In a recent Delaware Chancery opinion, Kim, et al. v. FemtoMetrix, Inc. (Del. Ch.; 8/25), Vice Chancellor Will addressed the enforceability of a voting agreement amendment. She found the amendment was allowed under the terms of the voting agreement even though it altered a party’s right to designate a director without its consent. Law Prof Ann Lipton (now of the University of Colorado Law School) blogged about the decision last week:

Avaco was a stockholder in FemtoMetrix, 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:

Section 1.2(a) granted Avaco had a designation right, subject to sections 1.6 and 1.4(a) . . . Section 1.4(a) provided that Avaco’s designee could be removed without Avaco’s approval, but only for “cause.” 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.

FemtoMetrix and Avaco also had a commercial relationship and, for whatever reason, that relationship soured and Avaco filed a lawsuit against FemtoMetrix. To “prevent Avaco from obtaining sensitive information while the parties were embroiled in litigation,” the company and certain stockholders entered into an amendment to the voting agreement that did not revise Section 1.2 containing Avaco’s designation right, but revised Section 1.4 in a way that effectively prevented Avaco from exercising that designation right.

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 FemtoMetrix, 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. FemtoMetrix then kicked Kim off the board, Avaco sued, and the two sides moved for summary judgment.

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.

Ann points out:

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.

But Vice Chancellor Will found this to be copacetic under the strict language of the voting agreement and granted summary judgment.

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 . . . 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 FemtoMetrix would have received the same treatment . . . The contract required equal application of a contract amendment; not equal effect. 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.

– Meredith Ervine