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PWP Xerion Holdings III LLC v. Red Leaf Resources, Inc.

Court of Chancery of Delaware

October 23, 2019

PWP XERION HOLDINGS III LLC, Plaintiff,
v.
RED LEAF RESOURCES, INC., a Delaware corporation, Defendant.

          Date Submitted: September 18, 2019

          S. Michael Sirkin, Benjamin Z. Grossberg, R. Garret Rice, ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; Jonathan D. Schiller, Christopher D. Belelieu, Karen A. Chesley, Gary R. Studen, BOIES SCHILLER FLEXNER LLP, New York, New York; Counsel for Plaintiff.

          Michael A. Pittenger, Timothy R. Dudderar, Mathew A. Golden, David M. Hahn, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Kenneth B. Black, Lauren A. Shurman, Wesley F. Harward, STOEL RIVES LLP, Salt Lake City, Utah; Counsel for Defendant.

          MEMORANDUM OPINION

          LASTER, V.C.

         Defendant Red Leaf Resources, Inc. ("Red Leaf" or the "Company") is a Delaware corporation seeking to develop technology to extract oil from shale. Under the certificate of designations that governs its Series A Preferred Stock, the consent of holders of a majority of the Series A shares is necessary for authorizing or effecting (i) any transaction for the benefit of an affiliate of a director of the Company, (ii) any material change in the Company's business plan, and (iii) any purchase or redemption of any equity interest in the Company. At all relevant times, plaintiff PWP Xerion Holdings III LLC ("Xerion") held a majority of the Series A shares, meaning that Xerion's consent was required before the Company could authorize or effect any of the foregoing actions.

         In 2012, the Company entered into a set of joint venture agreements with TOTAL E&P USA Oil Shale, LLC ("TOTAL Sub"), an indirect, wholly owned subsidiary of TOTAL S.A. ("TOTAL Parent"). TOTAL Parent is one of a handful of supermajor oil companies in the world. For a company seeking to develop oil shale technology, an alliance with a supermajor like TOTAL Parent was obviously a significant development. Not surprisingly, the Company told its investors that the joint venture represented a material change in its business plan. As part of the parties' new relationship, TOTAL Sub purchased an equity interest in the Company and received the right to designate a member of the Company's board of directors (the "Board").

         In 2016, TOTAL Sub notified the Company that it was exiting from the joint venture, before the planned completion date and without fulfilling all of its contractual obligations. To settle the ensuing dispute, TOTAL Sub agreed to pay the Company $85 million and return its equity interest. When the Board authorized the settlement, an officer of TOTAL Sub served as its director designee on the Board.

         The Company initially asked Xerion to consent to the settlement. After Xerion declined, the Company and TOTAL Sub went forward without Xerion's consent. In an effort to sidestep the consent requirement, the Company obtained a non-reasoned, conclusory opinion from its outside counsel stating that TOTAL Sub and the officer of TOTAL Sub who served on the Board were not affiliates. The Company also tweaked the settlement so that TOTAL Sub would remain the owner of its equity interests in the Company unless and until Xerion consented to the settlement and released any claims it might have under a stockholders agreement and an investors' rights agreement.

         The unwinding of the joint venture represented a material change in the Company's business plan. Before the settlement, TOTAL Sub was supporting the Company with financial, operational, and technological assistance. Together, the Company and TOTAL were pursuing a pilot project in Seep Ridge, Utah, designed to demonstrate the viability of extracting oil by heating shale in a single-use, earthenware capsule. After the settlement, the Company no longer had the support of a supermajor oil company. Moreover, the Company decided to pivot away from its pilot project in Utah and attempt instead to commercialize a multi-use, steel capsule that could extract oil from a different form of shale found in the middle eastern country of Jordan.

         Xerion filed this lawsuit for breach of its consent rights. This decision grants Xerion's motion for summary judgment on the question of breach. For the reasons set forth herein, the Company breached Xerion's consent rights by failing to obtain Xerion's consent before (i) authorizing and later effecting a transaction for the benefit of an affiliate of a director and (ii) authorizing and later effecting a material change in the Company's business plan. The Company did not breach its obligation to obtain Xerion's consent before authorizing a redemption.

         I. FACTUAL BACKGROUND

         The facts are drawn from the materials that the parties submitted in connection with the motion for summary judgment.[1] When considering Xerion's motion, any conflicts in the evidence are resolved in the Company's favor, and the Company receives the benefit of all reasonable inferences that can be drawn from the evidence. At this stage of the case, the court cannot weigh the evidence, decide among competing inferences, or make factual findings.

         A. The Series A Issuance

         The Company is a privately held Delaware corporation formed in 2006. For over a decade, the Company has sought to develop and commercialize technology for extracting oil from shale.

         In 2010, the Company raised capital by issuing shares of Series A Preferred Stock. Xerion is a hedge fund that purchased and continues to own a majority of the issuance.[2]

         During the negotiations over the terms of the Series A Preferred Stock, Xerion insisted on a "consent rights package" for "fundamental business events." OX 2 at '748. The final certificate of designations stated:

For so long as shares of the Series A Preferred representing in aggregate more than 4.5% of the outstanding equity interests in the Corporation on a fully-diluted and as-if-converted basis are outstanding in addition to any other vote or consent required herein by law, the vote or written consent of the holders of more than 50% of the outstanding shares of Series A Preferred, voting together as a single class, shall be necessary for authorizing, effecting or validating the following actions (whether by merger, amendment, consolidation, reclassification, reorganization, recapitalization or otherwise) by the Corporation . . . .

         OX 4 § 3(b)(i). The certificate of designations then listed thirteen different categories of actions. See id. Three are relevant to this case:

• "Any purchase or redemption of, or payment of any dividend or other distribution on, any capital stock or any other equity interest in the [Company] . . . ." Id. § 3(b)(i)(F) (the "Redemption Clause").
• "Any material alteration to, or change of, the business or business plan of the [Company] or any of its subsidiaries." Id. § 3(b)(i)(I) (the "Business Plan Clause").
• "Any transaction with or for the benefit of any director or officer (or their respective affiliates)." Id. § 3(b)(i)(M) (the "Interested Party Clause").

         Because Xerion purchased and has continued to hold a majority of the Series A shares, Xerion's consent was necessary for authorizing or effecting any transaction that fell within the scope of the Redemption Clause, the Business Plan Clause, or the Interested Party Clause.

         B. The Joint Venture

         In 2012, the Company entered into a set of joint venture agreements with TOTAL Sub, a Delaware limited liability company.[3] The sole member of TOTAL Sub was TOTAL E&P USA, Inc. ("TOTAL USA"), which in turn was a wholly owned subsidiary of TOTAL Parent. To reiterate, TOTAL Parent is one of the few supermajor oil companies in the world.

         Under the terms of the Joint Venture Agreements, TOTAL Sub made an initial investment of $25 million in the Company and committed to provide personnel and advisory support for the Company's laboratory and scientific work. In return, TOTAL received (i) 16, 667 shares of the Company's common stock, reflecting a 3.5% ownership stake in the Company, (ii) a warrant exercisable for additional shares of the Company's common stock, and (iii) a worldwide license to use the Company's EcoShale Technology. TOTAL Sub also received the right to designate a member of the Board.

         The Joint Venture Agreements provided that TOTAL Sub and the Company would each own a 50% interest in certain oil shale assets and projects located in Utah. The Joint Venture Agreements contemplated that the parties would develop the Utah projects in a coordinated manner and identify and acquire additional oil shale assets for joint exploration and development.

         Before entering into the Joint Venture Agreements, the Company "planned to develop the EcoShale technology and move directly into commercial production." AB 11. Under the Joint Venture Agreements, the parties agreed first to pursue an "Early Production System Phase" (the "EPS Phase") during which the parties would develop and test the EcoShale technology at a site in Seep Ridge, Utah. AX 21 at 47. The Seep Ridge project sought to demonstrate the Company's ability to extract oil from shale by heating the rock inside a single-use, earthenware capsule. See generally AX 22, AX 23, AX 25, AX 26.

         TOTAL Sub committed to invest $160 million towards developing the EcoShale Technology, representing 80% of the project budget. OX 9 at '367. If the technology proved commercially viable, then the parties would move on to a production phase. See OX 1 at '462; AX 10 at '739; AX 13 at '298.

         The Company asked Xerion for its consent before entering into the Joint Venture Agreements. Xerion provided it.

         C. The Company's Pursuit Of The Joint Venture

         During the next four years, the Company's business plan consisted of pursuing the joint venture with TOTAL Sub. In 2013, a Board member suggested relocating the EPS Phase from Utah to Jordan, arguing that it would save the Company money. OX 10 at '056. The Company's CEO opposed the idea, stressing that the Company needed to remain focused on "execut[ing] our business plan as defined by the Board and our JV Partner." OX 10 at '057.

         In 2014, after the price of oil dropped significantly, the Company and TOTAL Sub agreed to reduce the size of the capsule and to extend the anticipated completion date of the EPS Phase by eighteen months. In May 2015, the Company and TOTAL Sub agreed to suspend all work for a period of two years to give the Company an opportunity to re-engineer a more cost-effective capsule. See AB 13; AX 23 at '179, '185; AX 28 at '730; AX 29 § 2; DeRidder Dep. 123-25. The re-engineered capsule would still be earthenware and single-use, but it would have a partially re-designed heating system. AX 23 at '185.

         D. The Agreement In Principle

         In May 2016, TOTAL Sub informed the Company that it wanted to exit the joint venture, citing concerns over the Company's technology, declining oil prices, and environmental issues. See AX 33 at '533 to '535; DeRidder Dep. at 138, 143, 147-48, 150- 52, 154. The Company estimated that TOTAL Sub still owed $150 million in commitments to the joint venture through 2020. OX 11 at '712.

         The Company decided to negotiate a settlement with TOTAL Sub. See OX 13 at '159. Around the time that negotiations began, TOTAL Sub replaced its Board designee with Pierre Germain, an officer of TOTAL Sub who was employed as Vice President for Business Development at TOTAL USA, the immediate parent of TOTAL Sub. Recognizing the conflicts of interest that would arise from Germain's affiliation with TOTAL Sub, the Company asked Germain to recuse himself from any board discussions regarding the settlement negotiations. Germain agreed.

         By January 2017, the parties had reached an agreement in principle that contemplated the Company releasing TOTAL Sub from all of its obligations under the Joint Venture Agreements in return for TOTAL Sub (i) paying the Company $85 million, (ii) forgoing all right, title, and interest in any assets related to the joint venture, and (iii) returning its 16, 667 shares of common stock and the warrant to the Company (collectively the "Equity Interests"). See AX 39 at '695 to '696. During the settlement negotiations, both the Company's General Counsel and its outside counsel concluded that Germain's affiliations with TOTAL Sub meant that Xerion's consent would be required under the Interested Party Clause. See OX 16. The Company's General Counsel prepared a "voting matrix" for the Board, which noted that Xerion would need to approve the settlement. OX 17 at '094. When the Board met to approve the agreement in principle, the Company's General Counsel advised the Board that the Company "will need to obtain approval from [Xerion] . . . because Pierre [Germain] is serving as Director so the transaction may be considered to be a transaction for the benefit of an affiliate of a Director." AX 39 at '695.

         The Board approved the agreement in principle subject to "receiving an affirmative vote in favor of the . . . settlement from [Xerion]." Id. at '696. Xerion's designee to the Board voted in favor of the resolution. Id. at '697.

         E. Xerion Objects To The Post-TOTAL Business Plan.

         Also during January 2017, the Board considered what the Company's business plan should be after the termination of the joint venture. Without TOTAL Sub, the Company lacked the funds to finish the EPS Phase. The Company's CEO believed that pursuing the EPS Phase was the Company's "only approved business plan." OX 34; see OX 23 at '554. Put differently, the Company had no "approved plan forward other than to advance the EPS." OX 35.

         On January 28, 2017, the Company's CEO advised the Board that "hav[ing] completed a successful negotiation with TOTAL, . . . the [Company] management team is turning our full attention back to the task of executing our business plan to advance the Ecoshale technology." OX 23 at '555. Xerion's director designee objected, asserting that this course of action was not "funded, wise, or authorized by the board or the shareholders." OX 23 at '555. As he saw it, TOTAL Sub's exit meant there was "no funding or approved business plan." OX 23 at '255.

         F. Xerion Withholds Consent.

         On January 31, 2017, the Company formally asked Xerion for consent to the agreement in principle, explaining that its consent was required "[b]ecause a TOTAL representative is currently serving ...


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