DELAWARE COURT OF CHANCERY RULES PREFERRED STOCKHOLDERS CAN BRING STOCKHOLDER DERIVATIVE ACTIONS

Date: July 1st, 2010
Categories: Corporate Law

In MCG Capital Corp. v. Maginn (Del. Ch., Civil Action No. 4521-CC, May 5, 2010), the Delaware Court of Chancery decided the first case to come before it directly addressing the standing of a preferred stockholder of a Delaware corporation to bring a stockholder derivative action on behalf of the corporation, holding that preferred stockholders do have standing to bring these types of actions unless the ability to do so is expressly limited in the corporation’s charter, the terms of the preferred stock or another appropriate document.

Stockholder derivative actions are a well-established means for common stockholders to pursue on behalf of the corporation a cause of action that the corporation is unwilling to pursue independently. Often, the context of a derivative action has stockholders bringing suit on behalf of the corporation on a cause of action they allege the corporation has against its own executives, but which the executives in control of the corporation are not pursuing for self-interested reasons.

Plaintiff MCG Capital Corp.’s derivative action was based on factual claims very recognizable in the landscape of stockholder derivative actions, including allegations about improper compensation increases and bonuses for senior executives. The unusual feature was that MCG held no common stock of the corporation, but only preferred stock and common stock purchase warrants. While it is settled law in Delaware that a holder of common stock warrants cannot bring a derivative action on that basis (holding only a right to purchase stock, and thus not having been a stockholder of the corporation at the relevant time), courts had never considered whether preferred stockholders may bring derivative actions based solely on their ownership of preferred stock.

In holding that preferred stockholders do have that right, Chancellor Chandler wrote that “all stock is created equal . . . . all classes of stock enjoy the same rights and privileges unless an affirmative expression alters those rights.” The Delaware General Corporation Law contains nothing to suggest common and preferred stockholders should be treated differently in their ability to bring a stockholder derivative action. Citing precedent from the Delaware Supreme Court that “[a]ny rights, preferences and limitations of preferred stock that distinguish that stock from common stock must be expressly and clearly stated,” the Chancellor concludes that “preferred stockholders have standing to bring derivative actions unless the ability to bring a derivative claim has been expressly limited in the articles, preferred stock designations, or some other appropriate document.”

The Washington Business Corporation Act shareholder derivative proceedings provisions, RCW 23B.07.400, use the term “shareholder” without making any reference to the class or series of shares. We believe it is very likely that a Washington court would conclude that a holder of preferred stock in a Washington corporation has standing to bring a shareholder derivative proceeding on behalf of the corporation.