Corporate Tax

With respect to Tilray, Inc. Reorg. Litigation: DE courtroom finds founding members as management group Hogan Lovells

In 2010, Brendan Kennedy, Christian Groh and Michael Blue (the founders) founded Privateer, a private equity firm focused on investing in the cannabis industry. Together, the founders held 70 percent of Privateer’s voting rights. In 2013, they formed Tilray as a subsidiary of Privateer to conduct cannabis research, cultivation, processing and distribution rather than investing in the established companies of others in the industry. Privateer’s initial investment in Tilray was approximately $ 31.7 million for 75 million shares, or approximately $ 0.42 per share.

On July 19, 2018, Privateer listed Tilray for $ 17 per share, which skyrocketed the value of Privateer’s 75 million shares to $ 1.275 billion. With two share classes, Privateer held an economic stake of 75 percent and a voting share of 90 percent in Tilray.

While the founders had significant fortunes tied up in Privateer, they struggled to access that fortune for a variety of reasons, including tax issues and fears of bringing Tilray’s share price down through large block sales. To solve these problems, the founders considered a two-stage reorganization (the reorganization). The first step was the spin-off of the non-Tilray portfolio companies that Privateer held. The second was to do a downstream merger, delete Privateer’s Tilray stock, and issue Tilray stock to Privateer’s shareholders. This would allow the founders to maintain control of Tilray while enjoying their newfound wealth tax-free.

Plaintiffs, holders of Tilray Class 2 shares, challenged the reorganization alleging (1) a direct breach of fiduciary claims against the founders and privateers, and (2) an inferred breach of fiduciary claims against Tilray and Tilray directors. The defendants moved to dismiss both charges and the court denied the motion altogether on a number of grounds.

First, the court rejected the defendant’s argument that the founders were not a control group and that the reorganization was not a sure-fire success. On the question of a control group, the court applied Sheldon v. Pinto Technology Ventures, LP that requires proof of an agreement to work towards a common goal.

The court concluded that plaintiffs reasonably alleged a number of historical and transactional links between the founders, including: (1) a longstanding friendship; (2) Co-founding and running privateers and other companies; (3) endure each other as partners and founders; (4) joint retention of advisors; and (5) acting as a founder’s voting block in connection with the reorganization. The court found that these measures served the founders’ common goal of paying off their assets and avoiding tax consequences, which was a unique goal of the founders.

On the question of proprietary business, the court rejected the defendant’s argument that the minority shareholders had not suffered any disadvantage because the advantage was neither withdrawn nor accessible to the minority shareholders. The defendants have drawn a one-time or non-creditable benefit. As far as it was necessary to show the minority shareholders a disadvantage, the disadvantage, according to the court, was that the Tilray board of directors had no influence over the defendants during the reorganization negotiations.

Second, plaintiffs filed a derivative action lawsuit against Tilray and Tilray directors Kennedy, Maryscott Greenwood and Michael Auerbach for alleging breach of their fiduciary duties as directors. Tilray and its directors moved under Court of Chancery Rule 23.1 for the second charge to be dismissed, arguing that pre-litigation was necessary and not pointless. Citing Aronson v. Lewis, the court found that plaintiffs specifically asserted that the claim was futile because the individual directors were in conflict: Kennedy was a founder and part of the founder control group; Auerbach was a director of Privateer and Tilray; and Greenwood was a cannabis lobbyist who previously advocated the deregulation of cannabis on behalf of the founders. Given the likelihood that all three directors were interested in the reorganization, the court found that plaintiffs had reasonably pleaded that the claim was futile.

The court also ruled that Groh and Blue have personal jurisdiction based on the conspiracy theory of the jurisdiction that treats one person’s co-conspirators as their agents, thereby adding to the forum-directed activities of the agents to the Long-Arm Statute of Delaware in relation to the individual. In analyzing the question against the five elements set out in Istituto Bancario SpA v Hunter Engineering Co., the court found that the plaintiff was correct in claiming that Groh and Blue were part of a control group that fulfilled the first two elements, one Conspiracy and that the accused was involved in the conspiracy. As a third element, both Blue and Groh took steps to file and amend Privateer’s Charter of Delaware in what the court called “an essential act. . . In support of the conspiracy. ”And for the fourth and fifth items, the court found that the lawsuit was reasonable enough that Blue and Groh knew the documents related to the reorganization were filed.

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