Directors Owe No Fiduciary Duty to Warrant Holders, But They Deserve Truthful Answers

Directors did not have a fiduciary duty to holders of warrants in the company’s stock, ruled the Delaware Chancery court, and thus had no duty to give the warrant holders advance notice of dividend declarations. Analogizing warrant holders to holders of convertible debentures, Vice Chancellor Strine said that the Delaware courts have consistently held that directors owe no fiduciary duty to future stockholders. But the court also held that the warrant holders deserved a truthful answer from the company when they inquired about a second dividend. (Corporate Property Associates v. CHR Holding Corp., Delaware Chan Ct. No 3231-VCS).

A few weeks before the second dividend was issued, the warrant holders asked the company to discuss any significant developments related to the business over the course of the past six months. Rather than remaining silent, which it could have, the company provided an answer that omitted any reference to the second dividend or related refinancing. The warrant holders contended that, had the company given a complete answer to their question, they would have chosen to exercise their warrants before the second dividend was issued.

In holding that the directors did not have a fiduciary duty to the warrant holders, the Vice Chancellor cited a 1988 Delaware Supreme Court ruling that a convertible debenture represents a contractual entitlement to the repayment of a debt and does not represent an equitable interest in the issuing company necessary for the imposition of a trust relationship with concomitant fiduciary duties. The same analysis applies to warrants, said the chancery court, in that the convertibility of the warrants does not result in the imposition of fiduciary duties. Just like with convertible debentures, the court reasoned, the convertibility feature of warrants does not bestow stockholder status until the warrant is in fact converted. Any rights that warrant holders may have are based, not on any fiduciary duty, but are contractual.

However, regarding fraud and negligent misrepresentations claims, the court reasonably inferred that the company was in the final throes of implementing a large dividend and knew that the warrant holders would exercise their warrants promptly if told of that development, and consciously decided to omit that development from its response to the questions. Importantly, by the time the company answered, it knew that the warrant holders were interested in the question of dividends from their prior demand to participate in the first dividend, said the court, raising an inference that the company did not want to tip the warrant holders that another dividend was coming, especially one that was three times the amount of the first.

The company had a duty to provide materially complete information once it voluntarily chose to speak in a situation when it could have remained silent. Thus, these circumstances stated a claim for fraud in the face of a duty to speak.