In Re Trados: Directors Dodge A Bullet

Vice Chancellor J. Travis Laster's August 16 post-trial opinion in In re Trados Inc. Shareholder Litigation1 (hereinafter, "In re Trados") has attracted a significant amount of attention. Much as both the Chancery and the Delaware Supreme Court did in the Disney/Ovitz case2 of the mid-2000s, the In re Trados court portrays an extremely deficient board process in vivid and unflattering detail, while ultimately finding — perhaps reluctantly — in favor of the defendants. Disney and In re Trados differ substantially on the factual circumstances (Disney involved an employment contract with a senior executive under which extraordinary severance amounts were paid when the executive's brief tenure with the company was terminated; In re Trados, a merger in which common shareholders received no consideration) as well as the standard of review applied by the courts to the actions in dispute (Disney considered whether the actions were protected by the business judgment rule; In re Trados, whether the challenged merger could withstand "entire fairness" review). However, in addition to the similarity of the respective defendant directors escaping liability seemingly by the skin of their teeth, In re Trados like Disney provides an example of how not to manage a board process in a manner designed to avoid disruptive litigation (if not actual liability).

In re Trados: The Facts and Holdings

Facts

Trados Inc. ("Trados") was a privately held company that produced translation software. In 2000, Trados obtained funding from various venture capital ("VC") investors. The VC investors received preferred shares with liquidation preferences payable upon a change-of-control transaction, voting rights identical to common shares on an as-converted basis and other customary VC negative control rights (including the right to veto a change-in-control transaction). Additionally, certain of the VC investors received the power to designate representatives to the Trados Board of Directors (the "Board").

The VC investors collectively controlled a majority of the voting power on an as-converted basis and the power to elect the majority of directors on the Board. The Board was composed of three VC employees, two members of management and two ostensibly independent directors.

Faced with financial setbacks, in July 2004 the Board approved hiring a new CEO. Later that year, the Board approved a management incentive plan (the "MIP") that would incentivize senior executives to pursue a sale of Trados even if it yielded nothing for common shareholders. The Board also rejected an initial $40 million acquisition proposal from SDL plc as it considered the offer too low.

After commencing his employment in August 2004, the CEO advised the Board of its options: to invest additional capital in Trados and reposition its core business for growth or to focus on a potential sale or merger transaction. Although the stand-alone alternative may have permitted Trados to remain solvent, it did not appear to offer a clear opportunity for achieving any meaningful returns for the VC investors or any meaningful (if any) common equity value. Further the VC investors, who each preferred the merger alternative, declined to provide additional capital to ameliorate Trados' financial situation. Under the new CEO, Trados secured a third-party loan allowing it to slightly improve its financial situation. Nonetheless merger discussions with SDL re-commenced in November 2004.

In June 2005, Trados agreed to be acquired by SDL for $60 million in cash, of which the first $7.8 million was paid to management under the MIP and the remaining $52.2 million (less an indemnification holdback) was paid to the holders of the preferred shares, whose liquidation preference was $57.9 million. The common shareholders received nothing.

The plaintiff, who owned 5% of the common shares, sought appraisal and subsequently sued the directors both individually and on behalf of the class of common shareholders, alleging that Trados' directors had breached their fiduciary duties to the common shareholders in approving the merger.

Holdings

Six of the seven members of the Board were conflicted...