Donnelly v. Keryx Biopharmaceuticals, Inc., C.A. No. 2018-0892-SG (Del. Ch. Oct. 24, 2019) (Glasscock, V.C.)
In this memorandum opinion, the Court of Chancery granted a stockholder’s (“Plaintiff”) demand to inspect certain books and records of Keryx Biopharmaceuticals, Inc. (the “Company”) pursuant to 8 Del. C. § 220 (“Section 220”). The Court found that Plaintiff had shown a credible basis to suspect wrongdoing and rejected the Company’s defense that the demand was counsel-driven and Plaintiff’s stated purpose was therefore pretextual. The Court declined, however, to shift attorneys’ fees under the bad faith exception to the American Rule, finding that the Company raised a “vigorous but good-faith dispute over purpose and scope.”
Plaintiff’s demand related to the 2018 merger (the “Merger”) between the Company and Akebia Therapeutics, Inc. (“Akebia”). Before the Merger, Baupost Group Securities, L.L.C. (“Baupost”) was the Company’s largest stockholder, holding approximately 21.4% of the Company’s common stock and $164.75 million in Company senior notes, which, if converted, would result in a 39% ownership stake. Baupost also had the contractual right to appoint a director and an observer to the Company’s board.
In December 2017, the Company’s board formed a special committee (the “Committee”) to consider a potential merger with Akebia and other alternatives. Baupost’s appointee to the Company’s board was selected to chair the Committee, and the Committee retained Perella Weinberg Partners as a financial advisor. In February 2018, the board, upon the Committee’s recommendation, decided not to pursue a merger with Akebia. The Company then retained a new financial advisor, and the Committee continued exploring other potential transaction partners, but none were interested in a merger or acquisition.
Meanwhile, Baupost conducted its own diligence on Akebia, which was presented to the Company at an April 2018 board meeting. At that same meeting, the Company’s CEO stepped down, and the board appointed an interim CEO. The board instructed the interim CEO to ask whether Akebia was interested in restarting merger discussions. In addition, the board reconstituted the Committee, appointing the interim CEO and two independent directors as members.
During negotiations, the Company, Akebia, and Baupost agreed to an early conversion of Baupost’s notes in exchange for providing Baupost $20 million worth of additional common stock. The Company also negotiated various agreements with executives, including retention agreements that provided a combined $450,000 in bonuses to three executives upon a change of control, an extension of employment for the interim CEO (in addition to a $150,000 cash payment and a potential $200,000 payment upon closing), and an agreement to select the interim CEO, as well as four other Company directors, to serve on the board of a combined entity. The Merger was recommended by the Committee, and later approved by the Company’s board and stockholders.
Before the Merger closed, Plaintiff served a demand letter. The demand letter raised issues with potential breaches of the duty of loyalty related to the merger price, Baupost’s influence, bonuses related to the merger, the directors’ independence and disinterestedness, and allegedly inadequate disclosures in the proxy statement. After the Company refused to produce books and records, Plaintiff filed suit.
In resolving the demand for books and records, the Court first rejected the Company’s defense that the demand was “pretextual.” The Company’s evidence for that defense was that the demand letter, which was based on a template Plaintiff’s counsel directed to other companies, stated that one of the purposes was to investigate the disclosures in the proxy statement. At his deposition, however, Plaintiff did not mention those disclosures as one of the reasons for his demand until he was prompted, instead mentioning deal price, changes in leadership, bonuses paid to corporate personnel, potential board conflicts, and the influence of Baupost. Further, Plaintiff testified that he would have voted against the deal even if he had the additional disclosures. As a result, the Company argued that disclosure was solely a concern of Plaintiff’s counsel, not Plaintiff, and that under Wilkinson v. A. Schulman, Inc., 2017 WL 5289553 (Del. Ch. Nov. 13, 2017), the Court should deny Plaintiff’s demand as pretextual. In determining whether the stated purposes were pretextual, the Court found that, unlike in Schulman, there was not a “total” misalignment between Plaintiff’s purpose and his counsel’s purpose. The Court also found that, even though the demand letter was based on a template, Plaintiff’s individual concerns could have nevertheless been included. The Court explained that because Plaintiff had a non-pretextual purpose of investigating potential breaches of the duty of loyalty, documents concerning disclosure would be necessary to that purpose. In doing so, the Court cited to Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), which held that a board’s decision to approve a merger will be subject to the protections of the business judgment rule if the merger is approved by an uncoerced, fully informed vote of a majority of the minority stockholders.
Next, the Court found that Plaintiff had adequately shown a credible basis to infer wrongdoing. The Court, noting the relatively low evidentiary hurdle that a Section 220 plaintiff must clear, found there was evidence from which it could infer that Baupost used a control position to extract benefits that other stockholders did not receive. The Court highlighted Baupost’s ability to wield nearly 40% of the Company’s voting power, its financial leverage, and its right to appoint a director and board observer. The Court also cited the circumstances surrounding the negotiation of the merger, including Baupost’s decision to continue diligence of Akebia after the Committee determined not to pursue a merger with Akebia, the Company’s retention of a new financial advisor, and Baupost’s negotiation of a side-deal accelerating the debt-equity conversion. Consequently, the Court held Plaintiff could investigate whether Baupost “improperly competed” with the other stockholders.
The Court found that the allegations also supported an inference that management and directors were conflicted. While the interim CEO received a fairly typical payment, the Court noted that she led the Committee and that she and four other directors obtained seats on the surviving company’s board. The Court also cited the change-in-control bonuses three other executives received after the commencement of merger negotiations. Consequently, the Court held that Plaintiff had the right to investigate if the interests of management and the directors were aligned with the interests of the stockholders.
Finally, the Court turned to Plaintiff’s request to shift fees due to the Company’s alleged bad faith. The Court expressed concern over the recent proliferation of motions alleging bad faith: “Allegations of bad faith, unfortunately, are not rare birds in this Court; in fact, they are becoming the starlings of misplaced motion practice.” In refusing to shift fees, the Court found that the Company’s defenses were legitimate disputes over the purpose and scope of Plaintiff’s demand, and did not rise to the level of “abuse of process” or “frivolous opposition” necessary to establish bad faith. The Court, however, did not dismiss the possibility that “a legitimate books and records request, met by company intransigence leading to needless litigation,” could rise to the level of bad faith and justify sanctions.