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In re Nanthealth, Inc. Stockholder Litigation

Court of Chancery of Delaware

January 14, 2020

IN RE NANTHEALTH, INC. STOCKHOLDER LITIGATION

          ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS

         WHEREAS:[1]

         A. Nominal defendant NantHealth, Inc. ("NantHealth" or the "Company") is a healthcare company. Its core product is a proprietary process to diagnose patients at the molecular level and predict the patient's response and resistance to particular treatments. NantHealth offers this process, the Genomic Proteomic Spectrometry ("GPS") solution, under the brand name GPS Cancer. Plaintiff Erik Petersen allegedly purchased NantHealth stock on June 14, 2016, and has held it continuously since then.

         B. Defendant Patrick Soon-Shiong founded the Company in July 2010 and has served as the Company's CEO and Chairman since then. Soon-Shiong is also the Founder and CEO of three nonprofit entities: the Chan Soon-Shiong Family Foundation, the Chan Soon-Shiong NantHealth Foundation, and the Chan Soon-Shiong Institute of Molecular Medicine (collectively, the "Nonprofits").

         C. Defendant Paul A. Holt was the CFO of NantHealth until he resigned in August 2018. Defendant Edward Miller is a former director of the Company, serving from May 2016 to June 2017. The remaining four defendants-Michael Blaszyk, Mark Burnett, Kirk K. Calhoun, and Michael S. Sitrick-served on the board when this action was filed.

         D. On September 15, 2014, the Nonprofits entered into an agreement with the University of Utah to donate $12 million to support the Heritage 1K project-a research project on the genetic causes of certain hereditary diseases (the "Gift Agreement").[2] Soon-Shiong signed the Gift Agreement on behalf of the Nonprofits.

         E. The Gift Agreement provided that the University of Utah could use $10 million of the donation from the Nonprofits to pay outside entities to analyze patient data or perform work for the Heritage 1K project.[3] Any outside provider, however, was required to meet specific standards set out in the Gift Agreement that only NantHealth allegedly could satisfy.[4]

         F. Before the Gift Agreement was executed, the University of Utah entered into a Memorandum of Understanding ("MOU") providing that "[d]onor-affiliated Scientists shall have the right to analyze the sequence data for any or all of the Heritage 1K projects" and requiring that the genetic analysis be performed "by a bioinformatics team associated with the Donor [i.e., defendant Soon-Shiong]."[5]

         G. On January 28, 2015, the University of Utah and NantHealth entered into an agreement to provide comprehensive whole genome sequencing and other research services for the Heritage 1K project (the "Services Agreement").[6] In exchange for the services, NantHealth received the $10 million from the Nonprofits. Soon-Shiong signed the Services Agreement for NanthHealth.

         H. In 2016, the Company hired Ernst & Young LLP ("EY") to perform an audit. EY determined in an April 2016 report that the Gift Agreement and the Services Agreement "were linked," which NantHealth did not disclose.[7]

         I. On June 1, 2016, NantHealth commenced an initial public offering.

         The registration statement for the IPO disclosed that the Nonprofits had provided "partial" funding for the Heritage 1K project and that the University of Utah was not obligated to use NantHealth as part of the gift it received from the Nonprofits:

At the request of the university, certain public and private charitable 501(c)(3) non-profit organizations provided partial funding for the sequencing and related bioinformatics costs associated with the project. . . . The university was not contractually or otherwise required to use [NantHealth] as part of the charitable gift.[8]

         J. In early August 2016, the Audit Committee of NantHealth's board, consisting of Blaszyk, Calhoun, and Sitrick, met three times and reviewed accounting methods and expected revenue for GPS Cancer.[9] On August 9, 2016, during an investor call, Soon-Shiong stated that NantHealth's "machines are running at full tilt" and the Company was "processing 350-whole genome simultaneously."[10]At this time, the Company was only expecting $85, 000 in revenue from GPS Cancer for the quarter, yet the average price per sequence was $6, 787.[11] On August 15, 2016, the Company filed its Form 10-Q, which included the same statements about the Heritage 1K project, quoted above, that appeared in the IPO documents.

         K. On October 6, 2016, the Audit Committee met to discuss, among other matters, the Company's financial results for the third quarter ended September 30, 2016, and how to calculate revenue for GPS Cancer.

         L. On November 7, 2016, the Company issued a press release highlighting the financial results for the third quarter.[12] The Company said that it had received 524 GPS Cancer orders, although NantHealth had only completed 334 GPS Cancer tests.[13] The Company stated that 180 of those orders were for the Heritage 1K project, which prevented the Company from recognizing any revenue from them.[14]

         M. On March 6, 2017, a medical publication, STAT, published an article that raised suspicions about the propriety of NantHealth's arrangement with the University of Utah and the commercial demand for GPS Cancer.[15] The article contended that this arrangement "made it possible for [the] company to inflate, by more than 50 percent, the number of test orders it reported to investors late last year while updating them on interest in . . . GPS Cancer . . . even though the work for the university did not have anything to do with diagnosing or recommending treatments for cancer patients."[16]

         N. On March 27, 2017, the entire board discussed, among other matters, GPS Cancer.[17] On March 31, 2017, the Company filed its Annual Report on Form 10-K, which included the same statements about the Heritage 1K project that appeared in the IPO documents and its August 2016 Form 10-Q.[18]

         O. On June 26, 2017, investors filed an amended complaint in a securities class action in the United States District Court for the Central District of California against all of the defendants in this action and other parties (the "Securities Action").[19] On March 27, 2018, the district court denied defendants' motion to dismiss the Securities Action except as to one claim against Holt.[20]

         P. On April 23, 2018, Petersen filed his initial complaint in this action, which the court consolidated with a related case on July 30, 2018. On October 29, 2018, Petersen filed an Amended Complaint asserting three derivative claims for breach of fiduciary duty (Count I), waste of corporate assets (Count II), and unjust enrichment (Count III).[21]

         Q. On November 14, 2018, defendants moved to dismiss the Amended Complaint in its entirety under Court of Chancery Rules 12(b)(6) and 23.1. During briefing, Petersen withdrew Count II.[22]

         NOW THEREFORE, the court having considered the parties' submissions, IT IS HEREBY ORDERED, this 14th day of January, 2020, as follows:

         1. Legal Standards. The standard governing a motion to dismiss under Court of Chancery Rule 12(b)(6) for failure to state a claim for relief is well-settled:

(i) all well-pleaded factual allegations are accepted as true; (ii) even vague allegations are "well-pleaded" if they give the opposing party notice of the claim; (iii) the Court must draw all reasonable inferences in favor of the non-moving party; and ([iv]) dismissal is inappropriate unless the "plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances susceptible of proof."[23]
2. Under Court of Chancery Rule 23.1, a stockholder who wishes to bring a derivative claim on behalf of a corporation must "allege with particularity the efforts, if any, made . . . to obtain the action the plaintiff desires from the directors . . . and the reasons for the plaintiff's failure to obtain the action or for not making the effort." There are two different tests for determining whether demand is excused under Delaware law:
The test articulated in Aronson v. Lewis applies when a decision of the board of directors is being challenged in the derivative suit. The test set forth in Rales v. Blasband, on the other hand, governs when the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit, such as instances where directors are sued derivatively because they failed to do something.[24]

         Under either test, a plaintiff "must impugn the ability of at least half the directors in office when [he] initiated [his] action . . . to have considered a demand impartially."[25] To do so, a plaintiff must allege a "constellation of facts that, taken together, create a reasonable doubt about [the director]'s ability to objectively consider a demand."[26]

         3. Count I. This claim asserts that the individual defendants breached their fiduciary duty of loyalty "by allowing defendants to cause, or by themselves causing, the Company to make a series of false statements concerning the Company's relationship with the University and orders of GPS Cancer tests."[27]

         4. Pre-IPO Statements. Defendants assert that Petersen lacks standing to bring a fiduciary duty claim based on pre-IPO statements because he was not a stockholder of the Company at that time.[28] Citing Chirlin v. Crosby, [29] Petersen counters that he can pursue claims for statements that pre-date his ownership under the continuing wrong doctrine because "the misleading nature of the public statements demonstrate a pattern and overall plan to inflate the perceived demand for GPS Cancer that constitutes a continuing wrong."[30]

         5. In Chirlin, the court explained that if "the wrong is a continuing wrong, the stockholder need only to have been the owner of stock during any time the wrong continued."[31] As then-Vice Chancellor Strine explained in Desimone v. Barrows, however, if the alleged wrongs can be "easily segmented," the "continuing wrong" doctrine does not apply even if the "earlier wrongs that pre-date [one's] stock ownership . . . may be similar or related."[32] Here, the alleged post-IPO "wrongs" easily can be segmented because each allegedly misleading statement during this period was made at different times with distinct contents.[33] Accordingly, the continuing wrong doctrine does not apply and Count I is dismissed for lack of standing insofar as it seeks to challenge pre-IPO statements.

         6. Post-IPO Statements. The Amended Complaint challenges post-IPO statements that were made from July 25, 2016 to March 31, 2017 in two press releases, during investor calls, in two quarterly reports, and in one annual report.[34]The challenged disclosures fall into three categories, i.e., (i) misrepresentations that the Nonprofits' $12 million gift to the University of Utah did not obligate the University to obtain services from NantHealth when, in actuality, it did; (ii) misrepresentations that the Nonprofits provided only partial funding for the Heritage 1K project when, in actuality, they provided the entire funding; and (iii) statements portraying the commercial demand for GPS Cancer to be greater than it was.[35]Defendants' lead argument for dismissal of Count I insofar as it challenges post-IPO disclosures is that plaintiff failed to make a demand under Rule 23.1.

         7. Demand Futility. When this action was filed, there were five directors on the Company's board: Soon-Shiong, Blaszyk, Burnett, Calhoun, and Sitrick (the "Demand Board").[36] The question before the court is whether plaintiff has plead with sufficient particularity facts that create a reasonable doubt concerning the disinterestedness or independence of three of these individuals so as to impugn the ability of at least half of the Demand Board to consider a demand impartially.[37]

         8. Defendants concede for purposes of this motion, as they credibly must, that Soon-Shiong is interested.[38] The gravamen of the Amended Complaint is that Soon-Shiong caused the Nonprofits he controlled to make a donation to the University of Utah with the understanding-which was not disclosed-that the University would be required to turn around and pay those funds (less some "scientific and administrative support" costs) to NantHealth to use its GPS technology. As NantHealth's controlling stockholder, Soon-Shiong stood to benefit from this scheme to make it appear as if a ...


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