LAMB, Vice Chancellor.
The plaintiff sold assets to a competitor in return for a mixture of cash and shares of the competitor's publicly traded common stock. The purchaser later refused to perform its obligation under a related registration rights agreement to file a registration statement covering the shares so that they could be sold in compliance with the federal securities laws. Shortly afterwards, the market price of the shares plummeted, and, eventually, the shares were delisted after the seller's public accountants withdrew their report on its prior period financial statements.
The seller sought a variety of remedies for this breach of contract, including specific performance and, alternatively, money damages. The claim for money damages was tried beginning on March 31, 2003. In this post-trial opinion, the court concludes that the seller is entitled to damages measured by reference to the market price of the shares over a period of five consecutive trading days beginning when the seller could first have sold them had the necessary registration statement been filed in a timely manner.
A. The Parties
Plaintiff BioLife Solutions, Inc., which was formally named Cryomedical Sciences, Inc. ("CMS"), is a Delaware corporation with its principal place of business in Binghamton, New York. BioLife's current business is the development, manufacture and marketing of solutions for the preservation of cells, tissues and organs at low temperatures (the "Solutions Business"). Before June 24, 2002, BioLife also was engaged in developing, manufacturing and marketing minimally invasive cryosurgical devices for the ablation of tissues (the "Cryosurgical Business").
CMS was one of the first companies to perfect the use of cryosurgical devices for the treatment of prostate diseases. During the early 1990s, it had essentially 100% of the worldwide market for this application. CMS began to struggle thereafter, and was quickly passed in marketplace acceptance by Endocare, Inc. (and a competitor, Galil Medical Systems, Inc.), whose cryosurgical equipment was viewed
Defendant Endocare, is a Delaware corporation with its principal place of business in Irvine, California. Endocare is engaged primarily in the development, manufacture, and marketing of temperature-based, minimally invasive surgical devices and technologies designed to treat certain cancers. Endocare was a direct competitor of CMS. By the spring of 2002, Endocare had approximately 80% of the market share for cryosurgical equipment used for prostate cancer.
B. The Transaction
In early 2002, BioLife and Endocare entered into negotiations regarding the acquisition of the Cryosurgical Business by Endocare. On May 28, 2002, BioLife and Endocare entered into an Asset Purchase Agreement (the "Agreement"). Closing on the Agreement occurred on June 24, 2002 (the "Closing"). Pursuant to the Agreement, Endocare acquired all of the tangible and intangible assets relating to BioLife's Cryosurgical Business. At the Closing, Endocare paid to BioLife $2,200,000 in cash, and provided BioLife with a stock certificate representing 120,022 shares of Endocare's common stock.
Included among the financial information provided in the Agreement was the Statement of Operations for the CMS business. This Statement showed that CMS's revenue for calendar year 2001 was approximately $954,000 (or an average of approximately $240,000 per quarter), while its revenue for the first three months of 2002 (the only quarter available as of either the signing of the Agreement or the Closing) had declined to $82,893.
At Closing, the parties also entered into a Registration Rights Agreement. Pursuant to Section 1.2 of the Registration Rights Agreement, Endocare agreed, "as soon as reasonably practicable after the [June 24, 2002] Closing Date ... but in no event more than 90 days thereafter" to file a registration statement on SEC Form S-3 and "as soon as reasonably practicable thereafter, effect all such qualifications and compliances as may be reasonably necessary and as would permit or facilitate the sale and distribution of" the stock transferred pursuant to the Agreement.
Section 1.2(a) of the Registration Rights Agreement also gave Endocare the right to delay filing the Form S-3, but only under the following limited circumstances:
C. Delivery Of The Assets
Pursuant to Section 2.1 of the Agreement, the assets sold to Endocare consisted for the most part of intellectual property, 47 pieces of tangible assets (primarily equipment), inventory and accounts receivable. According to Endocare, "[t]he primary assets sought ... were the intangible assets held by BioLife-its patents, trademarks, and customer lists."
1. The "Primary Assets"
The intellectual property (the patents, trademarks, and copyrights) were delivered at Closing in the form of an Assignment of Patents, an Assignment of Servicemarks and Trademarks, and an Assignment of Copyrights. The customer lists were provided to Endocare on May 27, 2002, the day before the Agreement was signed.
In addition to the actual assignment of the patents, there were also patent files that BioLife was required to deliver to Endocare. These files, which were maintained by BioLife's patent attorneys, contained the material that had been collected in connection with the various patent applications-correspondence to the patent office and the client, and notes and memoranda to the file by the patent attorneys. There is no doubt that Endocare was entitled to receive those documents, and there is also no doubt that delivery of those documents occurred slowly.
On August 9, 2002, Lawrence Ginsberg, Endocare's intellectual property counsel, contacted the law firm of Pillsbury Winthrop, LLP, which had represented BioLife in connection with the Agreement. The purpose of this call was to ascertain why the patent files had not been transferred and when they would be transferred. Following that initial conversation, Ginsberg again made contact with Pillsbury, and was told by Glenn Perry, a Pillsbury attorney, that he would "set the wheels in motion."
On November 11, 2002, BioLife transferred what Endocare initially thought were the complete patent files. However,
John Baust, CMS's president and CEO at the time of the Agreement, testified at trial that the late delivery of these patent files was due to the actions of one of CMS's former patent firms. He stated:
Although Endocare argues that BioLife's failure to provide all the patent files constitutes a material breach of the Agreement, it is clear that Endocare was primarily concerned with one particular patent file. By the time of trial, Endocare focused its argument in this regard almost exclusively on the patent file for the urethral warmer (Patent No. 5,437,673; the "673 Patent"). In particular, Paul Mikus, Endocare's former CEO and current chairman of its board, claimed at trial that Endocare's patent counsel needed the file related to the 673 Patent in order to perform proper due diligence on its contents before determining whether to commence an infringement action against one of Endocare's competitors (Galil).
2. The Remaining Assets
The tangible assets and inventory (which Endocare has implicitly conceded were secondary considerations) were transferred at Closing by a bill of sale and assignment. The accounts receivable were also transferred at Closing by an assignment, and all accounts receivable collected by BioLife have been remitted to Endocare.
Physical delivery of the tangible assets, inventory, and certain files related to those assets was to take place post-Closing. At the Closing, Endocare and BioLife entered into a letter agreement providing for delivery of most of the tangible assets to Endocare at a designated location in Eden Prairie, Minnesota "via a reputable courier or shipping service within a reasonable period of time;" the other tangible assets were to be destroyed.
The manufacture and operation of medical equipment is highly regulated by the U.S. Food and Drug Administration (the "FDA"). As a manufacturer of devices used in the treatment of cancer and other diseases, CMS was, and Endocare is, required to maintain compliance with the rules and regulations of the FDA, including
John Baust was the only person that testified at trial concerning his personal knowledge of what documents related to the physical assets were delivered by BioLife to Endocare. With respect to the documents necessary to comply with GMPs, he testified that:
Charles Cannon took possession of these documents and took them to an Endocare facility in Jersey Shore, Pennsylvania.
The device master record (one of the categories of FDA-mandated documents included in Endocare's complaint)
On September 11, 2002, Cannon sent an intra-company e-mail to Bill Phillips, an Endocare manager in its California office. In that e-mail, Cannon stated:
D. Endocare Refuses To Register The Shares
On September 12, 2002, Endocare sent a letter to BioLife at its prior address in Kennesaw, Georgia. Endocare, however, did not send a copy of that letter to BioLife's new offices in Binghamton, New York (which it may not have known about), nor did it send a copy of this letter to Breslow & Walker, BioLife's principal outside counsel (whom it certainly did know about), even though the Registration Rights Agreement mandated that "[a]ll notices and other communications required or permitted" by that agreement be sent to that counsel as well.
In the September 12 letter, Endocare claimed that it "has not received any material portion of the Assets from [BioLife]."
E. Endocare's Discussions With A Third Party And The Initiation Of An Audit Committee Investigation
On or about August 30, 2002, Mikus received a letter from a third party proposing strategic business discussions. Thereafter, Endocare began discussions with this third party, and over the next several weeks the parties performed due diligence relating to a potential transaction. Ultimately, the discussions terminated on October 18, 2002.
On October 24, 2002, an Endocare employee raised concerns regarding matters relating to Endocare's financial accounting. Based on the expression of those concerns, Endocare began an audit committee investigation that same day. On October 30, Endocare announced that "it will delay the release of its earnings for the quarter ended September 30, 2002 while the Company completes the review process of the quarter's financial results."
On November 6, 2002, Endocare's attorneys sent a letter to BioLife (this time to its correct address and with a copy to its attorneys, Breslow & Walker). In that letter, Endocare asserted, for the first time, that although it "would have been willing to file the Registration Statement
On November 14, 2002, Endocare issued another press release stating that it "[would] delay its third quarter [ending September 30, 2002] 10-Q regulatory filing while the company continue[d] its financial review process."
Within one half hour of that press release, the NASDAQ Stock Market announced that trading was halted in Endocare's common stock because the NASDAQ had requested additional information from Endocare (no doubt related to the revelations in the press release only a few minutes before). NASDAQ further announced that trading would remain halted until Endocare "has fully satisfied NASDAQ's request for additional information."
A three-day trial was held beginning on March 31, 2003. To prevail at trial, BioLife, as the plaintiff, must prove its case by a preponderance of the evidence.
A. Endocare Breached The Registration Rights Agreement And Was Not Justified In Doing So
Based on the evidence adduced at trial, Endocare breached its obligations under the Registration Rights Agreement when it failed to file a Form S-3 registration statement within 90 days of the June 24, 2002 Closing, or by September 20, 2002.
It is undisputed that no such certificate has ever been furnished to BioLife (either within the 90-day period or otherwise). Nevertheless, Endocare now claims (based on the report and trial testimony of its expert, David Hahn) that it did not breach the Registration Rights Agreement because (as a result of then-ongoing discussions with a third party) it allegedly would have taken advantage of the escape clause of Section 1.2(a)(iii). As a result, according to Endocare, it "would have deferred" filing the registration statement within the 90-day period, and the Form S-3 would not have been filed until (at the earliest) October 19, 2002.
Endocare's post hoc reliance on Section 1.2(a)(iii) because it "would have" or "could have" utilized that provision is unavailing. The "out" created in Section 1.2(a)(iii) does not permit Endocare, at any time in the future, to justify its failure to file a registration statement if it can prove it had a reasonable basis for not doing so. To the contrary, this escape clause (which was created solely by the contract between the parties) is wholly contingent: if Endocare furnishes the certificate signed by its CEO in good faith within the 90-day period, then ("in which event") it may forego filing the registration statement for a certain period of time. Because Endocare never
B. Endocare Has Not Shown That Failure To Deliver Certain Assets Was Material To The Transaction
A party is excused from performance under a contract if the other party is in material breach thereof.
Section 241 of the Restatement (Second) of Contracts sets forth several factors to consider when determining whether "a failure to render ... performance is material" (thus justifying repudiation of a contract).
Endocare argues that even if it breached the Registration Rights Agreement, it was justified in doing so because BioLife had already materially breached its obligations under the Agreement. The first document that formally set forth Endocare's position regarding its refusal to file a registration statement was a letter dated September 12, 2002 from Endocare's outside attorneys to BioLife's Chief Executive Officer. That letter states that "[a]s of the date hereof, Endocare has not received any material portion of the Assets from Cryomedical."
1. Documents Required To Be Maintained By The FDA
Endocare claims that it never received either (a) the FDA-required documents with respect to how to build the cryosurgical equipment it was acquiring from BioLife or (b) the service records with respect to that equipment. As discussed below, the failure to timely deliver these assets was not a material breach, and materially all of the assets were in fact delivered before Endocare was obligated to file a registration statement.
a. Endocare Had No Real Interest In Acquiring An Ongoing Business
Evidence adduced at trial demonstrated that Endocare never intended to build new CMS cryosurgical equipment. Instead, its focus was on CMS's existing customer base transfer to Endocare's equipment.
The cryosurgical equipment acquired from CMS was a very different technology than Endocare's own. CMS's equipment "was a liquid nitrogen system."
It would be unreasonable to believe that Endocare meant to acquire CMS-in its view a second-rate system incompatible with its own-and then try to sell it to customers. Mikus's testimony supports the conclusion that Endocare's purchase of the Cryosurgical Business was done only to eliminate competition. For example, Endocare did little due diligence with respect to the Cryosurgical Business, as Mikus did not know if anyone had toured CMS's facilities before the Closing. Moreover, Endocare had no plans to hire any former CMS employees (with the possible exception of the former Chief Executive Officer). In addition, Mikus did not know how many active accounts CMS had as of the Closing.
Another example of Endocare's lack of interest in the continuation of the Cryosurgical Business relates to CMS's inventory of cryosurgical consoles. Although CMS had an inventory of cryosurgical consoles as of the Closing, Mikus did not know if CMS was still manufacturing consoles or when the last console had been made. Moreover, Mikus admitted that Endocare never intended to manufacture new CMS consoles.
With respect to cryosurgical probes, Mikus did not know if CMS was still manufacturing them as of the Closing, did not know how many probes were in CMS's
Endocare argues it entered into the Agreement "with the expectation that it would receive substantial revenue from BioLife's existing cryosurgical business."
b. All Necessary Documents Were Delivered
Although Endocare originally claimed, on September 12, 2002, that it had "not received any material portion of the Assets from Cryomedical,"
Cannon actually testified in a manner contrary to what Endocare implies. In particular, Cannon explained that he maintained his own equipment for the mobile services, and kept the service records for that equipment at his office in Jersey Shore, Pennsylvania. Moreover, Cannon testified that Dave Rust, an Endocare regional manager, "came down [to Jersey Shore] and collected copies of the shipping and mobile service records."
2. The Patent Files
BioLife does not dispute, because it cannot, that it failed to transfer certain patent files to Endocare by September 20, 2002, the last business day during the 90-day period under the Registration Rights Agreement. The undisputed evidence in the case demonstrates that BioLife transferred additional patent files on November 11, 2002, but that it was not until March 13, 2003 that it transferred what it now contends are all the remaining patent files. This late transfer of patent files, however, did not amount to a material breach of the Agreement sufficient to justify Endocare's refusal to file a registration statement.
First, the Agreement itself places no heightened emphasis on the patent files themselves. This is so despite the fact that Endocare now claims that the patent files, and particularly the patent file associated with the 673 Patent, were the cornerstone of its acquisition of CMS. Second, had those patent files been material to the Agreement, one would expect Endocare to have made arrangements to receive them at Closing or at least to specifically mention them by name in its September 12 letter when it relied on the alleged failure to deliver assets to justify its decision to refuse to file a registration statement. Instead, the September 12 letter merely stated, in a substantial overstatement, that "Endocare has not received any material portion of the Assets from [CMS]...."
Finally, Endocare now has the patent files it complains it never received. Although Endocare may have suffered some damage as a result of the late delivery, such damage cannot be so material as to justify its refusal to file a registration statement. Endocare primarily sought the 673 Patent file to determine if another competitor (Galil) could be subject to a patent infringement lawsuit. Now that Endocare has the patent files associated with the 673 Patent, it can presumably reach a decision whether to pursue its lawsuit against Galil.
Endocare also complains about having never received a so-called "lab notebook" for the 673 Patent.
For all these reasons, the court concludes that the failure to timely deliver patent files was not a material breach of the Agreement by BioLife, and that Endocare was not justified in refusing to satisfy
C. BioLife Is Entitled To An Award Of Damages Equal To The Value It Would Have Received Had Endocare Timely Filed A Registration Statement
1. BioLife's Contentions
BioLife proposes that it is entitled to damages equal to the sales proceeds it would have received if Endocare had filed its S-3 Registration Statement in compliance with the Registration Rights Agreement. BioLife argues that, had Endocare fulfilled its contractual obligations, BioLife would have sold the newly-registered stock within five trading days of the effective date of such a registration statement, and therefore it should receive damages equal to the amount it would have received by selling its shares at that time. In this connection, BioLife offers to surrender its shares for cancellation.
The plaintiffs presented the expert testimony of Dr. Brett A. Margolin to substantiate their damages claim. Dr. Margolin testified that the first step in his analysis was to determine when the registration statement would have become effective, assuming a September 20, 2002 filing date. Dr. Margolin acknowledged that, based on his research of other S-3 filings and survey of financial databases, there was no systematically reliable way of determining when such a registration statement would have become effective. Nevertheless, Dr. Margolin did observe that the likelihood of review by the SEC for a repeat S-3 filer in 2002 was approximately 3%.
2. Endocare's Defenses
Endocare first responds that its performance obligation to file the registration statement was excused by BioLife's material breach of the Agreement. The court has already concluded that BioLife was not in material breach of the Agreement; therefore, Endocare was not, for that reason, justified in its failure to meet its filing obligation.
Endocare next argues that BioLife's damage calculation is unjustified and baseless because, even if Endocare had tried to comply with its obligations under the Registration Rights Agreement, BioLife would never have been in a position to sell its shares. There are several premises for
3. The Court Is Persuaded By The Calculation Of Damages Based On BioLife's Timeline Of Events
The problem with Endocare's defense is that it ignores the fact that the Registration Rights Agreement (in Section 1.2(a)) specifically provided Endocare with the right to delay its filing obligation, and Endocare failed to exercise that right. The Registration Rights Agreement, in clear and unambiguous language, stated how Endocare could extend its time for filing the registration statement, and the evidence is unrebutted that Endocare did not take advantage of that provision. Because Endocare did not avail itself of the contractual relief mechanism, it is hard pressed in arguing its performance is somehow excused by the factual circumstances that existed at the time its performance was due. Quite obviously, Endocare could have met its obligations under the Registration Rights Agreement by terminating its strategic business discussions with the third party. The fact that it chose not to do so does not mean that it could not have complied with its contract duties.
The issues remaining to be decided in calculating damages are when a registration statement would have become effective, how quickly the shares could have been sold and at what price.
In Duncan v. TheraTx, Inc., the Delaware Supreme Court discussed the proper calculation of damages where a defendant corporation has failed to comply with a contractual obligation to register shares of its stock for sale to the public.
The second issue raised by Endocare is whether the shares held by BioLife could have been absorbed into the market over the five trading days, as BioLife assumes. The Agreement (or a related contract) limited trading of the shares to a maximum of 25,000 per diem. If BioLife had begun selling its shares on October 1, 2002, it would have taken at least five trading days to sell all of its 120,022 shares-25,000 for the first four days, and 20,022 on the fifth day. Dr. Margolin testified that there was an active market for Endocare shares for the period October 1-7, and Endocare offered no contrary testimony. Thus, the court will assume, in calculating damages, that BioLife would have sold its shares in the indicated amounts on those days.
Finally, while acknowledging the degree of uncertainty that characterizes a damage calculation for the hypothetical sale of shares that were never registered and never sold into the market, the court must measure damages by determining the proceeds BioLife could have received for its shares. In Duncan, the Delaware Supreme Court held that the "defendant should bear the risk of uncertainty in the share price because the `defendant's acts prevent a court from determining with any degree of certainty what the plaintiff would have done with his securities had they been freely alienable.'"
In keeping with the teaching of Duncan, Dr. Margolin multiplied the high price of the shares on each of the five trading days by the number of shares presumed sold on each such date to determine the expected gross proceeds.
For all the foregoing reasons, judgment shall be entered in favor of the plaintiff BioLife Solutions, Inc. and against the defendant Endocare, Inc. in the amount of $1,648,935, plus prejudgment interest at the legal rate. The plaintiff is to submit a form of order in conformity with this decision within 10 days of the date of this opinion.