(Reuters) - The generic drugmaker Akorn is facing a world of trouble. The German healthcare giant Fresenius, which received court approval last year to walk away from a $4.75 billion deal to acquire Akorn, is suing Akorn in Delaware Chancery Court for damages from the busted deal. The U.S. Food and Drug Administration is investigating data integrity issues at the company’s manufacturing plants, issuing two warning letters this year about potential regulatory shortcomings. Akorn is also feeling pressure from its lenders. The company said in its most recently-filed quarterly financial statement that it’s working on a refinancing deal, but said that if those negotiations fail, Akorn faces a default that “could materially affect the company’s business, financial position and results of operations.”
In all, the company’s shares have fallen 90% in the last 18 months.
Akorn’s shareholders blamed the company for that disastrous run. In an amended complaint filed in April in a securities class action in Chicago federal court, lead plaintiffs’ counsel from Entwistle & Cappucci claimed that top Akorn executives were aware of the FDA’s concerns about the integrity of its quality control data yet downplayed the impact of those regulatory warning signs. Shareholders’ damages experts estimated that class members lost more than $1 billion because of the alleged fraud.
Akorn, represented by Cravath Swaine & Moore, has always denied shareholders’ fraud claims. It also opposes Fresenius’ damages claims over the abandoned merger and has said the company is responding to FDA inquiries.
Nevertheless, on July 30, the company announced that it had reached a tentative settlement of the securities class action. And on Friday, Entwistle & Cappucci moved for approval of the proposed settlement from U.S. District Judge Matthew Kennelly of Chicago.
Under the terms of the proposed agreement, shareholders will receive $30 million in cash - the entire amount of Akorn’s insurance coverage for directors and officers. Investors are entitled to additional cash payments of as much as $60 million over the next five years if Akorn either hits certain financial benchmarks, is sold to another company or enters bankruptcy. Finally, shareholders in the class action will receive as many as 8.7 million additional shares of Akorn stock.
Wait, what? Akorn shareholders who have seen the value of their shares evaporate in the face of alleged fraud want to settle for … more shares of the company that allegedly duped them?
That’s right – and they wouldn’t be the first investors to receive company stock in a securities class action settlement. In 2014, U.S. District Judge William Alsup of San Francisco granted final approval to a settlement that gave Diamond Foods shareholders about 4.5 million shares of the company, along with just $11 million in cash. Back in 2004, Lucent Technologies settled a shareholder class action for about $103 million in cash (the entirety of its D&O insurance) and nearly $400 million in Lucent stock and warrants. Nortel made a deal in 2006 to settle two U.S. securities class actions and several Canadian shareholder suits for about $300 million in cash and 315 million shares of the company.
The common characteristic in all of these cases is that the defendants were in precarious financial shape. That’s certainly how shareholders describe Akorn. Their motion for preliminary approval of the proposed settlement said Akorn “is in dire financial condition (and) has not earned a profit in two years.” Settlement negotiations, the filing said, took place against a backdrop of an “overarching risk of bankruptcy.” (In fairness to Akorn, I should note that the company has brought in mostly new management and is working on a deal with lenders to avert a default in December.)
Lead counsel in the Akorn case, Vincent Cappucci of Entwistle & Cappucci, told me that Akorn’s financial problems drove the deal that shareholders have proposed. “We wanted to maximize the insurance proceeds and give investors a chance to participate if the company turns around,” he said.
In the unusual circumstance of a company “teetering on the edge,” Cappucci said, it may not be in shareholders’ best interests to push for a big judgment that could send the business into Chapter 11. Shareholders would then be just another unsecured creditor, he said. On the other hand, he said, a deal that give plaintiffs some cash now and a stake in the company’s future – which looks rosier without the dark cloud of liability from the shareholder class action – can be the best option.
Importantly, Cappucci’s firm isn’t asking for all of its fees to be paid in cash. It is requesting a 25% share of the class recovery, but is proposing that its fees take the same form as the class payout: part cash, part contingency value rights and part stock. It’s also worth noting that Akorn shares won’t be diluted by the stake that will go to plaintiffs if the settlement is approved. The shares are either already in the company’s control or were reserved for Akorn executives under options plans that will not be exercised at the company’s current share price.
Akorn said in its SEC filing on the settlement that it has taken a $74 million charge reflecting the value of the settlement. The Entwistle & Cappucci motion for preliminary approval suggests the deal could be worth more than $155 million, depending on the value of the shares the class receives.