Chancery Enjoins Board in Potential Stockholder Dilution Scheme

Directors and officers of struggling corporations seeking capital or startups willing to trade equity for cash should read the Delaware Court of Chancery’s recent transcript ruling in Elite Horse Investments Ltd. v. T3 Motion, C.A. No. 10550-CB (Del. Ch. Jan. 23, 2015), carefully and consider it a cautionary tale. If control of a business can be purchased, sitting directors and officers should not be surprised when the new controlling stockholder or control group installs their own directors and replaces management. Moreover, directors and officers should think long and hard before attempting defensive measures aimed at protecting their positions or other entrenchment motives. As discussed below, the Court of Chancery will not hesitate in enjoining such conduct.

Elite Horse Investments Ltd. (EHI) is one of a group of stockholders of T3 Motion Inc., a Delaware corporation headquartered in Costa Mesa, California, that designs, manufactures and markets electric-motor-powered personal mobility vehicles. In or around December 2014, EHI and a group of seven others invested $6 million in T3 Motion in exchange for approximately 60 million shares or roughly 60 percent of T3 Motion’s equity. At the time of EHI’s investment, T3 Motion’s board of directors was composed of three members: CEO William Tsumpes, Steven Healy and Ki Nam. However, T3 Motion’s bylaws authorized the company to have seven directors on the board. On Dec. 26, 2014, EHI and seven other T3 Motion stockholders, holding in excess of 60 percent of T3 Motion’s shares, delivered a signed stockholder written consent dated Dec. 17, 2014, electing four individuals to T3 Motion’s board, thus filling the four vacant director seats. In response, on Jan. 15, Tsumpes contacted Healy and Nam to hold a board meeting, excluding the directors appointed to the T3 Motion board by the December 2014 written consent. The tentative agenda of the board meeting included the “urgent” matter of selling T3 Motion equity to a third-party investor, converting T3 Motion debt held by Tsumpes and an entity called T-Energy to equity and converting Tsumpes’ unpaid salary to common stock. The motive behind these actions was to dilute EHI’s and the other seven investor stockholders’ interests in T3 Motion to less than a controlling majority.