Airborne Health, Inc. v. Squid Soap, Lp

• Decision Date: 23 November 2009
• Docket Number: C.A. No. 4410-VCL.
• Parties: AIRBORNE HEALTH, INC. and Weil, Gotshal & Manges LLP, Plaintiffs, v. SQUID SOAP, LP, Defendant.
• Court: Court of Chancery of Delaware

984 A.2d 126

AIRBORNE HEALTH, INC. and Weil, Gotshal & Manges LLP, Plaintiffs, v. SQUID SOAP, LP, Defendant.

C.A. No. 4410-VCL.

Court of Chancery of Delaware.

Submitted: November 13, 2009.

Decided: November 23, 2009.

Joseph J. Bellew, Esquire, Cozen O'Connor, Wilmington, DE, for Plaintiff/Counterclaim Defendant Airborne Health, Inc.

William J. Wade, Esquire, Jeffrey L. Moyer, Esquire, David Schmerfeld, Esquire, Sarah R. Stafford, Esquire, Richards, Layton & Finger, P.A., Wilmington, DE, for Plaintiff/Counterclaim Defendant Weil, Gotshal & Manges LLP.

James S. Green, Sr., Esquire, Jared T. Green, Esquire, Seitz, Van Ogtrop & Green, P.A., Wilmington, DE; Brian Smith, Esquire, J. Craig Falls, Esquire, Falls Smith LLP, Austin, TX, for Defendant Squid Soap, L.P.

OPINION

LASTER, Vice Chancellor.

Plaintiffs Airborne Health, Inc. ("Airborne") and Weil, Gotshal & Manges LLP ("Weil") have moved for judgment on the pleadings against defendant Squid Soap, LP ("Squid Soap"). Except for two minor issues, I grant the motion. The two issues that remain are Airborne's request for a decree of specific performance, which I see no need to resolve at this stage of the proceedings, and any claim for damages based on Squid Soap's breach of the exclusive forum selection clause, which the parties have not addressed.

I. FACTUAL BACKGROUND

I assume the following facts to be true for purposes of the motion for judgment on the pleadings. The facts are drawn solely from the pleadings, which consist of Airborne and Weil's complaint, Squid Soap's first amended answer and counterclaims, and Airborne and Weil's replies to the counterclaims. I also have considered the Asset Purchase Agreement (the "Agreement" or the "APA"), which is incorporated by reference in all of the pleadings. Because this is a motion for judgment on the pleadings, I have assumed that all disputed factual allegations would be resolved in favor of Squid Soap, the non-movant. I likewise have given Squid Soap the benefit of all reasonable factual inferences.

A. The Parties.

Defendant Squid Soap is a Texas limited partnership with its principal place of business in Austin, Texas.

Plaintiff Airborne is a Delaware corporation with its principal place of business in Minneapolis, Minnesota. Effective as of June 15, 2007, Airborne and Squid Soap entered into an Asset Purchase Agreement by which Airborne acquired all of Squid Soap's assets, including certain intellectual property.

Plaintiff Weil is a New York limited liability partnership with its headquarters in New York, New York. Weil served as legal counsel to Airborne for purposes of drafting and negotiating the APA.

B. Squid Soap's Potential.

In the early 1990s, John Lynn saw a business opportunity in society's growing awareness that thorough hand washing limits the spread of germs. According to the counterclaims, the Center for Disease Control, the United States Food and Drug Administration, and the National Institute of Allergy and Infectious Diseases all launched nationwide programs to promote good hand-washing habits. I am told that the consensus view among reputable health authorities calls for at least a twenty second wash.

In addition to the general hand-washing trend, Mr. Lynn perceived a lack of specialized hand-washing products for children. To fill the void, he developed a soap dispenser that leaves a small spot of ink on a child's hand that only can be removed after twenty seconds of hand washing. He named the product "Squid Soap." Mr. Lynn obtained three patents for the background technology and another patent for the specialized soap dispenser (together, the "Patents").

Mr. Lynn believed that germ-focused parents, educators, and health professionals would embrace his invention. According to the counterclaims, he was right. Squid Soap received national attention. It was featured in magazines such as Redbook, Woman's Day, InStyle, and Parenting, and it appeared on television shows such as Good Morning America and the Fox Morning Show. Newspapers and websites praised it.

Buoyed by its unique attributes and the same favorable market trends that propelled sales of hand sanitizer and anti-bacterial wipes, Squid Soap became a hit. Retailers like Wal-Mart, Target, CVS, and Walgreen's stocked Squid Soap products. A consumer product paradise beckoned with high recurrent sales and patent-protected margins. All Squid Soap needed was a nationwide marketing platform and brand-name recognition.

C. Squid Soap Talks With Potential Strategic Partners.

In early 2007, Mr. Lynn was approached by companies and investment groups seeking to capitalize on Squid Soap's potential. Each group expressed great interest in Squid Soap. The suitors included the consumer products powerhouse Procter & Gamble, a multibillion dollar hedge fund HBK Investments, and a publicly traded business development company Capital Southwest Corporation.

Squid Soap's discussions with Capital Southwest progressed to the point that Capital Southwest suggested a candidate to run Squid Soap, Joseph Rainone. Capital Southwest also suggested that Elise Donahue, then-CEO of Airborne, could add value as a Squid Soap director. Mr. Lynn contacted Ms. Donahue, who immediately perceived Squid Soap's potential.

Led by Ms. Donahue, Airborne aggressively pursued Squid Soap for itself, going so far as to hire Mr. Rainone away from Capital Southwest. Airborne worked hard to convince Mr. Lynn that Airborne was the ideal partner for Squid Soap. Ms. Donahue repeatedly touted what she described as Airborne's marketing prowess, positive brand-name recognition, and the resulting opportunities for joint marketing of Squid Soap under Airborne's brand.

D. Airborne's Story.

Like Squid Soap, Airborne started out as a small, single-product company focused on stopping the spread of germs. Airborne's initial product was a cocktail of various vitamins, herbs and other ingredients that Airborne marketed as preventing and even curing the common cold. Indeed, Airborne required vendors to place its product displays on their cough and cold remedy aisles.

Victoria Knight-McDowell founded Airborne in 1997. In 2005, Summit Partners acquired majority ownership of Airborne. Ms. Donahue became CEO, replacing Mrs. Knight-McDowell, who continued her role as a brand spokesperson and board member.

By 2006, propelled by celebrity endorsements and aggressive advertising, Airborne ranked at the top of a list of the fastest-growing privately held companies. It experienced furious growth and at one time projected $300 million in annual sales. Airborne was at the pinnacle of brand recognition. Its name was its product.

E. Squid Soap Sells To Airborne.

Airborne's story charmed Mr. Lynn. The counterclaims allege that "[b]ased on Airborne's representations about, among other things, its brand name, sterling reputation, marketing prowess, and in particular its promises to leverage the Airborne name and marketing platform to fully maximize Squid Soap's potential, Squid Soap, relying on and induced by Airborne's representations and promises, re-focused its acquisition talks to Airborne, to the exclusion of its other suitors."

Squid Soap and Airborne eventually agreed on a transaction through which Airborne would purchase Squid Soap's assets (the "Asset Purchase"). The terms of the Asset Purchase are memorialized in the APA. The APA was an integrated contract, and in Section 10.3, the parties agreed that it reflected their compete agreement on the terms for the transaction.

Several aspects of the APA stand out. Most notably, Squid Soap agreed to sell its assets for $1 million in cash at closing, plus the potential for earn-out payments of up to $26.5 million if certain targets were achieved. Squid Soap asserts in the counterclaims that "[t]he high price tag was a reflection of Squid Soap's enormous market value." What an earn-out (and particularly a large one) typically reflects is disagreement over the value of the business that is bridged when the seller trades the certainty of less cash at closing for the prospect of more cash over time. In theory, the earn-out solves the disagreement over value by requiring the buyer to pay more only if the business proves that it is worth more. But since value is frequently debatable and the causes of underperformance equally so, an earn-out often converts today's disagreement over price into tomorrow's litigation over the outcome. Based on an earn-out of this magnitude (viewed in terms of the portion of total potential consideration), the plain inference is that Squid Soap believed that its business had tremendous value and was willing to bet heavily on that proposition.

Reinforcing this inference is a second notable feature of the APA. Airborne purchased Squid Soap's brand name, goodwill, and intellectual property, including the Patents, but the APA required that Airborne return the assets to Squid Soap if certain business targets were not met. Section 3.2 of the APA states:

Notwithstanding anything herein to the contrary, in the event that (i) Purchaser does not incur at least $1,000,000 of marketing, account retail programs and/or advertising spending (including brand spending but excluding co-op fees, slotting fees and product discounts) specifically focused upon the [Squid Soap] Products within the first twelve months after Closing ..., and (ii) Net Sales of the [Squid Soap] Products have not reached $5,000,000 within the first twelve months after Closing, then Purchaser shall transfer the Purchased Assets existing as of such date (other than inventory) back to Seller for the consideration of $10.00 and other valuable consideration of which the Purchaser and Seller both agree is valuable and adequate consideration. Upon such transfer, each person's obligations under this Agreement shall terminate except for obligations due and payable up through the date of termination.

Similarly, Section 3.2(g) provides:

Notwithstanding anything herein to...