Polsinelli business litigators R. Montgomery (“Monty”) Donaldson, Robert Penza and Robert Spake represented Plaintiffs (Basho Technologies, Inc.’s co-founder, former CEO and Chairman of the Board and numerous affiliated investment entities).
In a 126-page post-trial opinion, Delaware Court of Chancery Vice Chancellor J. Travis Laster determined that a venture capital investor and its board designees committed serial breaches of fiduciary duty to secure majority control over and extract value from Basho (a data software technology company), which caused the company to fail. The Vice Chancellor awarded $20 million in damages.
Defendant Georgetown Basho Investors, LLC (individually and later with its board designees, “Georgetown”), itself controlled by a prominent investor named Chester Davenport, invested in Basho with the goal of selling quickly. Eventually realizing that the market wouldn’t support an early exit, Davenport and others aligned with him sought hard (i.e., majority voting) control over Basho to posture Georgetown for a significant premium when a sale eventually closed. To force its onerous funding terms on the company, Georgetown engaged in a course of self-dealing that included withholding funding under a convertible note to create a cash crisis, intentionally deterring a bona fide investor and preventing Basho’s board from considering or seeking out available funding options. Through the challenged Series G transaction, Georgetown gained hard control over Basho and other valuable financial and governance concessions, as well as the voting proxies necessary to “push it to the company,” to use Davenport’s own words.
Immediately after the Series G round transaction closed, Georgetown re-tooled Basho’s governance structure, engaged in unauthorized self-interested transactions, and extracted value from Basho in violation of its duty of loyalty and to the detriment of Basho and its minority shareholders. Due to Georgetown’s actions and breach of fiduciary duty, Basho was forced into financial ruin and this case proceeded to trial in October 2017.
Vice Chancellor Laster agreed with Plaintiffs’ contention that, though not a majority shareholder, Georgetown was exercising “effective control” over Basho and its board in the period leading up to and in connection with the Series G round transaction. Based on this, and the absence of an effective special committee process and majority-of-the-minority shareholder vote, the G round was subject to Delaware’s demanding “entire fairness” review, as were the post-Series G transactions involving undocumented loans and lavish consulting agreements, among other things.
Vice Chancellor Laster concluded that Defendants failed to refute the overwhelming evidence presented by Plaintiffs at trial demonstrating that Basho had been maneuvered into a state of financial crisis, and that Defendants engaged in a bad faith campaign to gain control and profit from the sale of the company. The Vice Chancellor found that Plaintiffs met their burden of proving that they suffered losses of $20 million due to Defendants’ fiduciary breaches, concluding: “In my view, a damages award of this nature is warranted on the facts of this case, given the egregious manner in which Georgetown operated the Company after taking control through the Series G Financing.”
The lengthy opinion represents a complete victory for Polsinelli’s clients and is remarkable in three respects:
- First, it showcases the detailed and exacting evidentiary and legal analyses that are the hallmark of Delaware Chancery Court jurisprudence.
- Second, though drawing on well-established legal principles, it demonstrates (albeit through an extreme example) the risks associated with a finding of effective control and its ramifications for inside funding rounds in venture-backed companies.
- Third, it illustrates Delaware’s commitment to holding heavy-handed investors accountable to minority interests, be they interests held by sophisticated founders or otherwise.
The opinion should be consulted where venture-led inside funding rounds are considered, and the contours of appropriate procedural safeguards are under discussion.
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