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Director Equity Grants and Vote Buying Subject to Entire Fairness Review

by   |   June 28, 2017

In Williams v. Ji et al, the Delaware Court of Chancery examined an alleged scheme in which the Directors of Sorrento Therapeutics, Inc. granted themselves options and warrants for the stock of five subsidiaries over which the corporation had voting control. Shortly before or after the options grants, the board transferred valuable assets and opportunities of the corporation to the subsidiaries.  The subsidiary option plans and grants were not approved by the stockholders of Sorrento.  The Plaintiff also claimed a voting agreement amounted to improper management vote buying.

By way of example, LA Cell, a Sorrento subsidiary, granted options to purchase 1,700,000 shares of LA Cell common stock to the Sorrento directors and a warrant to purchase 9,500,000 shares of LA Cell Class B stock with 10 to 1 voting rights to Sorrento Director Ji. The warrant and the options had an exercise price of $0.01 per share. The options and warrant gave Ji the right to purchase over 18% of the economic interest and 25% of the voting interest in LA Cell. Subsequently, LA Cell entered an exclusive licensing agreement with City of Hope, a medical research center, under which LA Cell licensed to City of Hope certain technology. Sorrento announced that the total deal value with City of Hope could be in excess of $170 million.

The Court rejected the Defendants’ characterization that these were typical compensation decisions subject to business judgment review noting that “self-interested compensation decisions made without independent protections are subject to the same entire fairness review as any other interested transaction.” Here, every member of the Board was interested in the grants.  Thus, entire fairness review applied so long as Plaintiff had pled some specific facts suggesting unfairness in the option and warrant grants.  Assuming the allegations were true, Plaintiff sufficiently alleged the grants were excessive given the size of the grants to Ji and the $170 million value of the City of Hope transaction.

The vote buying allegations involved a private placement where an investor purchased 2.75% of Sorrento’s outstanding common shares. The investor executed a voting agreement that required the investor to vote the shares as directed by the Board. The Court held management may not use corporate assets to buy votes unless it can be demonstrated that management’s vote-buying activity does not have a deleterious effect on the corporate franchise.”  Here, Sorrento’s Directors allegedly made the voting agreement a condition of a Sorrento capital raise and, thus, used corporate assets to buy the votes. As such, the Defendants must prove that the agreement is intrinsically fair and not designed to disenfranchise Sorrento’s stockholders.

As this was a motion to dismiss, the Court did not make any determination that any of the Defendants acted improperly.