Rethinking Jedwab: A Revised Approach to Preferred Shareholder Rights

Abstract

Preferred stock plays an important, yet often overlooked, role in U.S. corporate law.  The interests of preferred shareholders often come in direct conflict with the interests of common shareholders. This is because each group is trying to draw separately from the same pool of resources, thus creating a “horizontal conflict.”  The highly influential Delaware Chancery decision in Jedwad v. MGM Grand Hotels, Inc. established an analytical framework for resolving such horizontal conflicts: when the “preferential” rights of preferred shareholders are invoked, the contractual terms of the preferred stock certificate strictly govern; when “equitable” rights (those shared equally with the common shareholders) are invoked, preferred shareholders are entitled to the same fiduciary duties as common shareholders.

The Note argues that the Jedwab rule is unsatisfactory for two reasons.  First, it provides opportunity to justify favoritism toward common shareholders when “equitable” rights are invoked.  Second, recent case law developments suggest that when “preferential” rights are invoked, the rule leads to overly strict interpretation of contract terms and fails to address the current trend of favoring fiduciary duties owed to the common shareholders over contractual obligations owed to preferred shareholders.

The Note argues that a potential remedy to this problem is to provide preferred shareholders with meaningful rights through contracting for fiduciary duties.  Alternatively, relaxing the strict interpretation of contractual terms and reading an implied covenant of good faith into the terms of the stockholder contract could ameliorate the problem of vulnerable preferred shareholders.  A final potential solution the Note explores is the creation of special committees to represent preferred shareholders during certain corporate transactions.