In the

United States Court of Appeals

For the Seventh Circuit ____________

No. 02-3500

ROBERT FAIT, as Trustee of the

Robert L. and Judith R. Trust,

 Plaintiff-Appellant,

v.

ALBERT HUMMEL, JAMES LUMSDEN,

HOWARD MYLES, FF-PENTECH, L.P.,

PENTECH INVESTORS, LLC and

PENTECH PHARMACEUTICALS, INC.,

an Illinois corporation,

Defendants-Appellees.

____________

Appeal from the United States District Court

for the Northern District of Illinois, Eastern Division.

No. 01 C 2771—Suzanne B. Conlon, Judge.

____________

ARGUED MAY 13, 2003—DECIDED JUNE 27, 2003

____________

Before ROVNER, DIANE P. WOOD, and EVANS, Circuit

Judges.

EVANS, Circuit Judge. In May 2001, the board of directors of Pentech Pharmaceuticals, Inc. approved a stock

offering they hoped would ward off bankruptcy by infusing the company with more than $4 million. But the ability to keep the company afloat wasn’t the transaction’s

only selling point to the board. In addition, the offering

diluted the voting power of the existing common stock,
2 No. 02-3500

allowing the preferred shareholders (who had elected all

of the board members at the time) to keep control of the

company out of the hands of Fait—Robert Fait, who, along

with Pentech founder Ragab El-Rashidy, owned more

than two-thirds of Pentech’s common stock. In this appeal, as Fait would have it, the power grab was the

board’s sole motivation for the transaction and the offering was not fair to the corporation and its shareholders.

In order to understand how the preferred shareholders

had the chance to seize control of the company, we must

look back to 1998 when Pentech, a pharmaceutical company in the business of developing drugs, issued Series A

preferred shares to a number of investors, including several of our defendants. As part of that offering, the Series

A shareholders entered into an investor rights agreement that gave them the right of first refusal on any

newly issued stock. The agreement also gave the preferred shareholders the right to elect two of the five

board members and the power to elect four of the five for

a period of 2 years if Pentech violated certain covenants

in the agreement.

The Series A shareholders took advantage of the latter

provision in the fall of 2000 when an Illinois court

agreed with the Series A shareholders’ contention that

Pentech had violated the rights agreement, giving the

preferred shareholders the right to elect four of the five

directors. They used their opportunity to replace Fait

and another director elected by the common shareholders

and then placed El-Rashidy on administrative leave from

his duties as CEO. El-Rashidy resigned from the board

of directors soon after and was not immediately replaced,

leaving just four board members (all elected by the preferred shareholders) at the time of the offering—Dr. Bruce

Ronsen and defendants James Lumsden, Albert Hummel,

and Howard Myles.
No. 02-3500 3

On May 3, 2001, Ronsen, Hummel, and Myles voted

unanimously to offer 4,220,921 shares of common stock

for $1/share (because of his close ties to many of the

Series A shareholders, Lumsden abstained). On the advice of Lumsden, the Series A shareholders exercised

their right of first refusal and bought all of the available

shares. Fait challenged the validity of the transaction,

claiming it was unfair because it diluted the interest of

the common shareholders and because the $1/share

price was inadequate. He thinks Pentech would have

been better off raising capital by taking on an investor,

specifically Julphar Pharmaceuticals, Inc. Julphar had

been discussing the possibility of buying up to $20 million

worth of Series B preferred stock from Pentech, but the

talks broke down. Fait claims the Pentech board gave up

on the deal with Julphar prematurely because the May 3

offering gave the Series A shareholders a chance to

achieve their true objective of retaining permanent control of Pentech. As such, he says the board should have

had to prove that the offering was the best option for

Pentech and that it was fair. The district court denied

the board’s motion for summary judgment but found in

favor of the board after a 7-day bench trial, concluding

that Fait had the burden of proving that the offering

was not fair and that he did not meet that burden. Fait

appeals that ruling.

Under Illinois law (which applies in this diversity case)

a director who receives a personal benefit from a corporate transaction has the burden of showing that the

transaction was fair to the corporation, unless the transaction was approved by disinterested directors or shareholders with knowledge of all material facts. 805 ILCS

5/8.60; Olsen v. Floit, 219 F.3d 655, 657 (7th Cir. 2000). Fait

admits that the transaction was approved by a majority

of the disinterested directors (as a Series A shareholder,

Hummel benefitted from the offering, but Myles and
4 No. 02-3500

Ronsen were disinterested). Instead, Fait argues that the

interested directors should have borne the burden of

proving the fairness of the offering because Myles and

Ronsen did not have sufficient knowledge of all material

facts. Fait wants us to review the knowledge requirement de novo, but his argument ignores the fact that

the district court’s interpretation of the knowledge requirement was based on her factual findings, which

we review only for clear error. See, e.g., Olsen, 219 F.3d

at 657.

Although Illinois courts have rarely explored what

constitutes “knowledge” in this context, some factors

include whether the disinterested directors knew the

market value of the proposed shares, whether they knew

of the effects of the deal on the existing shareholders,

and whether they knew of possible alternative sources

of revenue. See, e.g., Shlensky v. South Parkway Bldg.

Corp., 166 N.E.2d 793, 801-02 (Ill. 1960) (outlining factors to examine in deciding whether a transaction was

“fair”). Myles and Ronsen knew all of that and more.

Fait admits that Myles had general knowledge of

Pentech’s financial condition but says that he should

have had more specific information and done more independent research, especially as to an appropriate share

price, before making his decision. Similarly, Fait argues

that Ronsen, who has a doctorate in pharmacology, knew

a lot about the drugs Pentech was developing but very

little about the business side of the company. Fait also

claims that any information Myles and Ronsen had

about the transaction was tainted because it came from

Lumsden and Hummel, who stood to gain financially if

the offering went through.

Although Myles and Ronsen could have hired outside

experts or done more research, both had sufficient knowledge to meet the requirements of 805 ILCS 5/8.60. Myles
No. 02-3500 5

worked as an independent consultant for pharmaceutical

medical device companies, so he was very familiar with

the industry. In addition, he had spent nearly 5 years

during two stints on the Pentech board, reviewed monthly

reports on Pentech’s financial condition, and frequently

attended meetings and discussed Pentech’s financial

condition and options with other members of the board.

Ronsen was equally well-informed. He voted for the offering after spending 7 years as Pentech’s senior vice-president. During that time he was in charge of all of Pentech’s

daily operations, making him, as the district judge accurately noted, “personally familiar with Pentech’s financial

history and the value of its stock.” In addition, both

Myles and Ronsen had first-hand information about

Julphar and other opportunities for outside investment.

They knew about Pentech’s dire financial situation, and

they knew of the risks of trying to strike a deal with

Julphar (which had never done business in the United

States) or waiting for another outside investor. And although much of their information came from discussions with Lumsden and Hummel, they knew that their

fellow board members had personal stakes in seeing

the deal go through and were able to evaluate those conversations accordingly. Put together, Myles and Ronsen

had knowledge of all material facts, leaving Fait with

the burden to prove that the offering was not fair to the

corporation.

Almost by his own admission, Fait cannot meet that

burden. He fails to offer any experts or evidence to counteract the board’s two expert witnesses, who testified

that $1/share was a fair price. In fact, at oral argument,

Fait was unable to offer a price he would have considered

fair. In addition, neither side disputes that Pentech

was experiencing serious financial problems, with bankruptcy (which would have left the common stock virtually

worthless) a real possibility. Although Fait and the board
6 No. 02-3500

disagreed about the best place to secure the capital

they agree Pentech needed, the ultimate decision rested

with the board as long as that decision was fair to Pentech,

and Fait has not proven that it was not.

Because we find that Fait did not prove the transaction was unfair, we do not have to reach the issues

he appeals regarding an appropriate remedy.

AFFIRMED.

A true Copy:

Teste: 

 ________________________________

Clerk of the United States Court of

Appeals for the Seventh Circuit 

USCA-02-C-0072—6-27-03