## Facts

- Pentech Pharmaceuticals, Inc. faced serious financial trouble and risk of bankruptcy.
- Pentech’s CEO, Ragab El-Rashidy, and Robert Fait (plaintiff), then a director and large common shareholder, controlled a majority of the common stock’s voting power.
- Pentech had issued Series A preferred stock and entered an investor-rights agreement granting the preferred shareholders (1) a right of first refusal on newly issued shares and (2) the right to elect four of Pentech’s five directors for two years if Pentech violated specified covenants (otherwise, they could elect two directors).
- In fall 2000, an Illinois court found Pentech had violated the agreement’s covenants, triggering the preferred shareholders’ right to elect four directors.
- The preferred shareholders replaced Fait and another common-elected director, placed El-Rashidy on administrative leave, and El-Rashidy soon resigned from the board.
- By May 2001, the board had four directors, all elected by the preferred shareholders: Dr. Bruce Ronsen and defendants James Lumsden, Albert Hummel, and Howard Myles.
- On May 3, 2001, Ronsen, Hummel, and Myles approved an offering of 4,220,921 shares of common stock at $1 per share, intended to raise more than $4 million; Lumsden abstained due to close ties with the preferred shareholders.
- Exercising their contractual right of first refusal, the preferred shareholders purchased all the offered shares, providing capital but also diluting existing common shareholders’ voting power and helping the preferred group maintain control.
- Fait, as trustee of the Robert L. and Judith R. Trust, sued in federal district court (diversity jurisdiction), challenging the offering as unfair and as a breach of fiduciary duty by directors and related entities.
- After a trial, the district court upheld the offering, finding the approving directors had extensive knowledge of Pentech’s financial condition and that Fait did not carry his burden to prove unfairness.
- Fait appealed.

## Issues

1. Whether the directors breached fiduciary duties under Illinois law by approving a stock offering that raised needed capital but diluted common voting power and helped the preferred shareholders keep control.
2. Whether Fait proved the offering was unfair to the corporation or shareholders, such that the transaction should be set aside.
3. Whether the court of appeals should review the district court’s findings about the directors’ knowledge and motives de novo or only for clear error.

## Decision

- The Seventh Circuit affirmed the district court’s judgment for defendants.
- The court held Fait failed to prove the stock offering was unfair or that the approving directors breached fiduciary duties.
- The court rejected Fait’s attempt to obtain de novo review of the directors’ “knowledge” showing, holding that the district court’s treatment of that requirement rested on factual findings reviewed only for clear error.
- The court found no clear error in the district court’s findings that the directors were well informed about Pentech’s financial distress and approved the offering as a means to raise capital to avoid bankruptcy.

## Legal Principles

- Under Illinois law, courts generally do not second-guess a board’s business decision absent proof of misconduct such as bad faith, fraud, or unfair dealing.
- A plaintiff challenging a board-approved stock issuance bears the burden to show the issuance was unfair to the corporation or its shareholders; an effect on voting power or control, by itself, does not establish a breach.
- When a challenged transaction is supported by a legitimate corporate objective (such as raising funds to avert insolvency), the plaintiff must still show the transaction was unfair in light of the circumstances.
- A director’s knowledge, purpose, and good faith are fact-bound questions; on appeal, a trial court’s factual findings on those matters are reviewed for clear error, not reweighed from scratch.
- Contractual rights negotiated with investors—such as rights of first refusal and contingent board-election rights—inform the setting in which later board actions are evaluated.

## Conclusion

The Seventh Circuit upheld Pentech’s May 2001 common-stock offering to preferred investors, concluding that although the issuance diluted common shareholders’ voting power and helped the preferred group keep control, Fait did not prove the transaction was unfair or that the directors breached fiduciary duties, and the district court’s findings about the directors’ knowledge and motives were not clearly erroneous.


Fait v. Hummel, 333 F.3d 854 (2003)