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In re Chelsea Therapeutics Int’l Ltd. Stockholders Litig., C.A. No. 9640-VCG (Del. Ch. May 20, 2016) (Glasscock, V.C.)

May 20, 2016

In this memorandum opinion, the Court of Chancery dismissed pursuant to Rule 12(b)(6) former stockholders post-closing claims that an otherwise unconflicted board of directors acted in bad faith and breached their duty of loyalty by choosing to disregard, and instructing its financial advisor to disregard, certain financial projections in connection with the sale of Chelsea Therapeutics International Ltd. (“Chelsea”) to Lundbeck A/S (“Lundbeck”).

The sale of Chelsea arose out of its development of the drug Northera, which is used to treat neurogenic orthostatic hypotension. In February 2014, Chelsea received FDA approval for additional applications of Northera and several potential buyers expressed interest in acquiring the company, including Lundbeck.

Lundbeck made an initial offer to acquire Chelsea for $6.44 per share in cash but it was rejected by the board of directors based on analyses prepared by its financial advisor, including a discounted cash flow analysis indicating a much higher value if its main competitor, Midodrine, was removed from the market (the “No-Midodrine Projection”). Lundbeck made with a revised offer of $6.44 per share in cash with additional consideration worth up to $1.50 per share if Chelsea met certain future sales targets.  The board ultimately accepted Lundbeck’s revised offer after instructing its financial advisor to disregard the No-Midodrine Projection because the study was “highly speculative” and market withdrawal of Midodrine “was viewed as an unlikely scenario.”

The gravamen of plaintiffs’ “narrow bad-faith claim” relates to the board’s decision to disregard certain financial projections in approving the sale of Chelsea. The No-Midodrine Projection “estimates the potential increase in Northera’s market share in the event that the FDA removes . . . Midodrine from the market.” The other disregarded projection, the L.E.K. Study, estimates Chelsea’s potential “profits in 2030, more than 15 years out from the time of the study, if Northera were hypothetically approved by the FDA for treatment of other conditions, for which its use is currently prohibited, and implies a value without adjusting for risk.”  Plaintiffs allege that the board of directors acted in bad faith by choosing to disregard financial projections that were more favorable to Chelsea’s projected value.

The Vice Chancellor began his analysis by rejecting any remaining disclosure claims because the board previously disclosed that it considered the financial projections to be “too speculative to be quantifiable” and plaintiffs have since failed to allege any new claims. Given the lack of disclosure claims, defendants urged the Court to extend the ruling in Corwin v. KKR Financial Holdings LLC to hold that the disclosures were adequate to cleanse any bad faith on part of the directors.  The Court chose not to address the Corwin decision, however, finding it was unnecessary to consider whether the ruling would cleanse a bad-faith act or apply to a tender offer.  As a result, the plaintiffs were left with their bad faith claim to demonstrate that the board’s decision was “so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”

The Court held that plaintiffs failed to meet this burden because the board’s decision to exclude the projections was not egregious enough to overcome the lack of any allegations that the directors were interested or lacked independence. The Court reasoned that “it is not without the bounds of reason – in fact, it is readily explicable – that the Board would decline to use the Projections to value the Company, as both are highly speculative.” The financial projections relied on hypothetical situations that were either unlikely to occur or that could possibly occur fifteen years later without adjusting for any risk over that time period.  Lending further support was the fact that the projections were made available to potential buyers and if they were realistic “another bidder likely would have emerged throughout the 20-month long sales process.”  Accordingly, the Court dismissed the plaintiffs’ bad faith claim for failure to state a claim upon which relief could be granted.

The full opinion is available here