Chancery Court Holds Business Strategy Disputes May Not Be Resolved by Appointment of a Receiver Under Section 291
In, In re: Geneius Biotechnology, Inc., C.A. No. 2017-0297-TMR (Del. Ch. Dec. 8, 2017), the Delaware Court of Chancery denied a minority stockholder’s petition for the appointment of a neutral third-party receiver under Section 291 of the Delaware General Corporation Law (“DGCL”) because the petitioner minority stockholder failed to prove, by clear and convincing evidence, that Geneius Biotechnology, Inc. (“Geneius”) was insolvent. The court held that Section 291 actions are not to be used as a method of resolving business strategy disputes between stockholders and management.
This case arises out of a business management dispute between a minority stockholder, Empery Asset Master, Ltd. (“Petitioner”), whose managing partner, Ryan Lane, is a former Board member of Geneius, and Dr. Alfred Slanetz, founder of biotechnology start-up Geneius, which develops and manufactures T-cell therapy technology implicated in treating and curing cancer. Geneius requires sizable capital injections to fund its research and development, but the parties disagreed on how best to raise it. The dispute led to the resignation of Petitioner from the Geneius Board, and the filing of this action for appointment of a receiver by Mr. Lane on behalf of Empery as a stockholder of Geneius and a motion to expedite. The parties conducted a trial followed by extensive post trial briefing.
The court may appoint a receiver of and for an insolvent corporation if the petition passes the “insolvency plus” test. As a threshold question, a petitioner for Section 291 relief must demonstrate, by clear and convincing evidence, the company’s insolvency. Id. Second, the petitioner must demonstrate the necessity of a neutral third-party “to protect the insolvent corporation’s creditors or stockholders by showing ‘some benefit that such an appointment would produce or some harm it could avoid,’” and “the potential benefits must outweigh any potential harm that appointment of a receiver could cause.” Badii ex rel. Badii v. Metro. Hospice, Inc., 2012 WL 7764961, at *7, 10 (Del. Ch. Mar. 12, 2012) (quoting Pope Invs. LLC v. Benda Pharm., Inc., 2010 WL 5233015, at *8 (Del. Ch. Dec. 15, 2010)).
Delaware case law establishes insolvency by either irretrievable insolvency, “a deficiency of assets below liabilities with no reasonable prospect that the business can be successfully continued in the face thereof,” or cash flow insolvency, “an inability to meet maturing obligations as they fall due in the usual course of business.” Prod. Res. Gp., LLC v. NCT Gp., Inc., 863 A.2d 772 782 (Del. Ch. 2004) (demonstrating use of the irretrievable insolvency test); Siple v. S & K Plumbing & Heating, Inc., 1982 WL 8789, at *2 (Del. Ch. Apr. 13, 1982) (demonstrating use of the cash flow insolvency test). The court found Petitioner had failed to meet its burden of establishing insolvency under both standards.
In applying the irretrievable insolvency test, the court determined the liabilities of Geneius to be approximately $605,000 based on invoices and testimony provided by Geneius. Geneius set forth an asset valuation of $892,546.84 based on cash, fixed assets, research support fund agreements, and lab materials. Petitioner did not offer its own opinion or evidence on the asset valuation presented by Geneius, but merely made evidentiary objections to and argued against the valuation proposed by Geneius. While arguing that research support and lab equipment agreements with Swedish-based Krolinska Institutet provided no certain value and cannot be included with the asset valuation, Petitioner conceded that the agreement requires that unused funds provided by Geneius be returned and must, therefore, have some value.
Additionally, the parties agreed the most valuable asset of Geneius was its intellectual property, which Geneius valued at $31 million based on a report that was created by Petitioner before the falling out between the parties. Petitioner did not offer evidence that contradicted this valuation, despite conceding that the intellectual property of Geneius is its most valuable asset, but instead argued that its own document was irrelevant. Petitioner objected to this as irrelevant because it was a write-down schedule, and contended the value was now zero. However, the court disagreed, opining that rather than be demonstrative of the undervaluation by Petitioner, the document was “reflective of the flaw in [Petitioner’s] approach to [the] entire case… Petitioner [attempted] to shift the burden to Geneius.”
Petitioner also failed the second prong of the irretrievable insolvency test, which requires “no reasonable prospect that the business can be successfully continued in the face [of the insolvency].” Prod. Res., 863 A.2d at 783. Petitioner conceded that, as a Board member, he had offered and discussed many proposals and potential opportunities to obtain financing, all of which had been dismissed by the Board. Opportunities for additional financing are therefore available, but had been dismissed by the Board.
Petitioner contended that Geneius was cash flow insolvent as well. Geneius conceded its lack of cash to pay all of its outstanding invoices, but that those necessary to keep the business running could be paid, and that others were subject to a payment plan. Again, Petitioner failed to meets its burden of clear and convincing evidence of insolvency, instead relying on arguments against evidence presented by Geneius. The court took notice of the absence of evidence indicating current or imminent insolvency and was skeptical of the claim that Geneius was financially hopeless.
Petitioner failed its § 291 claim because it failed to proffer evidence sufficient to establish by clear and convincing evidence on its behalf the threshold issue—the company was insolvent. “When a company is solvent, § 291 is by its plain terms not even implicated.” Prod. Res., 863 A.2d at 785. The burden of proof cannot be shifted to the Geneius to show its business is failing. As a result, the court denied Petitioner’s petition for the appointment of a receiver.