Sponsored by the ABA’s Private Equity and Venture Capital Committee, corporate attorney Jon Gworek moderated a Breaking News webinar entitled “Basho Technologies: Examining the Contours of ‘Control’ and the Attendant Fiduciary Duties Owed by VC’s”. The panel featured John Mark Zeberkiewicz and Stephanie Norman of Richards, Layton & Finger, P.A., in Wilmington, Delaware. It examined the Delaware Court of Chancery’s recent opinion in Basho Technologies Holdco B, LLC v. Georgetown Basho Investors, LLC, C.A. No. 11802-VCL (Del. Ch. July 6, 2018). Controlling stockholders, like directors, have fiduciary duties to the corporation and its stockholders. The Basho Court found that a venture capital investor with a significant minority stake in Basho Technologies, Inc. exercised effective control over the corporation through, among other things, its charter-based blocking rights over financings. The Court held that the venture capital investor and its director-designees exerted their control in connection with an inside led financing round and held them jointly and severally liable for damages.
While the Basho Court was careful to limit the holding in the case to what might be viewed as a somewhat egregious set of underlying facts and misconduct by the controlling stockholder, the Basho case is nonetheless a cautionary tale that, under certain circumstances, blocking rights could form the basis for the assertion that a controlling VC investor has breached fiduciary duties to the corporation and its stockholders. When the VC is also interested in the transaction by, for example, leading an inside led round of financing, the entire fairness standard of review will apply and could be very difficult to overcome resulting in significant damages to the VC firm and its directors.
This reinforces the need in these situations to run a fair process to find alternative sources of financing, and when possible to either establish an independent committee of directors to approve an inside led financing, or even better, obtain the approval of a majority of the disinterested stockholders. These are well recognized steps to take in order to insulate a transaction from scrutiny, and should allow VC investors to refute any future allegations of control by virtue of veto rights which are certain to flow from the Basho holding.
For more information, please contact Jon Gworek.