Opinion ID: 1548673
Heading Depth: 1
Heading Rank: 14

Heading: Restricted Stock Grant Agreement Violated

Text: The defendants-appellants next argue that, even if the Purchase Agreement did not constitute improper vote buying, Kurz should not be allowed to vote the Boutros shares, because by entering into the Purchase Agreement, Boutros breached the transfer restrictions in the Restricted Stock Grant Agreement. The Restricted Stock Grant Agreement provided that [p]rior to [March 3, 2011], [Boutros] shall not be entitled to transfer, sell, pledge, hypothecate or assign any shares of Restricted Stock. The Court of Chancery assumed that the restrictions are operative and binding. The factual findings made by the Court of Chancery are important. On Thursday, December 17, 2009, Kurz was told we need to buy someone's shares this weekend. As of Friday, TBE had consents for approximately 48.4% of the common shares and needed another 116,325 votes to prevail. Boutros owned 175,000 shares of restricted stock, all of which were all entitled to vote. Kurz was provided with copies of both of Boutros' stock restriction agreements on Sunday, December 20, 2009, before entering into the Purchase Agreement. Kurz read the agreements and parsed the restrictions. He focused on the language in the Resale Restriction Agreement that extended beyond any sale to encompass any contract to sell, any option to purchase, and any transfer of the economic risk of ownership. He noted that the Restricted Stock Grant Agreement did not contain similar language and appeared to restrict only an actual sale, transfer, pledge, hypothecation, or assignment. Kurz concluded that he could contract with Boutros to buy however many shares Boutros could sell at the time, and to obtain in the future however many shares Boutros eventually could transfer, if and when Boutros became able to transfer them. The Court of Chancery held that Kurz and Boutros had successfully contracted around the sale and transfer restrictions, because the Restricted Stock Grant Agreement does not prohibit Boutros from agreeing to take those actions at a future date. The record supports the Court of Chancery's conclusion that Kurz did not engage in illegal vote buying because that court found that, along with the votes, Kurz simultaneously purchased and immediately received the full economic interests associated with the Boutros shares. That finding, however, leads inexorably to the conclusion that the Purchase Agreement violated the Restricted Stock Grant Agreement. The Court of Chancery's determination that there was no actual sale or transfer is not supported by the record, the language and purpose of the Restricted Stock Grant Agreement, or the court's own findings. In their comprehensive analysis of new vote buying and its corporate governance implications, Professors Henry Hu and Bernard Black have examined modern vote buying techniques. In doing so they defined three terms that are relevant to our review of what was actually transferred immediately by the Purchase Agreement between Kurz and Boutros. [F]ormal voting rights [] the legal right to vote shares under company law (as supplemented by SEC and stock exchange rules governing voting of shares held in street name), including the legal power to instruct someone else how to vote. [E]conomic ownership [] the economic returns associated with shares. This ownership can be achieved directly by holding shares, or indirectly by holding a coupled asset, which conveys returns that relate directly to the returns on the shares. Economic ownership can either be positive  the same direction as the return on shares  or negative  the opposite direction from the return on shares. Full ownership consist[s] of voting ownership plus direct economic ownership. [19] Professors Hu and Black also noted: Our system of record ownership already decouples economic ownership from formal voting rights. The record owner is typically at least two persons removed from the economic owner of the shares. Shares held in street name are generally held of record by Depository Trust Company or another securities depository, which holds the shares on behalf of another intermediary (such as a broker-dealer or bank), which holds the shares for economic owners. Our legal system has responded by partly recoupling voting and economic ownership. Depositories pass voting rights to their bank and broker clients, who must request voting instructions from economic owners. If the customer does not provide instructions, New York Stock Exchange (NYSE) Rule 452 allows a bank or broker to vote on routine matters, but not on a contested matter or on a merger or similar transaction which may substantially affect the value of the shares. [20] Professors Hu and Black concluded that the foregoing rules on when record owners can vote provide precedent for an effort to reconnect voting rights to economic ownership, when technology has severed them. Those observations helpfully aid our analysis of the Purchase Agreement. Kurz paid Boutros for the immediate receipt of all economic interest in the shares. The Restricted Stock Grant Agreement, however, required the continued decoupling of the formal voting rights, by requiring that Boutros remain as the record owner until 2011. Nevertheless, Kurz was able to connect the economic rights he purchased from Boutros with the formal voting rights that Boutros would otherwise retain by requiring Boutros to execute an Irrevocable Proxy. Therefore, unlike other beneficial owners, Kurz could vote the shares on any future corporate matter without ever again contacting the record owner, Boutros, for another proxy. By reconnecting the voting rights to the economic ownership via the Irrevocable Proxy, the Purchase Agreement immediately conferred upon Kurz the functional equivalent of full ownership, in consideration for the $225,000 he paid to Boutros. There was nothing for Boutros to transfer to Kurz in the future, other than the bare legal title. The Court of Chancery found that Kurz believed he obtained the economic and voting rights (albeit not legal title) to 150,000 shares for a price of $1.50 per share. Kurz testified that when he entered into the Purchase Agreement, the financial results and forecasts he received suggested he was overpaying Boutros for his shares. In rejecting the defendants' insider trading arguments, [21] the Court of Chancery concluded that Kurz's testimony was credible and that Kurz bought Boutros' shares because TBE needed another 116,325 votes to win. The purpose of the Restricted Stock Grant Agreement was to provid[e] employees and consultants of [EMAK] with a proprietary interest in pursuing the long-term growth, profitability and financial success of the Corporation. That is consistent with the purpose of restricted stock agreements generally. [22] The structure of the Restricted Stock Agreement, providing that Restricted Stock will fully vest in Boutros only after three years of continued employment beyond the grant date, is also consistent with this purpose. The Court of Chancery found that although Kurz did not take title to the 150,000 shares that Boutros owned, and although I assume the Restricted Stock Grant Agreement prohibits Boutros from transferring title to Kurz until March 3, 2011, Boutros nevertheless transferred to Kurz, and Kurz now bears, 100% of the economic risk from the 150,000 shares. Boutros' immediate divestiture of all voting and economic rights in his shares frustrates the purpose of the Restricted Stock Grant Agreement, because bare legal title, alone and without more, does not give Boutros a stake in the corporation's future. The Restricted Stock Agreement prohibits any transfer, [sale], pledge or hypothecat[ion] of Boutros' restricted EMAK shares. The Court of Chancery found that the odd framing of what Boutros sold and Kurz bought reflects their efforts to contract around those transfer restrictions. [23] The Boutros/Kurz Purchase Agreement recites that Boutros agrees to sell all shares that he owns and is permitted to sell, transfer or assign. . . . By its very terms, the Restricted Stock Grant Agreement prohibits what the Boutros/Kurz Purchase Agreement purports to do, i.e., sell, transfer or assign his shares. Therefore, we hold that the Purchase Agreement did not operate as a legally valid sale or transfer of Boutros' shares, and that Kurz was not entitled to vote those shares.