Carsanaro v. Bloodhound Techs., Inc.

• Decision Date: 15 March 2013
• Docket Number: C.A. No. 7301–VCL.
• Parties: Joseph A. CARSANARO, Samir Abed, Aaron Seib, Aldo Kiamtia, and Barry Taylor, Plaintiffs, v. BLOODHOUND TECHNOLOGIES, INC., Gary G. Twigg, Patrick E. Kennedy, Noro–Moseley Partners V, L.P., Noro–Moseley Partners V–B, L.P., Moseley and Company V, LLC, Allen S. Moseley, Wakefield Group III, LLC, George M. Mackie, IV, David Gilroy, Michael Elliot, The North Carolina Bioscience Investment Fund, L.L.C., Eno River Capital, L.L.C., Daniel Egger, Michael Moran, William F. Chastain, Jr., Ron G. Roma, and Kevin R. Brown, Defendants.
• Court: Court of Chancery of Delaware

65 A.3d 618

Joseph A. CARSANARO, Samir Abed, Aaron Seib, Aldo Kiamtia, and Barry Taylor, Plaintiffs,

v.BLOODHOUND TECHNOLOGIES, INC., Gary G. Twigg, Patrick E. Kennedy, Noro–Moseley Partners V, L.P., Noro–Moseley Partners V–B, L.P., Moseley and Company V, LLC, Allen S. Moseley, Wakefield Group III, LLC, George M. Mackie, IV, David Gilroy, Michael Elliot, The North Carolina Bioscience Investment Fund, L.L.C., Eno River Capital, L.L.C., Daniel Egger, Michael Moran, William F. Chastain, Jr., Ron G. Roma, and Kevin R. Brown, Defendants.

C.A. No. 7301–VCL.

Court of Chancery of Delaware.

Submitted: Dec. 18, 2012.

Decided: March 15, 2013.

Sidney S. Liebesman, Montgomery, McCracken, Walker & Rhoads, LLP, Wilmington, Delaware; James A. Roberts, III, Brooke N. Albert, Lewis & Roberts, PLLC, Raleigh, North Carolina; Gary V. Mauney, Lewis & Roberts, PLLC, Charlotte, North Carolina; Attorneys for Plaintiffs.

Raymond J. DiCamillo, John D. Hendershot, Nicole C. Bright, Kevin M. Gallagher, A. Jacob Werrett, Richards, Layton & Finger, P.A., Wilmington, Delaware; Attorneys for Defendants Bloodhound Technologies Inc., Gary G. Twigg, Patrick E. Kennedy, Noro–Moseley Partners V, L.P., Noro–Moseley Partners V–B, L.P., Moseley and Company V, LLC, Allen S. Moseley, Wakefield Group III, LLC, George M. Mackie, IV, David Gilroy, Michael Elliot, Daniel Egger, Michael Moran, William F. Chastain, Jr., Ron G. Roma, and Kevin R. Brown.

OPINION

LASTER, Vice Chancellor.

Bloodhound Technologies, Inc. (“Bloodhound” or the “Company”) created web-based software applications that allowed healthcare providers to monitor claims for fraud. The plaintiffs are five software developers, including Bloodhound's founder, who contend that their years of hard work laid the foundation for the Company's success. All held common stock. They claim that after Bloodhound raised its initial rounds of venture capital financing, the venture capitalists obtained control of the Company's board of directors. From that point on, they say, the venture capitalists financed the company through self-interested and highly dilutive stock issuances. The plaintiffs did not learn of the issuances or their consequences until late April 2011, when Bloodhound was sold for total consideration of $82.5 million. At that point, the plaintiffs discovered that their overall equity ownership had been diluted to under 1%. After members of management received transaction bonuses of $15 million and the preferred stockholders received nearly $60 million in liquidation preferences, the plaintiffs were left collectively with less than $36,000.

In this action, the plaintiffs challenge the dilutive transactions, the allocation of $15 million in merger proceeds to management, and the fairness of the merger. The plaintiffs have sued the members of the board who approved the transactions and their affiliated funds. The defendants have moved to dismiss on a wide range of theories. With limited exceptions, the motions to dismiss are denied.

I. FACTUAL BACKGROUND

The facts for purposes of the motions to dismiss are drawn from the verified complaint and the documents it incorporates by reference. At this stage of the case, the allegations of the complaint are assumed to be true, and the plaintiffs are given the benefit of all reasonable inferences.

A. The Early Days Of Bloodhound

In 1996, plaintiff Joseph A. Carsanaro saw a business opportunity in the growing use of the internet for submitting and processing healthcare claims. Carsanaro envisioned software that could monitor web-based claims in real time, detecting fraud, abuse, and errors before claims were paid. Carsanaro spent much of 1996 and 1997 identifying, integrating, and testing the core technologies that would form the basis for web-based applications. In July 1997, Carsanaro added plaintiffs Aldo Kiamtia, Barry Taylor, and David Whipple to his software development team.

In April 1998, Carsanaro formed Bloodhound to carry out his vision. Carsanaro served as CEO and Chairman of the Board, managed Bloodhound's day-to-day operations, and developed its business and financial plans. Kiamtia served as a member of the board and oversaw the software development process. Carsanaro initially financed Bloodhound with money raised from friends and family.

B. The Series A Financing

In the third quarter of 1999, Bloodhound released its first web-based application. At this point, Bloodhound sought venture capital funding, and Carsanaro traveled to a series of investor conferences and spoke to numerous venture capital firms. His efforts paid off, and Bloodhound successfully raised $1.9 million. The lead investor was defendant North Carolina Bioscience Fund, LLC (“NC Bioscience”), a fund managed by defendant Eno River Capital LLC (“Eno Capital”) and its principal, defendant Daniel Egger. Bloodhound issued 4,054,953 shares of Series A Preferred Stock, representing 44.42% of the fully diluted equity, at a price of $0.47 per share (the “Series A Financing”). According to the complaint, the terms implied a $3 million pre-money valuation for the Company.

Bloodhound used the proceeds from the Series A Financing to expand its operations. In 2000, Carsanaro hired plaintiff Samir Abed to serve as Chief Technology Officer and plaintiff Aaron Seib to work as a Product Manager and Senior Director of Software Operations. In this capacity, Seib managed three software development teams. Abed joined the board.

Together Carsanaro, Kiamtia, Taylor, Seib, and Abed worked to develop a suite of web-based claims management applications that would provide a comprehensive range of overpayment protection services. Bloodhound closed sales agreements with more than two dozen customers, including large industry leaders, and its software suite began processing over one million claims nightly. In light of their collective efforts to create Bloodhound's products and get the Company off the ground, Carsanaro, Kiamtia, Taylor, Seib, and Abed refer to themselves collectively as the “Founding Team.”

C. The Series B Financing

In early 2000, Bloodhound sought additional venture capital funding. Carsanaro made presentations around the country to approximately 23 venture capitalist firms. His efforts again were successful, and Bloodhound raised $3.1 million. The lead investor was defendant Wakefield Group III, LLC (the “Wakefield Fund”). Bloodhound issued 4,306,324 shares of Series B Preferred Stock, representing 30.12% of the fully diluted equity, at a price of $0.72 per share (the “Series B Financing”). The terms implied a pre-money valuation for the Company of $8 million.

The complaint does not attack the Series A Financing or the Series B Financing. The complaint details Carsanaro's wide-ranging efforts and arm's length negotiations with third party capital providers for contrast with the defendants' later decisions to provide additional financing themselves on terms they set unilaterally.

D. The Venture Capitalist Takeover

As of June 2000, the Bloodhound board of directors had five members: plaintiffs Carsanaro and Abed from the Founding Team; defendant Mike Moran, an outside director recruited by Carsanaro; defendant Egger from Eno Capital; and defendant David Gilroy, Vice President and General Partner of the Wakefield Fund. From this point on, the complaint weaves a tale in which the venture capitalists maneuvered to gain control of the board, then used self-interested financing transactions to position themselves to reap the vast majority of the Company's value at the expense of the Founding Team.

The venture capitalists' first move was to ease Carsanaro out of the top spot. According to the complaint, the venture capitalists convinced the board that “hiring a CEO with additional Healthcare domain experience would make [Bloodhound] more marketable to potential acquirers.” Compl. ¶ 54. Carsanaro agreed with the plan, but only because he expected to remain Chairman and President.

The next step was to bring in another like-minded venture capitalist. To this end, the venture capitalists convinced the board that Bloodhound should raise “one last round of financing for the Company, in the form of a new round of Series C convertible preferred stock.” Compl. ¶ 54. Carsanaro, Egger, and Gilroy reached out to Allen S. Moseley, the principal in an eponymously named venture capital firm, and began discussing a potential investment of $8–10 million. They eventually worked out terms on which Moseley-affiliated funds would purchase shares of SeriesC Preferred Stock representing a 28.57% fully diluted ownership interest in the Company at a price of $1.11 per share. The terms implied a pre-money valuation for the Company of $20–25 million.

In August 2000, the board hired William F. Chastain, a veteran healthcare executive, as Bloodhound's new CEO. The size of the board was increased from five to six, and Chastain joined as a director. After taking over as CEO, Chastain replaced Carsanaro in the discussions with Moseley. Egger, Gilroy, and Chastain then reopened the terms of the Series C Preferred. Carsanaro and Abed were excluded and not kept informed.

In October 2000, at Chastain's request, the size of the board was increased again, and Ron G. Roma became a director. The complaint alleges that Roma was an ally of Chastain but does not provide any facts to support this contention. I assume that Roma was an independent, disinterested director.

In December 2000, “[t]o his surprise,” Carsanaro was asked by the board “to resign as a director, officer, and employee of the Company, effective December 20, 2000.” Compl. ¶ 62. Contrary to his understanding, Carsanaro was not kept on as Chairman, President, or in any other capacity. “Abed had not been privy to any discussions concerning Carsanaro's forced resignation and was upset by the situation.” Id. ¶ 63. Abed was then asked to resign from the board, although he would continue as Chief Technology Officer. Both men acceded to the resignation...