EFiled: Jul 21 2021 04:39PM EDT Transaction ID 66787823 Case No. 2021-0636- IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE TICE BROWN, ) ) Plaintiff, ) ) C.A. No. ___________________ v. ) ) JOSEPH HALLIGAN, RICHARD ) IRWIN, and DAVID LATTANZIO, ) ) Defendants. ) VERIFIED COMPLAINT FOR INJUNCTIVE AND OTHER RELIEF FOR VIOLATION OF STOCKHOLDER RIGHTS AND BREACHES OF FIDUCIARY DUTIES Plaintiff Tice Brown (“Plaintiff”), by and through his undersigned counsel, alleges as follows against Defendants Joseph Halligan, Richard Irwin, and David Lattanzi: INTRODUCTION 1. PharmChem, Inc. (“PharmChem” or “the Company”) is a Delaware corporation with its business focused on providing drug testing solutions to its clients. Specifically, PharmChem, through its Sweat Patch and other offerings, has provided customers with in-house drug testing solutions for over thirty years. 2. However, PharmChem has gone through much turmoil. Failing to adapt its business model to out-of-house drug testing, PharmChem began to lose customers and contracts in the early 2000s. 3. Unable or unwilling to right the ship, in 2004, the Board of Directors of PharmChem (the “Board”) failed to adapt and failed to address changing market demands. 4. This resulted in the Company going into what it stated to be a dissolution and liquidation. While the Company floundered, it continued to sell Sweat Patch through its PharmChek division (“PharmChek”). Despite alleging efforts over many years to sell its remaining operations, the Company failed to find a buyer. 5. In the midst of their many missteps, the Board, made up of Defendants Joseph Halligan, Richard Irwin, and David Lattanzio (collectively, “Defendants”) awarded each of Defendants large swathes of stock options at unreasonable and egregious discounts (the “Options”). Importantly, while these Options appear to have been granted in 2015, they were not publicly disclosed to shareholders until 2018, and most egregiously of all Defendants intentionally withheld and failed to disclose the self-serving pricing on the Options they issued to themselves until June 2021. It was then that Defendants, for the first time, disclosed that the Options they awarded themselves were awarded at a paltry $0.15 per share. 6. This information came to light contemporaneously with, and, upon information and belief, in response to, Plaintiff’s efforts to exercise his rights as the 2 largest stockholder of the Company and to issue a proxy to install new members on the Board that will properly manage and oversee the Company. 7. Indeed, now that Plaintiff has sought such a proxy, the Board disclosed the self-interested granting of the Options to Defendants and their paltry price. Defendants have threatened to exercise those Options for the sole purpose of diluting Plaintiff’s ownership interests and to try and impede his proposed proxy. Defendants’ actions are not taken for the benefit of the Company or its stockholders, but protect entrenched and ineffective management. 8. Plaintiff brings this suit to halt Defendants’ breaches of their fiduciary duties in entering into an economically irrational, self-dealing, and wholly self- interested transactions in granting the Options, and to cease Defendants’ attempt to impede his rights as a stockholder in the Company. THE PARTIES 9. Plaintiff Tice Brown is an individual residing in New York. Plaintiff is a record and beneficial owner of approximately 23.3% of PharmChem common stock before the dilutive effect of the options at issue. Upon information and belief, Brown is the largest individual shareholder of PharmChem common stock. 10. Defendant Joseph W. Halligan is the President and Chief Executive Officer of PharmChem. Upon information and belief, Halligan is a resident of California. 3 11. Defendant Richard Irwin is the Chairman of the Board of PharmChem. Upon information and belief, Irwin is a resident of Connecticut. 12. David Lattanzio is the Vice President of PharmChem and member of the Board. Upon information and belief, Lattanzio is a resident of Arizona. BACKGROUND INFORMATION Management Runs The Company Into The Ground 13. The Company has been in the business of providing in-house drug testing solutions for nearly 30 years. However, in the 2000s, the Company’s management, including Defendants, failed to adapt to the changing marketplace and failed to execute on purported cost savings endeavors such as relocating its headquarters in Texas from California. 14. As a result, in 2003, the Company filed its Form 15 with the Securities and Exchange Commission (“SEC”) to terminate its registration under the Securities Exchange Act of 1934. Then, on October 21, 2004, Defendant Halligan submitted a letter to the stockholders (the “Liquidation Notice”) informing them that “the time has come for us to exit the drug-testing business and commence liquidation of the Company” and to sell significant assets of the company to Kroll Laboratory Specialists, Inc. (“Kroll”). 15. The Liquidation Notice explained that the “business has declined considerably,” blaming economic downturns and governmental constraints on the 4 Company’s poor performance. The Liquidation Notice identified several management missteps, including failing to control costs, losing marquee clients, and failing to retain a lucrative government contract. 16. Apparently with no other option, the Liquidation Notice sought the approval of the stockholders for the sale to Kroll of the Company’s customer list relating to its non-managed lab-based business, as well as to dissolve and liquidate the Company. Notably, the Liquidation Notice explained that the Company’s then- Chief Financial Officer, Defendant Lattanzio, would be paid compensation of $200,000 per year, and the Company’s Board would be paid fees and retainers, for the privilege of overseeing the Company’s liquidation. 17. On November 16, 2004, the Company held a special meeting of the stockholders and adopted a resolution to be voluntarily dissolved and liquidated (the “November 2004 Resolution”) to conform with the request in the Liquidation Notice. Management Fails To Sell Off All Assets And Retains One Valuable Division. 18. Seven years later, on April 23, 2011 (the “April 2011 Letter”), Defendant Halligan issued a letter to the PharmChem stockholders, stating that the Company had consummated the sale of its assets except for those relating to its PharmChek Sweat Patch division—the only division that continued to operate while 5 the Company liquidated assets. Sweat Patch is a drug testing solution that uses sweat to detect the presence of illegal drugs. 19. Halligan noted that the Company sought to market the division during its liquidation of the Company’s other assets, but failed to find a buyer. 20. Because PharmChek generated revenues, allowing for payment of the Company’s debts which were not settled through the other asset sales, it was decided that the division would continue to operate unless sold or its operations ceased to be profitable. 21. In the April 2011 Letter, Halligan stated that the company would continue to be operated pursuant to the November 2004 Resolution and that he would provide further updates as they arose. 22. Two years later, on May 15, 2013, Halligan issued another letter to the PharmChem stockholders stating substantially the same information as in the April 2011 Letter, and providing minimal other information regarding operations. Management Finally Focuses On Operations 23. Two years later, on November 23, 2015, Halligan issued another letter to PharmChem stockholders (the “November 2015 Letter”). The November 2015 Letter noted that, at long last, the Company “shifted its customer base from those customers who are federally directed to state-funded Drug Court monitoring 6 programs, including rehabilitation facilities” and intended to provide more “marketing efforts” into Sweat Patch. 24. The November 2015 Letter also explained that the Company had hired Kerri Wagner as President of PharmChek to be responsible for the Company’s growth efforts. The letter also noted that Wagner had been providing “consulting, training and services to the Company since 2011.” 25. As a result of the increase of drug courts and federal funding for the same, Halligan stated that Company was able to achieve $2,522,857 in sales, translating to $433,995 in net income for 2014. Despite this, Halligan mentioned that the Company was still seeking to sell off the PharmChem division as its main business strategy. 26. Unlike the prior stockholder letters, the November 2015 Letter provided rudimentary financial statements. However, no information regarding compensation was disclosed, despite the hiring of Wagner as President of PharmChek. 27. On December 2, 2016, Halligan provided another letter to PharmChem stockholders discussing the results of the year ended December 2015 (the “December 2016 Letter”). In the letter, Halligan announced a dividend of $0.05 per share, payable on January 4, 2017. Halligan explained that the Company continued 7 to focus on drug courts and rehabilitation centers as areas of potential growth, and reiterated that a sale of PharmChek continued to be a top priority for the Company. 28. On December 5, 2017, Halligan issued another letter to PharmChem Stockholders, announcing another $0.05 dividend per share (the “December 2017 Letter”). Of note was that the Company’s Vice President of Finance, Defendant Lattanzio, would be winding down his involvement in the day-to-day of the Company, but would remain a compensated board member. Shana Veale was hired as Vice President & Controller to assume Lattanzio’s duties. Like the November 2015 and December 2016 Letters, the December 2017 Letter deliberately failed to mention executive compensation, despite the stepping-down of Lattanzio and hiring of Veale. Halligan Discloses A Stock Option Plan But Fails To Disclose Its Self-Dealing Compensation Scheme. 29. On December 3, 2018, Halligan wrote to the stockholders of PharmChem, disclosing the issuance of a $0.06 dividend (the “December 2018 Letter”). The December 2018 Letter noted that “[n]early every segment of our customer base has slowed their testing,” and as a result, “[o]ur growth in 2018 is expected to ease somewhat . . . .” Significantly, this December 2018 letter was the first public acknowledgement that any options of any amount or value had been granted to management, three years after the granting of those options in 2015. 8 30. Despite this, Halligan requested that the Company stockholders “support and vote on the enclosed ballot to increase by 500,000 the number of shares available under our 2015 Employee Stock Option Plan for issuance to current and future employees.” The December 2018 Letter explained that the Board recommended an approval of the increase in the number of shares under the Option Plan. 31. The Action by Written Consent of the Stockholders of PharmChem provided with the December 2018 Letter (the “Written Consent”) explained that on January 27, 2015, the Company adopted an Employee Stock Option Plan (the “Option Plan”), that 1,140,000 shares had been previously granted as options, and that the Company was seeking to increase the amount of shares available under the Option Plan by an additional 500,000 shares. Under the Option Plan, which is administered by the Board, the Company can issue stock options with varying vesting dates of up to sixty months. At the time of the December 2018 Letter, 25,000,000 shares of the Company were authorized with 5,852,593 being issued and outstanding. 32. Nowhere in the Written Consent nor the December 2018 Letter did the Company disclose the strike price for the 1,140,000 shares that had been granted as options, or how the granted options were determined or valued. The Written 9 Consent noted that the Option Plan was only available upon written request to the Secretary of the Company. 33. On July 31, 2019, Halligan wrote to PharmChem stockholders and stated that the Company would issue a dividend of $0.08 per share with an additional special dividend of $0.04 per share (the “July 2019 Letter”). Halligan reiterated the ongoing but still yet-to-be-realized goal of selling the Company, and, at long last, called a stockholder meeting. The July 2019 Letter failed to disclose anything regarding executive compensation or pricing on the options under the Options Plan. 34. On April 29, 2020, Halligan issued a letter to the PharmChem Stockholders, declaring a $0.10 per share dividend (the “April 2020 Letter”), but suspended special dividends. In the letter, Halligan noted that PharmChem would finally begin paying federal and state income taxes as the Company’s net operating loss carry-forwards would likely be exhausted in 2020. Halligan again stated the Board’s intent to explore opportunities to present PharmChem to companies for purchase. The April 2020 Letter failed to disclose anything regarding executive compensation or pricing on the options under the Options Plan. 35. On July 17, 2020, the Company issued its six-month results for 2020 (the “July 2020 Letter”). As with the prior communications, the July 2020 Letter failed to disclose anything regarding executive compensation or pricing on the options under the Options Plan. 10 36. On April 9, 2021, Halligan issued a letter to the PharmChem stockholders detailing the financial results of 2020 (the “April 2021 Letter”). In the letter, Halligan informed Stockholders of a $0.12 per share dividend. Demonstrating the Board and management’s inability to adjust to changing circumstances, the letter admitted that the Company’s marketing efforts were “severely limited” because conferences were cancelled. As with all prior stockholder communications, the April 2021 Letter failed to disclose anything regarding executive compensation or pricing on the options under the Options Plan. Plaintiff Sees Untapped Value In The Company And Begins Accumulating Shares. 37. Plaintiff has built a career on investment and management and discovering and turning around underperforming assets and businesses. 38. Plaintiff learned of PharmChem in early 2021 and, based on his research of the Company’s public filings, found a company that was poised for growth, but that was held back by a Board and management that showed little interest in changing the status quo. 39. Accordingly, Plaintiff began accumulating interests in the Company in April of 2021. At the time, the Company was trading for $4.00 to $5.00 per share. Through these acquisitions, Plaintiff is now the Company’s largest stockholder with approximately 1,362,322 shares, or 23.3% of shares outstanding. 11 40. On April 27, 2021, Plaintiff began communications with the Board to discuss what steps could be taken to improve growth and profitability of the Company. 41. Rather than have substantive discussion regarding what would benefit the Company, Halligan would repeatedly and consistently try to steer discussions to how management could sell their current options, or their shares when exercised, to Plaintiff. 42. Indeed, the Board refused to discuss basic capital allocation, reporting of information, and appropriate transparency of operations and expenses to the stockholders. 43. As discussions continued, it became apparent, and past history confirms, that the Board is interested only in its own financial well-being and not that of the Company or its stockholders. 44. Faced with a Board that refused to entertain suggestions on how to maximize growth and value of the Company, Plaintiff was left with no other choice than to pursue a proxy to empanel a board that will undertake these necessary duties neglected by the current Board. Plaintiff filed a Notice of Director Nomination on May 24, 2021, and is currently running a proxy contest along with other concerned shareholders. The Company’s Annual Meeting is currently scheduled for August 30, 2021. 12 Defendants Reveal Their Improper Self-Dealing In Response To Plaintiff’s Proxy 45. Upon information and belief, in reaction to the pending proxy fight, on June 23, 2021, at 9:37 p.m., PharmChem filed with OTC Bulletin Board its detailed financial statements for years ended 2020 and 2019 (The “2021 Report”), which upon information and belief, it had in hand since February of 2021. 46. The 2021 Report, for the first time, disclosed that 1,140,000—i.e., all available shares under the Option Plan—were issued and exercisable as of December 31, 2020. Upon information and belief, the vast majority – if not every single one – of these Options were issued to Defendants. 47. Upon information and belief, nearly 100% of Defendants’ shares in the Company were obtained by delisting the Company, and then issuing themselves the Options while asserting that they had no disclosure obligations. 48. The 2021 Report, also for the first time, disclosed that the Options were given a strike price of a paltry $0.15 per share. The 2021 Report makes vague refence to the use of the Black-Scholes stock option pricing model but offers no details in why that model was chosen or how it was applied. 49. Yet, the $0.15 per share price was only less than half of the book value of the Company, and only 1.5 times earnings in 2015. Most egregiously of all, that price was less than half of the net cash per share on the balance sheet at the time of the option issuance. 13 50. With 5,852,593 shares outstanding, this option strike price effectively valued the company at $877,888.95. The inexplicable and egregiously low valuation—determined by the Board and issued to itself—is demonstrated by the Company’s financial performances. In the years 2014-2017, the Company reported net sales of $2,522,857, $3,233,777, $4,168,305, and $4,690,663, respectively, with stockholders’ equity in the millions during the same period. 51. The Board’s own pricing of the options further exemplifies Defendants’ self-serving valuation. The Options were initially valued at $0.48 per share in 2015, and, in 2016, the Board lowered the strike price to $0.15. Yet, in 2016, net income per share was $0.173 and cash per share was $0.50. 52. In addition to the finally revealed self-dealing and self-interested issuance and valuation of the Options to itself, the Board has continued to fail to disclose its and management’s other compensation. 53. The reason for this egregiously low valuation is simple: the Board was issuing the Options to itself at fire-sale prices, and hoping that the information would not see the light of day. 54. In essence, Defendants delisted the Company and during a period in which they claimed no obligation to provide information to stockholders, issued themselves the Options at unreasonable and unsupported pricing, resulting in giving 14 away approximately 16% of the company with no stockholder disclosure or transparency. 55. It was not until Plaintiff began asking questions about the operations of the Company and began to engage in a proxy fight that Defendants were forced to disclose their breaches of fiduciary duty and incomplete disclosures. Indeed, management had this information in audited financial reports for years ended 2017 and 2018, but failed to disclose the information to PharmChem stockholders. Defendants are now poised, upon information and belief, to exercise their Options in an effort to dilute Plaintiff’s ownership rights and impede his ability to successfully pursue the proxy fight. COUNT I (Interference with Stockholder Rights) 56. The foregoing paragraphs are repeated and realleged as if fully set forth herein. 57. Plaintiff is afforded rights by virtue as his position as a stockholder of a Delaware corporation. 58. Defendants violated those rights by, among others, seeking to prevent or impede Plaintiff’s proxy challenge by belatedly disclosing the valuation of their improper Options and by threatening to dilute Plaintiff’s position by exercising those Options. Defendants’ efforts to impede and diminish Plaintiff’s stockholder rights 15 and influence is not for the benefit of the Company, but is instead to protect their Board and management positions. 59. Due to Defendants’ unlawful conduct, Plaintiff has or will suffer damages in an amount to be determined at trial. COUNT II (Breach of Fiduciary Duty of Loyalty) 60. By virtue of their positions as directors and officers of PharmChem, Defendants owe the PharmChem stockholders, including Plaintiff, fiduciary duties of loyalty, care and good faith. 61. Defendants breached their fiduciary duty of loyalty to the PharmChem stockholders by approving the grant of the Options at unreasonable prices that were wholly unrelated to the fair market value of the Company. These Options were issued by Defendants for their own benefit and gain. 62. In addition to the monetary benefits Defendants stand to gain, the Options issuances are self-interested transactions, in that they potentially shift nearly 25% of the voting power into the Board’s hands. Moreover, such Options are being pursued and exercised at this time solely to entrench the Board and to impede Plaintiff’s rights as stockholder to successfully engage in a proxy vote. 63. By virtue of the Defendants’ conflicts of interest and divided loyalties in connection with the issuance and pricing of the Options, they have the burden of 16 establishing the entire fairness of the issuance and pricing of the Options and the timing of their exercise. 64. Due to the Defendants’ breaches of their fiduciary duty of loyalty, Plaintiffs has or will suffer damages in an amount to be determined at trial. COUNT III (Breach of the Fiduciary Duty of Candor/Disclosure) 65. The foregoing paragraphs are repeated and realleged as if fully set forth herein. 66. By virtue of their positions as directors and officers of PharmChem, the Defendants owe the PharmChem stockholders, including Plaintiff, fiduciary duties of loyalty, due care and good faith. As part of these fiduciary duties, the Defendants had an obligation to act with candor and fully disclose all material facts to the PharmChem stockholders in connection with the issuance and pricing of the Options. 67. Defendants breached their fiduciary duties by disseminating the incomplete and misleading information relating to the Options. 68. Due to Defendants’ breaches of their fiduciary duties, Plaintiff has or will suffer damages in an amount to be determined at trial. COUNT IV (Breach of Fiduciary Duty -- Breach of the Duty of Good Faith) 69. The foregoing paragraphs are repeated and realleged as if fully set forth herein. 17 70. By virtue of their positions as directors and/or officers of PharmChem, Defendants owed the Plaintiff fiduciary duties of loyalty, care and good faith. 71. Defendants breached their fiduciary duty of good faith by seeking to wrongfully impede and prevent Plaintiff from exercising his rights as a stockholder by seeking a proxy vote on the members of the Board. 72. Defendants’ efforts to stop or dilute Plaintiff’s influence is not for the benefit of the Company but to protect their positions so that they can further enrich themselves at the stockholders’, including Plaintiff’s, expense. 73. Defendants also breached their fiduciary duty of good faith by their failure to discharge their duties as officers and/or directors of a Delaware corporation as alleged above in connection with the Options and the proper disclosure of the same. 74. Due to Defendants’ breaches of their fiduciary duty of good faith, Plaintiff has or will suffer damages in an amount to be determined at trial. COUNT V (Unjust Enrichment) 75. The foregoing paragraphs are repeated and realleged as if fully set forth herein. 76. As a result of the Options they granted to themselves, the Defendants have and will continue to be unjustly enriched. 18 77. Accordingly, this Court should order Defendants to disgorge all profits, benefits and other compensation they obtained from these invalidly granted options. 78. Plaintiff has no adequate remedy at law. COUNT VI (Breach of Fiduciary Duty -- Wrongful Dilution) 79. The foregoing paragraphs are repeated and realleged as if fully set forth herein. 80. By virtue of their positions as directors and officers of PharmChem, Defendants owe the PharmChem, including Plaintiff, fiduciary duties of loyalty, due care and good faith. 81. Defendants breached their fiduciary duties by wrongfully causing the dilution of Plaintiff’s interest in the Company for the purpose of staving off his proxy fight. 82. Due to Defendants’ breaches of their fiduciary duties, Plaintiff has suffered damages in an amount to be determined at trial. WHEREFORE, plaintiff prays for judgment and requests that the Court: A. Prevent the Defendants from exercising the Options; B. Prevent the Defendants from counting any votes gained from the exercising of the Options in the proxy contest; C. Order that the Company revalue the Options at fair market value through a fair, disinterested valuation process; 19 D. Award Plaintiff damages arising from the Defendants’ violations of his rights as a stockholder; E. Award Plaintiff damages arising from the Defendants’ breaches of their fiduciary duties; F. Grant Plaintiff the costs of this action, including reasonable attorneys’ fees and expenses; and G. Grant such other and further relief as the Court deems just and appropriate. POTTER ANDERSON & CORROON LLP By: /s/ John A. Sensing John A. Sensing (#5232) Jesse L. Noa (#5973) 1313 Market Street Hercules Plaza, 6th Floor P.O. Box 951 Wilmington, DE 19899-0951 (302) 984-6000 – Telephone [email protected] [email protected] Date: July 21, 2021 Attorneys for Plaintiff 7296315 / 52030 20
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