Fox v. CDX Holdings, Inc., C.A. No. 8031-VCL ( 2015 )

EFiled: Jul 28 2015 08:00AM EDT
Transaction ID 57611881
Case No. 8031-VCL
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
KURT FOX, on behalf of himself and all )
others similarly situated, )
)
Plaintiff, )
)
v. ) C.A. No. 8031-VCL
)
CDX HOLDINGS, INC. (F/K/A CARIS )
LIFE SCIENCES, INC.), )
)
Defendant. )
MEMORANDUM OPINION
Date Submitted: May 5, 2015
Date Decided: July 28, 2015
Richard H. Cross, Jr., Christopher P. Simon, David G. Holmes, CROSS & SIMON, LLC,
Wilmington, Delaware; Daniel S. Cahill, Louis Gambino, CAHILL GAMBINO LLP,
Saratoga Springs, New York; Attorneys for Plaintiff Kurt Fox and the Class.
Gregory P. Williams, Thomas A. Beck, Brock E. Czeschin, Susan M. Hannigan, Rachel
E. Horn, Matthew D. Perri, RICHARDS, LAYTON & FINGER, P.A., Wilmington,
Delaware; Attorneys for Defendant CDx Holdings, Inc.
LASTER, Vice Chancellor.
Caris Life Sciences, Inc. (―Caris‖ or the ―Company‖) was a privately held
Delaware corporation. Through subsidiaries, it operated three business units: Caris
Diagnostics, TargetNow, and Carisome.1 Caris Diagnostics was consistently profitable.
TargetNow generated revenue but not profits. Carisome was in the developmental stage.
To achieve the dual goals of securing financing for TargetNow and Carisome and
generating a return for its stockholders, Caris sold Caris Diagnostics to Miraca Holdings,
Inc. (―Miraca‖). To minimize taxes, the transaction was structured using a spin/merge
structure (the ―Miraca Transaction‖). Caris first transferred ownership of TargetNow and
Carisome to a new subsidiary, then spun off that subsidiary to its stockholders (the
―Spinoff‖). At that point, owning only Caris Diagnostics, Caris merged with a wholly
owned subsidiary of Miraca (the ―Merger‖).2
1
TargetNow sometimes appeared in the record with an intervening space as
―Target Now,‖ and Carisome sometimes appeared in the plural as ―Carisomes.‖ This
decision has chosen to omit the space and use the singular. If a quotation from an
underlying document uses the alternative form, this decision has modified the quotation
without bracketing the change.
2
The actual Miraca Transaction was more complex, and keeping track of the
various entities is more difficult. For example, Caris owned TargetNow through a direct
subsidiary called Caris Molecular Diagnostics, Inc. (―CMD‖) and an indirect subsidiary
called Caris MPI, Inc. Caris owned Carisome through a direct subsidiary called Caris
Life Sciences (Gibraltar) Limited (―GibCo‖) and an indirect subsidiary called Caris Life
Sciences Luxembourg Holdings. To carry out the Spinoff, Caris transferred CMD to
GibCo, next transferred ownership of GibCo to a newly created Cayman Islands entity,
then spun off the Cayman Island entity. After the Merger, the Cayman Islands entity
changed its name to Caris Life Sciences. Before the Merger, CDx Holdings, Inc. was the
name of the direct subsidiary through which Caris owned the Caris Diagnostics business.
Through the Merger, Caris changed its name to CDx, and the direct subsidiary became
1
David Halbert, the founder of Caris, owned 70.4% of its fully diluted equity. JH
Whitney VI, L.P. (―Fund VI‖), a private equity fund, owned another 26.7%. They
received a proportionate equity stake in the spun-off entity (―SpinCo‖), which kept them
whole for purposes of their pre-transaction beneficial ownership of TargetNow and
Carisome. In the Merger, Miraca paid $725 million for what was left of Caris
(―RemainCo‖). Each share of RemainCo stock was converted into the right to receive
$4.46 in cash. Halbert and Fund VI received their share of the cash, representing the
value of their pre-transaction beneficial interest Caris Diagnostics.3 Through the Miraca
Transaction, Halbert and Fund VI received total proceeds of approximately $560 million.
They financed SpinCo by reinvesting $100 million.
Most of the remaining approximately 2.9% of Caris‘s fully diluted equity took the
form of stock options that were cancelled in connection with the Merger. Under the terms
of the 2007 Stock Incentive Plan (the ―Plan‖), each holder was entitled to receive for each
share covered by an option the amount by which the ―Fair Market Value‖ of the share
exceeded the exercise price. The Plan defined Fair Market Value as an amount
determined by the Caris board of directors (the ―Board‖). The Plan required the Board to
something else. The named defendant in this case, CDx, is the same entity that this
decision refers to as Caris.
3
This too is an oversimplification. Halbert and Fund VI held most of their equity
in the form of preferred stock. In the Merger, they received the liquidation preference or
other payment contemplated by the preferred stock in addition to $4.46 per share for their
common stock.
2
adjust the options to account for the Spinoff. Under the terms of the Plan, the Board‘s
good faith determinations were conclusive unless arbitrary and capricious.
Caris told the option holders that they would receive the difference between $5.07
per share and the exercise price of their options, minus 8% that would go to an escrow
account contemplated by the merger agreement. Of the $5.07, $4.46 was for RemainCo;
the remaining $0.61 was for SpinCo. Caris represented in discovery that it used this
methodology, and the pre-trial order contained stipulations to that effect. During post-
trial argument, Caris revealed that it engaged in a very different calculation. It claims the
different method generated the same result.
The plaintiff, Kurt Fox, sued on behalf of a class of option holders. He contends
that Caris breached the Plan because members of management, rather than the Board,
determined how much the option holders would receive. He also contends that regardless
of who made the determination, the $0.61 per share attributed to SpinCo was not a good
faith determination and resulted from an arbitrary and capricious process. He lastly
contends that the Plan did not permit Caris to withhold a portion of the option
consideration as part of the escrow holdback contemplated by the merger agreement.
The evidence at trial established that the Board did not make the determinations it
was supposed to make. Gerard A. Martino, the Executive Vice President, Chief Financial
Officer, and Chief Operating Officer, made the determinations, then received perfunctory
signoff from Halbert. The evidence at trial further established that the number Martino
picked for SpinCo was not a good faith determination of Fair Market Value. It was the
figure generated by PricewaterhouseCoopers (―PwC‖), the Company‘s tax advisor, using
3
an intercompany tax transfer analysis that was designed to ensure that the Spinoff would
result in zero corporate level tax. Martino told PwC where to come out, and he supplied
PwC with reduced projections to support the valuation he wanted. PwC‘s conclusion that
SpinCo had a value of $65 million conflicted with Martino‘s subjective belief from
earlier in the year that TargetNow alone was worth between $150 and $300 million. It
likewise conflicted with the views held by Halbert, Fund VI, and the Company‘s
financial advisor. It contrasted with higher values that a different accounting firm, Grant
Thornton LLP, generated for the same businesses in a series of valuation reports prepared
during 2011.
Miraca questioned PwC‘s valuation and insisted on a second opinion from Grant
Thornton. Martino and PwC met with Grant Thornton before the firm started work. Two
days later, Martino sent an email to Halbert that precisely anticipated the range of
consideration per share that the two reports would support. Grant Thornton then
proceeded to prepare a valuation that largely—and admittedly!—copied PwC‘s analysis.
Grant Thornton‘s answer came in just below PwC‘s. The valuation was not determined in
good faith, and the process was arbitrary and capricious.
Finally, the plain language of the Plan did not permit Caris to withhold a portion
of the option consideration in escrow. The merger agreement was not the contract that
governed the relationship between the option holders and Caris. The Plan was.
Caris breached the Plan. The class is entitled to damages of $16,260,332.77, plus
pre- and post- judgment interest at the legal rate, compounded quarterly, from November
22, 2011 until the date of payment.
4
I. FACTUAL BACKGROUND
Trial took place from December 3-5, 2014. The plaintiff bore the burden of
proving his contentions by a preponderance of the evidence.4 The parties introduced 217
exhibits, lodged depositions for nine witnesses, and presented live testimony from five
fact witnesses and one expert. After trial, Caris was permitted to supplement the record
with two additional exhibits.
The central fact issue was what Halbert, Martino, and other Caris principals
believed in fall 2011 about the value of TargetNow and Carisome. Extensive
contemporaneous evidence established that principals believed the businesses had value
exceeding the $65 million that Martino assigned them for the Miraca Transaction.
At trial, the defense witnesses testified differently. Except for Martino and
Halbert, the defense witnesses seemed honestly to believe when testifying that they
thought TargetNow and Carisome had very little value in fall 2011. In my view, this was
4
See Estate of Osborn ex rel. Osborn v. Kemp, 2009 WL 2586783, at *4 (Del. Ch.
Aug. 20, 2009) (―Typically, in a post-trial opinion, the court evaluates the parties‘ claims
using a preponderance of the evidence standard.‖), aff’d, 991 A.2d 1153 (Del. 2010);
United Rentals, Inc. v. RAM Hldgs., Inc., 937 A.2d 810, 834 n.112 (Del. Ch. 2007) (―The
burden of persuasion with respect to the existence of the contractual right is a
‗preponderance of the evidence‘ standard.‖). ―Proof by a preponderance of the evidence
means proof that something is more likely than not. It means that certain evidence, when
compared to the evidence opposed to it, has the more convincing force and makes you
believe that something is more likely true than not.‖ Agilent Techs, Inc. v. Kirkland, 2010
WL 610725, at *13 (Del. Ch. Feb. 18, 2010) (Strine, V.C.) (internal quotation marks
omitted). ―Under this standard, [the plaintiff] is not required to prove its claims by clear
and convincing evidence or to exacting certainty. Rather, [the plaintiff] must prove only
that it is more likely than not that it is entitled to relief.‖ Triton Constr. Co. v. E. Shore
Elec. Servs., 2009 WL 1387115, at *6 (Del. Ch. May 18, 2009), aff’d, 988 A.2d 938 (Del.
2010) (TABLE).
5
a product of of hindsight bias. ―Hindsight bias has been defined in the psychological
literature as the tendency for people with outcome knowledge to believe falsely that they
would have predicted the reported outcome of an event.‖ Hal R. Arkes & Cindy A.
Schipani, Medical Malpractice v. the Business Judgment Rule: Differences in Hindsight
Bias, 73 Or. L. Rev. 587, 591 (1994). ―[S]tudies have demonstrated not only that people
claim that they would have known it all along, but also that they maintain that they did, in
fact, know it all along.‖ Jeffrey J. Rachlinski, A Positive Psychological Theory of Judging
in Hindsight, 65 U. Chi. L. Rev. 571, 577 & n.22 (1998) (collecting sources). Unlike the
process of learning from experience and predicting a future event, hindsight bias refers to
the assessment of a past event. Id. at 577. The bias results from ―the fact that those who
know the outcome cannot ignore that knowledge as they try to perform an objective
evaluation of the a priori condition.‖ Arkes & Schipani, supra, at 593. Unsurprisingly,
―the law is not blind to the influence of the hindsight bias.‖ Rachlinski, supra, at 573.
In the years after the Miraca Transaction, TargetNow did not reach profitability,
and Carisome did not develop a marketable product. Caris also tried unsuccessfully to
sell TargetNow. The defense witnesses testified with conviction that they believed these
things in fall 2011, but the contemporaneous evidence showed they did not. In fall 2011,
they believed TargetNow was crossing into profitability and would continue on its
promising trajectory. They believed that Carisome had a strong chance of producing a
marketable product in early 2012 that would revolutionize the healthcare industry. They
also believed that TargetNow could be sold for as much as $150 to $300 million based on
6
expressions of interest from multiple strategic buyers and advice from Caris‘s financial
advisor.
Martino and Halbert fell into a different category. As discussed below, they both
testified in substance that they sought to defraud bidders for TargetNow by knowingly
providing the bidders with projections that Martino and Halbert did not believe. See Part
II.B.1.b, infra. Martino‘s willingness to provide falsely high numbers to bidders in
pursuit of a desired result—the sale of TargetNow—fit with and corroborated evidence
that he provided falsely low numbers to PwC and Grant Thornton in pursuit of a different
desired result—zero corporate-level tax from the Miraca Transaction.
Martino was the most deeply involved in generating the zero-tax outcome, which
was critical if the Miraca Transaction was going to close. Martino knew that the PwC
valuation was a tax transfer valuation, not a fair market valuation. He provided PwC with
lowered projections to use in deriving its valuation, and he subsequently provided PwC
with strained memos justifying the assumptions that drove the valuation. When Miraca
insisted on a second opinion from Grant Thornton, Martino met with the firm before it
began work and two days later predicted where the valuation exercise would end up.
Both Martino and Halbert were personally involved in determining what the
option holders would receive. Martino recommended the amount, and Halbert signed off.
Both knew that the Board never actually determined Fair Market Value or adjusted the
options for the Spinoff. Both knew that the Board never saw the Grant Thornton report.
Yet during discovery, Halbert went so far as to testify that the Board relied entirely on
PwC and Grant Thornton, explaining that the directors were incapable of determining the
7
Fair Market Value of TargetNow and Carisome themselves.5 The plaintiff‘s pre-trial brief
so effectively dismantled the reliance theory that the defense pivoted at trial to a different
explanation: the Board did not rely exclusively on PwC and Grant Thornton; the Board
members used their extensive knowledge to determine the value of the businesses
independently.6 In contrast to Halbert‘s testimony that the Board was incapable of
valuing those businesses, the post-trial brief asserted that ―the directors independently
believed that TargetNow and Carisome were collectively worth less than the $65 million
concluded by PwC and used to calculate the Fair Market Value of the options.‖7
5
Halbert Dep., I 118 (―The board can‘t value it themselves. They have to hire
someone who is a professional and expert in the field to value it . . . .‖); id. (―There‘s no
way that a board can value assets like this.‖). The Company‘s pre-trial brief embraced the
reliance defense. See, e.g., Dkt. 72 at 3 (―Relying on values calculated by competent and
independent valuation experts is neither arbitrary nor capricious—in fact, it is the
hallmark of a process undertaken by directors acting in good faith and with due care.‖);
id. at 29 (―The Board made the downward adjustment to the exercise price of the options
. . . by relying, in good faith, on valuations of the Spun-Off Businesses performed by
independent third-party valuation experts.‖); id. at 31 (arguing that the Board adjusted the
option strike prices ―in reliance on independent valuation experts‖); id. at 34 (asserting
that the Board reduced the option strike prices ―relying in good faith on the valuation of
the Spun-off Businesses prepared by PwC‖); id. at 47 (―The Board Reasonably Relied On
PwC‘s Independent Valuation‖).
6
See, e.g., Johansen 553, 566; Castleman 500, 502, 507; Knowles 472-73; Halbert
235, 259, 282; Martino 124, 193.
7
Dkt. 105 at 1; accord id. at 22 (―The Board determined the value of the retained
businesses . . . .‖); id. at 36 (―Contrary to Plaintiff‘s assertions, the Board did not blindly
accept the conclusions of PwC.‖). In a particularly stark example of the defense‘s
reversal of position, Caris argued in its pre-trial brief that the Board relied entirely on two
valuation experts—plural. See note 5, supra. In its post-trial brief, Caris conceded that
Grant Thornton‘s report ―was not relied upon by the Board . . . .‖ Dkt. 105 at 30.
8
Caris has pointed out that the option holders were Caris employees and posited
that neither Halbert nor Martino set out to harm the employees. That is true. The option
holders were collateral damage. The purpose of the valuation exercise was to arrive at a
number that would result in zero corporate-level tax from the Spinoff, and hence zero tax
liability indirectly for Halbert and Fund VI.8 The goal was to avoid paying the IRS. But
once committed to that end, Martino could not undervalue SpinCo for tax purposes while
valuing it fairly for the option holders. After Halbert recognized this conundrum, he
explored whether the option holders could receive replacement options in SpinCo. The
exchange would have avoided the need to value the options and hence the necessity of
imposing an IRS-driven valuation on the employees. But despite Halbert‘s pressing, legal
counsel vetoed the rollover. Halbert then faced a choice between (i) a realistic valuation
that would result in Halbert and Fund VI paying tax on 97% of the equity or (ii) a zero-
tax valuation that would generate an unrealistically low payout for the options. Halbert
chose the latter, which obviously benefitted himself.
I reach these conclusions about Martino and Halbert reluctantly. Other aspects of
their testimony were credible, and I am not suggesting that either is inherently bad or
malicious. Like all of us, they are multidimensional. Martino appears to have had a
respectable career, and he testified to other instances when he has done the right thing.
Halbert has achieved great things and, at least through Caris, devoted much of his time
8
Miraca insisted on a side-letter obligating SpinCo to bear the tax. Because
Halbert and Fund VI owned all of SpinCo, the obligation effectively returned to them.
Achieving zero tax ultimately benefitted Halbert and Fund VI, not Miraca.
9
and treasure to improving the lives of others. But humans respond to incentives, and
powerful incentives can lead humans to cross lines they otherwise would respect.9 This is
particularly true when the transgression can be rationalized, the benefits are immediate
and concrete, and the potential costs are distant, conditional, and readily discounted by
the chance of detection and the possibility of a successful defense or settlement.10
9
See, e.g., JONATHAN R. MACEY, THE DEATH OF CORPORATE REPUTATION 134
(2013) (explaining implications of demands for client-retention on auditor reliability);
Mei Feng et al., Why do CFOs Become Involved in Material Accounting Manipulations?,
51 Journal of Acct. & Econ., 21 (2011) (positing that CFOs engage in accounting
manipulation due to pressure from CEOs rather than a desire for personal gain); Mark
Peecher, The Influence of Auditors’ Justification Processes on Their Decisions: A
Cognitive Model and Experimental Evidence, 34 J. Acct. Res. 125 (1994) (demonstrating
that auditors whose supervisors want them to accept their clients‘ explanations for
account balance discrepancies often adopt those explanations without testing them);
Julian J. Z. Polaris, Backstop Ambiguity: A Proposal for Balancing Specificity and
Ambiguity in Financial Regulation, 33 Yale L. & Pol‘y Rev. 231, 261 (2014) (observing
―that rational and well-intentioned people can fall prey to the pernicious effects of
chronic underestimation of risk and overestimation of compliance, especially when those
self-serving biases are reinforced by internal feedback loops within the company‖). The
idea is not new: ―[A] range of human motivations, including but by no means limited to
greed, can inspire fiduciaries and their advisors to be less than faithful.‖ In re El Paso
Corp. S’holder Litig., 41 A.3d 432, 439 (Del. Ch. 2012) (Strine, C.).
10
See, e.g., MACEY, supra note 9, at 91 (―But swindling often is so enormously
profitable that massive piles of money remain. And these massive piles of money provide
a strong incentive to cheat, because not only is getting away with it incredibly profitable,
but getting caught is not as bad as people used to think.‖); id. at 90-96 (describing effects
of reduction in personal accountability); id. at 135 (arguing that ―competent professionals
within failed firms . . . do not suffer much, if any, personal damage‖); Pamela H. Bucy et
al., Why Do They Do It?: The Motives, Mores, and Character of White Collar Criminals,
82 St. John‘s L. Rev. 401, 406-18 (2008) (discussing motivations for engaging in white
collar crime); Steven M. Davidoff et al., The SEC v. Goldman Sachs: Reputation, Trust,
and Fiduciary Duties in Investment Banking, 37 J. Corp. L. 529, 543-46 (2012)
(describing the cultural shift away from reputation-based norm where ―the need to protect
the firm‘s reputation informed every one of its partners‘ decisions‖ towards a
transactional business model focused on immediate profit); Robert A. Prentice, Beyond
10
In this case, the goal was closing the Miraca Transaction. Achieving that goal
required a valuation that resulted in zero corporate-level tax. Halbert benefited the most
from achieving that goal. Martino worked for Halbert. Martino ensured that the tax issue
was resolved, then Halbert approved the result that Martino achieved.
A. Caris And Its Business Units
In 1987, Halbert founded what became AdvancedPCS, a leading prescription
benefit plan administrator. In 2003, Halbert sold it for $7 billion. During the sale process,
Halbert‘s mother died from multiple myeloma. After witnessing firsthand the state of the
art in cancer treatment, Halbert became convinced that personalized medicine could
revolutionize that discipline and healthcare in general. Thanks to the successful sale of
AdvancedPCS, Halbert had the resources to pursue his newfound passion.
In 2005, Halbert founded Caris. It would develop advanced diagnostic and
prognostic tools to enable doctors to more easily identify specific medical conditions,
such as particular types of cancer. It also would develop ―theranostic‖ tools, a turn-of-
the-century portmanteau of ―therapy‖ and ―diagnostic.‖ The term refers to a medical test
that identifies a variant of a condition well-suited for a specific form of treatment.
Temporal Explanations of Corporate Crime, 1 Va. J. Crim. L. 397 (exploring
nonmonetary factors that affect decisions leading to white-collar crime); Sally S.
Simpson & Nicole Leeper Piquero, Low Self-Control, Organizational Theory, and
Corporate Crime, 36 Law & Soc‘y Rev. 509, 535 (2002) (observing phenomenon in
which ―illegal acts become so commonplace or normalized within the corporate culture
that insiders come to view them as acceptable‖).
11
In 2005, Caris bought a company that became Caris Diagnostics, which witnesses
generally called the anatomic pathology or ―AP‖ business. The concept of anatomic
pathology refers to the diagnosis of human disease through the examination of cells,
fluids, and tissues. Professionals working for the AP business examined biopsies and
blood samples for indications of gastrointestinal, dermatologic, genitourinary, and
hematologic diseases. Caris Diagnostics established itself in the medical community and
generated steady returns. Halbert saw its reliable cash flows as a means of supporting
more novel, developmental-stage ventures.
In 2008, Caris purchased a company that became TargetNow. This business
profiled the genetic and molecular changes unique to a cancer patient‘s tumor, then
identified treatments based on the tumor‘s profile. Traditionally, doctors diagnose cancer
and prescribe treatments based on the cancer‘s location. Certain therapies represent the
standard of care for lung cancer, others for liver cancer, and still others for brain cancer.
The insight driving TargetNow was that tumors respond to treatment based on their
genetic makeup, not their location. By matching treatment options to the particular tumor,
TargetNow could identify efficacious therapies that otherwise would not be considered.
Also in 2008, Caris acquired a company that held patents for blood-based
molecular tests. Caris used the patents to develop its Carisome business, which sought to
develop simple blood tests that could detect specific cancers and other complex diseases.
Such a test would allow doctors to screen patients more easily and detect cancers at an
earlier stage when they could be treated more effectively.
12
B. Carisome And TargetNow Encounter Difficulties.
Although Carisome and TargetNow had great promise, both encountered
difficulties. In 2010, after nearly two years of research and development, Carisome
launched its first product: a blood test for detecting prostate cancer. Unfortunately, it did
not work in the field. After another year of effort, Carisome tried again, but the second
version failed as well. The technology could identify cancer in the blood sample, but not
a specific type of cancer. The test served as a general alarm, not a screening device. In
addition, sample collection was complicated, and Carisome could not obtain sufficient
quantities of the antibodies needed for commercial production.
TargetNow also faced challenges. Unlike Carisome, the cancer profiling service
worked, but gaining market share proved difficult. In essence, doctors had to change how
they thought about cancer. As noted, the traditional standard of care was to treat tumors
based on their location. The insight driving TargetNow was that tumors responded to
treatments based on their genetic makeup. As logical as it sounds, it was revolutionary
thinking. With patients‘ lives on the line, doctors were reluctant to make the leap without
clinical data demonstrating the efficacy of the new approach. Plus TargetNow was
expensive, and insurance companies often would not cover it. Another problem was that
hospitals had their own oncology labs. They perceived TargetNow as another competitor
and resisted attempts by their doctors to use it.
Despite these setbacks, Halbert and the Board continued to have high hopes for
both businesses. They saw TargetNow as a unique and vastly superior approach that
would steadily gain converts. See Halbert Dep., I 26, 84. They also believed Carisome
13
eventually would develop a functional product. Once it did, the addressable market would
be in the hundreds of billions. As Halbert explained at trial, a successful Carisome
product ―would be the largest product launch in the history of mankind.‖ Halbert 236.
C. The Board Explores Options For Raising Capital.
Caris supported TargetNow and Carisome by borrowing money on the strength of
the AP business‘s cash flows. By March 2011, the Board was concerned that Caris was
approaching the limits of its existing debt agreements. At the time, the Board‘s members
were:
 Halbert, who served as Chairman and CEO.
 Laurie Johansen, who served as President of Caris Diagnostics and as a Vice
Chairman of the Board. She had worked for Halbert as an executive at
AdvancedPCS and, after the acquisition, continued to work for him in his family
office. She functioned as a senior executive at Caris.
 Dr. Jonathan Knowles, who split his time working for Caris and as a professor of
translational medicine in Switzerland. He also served as a Vice Chairman of the
Board. Knowles received $540,000 per year from Caris.
 Peter Castleman, a principal at JH Whitney, the private equity firm that managed
Fund VI. JH Whitney had backed AdvancedPCS and received an excellent return
on its investment. Castleman and JH Whitney were strong believers in Halbert‘s
entrepreneurial acumen.
 Dr. George Poste, who was an outside director with a distinguished academic
resume. He also acted as a consultant to healthcare companies and served as a
director of other science companies, including Monsanto.
 Stephen Green, who was another outside director. He had held senior positions
with General Electric‘s corporate finance, venture capital, and leveraged buyout
businesses. After retiring from GE, he joined an investment fund where he
specialized in financing companies involved in healthcare, information
technology, and manufacturing. That firm does not appear to have invested in
Caris.
14
In April 2011, the Board began considering strategic alternatives and retained
Citigroup Global Markets (―Citi‖) as its investment advisor. One possibility was an initial
public offering (―IPO‖) of shares in a subsidiary that would own the AP business and
possibly TargetNow. Particularly if the TargetNow business were included, the IPO
would require an internal reorganization and raise significant tax issues.
To vet the tax issues, Caris turned to PwC, which previously had helped Caris with
a tax-driven internal reorganization. In April 2010, PwC had provided a valuation to
support the transfer of Carisome‘s intellectual property to a Gibraltar-domiciled
subsidiary that could benefit from that jurisdiction‘s favorable tax laws. At the time, PwC
used the cost-basis method to value Carisome‘s intellectual property at $10.25 million as
of March 31, 2010. JX 12 at CDX34388; JX 14.
In April 2011, PwC was just starting its tax planning, and all the firm needed was
a sense of TargetNow‘s value as a going concern. PwC asked Martino for his view.
Martino told PwC that he believed TargetNow was worth between $150 and $300
million. He based this estimate on projected annual revenue of $70 million and projected
EBITDA of $13 million. JX 27. PwC treated Martino‘s estimate as reliable and used it in
its preliminary analysis, including in a presentation to the Board.
D. Citi Provides Its Recommendations To The Board.
On May 25, 2011, Citi gave the Board a presentation that discussed a series of
strategic alternatives, including a high-yield debt financing, an IPO, and the sale of either
all of Caris or a subset of its businesses. See JX 37. The presentation provided the most
detail on three alternatives: (i) the sale of Caris as a whole, (ii) a sale of the AP business,
15
and (iii) an IPO. The presentation indicated that in addition to obtaining funds to finance
TargetNow and Carisome, Halbert and Fund VI were interested in receiving a return.
Citi noted that selling Caris as a whole was the most straightforward and would
―[m]aximize up-front proceeds for Caris shareholders.‖ Id. at CDX46514. At the same
time, Citi warned that buyers might not assign full value to TargetNow and Carisome and
that selling these businesses at their current stage of development would reduce the
stockholders‘ potential upside. Id.Citi noted that Caris could achieve a tax-efficient sale of the AP business through
a spin/merge structure. If Caris sold the AP business outright and then distributed cash to
its stockholders, the proceeds would be subjected to double taxation: first at the corporate
level when Caris paid taxes on its gain from the sale, then again at the stockholder level
when cash was distributed. In the spin/merge structure, Caris would spin off TargetNow
and Carisome, then merge with the acquirer. Through the merger, stockholders could
receive full value for the AP business and only be taxed at the stockholder level. They
could then finance the spun-off entity by re-investing a portion of their proceeds.
The last alternative was an IPO of a minority stake in the AP business and
TargetNow. Citi projected that an IPO could raise $200 million, with Caris receiving
$100 million from the primary offering and Halbert and Fund VI receiving $100 million
through a secondary offering. Citi anticipated that the equity issuance would be combined
with a $250 million bond offering. Halbert and Fund VI would receive a dividend from
the bond offering for total proceeds of approximately $164 million. See id. at CDX46522.
16
As part of its analysis, Citi developed valuation ranges for the AP business and
TargetNow. Citi did not attempt to value Carisome. Citi‘s analysis of the AP business
assumed revenue of $295 million and EBTIDA of $74 million. Using revenue multiples
of 2.6x to 4.0x and EBITDA multiples of 13.0x to 20.0x, Citi valued the AP business at
$767 to $1,180 million. Id. Citi‘s analysis of TargetNow assumed $75 million in revenue
and $0 EBITDA. Id. n.1. Using the same revenue multiples, Citi valued TargetNow at
$195 to $300 million. Citi‘s range was consistent with the numbers Martino gave PwC.
E. The Sale Process For The AP Business
The Board decided to explore a sale of the AP business. Tai Hah was the lead
banker for Citi. Martino acted as the principal point of contact at Caris. Citi kicked off the
process in June and followed a schedule leading up to final bids in September 2011.
Citi initially contacted twenty-three strategic and financial buyers. Nineteen signed
non-disclosure agreements and seventeen received the Confidential Information
Memorandum, which provided detailed information and financial data about the AP
business. JX 50 at CDX7390. The memorandum included marketing materials that
provided high-level information about TargetNow.
Citi asked for expressions of interest from parties who wished to participate in the
second round of the process. Ten potential bidders submitted expressions of interest with
most clustering in the range of $600 to $700 million. Three were strategic buyers; the
others were financial buyers. Two of the strategic buyers volunteered their interest in
TargetNow. See JX 38 at CDX46485. Three more strategic buyers—Miraca, Danaher
Corp., and Illumina, Inc.—entered the process after initial indications were due. Miraca
17
proposed to buy the AP business for $650 to $700 million and also expressed interest in
TargetNow. Although Citi only asked for an indicative range for the AP business,
Danaher expressed interest in buying both the AP business and TargetNow for total
consideration of $825 to $900 million. Illumina also wanted to explore an acquisition of
both businesses and was a sufficiently credible buyer that Citi did not require an
expression of interest. JX 72.
During the second phase of the process, interested parties received presentations
on TargetNow. As part of the presentation, Caris described the business‘s strong revenue
growth. When Caris acquired TargetNow‘s predecessor in 2008, it paid $40 million for a
business that was generating approximately $1 million in annual revenue. Over the next
three years, Caris grew TargetNow‘s annual revenue to approximately $50 million. To
illustrate this success graphically, the presentation materials included the following chart:
18
JX 44. The presentation materials also included projections for TargetNow. See JX 43;
JX 54. Martino and his team prepared the projections, and the Board reviewed and
approved them. The projections forecast that if TargetNow‘s growth continued at a linear
rate, market share would increase from 4.1% in 2011 to 19.4% in 2016. In an upside
scenario, Caris projected that TargetNow‘s market share would reach 34.5% in 2016. The
following chart depicts the revenue and EBITDA figures for TargetNow that Caris
provided to bidders:
2011 2012 2013 2014 2015 2016
Base Case With Current Pricing
Revenue 63,438 93,330 129,147 184,005 235,077 267,568
EBITDA 1,820 11,026 22,352 41,591 59,156 68,829
Base Case With Value Pricing
Revenue 63,438 93,330 262,330 373,759 477,500 543,497
EBITDA 1,820 11,026 88,944 136,469 180,367 206,794
Upside Case With Current Pricing
Revenue 63,438 126,377 200,730 305,623 406,229 476,667
EBITDA 1,820 9,006 13,258 31,320 76,768 104,358
Upside Case With Value Pricing
Revenue 63,438 126,377 407,732 620,796 825,152 968,229
EBITDA 1,820 9,006 220,261 346,493 495,691 595,920
During this litigation, Martino testified that he did not believe any of the projections that
Caris gave to the bidders. Halbert said the same thing.
After receiving the presentation, Illumina sought an indication from Citi regarding
the value that Caris placed on TargetNow. Citi suggested that Caris valued TargetNow in
the range of $200 to $250 million. Citi‘s lead banker, Hah, reported the conversation to
Halbert and Johansen, who did not disagree. That figure was consistent with Martino‘s
estimate in April 2011 that TargetNow was worth $150 to $300 million, as well as Citi‘s
estimate that same month that that its value was between $195 to $300 million.
19
Elsewhere, Hah gave a back-of-the-envelope estimate for what a buyer would pay as
―[p]robably couple of hundred million.‖ JX 60. In the same email, Hah accurately
estimated that the AP business would generate bids in the vicinity of $700 million. Id.
Of all the buyers, TPG seemed the most interested in Carisome and asked
numerous questions during due diligence. In response, Citi sent TPG a presentation
which estimated that if Carisome could develop a successful product, the commercial
opportunities would approach $130 billion. JX 67 at CDX12101. The potential global
market for a blood test for prostate cancer alone was worth $8.8 billion.
During the sale process, Halbert debated whether to sell just the AP business or
also sell TargetNow. See JX 55 (―DH may sell TargetNow depending on price.‖); JX 82
(―DH changes his mind on that [selling both] all the time . . . .‖). He considered selling
the AP business to one buyer and TargetNow to another. See JX 52. He ultimately
decided to sell only the AP business with the possibility of selling TargetNow later. He
was not willing to consider selling Carisome, which he saw as having a potentially
revolutionary technology. Citi noted internally that Halbert was ―thinking in billions for
the Carisome stuff.‖ JX 65.
F. PwC Works On The Tax Issues.
During August 2011, as the sale process heated up, PwC began concentrating on
the tax issues. The valuation of TargetNow and Carisome was critical to achieving a tax-
efficient result. Under Section 355(e) of the Internal Revenue Code, RemainCo would
recognize taxable gain from the Spinoff as if it had sold TargetNow and Carisome to
Caris‘s stockholders for the fair market value of those businesses on the date when the
20
Spinoff occurred. See 26 U.S.C. § 355(e)(1). If the fair market value of those businesses
exceeded their tax basis, then RemainCo would owe tax on the difference. Critically,
because the acquirer of the AP business would own RemainCo post-Merger, the acquirer
would foot the tax bill. The last thing any acquirer wanted was to pay for the AP
business, then pay tax on top of that for the gain on a deemed sale of TargetNow and
Carisome in the Spinoff. But if the value of TargetNow and Carisome was less than
Caris‘s basis in those entities, then the Spinoff would result in zero corporate-level tax.
David Parrish was the lead PwC partner for the tax engagement. On August 16,
2011, a member of Parrish‘s team asked Martino and Dan Sawyers, the Chief Accounting
Officer for Caris, to provide ―additional information in order to complete the valuations
and the basis and E&P studies needed to quantify the consequences of [the Spinoff].‖ JX
59. Among other things, PwC asked for financial projections for ten years. In the
ordinary course of business, Caris did not create ten-year projections.
Martino told Sawyers to ―us [sic] the TN projections used in the stock valuation
analysis.‖ Id. The ―stock valuation analysis‖ was the latest in a series of stock option-
related valuations that Grant Thornton had prepared for Caris. Federal law requires that if
an issuer wants to avoid generating immediate income for a recipient of stock options,
then the exercise price for the option must be equal to or greater than the ―fair market
value of the stock at the time such option is granted . . . .‖ 26 U.S.C. § 422(b)(4). IRS
regulations require that a non-public company determine fair market value by taking into
account ―the company‘s net worth, prospective earning power and dividend-paying
21
capacity, and other relevant factors.‖ 26 C.F.R. § 20.2031–2(f)(2). Serious penalties
attach when taxpayers make false statements to the IRS.11
To satisfy their reporting obligations, non-public companies typically commission
an opinion about the fair market value of their stock. Grant Thornton regularly prepared
valuations for Caris to use for income tax and financial statement reporting related to the
issuance of stock options. As an initial step, Grant Thornton valued each of Caris‘s three
component businesses. Each time, management provided Grant Thornton with
projections for each business including a base case, a downside case, and an upside case.
Grant Thornton used the projections to prepare discounted cash flow valuations
for the three businesses. Grant Thornton also derived revenue and EBTIDA estimates
from the projections, which it used to prepare a comparable company valuation for each
business. Because of the methods Grant Thornton used, the values were determined as of
a future date, such as December 31, 2014. Grant Thornton then calculated a weighted
average valuation for each business, which it used to develop a sum-of-the-parts
valuation for Caris. Grant Thornton then calculated the fair market value of an individual
share and discounted that figure back to the valuation date.
One disadvantage of Grant Thornton‘s method is that the values of the component
businesses are future values that must themselves be discounted back to the valuation
11
See, e.g., 26 U.S.C. § 6662 (civil penalty for accuracy-related tax
underpayment); id. § 6663 (civil penalty for fraudulent tax underpayment); id. § 6701
(civil penalty for aiding and abetting understatement of tax liability); id. § 7201 (criminal
penalty for willfully attempting to evade or defeat tax).
22
date. Fortunately, Grant Thornton calculated business-specific discount rates that can be
used for that purpose. One advantage of Grant Thornton‘s method is that the future
values can be discounted back to a different valuation date. In this case, PwC and Grant
Thornton valued SpinCo as of October 31, 2011. For an apples-to-apples comparison, the
future values generated in Grant Thornton‘s stock option valuations can be discounted
back to October 31, 2011 as well. Exhibit A to this opinion collects the different Grant
Thornton valuations. Where possible, it calculates present values of the individual
businesses as of the valuation date for each report and separately calculates present
values as of October 31, 2011.
In July 2011, Martino and his team had created projections for Grant Thornton to
use in its latest stock option-related valuation. Not surprisingly, Martino told Sawyers to
send those to PwC. Sawyers responded that to derive the ten-year projections that PwC
had asked for, he would start with the projections that management provided to Grant
Thornton, then extend them by ―keep[ing] the same trajectory as year 5 growth.‖ JX 59.
Martino approved, saying ―Sounds good.‖ Id. Sawyers used this approach for the
downside case, base case, and upside case projections, and he sent an Excel spreadsheet
containing all three sets to PwC. Martino stressed at trial that he did not see the
spreadsheet before it went out, but he had told Sawyers which projections to use and
approved the methodology that Sawyers proposed.
Except for 2011 EBITDA, the first five years of the base case projections for
TargetNow that Sawyers sent to PwC were materially lower than the projections that
Caris provided to potential bidders. Even the upside case was materially lower. The
23
following table compares the base case and upside case projections for 2011-2017 that
Sawyers sent PwC with the projections that Caris gave to bidders:
2011 2012 2013 2014 2015 2016
Sawyers Base Case As Sent To PwC
Revenue 61,674 84,507 96,474 106,121 116,733 124,905
EBITDA 2,691 9,344 10,943 12,840 14,991 16,977
Sawyers Upside Case As Sent To PwC
Revenue 61,674 87,525 104,264 117,818 133,134 146,448
EBITDA 2,691 10,340 13,646 16,667 20,205 23,231
Bidder Base Case With Current Pricing
Revenue 63,438 93,330 129,147 184,005 235,077 267,568
EBITDA 1,820 11,026 22,352 41,591 59,156 68,829
Bidder Base Case With Value Pricing
Revenue 63,438 93,330 262,330 373,759 477,500 543,497
EBITDA 1,820 11,026 88,944 136,469 180,367 206,794
Bidder Upside Case With Current Pricing
Revenue 63,438 126,377 200,730 305,623 406,229 476,667
EBITDA 1,820 9,006 13,258 31,320 76,768 104,358
Bidder Upside Case With Value Pricing
Revenue 63,438 126,377 407,732 620,796 825,152 968,229
EBITDA 1,820 9,006 220,261 346,493 495,691 595,920
In my view, the contrast between the sets of projections fits the typical scenario in which
a seller gives stretch projections to bidders to induce a higher bid, but has more realistic
internal projections that it uses in the ordinary course of business. Here, Sawyers sent
PwC the more realistic internal projections that management had developed for Grant
Thornton to use in its next valuation report for stock option reporting.
G. Final Bids
Citi scheduled September 12, 2011, as the date for interested parties to submit
final bids for the AP business. Miraca, Danaher, Illumina, and PerkinElmer asked about
also bidding for TargetNow. Citi told them that Halbert had decided to wait. Caris would
24
take bids for the AP business, then determine what to do on TargetNow. Citi indicated
that Halbert understood their interest in TargetNow and was open to a separate deal.
On September 9, 2011, Danaher told Caris that it would not be bidding on the AP
business but was interested in a stand-alone acquisition of TargetNow. Danaher offered
to begin immediately and work quickly. See JX 86. Citi again told Danaher to wait.
On the bid deadline, Miraca submitted a bid of $725 million for the AP business.
JX 88. PerkinElmer submitted a bid of $650 million. JX 89. Both bidders expressed their
continued interest in acquiring TargetNow.
Miraca‘s bid was superior. Although Caris engaged further with both PerkinElmer
and Miraca, the Board selected Miraca as its transaction partner.
H. PwC Achieves Zero Tax.
Miraca‘s bid letter identified the tax issues presented by the Spinoff and made
clear that it did not want to be responsible for any taxable gain. On September 21, 2011,
Miraca supplemented its initial bid letter with an additional letter that stressed the
importance of the tax issues: ―Given the significant potential tax implications relating to
the Separation, the parties agreeing on a reasonable valuation of the separated businesses,
as well as finalizing a Separation Agreement, would be condition [sic] to the signing of
the Merger Agreement.‖ JX 102 at CDX24007.
With Miraca‘s letters in hand, Martino instructed PwC to ―come up with a tax
transfer valuation for TargetNow and Carisome to determine the tax liability.‖ Martino
60-61. On September 20, 2011, Martino sent PwC revised projections to use for purposes
of their valuation. Later that day, he gave PwC the bogey to hit. His email stated:
25
Guys,
A real point of issue for the buyer is getting comfortable with the tax
liability at closing. Can you guys prepare something in draft based on a 40
million or so valuation on RetainCo and the financial information on results
for 2011 that I sent this morning? Thanks!!!!!
JX 96. Parrish understood. He responded saying, ―We‘re on it.‖ JX 97.
The ―financial information‖ that Martino sent consisted of reduced forecasts for
TargetNow. He started with the same projections that Sawyers sent PwC in August. As
noted, those projections were prepared in the ordinary course of business for use by Grant
Thornton and were materially more conservative than the projections that Caris had given
to bidders. Martino kept the same top line revenue figures, but he cut the EBITDA across
the board. Metadata from the spreadsheet shows that Martino created the projections on
the morning of September 20, 2011, then emailed them to PwC at 8:35 a.m. After that,
the file was never amended or adjusted. The following table shows the reductions
Martino made to the August projections that Sawyers previously sent PwC:
August September
August EBITDA As % September EBITDA As % of % Reduction
Year Revenue EBITDA of Revenue EBITDA Revenue In EBITDA
2011 61,674,000 2,691,000 4.36% -2,284,000 -3.70% 184.88%
2012 84,507,000 9,344,000 11.06% -422,000 -0.49% 104.52%
2013 96,474,000 10,943,000 11.34% 2,428,000 2.51% 77.83%
2014 106,121,000 12,840,000 12.09% 4,241,000 3.99% 66.97%
2015 116,733,000 14,991,000 12.84% 6,006,000 5.14% 59.94%
The next day, Parrish emailed back with the answer he knew Martino wanted:
―Jerry – please see attached model below. We are at zero tax.‖ JX 99. The model valued
TargetNow at $47 million and Carisome at $15 million.
26
Later on September 21, 2011, PwC sent Martino a revised valuation. Perhaps the
PwC team noticed that although they had delivered ―zero tax,‖ the aggregate value of $62
million exceeded the ―40 million or so‖ that Martino had requested. The new model
―reduced the Base Case value of the [TargetNow] technology from USD 47.234 to USD
32.900 million.‖ JX 100. With another $15 million for Carisome, the aggregate value was
now at $48 million.
Martino wrote back, ―I‘m staying with the old version. Thanks!‖ JX 101. Once the
goal of zero-tax was achieved, then there was no benefit to being more aggressive.
Overwhelming evidence in the record makes clear that in rendering its decision,
PwC did not determine the fair market value of TargetNow and Carisome. PwC‘s
engagement letter, dated September 6, 2011, specified that PwC was being engaged to
―provide an arm‘s-length range of the fair market value of the TargetNow IP,‖ defined as
the intellectual property of TargetNow. JX 80. PwC also stated that its engagement would
include ―update[ing] its previous analysis of the value of the [Carisome] IP.‖ Id. Martino
agreed that PwC was ―engaged to do the valuation for tax purposes‖ and produced ―an IP
transfer valuation . . . .‖ Martino Dep. 164; accord Martino 84-85.
A transfer pricing valuation of intellectual property is not the same as a
determination of the fair market value of a business. PwC explained this point in an email
to Miraca and its advisors:
The valuation under review considers a transfer pricing view of the
transaction—an analysis of the sale of US-owned assets to a non-US related
party under the arm‘s length standard—that may not equate to the
definition of fair market value under Revenue Ruling 59-60, or to the
concept of fair value in the financial reporting context.
27
JX 119 at CDX30894. Martino agreed. Martino Dep. 78-79, 172-74. So did Parrish, the
lead partner for PwC. Parrish Dep. 78-79.
Although Martino told PwC that he was ―staying with the old version,‖ it turned
out that additional steps were necessary to justify the low value that PwC placed on
Carisome. Parrish‘s email dated September 20, 2011, in which he informed Martino that
PwC had achieved ―zero tax,‖ included internal emails among the PwC team. One of the
team members questioned the $15 million valuation for Carisome:
As I mentioned on the call earlier today, I am still a bit perplexed on the
$26M of tax basis in the Gibco stock [the holding company for Carisome]
and a fair value of $15M [for the Carisome IP]. Given its recent formation
and background, this surprises me.
JX 99 at CDX34852. The problem was that PwC was valuing Carisome using the cost-
basis method. Under that approach, PwC valued Carisome‘s technology according to
what Caris had invested in it. Consequently, the tax basis of the technology and the tax
basis of the holding company that owned the technology should not have diverged. Yet as
the PwC email pointed out, they did.
To address the issue, Martino sent PwC a spreadsheet on September 22, 2011, that
tracked the monthly R&D spending for Carisome from January 2010 to August 2011. But
the total was $31.838 million, more than the $26 million used for the holding company
and more than twice the value PwC had placed on the IP. Martino instructed PwC to
exclude the spending from March 2010 through March 2011 because it related to the first
blood-based testing product that had failed commercially. Martino later instructed PwC to
exclude the R&D spending from April to June 2011 as well. JX 111.
28
During the same period, Grant Thornton was working on the stock option-related
valuation for grants made during the first quarter of 2011. Grant Thornton had projections
from management for all three businesses, including Carisome. The following table
shows that the EBITDA figures for TargetNow were closer to the August version that
Sawyers prepared, rather than the September version with Martino‘s cuts.
2011 2012 2013 2014 2015 2016
Sawyers Base Case As Sent To PwC
Revenue 61,674 84,507 96,474 106,121 116,733 124,905
EBITDA 2,691 9,344 10,943 12,840 14,991 16,977
Martino Base Case As Sent To PwC
Revenue 61,674 84,507 96,474 106,121 116,733 124,905
EBITDA -2,284 -422 2,428 4,241 6,006 23,231
Grant Thornton Base Case
Revenue 63,613 84,507 96,474 106,121 116,733 N/A
EBITDA 216 5,686 8,823 12,489 16,781 N/A
Martino did not give Grant Thornton the lowered projections for TargetNow. He simply
told them to stop working on their valuation.
I. Miraca Insists On A Second Opinion From Grant Thornton.
On September 22, 2011, Martino forwarded PwC‘s valuation of $62 million to
Deloitte, Miraca‘s tax advisor. The advisors subsequently held a call to discuss the
Spinoff. Deloitte had a number of questions about PwC‘s work and regarded what had
been provided as falling short of what was promised. PwC initially was not responsive.
Miraca‘s bankers then reached out to Citi, who contacted Halbert directly. Halbert made
clear that Caris and PwC needed to be fully responsive.
Deloitte requested a wide range of valuation materials from Caris and PwC. One
of the next items in the record after Deloitte‘s request is an email from Martino to PwC
29
that attached a three-page memorandum seeking to justify the September projections for
TargetNow. Recall that those projections anticipated approximately the same top line
revenue as Grant Thornton‘s draft valuation, but that Martino cut the EBITDA. Martino‘s
memo attributed the changes predominantly to an increased allocation of SG&A.
On September 26, 2011, Caris, PwC, and Deloitte convened a call during which
PwC made a presentation to defend its valuation of Carisome‘s intellectual property.
Among other things, the presentation sought to explain why PwC excluded $25 million in
development costs. PwC prepared a supporting memorandum in which it advised Caris
that the tax treatment was appropriate. See JX 116.
Deloitte remained skeptical of PwC‘s valuation work. After the call, Deloitte re-
circulated a list of specific valuation questions that it still wanted answered, including the
following:
• Is there any support for the discount rate calculation?
• Explain why there are no cash flow adjustments such as change in
working capital, depreciation and capex
• Explain what the routine return amounts are
• Have you performed a market approach looking at comparable
companies or transactions?
• Please provide a list of comparable companies
JX 117. Deloitte asked whether Clarient was a comparable company. In October 2010,
GE Healthcare had acquired Clarient for $580 million, representing a multiple of 5.3x
revenue. In presentations to the Board, Caris had identified Clarient as a competitor of
TargetNow, and after the transaction was announced, Halbert and Citi invited GE
30
representatives to visit Caris to show them that TargetNow was a superior offering that
GE should purchase. Deloitte logically thought that the Clarient transaction should be
used as a data point for valuing TargetNow.
Martino responded to Deloitte‘s request about comparable companies by preparing
a memorandum which argued that Clarient was not a comparable company. JX 118. PwC
asserted in its responses that there were no comparable companies. Id. Yet Grant
Thornton had used a comparable companies analysis to value TargetNow for two
valuation reports in February 2011 (JX 22 & JX 23), a valuation report in April 2011 (JX
26), a valuation report in May 2011 (JX 35), and a draft report in July 2011 (JX 42). Fund
VI also valued TargetNow using comparable companies. See JX 191 at JHW875.
Like Deloitte, Miraca‘s outside counsel expressed concern about the valuation of
TargetNow and Carisome. In an email to Martino and others dated September 29, 2011,
counsel stated:
Relating to the valuation of the spun off businesses, it would help if we
could review the current financial projections of TargetNow, Carisome and
Pharma, including backup regarding the rationale and assumptions made
thereof. Could you also confirm whether these projections have been
reviewed and authroized [sic] by the board of directors.
JX 126. Martino responded that ―[t]he projections have been reviewed and approved by
David [Halbert] and JH Whitney. All the information we have has been provided to
Deloitte via the PWC valuation.‖ Id. Those statements do not appear to be accurate.
There is nothing in the record to suggest that Halbert or Fund VI approved the projections
he sent in September to PwC. The metadata from the projections shows that Martino
created them on the morning of September 20, then emailed them to PwC at 8:35 a.m.
31
The only projections that the Board reviewed for TargetNow were the materially higher
projections provided to the bidders.
By the end of September 2011, despite the extensive back and forth between
advisors, Miraca remained uncomfortable on the valuation front—to the point where it
suggested seeking a ruling from the IRS on the valuation issues before completing the
Spinoff. See JX 130. With the signing of a final transaction agreement contemplated for
the following week, Miraca and Caris appear to have compromised. Caris would provide
a side letter indemnifying Miraca for any tax liability, and Caris would obtain a second
valuation from Grant Thornton.
J. The Board Approves The Transaction.
On October 5, 2011, the Board met telephonically with Citi, PwC, its legal
counsel, and Caris executives to consider and approve an Agreement and Plan of Merger
with Miraca. JX 144 (the ―Merger Agreement‖ or ―MA‖). The closing of the Merger was
conditioned on the completion of the Spinoff, to be governed by a Separation and
Distribution Agreement. JX 174 (the ―Separation Agreement‖ or ―SA‖). As Caris and
Miraca had agreed, the Merger Agreement obligated Caris ―to obtain a valuation report
with respect to the Separated Businesses [i.e., TargetNow and Carisome] from Grant
Thornton LLP.‖ MA § 5.17.
The Merger Agreement called for each non-dissenting share of RemainCo
common stock to be converted into the right to receive $4.46 in cash. The Merger
Agreement provided that stock options would be treated as follows:
32
At the Effective Time, each in-the-money Company Option issued and
outstanding immediately prior to the Effective Time shall be converted into
the right to receive the Option Payment with respect to such Company
Option and its portion of any Residual Funds payable to the Participating
Sellers in accordance with the terms of this Agreement. As of the Effective
Time, all Company Options shall no longer be outstanding and shall
automatically be canceled and retired and shall cease to exist, and each
holder of any Company Option shall cease to have any rights with respect
thereto, except as otherwise provided for herein or by applicable Law.
Id. § 2.08(d) (the ―Option Conversion Provision‖). The Merger Agreement defined the
―Option Payment‖ as
an amount equal to (a) the product of (i) the Per Share Common Payment . .
. multiplied by (ii) the aggregate number of Company Common Shares
issuable in respect of such Company Option outstanding as of immediately
prior to the Effective Time, minus (b) the aggregate exercise price that
would be paid to the Company in respect of such Company Option had
such Company Option been exercised in full immediately prior to the
Effective Time, in each case, in accordance with the terms of the applicable
option agreement with the Company pursuant to which such Company
Option was issued and without regard to vesting or any other restriction
upon exercise and assuming concurrent payment in full of the exercise price
of such Company Option solely in cash.
Id. § 1.01. The Merger Agreement defined the ―Per Share Common Payment‖ as the
result of the following formula:
(a) the difference of (i) the Purchase Price, minus (ii) the Escrow Amount,
minus (ii) [sic] the Seller Representative Expense Amount, minus (iv) the
aggregate amount of (A) Per Share Series A Preferred Payments, (ii) [sic]
Per Share Series B Preferred Payments and (iii) [sic] Per Share Series C
Preferred Payments, in each case to the extent such payments constitute
Liquidation Preferences and not Alternative Amounts, [divided] by (b) the
number of Aggregate Company Shares Deemed Outstanding.
Id.
Two aspects of the Option Conversion Provision stand out. First, the Option
Conversion Provision purported to effectuate the ―conversion‖ of the in-the-money
33
options by operation of the Merger and to deem all of the options cancelled as a result.
Second, the Option Conversion Provision purported to convert the options into
consideration tied to the Per Share Common Payment, which incorporated a withholding
for the ―Escrow Amount.‖ The Merger Agreement defined the Escrow Amount as
$40,000,000. Id. § 2.10(b)(i). The option holders then would have the opportunity to
receive back a portion of the escrow as additional merger consideration as part of the
release of any ―Residual Funds,‖ defined to include any amounts left over from the
Escrow Amount after all claims against it had been released or satisfied. Id. § 1.01.
Importantly, the Plan provided for different treatment of options in the event of a
merger. Section 12.3 of the Plan stated:
Change of Control – Asset Sale, Merger, Consolidation or Reverse Merger.
In the event of a dissolution or liquidation of the Company, or any
corporate separation or division, including, but not limited to . . . a reverse
merger in which the Company is the surviving entity, but the shares of
Common Stock outstanding immediately preceding the merger are
converted by virtue of the merger into other property . . ., then, the
Company, to the extent permitted by applicable law, but otherwise in the
sole discretion of the Administrator may provide for . . . (iv) the
cancellation of such outstanding Awards in consideration for a payment
equal in value to the Fair Market Value of vested Awards, or in the case of
an Option, the difference between the Fair Market Value and the exercise
price for all shares of Common Stock subject to exercise (i.e., to the extent
vested) under any outstanding Option . . . .
JX 1 § 12.3. The Plan defined the ―Administrator‖ as ―the Board or the Committee
appointed by the Board in accordance with Section 3.5.‖ Id. § 2.2. The Plan defined ―Fair
Market Value‖ to mean ―as of any date, the value of the Common Stock as determined in
good faith by the Administrator . . . .‖ Id. § 2.25. Section 12.3 thus contemplated the
cancellation of outstanding options in exchange for ―the difference between the Fair
34
Market Value and the exercise price for all shares of Common Stock subject to exercise.‖
It did not contemplate deductions for, among other things, an escrow holdback.
The Plan also contained a section implicated by the Spinoff. Section 12.1 of the
Plan stated:
Capitalization Adjustments. If any change is made in the Common Stock
subject to the Plan, or subject to any Award, without the receipt of
consideration by the Company (through . . . stock dividend . . . or other
transaction not involving the receipt of consideration by the Company),
then . . . (v) the exercise price of any Option in effect prior to such change
shall be proportionately adjusted by the Administrator to reflect any
increase or decrease in the number of issued shares of Common Stock or
change in the Fair Market Value of such Common Stock resulting from
such transaction. . . . The Administrator shall make such adjustments, and
its determination shall be final, binding and conclusive.
Id. § 12.1. Section 12.1 thus required that the Board account for the Spinoff by adjusting
the exercise price of the options to reflect ―the change in the Fair Market Value of such
Common Stock‖ resulting from the Spinoff.
During the meeting, PwC presented the preliminary results of its tax transfer
valuation. The minutes of the October 5, 2011 meeting reflect that the Board recognized
the need to adjust the exercise price of the stock options to reflect the value of the
Spinoff. But the Board never set the adjusted price. The resolutions adopted at the
meeting state:
RESOLVED, that, subject to the consummation of the Distribution [i.e.,
the Spinoff], the exercise price of each Option shall be proportionately
adjusted to take into account the Distribution;, [sic] provided, however, that
any fractional shares resulting from the adjustment shall be eliminated[.]
JX 137 at CDX41619. And this makes sense. As part of the compromise with Miraca, the
Separation Agreement called for Caris to get a second valuation report from Grant
35
Thornton. It would not have made sense for the Board to adjust the options before that
process was complete.
The Board approved the Merger Agreement and the Separation Agreement. The
Board expected the Miraca Transaction to close in five to six weeks. Citi discussed next
steps with Halbert and Johansen, including a follow-on sale of TargetNow. Citi had
already fielded a call from Illumina, who remained interested in purchasing TargetNow.
Citi also knew that other participants from the AP business sale process were interested,
as well as some potentially new parties. See JX 141 & 142.
K. Martino Determines The Potential Range Of Consideration For Option
Holders.
Also on October 5, 2011, the same day as the Board meeting, Martino held an in-
person meeting with PwC and Grant Thornton. Before the meeting, Martino emailed
PwC about preparing for ―the valuation discussions we need to have with Grant
Thornton.‖ JX 133. Martino denied giving any instructions to Grant Thornton during the
meeting about how they were supposed to proceed. See Martino Dep. 212, 221.
After the meeting, Grant Thornton sent Martino a draft engagement letter which
contemplated that the firm would determine ―the tax basis of the businesses excluded
from the Transaction,‖ i.e., TargetNow and Carisome. JX 148 at CDX38291. Grant
Thornton had never performed a tax-related valuation for Caris before. A tax transfer
valuation was exactly what PwC prepared. Martino struck the words ―tax basis‖ and
changed them to ―valuation.‖ Id. at CDX38283.
36
On October 6, 2011, the day after the Board meeting, Caris announced the Miraca
Transaction. As part of the announcement, Caris sent a list of frequently asked questions
to its employees. The FAQs stated that ―[a]t the time of closing, an option holder will be
entitled to receive a cash amount equal to the difference between (i) the per-share value
of the company minus (ii) the per-share exercise price of the option.‖ JX 145 at
CDX75816. According to the FAQs,
[t]he per share price of the Company is expected to be between $5.04-
$5.14. This value is made up from the sale of the AP business to Miraca
Holdings as well as the value of the Carisome and TargetNow businesses.
The valuation of the separated businesses was based upon a detailed
examination of these businesses by two independent and nationally-
recognized business valuation firms.
Id. (emphasis added). The italicized portion was not accurate. The valuation was not
based on a detailed examination by two firms. Grant Thornton had not yet started work.
The source of the valuation was Martino. On October 6, 2011, before sending out
the FAQs, he emailed Halbert and Johansen, proposed ―a range of $5.06 to $5.14 per
share,‖ and asked them to ―[l]et [him] know if we can put the range in the [FAQs].‖ JX
217 (emphasis in original). Johansen suggested that Martino give himself a two cent
―cushion‖ by changing the range to $5.04 to $5.14. Id. Halbert said ―Ok.‖ Id.
Martino‘s estimate was prescient. One month later, after Grant Thornton
completed its report, Martino would set the final option payout at $5.07 per share. The
fact that Martino could forecast the range of value so precisely shows how deeply he had
his hands in the valuation dough. Grant Thornton supposedly was going to value
TargetNow and Carisome independently. Its valuations of those businesses historically
37
came in higher than the figures PwC had used for tax transfer purposes. Yet Martino
accurately foresaw the outcome of the process. Unless Martino told Grant Thornton what
he needed during the meeting with PwC on October 5, 2011, he should not have been
able to predict where Grant Thornton would end up, particularly since Grant Thornton‘s
report would have to depart from its earlier valuations.
L. Grant Thornton’s “Independent” Valuation
In theory, Grant Thornton should have been well positioned to prepare a reliable,
informed, and independent valuation of TargetNow and Carisome. The firm already had
provided Caris with three formal stock option-related valuations in 2011. Grant Thornton
also prepared the underlying valuation work for a fourth stock option-related valuation
that it sent to Martino but did not finalize. Despite different valuation dates, the inputs
were generally consistent. So were the results.
Exhibit JX 23 JX 22 JX 35 JX 42
Report Date 2/11/11 2/11/11 5/24/11 7/13/11
Valuation Date 3/31/10 6/30/10 12/31/10 3/31/11
TargetNow WACC 19.2% 19.3% 19.3% 19.1%
TargetNow Long Term Growth Rate 8% 7% 7% 7%
TargetNow Capitalization Factor 9.64x 8.7x 8.7x 8.84x
TargetNow Revenue Multiple 1.9x 1.6x 1.4x 1.0x
TargetNow EBITDA Multiple 6.1x 6.0x 6.0x 6.1x
Future TargetNow Enterprise Value $170,875 $137,622 $119,790 $98,418
Carisome WACC 24.9% 25.1% 24.9% 24.7%
Carisome Long Term Growth Rate 20% 20% 20% 20%
Carisome Capitalization Factor 24.49% 23.53% 24.49% 25.53%
Carisome Revenue Multiple 1.9x 3.1x 3.0x 3.7x
Carisome EBITDA Multiple 15.4x 12.2 12.2x 13.3x
Future Carisome Enterprise Value $266,991 $401,639 $411,741 $567,512
Grant Thornton‘s pre-Spinoff valuation conclusions also were consistent in
another respect: the relative contributions of TargetNow and Carisome to the aggregate
38
value of Caris. Grant Thornton consistently determined that TargetNow and Carisome
contributed at least a third of Caris‘s total value. Because the following table focuses on
relative values, it uses the future, undiscounted values that Grant Thornton calculated.
Exhibit JX 23 JX 22 JX 35 JX 42
Report Date 2/11/11 2/11/11 5/24/11 7/13/11
Valuation Date 3/31/10 6/30/10 12/31/10 3/31/11
Future AP Business Enterprise Value $791,260 $930,328 $820,857 $897,016
Future TargetNow Enterprise Value $170,875 $137,622 $119,790 $98,418
Future Carisome Enterprise Value $266,911 $401,639 $411,741 $567,512
Combined Future Enterprise Value $1,229,046 $1,469,589 $1,352,388 $1,562,946
TargetNow and Carisome as % Of
Combined Future Enterprise Value 35.6% 36.7% 39.3% 42.6%
In addition, to the stock option valuations, Grant Thornton prepared a formal
valuation for Caris in 2011 for purposes of Accounting Standard Codification 350. This
type of valuation is used to determine whether the value of an asset has been impaired
such that its carrying value needs to be reduced. In April 2011, Grant Thornton
determined
the fair value of the invested capital in . . . TargetNow and Pharma (the
―TargetNow‖ reporting unit) . . . as well as the indefinite-lived trade name
of TargetNow (the ―MPI Trade Name‖ or the ―Trade Name‖) and database
of TargetNow (the ―Clinical Database‖ or ―Database‖), as of October 1,
2010 (the ―Valuation Date‖).
JX 26 at CDX174770. On its books, Caris was carrying TargetNow‘s trade name and the
clinical database at approximately $1 million each. Caris was carrying the reporting unit,
i.e., the business, at $54 million. Id. at CDX174771. As with its stock option valuations,
Grant Thornton valued TargetNow using management projections, the discounted cash
flow method, and comparable company methodologies. For the former, Grant Thornton
derived a WACC for TargetNow of 18.7%, used a long term growth rate of 7%, and
39
derived a terminal year capitalization multiple of 8.5x, slightly lower than but generally
consistent with the figures used in its stock market valuations. For the latter, Grant
Thornton calculated revenue and EBITDA figures, then applied multiples derived from
comparable companies. Grant Thornton chose a revenue multiple of 1.5x and an
EBITDA multiple of 7.4x, consistent with the multiples used in its stock option
valuations. Grant Thornton determined that the fair value of the TargetNow trade name
and database were approximately $3 million each. Grant Thornton determined that the
fair value of the reporting unit was $88 million. Excluding debt and adding the value of
the trade name and database, TargetNow had a value of approximately $104 million.
Grant Thornton concluded that no impairment of those assets had occurred.
Then Martino hired Grant Thornton to value TargetNow and Carisome for the
Spinoff. One might have thought that Grant Thornton would take positions consistent
with its prior work. Instead, after meeting with Martino, Grant Thornton‘s employees
viewed their task as ―just copying PwC‘s report and calling it our own . . . .‖ JX 150. And
that is predominantly what they did.
One example of Grant Thornton‘s copy job was its valuation of Carisome.
Ostensibly to perform their own calculations, the Grant Thornton personnel emailed
Caris, referenced a table that PwC included in its report, and asked for ―the same source
information that PwC had in constructing the table,‖ including ―the costs associated with
the failed assay.‖ JX 152. Caris responded that it spent $11.623 million on Carisome‘s
first failed product, comprising $7.587 million in 2010 and $4.036 million in 2011. JX
40
153. Caris also noted that ―V1 activities extended only through March 2011, with V2
beginning in April 2011.‖ Id. at GT444.
With this information, Grant Thornton supposedly created the following table:
JX 168 at CDX38085. The figures in the table matched up exactly with PwC‘s table.
JX 116 at CDX59308.
The problem is that PwC prepared its table using different inputs. Caris told PwC
to exclude $13.893 million in 2010, not $7.587 million, and to exclude $12.4 million in
2011, not $4.036 million. Martino also told PwC to exclude spending from March 2010
through June 2011, rather than from March 2010 through March 2011. Yet despite
receiving different information, Grant Thornton created an identical table. The only
41
possible explanation is that Grant Thornton did not prepare its table independently. It
copied PwC‘s table, just as its employees said they would do.
More fundamentally, Grant Thornton‘s use of the cost method and its rejection of
other valuation methods conflicted with all of its prior valuations. In its valuation for the
Spinoff, Grant Thornton opined that ―it is not possible to accurately forecast the cash
flows of Carisome,‖ and therefore it was necessary to use the cost method rather than the
discounted cash flow method or comparable company method. JX 168 at CDX38077-
38078. Yet Grant Thornton had relied on management projections and used both the
discounted cash flow and comparable company methods when valuing Carisome in all
three of the formal valuations that it prepared in 2011, as well as the draft valuation.
When Grant Thornton did not copy directly from PwC, it made significant errors.
Most notably, when developing the 2011 revenue figure that Grant Thornton used for
valuation purposes, the firm mistakenly used TargetNow‘s trailing nine-month revenue
for 2010 instead of its projected twelve-month revenue for 2011. The erroneous figure
was $39.684 million. The accurate figure was $55.052 million. The difference was
$15.368 million, an increase of 39%.
Not surprisingly, Grant Thornton‘s valuation for the Spinoff was inconsistent with
its prior valuation work. Grant Thornton valued TargetNow at $37.1 million and
Carisome at $17.6 million. Using the deal price of $725,000 for the AP business, those
values represented 7% of the combined enterprise value for Caris. At trial, Martino
acknowledged that Grant Thornton‘s work was ―somewhat flawed.‖ Martino 125.
42
M. Martino Recommends And Halbert Approves The Final Value For SpinCo.
PwC issued its final valuation on November 9, 2011. Its valuation stated that it
was an intercompany tax transfer valuation of intellectual property. PwC valued
TargetNow‘s intellectual property at $47.23 million and Carisome‘s at $17.79 million for
total value of $65.02 million.
On November 11, 2011, Martino received the final version of Grant Thornton‘s
report. Grant Thornton valued TargetNow‘s intellectual property at $37.122 million and
Carisome‘s at $17.634 million for total value of $54.756 million.
Martino forwarded Grant Thornton‘s report to Halbert and Johansen, noting that
Grant Thornton came in lower than PwC:
Total valuation was determined to be $54.7 million versus the $65 million
prepared by PWC. They both valued Carisome at around $17.6 million. The
difference in valuation was for the [TargetNow] franchise. I recommend we
stay with the $65 million valuation prepared by PWC for transaction
purposes.
JX 170. One minute later, Halbert agreed. Martino took that as sufficient. He informed
his reports that ―[f]or book and tax purposes we are going with the PWC valuation of
$65,030,000 as our final valuation.‖ JX 171.
Although the Board had approved the form of the Separation Agreement on
October 5, 2011, there were tweaks to the document, and the execution version was dated
as of November 16. JX 174. The Separation Agreement provided for the Board to adjust
the terms of the options to account for the Spinoff. Section 3.05 of the Separation
Agreement stated:
43
Effective upon the Distribution, the Company shall take all necessary
actions pursuant to Section 12.1 of the Company Equity Plan (and the
underlying option grant agreements) to proportionately adjust all of the
outstanding Company Options to take into account the Distribution;
provided that any fractional shares resulting from the adjustment shall be
eliminated.
SA § 3.05.
On November 21, 2011, the Board approved the Spinoff by unanimous written
consent. JX 177. The written consent did not make an adjustment to the outstanding
Company Options. The recitals noted the need for an adjustment, and the pertinent
resolution stated:
[E]ffective upon, and subject to, the consummation of the Distribution,
each Company Option shall be proportionately adjusted in accordance with
Section 12.1 of the Corporation Stock Plan and the underlying option grant
agreements to take into account the Distribution . . . .
Id. at CDX3996. Like the resolutions on October 5, the Board did not determine how the
options would be adjusted. Nor did it determine the Fair Market Value of a share of Caris
common stock.
N. Martino Sets The Specific Consideration To Be Received By Option Holders.
On November 22, 2011, the Merger closed. That same day, management sent an
email to its employees with the subject line ―U.S. Stock Option holders update.‖ JX 179.
The email stated:
Effective today, the transaction between Caris Life Sciences and Miraca
Holdings, Inc., has legally closed. Based on the final cost of the transaction,
the fair market value per share has been set at $5.07.
As communicated previously in the attached Q&A document, this means
each option holder is entitled to receive cash payments equal to the
difference between the fair market value per share ($5.07), minus the option
44
holder‘s per-share strike/exchange price of the option, multiplied by the
number of such stock options granted.
The initial payment distribution, 92 percent of the total payout, is expected
to occur within 10 business days, likely Nov. 30. . . . The remaining escrow
balance (final 8 percent of the total payout) will be paid (to the extent
monies are available) upon the conclusion of the 18-month escrow period . .
..
Id. The price of $5.07 disclosed in the email fell precisely within the range of $5.04 to
$5.14 that Martino recommended on October 6—ostensibly before he knew the outcome
of the Grant Thornton report—and which Johansen and Halbert approved. Of the $5.07,
$4.46 represented the value of the AP business. The remaining $0.61 per share
represented the value of TargetNow and Carisome.
The November 22 email informed option holders that Caris had withheld 8% of
their payment to account for the escrow. Caris told the stockholders the same thing in an
email dated December 1, 2011. JX 184. The December 1 email listed the six steps that
Caris went through to calculate the option payment. Step 3 stated that Caris had
―[m]ultipl[ied] the result of 2 above by .92 (92 percent – rounded), which gives you the
amount of initial proceeds you have after deducting the escrow holdback.‖ Id. Step 6
stated that ―[a]fter 18 months, the remaining escrow amount will be distributed to the
extent that the $40,000,000 escrow amount has remaining funds.‖ Id.
O. This Litigation
The plaintiff is a former salesman in the AP business who owned options to
purchase 71,600 shares of Caris common stock. He filed suit alleging that Caris breached
the Plan and that the option holders should have received greater consideration. On July
45
30, 2014, the court certified a class consisting of all holders of stock options pursuant to
the Plan whose options were repurchased or cancelled by Caris in connection with the
Miraca Transaction, excluding Caris, any current or former director of Caris or SpinCo
who was an administrator under the plan, any senior officer of SpinCo, and their
associates and affiliates. See Pre-Trial Order ¶ 9 (the ―Class‖).
II. LEGAL ANALYSIS
The plaintiff contends that Caris breached the Plan in three ways. First, he argues
that the Board failed to determine the Fair Market Value of a share of Caris common
stock and to adjust the options to account for the Spinoff. Second, he argues that
regardless of who determined the amount, it was not a good faith determination of Fair
Market Value and resulted from an arbitrary and capricious process. Third, he argues that
the Plan did not allow Caris to escrow a portion of the consideration for cancelled
options. The plaintiff also advances a claim for breach of the implied covenant of good
faith and fair dealing, but because of this decision‘s disposition of the express contract
claims, it does not reach that issue.
A claim for breach of contract has three elements: ―first, the existence of the
contract, whether express or implied; second, the breach of an obligation imposed by that
contract; and third, the resultant damage to the plaintiff.‖ VLIW Tech., LLC v. Hewlett-
Packard Co., 840 A.2d 606, 612 (Del. 2003). The first element is undisputed. The Plan is
the operative contract. The disputes are over breach and damages.
Analyzing the element of breach requires the application of principles of contract
interpretation. The Plan selects Delaware law to govern its terms. JX 1 § 19. When
46
interpreting a contract governed by Delaware law, ―the role of a court is to effectuate the
parties‘ intent.‖ Lorillard Tobacco Co. v. Am. Legacy Found., 903 A.2d 728, 739 (Del.
2006). ―If a writing is plain and clear on its face, i.e., its language conveys an
unmistakable meaning, the writing itself is the sole source for gaining an understanding
of intent.‖ City Investing Co. Liquidating Trust v. Cont’l Cas. Co., 624 A.2d 1191, 1198
(Del. 1993). The court‘s role is to ―give words their plain meaning unless it appears that
the parties intended a special meaning.‖ Norton v. K-Sea Transp. P’rs L.P., 67 A.3d 354,
360 (Del. 2013). When determining the plain or special meaning of a provision, the court
―must construe the agreement as a whole, giving effect to all provisions therein.‖ E.I. du
Pont de Nemours & Co. v. Shell Oil Co., 498 A.2d 1108, 1113 (Del. 1985). ―Moreover,
the meaning which arises from a particular portion of an agreement cannot control the
meaning of the entire agreement where such inference runs counter to the agreement‘s
overall scheme or plan.‖ Id. ―[A] court interpreting any contractual provision . . . must
give effect to all terms of the instrument, must read the instrument as a whole, and, if
possible, reconcile all the provisions of the instrument.‖ Elliott Assocs., LP. v. Avatex
Corp., 715 A.2d 843, 854 (Del. 1998).
A. The Board Failed To Determine Fair Market Value Or Adjust The Options
To Account For The Spinoff.
The plaintiff first argues that Caris breached the Plan because the Board failed to
determine the Fair Market Value of a share of Caris common stock and to adjust the
options to account for the Spinoff. He contends that Martino determined the value of
47
SpinCo and the amount of consideration that option holders would receive, then Halbert
gave perfunctory approval. The plaintiff proved this claim at trial.
As discussed, Section 12.3 of the Plan provides that if the Administrator decides to
cancel options in connection with a merger, the option holders are entitled to ―the
difference between the Fair Market Value and the exercise price for all shares of
Common Stock subject to exercise (i.e., to the extent vested) under any outstanding
Option . . . .‖ JX 1 § 12.3(iv). The Plan requires that the Administrator determine Fair
Market Value. Id. § 2.25. The Administrator is the Board. Id. § 2.2.
The Miraca Transaction did not only involve the Merger. It also involved the
Spinoff. Section 12.1 of the Plan states that in the event of a transaction like the Spinoff,
―the exercise price of any Option in effect prior to such change shall be proportionately
adjusted by the Administrator to reflect any increase or decrease in the number of issued
shares of Common Stock or change in the Fair Market Value of such Common Stock
resulting from such transaction . . . .‖ Id. § 12.1(v) (emphasis added).
Under the plain meaning of Section 12.1, the Board was obligated to adjust the
terms of the options to reflect the Spinoff. Under the plain meaning of Section 12.3, the
Board had discretion as to whether to cancel the options in connection with the Merger,
but if it did, then the option holders were entitled to receive ―the difference between the
Fair Market Value and the exercise price for all shares of Common Stock subject to
exercise.‖ The Plan imposed on the Board the obligation to determine the Fair Market
Value of a share of common stock.
48
The parties have stipulated that the ―entire Board of Directors served as the
Administrator under the Plan for purposes of the Option Transaction.‖ Pre-Trial Order ¶
26. The Administrator was not one or two directors acting informally. Nor was it an
officer getting approval from the controlling stockholder.
Valid board action requires that the directors act at a properly convened meeting
or unanimously by written consent. See 8 Del. C. § 141. ―Only the duly authorized board
has the power to act for the corporation, and all members of the corporation‘s board must
be given an opportunity to participate meaningfully in board meetings.‖ Grayson v.
Imagination Station, Inc., 2010 WL 3221951, at *5 (Del. Ch. Aug. 16, 2010).
Under the Plan, the Board could have delegated its authority as Administrator to a
committee made up of directors. Section 3.5 of the Plan authorized the Board to ―delegate
administration of the Plan to a Committee or Committees of one or more members of the
Board,‖ in which case ―the Committee shall have, in connection with the administration
of the Plan, the powers theretofore possessed by the Board . . . .‖ JX 1 § 3.5(a). The
Board could have empowered Halbert as a one-person committee. It didn‘t.
The trial record established that Martino determined the value that option holders
would receive. Halbert signed off on Martino‘s determination, and Halbert and Johansen
were the only directors who had any input in the process. On October 6, 2011, when they
picked the range of $5.04 to $5.14, they only had seen PwC‘s draft report. On November
11, Martino sent them Grant Thornton‘s report and recommended that ―we stay with the
$65 million valuation prepared by PWC . . . .‖ JX 170. Martino‘s use of the term ―we‖
illustrated who the decision makers were. One minute later, Halbert gave his consent.
49
Johansen did not reply. Martino treated Halbert‘s signoff as sufficient. That was the
extent of the determination for both the Fair Market Value of a share of common stock
and the adjustment of the stock options for purposes of the Spinoff.
Other evidence confirms that the Board never determined Fair Market Value.
Knowles, a Vice Chairman of the Board, did not know that the Plan existed. He did not
know that the Board was the Administrator or that the Plan required the Board to act. He
could not recall any Board discussions about fair market value, any vote on the options,
or any determination of what the option holders ultimately received. See Knowles 485-
87; Knowles Dep. 106-13.
What Knowles instead believed was that the Board simply advised Halbert who,
as Caris‘s controlling stockholder, CEO, and Chairman, had the final say on all decisions.
Knowles testified, ―[I]t‘s clear that what – that David will – that the majority shareholder,
the president and CEO, will and does take into account feedback and input. However,
ultimately he will make the decision.‖ Knowles 481; Knowles Dep. 42 (―[U]ltimately,
either in the meeting or outside the meeting, then it is David‘s right to make the decision.
We [the Board] respect that.‖).
Although some controllers and boards may act this way, Section 141(a) of the
Delaware General Corporation Law (the ―DGCL‖) establishes ―the bedrock statutory
principle of director primacy.‖ Klaassen v. Allegro Dev. Corp., 2013 WL 5967028, at *9
(Del. Ch. Nov. 7, 2013). ―[D]irector primacy remains the centerpiece of Delaware law,
even when a controlling stockholder is present.‖ In re CNX Gas Corp. S’holders Litig.,
2010 WL 2291842, at *15 (Del. Ch. May 25, 2010).
50
The reality is that controlling stockholders have no inalienable right to
usurp the authority of boards of directors that they elect. That the majority
of a company‘s voting power is concentrated in one stockholder does not
mean that that stockholder must be given a veto over board decisions when
such a veto would not also be afforded to dispersed stockholders who
collectively own a majority of the votes. Like other stockholders, a
controlling stockholder must live with the informed (i.e., sufficiently
careful) and good faith (i.e., loyal) business decisions of the directors unless
the DGCL requires a vote. That is a central premise of our law, which vests
most managerial power over the corporation in the board, and not in the
stockholders.
Hollinger Inc. v. Hollinger Int’l, Inc. (Hollinger II), 858 A.2d 342, 387 (Del. Ch. 2004)
(Strine, V.C.), appeal refused, 2004 WL 1732185, at *1 (Del. July 29, 2004) (TABLE).
Caris has argued that the entire Board, including Knowles, really did determine
Fair Market Value and make the necessary adjustments on October 5, 2011, when they
approved the Merger Agreement. They did not. Consistent with Knowles‘s testimony, the
minutes of the Board meeting reflect only that the Board noted the need for an
adjustment. The resolution did not make an adjustment or determine Fair Market Value.
It stated:
RESOLVED, that, subject to the consummation of the Distribution [i.e.,
the Spinoff], the exercise price of each Option shall be proportionately
adjusted to take into account the Distribution;, [sic] provided, however, that
any fractional shares resulting from the adjustment shall be eliminated[.]
JX 137 at CDX41619. The Board just as easily could have passed a resolution saying
―the Company shall be in compliance with all of its contractual commitments.‖ Passing
such a resolution would not make it so.
The same thing happened on November 21, 2011, when the Board approved the
Spinoff by unanimous written consent. JX 177. The written consent did not determine
51
Fair Market Value or make an adjustment to the options. As on October 5, the recitals
noted the need for an adjustment, and the pertinent resolution stated:
[E]ffective upon, and subject to, the consummation of the Distribution,
each Company Option shall be proportionately adjusted in accordance with
Section 12.1 of the Corporation Stock Plan and the underlying option grant
agreements to take into account the Distribution . . . .
Id. at CDX3996. The Board did not state what the adjustments were, nor did it determine
Fair Market Value.
Because the Board did not act as the Administrator to set the value that holders of
options would receive, Caris breached the Plan.
B. The Valuation Determination Was Not Made In Good Faith And Was
Arbitrary And Capricious.
The plaintiff next contends that irrespective of who determined what option
holders would receive, it was not made in good faith. As noted, the Plan defines Fair
Market Value as a value ―determined in good faith by the Administrator . . . .‖ JX 1 §
2.25. The Plan also provides that ―[a]ll decisions made by the Administrator pursuant to
the provisions of the Plan shall be final and binding on the Company and the Participants,
unless such decisions are determined to be arbitrary and capricious.‖ Id. § 3.4.
In its post-trial brief, Caris treated both provisions as if they established standards
of review. Caris then argued that the good faith standard is a more specific provision that
applies to the determination of Fair Market Value, while the arbitrary and capricious
52
standard is a more general standard that applies to ―[a]ll decisions made by the
Administrator.‖ According to Caris, the more specific good faith standard controls.12
In my view, the Plan read as a whole supports a different construction in which
both standards work together without conflict. First, under the good faith standard, the
Administrator must believe subjectively in the Fair Market Value it has selected. Second,
the decision reached must result from a process and fall within a range of outcomes that
is not ―arbitrary and capricious.‖ Under this two part test, a Board could believe
subjectively in the Fair Market Value it selected, and yet a reviewing court could
determine nevertheless that the result was arbitrary and capricious. This reading gives
―each provision and term effect, so as not to render any part of the contract mere
surplusage.‖ Kuhn Constr., Inc. v. Diamond State Port Corp., 990 A.2d 393, 396-97 (Del.
2010).
12
In its pre-trial brief, Caris appeared to accept that both contractual standards
could apply. See Dkt. 72 at 3 (―Thus, Plaintiff‘s claim fails unless he is able to establish
that the Board acted either in bad faith or arbitrarily and capriciously in determining the
Fair Market Value of the underlying common stock.‖). In its post-trial brief, Caris
claimed the plaintiff had never before argued that the determination of Fair Market Value
was arbitrary and capricious. Dkt. 105 at 35-36. Actually, his complaint made that
allegation, and Caris devoted large portions of its pre-trial brief to addressing it. See Dkt.
10 ¶¶ 7, 58; Dkt. 72 at 3, 30-34. Caris likewise asserted that the plaintiff cited the implied
covenant in its post-trial brief ―for the first time in these proceedings . . . .‖ Dkt. 105 at 41
(emphasis in original). Yet the complaint had cited the implied covenant, as did the pre-
trial order. See Dkt. 10 ¶ 117, Dkt. 91 ¶ 7. And Caris said that the complaint omitted any
claim for breach of the Plan based on by escrowing a portion of the option proceeds. In
truth, it was there. See Dkt. 10 ¶ 116 (―Additionally, in exercising its repurchase right
under the Plan, Defendant improperly withheld approximately eight percent (8%) of the
price paid to repurchase the option holders‘ options.‖). Caris‘s contention that the
plaintiff waived each of these arguments was not well founded.
53
1. The Valuation Determination Was Not Made In Good Faith.
The plaintiff contends that the determination of what the option holders received
could not have been reached in good faith. The plaintiff proved this contention at trial.
When a contract governed by Delaware law calls upon a party to act or make a
determination in good faith, without any qualifier, it means that the party must act in
subjective good faith.13 Under a subjective good faith standard, ―the ultimate inquiry
must focus on the subjective belief of the [party] accused of wrongful conduct.‖ Encore
Energy, 72 A.3d at 107. The Delaware Supreme Court has admonished that when
applying the subjective belief standard, ―[t]rial judges should avoid replacing the actual
[decision-makers] with hypothetical reasonable people . . . .‖ Id. Nevertheless, objective
facts remain logically and legally relevant, because ―objective factors may inform an
analysis of a defendant‘s subjective belief to the extent they bear on the defendant‘s
credibility when asserting that belief.‖ Id. When witnesses have testified that they
believed subjectively in what the contract required, the trial judge must ―make credibility
determinations about [each] defendant‘s subjective beliefs by weighing witness testimony
against objective facts.‖ Id. at 106. The credibility determination turns in part on ―the
demeanor of the witnesses whose states of mind are at issue . . . .‖ Johnson v. Shapiro,
2002 WL 31438477, at *4 (Del. Ch. Oct. 18, 2002).
13
ev3, Inc. v. Lesh, 114 A.3d 527, 539 (Del. 2014) (Strine, C.J.); DV Realty
Advisors LLC v. Policeman’s Annuity & Benefit Fund of Chi., 75 A.3d 101, 110 (Del.
2013); Allen v. Encore Energy P’rs, L.P., 72 A.3d 93, 104 (Del. 2013).
54
The Plan called upon the Board to determine Fair Market Value in good faith and
to adjust the options to reflect the Spinoff. Because the Board did not act, the good faith
standard arguably does not even apply. Assuming it does, it is not immediately clear to
whom it should be applied. In this case, Martino actually made the determination, and
Halbert signed off, so this decision analyzes whether they acted in subjective good faith.
The operative question is whether the $65 million value they placed on SpinCo reflected
their subjective belief about the value of TargetNow and Carisome. It did not.
a. Evidence Of Subjective Belief
Martino and Halbert did not believe that TargetNow was worth only $47 million.
The first indication is Martino‘s estimate in April 2011, provided in response to a
question from PwC. Martino told PwC that TargetNow was worth between $150 million
and $300 million. His figure matched up with Citi‘s estimate in May 2011 that the value
of TargetNow was $195 to $300 million.
During the bidding process for the AP business, Caris received strong indications
of interest in TargetNow from multiple bidders. Five of the strategic buyers expressed
interest in TargetNow. Although Caris instructed the bidders not to provide price
indications and to wait until after the sale of the AP business, Danaher expressed interest
in acquiring both the AP business and TargetNow for $825 to $900 million. Assuming
Danaher valued the AP business at Miraca‘s market-clearing price of $725 million, the
bid implied a value of $100 to $175 million for TargetNow. Danaher later declined to bid
on the AP business but stated that it still wanted to bid on TargetNow, implying that it
placed less value on the former and more on the latter. After the AP business was sold,
55
Illumina told Caris that it remained ―very interested in TargetNow.‖ JX 180. Danaher and
others, including Leica Microsystems, also remained interested. See JX 181; JX 186; JX
196; JX 197; JX 198; JX 199. Multiple documents indicate that as a result of the
information gained through the sale of AP business, Citi believed and was advising Caris
that TargetNow could sell for around $200 million. Martino was the point person for
Caris, and Halbert was kept informed throughout the process. Both knew about the
indications of value that the market was providing.
In addition, there were the valuations that Grant Thornton prepared in the ordinary
course. During 2011, Martino received three final reports and one draft report for use in
valuing stock options, and a valuation report for purposes of ASC 350 impairment
analysis. The ASC 350 report was the most thorough. It valued TargetNow‘s business,
trade name, and database on a debt free basis at $104 million. See JX 26.
There was also TargetNow‘s performance since Caris had bought it. Three years
earlier, Caris paid $40 million for TargetNow when it was generating approximately $1
million in annual revenue. Caris grew TargetNow‘s annual revenue to approximately $50
million. During the sale process for the AP business, Caris made presentations to bidders
that highlighted the increase and included bullish projections. It defies belief that Martino
and Halbert thought TargetNow‘s value had increased by only 17% when Caris had
grown its revenue by 5,000%.
Martino and Halbert likewise did not believe that Carisome was only worth $17.79
million. They thought it was worth at least as much as TargetNow. Placing an actual
value on Carisome was extremely difficult because if it succeeded, the company would
56
be worth billions, but if it failed, it would be worth nothing. Martino and Halbert
understood the risk. They thought Carisome could succeed.
One source of evidence is the Miraca Transaction itself. Although Halbert and
Fund VI were happy to take some profits, the other major purpose of the sale was to
provide ongoing funding for Carisome. TargetNow appeared to be on the verge of
achieving profitability. Halbert and Fund VI reinvested $100 million of the Merger
proceeds in SpinCo to fund Carisome. It was an early-stage investment in a promising
technology, but the size of the investment indicates their confidence in the project.
Consistent with their bullish view, Halbert and other members of management spoke
glowingly and optimistically about Carisome‘s prospects.14 Post-closing presentations to
the Board contemplated expanding Carisome with particular emphasis on its sales
function. JX 182. Management and the Board actually believed at the time that Carisome
could have a product to launch in early 2012. Id.Here too, Grant Thornton provided stock option valuations in the ordinary course
of business. The three final and one draft reports valued Carisome at $267 million (JX
23), $402 million (JX 22), $412 million (JX 35), and $568 million (JX 42). Those were
14
See JX 173 (Halbert email regarding closing: ―Thank you all for all of your hard
and good work getting this very important transaction completed!! Now its [sic] on to
Carisome!! And transforming the world!!!!‖); JX 163 (Johansen email to Halbert
regarding future plans for SpinCo: ―As we think about SpinCo as a juggernaut
developing and rolling out Carisome diagnostic tests over the next few years (and
beyond!), we would really like to get your candid feedback on how you think the
organization should ideally be designed and function.‖).
57
future valuations. The discounted figures were $116 million (JX 23), $147 million (JX
22), $169 million (JX 35), and $199 million (JX 42).
Some of the most probative evidence comes from the files of JH Whitney, a
sophisticated private equity firm whose representative, Castleman, served on the Board.
On November 3, 2011, JH Whitney gave a presentation to the advisory board of Fund VI
in which it valued Fund VI‘s 26.7% of TargetNow at $41 million, implying a value for
the whole business of $153.5 million. JX 161 at JHW884. In a presentation to investors in
Fund VI at its annual meeting, JH Whitney reported that Caris had a ―[s]igned purchase
agreement to sell [the] lab business‖ that would generate approximately $120 million for
Fund VI and was ―[e]xpecting [a] sale of Caris TargetNow to generate another $50mm+
in six to nine months[.]‖ JX 162 at JHW886. Because Fund VI owned 26.7% of SpinCo,
that estimate implied a value for TargetNow of approximately $187.2 million. Id. The
presentation provided the following additional information:
• TargetNow is run-rating $60mm+ revenue
- Attracted buyer interest during sale process of AP business
- Expect sale in six to nine months
Id. at JHW890. Other JH Whitney documents from the same period contained similar
assessments.15
15
See JX 191 (estimating that equity value of SpinCo was $159.8 million,
approximately 119% higher than the figure Fund VI was carrying on its financial
statements, which was $141.6 million); JX 193 at JHW880 (―TargetNow, the molecular
profiling business, is run-rating at over $60mm of revenue. The Company‘s current
expectation is to explore selling this asset in the next six to nine months.‖); JX 195
58
The JH Whitney documents were understandably more vague about the value of
Carisome, because there was far less certainty about its prospects. But they expressed
significant optimism. The annual meeting presentation described Carisome as a ―highly
valuable molecular diagnostics business[.]‖ JX 162 at JHW886. It also stated that there
was ―[c]ontinued momentum towards Carisome platform commercialization[.]‖ Id. at
JHW890. The ―Final Valuation Summary‖ stated that Carisome was ―well capitalized to
get to . . . commercialization of [a] blood test for cancer[.]‖ JX 191 at JHW873. JH
Whitney‘s year-end summary to Fund VI investors stated that
Carisome, Caris‘s molecular diagnostics business, continues to be a work in
process with tremendous upside potential. The Company is continuing to
invest aggressively in the Carisome platform with the expectation that it
will have a blood based test for cancer on the market by the end of the year.
JX 193 at JHW880. These documents reinforce my belief that Carisome was regarded as
at least as valuable as TargetNow.
Given this powerful evidence, it is impossible to credit that Martino and Halbert
actually believed in November 2011 that the value of TargetNow was only $47.23
million and that the value of Carisome was only $17.79 million. They subjectively
believed that both were worth much more.
b. Evidence Of Scienter
(placing enterprise value of SpinCo at $179.2 million). At trial, Castleman disavowed the
contemporaneous documents and testified directly contrary to them. He claimed that he
―did not think TargetNow could be sold‖ and that Carisome was ―ten years or 20 years‖
from commercialization. Castleman 507, 518-19. I credit the contemporaneous
documents.
59
In addition to the evidence of what Martino and Halbert actually believed, there is
persuasive evidence that Martino manipulated the valuation process. Also relevant to
their credibility is Martino and Halbert‘s testimony that they had no problem giving false
projections to bidders. These actions support a finding of subjective bad faith.
For the Miraca Transaction to be close, it was critical that Caris address the tax
issue. The goal was a valuation that would result in zero corporate level tax, and Martino
made sure to get there. Initially he pointed PwC to the figure that they needed to reach by
asking the firm to ―prepare something in draft based on a 40 million or so valuation . . . .‖
JX 96. At the same time, he provided PwC with reduced forecasts for TargetNow. PwC
used the projections to deliver the ―zero tax‖ result that its client wanted. JX 99. A day
later, they sent an even lower valuation that achieved the client‘s desire for something
around ―40 million or so.‖ JX 100.
Martino claimed in his deposition and at trial that the projections he prepared on
the morning of September 20, 2011, and sent to PwC were the Company‘s ―official
projections‖ and reflected his ―best estimate of what the future would hold . . . .‖ Martino
Dep. 110; see Martino 180-82. I do not credit that testimony, which was contrary to the
contemporaneous evidence and seemed crafted to parrot a legal standard. Martino also
testified that the goal of the valuation exercise was not to minimize taxes in connection
with the Spinoff but rather to ―come up with . . . the best estimate of the value of the
business based upon . . . how the business is going to perform.‖ Martino Dep. 145; see
Martino 182-83. I do not credit that testimony either.
60
After obtaining the zero-tax answer he wanted, Martino manufactured support for
PwC‘s suppressed valuation. When a member of the PwC team questioned the difference
between the tax basis for the holding company and the tax basis valuation for Carisome,
Martino instructed PwC that it could exclude R&D spending by Carisome from March
2010 to June 2011. When Deloitte questioned PwC‘s valuation and suggested that
Clarient was a comparable company, Martino drafted a memorandum asserting that it
was not. JX 118. Yet Caris had identified Clarient as a competitor in Board presentations,
Citi had pointed Illumina to the Clarient transaction as a comparable, and after GE
Healthcare bought Clarient, Halbert and Citi had invited GE to visit Caris to show them
that TargetNow was a superior offering that GE should purchase. Moreover, at the same
time Martino took the position that Clarient was not comparable in his memorandum for
Deloitte, he prepared a memorandum for PwC in which he justified his cuts to the
projections based in part on ―formidable‖ competition from Clarient, which he described
as having a ―TargetNow like offering.‖ JX 116. And on the bigger question of whether
TargetNow could be valued using comparable companies, Grant Thornton had done so in
two valuation reports in February 2011 (JX 22 & JX 23), another report in April (JX 26),
another in May (JX 35), and a draft report in July (JX 42). JH Whitney also valued
TargetNow using comparable companies. See JX 191 at JHW875.
Martino showed a similar lack of candor when Miraca‘s outside counsel expressed
concern about the valuation of TargetNow and Carisome and asked for information about
the lowered projections. Martino responded that ―[t]he projections have been reviewed
and approved by David [Halbert] and JH Whitney. All the information we have has been
61
provided to Deloitte via the PWC valuation.‖ JX 126. Those statements do not appear to
be accurate. The metadata from the file shows that Martino created them on the morning
of September 20, 2011, then emailed them to PwC at 8:35 a.m. The only projections that
the Board reviewed for TargetNow were the materially higher bidder projections.
Despite its concerns about PwC‘s valuation work, Miraca and Caris ultimately
compromised on an indemnification letter and a second opinion from Grant Thornton. At
that point, Martino intervened again. Rather than leaving Grant Thornton to its own
devices, he made sure Grant Thornton reached the right result. He arranged a meeting
with Grant Thornton and PwC before Grant Thornton started work, and he communicated
with PwC before the meeting about what they needed to tell Grant Thornton. Regardless
of what was claimed, Grant Thornton clearly understood the task it was assigned, because
the draft engagement letter that Grant Thornton sent Martino called for a ―tax basis‖
determination. JX 148 at CDX38291. Grant Thornton‘s employees got the message as
well: they correctly understood their task as ―just copying PwC‘s report and calling it our
own . . . .‖ JX 150. In support of that effort, Grant Thornton abandoned its historical
methods of valuation and tracked PwC‘s report.
Although Martino claimed at trial that he did not manipulate the projections, he
testified that he was willing to provide false projections for other purposes. During the
sale process for the AP business, Caris provided bidders with projections for TargetNow.
Martino and his team prepared them, and the full Board reviewed them. The projections
were materially higher than what Sawyers sent to PwC in August 2011, and the plaintiff
and his expert sought to rely on them when valuing TargetNow.
62
Martino and Halbert responded by testifying that they engaged in fraud. Martino
averred that ―at the time,‖ he did not believe ―at all‖ that it was possible for TargetNow to
achieve the numbers in ―any of the forecasts.‖ Martino 165. Halbert stated in his
deposition that when Caris provided the TargetNow projections to bidders, he believed
they were a ―fantasy land,‖ ―an impossibility,‖ and ―intentionally exaggerated.‖ Halbert
Dep., II 21. Counsel followed up:
Q. So you‘d be willing to provide information that you believed was
impossible as long as . . . the buyer believed it?
A. That‘s correct.
***
Q. But at least as far as the value-based pricing goes, you think these
were false at the time they were created?
A. They were fantasy.
Id. at 22-23.
During a sales process, a company may provide optimistic or bullish projections to
bidders, even ―extremely optimistic valuation scenarios for potential buyers in order to
induce favorable bids.‖16 There is an important line, however, between responsibly
aggressive projections and outright falsehoods: ―Pushing an optimistic scenario on a
potential buyer is to be expected; shoveling pure blarney at that stage is another.‖
16
In re Pennaco Energy, Inc., 787 A.2d 691, 713 (Del. Ch. 2001) (Strine, V.C.)
(citations and internal quotation marks omitted); see also In re Topps Co. S’holders
Litig., 926 A.2d 58, 76 (Del. Ch. 2007) (Strine, V.C.) (―[O]ne of the tasks of a diligent
sell-side advisor is to present a responsibly aggressive set of future assumptions to
buyers, in order to extract high bids.‖).
63
Pennaco Energy, 787 A.2d at 713. ―An optimistic prediction regarding a company‘s
future prospects‖ may rise to the level of a ―falsehood‖ if accompanied by ―evidence that
it was not made in good faith (i.e., not genuinely believed to be true) or that there was no
reasonable foundation for the prediction.‖17
By testifying that they knowingly provided projections to bidders that they did not
believe to be true, Martino and Halbert entangled themselves in a double-liar problem.
They asked me to believe them now that they were lying then. See Atr-Kim Eng Fin.
Corp. v. Araneta, 2006 WL 4782272, at *7, *17 (Del. Ch. Dec. 21, 2006) (Strine, V.C.)
(rejecting a ―believe-me-now-I-was-lying-then‖ explanation). My sense is that in reality,
17
Hubbard v. Hibbard Brown & Co., 633 A.2d 345, 350 (Del. 1993); accord
Eisenberg v. Gagnon, 766 F.2d 770, 776 (3d Cir. 1985) (―[A]n opinion must not be made
‗with reckless disregard for its truth or falsity,‘ or with a lack of a ‗genuine belief that the
information disclosed was accurate and complete in all material respects.‘‖ (quoting
McLean v. Alexander, 599 F.2d 1190, 1198 (3d Cir. 1979))); see, e.g., Osram Sylvania
Inc. v. Townsend Ventures, LLC, 2013 WL 6199554, at *13 (Del. Ch. Nov. 19, 2013)
(finding that the buyer under an agreement to purchase the remaining capital stock of a
company had a viable fraud claim against the seller by pleading that the seller
―intentionally inflated the sales figures, and otherwise manipulated the financial
statements, for Second Quarter 2011 to make it appear as though the Company had met
its forecasts and was more successful than it actually was‖); Abry P’rs V, L.P. v. F & W
Acq. LLC, 891 A.2d 1032, 1051 (Del. Ch. 2006) (Strine, V.C.) (declining to dismiss a
fraud claim in which the purchaser of a company alleged that the company intentionally
manipulated its financial statements to induce the buyer into purchasing the company at
an excessive price); Cobalt Operating, LLC v. James Crystal Enters., LLC, 2007 WL
2142926, at *27 (Del. Ch. July 20, 2007) (Strine, V.C.), aff’d, 945 A.2d 594 (Del. 2008)
(ruling that purchaser of radio station established the elements of common law fraud by
showing that the seller intentionally provided the purchaser with false financial
information that overstated the station‘s annual cash flow); see also Miramar Firefighters
Pension Fund v. AboveNet, Inc., 2013 WL 4033905, at *8 (Del. Ch. July 31, 2013)
(finding that ―alleged modifications to projections were not so far beyond the bounds of
reasonable judgment that the Board had to have known that the inputs were inaccurate or
that the use of such inputs was inexplicable on any ground other than bad faith‖).
64
the bidder projections were aggressive but provided in good faith. I further suspect that if
Martino and Halbert had to face a fraud claim, that is what they would say. But that only
creates a different credibility problem: their willingness to say what they believed would
help them in this litigation, regardless of whether it was actually true.
Martino suppressed the valuation of SpinCo to achieve zero tax. Halbert approved
it. The value of SpinCo was not determined in good faith.
2. The Valuation Determination Was Arbitrary And Capricious.
Assuming for purposes of analysis that Martino and Halbert did believe
subjectively in the valuation they selected, the process they followed was nonetheless
arbitrary and capricious. Although the Plan does not define this standard, a well-
developed body of law exists applying it in the context of decisions by administrative
agencies. Under the federal Administrative Procedures Act, a court reviewing agency
action ―shall hold unlawful and set aside agency action, findings, and conclusions found
to be arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with
law.‖ 5 U.S.C. § 706(2)(A). The United States Supreme Court has emphasized that ―the
scope of review under the ‗arbitrary and capricious‘ standard is narrow and a court is not
to substitute its judgment for that of the agency.‖ Motor Vehicle Mfrs. Ass’n of U.S., Inc.
v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983). A court should ―uphold a
decision of less than ideal clarity if the agency‘s path may reasonably be discerned.‖
Bowman Transp., Inc. v. Ark.–Best Freight Sys., Inc., 419 U.S. 281, 286 (1974).
―Nevertheless, the agency must examine the relevant data and articulate a
satisfactory explanation for its action including a ‗rational connection between the facts
65
found and the choice made.‘‖ Motor Vehicle Mfrs. Ass’n, 463 U.S. at 43 (quoting
Burlington Truck Lines, Inc. v. United States, 371 U.S. 156, 168 (1962)). A court may
find agency action to have been arbitrary and capricious
if the agency has relied on factors which Congress has not intended it to
consider, entirely failed to consider an important aspect of the problem,
offered an explanation for its decision that runs counter to the evidence
before the agency, or is so implausible that it could not be ascribed to a
difference in view or the product of agency expertise.
Id. ―The reviewing court should not attempt itself to make up for such deficiencies: ‗We
may not supply a reasoned basis for the agency‘s action that the agency itself has not
given.‘‖ Id. (quoting SEC v. Chenery Corp., 332 U.S. 194, 196 (1947)).
Delaware courts have explained the ―arbitrary and capricious‖ standard in similar
terms. This court has described as ―arbitrary and capricious‖ action which is
―unreasonable or irrational, or . . . that which is unconsidered or which is wilful and not
the result of a winnowing or sifting process.‖ Willdel Realty, Inc. v. New Castle Cnty.,
270 A.2d 174, 178 (Del. Ch. 1970), aff’d, 281 A.2d 612 (Del. 1971). The concept refers
to action taken ―without consideration of and in disregard of the facts and circumstances
of the case.‖ Id. ―Action is also said to be arbitrary and capricious if it is whimsical or
fickle, or not done according to reason; that is, it depends upon the will alone.‖ Id.This court has explained that an agency has satisfied the arbitrary and capricious
standard when it has ―a decision-making process rationally designed to uncover and
address the available facts and evidence that bear materially upon the issue being
decided.‖ Harmony Constr., Inc. v. State Dep’t of Transp., 668 A.2d 746, 751 (Del. Ch.
1995). The standard of review ―clearly is deferential, and its function is similar to that
66
performed by the business judgment standard for reviewing decisions of corporate boards
of directors.‖ Id. ―The purpose of both review standards is to prevent ‗second guessing‘
by courts of decisions that properly fall within the competence of a governmental (or
corporate) decision-making body, so long as those decisions rest upon sufficient evidence
and are made in good faith, disinterestedly, and with appropriate due care.‖ Id. As such,
arbitrary and capricious review is predominantly process-based. The reviewing court
should consider the adequacy of (i) ―the evidence considered by the [decision-maker]‖
and (ii) ―the process by which the relevant evidence and facts were obtained.‖ Id. at 750.
A decision can fall short under this standard if the decision-maker relied ―solely upon
selected facts or evidence that would support one particular outcome while at the same
time blinding itself—or refusing to inquire into—material facts or evidence that might
compel an opposite outcome.‖ Id.a. Martino Set Out To Achieve Zero Tax.
The determination of the consideration that option holders received was arbitrary
and capricious because it was not the result of a process ―designed to uncover and
address the available facts and evidence that bear materially upon the issue being
decided.‖ Harmony Constr., 668 A.2d at 751. As discussed previously, Martino set out to
achieve zero tax, and he succeeded in that goal.
b. The Use Of A Transfer Tax Valuation
The determination of the consideration that option holders received was also
arbitrary and capricious because Martino relied on a valuation prepared for a different
purpose. PwC did not determine the Fair Market Value of a share of common stock of
67
SpinCo. As its engagement letter stated, PwC prepared a tax transfer valuation of
TargetNow and Carisome‘s intellectual property. JX 80. PwC‘s lead relationship partner
testified that the only valuations PwC ever performed for Caris were transfer pricing
valuations. Moore Dep. 31-32. The parties stipulated in the pretrial order that PwC‘s final
report ―was completed for the purpose of determining intercompany transfer tax liability
under U.S. Internal Revenue Code §482 and the Treasury Regulation promulgated
thereunder . . . .‖ Pre-Trial Order ¶ 40. That section addresses the transfer of intangible
property between related parties.
PwC warned that its tax transfer valuation ―may not equate to the definition of fair
market value under Revenue Ruling 59-60, or to the concept of fair value in a financial
reporting context.‖18 When PwC conducted its Section 482 valuation, it applied what is
known as the arm‘s length method. This method ―seeks to ascertain the prices that would
be charged in transactions between related parties if they were independent entities
dealing at arm‘s length and then to determine tax consequences as if those arm‘s-length
prices had been used by the related parties.‖ J. Clifton Fleming, Jr. & Robert J. Peroni, A
Hitchhiker’s Guide to Outbound International Tax Reform, 18 Chap. L. Rev. 133, 146
n.41 (2014). But the arm‘s length method omits certain assets, including goodwill.
―Goodwill is not an intangible asset subject to the Section 482 Regulations regarding
18
JX 119 at CDX3094. Revenue Ruling 59-60 sets forth the ―methods, and factors
which must be considered in valuing . . . . corporate stocks on which market quotations
are either unavailable or are of such scarcity that they do not reflect the fair market
value.‖ Rev. Rul. 59-60, 1959-1 C.B. 237 (1959).
68
international transfers between controlled taxpayers.‖ Robert F. Reilly, Goodwill
Valuation Approaches and Methods, 94 PRACTXST 65, 66 (2015). By omitting
goodwill, a tax transfer valuation does not value the business as a going concern.
For TargetNow and Carisome, the difference between a tax transfer valuation and
a fair market valuation was substantial. The differential can be seen by comparing
competing valuations that PwC and Grant Thornton prepared with a valuation date of
March 31, 2010. PwC provided its valuation to support the transfer of Carisome‘s
intellectual property to a Gibraltar-domiciled subsidiary. Using the cost-basis method,
PwC valued Carisome‘s intellectual property at $10.25 million. JX 12 at CDX34388; JX
14. Meanwhile, Grant Thornton prepared its valuation for tax and financial reporting in
connection with stock options.19 Grant Thornton concluded that the value of the
Carisome business as of December 31, 2013, would be $266,991,000. After discounting
that value back to the March 31, 2010, valuation date, Grant Thornton‘s report assigned
Carisome a value of $115,981,000—fifteen times higher than what PwC derived using the
cost-basis method.20
19
Grant Thornton actually prepared two valuations with a valuation date as of
March 31, 2010. The firm initially prepared a draft valuation dated June 23, 2010. JX 13.
Grant Thornton later finalized its valuation in a report dated February 11, 2011. JX 23.
20
JX 22. Grant Thornton calculated a base case value of $226,614,000, an upside
case value of $388,123,000, and a downside case value of $24,750,000. For its fair
market value determination, Grant Thornton used a 50% weighting for the base case and
a 25% weighting for the other two cases. These figures are from the final report dated
February 11, 2011.
69
At trial, the defense witnesses claimed not to have understood the nature of PwC‘s
valuation. That may be true, but it is also another strike against Caris under the arbitrary
and capricious standard. ―When an agency makes a factual mistake because it relied on
incorrect information, it cannot be said to have made a rational decision.‖ Prison Health
Servs., Inc. v. State, 1993 WL 257409, at *3 (Del. Ch. June 29, 1993). Relying on a
transfer tax valuation of intellectual property to determine the fair market value of a
business was arbitrary and capricious.
3. The Grant Thornton Report
The Grant Thornton report deserves separate mention because its contents were so
flawed as to support both an inference of bad faith and a finding the process was arbitrary
and capricious. Previous Delaware decisions have criticized erroneous or seemingly
motivated analyses by financial advisors,21 but the Grant Thornton report reached a new
low. As Grant Thornton‘s employees recognized, they were ―just copying PwC‘s report
and calling it [their] own . . . .‖ JX 150. The copy job was so blatant that the output
matched PwC‘s, even when the inputs differed. And when Grant Thornton did its own
21
See, e.g., El Paso, 41 A.3d at 441 (noting ―questionable aspects to Goldman
[Sachs]‘s valuation of the spin-off‖); In re S. Peru Copper Corp. S’holder Deriv. Litig.,
52 A.3d 761, 771-73, 803-804 (Del. Ch. 2011) (Strine, C.) (critiquing misleading
analyses performed by Goldman Sachs); In re Loral Space & Commc’ns Inc., 2008 WL
4293781, at *10-11, *14-15 (Del. Ch. Sept. 19, 2008) (Strine, V.C.) (critiquing
misleading presentation by North Point Advisors); Robert M. Bass Gp., Inc. v. Evans,
552 A.2d 1227, 1245 (Del. Ch. 1988) (critiquing misleading analyses performed by
Lazard and noting ―at least one assumption that is incorrect, and upon others that are
highly questionable‖).
70
work, it made fatal errors, such as using the materially lower figure for nine-month
trailing revenue rather than twelve-month projected revenue.
Grant Thornton was capable of valuing TargetNow and Carisome as going
concerns. Grant Thornton did so in 2011 three times formally and one time in draft. Grant
Thornton also prepared a formal valuation for an ASC 350 impairment analysis. Each
time, Grant Thornton used management projections and a combination of the DCF and
comparable company methods. Each time, Grant Thornton valued TargetNow and
Carisome at multiples of the value it reached for the Spinoff. For the Spinoff, Grant
Thornton abandoned its prior methodologies and reached a valuation so much lower as to
be itself suggestive of bad faith.
At trial, the defense witnesses wisely tried to distance themselves from Grant
Thornton‘s work by conceding that it was flawed and arguing that no one relied on it. But
the report nevertheless reflects on the integrity of the process. It is an example of action
―so egregiously unreasonable‖ as to be ―essentially inexplicable on any ground other than
subjective bad faith.‖ Encore Energy, 72 A.3d at 107 (alterations and internal quotation
marks omitted).
C. Caris Breached The Plan By Retaining A Portion Of The Consideration In
Escrow.
As his third claim of breach, the plaintiff argues that Caris breached the Plan by
withholding a portion of the merger consideration to fund the option holders‘
proportionate share of the escrow fund. Caris has responded that it did what the Merger
71
Agreement required. Unfortunately for Caris, the Plan governs the options, not the
Merger Agreement.
As a threshold matter, it is undisputed that some amount was withheld and placed
in escrow. Until the post-trial hearing, it appeared that the parties agreed as to both the
fact and the amount. The parties stipulated in the pretrial order that
[t]he initial cash payment to each option holder in connection with the
Option Transaction was equal to (A) the difference between (i) $5.07 per
share minus (ii) the applicable per share exercise price of such option
holder‘s options, multiplied by (B) the number of stock options granted,
minus (C) 8% of the cash payment to such option holder to be placed into
the holdback escrow account, minus (D) the amount of federal tax, state
income tax (where applicable) and payroll tax withheld.
Pre-Trial Order ¶ 19. The parties also stipulated that
[t]he aggregate cash payment to the option holders, in connection with the
Option Transaction, without regard of [sic] the escrow holdback or tax
withholdings, was approximately $22,520,414. After taking into account
the 8% escrow holdback, the aggregate cash payment to such option
holders was approximately $20,713,012.
Id. ¶ 20. Taken together, these facts established that the gross payment was $22,520,414,
that the payment net of the escrow holdback was $20,713,012, and therefore that the
amount deducted from the option payout and kept in escrow was $1,807,402.
These stipulations left the court to decide a question of law: did the Plan permit
Caris to withhold a portion of the consideration due to the option holders? Yet in their
post-trial brief, the defendants objected vociferously, claiming that Caris
did not withhold 8% of option holders‘ $5.07 consideration (less strike
price) and 8% of New Caris stockholders‘ $4.46 consideration. Instead, it
withheld $40 million, as required by Section 2.10(b)(i) [sic] the Merger
Agreement (JX144), which accounted for approximately 8% of the total
proceeds due to stockholders and option holders from the sale of the AP
72
Business. See JX167; JX136 at 2. In other words, approximately 8% of
$4.46 was withheld from both option holders and stockholders.
Dkt. 105 at 39-40. Caris contended that there were documents in the discovery record to
support its assertion, but that those documents had not been introduced at trial because
―Plaintiff made a tactical decision . . . not to submit any evidence into the record . . . .‖ Id.
at 40-41. Caris also claimed that the plaintiff had not raised this issue in his complaint.
The plaintiff actually had raised this issue in his complaint. See Dkt. 10 ¶ 116
(―Additionally, in exercising its repurchase right under the Plan, Defendant improperly
withheld approximately eight percent (8%) of the price paid to repurchase the option
holders‘ options.‖). And the plaintiff did not have to submit evidence into the record
because the plaintiff obtained stipulations of fact in the pre-trial order that eliminated the
need for proof.
Caris continued to object at the post-trial hearing. By this point, Caris had a
different argument: Caris had adjusted the exercise price and issued more shares. As
counsel explained, ―so what you got, if you were an option holder, is you got a bunch of
adjusted options, and you got more than you had before. So you got options with a lower
strike price, but you got more of them. . . .‖ Dkt. 115 at 62. Counsel provided the
following example:
So let‘s assume you have got a thousand of these $5 options. Okay. So what
happened in the merger was that they took the ratio [of 1.1367] . . . and they
used that in two ways. They multiplied your thousand options by that
number. So now you had 1,137 options. They also took that and divided it
into the exercise price to reduce your exercise price to $4.40. So now you
have 1,137 options, with a strike price of $4.40, where before you had a
thousand options with a strike price of 5.
73
***
So now what you‘ve done is now gotten the value that you should get, your
61 cents a share, the difference between 4.46 and 5.07. You‘ve gotten that.
But you didn‘t get it in cash from 5.07 a share; you have got it because you
got more shares. You now have 1,137 options; whereas before you had
1,000. And that way the math works. The exercise price is now 4.40. You
are covered because you got 4.46. You get your money; you are made
whole.
Id. at 64.
In an effort to ensure that I understood the Company‘s position, I permitted Caris
to supplement the record with additional exhibits and to make a supplemental
submission. The supplemental submission confirmed that Caris had handled the options
as described during post-trial argument. That reality was contrary to the stipulated facts,
earlier verified responses to interrogatories, earlier answers to requests for admissions,
and the description of the option payout that Caris send to option holders. What did not
change was the fact that Caris had withheld a portion of the payment to fund the escrow.
The relationship between Caris and its option holders was governed by contract.
The operative contract was not the Merger Agreement, but rather the Plan. See Nemec v.
Shrader, 2009 WL 1204346, at *4 (Del. Ch. Apr. 30, 2009) (―Whether the directors
possessed the right to redeem plaintiffs‘ shares and whether the directors properly
exercised that right is simply a matter of contract interpretation.‖), aff’d, 991 A.2d 1120(Del. 2010). Section 12.3 of the Plan gave the Board discretion as to whether to cancel
the options in connection with the Merger, but if it did, then the option holders were
entitled to receive ―the difference between the Fair Market Value and the exercise price
for all shares of Common Stock subject to exercise.‖ The Plan did not permit an escrow
74
holdback. It required a payment of the difference between Fair Market Value and the
exercise price.
The Merger Agreement did provide for an escrow holdback. As described in the
Factual Background, the Option Conversion Provision purported to convert the options
into the right to receive certain consideration, defined the consideration in terms of the
Per Share Common Payment, and thereby incorporated the escrow provisions in the
Merger Agreement. Section 251(b)(5) of the DGCL provides that a merger agreement
shall state
[t]he manner, if any, of converting the shares of each of the constituent
corporations into shares or other securities of the corporation surviving or
resulting from the merger or consolidation, or of cancelling some or all of
such shares, and, if any shares of any of the constituent corporations are not
to remain outstanding, to be converted solely into shares or other securities
of the surviving or resulting corporation or to be cancelled, the cash,
property, rights or securities of any other corporation or entity which the
holders of such shares are to receive in exchange for, or upon conversion of
such shares . . . .
8 Del. C. § 251(b)(5). Section 251(b) also provides that
[a]ny of the terms of the agreement of merger or consolidation may be
made dependent upon facts ascertainable outside of such agreement,
provided that the manner in which such facts shall operate upon the terms
of the agreement is clearly and expressly set forth in the agreement of
merger or consolidation. The term ―facts,‖ as used in the preceding
sentence, includes, but is not limited to, the occurrence of any event,
including a determination or action by any person or body, including the
corporation.
Id. § 251(b). By virtue of these provisions, a merger agreement can convert shares into
the right to receive consideration that incorporates the outcome of an indemnification
mechanism. See Aveta Inc. v. Cavallieri, 23 A.3d 157, 171-78 (Del. Ch. 2010). The
75
power to specify the package of consideration into which shares are converted and to
make the consideration dependent upon facts outside the merger agreement enables deal
planners to bind non-signatory stockholders to post-closing adjustments, including
escrow arrangements, when those stockholders otherwise would not be bound under basic
principles of contract and agency law. See id. at 169-71 (holding that principal
stockholders who signed merger agreement were bound to its terms).
Options are not shares, and option holders are not stockholders. See Harff v.
Kerkorian, 324 A.2d 215, 219 (Del. Ch. 1974), aff’d in part, rev’d on other grounds, 347
A.2d 133 (Del. 1975). Options are rights granted pursuant to Section 157 of the DGCL.
The rights and obligations of the parties to the option are governed by the terms of their
contract.22 Section 251(b)(5) does not authorize the conversion of options in a merger.
The Plan could have been drafted differently, such as by providing that holders of options
cancelled in connection with the merger would receive the same consideration received
by holders of stock, less the exercise price. The Plan did not say that. The Plan said that
holders of cancelled options would receive the difference between the Fair Market Value
of the underlying shares and the exercise price for their options.
Caris breached the Plan by deducting the escrow amount from the consideration it
paid to holders of cancelled options. The Plan obligated Caris to pay them the full amount
of the difference between Fair Market Value and the exercise price. Because of the
22
See AT&T Corp v. Lillis, 953 A.2d 241, 252 (Del. 2008); Gamble v. Penn.
Valley Crude Oil Corp., 104 A.2d 257, 260-61 (Del. Ch. 1954) (Seitz, V.C.); Kingston v.
Home Life Ins. Of Am., 101 A. 898, 900 (Del. Ch. 1917).
76
remedy granted in this decision, this holding does not give rise to separate element of
damages. As discussed in the next section, this decision awards the holders of cancelled
options the difference between what the Board should have determined in good faith to
be Fair Market Value and the amount the option holders received. Caris may decide to
pay a portion of the judgment by delivering the escrowed portion of the option
consideration to the option holders. Or Caris may pay the judgment separately, in which
case the option holders would not be entitled to any amount from the escrow. Awarding
the option holders damages plus permitting them to receive their share of the escrowed
funds would result in a duplicative recovery.
D. Damages
―To satisfy the final element [of a breach of contract claim], a plaintiff must show
both the existence of damages provable to a reasonable certainty, and that the damages
flowed from the defendant‘s violation of the contract.‖ eCommerce Indus., Inc. v. MWA
Intelligence, Inc., 2013 WL 5621678, at *13 (Del. Ch. Sept. 30, 2013). ―While courts will
not award damages which require speculation as to the value of unknown future
transactions, so long as the court has a basis for a responsible estimate of damages, and
plaintiff has suffered some harm, mathematical certainty is not required.‖ Thorpe v.
CERBCO, Inc., 19 Del. J. Corp. L. 942, 963 (Del. Ch. Oct. 29, 1993) (Allen, C.).
―[T]he standard remedy for breach of contract is based upon the reasonable
expectations of the parties ex ante.‖ Duncan v. Theratx, Inc., 775 A.2d 1019, 1022 (Del.
2001). ―It is a basic principle of contract law that remedy for a breach should seek to give
the nonbreaching the party the benefit of its bargain by putting that party in the position it
77
would have been but for the breach.‖ Genencor Int’l, Inc. v. Novo Nordisk A/S, 766 A.2d
8, 11 (Del. 2000). ―Expectation damages thus require the breaching promisor to
compensate the promisee for the promisee‘s reasonable expectation of the value of the
breached contract, and, hence, what the promisee lost.‖ Duncan, 775 A.2d at 1022. Here,
the plaintiff alleges that the Administrator‘s arbitrary and capricious determination of fair
market value undervalued the Caris options. The court must, therefore, ―determine
plaintiff‘s damages as if the parties had fully performed the contract.‖ Reserves Dev. LLC
v. Crystal Props., LLC, 986 A.2d 362, 367 (Del. 2009).
The question in this case is what the Board would have determined to be the Fair
Market Value of a share of Caris common stock in connection with the Merger, if it had
adjusted the options to take into account the Spinoff and made its determination in good
faith. I have considered the evidence as a whole, including the experts‘ opinions and the
various indications of value.
In my view, had the Board proceeded in good faith, it would have retained Grant
Thornton to determine the fair market value of TargetNow and Carisome. Absent
Martino‘s intervention, Grant Thornton would have prepared its report using methods and
techniques that were consistent with its prior work. The Board then would have used the
values of TargetNow and Carisome, in conjunction with the sale price for the AP
business, to determine what option holders would have received.
The record contains the draft stock option valuation that Grant Thornton prepared
in the ordinary course using figures that became the basis for the August 2011
projections. See JX 42. In that valuation, Grant Thornton derived values for the AP
78
business, TargetNow, and Carisome as of December 31, 2015, then discounted the
figures back to the valuation date of March 31, 2011. For the damages calculation, I will
discount the figures back to a valuation date of October 31, 2011, which is the same date
PwC and Grant Thornton used. It provides a convenient end-of-the-month date between
the approval of the Merger Agreement on October 5 and the closing of the Miraca
Transaction on November 22. The following table depicts the calculations:
GT Weighted Discount Value as of
Base Upside Downside Avg. Rate23 10/31/2011
AP Business $815,862 $1,140,479 $585,833 $897,016 15.3 $495,654
TargetNow $93,027 $114,589 $72,290 $98,418 19.1 $47,509
Carisome $485,851 $812,494 $178,123 $567,512 24.7 $226,220
As the table shows, combining TargetNow and Carisome implies a value for
SpinCo of $273,729,000. From the evidence presented at trial, this is a reasonable
approximation of the Board‘s subjective belief at the time. My assessment of what the
Board believed differs only in the relative weighting. I think that in fall 2011, the Board
valued TargetNow more highly—closer to $150 million. That figure is at the low end of
the $150 to $300 million that Martino estimated in April and below the $195 to 300
million that Citi estimated in May and suggested at other points in the process. It is
towards the low end of the values in JH Whitney‘s internal documents, which referenced
figures of $153.5 million (JX 161) and $187.2 million (JX 162).
23
The discount factor is the weighted average cost of capital for each business, as
calculated by Grant Thornton. See JX 42 at CDX177782.
79
My belief from the record is that the Board did not value Carisome as highly as the
Grant Thornton figures imply. The success of Carisome was still too contingent and
uncertain, and Carisome had experienced more significant setbacks than TargetNow.
What the evidence instead suggests is that the Board believed Carisome, although riskier,
was worth at least as much as TargetNow. The Board actually thought Carisome was
likely worth more, but only if the lottery ticket paid off.
Based on this reasoning, were I to set aside the Grant Thornton stock option
analysis, I would conclude from the balance of the record that the Board believed
TargetNow and Carisome together were worth around $300 million. Grant Thornton‘s
figure of $273 million is conservative relative to that assessment. It bears noting that
Grant Thornton‘s work implied a value for the AP business on the valuation date of $456
million, roughly 63% of the price Miraca paid. This comparison suggests that when
conducted in the ordinary course, Grant Thornton‘s valuation work was not overly
aggressive.
Using documents from the record, the plaintiff‘s expert constructed a table that
calculated the value per share generated in the Miraca Transaction. I have reproduced it
below with two additional columns to reflect my adjustment to the value of SpinCo.
80
Caris Fair Market Value Merger SpinCo Total Caris Adjusted Adjusted
Consideration Value Value SpinCo Caris
Miraca Transaction Price 725,000 725,000 725,000
FMV of TargetNow and
Carisome 65,030 65,030 240,000 240,000
Plus: Other Adjustments 3,326 3,326 3,326 3,326
Less Outstanding Debt (178,134) (178,134) (178,134)
Less Transaction Fee (7,345) (7,345) (7,345)
Less Transaction Expense (3,286) (3,286) (3,286)
Plus Option Exercise Cash 22,496 22,496 22,496
Plus Balance Sheet Cash 29,667 2,720 32,387 2,720 32,387
Less Working Capital Adj. (1,702) (1,702) (1,702)
Implied Equity Value 586,697 71,076 657,773 246,046 778,742
Less Value of Preferred (64,550) (64,550) (64,550)
FMV Common Shares 522,146 71,076 593,222 246,046 714,192
Total Common Shares (000) 116,991 116,991 116,991 116,991 116,991
Per Share FMV of Common
Shares ($) $4.46 $0.61 $5.07 $2.10 $6.57
The parties stipulated that options to purchase 9,663,026 shares were cancelled in
connection with the Merger. The parties stipulated that the aggregate exercise price of the
9,663,026 options was $26,467,487 and that the option holders received proceeds of
$20,713,012. This amount included the escrow deduction. Based on these figures, the
Class is entitled to damages of $16,260,332.77.
Cancelled Option Shares 9,663,026
FMV Per Share $6.57
Total FMV of Cancelled Option Shares $63,499,831.77
Less: Aggregate Exercise Price $26,476,487.00
Less: Proceeds Received $20,713,012.00
Damages Suffered By Class $16,260,332.77
The plaintiff has sought additional damages based on the tax treatment that the
option holders received. He observes that the proceeds from the cancellation of the
options were taxed as ordinary income. Halbert and Fund VI received capital gains tax
treatment for the combination of cash and stock that they received. The plaintiff observes
81
that Caris reached a special agreement with Knowles to make him whole for the
additional tax he paid on his options so that he would receive the functional benefit of
capital gains treatment. The tax treatment is a function of federal law. The option holders‘
proceeds would have been taxed as ordinary income even if Caris had fulfilled its
obligations under the Plan. This is not an element of damages to which they are entitled.
III. CONCLUSION
The Class is awarded damages of $16,260,332.77. Pre- and post-judgment interest
is due on this amount at the legal rate, compounded quarterly, from November 22, 2011,
until the date of payment.
82
EXHIBIT A
Exhibit JX 23 JX 22 JX 26 JX 35 JX 42 JX 168
Purpose Options Options ASC 350 Options Options Spinoff
Report Date 2/11/11 2/11/11 4/5/11 5/24/11 7/13/11 11/10/11
Valuation Date 3/31/10 6/30/10 10/1/10 12/31/10 3/31/11 10/31/11
Future Valuation
Date 12/31/13 12/31/14 NA 12/31/14 12/31/15 NA
AP Business Base
Case $763,947 $911,156 NA $761,326 $815,862 NA
AP Business
Upside Case $873,197 $987,844 NA $999,450 $1,140,479 NA
AP Business
Downside Case $626,147 $787,718 NA $519,756 $585,833 NA
AP Business
Weighted Average $791,260 $930,328 NA $820,857 $897,016 NA
AP Business
Discount Rate 15.40% 15.50% 14.90% 15.50% 15.30% NA
AP Business as of
Valuation Date $462,431 $486,426 $650,671 $461,253 $456,154 $725,000
AP Business as of
10/31/11 $580,149 $589,467 NA $520,105 $495,654 $725,000
TargetNow Base
Case $167,154 $135,533 NA $114,285 $93,027 NA
TargetNow Upside
Case $182,037 $143,888 NA $136,305 $114,589 NA
TargetNow
Downside Case $148,830 $126,429 NA $97,382 $72,290 NA
TargetNow
Weighted Average $170,875 $137,622 NA $119,790 $98,418 NA
TargetNow
Discount Rate 19.20% 19.30% 18.70% 19.30% 19.10% NA
TargetNow as of
Valuation Date $88,439 $62,202 $104,278 [2] $59,137 $42,903 $37,122
TargetNow as of
10/31/11 $116,792 $78,703 NA $68,506 $47,509 $37,122
Carisome Base
Case $226,614 $322,232 NA $343,267 $485,851 NA
Carisome Upside
Case $388,123 $639,861 NA $617,162 $812,494 NA
Carisome
Downside Case $24,750 $236,666 NA $103,639 $178,123 NA
Carisome
Weighted Average $266,991 $401,639 NA $411,741 $567,512 NA
Carisome Discount
Rate 24.90% 25.10% NA 24.90% 24.70% NA
Carisome as of
Valuation Date $115,981 $146,615 NA $169,190 $198,888 $17,634
Carisome as of
10/31/11 $164,922 $197,631 NA $203,630 $226,220 $17,634
Notes:
1. All dollar figures are in 000s.
2. The ASC 350 report separately valued the TargetNow tradename at $2,767,000 and that database at
$3,150,000. Those assets have been added to the TargetNow value. In addition, the report valued
TargetNow's equity after allocating to TargetNow $12,271,000 of Caris’s debt. The other reports value
TargetNow as a debt-free enterprise, so the value of the debt has been added back to generate a similar
enterprise value.
3. Present Value Periods used for discounting:
3/31/2010 6/30/2010 12/31/2010 3/31/2011 10/31/2011
12/31/2013 3.75 3.5 3 2.75 2.16666667
12/31/2014 4.75 4.5 4 3.75 3.16666667
12/31/2015 5.75 5.5 5 4.75 4.16666667