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Delaware Chancery Court Declines To Dismiss Challenges To Director Option Grants And Outside Investor Voting Agreement
07/11/2017On June 28, 2017, Vice Chancellor Tamika Montgomery-Reeves of the Delaware Court of Chancery declined to dismiss purported derivative and direct stockholder claims for breaches of fiduciary duty against the directors of Sorrento Therapeutics, Inc. (“Sorrento”) regarding the directors’ decisions to grant themselves stock options in several subsidiaries and their decision to condition a private placement investor’s acquisition of newly issued shares on a voting agreement requiring the investor to vote the shares as the board directs. Williams v. Ji, C.A. No. 12729-VCMR (Del. Ch. June 28, 2017). Declining to dismiss the complaint, the Court determined that the options grants to the directors themselves “are subject to the same entire fairness review as any other interested transaction.” As to the voting agreement, the Court held that defendants must establish that “the agreement is intrinsically fair and not designed to disenfranchise Sorrento stockholders.”
Plaintiff, a stockholder of Sorrento, alleged that the defendant directors breached their fiduciary duties by approving several grants to themselves of options and warrants to purchase shares in multiple subsidiaries controlled by Sorrento. Plaintiff also alleged that a voting agreement with an investor in connection with a private placement that required—as a condition to closing the private placement—the investor to vote the shares as directed by the Sorrento board constituted vote buying designed to disenfranchise Sorrento’s stockholders and entrench the board. Defendants moved to dismiss for failure to state a claim, arguing that compensating directors for their service to a subsidiary is permissible and subject to the business judgment rule, and asserting that “the purpose of the agreement was to prohibit [the investor], a Sorrento competitor, from obtaining a competitive advantage by voting against Sorrento’s interests.”
Denying the motion to dismiss, the Court held that the challenged options grant transactions were subject to entire fairness review, which requires defendants to show both “fair dealing and fair price” and “normally will preclude dismissal of a complaint on a Rule 12(b)(6) motion to dismiss.” Here, the Court found that the complaint “adequately alleges both an unfair process and unfair prices for the Grants.” As to process, the Court highlighted that “no one other than the interested directors ever independently approved the Grants” and that the complaint alleged that “[t]he Grants were also timed soon before or after Sorrento transferred valuable assets or opportunities to the subsidiaries.” The Court also noted that the grants were not timely disclosed. As to price, the Court concluded that the complaint sufficiently alleged that the grants “were excessive” and referenced as an example one grant allegedly amounting to 18% of the economic value of a subsidiary that had recently been disclosed to have engaged in a transaction worth in excess of $170 million.
Regarding the voting agreement, the Court cited allegations that the board “handpicked” the investor, “made the voting agreement a condition” of the private placement, and entered into the agreement on the record date for a director election, and “thus, used corporate assets to buy . . . votes.” The Court concluded that the complaint “adequately alleges a disenfranchisement purpose, shifting the burden of proving that the agreement was intrinsically fair to Defendants, which the Defendants have not done through their motion to dismiss.”
