Fait v. Hummel

Pentech Pharmaceuticals, Inc. (Pentech) experienced financial troubles. Pentech’s CEO, Ragab El-Rashidy, and Robert Fait (plaintiff), a member of the board of directors, controlled a majority of the common stock’s voting power. An investor-rights agreement gave Pentech’s preferred shareholders the right to elect four of the five board members if Pentech violated certain covenants. After a court found such a violation, the preferred shareholders replaced Fait and another director. Additionally, El-Rashidy was placed on administrative leave and soon resigned from the board. This left four board members: Bruce Ronsen (defendant), James Lumsden (defendant), Albert Hummel (defendant), and Howard Myles (defendant). Ronsen, Hummel, and Myles voted to approve a stock offering of more than 4 million shares of common stock for $1 per share. Lumsden abstained from the vote due to close ties with preferred shareholders. The preferred shareholders, who had a right of first refusal, purchased all the available shares. The offering was intended as an infusion of capital to prevent bankruptcy, but it also had the effect of diluting the voting power of the common stock and allowing the preferred shareholders to keep their control of the company. Fait challenged the validity of the offering in federal district court. The court found that the offering was valid, because Ronsen, Hummel, and Myles had extensive knowledge of Pentech’s financial state, and that Fait had failed to meet the burden of proving that the transaction was unfair. Fait appealed. The United States District Court for the Seventh Circuit granted certiorari.