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Corporate Quick Hit: LLC Minority Investor Rights, Stock Option Backdating and "Spring-Loading," Drugmakers have Greater Right to Challenge Patents, Duty of Care of Independent Director Committees, Shareholder Derivative Lawsuits, Hart-Scott-Rodino Act
February 2007
Authors: Irwin A. Kishner, Daniel A. Etna

LLC Minority Investor Rights Strengthened

A New York appellate court recently decided that minority members of a limited liability company have the right to bring a derivative action on behalf of the LLC even though there was no explicit statutory authority in the New York Limited Liability Company Law for members of an LLC to bring a derivative action. In the particular case, minority members of a LLC holding property interests in an apartment building challenged the transfer of title of such property interests on behalf of the LLC. The court based its decision on the fact that LLCs are hybrids of limited partnerships and corporations—entities against which equity holders may bring derivative actions under statutory and common law. This ruling will strengthen minority investors rights in LLCs and increase the accountability of managing members and majority interest holders.

Tzolis v. Wolff, (http://www.courts.state.ny.us/reporter/3dseries/2007/2007_01190.htm) (Feb. 8, 2007)

Delaware Chancery Court Addresses Stock Option Backdating and "Spring-Loading"

The Delaware Court of Chancery recently issued two seminal decisions addressing whether lawsuits that seek to hold directors liable for option backdating, as well as for so-called "spring-loaded" and "bullet-dodging" option grants, can proceed.

In Ryan v. Gifford, the plaintiff sued the directors of a microchip maker alleging that they had breached their fiduciary duties by approving backdated options that violated shareholder-approved stock option plans, which specifically provided that the exercise price of all options would be no less than the fair market value of the common stock on the day the options were granted. Based solely on empirical data and statistical analyses indicating that the advantageously low stock prices on option grant dates were unlikely to be the result of mere coincidence, the complaint alleged that the CEO was awarded backdated options on at least nine occasions. The court found that the complaint's factual allegations were sufficient to support a claim that the directors' actions were intentional and in violation of their duty of loyalty.

In re Tyson Foods, plaintiffs alleged that the board of directors granted "spring-loaded" stock options to insiders. Spring-loaded options are granted before the release of material information that is reasonably expected to drive the stock price higher while the company's public disclosures represent that the grants were issued at market rates. (Conversely, "bullet-dodging" takes place when options are granted after the release of materially damaging information.)  The court, while acknowledging that it is unclear if spring-loading constitutes a form of insider trading under the federal securities laws, held that for purposes of Delaware law, a director who intentionally uses inside information to enrich employees in violation of shareholder-approved stock option plans breaches his fiduciary duties of good faith and loyalty.

These decisions establish that intentional stock option backdating and spring-loading, if proven, are violations of a director's duty of loyalty and do not constitute good faith conduct, either of which would preclude such director from being able to take advantage of certain liability protections afforded by the Delaware General Corporation Law, and leave the director open to liability for monetary damages to the corporation.

Ryan v. Gifford, C.A. No. 2213-N (Del. Ch. Feb. 6, 2007); In re Tyson Foods, Inc. Consol. S'holder Litig., CA.No. 1106- N (Del. Ch. Feb. 6, 2007)

U.S. Supreme Court Provides Drugmakers with Greater Right to Challenge Patents

The U.S. Supreme Court struck down a U.S. Court of Appeals for the Federal Circuit rule that if a drug company pays royalties for a patent, it gives up the right to challenge the patent's validity. The Court ruled for MedImmune, Inc. which had paid Genentech, Inc. a royalty for a drug used to treat respiratory tract problems and then challenged the patent for such drug. The Court held that MedImmune, Inc. was not required to break or terminate the license agreement before seeking a declaratory judgment that the underlying patent was invalid, unenforceable or not infringed. This decision affords biotech companies more leeway in getting out of unfavorable licensing agreements with large pharmaceutical companies.

MedImmune, Inc. v. Genentech, Inc., Slip Op. No. 05-608 (Jan. 9, 2007)

Delaware Court of Chancery Rules on Duty of Care of Independent Director Committees

The Delaware Court of Chancery recently addressed the liability of an independent committee of corporate directors which failed to properly inform itself prior to approving corporate action. In the case before the court, the compensation committee ratified a management stock incentive plan which later resulted in a shareholder complaint that the plan was a wasteful management entrenchment scheme. The court focused on the behavior of the compensation committee that approved the plan. The compensation committee was found to have deliberated only briefly on the merits of the plan and relied extensively on the advice of an outside attorney who helped devise the plan. In denying the defendants' motion to dismiss, the court observed that the poorly-informed decision based on conflicted advice from an attorney subservient to management supported a claim for breach of fiduciary duty.

Sample v. Morgan, 2007 WL 177856 (Del. Ch., Jan. 23, 2007)

U.S. Supreme Court to Review Federal Standards for Shareholder Derivative Lawsuits

The U.S. Supreme Court recently announced that it will review a decision by the Court of Appeals for the 7th Circuit that lowered the bar for shareholders litigating federal securities law fraud claims. The decision involves a telecommunications equipment maker accused by shareholders of, among other things, providing false information regarding revenue, making false projections, and illegally attempting to inflate its stock price. The telecommunications equipment maker argued that under federal law, the case by its shareholders should not have proceeded since the shareholders failed to sufficiently prove that it had the requisite state of mind to commit the alleged wrongful acts.

The federal district court initially held that the shareholders' allegations were too vague to support a claim. The 7th Circuit reversed the district court's decision, holding that the shareholders' suit could proceed if "a reasonable person could infer that the defendant acted with the requisite intent." With the 7th Circuit being one of several Federal circuit courts applying varying standards for proving fraudulent intent in shareholder derivative actions, the U.S. Supreme Court is expected to provide clarity as to the level of proof required for these types of claims.

Tellabs, Inc. v. Makor Issues & Rights, Ltd., 437 F3d 588 (7th Cir. 2006)

Revised Hart-Scott-Rodino Act Reporting Thresholds

The Federal Trade Commission has announced revised reporting thresholds for the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and its implementing rules, as amended (the "HSR Act"). These new thresholds apply to all transactions that closed on or after February 21, 2007.

The HSR Act requires that parties to proposed stock or asset acquisitions exceeding certain thresholds file premerger notification reports with the FTC and the Antitrust Division of the U.S. Department of Justice and then observe statutorily prescribed waiting periods (usually 30 days) prior to closing the transaction.

The primary changes are increases in the "size-of-transaction" and "size-of-person" thresholds under the HSR Act. Under the new thresholds, an acquisition of voting securities or assets may be reportable if the securities or assets held as a result of the transaction are valued in excess of $59.8 million, and either the acquiring party or acquired party has annual net sales or total assets of at least $12 million and the other party has annual net sales or total assets of at least $119.6 million. The size of the parties is irrelevant if the value or size of the transaction exceeds $239.2 million.

The revisions also increased notification thresholds for acquisitions of additional voting securities from the same party. As a result, notifications will be required at each of the following thresholds: $59.8 million; $119.6 million; $597.9 million; 25 percent of the voting securities if their value exceeds $1,195.8 million; and 50 percent of the voting securities if their value exceeds $59.8 million.

Filing fees remain the same, but the thresholds that determine the fees have been revised. Under the new thresholds, acquiring persons in transactions valued above $59.8 million up to $119.6 million must pay a fee of $45,000. For transactions valued at $119.6 million up to $597.9 million, a $125,000 fee is required. A $280,000 fee is applied to transactions valued at or above $597.9 million.

Finally, the thresholds applicable to certain exemptions under the HSR Act have also been revised upwards. For example, acquisitions of non-U.S. assets are not reportable unless the acquired assets generated sales in or into the U.S. exceeding $59.8 million. Similar changes apply with respect to acquisitions of voting securities of non-U.S. issuers.

For more information on these issues or other corporate matters, please contact:

Irwin Kishner at 212.592.1435 or email ikishner@herrick.com
Daniel Etna at 212.592.1557 or email detna@herrick.com 

Copyright © 2007 Herrick, Feinstein LLP. Corporate Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.