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Background on Litigation

On June 14, 2024, Discovery Global Opportunity Master Fund, Ltd. and Discovery Global Beacon Partners LP (collectively, 鈥淒iscovery鈥�) filed a complaint (the 鈥淐omplaint鈥�) (attached ) against Hertz Global Holdings, Inc. (鈥淗ertz鈥�) in the Court of Chancery of the State of Delaware (the 鈥淐ourt鈥�). The Complaint asserts three causes of action related to Hertz鈥檚 alleged breach of a certain Warrant Agreement, dated June 30, 2021 (the 鈥淲arrant Agreement鈥� or 鈥淲A鈥�) (click ), that was executed in connection with Hertz鈥檚 confirmed plan of reorganization in June 2021 (the 鈥淧lan鈥�) (click听).

The Plan provided that Hertz鈥攚hich became a solvent debtor during the course of its chapter 11 bankruptcy case鈥攚ould 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.听See听WA 搂 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 鈥渞ecapitalization鈥� 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.听We start with the general rule found in 搂 14 of the Warrant Agreement, which provides that Hertz may not redeem the warrants unless it is done pursuant to 搂 12(g)(v).

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

Change of Control Event.听The term 鈥淐hange of Control Event鈥� is a defined term,听see听WA 搂 32(b)(x), and it includes 鈥渁ny . . .听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鈥� (emphasis added). 鈥淩egistered and Listed Shares鈥� 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鈥檚 theory, there must have been a 鈥淩eorganization Event,鈥� and the Reorganization Event must have occurred such that 鈥渉olders of the Common Stock receive[d] or [were] entitled to receive鈥� assets that were more than 10% cash consideration.

Reorganization Event.听Next, we turn to the definition of 鈥淩eorganization Event.鈥� 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 鈥淩ecapitalizations, Reclassifications and Other Changes.鈥澨�See听WA 搂 12(g)(i). Specifically, 搂 12(g)(i) provides that:

(i) If any of the following events occur:

(础)听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鈥檚 assets; or

(E) any statutory share exchange,

(each such event a 鈥淩eorganization Event鈥�), 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 鈥淩eference Property鈥�), 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 鈥淯nit of Reference Property鈥�); 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.听The Warrant Agreement does not define the define the term 鈥渞ecapitalization,鈥� and we understand that courts in Delaware have suggested that the term 鈥渞ecapitalization鈥� is a term with no universally accepted meaning, and that its meaning is dependent on the context of each situation. Interestingly, the Complaint cites听Tex. Pac. Land Corp. v. Horizon Kinetics LLC, 306 A.3d 530 (Del. Ch. 2023), for the proposition that the term recapitalization 鈥渋s commonly understood to mean a revision in the capital structure of a corporation.鈥� The Complaint then quotes from听Horizon Kinetics, saying the case defines recapitalization as 鈥渋nvolving a reshuffling of a capital structure within the framework of an existing corporation,鈥� and further explaining that 鈥淸i]t generally involves bringing in capital, as in 鈥榬e鈥� (again) capitalizing the entity. The new capital could be equity or debt, but there is new money coming from somewhere.鈥�

Discovery is certainly correct that the cited quotations can be found in听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鈥檚 activities are, in fact, a recapitalization. The issue in听Horizon Kinetics听was whether an increase in the number of a company鈥檚 authorized shares was a 鈥渞ecapitalization,鈥� 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听Horizon Kinetics听court held that the word 鈥渞ecapitalization鈥� was ambiguous, particularly in light of competing arguments from the company and investors about the term鈥檚 meaning. Ultimately, the court held that the investors had failed to satisfy their burden鈥攖hrough the use of extrinsic evidence鈥攖hat the issuance of new shares would be a 鈥渞ecapitalization鈥� for the purpose of the investor鈥檚 commitment to vote at the board鈥檚 direction.

Discovery鈥檚 Theory of the Alleged Breach

The Complaint alleges that Hertz鈥檚 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 鈥渞ecapitalization,鈥� and therefore, it is a 鈥淩eorganization Event.鈥� Moreover, because the 鈥淩eorganization Event鈥� 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鈥� 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鈥檚 creditors as dictated by the Warrant Agreement.听See听WA 搂 12(g)(v)(I);听听(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 鈥渞ecapitalization,鈥� 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 鈥渞ecapitalization,鈥� Discovery may still face other arguments. For instance, Hertz will likely argue that the definition of 鈥淩eorganization Event鈥� includes the phrase 鈥渋n 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).鈥� This quoted phrase appears immediately after the parenthetical creating the 鈥淩eorganization Event鈥� 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 鈥淩eorganization Event鈥� occurred within the meaning of the defined term.

But even assuming that the transactions听were听a 鈥渞ecapitalization鈥澨�and听a 鈥淩eorganization Event,鈥� Hertz will likely argue that Discovery cannot prove a Change of Control Event even occurred since it necessitates proving听both: (1) a Reorganization Event,听and听(2) a condition whereby 鈥渉olders 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.鈥� 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鈥檚 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.听See听.