Corporate Governance

SV Investment Partners, LLC v. ThoughtWorks, Inc.: Court Interprets "Funds Legally Available" for Redemption

By Sana Hamelin

In SV Investment Partners, LLC v. ThoughtWorks, Inc., 7 A.3d 973 (Del. Ch. 2010), preferred shareholders sought to enforce a mandatory redemption of their shares.  The provison required redemption from "funds legally available."  Preferred shareholders filed a declaratory action asserting that the phrase meant "surplus" and that the company was obligated to redeem the shares. 

The Court of Chancery, however, rejected this interpretation, holding that "funds legally available" meant cash that was "available" (cash on hand or readily accessible through sales or borrowing) and that could be deployed "legally" for redemptions without violating state or common law restrictions on redemptions.  See Del. Code Ann. Title 8, § 160.

In 2000, SV Investment Partners, LLC ('SVIP') invested $ 26.6 million in ThoughtWorks, Inc. ('ThoughtWorks') in exchange for 2,970,917 shares of preferred stock.  ThoughtWorks' certificate of incorporation contained a provision that granted SVIP the right to have all of its shares of preferred stock redeemed for cash five years after their issuance from funds "legally available," subject to a one-year working capital carve-out.  In the absence of legally available funds, the redemption requirement was "continuous.' Any funds made that became legally available after exercise of the the redemption right were to be applied until the preferred stock was fully redeemed.

After the dot-com bubble burst, ThoughtWorks concluded it could not redeem the preferred stock in April 2005, and SVIP agreed to postpone exercising its redemption rights until July 5, 2005.  On that date, SVIP duly exercised its right.  The Board, however, concluded that it had no usable cash to redeem the preferred share.  A year later, in August 2006, SVIP again exercised its redemption right. In response, the Board obtained legal and financial advice and determined that ThoughtWorks had $500,000 of funds legally available and redeemed preferred stock in that amount.  In each of the subsequent sixteen quarters, the Board followed the same process to determine the extent to which funds were legally available for redemptions. Through this quarterly process, ThoughtWorks redeemed a total of $4.1 million of preferred stock. 

SVIP filed suit seeking redemption of the remaining shares.  SVIP argued that the phrase "funds legally available" was equivilant to "surplus." Under Delaware law, a corporation's surplus would be legally available for the redemption of its stock.  At trial, SVIP's expert used three standard business valuation methods to determine the amount of ThoughtWorks' surplus, with all three methods producing surplus in excess of the amount necessary to redeem all of the preferred stock.

The court disagreed with SVIP's assertion that "funds legally available" meant "surplus."  Reliance on surplus entailed the use of an 'accounting convention' rather than a true appraisal of ThoughtWorks' assets.  Such an interpretation would have required a redemption whenever surplus existed, even if the effect was to render the company insolvent.  As a result, not all 'surplus' funds were 'funds legally available.' SVIP's claim therefore failed as a matter of law.

SVIP also failed to prove at trial that the Board ever (i) acted in bad faith in determining whether ThoughtWorks had legally available funds, (ii) relied on methods and data that were unreliable, or (iii) made determinations so far off the mark as to constitute actual or constructive fraud.  The court was impressed with the diligence of ThoughtWorks' Board in determining the amount of funds legally available for redemption, noting its consultations with financial and legal advisors and frequent evaluations of the business. Finding the Board's process 'impeccable,' the court concluded that the Board had acted responsibly to fulfill its contractual commitment to the holders of the preferred stock, and was not obligated to redeem the stock in full.

The court's opinion concluded by pointing out that SVIP could have protected itself and "avoided its current fate" but chose not to.  As the court described: 

• SVIP easily could have protected its investment and avoided its current fate through any number of means.  SVIP decided not to, and that choice was rational at the time.  SVIP bought the Preferred Stock at the height of the dot-com mania from a technology firm with an established track record, real revenues, and actual earnings – all of which compared favorably with many issuers then embarking on over-subscribed and first-day-popping IPOs.  Everyone involved anticipated that ThoughtWorks soon would go   public at a multi-billion dollar valuation. Instead, the bubble burst. Now, with hindsight, SVIP understandably wishes it had additional rights, but 'it is not the proper role of a court to rewrite or supply omitted provisions to a written agreement.'

The primary materials for this post may be found on the DU Corporate Governance website.

Full post as published by The Race to the Bottom on March 22, 2011 (boomark / email).