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.
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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.
Charles approached 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 consummated.
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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.