This is a timely article focusing on the conflicting duties owed to preferred and common stockholders. Delaware is the leading corporate law jurisdiction in the United States. Preferred stock is a key component in angel and venture capital transactions. Historically the Delaware courts have accepted as a general principle the proposition that since the preferred rights are contractual in nature, they must be expressly defined in the preferred stock contract in order for the preferred to successfully assert those rights. Accordingly, the directors owe correlative duties to the preferred to the extent that the rights are articulated in the contract. The Delaware courts maintained such position for many decades. In contrast, the Jedwab decision rendered in 1986 stated that the application of the general rule is confined to the situation where the matters relate to the preferences themselves. The Jedwab court then held that where the right asserted by the preferred does not relate to a preference as against the common stockholders, but rather the rights shared equally with the common, then fiduciary, rather than contractual, principles apply. Controversy ensued as to whether the Jedwab decision was an exception to, or a violation of, the general rule.
In connection with the proposition that the directors’ duties to the preferred are limited to the extent that the preferred rights are defined in the contract, the recently decided Trados case added another layer to the ongoing debate. In 2009, the Trados court addressed the issue of whether directors breached their duty of loyalty to the common stockholders by improperly favoring the interests of the preferred stockholders. In that case, the court determined that it is possible a director could breach her duty by improperly favoring the interests of the preferred over those of the common. The court examined the role of directors who were affiliated with preferred stock investors, which is not an uncommon situation in venture and start-up capital situations. As a consequence, this case will likely have a significant impact on corporate lawyers and their clients.
The Trados decision has been discussed both in the press and at major continuing legal education conferences. In March of 2010, the Delaware Court, in the LC Capital case , attempted to reconcile the Trados decision with the Jedwab decision. In examining the above cases, along with other recent cases, developments concerning preferred stockholder rights under Delaware law are analyzed.