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QC Holdings, Inc. v. Allconnect, Inc.

Court of Chancery of Delaware

August 28, 2018

QC HOLDINGS, INC., Plaintiff,
v.
ALLCONNECT, INC., Defendant.

          Date Submitted: June 11, 2018

          S. Mark Hurd, Alexandra M. Cumings, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Danny David, Benjamin Sweet, Kelly Hanen, BAKER BOTTS L.L.P., Houston, Texas, Counsel for Plaintiff.

          A. Thompson Bayliss, Cameron T. Kirby, ABRAMS & BAYLISS LLP, Wilmington, Delaware; Matthew L. DiRisio, WINSTON & STRAWN LLP, New York, New York; Thomas G. Weber, WINSTON & STRAWN LLP, Chicago, Illinois, Counsel for Defendant.

          MEMORANDUM OPINION

          LASTER, V.C.

         Pursuant to a written put agreement, [1] defendant Allconnect, Inc. (the "Company") granted plaintiff QC Holdings, Inc. the right to cause the Company to repurchase 18, 604, 071 shares of its common stock (the "Put Shares") in return for a cash payment of $5 million (the "Put Price"). The Put Agreement recognized that the Company could not pay the Put Price unless it had sufficient funds legally available, including sufficient surplus under Section 160 of the Delaware General Corporation Law (the "DGCL").[2] The Put Agreement also subordinated the Company's obligation to pay the Put Price to any amounts due on its "Senior Indebtedness," which is a term defined in the Put Agreement.

         On November 16, 2015, QC Holdings exercised the Put Right. QC Holdings delivered the original share certificate for the Put Shares to the Company, endorsed in favor of the Company. QC Holdings also provided an executed assignment in favor of the Company and represented in the exercise notice that it was transferring to the Company good title to the shares. All of these steps were required by the Put Agreement.

         Under the Put Agreement, the Company's obligation to pay the Put Price did not mature until November 15, 2016. But when the time came to complete the purchase, the Company had Senior Indebtedness outstanding and lacked sufficient funds legally available to make payment. QC Holdings continued to wait for payment of the Put Price.

         In September 2017, non-party New Imagitas Inc. ("Imagitas") acquired the Company via a reverse triangular merger, with the Company surviving as a wholly owned subsidiary of Imagitas (the "Merger"). Just before the effective time of the Merger, as part of the transaction, the Company paid off all of its Senior Indebtedness. In the Merger, the Company's various classes and series of shares were converted into the right to receive cash payments. Each share of common stock was converted into the right to receive approximately two cents per share. The Company did not use any of the merger proceeds to pay the Put Price, which equates to consideration for QC Holdings of approximately twenty-seven cents per share. Imagitas insisted, however, that the Company's preferred stockholders place $5.1 million in escrow (the "Escrow Fund") as a reserve against QC Holdings' claim to the Put Price.

         QC Holdings filed this lawsuit to recover the Put Price and has moved for summary judgment. The Company opposes the motion and has cross moved for summary judgment. This decision directs the Company to use the Escrow Fund to satisfy QC Holdings' claims. If the Escrow Fund is insufficient to pay the Put Price in full, then further proceedings will be necessary to address the deficiency. Further proceedings also will be necessary to quantify the amount of expenses (including attorneys' fees) to which QC Holdings is entitled under the prevailing-party provision in the Put Agreement.

         I. FACTUAL BACKGROUND

         The facts for purposes of this decision are drawn from the affidavits and documents that the parties submitted in support of their cross motions for summary judgment. Neither side has asserted that there are any disputes of material fact. For purposes of the issues presented on the cross motions, therefore, this matter is deemed to have been submitted for decision on a written record under Court of Chancery Rule 56(h).

         A. The Asset Sale

         Pursuant to an asset purchase agreement dated October 28, 2013, the Company acquired substantially all of QC Holdings' assets (the "Asset Sale").[3] As consideration, the Company paid QC Holdings $7.5 million at closing, assumed certain liabilities, and agreed to pay QC Holdings an additional $2.5 million on the one-year anniversary of the closing. The Company also issued the Put Shares to QC Holdings, and the parties contemporaneously entered into the Put Agreement. The Asset Sale closed on November 15, 2013.

         Section 1(a) of the Put Agreement gave QC Holdings the right to put the Put Shares to the Company in return for the Put Price.[4] QC Holdings could exercise the Put Right beginning on November 15, 2015, the second anniversary of the closing of the Asset Sale. Under Section 1(b) of the Put Agreement, starting on that date, QC Holdings would have sixty days in which to exercise the Put Right. If QC Holdings did not exercise the Put Right within the sixty-day period, then it would terminate.

         Assuming that QC Holdings exercised the Put Right, the Company's obligation to pay the Put Price did not mature immediately upon exercise. Section 1(c) of the Put Agreement did not require that the Company pay the Put Price until November 15, 2016, the third anniversary of the Closing Date of the Asset Sale. The payment obligation thus did not mature until approximately one year after QC Holdings could exercise the Put Right.

         Section 1(b) of the Put Agreement provided that QC Holdings' ability to exercise the Put Right would terminate early if one of several events occurred that would give QC Holdings an alternative path to liquidity. The Put Agreement referred to these events as "Deemed Liquidation Events," and they included: (i) an initial public offering, (ii) a third-party acquisition in which the Company's common stock was fully exchanged for cash or publicly traded securities, (iii) a sale of more than 50% of the Company's assets, or (iv) a transaction in which a third party acquired control of a majority of the Company's voting power. If any of the first three events occurred, and if the consideration that QC Holdings received was less than the Put Price, then the Company would owe QC Holdings a make-whole amount sufficient to enable QC Holdings to receive the Put Price. If the last of these events occurred-defined as a "Partial Liquidation Event," then the Company was obligated to require the acquirer to assume the Company's obligations under the Put Agreement or to allow the Put Right to become immediately exercisable.

         B. Impediments To The Payment Of The Put Price

         Even after the Company's obligation to pay the Put Price matured on November 15, 2016, the ensuing payment was not automatic. The Put Agreement recognized that the Company could comply only if it had sufficient funds legally available to make a redemption. Section 1(d) of the Put Agreement stated:

Notwithstanding anything to the contrary contained in this Section 1, the Company's obligation to repurchase any Put Shares under this Section 1 is subject to the General Corporation Law of Delaware and any other applicable local, state or federal law, statute or rule and, without limiting the effect of any other provision of this Agreement, including Section 3, the Company shall have no obligation to repurchase the Put Shares to the extent that doing so would conflict with the General Corporation Law of Delaware or other applicable law.

         By early 2015, it had become highly unlikely that the Company would have sufficient funds legally available to pay the Put Price.

         QC Holdings was not the only stockholder that held a redemption right. The holders of the Company's Series F and F-1 preferred stock ("Series F Preferred") also had the right to have their shares redeemed. In their case, it was for total redemption consideration of $64.8 million, and the Company was obligated to redeem one third of the shares on each of three dates: April 5, 2015, April 5, 2016, and October 5, 2016. Any redemption amounts that were not paid on the specified date would bear interest at a rate of 15% per annum.

         The Company finished 2014 with cash flow of negative $10 million and adjusted EBITDA of negative $1 million. At the beginning of 2015, the Company's board of directors formed a special committee to evaluate whether the Company had sufficient funds legally available to make the Series F Preferred redemption payment. In March 2015, the special committee concluded that the Company lacked sufficient funds. On April 1, the special committee informed the holders of the Series F Preferred that the Company would be unable to redeem the Series F shares until it possessed sufficient funds. The holders of the Series F Preferred exercised their redemption right anyway.

         Nor was a lack of legally available funds the only potential impediment to QC Holdings' receipt of the Put Price. Section 3(c) of the Put Agreement subordinated all of the Company's "Obligations" to QC Holdings under the Put Agreement, including its obligation to pay the Put Price, to any outstanding Senior Indebtedness.[5] The provision further stated that QC Holdings "will not demand or receive from the Company (and the Company will not pay to [QC Holdings]) all or any part of the Obligations, by way of payment, prepayment, setoff, lawsuit, or otherwise . . . for so long as any Senior Indebtedness remains outstanding."[6] The Put Agreement defined "Senior Indebtedness" as

the principal of (and premium, if any), unpaid interest on and amounts reimbursable, fees, expenses, costs of enforcement and other amounts due in connection with, (i) indebtedness for borrowed money of the Company, to banks, commercial finance lenders or other lending institutions regularly engaged in the business of lending money, and (ii) any extension, refinance, renewal, replacement, defeasance or refunding of any indebtedness described in clause (i).[7]

         These amounts would constitute Senior Indebtedness unless "expressly subordinated to, or made on a parity with, the amounts due by the Company under this Agreement."[8]

         In March 2015, Covestco-Seteura, LLC loaned the Company $3 million in exchange for a promissory note collateralized by certain accounts receivable (the "Covestco Loan"). The Company used the proceeds for working capital. The Covestco Loan originally had a maturity date of April 2015, but the parties extended it until January 2018.

         In December 2015, the Company obtained a revolving credit facility from Heritage Bank that authorized borrowings of up to $7 million (the "Heritage Loan"). The Heritage Loan required interest-only payments through its original maturity date in November 2017, which the parties subsequently extended. In December 2015, the Company drew approximately $3 million for working capital.

         C. QC Holdings Exercises The Put Right.

         On November 16, 2015, QC Holdings exercised the Put Right. Section 1(c) of the Put Agreement specified the procedure that QC Holdings needed to follow:

To exercise the Put Right, after the Exercise Date but no later than the Exercise Period End Date, [QC Holdings] shall deliver
[1] a written notice to the Company in the form attached hereto as Exhibit A and in accordance with Section 4(g) hereof indicating its election to exercise this Put Right with respect to all of the Put Shares along with
[2] an executed Assignment Separate from Certificate in the form attached as an exhibit to the Asset Purchase Agreement and
[3] the original stock certificate representing the Put Shares.[9]

         As required by the Put Agreement, QC Holdings sent the exercise notice, the original share certificate for the Put Shares, and an assignment of shares. The Company confirmed receipt and acknowledged that it would "conduct a payout according to the Terms of the Put Agreement."[10]

         Although it did not matter at the time because the obligation to pay had not yet matured, the Company lacked sufficient funds legally available to satisfy the Put Right in November 2015. The Company also could not have paid the Put Price because that obligation was subordinated to the Heritage Loan and the Covestco Loan.

         By letter dated November 2, 2016, the Company informed QC Holdings that it would not be paying the Put Price on November 15, 2016, because it had taken on Senior Indebtedness and the obligation to pay the Put Price was subordinated to that debt. The November 2, 2016 letter informed QC Holdings that the Senior Indebtedness was likely to continue past its stated maturity date on December 4, 2017.

         D. The Merger

         In mid-2017, the Company told QC Holdings that it was exploring strategic alternatives. The Company proposed that in lieu of the Put Price, QC Holdings should accept the per-share consideration that any sale generated for the common stockholders. QC Holdings declined.

         The Company subsequently entered into a merger agreement with Imagitas dated September 7, 2017 (the "Merger Agreement"). The Merger closed that same day. Under the Merger Agreement, a wholly owned acquisition subsidiary of Imagitas merged with and into the Company, with the Company surviving the Merger as a wholly-owned subsidiary of Imagitas.

         The Merger ascribed an enterprise value to the Company of approximately $83 million. Of this amount, $10.8 million was used at closing to pay off all of the Company's outstanding debt, including its Senior Indebtedness. Imagitas required that another $5.1 million be used to establish the Escrow Fund as a reserve to address QC Holdings' claim under the Put Agreement. Any amounts not used to satisfy QC Holdings' claim would be distributed to certain former preferred stockholders. The remaining $67 million was allocated to the Company's stockholders, with the bulk going to preferred ...


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