Fares v. Lankau et al
MEMORANDUM OPINION. Signed by Judge Sue L. Robinson on 8/15/2013. (nmfn)
IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF DELAWARE
Civ. No. 12-1381-SLR
PETER LANKAU, et al.,
Seth D. Rigrodsky, Esquire, Brian D. Long, Esquire, and Gina M. Serra, Esquire of
Rigrodsky & Long, P.AI, Wilmington, Delaware. Counsel for Plaintiff. Of Counsel:
Patrick W. Powers, Esquire, and Peyton J. Healey, Esquire of Powers Taylor LLP.
Dominick T. Gattuso, Esquire of Proctor Heyman LLP, Wilmington, Delaware. Counsel
for Defendants. Of Counsel: Jonathan K. Cooperman, Esquire, and Nicole M. Hudak,
Esquire of Kelley Drye & Warren LLP.
Dated: August I~ , 2013
Fares, a shareholder of Nautilus Neurosciences, Inc. ("Nautilus"), filed this action
on November 2, 2012 against Peter Lankau ("Lankau"), Douglas Karp ("Karp"), Eric
Liebler ("Liebler''), William Maichle ("Maichle"), Neil Milano ("Milano"), Geoffrey Raker
("Raker"), Frank Sica ("Sica"), Zubeen Shroff ("Shroff'), David Azad ("Azad"), John
Groom ("Groom"), Galen Partners V, L.P., Galen Partners International V, L .. P.,
Tailwind Capital Partners LP, Tailwind Holdings (Cayman), L.P., Tailwind Management,
L.P., Tailwind Capital Partners (AI), L.P., Tailwind Capital Partners (PP), L.P., and
Tailwind Capital Partners (ERISA), L.P. (collectively, "defendants"). 1 (D.I. 1) In his
amended complaint, filed January 14, 2013, Fares alleges that defendants breached
their fiduciary duty and/or aided and abetted a breach of fiduciary duty by wrongfully
diluting the value of Nautilus and failing to issue adequate disclosure. (D. I. 12)
On June 19, 2013, the court issued a memorandum opinion and order granting
defendants' motion to dismiss the amended complaint. (D.I. 28; D. I. 29) Currently
before the court is Fares' motion for reconsideration under Federal Rule of Civil
Procedure 60(b). (D. I. 30) The court has jurisdiction pursuant to 28 U.S.C.
A. Fares' Complaint
Fares founded Nautilus and was responsible for identifying, negotiating, and
acquiring the flagship product of the company, "Cambia," a migraine medication. (D.I.
The court will refer to Galen Partners V, L.P. and Galen Partners International V,
L.P. collectively as "Galen Partners." The court will refer to Tailwind Capital Partners
L.P., Tailwind Holdings (Cayman), L.P., Tailwind Management, L.P., Tailwind Capital
Partners (AI), L.P., Tailwind Capital Partners (PP), L.P., and Tailwind Capital Partners
(ERISA), L.P. collectively as "Tailwind."
12 at 1J 26) He invested $750,000 in Nautilus and has been a shareholder continuously
throughout the relevant time period. (/d. at 1J 27) Cambia was a successful venture,
achieving a sales run rate of $12 million between spring 2010 and spring 2011. (/d. at 1J
29) In April 2011, Fares left Nautilus but remained a shareholder. (/d. at 1f30) In 2010,
while still an employee, Fares was issued his shares of stock at $1,000 per share and,
upon termination, Tailwind Investor offered Fares a 10% premium over his purchase
price, or $1,100 per share. (/d. at 1J36)
Fares alleges that, after his departure, Tailwind Investor and Galen Partners
acted in concert to cause Nautilus to issue shares with the goal of increasing their
ownership while simultaneously diluting the ownership of minority shareholders. (/d. at
1f32) To this end, on May 9, 2012, defendants allegedly caused Nautilus to issue a
"Notice of Proposed Issuance of Notes" (the "May 9 notice"). (/d. at 1J 33) On May 11,
2012, defendants caused Nautilus to issue a "Notice of Proposed Issuance of Series C
Preferred Stock" (the "May 11 notice"), which superceded the May 9 notice. (/d. at 1f34)
The Series C Convertible Stock was offered at par value $0.01 per share, at a price of
$345 per share. (/d. at 1J 34)
Fares maintains that the offering price in the May 11 notice was unjustifiably low
relative to the value of Nautilus. (/d. at 1J36) To support his assertion that the company
was devalued, Fares cites a valuation of the company made in 2011 based on the sales
run rate or yearly sales and contends that Nautilus was expected to have a run rate of
between $23 and $25 million. (/d. at 1l1J 38-39) In contrast, when Fares was issued his
Fares refers to Tailwind Capital Partners LP, Tailwind Holdings (Cayman), L.P.,
Tailwind Management, L.P., Tailwind Capital Partners (AI), L.P., Tailwind Capital
Partners (PP), L.P., and Tailwind Capital Partners (ERISA), L.P. collectively as
"Tailwind Investor." (D.I. 12 at 1f21)
previous shares, the run rate was $12 million, yet Fares paid a higher purchase price of
$1,000 than the $345 purchase price offered in the May 11 notice. (/d. at ,-r 38)
After Fares received the notices, he sent a letter through counsel on June 4,
2012 to defendant Maichle, CEO of Nautilus, objecting to the proposed issuance
because it would dilute the interests of minority shareholders. (/d. at ,-r 41) On June 13,
2012, Fares sent another letter requesting access to Nautilus' books and records. (/d.)
His requests were denied. (/d. at ,-r 42) Nautilus, by way of defendant Milano, Chief
Financial Officer, Secretary and Treasurer, sent out a July 20 "Notice to Minority
Stockholders of Nautilus Neurosciences, Inc.," which explained the amendment of the
certificate of incorporation to reflect the addition of the new class of shares. (/d. at ,-r 43)
B. Procedural History
On February 6, 2013, defendants filed a motion to dismiss Fares' amended
complaint on various grounds. (D. I. 16) The court granted defendants' motion on June
19, 2013. (D. I. 28; D. I. 29) Fares then filed the motion for reconsideration currently
before the court, as well as a notice of appeal. (0.1. 30; D.l. 31) On July 24, 2013, the
Third Circuit issued an order staying the appeal pending this court's decision on the
motion for reconsideration. (0.1. 34)
In granting defendants' motion to dismiss, the court observed that, although
equity dilution claims are traditionally derivative, they may be both direct and derivative
when "(1) a stockholder having majority or effective control causes the corporation to
issue 'excessive' shares of its stock in exchange for assets of the controlling
stockholder that have a lesser value; and (2) the exchange causes an increase in the
percentage of the outstanding shares owned by the controlling stockholder, and a
corresponding decrease in the share percentage owned by the public (minority)
shareholders." Gentile v. Rossette, 906 A.2d 91, 98 (Del. 2006). Under the Gentile
framework, the court held that Fares' equity dilution claim was a derivative, not a direct,
cause of action. (D. I. 28 at 6-7) Specifically, Fares failed to adequately plead an
exchange of excessive shares for assets of the controlling stockholder that are of lesser
value; rather, the assertion that his cause of action met the standard for a direct dilution
claim was made by way of legal conclusions. (See id.)
The court then analyzed Fares' cause of action as a derivative claim and found
that it did not pass muster under the heightened standard of Federal Rule of Civil
Procedure 23.1 for pleading demand futility. (/d. at 7-8) The court did not reach the
other grounds for dismissal raised by defendants, that: (1) under the stockholders
agreement, Fares can only bring suit in New York court and waived the right to a jury
trial; (2) Fares released all claims against defendants in his separation agreement and
release; and (3) Fares' breach of fiduciary duty and abetting claims fail to state a claim
under Federal Rule of Civil Procedure 12(b)(6). (/d. at 3)
Ill. STANDARD OF REVIEW
Motions for reconsideration are the "functional equivalent" of motions to alter or
amend judgment under Federal Rule of Civil Procedure 59( e). See Jones v. Pittsburgh
Nat'/ Corp., 899 F.2d 1350, 1352 (3d Cir. 1990) (citing Fed. Kemper Ins. Co. v.
Rauscher, 807 F.2d 345, 348 (3d Cir. 1986)). The standard for obtaining relief under
Rule 59( e) is difficult to meet. The purpose of a motion for reconsideration is to "correct
manifest errors of law or fact or to present newly discovered evidence." Max's Seafood
Cafe ex ref. Lou-Ann, Inc. v. Quinteros, 176 F.3d 669, 677 (3d Cir. 1999). A court
should exercise its discretion to alter or amend its judgment only if the movant
demonstrates one of the following: (1) a change in the controlling law; (2) a need to
correct a clear error of law or fact or to prevent manifest injustice; or (3) availability of
new evidence not available when the judgment was granted. See id.
Fares' motion for reconsideration is premised on a recent Chancery Court case
that is allegedly inconsistent with this court's decision. Carsanaro v. Bloodhound
Technologies, Inc., 65 A. 3d 618 (Del. Ch. 2013), was decided by the Delaware Court of
Chancery on March 15, 2013, after Fares had filed his answering brief for the motion to
dismiss (D.I. 22) but before defendants filed their reply brief (D. I. 25).
The Court of Chancery in Carsanaro was faced with a suit brought by individual
plaintiffs against board members of Bloodhound Technologies, Inc. ("Bloodhound").
The plaintiffs, who had helped found Bloodhound, alleged that venture capitalists took
control of the board and approved self-interested and highly dilutive stock issuances
that left the plaintiffs with, collectively, less than 1% ownership of Bloodhound.
Carsanaro, 65 A.3d at 628. After a merger, the individual plaintiffs no longer had
standing to bring a derivative shareholder suit. On a motion to dismiss, the Court of
Chancery found that plaintiffs had stated a direct claim for "wrongful expropriation"
under the Gentile framework. The court held that "[s]tanding will exist if a controlling
stockholder stood on both sides of the transaction. Standing will also exist if the board
that effectuated the transaction lacked a disinterested and independent majority." /d. at
658. Because the various venture capital investors allegedly constituted a "control
group," the court concluded that the complaint pleaded a direct claim.
Fares asserts that Carsanaro stands for the proposition that the "exchange of
assets of lesser value" element of a direct dilution claim may be met by pleading that an
exchange of cash took place that was insufficiently low relative to the purchased stock.
(D. I. 30 at 6-7) In his initial response to defendants' motion to dismiss argument that
"[n]owhere does the Amended Complaint state which assets were allegedly 'exchanged'
or identify any alleged exchanged assets that were worth 'lesser value"' (D.I. 17 at 11 ),
Fares neither pointed to cash as the asset of lesser value nor cited any case law for
such an argument. Rather, Fares conclusively argued:
Plaintiff has alleged [the first element of a direct dilution claim] through the
exchange for assets of the controlling stockholder that have a lesser
value, alleging that Tailwind Investor "has caused the corporation to issue
excessive shares of its stock in exchange for assets of the controlling
stockholder that have lesser value."
(0.1. 22 at 14)
"[l]ntervening developments in the law by themselves rarely constitute the
extraordinary circumstances required for relief under Rule 60(b )(6)." Reform Party v.
Allegheny Cnty. Dep't of Elections, 174 F.3d 305, 311 (3d Cir. 1999) (quotation marks
omitted); see a/so Budget Blinds, Inc. v. White, 536 F.3d 244, 255 (3d Cir.2008)
(footnote omitted); Co/tee Indus., Inc. v. Hobgood, 280 F.3d 262, 273 (3d Cir. 2003).
Here, however, the court finds that Carsanaro clarified the first requirement of Gentile
such that the court's prior decision is arguably inconsistent with Delaware law.
In Carsanaro, the Court of Chancery noted that it "ha[d] struggled with how to
interpret Gentile" and proceeded to clarify when an equity dilution claim may be a direct
cause of action. Carsanaro, 65 A.3d at 657-61. With respect to the exchange of assets
requirement, the court held that "[t]he complaint alleges that ... Bloodhound issued
shares carrying significantly greater rights than the value of the cash the corporation
received, thereby increasing the ownership and control of the [controlling stockholders]
at the expense of the common stockholders." /d. at 659 (emphasis added). In other
words, the over-issuance of shares for cash of lesser value is an exchange for assets of
the controlling stockholder that have a lesser value.
Defendants argue that the facts of Carsanaro are distinguishable because the
Carsanaro court required an exchange for cash of shares with "significantly greater
rights." (D.I. 32 at 3) Defendants point out that the Series E financing at issue in
Carsanaro carried more favorable conversion rights than other shares. (/d.) (citing
Carsanaro, 65 A.3d at 631-32) However, defendants ignore that the Series D and
follow-on Series E financing that were also at issue did not carry such a liquidation
preference - they were simply exchanged for monetary payment. The Carsanaro
court's finding that such exchanges met the "exchange of assets" element of Gentile
was driven by the observation that a dilutive stock issuance at an unfair price harms
both the company (because it receives too little compensation) and stockholders
(because their proportional rights to vote and receive dividends are reduced). There
was no additional requirement that the shares being exchanged had to carry more
favorable rights than other shares. Rather, the court found that the over-issuance of
shares to the controlling stockholder for an insufficient payment constitutes "an improper
transfer- or expropriation - of economic value and voting power from the public
shareholders to the majority or controlling stockholder." Carsanaro, 65 A.3d at 656-67.
Previous cases in which dilution claims were found to be direct under Gentile had
never analyzed whether a cash exchange for shares, i.e., a sale of stock, could satisfy
the "exchange for assets" element. See, e.g., Gentile, 906 A.3d at 93 (considering a
case in which the controlling shareholder caused the corporation to issue him an
excessive number of shares in exchange for forgiveness of an outstanding debt);
Rhodes v. Silkroad Equity, Civ. No. 2133, 2007 WL 2058736, at *3, *5 (Del. Ch. July 11,
2007) (analyzing a case in which a controlling shareholder forced minority shareholders
to agree to a deal whereby it received $3 of preferred shares for every dollar borrowed
by the company and also loaded the company with employees and misappropriated the
company's funds). The only case that found an equity dilution claim to be direct where
there was a cash exchange for shares was an unpublished opinion in which the
"exchange for assets" element was not discussed. See Dubroff v. Wren Holdings, LLC,
Civ. No. 3940, 2011 WL 5137175, at *2-3, *7-8 (Del. Ch. Oct. 28, 2011 ). Therefore, the
court agrees with Fares that Carsanaro clarifies that a cash exchange for shares at a
price that the well-pled facts indicate is too low can satisfy the "exchange of assets"
requirement of Gentile.
Here, Fares's amended complaint contains allegations that the challenged stock
issuance was underpriced at $345 per share. He alleges that "the offering price of $345
[was] unjustifiably low and [did] not reflect the proper value of [Nautilus]. Notably in
2010, Fares was issued his shares at $1 ,000 per share. And when his employment
terminated in April 2011, Tailwind Investor offered Fares a 10% premium over his
purchase price- $1,100 per share." (0.1. 12 at ,-r 36; see a/so id. at ,-r 44) He also
asserts that the issuance for inadequate consideration "made [his] investment less
valuable" and "caused an increase in the percentage of the outstanding shares owned
by the controlling stockholder and a corresponding decrease in the share percentage
owned by the minority shareholders." (/d. at ,-r,-r 56-57) Fares' allegations, taken as true
at this stage of litigation, align with the Carsanaro court's finding that an over-issuance
of stock for insufficient consideration raises a reasonable inference of an expropriation
of both economic value and voting power. Under Carsanaro, this excessive issuance of
shares allegedly worth more than the cash received in exchange meets Gentile's
requirement for the issuance of '"excessive' shares of ... stock in exchange for assets
... that have a lesser value." 3 Gentile, 906 A.2d at 98.
Having found that Fares has met the "exchange of assets" requirement as
clarified by Carsanaro, the court moves on to the rest of the Gentile analysis.
Carsanaro also clarified that, under the first requirement of Gentile, a "controlling
stockholder'' for purposes of Gentile exists if the board that effectuated the transaction
lacked a disinterested and independent majority, not just a significant quantity of
common stock. Carsanaro, 65 A. 3d at 659-60. The Carsanaro court found that
plaintiffs had adequately alleged, under Rule 12(b)(6) standards, that three out of six
defendant directors were not independent due to their competing fiduciary role for a
third party entity and, thus (with a fourth interested
a control group for
purposes of Gentile. /d. at 638, 659. Fares has pled similar allegations in his
complaint, namely that five of Nautilus's nine directors- Karp, Raker, Sica, Shroff, and
Azad - had a conflict of interest by owing fiduciary duties to both Nautilus and either
Tailwind Investor or Galen Partners. (D.I. 12 at ,-r,-r 3, 7-10, 48, 50) Although the
court's motion to dismiss decision found that Fares had failed to raise a reasonable
doubt under the heightened standard of Rule 23.1 that a majority of the directors were
The court notes that, unlike many cases that have been held to be direct dilution
claims, Fares does not plead facts regarding the percentage by which the controlling
stockholder's ownership increased relative to the percentage by which the minority
shareholders' ownership decreased. See, e.g., Carsanaro, 65 A.3d at 630, 634 (noting
that the plaintiffs' interest decreased from 9% prior to the challenged dilutive
transactions to less than 1%); Gentile, 906 A.3d at 95 (noting that the controlling
shareholder's equity holding in the company increased from 61.19% to 93.49%,
whereas the minority shareholders' holding reduced from 38.81% to 6.51 %); Dubroff,
2011 WL 5137175, at *3 (noting that the control group's holdings increased from
approximately 56% to approximately 90%). Although Fares' complaint passes muster
at this stage, it does not indicate that Fares will necessarily prevail on the merits.
disinterested and independent, the court finds that he has pled a reasonable inference
that a majority of directors were interested or lacked independence under Rule 12(b)(6).
The second requirement for a direct dilution claim is that the exchange causes an
increase in the share percentage ownership of the controlling stockholder and a
corresponding decrease in the share percentage ownership of the minority
shareholders. Gentile, 906 A.2d at 98. Defendants contend that Fares' complaint fails
to meet this second prong because Fares was given an opportunity to buy his
proportionate share of the challenged stock issuance. (D.I. 17 at 11) In addition,
defendants assert that any change in Fares' percentage ownership was the result of his
decision not to participate in the issuance. (/d.) Fares does not dispute that he was
given notice of the challenged issuance and afforded the opportunity to buy his
proportionate share of the new shares. (See D.l. 12
The second prong of Gentile, however, does not require that the change in
percentage ownership be the result of an issuance that barred minority shareholders
from participating in the transaction. As the Court of Chancery found in Dubroff:
Although some Delaware courts have used the word 'exclusive,' or its
equivalent, in discussing direct equity dilution claims, the syllogism - if
anyone other than the controller benefits from the transaction, then the
minority may not assert a direct equity dilution claim - is much too
simplistic. A corporation's minority shareholders should not be denied a
direct equity dilution claim where a controller expropriates, from them, a
large percentage of the corporation's equity, keeps most of that
expropriated equity for itself, and gives a small amount to other people.
Dubroff, 2011 WL 5137175, at *8 (citing Gentile, 906 A.2d at 100; Feldman v. Cutaia,
956 A.2d 644, 658 (Del. Ch. 2007); St. Clair Shores Gen. Employees Ret. Sys. v.
Eibeler, 745 F. Supp. 2d 303, 313 n.1 0 (S.D.N.Y. 201 0)) (footnote omitted). The
Carsanaro court noted that an individual claim is possible when there is an "inter-class
conflict" in which the directors favored themselves and shifted value away from the
common stock. Carsanaro, 65 A.3d at 660. Therefore, Fares' allegation that Tailwind
Investor and Galen Partners "substantially and correspondingly increased their holdings
in Nautilus" at the expense of Fares is sufficient to meet the second prong of Gentile.
Fares' complaint meets the framework of Gentile for a direct dilution claim, as
clarified by Carsanaro. Moreover, he does not seek additional money on behalf of
Nautilus from the challenged issuance but, rather, a reallocation of rights at the
stockholder level. Accordingly, his claim is direct.
Because there is a pending appeal in this case, the court declines to consider at
this time the other arguments raised in defendants' motion to dismiss. If the appeal is
dismissed, the court will then address the other arguments.
For the foregoing reasons, Fares' motion for reconsideration is granted. An
appropriate order shall issue.
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