Date Submitted: October 31, 2013
Kevin G. Abrams, Esquire, J. Peter Shindel, Jr., Esquire, Daniel A. Gordon, Esquire, ABRAMS & BAYLISS LLP, Wilmington, Delaware, Attorneys for Plaintiff Fletcher International, Ltd.
Kenneth J. Nachbar, Esquire, Leslie A. Polizoti, Esquire, Ryan D. Stottmann, Esquire, Angela C. Whitesell, Esquire, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware, Attorneys for ION Geophysical Corporation and ION International, S.àr.l.
In a prior decision in this case, this court, per Vice Chancellor Parsons, held that it was likely that the issuance of a note by a subsidiary of the defendant, ION Geophysical Corporation, which was formerly known as Input/Output ("ION"), in connection with a $40 million bridge financing that was a minor portion of a much larger transaction, violated the right of the plaintiff, Fletcher International, Limited ("Fletcher") to consent to the note issuance. Nevertheless, this court declined to grant a preliminary injunction because the balance of the equities weighed against granting an injunction and because damages could be an adequate remedy. In a later opinion, Vice Chancellor Parsons granted Fletcher's motion for partial summary judgment, holding that the note issued by the ION subsidiary was a security and that the issuance of that note without Fletcher's consent violated Fletcher's contractual right to consent to such issuances. This is the post-trial opinion in the case, in which the court determines Fletcher's damages based on its admittedly imperfect attempt to discern how a hypothetical negotiation would have occurred between ION and Fletcher over the consent.
In the fall of 2009, ION needed a transaction that would provide it with liquidity and enable it to continue operating and avoid bankruptcy. To alleviate its financial woes, ION reached an agreement to contribute its land equipment business to a newly formed joint venture with BGP Inc. ("BGP"), a Chinese state-owned enterprise. This was a strategically important investment for the Chinese government and its state-owned bank, the Bank of China, stepped in to help BGP secure the deal. As part of that help, the Bank of China provided ION with $40 million in bridge financing to give ION a cushion to ensure that it could operate through the closing of that transaction (collectively, the joint venture and the bridge financing are referred to as the "BGP Transaction"). ION already had a credit facility in place under which it borrowed money on a revolving basis from a consortium of banks (the "Existing Lenders"), so the Bank of China provided the bridge financing by entering into the existing credit facility. In connection with the bridge financing, ION International S.ár.l. ("ION S.ár.l."), an ION subsidiary, issued a $10 million convertible promissory note to the Bank of China without obtaining Fletcher's consent. The only consent right Fletcher had over the deal was over the $40 million bridge loan. The much larger overall BGP Transaction, in which BGP contributed between $195 million and $245 million in consideration to ION, was one that Fletcher had no right to veto.
During the two day trial, the parties attempted to quantify the damages that Fletcher is entitled to by presenting evidence to determine what Fletcher would have received in exchange for its consent in a hypothetical negotiation that occurred before the announcement of the BGP Transaction. Fletcher attempted to portray itself as a tough negotiator willing to blow up the entire BGP Transaction unless it received changes to its Preferred Stock that were valued at $78 million in exchange for its consent to a $40 million bridge financing, even though the BGP Transaction was expected to create value for all of ION's stakeholders, including Fletcher. Fletcher insisted that, because ION was a weak negotiator that had no other options, ION would have given in to anything Fletcher demanded in order to save the BGP Transaction. Thus it would have given $78 million to be able to receive a $40 million short-term loan.
This two-dimensional depiction of the hypothetical negotiation ignores the fact that BGP and the Existing Lenders — both of which had substantially more negotiating leverage than Fletcher did — would have been involved in any negotiation for Fletcher's consent. As a practical matter, BGP would have needed to agree to proceed with any consent payment to Fletcher and the Existing Lenders would have had the right to consent to the modifications to Fletcher's preferred stock that Fletcher says it would have demanded. The demands Fletcher says it would have made were ones that had costs to both BGP and the Existing Lenders and neither would have agreed to Fletcher's outrageous demands. In other words, ION could not have unilaterally given Fletcher what it wanted because Fletcher's demands would have come at the expense of ION's other constituencies, in particular BGP. Fletcher's version of the hypothetical negotiation also ignores the fact that ION, with the help of BGP and the Existing Lenders, could have structured the transaction to avoid implicating Fletcher's consent right. In fact, Fletcher's cartoonish portrayal of its own negotiation position is so extreme in contrast to its comparatively weak actual bargaining position, that ION argued that it would simply have worked with the Existing lenders and BGP to structure the deal around Fletcher's consent. Nevertheless, because Fletcher's consent right was violated, the court assumes that Fletcher would have acted with at least bare rationality in the bargaining process and consented in exchange for a very generous consent fee akin to a bank consent fee.
That is, although the court concludes that Fletcher would not have been able to use its consent right to extract the king's ransom that it apparently believes it was entitled to, Fletcher would have been able obtain valuable consideration from ION in exchange for its consent. The best measure of the consent fee that Fletcher could have extracted comes from a comparison to the consent fees that ION paid to the Existing Lenders to obtain their approval for the BGP Transaction.
II. Factual and Procedural Background
A. Fletcher's Investment in ION
ION is a Delaware corporation headquartered in Houston, Texas that provides technology-focused services and equipment to the global energy industry, particularly to exploration and production clients in the oil industry. ION's stock is listed on the New York Stock Exchange ("NYSE"). ION S.ár.l. is a wholly-owned subsidiary of ION, incorporated in Luxemburg.
On February 15, 2005, ION, seeking a "patient" and "supportive" investor, entered into an Agreement with Fletcher, a hedge fund organized in Bermuda, that portrayed itself as having those characteristics. Under that agreement, Fletcher paid $30 million to purchase 30, 000 shares of Series D-1 Cumulative Convertible Preferred Stock of ION at a price of $1, 000 per share and received the right to purchase up to 40, 000 additional shares of ION at the same price and on similar terms and conditions.  Fletcher exercised its right to purchase additional shares under the agreement in 2007 and 2008 by purchasing 5, 000 shares of Series D-2 Cumulative Convertible Preferred Stock and 35, 000 shares of Series D-3 Cumulative Convertible Preferred Stock, respectively (the Series D-1, Series D-2, and Series D-3 Cumulative Convertible Preferred Stock are collectively referred to as the "Preferred Stock"). Each of the three series of Preferred Stock was governed by a Certificate of Rights and Preferences with substantially similar terms that included a provision giving Fletcher the right to consent to the issuance of any security issued by a wholly-owned subsidiary of ION.
Fletcher portrayed itself as a "passive and supportive partner" and claimed that its "fundamental investment principle [was] to facilitate management's efforts to enhance equity value through a significantly improved capital structure." According to Fletcher's marketing materials "[t]his [principle] allows management to focus on the implementation of its business plan." Fletcher's marketing materials also stated that Fletcher had an "uncompromising commitment to enter into only those transactions that [would] create value for all parties to the transactions, " including the companies it invested in, which it referred to as its "corporate partners."
Fletcher's investment in ION was essential to Fletcher's own survival, which was unusual even for an aggressive hedge fund. As of December 31, 2008, the Preferred Stock made up 43.25% of Fletcher's investment portfolio. By December 31, 2009, the Preferred Stock made up 65.68% of Fletcher's investment portfolio. Thus, Fletcher had staked its future on ION and taken a large, non-diversified risk by placing nearly two-thirds of its assets in a single investment — an investment that came with no control rights or board seats.
B. ION's Financial Performance Declines And Its Relationship With Fletcher Sours
On July 3, 2008, ION and ION S.ár.l. entered into a new $100 million credit facility with the Existing Lenders (the "Credit Facility") that leveraged both ION's domestic and international assets. That Credit Facility replaced ION's old $75 million credit facility that had leveraged only the domestic assets. HSBC Bank USA ("HSBC") acted as the lead bank in the Credit Facility. No more than $75 million could be borrowed under the Credit Facility at the domestic level by ION and no more than $60 million could be borrowed at the foreign level by ION S.ár.l., meaning that if ION wanted to borrow the maximum amount under the Credit Facility, the borrowing had to be split between the domestic parent, ION, and the foreign subsidiary, ION S.ár.l. (the "Split Requirement"). A waiver of the Split Requirement required unanimous approval from the Existing Lenders. Although the Split Requirement limited the amount that could be drawn down by either the domestic parent or foreign subsidiary, the Credit Facility was cross-collateralized so that all of the assets of ION and ION S.ár.l. secured both the foreign and domestic notes. The Credit Facility also included a $50 million accordion feature so that it could be expanded to a $150 million revolving facility.
In addition to provisions that governed the functioning of the Credit Facility, the Credit Agreement contained a litany of restrictive covenants that prohibited ION from engaging in activities such as making any dividend payments that were not specifically exempted under the Credit Agreement,  exceeding a specified leverage ratio,  and maintaining a certain net worth. If ION failed to comply with any of the restrictive covenants in the Credit Agreement, the Existing Lenders could declare a default, which would result in, among other things, the entire amount of the loans outstanding under the Credit Facility becoming immediately due. The power to declare a default gave the Existing Lenders substantial influence over ION.
The financial problems ION faced in 2009 had their origins in a prior transaction. In early 2008, ION's management began considering a strategic transaction with ARAM Systems Ltd. and Canadian Seismic Rentals Inc. (collectively "ARAM"). The transaction was expected to increase ION's footprint in certain international markets and solidify ION's position in the industry. On July 8, 2008, ION executed a share purchase agreement with ARAM under which ION agreed to purchase ARAM from its stockholders in exchange for a total of $350 million (Canadian). ION financed the ARAM transaction through the combination of an equity issuance to the ARAM stockholders, a $125 million Term A Facility, a $41 million short-term bridge loan from its investment bank, Jefferies, LLC ("Jefferies"), that was set to mature on December 31, 2008, and $45 million in short-term notes issued to the ARAM stockholders that matured on December 31, 2008. The $45 million short-term notes were issued by Nova Scotia Co. ("Nova Scotia"), a wholly-owned subsidiary of ION. To obtain the interim financing that was provided by the Term A Facility, ION had to secure approval from the Existing Lenders for, among other things, a waiver to the Split Requirement. The Existing Lenders unanimously agreed to waive the Split Requirement to facilitate the ARAM transaction, and the First Amendment to the Credit Facility was entered into on September 17, 2008.
ION planned to replace the interim financing structure that it used to close the ARAM transaction by issuing a bond in the public market. To protect itself in the event that the public bond offering failed, ION had obtained a backstop commitment from Jefferies to provide ION with a $150 million loan. Unfortunately, the ARAM transaction closed on September 18, 2008, mere days after the collapse of Lehman Brothers and in the midst of a severe financial crisis. Because of the financial crisis, ION was unable to raise the money needed to replace the interim financing through a public bond offering, and Jefferies was either unwilling or unable to provide the backstop financing that it had agreed to provide. ION managed its cash and made the required payment on its revolving loan, but with the capital markets frozen, it was forced to enter into a new $40 million twelve-month loan with Jefferies at an interest rate that ION's then-CFO Brian Hanson described as "egregious."
Although the ARAM transaction had been expected to create value for ION, the transaction's inauspicious closing date left ION with a highly leveraged balance sheet and put strain on the company at a time when the recession resulting from the financial crisis was reducing demand for ION's products and services. By the end of 2008, the financial performance of ION "really started to decline. . . . And 2009 saw a series of successive declines in financial performance . . ." At trial, Hanson testified that "it felt like we were chasing a ball down the hill. And we consistently were forecasting our business and missing the reforecast because it was falling off sharper than we thought it would."When asked what happened to ION's stock price during that period, Hanson testified that "it was completely under pressure . . . it was trading more as an option whether or not we were going to survive."
On top of its growing financial problems, ION's managers also had to deal with discontent from their purportedly patient and supportive investor, Fletcher. On January 23, 2009, Fletcher's then-attorneys informed ION that Fletcher believed that the notes issued by Nova Scotia in connection with the ARAM transaction violated Fletcher's contractual right to consent to the issuance of a security by any ION subsidiary and "demand[ed] that ION take immediate action to rectify its violation and remedy the harm to Fletcher." On January 30, 2009, ION responded through its own counsel and stated that it believed that the notes issued by Nova Scotia did not violate Fletcher's consent right. Even though ION disagreed with Fletcher's assertion that its consent right had been violated, ION attempted to assuage Fletcher's concerns and eliminate the problem by assigning the note to itself.
But ION's efforts to appease Fletcher were unsuccessful. On March 31, 2009, Fletcher made a demand for inspection of records under § 220 of the Delaware General Corporation Law for the purpose of, among other things, investigating potential violations of its rights as a holder of the Preferred Stock. ION rejected Fletcher's demand, and Fletcher filed suit in this court to enforce its right to inspect ION's books and records.
Fletcher's accusations and its request to inspect ION's records were not the only challenges ION's management had to deal with in the Spring of 2009. By April 2009, the Existing Lenders were worried about ION's declining financial performance and its lack of liquidity. In response to the Existing Lenders' concerns, ION began to search for transactions that would improve its liquidity. In June 2009, ION sold around $40 million of equity in a private placement and used the proceeds to pay off the Jefferies loan.ION also obtained secured equipment financing worth $20 million, which it used for working capital. The Credit Facility was also amended on June 1, 2009 (the "Fifth Amendment") to give ION permission to do the secured financing, relax the covenants that ION's financial forecasts indicated it would soon violate, and increase the pricing of the debt by, among other things, increasing the rates on the revolving loans. If the Existing Lenders had not relaxed the covenants through the Fifth Amendment, ION would have violated the covenants in the Credit Facility, giving the Existing Lenders the right to declare a default. In connection with the Fifth Amendment, which required majority approval of the banks in the Credit Facility, ION paid a fee to the Existing Lenders of around $3.6 million, or 75 basis points on the amount of the loan outstanding at that time. Although ION was able to obtain approval from the banks for the Fifth Amendment in June 2009, ION's relationship with the Existing Lenders was deteriorating and ION had been designated as an "exit name" by at least one of the Existing Lenders.
In Hanson's words, the transactions in June 2009 "gave [ION] breathing room" but they did not solve ION's liquidity issues and ION recognized that it could "burn through [its] cash by the end of the year." By July 2009, ION was focused on finding a longer term solution to its liquidity problems. ION began to consider entering into some type of strategic transaction with BGP after BGP's chairman reached out to ION to discuss the possibility of the two companies engaging in a Joint Venture.
C. The BGP Transaction
BGP is a wholly-owned subsidiary of China National Petroleum Corporation ("China National Petroleum"), which is a large oil company owned by the Chinese government. BGP was a long-time client of ION's, and the two companies had previously considered entering into a strategic transaction. In 2006, ION approached BGP about the possibility of the two companies engaging in a joint venture. Although ION and BGP did not form a joint venture in 2006 because BGP did not have the ability to enter into joint ventures with foreign companies at that time, BGP remained a major client of ION's. In 2007 and 2008, they formed a "technology alliance" and BGP was an early adopter of technology developed by ION. When BGP approached ION in 2009 and proposed a possible joint venture, ION viewed the proposed transaction as both a solution to its liquidity problems and a strategic opportunity that could lead to long-term growth.
The negotiations with BGP regarding the transaction began in late July 2009, when Jay Lapeyre, the chairman of ION's board of directors, met with Wang Tiejun, the President of BGP, to discuss the transaction. Lapeyre reported that "[o]verall [it was a] good initial meeting." On July 31, 2009, ION's CEO, Bob Peebler, emailed Wang to inform him that ION's board had directed him to proceed with exploring a strategic joint venture between the two companies.
In early August, Hanson traveled to China to meet with representatives from BGP regarding the joint venture. Back in the United States, ION's lenders and Fletcher were still concerned with ION's projections for the remainder of 2009. After looking at the projections, Benson "shift[ed] [his] opinion about ION's near-term solvency from thinking it is likely solvent to think[ing] it may not be solvent." On August 12, 2009, Steven Larsen, ION's contact at HSBC, emailed Hanson to express his concerns over the company's projections and the possibility that ION would need another amendment to the Credit Facility to avoid breaching the newly-relaxed covenants during the third quarter.
The major points of the deal were negotiated extensively during August and September. ION opened the negotiations by proposing that the two companies enter into a joint venture that centered around technology. Under the initial proposal, ION would have owned 70% of the joint venture and BGP would have owned the remaining 30%.When Peebler and Hanson presented their proposal to Wang in China in early August, Wang informed them that their proposal was not what he had envisioned, that any transaction between the two companies would have to involve ION putting all of its land equipment business into the joint venture, and that BGP would have to have a controlling interest in the joint venture. BGP explained that, because of the precedent-setting nature of the transaction, it would be very difficult for BGP to enter into any joint venture if it was not at least a 51% owner. BGP also made it clear at this early stage in the negotiations that, in addition to control of the joint venture, it wanted a substantial equity stake in ION.
BGP considered this to be a precedent-setting transaction because it was one of the first situations in which a Chinese state-owned enterprise was given permission to enter into a strategic joint venture with an American company. This joint venture was also in the energy technology industry, which has economic importance to both China and the United States. As shall be seen, because BGP is an instrumentality of the Chinese government and its entry into the United States market was important to the Chinese government, BGP had the financing support of the Bank of China, a state-owned bank.
When ION realized that it would have to give in to BGP's demand that it control the joint venture for the transaction to go forward, ION agreed to take the minority position in the joint venture but insisted in exchange that BGP set aside its demand for an equity stake in ION itself. Although BGP purported to agree during the first round of negotiations that it would not insist on owning a large chunk of ION equity, in fact, BGP never stopped pushing for it. At the banquet following the first round of negotiations, on the very day that BGP had "agreed" to a transaction structure in which it would not receive any ION equity, Peebler was seated next to a top executive at China National Petroleum who spent the dinner explaining to Peebler all of the reasons that it would be good for ION if BGP owned ION equity.
On August 13, 2009, when Peebler boarded his plane after the meetings in China, he believed that they had agreed to a deal in which BGP would take a majority ownership interest in the joint venture but would not own any of ION's equity. But by the time he landed in Texas, BGP was already renegotiating the deal in an effort to obtain a major equity stake in ION. The week after Peebler returned, the BGP team arrived in Houston to continue to flesh out the terms of the deal. It became clear during these meetings that any final transaction would have to be approved not only by BGP, but also by both its parent, China National Petroleum, and the Chinese Government. While in Houston, BGP insisted on receiving an ownership interest in ION. By the time the meetings in Houston ended on August 24, 2009, ION ...