ORACLE PARTNERS, L.P., a Delaware limited partnership, Plaintiff/ Counterclaim Defendant,
BIOLASE, INC., a Delaware corporation, Defendant/ Counterclaim Plaintiff.
Date Submitted: April 25, 2014
Kenneth J. Nachbar, Esquire and Bradley D. Sorrels, Esquire of Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware; and Steven E. Cohen, Esquire of Kane Kessler, P.C., New York, New York, Attorneys for Plaintiff/Counterclaim Defendant.
Stephen C. Norman, Esquire and Angela C. Whitesell, Esquire of Potter, Anderson & Corroon LLP, Wilmington, Delaware; Eric Landau, Esquire, Travis Biffar, Esquire, Jacqueline K.S. Lee, Esquire, and Alexandra N. Fries, Esquire of Jones Day, Irvine, California; and Kevin H. Logan, Esquire of Jones Day, Washington, D.C., Attorneys for Defendant/Counterclaim Plaintiff.
NOBLE, Vice Chancellor
Telephonic board meetings are undoubtedly routine for Delaware corporations. They allow dispersed directors to confer quickly over important issues regarding the corporation's business affairs. Despite their prevalence and utility, however, telephonic meetings have certain disadvantages—foremost among them being the lack of non-verbal communication, such as shaking another's hand or nodding one's head in agreement. The comparative strengths and weaknesses of telephonic and in-person board meetings generally may not matter that much. But, as this action demonstrates, when what was communicated on the phone is in dispute—and thereby becomes the subject of a fundamental corporate governance dispute among a corporation's directors, officers, and stockholders—the Court cannot help but wonder whether there would have even been a dispute had the directors simply met in person.
At issue in this action is what was said, and the legal effect of those statements, during a telephonic meeting on Friday, February 28, 2014, (the "Meeting") of the board of Defendant and Counterclaim-Plaintiff Biolase, Inc. ("Biolase"). Before the Meeting, Biolase had six directors: Federico Pignatelli ("Pignatelli"), Frederick Moll, M.D. ("Moll"), Norman Nemoy, M.D. ("Nemoy"), James Talevich ("Talevich"), Alexander Arrow, M.D. ("Arrow"), and Samuel Low, D.D.S. ("Low").
On March 3, the Monday following the Meeting, Biolase issued a press release announcing that Arrow and Low had resigned from the board and that two individuals—Paul Clark ("Clark") and Jeffrey Nugent ("Nugent")—had been appointed to the board, which still had six members. But, three days later, the company filed a Form 8-K with the Securities and Exchange Commission ("SEC") disclosing that Clark and Nugent had been appointed to the board, which purportedly had increased to eight members. The March 6 Form 8-K included the March 3 press release as an exhibit.
Within a week, Plaintiff and Counterclaim Defendant Oracle Partners, L.P. ("Oracle"), a Biolase stockholder,  initiated this action pursuant to 8 Del. C. § 225 to determine the proper composition of the board. The directorships of Pignatelli, Moll, Nemoy, and Talevich (collectively, the "Undisputed Directors") are not at issue. Oracle seeks a declaration that the current board consists of the Undisputed Directors, Clark, and Nugent. In opposition, Biolase seeks a declaration that only the Undisputed Directors are current members of the board. Biolase has also asserted counterclaims against Oracle for fraud and negligent misrepresentation.
This post-trial memorandum opinion sets forth the Court's findings of fact and conclusions of law. For the reasons set forth below, the Court concludes: (i) the current directors of Biolase are the Undisputed Directors and Clark, who was appointed during the Meeting to the vacancy that had been created when Arrow verbally and effectively resigned; (ii) the Biolase board has one vacancy that was created when Low resigned by email after the Meeting; and (iii) Oracle is not liable to Biolase for fraud or negligent misrepresentation.
A. The Parties
Oracle, a Delaware limited partnership based in Greenwich, Connecticut, is a "strategic investment firm solely within the health care industry." Larry Feinberg ("Feinberg") is the managing member of Oracle's general partner.Oracle has never been involved in a proxy contest, a going-private transaction, or, prior to this action, any litigation. Presently, it beneficially owns 16.4% of Biolase's common stock.
Biolase, a publicly traded Delaware corporation with its headquarters in Irvine, California, is a medical device manufacturer focused on the dental industry. Its main products are laser-based devices. Pignatelli is Biolase's chairman and Chief Executive Officer ("CEO"). Arrow is the company's President and Chief Operating Officer ("COO"). Frederick Furry ("Furry") is the company's Chief Financial Officer ("CFO") and was offered as its witness pursuant to Court of Chancery Rule 30(b)(6).
For several years, Biolase has had a stockholder Rights Agreement (i.e., a poison pill) under which rights certificates would be distributed when a stockholder acquired 15% of the company's common stock. The Biolase board raised the pill threshold to 20% on February 4, 2014,  in anticipation of the private placement by which Oracle became a 16.4% stockholder later that month.
B. Key Individuals
1. The Undisputed Directors: Pignatelli, Moll, Nemoy, and Talevich
Pignatelli first became involved with Biolase in 1991, when he financed the company with approximately $1 million. He has been a director since 1991 and the chairman of the board since 2010. Pignatelli asserts that he spends "110 percent" of his time as chairman and CEO of Biolase, but he conceded that he has engagements with several other businesses. Perhaps because of these other commitments, Pignatelli regularly works remotely.
Nemoy has been a director of Biolase since 2010,  and Moll and Talevich have been directors since 2013. Nemoy is the chair of the board's nominating and corporate governance committee.
2. Arrow and Low
Arrow joined the board in July 2010 and became President and COO in 2013. From Arrow's perspective, Pignatelli has run both the business and the board of Biolase with a "dictatorial management style."
Low joined the board in mid-December 2013. Pignatelli and Arrow recruited him to become a director after they had met at an industry conference.
3. Clark and Nugent
Clark has significant experience in the pharmaceutical industry, both at the officer and board levels. As of March 2014, he was serving as a director on three other boards, including of a private company of which Moll was also a director.Nugent likewise has considerable executive and director experience with medical device and related companies, most recently with an aesthetic dermatology business that used laser technology similar to that of Biolase.
C. Oracle Becomes Interested in Investing in Biolase
Based on a suggestion from one of his analysts, Feinberg first looked into investing in Biolase during the summer of 2013. His interest was piqued when Moll, an acquaintance and a medical device "innovator, " joined the board. The more Feinberg looked into Biolase, the more he viewed it as an "exciting company" with "great technology."
Feinberg eventually met Pignatelli, and the two discussed a potential "large investment" by Oracle in Biolase.  Two of Feinberg's initial concerns were that the company had "very poor corporate governance" and, in particular, that it "need[ed] a real CEO to run the company." He was not discussing a co-CEO arrangement. Pignatelli seemed generally receptive to these ideas, although he was hesitant about a current investment because he believed the company's stock was undervalued.
On September 4, Feinberg emailed Pignatelli and Arrow a proposed term sheet for an investment of $6 million for stock and warrants. The proposal also contemplated that the Biolase board would expand by two members, with the new directors nominated by Oracle and reasonably acceptable to the company. At Pignatelli's direction,  Arrow responded with an $11 million investment proposal under which Oracle would purchase $6 million of Biolase stock then and commit to buy $5 million more by the end of the year. Feinberg found this proposal "ridiculous."
In a series of emails, the parties debated whether Oracle's proposal would be dilutive to other Biolase stockholders or "long-term accretive." During the exchange, Feinberg repeated his views on the company's corporate governance and management needs to both Pignatelli and Arrow:
We believe Biolase needs to both supplement its current Board of Directors with more experienced operational personnel, as well as bring in a full-time CEO with medical device experience to help fix the operational issues and implement the strategic vision of Federico.
This subject was not new to Arrow; he had frequently discussed the possibility of hiring a new CEO with Pignatelli, who regularly agreed that it would be "appropriate for him to step aside when the right person could be brought in."
Frustrated by the company's response, Feinberg and one of his analysts considered other options. At one point, it was suggested that Oracle might want to "add on weakness and go hostile anytime." Feinberg's understanding of the term "hostile" in this context was that Oracle would "actively attempt to influence management . . . to improve the board of directors and improve management." In other words, Oracle was not seeking to "control" Biolase—Feinberg wanted strong, independent directors to manage the company.
Another possibility they considered was that Pignatelli might eventually be replaced as CEO. At no point did Feinberg suggest that he wanted to be the CEO of Biolase or that some specific person should have that position. Feinberg testified that this was not so much a plan, or even a goal, but rather a discussion of "what might transpire with this investment over time." At least in part, it appeared to be a reaction to the lack of commitment and business sophistication that Feinberg perceived in Pignatelli during their negotiations. Oracle did not directly invest in Biolase at that time.
D. Oracle Buys Biolase Stock on the Open Market
Throughout the fall of 2013, Oracle bought Biolase stock in the public markets. Some of these purchases were made before Biolase announced its 2013 third quarter results, which revealed that the company was running out of cash.Feinberg had exchanged at least one email with Moll about this problem.
Oracle continued to accumulate Biolase stock. In November 2013, it filed a Schedule 13D with the SEC disclosing that it beneficially owned 9.89% of the company's stock. The "Purpose of the Transaction" section of the Schedule 13D stated, in part:
To the extent permitted by law, the Reporting Persons [i.e., Oracle and its affiliates] may take such actions with respect to their investment in the Issuer [i.e., Biolase] as they deem appropriate in order to protect their investment and maximize shareholder value. Such actions may include, without limitation, discussions with other stockholders and/or with management and the Board of Directors of the Issuer concerning the business, operations or future business and strategic plans of the Issuer and composition of the Board of Directors, as well as purchasing additional Shares, selling Shares, engaging in hedging or similar transactions with respect to the Common Stock or taking any other action with respect to the Issuer or any of its securities in any manner permitted by law . . . .
Feinberg understood this language to reflect that Oracle was "considering all possible options" with a goal of "improv[ing] shareholder value." This section was not modified when Oracle later filed several amendments to its Schedule 13D.
E. Feinberg's Thoughts on Biolase's Need for Management
Around this time, Feinberg expressed his view privately to Clark, a casual friend with whom he occasionally invested,  that he felt Biolase needed "new management, two boards seats, and to recapitalize." Earlier, Feinberg had suggested to Clark that "[t]he board will easily swing in our direction" on these points. He based this expectation on conversations he had had with several Biolase directors—namely, Erin Enright ("Enright") and Gregory Lichtwardt ("Lichtwardt")—who wanted Oracle "to get involved to help recapitalize the company and to bring in and effect better corporate governance." Enright and Lichtwardt were in the midst of a significant disagreement with other Biolase directors, led primarily by Pignatelli, over the financial direction of the company. They wanted to form a special committee to raise approximately $20 million to pay accounts payable, to reduce a line of credit, and to create working capital. Pignatelli strongly opposed this effort. Unable to resolve this fundamental disagreement, Enright and Lichtwardt resigned from the Biolase board on December 4, 2013.
Internally at Oracle, Feinberg explained that he thought Enright was quitting the board because "she thinks we're not being aggressive enough." Specifically, he understood Enright as wanting Oracle "to do a proxy fight." Perhaps reacting to the news that two directors sympathetic toward improving the company's corporate governance had just resigned, Feinberg suggested to a third party that Oracle might "get active and perhaps nasty" regarding its Biolase investment.
F. Oracle Continues to Buy Biolase Stock
Almost in passing, Pignatelli suggested in December 2013 that Oracle might want to take Biolase private "in the $5 range." Feinberg never seriously considered that option. Going private was not part of his investment thesis, and he was concerned that if Oracle attempted a takeover, then "a corporate buyer would step in and take the company" at a higher price.
Near the end of 2013, Oracle bought additional Biolase stock on the public markets. It also purchased approximately $612, 000 worth of stock from the company in a private placement. Altogether, Oracle's beneficial ownership had increased to 11.4%. Biolase notes that Oracle's amended Schedule 13D did not include any of the sentiments that Feinberg may have shared with others in the interim.
Feinberg grew more eager to effect corporate governance changes at Biolase as the new year began. In January, Feinberg emailed Clark to let him know that Oracle was "considering launching a proxy contest for 2 board seats in a few weeks, " and he apparently wanted to gauge Clark's interest in participating. Feinberg thought they both could get elected, and he expected they would likely "have enough support to force the hiring of a new CEO and a refinancing." Clark said he would "be happy to join [Feinberg] on the board." It does not appear that Oracle took any further steps toward initiating a proxy contest at the time.
Coincidentally, the company's need for financing appeared again in 2014. The company filed a shelf registration statement for $12.5 million, the maximum to which Pignatelli would agree,  in January. But, as of the date of trial in this action, Biolase had not yet sold any stock pursuant to this registration statement— perhaps because it already had a willing investor: Oracle.
Pignatelli asked Feinberg if Oracle would be interested in making a $5 million investment in Biolase in February 2014. As the parties negotiated an investment in that range, it became clear that an additional purchase by Oracle of that much stock, at current prices, would have taken its ownership over the company's 15% poison pill threshold. After he discussed the merits of amending the pill with Feinberg, Pigantelli recommended to the board that it raise the threshold from 15% to 20%. The board quickly did so. Oracle then invested approximately $5 million in ...