Newman v. KKR Phorm Inv'rs

1

Joel Newman v. KKR Phorm Investors, L.P., et al.

C. A. No. 2022-0310-NAC

Court of Chancery of Delaware

August 31, 2023

Dear Counsel:

This letter decision resolves Defendants' motions to dismiss under Court of Chancery Rule 23.1. For the reasons below, the motions are granted.^[1]

I. FACTUAL BACKGROUND

I have drawn the relevant facts from the Verified Amended Stockholder Derivative Complaint (the "Amended Complaint") and the documents incorporated into and integral to it. At this stage, I assume all well-pleaded allegations are true.

A. The Parties

Plaintiff is a stockholder of Transphorm, Inc. (the "Company"). During the relevant events, the seven individual defendants served on the Company's board of directors (the "Board"). Four of them simultaneously served on the Company's "Audit Committee" (together, the "Audit Committee Directors").^[2]

Defendant KKR Phorm Investors, L.P. is the Company's largest stockholder. During the relevant events, KKR Phorm held up to 47.3% of the Company's stock. Under a stockholder agreement, KKR Phorm's percent ownership entitled it to seat a majority of the Board at any time. Plaintiff does not allege that KKR Phorm ever invoked that right or threatened to use it.

B. The Policy

The Board adopted a "Related Person Transactions Policy" (the "Policy"). The Policy applies to transactions involving the Company and a person that owns 5% or more of Company stock ("Related Person Transactions").^[3] The Policy delegates to the Audit Committee the power to review and approve or ratify Related Person Transactions. "[T]o the extent relevant" to a given Related Person Transaction, the Audit Committee "will consider, among other factors":

(i) whether the Related Person Transaction is fair to the Company and on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances;

(ii) the extent of the Related Person's interest in the transaction;

(iii) whether there are business reasons for the Company to enter into the Related Person Transaction;

(iv) whether the Related Person Transaction would impair the independence of an outside director . . .; and

(v) whether the Related Person Transaction would present an improper conflict of interest for any director or executive officer of the Company, taking into account the size of the transaction, the overall financial position of the director, executive officer or Related Person, the direct or indirect nature of the director's, executive officer's or Related Person's interest in the transaction and the ongoing nature of any proposed relationship, and any other factors the Committee . . . deem[s] relevant.^[4]

The Policy does not require the Audit Committee to review a Related Person Transaction before the Board approves it:

A Related Person Transaction entered into without pre-approval will not violate this Policy . . . so long as the Related Person Transaction is brought to and ratified by the Committee . . . as promptly as reasonably practical after it is entered into or after it becomes reasonably apparent that the transaction is covered by this Policy.^[5]

C. The Private Placement

In 2020, the Company set out to "up-list" itself from the OTC markets to NASDAQ. But it lacked the funds to get there. As of June 2021, the Company was $35 million short. And its cash had been burning quickly.

On September 1, 2021, the Board met to determine how to bridge the gap and mitigate an impending liquidity crisis. During the meeting, the Board discussed three fundraising transactions that were designed to solve both problems (the "September Transactions"). The September Transactions contemplated equity issuances at $5.00 per share, for a total cash infusion that would exceed the Company's short-term needs. Still, the Board believed that the Company could need to raise additional cash through "an offering" to "provide more leeway" into 2022.^[6]

The September Transactions were expected to close by the end of the month. But that did not happen. As of October 2021, only one of the September Transactions closed. And the remaining two were uncertain to close. Consequently, the Company was still behind by at least $20 million. Worse, the Board learned that the Company "was expected to run out of cash" by December 2021.^[7]

On November 1, 2021, the Board called a special meeting (the "November Meeting") to discuss an equity financing transaction "led by" an unaffiliated investor, AIGH Investment Partners (the "Private Placement").^[8] The Audit Committee Directors attended the November Meeting. The Private Placement contemplated an equity issuance valued at $20 million or more. The economics mirrored the September Transactions-e.g., a per-share price of $5.00-and the deal would close before December. Under the terms, KKR Phorm would invest $5 million and AIGH and third parties would supply the rest of the capital. Otherwise, KKR Phorm is not alleged to have been treated differently than any other investor.

At the end of the November Meeting, the Board concluded that the Private Placement "was the best financing option for the Company under the circumstances and fair, just, equitable and reasonable to the Company and its stockholders."^[9] The Board implemented its fairness determination through a unanimous written consent approving the Private Placement (the "Written Consent").

Given its percent ownership, KKR Phorm's participation in the Private Placement brought KKR Phorm within the Policy. The Written Consent separately declares that the Audit Committee approved KKR Phorm's participation "for purposes of the Policy":

WHEREAS, under the [Policy], KKR [Phorm], as a beneficial owner of more than 5% of the Common Stock, is a Related Person (as defined in the Policy) and KKR [Phorm's] participation in the Private Placement is a Related Person Transaction (as defined in the Policy).

WHEREAS, pursuant to the Policy, the Audit Committee must review and approve, ratify or disapprove all Related Person Transactions.

WHEREAS, the Audit Committee has reviewed with management the Private Placement, including the terms of KKR [Phorm's] participation therein.

NOW, THEREFORE, BE IT RESOLVED: That the Audit Committee hereby approves the Private Placement and the transactions contemplated thereby, including KKR [Phorm's] participation therein, for purposes of the Policy.^[10]

The Private Placement closed before December 2021. Then the remaining September Transactions closed. The Company outpaced its cash burn, its stock price increased, and it began trading on NASDAQ in February 2022.

D. This Litigation

Plaintiff brought this derivative suit without making a demand on the Board. The Amended Complaint alleges that the Board breached its fiduciary duties by approving the Private Placement. The Amended Complaint further alleges that KKR Phorm breached its fiduciary duties as the Company's "controller" by participating in the Private Placement. Defendants have moved under Rule 23.1 to dismiss the Amended Complaint for failure to plead demand futility.

II. LEGAL ANALYSIS

"Stockholders cannot shortcut the board's control over the corporation's litigation decisions without first complying with Court of Chancery Rule 23.1."^[11]Rule 23.1 is the "procedural embodiment" of the demand requirement.^[12] Under Rule 23.1, a derivative plaintiff must plead with factual "particularity" its efforts (or lack thereof) to satisfy the demand requirement.^[13] This standard is "stringent[.]"^[14] Under Rule 23.1, a derivative plaintiff is entitled only to "reasonable inferences" that "logically flow from [the] particularized facts alleged .... [I]nferences that are not objectively reasonable cannot be drawn in the plaintiff's favor."^[15]

Where, as here, a stockholder forgoes demand, the complaint must be dismissed unless particularized facts support a reasonable inference of demand futility. "Demand is not excused [as futile] solely because the directors would be deciding to sue themselves."^[16] Instead, demand futility arises when "the directors are incapable of making an impartial decision" to pursue a corporate claim.^[17] To determine if a conflict exists, the Court asks three questions:

(i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;

(ii) whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand; and

(iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.^[18]

"If the answer to any of the questions is 'yes' for at least half of the members of the demand board, then demand is excused as futile."^[19]

Although a plaintiff "is not required to plead evidence" to establish demand futility,^[20] the Court cannot ignore the "evidence" that the plaintiff does plead. Plaintiff incorporated into the Amended Complaint books and records he obtained from the Company under Section 220 of the Delaware General Corporation Law. Those documents, as well as any "public materials" referenced in the Amended Complaint, "necessarily shape the range" and "outcomes" of pleading-stage inferences.^[21] On a Rule 23.1 motion, the Court may review an incorporated document as a whole "to ensure that the plaintiff has not misrepresented its contents and that any inference the plaintiff seeks to have drawn is a reasonable one."^[22] When "a plaintiff chooses to refer to a [Section 220] document in its complaint, the Court may consider...