Nevada Court Order Regarding Convertible Notes

If a Nevada court is right, everything you thought you knew about Convertible Notes just went out the window.

A Nevada court recently ruled that an investor’s right to convert a convertible promissory note into equity expired upon the note’s “maturity date”  (see the attached). The form and structure of the Note used by the investor in this case is similar to the vast majority of convertible notes used in venture investing.

What’s the issue?

The working understanding for convertible notes has been that at maturity, the investor has the right, but not the obligation to demand repayment. This option continues until the investor demands payment or the note is otherwise converted by its terms. The Nevada court held that this right terminates at the maturity date, after which the investor is only allowed repayment.

Why is this important?

The interest rates on convertible notes are not appealing to venture investors. In fact, if the notes are not converted, in many cases the ventures do not have sufficient funds to repay the notes in full. The notes are basically a way to: (1) simplify the documentation of funds transfer; and (2) do so, without setting a valuation. In other words, they are a placeholder. The debt nature of the note is a secondary protection. The venture investor is focused on the equity that will ultimately issue and its return potential. This ruling essentially forces an investor using the current documentation to convert prior to the maturity date if they want to get the potential for equity returns.

If you are an investor, what should you do?

Important to keep in mind that this is one state court ruling, subject to very likely appeal and far from the law of the land.

That said, likely no down side to adding language to future convertible note agreements expressly extending the period for note conversion past the maturity date for as long as the note is outstanding. Also worth considering introducing the language when an existing note is extended.

In terms of current notes using the commonly used agreements today, if you are approaching the maturity date, worth consulting with counsel.

This summary is provided for informational purposes only and is not intended to constitute legal advice nor does it create an attorney-client relationship with Rimon, P.C. or its affiliates. Prior results referred to in these materials do not guarantee or suggest a similar result in other matters.

About the Author:

Dror Futter focuses his practice on startup companies and their investors, and has worked with a wide range of technology companies. His fifteen years’ experience as in-house counsel includes positions with Vidyo, Inc., a venture-backed videoconferencing company, and New Venture Partners, a venture fund focused on corporate spinouts. Prior to that, Mr. Futter was Counsel to the CIO of Lucent Technologies, as well as supporting parts of its sourcing organization. Read more here.