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In A Reckless Re-Price, Results Are Not Realized

In Howland v. Kumar, C.A. no. 2018-0804-KSJM, the Delaware Chancery Court issued a Memorandum Opinion under Chancery Rule 12(b)(6) denying a motion to dismiss claims of breach of fiduciary duty and unjust enrichment on the basis that the defendants repriced stock options that they held immediately prior to making a public announcement that was sure to increase the stock price.  The Court also ruled under Chancery Rule 23.1 that the plaintiff adequately plead demand excusal. Thomas S. Howland, Jr. (“Plaintiff”), a stockholder of Anixa Biosciences, Inc. (“Anixa”), brought two derivative claims against Anixa and its directors and officers. The Anixa board of directors consisted of Chairman, President, and CEO Amit Kumar (“Kumar”), Lewis H. Titterton, Jr. (“Titterton”), Arnold M. Baskies (“Baskies”), John Monahan (“Monahan”), and David Cavalier (“Cavalier”). The officers included Kumar, John A. Roop (“Roop”), Michael J. Catelani (“Catelani”) and Anthony Campisi (“Campisi”, collectively, “Individual Defendants,” and, collectively with Anixa, “Defendants”).

Anixa was a publicly traded Delaware corporation that developed a cancer-testing platform. To protect Anixa’s cancer-testing technology, it periodically filed patents. Plaintiff alleged that the public announcement of such a filing in May of 2017 caused the price of Anixa stock to rise considerably. On August 3, 2017, Kumar and Roop received confirmation that the patent would be issued on August 22, 2017 (the “August 22 Patent”). The August 22 Patent was issued as expected.

The Individual Defendants held stock options that were underwater. Kumar called a meeting of the Compensation Committee (the “Committee”) to consider re-pricing those options. The meeting took place on September 6, 2017 and consisted of two members of the Committee (Titterton and Baskies), Kumar, and Catelani. At that meeting, the Committee re-priced 2,029,600 options, 95% of which belonged to Anixa officers or directors, to the share price as of market close that day. Original strike prices were significantly higher. Cavalier was the only director or defendant that did not hold any such options. Anixa publicly disclosed the re-pricing on September 8, 2017 when it filed its 10-Q. It later announced the issuance of the August 22 Patent on September 18, 2017 resulting in a significantly increased the value of Anixa stock. As a result of the re-pricing, Anixa suffered a $261,000 non-cash charge, while the difference in the value of Kumar’s repriced stock totaled approximately $1.7 million.

Plaintiff filed his complaint and alleged two counts: one of Breach of Fiduciary Duty, and one of Unjust Enrichment. Defendants moved to dismiss Plaintiff’s complaint pursuant to Court of Chancery Rules 12(b)(6) and 23.1. The Court considered the Rule 12(b)(6) motion first, as its findings under that motion would bear on the Rule 23.1 analysis, giving the Plaintiff the benefit of all inferences to which he was entitled.

In assessing the sufficiency of Plaintiff’s allegations supporting Count I, the Court considered whether Plaintiff alleged that (1) a fiduciary duty exists, and (2) the fiduciary breached that duty. The standard for fiduciary duty in the context of director and officer compensation is whether such a fiduciary accepted compensation “that is clearly improper or by wrongfully influencing compensation decisions.” While the Court did not specifically address whether Plaintiff had pled that the Individual Defendants held a fiduciary duty, it summarized all of Plaintiff’s allegations supporting the claim that the Individual Defendants “misus[ed] corporate information and process to benefit themselves rather than Anixa.” Specifically, the Court focused on the following factual allegations: (1) the Board was aware of the issuance of the patent, (2) the Board failed to immediately announce the issuance of the patent, (3) the Board re-priced options of which the vast majority belonged to Board members and Officers, (4) Anixa disclosed the re-pricing, and (5), only after the re-pricing was finalized did Anixa announce the issuance of the patent.

On alternative grounds, the Court found that the entire fairness standard of review applies because Titterton and Baskies, as committee members present at the re-pricing meeting, rendered themselves “interested” by approving their own compensation. The Court stated that Plaintiff had alleged facts “sufficient to support an inference that Titterton and Baskies had knowledge of the August 22 Patent’s issuance and that, therefore, the re-pricing was a product of an unfair process. Ultimately, the Court found that, with the exception of Campisi (who was not present at the meeting and was not alleged to have any knowledge of the August 22 Patent’s issuance), Defendants’ motion as to Count I was denied.

Next, the Court easily dealt with Plaintiff’s second count of unjust enrichment. The Court laid out the elements of such a claim as follows: “(1) an enrichment, (2) an impoverishment, (3) a relation between the enrichment and the impoverishment, (4) the absence of justification, and (5) the absence of a remedy provided by law.” Defendants only challenged elements 1-4. The Court quickly identified the enrichment of those officers and directors holding the re-priced shares, and the impoverishment of Anixa of $261,000 that Defendants conceded. Likewise, it found that Plaintiff alleged the relation of the two by stating that the purpose of the repricing was to provide a benefit to the Individual Defendants at the expense of Anixa and other stockholders. Finally, the Court held that it was “reasonably conceivable” that there was no justification for the repricing. As such, Defendants’ motion as to Count II was denied.

Finally, the Court addressed Defendants’ claim that Plaintiff failed to plead demand excusal. The Court discussed the application of the two tests of demand excusal in Delaware: (1) the Aronson test, and (2) the Rales test. It identified that Rales applied here because the re-pricing decision was made by a committee that consisted of less than half of the directors in office at the time. The Court stated the Ralesanalysis requires the Plaintiff to plead facts that create a reasonable doubt that the Board could have properly exercised its independent and disinterested business judgment in responding to a demand. Plaintiff conceded that the Board members were independent, but alleged that Kumar, Titterton, Baskies, and Monahan were interested. The Court found that considering a potential benefit to Kumar and Monahan of $1.7 million and $70,000, respectively, it is reasonable to conclude that those amounts would be sufficiently material to render both of them interested. Accordingly, the Court denied Defendants Rule 23.1 motion.

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David L. Forney, KL Gates, strategic joint venture lawyer, Corporate Transactions,
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David Forney is a “company side” corporate lawyer specializing in corporate, strategic joint venture and M&A transactions. For nearly 30 years, David has represented industry parties in complex joint venture, M&A, and other strategic transactions. This experience allows David to have a greater perspective and understanding of company side concerns and processes, whether the other side in the transaction is a competitor, another strategic party or a private equity fund.  His experience includes developing close working relationships with in-house counsel, in-house...

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Tom Sperber K&L Gates corporate, M&A group,maritime litigation
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Thomas Sperber is an associate at the New York office. He is a member of the corporate/M&A practice group. His practice focuses on mergers and acquisitions, private equity investments, and corporate governance. His work outside of the corporate/M&A group consists mostly of maritime litigation matters.

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