FLETCHER INTERNATIONAL, LTD. v. ION GEOPHYSICAL CORPORATION Civil Action No. 5109-CS.
FLETCHER INTERNATIONAL, LTD., Plaintiff, v. ION GEOPHYSICAL CORPORATION, f/k/a INPUT/OUTPUT, INC. and ION INTERNATIONAL S.àr.l., Defendants.
Court of Chancery of Delaware.
Decided: December 4, 2013.
Kevin G. Abrams, Esquire, J. Peter Shindel, Jr., Esquire, Daniel A. Gordon, Esquire, ABRAMS & BAYLISS LLP, Wilmington, Delaware, Attorneys for Plaintiff Fletcher International, Ltd.
Kenneth J. Nachbar, Esquire, Leslie A. Polizoti, Esquire, Ryan D. Stottmann, Esquire, Angela C. Whitesell, Esquire, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware, Attorneys for ION Geophysical Corporation and ION International, S.àr.l.
In a prior decision in this case, this court, per Vice Chancellor Parsons, held that it was likely that the issuance of a note by a subsidiary of the defendant, ION Geophysical Corporation, which was formerly known as Input/Output ("ION"), in connection with a $40 million bridge financing that was a minor portion of a much larger transaction, violated the right of the plaintiff, Fletcher International, Limited ("Fletcher") to consent to the note issuance.
In the fall of 2009, ION needed a transaction that would provide it with liquidity and enable it to continue operating and avoid bankruptcy. To alleviate its financial woes, ION reached an agreement to contribute its land equipment business to a newly formed joint venture with BGP Inc. ("BGP"), a Chinese state-owned enterprise. This was a strategically important investment for the Chinese government and its state-owned bank, the Bank of China, stepped in to help BGP secure the deal. As part of that help, the Bank of China provided ION with $40 million in bridge financing to give ION a cushion to ensure that it could operate through the closing of that transaction (collectively, the joint venture and the bridge financing are referred to as the "BGP Transaction"). ION already had a credit facility in place under which it borrowed money on a revolving basis from a consortium of banks (the "Existing Lenders"), so the Bank of China provided the bridge financing by entering into the existing credit facility. In connection with the bridge financing, ION International S.ár.l. ("ION S.ár.l."), an ION subsidiary, issued a $10 million convertible promissory note to the Bank of China without obtaining Fletcher's consent. The only consent right Fletcher had over the deal was over the $40 million bridge loan. The much larger overall BGP Transaction, in which BGP contributed between $195 million and $245 million in consideration to ION, was one that Fletcher had no right to veto.
During the two day trial, the parties attempted to quantify the damages that Fletcher is entitled to by presenting evidence to determine what Fletcher would have received in exchange for its consent in a hypothetical negotiation that occurred before the announcement of the BGP Transaction. Fletcher attempted to portray itself as a tough negotiator willing to blow up the entire BGP Transaction unless it received changes to its Preferred Stock that were valued at $78 million in exchange for its consent to a $40 million bridge financing, even though the BGP Transaction was expected to create value for all of ION's stakeholders, including Fletcher. Fletcher insisted that, because ION was a weak negotiator that had no other options, ION would have given in to anything Fletcher demanded in order to save the BGP Transaction. Thus it would have given $78 million to be able to receive a $40 million short-term loan.
This two-dimensional depiction of the hypothetical negotiation ignores the fact that BGP and the Existing Lenders — both of which had substantially more negotiating leverage than Fletcher did — would have been involved in any negotiation for Fletcher's consent. As a practical matter, BGP would have needed to agree to proceed with any consent payment to Fletcher and the Existing Lenders would have had the right to consent to the modifications to Fletcher's preferred stock that Fletcher says it would have demanded. The demands Fletcher says it would have made were ones that had costs to both BGP and the Existing Lenders and neither would have agreed to Fletcher's outrageous demands. In other words, ION could not have unilaterally given Fletcher what it wanted because Fletcher's demands would have come at the expense of ION's other constituencies, in particular BGP. Fletcher's version of the hypothetical negotiation also ignores the fact that ION, with the help of BGP and the Existing Lenders, could have structured the transaction to avoid implicating Fletcher's consent right. In fact, Fletcher's cartoonish portrayal of its own negotiation position is so extreme in contrast to its comparatively weak actual bargaining position, that ION argued that it would simply have worked with the Existing lenders and BGP to structure the deal around Fletcher's consent. Nevertheless, because Fletcher's consent right was violated, the court assumes that Fletcher would have acted with at least bare rationality in the bargaining process and consented in exchange for a very generous consent fee akin to a bank consent fee.
That is, although the court concludes that Fletcher would not have been able to use its consent right to extract the king's ransom that it apparently believes it was entitled to, Fletcher would have been able obtain valuable consideration from ION in exchange for its consent. The best measure of the consent fee that Fletcher could have extracted comes from a comparison to the consent fees that ION paid to the Existing Lenders to obtain their approval for the BGP Transaction.
Factual and Procedural Background
Fletcher's Investment in ION
ION is a Delaware corporation headquartered in Houston, Texas that provides technology-focused services and equipment to the global energy industry, particularly to exploration and production clients in the oil industry. ION's stock is listed on the New York Stock Exchange ("NYSE"). ION S.ár.l. is a wholly-owned subsidiary of ION, incorporated in Luxemburg.
On February 15, 2005, ION, seeking a "patient" and "supportive" investor,
Fletcher portrayed itself as a "passive and supportive partner" and claimed that its "fundamental investment principle [was] to facilitate management's efforts to enhance equity value through a significantly improved capital structure."
Fletcher's investment in ION was essential to Fletcher's own survival, which was unusual even for an aggressive hedge fund. As of December 31, 2008, the Preferred Stock made up 43.25% of Fletcher's investment portfolio.
ION's Financial Performance Declines And Its Relationship With Fletcher Sours
On July 3, 2008, ION and ION S.ár.l. entered into a new $100 million credit facility with the Existing Lenders (the "Credit Facility") that leveraged both ION's domestic and international assets.
In addition to provisions that governed the functioning of the Credit Facility, the Credit Agreement contained a litany of restrictive covenants that prohibited ION from engaging in activities such as making any dividend payments that were not specifically exempted under the Credit Agreement,
The financial problems ION faced in 2009 had their origins in a prior transaction. In early 2008, ION's management began considering a strategic transaction with ARAM Systems Ltd. and Canadian Seismic Rentals Inc. (collectively "ARAM"). The transaction was expected to increase ION's footprint in certain international markets and solidify ION's position in the industry.
ION planned to replace the interim financing structure that it used to close the ARAM transaction by issuing a bond in the public market.
Although the ARAM transaction had been expected to create value for ION, the transaction's inauspicious closing date left ION with a highly leveraged balance sheet and put strain on the company at a time when the recession resulting from the financial crisis was reducing demand for ION's products and services. By the end of 2008, the financial performance of ION "really started to decline. . . . And 2009 saw a series of successive declines in financial performance . . ."
On top of its growing financial problems, ION's managers also had to deal with discontent from their purportedly patient and supportive investor, Fletcher. On January 23, 2009, Fletcher's then-attorneys informed ION that Fletcher believed that the notes issued by Nova Scotia in connection with the ARAM transaction violated Fletcher's contractual right to consent to the issuance of a security by any ION subsidiary and "demand[ed] that ION take immediate action to rectify its violation and remedy the harm to Fletcher."
But ION's efforts to appease Fletcher were unsuccessful. On March 31, 2009, Fletcher made a demand for inspection of records under § 220 of the Delaware General Corporation Law for the purpose of, among other things, investigating potential violations of its rights as a holder of the Preferred Stock.
Fletcher's accusations and its request to inspect ION's records were not the only challenges ION's management had to deal with in the Spring of 2009. By April 2009, the Existing Lenders were worried about ION's declining financial performance and its lack of liquidity.
In Hanson's words, the transactions in June 2009 "gave [ION] breathing room" but they did not solve ION's liquidity issues and ION recognized that it could "burn through [its] cash by the end of the year."
The BGP Transaction
BGP is a wholly-owned subsidiary of China National Petroleum Corporation ("China National Petroleum"), which is a large oil company owned by the Chinese government. BGP was a long-time client of ION's, and the two companies had previously considered entering into a strategic transaction. In 2006, ION approached BGP about the possibility of the two companies engaging in a joint venture.
The negotiations with BGP regarding the transaction began in late July 2009, when Jay Lapeyre, the chairman of ION's board of directors, met with Wang Tiejun, the President of BGP, to discuss the transaction. Lapeyre reported that "[o]verall [it was a] good initial meeting."
In early August, Hanson traveled to China to meet with representatives from BGP regarding the joint venture. Back in the United States, ION's lenders and Fletcher were still concerned with ION's projections for the remainder of 2009. After looking at the projections, Benson "shift[ed] [his] opinion about ION's near-term solvency from thinking it is likely solvent to think[ing] it may not be solvent."
The major points of the deal were negotiated extensively during August and September. ION opened the negotiations by proposing that the two companies enter into a joint venture that centered around technology. Under the initial proposal, ION would have owned 70% of the joint venture and BGP would have owned the remaining 30%.
BGP considered this to be a precedent-setting transaction because it was one of the first situations in which a Chinese state-owned enterprise was given permission to enter into a strategic joint venture with an American company. This joint venture was also in the energy technology industry, which has economic importance to both China and the United States. As shall be seen, because BGP is an instrumentality of the Chinese government and its entry into the United States market was important to the Chinese government, BGP had the financing support of the Bank of China, a state-owned bank.
When ION realized that it would have to give in to BGP's demand that it control the joint venture for the transaction to go forward, ION agreed to take the minority position in the joint venture but insisted in exchange that BGP set aside its demand for an equity stake in ION itself.
On August 13, 2009, when Peebler boarded his plane after the meetings in China, he believed that they had agreed to a deal in which BGP would take a majority ownership interest in the joint venture but would not own any of ION's equity.
A mere four days after ION agreed to consider allowing BGP to take a large equity position in ION, BGP sent ION a draft term sheet that contemplated BGP receiving not only a 19.99% equity interest, but also anti-dilution protection that would give BGP the right to subscribe to any future issuance of ION common stock in order to maintain that 19.99% interest.
Peebler had become frustrated with the slow progress on the deal and on September 1, 2009, he emailed his counterpart at BGP and wrote that "it appears that BGP is attempting to put further financial stress on [ION]" by delaying payments on some receivables that Peebler believed were owed to the company.
By this point, ION needed a solution to its financial woes and it had very little leverage with either BGP or the Existing Lenders.
As Hanson prepared to meet with BGP in Beijing in mid-September, Peebler advised him not to let the "discussion get tied back to the anti-dilution ask [BGP had] in [its] term sheet" and stated "[w]e've got to get that one put to bed early."
Eventually, the parties agreed that BGP would receive anti-dilution protection from issuances of additional equity, but that did not extend to any dilution that would occur if Fletcher exercised its right to convert its Preferred Stock into ION common stock under the Certificates of Rights and Preferences then in place.
As September drew to a close, BGP and ION had agreed on the structure of the joint venture, but it was evident that it would take months to get final regulatory approvals for the transaction.
BGP and the Bank of China initially proposed to amend the Credit Facility to enable the provision of bridge financing through a separate tranche of lending that would be added to the existing Credit Facility.
ION and its advisors viewed it as very unlikely that ION could secure unanimous approval from the Existing Lenders to add additional debt to the Credit Facility beyond the $40 million that could be added through the Credit Facility's accordion feature.
Therefore, ION, BGP, and the Bank of China agreed that the easiest way to provide the bridge financing was to amend the Credit Facility so that the Bank of China could be a lender in the Credit Facility under the same terms and conditions as the Existing Lenders and then to exercise the accordion feature of the Credit Facility so that the Bank of China could provide ION with the $40 million of bridge financing. Although ION still felt that it only needed $20 million, and BGP still would have preferred to provide more, the companies settled on $40 million because it was the most that could be provided under the Credit Facility's accordion feature.
By mid-October, BGP and ION had agreed on the structure of the bridge financing. ION's management team next turned its attention to making sure the Existing Lenders understood how delicate ION's financial situation was and that, under the deal with BGP, the Existing Lenders would be paid back in full at closing.
After securing the approval of the Existing Lenders, BGP and ION prepared to proceed with a public announcement of the term sheet. At 10:26 p.m. on October 22, 2009, the day before the deal was to be announced and the term sheet signed, BGP's attorney emailed David Roland, ION's General Counsel, with several changes to the documents for the bridge financing. Negotiations continued throughout the night, and the final term sheet was agreed to less than three hours before the deal was to be announced.
On October 23, 2009, ION announced that it had entered into a binding term sheet with BGP that set forth the principal terms for a proposed joint venture between the two companies, entered into the Sixth Amendment, and issued the Convertible Promissory Notes evidencing the bridge loan from the Bank of China.
The announcement of the term sheet had an immediate positive effect on ION's stock price and on Fletcher's investment in ION. Internally, Fletcher circulated an email that noted that ION's stock price increased by as much as 47% following the announcement of the term sheet.
Fletcher Sues ION
On November 25, 2009, a little over one month after the announcement of the BGP Transaction, Fletcher, then represented by Skadden and Proskauer Rose, LLP, filed a complaint in this court seeking, among other things, a declaration that its right to consent to any issuance of a security by ION S.ár.l. had been violated, an injunction of the BGP Transaction until ION had provided Fletcher with all material information regarding the transaction and obtained Fletcher's consent, and an award of damages.
On December 23, 2009, Fletcher moved for partial summary judgment "ask[ing] the Court to declare that ION breached its obligations under its Certificate of Incorporation by permitting the issuance of the ION S.àr.1 Note `without first obtaining a meaningful and informed vote of approval by Fletcher'" and "that the Note is ineffective and unenforceable unless and until ION provides Fletcher with facts concerning the BGP Transactions and obtains Fletcher's consent to the issuance of the ION S.ar.l Note after providing Fletcher a reasonable time to consider that issuance."
The next day, on March 25, 2010, the BGP Transaction closed. As part of the closing, BGP acquired 23.8 million shares of ION common stock by converting the principal balance of the Convertible Promissory Notes, which the Bank of China had assigned to BGP, thereby extinguishing the ION S.àr.l. Note. ION also entered into a new credit agreement with China Merchants Bank Co. Ltd. (hereinafter "China Merchants Bank") on terms and conditions that were substantially improved from its earlier Credit Facility, and it repaid all of its outstanding loans under the Credit Facility. The BGP Transaction reduced ION's total overall debt from over $240 million to only $106 million, all of which was in the form of a term loan under the new credit facility with China Merchants Bank.
Contrary to Fletcher's assertions in its original complaint, Fletcher actually believed that the BGP Transaction was value-enhancing for Fletcher, ION, and ION's common stockholders.
On May 28, 2010, Vice Chancellor Parsons issued an opinion addressing the issues on which he had reserved judgment in Fletcher I and granted Fletcher's motion for summary judgment in part (Fletcher II), holding that Fletcher had a right to consent to any issuance of a security by an ION subsidiary, that the ION S.àr.l. Note was a security, and that ION had violated Fletcher's consent right when the ION S.àr.l. Note was issued without Fletcher's consent.
Fletcher then began concentrating on obtaining damages for the bypass of its consent rights as to both the ARAM transaction and the BGP Transaction. Fletcher made plain that it viewed itself as having claims for big dollars — dollars larger, in the case of the BGP deal, than the $40 million bridge loan that Vice Chancellor Parsons held triggered its consent right.
On June 29, 2012, after more than two years of litigation and after all of the pre-trial discovery had been completed and all of the expert reports filed, Fletcher filed a voluntary petition for bankruptcy under Chapter 11 of the United States Bankruptcy Code.
Although the report filed by Fletcher's expert, Peter Fowler,
The sole issue left for determination is the amount of damages that Fletcher is entitled to as a result of the breach of its contractual right to consent to the issuance of any security by an ION subsidiary. In accordance with Vice Chancellor Parsons's letter opinion issued on March 24, 2010 — which held that Fletcher would not be irreparably injured by the denial of its request for an injunction because "Fletcher could still pursue its claim for money damages" and that the court could resolve that issue by "determining the amount Fletcher would have received in a hypothetical negotiation regarding its asserted right to consent to the ION S.àr.1 Note, before it issued[,]"
Fletcher's Damages Theories And Its Version Of The Hypothetical Negotiation
Fletcher's version of the hypothetical negotiation pits Fletcher and its eponymous then-CEO Alphonse "Buddy" Fletcher ("Buddy Fletcher"), a tough negotiator ready to use his consent right to extract as much value as possible, against ION, a weak and hapless negotiator that was desperate and would have done anything to close the BGP Transaction. Although Buddy Fletcher never appeared at trial, how he would have behaved during the hypothetical negotiation was discussed extensively. In Fletcher's own version, Buddy Fletcher was portrayed as an exceedingly self-confident and opportunistic individual who believed that he could extract almost two dollars of value from ION and BGP for every dollar of bridge financing over which he had a consent right by refusing to grant his consent unless his demands were met.
Thus, as its core theory of damages at trial, Fletcher contended that it would have demanded and received several changes to the terms of its Preferred Stock in exchange for its consent to the issuance of the ION S.àr.1 Note. According to Fletcher's Vice Chairman, Kell Benson, Fletcher concluded shortly after the announcement of the BGP Transaction that its consent right had been violated and, from the very beginning, was focused on obtaining changes to its conversion price and the interest rate on its Preferred Stock in exchange for its consent.
At trial, Fletcher's advocates and expert witness premised its case on this extreme position. Fletcher told this court that Buddy Fletcher would not have consented to the BGP Transaction without receiving consideration greater in value than the bridge financing itself. Even more, Buddy Fletcher was portrayed as a person willing to bring it all down on his own head — and the heads of the Fletcher investors of which he was a fiduciary.
Fletcher assumed that in the hypothetical negotiation for its consent, "[it] would essentially be re-underwriting or re-evaluating its investment in [the] negotiation."
The hypothetical negotiation that Fletcher believes would have happened is misleadingly simple: ION and Fletcher would have been the only parties involved in the negotiation, and ION would have been so desperate to close the BGP Transaction that it would have simply acceded to all of Fletcher's demands. In other words, under Fletcher's version of the hypothetical consent negotiation, Fletcher would have requested the three changes to its Preferred Stock listed above and ION would have, immediately and without consulting BGP or the Existing Lenders, granted those requests in exchange for Fletcher's consent.
In his expert report and at trial, Fowler took the position that Fletcher had "significant leverage" because ION did not have a realistic alternative to the BGP Transaction.
Fowler also opined that the fact that Fletcher's investment in ION made up almost two-thirds of its investment portfolio would not have been material to Fletcher and that, because Fletcher would not have believed ION if it had threatened to pursue bankruptcy instead of making a consent payment to Fletcher, Fletcher would have held fast to its demands and ultimately received everything that it asked for.
After it became evident at trial that Fowler's two-dimensional depiction of the hypothetical negotiation for Fletcher's consent was unrealistic because it assumed that the negotiation occurred in a vacuum between ION and Fletcher and that no other parties would have been involved, Fletcher attempted to argue that neither the Existing Lenders nor BGP would have cared if ION agreed to give tens of millions of dollars in value to Fletcher in exchange for its consent. Fowler conceded that as a practical matter, BGP would find out about any negotiation with Fletcher for its consent and need to approve the concessions as they came in material part at BGP's expense, but he contended that BGP would not have objected to the changes to Fletcher's Preferred Stock that Fletcher would have asked for.
Fowler's opinion thus ignored several key facts. First, BGP had been insistent on a substantial equity stake and accompanying anti-dilution protection. Although BGP had begrudgingly agreed to let itself be diluted if Fletcher, which had existing contractual rights, converted its Preferred Stock under the existing Certificates of Rights and Preferences, the negotiation history reveals that BGP's equity stake and its protection of that stake from dilution were both very important to BGP. Fletcher's hypothetical demands were critically different from the existing Certificates of Rights and Preferences and would have subjected BGP to additional dilution because of a consent payment to Fletcher.
Fowler also erroneously premised his report on the presumption that ION would not have been required to obtain the consent of the Existing Lenders to make the changes Fletcher would have requested to its Preferred Stock. But that position is directly contradicted by the language of the Credit Agreement. Section 6.07 of the Credit Agreement prohibited ION from agreeing to make any "Restricted Payments" that were not specifically exempted from the prohibition.
It was this provision in the Credit Agreement that enabled ION to make dividend payments to Fletcher, even though ION was generally prohibited from making dividend payments by the terms of the Credit Agreement. The exception for dividend payments to Fletcher, however, was clearly limited to the terms of the specific existing Certificates of Rights and Preferences that governed Fletcher's Preferred Stock. For ION to increase the dividend payments to Fletcher, as Fletcher and its expert contend ION would have done, ION would have had to get the consent of the Existing Lenders to amend the Credit Agreement to allow the payment of the increased dividends. Fowler's assumption that the Existing Lenders would not have been part of the negotiation for Fletcher's consent was, therefore, incorrect. Not only would the Existing Lenders have been involved in the negotiation, but they would have been required to consent to any increase of Fletcher's dividend.
Fowler's opinion never considered that the demands he contended Fletcher would have been seeking would have required ION to go to BGP and the Existing Lenders and obtain their consent. If ION had gone to BGP and the Existing Lenders with Fletcher's request, they would have asked ION why they should agree to approve changes that would transfer value to a preferred stockholder that nearly doubled the value of the bridge financing the preferred stockholder was being asked to consent to, especially when that preferred stockholder faced catastrophic loss if BGP walked away and the BGP Transaction didn't happen. These were critical real world factors Fowler either chose to ignore or just overlooked.
After it became evident at trial that Fowler's report was based on erroneous and unsupported assumptions, Fletcher completely abandoned its earlier damages theory and, in its post-trial opening brief filed on September 13, 2013, disclosed its new damages theory: that the hypothetical negotiation would have resulted in a decrease of Fletcher's Preferred Stock conversion price from $4.4517 to $4.0867.
Unlike its shifting damages calculations, Fletcher has maintained consistency on one point: that ION had no options other than to pay the ransom that Fletcher would have demanded in exchange for its consent and that ION would have rolled over and agreed to Fletcher's demands in order to avoid bankruptcy.
ION's Version Of The Hypothetical Negotiation
By the time of post-trial briefing, ION's patience reserves were understandably depleted. Before it entered bankruptcy, Fletcher aggressively litigated this case and made plain that it thought big, big dollars were owed it for the deprivation of its consent right to the $40 million bridge loan. ION was, of course, forced to spend a great deal of money seeking to rebut the case Fletcher was making. Then Fletcher filed for bankruptcy, causing a delay in the litigation. After that, the bankruptcy trustee entered the litigation with new counsel, and Fletcher tried to fundamentally change its approach. After being denied that chance once after motion practice, Fletcher tried it again in its pre-trial briefing, and ION again had to spend resources to prevent this. At trial, Fletcher presented its long established damages theory, which is that it would accept nothing less than the changes to its Preferred Stock which it valued at $78 million and that anything materially less than this demand would have been rejected. Seizing on Fletcher's own portrayal of itself as prepared to be nihilistic, ION's post-trial briefing took on a cartoonish character of its own, albeit one with more realistic qualities than that drawn by Fletcher.
Building on Fletcher's own case theory, in ION's version of events, Fletcher would have opened the negotiations by requesting the three changes to its Preferred Stock that would have had a present value of around $78 million. ION contends that because neither itself, BGP, or the Existing Lenders would have agreed to those changes, and because Fletcher has maintained that it never would have accepted anything less, ION, BGP, and the Existing Lenders simply would have found a way to structure the transaction so that it did not require Fletcher's consent, thereby obviating the need to make any consent payment to Fletcher. To buttress this position, ION spells out several ways for ION to get bridge financing that would have been far less painful to the most powerful players at the negotiating table, BGP and the Existing Lenders, and to ION — whose common stockholders Fletcher erroneously believes could be trampled upon at will. If Fletcher had acted in the extreme manner it claims it would have, one of these less painful alternatives would have been taken, resulting in nothing for Fletcher.
Damages for breach of contract are determined by the reasonable expectations of the parties before the breach occurred.
Damages are to be measured as of the time the contract was breached.
To prevail in a claim for damages for breach of contract, a plaintiff "must show both the existence of damages provable to a reasonable certainty, and that these damages flowed from defendant's violation of the contract."
Consent rights are commonly viewed as protective devices meant to shield the holder of the right against being harmed by a new transaction that is adverse to its interests.
Nonetheless, Fletcher's contractual consent right was violated, it had some leverage in a hypothetical negotiation, and it is entitled to have its reasonable expectations honored. But the term "reasonable" is essential to a proper damages analysis. Fletcher's view that its expectation damages should be measured by reference to its fantasy "ask" does not accord with our law, especially because: (1) Fletcher knew the BGP Transaction was good for ION and itself037e (2) Fletcher stood to become insolvent itself if the BGP Transaction did not go forward037e (3) other parties had far greater leverage than Fletcher037e (4) Fletcher had consent rights only to an optional part of a much larger transaction037e (5) and there were viable ways to structure around Fletcher's consent right.
To determine the amount of damages that Fletcher suffered as a result of the breach of its contractual right to consent to the issuance of any security by ION S.àr.l., the parties have presented evidence to determine what they would have agreed to in a hypothetical negotiation for Fletcher's consent that occurred before the issuance of the ION S.àr.l. Note in the fall of 2009.
The Hypothetical Negotiation For Fletcher's Consent
Determining what Fletcher would have received for its consent to the bridge financing in a hypothetical negotiation is not easy. It is an exercise in counterfactual historical imagination that is, by its very nature, fraught with uncertainty. In general, this is why consent rights cases are better dealt with by injunctive relief if the court can act with alacrity and give the parties a reasonable period to have the negotiation or work around the consent rights. Vice Chancellor Parsons found that was not the situation here.
Parties In The Hypothetical Negotiation
To determine the outcome of a hypothetical negotiation for Fletcher's consent, the court must consider the relative bargaining power of each of the parties that would be involved in the hypothetical negotiation: Fletcher, ION, the Existing Lenders, and BGP. At trial, Fletcher's attorneys attempted to paint a picture in which Fletcher and ION were the only two parties involved in the hypothetical negotiation. In Fletcher's version of events, it had all of the bargaining power and ION was weak and willing to capitulate to whatever Fletcher demanded, no matter how unreasonable those demands may have been. This simplified picture of the negotiations is unrealistic and does not comport with the record.
The hypothetical consent negotiation would have occurred just before the announcement of the BGP Transaction in the fall of 2009. For months before the hypothetical consent negotiation, BGP and ION had engaged in numerous rounds of intense and detailed negotiations over the structure of the BGP Transaction and the bridge financing. Contrary to Fletcher's assertions, the record indicates that BGP was concerned not only with the joint venture, but also with the 19.99% equity stake that it was taking in ION. BGP had reiterated the importance of its equity investment at every step in the negotiation and, in addition to negotiating for an equity stake, BGP also took steps to protect its investment from dilution.
Of all of the parties involved in the hypothetical negotiation, BGP had the most leverage. Although Fletcher rightly points out that BGP had certain interests in the transaction and that they wanted the deal to be consummated, BGP also had the least to lose from walking away from the transaction. Even Fletcher's expert, Fowler — who did not take BGP's participation in the negotiation or its substantial leverage into account in his report on the hypothetical negotiation — agreed that, of all the parties involved, BGP had the least to lose if the transaction failed to close.
The party with the second most leverage would have been the Existing Lenders. Fowler initially took the position that the Existing Lenders would not have had any right to consent to the changes to Fletcher's Preferred Stock that were being requested.
Although it is clear that the Existing Lenders wanted the BGP Transaction to close and to ensure that they would be fully repaid, they had greater negotiating leverage than either Fletcher or ION, a fact that Fletcher's own expert, Fowler, conceded at trial.
The other two parties, Fletcher and ION, had much less leverage than either BGP or the Existing Lenders. Both of them needed the BGP Transaction to close, because without it they were both likely facing bankruptcy. The primary difference between the two is that ION had the Chinese and the Existing Lenders in its corner, and with those tough negotiators willing to work to find solutions to avoid paying an exorbitant fee to Fletcher in exchange for its consent to a transaction that would provide it with immense benefit, there is no reason to believe that ION would have rolled over and given in to the crazy man in the corner threatening to blow up the transaction. Fletcher imagined that BGP, the Existing Lenders, and ION were trapped in the locked vault with the crazy man with the bomb, giving the crazy man the opportunity to coerce immense value from them in exchange for not blowing itself up. The problem for Fletcher is that only the crazy man was actually in the bomb-testing vault, in the far corner away from the door037e the others were already outside the vault with their hands on the door and just had to push the vault door closed to be safe. The bomber could then detonate if he wished, but he would have been the only one injured.
Even if the court credits Fletcher's theory that ION was a weak negotiator who ordinarily could have been bullied by Fletcher into acceding to Fletcher's demands, the court must deal with the fact that in this instance, ION would have had to go and get the permission of two much larger and stronger bullies before it could give into Fletcher's demands. Even if ION so desperately wanted the BGP Transaction to close that it was willing to agree to changes to Fletcher's Preferred Stock that would transfer tens of millions of dollars in value to Fletcher in order to get the deal done, there is nothing that suggests that BGP or the Existing Lenders were that desperate or that they would have agreed to the changes Fletcher was requesting. This reality also undercuts Fletcher's case theory that the Existing Lenders would not give a unanimous consent if necessary to get the BGP Transaction done. Because the Existing Lenders wanted to get out and because the BGP Transaction promised them not only full repayment but a complete exit in a few months time, had Fletcher made demands that came at the expense of BGP and led BGP to consider walking away, the equation would have been fundamentally changed for the Existing Lenders. If the Existing Lenders found out that a preferred stockholder without a put option or other exit right was seeking $78 million in value for consenting to a $40 million bridge loan, the Existing Lenders would have had every reason to work with ION and BGP to restructure the deal and avoid the consent and give Fletcher no extra consideration at all.
The Hypothetical Negotiation And Its Likely Outcome
In its post-trial briefs, Fletcher's new counsel drastically altered its damages case. As noted, throughout discovery and at trial, Fletcher had insisted that it would have sought and obtained economic consideration that was substantial in comparison to the $40 million to which it had consent rights. When Fletcher finally quantified the damages theory in its expert report before trial, the damages it sought amounted to $78 million, or nearly two times the $40 million loan it had a consent right over.
After being denied the chance to file an untimely expert report raising other theories to justify a number of this comparative enormity, Fletcher proceeded to push its $78 million damages theory at trial, and it steadfastly asserted that it would not have consented unless it received something close to that level. After the viability of that theory was undercut at trial, Fletcher's new counsel put forward, for the first time, a more moderate — if still aggressive — position in its post-trial briefs. Under Fletcher's new post-trial damages theory, Fletcher claims that it would have received a decrease in its stock conversion price from $4.4517 to $4.0867, which it valued at $6,236,553. Fletcher also claims that the "floor" on its damages should be set at $3,653,105, or the total amount that Fletcher paid to the Existing Lenders in connection with the Fifth Amendment.
This new position was more measured, but it was not fairly raised nor is it supported by the record. To accept it would require the court to discount all of Fletcher's witness testimony at trial and in depositions, all the previous briefs, and its key expert report. Fletcher itself chose to portray its eponymous leader as willing to bring down Fletcher and its investors in a suicidal grab for ransom from ION and BGP. Although the court will indulge in leniency toward Fletcher because its contract rights were violated and take a less caricatured view of Fletcher than it has drawn of itself, the court cannot assume that Fletcher would have either started or ended negotiations with anything close to its post-trial request of $6,236,553. Rather, the court assumes, as it must, that Fletcher would have come out recklessly over-the-top bold with something like the demand in its expert report. This is charitable to Fletcher. If Fletcher is positing it would have received $78 million, one assumes that its initial demand would have been closer to $100 million in value — two and a half times the $40 million bridge loan over which it had a consent right. For the purposes of this opinion, the court need not assume, though, that Fletcher acted with more audacity than to demand two times the loan to which it was being asked to consent. That is enough to frame what is likely to have happened if, contrary to Fletcher's portrayal, Buddy Fletcher had a basic, residual sense of rationality and a rudimentary regard for his fiduciary duties to his investors. The court credits Buddy Fletcher with these characteristics even though it had no chance to hear Buddy Fletcher's testimony in person, Buddy Fletcher's deposition testimony was consistent with the over the top portrayal of him, and the trial testimony of his subordinate — Benson — was consistent with that extreme posture. Because Fletcher's rights were violated, the court errs on the side of assuming that Buddy Fletcher was a very bold, but ultimately practical hedge fund manager who would, in the end, not be nihilistic and end up with nothing when he had the chance to pocket something tangible.
The court therefore assumes that if ION had approached Fletcher in October 2009 to ask for its consent to issue the ION S.ár.l. Note, before the announcement of the BGP Transaction, Fletcher would have started the negotiations by asking for the changes to the terms of its Preferred Stock that Fletcher has contended it was entitled to. The court assumes that Fletcher would have opened the negotiations by requesting the following three changes to its Preferred Stock: (1) an increase in the dividend rate of 250 to 350 basis points, (2) a decrease in the conversion price from $4.45 to $2.80, and (3) a reinstatement of Fletcher's redemption right without a Minimum Price Provision.
ION would have been speechless at Fletcher's audacity. When ION's managers recovered their equilibrium, they would have gone back to ION's legal and financial advisors to discuss this astonishing ask. There is nothing in the record to support the proposition that ION, BGP, and the Existing Lenders would have agreed to the transfer of tens of millions of dollars in value to Fletcher in exchange for its consent, especially when the transaction at issue was expected to benefit Fletcher immensely and where Fletcher faced disaster itself if ION went into bankruptcy. Because of the nature and magnitude of the changes that Fletcher sought to its Preferred Stock, ION could not and would not have merely granted Fletcher's request without consulting with and receiving permission from BGP and the Existing Lenders. ION's negotiators may not have been bold, but they were intelligent. Their lack of bravado, moreover, would lead them to realize there was no way to give in to Fletcher without first going to the more powerful players — BGP and the Existing Lenders. The people acting on behalf of BGP and the Existing Lenders were also intelligent business people advised by intelligent legal and financial advisors, and they would have realized that the changes Fletcher was requesting — which Fletcher valued at $78 million — would result in a value transfer that nearly doubled the value of the $40 million bridge financing Fletcher was consenting to. There is nothing in the record that would explain why the intelligent business people at ION, BGP, and the Existing Lenders would have agreed to pay $78 million in exchange for consent to complete a $40 million bridge financing.
ION would therefore have responded in due course to Fletcher's demands by explaining the following: (1) the request for an increase in the dividend rate would require the Existing Lenders to approve an amendment to the Credit Facility037e and (2) that BGP was very focused on its equity interest in ION and would be unlikely to approve changes to Fletcher's Preferred Stock that would result in dilution. The record indicates that BGP would have been particularly unwilling to give in to Fletcher's demands because one of Fletcher's asks — a reduction in the conversion price of its Preferred Stock — would have resulted in substantial dilution to BGP's equity stake in ION. The importance that BGP placed on its 19.99% equity stake in ION was clear from the extensive negotiations over both how much equity BGP would receive and what the contours of its anti-dilution protections would be. Therefore, there is no reason to believe that BGP would have agreed to the changes Fletcher was requesting to its Preferred Stock. Furthermore, because BGP was taking an equity stake, there was no reason for it to indulge a request by a vulnerable party like BGP for an increase in dividend payments on its Preferred Stock. Those dividend payments would cost ION money, and they would come at the expense of its ability to invest in future projects and at the expense of BGP as a stockholder.
Having thought about it, ION also would have explained to Fletcher that it had alternatives to the issuance of the $10 million ION S.ár.l Note, which was the only part of the BGP Transaction that implicated Fletcher's consent right and which was severable from the larger BGP Transaction. The record indicates that there were at least two viable alternatives ION could have pursued to structure the bridge financing around Fletcher's consent right: (1) the $40 million Convertible Promissory Notes issued by ION and ION S.ár.l could have been made non-convertible, and therefore not a security according to Vice Chancellor Parsons's reasoning in Fletcher II; and (2) ION could have obtained a waiver to the Split Requirement, and the entire $40 million in convertible notes could have been issued by ION so that Fletcher did not have the right to consent.
The easiest way that ION could have structured around Fletcher's consent right would have been to remove the convertibility feature on the notes. In Fletcher II, which is the law of this case, Vice Chancellor Parsons noted that not all notes are securities,
Fletcher took the position in its post-trial briefs and at post-trial oral arguments that the purpose of the convertibility feature was to protect BGP and the Bank of China in the event that the transaction did not close and that they would not have agreed to issue the notes if they were not convertible.
Furthermore, BGP would have been aware that Fletcher's consent was only required because of the $40 million in bridge financing that BGP insisted ION take to ensure that ION made it through closing. ION had maintained, throughout the negotiations, that it only needed an additional $20 million to make it to closing. Even more, Fletcher was asking for considerable value that would have come largely out of BGP's own hide. Therefore, BGP and ION could have agreed to reduce the amount of the bridge financing to $20 million and, as was the case if the full $40 million bridge loan was restructured with no convertibility feature, it was even more likely that the Bank of China would have agreed to lend only the $20 million that ION actually needed without that feature. In this respect, it is important to remember why the Bank of China was even involved in lending to ION. The Bank of China was only involved to facilitate the completion of a precedent-setting investment in America in an important industry sector by its fellow state-owned enterprise, BGP. Given that context, there is no reason to believe that the Bank of China would not have agreed to structure the transaction so that it was not convertible, which would mean no extra credit risk for itself, in order to help BGP get a better deal than would be the case if it gave in to Fletcher's $78 million demands.
The second way that ION could have avoided Fletcher's consent right is to have ION issue the entire $40 million convertible note itself. Fletcher correctly points out that, in order for the entire bridge financing to occur at the parent level, ION would have had to secure a waiver to the Credit Facility's Split Requirement, which required unanimous approval from the Existing Lenders. Fletcher and its expert contended that ION never would have taken this proposal to the Existing Lenders because it required unanimous consent and that the Existing Lenders never would have unanimously consented. This argument is based entirely on emails indicating (1) that HSBC did not believe it would be able to secure unanimous approval from the Existing Lenders for an amendment to the Credit Facility that would add a separate tranche of debt that would have a shorter commitment period and an earlier maturity date than their loans; and (2) that ION did not believe the Existing Lenders would unanimously agree to add more than the $40 million that could be added under the accordion feature of the Credit Facility because doing so would dilute the collateral that secured the loans already outstanding under the Credit Facility. From these emails, Fletcher draws the conclusion that seeking unanimous approval from the Existing Lenders for an amendment to the Credit Facility was some kind of "untouchable `third rail'" and that BGP and ION would not have requested anything that required unanimous lender approval.
In both of the instances where ION and BGP indicated that they did not want to seek unanimous lender approval, it was for a transaction structure that would have disadvantaged the Existing Lenders. The fact that ION and BGP did not believe they could get unanimous approval from the Existing Lenders for transaction structures that gave the Bank of China better terms than the Existing Lenders or that would dilute the collateral of the Existing Lenders by more than the amount agreed to under the accordion feature does not mean that BGP and ION would have been unwilling to request a waiver of the Split Requirement. Because the Credit Facility was entirely cross-collateralized, there would have been no adverse economic consequences to the banks from a waiver of the Split Requirement.
There is another reason to believe that ION and BGP could have obtained the unanimous consent of the Existing Lenders to waive the Split requirement. Under Fletcher's theory, it was demanding a concession — an increase to the dividend rate on its Preferred Stock — that would already have required the unanimous consent of the Existing Lenders. If the Existing Lenders were going to have to give a unanimous consent to enable the BGP Transaction to proceed, a waiver of the Split Requirement would have been much more palatable to them than giving value to Fletcher for acting as a spoiler.
But the fact that BGP, ION, and the Existing Lenders could have structured the BGP Transaction to avoid Fletcher's consent right does not mean that they would have done so. To restructure the bridge financing in late October, after the majority of the negotiations had already taken place, the parties likely would have needed to pay hundreds of thousands of dollars to their legal and financial advisors to redraft the documents, which would have wasted everyone's time. They would have also had to spend time with the Existing Lenders, securing consents, depending on the option taken. All else being equal, ION and BGP would have preferred to pay a reasonable consent fee to Fletcher to avoid the complication of having to restructure the bridge financing.
For the reasons previously indicated, the court assumes that when ION responded to Fletcher by pointing out the realities that it was asking for value in excess of the bridge loan, Buddy Fletcher would listen in a gruff way and then consult with his own brain, conscience, and advisors. Fletcher would have to recognize that BGP was highly unlikely to agree to the changes Fletcher requested, that the Existing Lenders would have to give unanimous consent for those changes to proceed, and that ION was inclined to work with BGP and the Existing Lenders so that no consent was needed at all. After a quick "walk around the block" to allow the cold, brisk air of rationality to ease through his respiratory system, Fletcher would have come back with a responsible, aggressive, demand, still displaying some chutzpah, but attractive enough to make ION (and BGP in turn) think it less painful and more efficient than restructuring the bridge financing.
This outcome is supported by the fact that both Fletcher and ION have agreed that the consent fees that were paid to the Existing Lenders are relevant benchmarks that can be used to determine what a reasonable consent fee would be.
For all of these reasons, I impose a monetary damage award of $300,000 (.75% x 40,000,000). Because Fletcher has subjected ION to unnecessary prejudice and expense by violating its discovery obligations, attempting to circumvent the rulings of this court, and changing its damages theories, I exercise my discretion to award pre-judgment interest calculated at two-thirds of the statutory rate, compounded on an annual basis. The court will not entertain any further applications for fee-shifting. ION shall submit a conforming final judgment within five days, after giving notice as to form to Fletcher.
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