GLASSCOCK, Vice Chancellor.
This case involves a claim for breach of the fiduciary duty of loyalty. At the center of this dispute are the assets (mostly intellectual property) of Integrated Fuel Cell Technologies, Inc. ("IFCT" or the "Company"), a now-defunct tech startup company founded by Stephen Marsh to develop potentially revolutionary micro fuel cell technology. This technology, if perfected, could have replaced batteries in portable electronic devices such as cell phones and laptops. Despite several rounds of financing, IFCT was never able to develop the technology into a commercially viable product, and the Company never produced a consistent stream of revenue. This was a problem, of course, for IFCT's investors, particularly Echelon Ventures, L.P. ("Echelon"), a Boston-area venture capitalist firm that was IFCT's principal investor and a holder of the majority of the Company's preferred stock. Since investing in IFCT, Echelon had worked consistently to reduce Marsh's influence at IFCT.
As IFCT approached insolvency, it became apparent to IFCT's board that a sale of the Company's assets was the only viable solution. The board, which consisted of two Echelon-appointed directors, Marsh, an independent director, and the CEO, conducted a bidding process to sell IFCT's assets. The Company received several bids, but the major bids at issue in this case came from a group of investors organized by Marsh and from a group of investors organized by Echelon. Several of the investors in Marsh's group (notably including Marsh himself) went on to form Encite LLC ("Encite"), the plaintiff in this case. Echelon's group comprised individuals and entities that had participated in a bridge loan to finance the sale of IFCT's assets, and most of these participants were holders of the same class of preferred stock as Echelon.
The bidding process lasted about five months, and the board eventually approved the Echelon-backed bid. Marsh believed that the rest of the board had not adequately considered, or had wrongfully rejected, the Marsh-backed bid. While the CEO was working out a consent solicitation with IFCT's lawyers to send to the stockholders, Marsh informed the stockholders that they were about to be sent a bid approved by interested directors, and that superior bids had been ignored or cursorily negotiated. Based on a leaked draft consent solicitation and at Marsh's direct urging, an IFCT stockholder and friend of Marsh's filed a derivative suit. Apparently this was the last straw in the Marsh-Echelon relationship, a relationship that had been difficult since its inception. The board withdrew the Echelon-backed offer, and all of its members besides Marsh quickly resigned. Marsh, then the sole director of IFCT, instead of pursuing any outstanding offers, took the company into bankruptcy, wherein the Marsh-led group of investors (Encite) submitted the winning bid for IFCT's assets, beating out a competing Echelon-backed bid.
Having secured the intellectual property of IFCT for himself and facing the opportunity to start over with the technology he had created, Marsh could have continued on his way, content with his victory over the venture capitalist firm that from the outset had tried to force him out of any position of power in IFCT. Instead of taking his victory to the bank and proceeding to develop his nascent fuel cell technology, Marsh decided that the best course was to continue his struggle with his former fellow board members and Echelon, and he filed this suit alleging that the Director Defendants breached their fiduciary duties to IFCT, abetted by Echelon.
Among the assets purchased by Marsh and Encite via the bankruptcy proceeding were choses in action, arguably including this breach of fiduciary duty action against the Director Defendants. The crux of the Plaintiff's argument is that the Director Defendants conducted an unfair and disloyal bidding process, whereby they favored the Echelon-backed bid and refused to follow up on or negotiate other superior bids. As a result, according to the Plaintiff, IFCT missed its chance to sell its assets at the peak of their value and was forced to sell its assets at a discount in bankruptcy. The Plaintiff also contends that Echelon aided and abetted the Director Defendants' breach. The Plaintiff claims as damages the highest value of IFCT's assets during the bidding period, less the amount IFCT received for its assets in bankruptcy. For the reasons stated later in this Opinion, I accept this theory of damages with a slight modification.
Such an argument raises an issue on its face as to whether a person can purchase a claim for breach of fiduciary duty in a bankruptcy proceeding. In doing so, the Plaintiff has found itself in a somewhat absurd position. The Plaintiff is essentially arguing that it purchased IFCT's assets at a price that was depressed due to the Director Defendants' breach of fiduciary duty, yet at the same time the Plaintiff is seeking to recover the difference between this depressed value and the assets' true value—all the while holding those very assets, for which it paid only the depressed value. In other words, the better the bargain Encite received, the higher the damages to which it (derivatively of IFCT) is entitled. The Plaintiff assures me that its claim here is the same as any other purchased lawsuit, and the Defendants have not persuasively disputed this point; accordingly, I have assumed that the Plaintiff did purchase the breach of fiduciary duty claim it seeks to prosecute here.
The Director Defendants have moved for summary judgment, alleging that IFCT's board conducted an entirely fair bidding process and that Encite has suffered no damages. Echelon has also moved for summary judgment, restating the arguments of the Director Defendants and additionally asserting that, if a breach is found, Echelon did not knowingly participate. The Defendants also argue that Encite's claim should fail on the grounds that Stephen Marsh has unclean hands.
Echelon filed a third-party complaint against Marsh, accusing him of tortiously interfering with Echelon's prospective business relationship with IFCT and contributing to any damage suffered by IFCT as a result of the bidding process. Marsh has moved for summary judgment against those claims, asserting that Echelon was never a party to any agreement with IFCT and that Echelon did not have a reasonable expectation of a business relationship.
These claims are intertwined and arise from a long and complex history of bickering between the creator of a technology with great potential and the venture capitalist firm that provided the funds to develop that technology. It is a story of strong personalities and soured relationships. If the technology had been successful, the parties' interests would have remained aligned. Unfortunately, the technology was never perfected, the parties made competing moves to claim the intellectual property, feelings were hurt, bids were spurned, and our cell phones are still fueled by batteries.
Given that the Director Defendants have conceded the applicability of entire fairness review and given the fact-intensive nature of that review, I find that the Director Defendants have not met their burden at this stage to achieve summary judgment against Encite. I also find that material facts remain as to the liability of Echelon for aiding and abetting the alleged breach of fiduciary duty by the Director Defendants, and I therefore deny Echelon's motion for summary judgment on that claim. Finally, I find that material facts also remain regarding Echelon's third party claims, and so I deny Marsh's motion for summary judgment.
Encite, the Plaintiff, is a Delaware limited liability company that owns substantially all of the assets of Integrated Fuel Cell Technologies, which Encite acquired through IFCT's Chapter 11 bankruptcy proceeding. IFCT was a Delaware corporation with its principal place of business in Massachusetts. It was a startup company developing micro fuel cell technology.
Stephen Marsh is a principal of Encite. He founded IFCT in 1999 and was its CEO until September 2004 and its Chairman until October 2006. Marsh is also the Third Party Defendant in this case.
Echelon, a Defendant, is a venture capital firm based in New England that invests in early-stage technology companies. Echelon was co-founded by Alfred Woodworth (who is now a managing partner) and Scott McCabe (a current partner). Echelon owns over 50% of IFCT's Series B preferred stock, which represents about 20% of the total voting stock of IFCT. Two affiliates of Echelon, Lewis Wharf Partners ("LWP") and James Daniell, also own Series B stock.
Rob Soni, James Dow, Frank Weigold, and Rick Hess are former directors of IFCT (collectively, the "Director Defendants," and with Echelon, the "Defendants"). Soni owns Series B stock and a small amount of Series A and common stock of IFCT. Dow and Weigold were elected to IFCT's board as representatives of the Series B stockholders. Dow and Weigold are also partners in LWP, an Echelon affiliate that owns Series B stock. Hess owns IFCT common stock and served as the CEO of IFCT after Marsh's resignation in 2004.
Stephen Marsh formed IFCT in 1999 in an attempt to develop a micro fuel cell that could replace batteries in portable electronic devices such as cell phones and laptop computers. Upon its formation, IFCT's board consisted of Marsh, who initially served as Chairman and CEO of the company, and Aaron Kleiner, a Massachusetts-based investor and friend of Marsh's.
Marsh and his investors had high hopes for the fuel cell technology. According to the Plaintiff, had IFCT succeeded in developing and commercializing a viable product, it could have revolutionized the powering of portable electronic devices and potentially generated large revenues through the sale and licensing of its intellectual property. As is apparent from the continued presence of batteries in our society, Marsh's technology never got off the ground. Rather, from Marsh's foundation of IFCT through the eventual sale of IFCT's assets in bankruptcy, the Company never produced a viable commercial product and never generated a consistent stream of revenue.
Like any nascent technology, Marsh's micro fuel cells needed investors. IFCT initially raised financing through a sale of Series A preferred stock to Marsh's friends and family, including Kleiner and Alan Spiro, an attorney whose law firm began representing IFCT as its regular outside counsel. Marsh also convinced James Daniell, a Boston-area investor, to purchase Series A preferred stock. Daniell began to serve as an unpaid consultant to IFCT.
After depleting this initial investment, IFCT began to seek additional financing. In the process of searching for venture capital ("VC") firms to invest in IFCT, Daniell met Scott McCabe and Alfred Woodworth, the two principals of Echelon. Daniell spoke with them about the possibility of investing in IFCT, and Echelon agreed to contribute to a bridge loan to IFCT that would convert into preferred stock during the next round of financing. Marsh and Kleiner then asked Daniell to serve as president of IFCT, and Daniell accepted.
Daniell prepared a business plan and began making presentations to Boston-area VC firms. Despite his efforts, IFCT struggled to raise money. Potential VC investors found that Marsh over-valued the company.
With little success among other VC firms, IFCT returned to Echelon. Marsh and Echelon were able to get along initially because Echelon would not insist on Marsh's stepping down immediately. Echelon made clear, however, that Marsh had to go within a year. IFCT and Echelon eventually signed a term sheet whereby Echelon agreed to lead the next round of financing. This agreement ultimately lead to IFCT's issuing Series B preferred stock to Echelon along with several other investors. Echelon would hold the majority of the Series B stock.
Echelon and the other Series B investors negotiated several rights in connection with their investment. The parties do not dispute that these rights were typical for senior preferred stock in a startup company like IFCT. These rights included (1) the right of the Series B stockholders to appoint two representatives to IFCT's board, (2) the right of the Series B stockholder director representatives to pre-approve any debt secured by the assets of IFCT, (3) the requirement that IFCT hire a new CEO, (4) the right of the Series B stockholders to pre-approve a sale of all or substantially all of IFCT's assets, and (5) a 2X liquidation preference.
Echelon and IFCT also agreed that the Series B 2X liquidation preference would be reduced from 2X to 1X if, by July 10, 2004 (the one-year anniversary of the Series B financing), IFCT technology reached a certain "power density milestone" and the board hired a new CEO.
In connection with the Series B financing, IFCT and its stockholders (now comprising the common, Series A, and Series B holders) entered into a Stockholders Agreement that reconstituted the company's board. Per that agreement, the Series B stockholders had the right to appoint two directors, the common and Series A stockholders together had a right to appoint one director (provided that this director would be IFCT's CEO to the extent that the CEO had a contractual right to serve on the board), Marsh had the right to appoint one director, and all of IFCT's stockholders together would mutually agree upon an independent fifth director who had relevant experience in the industry.
The Series B stockholders nominated James Dow and Franklin Weigold to serve on the board. Dow and Weigold were both partners in LWP, an affiliate of Echelon's and an investor in IFCT's Series B stock. Marsh, who was then the CEO, was appointed to fill the position elected by the common and Series A stockholders. Marsh himself nominated Kleiner to the board. Marsh also suggested and supported Rob Soni for the fifth and independent position.
Following the Series B financing and the reorganization of IFCT's board, Marsh controlled a majority of the combined common and Series A stock, and Echelon controlled a majority of Series B stock. Thus, Marsh could unilaterally control any action requiring the consent of the common and Series A stockholders, and Echelon could unilaterally control any action requiring the consent of the Series B holders (namely, the rights earned through the Series B financing described above). With IFCT's founder on one side, its principal investor on the other, and its dearth of revenue-generating technology, the stage was set for conflict.
Shortly after the closing of the Series B financing, the board began to look for a new CEO. Marsh initially resisted this process, asserting that Echelon had orally agreed not to push for a new CEO immediately.
In November 2003, the board decided to revisit the CEO issue at the February 2004 board meeting. Following the November meeting, the Echelon board appointees communicated with Scott McCabe, who had been appointed as Echelon's representative to IFCT's board following the Series B investment.
At the February 24, 2004 board meeting, the board hired Myron Feld, a friend of Kleiner's, as president of IFCT. Feld had no background in fuel cell technology but was to assist with "business planning."
At the same meeting, the board formed a CEO search committee with Soni, Marsh, and Dow serving as its members. The committee immediately sought proposals from search firms to do a CEO search. Christian & Timbers ("C&T") submitted a bid in early March 2004, although the formal search did not begin until June 28, twelve days before the CEO hiring deadline.
The delayed start of C&T's CEO search was due at least in part to Weigold's indication to C&T that the search for a VP of Engineering should take priority over the CEO search and that the CEO search was expected to take place in the fall of 2004.
Compounding the above actions, the power density milestone requirement also appeared unreachable by the July 10 deadline. The March 2004 board meeting materials reported that power output remained low.
Nonetheless, in June 2004, IFCT scheduled a test for the power density milestone and managed to meet the requirement. Now needing only to hire a CEO to reduce the 2X liquidation preference of the Series B stockholders, Marsh called an emergency board meeting to nominate Feld for CEO. The meeting was to be held on July 8, 2004, two days before the hiring deadline. Soni was unable to attend the meeting, leaving Marsh, Kleiner, Dow, and Weigold to vote on Feld.
The vote was split, with Marsh and Kleiner voting in favor and Dow and Weigold voting against.
Finally, in October 2004, the board hired Rick Hess, the former president of a major electronic manufacturing company responsible for bringing new integrated circuits from development to market. As CEO, Hess also replaced Kleiner as a director of IFCT.
In the first half of 2005, Marsh and Hess met with VC firms to obtain new financing for IFCT. Yet Marsh and Hess had trouble attracting investors. VCs were proposing pre-money valuations that were lower than IFCT's then post-money valuation. Woodworth alleged at his deposition that Marsh's over-valuation of the company was precluding VC deals because Marsh insisted on a pre-money valuation that would prevent his ownership from being diluted (approximately $18 million).
In early September 2005, OnPoint Technologies, a Series B stockholder of IFCT and a private equity investor in technology of interest to the U.S. Army, made a financing proposal to recapitalize IFCT at $5 million.
After the failed negotiations with OnPoint, IFCT's board decided that the appropriate course of action was a sale of IFCT's assets. The board considered filing for bankruptcy, but ultimately determined that the company could achieve more value outside of bankruptcy.
Because IFCT was out of money and still had not achieved a viable product, the company needed to borrow money to fund the process to sell its assets. In September 2005, Echelon led a group of primarily Series B stockholders
Around this time, Marsh submitted, on behalf of a group of investors including himself and Kleiner (the "Marsh Group"), an offer to purchase IFCT's assets (the "Marsh Group's September Offer"). This offer consisted of (1) $215,000 in cash, (2) the cancellation of $104,000 that Marsh alleged was owed to him, (3) the cancellation of $21,000 that Marsh alleged was owed to his friend, Don Parker, (4) a non-transferable 1% royalty on gross revenues from product sales up to $25 million, and (5) an exclusivity provision.
At a board meeting on September 20, 2005, the board approved the general terms of the 2X Notes and authorized Hess to continue negotiating the specific terms with the Noteholders. At the same meeting, the board asked Marsh—and Marsh agreed—to extend the deadline of his offer, on the grounds that the board wanted to see all of the available offers before approving any sale.
On October 4, 2005, Marsh proposed an alternative bridge loan (the "Marsh Group Notes") to IFCT. The Marsh Group Notes were 1X notes; that is, they provided no premium over face value, as opposed to the 2X Premium offered by the Noteholders.
Woodworth, in an email to Echelon's investors, acknowledged that the Marsh Group Notes' terms were, at the time, superior to the terms of the 2X Notes, and Woodworth expressed concern that Marsh's involvement with the Marsh Group Notes would jeopardize the rights and interests of the Series B stockholders.
Dow and Weigold, not surprisingly given the concerns expressed by Woodworth and their own participation as Series B stockholders in the 2X Notes, were unwilling to approve the Marsh Group Notes' security interest.
When the board requested that the Marsh Group amend its proposal to remove any security interest, the Marsh Group refused.
The financing for the 2X Notes closed on October 17, 2005, and the loan was made available to all IFCT stockholders on a pro rata basis.
While still in the process of approving the bridge loan, IFCT's board began to search for potential buyers for IFCT's assets. The board did not engage a financial advisor to assist with the sales process, allegedly because the company could not afford one.
As a first step, the board assembled a list of potential acquirers. The parties differ in their accounts of who was primarily responsible for assembling this list and what the criteria were. The Director Defendants seem to credit IFCT's board with this task.
IFCT assembled a list of around 100 potential buyers, and it narrowed that list down to around 30 "targets." The Defendants do not specify what criteria moved a company from the initial list to the "target" list, other than a general recommendation from anyone who was at the board meetings.
Through these initial contacts, the board set up meetings with approximately 15 potential buyers, and board members allegedly made presentations to many of them.
Despite its efforts, the board received no offers from potential buyers from October through the first half of December 2005. Neither party specifically addresses the cause of this difficulty. Hess, however, remarked in his deposition that Marsh had refused to speak with certain bidders since Marsh himself was bidding for IFCT's assets.
Hoping to close a deal by the end of the year, the board invited bidders to submit bids by December 20, 2005. After receiving only a few offers by that date, the board extended the deadline to January 30, 2006. By the end of January, IFCT had received only a handful of bids for its assets.
By the January 30, 2006 deadline, IFCT had received five bids. Two of these—a bid from a group led by Peter Palmer and a bid from David Pelly—were submitted in late December.
The board received a bid from a group led by Peter Palmer on December 20, 2005. Marsh was a member of the group.
On December 21, 2005, David Pelly submitted an offer with incomplete and very general terms for capitalizing a new company to purchase IFCT's assets.
On January 23, 2006, TRK Engineering Services submitted an offer, the terms of which were (1) $200,000 in cash, (2) a $406,000 promissory note payable to the Noteholders (to cover the outstanding 2X Notes), and (3) a 2% non-transferable royalty on gross revenues from product sales capped at $20 million distributed to IFCT stockholders equally. The board allegedly responded to TRK but never heard back.
Peter Besen submitted an offer to the board on January 30, 2006. The terms were (1) cash in the amount of the face value of the 2X Notes or the conversion of the 2X Notes into stock of the acquiring company, (2) 10% of common stock of the acquiring company to IFCT Series A and B stockholders who were accredited investors, and (3) the assumption of certain obligations such as IFCT's lease. Echelon was involved with and backed the Besen Offer, and Echelon contends that it disclosed its involvement to IFCT's board.
Also on January 30, the Marsh Group submitted an offer. In addition to Marsh, Philip Huyck (Encite's current CEO) participated in the bid. The Marsh Group's January Offer proposed to acquire IFCT's assets through a to-be-created company for (1) $420,000 in cash, (2) a promissory note for $600,000, (3) a 2% non-transferable royalty on product revenue
Unfortunately, Huyck failed to set up a meeting with HARC. When Hess emailed Huyck asking for an update on February 7, Huyck responded on February 13 that he had been unable to set up a meeting with HARC and that the IFCT board "should proceed with [its] efforts on the assumption that HARC and its affiliates will not be involved."
The parties have differing accounts of the effect of Huyck's February 13 email. Huyck's deposition testimony regarding his email was contradictory: At one point, he indicated that he meant that HARC's non-participation effectively killed the Marsh Group's January Offer.
The Defendants assert that Huyck's February 13 email terminated the Marsh Group's January Offer. Accordingly, the board did not pursue negotiations with the Marsh Group on the terms of its January Offer. Nonetheless, Hess, in his response to Huyck's email, made it clear that the board was still interested in negotiating with Huyck: "Please let me know if there is anything I can do to make this possible. The board was hopeful that in extending the process you could participate."
On February 9, 2006, having determined that none of the initial offers were acceptable, the board decided to outline what it considered to be a good structure for bids. The board proposed: (1) that the 2X Notes held by the majority of Series B stockholders would be paid at face value ($431,000), (2) that the IFCT stockholders would receive a 20% ownership interest in Series A preferred stock of the new company based on an initial capital investment by new investors of $3 million, and (3) the current stockholders would receive a note for the full amount of their current invested capital in IFCT ($7.9 million) with 8% interest, payable in five years and secured by IFCT's intellectual property. The board then forwarded this outline to at least some of the bidders, asking them to respond by February 15, 2006.
The Marsh Group responded on February 14, 2006 with a new offer (the "Marsh Group's February Offer"): (1) $431,000 in cash, (2) IFCT would receive 15% of the non-voting common stock of a new company, Encite, created to receive and utilize IFCT's assets,
Peter Besen also submitted a revision of his January offer, adding more specificity. The new Besen Offer raised the offer of common stock in the acquiring company to 20% and provided that the common stockholders would have the right to participate pro rata in any additional financing, up to and including the first "qualified financing." Besen no longer offered, however, to assume any obligations of IFCT, and the new offer required a "stand still agreement (no shop)."
Shortly before receiving the Marsh Group's and Besen's revised offers, Hess emailed Woodworth to ask him what terms Echelon, as the largest of the Noteholders and Series B investors, would find acceptable in a bid for IFCT's assets. Echelon's input was important because the Series B stockholders had a right to veto any sale of all or substantially all of IFCT's assets, and Echelon, as the majority Series B holder, could exercise that right unilaterally. Woodworth responded:
In the event, however, that a bid was from a company formed for the purpose of acquiring IFCT, Woodworth had other criteria, including the repayment of at least the face value of the 2X Notes and an equity interest in the acquiring company at least equal to the Series B current equity holding in IFCT.
After receiving these guidelines from Woodworth, the board then met in mid-February to discuss the Marsh Group's February Offer and the revised Besen Offer. The board was not satisfied with either bid.
Hess met with Woodworth for lunch to discuss the status of the bidding process and to seek an extension of the due date of the 2X Notes. Echelon ended up granting several extensions to the board, eventually pushing the maturity date to April 9, 2006, allegedly to give the board more time to find a satisfactory offer.
Around March 6, 2006, the Noteholders submitted a bid for IFCT's assets, which included (1) deeming the 2X Notes fully paid, (2) converting all outstanding IFCT stock to common stock, thereby waiving the Series B liquidation preference, and (3) offering to all IFCT stockholders warrants to acquire 10% of the stock in the new company (which came to be called "iProton") that would purchase IFCT's assets. After discussions with IFCT's board, the Noteholders revised their offer to include additional consideration of a $3 million note convertible into 10% of the equity of iProton in connection with a sale, merger, or IPO.
The day after the Noteholders submitted their bid, IFCT's board met with Marsh and Huyck to discuss the Marsh Group's February Offer.
After the meeting, the Marsh Group withdrew its February Offer. Huyck testified that "there was no reason to leave an offer on the table because [the board] had absolutely no interest in discussing it."
Following its meetings with the Marsh Group and Besen, IFCT's board made additional comments on the Noteholders' revised bid. On March 13, 2006, the Noteholders submitted a restructured bid, the terms of which were (1) cancellation of the 2X Notes ($431,000), (2) payment of IFCT's reasonable transaction costs, (3) assumption of IFCT's lease, (4) for all IFCT stockholders, on an as-if converted to common stock basis, a 3% transferable royalty up to $7 million payable after $10 million of revenues from products or licenses that involved intellectual property covered by IFCT's patents, pre-payable at a 30% discount, and (5) waiver of the Series B stockholders' 2X liquidation preference.
At this time, the board felt that it was "running out of money" and "running out of time."
Although Marsh recused himself from the board meetings while he was involved in bidding for IFCT's assets, he nonetheless remained updated on Echelon's bid. Luke Pustejovsky, or as Marsh came to call him, "The Mole,"
How Pustejovsky obtained confidential information regarding Echelon's bids remains unclear. Pustejovsky was no longer an Echelon employee after his departure in early 2005, and he was not an investor in Echelon during the bidding process.
Regardless of how Pustejovsky obtained the confidential information, the parties do not dispute that Pustejovsky obtained confidential information about Echelon's bids and forwarded that information to Marsh, who was at the time participating in the bidding process. Marsh never disclosed his receipt of this information to IFCT's board.
On March 15, 2006, Woodworth notified Echelon's investors that IFCT's board had accepted the Noteholders' Offer. Pustejovsky forwarded this email to Marsh later that evening.
The terms of the Marsh Group's March Offer were: (1) $500,000 in cash, (2) assumption of IFCT's lease, and (3) a 1.5% non-transferable royalty up to $15 million to Series B stockholders and a 0.5% non-transferable royalty to common and Series A stockholders up to $5 million from product sales payable after four years.
Despite having already approved the Noteholders' Offer, IFCT's board evaluated the Marsh Group's March Offer at a meeting on March 20, 2006. The board found that the Noteholders' Offer was superior and that the Marsh Group's Offer lacked detail ordinarily included in a term sheet. The board instructed Hess to request further information from Huyck, and the Marsh Group twice submitted a more detailed term sheet.
On March 31, 2006, after discussing the final Noteholders' Offer and the Marsh Group's March Offer, the board formally approved the Noteholders' Offer by a vote of four to one (with Marsh voting against).
While the lawyers for iProton (the Noteholders' inchoate acquisition company) and IFCT negotiated the documentation for the sale, IFCT's board began to prepare the solicitation materials that were to be sent to stockholders to obtain their approval of the deal. IFCT's outside counsel at Wilmer Hale wrote the initial draft of the consent solicitation. Following comments from Hess, Wilmer Hale revised the letter to disclose that certain directors were interested in or affiliated with the acquiring company, iProton, although the solicitation did not list the names of the interested directors.
Hess then circulated this revised version (the "Draft Solicitation") to the board at the beginning of the March 31 board meeting.
Despite the approval of the Draft Solicitation by the board, Hess delayed sending the solicitation to IFCT's stockholders out of concern that, as raised by Marsh at the meeting, the letter did not adequately disclose that a majority of the board was conflicted.
Marsh, however, allegedly believed after the March 31 board meeting that the Draft Solicitation was being sent immediately to stockholders. Over the April 1-2 weekend, without consulting the rest of the board, Marsh sent an email to IFCT's stockholders informing them that a conflicted board had approved the Noteholders' Offer and that there was a better offer available; namely, the Marsh Group's March Offer.
In addition to sending an email to the stockholders, on March 31 Marsh forwarded the Draft Solicitation to David Jenkins, Encite's current counsel and Marsh's personal lawyer for a short period in late March 2006.
Meanwhile, on Sunday, April 2, Huyck informed Hess that the Marsh Group was improving its March Offer by increasing the royalty rate from 1.5% to the Series B and 0.5% to the remaining stockholders to 3% and 1%, respectively.
The next day, on April 3, 2006, the board sent the final version of the consent solicitation (which named the interested directors) to the stockholders (the "April 3 Consent Solicitation").
Marsh testified at his deposition that he had wanted to bring the derivative claim, but that he "had so many hats on" that he did not think it was appropriate for his name to be on the suit.
After Setrin filed his lawsuit, things quickly fell apart at IFCT. On April 4, following the filing of Setrin's lawsuit, IFCT informed Setrin that it would temporarily withdraw the April 3 Consent Solicitation and make a corrective disclosure.
As the sole director of IFCT,
Marsh and Echelon butted heads yet again in the bankruptcy proceeding. Marsh formed Encite, which submitted a stalking horse bid. The only other bidder was a group affiliated with the Noteholders. And of course, a bidding war between Marsh and Echelon would not have been complete without "The Mole." Just as he had done during the earlier bidding process, Pustejovsky forwarded to Marsh email updates sent by Woodworth to Echelon's investors, which included a discussion of Echelon's participation in a bid for IFCT's assets in the bankruptcy case.
On June 9, 2006, the Bankruptcy Court entered a sale order under Section 363 of the Bankruptcy Code approving the sale of substantially all of IFCT's assets to Encite. These assets consisted mostly of intellectual property but also included, according to the Plaintiff, the right to sue the Director Defendants for breach of fiduciary duty. Encite's winning bid comprised $652,000 in cash
Encite alleges that the Director Defendants breached their fiduciary duty of loyalty by failing to conduct an effective and fair bidding process. Encite asserts that the Director Defendants failed to adequately explore buyers, ignored some bidders, and wrongfully focused on selling IFCT's assets to the Noteholders. According to Encite, the Director Defendants did this by (1) approving the 2X Notes in an interested transaction, which later gave the Noteholders leverage in the bidding process, and (2) approving the Noteholders' Offer without adequately negotiating with any of the other bidders. Encite claims that, as the purchaser of IFCT's breach of fiduciary duty claim against its directors, it is entitled to recover any damages suffered by IFCT as a result of the Director Defendants' actions. Encite also alleges that Echelon aided and abetted the Director Defendants' breach of fiduciary duty.
The Director Defendants, conceding that they were conflicted, argue that the bidding process and their approval of the 2X Notes and the Noteholders' Offer were entirely fair. The Director Defendants also assert that IFCT was not damaged by the alleged breach and that Marsh should be denied relief under the unclean hands doctrine for obtaining and using confidential information regarding Echelon's bid while the Marsh Group was a competing bidder.
Echelon offers the same defenses as the Director Defendants and also argues that there is no evidence suggesting that Echelon knowingly participated in the Director Defendants' alleged breach of fiduciary duty.
Echelon has also filed a third-party complaint against Stephen Marsh, alleging that Marsh tortiously interfered with Echelon's prospective business relationship with IFCT by misleading stockholders during the consent solicitation process. Echelon also seeks contribution against Marsh in the event that it is found liable for aiding and abetting the Director Defendants' alleged breach of fiduciary duty on the grounds that Marsh was at least partly responsible for frustrating the bidding process for IFCT's assets.
For the reasons stated below, I find that there are genuine issues of material fact requiring a trial regarding the Director Defendants' alleged breach of fiduciary duty, Echelon's aiding and abetting of that alleged breach, and Echelon's third party claims for tortious interference and contribution. Accordingly, I deny summary judgment on all claims.
Summary judgment is appropriate where there is no genuine issue of material fact requiring a trial and the moving party is entitled to judgment as a matter of law.
There are three motions before me. The Director Defendants have moved for summary judgment against Encite's claim that they breached their fiduciary duties in failing to conduct an entirely fair bidding process. Echelon has moved for summary judgment against Encite's claim that Echelon aided and abetted the Director Defendants' breach. Both the Director Defendants and Echelon also seek summary judgment in favor of their defenses that Encite cannot prove damages resulting from the breach and that Marsh/Encite has unclean hands. Finally, Marsh has moved for summary judgment against Echelon's counterclaims for contribution and tortious interference with Echelon's prospective business relationship. I examine each of these motions in turn.
The Plaintiff has been inconsistent in the framing of its argument, although perhaps not by its own devices. While its briefing suggested specific and separate challenges to the approvals of the 2X Notes and the Noteholders' Offer, the Plaintiff clarified at oral argument that it was challenging the fairness of the bidding process as a whole.
Without a specific transaction to analyze, I see only one way to interpret the Plaintiff's argument comprehensibly, which I set out as follows: From the time that IFCT's board decided to sell the company's assets to the time when Marsh took the company into bankruptcy, IFCT's assets had a certain value, and this value was at least equivalent to the highest offer received by IFCT before it filed for bankruptcy in April 2006. In order to fulfill its fiduciary obligations, the board was required to take advantage of this value and approve an offer that provided fair consideration for IFCT's assets. In other words, when the board decided to sell IFCT's assets, the board had a window of opportunity to achieve the highest value reasonably available. The Director Defendants breached their fiduciary duties when they squandered the opportunity to realize the true value of IFCT's assets by failing to consider and negotiate the available offers and ultimately attempting to force through an inferior offer made by the Noteholders. The failure of that attempt by the Director Defendants left Marsh with no choice but to take IFCT into bankruptcy and sell off its assets for less than they were worth at their peak during the bidding process (whatever that amount is). Thus, the damage to IFCT, and the amount recoverable by the purchaser of IFCT's claim, Encite, is the highest value of the company during the bidding process less the value IFCT received for its assets in the bankruptcy proceeding.
As a preliminary matter, I do not accept the Plaintiff's argument precisely as stated. The Plaintiff seeks to use the Encite Bankruptcy Offer as the value arrived at due to the Director Defendants' breach, and the Plaintiff proposes to subtract this value from the value that the Director Defendants should have achieved through the bidding process. When the Director Defendants resigned, however, Marsh, as the sole remaining director, had the option to continue the bidding process or accept any outstanding offer, including his own. Marsh, not the Director Defendants, chose to take IFCT into bankruptcy. Therefore, if the Director Defendants did indeed breach their duties and this breach led to a decline in IFCT's value, the only damages fairly attributable to this breach would represent the difference in IFCT's value from the time period before the Director Defendants' resignations, less the value achievable by Marsh, as director in exercise of his duty of loyalty to IFTC, after the Director Defendants' resignations. I need not determine at this stage whether the latter value exceeds the amount realized from the bankruptcy proceeding. Put simply, I will credit the Director Defendants with the highest value reasonably available to IFCT from the moment they resigned through the sale of IFCT's assets in bankruptcy.
With the Plaintiff's argument thusly framed, the critical question for entire fairness review (which the Director Defendants concede is the applicable standard) is whether the Director Defendants used fair process in seeking and negotiating bids for IFCT's assets, or whether the Director Defendants breached their duty of loyalty by favoring the Noteholders in such a way that other, higher bids were discouraged or precluded, thus causing IFCT to lose its chance to secure the highest value for its assets.
The Director Defendants' motion for summary judgment is unusual under the circumstances of this case. In a more typical case involving a breach of fiduciary duty claim, the defendants at the summary judgment stage invoke the business judgment rule and argue that summary judgment should be granted in their favor because the plaintiffs have failed to establish a genuine issue of material fact as to whether the directors were independent, disinterested, informed, or acting in good faith.
In this case, however, the Director Defendants have conceded that the entire fairness standard applies. This concession is significant given that "a determination that entire fairness is the appropriate standard of review is often of critical importance."
Entire fairness places the burden on the Director Defendants to establish "to the court's satisfaction that the transaction was the product of both fair dealing and fair price."
This case, of course, presents a few challenges for the traditional approach to determining fair price. Ordinarily, where the contested action is the sale of a company, "the `fair price' aspect of an entire fairness analysis requires the board of directors to demonstrate `that the price offered was the highest value reasonably available under the circumstances.'"
The lack of a specific offer to analyze forces me to look instead at the "price" that was still available to IFCT after the board's alleged breach of fiduciary duty. As discussed above, the only possible measure of this "price" would be the best value reasonably available to IFCT in the time from the board's resignation through the sale of IFCT's assets in bankruptcy. If indeed this price was depressed by the board's favoring the Noteholders during the bidding process, I must analyze the process used by the board that led to this decrease in value.
With the above considerations in mind, I now turn to whether the evidence in the record, as viewed in the light most favorable to Encite, the non-moving party, establishes that the bidding process for IFCT was entirely fair. As discussed below, significant questions remain as to the extent of the board's negotiations with bidders other than the Noteholders and the likelihood that further negotiations or follow-ups would have lead to a transaction superior to the value available to IFCT after the Defendant Directors resigned. I therefore find that material issues of fact remain and that a determination of the entire fairness of the bidding process requires a trial.
The uncontroverted evidence in the record does not demonstrate that the Director Defendants engaged in fair dealing in the events that led to the sale of IFCT's assets in bankruptcy. Fair dealing "embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained."
The burden of producing such evidence belongs to the Director Defendants, not Encite. Having conceded that entire fairness applies, it is the Director Defendants who must provide the details of what actions they took during the sales process, what discussions they had, and what advice they were provided by counsel, and it is the Director Defendants who, through those details, must demonstrate that the process was entirely fair.
In the same paragraph, the Director Defendants conclude, with no elaboration: "[T]he record is irrefutable and replete with evidence that the Director Defendants' analysis and affirmative vote to approve the Noteholders' Offer was consistent with the advice of counsel and entirely fair—both in process and price."
Material factual issues also remain with respect to the negotiations between the Director Defendants and the bidders. It appears that some bidders, like TRK, never received a response from IFCT's board. Other bidders, like Peter Palmer, were simply told that their bids were not competitive. It appears that these bidders were never told that the board was considering a better offer and were never encouraged to beat that offer. It is not clear from the record what discussions the board had with every bidder, but, viewing the facts in the light most favorable to the Plaintiff, an inference can certainly be drawn that the board was favoring the Noteholders' Offer and forcing other bidders to negotiate against themselves. Without a fuller account of these negotiations, I cannot conclude based on the record before me that the board engaged in fair dealing with respect to the bidding process.
The Director Defendants' generalized contentions that they relied on expert counsel during the bidding process are also insufficient to establish fair dealing. "Although `reasonable reliance on expert counsel is a pertinent factor in evaluating whether corporate directors have met a standard of fairness in their dealings with respect to corporate powers,' its existence is not outcome determinative of entire fairness."
In arguing for the fairness of the bidding process, the Director Defendants repeatedly rely on the defense that they solicited and followed the advice of counsel. Nowhere in these assertions, however, do the Director Defendants specify even the general content of the advice they received. The record evidence fails to demonstrate that the Director Defendants were told by counsel that they could exercise independent business judgment. Additionally, the Defendants have offered no evidence suggesting that counsel advised them of what a fair bidding process requires. The Director Defendants need not provide the substantive details of the advice they received from their attorneys, but some evidence of their counsel's legal conclusions is required if they wish to rely on counsel's advice to prove fair dealing. Mere conclusory statements alleging that the board "consistently consulted with, relied on and followed the advice provided by IFCT's corporate counsel" will not suffice.
Finally, the Director Defendants rely overmuch on the fact that Delaware law imposes no specific procedural requirements on the sale of assets or a change of control. While it is true that "there is no single blueprint that a board must follow to fulfill its duties. . . . [and] no requirement that there be a bidding contest or even an active market survey,"
The Director Defendants have also failed to establish fair price based on uncontroverted evidence. Fair price "relates to the economic and financial considerations of the proposed [transaction], including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock."
The Defendants argue that the doctrine of unclean hands precludes recovery by Encite. Under the unclean hands doctrine, the court may "refuse[ ] to consider requests for equitable relief in circumstances where the litigant's own acts offend the very sense of equity to which he appeals."
In support of this defense, the Defendants allege that Marsh, often in cahoots with Kleiner or Huyck, refused to consider financing that would have diluted his stock, intentionally obstructed the appointment of a new CEO, received confidential information regarding Echelon's bids for IFCT and used that information to adjust Encite's bid, and intentionally drove the Company into bankruptcy. The egregiousness of some of these alleged offenses depends on the intentions of Marsh and his alleged conspirators, a factual issue that would require a credibility determination at trial. Moreover, the Defendants have not presented evidence regarding Marsh's ownership interest in Encite or the extent to which Marsh's conduct is fairly attributable to Encite. Although Marsh's alleged conduct, particularly his use of information from "The Mole," is strongly redolent of inequity and is described with some particularity, I cannot on this record find Encite barred here as a plaintiff as a matter of law under the doctrine of unclean hands.
Even if I were to find that the Director Defendants breached their fiduciary duties, the Plaintiff would still be required to demonstrate some damages. It is well-settled that "[p]laintiffs must prove their damages by a preponderance of the evidence."
Admittedly, the Plaintiff's theory of damages in this case has a peculiar equitable flavor. The Plaintiff argues that because the Director Defendants beached their fiduciary duty to IFCT, the resulting claim against the Director Defendants for this breach was an asset of IFCT's, and Encite purchased this asset at the bankruptcy proceeding. The Plaintiff therefore measures its damages as
In other words, the better the bargain obtained by the Plaintiff at the bankruptcy sale, the more damages, derivative of IFCT, it is entitled to in this action—thus, in the Defendants' view, seeking the same benefit twice. As discussed earlier in this Opinion, I do not accept the Plaintiff's damages calculation precisely as worded. After the Director Defendants resigned, Marsh—the sole board member—was left with the option of pursuing and accepting an available offer or taking IFCT into bankruptcy, and Marsh decided to declare bankruptcy. Therefore, the Director Defendants are not stuck with the Encite Bankruptcy offer as the price they "achieved," but rather are credited (under the peculiar facts of this case) with the highest value of IFCT's assets following the Director Defendants' resignations. Along that same line, since Marsh had at least one offer for the IFCT assets (his own), and apparently the Noteholders' Offer as well, available outside of bankruptcy, and since he alone decided to declare bankruptcy, I find that Encite cannot separately recover for the cost of bankruptcy. It is not as if IFCT was a thriving company before the bidding process, and the Director Defendants drove it into insolvency. IFCT was a doomed company before the Director Defendants reached a decision to auction its assets, and the asset sale in bankruptcy is more appropriately viewed as one of the potential "deals" that was available to IFCT.
With those considerations in mind, I now address the Director Defendants' specific challenges to the Plaintiff's claim for damages. The Director Defendants assert that the Plaintiff's theory of damages fails on its face because it leads to the inequitable result that Encite's damages are inversely related to the price it paid for IFCT's assets in bankruptcy. According to the Director Defendants, the Plaintiff is effectively arguing that because the Director Defendants failed to conduct a fair bidding process, the Plaintiff did not pay IFCT enough for IFCT's assets.
The Director Defendants further contend that the Plaintiff has suffered no damages because the Director Defendants never rejected or failed to consider an offer that was materially superior to the Noteholders' Offer or the Encite Bankruptcy Offer. The Director Defendants maintain that the Noteholders' Offer was superior to any other offer reasonably available to IFCT during the bidding process.
Where this Court finds that a breach of fiduciary duty has occurred, the specificity and amount of evidence required from the Plaintiff on the issue of damages is minimal. "Damages resulting from breaches of fiduciary duty are to be liberally calculated, and will be awarded as long as there is a basis for estimating damages. Also, a duty of loyalty breach `loosen[s] the stringent requirements of causation and damages.' Any uncertainty in awarding damages is resolved against the wrongdoer."
By a prior ruling of this Court that is the law of this case, the Plaintiff is precluded from submitting expert testimony, including its expert report regarding the value of IFCT's assets as of April 2006.
I now address the Plaintiff's claim that Echelon aided and abetted the Director Defendants' alleged breach of fiduciary duty. The Plaintiff contends that Echelon knowingly participated in the Director Defendants' breach by exploiting its relationship with conflicted directors on IFCT's board and improperly influencing those directors' decisions on matters such as the approvals of the 2X Notes and the Noteholders' Offer. Although the Plaintiff has offered limited evidence suggesting that Echelon acted improperly, I find that my analysis of this claim would benefit from a full trial record, and I therefore deny Echelon's motion for summary judgment on the Plaintiff's aiding and abetting claim.
To prevail on an aiding and abetting claim, a plaintiff must prove that a fiduciary relationship existed, that a third party breached that relationship, that the defendant knowingly participated in that third party's breach, and that the breach proximately caused damages.
Admittedly, the Plaintiff has provided scant evidence suggesting that Echelon participated knowingly in any breach by the Director Defendants. The Plaintiff has not pointed to any specific communications between Echelon and the Defendant Directors that evidence impropriety. Nor has the Plaintiff provided any evidence suggesting that the Director Defendants provided Echelon with confidential information on competing bids. Rather, the Plaintiff seems to infer wrongdoing on Echelon's part simply because Echelon exercised its bargained-for rights as the majority Series B stockholder, and because a majority of the board was interested in Echelon or held Series B stock.
Nonetheless, a key component of any aiding and abetting claim is whether a fiduciary breach occurred, an issue remaining for trial, and given that a majority of the Director Defendants were affiliated with the Noteholders, I find it to be in the interests of justice to reserve judgment on the Plaintiff's aiding and abetting claim until the parties fully develop the facts of this case. Accordingly, I deny Echelon's motion for summary judgment on the Plaintiff's aiding and abetting claim.
I now turn to the two third-party claims in this case, both of which involve claims by Echelon against Stephen Marsh. In the first claim, Echelon alleges that Stephen Marsh tortiously interfered with Echelon's prospective business relationship with IFCT. Specifically, Echelon asserts that Marsh's actions between March 2006 and April 2006—receiving confidential information from "The Mole," using that information to submit a last-second offer, and giving Jeffrey Setrin the Draft Solicitation to support Setrin's shareholder lawsuit—wrongfully prevented Echelon from consummating a deal for IFCT's assets and thereby deprived Echelon of the value of the stock Echelon would have owned in iProton. Echelon claims that its damages are the net value of the stock it would have owned in iProton but for the tortious conduct of Marsh. The parties agree that Massachusetts law applies to this claim.
To succeed on a claim for tortious interference with a prospective business relationship, Echelon must prove that (1) Echelon had a prospective advantageous relationship with IFCT, (2) Marsh knowingly induced a breaking of the relationship, (3) Marsh's interference with the relationship, in addition to being intentional, was improper in motive or means, and (4) Echelon was harmed by Marsh's actions.
To the extent Echelon is arguing that it had a reasonable expectation of owning an asset (i.e. stock in a corporation that would own IFCT's assets) by way of a business relationship with IFCT, and that because of Marsh's conduct, Echelon lost the net value of this stock, I find that Echelon has standing to sue for tortious interference with a prospective business relationship. Echelon is not claiming its proportionate share of iProton's lost profits, as Marsh seems to argue. Rather, Echelon is arguing that its damages are the lost value of the stock it would have owned in a corporation that would have owned IFCT's assets.
With regards to the issue of whether Echelon's expectation of a business relationship was reasonable, I simply cannot rule as a matter of law that the board's approval of the Noteholders' Offer would not have led to an economic benefit to Echelon. This is a fact-intensive issue requiring at least a finding that it was reasonably likely that the stockholders would have approved the Noteholders' Offer had it not been withdrawn. The present record contains little more than conflicting allegations regarding how certain stockholders would have voted. Because I find that Echelon has grounds to assert standing and because there are material facts in dispute as to the likelihood of the Noteholders' Offer being approved by the stockholders, I deny Marsh's motion for summary judgment on Echelon's claim for tortious interference.
Finally, Echelon seeks contribution from Marsh to the extent Echelon is held liable for causing damage to IFCT. Based on then-Chancellor Chandler's ruling at the motion to dismiss stage of this case, I find that it is law of the case that Echelon can seek contribution from Marsh for the portion of the injury to IFCT for which Marsh is responsible, but only if Echelon can prove that Marsh caused the same injury to IFCT as did Echelon.
This Opinion, while denying summary judgment, should have made clear both my concerns with the Director Defendants' (and Marsh's) conduct in their attempted transfer of IFCT's assets and my doubts about Encite's ability to prove damages at trial. This matter has proceeded in this Court for five years, outlasting the tenure of its original judicial officer. In cases such as this, it strikes me that pursuit of litigation may fail where an honest conversation with the opposing side about the costs and benefits of continuing would likely reveal a more rational economic alternative. Perhaps the pursuit of litigation is inevitable, however, when emotions run high and "winning" becomes divorced from economic incentive. In any event, given my denial of summary judgment, these litigants are entitled to pursue their claims through trial.
For the reasons stated above, I find that there are material issues of fact requiring a trial on all issues before me on summary judgment. I therefore deny the Director Defendants' motion for summary judgment, I deny Echelon's motion for summary judgment, and I deny the Third Party Defendant's motion for summary judgment.
An order has been entered consistent with this Opinion.
