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A consortium of venture capitalists says a misdrafted paragraph regarding the sale of stock shares cost them millions of dollars, and they are suing Alston & Bird over the alleged mistake. Alston & Bird partners W. W. Thomas Carter III and Randolph A. Moore III are named in the suit, along with their firm. The two are alleged to have made a mistake in drawing up the funding agreement in October 2000. The 11-count suit includes charges of legal malpractice, breach of fiduciary duty, breach of contract and unjust enrichment, among others. Mellon Ventures II v. Alston & Bird (No. 2006CV116281, Fulton Super., May 8). The suit, filed May 8 in Superior Court of Fulton County, says the consortium, which includes Mellon Ventures and GE Capital Equity Investments, both registered in Delaware, and Georgia-based Noro-Moseley IV, Noro-Moseley IV-B and SBK Capital, hired Alston & Bird to draft agreements providing $16,250,000 to Atlanta-based SecureWorks Inc., an Internet and computer-network security company. SecureWorks is not a party to the suit. The suit seeks more than $6 million, including $5.3 million paid to resolve the issue following a separate suit settled in January, fees previously paid to the firm, and fees related to the earlier suit. ‘Wrongly drafted’ provision Under the terms of the funding agreement, the investors were issued shares of preferred, “C” stock in exchange for the funds. In the event of corporate liquidation-through a consolidation or merger, for instance-the holders of that stock would be the preferred beneficiaries, and holders of “A” and “B” stock would be next in line, a common construction in such deals known as a “waterfall” provision. “As the term ‘waterfall’ implies, the provision directs the flow of proceeds from the top to the bottom,” says the complaint. But in what the suit terms a “wrongly drafted” provision of the agreement, three of the company’s founders, termed the “managers” in the suit, who held shares of the B stock, were essentially given the same preferential consideration. In a provision known as a “tag-along provision,” if holders of a preferred stock are preparing to sell a large block of stock, holders of a lower-status preferred stock would be offered a chance to participate. “In the case of SecureWorks,” says the complaint, the provision would allow “B” stock holders “an opportunity to sell stock if any holder of Series A preferred stock or Series C preferred stock proposes to divest to a third party a large portion of its capital stock under certain circumstances, but not in a merger, consolidation or other ‘Liquidation Event’ already covered by the Waterfall provision.” But, says the complaint, the provision was misdrafted as a result of a “cut and paste” error, and language including the liquidation events was inserted. “Without the liquidation preferences contained in the Waterfall provision, Clients would never have even considered investing” in the company as agreed upon, says the complaint. Attached to the document is a 2002 letter from Carter and Moore to Mellon Ventures Vice President John Adams referring to the problem phrase. “While the language is relatively clear,” it reads, “it was clearly not the intent of the parties as to the economics, as such would gut the economic rationale of the investment by the Series C … Apparently, the language was copied from the drag along rights” in another section of the agreement. Other letters referred to in the complaint offer details of meetings between Carter and an attorney for the managers in which it becomes clear that they intend to hold the investors to the letter of the agreement. In 2004, the investors filed a suit in Superior Court of Fulton County against the managers and SecureWorks, seeking to ensure the waterfall provision would control the distribution of proceeds in case of a merger or consolidation. GE Capital Equity Investments Inc. v. Jardon Bouska, 2004CV89825 Fulton Sup., Aug. 17, 2004). The investors were concerned that any plans to sell, merge or consolidate SecureWorks would be stymied unless the provision was changed. “The practical effects of such a controversy is that no third party would enter into a transaction with a company with the controversy in place, because in general, no third party would want to become involved in a lawsuit,” says the complaint. “[The Alston & Bird partners] were invited by Clients to participate in such settlement negotiation … but the Attorneys refused to participate,” says the complaint. “The attorneys asserted a ‘sue me’ attitude regarding the claims of Clients,” the complaint says. That case was settled when the investors paid the managers $5,371,777.32 in promissory notes, according to the new suit. ‘No particular joy’ in filing suit The suit seeks to recoup that money, plus $861,139.29 paid to Jones Day attorneys G. Lee Garrett Jr., David M. Monde and Brett J. Berlin for litigating the 2004 suit; $71,234.64 in fees paid to Alston & Bird for drafting the original agreement; and attorneys’ fees and expenses for the current suit. Edwin J. Schklar of Schklar, Wright & Henderson, who filed the suit along with the firm’s William Brent Ney and Maggie Heim-Smith, said he was not authorized to talk about the action. “The complaint, I think, states in great detail what the lawsuit is about,” he said. “But I would like to say that neither my clients, my partners nor myself take any particular joy in having to file this action,” he noted. “I and members of my firm have personal friends at Alston & Bird.” Schklar referred queries to Mellon’s director of corporate communications, Ken Herz, who declined to comment, citing the pending litigation. He did, however, say that no mergers or consolidations had yet occurred in relation to SecureWorks. Alston & Bird partner Carter said any questions concerning the suit should be directed to the firm’s managing partner, Ben F. Johnson III, who did not return a request for comment. Greg Land can be reached at [email protected]

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