"Although 'beneficial interest' is a term laden with ambiguity...it at least implies the existence of some enforceable right or benefit."1

On December 1, 2009, the Delaware Court of Chancery granted summary judgment to the plaintiff stockholder in the case of Mangano v. PeriCor Therapeutics, Inc.2 In issuing this ruling, the Court of Chancery provided guidance on the meaning of a "beneficial interest" in stock under Delaware law in the context of a stock purchase transaction, holding that a "beneficial interest" requires some enforceable right or benefit.3

The action was brought by the largest single stockholder of the defendant, PeriCor Therapeutics, Inc., a Delaware corporation, and involved the terms of a 2005 Stock Purchase Agreement and a related Voting Trust Agreement.4 The plaintiff, Dr. Mangano, was a co-founder of PeriCor and acquired his stock pursuant to the Stock Purchase Agreement in exchange for the contribution of several intellectual property licenses.5 At the time of this issuance to Dr. Mangano, several mechanisms were put in place to address control-related issues for other investors and to protect against potential conflicts of interest of Dr. Mangano and his affiliates.6 First, the Stock Purchase Agreement gave PeriCor a right of first refusal for any transfer of stock by Dr. Mangano, with an exception for intra-family transfers.7 Second, Dr. Mangano transferred a portion of his stock to a voting trust pursuant to a Voting Trust Agreement that required the trustee to vote the shares in conformity with the majority vote of the stock of the corporation, other than the trust shares.8 Under the terms of the Voting Trust Agreement, the agreement was to terminate when Dr. Mangano's "beneficial interest" in PeriCor fell below 45 percent of PeriCor's outstanding voting stock.9 This Voting Trust Agreement was governed by Delaware law.10

In 2008, Dr. Mangano transferred a number of his shares to his sister pursuant to the inter-family transfer exception in the Stock Purchase Agreement in an effort to terminate the voting trust.11 Left with slightly less than 45 percent of the outstanding stock of PeriCor, Dr. Mangano tendered his trust certificates and asked that the stock certificates for the trust shares be returned to him.12 Subsequently, at the annual stockholder's meeting, Dr. Mangano nominated his own slate of directors, in opposition to the slate nominated by the Board of PeriCor.13 Dr. Mangano would have succeeded in electing his slate, but PeriCor refused to recognize Dr. Mangano's votes for the trust shares, and therefore seated the Board's slate.14 Thereafter, Dr. Mangano commenced his action under Section 225 of the Delaware General Corporation Law, which allows the Court of Chancery to determine the validity of contested director elections.15

At issue in Dr. Mangano's motion for summary judgment was whether, under the Voting Trust Agreement, Dr. Mangano retained a "beneficial interest" in the shares he transferred to his sister.16 PeriCor's argument was that Dr. Mangano retained a "beneficial interest" because Dr. Mangano's sister was unsophisticated and Dr. Mangano was the respected "patriarch" of his family.17 Therefore, Dr. Mangano "could expect that his sister would vote in accordance with his wishes," and essentially retained voting control over the transferred shares.18 According to PeriCor, this interpretation of "beneficial interest" under the Voting Trust Agreement was bolstered by the contextual background of the Voting Trust Agreement, which was to "prevent Mangano from taking control of the Company."19

The Court of Chancery disagreed with PeriCor and granted summary judgment to Dr. Mangano.20 It acknowledged that the term "beneficial interest" is "laden with ambiguity" and that, as suggested by PeriCor, two prior Delaware decisions had examined the context in which the term "beneficial interest" was used to step outside the language of the contract and interpret the term's meaning.21 Nonetheless, the court held that there is an unambiguous core requirement for there to be a "beneficial interest"—some enforceable right or benefit must exist for there to be a "beneficial interest."22 In other words, although legal title may go to the transferee, some "equitable title" must exist, for example, economic benefit or control or voting rights, for a "beneficial interest" to be retained.23 Unless parties have "expressly defined beneficial interest to go beyond those boundaries," a court applying Delaware law will not "read past [this] unambiguous limit" without first determining whether the party alleged to have a "beneficial interest" has some enforceable right or benefit.24 Only once this initial analytical hurdle has been cleared should a court look to the context to determine what the parties intended the ambiguous term "beneficial interest" to mean.25

In examining the facts in PeriCor Therapeutics, the Court of Chancery found that Dr. Mangano "retained no right or benefit in the transferred stock."26 Despite PeriCor's argument that the sister's "lack of sophistication and reverence for her brother" meant that Dr. Mangano still had voting control over the transferred shares, the court found no evidence of an "agreement or understanding, formal or otherwise" that the sister would vote her shares "in accord with her brother's wishes."27 Therefore, even though the sister's votes were "likely to run parallel" to Dr. Mangano's, the court found she was free to "vote her shares as she wishes," and that she took "full legal and equitable title to the transferred shares with no reserved interest for her brother."28 Moreover, the court observed that Dr. Mangano was likely less interested in retaining voting rights in transferring the shares to his sister, and more interested in breaking the voting trust, noting that Dr. Mangano's slate of directors would have won regardless of how his sister voted the transferred shares.29

PeriCor did urge the court to apply the broader definition of "beneficial owner" under the federal securities laws, citing the Securities and Exchange Commission's definition of a "beneficial owner" as "any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares: (1) voting power which includes the power to vote, or to direct the voting of, such security...." (emphasis included)30 The Court of Chancery declined this broad definition for two reasons.31 First, the parties agreed that the Voting Trust Agreement would be governed by Delaware law, not federal law.32 Second, the Court of Chancery found the federal securities law definition "inapposite" for policy reasons, noting that the policy behind the broad federal definition was to "protect investors," "alert the marketplace" as to a "potential shift in corporate control," and provide a "heightened knowledge of who exactly is in a position to influence the corporation."33 The court found this policy inapplicable to the case before it because PeriCor did not need "an expansive reading of beneficial ownership or interest for its protection."34

Ultimately, the court found that if PeriCor, which negotiated and took the lead in drafting the Stock Purchase Agreement and the Voting Trust Agreement, needed a definition of "beneficial interest" that extended beyond the core requirement of there being some retained right or benefit, PeriCor could have drafted the Voting Trust Agreement to provide a broader definition or could have eliminated the intra-family transfer exception from the Stock Purchase Agreement.35

Additionally, the Court of Chancery disposed of two additional arguments by PeriCor.36 First, PeriCor argued that the stock certificates for the trust shares could not be returned to Dr. Mangano until a new trustee was appointed (the previous trustee had resigned), and that without having possession of the stock certificates, Dr. Mangano could not vote the shares.37The Court of Chancery held that the Voting Trust Agreement had terminated upon the transfer of shares to the sister, that Dr. Mangano was therefore entitled to the stock certificates and that, regardless of his possession of the certificates, he was entitled to vote the shares.38Second, PeriCor alleged that Dr. Mangano was not entitled to relief from the court because he had "unclean hands."39 PeriCor alleged that Dr. Mangano's intent was to take control of the corporation to the benefit of two of his affiliated entities and that some of those on his proposed slate of directors were involved with those affiliates.40 The Court of Chancery held, however, that a defense of "unclean hands" must be "related directly to the issue before the court."41 Because Dr. Mangano's alleged misdeeds on behalf of his affiliates had no direct relation to the status of his rights as a stockholder, the court found that PeriCor's defense of unclean hands failed and noted that such allegations are better-suited for a fiduciary duty action at the appropriate time.42

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The holding in PeriCor Therapeutics is an important one for Delaware corporations and merger and acquisitions law practitioners because of the guidance it offers in establishing and transferring beneficial interests in stock under Delaware law. Additionally, it underscores the importance of giving clear definitions to otherwise ambiguous terms like "beneficial interest," so that a later-reviewing court has the tools it needs to give effect to the parties' intent. Moreover, the decision is important because the establishment of a threshold requirement that there be some retained right or benefit for there to be a "beneficial interest" provides certainty. To hold otherwise may have called into question whether the transferor retained a "beneficial interest" in any number of transfers to related parties where the transferee subsequently votes in the same manner as the transferor.