Contractual disputes are an ongoing source of amusement to me, especially when the words of the deal are used to defeat the actual meaning of what the parties bargained for. To wit: VC Will’s recent opinion in Kim, et al. v. FemtoMetrix, Inc.
Avaco was a stockholder in FemoMetrix, and had signed a voting agreement with other stockholders. That agreement gave Avaco the right to designate one director, and it chose Kim, who was then an Avaco employee.
The voting agreement had the following relevant terms:
1) Section 1.2(a) granted Avaco a designation right, subject to sections 1.6 and 1.4(a).
2) Section 1.6 provided that Avaco could not designate a “bad actor” as defined by SEC rules.
3) Section 1.4(a) provided that Avaco’s designee could be removed without Avaco’s approval, but only for “cause.”
4) Section 7.8 provided that amendments to the voting agreement required a stockholder vote, but an amendment specific to a particular investor – that did not “appl[y]” to all equally – would require that investor’s consent. It also provided that Section 1.2(a) could not be amended without Avaco’s consent.
(At this point, “Jaws” music should be playing in your head.)
Avaco got into a commercial dispute with FemoMetrix, unrelated to its status as a stockholder, and sued the company. At that point, the stockholders – other than Avaco – voted to amend the agreement. Specifically, they amended section 1.4 by adding a new subsection, (d), defining a “conflicted director” to mean a director who is affiliated with an entity engaged in commercial litigation against FemoMetrix, and they amended 1.4(a) to define “cause” to reference the new 1.4(d). They also added a new Section 1.7, preventing stockholders with designation rights from appointing conflicted directors.
FemoMetrix then kicked Kim off the board, Avaco sued, and the two sides moved for summary judgment.
You can see where this is going. The company claimed that, in all respects, it complied with the voting agreement. Section 1.2(a) had not been amended at all, so Avaco’s consent was not required. The other sections had been amended, but – because they applied equally to all investors – Avaco’s consent was still not required.
Except for god’s sake, of course Section 1.2(a) was amended! Avaco previously had a designation right, unrestricted except for SEC bad actors, and now it didn’t! Avaco’s director previously could only be removed for “cause” – which as a background concept usually means misconduct of some kind – and now could be removed for other reasons!
And of course the amendment was limited to Avaco; the investors chose an Avaco-specific quality and targeted the amendment to that quality. They didn’t even define “conflicted directors” to mean all directors with some kind of financial conflict or divergent interests; the relevant “conflict” was defined to mean only commercial litigation, i.e., Avaco’s conflict.
Nonetheless, VC Will held that there had been no violation of the voting agreement. After all, Avaco was protected against amendments to Section 1.2(a), and the actual words that were changed appeared in Sections 1.4 and 1.7. Sure, if the stockholders had amended 1.2(a) to say “the designee may not be affiliated with a stockholder engaged in litigation,” that would have violated the agreement. But because the actual numbers that were placed in front of those words were 4 and 7, there was no problem. Those are totally different numerals, 2, 4, and 7.
As for whether the amendments concerned a specific investor – they were phrased in general terms, so those were okay too! Any investor engaged in commercial litigation against FemoMetrix would have received the same treatment.
What if, though, the amendments had limited the designee rights of any stockholder based in Korea that provides mass production manufacturing services? Or any stockholder whose name begins with “A” and ends with “o”? At what point do we look beyond the actual words used to effectuate the change to their practical effect?
In VC Will’s view, however, that was the wrong frame. The contract required equal application of a contract amendment; not equal effect. Op. at 15. The fact that the amendment had a disparate effect (and was clearly intended to have a disparate effect) played no part in the analysis because the agreement only guaranteed against disparate application.
So Avaco offered a final last ditch argument – this all violated the implied covenant of good faith and fair dealing. But, unfortunately for Avaco, the complaint had not alleged any claims under the implied covenant, which VC Will took as a waiver.
Case dismissed. The end.
