Delaware Case Validates Pay-to-Play Strategy

By John LeClaire, Michael J. Kendall and Kingsley L. Taft

A recent Delaware Chancery Court case provides further support for using "pay-toplay" techniques to reduce or remove the rights of preferred stock investors who fail to support a company in subsequent fundraisings. In Watchmark Corp. v. ARGO Global Capital, LLC, et. al., the court decided that Watchmark’s directors, five out of six of whom were representatives of the preferred stock investors, did not breach their fiduciary duties in approving a financing that converted preferred stock of nonparticipating investors into common stock.

Watchmark is a wireless network software company based in Bellevue, Washington. In early 2004, Watchmark sought to acquire the Metrica Service Assurance Software Group from ADC Telecommunications, an acquisition the board expected could double Watchmark’s revenues. Watchmark’s board (including the representative of ARGO Global Capital, a Watchmark investor and the eventual contesting party) was