This appeal is from an order of the Court of Chancery dismissing the complaints in a consolidated class action filed by the owners of two series of preferred stock
The facts out of which the dispute arises involve the sale and delivery of natural gas to many cities and corporate users in the State of Texas and, although our involvement is limited, we must recite some of them to put the appeal into context. For that purpose, the relevant facts are these:
A significant part of Coastal's business is the gathering, transporting and marketing of natural gas, all of which is conducted by a subsidiary, Coastal States Gas Producing Co. (Producing), also a defendant in this action. Producing, in turn, has a subsidiary, Lo-Vaca Gathering Co. (Lo-Vaca), another defendant, which supplies the gas to intrastate customers in Texas, including the Cities of Austin, Brownsville, Corpus Christi and San Antonio.
As a result of several factors associated with the "energy crisis" in the early 1970s, the wellhead price of natural gas increased significantly (from about 20¢ per 1000 cubic feet to about $2.00 for the same quantity) and Lo-Vaca was unable to honor its obligations to deliver gas to its customers at contract prices. In 1973, Lo-Vaca sought and obtained interim permission from the Railroad Commission of Texas (the agency vested with jurisdiction over intrastate utilities in Texas) to increase its rates; that authorization permitted Lo-Vaca to pass to its customers certain of its own cost increases. After the higher rates went into effect, a large number of Lo-Vaca industrial and municipal customers filed suits against Lo-Vaca, Producing, Coastal and Oscar Wyatt (Coastal's chief executive officer, the owner of the single largest block of its common stock and a defendant in this suit) for breach of contract.
In December 1977, the Commission entered a final order denying Lo-Vaca's original petition for rate relief and, in effect, rescinding the interim order which had authorized the increase. The Commission then directed Lo-Vaca to comply with the contract rates and ordered Coastal, Producing and Lo-Vaca to refund the rate increment
Given this state of affairs, with its obvious and enormous implications for a large section of Texas, settlement negotiations were undertaken and, eventually, a complex plan evolved. It is unnecessary for us to detail the plan, but the following summary states its substance:
In addition, there will be a distribution by Coastal, in the form of an extraordinary dividend chargeable to earned surplus, to its common stockholders (except Wyatt) of the balance (86.6%) of the Valero common stock not transferred to the trust referred to in (3)(c) above.
Coastal's Board of Directors unanimously approved the settlement
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Holders of the Series A and Series B preferred stock, (plaintiffs), filed an action in the Court of Chancery to enjoin the special shareholders meeting. They alleged that the settlement plan breaches the "Certificate of the Designations, Preferences and Relative, Participating Optional or other Special Rights" (Certificate) of the Series A and Series B preferred stock. In essence, plaintiffs say that the plan violates their Certificate rights because the preferred will not receive any of the Valero shares, that is, the 86.6% to be distributed entirely to the Coastal common.
After a trial on the merits, the Vice Chancellor entered judgment for defendants and ordered plaintiffs to pay the costs of giving notice to the members of the class of the pendency of the action. See Court of Chancery Rule 23. The Court determined that the settlement plan and, more specifically, the spin-off of Producing and the distribution of Valero stock to the common stockholders of Coastal, is not a "recapitalization" within the meaning of the Certificate. (If it is, all parties concede that the preferred is entitled to participate in the distribution of the Valero shares.) The Vice Chancellor reasoned that a key phrase, "in lieu of," in the Certificate implies that the existing shares of Coastal common must be exchanged for something else before there is a "recapitalization" which creates rights in the preferred. And he found support for that conclusion in another Certificate provision which permits Coastal to pay a dividend to holders of common stock, in other than its own common, without affecting the rights of the preferred.
The Court also ruled that the holders of the preferred stock were not entitled to vote as a class on the settlement plan, because the requirements of the Certificate for such a vote had not been met.
Finally, the Court considered plaintiffs' claims that the settlement plan is unfair to the preferred, unjustly enriched the common and did not have a proper business purpose, and concluded that the rights of the preferred are found, under the circumstances of this case, solely in the Certificate, not in concepts of fairness or fiduciary duty.
On appeal, plaintiffs challenge each of these rulings, as well as the order requiring them to pay the costs of giving notice to the class.
Before discussing the merits of the controversy, we emphasize that this lawsuit is not a general attack upon the settlement plan. On the contrary, plaintiffs say that they approve the plan and hope to see it executed. As we have observed, the case involves a dispute between the preferred vis-a-vis the common over participation rights in the Valero stock to be distributed as part of the spin-off. As we understand it, that is the extent of plaintiffs' attack upon the plan.
The preferred has a conversion right to exchange for the common on a one-to-one basis. Briefly stated, the preferred argues that a distribution of Valero stock to the common only, and without provision for permitting the preferred to share therein now or at the time of conversion, violates its Certificate rights. We now examine those rights in some detail.
In pertinent part, the Certificate states:
For most purposes, the rights of the preferred shareholders as against the common shareholders are fixed by the contractual terms agreed upon when the class of preferred stock is created. Judah v. Delaware Trust Co., Del.Supr., 378 A.2d 624, 628 (1977); Ellingwood v. Wolf's Head Oil Refining Co., Del.Supr., 38 A.2d 743 (1944); Holland v. National Automotive Fibres, Del.Ch., 194 A. 124, 126 (1937). And, as to the conversion privilege, it has been said that the rights of a preferred shareholder are "least affected by rules of law and most dependent on the share contract." Buxbaum, "Preferred Stock — Law and Draftsmanship," 42 Cal.L.Rev. 243, 279 (1954).
Our duty, then, is to construe the contract governing the preferred shares. In so doing, we employ the methods used to interpret contracts generally; that is, we consider the entire instrument and attempt to reconcile all of its provisions "in order to determine the meaning intended to be given to any portion of it." Ellingwood v. Wolf's Head Oil Refining Co., supra at 747. More to the point, we must construe the several qualifications of the conversion privilege which are stated in Sections (c)(4)-(7) of the Certificate.
The basic conversion privilege is stated in Section (a) of the Certificate: at the option
Section (c)(4) in the Coastal Certificate is such an "anti-dilution" clause. It provides for a proportionate change in the conversion ratio in the event of a stock split or a stock combination (that is, a reverse split). In each of those events, the number of outstanding shares of Coastal common would change so, in order to preserve the parity relationship, a proportionate adjustment to the conversion ratio is essential.
Section (c)(6) is directed to the same anti-dilution purpose. While (c)(4) applies to subdivisions and combinations (which enlarge or decrease the number of outstanding shares), (c)(6) is directed to a stock dividend, that is, the issuance of Coastal shares to its stockholders as a dividend. That, too, is a circumstance which, by definition, would dilute the prior parity relationship and, to prevent that, the conversion ratio is "proportionately increased" by (c)(6).
Since Coastal is neither splitting nor reverse-splitting its shares, nor distributing them as a dividend, (c)(4) and (6) do not directly apply to this case.
This brings us to (c)(5) which plaintiffs contend is the heart of the matter. The short of it is that unless the plaintiffs can find something in this paragraph which, directly or by implication, prohibits Coastal from distributing the Valero stock to the holders of its common, without giving its preferred a right to participate therein (now or at the time of conversion), then, under our settled law, restated only eighteen months ago in Judah and running back at least to 1929 in Gaskill v. Gladys Belle Oil Co., Del.Ch., 146 A. 337, 339, the preferred has no such right. The Vice Chancellor found none. Nor do we.
Given the significance of (c)(5) in the dispute, we quote it again, this time omitting the references to consolidations, mergers, sales, and so on, which are not directly germane here. Thus:
After noting that the "recapitalization" has no generally accepted meaning in law or accounting, the Vice Chancellor focused on the phrase, "in lieu of," as it appears in (c)(5) and concluded that, before the Section becomes applicable, the "Common Shares of Coastal must cease to exist and something [must] be given in lieu of them." Since the Coastal shares will continue in being after the spin-off, he concluded that the plan is not a recapitalization within the meaning of the Certificate.
Plaintiffs contend that Section (c)(5) is the key to analysis of the Certificate. They say that the settlement plan constitutes a "recapitalization" of the Coastal, which triggers the adjustment called for in that section.
Relying on the significant changes which the plan will effect in Coastal's capital structure,
Section (c)(5) contains what is typically considered to be "anti-destruction" language. See Buxbaum, supra at 287. Transactions listed therein — a merger or consolidation, for example — are the kind of events that will not merely dilute the conversion privilege by altering the number of shares of common but, rather, may destroy the conversion privilege by eliminating the stock into which a preferred share is convertible. We focus, however, on the preferred's claim of right if Coastal "shall be recapitalized."
At trial, both sides offered the testimony of experts
The parties have also cited cases
We agree with plaintiffs that the changes which the plan will bring to Coastal's financial structure are enormous. And it may be concluded that, collectively, these amount to a "reshuffling of the capital structure" under the general definition to which Professor Sametz testified. But that is not the test. The critical question concerns what is said in the contract.
Section (c)(5) provides that in the event of "recapitalization" one of the provisions shall be that a holder of preferred may "thereafter" receive — something. When he may receive it is clear: he may receive it "upon conversion" after the recapitalization has taken place. After that event, he may receive, not what he would have received before recapitalization; that was the common stock which was "otherwise issuable to him upon conversion." Certainly this clause is meaningless if the common share remains issuable to him after recapitalization. And so is the remainder of the paragraph which requires that the same conversion
Since the settlement plan does not include an exchange of the common and, given the added circumstances that the dividend or liquidated preference of the preferred is not threatened and that earned surplus is ample to support the distribution of the Valero shares to the common, the settlement plan does not include a recapitalization within the meaning of Section (c)(5).
We turn now to (c)(7) which, we think, is related to what is said in (c)(5) and our construction of it; (c)(7) states:
This section, plainly and clearly, lists transactions which do not call for an adjustment to the conversion ratio. Thus an adjustment is not made for:
Section (c)(7) concludes with the phrase, "except as expressly provided herein," which creates an ambiguity that must be resolved.
Plaintiffs contend that the phrase relates to all of Section (c), including (c)(5), and thus if a property dividend (the Valero stock) is regarded as a "recapitalization," the latter section controls. It is somewhat difficult to follow that argument but, as we understand it, plaintiffs contend that (c)(7) does not apply here.
In our opinion, the phrase, "except as expressly provided herein," refers to those paragraphs of Section (c) which "expressly... [provide]" for a change in the conversion ratio. In so doing, the phrase does modify the preceding phrase, "any other reason" (which is all-encompassing). But the transactions referred to are those in (c)(4) and (c)(6), and thus they are the exceptions "expressly provided" for. There are no exceptions provided for in (c)(7) and, therefore, the phrase would be meaningless if it were construed as applying to (c)(7).
Section (c)(7) states flatly that an adjustment shall not be made in the conversion ratio in the event any of the three specified events occurs: a dividend in property other than Coastal common, a redemption of the common or the issue of securities convertible into common. And the three specifics are enlarged by the general reference to "any other reason." Given what we believe to be mandatory language ("[n]o adjustment ... shall be made") prohibiting a change in the conversion ratio, we conclude that such a change may be made only if it is "expressly provided" in Section (c), and, as we have said, that means by the anti-dilution provisions of (c)(4) and (c)(6), i. e., by a stock split, reverse split or a stock dividend. It is only in those paragraphs that provisions are found for an adjustment in the conversion ratio.
But even if one were to find some inconsistency or contradiction between (c)(5) and (c)(7), then, under familiar and well-settled rules of construction, the specific language of (c)(7) (as applied to the Valero stock) controls over any general language in (c)(5) regarding recapitalization. Stasch v. Underwater Works, Inc., Del. Supr., 2 Storey 397, 158 A.2d 809, 812 (1960); Restatement of Contracts § 236(c).
We have reviewed Sections (c)(4) through (c)(7) independently but failed to find therein any merit to the contentions which plaintiffs argue. And considering the paragraphs together, Ellingwood v. Wolf's Head Oil Refining Co., supra, confirms our conclusion. So viewed, the basic scheme is that parity between the common and preferred is maintained through any changes in the number of outstanding shares which are unaccompanied by other balance sheet changes: thus a stock split, reverse split or stock dividend changes only the number of shares outstanding without any change in corporate assets. Sections (c)(4) and (c)(6) provide for continuing parity by making the appropriate adjustment to the conversion ratio (that is, what will be given for one share of preferred) in such instance. But it appears that a reduction in assets by distribution to the common may be made without adjustment to that exchange basis. Thus a cash dividend is permissible under (c)(7),
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In summary, we conclude that a distribution of the Valero stock to the holders of coastal common is permissible under Section (c)(7) and may be made without adjustment to the conversion ratio; such distribution is not a recapitalization under Section (c)(5).
Next, plaintiffs contend that the settlement plan should have been put to a special (two-thirds) vote of the preferred shareholders as a class, as provided for in Section VII of the Certificate.
For most purposes, the voting rights of the preferred shareholders are found in Section IV of the Certificate and, for most purposes, their rights are the same as the holders of the common. In our opinion, the special voting provisions for which plaintiffs argue are triggered only by the two events stated above. And neither of those has occurred.
Thus, shares are not to be issued under the settlement plan which would rank superior to plaintiffs' shares, either as to payment of dividends or distribution of assets. And the settlement plan will not change the preferences, rights or powers of the preferred. As we have said, the special features of the preferred stock are those fixed by the share contract and the settlement plan comports with that contract, as we have construed it. It follows that Coastal has not "change[d] the preferences, rights or powers" of the preferred shareholders and, so, the latter are not entitled to vote on the plan as a class.
Plaintiffs also argue that the settlement plan unjustly enriches the common shareholders at the expense of the preferred shareholders.
There is no contention that Coastal is in arrears on dividends payable to the preferred, nor is the Company in the process of dissolution.
Finally, plaintiffs challenge that part of the order of the Court of Chancery directing that they pay the cost of giving notice to the class of the pendency of this action. That order is, under Rule 23, at the discretion of the Trial Judge and plaintiffs have not shown that he abused his discretion in assigning costs to them.
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