7-1

Chapter 7 Preferred Stock

7-2

• Preferred like debt and sometimes like equity.

• Dividend– Rate– Cumulative or not– Participating

• Liquidation Preference– Include accrued dividends?

• Voting– Board Seat– Special Events

• Conversion

7-3

• Corporate Debt is a creature of contract.

• What is Preferred Stock?

• RMBCA § 7.21(a) - Voting Entitlement of Shares 7-4

• (a) Except as provided in subsections (b) and (c) or unless the articles of incorporation provide otherwise, each outstanding share, regardless of class, is entitled to one vote on each matter voted on at a shareholders’ meeting. Only shares are entitled to vote.

• Del. § 212(a) Voting Rights of Stockholders: Proxies; Limitations

• (a) Unless otherwise provided in the certificate of incorporation and subject to the provisions of section 213 of this title, each stockholder shall be entitled to one vote for each share of capital stock held by such stockholder. If the certificate of incorporation provides for more or less than one vote for any share on any matter, every reference in this chapter to a majority or other proportion of the stock shall refer to such majority or other proportion of the votes of such stock.

• RMBCA § 6.01. Authorized Shares 7-5

• (b) The articles of incorporation must authorize: • (1) One or more classes or series of shares that together have unlimited

voting rights; and • (2) One or more classes or series of shares (which may be the same

class or classes as those with voting rights) that together are entitled to receive the net assets of the corporation upon dissolution.

• (c) The articles of incorporation may authorize one or more classes or series of shares that:

• (1) Have special, conditional, or limited voting rights, or no right to vote, except to the extent prohibited by this Act;

• (2) Are redeemable or convertible as specified in the articles of incorporation:

• (i) At the option of the corporation, the shareholder, or another person or upon the occurrence of a specified event;

• (ii) For cash, indebtedness, securities, or other property; and • (iii) At prices and amounts specified, or determined in accordance

with a formula; • (3) Entitle the holders to distributions calculated in any manner, including

dividends that may be cumulative, noncumulative, or partially cumulative; or • (4) Have preference over any other class or series of shares with respect

to distributions, including distributions upon the dissolution of the corporation.

Del. § 151(a). Classes and Series of Stock; Rights, etc. 7-6

• (a) Every corporation may issue 1 or more classes of stock or 1 or more series of stock within any class thereof, . . . and which classes or series may have such voting powers, full or limited, or no voting powers, and such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof, as shall be stated and expressed in the certificate of incorporation or of any amendment thereto, or in 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. Any of the voting powers, designations, preferences, rights and qualifications, limitations or restrictions of any such class or series of stock may be made dependent upon facts ascertainable outside the certificate of incorporation or of any amendment thereto, or outside the resolution or resolutions providing for the issue of such stock …. provided that the manner in which such facts shall operate upon the voting powers, designations, preferences, rights and qualifications, limitations or restrictions of such class or series of stock is clearly and expressly set forth in the certificate of incorporation or in the resolution or resolutions providing for the issue of such stock adopted by the board of directors. * * *

• Del. § 151(g) 7-7

• (g) 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 . . . 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 . . ., 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 and shall become effective, in accordance with § 103 of this title. * * * A certificate which (1) states that no shares of the class or series have been issued, (2) sets forth a copy of the resolution or resolutions and (3) if the designation of the class or series is being changed, indicates the original designation and the new designation, shall be executed, acknowledged and filed and shall become effective, in accordance with § 103 of this title. When any certificate filed under this subsection becomes effective, it shall have the effect of amending the certificate of incorporation; . . . .

Model Act, § 6.02 7-8

• (a) If the articles of incorporation so provide, the board of directors is authorized, without shareholder approval, to:

• (1) classify any unissued shares into one or more classes or into one or more series within a class, * * *

• (b) If the board of directors acts pursuant to subsection (a), it must determine the terms, including the preferences, rights and

limitations, to the same extent permitted under section 6.01of:

• (1) any class of shares before the issuance of any shares of that class, or

• (2) any series within a class before the issuance of any shares of that series.

• (c) Before issuing any shares of a class or series created under this section, the corporation must deliver to the secretary of state for filing articles of amendment setting forth the terms determined

under subsection (a).

• Del. § 104. Certificate of incorporation; definition 7-9

• The term "certificate of incorporation," as used in this chapter, unless the context requires otherwise, includes not only the original certificate of incorporation filed to create a corporation but also all other certificates, agreements of merger or consolidation, plans of reorganization, or other instruments, howsoever designated, which are filed pursuant to §§ 102, 133-136, 151, 241-243, 245, 251-258, 263-264, 303, or any other section of this title, and which have the effect of amending or supplementing in some respect a corporation's original certificate of incorporation.

• § 245. Restated certificate of incorporation • (a) A corporation may, whenever desired, integrate into a single

instrument all of the provisions of its certificate of incorporation which are then in effect and operative as a result of there having theretofore been filed with the Secretary of State 1 or more certificates or other instruments pursuant to any of the sections referred to in § 104 of this title, . . . by adopting a restated certificate of incorporation.

• (b) If the restated certificate of incorporation merely restates and integrates but does not further amend the certificate of incorporation, as theretofore amended or supplemented by any instrument that was filed pursuant to any of the sections mentioned in § 104 of this title, it may be adopted by the board of directors without a vote of the stockholders, . . . .

7-10

Constantin Cases• The Third Circuit decision holds that the

dividends were mandatory if earned, while the New Jersey decision makes payment contingent on a declaration, using as authority a board resolution.

• RMBCA § 6.40 Distributions to Shareholders 7-11

• (a) A board of directors may authorize and the corporation may make distributions to its shareholders subject to restriction by the articles of incorporation and the [solvency] limitation in subsection (c).

• Del. § 170. Dividends; Payment; Wasting Asset Corporations

• (a) The directors of every corporation, subject to any restrictions contained in the certificate of incorporation, may declare and pay dividends upon the shares of its capital stock … either (1) out of its surplus, as defined and computed in accordance with sections 154 and 244 of this title, 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.

L. L. Constantin & Co. Preferred Terms 7-12

• “The holders of the preferred stock shall be entitled to receive, and the Company shall be bound to pay thereon, but only out of the net profits of the Company, a fixed yearly dividend of Fifty Cents (50 cents) per share, payable semi-annually.”

L. L. Constantin & Co. Preferred Terms 7-13

1.How would a court be likely to decide the dispute over Constantin’s dividend obligations under RMBCA §§6.40 and 8.01(b)?

RMBCA § 6.40 7-14

• (a) A board of directors may authorize and the corporation may make distributions to its shareholders subject to restriction by the articles of incorporation and the limitation in subsection (c).

• (b) If the board of directors does not fix the record date for determining shareholders entitled to a distribution (other than one involving a purchase, redemption, or other reacquisition of the corporation's shares), it is the date the board of directors authorizes the distribution.

• (c) No distribution may be made if, after giving it effect:

– (1) The corporation would not be able to pay its debts as they become due in the usual course of business; or

– (2) The corporation's total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise) the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution.***

Directors’ Authority 7-15

• RMBCA §8.01. Requirement for and Duties of Board of Directors

• “(b) All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed by or under the direction of, its board of directors, subject to any limitation set for in the articles of incorporation or in an agreement authorized under section 7.32.”

• *

Constantin 7-16

2. How would the Delaware courts be likely to decide this question under Del. Gen. Corp. L. §§ 141 and 170?

Directors’ Authority 7-17

• Del. § 141:

• (a) The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. * *

Directors’ Authority 7-18

• Del. GCL § 170(a) provides:• (a) The directors of every corporation, subject to any restrictions

contained in its certificate of incorporation, may declare and pay dividends upon the shares of its capital stock, or to its members if the corporation is a nonstock corporation, either (1) out of its surplus, as defined in and computed in accordance with §§ 154 and 244 of this title, 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, computed in accordance with §§ 154 and 244 of this title, 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 capital represented by the issued and outstanding stock 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 of any classes of its capital stock until the deficiency in the amount of capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets shall have been repaired. Nothing in this subsection shall invalidate or otherwise affect a note, debenture or other obligation of the corporation paid by it as a dividend on shares of its stock, or any payment made thereon, if at the time such note, debenture or obligation was delivered by the corporation, the corporation had either surplus or net profits as provided in clause (1) or (2) of this subsection from which the dividend could lawfully have been paid.

Constantin 7-19

3. Why would a company commit to a preferred stock with a dividend that was mandatory if earned? Why not issue corporate bonds instead?

Constantin 7-20

3. Why would a company commit to a preferred stock with a dividend that was mandatory if earned? Why not issue corporate bonds instead?

• The tax treatment might explain it. A corporate holder might prefer dividends to interest.

• Preferred stock can be given voting rights, while debt only gets negative covenants.

Constantin 7-21

4. Assuming that there is an ambiguity in the Constantin language governing dividends on the preferred stock, would the following provisions resolve that ambiguity?

Alternative Dividend Language 7-22

• “The holders of first preferred shares will be entitled to receive semiannually or quarterly all net earnings of the corporation determined and declared as dividends in each fiscal year up to but not exceeding ___ percent per annum on all outstanding first preferred shares before any dividend will be set apart or paid upon any other shares of the company.”

• “Dividends upon the Series B Preferred Stock shall be paid out of funds legally available therefore, annually beginning on August 1, 2001, at the rate per annum of $.27 per share (annually the "Mandatory Dividend") and collectively the "Mandatory Dividends"). In addition, commencing on August 1, 2001, the holders of Series B Preferred Stock shall be entitled to receive, out of funds legally available therefore, additional annual dividends at the rate per annum of $.27 per share (the “Elective Dividend" and collectively the "Elective Dividends"), when, as and if declared by the Board of Directors. Elective and Mandatory Dividends (the "Series B Accruing Dividends") shall accrue from day to day, whether or not earned or declared, and shall be cumulative, from August 1, 2001.”

FNX Articles

Guttman v. Illinois Central Railroad Co. 7-24

• A preferred shareholder sued to stop the payment of 1950 dividends to the common stock, without payment of arrearages on preferred.

• Trial Court apparently denied relief. Affirmed.

• Charter provision:

Illinois Central Dividend Provision 7-25

• Dividends at 7% “out of the surplus or net profits of the Company, in each fiscal year...as shall be determined by the Board of Directors..... No dividends shall be paid, ... on the common... in any fiscal year, unless the full dividend on the preferred stock for such year shall have been paid or provided for.”

FNX

Guttman 7-27

• No dividends were paid 1932-1948.

• In 1937-1948 the company annually had sufficient profits to pay preferred dividends.

• But the board took a cautious position and didn’t pay any dividends.

• Can the Board declare and pay a dividend on the common in 1950, after declaring a dividend on the preferred for 1950, without paying arrearages? Yes.

Guttman 7-28

1. What justifies passing preferred non-cumulative dividends when the company has sufficient profits to declare and pay them?

Guttman 7-29

1. What justifies passing preferred non-cumulative dividends when the company has sufficient profits to declare and pay them?

• A justifiable application of profits to capital improvements or other uses.

• This is the business judgment rule.

Guttman 7-30

2. Is there any limit on the kinds of investments of profits a company can make when it passes on preferred dividends?

Guttman 7-31

2. Is there any limit on the kinds of investments of profits a company can make when it passes on preferred dividends?

• No. The court declines to distinguish between kinds of capital outlays the board can make. It uses the example of a purchase of land that turns out not to be needed. When it sells the land, it does not owe back dividends.

Guttman 7-32

3. Does this mean the board has complete discretion about paying preferred non-cumulative dividends, as long as it acts in good faith?

Guttman 7-33

3. Does this mean the board has complete discretion about paying preferred non-cumulative dividends, as long as it acts in good faith?

• Yes. This is really the Business Judgment Rule.

Guttman 7-34

4. Why doesn’t the court exercise its equitable powers to provide some rights to passed dividends, when past profits are available?

Guttman 7-35 4. Because a contract is a contract is a contract.

Preferred shareholders are not wards of the judiciary, “like sailors or idiots or infants.”

• Because of the position of preferred shareholders when dividends are non-cumulative, most contracts provide some protection for preferred.

• Typically this is the right to elect directors, if preferred doesn’t normally have that right.

• NYSE Listed Company Manual, §703.05D requires giving preferred the power to elect at least 2 directors if 6 quarterly dividends are passed.

• This is common practice, after missing 4 to 6 quarterly dividends.

FNX 7-36 4. As converted voting with the common and some special

class votes.

Guttman 7-37

5. Does the statement of the board’s discretion to omit dividends on preferred stock differ in any significant way from the rule for common stock that you can discern?

Guttman 7-38 5. Yes, in one sense.• Citing Wabash Ry. Co. v. Barclay, the court held

that once non-cumulative dividends had passed, the board had no discretion to pay any more than the current year’s dividend.

• With common stock, the board can pay as large or small a dividend as it chooses.

• In another sense, there is little difference between common and preferred. So long as the board has uses for the funds.

• The court rejected a proposed rule that would only have allowed the board to pass preferred dividends if it had investments in tangible property.

Guttman 7-39

6. Recall the rules of interpretation for corporate bonds set forth in Metropolitan Life Insurance Company v. RJR Nabisco, Inc., 716 F. Supp. 1504 (S.D.N.Y. 1989) in Chapter Six, Part 3.A. Does this opinion suggest rules governing interpretation of preferred stock contracts are closer to those of corporate debt or common stock? Does any rationale suggest itself for such an approach?

Guttman 7-40 • The court emphasizes the contract language,

suggesting that the preferred’s rights are largely, if not exclusively, contractual.

• Note the statement that the court is “interpreting a contract into which uncoerced men entered.” - page 463.

• “...it may not be inappropriate to paraphrase a modern poet and to say that ‘a contract is a contract is a contract.’” - page 463.

• The fact that it may be a bad contract doesn’t empower the court to revise it. - page 464.

•

Guttman 7-41 • The court doesn’t discuss any rationale for its

result, but there are several possible reasons.• (1) Imposing a rule that is fact intensive – that

depends on the particular type of “worthy” investments made by the board – would reduce certainty for investors.

• (2) Most preferred stock is held by corporate & institutional investors today, because of the dividends received tax deduction, and they, like Metropolitan Life, are able to look out for themselves.

Guttman 7-42

• Straight preferred is very risky. Board can pass dividends for years than pay the stated dividend and a massive common dividend which has been storing up.

New Jersey’s Dividend Credit Rule 7-43

• Doctrinal rationale: “Non-cumulative” only means that if there are no earnings in a year, the opportunity for a preferred dividend for that year is lost. - Dohme v. Pacific Coast Co., 5 N.J.Super. 477, 68 A.2d 490 (1949).

• When directors fail to declare a dividend in a year in which there are profits, shareholders have an “inchoate right” to a dividend from those profits, before dividends are declared on the common. Id.

• Policy rationale: “There seems to be little doubt that equitable factors did play a significant part in the development of New Jersey’s doctrine.” - Sanders v. Cuba Railroad Co., 21 N.J. 78, 120 A.2d 849, 852 (1956).

• If the common stockholders can pass on preferred dividends for a few years “without any dividend credit consequences, then the preferred stockholders will be substantially at the mercy of others who will be under temptation to act in their own self-interest.”

New Jersey’s Dividend Credit Rule 7-44

• No other jurisdictions have followed this rule!!!

Hay v. Hay –Preference Clause 7-45

• “(a) The holders of the preferred stock shall be entitled to receive, when and as declared by the Board of Trustees of this Corporation, cumulative dividends thereon . . . At the rate of six (6%) per annun and no more, payable out of the surplus profits of this Corporation annually … before any dividend shall be paid or set apart for the common stock . . . .”

• “(d) In the event of any liquidation, dissolution or winding up of the Corporation the holders of the preferred stock shall be entitled to be paid in full the par value thereof, and all accrued unpaid dividends thereon before any sum shall be paid to or any assets distributed among the holders of the common stock, but after payment to the holders of the preferred stock of the amounts payable to them as hereinbefore provided, the remaining assets and funds of the Corporation shall be paid to and distributed among the holders of the common stock.”

Hay v. Hay –Preference Clause 7-46

• The company never declared and preferred dividends and never had any surplus from which dividends could have been paid.

• Question: Is the preferred entitled to payment of passed dividends? Yes.

Hay v. Hay 7-47

1. The dissenting judge stated that “the capital stock or assets of The Big Bend Land Company belong to the common stockholders.” What does he mean by this?

Hay v. Hay 7-48

1.The dissenting judge stated that “the capital stock or assets of The Big Bend Land Company belong to the common stockholders.” What does he mean by this?

• It’s hard to know. Corporations are nexuses of contractual relationships, in Jensen & Meckling’s language.

• In dissent, Judge Grady seems to be working with a default model that starts with common stockholders, who then cede certain rights to other claimants, which are to be interpreted strictly against them.

Hay v. Hay 7-49

2. The dissenting judge also stated that if there were profits and “dividends were made, but were not paid to the stockholder ... he would have a preference right over common stockholders later to have them paid to him. Such dividends would be the property of the corporation, and when ultimately paid would not be as dividends, but as corporate funds.” What does he mean by this?

Hay v. Hay 7-50

2. First, he misstates the legal status of the preferred shareholder once a dividend is paid. They becomes creditors.

• He seems to compound the error when he says the dividend is the “property of the corporation,” when the preferred shareholder is a creditor.

Hay v. Hay 7-51

3. The dissenting judge interpreted the language of the relevant charters as requiring payment on dissolution of only declared but unpaid dividends. If declared dividends are a liability of the company, how meaningful is such a provision?

Hay v. Hay 7-52

3. The dissenting judge interpreted the language of the relevant charters as requiring payment on dissolution of only declared but unpaid dividends. If declared dividends are a liability of the company, how meaningful is such a provision?

• It’s trivial at best. Once declared, preferred dividends are a liability and the preferred shareholders are creditors. As such, in bankruptcy their claims are creditors’ claims, entitled to a priority over the common in all respects.

• Further, directors never declare dividends unless they intend to pay them immediately.

Hay v. Hay 7-53

4. Modern statutes, such as the RMBCA, contain no legal capital requirements: shares need not have par value, no part of the price paid for shares must be segregated as “capital,” and prohibitions on dividends under §6.40(c) are couched solely in terms of insolvency, rather than impairment of “capital.” What effect would incorporation under such a statute have on the reasoning of the two sides in this case?

Hay v. Hay 7-54

4. Under the Model Act creditor protection is achieved by insolvency rules, not by legal capital rules.

• There is no prohibition against declaring dividends when there are no net profits.

• So long as creditors aren’t jeopardized.

• Just as at dissolution, the only rule is that creditors must be paid first.

Hay v. Hay 7-55

5. If you wished to draft language for a corporate charter that would convince a court that undeclared past dividends were intended to be paid on liquidation, how would you write it?

Hay v. Hay 7-56

5. Avoid reference to dividends to which the preferred holders may be “entitled.”

• In Matter of Dissolution of Chandler & Co., 230 N.Y.S.2d 1012 (Sup. 1962), the charter provided that preferred shareholders were entitled to “One Hundred Dollars ($100), and also accrued dividends, before any amount shall be paid on account of the Second Preferred Stock and Common Stock.”

• The court held that cumulative dividends “accrued” regardless of declaration.

Deere & Co. 7-57 • “2.2 DEFINITIONS• “2.21 The term "arrearages," whenever used in connection with

dividends on any share If preferred stock, shall refer to the condition that exists as to dividends, to the extent that they are cumulative (either unconditionally, or conditionally to the extent that the conditions have been fulfilled), on such share which shall not have been paid or declared and set apart for payment to the date or for the period indicated; but the term shall not refer to the condition that exists as to dividends, to the extent that they are non-cumulative, on such share which shall not have been paid or declared and set apart for payment.

• 2.4 LIQUIDATION RIGHTS• “2.41 In the event of any liquidation, dissolution or winding up of

the corporation, whether voluntary or involuntary, the holders of preferred stock of each series shall be entitled to receive the full preferential amount fixed by the certificate of incorporation or any amendment thereto, or by the resolutions of the board of directors providing for the issue of such series, including any arrearages in dividends thereon to the date fixed for the payment in liquidation, before any distribution shall be made to the holders of any stock junior to the preferred stock. After such payment in full to the holders of the preferred stock, the remaining assets of the corporation shall then be distributable exclusively among the holders of any stock junior to the preferred stock outstanding, according to their respective interests.”

Adolor Liquidation Preference 7-58

• “4. Preference on Liquidation. In the event of the voluntary or involuntary liquidation, dissolution or winding up of the Corporation, holders of each series of Preferred Stock will be entitled to receive the amount fixed for such series plus, in the case of any series on which dividends will have been determined by the board of directors to be cumulative, an amount equal to all dividends accumulated and unpaid thereon to the date of final distribution whether or not earned or declared before any distribution shall be paid, or set aside for payment, to holders of Common Stock.”

Krispy Kreme Liquidation Preference 7-59

• “SECTION 6. LIQUIDATION, DISSOLUTION OR WINDING UP. Upon any liquidation, dissolution or winding up of the Corporation, no distribution shall be made (1) to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock unless, prior thereto, the holders of shares of Series A Preferred Stock shall have received $1.00 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment; ...”

EOG Resources Liquidation Preference 7-60

• “6. Liquidation Preference.• • “(a) Upon the dissolution, liquidation or winding up of the

Corporation, voluntary or involuntary, the holders of the then outstanding shares of Series B Senior Preferred Stock shall be entitled to receive and be paid out of the assets of the Corporation available for distribution to its stockholders, before any payment or distribution of assets shall be made on the Common Stock, the Junior Preferred Stock or any other class of stock of the Corporation ranking junior to the Series B Senior Preferred Stock upon liquidation, the amount of $1,000.00 per share, plus an amount equal to the sum of all accrued and unpaid dividends (whether or not earned or declared) on such shares to the date of final distribution.”

EOG Resources Liquidation Preference 7-61

•

Smith v. Nu-West 7-62

• Nu-West redeemed its Class A preferred stock on Dec. 13, 1996.

• It paid $100 plus accrued and unpaid dividends through Dec. 31, 1995, but nothing for 1996.

• Does the charter require dividends to be accrued and paid for a partial year to the date of redemption? Yes.

Nu-West’s Charter Language 7-63

• “(c) For the third and each subsequent full fiscal year of the corporation after the Class A Preferred Issuance Date, cash dividends shall be payable only to the extent of Excess Cash Flow for each such period and unpaid dividends for each such period shall be cumulative.”

• Art. IV, §2(1)(D)(5): “dividends shall cease to accrue from and after the Class A Redemption Date designated in the notice of redemption.”

• Art. IV, §2(1)(E)(2): “dividends on the shares of Class A Preferred Stock to be exchanged will cease to accrue on such Exchange date.”

• Art. IV, §2(1)(G)(1), holders of Class A are entitled to receive $100 per share “plus a sum equal to all cumulative dividends on such shares accrued and unpaid thereon to the date of the final distribution.”

Nu-West 7-64

• There are three separate concepts:• (1) When dividends are payable.

– Dividends are payable only to the extent of excess cash flow for a fiscal year.

• (2) When dividends cumulate.– If excess cash flow at the end of a fiscal

year is insufficient, the dividend isn’t payable for that period, but cumulates.

• (3) When does a shareholder’s rights to a dividend accrue.– The provisions stating that accrual stops

on the Redemption Date make it clear that dividends accrue daily.

Elliot Associates v. Avatex Corporation 7-65

• Avatex’s board approved plan of merger into a wholly-owned sub, Xetava.

• Subject to vote of common s/h, but no vote provided for preferred.

• Preferred shares would be converted into common & would own 73% of common.

Avatex 1st Series Pfd. Cert. Of Designation 7-66

• § 6: "except as expressly provided hereinafter in this Section (6) or as otherwise from time to time required by law, the First Series Preferred Stock shall have no voting rights."

• “So long as any shares of the First Series Preferred Stock remain outstanding, the consent of the holders of at least two-thirds of the shares of the First Series Preferred Stock outstanding at the time . . . shall be necessary to permit, effect or validate any one or more of the following:

• * * *

• “(b) The amendment, alteration or repeal, whether by merger, consolidation or otherwise, of any of the provisions of the Restated Certificate of Incorporation or of these resolutions which would materially and adversely affect any right, preference, privilege or voting power of the First Series Preferred Stock or of the holders thereof. . . .”

Elliot v. Avatex 7-67

• Are the rights of the First Series Preferred adversely affected by the amendment, alteration or repeal, whether by merger, consolidation or otherwise of Avatex’s certificate of incorporation? Yes. Distinguishes Warner Case.

• Is it the merger that adversely affects their right or the exchange of their shares for common? The merger.

The Warner Preferred Voting Protections 7-68

• Section 3.3(i): The affirmative vote of at least two-thirds of the . . . outstanding shares of Series B Stock . . . shall be necessary to alter or change any rights, preferences of limitation of the Preferred Stock so as to affect the holders of all such shares adversely.

•  • Section 3.4(i): Without first obtaining the consent or

approval of the holders of at least two-thirds of the number of shares of the Series B Stock at the time outstanding . . . the Corporation shall not (i) amend, alter or repeal any of the provisions of the Certificate of Incorporation of By-laws of the Corporation so as to affect adversely any of the preferences, rights, power or privileges of the Series B Stock or the holders thereof. . . .

Del. G.C.L. § 251(b) & (e) 7-69

• § 251. Merger or consolidation of domestic corporations.• (b) The board of directors of each corporation which desires to

merge or consolidate shall adopt a resolution approving an agreement of merger or consolidation. The agreement shall state: (1) The terms and conditions of the merger or consolidation; (2) the mode of carrying the same into effect; (3) in the case of a merger, such amendments or changes in the certificate of incorporation of the surviving corporation as are desired to be effected by the merger, or, if no such amendments or changes are desired, a statement that the certificate of incorporation of the surviving corporation shall be its certificate of incorporation; (4) in the case of a consolidation, that the certificate of incorporation of the resulting corporation shall be as is set forth in an attachment to the agreement; (5) the manner of converting the shares of each of the constituent corporations into shares or other securities of the corporation surviving or resulting from the merger or consolidation and, if any shares of any of the constituent corporations are not to be converted solely into shares or other securities of the surviving or resulting corporation, the cash, property, rights or securities of any other corporation or entity which the holders of such shares are to receive in exchange . . .; and (6) such other details or provisions as are deemed desirable . . . .

• * * *• (e) In the case of a merger, the certificate of incorporation of the

surviving corporation shall automatically be amended to the extent, if any, that changes in the certificate of incorporation are set forth in the agreement of merger.

Elliot v. Avatex 7-70

• Avatex argued the provision only protected against amendments described in Del. G.C.L. § 251(b)(3).

• The court rejects this, as failing to account for the “consolidation” language in §251(b)(4), in which all prior charters disappear.

• Use of this language of “consolidation” must mean that the drafters intended the voting requirement to apply in some transactions where the Avatex charter would disappear.

• The exchange of preferred for common adversely affects the preferred by eliminating their protections.

NYSE Listed Company Manual ¶313.00(C) 7-71

• 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. 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.

The Holding Company Merger 7-72

• Common S/H Preferred S/H

• Operating Co.• 2(a) owns 100%• Stock Exchange (1) Merger• Sub. # 1 (2)• owns 100%• (1)• Sub. # 2

• (1) Operating Co. creates 2 subs.

• (2) Operating Co. & Sub 2 merge

• (a) Operating Co. shareholders receive common stock in Sub. 1

• (b) Operating Co. survives merger with Sub 2

• (3) Sub 1 is now public company

• (4) Preferred shareholders remain in Operating Co., which is sub of Sub 1.

Schreiber v. Carney 7-73

• Jet Capital Corp. owns 35% of Texas International stock.• Texas Air was a holding company for Texas International,

achieved by merger in 1980.Texas International shareholders received Texas Air shares in exchange.

• The purpose of the merger was to allow Texas International to diversify from being a small carrier serving Houston and Dallas.

• Jet Capital threatened to block the merger because it would impose a tax burden because of warrants Jet Capital held on Texas International’s Common.

Texas International’s Capital Structure 7-74

• Common stock - 4,669,182 shares• Warrants to Purchase common - 1,029,531 shares @ $4.18 (Jet

Capital owned 799,880)• Series A convertible preferred - 32,318 shares• Series B convertible preferred - 66,075 shares• Series C convertible preferred - 2,040,000 shares (Jet Capital

owned 100%)•  • To approve the merger, approval of the following classes was

required:•  • Common, voting separately• Series A, voting separately• Series B and C, voting as a single group.

Jet Capital’s Options 7-75

• 1. Approve the merger and exchange Texas International warrants for Texas Air warrants.

• This would make gains from the merger realized and taxable for Jet Capital, at $800,000 tax cost.

•  • 2. Exercise Texas International warrants prematurely, so

the merger would be tax free for Jet Capital.•  

• Problem - Jet Capital lacked $3 million cash to exercise, and borrowing was too expensive. [Recall that the prime rate reached 18% in either late 1980 or early 1981.]

•  • 3. Vote against merger (this was the choice).

Jet Capital’s Options 7-76

• The solution proposed was a loan by Texas International to Jet Capital to allow it to exercise the warrants before the merger.

• A special independent committee of Texas International directors with no connection with Jet Capital was created to consider the loan, with independent counsel and investment banker.

• The special committee approved a loan of $3.3 million at 5% until the 1982 expiration date of warrants, and thereafter at the prime rate.

Jet Capital’s Options 7-77

• The 5% rate was Justified as necessary to compensate Texas International for dividends on the new stock that would be owned by Jet Capital.

• The Texas International board unanimously approved the loan and submitted the proposal to shareholders for approval, with the condition that it be approved by majority of all outstanding shares, and by a majority of independent shares (excluding Jet Capital and its officers and directors).

• The proposal was overwhelmingly approved by the shareholders after full disclosure.

• 1. Was the loan agreement an illegal purchase of votes? No.

• 2. Was the loan corporate waste, since the loan could have been held to $800,000 to cover Jet Capital’s tax liability? No.

The opinion on vote buying 7-78

"It Is clear that the loan constituted vote-buying as that term has been defined by the courts. Vote buying, despite its negative connotation, is simply a voting agreement supported by consideration personal to the stockholder, whereby the stockholder divorces his discretionary voting power and votes as directed by the offeror."

The opinion on vote buying 7-79

"The present case presents a peculiar factual setting in that the proposed vote-buying consideration was conditional upon the approval of a majority of the disinterested stockholders after a full disclosure to them of all pertinent facts and was purportedly for the best interests of all Texas International stockholders."

Del. G.C.L. §251(c) 7-80 • (c) The agreement required by subsection (b) shall be

submitted to the shareholders of each constituent corporation at an annual or special meeting thereof for the purpose of acting on the agreement. * * * If a majority of the outstanding stock of the corporation entitled to vote thereon shall be voted for the adoption of the agreement, that fact shall be certified on the agreement by the secretary or assistant secretary of the corporation. If the agreement shall be so adopted and certified by each constituent corporation, it shall then befiled, and shall become effective . . . .

Eisenberg v. Chicago Milwaukee 7-81 • The company consists of $300 million cash plus real estate.• The common stockholders’ equity is $390 million.• The Preferred is $5 noncumulative, with a $100 liquidation

preference and the same for redemption (plus up to $7.50 of unpaid dividends).

• There is no redemption obligation.• No dividends have been paid on the Preferred or common

since 1971.• The board had announced a “no-dividend” policy to conserve

assets for an acquisition.• The directors, including 4 who are part of a 13D group, own

41% of common, along with the 13D group.• 1986 - early Oct. 1987, the trading price of the preferred was

$52.50 - $88.50, with downward trend.

Eisenberg v. Chicago Milwaukee 7-82 • On “Black Monday” - Oct. 19, 1987, the market lost > 20% of

value.• The preferred fell to $41.50.• The company president, Jacobson, immediately suggested a

tender offer for Preferred.• Oct. 23-27, Pain Webber valued the Preferred at $20-$30.• But a tender offer would require a premium over market, so it

suggested tender at $48.• On Oct. 27, Board approved a tender offer at $50-55,

delegating ultimate pricing to the Executive Committee.• On Oct. 27 the Executive Committee set the price at $55.

Eisenberg v. Chicago Milwaukee 7-83 • Tender offer disclosures:• The opinion of both the Board and Paine Webber that $55 was

fair.• The Board wasn’t recommending whether to tender.• One purpose of the bid was to reduce administration and

bookkeeping costs.

Eisenberg v. Chicago Milwaukee 7-84 • 1. Was disclosure adequate? No.

• 2. Was the offer inequitably coercive?

Eisenberg v. Chicago Milwaukee 7-85 • 1. Was disclosure adequate? No.

• When a corporation tenders for its own shares it has a conflict of interest that “imposed upon them the heavy responsibility of advising the stockholders fully and impartially about the advantages and disadvantages of the tender....”

• The statements that the bid was motivated by a reduction in administrative and bookkeeping costs were false. The only motivation was to take advantage of the depressed price.

• The “fair price” disclosures didn’t mention that the offer was pegged to $41.50, the lowest price at which the stock had traded in 5 years or that Paine Webber’s opinion was prepared over a long weekend.

Eisenberg v. Chicago Milwaukee 7-86 2. Was the offer inequitably coercive? • “no-dividend” policy is protected by the Business Judgment

Rule.• While the timing of offer at low in market and the no-dividend

policy have coercive effects, this isn’t enough to conclude the offer is unfairly coercive.

• It is the disclosure of an intent to delist the stock “which tips the balance.”

• Directors are fiduciaries for the preferred as well as the common.

• The board doesn’t claim its “obliged to seek delisting in order to protect a paramount interest of the corporation or an overriding interest of the common stockholders.”

• The Defendants argue that disclosing this intent is immaterial, because NYSE will delist anyway.

NYSE Listed Company Manual ¶801 7-87

• 801.00 Policy Securities admitted to the list may be suspended from dealings or removed from the list at any time that a company falls below certain quantitative and qualitative continued listing criteria. When a company falls below any criterion, the Exchange will review the appropriateness of continued listing. The Exchange may give consideration to any definitive action that a company would propose to take that would bring it above continued listing standards. The specific procedures and timelines regarding such proposals are delineated in Sections 802.02 and 802.03.

NYSE Listed Company Manual ¶ 802 7-88

• 802.01 Continued Listing Criteria The Exchange would normally give consideration to delisting a security either a domestic or non-U.S. issuer when:

• 802.01A. Distribution Criteria for Capital or Common Stock— • Number of total stockholders is less than...................................................400 • Number of total stockholders is less than................................................1,200

and • Average monthly trading volume is less than..........................100,000 shares • (for most recent 12 months) • The number of beneficial holders of stock held in the name of Exchange

member organizations will be considered in addition to holders of record. • Number of publicly-held shares (A) is less than............................600,000(B)

• 802.01B Numerical Criteria for Capital or Common StockA company that falls below the criteria applicable to it is subject to the procedures outlined in Paras. 802.02 and 802.03. * * *

• Preferred Stock, Guaranteed Railroad Stock and Similar Issues-• Aggregate market value of publicly-held shares is less than...... $2,000,000• Publicly-held shares is less than .................................................... 100,000

Terminating Registration 7-89

•  § 240.12g-4 Certifications of termination of registration under section 12(g).

    (a) Termination of registration of a class of securities shall take effect 90 days, or such shorter period as the Commission may determine, after the issuer certifies to the Commission on Form 15 that:

(1) Such class of securities is held of record by:

(i) Less than 300 persons; or

(ii) By less than 500 persons, where the total assets of the issuer have not exceeded $ 10 million on the last day of each of the issuer's most recent three fiscal years; or . . . [further provisions relate to foreign issuers]

Terminating Registration 7-90

• Court rejects Defendant’s argument on two grounds:• The tender offer materials said NYSE “would consider”

delisting - not that it was mandatory.• Second, if delisting happens automatically, why state

an intent to seek delisting?• The only possible reason is to coerce.

Terminating Registration 7-91

• Remedy discussion:

• Unless cured, the current disclosures are coercive.

• But the offer may be desirable for some stockholders to realize a premium.

• So if the Company commits to a disclaimer not to seek delisting, the offer can continue.