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Leaving the Contractual Term “Voting Power” Undefined Could Be Risky Business

What does the contractual term “voting power” mean?  Does it refer only to the power to elect corporate directors, or does it refer to the power to vote on any fundamental matter of corporate governance?  Is voting power an attribute of stock, or is it something that shareholders possess?  Commercial Division Justice Marcy Friedman’s recent decision in Special Situations Fund III QP, LP. v. Overland Storage, Inc.,[1] suggests that the contractual term “voting power” could conceivably bear any of these meanings, depending on context and the parties’ intent—which suggests that leaving this term undefined in a contract could be risky business.  Any attorney who regularly drafts stock purchase agreements, voting agreements, or other contracts that use the term “voting power” would do well to take note of this recent Commercial Division decision.

Factual Background

The defendant in Special Situations Fund, Overland Storage, Inc. (“Overland”), is a California-based provider of data management, data storage, and data protection technologies and services.[2]  The plaintiffs, several investment funds (the “Funds”), acquired the rights to 7.7 million of Overland’s common shares in February 2010.  In August 2010, Overland commenced a patent infringement lawsuit against one of its competitors in federal court and before the International Trade Commission.  Several months later, in December 2010, Overland sold the Funds a 20% interest of the recovery from the patent infringement litigation in exchange for $3 million, as memorialized in the “Purchase Agreement.”

The Purchase Agreement gave Overland sole discretion to determine whether to settle the litigation.  It also stated that Overland was required to pay the Funds a $6 million lump-sum payment in lieu of the 20% share of the recovery if a “Specified Transaction” occurred prior to final resolution of the litigation.  The Purchase Agreement defined “Specified Transaction” as “(i) an acquisition by any Person and its Affiliates of more than 50% of the then outstanding voting power of [Overland],” or “(ii) “the merger, consolidation or other business combination transaction of [Overland] with any Person or any of its Affiliates pursuant to which the shareholders of [Overland] immediately prior to such transaction own less than a majority of the aggregate voting power of [Overland] or the successor entity of such transaction.”[3]

In November 2013, Overland acquired one of its competitors, Tandberg Data Holdings S.á.r.l. (“Tandberg”), which was owned by the special-purpose investment vehicle FBC Holdings S.á.r.l. (FBC), which was in turn owned by certain investment funds managed by Cyrus Capital Partners, L.P. (“Cyrus”).  As a result of the Tandberg acquisition, Cyrus and FBC came to own 63% of Overland’s outstanding stock.  Additionally, Overland and FBC entered into a voting agreement that restricted FBC's rights to nominate and vote for directors of Overland’s corporate board—and in particular, the voting agreement precluded FBC from nominating more than two individuals for Overland’s seven-member board.[4]

The Funds notified Overland that they considered the Tandberg transaction to be a Specified Transaction under the Purchase agreement, and demanded a $6 million payment, but Overland refused to pay.  Overland then settled the patent infringement litigation for no cash consideration, thereby rendering the Funds’ stake in the recovery essentially worthless, and proceeded to merge with Sphere 3D Corporation (“Sphere”).[5]

The Funds brought suit in the Commercial Division, arguing (1) the Tandberg transaction was a Specified Transaction under the Purchase Agreement, which obligated Overland to pay the Funds $6 million, and (2) Overland breached the implied covenant of good faith and fair dealing in the Purchase Agreement by settling the patent litigation before entering into the Sphere merger, which had the effect of depriving the Funds of any recovery or payment, as contemplated by the Purchase Agreement.  Both parties moved for summary judgment, and the Court granted summary judgment for Overland.[6]


Whether the Tandberg Transaction Was a “Specified Transaction”

First, the Court addressed whether the Tandberg transaction was a “Specified Transaction,” which turned on the interpretation of the contractual terms “person and its affiliates” and “voting power,” as well as the effects of the voting agreement.  In doing so, the Court applied California law, which governed the interpretation of the Purchase Agreement.

The Court began by addressing Overland’s argument that the Tandberg Transaction was not a Specified Transaction under clause (i) of the Specified Transaction Provision because it resulted in the acquisition of voting power by a single person—FBC—and not by a “Person and its Affiliates.”  The Court rejected this argument, noting that while it might be supported by a “very literal reading” of the contractual language, it was belied by the contemporaneous documentation of the parties’ negotiations and both sides’ testimony, which evinced the parties’ intent for the Specified Transaction provision to mandate a payment if a third party obtained control of Overland.[7]

The Court next addressed Overland’s argument that the Tandberg Transaction was not a Specified Transaction because FBC did not acquire more than 50% of Overland’s “voting power.”  This issue was particularly tricky because “voting power” was undefined in the Purchase Agreement.  Overland argued that “voting power” meant only the power to elect corporate directors, whereas the Funds argued that “voting power” meant the ability to vote on fundamental matters of corporate governance, including “approving executive compensation; amending the Articles of Incorporation; approving mergers and acquisitions; and approving 'golden parachute' compensation.”[8]  Based on California contractual interpretation principles, the Court looked to extrinsic evidence to interpret the term.  After surveying numerous authorities—including the California Corporations Code, the corporations statutes of other jurisdictions, the common and technical usage of the term in the corporate context in California, and federal tax authorities—as well as evidence of the parties’ intent, the Court concluded that Overland’s interpretation was more persuasive, and held that “voting power” referred only to the power to elect corporate directors.[9] 

Next, the Court addressed the Funds’ argument that FBC had actually acquired voting power, thereby bringing the Tandberg transaction within the ambit of the “Specified Transaction” provision.  The key question here was whether “voting power” under the Purchase Agreement was based on FBC's actual power to control corporate management during the effective period of the voting agreement, or whether FBC's mere acquisition of stock and concomitant right to vote in director elections was sufficient.  The Court noted that authorities that have analyzed this issue are not in agreement, and “[i]t appears that some of the tax statutes and regulations analyzed by these authorities describe ‘voting power’ as an attribute of stock, while others describe ‘voting power’ as a possession of shareholders.”  However, there was no need to resolve this issue, because the resulting ambiguity could be resolved by construing the agreement against the Funds based on the extrinsic evidence in the record as to the parties’ actual intent, which was to protect the Funds from an actual change in the control of Overland’s management, which could have posed a threat to the Funds’ interest in the patent litigation.  The Court therefore interpreted “voting power” to refer to a shareholder’s actual power and discretion to control the election of directors.  Ultimately, the Court concluded that the Tandberg Transaction was not a Specified Transaction, and granted summary judgment for Overland on this issue.[10]

Whether the Sphere Merger Violated the Implied Covenant of Good Faith and Fair Dealing

Next, the Funds argued that Overland breached the implied covenant of good faith and fair dealing in the Purchase Agreement by settling the patent litigation shortly before merging with Sphere.  The parties did not dispute that if Overland had not settled the patent litigation before the merger, the merger would have been a Specified Transaction that would have obligated Overland to pay the Funds $6 million.  Thus, by settling the patent infringement lawsuits for no cash consideration, Overland was able to avoid paying the Funds altogether—seemingly in violation of the spirit of the Purchase Agreement.

Under California law, every contract contains an implied covenant of good faith and fair dealing, which applies when one party is afforded discretionary power.  This implied covenant can be limited by the express terms of the contract; however, a Court may nevertheless imply a covenant of good faith and fair dealing so as to override an express provision of the contract “in those relatively rare instances when reading the provision literally would, contrary to the parties' clear intention, result in an unenforceable, illusory agreement.”[11]  Although the Purchase Agreement expressly afforded Overland sole discretion whether and on what terms to settle the patent litigation, the Court nevertheless implied a covenant of good faith and fair dealing into the contract because Overland had the power to effectively deprive the Funds of their investment.  Ultimately, though, the Court concluded that based on the evidence, the Funds had failed to raise a bona fide issue of fact for trial as to whether Overland settled the patent infringement litigation in bad faith, because their evidence “ultimately amounts to nothing more than speculation based on the timing of the settlement in relation to the closing of the Sphere Transaction.”  Summary judgment for Overland was therefore warranted.[12]


Special Situations Fund raises several interesting issues relating to the use of the contractual term “voting power.”  Practitioners who regularly draft stock purchase agreements, voting agreements, or other contracts that use the term “voting power”, may find that in light of this decision, an express definition of the term in contracts that use it may be a wise course of action, given the potential range of interpretations for the term.

By Benjamin F. Jackson and Stephen P. Younger

[1] No. 651557/2014, 2017 BL 367788 (Sup. Ct. Sept. 27, 2017).

[2] Id. at *1.

[3] Id. at *1-2.  The Specified Transaction provision also contained two other clauses that were not relevant to the parties’ dispute.

[4] Id. at *3.

[5] Id. at *3-4.

[6] Id. at *1, *25.

[7] Id. at *6-8.

[8] Id. at *8.

[9] See id. at *10-13.

[10] Id. at *13-17.

[11] Id. at *18-20.

[12] See id. at *21-25.