Adlerstein v. Wertheimer

2002 WL 205684 (2002)

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Nature of the Case

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Facts

P is a scientist and entrepreneur. He has a Ph.D. in physics and was involved with the funding and management of a number of start-up technology companies before founding SpectruMedix. In 1997, SpectruMedix completed an initial public offering of its common stock, raising net proceeds of $4.67 million, but between debt and continuing losses, the money was gone by 1999. In July 1999, SpectruMedix entered into an agreement with Applied Biosystems, Inc. and certain of its affiliates and received $5 million in cash in exchange for a sublicense to certain technology licensed by SpectruMedix, shares of SpectruMedix Series A Preferred Stock, and a consulting agreement. For the most part, SpectruMedix received no other funds between July 3 1, 1999 and July 9, 2001. In 1999, to avoid a liquidity crisis, P loaned SpectruMedix $500,000. P got a note that was convertible into shares of a new Series B Preferred Stock of SpectruMedix that voted with the common and carried 80,000 votes per share. In January 2000, P converted approximately $103,000 outstanding under this loan agreement into shares of Series B Preferred Stock. As a result, although P owned only 21.41% of the equity of SpectruMedix, and controlled 73.27% of the voting power of the Company. P had made a decision to increase staffing levels from 23 to 51. This increased payroll by just over 100 %. A sexual harassment claim was also made against P, but he kept that under wraps for a period of time. On April 11, 2001, a meeting of the SpectruMedix board was held. At that meeting, P represented to the board, and the minutes of the meeting state, that three instruments had been purchased and shipped during the quarter ending March 3 1, 2001 and the Company was projecting sales of six to nine instruments for the quarter ending June 30, 2001. In fact, according to uncontroverted testimony, the Company sold only one instrument during the quarter ending March 3 1, 2001 and that sale was made on the condition that SpectruMedix would further develop the instrument to a commercially viable level of functionality. At another board meeting, P did not regard the financial situation as quite as desperate as the other directors. He said that the Company had previously faced similar cash crises and had weathered them. He said that he had found money to keep the Company alive in the past, and if required to do so again, he would find the resources, Mr. Wertheimer and Ms. Mencher lauded him for his past efforts to save the Company, but said that they were seeking to bring the Company to a cash neutral or profitable position as promptly as possible. The board met again on May 25, 2001. P reported that the Company was “low on cash” but delivered an upbeat report on the status of discussions he was having with several potential strategic partners. Wertheimer and Mencher remained concerned about the Company’s deteriorating financial condition and began to question seriously the information P was providing to them. A consultant helped organized the company and reduced the number of employees, but P refused to sign a written contract with the consultant notwithstanding the direction of the board that he do so. P acted to undo changes that had been implemented. Three of the four department heads at the Company were planning to quit their jobs with SpectruMedix if organizational and other changes implemented by the consultants were not kept in place. In June 2001, Wertheimer contacted Reich to discuss involving him as both an investor and manager of SpectruMedix. The board was aware that in the mid-1980s Reich had pleaded guilty to federal charges of trading on inside information while he was a partner in a prominent New York City law firm and served a one-year prison sentence. They also knew that from 1998 to 2000, Reich was employed as the President and CEO of Inamed Corporation, a publicly traded company, and had accomplished a significant turnaround of that company. On July 2, 2001, Reich participated in a conference call with Wertheimer and Mencher and later that day met with Wertheimer to discuss his potential investment. At that meeting, the option of firing P for cause from his position as CEO due to his sexual harassment of a Company employee was discussed, as was P’s voting control over the Company. P had no idea this meeting was taking place. But by this time Reich knew he would have an opportunity to take over SpectruMedix. By the beginning of July 2001, if not earlier, SpectruMedix was either insolvent or operating on the brink of insolvency. P was not communicating with creditors, and key parts vendors were refusing to make deliveries unless paid in cash. SpectruMedix did not have sufficient cash on hand to meet its next employee payroll on July 13, 2001, and had no realistic expectation of receiving sufficient funds to do so from its operations. The parties are in sharp disagreement over whether a board meeting had been called for July 9, 2001. The documents necessary for a transaction with Reich were in draft form by July 6, 2001. They were not sent to P, who was deliberately kept unaware that Reich had made a proposal until the July 9 meeting. Reich and Wertheimer were still negotiating some terms of the deal on the morning of July 9, and that final documents were not ready until that time. The deal finally negotiated provided, subject to board approval, that the Reich Partnership would invest $1 million in SpectruMedix, Reich would assume the active management of the company. When P arrived for the meeting, he was shown the Reich deal. P told Wertheimer and Mencher that he was not interested in the Reich proposal because it would dilute his shares in the Company and result in him losing voting control. Wertheimer asked P directly if he was personally in a position to provide the needed funds. P responded that he was not. Wertheimer and Mencher tried to engage P in further discussion about the Reich proposal, but P sat silent. Wertheimer moved the transaction for a vote. The transaction was approved. P was then removed for cause for mismanagement of the Company, misrepresentations to his fellow board members as to its financial situation, and sexual harassment in contravention of his employment contract. On July 9th, P executed a written consent to vote his shares to remove Wertheimer and Mencher from the board. P initiated this Section 225 action on September 11, 2001.