Abstract

This Article examines whether corporations should owe fiduciary duties to its preferred stockholders as preferred stockholders across all settings of preferred stock holding. In one context, sophisticated venture capitalists purchase preferred stock after carefully negotiating the stock price, control over the corporate governance, and other key stipulations by contract. Additionally, because the initial preferred stockholder could protect its interests through staged financing or board control, the preferred stockholder might not discount the stock even if it lacked protection since the other protective devices made the lack of such protections inconsequential so the initial holders won’t pay for these added fiduciary protections. In such settings it does not make sense for the corporation to owe fiduciary duties to the preferred stockholders as preferred. In fact, doing so rearranges the basis on which the initial stockholders purchased the stock and implying a fiduciary term constitutes a hit to the common stockholders and thus ignores the terms of the claimants and the risk and targeted return for each of them. However, while it makes sense for sophisticated venture capitalists to rely only on bargained-for contractual protections, this Article identifies two specific contexts where a limited fiduciary obligation should be extended to preferred stockholders who lack bargaining power. The first is when non-working children are given preferred stock in a family business. The second is when a corporation takes on a new unfamiliar product line, allowing common stockholders to wipe out the value of publicly traded preferred stock. When the preferred stock is purchased in the public marketplace, the preferred stockholders will not have any bargaining power in the preferred stock’s contractual arrangement. Moreover, the additional terms routine in shareholder agreements between VC’s and founders are almost never found in the Charter documents, so those provisions won’t be transferable. To the subsequent purchaser of preferred stock the lack of such protections might call for a limited fiduciary duty if the markets for preferred stock are not as efficient as for common stock or if there are chinks in the efficient capital market hypothesis. Where the disciplining effects of the market are weaker, subsequent buyers of the preferred stock may not price the stock accurately to reflect the lack of transferable protections, providing a justification for a limited fiduciary duty in that context if implying the term would add value.

to be published by the Rutgers University Law Review.

Keywords

corporations, fiduciary duties. preferred stockholders, venture capitalist, Targeted return, Pricing, Risk, Information costs, Efficient capital market, Customization, Implied duties

Publication Date

2017

Document Type

Article

Place of Original Publication

Rutgers University Law Review

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COinS Juliet P. Kostritsky Faculty Bio