claims, it was clear to all of the parties that he would eventually receive the two million shares if STAAR
could not find alternate financing for the loan.
The Waggoners also contest STAAR's interpretation of Triplex, claiming that it is distinguishable
on its facts. The Waggoners argue that the certificate of incorporation in Triplex, and the then current
corporate law, did not authorize the board to issue new shares of a certain type of stock. Therefore, they
contend, the stock in Triplex was void and subsequent board action could not have validated those shares.
In contrast, the Waggoners argue that the STAAR certificate of incorporation at all times authorized the
board to issue new shares of common stock and thus Triplex is not dispositive.

D.

We must reject the Waggoners' attempt to separate the common shares from the preferred stock.
We also reject their very limited interpretation of Triplex. Stock issued without authority of law is void
and a nullity.
It is undisputed that Waggoner could not receive his common stock without exercising the
conversion option of at least one preferred share. The December 17, 1987 resolution and the certificate of
designation purportedly authorized the issuance of the preferred shares. Without validly issued preferred
stock, there was simply no other legal mechanism by which the common shares could be issued. Simply
stated, if the preferred shares were void, as the Court of Chancery assumed, then the common stock could
not be created out of whole cloth.
Based on the trial court's findings, it is clear that the preferred convertible shares originally issued
to the Waggoners were invalid and void under Delaware law. There was no compliance with the terms of
8 Del. C. § 151. The directors never formally adopted either the December 17, 1987 resolution or the
certificate of designation.
The Waggoners' attempt to trivialize the unassailable facts of this case as mere "technicalities" is
wholly unpersuasive. The issuance of corporate stock is an act of fundamental legal significance having a
direct bearing upon questions of corporate governance, control and the capital structure of the enterprise.
The law properly requires certainty in such matters.
There are many interacting principles of established law at play here. First, it is a basic concept
that the General Corporation Law is a part of the certificate of incorporation of every Delaware company.
See 8 Del. C. § 394. Second, a corporate charter is both a contract between the State and the corporation,
and the corporation and its shareholders. See Lawson v. Household Finance Corp., Del. Supr., 152 A.
723, 727 (1930). The charter is also a contract among the shareholders themselves. See Morris v.
American Public Utilities Co., Del.Ch., 122 A. 696, 700 (1923). When a corporation files a certificate of
designation under § 151(g), it amends the certificate of incorporation and fundamentally alters the
contract between all of the parties. See 8 Del. C. §§ 104, 151(g). A party affecting these interrelated,
fundamental interests, through an amendment to the corporate charter, must scrupulously observe the
40
law.
Finally, it is a basic concept of our corporation law that in the absence of a clear agreement to the
contrary, preferred stock rights are in derogation of the common law and must be strictly construed. See
generally Goldman v. Postal Telegraph, Inc., 52 F. Supp. 763, 767 (D. Del. 1943) . . . .

                                                            
40
[1] We put aside the wholly inapplicable circumstances of correcting mistakes under § 103(f), or the reformation of corporate
instruments to reflect the actual intention of the parties. . . . However, the failure of STAAR's Board to approve the December 17
resolution and subsequent certificate of designation was not a mere mistake but reflected a total failure to conform with the
corporation law.

32
 This principle of "strict construction" applies with equal force to the creation of preferred stock
and its attendant rights, powers, designations and preferences. Accordingly, a board's failure to adopt a
resolution and certificate of designation, amending the fundamental document which imbues a
corporation with its life and powers, and defines the contract with its shareholders, cannot be deemed a
mere "technical" error.
Thus, we must reject the trial court's authorization of the two million shares of common stock on
equitable grounds. Stock issued in violation of 8 Del. C. § 151 is void and not merely voidable. See
Triplex, 152 A. at 347 . . . . A court cannot imbue void stock with the attributes of valid shares.

E.

The Waggoners argue that the board's failure to ratify its resolution to issue the convertible
preferred shares merely rendered the common stock voidable, not void. The Waggoners claim that,
unlike Triplex, where this Court found that the corporation did not have the power or authority to issue no
par stock, STAAR's charter specifically authorized the issuance of their two million shares of common
stock. Therefore, the Waggoners conclude that the issuance of the two million shares of common stock
was merely a voidable act.
The Court of Chancery has correctly recognized that the available form of equitable relief
depends on the facts of each case. If the stock is indeed void, then "cancellation is the proper remedy."
However, if the stock is voidable then a court may grant "‘that form of relief [that] is to be most in accord
with all of the equities of the case.’" See Diamond State Brewery, Inc. v. De La Rigaudiere, Del. Ch., 17
A.2d 313, 318 (1941) (quoting Blair v. F.H. Smith Co., Del. Ch., 156 A. 207, 213 (1931)).
We have already rejected the Waggoners' narrow reading of Triplex in Waggoner I . . . . We cited
to Triplex in Waggoner I for the proposition that the equitable doctrine of estoppel is inapplicable to
agreements or instruments that violate either express law or public policy. . . . We also rejected the
Waggoners' argument that Triplex was limited only to instances where a corporation illegally issued
stock. . . . Accordingly, we ruled that the Waggoners could not invoke the equitable doctrine of estoppel
to validate the super-majority voting rights associated with their preferred shares after the court had
already declared those rights void under the corporation law. . . .
Parity of reason compels us to reach a similar result here. Under the present circumstances, the
Court of Chancery had no basis to grant equitable relief "akin" to specific performance after it concluded
that the Waggoners' preferred shares were invalid. Neither logic nor equity compel the validation of a
41
legally void act.
The judgment of the Court of Chancery is REVERSED.

§ 4.05 THE MEANING AND EFFECT OF CUMULATIVE DIVIDENDS

Page 332, change the title of § 4.05 to PREFERRED STOCK DIVIDEND PROVISIONS and insert
the following before the Guttmann case.
State corporation statutes generally provide that dividends can be paid only out of funds legally
available for that purpose. It is for that reason that paragraph (b) 1 of the above resolutions creating the
Series A Preferred Stock states that cash dividends are to be paid "out of the surplus or net profits of
Corporation legally available for dividends." Moreover, the resolutions provide that such dividends are to
be paid only "when and as declared by the board of directors." Another formulation of that discretionary
concept is that dividends are payable "if, as and when declared" by the board. There is thus no obligation
                                                            
41
[2] Again, we emphasize that our courts must act with caution and restraint when granting equitable relief in derogation of
established principles of corporate law. See Alabama By-Products Corp. v. Neal, Del. Supr., 588 A.2d 255, 258 (1991).

33
on the part of the board to declare a dividend on the Series A Preferred Stock, and no corresponding right
of a holder thereof to receive the same. Instead, the dividend decision is to be made by the directors
exercising their business judgment. If, on the other hand, the Series A Preferred Stock terms were to
require that the board pay dividends in the event that there were funds legally available therefor, a court
would nevertheless be hesitant to enforce those terms. Although dictum in a Delaware Chancery Court
opinion, Leibert v. Grinnell Corp, 194 A. 846, 851 (Del. Ch. 1963), suggests that such a provision might
be valid, it can be expected that a court would require the "clearest expression of intent" for the
declaration and dividends to be mandatory. Crocker v. Waltham Watch Company, 53 N.E.2d 230, 237
(Mass. 1944). Courts require this clarity because of strong policy considerations, best stated by Justice
Holmes when he wrote that "even if there are net earnings, the holder of stock, preferred as well as
common, is entitled to have a dividend declared only out of such part of them as can be applied to
dividends consistently with a wise administration of a going concern." Wabash Ry. v. Barclay, 280 U.S.
197, 203 (1930), quoted in Baron v. Allied Artists Pictures Corp.p.336, infra, 337 A.2d 653, 658-59
(1975) in which the Delaware Chancery Court stated "The determination as to when and in what amounts
a corporation may prudently distribute its assets by way of dividends rests in the honest discretion of the
directors in the performance of [their] fiduciary duty."
Paragraph (b) (1) of the Series A Preferred Stock terms set forth above also provides that
dividends thereon shall be cumulative; and articulates what is meant thereby, namely that the "right" of
the holders thereof to unpaid dividends adds up or, accumulates. This is supplemented by a provision that
prohibits dividend payments on, or repurchases of, junior stock while there are unpaid cumulative
dividends. Although such provisions can benefit the holders of the preferred shares, the existence of a
significant amount of unpaid cumulative dividends adversely affects the junior stock. (It was for this
reason that in March 2009 the US Treasury exchanged shares of cumulative preferred stock, which it had
received from American International Group Inc. ("AIG") in a 2008 TARP transaction, for shares of a
non-cumulative preferred which the Treasury intended subsequently to exchange for shares of common
stock of AIG). The Guttman case below explains the legal effect of non-cumulative preferred stock
dividend provisions, which are in stark contrast with the Series A cumulative provisions.
Page 335, remove Notes (1) and (2) and insert the following.
(1) The following language is appropriate for resolutions creating a non cumulative preferred
stock:
Dividends on the Series B Preferred Stock shall not be cumulative. Holders of Series B
Preferred Stock shall not be entitled to receive any dividends not declared by the Board
of Directors or any duly authorized committee of the Board of Directors, and no interest,
or sum of money in lieu of interest, shall be payable in respect of any dividend not so
declared. If the Board of Directors does not declare a dividend on the Series B Preferred
Stock to be payable in respect of any Dividend Period before the related Dividend
Payment Date, such dividend will not accrue and the Company will have no obligation to
pay a dividend for that Dividend Period on the Dividend Payment Date or at any future
time, whether or not dividends on the Series B Preferred Stock are declared for any future
Dividend Period. Holders of the Series B Preferred Stock shall not be entitled to any
dividends, whether payable in cash, securities or other property, other than dividends (if
any) declared and payable on the Series B Preferred Stock as specified in this Section.
(2) Because the existence of unpaid cumulative preferred stock dividends can be a significant
impediment to a corporation’s ability to obtain common stock equity at the very time additional capital is
needed, the Board of Governors of the Federal Reserve System considers non cumulative preferred stock
an appropriate level of regulatory capital for bank holding companies. The Board has stated that "by
allowing the noncumulative waiver of dividends, noncumulative perpetual preferred securities avoid the

34
accumulation of deferred dividends, which could possibly impede an issuer’s ability to raise additional
equity in times of stress" (letter dated Jan. 23, 2006 to Wachovia Corporation).
Page 344, insert the following immediately above the separation line.

§ 4.07 THE LIQUIDATION PREFERENCE

LC CAPITAL MASTER FUND v. JAMES

Delaware Chancery Court
990 A.2d 435 (2010)

STRINE, VICE CHANCELLOR.

I. INTRODUCTION

Plaintiff LC Capital Master Fund, Ltd. ("LC Capital"), a preferred stockholder of QuadraMed
Corporation ("QuadraMed"), seeks to enjoin the acquisition by defendant Francisco Partners II, L.P.
("Francisco Partners") of QuadraMed (the "Merger") because the consideration to be received by the
preferred stockholders of QuadraMed does not exceed the "as if converted" value the preferred were
contractually entitled to demand in the event of a merger. That "as if converted" value was based on a
formula in the certificate of designation (the "Certificate") governing the preferred stock, and gave the
preferred the bottom line right to convert into common at a specified ratio (the "Conversion Formula")
and then receive the same consideration as the common in the Merger. The plaintiff purports to have the
support of 95% of the preferred stockholders in seeking injunctive relief and I therefore refer to the
plaintiff as the preferred stockholders.
Based on certain contractual rights that the preferred had in the event that a merger did not take
place, the preferred stockholders argue that the QuadraMed board of directors (the "Board") had a
fiduciary duty to allocate more of the merger consideration to the preferred. Notably, the preferred
stockholders do not argue that the Board breached any fiduciary duty owed to all stockholders; in
particular, they do not claim that the board did not fulfill its fiduciary duty to obtain the highest value
42
reasonably attainable, a duty commonly associated with Revlon. Rather, the preferred stockholders
contend that the preferred stock has 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 preferred stockholders seek to enjoin the Merger because of
this supposed breach of duty.
In this decision, I find that the preferred stockholders have not proven a reasonable probability of
success on the merits of their fiduciary duty claim. Under Delaware law, a board of directors 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. But, when a certificate of designations 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, I conclude that a 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. Consistent
43
with decisions like . . . In re Trados Incorporated Shareholder Litigation, once the QuadraMed Board
honored the special contractual rights of the preferred, it was entitled to favor the interests of the common
stockholders. By exercising its discretion to treat the preferred entirely consistently with the Conversion
                                                            
42
[2] Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del.1986).
43
[4] 2009 Del.Ch. LEXIS 128 (July 24, 2009).

35
Formula the preferred bargained for in the Certificate, the QuadraMed Board acted equitably toward the
preferred.
For that reason alone, I would deny the preliminary injunction. But, given that plaintiff LC
Capital purports to represent 95% of the preferred stockholders, has an appraisal right, and an appraisal
action is therefore easily maintainable, I would be reluctant to enjoin the transaction and thereby deprive
the QuadraMed common stockholders, who under any reasonable measure are entitled to the bulk of the
Merger consideration, from determining for themselves whether to accept the Merger. The balance of the
equities in this unique context would seem to weigh in favor of requiring the preferred stockholders, who
I have no doubt are unwilling to post a full injunction bond, to seek relief through appraisal or through an
equitable action for damages.
In the pages that follow, I explain these reasons for denying the preliminary injunction motion in
more detail.

II. FACTUAL BACKGROUND

***
Under the terms of the challenged merger agreement (the "Merger Agreement"), Francisco
Partners will acquire QuadraMed at a price of $8.50 per share of common stock. The preferred
stockholders will receive $13.7097 in cash in exchange for each share of preferred stock. The price for
the preferred stock set forth in the Merger Agreement was pegged to the conversion right the Certificate
granted to the preferred stockholders in the event of a merger. That conversion right allowed the
preferred stockholders to convert their preferred shares into common shares and then to receive the same
consideration as the common stock received in the merger. The conversion was determined by using the
Conversion Formula of 1.6129 shares of preferred stock to one share of common stock. That is, in order
to value the preferred stock, the merging parties agreed to simply cash out the preferred stock at the price
the preferred stockholders would receive if they exercise their right to convert to common stock.
The preferred stockholders seek to enjoin the Merger on the grounds that the defendants breached
their fiduciary duties of care and loyalty. But, the preferred stockholders do not allege that the defendants
breached their Revlon duties as to all shareholders by approving a transaction that does not fully value
QuadraMed as an entity. Instead, the preferred stockholders argue that the Merger consideration was
unfairly allocated between the common and preferred stock. That is, the preferred stockholders do not
challenge the overall adequacy of the Merger consideration. Rather, the preferred stockholders claim that
they simply did not receive a big enough slice of the pie because the Board allocated the Merger
consideration to the preferred stock on an "as-if converted" basis, which the preferred stockholders
believe understates the value of their shares.

1. The Rights of the Preferred Stockholders

Requesting a preliminary injunction is the only means the preferred stockholders have to block
the transaction because, per the Certificate, the preferred stock does not have the right to vote on a
merger. The circumstances in which the preferred stock has voting rights are limited to: (1) if the
Certificate were to be amended in a way "that materially adversely affects the voting powers, rights or
preferences" of the preferred stockholders; (2) if any class of shares with ranking before or in parity with
the preferred stock were to be created; and (3) if the company were to incur "any long term, senior
indebtedness of the Corporation in an aggregate principal amount exceeding $8,000,000. Relatedly, if
four quarterly dividends are in arrears, the preferred stockholders can elect two substitute directors.

36
 The Certificate includes a number of other rights for the preferred stock that are arguably relevant
to the current dispute. As mentioned, the preferred stock has a dividend right. This provides for the
payment of a dividend of $1.375 per year, but it is to be paid only "when, as and if authorized and
declared" by the Board.
The Certificate also provides a liquidation preference of $25 (plus accrued dividends) for each
share of preferred stock. But, the Certificate does not afford the preferred stock a right to force a
liquidation. Most relevantly, the Certificate expressly provides that a merger does not trigger the
preferred stock's liquidation preference.
The preferred stockholders also point out that the Certificate includes a mandatory conversion
right that allows QuadraMed to force the preferred stockholders to convert into common shares. The
preferred stockholders stress that this provision of the Certificate may only be used by QuadraMed to
force conversion when the company's common stock hits a price of $25 per share, far above the $8.50 per
common share Merger value. But, like the liquidation preference, the mandatory conversion provision
does not have bite in a merger. That is, the Certificate does not provide that, in the event of a merger, the
preferred stockholders must be converted at a formula that affords the preferred stockholders an implied
common stock value of $25 per share.
To the contrary, in a merger, the preferred stockholders will receive either: 1) the consideration
determined by the Board in a merger agreement; or 2) if the preferred choose, the right to convert their
shares using the Conversion Formula into common shares and re[ceive] the same consideration as the
common stockholders. The bottom line right of the preferred stockholders in a merger, therefore, is not
tied to its healthy liquidation preference or the company's mandatory conversion strike price-it is simply
the right to convert the shares into common stock at the Conversion Formula and then be treated pari
passu with the common.

2. The Board's Decision to Accept Francisco Partners' Bid for QuadraMed

Over the years, QuadraMed received expressions of interest from a number of potential acquirors.
From 2008 to date, QuadraMed has been seriously considering a sale. From early on in this strategic
process, the preferred stockholders demanded a high price, even $25, for their stock, apparently under the
mistaken view that they had a right to their liquidation preference in the event of a merger. Initially, some
bidders indicated an interest in either meeting the preferred stockholders' asking price-which would mean
paying much more for the preferred stock than the common-or at least allowing the preferred stock to
remain outstanding after the consummation of a merger. For example, Francisco Partner's first bid for
QuadraMed, made in October 2008, offered to acquire the company at $11 per share of common stock
and to allow the preferred stock to remain outstanding. And, a later bid, received August 31, 2009 from a
bidder referred to as "Bidder D" in the proxy materials, proposed acquiring QuadraMed for $10.00 per
share of common stock, and $25.00 par value for each share of preferred stock. By "par value," Bidder D
seems not to have meant to offer the preferred stockholders $25 per share in current value but a security
with the future potential of reaching that value. But this was perhaps not as clearly expressed as it could
have been.
As the negotiations continued, moreover, both Francisco Partners and Bidder D revised their
offers downward. After several months of negotiating, Francisco Partners submitted a revised offer of
$9.50 per share of common stock, with the requirement that the preferred stock be cashed-out. In March
2009, the Board rejected this offer, and negotiations with Francisco Partners were suspended. And, after
its initial approach, Bidder D made very plain its earlier position and explained that it "never intended to
offer face value" for the preferred stock and was instead interested in paying $10 per share of common
stock and reaching agreement with the holders of preferred stock on the terms of a debt instrument with a
$25 face value, but a present value equal to $10 per share on an as-if converted basis. Therefore, the

37
treatment of the preferred stock and common stock under Bidder D's initial proposal and under the
Merger is not as different as at first appears.
In light of the various bids being made for the company, QuadraMed's outside counsel, Crowell
& Moring, LLP ("Crowell & Moring"), sent the QuadraMed Board a memorandum on September 1, 2009
addressing the legal issues relating to apportioning merger consideration between the common stock and
preferred stock (the "September 2009 Memorandum"). In substance, the September 2009 Memorandum
was Crowell & Moring's distillation of and update to a memorandum that Richards, Layton & Finger,
P.A. ("Richards Layton"), QuadraMed's Delaware counsel, had prepared in June 2006. In 2006, while
QuadraMed was in negotiations over a possible acquisition by a private equity firm, referred to as "Bidder
B" in QuadraMed's proxy materials, Richards Layton authored a memorandum, dated June 22, 2006, that
provided a general overview of the legal authority relevant to allocating merger consideration between
common stock and preferred stock in a merger. The memorandum was addressed to counsel, Crowell &
Moring, not the QuadraMed Board Crowell & Moring's September 2009 Memorandum summarized
Richards Layton's 2006 advice and discussed this court's April 2009 decision In re Appraisal of
44
Metromedia Int'l Group, Inc., which addressed the allocation of merger consideration between common
and preferred stock in the context of an appraisal action.
The QuadraMed Board formed a special committee of independent directors (the "Special
Committee") to evaluate the various bids. QuadraMed's Board is comprised of six individuals: Duncan
James, William Jurika, Lawrence English, James Peebles, Robert Miller, and Robert Pevenstein
(collectively, the "Special Committee members"). The Special Committee was comprised of Jurika,
English, Peebles, Miller, and Pevenstein-that is, all of the Special Committee members except James, who
was also QuadraMed's Chief Executive Officer. With the exception of Jurika, who owns over 650,000
shares of QuadraMed common stock, the Special Committee members hold a nominal amount of
QuadraMed shares and in the money stock options. The preferred stockholders have not presented any
evidence that these members' holdings of QuadraMed shares and options constitute a material portion of
their personal wealth.
In early autumn 2009, after Bidder D's approach in August, QuadraMed's investment bankers
shopped the deal. At this time, Francisco Partners made a second bid, offering $8.50 per share of
common stock and requiring the cash-out of the preferred stock on an as-if converted basis, which yielded
a value of $13.7097 per preferred share. Francisco Partners insisted on cashing out the preferred stock
because it did not want to bear the risk of a voluntary conversion of the preferred stock into common
stock after the Merger. The evidence also indicates that Francisco Partners wanted to increase
QuadraMed's borrowing after the Merger, and therefore wanted to eliminate the preferred stock because
the Certificate gives the preferred stock a right to vote on any incurrence of debt in excess of $8,000,000.
Because the preferred stockholders were demanding more consideration than the common stock,
one of the questions before the Special Committee was what fiduciary duties it owed to the common stock
and preferred stock when allocating the proposed Merger's consideration. The evidence indicates that the
Special Committee carefully considered the duties it owed to both the preferred and common
stockholders, and was concerned about any perception that it was favoring one class over the other. In a
series of meetings, the Special Committee reviewed the bids, and at those meetings, QuadraMed's counsel
informed the Special Committee that the Board could adopt a merger agreement that cashed out the
preferred stockholders, and that, if the Board respected the bottom line contractual rights of the preferred
stockholders in a merger, it did not have to allocate additional value to the preferred stockholders.
Indeed, Crowell & Moring said that the Board had to be careful about giving the preferred stockholders
more unless there were special reasons to do so. Crowell & Moring also reported that Francisco Partner's
counsel, Shearman & Sterling, LLP, had also reached the conclusion that a cash out of the preferred stock
at closing was permissible under Delaware law, and that Francisco Partners would not insist on an
                                                            
44
[24] 971 A.2d 893 (Del. Ch. 2009).

38
"appraisal out" provision in the Merger Agreement so as to satisfy any concerns the Special Committee
might have regarding the treatment of the preferred stock.
Meanwhile, Bidder D had been attempting to persuade the preferred stockholders to take a new
debt security with a current value equal to what the common would receive but with a future upside. But,
Bidder D found it "extremely difficult" to convince the holders of preferred stock to exchange their stock
for a new debt security, and its bid foundered. Once Bidder D withdrew its offer on November 22, 2009,
Francisco Partners became the only remaining bidder for QuadraMed. Although the Special Committee
resisted cashing out the preferred stock for some time, the Committee eventually relented once it became
clear that Francisco Partners would not do a deal that allowed QuadraMed's preferred stock to survive the
Merger.
On December 7, 2009, a Special Committee meeting was held to consider approval of the Merger
with Francisco Partners. At that meeting, Piper Jaffray, QuadraMed's financial advisor, presented an
opinion that $8.50 per common share was fair to the common stockholders from a financial point of view.
There was no separate opinion addressing the fairness of the Merger to the preferred stockholders. After
deliberation, the Special Committee unanimously approved the Merger with Francisco Partners. From the
meeting minutes, it appears that the Special Committee was wary of doing a deal that allocated more
consideration to the preferred stock than to the common stock for two reasons: (1) shifting additional
merger consideration to the preferred stock would cause the holders of common stock, who were the only
stockholders who had a right to vote on the Merger, to vote against the transaction; and (2) there was no
special reason to deviate from the Conversion Formula provided in the Certificate for allocating
consideration to the preferred stock.
In the latter regard, it is fair to say that the Special Committee's equitable heartstrings were not
moved to bestow upon the preferred stockholders anything better than receipt of the same treatment as the
common stockholders on an as-if converted basis. Had a particular bidder insisted, after negotiations with
the preferred, on doing a deal with differential consideration, the Special Committee would seem to have
had an open and receptive mind if the proposal offered a more favorable valuation to all stockholders.
But even then, the Special Committee, I infer, would have harbored a concern if the allocation system
strayed too far (in either direction) from the Conversion Formula in the Certificate.

III. LEGAL ANALYSIS

***
B. The Preferred Stockholders Have Not Met Their Burden to Justify Enjoining The Merger

1. The Preferred Stockholders Have Not Shown That the QuadraMed Board Likely
Breached Its Fiduciary Duties by Allocating to the Preferred Stock the Bottom Line
Consideration Contractually Owed to Them

The contending arguments of the parties are starkly divergent. The preferred stockholders,
45
pointing to the decisions of this court in Jedwab v. MGM Grand Hotels, Inc. and In re FLS Holdings,
46
Inc. Shareholders Litigation, argue that the QuadraMed board had the duty to make a "fair" allocation
of the Merger consideration between the common and preferred stockholders. To do this fairly, the
preferred stockholders argue that the board had to 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. This

                                                            
45
[38] 509 A.2d 584 (Del. Ch. 1986).
46
[39] 1993 Del. Ch. LEXIS 57 (Apr. 2, 1993).

39
need, the preferred stockholders say, is heightened because of an unsurprising fact: the directors of
QuadraMed own common stock and do not own preferred stock. Indeed, the preferred stockholders say,
every member of the Special Committee owned common stock and one member, Jurika, owned over five
million dollars worth. How, they say, could such directors fairly balance the interests of the preferred
against their own interest in having the common get as much as possible? At the very least, the preferred
imply, the QuadraMed Board should have charged certain directors with representing the preferred, and
enabled them to retain qualified legal and financial advisors to argue for the preferred and to value the
preferred based on its unique contractual rights and their economic value.
By contrast, the defendants say that the QuadraMed Board discharged any fiduciary obligation of
fairness it had by: 1) fulfilling its Revlon obligations to all equity holders, including the preferred, to seek
the highest reasonably available price for the corporation; and 2) 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. Given that the preferred stockholders had no contractual right to impede,
vote upon, or receive consideration higher than the common stockholders in the Merger, the defendants
argue that 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. That is especially so when the preferred bases
its claim for a higher value entirely on contractual provisions that do not guarantee them any share of the
company's cash flows if the company does not liquidate, and that do not even condition a merger on the
payment of any accrued, but undeclared dividends. Indeed, because the QuadraMed Board honored all
contractual rights belonging to the preferred, the defendants say it was the duty of the Board not to go
further and bestow largesse on the preferred stock at the expense of the common stock.
47
The defendants cite In re Trados Inc. Shareholder Litigation . . . for the proposition that it was
the Board's duty, once it had ensured treatment of the preferred in accord with their contractual rights, to
act in the best interests of the common. To have added a dollop of crème fraiche on top of the merger
consideration to be offered to the preferred would itself, in these circumstances, have amounted to a
breach of fiduciary duty. Finally, the defendants argue that even if there is a case where directors might
be found to be "interested" in a transaction simply because they own common stock and no preferred
stock, this is not that case. For example, a sizable premium to the preferred of 10% to 20% would cause a
reduction in the common stock price of approximately $1.30 to $2.60 per share. Because four of the five
Special Committee members own very modest common stock stakes, this would reduce those Special
Committee members' Merger take by, at most, several thousand dollars, an amount the preferred
stockholders have done nothing to show is material to these directors.
In my view, the defendants have the better of the arguments. After reviewing the evidence, I
perceive no basis to find that the directors sought to advantage the common stockholders at the unfair
expense of the preferred stockholders. What the preferred stockholders complain about is that the
directors did not perceive themselves as having a duty to allocate more Merger consideration to the
preferred than the preferred could demand as an entitlement under the Certificate. Had the Board been
advised properly and had the right mindset, the preferred stockholders say, they would have given weight
to various contractual rights of the preferred, such as their liquidation preference rights, and determined
that on the basis of those rights, they should get a higher share than the Certificate guaranteed they could
demand. Ideally, in fact, the Board should have employed a bargaining agent on their behalf to
vigorously contend for the proposition that the largest part of the roast should be put on the preferred
stockholders' plate.
In arguing for this, I admit that the preferred stockholders can point to cases in which broad
language supporting something like a duty of this kind to preferred stockholders was articulated. In FLS
Holdings, for example, Chancellor Allen found that:

                                                            
47
[40] 1993 Del. Ch. LEXIS 57 (Apr. 2, 1993).

40
 FLS was represented in its negotiations . . . exclusively by directors who . . . owned large
amounts of common stock. . . . No independent adviser or independent directors'
committee was appointed to represent the interests of the preferred stock who were in a
conflict of interest situation with the common. . . . [N]o mechanism employing a truly
independent agency on behalf of the preferred was employed before the transaction was
formulated. Only the relatively weak procedural protection of an investment banker's ex
48
post opinion was available to support the position that the final allocation was fair.
Likewise, in Jedwab, Chancellor Allen said that directors owe preferred stockholders a fiduciary
duty to "exercise appropriate care in negotiating [a] proposed merger" in order to ensure that preferred
49
shareholders receive their "‘fair’ allocation of the proceeds of [a] merger."
A close look at those cases, however, does not buttress the preferred stockholders' arguments.
Notable in both cases was the absence of any contractual provision such as the one that exists in this case.
That is, from what one can tell from FLS Holdings and Jedwab, there was no objective contractual basis-
such as the conversion mechanism here-in either of those cases for the board to allocate the merger
consideration between the preferred and the common. In the absence of such a basis, the only protection
for the preferred is if the directors, as the backstop fiduciaries managing the corporation that sold them
their shares, figure out a fair way to fill the gap left by incomplete contracting. Otherwise, the preferred
would be subject to entirely arbitrary treatment in the context of a merger.
The broad language in FLS Holdings and Jedwab must, I think, be read against that factual
backdrop. I say so for an important reason. Without this factual context, those opinions are otherwise in
sharp tension with the great weight of our law's precedent in this area. In his recent decision in Trados,
Chancellor Chandler summarized the weight of authority very well:
Generally the rights and preferences of preferred stock are contractual in nature. This Court has
held that directors owe fiduciary duties to preferred stockholders as well as common stockholders where
the right claimed by the preferred "is not to a preference as against the common stock but rather a right
shared equally with the common." Where this is not the case, however, "generally it will be the duty of
the board, where discretionary judgment is to be exercised, to prefer the interests of the common stock-as
the good faith judgment of the board sees them to be-to the interests created by the special rights,
preferences, etc., of preferred stock, where there is a conflict." Thus, in circumstances where the interests
of the common stockholders diverge from those of the preferred stockholders, it is possible that a director
could breach her duty by improperly favoring the interests of the preferred stockholders over those of the
50
common stockholders.

***
This, of course, is not to say that the QuadraMed Board did not owe the preferred stockholders
fiduciary duties in connection with the Merger. The Board certainly did. But those were the duties it also
owed to the common. In the context of a sale of a company, those are the duties articulated in Revlon and
its progeny; namely, to take reasonable efforts to secure the highest price reasonably available for the
corporation. Notably, the preferred stockholders do not argue that the Board fell short of its obligations in
this regard. They simply want more of the proceeds than they are guaranteed by the Certificate. But I do
not believe that the Board acted wrongly in viewing itself as under no obligation to satisfy that desire.

                                                            
48
[42] 1993 Del. Ch. LEXIS 57 (Apr. 2, 1993).
49
[43] 509 A.2d at 594.
50
[44] Trados, 2009 Del. Ch. LEXIS 128 (quoting Jedwab, 509 A.2d at 594, and Equity-Linked Investors, L.P. v. Adams, 705
A.2d 1040, 1042 (Del. Ch. 1997)).

41
 ***
Another counterproductive consequence would result from accepting the preferred stockholders'
arguments. For its entire history, our corporate law has tried to insulate the good faith decisions of
disinterested corporate directors from judicial second-guessing for well-known policy reasons. The
business judgment rule embodies that policy judgment. When mergers and acquisitions activity became a
more salient and constant feature of corporate life, our law did not cast aside the values of the business
judgment rule. Rather, to deal with the different interests manager-directors may have in the context of
responding to a hostile acquisition offer or determining which friendly merger partner to seek out, our law
has consistently provided an incentive for the formation of boards comprised of a majority of independent
directors who could act independently of management and pursue the best interests of the corporation and
its stockholders This impetus also recognized that managers' incentives and the temptations they face,
when combined with fallible human nature, make it advisable to have independent directors to monitor
the corporation's approach to law compliance, risk, and executive compensation. Consistent with this
viewpoint, it has been thought that having directors who actually owned a meaningful, long-term common
stock stake was a useful thing, because that would align the interests of the independent directors with the
common stockholders and give them a personal incentive to fulfill their duties effectively.
To hold that independent directors are disabled from the protections of the business judgment
rule when addressing a merger because they own common stock, and not the corporation's preferred
stock, is not, therefore, something that should be done lightly. Corporate law must work in practice to
serve the best interests of society and investors in creating wealth. Director compensation is already a
difficult enough issue to address without adding on the need to ponder whether the independent directors
need to buy or receive as compensation a share of any preferred stock issuance made by the corporation,
for fear that, if they do not have an equally-weighted portfolio of some kind, they will not be able to
impartially balance questions that potentially affect the common and preferred stockholders in different
ways. Adhering to the rule of . . . Trados, and other similar cases, which hold that it is the duty of
directors to pursue the best interests of the corporation and its common stockholders, if that can be done
faithfully with the contractual promises owed to the preferred, avoids this policy dilemma. Admittedly, it
does not solve for certain situations that directors might create themselves by authorizing multiple and
sometimes exotic classes of common stock, situations that have led this court to, as a matter of necessity,
consider the directors' portfolio balance, but it at least does not exacerbate the already complex challenge
of compensating independent directors in a sensible way. And, given the unique nature of preferred stock
and the often-fraught circumstances that lead to its issuance, our law should be chary to somehow suggest
that otherwise independent directors should be receiving shares of this kind at the risk of facing being
called "non-independent" or, worse, being deemed by loose reasoning to be "interested" and therefore
somehow personally liable under the entire fairness standard for a merger allocation decision.
Here, the plaintiffs have also failed to impugn the Board's entitlement to the business judgment
rule for a more mundane reason. Even if the court must, as I think it does not in this situation, consider
whether the otherwise independent directors comprising the Special Committee could, because of their
ownership of common stock and no preferred stock, impartially balance the interests at stake, the
plaintiffs have not advanced facts that support a reasonable inference that any of the Special Committee
members are materially self-interested. I say any forthrightly. As to director Jurika, who owns a large
common stock stake, a shift in the merger consideration of 10% to the preferred would cost him
approximately $500,000. That amount of money, of course, would be material to most Americans. But
most Americans are not corporate directors, and do not have a $5.6 million stake of common stock in any
company. And, the plaintiffs have not advanced any reason to believe that the hypothetical 10% shift
would be important to Jurika. The man could be as rich as Croesus or Jimmy Buffett. The plaintiffs have
a burden here and they have not even tried to meet it. As to the other directors on the Special Committee,
they have failed even more obviously. Directors English, Miller, Peebles, and Pevenstein own only

42
$61,284 worth of common stock and in the money options collectively. Even a fairly drastic shift of 20%
of the merger consideration from the preferred to the common would only reduce those directors'
collective take by approximately $28,000, and the plaintiffs do not make any attempt to show that this
would be material to these directors' personal economic circumstances. Thus, even under the plaintiffs'
theory, the business judgment rule, and not the entire fairness standard, applies to the Special Committee's
decision.
Finally, the preferred stockholders have not established a likelihood of success on their claim that
the defendants breached their duty of care. 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.

***
IV. CONCLUSION

For the reasons discussed above, I refuse to enjoin the transaction. The preferred stockholders'
motion is therefore denied . . . .

§ 4.08 INTERPRETATION AND EFFECT OF CLASS VOTING PROVISIONS

[A] Special Directors

Page 352, insert the following immediately above [B] Judicial Construction of Preferred Stock and
Statutory Voting Provisions.

The voting provisions of the Series A Preferred Stock set forth above solve the problem presented
in the Baron case by designating the minority directors elected by the holders of the Common Stock as a
Committee of the Board with authority to declare and pay dividends on the Series A Shares.

________________
It is also possible to provide for the election of special directors in the event that a corporation
fails to pay dividends on non-cumulative preferred stock:

VOTING RIGHTS

(a) General. The holders of the Series B Preferred Stock shall not have any voting rights
except as set forth below or as otherwise from time to time required by law.
(b) Series B Preferred Stock Directors. Whenever, at any time or times, dividends payable
on the shares of the Series B Preferred Stock have not been paid for an aggregate of four quarterly
Dividend Periods or more, whether or not consecutive, the authorized number of directors of the
Company shall automatically be increased to accommodate the number of the Preferred Directors
specified below and the holders of the Series B Preferred Stock shall have the right, voting as a separate
class, to elect the greater of two directors and a number of directors (rounded upward) equal to 20% of the
total number of directors of the Company after giving effect to such election (hereinafter the "Preferred

43
Directors" and each a "Preferred Director") to fill such newly created directorships at the Company’s next
annual meeting of stockholders (or at a special meeting called for that purpose prior to such next annual
meeting) and at each subsequent annual meeting of stockholders until dividends payable on all
outstanding shares of the Series B Preferred Stock have been declared and paid in full for four
consecutive quarterly Dividend Periods, at which time such right shall terminate with respect to the Series
B Preferred Stock, except as herein or by law expressly provided, subject to revesting in the event of each
and every subsequent payment failure of the character above mentioned; provided that it shall be a
qualification for election for any Preferred Director that the election of such Preferred Director shall not
cause the Company to violate any corporate governance requirements of any securities exchange or other
trading facility on which securities of the Company may then be listed or traded that listed or traded
companies must have a majority of independent directors. Upon any termination of the right of the
holders of shares of the Series B Preferred Stock to vote for directors as provided above, the Preferred
Directors shall cease to be qualified as directors, the term of office of all Preferred Directors then in office
shall terminate immediately and the authorized number of directors shall be reduced by the number of the
Preferred Directors elected pursuant hereto. Any Preferred Director may be removed at any time, with or
without cause, and any vacancy created thereby may be filled, only by the affirmative vote of the holders
of a majority of the shares of the Series B Preferred Stock at the time outstanding voting separately as a
class. If the office of any Preferred Director becomes vacant for any reason other than removal from
office as aforesaid, the remaining Preferred Director may choose a successor who shall hold office for the
unexpired term in respect of which such vacancy occurred.
[1] Duties of Directors Elected By Holders of Preferred Stock

IN RE TRADOS INCORPORATED SHAREHOLDER LITIGATION

Delaware Court of Chancery
2009 Del. Ch. LEXIS 128 (July 24, 2009)

CHANDLER, CHANCELLOR.

This is a purported class action brought by a former stockholder of Trados Incorporated

("Trados," or the "Company") for breach of fiduciary duty arising out of a transaction whereby Trados
became a wholly owned subsidiary of SDL, plc ("SDL"). Of the $60 million [paid] by SDL, Trados’
preferred stockholders received approximately $52 million. The remainder was distributed to the
Company’s executive officers pursuant to a previously approved bonus plan. Trados’ common
stockholders received nothing for their common shares.
Plaintiff contends that this transaction was undertaken at the behest of certain preferred
stockholders that desired a transaction that would trigger their large liquidation preference and allow them
to exit their investment in Trados. Plaintiff alleges that the Trados board favored the interests of the
preferred stockholders, either at the expense of the common stockholders or without properly considering
the effect of the merger on the common stockholders. Specifically, plaintiff alleges that the four directors
designated by preferred stockholders had other relationships with preferred stockholders and were
incapable of exercising disinterested and independent business judgment. Plaintiff further alleges that the
two Trados directors who were also employees of the Company received material personal benefits as a
result of the merger and were therefore also incapable of exercising disinterested and independent
business judgment. . . .
As explained below, plaintiff has alleged facts sufficient, at this preliminary stage, to demonstrate
that at least a majority of the members of Trados’ seven member board were unable to exercise
independent and disinterested business judgment in deciding whether to approve the merger.
Accordingly, I decline to dismiss the breach of fiduciary duty claims arising out of the board’s approval
of the merger. . . .

44
 I. BACKGROUND

A. The Parties

Before the merger, Trados developed software and services used by businesses to make the
translation of text and material into other languages more efficient. Founded in 1984 as a German entity,
Trados moved to the United States in the mid-1990s with the hope of going public, and became a
Delaware corporation in March 2000. To better position itself for the possibility of going public, Trados
accepted investments from venture capital firms and other entities. As a result, preferred stockholders
had a total of four designees on Trados’ seven member board. Each of the seven members of Trados’
board at the time of the board’s approval of the merger is named as a defendant in this action.
David Scanlan was the board designee of, and a partner in, Wachovia Capital Partners, LLC
("Wachovia"). At the time of the merger, Wachovia owned 3,640,000 shares of Trados’ Series A
preferred stock (100% of that series) and 1,007,151 shares of Trados’ Series BB preferred stock
(approximately 24% of that series).
Lisa Stone was the board designee of Rowan Entities Limited and Rowan Nominees Limited RR
(together, the "Rowan Entities"), transferees of Trados’ preferred stock held by Hg Investment Managers
Limited (collectively, "Hg"). Stone was a director and employee of both Hg Investment Managers
Limited and the Rowan Entities. At the time of the merger, Hg owned 1,379,039 shares of Trados’
common stock (approximately 4.3%), 2,014,302 shares of Trados’ Series BB preferred stock
(approximately 48.3% of that series), 5,333,330 shares of Trados’ Series C preferred shares (all of that
series), and 862,976 shares of Trados’ Series D preferred stock (approximately 28.6% of that series).

***
Sameer Gandhi was a board designee of, and a partner in, several entities known as Sequoia.
Sequoia owned 5,255,913 shares of Trados’ Series E preferred stock (approximately 32% of that series).
Joseph Prang was also a board designee of Sequoia. Prang owned Mentor Capital Group LLC
("Mentor Capital"), which owned 263,810 shares of Trados’ Series E preferred stock (approximately 1%
of that series).
Wachovia, Hg, Sequoia, and Mentor combined owned approximately 51% of Trados’ outstanding
preferred stock. Plaintiff alleges that these preferred stockholders desired to exit their investment in
Trados.51
Two of the three remaining director defendants were employees of Trados. Jochen Hummel was
acting President of Trados from April 2004 until September or October 2004, and was also the
Company’s chief technology officer. Joseph Campbell was Trados’ CEO from August 23, 2004 until the
merger. The remaining Trados director was Klaus-Dieter Laidig.

                                                            
51
[2] Compl. ¶¶ 30, 35-37, 44, 51, 79, 84, 101-102. Plaintiff alleges, for example, that in January 2003 Gandhi wrote that
Sequoia's "only real opportunity is to capture a fraction of our 13m investment," and that in June 2003 Gandhi acknowledged that
Trados' long term prospects were improving, but wrote that Sequoia "d[id] not own enough of the company to make a meaningful
return." Id. ¶ 30. Plaintiff further alleges that by mid-2004 Wachovia wanted to exit its investment in Trados because Scanlan
felt that the investment was underperforming and consuming too much of his time relative to the size of the investment. Id. ¶ 35.
Plaintiff also contends that Hg and Mentor wanted to exit their investments in Trados.

45
B. The Negotiations

In April 2004, the Trados board began to discuss a potential sale of the Company, and later
formed a mergers and acquisitions committee, consisting of Stone, Gandhi, and Scanlan, to explore a sale
or merger of Trados. Around the same time, the Company’s President and CEO was terminated due to,
among other issues, a perception by the rest of the board that Trados was underperforming. The board
appointed Hummel as an interim President, but instructed him to consult with Gandhi and Scanlan before
taking material action on behalf of the Company. In July 2004, Campbell was hired as the Company’s
CEO, effective August 23, 2004. Gandhi described Campbell as "a hard-nosed CEO whose task is to
grow the company profitably or sell it."52 At the time Campbell joined Trados, however, the Company
was losing money and had little cash to fund continuing operations.53 At a July 7, 2004 meeting, Trados’
board determined that the fair market value of Trados’ common stock was $0.10 per share.
In June 2004, Trados engaged JMP Securities, LLC, an investment bank, to assist in identifying
potential alternatives for a merger or sale of the Company. By July 2004, JMP Securities had identified
twenty seven potential buyers of Trados, and contacted seven of them, including SDL. By August 2004,
JMP Securities had conducted discussions with SDL CEO Mark Lancaster, who made an acquisition
proposal in the $40 million range. Trados informed Lancaster that it was not interested in a deal at that
price, and Campbell formally terminated JMP Securities in September 2004.

***
Trados’ financial condition improved markedly during the fourth quarter of 2004, in part due to
Campbell’s efforts to reduce spending and bring in additional cash through debt financing. By the time of
the December 2004 board meeting, Trados had arranged to borrow $2.5 million from Western
Technology Investment, with the right to borrow an additional $1.5 million.
Despite the Company’s improved performance, the board continued to work toward a sale of the
Company. In December 2004, Gandhi reported to Sequoia Capital that the Company’s performance was
improving, but that Campbell’s "mission is to architect an M & A event as soon as practicable." At a
February 2, 2005 board meeting, Campbell presented positive financial results from the fourth quarter of
2004, including record revenue and profit from operations. As a result of its improved performance and
the lack of an immediate need for cash, the board extended by six months the period during which it could
obtain additional cash from Western Technology Investment.

***
In January 2005, SDL initiated renewed merger discussions with Campbell. Upon learning of
SDL’s interest, the Trados board expressed that it was not interested in any transaction involving less than
a "60-plus" million dollar purchase price. Lancaster first discussed a transaction at $50 million, but later
offered $60 million. At the February 2, 2005 meeting, the board instructed Campbell to continue
negotiating with Lancaster under the general terms SDL proposed, including the $60 million price. In
mid-February 2005, Campbell made inquiries with two other potential acquirers of Trados, but neither
expressed any substantive interest.

                                                            
52
[3] Compl. ¶ 40. In June 2004, Gandhi also reported to Sequoia that a "banker has also been retained to explore the M & A
options for the business. I would expect that the company is sold within the next 18 months (perhaps sooner)." Id.
53
[4] Plaintiff alleges that Campbell believed that his "mission on joining TRADOS was to help the company understand its
future path, which in the mind of the outside board members at that time was some type of either merger or acquisition event due
to the company's performance that year and prior years." Compl. ¶ 44.

46
 In a theme that runs throughout his allegations, plaintiff alleges that there was no need to sell
Trados at the time because the Company was well financed and experiencing improved performance
under Campbell’s leadership. For example, plaintiff contends that by February 2005 Trados was beating
its revenue budget for the year, a trend that continued as Trados beat its revenue projections for the first
quarter of 2005 and through the end of May 2005.
By February 2005, Campbell and Lancaster agreed to the basic terms of a merger at $60 million.
Trados then re-engaged JMP securities, which plaintiff alleges acted as little more than a "go-between."
In April 2005, SDL and Trados signed the letter of intent for the merger at the $60 million price.

***
D. The Merger

The director defendants unanimously approved the merger, and on June 19, 2005 Trados and
SDL entered into an Agreement and Plan of Merger. Of the $60 million merger price, approximately $7.8
million would go to management [pursuant to the terms of a bonus plan] and the remainder would go to
the preferred stockholders in partial satisfaction of their $57.9 million liquidation preference. Plaintiff
alleges that the directors know both of these facts, and thus knew that the common shareholders would
receive nothing in the merger. The merger was consummated on July 7, 2005.

***
On July 21, 2005, plaintiff filed a petition for appraisal, seeking payment of the fair value of his
stock as of the date of the merger. Almost three years later, on July 3, 2008, plaintiff commenced a
second action, both individually and purportedly on behalf of a class of former stockholders of Trados,
against the director defendants. On December 12, 2008, plaintiff filed the First Amended Verified
Complaint (the "Complaint"), which includes new facts allegedly discovered by plaintiff in discovery
conducted as part of the appraisal action. Defendants have moved for dismissal of the Complaint for
failure to state a claim upon which relief may be granted.

II. ANALYSIS

***
C. Fiduciary Duty Claims

Count I of the Complaint asserts a claim that the director defendants breached their fiduciary duty
of loyalty to Trados’ common stockholders by approving the merger. Plaintiff alleges that there was no
need to sell Trados at the time because the Company was well-financed, profitable, and beating revenue
projections. Further, plaintiff contends, "in approving the Merger, the Director Defendants never
considered the interest of the common stockholders in continuing Trados as a going concern, even though
they were obliged to give priority to that interest over the preferred stockholders’ interest in exiting their
investment."

***
Directors of Delaware corporations are protected in their decision-making by the business
judgment rule, which "is a presumption that in making a business decision the directors of a corporation

47
acted on an informed basis, in good faith and in the honest belief that the action taken was in the best
interests of the company."54
The rule reflects and promotes the role of the board of directors as the proper body to manage the
business and affairs of the corporation.55
The party challenging the directors’ decision bears the burden of rebutting the presumption of the
rule.56 If the presumption of the rule is not rebutted, then the Court will not second-guess the business
decisions of the board.57 If the presumption of the rule is rebutted, then the burden of proving entire
fairness shifts to the director defendants.58 A plaintiff can survive a motion to dismiss under Rule 12(b)(6)
by pleading facts from which a reasonable inference can be drawn that a majority of the board was
interested or lacked independence with respect to the relevant decision.59
A director is interested in a transaction if "he or she will receive a personal financial benefit from
a transaction that is not equally shared by the stockholders" or if "a corporate decision will have a
materially detrimental impact on a director, but not on the corporation and the stockholders."60 The
receipt of any benefit is not sufficient to cause a director to be interested in a transaction. Rather, the
benefit received by the director and not shared with stockholders must be "of a sufficiently material
importance, in the context of the director’s economic circumstances, as to have made it improbable that
the director could perform her fiduciary duties . . . without being influenced by her overriding personal
interest. . . ."61
"Independence means that a director’s decision is based on the corporate merits of the subject
before the board rather than extraneous considerations or influences."62 At this stage, a lack of
independence can be shown by pleading facts that support a reasonable inference that the director is
beholden to a controlling person or "so under their influence that their discretion would be sterilized."63
Plaintiff’s theory of the case is based on the proposition that, for purposes of the merger, the
preferred stockholders’ interests diverged from the interests of the common stockholders. Plaintiff
contends that the merger took place at the behest of certain preferred stockholders, who wanted to exit
their investment. Defendants contend that plaintiff ignores the "obvious alignment" of the interest of the
preferred and common stockholders in obtaining the highest price available for the company. Defendants
assert that because the preferred stockholders would not receive their entire liquidation preference in the
merger, they would benefit if a higher price were obtained for the Company.64 Even accepting this
proposition as true, however, it is not the case that the interests of the preferred and common stockholders
were aligned with respect to the decision of whether to pursue a sale of the company or continue to
operate the Company without pursuing a transaction at the time.

                                                            
54
[24] Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
55
[25] 8 Del. C. § 141(a); In re CompuCom Sys., Inc. Stockholders Litig., 2005 WL 2481325, at 5 (Del.Ch. Sept. 29, 2005).
56
[26] Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993).
57
[27] Id.
58
[28] Id.
59
[29] Orman v. Cullman, 794 A.2d 5, 22-23 (Del. Ch. 2002).
60
[30] Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993).
61
[31] In re Gen. Motors Class H S'holders Litig., 734 A.2d 611, 617 (Del.Ch.1999); see Orman, 794 A.2d at 23.
62
[32] Aronson, 473 A.2d at 816.
63
[33] Rales, 634 A.2d at 936.
64
[35] Defendants also contend that the preferred stockholders would receive payment on an as converted basis with
the common stockholders. Id. at 12-13 ("[T]he preferred would receive the first $57.9 million of any transaction,
and would thereafter receive payment on an as converted basis with the common stockholders."); see Compl. ¶ 37
("[O]nce the Liquidation Preferences of Sequoia Capital and Mentor Capital's preferred stock were satisfied in a sale
or acquisition of Trados, those entities would not share in any further consideration, which mostly would go to
Trados' common stockholders.") (emphasis added); Pl.'s Answering Br. 22-23.

48
 ***
The merger triggered the $57.9 million liquidation preference of the preferred stockholders, and
the preferred stockholders received approximately $52 million dollars as a result of the merger. In
contrast, the common stockholders received nothing as a result of the merger, and lost the ability to ever
receive anything of value in the future for their ownership interest in Trados. It would not stretch reason
to say that this is the worst possible outcome for the common stockholders. The common stockholders
would certainly be no worse off had the merger not occurred.
Taking, as I must, the well-pleaded facts in the Complaint in the light most favorable to plaintiff,
it is reasonable to infer that the common stockholders would have been able to receive some consideration
for their Trados shares at some point in the future had the merger not occurred.65 This inference is
supported by plaintiff’s allegations that the Company’s performance had significantly improved and that
the Company had secured additional capital through debt financing. Thus, it is reasonable to infer from
the factual allegations in the Complaint that the interests of the preferred and common stockholders were
not aligned with respect to the decision to pursue a transaction that would trigger the liquidation
preference of the preferred and result in no consideration for the common stockholders.66

***
Generally, the rights and preferences of preferred stock are contractual in nature.67 This Court has
held that directors owe fiduciary duties to preferred stockholders as well as common stockholders where
the right claimed by the preferred "is not to a preference as against the common stock but rather a right
shared equally with the common."68 Where this is not the case, however, "generally it will be the duty of
the board, where discretionary judgment is to be exercised, to prefer the interests of common stock—as
the good faith judgment of the board sees them to be—to the interests created by the special rights,
preferences, etc., of preferred stock, where there is a conflict."69 Thus, in circumstances where the
interests of the common stockholders diverge from those of the preferred stockholders, it is possible that a
director could breach her duty by improperly favoring the interests of the preferred stockholders over
                                                            
65
[36] On a motion to dismiss for failure to state a claim, I am required to draw all reasonable inferences in favor of the non-
moving party. As a result, there are sometimes reasonable (even, potentially, more likely) inferences that must be passed over at
this stage of the proceedings. For example, it would be reasonable to infer from the allegations in the Complaint that pursing the
transaction with SDL was in the best interest of the Company because it secured the best value reasonably available for the
Company's stakeholders and did not harm the common shareholders because, in fact, there was no reasonable chance that they
would ever obtain any value for their stock even absent the transaction. Nothing in this Opinion is intended to suggest that it
would necessarily be a breach of fiduciary duty for a board to approve a transaction that, as a result of liquidation preferences,
does not provide any consideration to the common stockholders.
66
[38] Defendants do not argue that the board had an obligation to the preferred stockholders to pursue a transaction that would
trigger the large liquidation preference of the preferred stock. Thus, it is reasonable to infer, at this stage, that one option would
be for the Company to continue to operate without paying the large liquidation preference to the preferred, subject of course, to
any other contractual rights the preferred stockholders may have had. Indeed, in a situation in which the liquidation preference of
the preferred exceeded the consideration that could be achieved in a transaction, it would arguably be in the interest of the
common stockholders not to pursue any transaction that would trigger the liquidation preference. It is also reasonable to infer that
the preferred stockholders would benefit from a transaction that allowed them to exit the investment while also triggering their
liquidation preference, something they did not have a contractual right to force the Company to do. Again, at this stage, I am
required to make reasonable inferences in plaintiff's favor, even if there are other reasonable inferences that can be drawn from
the alleged facts and that would result in dismissal of the Complaint.
67
[39] Jedwab v. MGM Grand Hotels, Inc., 509 A.2d 584, 594 (Del.Ch.1986) ("[W]ith respect to matters relating to preferences
or limitations that distinguish preferred stock from common, the duty of the corporation and its directors is essentially contractual
and the scope of the duty is appropriately defined by reference to the specific words evidencing that contract. . . ."); see Matulich
v. Aegis Commc'ns Group, Inc., 942 A.2d 596, 599-600 (Del.2008).
68
[40] Jedwab, 509 A.2d at 594.
69
[41] Equity-Linked Investors, L.P. v. Adams, 705 A.2d 1040, 1042 (Del.Ch.1997) (citing Katz v. Oak Indus., Inc., 508 A.2d
873, 879 (Del.Ch.1986)).

49
those of the common stockholders.70 As explained above, the factual allegations in the Complaint support
a reasonable inference that the interests of the preferred and common stockholders diverged with respect
to the decision of whether to pursue the merger. Given this reasonable inference, plaintiff can avoid
dismissal if the Complaint contains well-pleaded facts that demonstrate that the director defendants were
interested or lacked independence with respect to this decision.
Defendants may be correct that the facts in Blackmore Partners are somewhat more "extreme"
than those alleged in the complaint because the Court in Blackmore Partners found "a basis in the
complaint to infer that the value of [the company’s] assets exceeded its liabilities by least $25 million."
Blackmore Partners, 864 A.2d at 85. The Court in Blackmore Partners, however, concluded, even in the
absence of factual allegations that supported an inference of interest or lack of independence by the
directors, that "the allegation that the Defendant Directors approved a sale of substantially all of [the
company’s] assets and a resultant distribution of proceeds that went exclusively to the company’s
creditors raises a reasonable inference of disloyalty or intentional misconduct." Id. at 86. Here, in
contrast, there is an allegation that a majority of the board was interested in the decision to pursue the
transaction; accordingly, the Court need not conclude that the decision to approve the transaction, of
itself, raises "a reasonable inference of disloyalty or intentional misconduct."

1. The Director Defendants’ Approval of the Merger

Plaintiff has alleged facts that support a reasonable inference that Scanlan, Stone, Gandhi, and
Prang, the four board designees of preferred stockholders, were interested in the decision to pursue the
merger with SDL, which had the effect of triggering the large liquidation preference of the preferred
stockholders and resulted in no consideration to the common stockholders for their common shares. Each
of these four directors was designated to the Trados board by a holder of a significant number of preferred
shares. While this, alone, may not be enough to rebut the presumption of the business judgment rule,
plaintiff has alleged more. Plaintiff has alleged that Scanlan, Stone, Gandhi, and Prang each had an
ownership or employment relationship with an entity that owned Trados preferred stock. Scanlan was a
partner in Wachovia; Stone was a director, employee and part owner of Hg; Gandhi was a partner in
several entities referred to as Sequoia; and Prang owned Mentor Capital. Plaintiff further alleges that
each of these directors was dependent on the preferred stockholders for their livelihood. As detailed
above, each of these entities owned a significant number of Trados’ preferred shares, and together these
entities owned approximately 51% of Trados’ outstanding preferred stock. The allegations of the
ownership and other relationships of each of Scanlan, Stone, Gandhi, and Prang to preferred stockholders,
                                                            
70
[42] See Blackmore Partners, L.P. v. Link Energy LLC, 864 A.2d 80, 85-86 (Del.Ch.2004) ("[T]he allegation that the
Defendant Directors approved a sale of substantially all of [the company's] assets and a resultant distribution of proceeds that
went exclusively to the company's creditors raises a reasonable inference of disloyalty or intentional misconduct. Of course, it is
also possible to infer (and the record at a later stage may well show) that the Director Defendants made a good faith judgment,
after reasonable investigation, that there was no future for the business and no better alternative for the unit holders. Nevertheless,
based only the facts alleged and the reasonable inferences that the court must draw from them, it would appear that no transaction
could have been worse for the unit holders and reasonable to infer, as the plaintiff argues, that a properly motivated board of
directors would not have agreed to a proposal that wiped out the value of the common equity and surrendered all of that value to
the company's creditors."). Defendants contend that Blackmore Partners can be distinguished from this case because "the Court in
Blackmore Partners found that defendants favored creditors to whom they did not owe fiduciary duties over unit holders to whom
they did owe fiduciary duties" and that plaintiff "does not, and cannot, allege that the Director Defendants favored anyone to
whom they did not owe a fiduciary duty." Reply Br. of Director Defendants in Further Support of their Mot. to Dismiss ("Defs.
Reply Br.") 23. As explained above, however, preferred stockholders are owed the same fiduciary duties as common stockholders
when the right claimed by the preferred is "a right shared equally with the common." Jedwab, 509 A.2d at 594. If and when the
interests of the preferred stockholders diverge from those of the common stockholders, the directors generally must "prefer the
interests of common stock-as the good faith judgment of the board sees them to be-to the interests created by the special rights,
preferences, etc., of preferred stock." Equity-Linked Investors, 705 A.2d at 1042. Based on the allegations in the Complaint, it
does not appear that the preferred stockholders had any contractual right to force a transaction that would trigger their liquidation
preference. Moreover, the transaction with SDL was, under at least one reasonable inference that can be drawn from the
Complaint, not in the best interest of Trados' common stockholders.

50
combined with the fact that each was a board designee of one of these entities, is sufficient, under the
plaintiff-friendly pleading standard on a motion to dismiss, to rebut the business judgment presumption
with respect to the decision to approve the merger with SDL.

***
At oral argument, defendants relied on Dubroff v. Wren Holdings, LLC71 for support of the
argument that plaintiff had failed to state a claim because he had not alleged that the preferred
stockholders were acting in concert or had otherwise formed a controlling group. The discussion of a
"control group" in Wren Holdings was in connection with the general rule that "equity dilution" claims
are derivative, rather than direct. As explained in Wren Holdings, there is an exception to this general
rule "where a controlling shareholder causes the corporate entity to issue more equity to the controlling
shareholder at the expense of the minority shareholders."72 The emphasis on a control group in Wren
Holdings arose from the plaintiffs’ attempt to establish that certain of the defendants had collectively
formed a controlling shareholder group so that plaintiffs would be able to bring a direct claim for the
alleged equity dilution.73 Here, in contrast, there is no need for plaintiff to allege that there was a
controlling shareholder or control group in order to establish that individual director defendants were
interested.74

***
Plaintiff has alleged facts that support a reasonable inference that a majority of the board was
interested or lacked independence with respect to the decision to approve the merger. Accordingly,
plaintiff has alleged sufficient facts to survive defendants’ motion to dismiss the fiduciary duty claims
based on the board’s decision to approve the merger.75

III. CONCLUSION

For the reasons set forth above, defendants’ motion to dismiss is granted in part and denied in
part. The motion to dismiss is denied with respect to the claim in Count I for breach of fiduciary duty
arising out of the board’s approval of the merger . . .

NOTE
In Morgan v. Cash, 2010 Del. Ch. LEXIS 148 (Jul. 16, 2010), the court, in rejecting a claim that a
third party bidder had aided and abetted a breach of fiduciary duty owed to common stock holders by
directors elected by the holders of preferred stock of the target, stated:
To hold that a claim for aiding and abetting against a bidder is stated simply because a bidder
knows that the target board owns a material amount of preferred stock, knows that the target’s value is in
a range where a deal might result in no consideration to the common stockholder, and that the bidder
nonetheless insists on a price below the level that yields a payment to the common stockholders would set
a dangerous and irresponsible precedent. The reality is that there are entities whose value is less than the
                                                            
71
[46] [2009 Del. Ch. LEXIS 89] (Del. Ch. May 22, 2009).
72
[47] [2009 Del. Ch. LEXIS 89].
73
[48] [2009 Del. Ch. LEXIS 89].
74
[49] While it is true that an individual stockholder that is not a controlling stockholder can generally vote in its individual
interest, the same cannot be said of directors designated to the board by such a stockholder.
75
[57] Because, at this stage, plaintiff has rebutted the business judgment presumption for a majority of the board, I need not
reach plaintiff's allegations as to the remaining director defendants.

51
value to which its preferred stockholders and bondholders are due in a sale. If our law makes it a
presumptive wrong for a bidder to deal with a board dominated by preferred stockholder representatives,
then value-maximizing transactions will be deterred. It is hardly unusual for corporate boards to be
comprised of representatives of preferred stockholders, who often bargain for representational rights
when they put their capital up in risky situations. Notably, those capital investments often end up
benefiting common stockholders by helping corporations weather tough times. What [plaintiff] asks is
that this court hold that the mere fact that a bidder knowingly enters into a merger with a target board
dominated by preferred holders at a price that does not yield a return to common stockholders creates an
inference that the bidder knowingly assisted in fiduciary misconduct by the target board. That is not and
should not be our law, particularly when the plaintiff cannot even plead facts suggesting that the bidder
was paying materially less, or in this case even anything at all less than, fair market value.
Page 352, insert the following above TERRY v. PENN CENTRAL CORP.

FLETCHER INTERNATIONAL, LTD v. ION GEOPHYSICAL CORPORATION

Delaware Chancery Court
2010 Del. Ch. LEXIS 125 (May 28, 2010)

PARSONS, VICE CHANCELLOR.

In a letter opinion issued on March 24, 2010, I examined part of Fletcher International, Ltd.'s
("Fletcher") motion for partial summary judgment relating to the issuance of a convertible promissory
note (the "ION S.àr.l. Note") by ION Geophysical Corporation ("ION") through its wholly-owned
76
subsidiary ION International S.àr.l. ("ION S.àr.l."). In that opinion, I denied Fletcher's motion "insofar
as it could be construed as a request for a preliminary injunction effectively invalidating ION's issuance
of the ION S.àr.l. Note or requiring that ION repay funds borrowed under that Note," but reserved
77
judgment on certain other issues raised by Fletcher's motion. This Memorandum Opinion addresses
those issues.
Specifically, this Court now must determine (1) whether Fletcher has a contractual right to
consent to the issuance of any security by a subsidiary of ION, (2) whether the ION S.àr.l. Note is such a
security and, if it is, whether ION violated Fletcher's rights by issuing it without first seeking Fletcher's
consent, and (3) whether ION's board of directors breached their fiduciary duty to Fletcher by failing to
seek Fletcher's timely consent to issuance of the ION S.àr.l. Note or disclose material facts to Fletcher in
connection with that Note.
Having examined the language of the relevant documents and finding no ambiguity, I hold that
Fletcher does have a contractual right to consent to the issuance of any security-as that term is defined
under Delaware and federal law-by a subsidiary of ION. Additionally, after examining the features of the
ION S.àr.l. Note, particularly its convertibility feature, I conclude that it is a security of ION S.àr.l. that
was issued by ION S.àr.l. Therefore, I hold that ION violated the terms of Section 5(B)(ii) of the
Certificates of Rights and Preferences governing Fletcher's preferred stock by issuing the Note without
Fletcher's consent. Finally, because Fletcher's claims against ION's board of directors for breach of
fiduciary duty in connection with the issuance of the ION S.àr.l. Note seek to remedy the same conduct
complained of in Fletcher's claim for breach of contract, I grant summary judgment for Defendants on
that claim.

                                                            
76
[1] See Fletcher Int'l, Ltd. v. ION Geophysical Corp., 2010 Del. Ch. LEXIS 61 (Mar. 24, 2010).
77
[2] 2010 Del. Ch. LEXIS 61….

52
 I. BACKGROUND

A. The Parties
Plaintiff, Fletcher, is a Bermuda corporation and the beneficial owner of all outstanding Series D
Preferred Stock of ION.
Defendant ION is a technology-focused seismic solutions company organized in Delaware.
Defendant ION S.àr.l. is a Luxembourg private company. Defendants also include members of ION's
board of directors . . . the "Director Defendants").
B. Facts
Beginning on February 15, 2005, and pursuant to the terms of an agreement between Fletcher and
ION on that date, Fletcher purchased 30,000 shares of Series D-1, 5,000 shares of Series D-2, and 35,000
shares of Series D-3 Cumulative Convertible Preferred Stock of ION. Fletcher completed its last
purchase in February 2008 and remains the sole holder of all outstanding Series D Preferred Stock.
The Certificates of Rights and Preferences for the Series D-1, D-2, and D-3 Preferred Stock (the
"Certificates") establish the rights, preferences, privileges, and restrictions of holders of that stock.
Section 5(B)(ii) of the Certificates provides, in pertinent part, that:
The Holders shall have the following voting rights . . . The consent of Holders of at least
a Majority of the Series [D-1, D-2, and D-3] Preferred Stock [respectively], voting
separately as a single class with one vote per share, in person or by proxy, either in
writing without a meeting or at an annual or a special meeting of such Holders called for
the purpose, shall be necessary to: . . . permit any Subsidiary of [ION] to issue or sell, or
obligate itself to issue or sell, except to [ION] or any wholly owned Subsidiary, any
security of such Subsidiaries.
On October 23, 2009, ION issued a press release announcing, among other things, that ION had
caused the issuance of two convertible promissory notes to BGP, Inc. ("BGP"), including the ION S.àr.l.
Note, under its amended credit facility as one of several transactions intended to lead to the formation of a
joint venture between ION and BGP (the "BGP Transactions"). Before the BGP Transactions closed on
March 25, 2010, the amount of money drawn down under the ION S.àr.l. Note was convertible into shares
of ION common stock at the discretion of the holder of the Note. After closing, however, the then-
outstanding principal amounts due under the Note were to be converted automatically into shares of ION
common stock unless the holder elected otherwise

***
D. Parties' Contentions
The Complaint asserts eight counts against ION, ION S.àr.l., and the Director Defendants,
including claims for breaches of contract and fiduciary duty. The pending motion, however, deals only
with the first two of those counts.
In Count I, Fletcher avers that, under Section 5(B)(ii) of the Certificates, ION cannot issue
securities of its subsidiaries through any of those subsidiaries without Fletcher's consent and that ION
violated that provision by unilaterally permitting ION S.àr.l. to issue the Note. In Count II, Fletcher
argues that the Director Defendants breached their fiduciary duties of loyalty by failing to (1) provide
Fletcher with a timely and meaningful vote on the issuance of the Note and (2) disclose all material facts
concerning the ION S.àr.l. Note.

53
 Defendants contend that Fletcher's motion must be denied as to Count I because the ION S.àr.l.
Note is not a security as that term is used in Section 5(B)(ii) of the Certificates. In this regard, Defendants
first argue that the parties intended "security" to include only equity securities. Second, they claim that,
when analyzed under the Reves "family resemblance" test and viewed in the context in which it was
issued, the Note represents nothing more than a commercial loan. Third, Defendants suggest the motion
for summary judgment should be denied because Fletcher did not provide the only reasonable
interpretation of "security." Defendants also urge denial of summary judgment on Count II because there
is no difference between Fletcher's breach of contract and breach of fiduciary duty claims.

II. ANALYSIS

***
. . . I first analyze Fletcher's claim as it relates to Count I by examining Section 5(B)(ii) of the
Certificates to determine if the meaning of "any security" in that provision is ambiguous and, if it is not,
whether the ION S.àr.l. Note fits within the meaning of that term.
B. Did ION Violate Fletcher's Rights by Issuing the ION S.àr.l. Note Without Seeking Fletcher's
Consent (Count I)?
Fletcher contends that, under Section 5(B)(ii) of the Certificates, ION must obtain Fletcher's
consent before an ION subsidiary may issue "any security" of that subsidiary. There is no dispute that
ION S.àr.l. is a subsidiary of ION. The parties do contest, however, whether the ION S.àr.l. Note fits
within the ambit of a "security" as that term is used in the Certificates. A preferred stockholder's rights
are primarily contractual in nature, and the construction of preferred stock provisions are matters of
contract interpretation for the courts. Thus, before determining what "any security" means, I review
briefly some pertinent principles of contract interpretation.
While the ultimate goal of contract interpretation is to give effect to the parties' shared intent,
Delaware adheres to the "objective" theory of contracts and its courts interpret the language of a contract
as it "would be understood by an objective, reasonable third party." As such, I must endeavor to
determine not only what "the parties to the contract intended it to mean, but what a reasonable person in
78
the position of the parties would have thought it meant."
79
Because "[l]anguage in a vacuum may take on any number of meanings," the Court examines
contractual language in the context of the document "as a whole" and "give[s] each provision and term
80
effect, so as not to render any part of the contract mere surplusage." Indeed, a court will "more readily
assign contract language its intended meaning if it reads the language at issue within the context of the
81
agreement in which it is located."
This Court ordinarily allows the plain meaning of a contract to control, unless it is ambiguous.
Importantly, "the language of an agreement . . . is not rendered ambiguous simply because the parties in
82
litigation differ concerning its meaning." The Court need only find ambiguity where the contested
provisions are "reasonably or fairly susceptible of different interpretations or may have two or more
                                                            
78
[21] Rhone-Poulenc Basic Chem. Co. v. Am Motorists Ins. Co., 616 A.2d 1192, 1196 (Del. 1992). . . .
79
[22] USA Cable v. World Wrestling Fed'n Entm't, Inc., 2000 Del. Ch. LEXIS 87 (June 27, 2000).
80
[23] Kuhn Constr., Inc. v. Diamond State Port Corp., 990 A.2d 393 (Del. 2010).
81
[24] USA Cable, 2000 Del. Ch. LEXIS 87 ("Accordingly, while the canons of contract interpretation instruct an examination
of the explicit contract language in order to determine the clause's meaning, one must simultaneously read that language within
the context of the contract surrounding that language in order to best elicit the most appropriate meaning.").
82
[26] City Investing Co. Liquid. Trust v. Cont'l Cas. Co., 624 A.2d 1191, 1198 (Del. 1993).

54
 83
different meanings." Thus, unambiguous words in a contract, though undefined, typically are given
their ordinary meaning unless multiple, reasonable interpretations exist. With these principles in mind, I
turn to the language of the Certificates at issue here.
1. Is the phrase "any security" in Section 5(B)(ii) ambiguous?
The Certificates do not define "any security," as that phrase is used in Section 5(B)(ii), nor did the
parties discuss the meaning of that phrase during negotiations. Nevertheless, Fletcher argues that the term
is unambiguous and must be viewed as co-extensive with the statutory definition of security under
Delaware and federal law. To support this interpretation of "any security," Fletcher notes that, in their
respective definition sections, the Certificates define "Other Securities" as "any stock . . . and other
securities of" ION. While not directly applicable to Section 5(B)(ii), that definition, according to
Fletcher, reflects an understanding that "the term ‘securities' [as used in that Section, encompasses]
something beyond stock because the definition includes the phrase ‘and other securities' in addition to any
stock." I find Fletcher's interpretation reasonable because the disputed term "security" is used in the
context of a contract prescribing the rights of holders of preferred stock in a publicly-traded corporation,
over which the securities laws cast a long shadow.
Defendants initially countered Fletcher's argument by asserting that, based on the parties' course
of conduct and the business context in which the Certificates were drafted, "any security" must be
interpreted to mean only "equity securities." Specifically, Defendants argued that Section 5(B)(ii) was
intended to address only the sale of equity of an ION subsidiary (which could dilute the value of
Fletcher's investment), not debt (which would not). Defendants did not, however, point to any cases or
evidence indicating that their narrow, idiosyncratic interpretation is reasonable, consistent with the plain
meaning of the phrase "any security," or in line with Fletcher's understanding of that phrase at the time
the parties entered into the Certificates. Moreover, the definition of "Other Securities" in the Certificates
contradicts even Defendants' subjective interpretation by indicating that the parties understood that term
to encompass more than simply equity securities when they drafted those documents.
But, even if I accepted Defendants' unsupported claim that they subjectively understood Section
5(B)(ii) to include only equity securities, it would be immaterial because I must interpret "any security"
objectively. In that regard, the evidence suggests that a reasonable person in the position of the parties
likely would have understood the term "any security" to include instruments generally recognized to be
securities under federal and state securities statutes and regulations. Defendants did not present any
reasonable, alternative definition. Therefore, I hold that "security" is not ambiguous and must be afforded
its ordinary meaning as it has developed under federal and state law.
2. Is the ION S.àr.l. Note a "security"?
Even under this definition, however, the question remains whether a convertible promissory note,
like the ION S.àr.l. Note, is indeed a security. Fletcher acknowledges that certain classes of notes are not
securities, but contends that notes that are convertible into stock unquestionably meet the definition of a
"security" under both Delaware and federal law. In response, Defendants claim that, under the Reves
"family resemblance" test, the ION S.àr.l. Note is not a security because the commercial context in which
84
the Note was issued indicates that it was, in reality, nothing more than a commercial bank loan. In this
regard, Defendants minimize the importance of the Note's convertibility feature as "simply a mechanism
designed" to allow this "loan" to be more conveniently unwound if the BGP Transactions failed to close.
For the reasons addressed below, I find Defendants' argument unpersuasive and hold that, as a debt

                                                            
83
[27] Rhone-Poulenc, 616 A.2d at 1196; see also E.I. du Pont de Nemours & Co., Inc. v. Allstate Ins. Co., 693 A.2d 1059, 1061
(Del. 1997) ("Contract language is not ambiguous simply because the parties disagree on its meaning."); Chambers, 2005 Del.
Ch. LEXIS 118.
84
[33] See Reves v. Ernst & Young, 494 U.S. 56, 63, 110 S. Ct. 945, 108 L. Ed. 2d 47 (1990).

55
instrument convertible into equity securities, the ION S.àr.l. Note qualifies as a "security" under Section
5(B)(ii) of the Certificates.
The United States Supreme Court held in Reves v. Ernst & Young that all notes presumptively fall
85
within the definition of a "security." This presumption can be rebutted only by showing that a particular
note bears a strong resemblance to one of a judicially crafted list of categories of instruments that are not
86
securities. To determine if a strong resemblance exists, a court must examine (1) the motivations that
would prompt a reasonable seller and buyer to enter into the transaction, (2) the plan of distribution of the
instrument, (3) the reasonable expectations of the investing public, and (4) the existence of some factor
that significantly reduces the risk of the instrument, thus rendering application of the securities statutes
unnecessary. Reves emphasized, however, that when examining these four factors, courts should
remember that the "fundamental essence of a ‘security’ [is] its character as an ‘investment.’"
Though Reves clearly applies to instruments solely evidencing debt, the convertibility feature of
the ION S.àr.l. Note may eliminate the need to examine that instrument under the "family resemblance"
test. Indeed, some courts have held convertible notes to be securities without any apparent examination
under Reves. Other courts have applied the Reves factors and, predictably, found a convertible note to be
a security.
In this case, the hybrid nature of the ION S.àr.l. Note, which its holder could convert at any time
into common stock of ION, strongly supports finding it to be a security under Delaware and federal
87
securities law. Moreover, even considering the ION S.àr.l. Note under the "family resemblance" test, I
hold it to be a security because the Note is most naturally understood as an investment in ION, rather than
a purely commercial or consumer transaction. The Note is "freely assignable and transferable" by its
holder, convertible into common shares of a publicly traded company, and subject to an investment risk,
even if that risk is arguably small. These factors all support the conclusion that the ION S.àr.l. Note is an
"investment," as that term is used in Reves, and, thus, a security. Furthermore, when I compare it to the
judicially crafted list of notes that are clearly not securities, I find that the ION S.àr.l. Note "neither fits
into . . . nor bears a strong family resemblance to any of those categories." Thus, I hold that the Note is a
88
security as that term is used in Section 5(B)(ii) of the Certificates.

                                                            
85
[35] 494 U.S. 56, 65, 110 S. Ct. 945, 108 L. Ed.2d 47 (1990). The Reves test was adopted by the Delaware Supreme Court in
Boo'ze v. State, 846 A.2d 237 (Del. 2004).
86
[36] The types of notes generally not considered securities include [1] a "note delivered in consumer financing, [2][a] note
secured by a mortgage on a home, [3][a] short-term note secured by a lien on a small business or some of its assets, [4][a] note
evidencing a ‘character’ loan to a bank customer, [5] short-term notes secured by an assignment of accounts receivable, or [6] a
note which simply formalizes an open-account debt incurred in the ordinary course of business (particularly if, as in the case of
the customer of a broker, it is collateralized)." 494 U.S. at 65 (quoting Exch. Nat'l Bank v. Touche Ross & Co., 544 F.2d 1126,
1138 (2d Cir. 1976)).
87
[41] The investment in the ION S.àr.l. Note apparently was conceived initially as a bridge loan from the Bank of China to ION
S.àr.l. in connection with the BGP Transactions. According to the terms of ION's amended credit facility, under which the Note
was issued, however, the anticipated repayment of the Note at closing would have triggered certain pro rata repayment
requirements. See supra note 7. Considering that option undesirable, the parties to the BGP Transaction included a convertibility
function in the Note to avoid the repayment requirement.
88
[45] This conclusion is buttressed by the fact that the ION S.àr.l. Note was issued with a legend that begins: "THE
SECURITIES REPRESENTED BY THIS CONVERTIBLE PROMISSORY NOTE HAVE NOT BEEN REGISTERED UNDER
THE SECURITIES ACT OF 1933. . . ." . . . . Such a legend is required whenever a security is sold pursuant to an exception to
the registration requirements of the Securities Act of 1933 ("Securities Act"). See 17 C.F.R. § 230.144A(d)(2) ("The seller and
any person acting on its behalf [must take] reasonable steps to ensure that the purchaser is aware that the seller may rely on the
exemption from the provisions of section 5 [of the Act provided by this section" in order for the exemption to apply). The Note
also states that "[i]n the event of any proposed transfer . . . the Issuer may require . . . that it receive reasonable transfer
documentation that is sufficient to evidence that such proposed transfer complies with the Securities Act and other applicable
state and foreign securities laws." . . . . While it may be true, as Defendants suggest, that the legend was added by the lawyers
negotiating the terms of the ION S.àr.l. Note simply out of "an abundance of caution," see Tr. 54-55, its inclusion nevertheless

56
 When the Note was issued, it was understood that, as the Note's holder, the Bank of
China almost certainly would exercise its right to convert it into ION common stock
because the option to convert was issued in the money. See supra note 9. As Brian
Hanson, CFO of ION, stated in his deposition: "I think absolutely the Chinese . . . will
exercise their conversion rights [to convert the Note into shares of ION common stock]
. . . prior to having their . . . rights expire." Tr. 68-69. Hanson further declared that "the
intent behind the bridge loan . . . was to advance the equity investment" reflected in the
BGP Transactions. Id. at 69-70.
Defendants add another wrinkle to this analysis, however. Specifically, they argue that issuance
of the ION S.àr.l. Note does not violate Section 5(B)(ii) because the Note is convertible into shares of
89
ION, not ION S.àr.l. According to this argument, because the Note is convertible into ION's common
stock, it must be considered a security of ION, and because ION did not need Fletcher's consent to issue
its own securities under the Certificates, Fletcher's voting rights were not violated. Fletcher responds that,
even though the ION S.àr.1 Note contains an option allowing it to be converted into shares of ION stock,
the Note is still a security of ION S.àr.l. because it issued the Note. I agree with Fletcher in this regard.
By its terms, the ION S.àr.l. Note closely resembles an option contract whereby ION S.àr.l. grants
the holder of the Note an option to voluntarily convert the amount drawn down under that Note into
shares of ION common stock. Generally, an option to purchase an equity security-like the ION S.àr.l.
Note-is itself a security. Additionally, at least some courts have held that options should be considered
securities of the entity issuing them. One basis for treating options as a security of the entity issuing
them, as opposed to the entity issuing the underlying securities, is that options and their underlying
securities are frequently sold on different markets and constitute separate financial products.
Here, the ION S.àr.l. Note, though convertible into securities of ION, was issued by ION S.àr.l.,
which received the benefit and bore the burden of issuing that Note. I, therefore, find that the Note is a
security of ION S.àr.l. and hold that ION violated Fletcher's consent rights when it allowed its subsidiary
to issue such a security without first seeking Fletcher's consent.
C. Did the Director Defendants Breach Their Duty of Disclosure (Count II)?
Having determined that ION violated Fletcher's consent rights by issuing the ION S.àr.l. Note, I
next turn to Fletcher's motion for summary judgment on Count II.
Fletcher claims that the Director Defendants breached their fiduciary duties to Fletcher as a
preferred stockholder by failing to (1) provide Fletcher with a timely, meaningful, and informed vote in
connection with the issuance of the ION S.àr.l. Note or (2) disclose fully and fairly all material
information within the board's control in connection with issuance of the ION S.àr.l. Note. Defendants
urge the Court to deny summary judgment on Count II, claiming that there is no difference between
Fletcher's contractual and fiduciary duty claims, all of which stem from Section 5(B)(ii) of the
Certificates and the same alleged wrongdoing. I agree with Defendants' contention.
The Director Defendants' failure to seek Fletcher's consent before issuing the ION S.àr.l. Note
implicates rights defined by the Certificates as opposed to those that may be defined by fiduciary duty
principles. Also, the Director Defendants premised their decision not to disclose material information in
connection with issuance of the ION S.àr.l. Note on their belief that Fletcher was not entitled to vote on
that transaction. Whether that decision was right or wrong, the Director Defendants acted on the basis of
their interpretation of Section 5(B)(ii) of the Certificates. Therefore, any fiduciary duty claims asserted
                                                                                                                                                                                                
evidences Defendants' own recognition that the Note could be viewed by investors and regulators as a security subject to the
Securities Act.
89
[46] Defendants base this argument on the facts that, according to the Certificates, ION does not need Fletcher's consent to
issue its own securities and need only seek such consent when one of its subsidiaries issues "any security of such Subsidiaries."
POB Ex. A § 5(B)(ii) (emphasis added).

57
by Fletcher based on an alleged violation of either the duty of loyalty or the "duty of disclosure" arise out
of and are superfluous to the breach of contract claims raised in Count I. As such, I grant summary
judgment in favor of Defendants as to Count II.
The rights of preferred stockholders are primarily contractual in nature. Yet, while a board of
directors does not owe fiduciary duties to preferred stockholders to the same extent as common
stockholders, that is not to say that such duties are nonexistent or that preferred stockholders only may
seek to hold directors liable for violation of explicit contractual duties. Indeed, "it has been recognized
that directors may owe duties of loyalty and care" to preferred stockholders, particularly in cases where
nonexistent contractual rights leave "the holder of preferred stock [in an] exposed and vulnerable position
vis-à-vis the board of directors." Thus, if preferred stockholders "share a right equally with the common
shareholders the directors owe the preferred shareholders the same fiduciary duties they owe the common
shareholders with respect to those rights." For instance, directors owe preferred stockholders a duty to
disclose material information in connection with common voting rights. But, rights arising from
documents governing a preferred class of stock, such as the Certificates, that are enjoyed solely by that
preferred class, do not give rise to fiduciary duties because such rights are purely contractual in nature.
Even when directors do owe fiduciary duties to preferred stockholders, however, if claims for
breach of such duties are based on the same facts underlying a breach of contract claim and relate to
"rights and obligations expressly provided by contract," then such claims are "superfluous." As a result,
unless the fiduciary duty claims are based on duties and rights not provided for by contract, a plaintiff
cannot maintain both contractual and fiduciary duty claims arising out of the same alleged wrongdoing.
In this case, Fletcher's right to vote on an ION subsidiary's issuance of securities is provided for
in Section 5(B)(ii) of the Certificates and, as a result, is "essentially contractual" in nature. Because
Fletcher can remedy the violation of that voting right through its breach of contract claim, it has no need
to assert a fiduciary duty claim based on the same contractual consent rights. Additionally, the duty to
disclose material information to preferred stockholders in connection with the right to vote is premised on
there actually being a vote. Here, the Director Defendants determined that Fletcher was not entitled to
vote based on their interpretation of the Certificates and, not surprisingly, saw no need to disclose
information to Fletcher in connection with the BGP Transactions. But whether or not that decision was
correct, it is inextricably intertwined with Fletcher's claim that Defendants breached the Certificates. Any
remedy for Defendants' conduct may thus be obtained under Count I, and there is no need for an
overlapping breach of fiduciary duty claim. Therefore, I grant summary judgment on Count II in favor of
Defendants.

III. CONCLUSION

For the foregoing reasons, I grant Fletcher's motion for summary judgment on Count I to the
extent it seeks declaratory judgment that Section 5(B)(ii) of the Certificates is valid and binding on ION
and that ION breached its obligations under that section by permitting ION S.àr.l. to issue the ION S.àr.l.
Note without first obtaining Fletcher's consent. Additionally, I deny Fletcher's motion on Count II and,
instead, grant summary judgment on that claim in favor of Defendants.

§ 4.09 REDEMPTION PROVISIONS

Page 392, insert the following at the end of § 4.09.

In applying the doctrine of independent legal significance, the Rauch court noted that there was
no claim that the cash merger price was unfair to the preferred stock holders. See generally C. Stephen
Bigler & Blake Rohrbacher, Form or Substance? The Past, Present and Future of the Doctrine of

58
Independent Legal Significance, 63 BUS. LAW. 1 (2007), for a discussion of the effect of alleged
unfairness on the application of the doctrine.

§ 4.10 NEW YORK STOCK EXCHANGE LISTING REQUIREMENTS REGARDING

PREFERRED STOCK

703.05 Preferred Stock Offerings Listing Process

(A) Listing Policy

The Exchange has not set any minimum numerical criteria for the listing of preferred stock. The
issue must be of sufficient size and distribution, however, to warrant trading in the Exchange market
system. The Exchange has set certain numerical delisting criteria for preferred stock. The Exchange will
normally give consideration to suspending or removing a preferred stock if the aggregate market value of
publicly-held shares is less than $2,000,000 and the number of publicly-held shares is less than 100,000.
The Exchange expects that a preferred stock will have voting provisions and other provisions
normally found in a security designated as preferred stock. (See Para. 313.00(C), "Preferred Stock,
Minimum Voting Rights Required".) While the minimum redemption rights set forth below are
acceptable under Exchange policy, they should not be regarded as an expression of opinion by the
Exchange as to the adequacy of protective provisions under all circumstances.
The Exchange is concerned about the issuance of preferred stock which by its terms would vote
separately as a class from the common stock on the approval of mergers and acquisitions, unless required
by law. (See "Defensive Tactics" in Para. 308.00.)

(B) Clearance of Terms

Before a company applies for the listing of a preferred stock, it should first submit the terms of
the preferred stock to the Exchange for clearance. In order to be called preference or preferred stock, the
issue should be preferred as to dividends and on liquidation. After the terms have been reviewed and
cleared by the Exchange, the company will be given permission to use a "listing intention statement" in
the offering prospectus.

(C) Title of Issue

The Exchange recommends that the following attributes of the preferred stock be disclosed in the
title of issue even if the preferred stock is not listed:

 The dividend rate should be shown.

 The seniority of the security in relation to other preferred issues should be
indicated.
 If dividends are non-cumulative, the title should indicate it.
 If an issue is convertible for life, the title should indicate it. If there is a limitation
on the conversion feature, it should be shown parenthetically.
 If the issue is one series of a class of preferred stock, the title should indicate it.

(D) Redemption Rights

The following describes the redemption rights of preferred shareholders.

59
Redemption—

 Redemption provisions should provide for a redemption date which is no less than
30 days nor more than 90 days following notification to holders.
 Rights of preferred shareholders may be terminated in advance of the redemption
date provided that adequate notice has been published that sufficient funds will be
made available to shareholders within 90 days. No rights should be terminated,
even if the redemption date has passed, if there is a default in funds available for
redemption.
 If an issue is convertible, conversion privileges should continue for a reasonable
period after the redemption notice is published.
 Partial redemption should be pro rata or by lot.

(E) Exceptions to Minimum Voting Rights

In the application of the policy relating to the [below]-stated minimum voting provisions for
preferred stock, the Exchange may make exception in a case where the laws of the state of incorporation
preclude, or make virtually impossible, the conferring of exclusive voting rights upon any particular class
of stock.
Exception may also be made in cases where the preferred stock has provisions which, while not
conforming exactly to the above-stated minimum provisions, give the stock the practical equivalent of
those minimum provisions.
Exception may also be made in a case where the company agrees to submit to its stockholders at a
reasonably early date, a proposal to amend the voting provisions of the preferred stock to conform, at the
least, to the minimum provisions stated above, along with the management's recommendation to
stockholders that the proposal be adopted.
However, such exceptions are made only after consideration of the circumstances of the particular
case, and it should not be assumed, in any case, that they will be made. Any company contemplating
issuance of a preferred stock which it desires to list on the Exchange, and which, for any reason, does not
have, at the least, the voting provisions described above, is urged to discuss the matter with the company's
Exchange representative at an early date and, if at all possible, before definitive steps are taken to fix the
provisions of the class.

(F) Filing a Listing Application Relating to Preferred Stock Offerings

The general instructions for preparation and filing of a listing application are described in Para.
703.01. The listing application format is presented in Para. 903.02.

(G) Supporting Documents

The following documents must be filed in support of the listing application.

 Timetable (if requested) — include proposed date of effectiveness under the

Securities Act of 1933 and closing date. Such information may be referenced in a
cover letter which accompanies the application.
 Definitive terms of preferred stock.

60
  Copies of opinions of counsel filed in connection with recent public offerings or,
if no opinions of counsel exist, a certificate of good standing from the company's
jurisdiction of incorporation.
 Distribution information, including notice of termination of selling group and
lifting of price restrictions.
 Specimen certificates (if requested).
 Notice of availability of eligible securities for trading (if requested).
 Prospectus — 4 copies, both preliminary, and final.
 Signed registration statement under the Securities Exchange Act of 1934. In lieu
of signed copy, Company may submit registration statement as filed via EDGAR.
Include a statement to the effect that the registration statement, as submitted, is a
true and complete copy of that which has been filed with the Securities and
Exchange Commission.
 Current form of Listing Fee Agreement (if not previously filed). (See
Para. 902.01.)
 Current form of Listing Agreement (if not previously filed). (See Para. 901.00).
 Indemnification Agreement. (See Para. 501.05).

313.00 Voting Rights

(A) Voting Rights Policy

On May 5, 1994, the Exchange's Board of Directors voted to modify the Exchange's Voting
Rights Policy, which had been based on former SEC Rule 19c-4. The Policy is more flexible than Rule
19c-4. Accordingly, the Exchange will continue to permit corporate actions or issuances by listed
companies that would have been permitted under Rule 19c-4, as well as other actions or issuances that are
not inconsistent with the new Policy. In evaluating such other actions or issuances, the Exchange will
consider, among other things, the economics of such actions or issuances and the voting rights being
granted. The Exchange's interpretations under the Policy will be flexible, recognizing that both the
capital markets and the circumstances and needs of listed companies change over time. The text of the
Exchange's Voting Rights Policy is as follows:
Voting rights of existing shareholders of publicly traded common stock registered under Section
12 of the Exchange Act cannot be disparately reduced or restricted through any corporate action or
issuance. Examples of such corporate action or issuance include, but are not limited to, the adoption of
time phased voting plans, the adoption of capped voting rights plans, the issuance of super voting stock,
or the issuance of stock with voting rights less than the per share voting rights of the existing common
stock through an exchange offer.

(B) Non-Voting Common Stock

The Exchange's voting rights policy permits the listing of the voting common stock of a company
which also has outstanding a non-voting common stock as well as the listing of non-voting common
stock. However, certain safeguards must be provided to holders of a listed non-voting common stock:
(1) Any class of non-voting common stock that is listed on the Exchange must meet all
original listing standards.
The rights of the holders of the non-voting common stock should, except for voting rights, be
substantially the same as those of the holders of the company's voting common stock.

61
 (2) Although the holders of shares of listed non-voting common stock are not entitled to vote
generally on matters submitted for shareholder action, holders of any listed non-voting common stock
must receive all communications, including proxy material, sent generally to the holders of the voting
securities of the listed company.

(C) Preferred Stock, Minimum Voting Rights Required

Preferred stock, voting as a class, should have the right to elect a minimum of two directors upon
default of the equivalent of six quarterly dividends. The right to elect directors should accrue regardless
of whether defaulted dividends occurred in consecutive periods.
The right to elect directors should remain in effect until cumulative dividends have been paid in
full or until non-cumulative dividends have been paid regularly for at least a year. The preferred stock
quorum should be low enough to ensure that the right to elect directors can be exercised as soon as it
accrues. In no event should the quorum exceed the percentage required for a quorum of the common
stock required for the election of directors. The Exchange prefers that no quorum requirement be fixed in
respect of the right of a preferred stock, voting as a class, to elect directors when dividends are in default.
The Exchange recommends that preferred stock should have minimum voting rights even if the
preferred stock is not listed.

Increase in Authorized Amount or Creation of a Pari Passu Issue.—

 An increase in the authorized amount of a class of preferred stock or the creation

of a pari passu issue should be approved by a majority of the holders of the
outstanding shares of the class or classes to be affected. The Board of Directors
may increase the authorized amount of a series or create an additional series
ranking pari passu without a vote by the existing series if shareholders authorized
such action by the Board of Directors at the time the class of preferred stock was
created.

Creation of a Senior Issue—

 Creation of a senior equity security should require approval of at least two-thirds

of the outstanding preferred shares. The Board of Directors may create a senior
series without a vote by the existing series if shareholders authorized such action
by the Board of Directors at the time of the existing series of preferred stock was
created.
 A vote by an existing class of preferred stock is not required for the creation of a
senior issue if the existing class has previously received adequate notice of
redemption to occur within 90 days. However, the vote of the existing class
should not be denied if all or part of the existing issue is being retired with
proceeds from the sale of the new stock.

Alteration of Existing Provisions—

 Approval by the holders of at least two-thirds of the outstanding shares of a

preferred stock should be required for adoption of any charter or by-law
amendment that would materially affect existing terms of the preferred stock.

62
 If all series of a class of preferred stock are not equally affected by the proposed
changes, there should be a two-thirds approval of the class and a two-thirds
approval of the series that will have a diminished status.
 The charter should not hinder the shareholders' right to alter the terms of a
preferred stock by limiting modification to specific items, e.g., interest rate,
redemption price.

63
Chapter 5

CONVERTIBLE SECURITIES

§ 5.05 THE CONVERSION PREMIUM

Page 427, insert the following at the end of § 5.05.

Because of the urgent need of many financial firms for increased capital in the lead-up to the
2008 Credit Crises and the resulting negotiating leverage of investors, the use of a conversion premium
was abandoned in certain cases. For example, in August 2007, Bank of America purchased for $2 billion
shares of a nonvoting convertible preferred stock of Countrywide Financial Corporation. The dividend
rate was 7.25 percent, and the shares were convertible into shares of common stock of Countrywide at a
price of $18 per share at the same time the market price was $21.82. In July 2008, Bank of America
acquired all of the outstanding shares of common stock of Countrywide for $4.25 per share.

§ 5.07 INTERPRETATION AND EFFECT OF ANTI-DILUTION PROVISIONS

Page 428, insert the following immediately before the Conversion Adjustment Examples.
For the right of conversion to be meaningful, the investor must be assured either that the
amount and character of the security received upon conversion will remain stable or that
adjustments will be made to protect his investment should the attributes of this
underlying security be changed. To protect the convertible shareholder’s interest against
such changes in the underlying securities, "anti-dilution" clauses are generally included
as a matter of course in modem convertible securities or in the charter or indenture
creating them. In the absence of specific provisions to protect against dilution, there is a
great probability that narrow and literal interpretation of the contractual right to convert
would limit the right to precisely what was specified, without adjustment for subsequent
substantial changes in the attributes of the underlying security.
Stanley A. Kaplan, Piercing the Corporate Boilerplate: Anti-Dilution Clauses in Convertible Securities,
33 U. CHI. L. REV. 1, 2–3 (1965).
Page 460, insert the following as the first paragraph in the NOTE.
The Broad three-judge panel took a different view of the interplay between Section 4.11 and
Article 13 of the Collins Indenture than that of the en banc panel:
We do not think that on its face the Collins debenture agreement speaks with the requisite
clarity to the issue before us. To be sure, § 4.11 does deal in the most detail with the
conversion rights in the event of a merger, but § 4.11 does not specify a limitation on the
reach of the provisions of Article Thirteen, which protects the debenture holders against
any supplemental indenture which would adversely affect the interests of the debenture
holders."
614 F.2d at 428.
Section 913 of the New York Business Corporation Law (reproduced in Chapter 1, § 1.07),
provides for an acquisition technique known as a mandatory share exchange, which produces the same
result as a reverse triangular merger without the necessity of merging a subsidiary of the acquirer into the

64
target corporation. Because few, if any, anti dilution clauses refer to a mandatory share exchange, there is
the possibility that under the Parkinson rule conversion rights might be lost in such a transaction. For this
reason, Section 913(i)(2) provides: "With respect to convertible securities and other securities evidencing
a right to acquire shares of a subject corporation, a binding share exchange pursuant to this section shall
have the same effect on the rights of the holders of such securities as a merger of the subject corporation."

§ 5.08 EFFECT OF REDEMPTION UPON THE CONVERSION RIGHT

Page 520, insert the following immediately above § 5.09 STAND- BY PURCHASE AGREEMENTS.

MICKEL v. CONTINENTAL RESOURCES CO.

United States Court of Appeals, Second Circuit
758 F.2d 811 (1985)

CARDAMONE, CIRCUIT JUDGE.

The issue on this appeal is whether there was a genuine issue of disputed fact as to whether notice
of redemption was mailed to debenture holders advising them of their option to convert their debentures
into common stock by a certain date. Appellants, agents for several debenture holders, instituted an
action alleging that the holders failed to take advantage of the favorable conversion option because the
redemption notice was inadequate. The substance of their argument below was, in effect, that "a word to
the wise is sufficient," and since some holders did not act timely in their own best interests, the "word"
obviously must not have been sent. The district court found that the notice given fully satisfied the legal
obligations of those whose duty it was to give notice and granted summary judgment dismissing the
complaint. We affirm.

I
Plaintiffs-appellants are the nine general partners of J & W Seligman & Co. (Seligman or
Seligman partners), a New York brokerage firm, who brought suit in the United States District Court for
the Southern District of New York (Stewart, J.) against Florida Gas Company (Florida Gas) and its
successor Continental Resources Company and Florida Exploration Company (jointly referred to as
Continental) and against Citibank, N.A., defendants-appellees. The undisputed facts reveal that on April
1, 1969 Florida Gas issued $15,000,000 of 5 3/4% convertible, subordinated debentures, redeemable at
any time, due 20 years later in 1989. The conversion price was $23.41 per share of common stock.
Citibank agreed to act as trustee for the debenture holders and entered into an indenture agreement with
Florida Gas dated April 1, 1969. Both the indenture agreement and the debentures themselves provided
for notice to be given by a mailing. The debenture called for "notice by mail." Section 1105 of the
indenture stated.
Notice of redemption shall be given by first-class mail, postage prepaid, mailed not less than 30
nor more than 60 days prior to the Redemption Date, to each Holder of Debentures to be redeemed at his
last address appearing in the Debentures Register.
In June 1979 Continental Resources Company and Florida Gas agreed to merge. Incident to the
merger, Florida Gas voted to redeem all outstanding 1969 debentures. It thereupon instructed Citibank to
prepare and mail a redemption notice to debenture holders. The notice gave debenture holders until
August 20, 1979, to convert their debentures into common stock.
Citibank claims that on July 16, 1979 it sent the redemption notice by first-class mail to the
approximately 190 debenture holders. The market price of Florida Gas common stock on the New York
Stock Exchange at the end of July 1979 was $48 per share, more than double the $23.41 per share
conversion price available for debenture holders. As of August 20, 1979 slightly over one-half million
65
dollars in debentures remained unconverted and 54 holders of these instruments had not exercised their
conversion option. The Seligman partners sought to recover for the failure of three of their customers, for
whom they were acting as agents, to convert their $42,000 worth of debentures into common stock.
Seligman's damages arose from its voluntarily crediting these three customers' accounts for any losses
90
they may have sustained, and not from any direct loss Seligman incurred as a debenture holder.
The gravamen of the complaint is that defendants failed to provide adequate notice of
redemption. The Seligman partners allege breach of fiduciary duty, unjust enrichment, breach of the
indenture agreement and various violations of securities laws, including violation of Rule 10b-5. The
partners also claim that the indenture, which provided that notice of a redemption need only be sent by
first-class mail, is an unenforceable contract of adhesion. The complaint further asserts that Florida Gas
breached certain rules of the New York Stock Exchange (NYSE or Exchange) by failing to issue a press
release and provide general publicity concerning the redemption. Finally, the partners sought class
certification on behalf of all those debenture holders who did not timely convert.

II
The record before us demonstrates that on July 16, 1979 Florida Gas directed Citibank to call the
entire outstanding series of debentures, and that August 20, 1979 was set as the Redemption Date. In
response to this request, a Citibank employee sent a notice of redemption to each holder by first-class
mail, postage prepaid. Seligman was included in the mailing. Proof of mailing of the notice is
established by the affidavit of a Citibank employee who "caused" the notice to be mailed, and by the
affidavit and deposition of a Citibank manager who testified about the regular procedures Citibank used
to mail notices to debenture holders.
The manager's affidavit and deposition testimony described the procedures Citibank used to
assure proper mailing. After obtaining a mailing list from a computer registry, Citibank used four
methods to verify that the number of labels, envelopes, stuffed envelopes and stamped envelopes
conformed to the count of holders as of the record date. First, under the regular office procedure a
computer generates a complete set of mailing labels based upon Citibank's registry of debenture owners
and nominees. These labels are reviewed and matched against a separate printout. Second, after the
employees of the mail room label the envelopes by machine, the machine counts the number of envelopes
labeled and that number is checked against the number of labels delivered to the mail room. Third, a
different machine encloses a notice of redemption in each envelope, which is sealed and metered. The
number of envelopes sealed and metered is then compared with the number generated by the labeling
machine, the computer printout, and the number of labels generated. The final check is when the postage
meter is read to verify the number of envelopes to be mailed. The notices are then delivered to the Post
Office. Seligman does not contend that its name and address were not accurately reflected in the
computer registry. Nor is there evidence that any of the notices were returned to Citibank from the Post
Office. Out of approximately 190 debenture holders, 54, or almost 30%, failed to convert prior to the
redemption date.
Appellants' counsel conducted an informal survey of the 53 other debenture holders (in addition
to Seligman) who failed to convert. A copy of a class action complaint accompanied each questionnaire.
The purpose of the survey was to determine how many, if any, holders failed to convert because they had
not received the notice. Accepting the district court's characterization of the results of the survey, we find
that Seligman presented "an unsigned list of fourteen individual debenture holders, half of whom are
described as stating that they never received notice and half of whom are described as stating that they

                                                            
90
[1] Seligman, as the registered holder of the debentures holding them in its own name on behalf of its customers, had standing
to sue as the signatory agent of the holders. Fed. R. Civ. P. 17(a); Bache & Co. v. International Controls Corp., 324 F. Supp. 998,
1004-05 (S.D.N.Y.1971), aff'd 469 F.2d 696 (2d Cir.1972). . . .

66
have no recollection of receiving notice." Meckel v. Continental Resources Co., 586 F. Supp. 407, 409
(S.D.N.Y.1984).
On April 16, 1984 Judge Stewart issued a decision granting summary judgment to Continental
and Citibank. Id. at 411. He held that the indenture only required that the notice be sent by first-class
mail, that there was no genuine dispute of the fact that Citibank had made a proper mailing, that there was
no basis for imposing a duty higher than that imposed by the indenture, and that neither Florida Gas nor
Citibank was required to give actual notice. Accordingly, the district judge dismissed all of plaintiffs'
claims that were based on inadequate notice. Judge Stewart also dismissed the claims relating to alleged
violations of the Rules of the NYSE. He found that the Rules did not apply to these debentures because
they were neither listed for trading on the Exchange, nor the subject of a listing application, and held it
unnecessary to consider whether a private right of action exists under the Exchange rules. . . . Seligman's
appeal challenges . . the grant of summary judgment in favor of appellees Continental and Citibank and
the resulting dismissal of Seligman's complaint.

III
Six of the eight claims contained in Seligman's complaint are based on its argument that
defendants failed to give adequate notice of the redemption. First, appellants argue that the notice was
inadequate as a matter of law under the Trust Indenture Act. Seligman urges that Citibank's failure to go
beyond the terms of the Indenture-for example, by sending a follow-up mailing or using registered mail-
violated its obligation of reasonable care and skill under the Trust Indenture Act . . . . The indenture
provided that notice be given by first-class, postage prepaid mail. That is all the law required Citibank to
do.
Trust indentures are important mechanisms for servicing corporate debt and banks play an
essential role in the process that brings corporate financings to the public market. It is important that a
bank's obligations with respect to notice be limited to those agreed upon, subject only to the requirement
that the provision for notice be reasonable. That Congress recognized these significant economic
considerations is reflected in [Section 15](a)(1) of the Trust Indenture Act. This governing statute
specifically states that an "indenture . . . may provide that . . . the indenture trustee shall not be liable
except for the performance of such duties as are specifically set out in such indenture." Paragraph 6.01(a)
of the indenture states that "(1) the Trustee undertakes to perform such duties and only such duties as are
specifically set forth in this Indenture, and no implied covenant or obligation shall be read into this
Indenture against the Trustee. . . ." An indenture trustee is not subject to the ordinary trustee's duty of
undivided loyalty. Unlike the ordinary trustee, who has historic common-law duties imposed beyond
those in the trust agreement, an indenture trustee is more like a stakeholder whose duties and obligations
are exclusively defined by the terms of the indenture agreement. See Hazzard v. Chase National Bank,
159 Misc. 57, 287 N.Y.S. 541 (Sup. Ct. N.Y. Cty.1936), aff'd, 257 A.D. 950, 14 N.Y.S.2d 14 (1st Dep't
1939), aff'd, 282 N.Y. 652, 26 N.E.2d 801 (1940), cert. denied, 311 U.S. 708, 61 S. Ct. 319, 85 L. Ed. 460
(1940).
Second, Seligman claims that the indenture provision is an adhesion contract because it only
provides for notice by first-class mail, which, Seligman argues, is contrary to what a debenture holder
might reasonably expect. In our view the provision in the debentures that notice would be given "by
mail" was not inherently unfair or unreasonable and it satisfied the debenture holders' reasonable
expectations as to the notice that they would receive. The debentures provide that they "are subject to
redemption upon not less than 30 days notice by mail . . . at any time . . . at the election of [Florida Gas]"
Appellants argue that this provision is ambiguous and that, properly construed, the debentures require
more than a single first-class mailing of notice. They urge as authority Van Gemert v. Boeing Co., 520
F.2d 1373 (2d Cir.), cert. denied, 423 U.S. 947, 96 S. Ct. 364, 46 L. Ed.2d 282 (1975), which held that the
defendants were required to give notice which conformed to "the debenture holders' reasonable
expectations as to notice," id. at 1383. Such "reasonable expectations," appellants contend, required

67
defendants to mail notice by certified or registered mail, to make follow-up efforts to reach debenture
holders who did not convert, or to supplement mailed notice with published notice. This argument is
unpersuasive.
To begin, the debentures here were not ambiguous. They stated explicitly that notice would be
given "by mail." The contrast with the debentures at issue in Van Gemert is striking. Those debentures
contained no indication as to the type of notice of redemption that was to be provided. It was the total
lack of a notice provision in the debentures that we held necessary as a condition precedent to an
imposition of a duty to provide "reasonable" notice. Nor was the notice given here unreasonable. In Van
Gemert the notice actually given and found by us not conform to the debenture holders' reasonable
expectations was not notice sent by first-class mail, but rather notice given by publication in the Wall
Street Journal. In fact, we strongly implied that notice by mail would have been adequate. Id. at 1384
(suggesting that including notice in mailing of proxy materials would have been reasonable). Moreover,
appellants' argument that notice by mail is unconscionable because of the inequality of bargaining power
and the probability that notice will not be received is contradicted by the very source upon which it relies.
Note, Convertible Securities: Holder Who Fails to Convert Before Expiration of the Conversion Period,
54 Cornell L. Rev. 271, 279, 281 (1969) (recommending notice by mail). Therefore, even if the
debentures had not been explicit as the form of notice to be given, we would remain unconvinced that
notice given by first-class mail was unreasonable.
Third, Seligman attacks the legal sufficiency of Citibank's affidavits describing its regular office
procedures, which served as its sole proof of compliance with the mailing requirements. Appellants
contend that since Citibank did not submit an affidavit by a person with actual knowledge of the mailing
or the routine office procedure, defendants' proof was insufficient and did not entitle them to the
presumption of mailing and receipt. Appellants further argue that the employee's affidavit regarding her
"causing" the mailing and the manager's affidavit describing standard office procedures were deficient as
proof because neither affiant had personal knowledge, as Fed. R. Civ. P. 56(e) requires. They point out
that the manager admitted in his deposition that he was not familiar with the transaction at issue because
he "wasn't doing that work at the time." Similarly, the employee admitted that she had no recollection of
anything pertaining to Florida Gas. Moreover, appellants continue, this employee did not work in the
mailroom, go to the post office, state the procedures that were followed, and did not personally do the
mailing. While this argument has superficial appeal, it is contrary to New York law. In Bossuk v.
Steinberg, 58 N.Y.2d 916, 460 N.Y.S.2d 509, 447 N.E.2d 56 (1983), the Court of Appeals rejected the
argument that there was insufficient proof of mailing "because the . . . employee who actually did so was
not produced[,]" finding that "[t]he proof of the . . . regular course of business in this regard sufficed." Id.
at 919, 460 N.Y.S.2d 509, 447 N.E.2d 56. Thus, under New York law personal knowledge is required
only to establish regular office procedure, not the particular mailing. Here, the presence of such proof
establishes prima facie evidence of the mailing and creates a rebuttable presumption as to receipt.
Fourth, appellants deny that they received the notice and allege that other debenture holders' non-
receipt could be inferred from either their failure to convert or from their responses to the survey. New
York law holds that when, as here, there is proof of the office procedure followed in a regular course of
business, and these procedures establish that the required notice has been properly addressed and mailed,
a presumption arises that notice was received. The mere denial of receipt does not rebut that
presumption. There must be-in addition to denial of receipt-some proof that the regular office practice
was not followed or was carelessly executed so the presumption that notice was mailed becomes
unreasonable. See Nassau Insurance Co. v. Murray, 46 N.Y.2d 828, 829-30, 414 N.Y.S.2d 117, 386
N.E.2d 1085 (1978). Whether the sender's duty is to sound the drum-beat, send up the smoke signal, or
mail the notice, proof that he performed suffices, regardless of what the receiver heard, saw, or read.
Under Nassau, the controlling inquiry is only whether Citibank fulfilled its duty to send the notice, not
whether the holders received it.

68
 But there remains the question whether proof that notice was not received is evidence that it was
not mailed. One recent New York case rejected this obverse of the presumption of receipt upon proof of
mailing, and held that mere denial of receipt does not raise a question of fact as to mailing. See Engel v.
Lichterman, 95 A.D.2d 536, 544, 467 N.Y.S.2d 642 (2d Dep't 1983) (rejecting position advanced by
Gibbons, J., concurring and dissenting, that "if a letter were not received, then it should be presumed not
to have been properly mailed," id. at 551, 467 N.Y.S.2d 642). Thus, Seligman's mere denial of receipt is
not enough. Although appellants do not contest the adequacy of Citibank's regular office procedures, we
do not read the memorandum decision in Nassau or the majority's opinion in Engel to hold that direct
proof of divergence from routine procedure is the sole or exclusive means to rebut proof that notice was
mailed. We think that in the context of a mass mailing there may be circumstantial evidence rebutting
proof of mailing, without direct proof that the routine office procedure was either not followed or
carelessly carried out.
The district court found that the only grounds to find disputed issues of fact were the inferences
that might be drawn from the relatively small percentage of holders who converted and from the fact that
seven of those who did not convert stated that they had never received notice and seven stated that they
did not recall receiving notice. We agree with Judge Stewart that this evidence of lack of receipt is
insufficient to create an issue of fact regarding mailing. The burden to produce such proof, after
defendants demonstrated that they mailed the notice, fell to Seligman. See Fed. R. Civ. P. 56(e). In the
circumstances of the present case, few inferences can be drawn from the percentage who did not convert.
Many reasons-running the gamut from neglect to a belief that conversion will not be economically
advantageous at that time-may exist for a failure to convert. In fact, a number of the non-converting
debenture holders contacted in appellants' survey affirmatively stated that they had not converted even
though they had received the notice mailed by Citibank. Moreover, the evidence of some holders who
merely could not recall receipt is not the kind of proof that will defeat a presumption of mailing. Thus, it
would take more substantial proof than that present in this record to create a genuine issue of fact
warranting jury resolution of whether notice was properly sent.

IV
It is unnecessary for us to consider whether a private right of action exists under Section A2 of
the Rules of the NYSE because the district court properly held that as the Florida Gas debentures were not
listed for trading on the Exchange, Section A2 did not apply. See New York Stock Exchange Company
Manual, § A2 (Aug. 1, 1977) (NYSE Rules applicable only to securities listed on the NYSE and subject
to a listing agreement). Nor is there merit to appellants' argument that the debenture holders, as third
party beneficiaries of the NYSE Company Manual and the Florida Gas Listing Agreement, had a right to
published notice of the redemption. No suggestion that the contracting parties intended to benefit
Seligman can be gleaned from the NYSE Company Manual or the Florida Gas Listing Agreement. See
Port Chester Electrical Constr. Corp. v. Atlas, 40 N.Y.2d 652, 655, 389 N.Y.S.2d 327, 357 N.E.2d 983
(1976).
Finally, in view of our conclusion that appellants' claims are without merit, we find it unnecessary
to address Citibank's claims that Seligman's own office procedure for handling mail was the proximate
cause of its damages and that in any event Seligman would not have relied on the notice. . . .
Accordingly, the grant of summary judgment below is affirmed.

69
§ 5.12 POISON PILL PROVISIONS

Page 554, Insert the following after the NOTE.

VERSATA ENTERPRISES, INC v. SELECTICA, INC

Delaware Supreme Court
5 A.3d 586 (2010)

HOLLAND, JUSTICE:

This is an appeal from a final judgment entered by the Court of Chancery. On November 16,
2008 the Board of Directors of Selectica, Inc. ("Selectica") reduced the trigger of its "poison pill"
Shareholder Rights Plan from 15% to 4.99% of Selectica’s outstanding shares and capped existing
shareholders who held a 5% or more interest to a further increase of only 0.5% (the "NOL Poison Pill").
Selectica’s reason for taking such action was to protect the company’s net operating loss carryforwards
("NOLs"). When Trilogy, Inc. ("Trilogy") subsequently purchased shares above this cap, Selectica filed
suit in the Court of Chancery on December 21, 2008, seeking a declaration that the NOL Poison Pill was
valid and enforceable. On January 2, 2009, Selectica implemented the dilutive exchange provision (the
"Exchange") of the NOL Poison Pill, which reduced Trilogy’s interest from 6.7% to 3.3%, and adopted
another Rights Plan with a 4.99% trigger (the "Reloaded NOL Poison Pill"). Selectica then amended its
complaint to seek a declaration that the Exchange and the Reloaded NOL Poison Pill were valid.
Trilogy and its subsidiary Versata Enterprises, Inc. ("Versata") counterclaimed that the NOL
Poison Pill, the Reloaded NOL Poison Pill, and the Exchange were unlawful on the grounds that, before
acting, the Board failed to consider that its NOLs were unusable or that the two NOL poison pills were
unnecessary given Selectica’s unbroken history of losses and doubtful prospects of annual profits.
Trilogy and Versata also asserted that the NOL Poison Pill and the Reloaded NOL Poison Pill were
impermissibly preclusive of a successful proxy contest for Board control, particularly when combined
with Selectica’s staggered director terms. After trial, the Court of Chancery held that the NOL Poison
Pill, the Reloaded NOL Poison Pill, and the Exchange were all valid under Delaware law.
Trilogy and Versata now appeal and assert two claims of error. First, they contend that the Court
of Chancery erred in applying the Unocal test for enhanced judicial scrutiny when confronting what they
frame as a question of first impression. The issue (as framed by them) is: "what are the minimum
requirements for a reasonable investigation before the board of a never-profitable company may adopt a
[Rights Plan with a 4.99% trigger] for the ostensible purpose of protecting NOLs from an ‘ownership
change’ under Section 382 of the Internal Revenue Code?" Second, they submit that the Court of
Chancery erred in holding that the two NOL poison pills, either individually or in combination with a
charter-based classified Board, did not have a preclusive effect on the shareholders’ ability to pursue a
successful proxy contest for control of the Company’s board. We conclude that both arguments are
without merit.

***
Facts91
The Court of Chancery described this as a case about the value of net operating loss
carryforwards ("NOLs") to a currently profitless corporation, and the extent to which such a corporation

                                                            
91
[1] The facts are taken from the Court of Chancery's opinion.

70
may fight to preserve those NOLs. The Court of Chancery also provided a helpful overview of the
concepts surrounding NOLs, their calculation, and possible impairment.
NOLs are tax losses, realized and accumulated by a corporation, that can be used to shelter future
(or immediate past) income from taxation.92 If taxable profit has been realized, the NOLs operate either
to provide a refund of prior taxes paid or to reduce the amount of future income tax owed. Thus, NOLs
can be a valuable asset, as a means of lowering tax payments and producing positive cash flow. NOLs
are considered a contingent asset, their value being contingent upon the firm’s reporting a future profit or
having an immediate past profit.
Should the firm fail to realize a profit during the lifetime of the NOL (twenty years), the NOL
expires. The precise value of a given NOL is usually impossible to determine since its ultimate use is
subject to the timing and amount of recognized profit at the firm. If the firm never realizes taxable
income, at dissolution it’s NOLs, regardless of their amount, would have zero value.
In order to prevent corporate taxpayers from benefiting from NOLs generated by other entities,
Internal Revenue Code Section 382 establishes limitations on the use of NOLs in periods following an
"ownership change." If Section 382 is triggered, the law restricts the amount of prior NOLs that can be
used in subsequent years to reduce the firm’s tax obligations.93 Once NOLs are so impaired, a substantial
portion of their value is lost.
The precise definition of an "ownership change" under Section 382 is rather complex. At its most
basic, an ownership change occurs when more than 50% of a firm’s stock ownership changes over a
three-year period. Specific provisions in Section 382 define the precise manner by which this
determination is made. Most importantly for purposes of this case, the only shareholders considered
when calculating an ownership change under Section 382 are those who hold, or have obtained during the
testing period, a 5% or greater block of the corporation’s shares outstanding.

The Parties
Selectica, Inc. ("Selectica" or the "Company") is a Delaware corporation, headquartered in
California and listed on the NASDAQ Global Market. It provides enterprise software solutions for
contract management and sales configuration systems. Selectica is a micro-cap company with a
concentrated shareholder base: the Company’s seven largest investors own a majority of the stock, while
fewer than twenty-five investors hold nearly two-thirds of the stock.94
Trilogy, Inc. ("Trilogy") is a Delaware corporation also specializing in enterprise software
solutions. Trilogy stock is not publicly traded, and its founder, Joseph Liemandt, holds over 85% of the
stock. Versata Enterprises, Inc. ("Versata"), a Delaware corporation and a subsidiary of Trilogy, provides
technology powered business services to clients.
Before the events giving rise to this action, Versata and Trilogy beneficially owned 6.7% of
Selectica’s common stock. After they intentionally triggered Selectica’s Shareholder Rights Plan through
the purchase of additional shares, Versata’s and Trilogy’s joint beneficial ownership was diluted from
6.7% to approximately 3.3%.

                                                            
92
[2] NOLs may be carried backward two years and carried forward twenty years.
93
[3] The annual limitation on the use of past period NOLs following a change-in-control is calculated as the value of the firm's
equity at the time of the ownership change, multiplied by a published rate of return, the federal long term exemption rate.
94
[4] However, because of the Shareholder Rights Plan first instituted in 2003, no stockholder holds more than 15% of the
outstanding shares.

71
 James Arnold, Alan B. Howe, Lloyd Sems, Jim Thanos, and Brenda Zawatski are members of the
Selectica Board of Directors (the "Board").95 Zawatski and Thanos also served as Co-Chairs of the Board
during the events at issue in the case.96 In this role, they handled the day-to-day operations of the
Company, as Selectica had been without a Chief Executive Officer since June 30, 2008.

Selectica’s Historical Operating Difficulties

Since it became a public company in March 2000, Selectica has lost a substantial amount of
money and failed to turn an annual profit, despite routinely projecting near-term profitability. Its IPO
price of $30 per share has steadily fallen and now languishes below $1 per share, placing Selectica’s
market capitalization at roughly $23 million as of the end of March 2009. By Selectica’s own admission,
its value today "consists primarily in its cash reserves, its intellectual property portfolio, its customer and
revenue base, and its accumulated NOLs." By consistently failing to achieve positive net income,
Selectica has generated an estimated $160 million in NOLs for federal tax purposes over the past several
years.

Selectica’s Relationship with Trilogy

Selectica has had a complicated and often adversarial relationship with Trilogy, stretching back at
least five years. Both companies compete in the relatively narrow market space of contract management
and sales configuration. In April 2004, a Trilogy affiliate sued Selectica for patent infringement and
secured a judgment that required Selectica, among other things, to pay Trilogy $7.5 million. While their
suit was pending, in January 2005 Trilogy made an offer to buy Selectica for $4 per share in cash—a 20%
premium above the then-trading price—which Selectica’s Board rejected. Nevertheless, during March
and April of that year, a Trilogy affiliate acquired nearly 7% of Selectica’s common stock through open
market trades. In early fall 2005, Trilogy made another offer for Selectica’s shares at a 16%-23%
premium, which was also rejected.
In September 2006, a Trilogy-affiliated holder of Selectica stock sent a letter to the Board
questioning whether certain stock option grants had been backdated.97 The following month, Trilogy filed
another patent infringement lawsuit against Selectica. That action was settled in October 2007, when
Selectica agreed to a one-time payment of $10 million, plus an additional amount of not more than $7.5
million in subsequent payments to be made quarterly. In late fall 2006, Trilogy sold down its holdings in
Selectica.

Steel Partners
Steel Partners is a private equity fund that has been a Selectica shareholder since at least 2006 and
is currently its largest shareholder. One of Steel Partners’ apparent investment strategies is to invest in
small companies with large NOLs with the intent to pair the failing company with a profitable business in
order to reap the tax benefits of the NOLs. Steel Partners has actively worked with Selectica to calculate
and monitor the Company’s NOLs since the time of its original investment.
                                                            
95
[5] Alan Howe was elected to the Board on January 12, 2009, after the events at issue in this case. He has not been charged
with any breach of fiduciary duty and has not been served with process. Trilogy purports to name Howe as a Counterclaim-
Defendant solely "in order to afford [Trilogy] complete relief."
96
[6] On August 19, 2009, Thanos stepped down as Co-Chair and Zawatski became sole Chair of the Board and continued to
handle the Company's daily operations.
97
[7] A special committee empanelled by the Board ultimately concluded that certain options had, in fact, been backdated.
Consequently, Selectica was required to restate its financial statements to record additional stock-based compensation and related
tax effects for past option grants and incurred fees associated with the investigation in excess of $6.2 million. This episode also
led to the resignation of Selectica's then-Chairmen and Chief Executive Officer Stephen Bannion (who had been the Company's
Chief Financial Officer at the time of the grants of question) and the appointment of then-Director Robert Jurkowski to the Chief
Executive and Chair position.

72
 By early 2008, Steel Partners was advocating a quick sale of Selectica’s assets, leaving a NOL
shell that could be merged with a profitable operating company in order to shelter the profits of the
operating company. In October 2008, Steel Partners informed members of Selectica’s Board that it
planned to increase its ownership position to 14.9% just below the 15% trigger of the 2003 Rights Plan,
which it later did. Jack Howard, President of Steel Partners, lobbied for a Board seat twice in 2008, citing
his experience dealing with NOLs, but was rebuffed.

Selectica Investigates Its NOLs

In 2006, at the urging of Steel Partners, Selectica directed Alan Chinn, its outside tax adviser, to
perform a high-level analysis into whether its NOLs were subject to any limitations under Section 382 of
the Internal Revenue Code. Chinn concluded that five prior changes in ownership had caused the
forfeiture of approximately $24.6 million in NOLs. Selectica provided the results of this study to Steel
Partners, although not to any other Selectica shareholder.
In March 2007, again at Steel Partner’s recommendation, Selectica retained a second accountant
who specialized in NOL calculations, John Brogan of Burr Pilger & Mayer, LLP, to analyze the
Company’s NOLs more carefully and report on Chinn’s Section 382 analysis. Brogan had previously
analyzed the NOLs at other Steel Partners ventures. Brogan ultimately determined that Chinn’s
conclusions were erroneous.
The Company engaged Brogan to perform additional work on the topic of NOLs in June 2007.
One of Steel Partners’ employees, Avi Goodman, worked closely with Brogan on the matter, although
Brogan was working for and being paid by Selectica and received no compensation from Steel Partners.
Brogan’s draft letter opinion, concluding that the Company had not undergone an "ownership change" for
Section 382 purposes since 1999, was shared with Steel Partners, although again not with any other
outside investors.
In the fall of 2007, Brogan proposed a third, more detailed, Section 382 study, which Selectica’s
then-CEO, Robert Jurkowski, opposed. In February 2008, the Board voted against spending $40,000-
$50,000 to fund this Section 382 study. By July, however, the Board asked Brogan to update his study.
Brogan delivered the draft opinion that, as of March 31, 2008, the Company had approximately $165
million in NOLs. Brogan was later asked to advise the Board in the fall of 2008 on the updated status of
its NOLs when the Board moved to amend its Rights Plan.

Lloyd Sems Elected Director

In April 2008, the Board began interviewing candidates for an open board seat, giving preference
to the Company’s large stockholders. Selectica investor Lloyd Sems had previously expressed interest in
joining the Board and had sought support from certain shareholders, including Steel Partners, through
Howard, and Lloyd Miller, another large Selectica shareholder not affiliated with Steel Partners. Both
Miller and Howard wrote to the Board in support of Sems’ appointment, although Sems was already
favored by the Board by that time. In June 2008, Sems was appointed to the Board.
As large shareholders, Sems, Howard, and Miller had periodically discussed Selectica as early as
October 2007. At that time, Sems had e-mailed Howard, stating, "I wanted to get your opinion of how or
if you would like me to proceed with [Selectica]." Howard replied, "Lloyd [Miller] said he would call
you about [Selectica]." Both before and after his appointment to the Board, Sems discussed with Howard
and Miller a number of the proposals that Sems ultimately advocated as a director, including that
Selectica should buy back its stock, that Selectica should consider selling its businesses, that the NOLs
were important and should be preserved through the adoption of a Rights Plan with a 5% trigger, and that
Jurkowski should be removed as CEO.

73
 Selectica Restructures and Explores Alternatives
In early July 2008, after determining that the Company needed to change course, the Board
terminated Jurkowski as CEO and eliminated several management positions in the sales configuration
business. Later that month, prompted by the receipt of five unsolicited acquisition offers over the span of
a few weeks, the Board announced that it was in the process of selecting an investment banker
(ultimately, Jim Reilly of Needham & Company) to evaluate strategic alternatives for the Company and to
assist with a process that ultimately might result in the Company’s sale. In view of the potential sale, the
Board decided to forgo the expense of replacing Jurkowski and, instead, asked Zawatski and Thanos
jointly to assume the title of Co-Chair and to perform operational oversight roles on an interim basis.

The Needham Process

Needham has actively carried outs its task of evaluating Selectica’s strategic options since its
selection by the Board. Needham first discussed with the Board the various strategic choices that the
Company could take. These included a merger of equals with a public company, a reverse IPO or other
going-private transaction, the sale of certain assets, and the use of cash to acquire another company, as
well as stock repurchases or the issuance of dividends if Selectica decided to continue as an independent
public company in the absence of sufficient market interest for an acquisition.
In October 2008, Needham prepared an Executive Summary of the assets and operations of
Selectica and subsequently reached out to potential buyers, keeping in touch with various interested
parties throughout the remainder of the year and into the first part of 2009. By February 2009, at least
half a dozen parties had come forward with letters of intent and were in the process of meeting with
Selectica management and conducting due diligence in the Company, with Needham evaluating their
various proposals for the purchase of all or part of Selectica’s operations. As of April 2009, Selectica,
through Needham, had signed a letter of intent and entered into exclusive negotiations with a potential
buyer.

Trilogy’s Offers Rejected

On July 15, 2008, Trilogy’s President, Joseph Liemandt, called Zawatski to inquire generally
about the possibility of an acquisition of Selectica by Trilogy. On July 29, Trilogy Chief Financial
Officer Sean Fallon, Trilogy Director of Finance Andrew Price, and Versata Chief Executive Officer
Randy Jacobs participated in a conference call with Selectica Co-Chairs Zawatski and Thanos on the
same topic. During the call, Thanos inquired as to how Trilogy would calculate a value for the
Company’s NOLs. Fallon replied that Trilogy, "really [did not] pursue them with as much vigor as
other[s] might since that is not our core strategy."98
The following evening, Fallon contacted Zawatski and outlined two proposals for Trilogy to
acquire Selectica’s business: (1) Trilogy’s purchase of all of the assets of Selectica’s sales configuration
business in exchange for the cancellation of the $7.1 million in debt Selectica still owed under the
October 2007 settlement with Trilogy; or (2) Trilogy’s purchase of Selectica’s entire operations for the
cancellation of the debt plus an additional $6 million in cash. Fallon subsequently followed up with an
email reiterating both proposals and suggesting that either proposal would allow Selectica to still make
use of its NOLs through the later sale of its corporate entity.
Shortly thereafter, the Board rejected both proposals, made no counterproposal, and there were no
follow-up discussions. On October 9, 2008, Trilogy made a second bid to acquire all of the Selectica’s
assets for $10 million in cash plus the cancellation of the debt, which the Board also rejected. Although
                                                            
98
[8] However, as part of its 2005 effort to acquire Selectica, Trilogy had performed "a pretty detailed analysis" of Selectica’s
NOLs. Johnston testified that this analysis was occasionally updated and that similar analyses had been performed on a dozen or
so other acquisition targets.

74
Trilogy was invited to participate in the sale process being overseen by Needham, Trilogy was apparently
unwilling to sign a non-disclosure agreement, which was a prerequisite for participation. Around this
same time, Trilogy had begun making open-market purchases for Selectica stock, although the Board
apparently was not aware of this fact at the time.

Trilogy Buys Selectica Stock

On the evening of November 10, Fallon contacted Zawatski and informed her that Trilogy had
purchased more than 5% of Selectica’s outstanding stock and would be filing a Schedule 13D shortly,
which it did on November 13.99 On a subsequent call with Zawatski and Reilly, Fallon explained that
Trilogy had begun buying because it believed that "the company should work quickly to preserve
whatever shareholder value remained and that we were interested in seeing this process that they
announced with Needham, that we were interested in seeing that accelerate. . . ." Within four days of its
13D filing, Trilogy had acquired more than 320,000 additional shares, representing an additional 1% of
the Company’s outstanding shares.

NOL Poison Pill Adopted

In the wake of Trilogy’s decision to begin acquiring Selectica shares, the Board took actions to
gauge the impact of these acquisitions, if any, on the Company’s NOLs, and to determine whether
anything needed to be done to mitigate their effects. Sems immediately asked Brogan to revise his
Section 382 analysis—which had not been formally updated since July—to take into account the recent
purchases. The revised analysis was delivered to Sems and the Company’s new CFO, Richard Heaps, on
November 15. It showed that the cumulative acquisition of stock by shareholders over the past three
years stood at 40%, which was roughly unchanged from the previous calculation, due to some double
counting that occurred in the July analysis.100
The Board met on November 16 to discuss the situation and to consider amending Selectica’s
Shareholder Rights Plan, which had been in place since February 2003. As with many Rights Plans
employed as protection devices against hostile takeovers, Selectica’s Rights Plan had a 15% trigger. The
Board considered an amendment that would reduce that threshold trigger to 4.99% in order to prevent
additional 5% owners from emerging and potentially causing a change-in-control event, thereby
devaluing Selectica’s NOLs. Also present at the meeting were Heaps, Brogan, and Reilly, along with
Delaware counsel.
Heaps gave an overview of the Company’s existing Shareholder Rights Plan and reviewed the
stock price activity since Trilogy had filed its Schedule 13D, noting that shares totaling approximately
2.3% of the Company had changed hands in the two days following the filing. Brogan reviewed the
Section 382 ownership analysis that his firm had undertaken on behalf of the Company, noting that
additional acquisitions of roughly 10% of the float by new or existing 5% holders would "result in a
permanent limitation on use of the Company’s net operating loss carryforwards and that, once an
ownership change occurred, there would be no way to cure the use limitation on the net operating loss
carryforwards." He further advised the Board that "net operating loss carryforwards were a significant
asset" and that he generally advises companies to consider steps to protect their NOLs when they
experience a 30% or greater change in beneficial ownership. Lastly, Brogan noted that, while he believed
that the cumulative ownership change calculations would decline significantly over the next twelve
months, "it would decline only modestly, if at all, over the next three to four months," meaning that "the
Company would continue to be at risk of an ownership change over the near term."

                                                            
99
[9] The November 13, 2008, Schedule 13D reported that Versata and affiliates had purchased 1,437,891 shares of Selectica
stock, increasing its ownership to 5.1%.
100
[10] A more formal analysis was provided on November 26, finding a 38.8% change in ownership over the relevant period.

75
 Reilly discussed the Company’s strategic alternatives and noted that Steel Partners and other
parties had expressed interest in pursuing a transaction that would realize the value of Selectica’s NOLs.
He also reviewed potential transaction structures in which the Company might be able to utilize its NOLs.
Responding to questions from the Board, Reilly noted that "it is difficult to value the Company’s net
operating loss carryforwards with greater precision, because their value depends, among other things, on
the ability of the Company to generate profits." He confirmed that "existing stockholders may realize
significant potential value" from the utilization of the Company’s NOLs, which would be "significantly
impaired" if a Section 382 ownership change occurred.
At the request of the Board, Delaware counsel reviewed the Delaware law standards that apply
for adopting and implementing measures that have an anti-takeover effect. The Board then discussed
amending the existing Shareholder Rights Plan, and the possible terms of such an amendment. These
included: the pros and cons of providing a cushion for preexisting 5% holders, the appropriate effective
date of the new Shareholder Rights Plan, whether the Board should have authority to exclude purchases
by specific stockholders from triggering the Rights Plan, and whether a review process should be
implemented to determine periodically whether the Rights Plan should remain in effect.
The Board then unanimously passed a resolution amending Selectica’s Shareholder Rights Plan,
by decreasing the beneficial ownership trigger from 15% to 4.99%, while grandfathering in existing 5%
shareholders and permitting them to acquire up to an additional 0.5% (subject to the original 15% cap)
without triggering the NOL Poison Pill.
The Board resolution also established an Independent Director Evaluation Committee (the
"Committee") as a standing committee of the Board to review periodically the rights agreement at the
behest of the Board and to "determine whether the Rights [Plan] continues to be in the best interest of the
Corporation and its stockholders." The Committee was also directed to review "the appropriate trigger
percentage" of the Rights Plan based on corporate and shareholder developments, any broader
developments relating to rights plans generally—including academic studies of rights plans and contests
for corporate control—and any other factors it deems relevant. The Board set April 30, 2009, as the first
date that the Committee should report its findings.

Trilogy Triggers NOL Poison Pill

The Board publicly announced the amendment of Selectica’s Rights Plan on Monday, November
17. Early the following morning, Fallon e-mailed Trilogy’s broker, saying "[W]e need to stop buying
SLTC. They announced a new pill and we need to understand it." Fallon also sent Liemandt a copy of
Selectica’s 8-K containing the amended language of the NOL Poison Pill. Trilogy immediately sought
legal advice about the NOL Poison Pill. The following morning, Liemandt e-mailed Price, with a copy to
Fallon, asking, "What percentage of [Selectica] would we need to buy to ruin the tax attributes that [S]teel
[P]artners is looking for?"101 They concluded that they would need to acquire 23% to trigger a change-in-
control event.
Later that week, Trilogy sent Selectica a letter asserting that a Selectica contract with Sun
Microsystems constituted a breach of the October 2007 settlement and seeking an immediate meeting
with Selectica purportedly to discuss the breach, even though members of Trilogy’s management had
been on notice of the contract as early as July. Fallon, Liemandt, and Jacobs from Trilogy, along with
Zawatski, Thanos, and Heaps from Selectica met on December 17. The parties’ discussions at this
meeting are protected by a confidentiality agreement that had been circulated in advance. However,
Selectica contends that "based solely on statements and conduct outside that meeting, it is evident that

                                                            
101
[11] Liemandt testified that his question meant, "what is the amount that we can buy without hurting it, which is the other
way of asking, what's the amount you can buy to ruin it." Price testified, however, that he understood the question as being more
straightforward, specifically, "what percentage would we have to buy to trigger a change of control as per Section 382."

76
Trilogy threatened to trigger the NOL Poison Pill deliberately unless Selectica agreed to Trilogy’s
renewed efforts to extract money from the Company."
On December 18, Trilogy purchased an additional 30,000 Selectica shares, and Trilogy
management verified with Liemandt his intention to proceed with "buying through" the NOL Poison Pill.
The following morning, Trilogy purchased an additional 124,061 shares of Selectica, bringing its
ownership share to 6.7% and thereby becoming an "Acquiring Person" under the NOL Poison Pill.
Liemandt testified that the rationale behind triggering the pill was to "bring accountability" to the Board
and "expose" what Liemandt characterized as "illegal behavior" by the Board in adopting a pill with such
a low trigger. Fallon asserted that the reason for triggering the NOL Poison Pill was to "bring some
clarity and urgency" to their discussions with Selectica about the two parties’ somewhat complicated
relationship by "setting a time frame that might help accelerate discussions" on the direction of the
business.
Fallon placed a telephone call to Zawatski on December 19 to advise her that Trilogy had bought
through the NOL Poison Pill. During a return call by Zawatski later that evening, Fallon indicated that
Trilogy felt, based on the conversations from December 17, that Selectica no longer wanted Trilogy as a
shareholder or creditor. He then proposed that Selectica repurchase Trilogy’s shares, accelerate the
payment of its debt, terminate its license with Sun, and make a payment to Trilogy of $5 million "for
settlement of basically all outstanding issues between our companies." Zawatski recalled that Fallon told
her that Trilogy had triggered the pill "to get our attention and create a sense of urgency;" that, since the
Board would have ten days to determine how to react to the pill trigger, "it would force the board to make
a decision."

Board Considers Options and Requests a Standstill

The Selectica Board had a telephonic meeting on Saturday, December 20, to discuss Trilogy’s
demands and an appropriate response. The Board discussed "the desirability of taking steps to ensure the
validity of the Shareholder Rights Plan," and ultimately passed a resolution authorizing the filing of this
lawsuit, which occurred the following day. On December 22, Trilogy filed an amended Schedule 13D
disclosing its ownership percentage and again the Selectica Board met telephonically to discuss the
litigation. It eventually agreed to have a representative contact Trilogy to seek a standstill on any
additional open market purchases while the Board used the ten-day clock under the NOL Poison Pill to
determine whether to consider Trilogy’s purchases "exempt" under the Rights Plan, and if not, how
Selectica would go about implementing the pill.
The amended Rights Plan allowed the Board to declare Trilogy an "Exempt Person" during the
ten-day period following the trigger, if the Board determined that Trilogy would not "jeopardize or
endanger the availability to the Company of the NOLs. . . ." The Board could also decide during this
window to exchange the rights (other than those held by Trilogy) for shares of common stock. If the
Board did nothing, then after ten days the rights would "flip in" automatically, becoming exercisable for
$36 worth of newly-issued common stock at a price of $18 per right.
The Board met again by telephone the following day, December 23, to discuss the progress of the
litigation and to consider the potential impact of the various alternatives under the NOL Poison Pill. The
Board agreed to meet in person the following Monday, December 29, along with the Company’s
financial, legal, and accounting advisors, to evaluate further the available options. The Board also voted
to reduce the number of authorized directors from seven to five.
On Wednesday, December 24, the Board met once again by telephone upon learning that the
Company’s counsel had not succeeded in convincing Trilogy to agree to a standstill. The Board resolved
that Zawatski should call Fallon to determine whether Trilogy was willing "to negotiate a standstill
agreement that might make triggering the remedies available under the Shareholder Rights Plan, as
amended, unnecessary at this time." Zawatski spoke with Fallon on the morning of December 26. Fallon

77
stated that Trilogy did not want to agree to a standstill, that relief from the NOL Poison Pill was not
Trilogy’s goal, and that Trilogy expected that the NOL Poison Pill would apply to it. Fallon reiterated
that the ten-day window would help "speed [the] course" towards a resolution of their claims.
The Board and its advisors met again on December 29. Thanos provided an update on recent
developments at the Company, including financial results, management changes, and the Needham
Process, as well as an overview of the make-up of the Company’s shareholder base. Reilly then provided
a more detailed report on the status of the Needham Process. Thereafter, Brogan presented his firm’s
updated analysis of Selectica’s NOLs, which found that the Company had at least $160 million in NOLs
and that there had been a roughly 40% ownership change by 5% holders over the three-year testing
period. Since those were not expected to "roll off" in the near term, there was "a significant risk of a
Section 382 ownership change."
Brogan subsequently discussed the possible consequences of the two principal mechanisms for
implementing the triggered NOL Poison Pill to the change-in-control analysis. He stated that employing
a share exchange would not likely have a materially negative impact on the Section 382 analysis. He
expressed concern, however, about the uncertain effect of a flip-in pill on subsequent ownership levels
(specifically, the possibility that a flip-in pill would, itself, trigger a Section 382 ownership change).
Reilly once again addressed the Board to explain the ways he believed the NOLs would be valuable to the
Company in its ongoing exploration of strategic alternatives, and reiterated his opinion that an ownership
change would "reduce the value of the Company."
The Board also discussed Trilogy’s settlement demands. It found them "highly unreasonable"
and "lack[ing] any reasonable basis in fact," and that "it [was] not in the best interests of the Company
and its stockholders to accept Trilogy/Versata’s settlement demands relating to entirely separate
intellectual property disputes as a precondition to negotiating a standstill agreement to resolve this
dispute." The Board discussed Trilogy’s actions at some length, ultimately concluding that they "were
very harmful to the Company in a number of respects," and that "implementing the exchange was
reasonable in relation to the threat imposed by Trilogy." In particular, that was because (1) the NOLs
were seen as "an important corporate asset that could significantly enhance stockholder value," and (2)
Trilogy had intentionally triggered the NOL Poison Pill, publicly suggested it might purchase additional
stock, and had refused to negotiate a standstill agreement, even though an additional 10% acquisition by a
5% shareholder would likely trigger an ownership change under Section 382.
The Board then authorized Delaware counsel to contact Trilogy in writing, one final time, to seek
a standstill agreement. It also passed resolutions delegating the full power of the Board to the Committee
to determine whether or not to treat Trilogy or its acquisition as "exempt," and nominating Alan Howe as
a new member of the Board. On the evening of December 29, Selectica’s Delaware counsel e-mailed
Trilogy’s trial counsel at the Board’s instruction, seeking a standstill agreement "so that the Board could
consider either declaring them an ‘Exempt Person’ under the Rights Plan . . . or alternatively, settle the
litigation altogether in exchange for a long term agreement relating to your clients’ ownership of
additional shares." The following afternoon, Trilogy’s counsel responded that Trilogy was not willing to
agree to the proposed standstill.
Two days later, on December 31, the Board met telephonically and was informed of Trilogy’s
latest rejection of a standstill agreement. The Board discussed its options with its legal advisors and
ultimately concluded that the NOL Poison Pill should go into effect and that an exchange was the best
alternative and should be implemented as soon as possible in order to protect the NOLs, even at the risk
of disrupting common stock trading. The Board directed advisers to prepare a technical amendment to
the NOL Poison Pill to clarify the time at which the exchange would become effective.

78
 Board Adopts Reloaded Pill and Dilutes Trilogy Holdings
On January 2, the Board met telephonically once more, reiterating its delegation of authority to
the Committee to make recommendations regarding the implementation of the NOL Poison Pill. The
Board also passed a resolution expressly confirming that the Board’s delegation of authority to the
Committee included the power to effect an exchange of the rights under the NOL Poison Pill and to
declare a new dividend of rights under an amended Rights Plan (the "Reloaded NOL Poison Pill"). The
Board then adjourned and the Committee—comprised of Sems and Arnold—met with legal and financial
advisors, who confirmed that there had been no new agreement with representatives from Trilogy,
reiterated that the NOLs remained "a valuable corporate asset of the Company in connection with the
Company’s ongoing exploration of strategic alternatives," and advised the Committee members of their
fiduciary obligations under Delaware law.
Reilly presented information to the Committee about the current takeover environment and the
use of Rights Plans (specifically, the types of pills commonly employed and their triggering thresholds),
and reviewed the Company’s then-current anti-takeover defenses compared with those of other public
companies. Reilly stated that "a so-called NOL rights plan with a 4.99% trigger threshold is designed to
help protect against stock accumulations that would trigger an ‘ownership change,’ " and that
"implementing appropriate protections of the Company’s net operating loss carryforwards was especially
important at present," given Trilogy’s recent share acquisitions superimposed on the Company’s existing
Section 382 ownership levels. Finally, Reilly reviewed the proposed terms and conditions of the
Reloaded NOL Poison Pill, discussed the methodology for determining the exercise price of the new
rights, and made recommendations. The Committee sought and obtained reconfirmed assurances by its
financial and legal advisors that the NOLs were a valuable corporate asset and that they remained at a
significant risk of being impaired.
The Committee concluded that Trilogy should not be deemed an "Exempt Person," that its
purchase of additional shares should not be deemed an "Exempt Transaction," that an exchange of rights
for common stock (the "Exchange") should occur, and that a new rights dividend on substantially similar
terms should be adopted. The Committee passed resolutions implementing those conclusions, thereby
adopting the Reloaded NOL Poison Pill and instituting the Exchange.
The Exchange doubled the number of shares of Selectica common stock owned by each
shareholder of record, other than Trilogy or Versata, thereby reducing their beneficial holdings from 6.7%
to 3.3%. The implementation of the Exchange led to a freeze in the trading of Selectica stock from
January 5, 2009 until February 4, 2009, with the stock price frozen at $0.69. The Reloaded NOL Poison
Pill will expire on January 2, 2012, unless the expiration date is advanced or extended, or unless these
rights are exchanged or redeemed by the Board some time before.

ANALYSIS
Unocal Standard Applies
In Unocal, this Court recognized that "our corporate law is not static. It must grow and develop
in response to, indeed in anticipation of, evolving concepts and needs."102 The Court of Chancery
concluded that the protection of company NOLs may be an appropriate corporate policy that merits a
defensive response when they are threatened. We agree.
The Unocal two part test is useful as a judicial analytical tool because of the flexibility of its
application in a variety of fact scenarios.103 Delaware courts have approved the adoption of a Shareholder
Rights Plan as an antitakeover device, and have applied the Unocal test to analyze a board’s response to

                                                            
102
[12] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 957 (Del.1985). [Reproduced on page 650 of the casebook.]
103
[13] Paramount Communications, Inc. v. Time, Inc., 571 A.2d 1140, 1153 (Del.1990).

79
an actual or potential hostile takeover threat.104 Any NOL poison pill’s principal intent, however, is to
prevent the inadvertent forfeiture of potentially valuable assets, not to protect against hostile takeover
attempts.105 Even so, any Shareholder Rights Plan, by its nature, operates as an antitakeover device.
Consequently, notwithstanding its primary purpose, a NOL poison pill must also be analyzed under
Unocal because of its effect and its direct implications for hostile takeovers.

Threat Reasonably Identified

The first part of Unocal review requires a board to show that it had reasonable grounds for
concluding that a threat to the corporate enterprise existed. The Selectica Board concluded that the NOLs
were an asset worth preserving and that their protection was an important corporate objective. Trilogy
contends that the Board failed to demonstrate that it conducted a reasonable investigation before
determining that the NOLs were an asset worth protecting. We disagree.
The record reflects that the Selectica Board met for more than two and a half hours on
November 16. The Court of Chancery heard testimony from all four directors and from Brogan, Reilly,
and Heaps, who also attended that meeting and advised the Board. The record shows that the Board first
analyzed the NOLs in September 2006, and sought updated Section 382 analyses from Brogan in March
2007, June 2007, and July 2008. At the November 16 meeting, Brogan advised the Board that the NOLs
were a "significant asset" based on his recently updated calculations of the NOLs’ magnitude. Reilly, an
investment banker, similarly advised the Board that the NOLs were worth protecting given the possibility
of a sale of Selectica or its assets. Accordingly, the record supports the Court of Chancery’s factual
finding that the Board acted in good faith reliance on the advice of experts106 in concluding that "the
NOLs were an asset worth protecting and thus, that their preservation was an important corporate
objective."
The record also supports the reasonableness of the Board’s decision to act promptly by reducing
the trigger on Selectica’s Rights Plan from 15% to 4.99%. At the November 16 meeting, Brogan advised
the Board that the change-of-ownership calculation under Section 382 stood at approximately 40%.
Trilogy’s ownership had climbed to over 5% in just over a month, and Trilogy intended to continue
buying more stock. There was nothing to stop others from acquiring stock up to the 15% trigger in the
Company’s existing Rights Plan. Once the Section 382 limitation was tripped, the Board was advised it
could not be undone.
At the November 16 meeting, the Board voted to amend Selectica’s existing Rights Plan to
protect the NOLs against a potential Section 382 "change of ownership." It reduced the trigger of its
Shareholders Rights Plan from 15% to 4.99% and provided that existing shareholders who held in excess
of 4.99% would be subject to dilutive consequences if they increased their holdings by 0.5%. The Board
also created the Review Committee (Arnold and Sems) with a mandate to conduct a periodic review of
the continuing appropriateness of the NOL Poison Pill.
The Court of Chancery found the record "replete with evidence" that, based upon the expert
advice it received, the Board was reasonable in concluding that Selectica’s NOLs were worth preserving

                                                            
104
[14] Moran v. Household Int'l, Inc., 500 A.2d 1346, 1356 (Del.1985).
105
[15] The Court of Chancery found that "typically, companies with large NOLs would not be at risk of takeover attempts if the
NOLs are the company's principal asset, as the takeover would likely trigger a change in control and impair the asset."
106
[16] The Delaware General Corporation Law Section § 141(e), states:
A member of the board of directors, or a member of any committee designated by the board of directors,
shall, in the performance of such member's duties, be fully protected in relying in good faith . . . upon such
information, opinions, reports or statements presented to the corporation . . . by any other person as to matters
the member reasonably believes are within such other person's professional or expert competence and who
has been selected with reasonable care by or on behalf of the corporation.
Del.Code Ann. tit. 8, § 141(e) (2010).

80
and that Trilogy’s actions presented a serious threat of their impairment. The Court of Chancery
explained those findings, as follows:
The threat posed by Trilogy was reasonably viewed as qualitatively different from the
normal corporate control dispute that leads to the adoption of a shareholder rights plan.
In this instance, Trilogy, a competitor with a contentious history, recognized that harm
would befall its rival if it purchased sufficient shares of Selectica stock, and Trilogy
proceeded to act accordingly. It was reasonable for the Board to respond, and the timing
of Trilogy’s campaign required the Board to act promptly. Moreover, the 4.99%
threshold for the NOL Poison Pill was driven by our tax laws and regulations; the
threshold, low as it is, was measured by reference to an external standard, one created
neither by the Board nor by the Court [of Chancery]. Within this context, it is not for the
Court [of Chancery] to second-guess the Board’s efforts to protect Selectica’s NOLs.
Those findings are not clearly erroneous.107 They are supported by the record and the result of a logical
deductive reasoning process.108 Accordingly, we hold that the Selectica directors satisfied the first part of
the Unocal test by showing "that they had reasonable grounds for believing that a danger to corporate
policy and effectiveness existed because of another person’s stock ownership."109

Selectica Defenses Not Preclusive

The second part of the Unocal test requires an initial evaluation of whether a board’s defensive
response to the threat was preclusive or coercive and, if neither, whether the response was "reasonable in
relation to the threat" identified.110 Under Unitrin, a defensive measure is disproportionate and
unreasonable per se if it is draconian by being either coercive or preclusive.111 A coercive response is one
that is "aimed at ‘cramming down’ on its shareholders a management-sponsored alternative."112
A defensive measure is preclusive where it "makes a bidder’s ability to wage a successful proxy
contest and gain control either ‘mathematically impossible’ or ‘realistically unattainable.’"113 A successful
proxy contest that is mathematically impossible is, ipso facto, realistically unattainable. Because the
"mathematically impossible" formulation in Unitrin is subsumed within the category of preclusivity
described as "realistically unattainable," there is, analytically speaking, only one test of preclusivity:
"realistically unattainable."
Trilogy claims that a Rights Plan with a 4.99% trigger renders the possibility of an effective
proxy contest realistically unattainable. In support of that position, Trilogy argues that, because a proxy
contest can only be successful where the challenger has sufficient credibility, the 4.99% pill trigger
prevents a potential dissident from signaling its financial commitment to the company so as to establish
such credibility. In addition, Professor Ferrell, Trilogy’s expert witness, testified that the 5% cap on
ownership exacerbates the free rider problem already experienced by investors considering fielding an
insurgent slate of directors, and makes initiating a proxy fight an economically unattractive proposition.114
                                                            
107
[17] Homestore, Inc. v. Tafeen, 888 A.2d 204, 217 (Del.2005).
108
[18] Levitt v. Bouvier, 287 A.2d 671, 673 (Del.1972).
109
[19] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d at 955 (citing Cheff v. Mathes, 199 A.2d at 554-55).
110
[20] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d at 955.
111
[21] Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d at 1387.
112
[22] Id. at 1387 (citing Paramount Communications, Inc. v. Time, Inc., 571 A.2d at 1154-1155 (Del.1990)). There are no
allegations contended that the NOL Poison Pill, the Exchange, and the Reloaded NOL Poison Pill are coercive.
113
[23] Carmody v. Toll Bros., Inc., 723 A.2d 1180, 1195 (Del.Ch.1998)(quoting Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d at
1389).
114
[24] According to Professor Ferrell, the free rider problem is that, even if an investor believes that replacing the board would
result in a material benefit to shareholders, the investor has to bear the full cost of a proxy fight while only receiving her

81
 This Court first examined the validity of a Shareholder Rights Plan in Moran v. Household
International, Inc.115 In Moran the Rights Plan at issue had a 20% trigger.116 We recognized that, while a
Rights Plan "does deter the formation of proxy efforts of a certain magnitude, it does not limit the voting
power of individual shares."117 In Moran, we concluded that the assertion that a Rights Plan would
frustrate proxy fights was "highly conjectural" and pointed to "recent corporate takeover battles in which
insurgents holding less than 10% stock ownership were able to secure corporate control through a proxy
contest or the threat of one."118
The 5% trigger that is necessary for a NOL poison pill to serve its primary objective imposes a
lower threshold than the Rights Plan thresholds that have traditionally been adopted and upheld as
acceptable anti-takeover defenses by Delaware courts. Selectica submits that the distinguishing feature of
the NOL Poison Pill and Reloaded NOL Poison Pill—the 5% trigger—is not enough to differentiate them
from other Rights Plans previously upheld by Delaware courts, and that there is no evidence that a
challenger starting below 5% could not realistically hope to prevail in a proxy contest at Selectica. In
support of those arguments Selectica presented expert testimony from Professor John C. Coates IV and
Peter C. Harkins.
Professor Coates identified more than fifty publicly held companies that have implemented NOL
poison pills with triggers at roughly 5%, including several large, well-known corporations, some among
the Fortune 1000. Professor Coates noted that 5% Rights Plans are customarily adopted where issuers
have "ownership controlled" assets, such as the NOLs at issue in this case. Professor Coates also testified
that Selectica’s 5% Rights Plan trigger was narrowly tailored to protect the NOLs because the relevant tax
law, Section 382, measures ownership changes based on shareholders who own 5% or more of the
outstanding stock.
Moreover, and as the Court of Chancery noted, shareholder advisory firm RiskMetrics Group
now supports Rights Plans with a trigger below 5% on a case-by-case basis if adopted for the stated
purpose of preserving a company’s net operating losses.119 The factors RiskMetrics will consider in
determining whether to support a management proposal to adopt a NOL poison pill are the pill’s trigger,
the value of the NOLs, the term of the pill, and any corresponding shareholder protection mechanisms in
place, such as a sunset provision causing the pill to expire upon exhaustion or expiration of the NOLs.120
Selectica expert witness Harkins of the D.F. King & Co. proxy solicitation firm analyzed proxy
contests over the three-year period ending December 31, 2008. He found that of the fifteen proxy
contests that occurred in micro-cap companies where the challenger controlled less than 5.49% of the
outstanding shares, the challenger successfully obtained board seats in ten contests, five of which
involved companies with classified boards.121 Harkins opined that Selectica’s unique shareholder profile
would considerably reduce the costs associated with a proxy fight, since seven shareholders controlled
                                                                                                                                                                                                
proportionate fraction of the benefit bestowed upon shareholders. Professor Ferrell testified that, along with the reduced
likelihood of success at a 5% position, the capped position would mean that the challenger would be unable to internalize more of
the benefits by increasing her share ownership.
115
[25] Moran v. Household Int'l, Inc., 500 A.2d 1346, 1356 (Del.1985).
116
[26] Id. at 1355.
117
[27] Id.
118
[28] Id. This Court additionally noted that "many proxy contests are won with an insurgent ownership of less than 20%," and
that "the key variable in proxy contest success is the merit of an insurgent's issues, not the size of his holding." Id.
119
[29] Coates' Report at 11 (citing Simpson Thacher & Bartlett, LLP, Client Memo: Rights Plans Offer Special Benefits for
Companies Whose Market Capitalization Has Declined to $500 Million or Below (2009), available at
www.stblaw.com/content/Publications/pub795.pdf and RiskMetrics Group, U.S. Proxy Guidelines Concise Summary (Digest of
Selected Key Guidelines) (2009), www.riskmetrics.com/sites/default/files/2009RMGUSPolicyConciseSummaryGuideline.pdf).
120
[30] Id.
121
[31] There were eight such contests at micro-cap companies in which the challenging shareholder held less than 4.99% of the
outstanding shares. Challengers prevailed in six of these contests, including at three companies that had classified boards.

82
55% of Selectica’s shares, and twenty-two shareholders controlled 62%. Harkins testified that "if you
have a compelling platform, which is critical, it would be easy from a logistical perspective; and from a
cost perspective, it would be de minimis expense to communicate with those investors, among others."
Harkins noted that to win a proxy contest at Selectica, one would need to gain only the support of owners
of 43.2% plus one share.122
The Court of Chancery concluded that the NOL Poison Pill and Reloaded NOL Poison Pill were
not preclusive. For a measure to be preclusive, it must render a successful proxy contest realistically
unattainable given the specific factual context. The record supports the Court of Chancery’s factual
determination and legal conclusion that Selectica’s NOL Poison Pill and Reloaded NOL Poison Pill do
not meet that preclusivity standard.
Our observation in Unitrin is also applicable here: "[I]t is hard to imagine a company more
readily susceptible to a proxy contest concerning a pure issue of dollars."123 The key variable in a proxy
contest would be the merit of the bidder’s proposal and not the magnitude of its stockholdings.124 The
record reflects that Selectica’s adoption of a 4.99% trigger for its Rights Plan would not preclude a hostile
bidder’s ability to marshal enough shareholder votes to win a proxy contest.
Trilogy argues that, even if a 4.99% shareholder could realistically win a proxy contest "the
preclusiveness question focuses on whether a challenger could realistically attain sufficient board control
to remove the pill." Here, Trilogy contends, Selectica’s charter-based classified board effectively
forecloses a bid conditioned upon a redemption of the NOL Poison Pill, because it requires a proxy
challenger to launch and complete two successful proxy contests in order to change control. Therefore,
Trilogy argues that even if a less than 5% shareholder could win a proxy contest, Selectica’s Rights Plan
with a 4.99% trigger in combination with Selectica’s charter-based classified board, makes a successful
proxy contest for control of the board "realistically unattainable."
Trilogy’s preclusivity argument conflates two distinct questions: first, is a successful proxy
contest realistically attainable; and second, will a successful proxy contest result in gaining control of the
board at the next election? Trilogy argues that unless both questions can be answered affirmatively, a
Rights Plan and a classified board, viewed collectively, are preclusive. If that preclusivity argument is
correct, then it would apply whenever a corporation has both a classified board and a Rights Plan,
irrespective whether the trigger is 4.99%, 20%, or anywhere in between those thresholds.
Classified boards are authorized by statute125 and are adopted for a variety of business purposes.
Any classified board also operates as an antitakeover defense by preventing an insurgent from obtaining
control of the board in one election.126 More than a decade ago, in Carmody, the Court of Chancery noted
"because only one third of a classified board would stand for election each year, a classified board would
delay—but not prevent—a hostile acquiror from obtaining control of the board, since a determined
                                                            
122
[32] Trilogy rejects Selectica's position that due to the concentrated shareholder base, one could simply pick up the phone and
call the shareholders, because Steel Partners, Director Sems, and Lloyd Miller owned 23.5% of Selectica's stock at the time.
Thus, their opposition would result in having to conduct a traditional proxy contest. However, twenty-two shareholders own a
combined 62% of the stock. If the 23.5% owned by Steel Partners, Sems, and Miller are subtracted from 62%, that leaves 38.5%
of Selectica owned by nineteen shareholders. Those nineteen shareholders plus the 4.99% amount allowed before triggering the
pill would equal 43.49% of Selectica's shares, an amount slightly in excess of what Harkins testified would be needed to win a
proxy contest.
123
[33] Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d at 1383.
124
[34] Id.
125
[35] Del. Code Ann. tit. 8, § 141(d) (2010).
126
[36] MM Companies, Inc. v. Liquid Audio, Inc., 813 A.2d 1118, 1122 (Del.2003) (citing Lucian Arye Bebchuk, John C.
Coates, IV & Guhan Subramanian, The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy, 54
Stanford L. Rev. 887 (2002)). See also Martin Lipton, Pills, Polls and Professors Redux, 69 U. Chi. L. Rev. 1037, 1059 (2002),
& John C. Coates IV, Takeover Defenses in the Shadow of the Pill: A Critique of the Scientific Evidence, 79 Tex. L.Rev. 271,
328-29 (2000).

83
acquiror could wage a proxy contest and obtain control of two thirds of the target board over a two year
period, as opposed to seizing control in a single election."127 The fact that a combination of defensive
measures makes it more difficult for an acquirer to obtain control of a board does not make such measures
realistically unattainable, i.e., preclusive.128
In Moran, we rejected the contention "that the Rights Plan strips stockholders of their rights to
receive tender offers, and that the Rights Plan fundamentally restricts proxy contests."129 We explained
that "the Rights Plan will not have a severe impact upon proxy contests and it will not preclude all hostile
acquisitions of Household."130 In this case, we hold that the combination of a classified board and a
Rights Plan do not constitute a preclusive defense.131

Range of Reasonableness
If a defensive measure is neither coercive nor preclusive, the Unocal proportionality test
"requires the focus of enhanced judicial scrutiny to shift to ‘the range of reasonableness.’"132 Where all of
the defenses "are inextricably related, the principles of Unocal require that such actions be scrutinized
collectively as a unitary response to the perceived threat."133 Trilogy asserts that the NOL Poison Pill, the
Exchange, and the Reloaded NOL Poison Pill were not a reasonable collective response to the threat of
the impairment of Selectica’s NOLs.
The critical facts do not support that assertion. On November 20, within days of learning of the
NOL Poison Pill, Trilogy sent Selectica a letter, demanding a conference to discuss an alleged breach of a
patent settlement agreement between the parties. The parties met on December 17, and the following day,
Trilogy resumed its purchases of Selectica stock.
Fallon testified that he and Liemandt had a discussion wherein Fallon advised Liemandt that
Trilogy had purchased additional shares, but not enough to trigger the NOL Poison Pill. Fallon then
asked if Liemandt really wanted to trigger the pill, and Liemandt expressly directed Fallon to proceed.
On December 19, 2008, Trilogy bought a sufficient number of shares to become an "Acquiring Person"
under the NOL Poison Pill. According to Fallon, this was done to "‘bring some clarity and urgency’ to
Trilogy’s discussions with Selectica about the two parties’ somewhat complicated relationship by ‘setting
a time frame that might help accelerate discussions’ on the direction of the business."
Fallon described Trilogy’s relationship with Selectica as a "three-legged stool," referring to
Trilogy’s status as a competitor, a creditor, and a stockholder of Selectica. The two companies had settled
prior patent disputes in 2007 under terms that included a cross-license of intellectual property and
quarterly payments from Selectica to Trilogy based on Selectica’s revenues from certain products.
Selectica argues that Trilogy took the unprecedented step of deliberately triggering the NOL Poison Pill—
exposing its equity investment of under $2 million to dilution—primarily to extract substantially more
value for the other two "legs" of the stool.

                                                            
127
[37] Carmody v. Toll Bros., Inc., 723 A.2d at 1186 n. 17 (emphasis added).
128
[38] In re Gaylord Container Corp. Shareholders Litig., 753 A.2d 462, 482 (Del.Ch.2000).
129
[39] Moran v. Household Int'l, Inc., 500 A.2d at 1357.
130
[40] Id. at 1356 (emphasis added).
131
[41] We note that Selectica no longer has a classified Board. After trial, the Selectica Board amended its charter to eliminate
its staggered board structure. On October 15, 2009 the Court of Chancery granted Trilogy's Second Motion for Judicial Notice,
which requested the court to take judicial notice of the Selectica proxy statement that referenced the foregoing charter
amendment eliminating the staggered board terms.
132
[42] Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d at 1388 (quoting Paramount Communications, Inc. v. QVC Network, Inc., 637
A.2d 34, 45-46 (Del.1994)).
133
[43] Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d at 1387 (citing Gilbert v. El Paso Co., 575 A.2d 1131, 1145 (Del.1990)).

84
 Trilogy’s deliberate trigger started a ten business day clock under the terms of the NOL Poison
Pill. If the Board took no action during that time, then the rights (other than those belonging to Trilogy)
would "flip-in" and become exercisable for deeply discounted common stock. Alternatively, the Board
had the power to exchange the rights (other than those belonging to Trilogy) for newly-issued common
stock, or to grant Trilogy an exemption. Three times in the two weeks following the triggering, Selectica
offered Trilogy an exemption in exchange for an agreement to stand still and to withdraw its threat to
impair the value and usability of Selectica’s NOLs. Three times Trilogy refused and insisted instead that
Selectica repurchase its stock, terminate a license agreement with an important client, sign over
intellectual property, and pay Trilogy millions of dollars. After three failed attempts to negotiate with
Trilogy, it was reasonable for the Board to determine that they had no other option than to implement the
NOL Poison Pill.
The Exchange employed by the Board was a more proportionate response than the "flip-in"
mechanism traditionally envisioned for a Rights Plan. Because the Board opted to use the Exchange
instead of the traditional "flip-in" mechanism, Trilogy experienced less dilution of its position than a
Rights Plan is traditionally designed to achieve.
The implementation of the Reloaded NOL Poison Pill was also a reasonable response. The
Reloaded NOL Poison Pill was considered a necessary defensive measure because, although the NOL
Poison Pill and the Exchange effectively thwarted Trilogy’s immediate threat to Selectica’s NOLs, they
did not eliminate the general threat of a Section 382 change-in-control. Following implementation of the
Exchange, Selectica still had a roughly 40% ownership change for Section 382 purposes and there was no
longer a Rights Plan in place to discourage additional acquisitions by 5% holders. Selectica argues that
the decision to adopt the Reloaded NOL Poison Pill was reasonable under those circumstances. We
agree.
The record indicates that the Board was presented with expert advice that supported its ultimate
findings that the NOLs were a corporate asset worth protecting, that the NOLs were at risk as a result of
Trilogy’s actions, and that the steps that the Board ultimately took were reasonable in relation to that
threat.134 Outside experts were present and advised the Board on these matters at both the November 16
meeting at which the NOL Poison Pill was adopted and at the Board’s December 29 meeting. The
Committee also heard from expert advisers a third time at the January 2 meeting prior to instituting the
Exchange and adopting the Reloaded NOL Poison Pill.
Under part two of the Unocal test, the Court of Chancery found that the combination of the NOL
Poison Pill, the Exchange, and the Reloaded NOL Poison Pill was a proportionate response to the
threatened loss of Selectica’s NOLs. Those findings are not clearly erroneous.135 They are supported by
the record and the result of a logical deductive reasoning process.136 Accordingly, we hold that the
Selectica directors satisfied the second part of the Unocal test by showing that their defensive response
was proportionate by being "reasonable in relation to the threat" identified.137

Context Determines Reasonableness

Under a Unocal analysis, the reasonableness of a board’s response is determined in relation to the
"specific threat," at the time it was identified.138 Thus, it is the specific nature of the threat that "sets the
parameters for the range of permissible defensive tactics" at any given time.139 The record demonstrates
                                                            
134
[44] Del. Code Ann. tit. 8, § 141(e) (2010).
135
[45] Homestore, Inc. v. Tafeen, 888 A.2d at 217.
136
[46] Levitt v. Bouvier, 287 A.2d at 673.
137
[47] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d at 955.
138
[48] See, e.g., Moran v. Household Int'l, Inc., 500 A.2d at 1354.
139
[49] Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d at 1384.

85
that a longtime competitor sought to increase the percentage of its stock ownership, not for the purpose of
conducting a hostile takeover but, to intentionally impair corporate assets, or else coerce Selectica into
meeting certain business demands under the threat of such impairment. Only in relation to that specific
threat have the Court of Chancery and this Court considered the reasonableness of Selectica’s response.
The Selectica Board carried its burden of proof under both parts of the Unocal test. Therefore, at
this time, the Selectica Board has withstood the enhanced judicial scrutiny required by the two part
Unocal test. That does not, however, end the matter.140
As we held in Moran, the adoption of a Rights Plan is not absolute.141 In other cases, we have
upheld the adoption of Rights Plans in specific defensive circumstances while simultaneously holding that
it may be inappropriate for a Rights Plan to remain in place when those specific circumstances change
dramatically. The fact that the NOL Poison Pill was reasonable under the specific facts and
circumstances of this case, should not be construed as generally approving the reasonableness of a 4.99%
trigger in the Rights Plan of a corporation with or without NOLs.142
To reiterate Moran, "the ultimate response to an actual takeover bid must be judged by the
Directors’ actions at that time."143 If and when the Selectica Board "is faced with a tender offer and a
request to redeem the [Reloaded NOL Poison Pill], they will not be able to arbitrarily reject the offer.
They will be held to the same fiduciary standards any other board of directors would be held to in
deciding to adopt a defensive mechanism."144 The Selectica Board has no more discretion in refusing to
redeem the Rights Plan "than it does in enacting any defensive mechanism."145 Therefore, the Selectica
Board’s future use of the Reloaded NOL Poison Pill must be evaluated if and when that issue arises.146

***
Conclusion
The judgment of the Court of Chancery [is] affirmed.
 

                                                            
140
[50] Moran v. Household Int'l, Inc., 500 A.2d at 1357.
141
[51] Id. at 1354.
142
[52] Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d at 1378 (citing Moran v. Household Int'l, Inc., 500 A.2d at 1355 and Revlon,
Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 179 (Del.1986)).
143
[53] Moran v. Household Int'l, Inc., 500 A.2d at 1357.
144
[54] Id. at 1354.
145
[55] Id.
146
[56] Id. at 1357.

86