Telos Wins Costa Brava Litigation

You win some and you lose some. Lately, hedge fund Costa Brava Partnerships III LP, has been on the losing end of their litigation activism approach.

Late Tuesday, April 15, the Circuit Court for Baltimore City dismissed a claim against information technology contractor Telos by the Boston-based hedge fund that the company was being managed for the benefit of insiders. The Costa Brava suit sought to have the court put Telos into receivership, wresting control away from existing management.

That loss piles up on a Jan. 7, Circuit Court of Baltimore City in Maryland order dismissing two claims against Telos by Costa Brava.

Costa Brava filed suit in 2005 claiming it was owed roughly $79 million in dividends.
Telos is privately owned, with 75% of its common stock owned by British investor, John Porter, while the rest is controlled by British investors, Telos management and employees. In 1989, the company issued publicly traded and redeemable preferred shares, some of which Costa Brava purchased, but the defense contractor didn’t pay dividends on the shares since their inception. In October 2005, shortly before a scheduled redemption date for the shares, a three-person committee of independent directors at Telos recommended that the company repurchase the entire package of preferred shares at what the panel considered a "substantial" discount.

One month later Costa Brava filed suit against the company and directors, arguing that it hadn't paid its obligations to preferred shareholders and that insiders were violating their fiduciary duty to investors. By August 2006 a special Telos litigation committee of six directors including two independent directors representing preferred holders, two Costa Brava representatives, set up by the company to investigate the matter, resigned.

Later, the company found other independent directors and set up a second special litigation committee that found that the counts against directors should be dismissed and that it was in the best interest of the company for the lawsuit to come to an end.

The Baltimore court in January concluded that the special litigation committee members "performed their duties in good faith" and "undertook a reasonable investigation" of Costa Brava's claims. The judge also dismissed claims against all directors, including Telos CEO John B. Wood. On April 15, the court also dismissed the activists other claims.

Costa Brava charged that when the ERPS was issued in 1989, Telos repeatedly stated in its Registration Statement to the SEC that the owners and prospective purchasers
of the ERPS should expect payment of [payment in kind] “PIK dividends in the first six years of the ERPS (1989-1995). But as part of the April 15 order: Judge Albert J. Matricciani, Jr. disagreed:

“…[I]n the judgment of the court neither the [Exchangeable Redeemable Preferred Stock] 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 [payment in kind] PIK dividends at the time of the first scheduled redemption date or anytime thereafter.”

The litigation activism approach wasn’t all bad news for Costa Brava. In a separate but related case, Costa Brava won a civil suit in Circuit Court of Fairfax County, Va., it launched in December 2005 against Telos' independent auditor, Goodman & Co (there were no damages awarded). The activist hedge fund alleged in the suit that Telos hire Goodman to produce an audit that would help it avoid redeeming millions of dollars of preferred stock of the IT firm owned by Costa Brava and other investors. Later, Goodman & Co. filed an appeal motion after the trial and on March 25, the Fairfax County judge reaffirmed the jury’s verdict.

Judge Bellows’ ruling of March 25: “As to sufficiency, the Court finds that there was sufficient evidence to support the jury’s verdict [that Goodman & Company aided and abetted a breach of fiduciary duty by Telos and its Directors].” Not introduced in the Fairfax case was a February letter from the SEC giving Telos a clean bill of health, accounting wise. -- Ron Orol