Out of Delaware’s Court of Chancery, we have another tale of messy startup contract drafting, with facts that are increasingly bizarre and horrifying.

Consultant was hired by a startup, and the startup fell into arrears paying its bills.  The CEO and sole director offered a warrant for stock in lieu of payment, at a cheap (“practically free”) exercise price.  The company’s counsel (Wilson Sonsini) drafted the warrant for 1% of outstanding shares at the time of the warrant’s issuance.  The consultant’s attorney then amended the agreement to say 1% of shares at exercise.  The consultant returned the signed amended agreement to the CEO, but not in blackline and with no warning of the change.  The CEO, apparently without reading it, signed the revised agreement.  The agreement was recorded on the company’s books as being for 100,000 shares, i.e., 1% at time of issuance.

Later, the company conducted a stock split, and the warrant was revised on the company’s books to reflect 1 million shares.  At one point, KPMG audited the company for a counterparty considering a transaction, and flagged the discrepancy, but the company made no change.

Eventually – plot twist! – the consultant apparently got into some kind of criminal trouble, and asked the CEO for help paying attorneys’ fees.  The CEO offered a personal loan, secured by the warrant.  The CEO drafted a security agreement that identified “a warrant to purchase Common Stock in the Issuer for one million shares” plus proceeds from their sale.

The consultant then defaulted on the loan, and the CEO transferred ownership of the warrant to himself. 

Then, the company went public via SPAC.  The CEO exercised the warrant for 1 million shares, which was converted into 121,730 shares of the new entity.  The CEO’s shares were subject to a lockup; as is not atypical in SPACs in those days, the new entity traded at over $30 per share, but crashed before the CEO sold.  The company was eventually acquired at a valuation of 74 cents per share.

So the consultant sued, claiming that the warrant should have entitled her to 1% of the outstanding shares at the time of exercise, which would have entitled her to nearly 8 times more shares in the post merger entity than those claimed by the CEO.

After trial, VC Fioravanti held:

(1) Not reading the consultant’s version of the warrant was no excuse; the CEO’s contract was binding.  Nor was it an excuse for the CEO to claim that, under Delaware law, only boards can authorize a fixed percentage warrant; he was the sole director and thus he was the board.

(2) Because the security agreement for the loan referenced a warrant for 1 million shares – and no such warrant in fact existed – the loan was unsecured under Delaware’s version of the Uniform Commercial Code.

(3) Therefore, the CEO improperly converted the entire warrant by exercising it for 1 million shares

(4) The CEO owed the consultant the entirety of the shares described in the warrant, i.e., eight times the number of shares in the post merger entity than he actually received at –

(5) pre-lockup prices, because one can speculate that maybe the consultant, had she claimed the shares, would have agreed to a lockup, but we don’t know.  So, a total judgment of in excess of $27 million.

So, first of all – whew.  Second of all, while I’m sure there are many such cases, I’m immediately reminded of Kingfishers v. Finesse, which also involved a rushed startup agreement (for a SAFE), which involved a six page contract with an obvious drafting problem but the investor signed without reading it. Litigation continues.

And third of all, well, look, I am not a contracts or secured transactions specialist, and I’m not sure it would have much of a financial difference anyway, but it seems to me that even the most generous, consultant-friendly reading of this series of events would suggest that, at absolute minimum, there was a meeting of the minds that the equivalent of 1 million pre-merger shares were to be used as security for the loan, and so the CEO should have been able to claim at least that many (even if he improperly converted more than that number).  Maybe the UCC wouldn’t permit such baby-splitting but it seems awfully harsh to conclude that there was no security interest for the loan at all.

In that respect, as corporate law becomes more contractual (see here and here and here and here), I wonder how much room there will continue to be for equity, and how much corporate disputes will come to resemble the creditor-on-creditor violence we see in today’s debt markets.

And another thing.  On this week’s Shareholder Primacy podcast, Mike Levin and I talk about Chancellor McCormick’s recent decision in the Activision merger litigation, and about the concept of corporate personhood.  Here at Apple, here at Spotify, and here at Youtube.