Hertz: Warrant Litigation Explained

Background on Litigation

On June 14, 2024, Discovery Global Opportunity Master Fund, Ltd. and Discovery Global Beacon Partners LP (collectively, “Discovery”) filed a complaint (the “Complaint”) (attached here) against Hertz Global Holdings, Inc. (“Hertz”) in the Court of Chancery of the State of Delaware (the “Court”). The Complaint asserts three causes of action related to Hertz’s alleged breach of a certain Warrant Agreement, dated June 30, 2021 (the “Warrant Agreement” or “WA”) (click here), that was executed in connection with Hertz’s confirmed plan of reorganization in June 2021 (the “Plan”) (click here).

The Plan provided that Hertz—which became a solvent debtor during the course of its chapter 11 bankruptcy case—would issue warrants to then-existing shareholders upon emergence from bankruptcy. The Warrant Agreement provided that holders could purchase up to 89,049,029 shares of Hertz common stock at a strike price of $13.80. See WA § 2. Discovery alleges that it holds 9,161,086 warrants, or 11% of all outstanding warrants (believed to be 82,710,029).

Discovery alleges that Hertz breached the Warrant Agreement by undertaking a “recapitalization” when Hertz engaged in a series of financing transactions between November 2021 and December 2023 during which Hertz incurred $2.2 billion of debt and repurchased $3.4 billion of its own common stock pursuant to a stock repurchase program. Discovery maintains that this alleged recapitalization triggered certain redemption requirements under the Warrant Agreement. As a result, Discovery contends that Hertz has been in breach of the Warrant Agreement since at least June 2022 when the various alleged recapitalization transactions were substantially completed. Discovery alleges that it is entitled to damages amounting to approximately $187.5 million resulting from the failure to redeem.

Relevant Provisions of the Warrant Agreement

The provisions of the Warrant Agreement are complicated, and we do not attempt to quote them all here. Instead, we highlight the key provisions that are necessary to understand the underlying dispute.

General Rule. We start with the general rule found in § 14 of the Warrant Agreement, which provides that Hertz may not redeem the warrants unless it is done pursuant to § 12(g)(v).

Mandatory Redemption. Section 12(g)(v), in turn, mandates a redemption of the warrants when there is something called a “Change of Control Event.” See WA §12(g)(v)(A). When that event occurs, Hertz must then pay holders an amount equal to the “Change of Control Payment Amount.” Discovery argues that the “Change of Control Payment Amount” would in this case be the Black Scholes Value at June 30, 2022.

Change of Control Event. The term “Change of Control Event” is a defined term, see WA § 32(b)(x), and it includes “any . . . Reorganization Event, which . . . is effected in such a way that the holders of Common Stock receive or are entitled to receive . . . with respect to or in exchange for Common Stock, cash, stock, securities or other assets or property . . . , wherein Registered and Listed Shares represent less than 90% of the Market Price of all such cash, stock, securities or other assets or property to be received in respect of or in exchange for Common Stock” (emphasis added). “Registered and Listed Shares” generally means registered and listed common shares of the surviving entity in a consolidation, merger, or combination or the acquiring entity in a tender offer.

Stated succinctly, for a Change of Control Event to have occurred, at least under Discovery’s theory, there must have been a “Reorganization Event,” and the Reorganization Event must have occurred such that “holders of the Common Stock receive[d] or [were] entitled to receive” assets that were more than 10% cash consideration.

Reorganization Event. Next, we turn to the definition of “Reorganization Event.” Curiously, the term is not defined in the definition section of the Warrant Agreement. It is instead defined within the section of the Warrant Agreement dealing with “Recapitalizations, Reclassifications and Other Changes.” See WA § 12(g)(i). Specifically, § 12(g)(i) provides that:

(i) If any of the following events occur:

(A) any recapitalization;

(B) any reclassification or change of the outstanding shares of Common Stock

(other than changes resulting from a subdivision or combination to which Section 12(a) applies);

(C) any consolidation, merger or combination involving the Company;

(D) any sale or conveyance to a third party of all or substantially all of the

Company’s assets; or

(E) any statutory share exchange,

(each such event a “Reorganization Event”), in each case as a result of which the Common Stock would be converted into, or exchanged for, stock, other securities, other property or assets (including Cash or any combination thereof) (the “Reference Property”), then following the effective time of the transaction, the right to receive shares of Common Stock upon exercise of a Warrant shall be changed to a right to receive, upon exercise of such Warrant, the kind and amount of shares of stock, other securities or other property or assets (including Cash or any combination thereof) that a holder of one share of Common Stock would have owned or been entitled to receive in connection with such Reorganization Event (such kind and amount of Reference Property per share of Common Stock, a “Unit of Reference Property”); provided in the event of a Change of Control Event, the Warrants shall be treated solely in accordance with Section 12(g)(v).

(emphasis added).

Recapitalization. The Warrant Agreement does not define the define the term “recapitalization,” and we understand that courts in Delaware have suggested that the term “recapitalization” is a term with no universally accepted meaning, and that its meaning is dependent on the context of each situation. Interestingly, the Complaint cites Tex. Pac. Land Corp. v. Horizon Kinetics LLC, 306 A.3d 530 (Del. Ch. 2023), for the proposition that the term recapitalization “is commonly understood to mean a revision in the capital structure of a corporation.” The Complaint then quotes from Horizon Kinetics, saying the case defines recapitalization as “involving a reshuffling of a capital structure within the framework of an existing corporation,” and further explaining that “[i]t generally involves bringing in capital, as in ‘re’ (again) capitalizing the entity. The new capital could be equity or debt, but there is new money coming from somewhere.”

Discovery is certainly correct that the cited quotations can be found in Horizon Kinetics, but we are hesitant to take away from the case that it meant to define what recapitalization means more broadly or that it necessarily answers the question of whether Hertz’s activities are, in fact, a recapitalization. The issue in Horizon Kinetics was whether an increase in the number of a company’s authorized shares was a “recapitalization,” which, in that case, would exempt certain investors from honoring a commitment to vote at the direction of the board of directors for the share issuance. The Horizon Kinetics court held that the word “recapitalization” was ambiguous, particularly in light of competing arguments from the company and investors about the term’s meaning. Ultimately, the court held that the investors had failed to satisfy their burden—through the use of extrinsic evidence—that the issuance of new shares would be a “recapitalization” for the purpose of the investor’s commitment to vote at the board’s direction.

Discovery’s Theory of the Alleged Breach

The Complaint alleges that Hertz’s incurrence of $2.2 billion of debt and the repurchase of $3.4 billion of its own common stock pursuant to a stock repurchase program amounts to a “recapitalization,” and therefore, it is a “Reorganization Event.” Moreover, because the “Reorganization Event” occurred in such a way that holders of Common Stock who sold their shares to facilitate the repurchase program received more than 10% of the consideration in the form of cash, the Change of Control Event was triggered, and the Warrants had to be redeemed for the Change of Control Payment Amount.

The following illustrates the logical steps behind the holders’ arguments:

Thoughts and Takeaways

We are still digesting the Complaint and what it means for Hertz and its stakeholders more generally. We nonetheless offer our initial thoughts and takeaways.

Our initial observation is that Discovery holds warrants representing approximately 11% of all outstanding warrants, implying that if all holders were to join in this litigation, the total exposure could reach $1.7 bn. We find it implausible that Hertz, which has a market cap of under $1 bn (as of June 14), would pay this sum voluntarily, or anywhere near it. One possible strategy for Discovery, as we see it, is to shoot for a settlement because obtaining a judgment (up to $1.7 bn in a worst-case scenario) might ultimately prove to be somewhat of a Pyrrhic victory as it might force Hertz to wash itself of the claim in a Chapter 22 bankruptcy case, which claim would be subordinated to Hertz’s creditors as dictated by the Warrant Agreement. See WA § 12(g)(v)(I); 11 U.S.C. § 510(a) (enforcing subordination agreements in bankruptcy).

But as to the merits of the claims, Discovery admittedly paints a straightforward story about how the text of Warrant Agreement should be interpreted, and how the redemption was triggered by the issuance of $2.2 billion in debt and the repurchase of $3.4 billion of common stock. However, we think Discovery will likely face a series of strong counterarguments.

As a threshold matter, the Warrant Agreement does not define “recapitalization,” and Delaware law suggests that its meaning depends on context. This will give Hertz plenty of room to argue that the transaction was not recapitalization, and to the extent a court finds the term to be ambiguous within the meaning of the Warrant Agreement, it will invite the Court to exercise some discretion and consider extrinsic evidence like course of dealing.

But even assuming that the Court were to find that these transactions fit within the definition of “recapitalization,” Discovery may still face other arguments. For instance, Hertz will likely argue that the definition of “Reorganization Event” includes the phrase “in each case as a result of which the Common Stock would be converted into, or exchanged for, stock, other securities, other property or assets (including Cash or any combination thereof).” This quoted phrase appears immediately after the parenthetical creating the “Reorganization Event” defined term, but we think that does not necessarily rule out the phrase from being included within the definition. Hertz may assert that common stock was neither converted nor exchanged as part of share repurchase transactions, so no “Reorganization Event” occurred within the meaning of the defined term.

But even assuming that the transactions were a “recapitalization” and a “Reorganization Event,” Hertz will likely argue that Discovery cannot prove a Change of Control Event even occurred since it necessitates proving both: (1) a Reorganization Event, and (2) a condition whereby “holders of Common Stock receive or are entitled to receive . . . with respect to or in exchange for Common Stock, cash, stock, securities or other assets or property . . . , wherein Registered and Listed Shares represent less than 90% of the Market Price of all such cash, stock, securities or other assets or property to be received in respect of or in exchange for Common Stock.” Hertz may argue that this second condition cannot be satisfied because all holders of Common Stock must be impacted for the condition to be triggered; in other words, share buybacks do not count because they only impacted specific selling shareholders and not the entire class of holders more broadly.

Finally, it would not surprise us if Hertz’s lawyers developed additional, thoughtful defenses to these arguments. We will follow this litigation, as well as other litigation involving Hertz like the pending make-whole appeal at the U.S. Court of Appeals for the Third Circuit, and issue subsequent reports as appropriate. See Make Wholes & More: Third Circuit Considers Hertz.