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Harris, M.D. v. Innovate Biopharmaceuticals, Inc.
Citation: Not availableDocket: N19C-01-055 RRC
Court: Superior Court of Delaware; October 15, 2019; Delaware; State Appellate Court
Original Court Document: View Document
Plaintiffs M. Scott Harris, M.D. and Middleburg Consultants Inc. filed a complaint against Defendant Innovate Biopharmaceuticals, Inc., asserting claims for breach of contract, negligent misrepresentation, breach of the implied covenant of good faith and fair dealing, and fraud. Innovate Biopharmaceuticals moved to dismiss the complaint, arguing that the claims lacked sufficient legal basis. The court granted the motion to dismiss, concluding that the Plaintiffs failed to assert valid claims. The court noted that the terms of the Consulting Agreement were clear and that Innovate had fulfilled its obligations by compensating for delays and delivering unrestricted shares after the stock options were exercised. The court also found no evidence of fraud. The Consulting Agreement, dated August 29, 2016, required Harris to provide regulatory guidance and included provisions for compensation, specifically stock options amounting to 0.5% of the company. The agreement stipulated terms regarding the vesting of shares and the exercise period for the options. North Carolina law was agreed upon by both parties for governing the contract. If the Company has not completed an underwritten initial public offering by June 30, 2017, it will pay Consultant $15,000 due to delays in asset liquidity on public markets. On March 21, 2017, Innovate granted Harris an option to purchase 232,725 shares of common stock at an exercise price of $0.785, with the shares fully vested on the grant date. This option is governed by the 2015 Stock Incentive Plan and the accompanying Nonstatutory Stock Option Agreement. Both documents emphasize that the shares are not registered under the Securities Act of 1933 and cannot be sold or transferred without proper registration or a satisfactory legal opinion. The Option Agreement confirms the grant of the option and incorporates the Plan and Notice, establishing them as the complete agreement between the parties, which supersedes any prior agreements. The governing law for the agreement is the General Corporation Law of Delaware and the internal laws of North Carolina. Additionally, a notice form provided in the Option Agreement outlines representations and warranties Harris must acknowledge upon exercising his option, including his ability to bear the economic risk of the shares, the understanding that the shares are restricted securities, and adherence to the terms of the Plan. Shares of Innovate cannot be sold, transferred, or disposed of unless they are registered under the Securities Act or an exemption is applicable. The exemption under Rule 144 is not available for at least six months or one year, depending on the Company's reporting obligations under the Securities Exchange Act of 1934. Compliance with Rule 144's terms and conditions is also necessary. Currently, there is no registration statement filed with the Securities and Exchange Commission regarding Innovate's stock, and the Company has no obligation or intention to register the Shares. Under Innovate's 2015 Stock Incentive Plan, options may be exercised by providing a written notice and payment for the shares. The delivery of shares will occur promptly or on a deferred basis as specified by the Board. The Company is not required to deliver shares or remove restrictions until all award conditions are satisfied, legal matters are addressed, and the participant provides necessary representations or agreements. At the time of entering into the Consulting Agreement and Option Agreement, Innovate was not publicly traded. Innovate considered an initial public offering (IPO) but opted for a reverse merger with Monster Digital, Inc., which was publicly traded on NASDAQ, due to time and cost considerations. Since Innovate did not complete an IPO by June 30, 2017, it paid Harris $15,000 as compensation for the delay in asset liquidity on public markets. The reverse merger was agreed upon on July 3, 2017, and closed on January 29, 2018, with shares starting public trading on February 1, 2018. Section 5.6(b) of the merger agreement mandates that the company must file a Form S-8 registration statement with the SEC within ten calendar days post-Effective Time, concerning shares of Monster Common Stock related to Innovate Options. The agreement explicitly states there are no third-party beneficiaries, meaning only the involved parties and their successors have enforceable rights. Innovate filed a Form S-3 Registration Statement on March 14, 2018, covering up to $175 million in new common stock and the resale of 13,990,403 shares held by existing investors. This Form S-3 was amended three times and became effective on July 13, 2018, detailing that shares were part of an earlier equity issuance by Innovate that raised approximately $18.1 million. On April 24, 2018, Innovate informed E. Harris about updated option terms due to the merger. Harris expressed interest in exercising his options starting May 2018 and exercised them on October 2, 2018, purchasing 87,706 shares for $182,428.48. By October 15, 2018, Innovate delivered the shares to him without restrictions, which he later sold for $378,359.81. From May to August 2018, Harris sought guidance from Innovate on making his shares marketable. An Innovate senior executive indicated that an SEC Form S-8 filing, contingent on the pending Form S-3, was necessary for the sale. During this period, as Innovate's stock value declined, Harris and his representatives pressed Innovate for information on the Rule 144 exemption. On June 26, 2018, the executive mistakenly informed them that Harris could not sell his options until the S-8 was filed and approved by the SEC, without giving a timeline. By August 7, 2018, the executive directed Harris to communicate with another individual for further inquiries. Subsequently, Harris retained a lawyer who sent a demand letter to Innovate, prompting the company to involve their legal counsel, Wilson Sonsini, in responding to Harris' attorney. On September 11, 2018, during a discussion between Wilson Sonsini (Innovate's legal counsel) and Dr. Harris’s lawyer, the potential for Dr. Harris to sell his Innovate stock under Rules 701 and 144 was evaluated. Wilson Sonsini, a highly regarded law firm in corporate and securities law, requested a brief period to assess the availability of these exemptions. However, after two weeks, they had not provided the opinion letter requested by Dr. Harris’s counsel. On September 26, 2018, Wilson Sonsini communicated that local counsel, Hutchison PLLC, should review the matter concerning Dr. Harris's option grant. Hutchison promptly concluded that the exemptions would apply, allowing the removal of restrictions on Dr. Harris's shares. Regarding stock prices, Innovate's stock fluctuated significantly, with values ranging from $46 per share in April 2018 to $3.46 per share by mid-November 2018. On January 8, 2019, Dr. Harris initiated legal action against Innovate, claiming breach of contract, negligent misrepresentation, and fraud, among other allegations. Innovate agreed to respond to the complaint and subsequently filed a motion to dismiss the claims, arguing that Harris had not established grounds for breach of contract, given the terms of the Consulting Agreement and the timely delivery of shares following his option exercise. Harris later agreed to withdraw specific claims related to breach of the Consulting Agreement and negligent misrepresentation. Defendant argues that Harris misinterprets a phrase from the Consulting Agreement to impose unwritten terms on the Option Agreement and Plan, suggesting that Innovate was obligated to make Harris's shares publicly tradeable before he could exercise his options. The defendant asserts that the express terms of the Option Agreement and Plan contradict Harris's claims, and since Innovate fulfilled its contractual obligations, there is no breach, leading to the failure of Harris's contract claims as a matter of law. Additionally, the defendant claims that Harris's breach of the implied covenant of good faith and fair dealing is inadequate because: (i) it should not be treated separately from the breach of contract claim when based on the same facts, (ii) the covenant cannot be breached if there is no breach of the underlying contract, and (iii) it cannot override the express terms of the agreements. Consequently, Harris's implied covenant claim is deemed legally insufficient. Furthermore, the defendant contends that Harris's fraud claim fails because: (i) the economic loss rule prevents tort claims when damages relate to the contract's subject matter and there is no separate legal duty identified, and (ii) Harris cannot demonstrate justifiable reliance on alleged misrepresentations due to his lack of investigation. In contrast, Plaintiff asserts that the Consulting Agreement aimed for 'asset liquidity to public markets' and that a $15,000 payment was solely for delays, not negating the understanding that options were to be marketable. Plaintiff maintains that the Nonstatutory Stock Option Agreement and related documents envisioned marketability of the shares, subject to specific qualifications. He claims that Innovate's Exhibit A to the Option Agreement was fraudulent and misleading regarding the Rule 144 exemption. Plaintiff argues that the option to remove restrictive legends and make shares marketable was available from February 1, 2018, and Innovate unjustifiably delayed this process until October 2018. He contends that he had no duty to verify Innovate's representations in the legal documents and justifiably relied on them, asserting that he complied with the requirements of the 2015 Innovate Stock Incentive Plan. Plaintiff alleges that representatives from Merrill Lynch requested guidance from Innovate's senior executives about making his options shares marketable, only to be misinformed that an SEC S-8 filing was necessary. He asserts that these misrepresentations and delays prevented him from selling his shares despite meeting the conditions for a registration exemption, resulting in lost economic opportunities. Plaintiff claims Innovate acted in bad faith, violating the implied covenant of good faith and fair dealing by undermining his legal rights and frustrating his reasonable expectations from the agreement. The legal standard for reviewing a motion to dismiss under Rule 12(b)(6) emphasizes accepting well-pleaded factual allegations as true, drawing reasonable inferences favoring the non-moving party, and only dismissing cases where no recovery is conceivable. The court notes that while Rule 12(b)(6) allows for leniency, conclusory allegations without specific supporting facts must be disregarded. Ultimately, the court finds that the Plaintiff's claims lack merit. The Consulting Agreement does not support his claim for relief, as it acknowledged the possibility that Innovate might not complete an IPO by a specific date, and Innovate fulfilled its obligation by paying $15,000. Furthermore, Innovate was only required to provide unrestricted shares after the exercise of options, which was done promptly. Since Innovate adhered to the terms of the agreements, no breach occurred, and the court dismisses the contract claims. The claim for breach of the implied covenant of good faith is also deemed deficient, as it cannot exist independently from a breach of contract claim, which is not present here. The implied covenant cannot supersede the explicit terms of the agreement either. Plaintiff's claim based on the implied covenant fails as it contradicts established legal principles. Additionally, the fraud claim is dismissed due to two main reasons: (i) the economic loss rule precludes tort claims related to damages that fall within the scope of the underlying contract, and Plaintiff has not identified any independent legal duty outside of that contract, and (ii) Plaintiff cannot demonstrate justifiable reliance on any misrepresentations because he did not investigate those statements and has not shown that he was hindered from doing so. Although Plaintiff argues that he had no duty to verify Innovate's representations and that Innovate's actions undermined his legal rights, he had the opportunity to seek independent legal advice at any time. Furthermore, while asserting that Innovate should have removed a restrictive legend upon inquiry about marketing shares, it is noted that Innovate was only required to provide unrestricted shares after Plaintiff exercised his stock options, which Innovate fulfilled within two weeks. Consequently, the Defendant's Motion to Dismiss is granted.