DISPUTE OVER PUT RIGHT ILLUSTRATES THE POTENTIAL PITFALLS OF AMBIGUOUS CONTRACT LANGUAGE
By: David Forney and Adam Heyd
In QC Holdings, Inc. v. Allconnect, Inc., C.A. No. 2017-0715-JTL (Del. Ch. August 28, 2018), plaintiff QC Holdings, Inc. (“QC Holdings”), a former stockholder of defendant Allconnect, Inc. (the “Company”), brought a claim against the Company to enforce its right (the “Put Right”) under a Put Agreement to sell its Company shares (the “Put Shares”) to the Company in exchange for $5 million (the “Put Price”). The Company had refused to pay the Put Price on the basis that it was contractually restricted from doing so on the date required under the Put Agreement, and therefore the Put Right was extinguished and never survived a subsequent merger of the Company when those restrictions arguably lifted. The Delaware Court of Chancery held that the Company’s arguments would have resulted in an improper forfeiture of QC Holdings’ contractual rights to the Put Price and that the exercise of the Put Right constituted a redemption of the Put Shares prior to the merger and a continuing contractual obligation by the Company to pay the Put Price. The Court ordered the Company to pay the Put Price to QC Holdings out of an escrow set up at the merger closing for this purpose.
In 2013, the Company entered into the Put Agreement with QC Holdings as partial consideration for the sale of substantially all of QC Holdings’ assets to the Company. The Put Agreement included a Put Right similar to redemption rights previously granted to the Company’s preferred shareholders. In November 2015, QC Holdings exercised the Put Right in accordance with the Put Agreement. Under the terms of the Put Agreement, the Company was not obligated to pay the Put Price for one year, and only then if the Company had (a) sufficient funds legally available, including under Section 160 of the Delaware General Corporation Law (the “DGCL”) and (b) no outstanding “Senior Indebtedness” (defined as money borrowed from banks or other institutions regularly engaged in lending). Almost a year later, the Company notified QC Holdings by letter that the Company would not pay the Put Price on the anniversary because it had outstanding Senior Indebtedness, and any payment of the Put Price would likely be “deferred” beyond 2017.
In September 2017, the Company entered into a merger agreement with New Imagitas Inc. (“Imagitas”), pursuant to which the Company became a wholly-owned subsidiary of Imagitas (the “Merger”). As part of the Merger, all of the Company’s outstanding Senior Indebtedness was paid off, and the preferred shareholders withdrew their redemption claim in exchange for their preferred share liquidation preference. All Company common stock was converted into the right to receive approximately 2 cents per share. Under the Merger terms, Imagitas required the Company’s preferred stockholders to place $5.1 million in an escrow fund for any potential payout to QC Holdings under the Put Agreement (the “Escrow Fund”). Nonetheless, the Company insisted it did not have any legal right to the merger consideration (including the Escrow Fund), and it did not have any other legally available funds to pay the Put Price. The Company also contended that the Put Right was a one-day-only obligation applying on the anniversary of the exercise date, and the Company was not permitted to pay the Put Price on that day under the terms of the Put Agreement. QC Holdings countered that the Put Right was merely suspended in November 2016 rather than being forfeited, that the Senior Indebtedness was paid off prior to the Merger, and that the Company possessed legally available funds in the form of the merger consideration which should have been used to pay the Put Price.
The Court found neither position to be consistent with Delaware law. The Court found the Company’s ‘one-day-only’ argument would result in a forfeiture, rendering it suspect and disfavored under existing case law unless it was “unambiguous” and commercially rational. The Put Agreement did not explicitly state that the Put Right was an ongoing obligation, and the Company argued that sophisticated parties normally would include such language if that was the intent (indeed the preferred shareholder redemption right clearly established an ongoing Company obligation). However the Court noted that the Put Agreement does not state explicitly that the obligation to pay the Put Price terminated on the anniversary date of the exercise. Moreover, the Put Agreement states that the Company is not obligated to pay the Put Price “for so long as” the Company owes Senior Indebtedness, implying that the Put Right is an ongoing obligation. The Court also found it would be irrational for QC Holdings to agree to a payout only on one particular future date, given the unlikelihood that the Company would be permitted to pay on that date. The Company’s actions further supported these findings: its November 2016 letter mentioned a “deferral” of the Put Right payout, and the Court noted that the Company carried the Put Right obligation on its books even after such right supposedly terminated under its argument.
The Court also found QC Holdings’ argument that the Company possessed legally available funds just prior to the Merger to be unpersuasive. The Court noted that the preferred shareholder redemption right was not withdrawn until after the Merger completion, so there was never a time prior to the Merger when the Company had legally available funds to pay the Put Price. Moreover, the Court stated that Delaware law provides that the merger consideration is a payment from Imagitas to the shareholders of the Company and not to the Company itself. As the Company itself never had a legal right to the merger consideration, such consideration could not be considered as part of the Company’s funds legally available to pay the Put Price prior to the Merger.
Having discredited both parties’ arguments, the Court instead found that QC Holdings had transferred the Put Shares to the Company in November 2015 under the terms of the Put Agreement. As a result of such transfer, QC Holdings was no longer a stockholder of the Company after November 2015. Instead QC Holdings had a contractual redemption right that, following the Merger, became an obligation of the surviving corporation under Section 259 of the DGCL. Had the Company respected that obligation, it should have been satisfied before the Company’s stockholders received their merger consideration. Both Imagitas and the stockholders apparently recognized this and established the Escrow Fund to pay the Put Price if the Company failed in its forfeiture argument. The Court noted that the Put Agreement could have been drafted to treat QC Holdings as a stockholder until the redemption was complete, in which case following the Merger and conversion of Company common stock, QC Holdings would only have been entitled to two cents per share. Instead, the Court ordered a decree of specific performance requiring the Company to pay the full Put Price to QC Holdings using the Escrow Funds, with further proceedings to be held if such Escrow Funds were insufficient to satisfy the Put Price.
QC Holdings, Inc., v. Allconnect, Inc., memorandum opinion 180828