## Facts

- A private equity sponsor acquired Series A preferred stock with a contractual redemption right conditioned on having sufficient surplus and “funds legally available,” plus a charter requirement that the board take only reasonable, good-faith actions consistent with fiduciary duties to generate redemption funds.
- The sponsor later obtained voting control of the company, becoming the controlling stockholder.
- The plaintiff, a minority common stockholder, alleged that the controller and board shifted from a growth strategy to a redemption-focused strategy starting in 2011.
- Alleged actions included selling business lines at depressed values, stopping acquisitions, reducing investment in the business, and accumulating large cash reserves to prepare for redemption.
- Management compensation arrangements allegedly promised special payouts if at least $75 million of preferred stock was redeemed, aligning key officers’ interests with the controller’s redemption objective.
- A two-member special committee was formed to evaluate financing alternatives and negotiate with the controller; the committee relied on officers whose compensation depended on achieving the redemption threshold.
- The controller exercised the redemption right when it matured; the company completed redemptions totaling at least $85 million over 2013–2014, triggering the redemption-linked bonuses.
- The plaintiff alleged the redemption-driven strategy contributed to a steep decline in company revenue and long-term value, harming common stockholders.

## Issues

1. Whether directors and a controlling stockholder can breach fiduciary duties by prioritizing funding preferred redemptions through a value-destructive strategy that disadvantages the corporation and common stockholders.
2. Whether the complaint stated a claim that the redemptions were unlawful under Delaware’s legal-capital restrictions (surplus and “funds legally available”).
3. Whether demand was excused because the controller’s influence and insiders’ conflicts supported a non-exculpated loyalty claim subject to stringent review.

## Decision

- The court dismissed claims asserting the redemptions were statutorily unlawful because the pleadings did not support a reasonable inference that the redemptions exceeded surplus or used funds not legally available.
- The court denied dismissal of fiduciary-duty claims challenging the strategy and decision-making used to generate funds for redemption, finding a plausible loyalty-based theory that the controller and conflicted fiduciaries favored preferred liquidity over common value.
- The court held the controller was plausibly alleged to be a controlling stockholder, supporting demand excusal and application of an exacting standard of review (including entire fairness at the pleading stage).
- Because the charter exculpated duty-of-care claims, only non-exculpated bad-faith/loyalty allegations could support damages; the complaint adequately pled such allegations against the relevant fiduciaries.

## Legal Principles

- Directors owe fiduciary duties to the corporation and, in conflict settings between preferred and common, must act for the benefit of the residual claimants (typically the common) unless valid contractual terms properly alter that result.
- Preferred contractual rights (including redemption provisions) do not eliminate fiduciary constraints; “funds legally available” and similar conditions can import fiduciary-duty limitations rather than create an absolute payment entitlement.
- A redemption that is lawful under Delaware’s legal-capital rules can still be the product of disloyal conduct if fiduciaries cause the corporation to pursue redemptions for a controller’s liquidity preference at the expense of corporate and common-stock value.
- When a controlling stockholder influences corporate action to benefit itself in a conflicted transaction or course of conduct, the resulting decisions may be reviewed for entire fairness, and demand may be excused where a majority of the board lacks independence or faces a substantial likelihood of liability on a non-exculpated claim.

## Conclusion

The court allowed loyalty-based claims to proceed where the pleadings supported an inference that a controlling stockholder and conflicted fiduciaries redirected corporate strategy to fund preferred redemptions at the expense of long-term common value, while dismissing claims that the redemptions themselves were unlawful under Delaware’s surplus and “funds legally available” requirements.


Frederick Hsu Living Tr. v. ODN Hldg. Corp., C.A. No. 12108-VCL, 2017 WL 1437308 (Del. Ch. Apr. 14, 2017)