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In DrugCrafters L.P. et al. v. Evan Loh et al., (Del Ch.; 11/25), the Chancery Court dismissed breach of fiduciary duty claims against five officers of a target, two of whom also served as directors, in connection with the 2023 acquisition of Paratek Pharma by Gurnet Point Capital and Novo Holdings. The plaintiffs alleged that the defendants engaged in a fraud on the board by withholding material information during the sale process.  Vice Chancellor Will rejected those claims, and held that the transaction satisfied the Corwin standard and was entitled to the protection of the business judgment rule.

Paratek was a biopharma company that had a promising product but that also faced significant financial challenges. Its primary product was called NUZYRA, which is name only a pharma (or maybe a bank holding company) could love. Nevertheless, NUZYRA but apparently showed promise as a treatment for pulmonary anthrax, which resulted in the government awarding a five-year contract to the company to continue development efforts on the drug.

In order to incentivize the company’s execs to market NUZYRA, the board’s comp committee approved an incentive plan under which the executives would receive a portion of a cash pool of $50 million based on the achievement of specified revenue milestones. The awards would become fully vested upon a change in control. Revenue milestones that were met before a change of control would be fully paid out at closing, while those that were partially achieved would be paid out using a preset formula. The five defendants were allocated 80% of this incentive pool.

Paratek spent heavily on marketing NUZYRA and its financial position weakened. In mid-2021, the board began evaluating strategic alternatives with its financial advisor. That led to an extended dance with potential merger partners that featured the usual back-and-forth involving a few serious contenders. One of those buyers repeatedly conditioned its acquisition proposals on the defendants’ accepting a haircut on the incentive payments that they would be entitled to upon a change in control.

Ultimately, that process resulted in a sale of the company to the buyer at a price of $2.15 per share in cash, together with a CVR that would entitle shareholders to an additional $0.85 per share upon the satisfaction of post-closing NUZYRA milestones. As part of the deal, the executives participating in the incentive plan agreed to reinvest a portion of their awards in the surviving company’s equity. However, they also received significant payments at closing – two defendants each received approximately $10.4 million, one received approximately $5.8 million, and two others each received approximately $3.3 million.

The incentive program played a central role in the plaintiffs’ fraud on the board allegations, as this excerpt from Vice Chancellor Will’s opinion explains:

Plaintiffs’ fraud-on-the-board theory is novel. It is, as they say, “essentially the inverse of the common factual scenario in which fiduciaries seek an early transaction to facilitate liquidity needs.” Plaintiffs assert that rather than tricking the board into approving a quick transaction to generate liquidity, Defendants were supposedly incentivized to “sabotage[] any potential deal for nearly two years” so that the Company could grow NUYZRA sales and increase the Defendants’ [incentive plan] payout.

But then, according to Plaintiffs, Defendants’ scheme simultaneously pushed the Company to the brink of bankruptcy (which would have wiped out the [incentive plan]), and at the last minute, Defendants coerced the Board into closing a deal with an acquirer willing to honor the [incentive plan’s] obligations in full. Plaintiffs allege that Defendants steered the sale process to Gurnet Point because it was willing to continue employing [three defendants] after the transaction and because all were offered additional upside benefits through the reinvestment of their [incentive plan] payouts into equity in the post-transaction company.

In support of their fraud claims, the plaintiffs pointed to the fact that initial contacts between the buyer and management were not reported to the board. However, Vice Chancellor Will noted that the plaintiffs failed to allege that the defendants tried to conceal those contacts, and that the plaintiffs failed to offer a persuasive argument that these early discussions, which were general in nature, were material.

The plaintiffs also argued that the defendants tilted the playing field in favor of their preferred bidder by sharing information that gave the ultimate buyer an “unfair tactical advantage” over a competing bidder and didn’t disclose that to the board. They pointed to a December 2022 meeting held by the defendants and the buyer during a period when the company had paused negotiations with a competing bidder because it had MNPI about NUZYRA’s status, and to a June 4, 2023 statement to the buyer by one of the defendants to the effect that a “competing strategic party had ‘meaningfully increased negotiation efforts.'”

Vice Chancellor Will didn’t bite on either of these.  As to the December 2022 meeting, she noted that there were no allegations that the defendants shared MNPI with the buyer, and that even if they did, the complaint didn’t allege that it gave the buyer an unfair advantage over competing bidders, particularly since the information in question was publicly disclosed shortly after the meeting and the buyer was still seeking financing and didn’t even submit a bid until February 2023.

The plaintiffs argued that the June 4th communication was a “tip” that encouraged the buyer to sign the merger agreement on June 6 and deprived the board of an opportunity to receive a counteroffer from the competing bidder.  The Vice Chancellor concluded that it was not reasonably conceivable from the complaint’s allegations that the communication in question rose to the level of a breach of fiduciary duty. In reaching this conclusion, she pointed to the fact that the competing bidder had already informed the board that it would be unable to meet the required timeline to submit a binding proposal.

Ultimately, the Vice Chancellor dismissed these allegations, as well as allegations that the board failed to adequately manage management’s role in the transaction process and various alleged disclosure shortcomings. She held that the transaction had been approved by a fully informed, uncoerced vote of the disinterested stockholders, and that, per Corwin, the business judgment rule applied.

– John Jenkins