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In re Geneius Biotechnology, Inc.

Court of Chancery of Delaware

December 8, 2017

In re: GENEIUS BIOTECHNOLOGY, INC., a Delaware corporation.

          Date Submitted: September 8, 2017

          Adam G. Landis, Rebecca L. Butcher, James S. Green Jr., and Matthew R. Pierce, LANDIS RATH & COBB LLP, Wilmington, Delaware; Attorneys for Petitioner.

          Patricia L. Enerio and Jamie L. Brown, HEYMAN ENERIO GATTUSO & HIRZEL LLP, Wilmington, Delaware; Francis J. Earley and Kaitlyn A. Crowe, MINTZ, LEVIN, COHN, FERRIS, GLOVSKY and POPEO, P.C., New York, New York; Attorneys for Respondent.



         The dispute in this case arises from business management disagreements between a minority stockholder and the founder of a biotechnology start-up company. The company is in the business of developing and manufacturing T-cell therapy technology implicated in treating and curing cancer. To do this, the company needs significant upfront capital, and the parties disagree, inter alia, about the manner in which the company should seek the much needed capital. Because of their disagreements, the minority stockholder petitioned this Court to appoint a receiver under 8 Del. C. § 291, alleging that the company is insolvent and a neutral party is necessary to salvage the company's remaining value, which is its intellectual property.

         The threshold issue in this case is whether the company is insolvent, which the petitioner has the burden to prove by clear and convincing evidence. But the petitioner attempts to prove insolvency without providing any opinion or evidence of the value of the company's assets. Consequently, I hold in this post-trial opinion that the petitioner has not met its burden of proving the company's insolvency by clear and convincing evidence; thus, the petitioner's request is denied.

         I. BACKGROUND

         On April 18, 2017, the petitioner filed a Verified Petition for Appointment of a Receiver Pursuant to 8 Del. C. § 291 (the "Petition") and a Motion to Expedite. On April 24, 2017, I granted the petitioner's Motion to Expedite, and the respondent filed a Response to the Petition on May 10. On July 12 and 19, 2017, the parties conducted trial, followed by extensive post-trial briefing.

         These are my findings of fact based on the parties' stipulations, documentary evidence, and testimony of two live witnesses during trial. I accord the evidence the weight and credibility I find it deserves.[1]

         A. Parties and Relevant Non-Parties

         Respondent Geneius Biotechnology, Inc. ("Geneius" or the "Company") is a Delaware corporation formed on January 23, 2015.[2] It is an early-stage[3] biotechnology company seeking "to develop and manufacture T-cell therapy technology implicated in treating and curing cancer."[4] Geneius owns one U.S. patent application that has yet to obtain approval from the United States Patent and Trademark Office.[5]

         Dr. Alfred E. Slanetz is the founder, president, and chief executive officer of Geneius and has been since its incorporation.[6] Slanetz also has served as a director on Geneius's board since its incorporation.[7] Slanetz owns approximately 8.2% of Geneius issued common stock "and controls an additional 18, 000, 000 shares of Geneius issued common stock (approximately 54.1%)."[8] Slanetz has a bachelor's degree in biotechnology from Hamilton College, a master's degree in biomedical engineering from Brown University, and a Ph.D. in immunology and molecular biology from Yale University.[9]

         Petitioner Empery Asset Master, Ltd. ("Empery") is a Cayman Islands limited company and minority stockholder of Geneius.[10] Empery is a hedge fund that "invested in Geneius because of the potential in Geneius's patents and intellectual property."[11] Ryan Lane is the managing partner and chief compliance officer of Empery.[12] He has a bachelor's degree in finance and accounting from Franklin & Marshall College.[13] Lane served as a director on the Geneius board from February 2015 until January 2017.[14] Lane brings this action on behalf of Empery as a stockholder of Geneius.

         Dr. Hingge Hsu joined the Geneius board as an outside director in April 2016 and resigned in January 2017.[15]

         Steven Kloeblen joined the Geneius board on the same day that Lane left the Geneius board, January 8, 2017.[16] Thus, Slanetz and Kloeblen are the current directors on the Geneius board, and the third board seat remains vacant.[17]

         Hugh Austin "controls or is otherwise affiliated with" Small Cap Nation, Valhalla Ventures, LLC, and Odin Ventures, LLC (Austin, collectively with Small Cap Nation, Valhalla Ventures, LLC, and Odin Ventures, LLC, the "Austin Entities").[18] Austin is involved with family office networking.

         B. Pertinent Facts

         Much of the parties' briefings and supporting exhibits relate to the various ways the parties blame one another for the Company's lack of success thus far. Because much of that information is not relevant to the resolution of this case-and because time is a finite judicial resource-I only recite the pertinent facts.

         1. Before Lane left the Geneius board

         On October 1, 2015, Geneius entered into a collaboration and license agreement with Karolinska Institutet ("Karolinska") in Sweden "to utilize Karolinska's expertise, patient access, facilities, and world class researchers, to develop a manufacturing process for its patented T-cell technology and perform clinical trials on patients in Sweden" (the "Karolinska Agreement").[19] Lane helped negotiate the Karolinska Agreement on behalf of Geneius, for which Lane received "a pretty decent amount of [Geneius stock] options."[20] Per the terms of the Karolinska Agreement, Geneius paid Karolinska 1.4 million up front to be used for patient enrollment; if Karolinska did not enroll patients, the money was to be returned to Geneius.[21]

         Unfortunately, the Karolinska Agreement failed to meet Geneius's expectations, [22] and eventually, the majority of the Geneius board in place at that time (Lane and Hsu) voted to terminate the Karolinska Agreement over Slanetz's objection.[23] After such termination, the board considered numerous proposals to obtain financing, including a reverse merger into a public company and a rights offering.[24] Ultimately, however, none of these proposals materialized for reasons on which Slanetz and Lane differ; suffice it to say that Slanetz and Lane disagreed about the manner in which the Company should obtain financing.[25]

         During their service on the Geneius board, Lane and Hsu grew increasingly frustrated with Slanetz's management and Geneius's lack of progress.[26] Lane averred that Slanetz "was good on the scientific side, the theorizing, and the process; but beyond that, he was not capable of managing the business."[27] Accordingly, Lane and Hsu notified Slanetz in June 2016 that if he did not improve his managerial and operational performance, they would replace him as CEO.[28] And Slanetz described his working relationship with Lane as "challenging" and "pretty combative at times."[29]

         2. After Lane left the Geneius board

         In January 2017, Lane and Hsu departed from the Geneius board, and Kloeblen joined. Nine days after Lane's departure, Lane emailed Geneius's stockholders to express his concerns about Geneius's future.[30] Approximately two months later, Lane (on behalf of Empery) filed a books and records request under 8 Del. C. § 220 to "figure out how much cash [Geneius] had left and try to understand the status of things from at least a financial perspective" because "there was no one baby-sitting" Slanetz.[31] On July 3, 2017, the parties filed a stipulation of dismissal in the Section 220 action.[32] The Company incurred approximately $150, 000 in legal fees in defending Empery's Section 220 lawsuit.[33]

         Also after Lane's and Hsu's departures from the Geneius board, Slanetz reinitiated the Karolinska Agreement, but he modified its terms.[34] In addition to reinitiating the Karolinska Agreement, the board decided to pursue family office networking to attract investors.[35] Slanetz felt that family office investors were "the perfect type" of investors to pursue "because they feel they'll get better returns without paying . . . to invest in different areas, and also they really want to leave a legacy and make an impact."[36] As part of his efforts, [37] he became involved with Austin, which appears to have been a disaster because Austin fraudulently charged over $50, 000 to Geneius's credit card between January and March 2017.[38]Fortunately, Slanetz recouped approximately $45, 000 by disputing such charges through the bank.[39] "In addition to and contemporaneously with these unauthorized charges, two unauthorized, fraudulent wire transfers totaling $29, 000 were sent from Geneius's account to John Austin, Hugh Austin's son."[40] Slanetz sought repayment from Austin, and Respondent claims that "Geneius is considering its legal options to recoup these amounts."[41] Petitioner claims that Slanetz's involvement with the Austin Entities was fraudulent and reckless mismanagement.

         3. Geneius's financial condition

         As is not uncommon of start-up companies, Geneius "has never operated at a profit and has no income."[42] In 2015, investors contributed $10 million (approximately $2 million of which came from Empery); since then, Geneius received $100, 000 from a single investor in May 2017.[43] While Geneius has not completed an update to its general ledger or accounts payable since January 2017, [44]Geneius's checking accounts had a balance of approximately $2, 500 at the time Petitioner filed its Petition.[45] With respect to assets, Slanetz testified that the Company has lab equipment valued at approximately $240, 000 as well as assets relating to the Karolinska Agreement worth approximately $650, 000.[46] The Company's liabilities amounted to approximately $600, 000, and Geneius does not have enough cash on hand to pay off in full all of its outstanding invoices.[47]

         By April 2017, the board implemented several measures to improve Geneius's financial state. For example, the board reduced the number of full-time employees to three people (Slanetz, Francis Kenny, and Terry Nakagawa)[48] and decreased each of their salaries to approximately the statutory minimum wage.[49] Additionally, the board approved Slanetz's personal contribution of a "temporary personal loan" in the amount of $78, 000, plus his payment of "all of the travel and other business expenses for the entire company."[50] While there are no written agreements for Slanetz's personal funding of Geneius, he explained that the Company would pay back the loan's principal without interest "at some time when the Company is in a better financial situation."[51] Moreover, when asked if he would be willing to continue to contribute funds if needed, he answered "completely, absolutely."[52]

         II. ANALYSIS

         Petitioner filed its Petition under 8 Del. C. § 291, alleging that the Company is insolvent, having no liquid assets available to satisfy existing or future obligations and no reasonable prospects of additional funding under Slanetz. Petitioner asserts that a receiver is necessary to "prevent complete loss of value for the Company's legitimate creditors and the stockholders, "[53] "by restoring order and independence to the Company's affairs."[54] Specifically, Petitioner asserts, in part, that "Slanetz always has controlled the Company and, since January 2017, has done so without independent oversight . . . ."[55] Petitioner argues that with such control, "Geneius will never have a marketable product under [] Slanetz's leadership."[56]

         Respondent counters that Geneius is solvent and that Petitioner's request for a receiver stems from disagreements between Lane and Slanetz.

         A. Standard for Appointment of a Receiver

         When a corporation is insolvent, Section 291 of the Delaware General Corporate Law affords this Court the discretion[57] to appoint a receiver of and for the corporation.[58] The Court applies an "insolvency plus" standard to determine whether to appoint a receiver under Section 291.[59] As a threshold matter, Petitioner must show that the Company is insolvent "at the time the [petition] was filed, "[60] by "clear and convincing proof."[61] But, as "insolvency plus" implies, insolvency alone is insufficient to invoke Section 291. Petitioner also must demonstrate the necessity of a neutral third party "to protect the insolvent corporation's creditors or shareholders by showing 'some benefit that such an appointment would produce or some harm it could avoid, '"[62] and "the potential benefits must outweigh any potential harm that appointment of a receiver could cause."[63]

         B. Insolvency Under Section 291

         While the statute is silent as to the meaning of insolvency, Delaware case law has defined insolvency in the receivership context in two ways: (1) "a deficiency of assets below liabilities with no reasonable prospect that the business can be successfully continued in the face thereof, "[64] or (2) "an inability to meet maturing obligations as they fall due in the usual course of business."[65]

         Petitioner contends that Geneius is-and was at the time the Petition was filed-insolvent under both insolvency tests set forth in the "insolvency plus" standard.[66] Petitioner fails to prove by clear and convincing evidence that Geneius is insolvent under either standard.

         1. Assets versus liabilities

         Petitioner avers that Geneius is insolvent because its liabilities exceed its assets. Petitioner has the burden to prove insolvency by clear and convincing evidence.

         I begin with the value of the Company's liabilities, which the parties divide into two categories: legal and non-legal invoices. The parties agree that at the time of the Petition, Geneius owed approximately $185, 000 in undisputed, non-legal invoices.[67] The parties also agree that "Geneius's legal fees due and outstanding are greater than or equal to $419, 912.70."[68] Respondent argues that of the $419, 912.70 due in legal fees, $161, 712.03 of invoices to patent counsel "are subject to dispute" and, thus, should not be considered in determining the value of the Company's liabilities.[69] Respondent further argues inter alia that Geneius's D&O insurance carrier has paid or will pay the majority or all of the remaining $258, 000 (of which $149, 899 primary relates to Empery's Section 220 lawsuit) in legal fees, and thus, these fees also should not be considered in my insolvency analysis.[70] But Respondent does not specify which legal invoices are challenged nor any dollar amount challenged. Likewise, Respondent does not specify any dollar amount that the Company's insurance will or has covered, nor is there any evidence relating to any insurance deductible. Thus, unable to determine which liabilities to exclude based on Respondent's arguments, I find that the Company's total liabilities amounted to approximately $605, 000 as of the date of the Petition, which is consistent with Slanetz's testimony that Geneius has approximately $500, 000 to $600, 000 in accounts payable.[71]

         Determining the value of the Company's assets is a more onerous task unfortunately. Respondent contends that the value of the Company's assets is (or was at the time of the Petition) $892, 546.84, which consists of (1) $2, 546.84 in cash;[72] (2) $241, 000 in lab equipment/fixed assets;[73] (3) $350, 000 in research support funds at Karolinska;[74] and (4) $300, 000 in lab materials/reagents at Karolinska.[75]

         In response, Petitioner provides no evidence of its own valuation of the Company's assets. Instead, Petitioner challenges Respondent's proposed evidence of the value of the Company's assets. Petitioner objects to the valuation of $241, 000 in lab equipment/fixed assets[76] on hearsay and authenticity grounds under Delaware Rule of Evidence 802 and Delaware Rule of Evidence 901, respectively. I overrule Petitioner's evidentiary objections on both grounds. This evidence falls under the business records exception in Delaware Rule of Evidence 803(6) because Slanetz ordered the specific content of the report from the Company's accountant in February 2017, received the report close in time to his request, is knowledgeable about its contents, and is a sufficiently qualified witness. Slanetz authenticated the document under Delaware Rule of Evidence 901(b) as a person with knowledge of the document because he identified the e-mail and report as a list of Geneius's equipment values that he requested and received from the Company's accountant. Petitioner also argues that Slanetz "does not have personal knowledge of the equipment's cost outside the information contained in this document, thus the Court cannot rely on Slanetz's trial testimony."[77] I disagree. Slanetz is highly involved in the Company and provided, based on his personal knowledge, a detailed explanation of the assets he included in his calculation without any reference to the fixed asset report in JX 157.[78]

         As for the $350, 000 in research support and $300, 000 in lab equipment relating to the Karolinska Agreement, Petitioner argues that both of those assets cannot be credited any value for insolvency purposes because Respondent's asset valuations are theoretical and do not represent any actual value.[79] Lane, however, concedes that the Karolinska Agreement requires any unused funds be returned to Geneius.[80] Thus, these assets have some value. But Petitioner provides no evidence of what it considers to be the actual value of these assets.

         With respect to Geneius's intellectual property-which both parties agree is the Company's most valuable asset-the only evidence of its value is Petitioner's own internal valuation of its interest, which it valued at $31 million at the time of the Petition.[81] Petitioner argues this document is irrelevant because it is really a "write-down" schedule and the value is now zero.[82] I need not rely on this document to determine the value of the Company's assets. Instead, it illustrates how Petitioner has not met its burden to prove insolvency by clear and convincing evidence. Petitioner argues, "[u]nable to present competent valuation evidence on its own, Geneius resorts to relying on an internal report created by Empery as proof of a $31 million Company valuation."[83] Petitioner, however, offers no evidence of the value of what Petitioner concedes is the Company's most valuable asset and, instead, provides reasons why its own document relating to the value is irrelevant. This argument is reflective of the flaw in Petitioner's approach to this entire case- Petitioner attempts to shift the burden to Respondent. These attempts fail. Having failed to provide any evidence of the value of the assets or to sufficiently rebut Respondent's evidence of the value of the assets, I conclude that Petitioner has not met its burden to prove by clear and convincing evidence that the Company's liabilities exceed its assets.

         Even assuming arguendo that I attribute no value to the Company's intellectual property, the value of the Company's assets appear to exceed its liabilities.[84] At the very least, Geneius's circumstances are similar to "cases where the relevant corporation's assets and liabilities were approximately equal and where, with traditional financing, there appeared a prospect for viability."[85]

         Alternatively, even if I were to exclude certain of Respondent's evidence of the value of its assets, I still would not appoint a receiver because the irretrievable insolvency test also requires "a deficiency of assets below liabilities with no reasonable prospect that the business can be successfully continued in the face thereof."[86] During Lane's tenure on the board, the board discussed potential alternative strategies to obtain financing after Geneius terminated the Karolinska Agreement, such as a rights offering and reverse merger. But Lane testified that the board chose not to utilize those potential opportunities:

I think through the course of . . . my term on the board, I brought a bunch of proposals and the board brought a bunch of proposals and we had a bunch of ideas that were never properly considered. And I think if there was someone who wasn't conflicted and was looking out for the minority shareholders in place, that those would have been given adequate consideration.[87]

         Thus, Lane appears to suggest that it may be possible for Geneius to pursue other financial strategies, if it so chooses; it just has not utilized the methods that Petitioner would prefer. Consequently, I am not convinced that Petitioner has demonstrated Geneius's irretrievable insolvency by clear and convincing proof.

         2. Cash flow insolvency

         Petitioner contends that Geneius is cash flow insolvent. Petitioner has the burden to prove by clear and convincing evidence that Geneius has "an inability to meet maturing obligations as they fall due in the ordinary course of business."[88]While Slanetz conceded that Geneius does not have enough cash on hand to pay off all of its outstanding invoices, [89] Slanetz testified that the Company "pay[s] all the invoices required to run the business and keep it moving forward on an ongoing basis."[90] Slanetz also testified that certain of the invoices are in dispute or subject to payment plans.[91] Petitioner rejects this assertion because of the lack of written, third-party evidentiary support.[92] But as I have repeatedly stated herein, it is Petitioner's burden to prove insolvency by clear and convincing evidence. Petitioner could have tested the veracity of Slanetz's testimony of such payment plans either on cross-examination or through the vendors; Petitioner made the strategic decision not to do that. I have no reason not to accept Slanetz's testimony on this.

         Furthermore, Slanetz testified that he is "willing to commit to fund this company as much as and as long as it takes to get us through."[93] The credibility of this evidence is supported by the fact that Slanetz made a $78, 000 interest-free personal loan to the Company in April 2017 and pays "all of the travel and other business expenses for the entire Company."[94] Moreover, Slanetz does not expect repayment of the interest-free personal loan until "the Company is sufficiently healthy, " and he will "absolutely" continue to fund the Company if needed.[95]

         Petitioner cites to Pope Investments LLC v. Benda Pharmaceutical, Inc. and Production Resources Group, L.L.C. v. NCT Group, Inc. to argue that Geneius "must demonstrate some other means by which it can pay off [its] debts in the ordinary course of business";[96] that "Geneius has expressed no intention to pay off its debts, much less demonstrate that it has some means to do so";[97] that Geneius has "no reasonable prospect of overcoming . . . insolvency"; and that Geneius "'is limping along but only through an unusual arrangement' with Slanetz's family trust 'and only by taking steps to avoid meeting its obligations.'"[98] Upon a closer review of the facts of Pope and Production Resources, I find that the instant case is readily distinguishable for the reasons explained below.

         In Pope, this Court concluded post-trial that the company was insolvent for purposes of 8 Del. C. § 291; however, it did not appoint a receiver due to the lack of exigent circumstances and beneficial purpose.[99] Nevertheless, this Court considered the following facts regarding the company's financial condition to find insolvency:

• the plaintiff investment fund had obtained a judgment against the defendant company, so the plaintiff (in its capacity as a creditor) sought a receiver to allow it to recover the amount of its judgment;
• a third party bank creditor obtained an execution order on one of the company's core assets;
• the company had defaulted on a number of financial obligations, which resulted in entry of judgments against it;
• the company's current liabilities exceeded $29 million and it had a working capital deficit of over $27 million;
• the company's auditor stated the company and its subsidiaries do "not have the ability to substantially increase its loan indebtedness with any financial institution, nor can the [company and its subsidiaries] provide any assurance it will be able to enter into any loan agreements in the future";
• the company's public disclosures evidenced that the company could not raise the necessary capital for its business by selling equity or taking on new debt;
• the company had problems meeting significant regulatory deadlines and had incurred more than $2.5 million ...

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