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Court of Chancery of Delaware

May 24, 2019

AG ONCON, LLC, AG OFCON, LTD, CALAMOS MARKET NETRAL INCOME FUND, CAPITAL VENTURES INTERNATIONAL, CITADEL EQUITY FUND, LTD, OPTI OPPORTUNITY MASTER FUND, POLYGON CONVERTIBLE OPPORTUNITY MASTER FUND, and WOLVERINE FLAGSHIP FUND TRADING LIMITED, Plaintiffs,

v.

LIGAND PHARMACEUTICALS INC., Defendant.

Date Submitted: April 1, 2019

Elena C. Norman, Daniel M. Kirshenbaum, YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Keith N. Sambur, Martin G. Durkin, Andrew T. Gillespie, HOLLAND & KNIGHT, LLP, New York, New York; Counsel for Plaintiffs.

David E. Ross, R. Garrett Rice, ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; Blair Connelly, Zachary L. Rowen, LATHAM & WATKINS LLP, New York, New York; Counsel for Defendant.

**MEMORANDUM OPINION**

LASTER, V.C.

The plaintiffs hold convertible notes issued by defendant Ligand Pharmaceuticals Inc. Ligand sold the notes in underwritten private placements based on disclosures in an offering memorandum. At closing, Ligand entered into an indenture to govern the notes.

The indenture authorized Ligand to conform its terms to the description of the notes in the offering memorandum. Three-and-a-half years after issuing the notes, Ligand invoked this right to replace a defined term in the conversion formula in the indenture.

The offering memorandum explained that the conversion value of the notes would depend on the "daily VWAP," defined as the value-weighted average price of Ligand's stock on each day of a fifty-trading-day observation period. The offering memorandum stated that for each trading day, the conversion value would be divided by the daily VWAP, generating a value-equivalent number of shares for that day.

Unfortunately, the indenture used a different term in the denominator of the conversion formula. Instead of referring to the daily VWAP, the indenture referred to the "Daily Principal Portion." That term was defined as one-fiftieth of the principal due on the note. It was a fixed dollar amount ($20 per $1, 000 of issuance) that had nothing to do with the trading price of Ligand's stock, and its use made no sense in light of what the formula attempted to calculate. Exercising its right to conform the terms of the indenture to the offering memorandum, Ligand replaced the reference to the Daily Principal Portion with a reference to the daily VWAP.

The plaintiffs are sophisticated bond traders who purchased the notes in the secondary market. In this lawsuit, they seek to invalidate the amendment and enforce the conversion formula as it originally appeared in the indenture. The relief they seek would give them munificent returns. The notes Ligand issued have a face value of $245 million. Four years after issuance, the plaintiffs claim they are entitled to conversion consideration amounting to $4 billion.

According to the plaintiffs, Ligand's exercise of its right to conform the terms of the indenture to the description of the notes in the offering memorandum improperly elevated the offering memorandum over the indenture. They also say that the change contravened restrictions on Ligand's ability to amend the indenture and violated the requirements of the Trust Indenture Act. Ligand moved to dismiss the complaint for failure to state a claim. This decision grants Ligand's motion.

**I.**
**FACTUAL BACKGROUND**

The facts are drawn from the complaint and the documents it incorporates by reference. At this stage of the proceedings, the complaint's allegations are assumed to be true. The plaintiffs also receive the benefit of all reasonable inferences, including inferences drawn from documents.

**A.**
**The Offering Memorandum**

In August 2014, Ligand sought to raise capital through underwritten private placements of 0.75% Convertible Senior Notes. A convertible note is a debt instrument that is convertible into shares of the issuer's stock at a specified conversion rate. The conversion rate is determined when the notes are issued. The conversion feature is "in the money" when the value of the shares that would be received upon conversion exceeds the value of the note as a debt instrument.

Ligand
and its underwriters marketed the notes through a
confidential offering memorandum dated August 12, 2014.
*See* Compl. Ex. C (the "Offering
Memorandum" or "OM"). In a thirty-one-page
section titled "Description of the Notes," the
Offering Memorandum described the consideration that the
holder of a note would receive in various scenarios. The
Offering Memorandum explained that the conversion rate for a
note with a principal amount of $1, 000 was 13.3251, meaning
that a $1, 000 note could be converted into 13.3251 shares of
Ligand common stock (assuming all of the requirements for
conversion were met). To protect the conversion value in the
event of changes to Ligand's capital structure, the
conversion rate was subject to adjustment for transactions
that would affect the ownership percentage reflected by
13.3251 shares, such as issuances of new shares, stock
splits, warrant distributions, or self-tenders. Generally
speaking, the adjustments would ensure that the conversion
rate generates a number of shares that is equivalent in value
to 13.3251 shares under Ligand's capital structure as it
existed when the notes were issued.

From
the noteholders' standpoint, the conversion rate of
13.3251 meant that the conversion feature would be in the
money when the value of 13.3251 shares of Ligand common stock
exceeded $1, 000. The Offering Memorandum explained that the
conversion rate was "equivalent to an initial conversion
price of approximately $75.05 per share of our common
stock." *Id.* at 26. Once the value of
Ligand's stock crossed that threshold, then the
conversion feature would be more valuable than the debt
instrument. If Ligand's stock price continued to climb,
then the value of the conversion feature would increase. When
Ligand issued the notes, its stock was trading in the
mid-fifties.

The Offering Memorandum framed these concepts as mathematical formulas. Those formulas were not so simple as multiplying the value of the notes times the conversion rate, then dividing by Ligand's stock price on the day of conversion. To protect against stock price volatility, the offering memorandum called for identifying an observation period of fifty consecutive trading days, and it broke up the conversion consideration into fifty pieces, one for each day in the observation period. The Offering Memorandum described the piece of consideration due for each day as the "Daily Settlement Amount." Upon conversion, the noteholder would receive the sum of fifty Daily Settlement Amounts.

Each Daily Settlement Amount consisted of two components of consideration:

• an amount of cash equal to the lesser of (i) one-fiftieth (1/50th) of $1, 000 [i.e., $20] and (ii) the daily conversion value for such VWAP trading day (such minimum, the "daily principal portion"); and

• to the extent the daily conversion value for such VWAP trading day exceeds the daily principal portion for such VWAP trading day, a number of shares equal to (i) the excess of the daily conversion value for such VWAP trading day over the daily principal portion for such VWAP trading day, divided by (ii) the daily VWAP for such VWAP trading day (the "daily share amount").

*Id.* at 31 (emphasis added). The Offering Memorandum
defined the daily conversion value as "one-fiftieth
(1/50th) of the product of (i) the conversion rate on such
VWAP trading day and (ii) the daily VWAP on such VWAP trading
day." *Id.* In other words, it called for
calculating the daily conversion value by multiplying the
conversion rate of 13.3251 times the daily VWAP, then
dividing by fifty.

The output of the formula in the first bullet-the "Daily Principal Portion"- determined whether the conversion feature was in the money. It called for comparing the daily conversion value with one-fiftieth of the face value of a $1, 000 note ($20). The converting noteholder would receive the "lesser" of the two, so the conversion feature would not have value (and a rational noteholder would not convert) unless the daily conversion value exceeded $20. If the conversion feature was in the money, then the formula caused the Daily Principal Portion to equal $20.

Once
the note was in the money, then the output of the formula in
the second bullet-the "Daily Share
Amount"-determined the value of the conversion feature.
It was defined as "a number of shares equal to (i) the
excess of the daily conversion value for such VWAP trading
day over the daily principal portion for such VWAP trading
day, divided by (ii) the daily VWAP for such VWAP trading
day." *Id.* at 31. In this formula, dividing the
in-the-money portion by the daily VWAP converted the former
into a value-equivalent number of shares. Although framed in
shares for purposes of the calculation, Ligand could pay the
resulting value in any combination of cash or stock. *See
id.* at 26.

An example illustrates the calculation. Assuming Ligand's shares had a daily VWAP of $207.17 for one of the fifty days in the observation period (equal to Ligand's closing price at the end of the second quarter of 2018), then the formulas would generate the following results:

Daily Principal Portion for the Day Daily VWAP for the Day Conversion Rate Daily Conversion Value

Formula(1/50) x $1, 000 =

Assumed to be

Defined as

(1/50) x [(C) x (B)] =

Value$20

$207.17 13.3251 $55.21

Reference(A)

(B)

(C)

(D)

Excess of Daily Conversion Value over Daily Principal Portion

(D) - (A) =

$35.21

(E)

Daily Shares Owed for Excess of Conversion Value over Daily Principal Portion:

(E) / (B) =

0.1700

(F)

Number of Shares Equivalent to Face Value

(A) / (B) =

0.0965

(J)

Total Number of Shares / Share Equivalents Owed Upon Conversion for the Day:(F) (J) =

0.2665

The formulas in the Offering Memorandum ensured that regardless of what price the stock reached, a noteholder who converted an in-the-money note would always receive value in the aggregate equal to 13.3251 shares of Ligand stock. Of this amount, Ligand would pay the fifty Daily Principal Portions in cash, and it could pay the fifty Daily Share Amounts in either cash or stock.

**B.**
**The Indenture**

After
the underwriters had lined up purchasers, Ligand closed the
offering. The closing took place on April 18, 2014, four days
after the issuance of the Offering Memorandum. At closing,
Ligand entered into an indenture to govern the notes.
*See* Compl. Ex. A. (the "Indenture" or
"Ind."). In the aggregate, the notes issued under
the Indenture had a face value of approximately $245 million
in principal.

The
Indenture reflected the same initial conversion rate as the
Offering Memorandum: "[A] Holder shall have the right, .
. . to convert the principal amount of its Notes, . . . at a
conversion rate initially equal to 13.3251 shares of the
Common Stock . . . per $1, 000 principal amount of
Notes." *Id.* § 10.01(a). As in the
Description of the Notes in the Offering Memorandum, the
Indenture established a fifty-day observation period for
determining the daily VWAP. *See id.* §§
1.01, 10.03. And like the Description of the Notes, the
Indenture separated the Daily Settlement Amount into (i) the
Daily Principal Portion, reflecting the 1/50th of the
principal amount of the note, and (ii) the Daily Share
Amount, reflecting 1/50th of the in-the-money conversion
feature. *See id.* § 1.01.

But the
conversion formula in the Indenture differed from the
conversion formula in the Offering Memorandum in one critical
respect. In the Indenture, the definition of the Daily Share
Amount called for the noteholder to receive a number of
shares equal to (i) the excess of the Daily Conversion Value
over the Daily Principal Portion divided by (ii) *the
Daily Principal Portion*. *Id.* § 1.01. The
definition in the Indenture thus changed the denominator in
the conversion formula from the daily VWAP to the Daily
Principal Portion.

Using the Daily Principal Portion as the denominator for the Daily Share Amount radically changed the conversion calculation. The Daily Share Amount was supposed to reflect the in-the-money portion of the conversion consideration, and using the daily VWAP as a denominator meant that the trading price would be used to convert the value back into shares and maintain the conversion rate. The Daily Principal Portion, by contrast, was a fixed number ($20) tied to the unchanging face value of the notes. Its introduction into the denominator meant that the formula no longer calculated the value-equivalent of 13.3251 shares per day. The formula instead derived a number divorced from that figure.

For example, assuming a VWAP of $207.17 across the fifty-day observation period, a note with a face value of $1, 000 would convert into more than ninety-two shares, nearly seven times the conversion rate. And as Ligand's stock price increased, the number of conversion shares would increase. Assuming the entire note issuance converted, the following chart illustrates the total number of shares Ligand would issue upon conversion using the formula in the Offering Memorandum (3, 264, 650), Ligand's total number of authorized shares (33, 333, 333), and the total number of shares that Ligand would have to issue under the formula in the Indenture (rising to >50, 000, 000).

(Image Omitted)

**C.
The Conversion Formula Amendment**

After Ligand completed the private placements, the notes traded in the secondary markets. During this period, Ligand's public filings described the conversion formula for the notes in a manner consistent with the Offering Memorandum. In other words, the filings described the denominator in terms of the daily VWAP, not the Daily Principal Portion.

In February 2018, Ligand amended the definition of Daily Share Amount in the Indenture. The amendment substituted the words "daily VWAP for a VWAP Trading Day" for the words "Daily Principal Portion for such Trading Day" as the divisor in the Daily Share Amount formula. This decision ...

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