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From Securities Regulation Daily, August 26, 2016

Fully informed stockholder vote cleansed pharmaceutical merger

By Lene Powell, J.D.

The Delaware Chancery court dismissed a suit alleging that directors of a pharmaceutical company breached their fiduciary duties by the causing the company to be acquired in a rushed sale, furthering the interests of venture capital firms to which they were tied. The plaintiffs did not plead facts to allow a reasonable inference that any controlling stockholder extracted personal benefits, and the merger was approved by a disinterested stockholder vote. Under Corwin v. KKR Financial Holdings and related authority, review under the irrebuttable business judgment rule was appropriate, even if the transaction might otherwise have been subject to the entire fairness standard due to conflicts faced by individual directors (Larkin v. Shah, August 25, 2016, Slights, J.).

Merger. Before being acquired, Auspex Pharmaceuticals, Inc. operated as a late-clinical stage biopharmaceutical company, completing a successful initial public offering in 2014. Over the next year, Auspex senior management considered strategic acquisition overtures from twenty-two different companies. In March 2015, the Auspex board recommended that stockholders approve an acquisition by Teva Pharmaceutical Industries, Inc. According to the board, the merger price was a 42 percent premium to the current Auspex stock price, and arms-length negotiations had pushed Teva as high as it would go. Stockholders voted to approve the acquisition.

Two Auspex stockholders brought a putative class action alleging that Auspex board members were conflicted because they were motivated to monetize the investments of several venture capital (VC) firms to which they were tied. The plaintiffs contended that shortly after the IPO, the Auspex board members expanded the board by two members in order to sterilize any future acquisition deal of the appearance of conflict. The board caused Auspex to enter into the first all-cash deal they could land, the plaintiffs asserted, and this netted other stockholders inadequate consideration for their shares and breached the board members’ fiduciary duties. The plaintiffs argued that despite the fact that stockholders had approved the acquisition, the court should apply entire fairness review because a majority of the Auspex board was conflicted.

Business judgment rule. The court held that by operation of Delaware Supreme Court’s decisions in Corwin v. KKR Financial Holdings, Inc. and related rulings on the legal effects of stockholder approval, the irrebuttable business judgment rule applied, extinguishing all challenges to the merger except those related to waste. Under Corwin and supporting authority, the business judgment rule irrebuttably applies if a majority of disinterested, uncoerced stockholders approve a transaction absent a looming conflicted controller.

The combined ownership interests of the VC firms amounted to 23 percent of Auspex’s outstanding common stock before the merger. Although a stockholder owning less than half of a company’s outstanding shares may nonetheless be deemed a controller where the stockholder can exercise actual control over the corporation’s board, it is a high hurdle to make this showing. Here, no possible permutation of the VC stockholders and VC directors amounted to a controlling stockholder because no well-pled allegations permitted a reasonable inference that any such controller or control block could exercise actual control over Auspex's board. No facts suggested that the VC directors compromised or otherwise influenced other directors’ free exercise of judgment.

No showing of conflict. Further, even if the plaintiffs had properly alleged the presence of a controller, they failed to plead that the controller engaged in a conflicted transaction. The theory that the venture capital firms’ desire to monetize their investments led to a rushed, inadequate sale was implausible, as it required the court to belief that rational economic actors chose to short-change themselves. The court noted it has generally been reluctant to find a liquidity-based conflict absent additional circumstantial indicators of conflict.

Complaint dismissed. The court noted that the stockholders had not pleaded any claim of waste, which was the only possible type of claim remaining. Accordingly, the court dismissed the complaint in entirety.

The court denied the plaintiffs’ request for leave to amend because it was procedurally improper and because the plaintiffs did not show good cause as to why dismissal with prejudice would be unjust.

The case is No. 10918-VCS.

Attorneys: James R. Banko (Faruqi & Faruqi, LLP) for Timothy Larkin. William M. Lafferty (Morris, Nichols, Arsht & Tunnell LLP) for Pratik Shah.

MainStory: TopStory CorporateGovernance DirectorsOfficers FiduciaryDuties MergersAcquisitions DelawareNews

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