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1、Words that Matter: Con siderati ons in Drafti ng Preferred StockProvisi onsPursuant to Delaware law, all capital stock, by default, is created equal unless the company s certificateof incorporation provides for certain classes or series of preferred stock that enjoy special contractual rights, power
2、s, and preferences over shares of another class or series of capital stock. While the General Corporation Law of the State of Delaware (the DGCL) permits a company to create preferred stock, it provides drafters of preferred stock provisions with no specific guidance as to the nature or form of the
3、preferred stock s rights and obligations. Similarly, Delaware case law imposes few express mandates other than to require that shares of preferred stock have preference over shares of common stock (which typically takes the form of a preference as to dividends and/or distributions upon liquidation o
4、f the company).With few requirements from the DGCL and Delaware case law, it is up to the drafter to set forth the particular terms, including the rights, powers, and preferences of the preferred stock. The terms of the preferred stock, particularly the economic rights, powers, and preferences, will
5、 be influenced by the context in which the preferred stock is being issued and the relative bargaining power of the company and its investors. The special rights, powers, and preferences typically associated with preferred stock consist of some combination of special dividends, liquidation, voting,
6、redemption and/or conversion rights, and such rights, powers, and preferences must be clearly and specifically set forth in the company scertificate of incorporation or in a certificate of designation (which has the effect of amending the company s certificate of incorporation). For purpo ses of thi
7、s article, a certificate of incorporation and a certificate of designation are referred to collectively as a“ certificate of incorporation.”The interpretation of the special contractual preferences of preferred stock is primarily governed by the principles of contract law. In addition, preferred sto
8、ck provisions must be interpreted in the context of the DGCL and the case law interpreting it. Drafters of preferred stock provisions are deemed to have been aware of and have an understanding of such applicable laws. If a preferred stockholder asserts a claim related to a contractual right, power,
9、or preference of the preferred stock, Delaware courts will interpret such rights, powers, and preferences as contractual rather than fiduciary in nature.On the other hand, preferred stockholders have rights that are separate from those created by their contractual preferences. These separate rights
10、are shared equally with the common stockholders and are fiduciary in nature. If a preferred stockholder asserts a claim related to a right that is not a preference, but instead is shared equally with the common stockholders, Delaware courts have suggested that both the preferred and common stockhold
11、ers are owed fiduciary duties. For example, if preferred and commo n stockholders are entitled to vote on a certain matter, the directors duty to disclose all materialinformation related to the matter extends to all of the company s stockholders. If there is a divergence ofinterests between the hold
12、ers of the preferred stock and common stock, however, it will generally be the duty of board of directors to prefer the interests of the common stockholders to those of the preferred stockholders. As a result, directors could be found to have breached their fiduciary duties if they favor the interes
13、ts of the preferred stockholders under these circumstances.s investment isAccordingly, precise legal drafting is the key to ensuring that a preferred stockholder adequately protected. The special rights, powers, and preferences of the preferred stock must be expressed clearly and will not be presume
14、d. This article sets forth common drafting pitfalls of which drafters of preferred stock provisions should be cognizant. Most of these pitfalls can be avoided by remembering one simple concept when drafting preferred stock provisions: the special rights, powers, or preferences of preferred stock mus
15、t be expressed clearly and will not be presumed or implied.Protecting Protective ProvisionsAmong the most highly negotiated contractual provisions related to preferred stock are the so-called“ protective provisions, ” which are contained in the certificate of incorporation and set forth a list of ac
16、tions that the company cannot take without the prior consent of a specified percentage of the outstanding preferred stock. As its name implies, these provisions seek to protect the investment of the preferred stockholders from actions by the company that may dilute or diminish their investment. As some holders of preferred stock learned the hard way, however, the absence of a single phrase or the reliance on a general, catch-all provision can result in th
