Zimmerman v. Crothall

• Decision Date: 31 January 2013
• Docket Number: C.A. No. 6001–VCP.
• Citation: 62 A.3d 676
• Parties: Robert ZIMMERMAN, Plaintiff, v. Katherine D. CROTHALL, Michael Gausling, Peter Molinaro, Robert Toni, Steve Bryant, Originate Adhezion A Fund, Inc., a Delaware corporation, Originate Adhezion Q Fund, Inc., a Delaware corporation, Originate Ventures, LLC, a Delaware limited liability company, Liberty Ventures II, L.P., a Delaware limited partnership, Liberty Advisors, Inc., a Delaware corporation, and Thomas R. Morse, Defendants, and Adhezion Biomedical LLC, a Delaware limited liability company, Nominal Defendant.
• Court: Court of Chancery of Delaware

62 A.3d 676

Robert ZIMMERMAN, Plaintiff,

v. Katherine D. CROTHALL, Michael Gausling, Peter Molinaro, Robert Toni, Steve Bryant, Originate Adhezion A Fund, Inc., a Delaware corporation, Originate Adhezion Q Fund, Inc., a Delaware corporation, Originate Ventures, LLC, a Delaware limited liability company, Liberty Ventures II, L.P., a Delaware limited partnership, Liberty Advisors, Inc., a Delaware corporation, and Thomas R. Morse, Defendants,andAdhezion Biomedical LLC, a Delaware limited liability company, Nominal Defendant.

C.A. No. 6001–VCP.

Court of Chancery of Delaware.

Submitted: Sept. 14, 2012.

Decided: Jan. 31, 2013.

Evan O. Williford, Esq., The Williford Firm LLC, Wilmington, Delaware; Attorneys for Plaintiff.

Richard A. Barkasy, Esq., Schnader Harrison Segal & Lewis LLP, Wilmington, Delaware; David Smith, Esq., Stephen A. Fogdall, Esq., Benjamin D. Wanger, Esq., Schnader Harrison Segal & Lewis LLP, Philadelphia, Pennsylvania; Attorneys for Defendants.

OPINION

PARSONS, Vice Chancellor.

This case addresses the allegations of a minority unitholder in a privately held medical device company. The unitholder is the co-founder and former CEO of the company. He became a minority stakeholder after accepting investments in the company in exchange for units and after he sold some of his own units. The company is managed by a board of directors under its limited liability company operating agreement. The board of directors caused the company to enter into several financing transactions. The unitholder alleges that these transactions were in breach of the company's operating agreement and that, by undertaking the transactions, the directors also breached their fiduciary duties. He further alleges that certain unitholders breached fiduciary duties and that they and their affiliates aided and abetted the directors' breach of fiduciary duties.

A three-day trial was held on the unitholder's claims. After careful review of the evidence presented at trial and the parties' post-trial briefs and oral arguments, I conclude that the directors acted outside of their authority under the company's operating agreement, but that they did not breach the fiduciary duties they owed thereunder when they engaged in the financing transactions. Apart from entering a declaratory judgment that the directors exceeded their authority in engaging in the financing transactions, I deny the unitholder's requested relief, including his request that the defendants reimburse the company for its advancement of their attorneys' fees in this matter. I hold instead that the directors' breach caused no damage and that all defendants were entitled to indemnification notwithstanding the directors' breach of the company's operating agreement.

I. BACKGROUND

A. The Parties

Plaintiff, Robert Zimmerman, is the co-founder, former CEO, and a former director of Adhezion Biomedical LLC (“Adhezion” or the “Company”). Zimmerman currently owns 86,900 Class A Common units and 40,000 Class B Common units in Adhezion.

Nominal Defendant, Adhezion, is a privately held Delaware limited liability company with its principal place of business in Wyomissing, Pennsylvania. Adhezion is a medical device company that develops and commercializes surgical, wound management, and infection-prevention technologies.

The defendants in this action include the five members of Adhezion's board of directors (the “Board”) and entities that have invested in, or are affiliated with an entity that invested in, Adhezion (collectively, “Defendants”).

Defendants Katherine D. Crothall, Michael J. Gausling, Peter Molinaro, Robert Toni, and Steven R. Bryant are Adhezion's Board members (the “Director Defendants”). Molinaro is Adhezion's CEO and the Board Chairman.

Defendant Liberty Advisors, Inc. invested in Adhezion through its subsidiary, Defendant Liberty Ventures II, L.P. (collectively, “Liberty”). Defendant Thomas R. Morse is the co-founder and principal of Liberty Advisors, Inc. Crothall serves as Liberty's Board designee.

Defendant Originate Ventures, LLC is a venture capital firm that has invested in Adhezion through Defendants Originate Adhezion A Fund, Inc. and Originate Adhezion Q Fund, Inc. (collectively, “Originate”). Gausling is one of three managing partners of Originate Ventures, LLC and serves as Originate's Board designee.

B. Facts

Adhezion makes three main products: SurgiSeal, DermaSeal, and FloraSeal. The product that is the focus of the events leading up to this litigation is SurgiSeal, a medical adhesive used to close both accident-caused wounds and surgical incisions. SurgiSeal received approval from the United States Food and Drug Administration (“FDA”) in December 2008. SurgiSeal competes with a Johnson & Johnson (“J & J”) product called Dermabond. Dermabond holds approximately 85% of the domestic market for high-strength medical adhesives. ¹ Molinaro estimates that the global market for high-strength medical adhesives was $500 million in 2008 and over $600 million in 2010.² Adhezion's SurgiSeal shows promise as a competitor to Dermabond. It allegedly has performance advantages over Dermabond ³ and is cheaper to produce. ⁴ Dermabond, however, has advantages over SurgiSeal including its existing market share and the powerful backing of J & J.⁵ In 2010, the Cleveland Clinic placed SurgiSeal on its “primary vendor list.” ⁶ In obtaining that business, Adhezion demonstrated that the Cleveland Clinic could save $300,000 annually if it converted 100% of its topical skin adhesive business to Adhezion.⁷ Due to stiff competition from J & J, however, the Clinic purchased only “4 or 5 percent of their annual purchase from [Adhezion] and they stayed with the J & J product.” ⁸

1. Originate invests; Operating Agreement amended

Although the Company faced strong competition, it showed promise. Molinaro joined Adhezion as a consultant in 2007.⁹ Zimmerman and Molinaro attracted at least two potential investors between 2007 and 2008. In March 2008, Originate invested $3 million in Adhezion in return for 375,000 Series A Preferred units at $8.00 per unit.¹⁰ This transaction valued Adhezion at $8 million.¹¹ In connection with this transaction, Adhezion adopted a new operating agreement (the “Amended Operating Agreement”).¹² Under the Amended OperatingAgreement, the Company had five directors on its Board.¹³ Its equity ownership was represented by Class A Common, Class B Common, and Series A Preferred units, the rights, preferences, and privileges of which were set forth in the Operating Agreement.

After the deal with Originate, Molinaro became Adhezion's CEO and a director. Also on the Board in March 2008 were Gausling, an initial Series A Preferred Director, and Zimmerman, the initial Common Director under the Amended Operating Agreement. In June 2008, and at Molinaro's suggestion, the Board elected Bryant to serve as Adhezion's Industry Director.¹⁴ Bryant works at Angiotech, a customer of Adhezion. Bryant and Molinaro have worked together in various engagements since the 1980s.¹⁵ They also have a personal friendship and have hunted together on several occasions and fished together once.¹⁶

2. Liberty invests; Second Amended Operating Agreement

In October 2008, while the Company was developing SurgiSeal and FloraSeal and attempting to secure FDA approvals, Molinaro sought and obtained funding from several additional investors, including Liberty, Crothall, and non-parties William Graham and his wife (collectively, the “Liberty Investors”).¹⁷ These investors contributed $2 million in exchange for 281,917 Series A Preferred units at approximately $7.05 per unit. This transaction effectively valued the Company at $10.5 million. As part of the transaction, the Amended Operating Agreement was amended again to create the Second Amended Operating Agreement. Among other things, the Second Amended Operating Agreement increased the number of directors on Adhezion's Board to six.¹⁸ Crothall and Gausling became the Series A Directors while Molinaro and Zimmerman remained the CEO and Common Directors, respectively. Bryant continued to serve as one Industry Director. The second Industry Director position apparently was never filled. The Company obtained the consent of the Common unitholders for this transaction with the Liberty Investors, including for the execution of the Second Amended Operating Agreement.¹⁹

In January 2009, Zimmerman's employment with Adhezion was terminated and he was removed as the Common Director. In March 2009, the Class A Common unitholders elected Toni, former president and CEO of Closure Medical, to replace Zimmerman as the Board's Common Director.²⁰ In the 1980s, Toni had worked with Bryant and Molinaro for approximately four years at a company called Cilco.²¹ Molinaro, Crothall, Gausling, Bryant, and Toni were the directors on the Board at all relevant times.

3. Adhezion's prospects in 2009

In January 2009, the Company began to have difficulty with its intellectual property (“IP”) rights. MedLogic Global Limited (“MedLogic”) notified Adhezion that MedLogic had concerns that the process Adhezion employed to sterilize SurgiSeal infringed MedLogic's '800 patent.²² Also in early 2009, Adhezion began negotiations with 3M Company (“3M”) regarding a proposed exclusive licensing and distribution agreement.²³ Adhezion initially hoped that 3M would pay a $3 million up-front licensing fee for both SurgiSeal and FloraSeal.²⁴ As negotiations progressed into the summer, however, 3M expressed several concerns, including that consumers perceived SurgiSeal to be not as strong as its competitor Dermabond,²⁵ that SurgiSeal was equivalent to Dermabond but not superior to it,²⁶ that SurgiSeal lacked clinical trials,²⁷ that SurgiSeal faced the threat of patent litigation,²⁸ and that SurgiSeal could not compete effectively with J & J on price.²⁹

4. July 2009 Issuance

On April 30, 2009, Adhezion was running low on cash and the Board resolved to accept a “bridge loan” in an amount up to...