Document: Zimmerman v. Katherine D. Crothall et al., C.A. No. 6001-VCP (Del. Ch. Mar. 27, 2012)
The Delaware Court of Chancery found that certain commonalities often shared by venture capital investors supported a reasonable inference that two venture capital investors in Adhezion Biomedical LLC (“Adhezion”) were a controlling stockholder group. As a result, the transactions at issue in which the investors received additional interests in Adhezion were held to be subject to entire fairness review.
Adhezion is an early-stage medical products company with two principal venture capital investors who hold preferred units: Liberty Ventures II, L.P. (“Liberty”) and Originate Ventures, LLC (“Originate” and, together with Liberty, the “VC Investors”). The VC Investors jointly possess more than 66% of Adhezion’s voting power and their representatives hold two of five seats on Adhezion’s board. Plaintiff, a co-founder and former CEO of Adhezion, alleged that Adhezion’s directors (aided and abetted by the VC Investors) breached their fiduciary duties of care and loyalty in approving a number of transactions in which the VC Investors made additional investments in the cash-strapped company on terms not offered to Adhezion’s common unitholders. The defendants moved for summary judgment on all counts.
The Court commenced by finding that plaintiff had failed to meet his burden of pleading with respect to the duty of care claims – i.e., the evidence did not show that the Adhezion board acted irrationally or recklessly in its capital raising efforts. The board contacted over 40 potential investors in a seven-month period and considered a range of funding options, including licensing deals and the sale of the entire company, before it approved the challenged transactions with the VC Investors.
However, the Court denied defendants’ motion for summary judgment on plaintiff’s duty of loyalty claims. Specifically, the Court found that the defendants had approved self-dealing transactions in which a controlling stockholder received additional equity interests in the company on terms that were not available to the common unitholders. In reaching the conclusion that the VC Investors jointly constituted a controlling stockholder, the Court focused on the fact that Originate and Liberty were Adhezion’s two largest investors, had invested in Adhezion at around the same time and each had one designee on the board. Further, the Court looked to e-mails and board minutes in which the VC Investors communicated similar concerns and solutions with respect to Adhezion’s capital raising efforts as evidence that they were acting in concert with respect to, and exercising actual control over, such efforts.
The Court also found that the challenged transaction constituted an interested transaction because a majority of the members of the board participated in the financings at issue. Accordingly, at trial, defendants would have to prove that the challenged transactions met the exacting entire fairness standard.