Equity-Linked Investors, L.P. v Adams
705 A.2d 1040 (Del.Ch. 1997)

  • Genta was a biotech startup firm that was not making any profits. They kept losing money, but they were working on some new technologies that looked promising and might one day lead to big profits.
  • Unfortunately, Genta was really teetering on the edge of bankruptcy. As they looked for additional investors, the preferred stockholders were getting ready to cut their losses and liquidate the company.
    • The preferred stockholders had a liquidation preference, which meant that if the company went under (or was delisted from the stock exchange), the assets would be sold off and used to pay back the preferred stockholders. The common stockholders would get nothing.
  • Genta was able to secure some additional capital to stay in business. The preferred stockholders (led by Equity-Linked) sued the Board for making such a bad business decision.
    • The preferred stockholders argued that the more loans Genta took to stay in business, the less they would get if the company was liquidated. They argued that Genta was violating their duty to the preferred stockholders by taking out more loans.
      • The stockholders were pretty sure that Genta was going to go bankrupt eventually, so why not do it now instead of waiting until they were so in debt that there was nothing left?
    • Genta argued that they were protecting the interests of the common stockholders by doing everything possible to stay in business.
  • The Trial Court found for Genta.
    • The Trial Court found that the imposition of additional economic risks on the preferred stockholders for the benefit of the common stockholders did not constitute a breach of duty.
    • The Court found that it is the duty of the directors, where discretionary judgment is exercised, to prefer the interests of the common stock to the interests created by the special rights of preferred stock, where there is a conflict.
    • The Court noted that whether a company liquidates or not is a business judgment, and the courts should apply the Business Judgment Rule.
  • The reason for preferring the common stock owner is because they are the residual owners. They are the ones who get what’s left after all the debt is paid off. They are the ones taking the most risk, and are therefore the most sensitive to fluctuations in the company. So it makes sense for the directors to think of them first.