Mickael A. Flaa v. Daniel C. Montano

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
MICKAEL A. FLAA, )
)
Plaintiff, )
)
v. ) Civil Action No. 9146-VCG
)
DANIEL C. MONTANO, VIKTORIYA )
T. MONTANO, JOHN W. JACOBS, )
ERNEST C. MONTANO, ERNEST )
MONTANO III and JOONG KI BAIK, )
)
Defendants, )
)
and )
)
CARDIOVASCULAR )
BIOTHERAPEUTICS, INC. )
)
Nominal Defendant. )
MEMORANDUM OPINION
Date Submitted: May 2, 2014
Date Decided: May 29, 2014
Richard P. Rollo, of Richards, Layton & Finger, P.A., Wilmington, Delaware; OF
COUNSEL: Barry F. Cannaday, of Dentons US LLP, Dallas, Texas, Attorneys for
the Plaintiff.
David L. Finger, of Finger & Slanina, LLC, Wilmington, Delaware, Attorney for
the Defendants.
GLASSCOCK, Vice Chancellor
This Memorandum Opinion concerns the latest skirmish in the battle for
control of CardioVascular BioTherapeutics, Inc. (“Cardio,” or the “Company”),
between forces allied with its founder, Daniel Montano, and those supporting a
large creditor of Cardio, Calvin Wallen. Although Cardio has not yet been able to
monetize any product, both parties view the Company as on the cusp of success.
The current dispute is over the second written consent action taken on behalf of the
Wallen faction in less than a year, seeking to seat a board of directors amenable to
him, and purporting to remove Montano and his supporters from the Cardio board.
The stockholders’ view, as revealed by the written consent actions, is in near
equipoise. The deciding votes in both consent actions were cast by Vizier
Investment Capital Limited (“Vizier”), an entity created by Montano to hold
Cardio stock he held jointly with his then-wife, Victoria “Vicki” Montano. Vicki,1
now divorced from Montano, purported to consent with respect to the Vizier shares
in favor of the Wallen slate in the first consent action; I found those consents to be
invalid, as Vicki lacked the authority to vote the shares. Montano has since
entered personal bankruptcy, and the Vizier shares are now under the control of a
trustee in bankruptcy. The trustee provided a proxy to Wallen which he used to
vote the Vizier shares in favor of his slate of directors in the second consent action;
for the reasons below, I find that the agreement between Wallen and the trustee
1
I refer to Vicki Montano by her first name to avoid confusion. No disrespect is intended.
2
was inadequately disclosed to stockholders of Cardio, and that the second consent
action is invalid.
Shortly after the first consent action, the Wallen faction was seated as the
“new” Cardio board, and one of the board members, Plaintiff Mickael A. Flaa,
brought the first incarnation of this action under Section 225 to confirm the validity
of that board. I entered a status quo order leaving the Wallen faction in place as
the interim board of directors, with its ability to act limited to actions in the normal
course of business, pending resolution of the dispute in this Court. After I found
that the first consent action was invalid, the Plaintiff appealed, and the parties
agreed that the status quo order should remain in effect. That appeal was delayed,
however, as Wallen mounted the second consent action. Because this second
action had the potential to moot all issues on appeal, the Supreme Court stayed
consideration of the appeal, and the current litigation ensued.
Cardio has been, effectively, in limbo for nearly a year, with a board of
directors unable to exercise plenary authority over the corporation. Moreover, the
record indicates that it has been years since an annual meeting of the stockholders
has taken place. A stockholder meeting presided over by the interim board would
inevitably drive more litigation, and seating the old Montano-faction board would
put back in place directors last elected years ago, who have not served in nearly a
year. In order to ensure a board of directors representing the preference of the
3
stockholders as expressed by exercise of their franchise, I employ my discretion to
order a stockholder meeting to be held promptly, presided over by a special master.
I. FACTS
1. Flaa I
As explained in a prior iteration of this action, Flaa I,2 Cardio is a Delaware
corporation that, due to its as-yet unsuccessful efforts to develop a drug candidate
for treating coronary artery disease, peripheral artery disease, venous ulcers, and
diabetic foot ulcers, has faced a serious liquidity crisis.3 This litigation involves
the second Court of Chancery action within a matter of months brought pursuant to
8 Del. C. § 225, seeking to confirm the removal of certain directors of Cardio,
including its founder Daniel Montano, by way of a written consent action led by
one of Cardio’s largest creditors, Calvin Wallen.
As presented in more detail in Flaa I, in January 2013, Wallen, hoping to
salvage some of his investment in Cardio, sent a letter to the Company’s board of
directors, in which he set forth a financing proposal intended to infuse $8,500,000
of capital into the Company, contingent on the immediate resignation of the
director Defendants, including Montano, and on Montano waiving all claims
2
Flaa v. Montano, 2013 WL 5498045 (Del. Ch. Oct. 4, 2013).
3
See Defs.’ Op. Pre-Trial Br. at 2 (“Finding investors who wanted to invest in a company with
no saleable products was difficult.”).
4
against Cardio.4 When the Cardio board rejected his financing proposal, Wallen
initiated a written consent action (the “First Consent Action”), requesting that
stockholders consent to (1) amending the Company’s bylaws with respect to
director removal and appointments, (2) removing the Defendant directors from the
Cardio board, and (3) directing the remaining directors to consider his financing
proposal. As a result of Wallen’s written consent solicitation, the Company
received consents from 51.22% of shares outstanding, and the Plaintiff filed suit in
this Court in June 2013, seeking to confirm the effectiveness of the First Consent
Action. However, I determined in Flaa I that a dispositive consent delivered on
behalf of Vizier, a Bahamian company jointly owned by Montano and his ex-wife,
Vicki, was executed without actual or apparent authority; accordingly, I found that
the First Consent Action was ineffective to remove the Defendant directors from
the Cardio board.
At the start of litigation in Flaa I, a status quo order was put in place (the
“Status Quo Order”), permitting incumbent directors Grant Gordon and Mickael
Flaa, as well as the incoming directors seated pursuant to the First Consent
Action—Wallen, Jon Ross, and Robert Schleizer—(collectively, the “Interim
4
That letter was preceded by both a June 2012 request by Wallen that Cardio convert his debt to
equity, which request was rejected by the Cardio board, and a September 2012 Nevada action in
which Wallen sought to enforce Montano’s personal guarantee of loans from Wallen to Cardio.
Those transactions are described in additional detail in Flaa I. See Flaa, 2013 WL 5498045, at
*2.
5
Board”) to sit on the Cardio board of directors pending resolution of the litigation.5
After I issued my October 4, 2013 Memorandum Opinion, the Plaintiff filed an
appeal of that decision in our Supreme Court. Pending that appeal, the parties
stipulated to abide by the Status Quo Order. As explained in more detail below,
the appeal of my October 4 Memorandum Opinion has been stayed pending
resolution of this 225 action,6 and the Interim Board continues to manage the
Company pursuant to the Status Quo Order.
2. The Second Consent Action
On November 6, 2013, as the parties were briefing the Defendants’ appeal in
Flaa I, Wallen caused Cardio stockholder CCM Partners Fund LP (“CCM”) to
deliver a written consent to Cardio’s registered agent, initiating a new written
consent action (the “Second Consent Action”). In a November 16, 2013 press
release, the Company said of the Second Consent Action, “[t]o avoid any potential
confusion, the solicitation is being made by Calvin Wallen III, a [Cardio]
stockholder, and not by [Cardio].”7 Upon delivery of CCM’s written consent,
Wallen circulated proxy solicitation materials, consisting of a proxy statement and
proxy card dated November 11, 2013, to Cardio’s stockholders.
The proxy card included in Wallen’s solicitation materials stated, in part:
5
Flaa v. Montano, No. 8632–VCG (Del. Ch. July 12, 2013) (ORDER).
6
Flaa v. Montano, No. 577,2013 (Del. Jan. 30, 2014) (Letter to Counsel).
7
JX 82.
6
The undersigned hereby acknowledges receipt of the proxy statement
in connection with the proposals to amend the Amended and Restated
Bylaws of [Cardio] and to remove all members of the Board of
Directors of the Corporation other than Mickael Flaa and Grant
Gordon . . . .
The undersigned hereby constitutes and appoints Calvin A. Wallen,
III, as his, her or its true and lawful agent and proxy with full power
of substitution and re-substitution, to execute a written consent,
withhold consent, or abstain on behalf of all of the shares held by the
undersigned as of the Record Date, in accordance with the instructions
given herein.8
The proxy statement included in the solicitation materials described Wallen’s
“proposals” in more detail: Proposition 1 purported to amend the Cardio bylaws
with respect to removal and appointments, and Proposition 2 to remove certain
directors. Specifically, Proposition 2 stated:
BE IT RESOLVED, that the undersigned hereby consents to, adopts
and approves the removal of all of the members of the Board of
Directors of the Corporation in office immediately prior to the
effective time of [the] Written Consent other than Mickael A. Flaa and
Grant Gordon (each director so removed, a “Removed Director,” and
all directors so removed, collectively, the “Removed Directors”), and
without limiting the intent of the stockholders to remove all such
Removed Directors, the Removed Directors shall specifically include
each of Daniel C. Montano, Viktoriya Tamlenova Montano, Ernest C.
Montano, Ernest Montano III, John (Jack) W. Jacobs and Joong Ki
Baik, if he or she is in office immediately prior to the effective time of
this Written Consent.9
Though stockholders received identical proxy solicitation materials, Wallen
obtained proxies in the Second Consent Action by three methods: (1) Vizier and
8
Pl.’s Pre-Trial Answering Br. at 5.
9
Compl. Ex. E at 1799982.2.
7
certain other stockholders not at issue here executed proxies by hand-delivery of
completed paper proxy cards; (2) certain Cardio stockholders of record executed
electronic proxies by telephone and internet, purporting to permit Wallen to deliver
written consents on their behalves; and (3) certain brokerage firms executed
powers of attorney to a proxy tabulating agency, Broadridge, which in turn
executed proxies purporting to permit Wallen to deliver written consents on behalf
of the stocks’ record owners. On November 27, 2013 and January 2, 2014, Wallen
delivered written consents to Cardio’s registered agent supported by proxies
obtained from these other Cardio stockholders, by which a majority of the Cardio
shares purported to consent to the removal of the “Removed Directors”—the
Defendants in this action.
A. The Vizier Proxy
In Flaa I, I determined that a written consent, executed by Montano’s ex-
wife Vicki on behalf of Vizier, was executed without actual or apparent authority.
At that time, Vizier held 30 million shares of Cardio, jointly owned by Daniel and
Vicki Montano. I found that Montano, as President of Vizier, had authority to vote
the Cardio shares, and that Vicki, in her capacity as either Vice President or
stockholder, did not.
In July 2013, Montano filed for bankruptcy under Chapter 7 of the U.S.
Bankruptcy Code. As a result of that filing, U.S. Bankruptcy Trustee Dotan
8
Melech (the “Trustee”) obtained control over Montano’s interest in 4 million
directly-held shares of Cardio, as well as his fifty-percent interest in the 30 million
Cardio shares held by Vizier. Soon after this Court issued its Memorandum
Opinion on October 4, 2013 in Flaa I, the Trustee began to discuss with Wallen
and the other members of the Cardio Interim Board the Company’s financial status.
Specifically, in late October, the Trustee “requested a copy of the [Cardio]
business plan and copies of the financial proposals [from Wallen] that will fund the
business plan,”10 which Flaa provided in detail by email dated November 1, 2013.
Around the same time in early November, Wallen communicated with the
Trustee via email and conference call in an attempt to secure Vizier’s proxy in the
Second Consent Action.11 As a preliminary matter, for the Trustee to obtain the
authority to execute the requested proxy on Vizier’s behalf, the Trustee and
Montano’s ex-wife Vicki, acting as stockholders of Vizier,
(a) . . . executed a Unanimous Written Consent (i) removing the
current directors of Vizier and appointing the Trustee and [Vicki]
Montano as the sole Directors of Vizier, and (ii) removing [Montano]
as President of Vizier and appointing the Trustee as President and
[Vicki] Montano as the Vice President of Vizier, and (b) [Vicki]
Montano and the Trustee, as the sole Directors of Vizier, executed a
10
JX 72 at 2014CVBT00005103.
11
Although the final written agreement into which Wallen and the Trustee ultimately entered, as
described in more detail below, did not include a requirement that the Trustee vote in favor of the
Second Consent Action, such was clearly the parties’ intent. See, e.g., JX 113 at
2014CVBT00003066 (“I fear that the vote will not get done unless we can get [the Trustee]
additional insurance re the below.”); id. at 2014CVBT00003067 (“Here is [Wallen’s] signature
on the share purchase agreement. Please let me know whether you now have everything you
need in order for the Trustee to be able to vote today.”).
9
Unanimous Written Consent of Board of Directors (i) appointing the
Trustee as President and [Vicki] Montano as the Vice President of
Vizier, (ii) affirming that, in accordance with the Memorandum of
Association and Articles of Association of Vizier, it is the sole
responsibility of the Trustee, as the President of Vizier, to manage the
day to day affairs of Vizier, including, but not limited to voting the
Vizier shares of [Cardio].12
In seeking to secure the Trustee’s commitment to execute a proxy on
Vizier’s behalf, Wallen and the Trustee also began negotiating a deal whereby
Wallen would purchase 1 million shares of Cardio from the Montano bankruptcy
Estate, in exchange for a sum of money (described by the Trustee as five times its
actual value) and a director seat on the Cardio board of directors; such an
agreement would provide the Montano Estate some much-needed liquidity in
addition to an ability to protect its only asset, Cardio stock. According to a series
of emails between counsel for the Trustee and Wallen, the Trustee’s bankruptcy
counsel “propos[ed] (subject to Bankruptcy Court approval) that the Trustee would
vote the Vizier shares ‘as requested,’ the Trustee would designate a member of the
[Cardio] board to replace a member of the Interim Board, Mr. Wallen or another
party would purchase 1 million shares of [Cardio] stock from Vizier for $1.00 per
share, and the estate would receive certain undefined minority stockholder
rights.”13 Wallen countered that “the Trustee’s vote would be irrevocable, [the
Trustee’s board designee] Mr. Moran would be appointed as an additional, and not
12
JX 78 at AR11.
13
Defs.’ Op. Pre-Trial Br. at 11-12.
10
a replacement, director, and Mr. Wallen would pay 5 cents a share for the 1 million
shares of [Cardio].”14 The parties eventually settled on an exchange under which
Wallen would purchase from the Montano Estate 1 million shares of Cardio at
$0.25 per share, in addition to granting the Trustee certain other rights described in
more detail below. Further, Wallen’s counsel explained to the Trustee that:
Under Delaware law, the Cardio Board of Directors has a fiduciary
duty to the shareholders to consider the qualifications of any proposed
addition to the Board and to make an independent determination that
it will be in the best interest of the shareholders of Cardio to appoint
the person who is put up for a vacant position on the Board (which is
what will happen here). They cannot agree in advance to simply
appoint anyone the Trustee designates.15
While the Trustee initially responded that the Cardio Interim Board’s inability to
commit to appointing the Trustee’s board designee was a “deal breaker,”16 the
parties eventually agreed to the following language in a November 22, 2013
Agreement for the Purchase and Sale of Stock (the “Stock Purchase Agreement”):
If Wallen is able to confirm the Wallen Group’s right to manage
[Cardio] . . . then Wallen will use his best efforts, consistent with his
fiduciary duties, to cause the Board of Directors to add an additional
two members, with one to be selected by the Wallen [sic] and the
other by the Trustee. If Wallen and his aligns are confirmed as
management of [Cardio] and these two positions are not added
through no fault of the Trustee, Wallen shall return the Shares to the
14
Id. at 12.
15
JX 86 at 6.
16
Id. at 5.
11
Trustee for no consideration, but the Trustee shall be entitled to retain
the Purchase Price and apply it to the Montano Estate asset base.17
In addition, the parties agreed that if the Second Consent Action was unsuccessful
or ineffective, “then the Trustee [would] promptly repurchase from Wallen
500,000 shares of [Cardio] stock for $0.25 per share with such $125,000 payment
to [be] made from the Purchase Price funds. The Trustee [would] then apply the
remaining $125,000 of the Purchase Price to the Montano Estate asset base.”18
In other words, Wallen and the Trustee agreed that, in exchange for the
Trustee’s proxy, Wallen would purchase 1 million Cardio shares from the Montano
Estate for $250,000. If the Second Consent Action was successful, Wallen would
use his best efforts to secure an additional seat on the Cardio board for the
Trustee’s designee; if, despite his best efforts, he failed to secure that seat, Wallen
would return all 1 million shares but the Trustee would retain the entire $250,000.
If the Second Consent Action was unsuccessful, Wallen would return 500,000
shares and the Trustee would return $125,000.
Prior to executing the November 22 Stock Purchase Agreement, on
November 8, 2013, the Trustee filed a Motion for Order Authorizing Trustee to
Take Certain Actions and Sell Certain Assets Free and Clear of Liens, Claims and
17
JX 87 at ¶ 5. Wallen’s counsel noted that “Wallen would not be doing this deal if he had any
uncertainty about being able to fulfill his obligations to have new directors appointed. If he
doesn’t meet his commitment, he forfeits $250,000 and the Trustee gets all the stock back. That
is a pretty drastic penalty for not performing, but [Wallen] is willing to agree to this because he
is very comfortable that he can fulfill this obligation.” JX 113 at 3087.
18
JX 87 at ¶ 3.
12
Encumbrances without Further Court Approval (the “Motion”) in the District of
Nevada U.S. Bankruptcy Court.19 In that Motion, the Trustee submitted to the
court that:
[Cardio] is . . . currently at a crossroads, where either (a) [Cardio] will
resolve its litigation and obtain sufficient funding to launch a new
product that may result in significant returns to its shareholders, or (b)
[Cardio] will not resolve its litigation, will not obtain funding, and
may ultimately wind up in its own bankruptcy proceeding, leaving
this Estate’s creditors with little to no return on account of their
claims.20
The Trustee sought in his Motion “authority, out of an abundance of caution, to
take actions necessary to allow the estate to vote the [Cardio] shares that it owns
[in Vizier],” as well as permission to sell 1 million Cardio shares held by the
bankruptcy estate to Wallen for $0.25 per share, in order “to provide for an
immediate return to the Estate, limiting the Estate’s downside should [Cardio]
ultimately be unsuccessful in its business endeavors.”21 The Trustee also
represented in his Motion that, based on “multiple meetings with Calvin Wallen,
[Montano], related parties, and their representatives to determine how to proceed
with regard to [Cardio],” “the Trustee ha[d] determined that it may be prudent to
19
JX 78.
20
Id. at AR8.
21
Id. at AR9.
13
take action with regard to the composition of [Cardio’s] board of directors to poise
[Cardio] for future success.”22
The bankruptcy court granted the Trustee’s Motion on November 18, 2013.
The court’s order indicated that:
The Trustee is authorized to take the following actions which are
consistent and fall within the Trustee’s ordinary course duties under
11 U.S.C. § 704:
a. to vote the Vizier Investment Capital Limited (“Vizier”)
shares to serve as President and director of Vizier and take all
actions attendant to serving as President and director . . . ; [and]
b. to sell up to 2 million of the 19 million shares at a price of no
less than $0.25 per share, provided any such sale shall include a
commitment to add a Trustee appointed representative to the
board of [Cardio], and the [Montano] Estate retains a right to
repurchase the shares within 1 year of any public offering of
such shares for 110% of the purchase price . . . .23
The Trustee noted in his declaration appended to the Motion that “$.25 per
share . . . appears to be at least five times what the shares are currently worth,” as
well as his belief that the Interim Board on which the Defendants are not directors
“provides the best opportunity for success of [Cardio] (because, in part, it will
result in necessary funding to [Cardio]), and therefore it is in the best interest of the
Estate to keep the [Interim] Board intact.”24
22
Id. at AR11.
23
JX 84 at ¶ 2(a)-(b).
24
JX 79 at ¶¶ 5, 7.
14
Wallen’s November 11 proxy solicitation materials failed to describe
negotiations—then well-advanced—leading up to the bankruptcy court’s
November 18 order or the resulting November 22 Stock Purchase Agreement
between Wallen and the Trustee. Instead, with respect to that transaction, the
proxy statement provided only that “[b]ased on the opinion of bankruptcy counsel,
it is my belief that the Trustee, with the cooperation of Montano’s ex-wife, has or
will obtain the right to grant a proxy with respect to the shares held by [Vizier],”25
and that “[i]t is anticipated that the Board might appoint one or two additional
directors after these initial designations.”26 On November 15, 2013, Montano
disseminated “proxy revocation” materials to the Cardio stockholders, “writing to
explain the full facts of the matter, to tell [stockholders] what [Montano had] done
for [Cardio], and to explain how [those] efforts are imminently poised to bring in
millions of dollars in partnering agreements that will save the company without
destroying the interests of the existing shareholders,” and urging stockholders not
to grant proxies in the Second Consent Action.27 Montano did not describe the
details of the Stock Purchase Agreement in those materials, although he had notice
of, objected to, and appeared before the bankruptcy court to oppose the Trustee’s
November 8 Motion seeking approval of, that Agreement.
25
JX 80 at 3.
26
Id. at 8.
27
JX 81 at 1.
15
B. The Parties’ Contentions
The Defendants contend (1) that the transaction described above constitutes
improper vote-buying, and (2) that because “Wallen had been negotiating (and was
continuing to negotiate) to place a director designated by the Trustee on the
[Cardio] board in connection with his purchase of [Cardio] stock, [and] he did not
disclose that fact in [his proxy solicitation] materials,”28 the Court should
invalidate the transaction under Portnoy v. Cryo-Cell International,
Incorporated.29 The Plaintiff responds that (1) the Vizier proxy is not the result of
improper vote-buying; (2) Montano acquiesced to the transaction in the bankruptcy
court proceedings; (3) the proxy statement disclosed all it could have given that the
parties were still in the process of negotiating the Stock Purchase Agreement when
the solicitations were sent to stockholders; and (4) the failure to disclose the terms
of the Stock Purchase Agreement does not result in the same unfairness present
under the facts in Portnoy.
II. STANDARD OF REVIEW
The Plaintiff brings this action to confirm the validity of the Second Consent
Action pursuant to 8 Del. C. § 225, in accordance with which, “[u]pon application
of any stockholder or director, or any officer whose title to office is contested, the
Court of Chancery may hear and determine the validity of any election,
28
Defs.’ Op. Pre-Trial Br. at 14-15.
29
940 A.2d 43 (Del. Ch. 2008).
16
appointment, removal or resignation of any director or officer of any corporation,
and the right of any person to hold or continue to hold such office . . . .”30 Such a
proceeding is summary in nature. Further, in a Section 225 action, “[t]he burden of
proving that a director’s removal is invalid rests with the party challenging its
validity”31—here, the Defendants.
The Court conducted a one-day trial in this action on May 2, 2014. The
following is my determination of the merits of the Section 225 dispute.
III. ANALYSIS
The bedrock principles underlying our conception of corporate governance
are that the directors run the corporation on behalf of the owners, the stockholders,
who delegate power to the directors through the operation of the stockholder
franchise. For this reason, both our statutory and common law are protective of the
right of stockholders to vote, and by exercising that vote, to choose the directors.
This Court can interfere with an effective operation of the franchise, in the consent
arena, in two ways, both equally deleterious: by invalidating actions properly taken
by consent; and by ratifying actions purportedly by consent, where those actions do
not represent the will of the stockholders. I have already invalidated one purported
vote to remove the Montano board, and I am therefore cognizant of the risk to
exercise of the franchise in invalidating a second. Nonetheless, imposing the
30
8 Del. C. § 225(a).
31
Unanue v. Unanue, 2004 WL 5383942, at *10 (Del. Ch. Nov. 9, 2004).
17
results of an uninformed vote is inimical to the exercise by the stockholders of
their right to elect the board of directors. For the reasons that follow, the Plaintiff’s
request to ratify the results of the Second Consent Action must be denied.
The Defendants challenge the validity of the Second Consent Action on four
grounds: they contend that (1) the Vizier proxy is invalid as vote-buying or due to
inadequate disclosure of the Stock Purchase Agreement in the solicitation
materials; (2) the electronic proxies are invalid as procedurally deficient; (3) the
brokerage proxies from the proxy tabulating agency, Broadridge, are invalid as
procedurally deficient; and (4) the Second Consent Action should be invalidated
because the proxy solicitation materials contained materially misleading
disclosures. I address only the Defendants’ first contention, as well as outstanding
requests for attorneys’ fees, below.
1. Vote-Buying
The Defendants seek to (1) invalidate the Vizier proxy on the basis that
Wallen and the Trustee’s Stock Purchase Agreement constitutes impermissible
vote-buying, or (2) invalidate the Second Consent Action in its entirety on the
basis that, even if not impermissible vote-buying, the Stock Purchase Agreement
was material such that its existence should have been disclosed to stockholders
considering whether to execute a proxy.
18
In Schreiber v. Carney, this Court defined vote-buying as any “voting
agreement supported by consideration personal to the stockholder, whereby the
stockholder divorces his discretionary voting power and votes as directed by the
offeror.”32 Although the Plaintiff suggests that the Stock Purchase Agreement did
not by its express terms compel the Trustee to deliver a proxy in favor of the
Second Consent Action, it is clear from the record before me that the Trustee’s
proxy was a vital part of that Agreement.33 In other words, because I understand
the transaction at issue involved the sale of both stock and a proxy, the Stock
Purchase Agreement constituted vote-buying under the definition articulated in
Schreiber. The mere existence of an agreement to vote shares in a particular way
does not end the inquiry, however.
Under Delaware law, “an agreement involving the transfer of stock voting
rights without the transfer of ownership is not necessarily illegal and each
arrangement must be examined in light of its object or purpose.” 34 In fact, under
most circumstances, “[s]hareholders are free to do whatever they want with their
votes, including selling them to the highest bidder.”35 However, “vote-buying is
illegal per se if its object or purpose is to defraud or disenfranchise the other
32
Schreiber v. Carney, 447 A.2d 17, 23 (Del. Ch. 1982).
33
See JX 113 at 2014CVBT00003071 (indicating that the Trustee would vote “as requested”);
see also supra note 11.
34
Schreiber, 447 A.2d at 25.
35
Hewlett v. Hewlett-Packard Co., 2002 WL 549137, at *4 (Del. Ch. Apr. 8, 2002).
19
stockholders.”36 In considering whether a vote-buying scheme has defrauded or
disenfranchised the stockholders, our case law distinguishes between vote-buying
agreements secured by corporate assets and assets owned by third parties.
Accordingly, a third party is prohibited from buying votes only where doing so
would be “disenfranchising” by “creat[ing] a misalignment between the voting
interest and the economic interest of [the] shares.”37 By contrast, even where
economic interests remain aligned, “[m]anagement . . . may not use corporate
assets to buy votes in a hotly contested proxy contest about an extraordinary
transaction that would significantly transform the corporation, unless it can be
demonstrated . . . that management’s vote-buying activity does not have a
deleterious effect on the corporate franchise.”38
The Plaintiff suggests that, were I to evaluate the Stock Purchase Agreement
as a third-party transaction, the Stock Purchase Agreement could not constitute
impermissible vote-buying under the authorities cited above, as the Agreement did
not misalign the Trustee’s voting and economic interests as a fiduciary of Vizier.
Specifically, the Plaintiff explains that, while the Trustee transferred to Wallen 1
million shares of Cardio from the Montano Estate, Vizier continued to hold an
additional 29 million Cardio shares, and therefore retained a significant economic
36
Schreiber, 447 A.2d at 24.
37
Crown EMAK Partners, LLC v. Kurz, 992 A.2d 377, 388 (Del. 2010).
38
Hewlett, 2002 WL 549137, at *4 (emphasis added).
20
stake in the Company.39 The alignment of interests relevant in a vote-buying
analysis, however, is an alignment of a vote-buyer’s interests upon the exercise of
his vote, not of the vote-seller’s interests upon forfeiture of his vote.40 That is
because “what legitimizes the stockholder vote as a decision-making mechanism is
the premise that stockholders with economic ownership are expressing their
collective view as to whether a particular course of action serves the corporate goal
of stockholder wealth maximization.”41 In other words, where a party has no
equity stake in the corporation, his vote distorts an effective exercise of the
franchise, the ultimate goal of which is the financial success of the company for the
stockholders’ benefit. Accordingly, it is Wallen’s equity interests, rather than the
Trustee’s, that are relevant to a third-party vote-buying analysis. Although Wallen
maintains a significant debt and equity stake in the Company, it is not clear from
the record before me to what extent those interests may be opposed. What is clear
is that, independent of the vote-buying arrangement, Wallen has a significant
economic interest in the success of Cardio, both as an equity-holder and as a
creditor, and that if the Company fails under the management of the Montano slate,
his interests will be extinguished as both shareholder and creditor. It is unlikely,
39
Pl.’s Pre-Trial Answering Br. at 21.
40
To the extent the Trustee’s interests are relevant, he acted under a fiduciary duty to advance
Vizier’s interest, and only if he were near-indifferent to the Wallen and Montano slates would an
ability to provide the Estate liquidity influence the Trustee’s decision to favor Wallen’s slate
over Montano’s.
41
Kurz v. Holbrook, 989 A.2d 140, 178 (Del. Ch. 2010), aff’d in part, rev’d in part sub nom.
Crown EMAK Partners, LLC v. Kurz, 992 A.2d 377 (Del. 2010).
21
therefore, that the voting rights obtained pursuant to the Stock Purchase Agreement
resulted in the agency problems that misalignment of incentives creates, and about
which third-party vote-buying doctrine is concerned.
It is not clear to me, however, that the Stock Purchase Agreement at issue
can rightly be characterized as a third-party transaction. While it is true that
Wallen used his personal assets to purchase the 1 million Cardio shares from the
Montano Estate, there remained another crucial term to be satisfied: the delivery of
a board seat on Cardio’s board of directors. Of course, Wallen could not deliver
that seat on his own, and the Interim Board’s legal counsel understood that under
Delaware law, its fiduciary duties to the Cardio stockholders prevented it from
entering into an enforceable agreement to deliver a seat to the Trustee’s designee.42
As a result, while Wallen contractually agreed only to use his “best efforts” to
secure the seat, he assured the Trustee that the Interim Board saw no reason its
fiduciary duties would prevent it from agreeing to the seat despite an inability to
enter into an enforceable agreement to that effect.43 Most revealingly, he
demonstrated his absolute confidence that the board seat would be approved by
42
See JX 86 at 6 (email from Barry Cannaday, counsel for the Plaintiff, to Justin Rawlins,
counsel for the Trustee) (“Under Delaware law, the Cardio Board of Directors has a fiduciary
duty to the shareholders to consider the qualifications of any proposed addition to the Board and
to make an independent determination that it will be in the best interest of the shareholders of
Cardio to appoint the person who is put up for a vacant position on the Board (which is what will
happen here). They cannot agree in advance to simply appoint anyone the Trustee designates.”).
43
See, e.g., id. at 2 (email from Cannaday, counsel for the Plaintiff, to Wallen, Gordon, and Flaa)
(“I have asked that [the Trustee’s counsel] provide [the Trustee’s designee] Al Moran’s resume,
so that it can be determined that there is a legitimate basis for making this statement.”).
22
agreeing to forfeit his 1 million purchased shares—while permitting the Trustee to
retain the $250,000 consideration—if despite his best efforts, he proved unable to
deliver the board seat. Wallen’s own bankruptcy counsel, in communications with
the Trustee’s counsel, explained that Wallen’s willingness to put $250,000 worth
of shares on the line if the Interim Board did not approve the Trustee’s designee
demonstrated that Wallen was “willing to agree [only] because he [was] very
comfortable that he [could] fulfill this obligation.”44 That confidence is
unsurprising given that the Interim Board and Wallen’s slate were identical.45
And, of course, the Plaintiff’s suggestion that the Trustee’s board seat was not an
essential term of the Stock Purchase Agreement is belied by the fact that the
Trustee, despite selling the Estate’s Cardio stock at five times its market value,
initially considered the Interim Board’s failure to agree to appoint his designee a
“deal breaker.”46 Based on those considerations, it is conceivable that the Interim
Board agreed to deliver a valuable corporate asset—a seat on the Cardio board—in
exchange for the Trustee’s proxy.
Ultimately, however, I need not determine whether the Stock Purchase
Agreement constituted impermissible vote-buying. The Defendants contend that
the Agreement, even if not impermissible vote-buying, was a material transaction,
44
JX 113 at 3087.
45
Both the Interim Board and Wallen’s slate include Wallen, Flaa, Grant Gordon, Jon Ross, and
Robert Schleizer. JX 80 at 7-8.
46
JX 86 at 5.
23
and Wallen’s failure to disclose it in his proxy solicitation materials provides a
compelling basis to invalidate the Second Consent Action. For the reasons detailed
below, I agree. Despite the Plaintiff’s suggestion that no duty to disclose could be
imputed to Wallen acting in his capacity as a stockholder, even acting in their
individual capacities, directors owe a duty of candor to the stockholders of the
corporation for which they serve,47 and in any event, assuming the Interim Board’s
collusion with respect to the Stock Purchase Agreement, the Interim Board itself
had a duty to update the stockholders regarding its participation in the transaction.
It is axiomatic that “directors of Delaware corporations are under a fiduciary
duty to disclose fully and fairly all material information within the board’s control
when it seeks shareholder action.”48 Information is material “if there is a
substantial likelihood that a reasonable stockholder would consider it important in
deciding how to vote.”49 For the reasons that follow, I find that the promise to
grant the Trustee’s designee a seat on the Company’s board in connection with the
47
See Zaucha v. Brody, 1997 WL 305841, at *4-5 (Del. Ch. June 3, 1997) (“[The plaintiff]
argues that he sought consents not as a director but as a stockholder. The statute does not limit
the right to seek consents to stockholders. More fundamentally, fiduciary duties are not limited
to the board as a body or to the controlling majority, but bind directors individually. . . . I see no
sound reason to relieve a director of his fiduciary duty simply on the basis that he is acting in
another capacity. One reason for the fiduciary duty of disclosure is directors’ greater access to
knowledge. A dissident director like [the plaintiff] has that knowledge no less when challenging
controlling board members. Stockholders have a right to assume that directors always act in
what they believe to be the stockholder’s best interest, and I see no reason why that assumption
should not apply to a dissident director who solicits stockholders’ consents.”).
48
Loudon v. Archer-Daniels-Midland Co., 700 A.2d 135, 143 (Del. 1997) (internal quotation
omitted) (citing Arnold v. Society for Savs. Bancorp, Inc., 650 A.2d 1270, 1277 (Del. 1994)).
49
Id.
24
Stock Purchase Agreement was material such that Wallen and the Interim Board
had a duty to disclose its existence to the Cardio stockholders, either in Wallen’s
initial solicitation materials, or in a supplement to those materials.
Several factors, taken together, lead to my conclusion that the board seat
secured by the Trustee pursuant to the Stock Purchase Agreement was information
a stockholder would likely find material. In executing a proxy in favor of Wallen’s
Second Consent Action, the Cardio stockholders believed they were delivering
proxies to remove six directors to be replaced by Wallen and his two designees,
Jon Ross and Robert Schleizer. In reality, a proxy in support of the Second
Consent Action effectuated the appointment not only of Wallen, Ross, and
Schleizer, but of both the Trustee’s designee, Moran, and an additional director to
be designated by Wallen.50 I find it likely that the Cardio stockholders would have
found it material to know that, by delivering proxies in favor of the Second
Consent Action, they were also supporting Moran’s appointment to the Cardio
board. Importantly, while the stockholders received written biographies on Flaa,
Gordon, Wallen, Ross, and Schleizer in their proxy solicitation materials, they
received no such information about Moran, and accordingly were denied any
50
See Portnoy v. Cryo-Cell Int’l, Inc., 940 A.2d 43, 73 (Del. Ch. 2008) (invalidating an election
on the basis that “the disinterested Cryo-Cell electorate voted in ignorance of the actual board
that would govern them in the event the Management Slate won”).
25
opportunity to assess his credibility before delivering the proxies that would
effectuate his appointment.51
Further, in addition to assessing Moran’s credibility, the stockholders likely
would have found the existence of the Stock Purchase Agreement relevant in
assessing Wallen’s credibility. Wallen has initiated two “successful” written
consent actions that squeaked by with majority approval only by obtaining the
support of a dispositive block of shares—the 30 million shares held by Vizier—in
both cases by conduct that has fallen under scrutiny in this Court. Tellingly, the
First Consent Action was invalidated because Vicki Montano, in response to a
request by Wallen, executed a written consent on behalf of Vizier without authority
to do so. While the proxy solicitation materials addressed that problem as if it
were a technical error that had been corrected, in fact the success of the Second
Consent Action still required that a proxy be delivered to Wallen on Vizier’s
behalf, and Wallen sought to secure the support of that dispositive block by
promising its fiduciary’s designee a seat on Cardio’s board. Thus, to the extent
stockholders read in the proxy solicitation materials that “it [was Wallen’s] belief
that the Trustee, with the cooperation of Montano’s ex-wife, has or will obtain the
51
See id. at 72 (“Problematically, the Cryo-Cell stockholders did not know that [the party to the
vote-buying arrangement] clearly intended to designate [a particular designee], a person whose
recent past would have weighed heavily on the mind of a rational stockholder considering
whether to seat him as a fiduciary.”).
26
right to grant a proxy with respect to the shares held by [Vizier],”52 and rightly
understood that statement to indicate that the primary concern in the first
litigation—Vicki’s authority to vote the Vizier shares—had been effectively
resolved, stockholders would have found it an important clarification that the
Trustee, though he had the right to grant the Vizier proxy, had at least in part
determined to do so as a result of his bargained-for ability to fill a newly-created
director seat. The relevant points here are that (1) in both the First and Second
Consent Actions, even after securing the Vizier block, Wallen’s slate was favored
only by a narrow majority of shares,53 and (2) stockholders would likely have
found it material to know that the slate they were supporting felt it necessary to
rely on the voting agreement described above in order to obtain the requisite
number of proxies.
The Plaintiff contends that, even if the existence of the Stock Purchase
Agreement was information material to the Cardio stockholders, Wallen could not
possibly have disclosed its contents on November 11 when his proxy solicitation
materials went sent, as the Agreement was not finalized until it was approved by
the bankruptcy court on November 18 and executed on November 22.54 I find it
52
JX 80 at 3.
53
See Portnoy, 940 A.2d at 72 (“What [the party to the vote-buying agreement] did with his own
bought shares is less the point than that the disinterested electorate voted in a razor-thin election
without knowledge of very material facts.”).
54
The Plaintiff suggests that the existence of the Stock Purchase Agreement was publically
available as it was approved in a public bankruptcy court proceeding and disclosed in Delaware
27
telling, however, that, despite his failure to describe the Stock Purchase Agreement
even in the conditional, Wallen did find the transaction sufficiently likely such that
it warranted the partial disclosure that “[i]t is anticipated that the Board might
appoint one or two additional directors after these initial designations.”55
Moreover, the Plaintiff contends that an effective number of proxies were
delivered five days after the Agreement was executed, on November 27; as the
parties were on the cusp of an agreement since mid-November, Wallen should
have provided a supplemental disclosure immediately upon execution of the
Agreement. Even so, Wallen continued to accept proxies through January 2, and
even then did not update his solicitation materials.56
Because I find that the Trustee’s agreement to deliver its dispositive proxy in
exchange for a seat on the Company’s board was material information that should
have been disclosed to the Cardio stockholders, I find it appropriate to invalidate
the Second Consent Action. I do so despite Montano’s failure to disclose the Stock
Supreme Court filings. Pl.’s Pre-Trial Op. Br. at 29. Though a diligent stockholder might have
discovered the existence of the Stock Purchase Agreement by seeking out and reviewing those
filings, as explained above, the Interim Board had a fiduciary duty to disclose all material
information—including the existence and terms of the Agreement—in the proxy solicitation
materials provided to stockholders; further, even the filings to which the Plaintiff refers did not
disclose that the Agreement was supported by the Trustee’s commitment to deliver a proxy on
behalf of the Vizier stock supporting the Second Consent Action.
55
JX 80 at 8.
56
The Plaintiff also suggests that “[n]o improper vote buying could have occurred here, where a
federal court explicitly sanctioned the transaction and, further, directed the Trustee be given the
ability to appoint a board representative.” Pl.’s Pre-Trial Op. Br. at 23. That the bankruptcy
court determined that approval of the Stock Purchase Agreement was appropriate under the U.S.
Bankruptcy Code has no bearing on whether disclosure of that Agreement was material as a
matter of Delaware corporate law.
28
Purchase Agreement in his own solicitation, which failure in no way justifies
depriving the Cardio stockholders of material information to which they should
have access when comparing the competing Montano and Wallen slates.
For almost twelve months, since June 2013, the Cardio stockholders have
had no certainty regarding who constitutes the Company’s proper board of
directors. Even prior to the First Consent Action, Cardio had not held an annual
election since 2008,57 despite the requirements of the DGCL and in the Company’s
bylaws that a director election be held annually.58 Significantly, were I to
invalidate the Second Consent Action and do no more, the Defendants would
return to positions on the Cardio board to which they were last elected more than
five years ago. Clearly, both Montano and Wallen believe that, in the right hands,
this struggling pharmaceutical company will eventually return value to its
stockholders, but without a board able to negotiate agreements to sell its drug
candidates, this company will at best continue on the brink of insolvency.
Therefore, rather than simply invalidating the Second Consent Action, I find that
an appropriate resolution of this action requires ordering an annual election
57
Montano Dep. (July 12, 2013) 303:2-3.
58
See Bylaws § 3.3 (“Except as provided in Section 3.4 of these Bylaws [governing resignations
and vacancies], directors shall be elected at each annual meeting of stockholders to hold office
until the next annual meeting. Each director, including a director elected or appointed to fill a
vacancy, shall hold office until the expiration of the term for which elected and until a successor
has been elected and qualified.”).
29
pursuant to Section 225(a).59 A special master shall be appointed by this Court to
oversee the election. The Cardio stockholders are entitled to certainty and to a
process free of the irregularities that have tainted the First and Second Consent
Actions over the last twelve months, as well as a board that can manage with
certainty the few assets of the Company that remain.
2. Requests for Attorneys’ Fees
Three issues remain to be decided in this action and in the earlier-filed
action, Civil Action No. 8632-VCG. Those issues include (1) a request by the
Defendants for attorneys’ fees in connection with their Motion to Compel; (2) the
Defendants’ Motion for Sanctions seeking attorneys’ fees for responding to the
Plaintiff’s Motion for Relief from the Status Quo Order; and (3) the Defendants’
Motion to Hold the Interim Board in Contempt for Violating the Status Quo Order.
59
See 8 Del. C. § 225(a) (“Upon application of any stockholder or director, or any officer whose
title to office is contested, the Court of Chancery may hear and determine the validity of any
election, appointment, removal or resignation of any director or officer of any corporation, and
the right of any person to hold or continue to hold such office, and, in case any such office is
claimed by more than 1 person, may determine the person entitled thereto; and to that end make
such order or decree in any such case as may be just and proper . . . . In case it should be
determined that no valid election has been held, the Court of Chancery may order an election to
be held in accordance with § 211 or § 215 of this title.”) (emphasis added); Portnoy v. Cryo-Cell
Int’l, Inc., 940 A.2d 43, 83 n.208 (Del. Ch. 2008) (ordering an election to be overseen by a
special master, noting that “[t]he DGCL gives this court wide discretion to craft a remedy in the
case of a tainted election,” and citing both Section 225(a) and Section 227(b)); Magill v. N. Am.
Refractories Co., 129 A.2d 411, 413 (Del. Ch. 1957) (“We think that under our statute the
reviewing court, which must make ‘such order or decree in any such case as may be just and
proper,’ is given a discretion to determine whether a new election should be ordered.”) (citation
omitted).
30
With respect to the Defendants’ requests for attorneys’ fees in connection
with defending against the Plaintiff’s earlier-filed Motions, that request is denied.
I find that while the parties aggressively litigated this action, neither party’s
conduct rose to a level of bad faith sufficient to trigger an exception to the
American Rule on fees. Specifically, in connection with the Defendants’ Motion
to Compel, I find that the Plaintiff’s opposition was substantially justified,
particularly in light of the over-breadth of the Defendants’ request. Further, with
respect to the Defendants’ request for attorneys’ fees for responding to the
Plaintiff’s Motion for Relief from the Status Quo Order, I find that such fees are
not warranted as it does not appear that the Plaintiff acted in bad faith in pursuing
that Motion. Accordingly, the parties shall bear their own fees in connection with
those Motions.
As to the Defendants’ Motion to Hold the Interim Board in Contempt for
Violating the Status Quo Order, that Motion is also denied, to the extent that it is
not moot in light of this Memorandum Opinion. Without addressing whether the
Plaintiff violated the spirit of the Status Quo Order by initiating the Second
Consent Action, I find that the relief the Defendants request—declaring written
consents delivered in the Second Consent Action ineffective, dissolving the Status
Quo Order, and awarding the Defendants attorneys’ fees—are either inappropriate
or moot at this juncture.
31
IV. CONCLUSION
For the reasons stated above, I find the Second Consent Action ineffective to
remove the Defendants from the Cardio board of directors, but order the Company
to hold, as soon as is convenient, an annual election, to be overseen by a special
master appointed by the Court. The parties should submit an appropriate Order.
32