Bright Smile (BS),
a publicly traded corporation incorporated in Delaware and headquartered in Las
Vegas, Nevada, had developed a range of laser-based products used in dental
care. Its photodynamic therapy (PDT) division, which was based in California, had
developed a technique for disinfecting bacterial films in root canals that
utilized a laser diode to excite a photosensitizing compound and an
oxygen-carrier solution. BS also sold an optical scaling system to remove
plaque normally removed by dental hygienists using metal tools to scrape the
teeth. The patents covering the PDT division’s key products were due to expire
in November 2008.
Angela Smith and Davis Lawrence ran the
photodynamic therapy division and were responsible for negotiating contracts on
Bright Smiles behalf. They were not officers or directors of BS but were
full-time employees bound by noncompete and nonsolicitation agreements.
In January 2008, Angela and Davis were approached
by Cleanse, a competitor of Bright Smile, which was interested in buying the
PDT division. Cleanse sold laser drills used for dental fillings, cavity
preparations, root canals, the removal of benign tumors, and the reshaping of
gums. It also sold dental X-ray machines. Without telling Bright Smile, Angela
and Davis sent an offer to Cleanse whereby they offered to create a management
company then turn around and sell it to Cleanse for $8 million. Angela and Davis promised to deliver
virtually all of PDT’s clients and employees to the new company.
As part of the proposal, they included a list they
had generated from memory of PDT’s major clients. While Cleanse was considering
their proposal, Angela and Davis negotiated a four-year lease on new office
space in San Jose, California, on behalf of Bright Smile. When Cleanse
ultimately rejected Angela and Davis’s proposal to buy the PDT business, they
resigned from Bright Smile and went to work in Cleanse’s X-ray division.
In 2003, Charles Farr and Nolan Quinn,
post-doctoral students at Stanford University who had gone to high school with Angela
and Davis, developed an optical imaging technology they dubbed Optical
Coherence Tomography (OCT). OCT utilized Fourier frequency technology licensed
by Lawrence Livermore National Laboratories to Stanford. Like an ultrasound
device, OCT generates a real-time two dimensional image of living tissue. The
OCT software analyzed light signals created when a pen-like handheld scanning
device emitted a laser beam that reflected off the tissue being imaged.
Charles was so excited about their discovery that
he e-mailed their findings on March 4, 2003, to his former lab partner in
Tokyo. That same month, Charles and Nolan then recruited Anna Holden, a recent
Yale SOM grad whose offer from Montgomery Securities was rescinded after the
Internet bubble popped in 2002, to prepare a business plan for a new company to
exploit the OCT technology.
Unhappy with Anna’s unsuccessful efforts to obtain
financing from the Silicon Valley venture capitalists, Charles and Nolan met
with the Stanford professor supervising their research in September 2003 and
persuaded him to introduce them to Connor Twist, a wealthy Stanford alumnus, in
exchange for 5 percent of the venture. Since August 2003, Nolan and Charles had
ignored Anna’s occasional e-mails asking whether they had ever obtained funding
and neglected to mention to Twist when the met in October 2003 that Anna had
written the business plan. Twist agreed to be an “angel” investor in Laser
Diagnostics Ltd., the corporation Charles and Nolan had formed in September
2003. After their meeting with Twist, Charles and Nolan issued themselves
100,000 shares each of common stock at a price of $.01 per share, with 60% of
each founder’s shares fully vested and the remaining 40% vesting monthly over
five years with accelerated vesting upon an initial public offering. The Twist
deal was funded in December 2003. In exchange for $50,000 Twist was issued
50,000 shares of participating preferred stock that was convertible on a
one-to-one basis into common stock. Laser Diagnostics filed for patent
protection of their invention in the United
States, the EU, and Japan on February 27, 2004, listing
Nolan and Charles as the inventors.
Nolan and Charles
then approached several venture capital firms, including Brigand Venture
Capital. Brigand offered a higher pre-money valuation than the other firms but
had no prior experience investing in medical devices. They raised $15 million
in venture capital from Brigand in late 2004 to prepare the FDA application and
fund preclinical trials in chimpanzees.
To the delight of Brigand, Laser Diagnostics began
receiving attention in early 2006 from investment banks that were hoping to
underwrite its IPO. The publicity and interest that they had received were
sufficient to merit the serious consideration of the matter. They met with the
underwriters to plan the IPO and took the company public in mid-2006.
The company performed well for its first year as a
public company. The FDA trials went well and the publicity was fantastic.
Michelle Micron, Nolan’s fiancée and a writer for Dentistry Today magazine, wrote a glowing feature article
highlighting the exciting new technology. Even though both Nolan and Charles thought
that the article overestimated the size of the market by 20%, they posted a
copy of it on the Laser Diagnostics website. The FDA approved the first devices
using OCT in late 2007.
By the February 2008, Charles and Nolan had begun
having major disagreements about the direction of the company. Charles wanted
to continue to focus on using OCT imaging to detect tooth decay and micro
structural defects (such as cracks), which often do not show up with X-ray, and
to expand distribution into international markets. In contrast, Nolan (whose
mother suffered from ocular degeneration) wanted to apply the technology to the
field of ophthalmology as a means to detect diseases of the eye much earlier
than possible using existing technology. Nolan decided that he would resign as
an officer and director immediately after the end of the third quarter of 2008.
After all, although he differed with Charles on a variety of issues, he didn’t
want to sabotage the business by storming out and did not want to suffer the
financial consequences of effectively devaluing his own stock. Rumors of his
imminent departure surfaced, but both Charles and Nolan denied them.
In September 2008, Michelle wrote a follow-up
piece about the company for Dentistry
Today magazine after Nolan told her of his plan to step down on November 1st.
She reported it in the story, knowing that it would be another six weeks before
the December 2008 issue hit the newsstands. By then, Nolan would have publicly
announced his departure.
Just to be on the safe side, however, Michelle
sold her small stake in Laser Diagnostics. When her editor came to her to ask
about the story he had just read in the galleys, she affirmed that it was true
but said, “Keep it under your hat, Tom. It won’t be announced for two more
weeks.” At Donaldson Printing, employee Quincy was preparing for a press check.
He thumbed though Dentistry Today’s
literally “hot of the presses” story on Laser Diagnostics and called his broker
to tell him to sell his stake in Laser Diagnostics.
Laser Diagnostics put out a press release on
November 1, 2008, announcing Nolan’s departure. The stock plunged in price the
next business day. The November 5th announcement of the successful
quarter ended September 30 buoyed the price somewhat, but not back up to the
price before the announcement of Nolan’s departure. The December issue of Dentistry Today magazine hit the
newsstands on November 10th. Confident that the stock would recover
soon, Nolan decided to take advantage of the depressed price and bought and
additional $20,000 of Laser Diagnostics shares on November 6th.
Brigand was less optimistic and sold its 12% stake over the next four weeks. In
early December 2008, Charles was
traveling on a plane seated in first class near Liz, a Skadden, Arps lawyer,
and began chatting with her. When he told her that he was the co-founder of
Laser Diagnostics, she couldn’t believe it. She asked how the company was
doing. “Fantastic,” he reported. In fact, he indicated that a major private
equity company had expressed interest in acquiring Laser Diagnostics. When they
landed, she called her client Cleanse and told them that Laser Diagnostics
might be in play.
Unbeknownst to Charles and Liz, Francine Fracture
was eavesdropping from her seat one row back. She thought she was too old to
learn about high-tech companies, but her grandson, Vincent Vision, was
fascinated by the ever-changing technology. Francine called Vincent and told
him that she sat on a plane behind the famous founder of Laser Diagnostics. In
fact, she said that the medical industry must be pretty popular. Vincent didn’t
pursue the comment, but hung up the phone. He called his broker and made a
significant purchase of shares in Laser Diagnostics.
Two weeks later, Cleanse announced a hostile
tender offer for Laser Diagnostics at $48 per share. The Laser Diagnostics
stock increased 50% in price overnight to $45 per share.
a business school classmate of his, Iris Icarus of the private equity firm
Icarus, LLC, about structuring a leveraged buyout to take the company private.
The Laser Diagnostics board of directors agreed that the firm should be sold
but were determined not to sell it to a competitor. Instead, they negotiated
only with Icarus, which had indicated its plan to keep the current management
team in place. Icarus offered $52 per share. As a condition of its offer of
$52, Icarus would not allow the company to shop for a higher price before the
deal was signed, but the merger agreement included a “go shop” provision
allowing the company 40 days after signing to find a better deal. Icarus also
entered into voting agreements with a group of Laser Diagnostics’ shareholders,
including Charles and Nolan, that owned roughly 49% of Laser Diagnostics’ stock
whereby they agreed to vote in favor of the Icarus deal. The agreement provided
that if another bidder makes a superior offer, then Icarus has a right to
match, or take a termination fee—3 percent
of the total deal price (plus expenses).
Just before the agreement was
signed, Bright Smileleft a voicemail stating that it was considering making a bid,
but Laser Diagnostics signed the Icarus agreement without responding. Laser
Diagnostics’ investment banker then launched the go shop process, contacting
more than 100 potential buyers, but no higher bid surfaced. The Icarus deal was
subsequently approved by the holders of 85% of the Laser Diagnostic shares and
* * * * *
Please prepare a memorandum outlining the legal
issues raised by the foregoing facts. Include ethical considerations and
strategies for resolution. The purpose of this question is to spot the issues;
knowing what is the issue is in some sense more important than knowing the
answers. It is okay to say that the answer is not clear; in such present both
sides of the argument, then say which argument should prevail, and why. State
any and all assumptions, but do not spend valuable space on non-issues or
extreme tangents. If you need further factual information to assess fully the
legal issues, note what additional facts you need to know and how those facts
would affect the outcome. Ignore any applicable statutes of limitation. Be sure
to explain the principles of law you are applying and your reasoning. Refer to
cases to the extent it’s helpful to do so. Your answer is limited to 1,800
words, double spaced, 12-point font, with 1-inch margins.