A recent case from the Delaware Court of Chancery serves as a reminder of the limitations of preferred stock redemption rights (sometimes called “put rights”) and of the importance of careful drafting in corporate charters.  In TCV v. TradingScreen, Vice Chancellor Noble found that a corporation was not required to pay a mandatory redemption payment to an investor where such payment could jeopardize the corporation’s ability to continue as a going concern.

A provision in TradingScreen’s corporate charter permitted the holders of a majority of its preferred stock, in certain circumstances, to require TradingScreen to redeem their shares.  The charter also provided that if TradingScreen defaulted on any such redemption payments, then interest would accrue on amounts owed at a rate of 13% per annum.

After TCV validly exercised the redemption right in early 2013, a special committee of the board of TradingScreen, relying on analysis from an outside financial advisor, determined that the company had funds on hand sufficient to repurchase only a small portion of shares offered for redemption.  TCV sued, alleging that TradingScreen had violated its obligation under the charter to honor the redemption and that any unpaid amounts should accrue interest at the agreed-upon 13% rate.

TCV contended that the only basis to limit TradingScreen’s obligation to comply with the charter provision was Section 160 of the Delaware General Corporation Law, which limits a corporation’s ability to purchase shares of its own capital stock to the corporation’s statutory surplus (net assets less the aggregate par value of its outstanding shares).  Based on this calculation, TradingScreen would have had sufficient funds to effect the full redemption.

But TradingScreen argued that Section 160 of the DGCL is not exclusive and that the common law imposes additional restrictions on a corporation’s obligation to redeem stock if such redemption would threaten the corporation’s ability to continue operating as a going concern.

The Chancery Court sided with TradingScreen.  In doing so, the Court reaffirmed its finding in its 2010 decision in SV Inv. Partners, LLC v. Thoughtworks, Inc., which held that a corporation could be required to effect a mandatory redemption only to the extent “the corporation [would] be able to continue as a going concern and not be rendered insolvent by the distribution.”  The TradingScreen Court also extended the Thoughtworks ruling by clarifying that even if a corporate charter does explicitly say that a redemption is to be effected only to the extent funds are “legally available” that such a qualification is implicitly read into every such provision.  The Court later certified the decision for interlocutory appeal to the Delaware Supreme Court, noting that the question of whether Section 160 of the DGCL is exclusive is a topic of debate (which the Supreme Court avoided resolving in the appeal of the Thoughtworks decision) and should be settled by the state’s highest court—so stayed tuned for potential further developments.

The Court also sided with TradingScreen on the issue of whether amounts remaining to be paid pursuant to the redemption would accrue interest at the 13% rate provided by the charter.  The Court reasoned that because the charter provided for such interest only following a “default” by TradingScreen, and because not paying the full redemption amount in compliance with Delaware law could not be considered a default of any duty, that the interest provision was not triggered.  The Court suggested that this result might have been different had the charter instead provided for such interest to be paid when TradingScreen “fails to make any payments due”, highlighting the need to carefully consider the drafting of these provisions.

The TradingScreen case is a further reminder of the sometimes limited utility of redemption rights in connection with preferred stock investments.  It is frequently the case that a corporation will be least willing or able to pay (and as demonstrated by Thoughtworks and TradingScreen, may be legally prohibited from paying) amounts due under a redemption or put right precisely at the time that the exercise of such right is most desired by investors – i.e., in the downside scenario.  Therefore, investors should pay careful attention to the language of redemption provisions (e.g., to avoid the result in TradingScreen where TCV was not entitled to interest payments) and should consider negotiating for additional protections for situations where a company is not able to pay the full redemption amount (e.g., preferred holders becoming entitled to elect a majority of the Board or having consents rights over Company cash expenditures until the redemption amount is fully paid).