Real life examples of private company proxy contest? In this brief blog post, I will relate two practice experiences we have had. [Factual information is deliberately omitted or obscured as necessary to preserve client confidences and secrets and otherwise comply with applicable ethical standards of professional conduct.]
The Clueless Limited Partners and Their Obtuse Attorneys
We represented a principal in connection with his capital raises to fund newly formed privately held partnerships. As commonly done in that particular industry, each partnership was formed to hold and manage a unique set of assets. That commonly used industry model means that, at any time, the principal and his affiliates are managing multiple separate small partnerships.
When the Great Recession hit, the business of all the partnerships was severely depressed. Many of the limited partners in those partnerships were suffering individually, too, because of economic contractions. So what did they do? A handful of them found a plaintiffs' law firm and sued the principal. Of course, the litigation they initiated brought about the collapse of the partnerships.
But here is where that story ties back to the theme of a private company proxy contest.
The attorneys for the plaintiff limited partners repeatedly insisted that they represented many of the limited partners, but they would not produce a complete list of their clients. The principal was convinced from his communications with limited partners that only a minority of the limited partners (for some entities a minority by percentage interest and by headcount, in other entities a minority by percentage interest) in each partnership were behind the lawsuits. (Here it should be remembered that in many disputes, there are not just two adversarial groups willing to openly confront each other; there is often a third group which prefers to play the role of spectators, and who may have sympathies for one side or the other but are definite only in their earnest desire to avoid direct confrontation with either of the other groups.) The facts that the dissident limited partners who were named plaintiffs in the suits held collectively only minority interests in each partnership AND also made no attempt to seek removal of the general partners of the entities by vote of the limited partners, left the principal (and us too) convinced that the entire litigation must have been driven by a minority group of disgruntled investors and that, as weeks passed, those same dissidents had been unable to get a majority of limited partners in any entity to join them.
Eventually we discovered that the plaintiffs did represent partners in some of the partnerships who were not named as plaintiffs in the lawsuits, and in the other entities had known (to them) sympathetic supporters among partners who were not clients of their attorneys. In hindsight, there seems no doubt that in most of the partnerships, the suing limited partners could have secured sufficient votes from among themselves, by proxies from their colleagues who were unnamed in the suits, and by proxies granted by legally unrepresented sympathetic partners who were reluctant to confront the principal directly, either to replace the general partners of those partnerships, to make a powerful equitable argument before the trial court for replacement of the management, or to persuade the principal that a majority of the investors wanted him to step aside (a step he would have taken voluntarily, because he would then have had to recognize the inevitability of his removal).
Why the named plaintiff limited partners and their attorneys elected not to take that course of action, we never learned, although I have my surmises.
In our opinion, the plaintiff limited partners possessed excellent and inexpensive contractual and statutory remedies for advancing and attaining their goal of displacing management by vote of their own partnership interests and vote, by proxy, of the partnership interests of other partners who, for one cause or another, preferred to remain in the background for as long as possible. And in our judgment, their failure to follow that route led to the needless expenditure of hundreds of thousands of dollars in attorneys' fees and court costs; caused the partnerships to miss out on several highly valuable commercial opportunities involving millions of dollars; and, in the end, resulted in the loss of many of the core assets of the partnerships.
The Hidden Control Key
In another practice illustration, an LLC's management strictly enforced the company agreement transferability restrictions against existing members, especially those with significant ownership percentages in the entity. Management was favorably disposed toward many small owners, whose aggregated interests could pose no threat to management's power, and to significant owners friendly with management; but management was wary of any large owner whose loyalty to it was uncertain.
The company's operating agreement left the term "membership interests" undefined, thereby deferring to the statutory definition of that term.
As a consequence, there was not even the slightest basis for an argument that the transfer restrictions in the company agreement applied to proxies. Management perhaps thought that the transferability restriction against pledges of membership interests would be adequate to block a member from granting a proxy to another member or an outsider.
But we structured a transaction where a significant member gave another party (our client) an irrevocable proxy to vote his membership interests, although those membership interests were not pledged to the grantee. Because the grantor's ownership was significant, and management had considered him favorably disposed toward it, the proxy grant substantially weakened management's position while at the same time shifting to our client veto type control over any significant financial transaction proposed by management.