Jeffrie J. Silverberg v. Shan Padda

• Court: Court of Chancery of Delaware
• Decided: October 18, 2019
• Docket: C.A. No.2017-0250-KSJM
• Status: Published

Opinion

COURT OF CHANCERY OF THE STATE OF DELAWARE KATHALEEN ST. JUDE MCCORMICK LEONARD L. WILLIAMS JUSTICE CENTER VICE CHANCELLOR 500 N. KING STREET, SUITE 11400 WILMINGTON, DELAWARE 19801-3734

October 18, 2019

Robert Karl Hill, Esquire Marc S. Casarino, Esquire Seitz, Van Ogtrop & Green, P.A. White & Williams LLP 222 Delaware Ave., Suite 1500 600 N. King St., Suite 800 Wilmington, DE 19801 Wilmington, DE 19801

Samuel A. Nolen, Esquire Thad Bracegirdle, Esquire Richards, Layton & Finger, P.A. Wilks, Lukoff & Bracegirdle, LLC 920 N. King St. 4250 Lancaster Pike, #200 Wilmington, DE 19801 Wilmington, DE 19805

David J. Teklits, Esquire Edward B. Micheletti, Esquire Morris Nichols Arsht & Tunnell LLP Skadden, Arps, Slate, Meagher & Flom LLP 1201 N. Market St. 920 N. King St. Wilmington, DE 19801 Wilmington, DE 19801

Gregory W. Hauswirth, Esquire Leech Tishman Fuscaldo & Lampl, LLC 1007 N. Orange St., 4th Floor Wilmington, DE 19801

Re: Jeffrie J. Silverberg v. Shan Padda, C.A. No. 2017-0250-KSJM

Dear Counsel:

This letter addresses Plaintiffs’ motion to reargue (the “Motion”) 1 portions of

the September 19, 2019, Memorandum Opinion (the “Opinion”)2 granting

Defendants’ motion to dismiss in part and ordering supplemental briefing.

1 Docket (“Dkt.”) 98, Pls.’ Mot. for Reargument of the Dismissal of the Thirteenth and Fourteenth Claims. 2 Silverberg v. Padda, 2019 WL 4566909 (Del. Ch. Sept. 19, 2019). Civil Action No. 2017-0250-KSJM October 18, 2019 Page 2 of 14

The Motion seeks reargument concerning dismissal of Counts Thirteen and

Fourteen, which challenge an offering of convertible debentures conducted by

Health Integrated, Inc. in 2015. Count Thirteen alleges that the directors who

approved this 2015 offering did so in breach of their fiduciary duties, and Count

Fourteen alleges that some of the investors who participated in the offering—

defendants Rivers Cities, Midwest, and Stonehenge3 (referred to in this decision as

the “Venture Capital Defendants”)—aided and abetted the directors’ breaches.

Plaintiffs conceded that Count Thirteen is derivative in nature, but they argued

that it should also be regarded as direct under Gentile v. Rossette. 4 The Opinion

considered the merits of Plaintiffs’ Gentile argument concerning Count Thirteen,5

only to reject it. As discussed in the Opinion, for a Gentile claim to be viable, a

plaintiff must adequately allege the existence of a controller or control group. 6 The

Opinion concluded that because Plaintiffs had not adequately alleged either a

controller or control group, Gentile did not apply, and thus the dismissal of Count

3 Terms not defined in this letter have the same meaning ascribed to them in the Opinion. 4 906 A.2d 91 (Del. 2006). 5 Id. Considering Plaintiffs’ Gentile argument as to Count Thirteen was generous on the part of the Court, because Plaintiffs did not expressly plead Count Thirteen as a direct claim under Gentile. Dkt. 33, Verified Sec. Am. Compl. (“Sec. Am. Compl.”) ¶¶ 290–98. Nor did Plaintiffs name the alleged control group members as defendants in Count Thirteen as Gentile requires. Id. 6 Silverberg, 2019 WL 4566909, at *5. Civil Action No. 2017-0250-KSJM October 18, 2019 Page 3 of 14

Thirteen was appropriate. 7 The Motion seeks reargument of this aspect of the

Opinion.

“A motion for reargument under Court of Chancery Rule 59(f) will be denied

unless the court has overlooked a controlling decision or principle of law that would

have controlling effect, or the court has misapprehended the law or the facts so that

the outcome of the decision would be different.” 8 “Reargument motions may not be

used to relitigate matters already fully litigated or to present arguments or evidence

that could have been presented before the court entered the order from which

reargument is sought.” 9 “A party may not present a new argument for the first time

in a motion for reargument.” 10

In support of reargument, Plaintiffs contend that the Opinion both overlooked

principles of law and misapprehended certain factual allegations supporting

Plaintiffs’ claim that the Venture Capital Defendants comprised a control group at

the time of the 2015 offering.

7 Id. at *7. Count Fourteen for aiding and abetting, in turn, failed for lack of a necessary predicate. Id. 8 Those Certain Underwriters at Lloyd’s, London v. Nat’l Installment Ins. Servs., Inc., 2008 WL 2133417, at *1 (Del. Ch. May 21, 2008). 9 Quantlab Gp. GP, LLC v. Eames, 2018 WL 5778445, at *1 (Del. Ch. Nov. 2, 2018) (citation omitted). 10 inTEAM Assocs., LLC v. Heartland Payment Sys., Inc., 2016 WL 6819734, at *2 (Del. Ch. Nov. 18, 2016) (citing Oliver v. Boston Univ., 2006 WL 4782232, at *1 (Del. Ch. Dec. 8, 2006)). Civil Action No. 2017-0250-KSJM October 18, 2019 Page 4 of 14

Turning first to the principles of law, Plaintiffs direct the Court to a Delaware

Supreme Court decision issued within a month after the Opinion—Sheldon v. Pinto

Technology Ventures, L.P., 11 which affirmed the Court of Chancery’s dismissal of a

Gentile claim where the complaint failed to allege stockholder connections sufficient

to form a control group.12 In directing the Court to Sheldon, Plaintiffs suggest that

Sheldon articulates a new legal principle that might alter the outcome of the Opinion.

Plaintiffs are mistaken.

Sheldon involved allegations that the venture capital defendants:

(i) collectively controlled a majority of the company’s voting equity; (ii) “were

parties to a voting agreement that gave them the right to appoint three directors to

[the board]”; (iii) “acted in concert” to complete the challenged transactions; and

(iv) enjoyed a “long and close relationship of investing together.” 13

In evaluating whether these allegations supported the finding of a control

group at the trial level, Vice Chancellor Zurn cited the standard set forth in Dubroff

v. Wren Holdings, LLC: “A group of stockholders ‘can collectively form a control

group where those shareholders are connected in some legally significant way—e.g.,

11 – A.3d –, 2019 WL 4892348 (Del. Oct. 4, 2019). 12 See Sheldon v. Pinto Tech. Ventures, L.P., 2019 WL 336985, at *9–10 (Del. Ch. Jan. 25, 2019). 13 Id. at *8 (citations omitted). Civil Action No. 2017-0250-KSJM October 18, 2019 Page 5 of 14

by contract, common ownership, agreement, or other arrangement—to work

together toward a shared goal.’” 14

To guide the Court’s analysis, the Vice Chancellor then turned to two Court

of Chancery decisions that applied the Dubroff standard at the pleadings stage. 15 In

van der Fluit, this Court deemed an agreement between alleged group members

insufficient to show that they were “connected in some legally significant way”

where the agreement did not relate to the underlying challenged transaction and was

not entered into exclusively by members of the control group.16 In Hansen, this

Court denied a motion to dismiss a control group theory where the two group

members were identified by the company as “key stockholders,” were allegedly

given exclusive power to negotiate the challenged transaction, and were alleged to

have coordinated their investment strategy in at least seven different companies over

the course of two decades. 17

14 Id. (quoting Dubroff v. Wren Hldgs., LLC, 2009 WL 1478697, at *3 (Del. Ch. May 22, 2009)). 15 Id. at *8–9 (discussing van der Fluit v. Yates, 2017 WL 5953514 (Del. Ch. Nov. 30, 2017) and In re Hansen Med. S’holders Litig., 2018 WL 3025525 (Del. Ch. June 18, 2018)). 16 van der Fluit, 2017 WL 5953514, at *5. 17 Hansen, 2018 WL 3030808, at *7. Civil Action No. 2017-0250-KSJM October 18, 2019 Page 6 of 14

Using van der Fluit and Hansen as barometers, the Vice Chancellor concluded

that the complaint failed to plead the existence of a control group.18 The Vice

Chancellor observed that in Sheldon, like in van der Fluit, the agreement at issue did

not bind the signatories with respect to their votes on the challenged transaction and

included persons other than the purported control group members. 19 The Vice

Chancellor further observed that in Sheldon, unlike in Hansen, the complaint failed

to sufficiently plead a factual basis for the allegation that the alleged group members

enjoyed a long-standing relationship of co-investments.20 For these reasons, the

Vice Chancellor concluded that Sheldon “more closely resemble[d] van der Fluit

than Hansen,” and thus found that the complaint failed to allege that the venture

capital defendants comprised a control group.21

On appeal, the Supreme Court adopted Dubroff and related cases as the

standard for demonstrating the existence of a control group, stating:

To demonstrate that a group of stockholders exercises control collectively, the Appellants must establish that they are connected in some legally significant way—such as by contract, common ownership, agreement, or other arrangement—to work together toward a shared goal. To 18 Sheldon, 2019 WL 336985, at *10. 19 Id. at *10 (noting the challenged agreement did not “bind the Venture Capital Defendants beyond selecting directors”). 20 Id. (concluding that “[p]laintiffs’ allegations merely indicate that venture capital firms in the same sector crossed paths in a few investments”). 21 Id. Civil Action No. 2017-0250-KSJM October 18, 2019 Page 7 of 14

show a legally significant connection, the Appellants must allege that there was more than a mere concurrence of self- interest among certain stockholders. Rather, there must be some indication of an actual agreement, although it need not be formal or written. 22

The Supreme Court then proceeded to track the Court of Chancery’s

comparative analysis using van der Fluit and Hansen as the two poles of the

spectrum, and then independently reached the conclusion that the facts alleged in

Sheldon failed to establish “anything but a ‘mere concurrence of self-interest.’”23

Thus, although Sheldon is notable in that it was the Delaware Supreme Court’s first

opportunity to address the standard for establishing that a group of stockholders

exercised control collectively, Sheldon did not alter Delaware law concerning

control group requirements.

The Opinion applied the same standard as, and in a manner consistent with,

Sheldon. The Opinion applied the Dubroff standard, searching the complaint for any

legally significant connection among the alleged group members.24 The Opinion

22 Sheldon, 2019 WL 4892348, at *4. In articulating this standard, the Supreme Court adopted Dubroff, cases on which Dubroff relied, including In re PNB Hldg. Co. S’holders Litig., 2006 WL 2403999, (Del. Ch. Aug. 18, 2006), and recent cases interpreting Dubroff, including In re Crimson Expl., Inc. S’holder Litig., 2014 WL 5449419 (Del. Ch. Oct. 24, 2014). Id. 23 Id. at *7 (quoting Carr v. New Enter. Assocs., Inc., 2018 WL 1472336, at *10 (Del. Ch. Mar. 26, 2018)). 24 Silverberg, 2019 WL 4566909, at *6–7. Civil Action No. 2017-0250-KSJM October 18, 2019 Page 8 of 14

concluded that the complaint failed “to allege more than parallel interests among the

alleged group members.”25 The Opinion, therefore, did not misapprehend any legal

principle germane to the control group analysis that would affect the outcome. Thus,

Sheldon does not support reargument.

The Motion further cites to four additional authorities in support of

reargument. The Opinion did not overlook these authorities; rather, Plaintiffs failed

to cite to them. 26 By failing to include them in briefing, Plaintiffs waived their right

to rely on them. 27 In any event, these authorities do not alter the outcome of the

Opinion. Of these four decisions, three involve distinguishable allegations that

supplied a legally significant relationship among group members sufficient to

support the existence of a control group, 28 and the fourth does not reach the merits

25 Id. at *6. 26 See Dkt. 98 at 10–12, ¶¶ 19–21 (citing Frank v. Elgamal, 2012 WL 1096090 (Del. Ch. Mar. 30, 2012); eBay Domestic Hldgs, Inc. v. Newmark, 16 A.3d 1 (Del. Ch. 2010); Carr, 2018 WL 1472336; Williamson v. Cox Commc’ns, Inc., 2006 WL 1586375 (Del. Ch. June 5, 2006)). 27 Emerald P’rs v. Berlin, 726 A.2d 1215, 1224 (Del. 2004) (“Issues not briefed are deemed waived.”). 28 See Frank, 2012 WL 1096090, at *4 (finding a series of contemporaneously executed agreements, including employment agreements reflecting that the alleged group members would together manage the post-merger entity, sufficient to support the existence of a control group); eBay, 16 A.3d at 13 (finding an agreement between two stockholders “spell[ing] out how [the two stockholders] will vote their shares in director elections” sufficient to support the existence of a control group); Williamson, 2006 WL 1586375, at *5 (deeming a confluence of “special business relationships” including revenue sharing agreements that linked controllers sufficient to plead they formed a control group). Civil Action No. 2017-0250-KSJM October 18, 2019 Page 9 of 14

of the control group issue.29 These four additional authorities do not support

reargument.

Turning next to the factual issues, the Motion describes Count Thirteen’s

control group theory as follows:

Plaintiffs allege that River Cities, [Midwest] and Stonehenge were a “control group” based on [1] their majority ownership of the preferred stock, [2] blocking rights afforded a majority of preferred shareholders under a 2014 amendment to the [Health Integrated] certificate of incorporation . . . , [3] their representatives on the [Health Integrated] board and [4] their de facto control of the officer directors Shan Padda and Sam Toney. 30

Although the Motion argues that the Court overlooked these four categories,31

it bears noting that the above articulation of Plaintiffs’ control group theory first

appeared in the Motion. It is true that the above-quoted passage cites to four

paragraphs of the operative complaint, creating the impression that the factual basis

for this articulation of the control group argument can be found in those four

paragraphs. But the four facts do not appear grouped together in the operative

complaint. Nor did Plaintiffs articulate their control group theory in this manner in

29 Carr, 2018 WL 1472336, at *10 (finding that the plaintiff failed to plead facts supporting the assertions that two stockholders constituted a control group where the agreement between the stockholders concerned only two of seven board seats, and thus was insufficient to establish control). 30 Dkt. 98 at 4–5, ¶ 8 (citing Sec. Am. Compl. ¶¶ 80, 122, 293, 295). 31 Id. at 10–12, ¶¶ 19–21. Civil Action No. 2017-0250-KSJM October 18, 2019 Page 10 of 14

briefing. 32 Indeed, the first two of the four facts—i.e., the Venture Capital

Defendants’ respective or collective stock ownership and the April 2014 amendment

to the Health Integrated Certificate of Incorporation (the “April 2014

Amendment”)—are not found in the complaint at all. 33 To be sure, Plaintiffs cited

32 See Dkt. 75, Pls.’ Corrected Br. in Opp’n to Defs.’ Mots. to Dismiss (“Pls.’ Ans. Br.”) at 19–22 (factual background section titled “The Transaction Challenged by the Thirteenth and Fourteenth Claims: The March 2015 Convertible Notes Offering”); id. at 46 (argument section addressing Counts Thirteen and Fourteen). Plaintiffs’ argument in briefing concerning Counts Thirteen and Fourteen can best be described as a “head counting” analysis intended to demonstrate that a majority of the board that approved the 2015 offering was conflicted with respect to that decision. But the Plaintiffs’ head counting analysis does not directly—nor, in this instance, even indirectly, as discussed below— speak to the standard for pleading the existence of a control group. 33 See Sec. Am. Compl. ¶ 80 (“On May 27, 2005, the Health Integrated certificate of incorporation was amended to reduce the number of authorized (but unissued) Series A shares, set an original issue price of $14.97 for the Series B stock, grant the Series B stock a liquidation preference in the multiple of 1.5x, reduce the liquidation preference of the holders of the Series A from 2x to 1.5x, subordinate the rights of the holders of the Series A stock upon liquidation to those of the holders of the Series B stock, and grant weighted average price protection to the holders of both the Series B stock. (The ratchet price protection previously granted the Series A stock had been withdrawn by a 2004 amendment to the certificate, and therefore both the Series A and Series B stock had only weighted average price protection.) These changes were necessitated in order to undertake an offering of Series B stock. The amendment also gave the holders of the Series B stock the same voting rights associated with the common stock.”); id. ¶ 122 (“McNabb, DiSalvo and Lux were conflicted with respect to the approval of this transaction since their firms, River Cities, [Midwest] and Stonehenge, respectively, received notes in this transaction. Padda and Toney were conflicted since they were beholden to River Cities, [Midwest] and Stonehenge. Kobielski, the representative of HealthNow-NY supported this transaction based on promises from McNabb, DiSalvo and Lux that they would support Health Integrated, granting future preferred rights to HealthNow-NY.”); id. ¶ 293 (“A majority of the directors who approved the March 2015 Notes Offering were either interested in or lacked independence in determining whether to approve that transaction. Specifically, McNabb, DiSalvo and Lux were conflicted because River Cities, [Midwest] and Stonehenge received securities in the offering. Kobielski supported this transaction in consideration for the approval McNabb and DiSalvo had in the past provided for the 2005 Civil Action No. 2017-0250-KSJM October 18, 2019 Page 11 of 14

to the April 2014 Amendment in their Answering Brief twice in passing, but

presented no argument concerning its significance. 34

Having failed to timely plead or argue the control group theory that Plaintiffs

now advance, Plaintiffs are barred from pursuing it on reargument. 35 At the very

least, because Plaintiffs neither pled the existence of nor argued the significance of

the first two facts that the Court supposedly overlooked, Plaintiffs cannot now claim

that these facts form a basis for reargument. 36

Series B offering and in consideration for promises from McNabb and DiSalvo that they would support future offerings benefitting HealthNow-NY. As Health Integrated officers whose employment, compensation and managerial authority were dependent on satisfying the demands of the existing preferred shareholders (River Cities, West Broadway, [Midwest], HealthNow-NY and Stonehenge) and the directors (McNabb, Liptak, DiSalvo, Kobielski and Lux) who represented the existing preferred shareholders, Padda and Toney were not independent with respect to the March 2015 Notes Offerings.”); id. ¶ 295 (“Because a majority of the directors who approved the March 2015 Notes Offering were either conflicted or not independent, the board has the burden of showing that these transactions were entirely fair to the holders of the common stock.”). 34 See Pls.’ Ans. Br. at 47, 61; Orman v. Cullman, 794 A.2d 5, 28 n.59 (Del. Ch. 2002) (“Briefs relating to a motion to dismiss are not part of the record and any attempt contained within such documents to plead new facts or expand those contained in the complaint will not be considered.”). 35 inTeam Assocs., 2016 WL 6819734, at *2 (“A party may not present a new argument for the first time in a motion for reargument.”). 36 Quantlab, 2018 WL 5778445, at *1 (“Reargument motions may not be used to . . . present . . . evidence that could have been presented before.”). Civil Action No. 2017-0250-KSJM October 18, 2019 Page 12 of 14

Plaintiffs’ factual allegations, addressed in order below, do not alter the

outcome of the Opinion in any event.37

First, Plaintiffs’ submission of the Venture Capital Defendants’ actual equity

ownership percentages does not affect the Opinion’s analysis. That analysis rested

on the lack of any alleged or reasonably inferred legally significant connection

between the Venture Capital Defendants. Whether the Venture Capital Defendants

wielded sufficient voting power to act collectively and exercise control did not factor

into the Opinion. Plaintiffs’ additional facts regarding the actual percentages are

thus of no moment.

Second, the April 2014 Amendment does not supply the legally significant

connection sufficient to create a control group under Dubroff.38 The April 2014

Amendment provided voting rights to the holders of categories of preferred stock,

which included the Venture Capital Defendants, concerning transactions required

for new equity financing. 39 Under the April 2014 Amendment, the Venture Capital

Defendants “retain[ed] at all times the right to vote [their preferred shares] in [their]

sole discretion on all matters presented to [Health Integrated’s] Shareholders for a

37 Those Certain Underwriters, 2008 WL 2133417, at *1 (noting reargument motions are denied even in the face of misapprehended facts unless “the outcome of the decision would be different”). 38 Dkt. 98 at 5, ¶ 9. 39 Id. at 7, ¶ 14. Civil Action No. 2017-0250-KSJM October 18, 2019 Page 13 of 14

vote.”40 Thus, the April 2014 Amendment did not evidence an agreement among

the Venture Capital Defendants to vote together on the challenged transaction. In

the end, Plaintiffs’ theory still only alleges the existence of parallel interests, and it

still “improperly conflates acts of consensus with the act of forming a group.” 41

Third and fourth, Plaintiffs repeat their “head counting” argument made in

briefing, contending that a control group can be inferred from the allegations that

five of the nine directors were conflicted with respect to the actions challenged by

Counts Thirteen and Fourteen.42 Specifically, Plaintiffs note as the third factor that

three of the directors on the Health Integrated Board were appointed by and affiliated

with the entities that participated in the challenged transaction. 43 They further

contend as the fourth factor that two of the remaining six directors were insiders who

were beholden to these entities given the Venture Capital Defendants’ board

nominees’ roles in setting executive salaries. 44

This argument, however, continues to conflate the existence of parallel

interests with the requirement that Plaintiffs plead a legally significant connection

40 Sheldon, 2019 WL 4892348, at *6. 41 Silverberg, 2019 WL 4566909, at *7. 42 Dkt. 98 at 12–13, ¶ 22–23. 43 Id. 44 Id. Civil Action No. 2017-0250-KSJM October 18, 2019 Page 14 of 14

among the alleged group members concerning the challenged transaction. Plaintiffs

presuppose that the Venture Capital Defendants’ parallel interests automatically

cause their board nominees to act in concert to exercise control over the insiders and

the 2015 offering. But as discussed above, Plaintiffs allege no legally significant

connection among the Venture Capital Defendants permitting this inference. Thus,

even assuming solely for the sake of argument that the Venture Capital Defendants

were interested in the 2015 offering, the Venture Capital Defendants’ board

nominees lacked independence from the Venture Capital Defendants, and the

insiders were beholden to the Venture Capital Defendants or their board nominees,

Plaintiffs still fail to plead the existence of a control group.

For the foregoing reasons, Plaintiffs’ Motion is DENIED.

IT IS SO ORDERED.

Very truly yours,

/s/ Kathaleen St. Jude McCormick

Kathaleen St. Jude McCormick Vice Chancellor

KSJM/lef

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