An exchange offer from the embattled biotech company Theranos to 40 of its biggest investors is such a peculiar creature that Vice-Chancellor Travis Laster of Delaware Chancery Court wants to do some poking and prodding before it’s too late.
Last week, the vice-chancellor temporarily enjoined the scheduled April 14 closing of Theranos’ tender offer, which, in broad terms, would have allowed certain preferred shareholders in the privately held company to exchange their shares for new equity with some enhanced rights – but would require those shareholders to release litigation claims against Theranos and its directors and officers. According to a transcript of the TRO hearing Vice-Chancellor Laster held on April 11, the judge wants Theranos to explain how the share exchange would re-allocate whatever value remains in the battered company, as well as why Theranos allegedly made its offer to investors in a self-destructing, Mission Impossible-type presentation the vice-chancellor christened “investor Snapchat.”
The vice-chancellor’s big concern is that the Theranos offer may contain provisions that effectively force investors to abandon their fraud claims. “I have something that sets up like a controller tender offer with disclosure problems with some type of coercion involved,” the Delaware judge said. “And so it's the type of thing that I do think needs, at a minimum, better explanation on both sides.”
The Theranos investors who have sued in Delaware aren’t the only ones who’ve raised that concern. Lead plaintiffs in a class action against Theranos in federal court in San Jose – two investors with a stake in funds that held Theranos shares – also alleged this month that the company was using the exchange offer to undermine their fraud case. Unlike Vice-Chancellor Laster, U.S. Magistrate Judge Nathanael Cousins of San Jose refused to block the offer, concluding that it “was not coercive or confusing or misleading in any way.”
The two cases offer seemingly irreconcilable depictions of Theranos investors. In Delaware – where, to be fair, the record is quite undeveloped – they’re the targets of a scheme to deprive them of claims against corporate insiders who have lied to them about the company practically from its inception. In California, they’re sophisticated risk-takers who have negotiated a deal to maximize any potential returns on their Theranos bets.
Theranos’ tender offer is, as far as I can tell, the first time a company has ever proposed a swap of additional equity rights for a release of investors’ litigation claims. It could be a brilliant way for the company to buy time and save itself the cost of defending fraud litigation – but not if the deal is being crammed down investors’ throats improperly.
So let’s take a look at the two portrayals of the offer. A cautionary note: Many of the specifics of Theranos’ offer to investors remain secret. Gibson Dunn & Crutcher, which represents the investors suing the company in Delaware, redacted the complaint and TRO brief so thoroughly that the filings reveal just about nothing about the substance of the tender offer. The California class action plaintiffs based their request for discovery on a Wall Street Journal scoop about the Theranos plan, so their filing doesn’t fill in the blanks either.
But Theranos disclosed considerable background in its opposition brief in the California case and an accompanying declaration from Theranos General Counsel David Taylor. Additional details came out during the hearings before Judge Cousins in California and Vice-Chancellor Laster in Delaware.
Theranos lawyers from Wilmer Cutler Pickering Hale & Dorr, Cooley and Richards Layton & Finger describe the tender offer as the product of months of collaboration between the company and its biggest investors. According to them, it was Theranos investors represented by Cravath Swaine & Moore who originated the whole idea of releasing potential litigation claims in exchange for additional equity rights. And those shareholders first broached the exchange concept, Theranos said, back in August 2016 – months before either the California or Delaware fraud cases began. The specifics of the tender offer came together, according to Theranos, in hundreds of communications between the company and these highly knowledgeable, well-informed and well-represented investors.
“Our shareholders brought this deal to us – it wasn’t our idea,” Theranos lawyer Timothy Perla said at the TRO hearing in California. “If you just look at the timing of this deal, it can’t be we did this as a coercive tactic against this case because the case didn’t exist when the deal was first discussed.”
The firms representing investors in the California class action – Hagens Berman Sobol Shapiro and Robbins Geller Rudman & Dowd – premised their initial demand to see tender offer documents on allegations that Theranos was improperly contacting class members. Much of the hours-long hearing before Judge Cousins was consumed with class action issues rather than the substance of the tender offer. But the magistrate seemed to be persuaded by Theranos’ arguments about the timing of its negotiations with shareholders and the sophistication of its investors.
The California plaintiffs could only hypothesize about coercion in the tender offer because, as indirect investors, they did not have access to the offering documents until the TRO hearing. In the Delaware case, Gibson Dunn’s clients, direct Theranos investors, actually received the tender offer. That gave Gibson Dunn a chance to tell Vice-Chancellor Laster about restrictions on viewing the tender offer, which, the firm said, could not be printed or emailed and could only be accessed within a short window of time, after which “it would evaporate.”
More importantly, Gibson Dunn was able to argue that a particular provision of the tender offer was meant to force its clients to take the exchange and drop their lawsuit. The so-called liquidity preference provision mandates that shareholders who participate in the tender offer will jump ahead of other equity holders if Theranos enters bankruptcy.
That “most problematic provision,” Gibson partner Reed Brodsky told Vice-Chancellor Laster, gives its client a Hobson’s choice: “either accepting the tender and being precluded from carrying on with the case or proceeding with the case to trial with the knowledge that this liquidity preference provision will prevent our clients (from) executing any judgment because they will declare bankruptcy and it will drop us – drop our client from a preferred status down to 25th in line.” Brodsky said Theranos lawyers more or less threatened his clients that they’d get nothing if they insisted on pursuing litigation that drove the company into bankruptcy.
Laster pointed out that judgment creditors typically line up in front of all shareholders in bankruptcy, but said he needed to hear from both sides on the impact of the bankruptcy provision. The Gibson “theory of coercion,” he said, “because of the waiver that’s involved, makes sense to me.”
Theranos had no opportunity to respond on paper before Vice-Chancellor Laster issued the temporary restraining order to block the close of its tender offer. During the TRO hearing, Theranos lawyer Perla said the liquidity preference was a red herring. “Plaintiffs are saying this company is worthless,” Perla said. If they are right, then they are doomed with the transaction or without. Either way, there's not going to be enough money for a litigation judgment.”
Vice-Chancellor Laster has scheduled a preliminary injunction hearing for the week of May 8.