Risk Management

Court Rules Against Funds in Telos Case

Maryland judge dismisses claims by hedge funds Costa Brava and Wynnfield that Telos preferred holders were deprived of payments.
Stephen TaubApril 17, 2008

A Maryland court dismissed all claims made by a pair of activist hedge funds against defense contractor Telos Corp. for alleged breach of fiduciary responsibility.

Telos said that the Circuit Court for Baltimore dismissed with prejudice all claims made by Boston-based Costa Brava Partnership III, L.P. and New York City-based Wynnfield Partners Small Cap Value L.P.

According to the company, Judge Albert J. Matricciani Jr. wrote: “The present litigation has been lengthy and certainly costly to the parties. As a result of the court’s ruling on the present motion, it will come to an end, at least in this forumÂ…. [T]he court has found that the plaintiffs have failed to state causes of action” in the complaint.”

Telos CEO John B. Wood said, “After nearly three long years, this case is over. The activist hedge fund, Costa Brava, has failed in its efforts to extract dividend payments out of turn at the expense of our other shareholders. We’ve had finding after finding against this hedge fund, and we’re gratified that the judge has ruled for Telos and all our shareholders, and has thrown out these claims.”

As previously reported, Costa Brava claimed that Telos management orchestrated a campaign that deprived preferred shareholders of mandatory payments due under a provision in the share registration agreement, and enriching themselves in the process. Costa Brava owns 16 percent of Telos’s preferred shares.

“We are disappointed in the judge’s decision yesterday,” a Costa Brava spokesperson said. “It’s interesting that an impartial jury in Fairfax, Va., came to an opposite conclusion in a recent trial a few months ago finding that Goodman & Co. aided and abetted a breach of fiduciary duty by Telos and its directors, a decision that was just recently upheld by the Fairfax court,” the statement continued.

According to the lawsuit, problems began when the contractor ceased declaring and paying mandatory preferred dividends in 1991, claiming it did not have “sufficient legally available funds to fulfill the financial obligation.” The cumulative accrued unpaid dividend currently exceeds $30 million, Costa Bravo said in its complaint.

The hedge fund claims Telos was able to avoid paying the mandatory dividend by manipulating and misrepresenting the company’s financial condition, which is a breach of fiduciary duty.

Telos noted that since 2005, the court has ruled repeatedly against Costa Brava, previously denying motions calling for the company to be placed in receivership, that the company be enjoined from selling any assets, and that the exchangeable redeemable preferred shares (ERPS) be classified as debt rather than equity. At one point, the Court issued a preliminary injunction against Costa Brava when it inappropriately communicated with Telos’ bank.

In the latest ruling, the judge also wrote, “Â…[I]n the judgment of the Court neither the ERPS registration statement nor the company charter and Articles of Amendment and Restatement can be read to give rise to a contractual obligation with Telos to pay plaintiffs accrued PIK dividends at the time of the first scheduled redemption date or anytime thereafter.”

In December, a jury in Virginia found accounting firm Goodman & Company guilty of aiding and abetting Telos. However, the jury did not award damages to the plaintiff, Costa Brava Partners.

Furthermore, Goodman was cleared of three other charges — two counts of conspiracy and one of interference with contractual relations.

Goodman was cited in the lawsuit for issuing a clean audit report in 2004 to Telos.

Costa Brava had asked Goodman for all documents related to Telos. After an aggressive 10-month legal campaign by Costa Brava to obtain the documents, Goodman turned over most of the material. Under instructions from Telos, it did not release the board minutes.

Telos argued in a court filing that the board minutes are protected by a federal rule known as the work product doctrine.