Delaware Law Watch

On September 23, 2024, the Court of Chancery issued a ruling in Roth v. Sotera Health Co., which addressed a compensation dispute between an officer and his former employer relating to his unvested equity.

Plaintiff Kurtis Roth (“Roth”) was a former officer of Defendant Sotera Health Company’s (“Sotera”) operating subsidiary, as well as a member of Sotera holding Class B-2 Units. Pursuant to Sotera’s limited liability company agreement (the “LLC Agreement”), Class B-2 Units would vest if Sotera’s private equity sponsors received a specified multiple on their investment. However, any Class B-2 Units that remained unvested at the time Roth’s employment was terminated would be forfeited.

In 2016, Sotera was converted to a limited partnership and its limited partnership agreement (the “L.P. Agreement”) retained the same vesting and forfeiture term for Class B-2 Units set forth in the LLC Agreement.

In 2020, Sotera became a public corporation, and Roth executed a restricted stock agreement (the “RSA”) pursuant to which Roth’s Class B-2 Units were exchanged for restricted shares of common stock (the “Restricted Stock”). Notably, the RSA incorporated the terms of the L.P. Agreement by reference, generally providing unvested shares of Restricted Stock would be subject to the same vesting and forfeiture restrictions that applied to unvested Class B-2 Units.

In 2022, Roth resigned and was advised that his unvested shares of Restricted Stock would be forfeited. Roth then filed this action.

On summary judgment, the Court held that the pre-IPO vesting and forfeiture terms applied to the Restricted Stock Roth received in exchange for his Class B-2 Units. The Court noted that the terms of the LLC Agreement were “carefully revised” into the L.P. Agreement when Sotera converted from a limited liability company to a limited partnership. Specifically, the Court highlighted that the defined terms in the LLC Agreement matched those in the L.P. Agreement. The RSA, on the other hand, “simply incorporate[d] the terms of the [L.P. Agreement] by reference.” The Court highlighted that this practice created several “ill-fitting” terms. Nevertheless, the Court found that “sloppy drafting does not necessarily create ambiguity.”

Despite the RSA’s “imperfect[ions],” the Court held that the LLC Agreement’s vesting and forfeiture terms, which “carried forward in identical provisions” in the L.P. Agreement, “continue[d] to apply to Roth’s unvested Sotera stock” through the RSA’s “clear incorporation provision,” which expressly stated those terms were “incorporated herein by reference as if fully set forth herein.” Accordingly, any shares of Restricted Stock that were unvested when Roth left Sotera were “forfeited and cancelled for no consideration.”

Finally, the Court rejected Roth’s argument that the incorporation failed under 8 Del. C. § 202(a) because the restrictions on his shares were not “contained in the notice or notices” provided with the stock grant. Section 202(b) allows restrictions to be imposed “by an agreement . . . among . . . security holders . . . and the corporation,” and Section 202(a) includes an exception for “persons with actual knowledge of the restriction.” Thus, the Court found that Roth had “signed and consented to the [RSA], which incorporate[d] vesting and forfeiture provisions he had been aware of since 2015.”

• When incorporating another instrument by reference, Practitioners should consider whether any of the terms to be incorporated (especially defined terms) are “ill-fitting” for the instrument interpreting them. For example, avoid incorporating terms by reference from an earlier instrument that refer to an entity as the “Partnership” into a later contract if the entity has since been re-organized into a limited liability company or a corporation.
• Even if “sloppy drafting does not necessarily create ambiguity” in a contract, it may still invite otherwise avoidable litigation.