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Sheldon v. Pinto Technology Ventures, L.P.

Supreme Court of Delaware

October 4, 2019

JEFFERY J. SHELDON and ANDRAS KONYA, M.D., PH.D., Plaintiffs-Below, Appellants,
v.
PINTO TECHNOLOGY VENTURES, L.P., PINTO TV ANNEX FUND, L.P., PTV SCIENCES II, L.P., RIVERVEST VENTURE FUND I, L.P., RIVERVEST VENTURE FUND II, L.P., RIVERVEST VENTURE FUND II (OHIO), L.P., BAY CITY CAPTIAL FUND IV, L.P., BAY CITY CAPITAL FUND IV CO-INVESTMENT FUND, L.P., REESE TERRY and CRAIG WALKER, M.D., Defendants-Below, Appellees.

          Submitted: September 11, 2019

          Court Below: Court of Chancery of the State of Delaware C.A. No. 2017-0838-MTZ

         Upon appeal from the Court of Chancery of the State of Delaware: AFFIRMED

          Thad J. Bracegirdle, Esquire (argued), Scott B. Czerwonka, Esquire, Wilks, Lukoff & Bracegirdle, LLC, Wilmington, Delaware, for Appellants Jeffery J. Sheldon and Andras Konya, M.D., Ph.D.

          Bruce E. Jameson, Esquire (argued), Samuel L. Closic, Esquire, Prickett, Jones & Elliott, P.A., Wilmington, Delaware. Of Counsel: B. Russell Horton, Esquire, Gary L. Lewis, Esquire, George Brothers Kincaid & Horton LLP, Austin, Texas, for Appellees Pinto Technology Ventures, L.P., Pinto TV Annex Fund, L.P., PTV Sciences II, L.P., Rivervest Venture Fund I, L.P., Rivervest Venture Fund II, L.P., Rivervest Venture Fund II (Ohio), L.P., Bay City Capital Fund IV, L.P., and Bay City Capital Fund IV Co-Investment Fund, L.P.

          Brian C. Ralston, Esquire, Jacqueline A. Rogers, Esquire, Potter Anderson Corroon LLP, Wilmington, Delaware. Of Counsel: Danny David, Esquire (argued), Rebeca Huddle, Esquire, Baker Botts L.L.P., Houston, Texas, for Appellees Resse Terry and Craig Walker, M.D.

          Before VALIHURA, SEITZ, and TRAYNOR, Justices.

          VALIHURA, JUSTICE:

         Appellants Jeffrey J. Sheldon and Andras Konya, M.D., Ph.D., alleged in the Court of Chancery that several venture capital firms and certain directors of IDEV Technologies, Inc. ("IDEV") violated their fiduciary duties by diluting the Appellants' economic and voting interests in IDEV. The Appellants argued that their dilution claims are both derivative and direct under Gentile v. Rosette[1] because the venture capital firms constituted a "control group." The Court of Chancery rejected that argument and held that the Appellants' dilution claims were solely derivative.[2] Because the Appellants did not make a demand on the IDEV board or plead demand futility, and because the Appellants lost standing to pursue a derivative suit after Abbott Laboratories purchased IDEV and acquired the Appellants' shares, the court dismissed their complaint. On appeal, the Appellants raise a single issue: They contend only that, contrary to the Court of Chancery's holding, they adequately pleaded that a control group existed, rendering their claims partially "direct" under Gentile. Therefore, according to the Appellants, their complaint should not have been dismissed. We agree with the Court of Chancery's determination that the Appellants failed to adequately allege that the venture capital firms functioned as a control group. Accordingly, we affirm the dismissal of the complaint with prejudice.

         I. Background

         IDEV, a Delaware corporation based in Texas, develops and manufactures devices used in interventional radiology, vascular surgery, and interventional cardiology. Sheldon founded IDEV in 1999 and served as its Chief Executive Officer from its founding until 2008. Konya invented certain devices licensed by IDEV and served as a consultant to IDEV between 2000 and late 2012.

         Between 2004 and 2008, IDEV completed three rounds of financing through which three venture capital firms (the "Venture Capital Firms")[3] acquired a substantial proportion of IDEV's outstanding shares. In 2009, IDEV went through a management change, restructured its sales force, and implemented a new strategic plan focused on leveraging and developing its core technologies. It also determined that to support its future growth, IDEV needed to raise additional equity capital.

         By early 2010, Sheldon owned 1, 250, 000 shares of common stock and 45, 998 shares of Series B Preferred Stock-comprising 2.5% of IDEV's total outstanding shares- and Konya owned 650, 000 shares of common stock, a 1.25% ownership stake in IDEV. The Venture Capital Firms held over sixty percent of IDEV's outstanding shares. Sheldon, Konya, the Venture Capital Firms, and the other Shareholders[4] were bound by the Fourth Amended and Restated Shareholders Agreement (the "Shareholders Agreement"), which, in relevant part, governed the election of several IDEV directors and provided certain Shareholders, including Sheldon, with preemptive rights.[5] Listed in the Shareholders Agreement were twenty "Key Shareholders" and seventy "Significant Shareholders." Sheldon was both a Key and Significant Shareholder, and Konya was a Key Shareholder only.

         Section 7 of the Shareholders Agreement was titled "Voting Agreement." Section 7(a), the director election provision, provided that: "each Shareholder will vote all of the Shareholder's Restricted Shares and take all other necessary or desirable actions" to cause the election of "[o]ne individual designated by Pinto TV Annex Fund, L.P.," "[o]ne individual designated by RiverVest Venture Fund II, L.P.," and "[o]ne individual designated by Bay City Capital Fund IV, L.P."[6] The Shareholders also agreed to elect to the board IDEV's Chief Executive Officer, as well as "[t]wo individuals designated by a majority of the PTV Designee, the RiverVest Designee and the Bay City Designee, which individuals shall initially be Reese S. Terry and Craig Walker, M.D." (together with the Venture Capital Firms, the "Defendants").[7] Aside from the director election and corresponding removal obligations, and as otherwise limited by IDEV's governing documents, each Shareholder "retain[ed] at all times the right to vote the Shareholder's Restricted Shares in its sole discretion on all matters presented to the Corporation's Shareholders for a vote . . . ."[8]

         In July 2010, IDEV implemented a new financing effort to bring in over $40 million of new capital (the "Financing"). The Financing consisted of two steps. Step one was to set the stage for raising the capital. The Venture Capital Firms first voted to convert IDEV's preferred stock to common stock. The Venture Capital Firms then, by written consent, amended IDEV's Certificate of Incorporation with the objective of (1) effecting a reverse stock split of common stock, converting every one-hundred shares into a single share, and (2) authorizing and issuing a new class of Series B-1 Preferred Stock. Finally, the Shareholders Agreement, which could be amended by a sixty percent vote, was amended by IDEV and the Venture Capital Firms to eliminate certain preemptive rights of the Significant Shareholders, including Sheldon.

         After implementing these changes, the Venture Capital Firms began the second step in the Financing. In an initial closing, IDEV raised $27 million by selling the newly authorized Series B-1 shares to new and existing investors. The company also instituted an exchange and purchase offering, which allowed previous holders of preferred stock to convert their common shares into Series A-2 Preferred Stock, so long as they also purchased Series B-1 Preferred Stock. The circulated Confidential Information Statement warned that the Financing would "result in substantial dilution to Common Stockholders, and the dilution will be significantly increased as to Common Stockholders that do not participate . . . ."[9] Nevertheless, neither Sheldon nor Konya participated in the Financing.[10]

         The Financing had an ancillary effect on certain promissory notes held by IDEV. The company held about $1.7 million of full-recourse promissory notes issued by certain of its employees to finance their purchases of IDEV common stock. The notes, which were secured by the purchased shares, became "substantially undersecured" as a result of the decrease in common stock value caused by the Financing. In November 2011, IDEV cancelled the notes, took back the purchased shares, and issued special bonuses to those employees.

         In 2013, roughly three years after the Financing, IDEV was acquired by Abbott Laboratories for approximately $310 million. Appellants collectively owned 0.012% of the outstanding IDEV shares at the time of sale, compared to the 3.75% they held preFinancing. Sheldon and Konya claim that instead of the respective $15, 000 and $7, 500 they were actually entitled to from the Abbott acquisition, they would have received $7.75 million and $3.875 million, respectively, had their shares not been diluted in the 2010 Financing.

         The Appellants first sued the Defendants in a Texas trial court, which dismissed their complaint. The Texas Supreme Court eventually agreed with the trial court's decision (at least as to the defendants sued here) based on a forum selection clause in the Shareholders Agreement requiring any action arising from that agreement to be brought in Delaware.[11] Appellants promptly re-filed their suit in the Delaware Court of Chancery. After the Defendants moved to dismiss, Appellants amended the complaint and the Defendants renewed their motion to dismiss.

         The Court of Chancery granted the Defendants' motion to dismiss on January 25, 2019. It noted that dilution claims are "classically derivative," and held that the Defendants' actions were not also "direct" claims under Gentile because the facts pleaded failed to show with reasonable conceivability that the Venture Capital Firms were a control group.[12] In addressing the control group issue, the court focused on two cases on opposite ends of the spectrum: In re Hansen Medical, Inc. Stockholders Litigation, [13] where the court held on a motion to dismiss that the plaintiffs had sufficiently pled the possible existence of a control group, and van der Fluit v. Yates, [14] where the plaintiff had failed to adequately plead a control group.

         The Court of Chancery determined that the control group alleged in this case is more like that in van der Fluit, noting that while the investors in Hansen had a long, well- documented history of coordinated investments, the Venture Capital Firms here were more loosely connected. The court found that the Venture Capital Firms' prior connections were likely coincidental in that they invested in the same industry, not because they operated in tandem. In light of this, employing the reasonable conceivability standard of Court of Chancery Rule 12(b)(6), the court held that the Appellants' dilution claims were solely derivative. Because the Appellants had not made a demand on the board or pled demand futility, and because the Appellants lost standing to bring a derivative suit following the Abbott acquisition, the court dismissed the Appellants' claims for failure to comply with the requirements of Court of Chancery Rule 23.1. The Appellants filed their notice of appeal on February 25, 2019.

         II. Analysis

         The Appellants raise only one issue on appeal: whether the Court of Chancery erred in dismissing their complaint by holding that the Venture Capital Firms were not a "control group," as alleged by the Appellants in their effort to plead a "dual-natured" claim under Gentile. As such, we address this sole issue.[15] We review de novo the question of whether it is reasonably conceivable, based on the allegations in the operative complaint, that the Venture Capital Firms constituted a control group.[16] We must accept all well-pled allegations as true and draw reasonable inferences in favor of the Appellants.[17] We need not accept conclusory allegations as true, nor should inferences be drawn unless they are truly reasonable.[18]

         The traditional rule is that dilution claims are "classically derivative."[19] But in Gentile, we recognized that dilution claims can be both derivative and direct in character when:

(1) a stockholder having majority or effective control causes the corporation to issue "excessive" shares of its stock in exchange for assets of the controlling stockholder that have a lesser value; and (2) the exchange causes an increase in the percentage of the outstanding shares owned by the controlling stockholder, and a corresponding decrease in the share percentage owned by the public (minority) shareholders.[20]

         "[A] stockholder could be found a controller under Delaware law: where the stockholder (1) owns more than 50% of the voting power of a corporation or (2) owns less than 50% of the voting power of the corporation but 'exercises control over the business affairs of the corporation.'"[21] Relevant here, our law recognizes that multiple stockholders together can constitute a control group exercising majority or effective control, with each member subject to the fiduciary duties of a controller.[22] To demonstrate that a group of stockholders exercises "control" collectively, the Appellants must establish that they are "'connected in some legally significant way'-such as 'by contract, common ownership, agreement, or other arrangement-to work together toward a shared goal.'"[23] To show a "legally significant" connection, the Appellants must allege that there was more than a "mere concurrence of self-interest among certain stockholders."[24] Rather, ...


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