The liquidating trustee overseeing the Sorrento Therapeutics Chapter 11 bankruptcy filed an adversary proceeding this week against the company’s directors and officers, alleging their breaches of fiduciary duty caused the company’s creditors to suffer at least $100 million in damages.
“This case arises from the duplicitous transfer of roughly half the value of Sorrento Therapeutics, Inc. in a one-time, extraordinary, and gratuitous dividend to Sorrento’s shareholders only one month before Sorrento filed voluntary petitions for Chapter 11 relief,” the 39-page complaint begins.
The liquidating trustee, David Weinhoffer, alleges nine of Sorrento’s officers and directors “designed, proposed, approved and implemented the dividend” despite five red flags: “a lack of internal financial, conflict, or transaction controls; mounting losses; an expensive, poorly performing, delayed, and unsustainable pharmaceutical product pipeline; evaporating financing options; and perhaps most egregiously, an adverse $173 million arbitration award against Sorrento just before the dividend that, once enforced, manifested an existential threat to the company.”
McKool Smith principal Josh Newcomer, who represents the liquidating trustee, David Weinhoffer, issued a statement calling the filing of the complaint the “first step toward holding Sorrento’s leadership and board of directors accountable for their actions and recovering these funds for the beneficiaries of the liquidating trustee.”
“Having operated Sorrento at a loss for years, without exercising control over the company, and in the face of an adverse arbitration award, the directors and officers of Sorrento paid a gratuitous dividend to shareholders knowing the company was insolvent,” Newcomer said. “Within a month, it filed for bankruptcy.”
San Diego-based Sorrento filed for Chapter 11 bankruptcy in the Southern District of Texas in February 2023.
The defendants in the lawsuit that was filed Thursday in the Southern District of Texas are CEO and chairman of the board of directors Henry Ji; executive vice president and chief financial officer Elizabeth Czerepak, board members Dorman Followwill, David Lemus, Kim Janda, Tammy Reilly, Jaisim Shah, Yue Wu and corporate controller Liang Zhao. The lawsuit alleges breach of fiduciary duty and aiding and abetting breaches of fiduciary duty.
The trustee pointed to Ji as the “mastermind and domineering force in the decision-making” that led to Sorrento’s “demise,” and said the other defendants “abdicated their fiduciary duties by doing Ji’s bidding.”
“The defendants enabled Ji’s irrational directives and conduct and failed to implement controls, to the detriment of all Sorrento stakeholders,” the suit alleges. “Given Sorrento’s mounting losses and chronic underperformance, there was no rational basis for Sorrento’s fiduciaries to approve and implement the dividend. Their failure to reconsider the dividend once the [$173 million arbitration award] was issued defies logic.”
The trustee alleges that in the entire history of Sorrento, the only dividend ever issued was the one that was paid out in January 2023, a month before it filed for bankruptcy. He also accused the fiduciaries of knowing the company had always “lacked any effective controls over its financial and transactional decision-making,” and knowing that the company “was never profitable and could not sustain itself based on its operational cash flows.”
“And, though its auditors warned that Sorrento’s lack of controls was a material risk to the company, Sorrento’s fiduciaries never took action to prevent the company’s ruin,” the suit alleges. “Indeed, its own Chief Financial Officer, hired as a face-saver to satisfy Sorrento’s auditors, was often kept in the dark with regard to the extent of the material risks that Sorrento’s fiduciaries knew it faced.”
Ji’s actions in the wake of the arbitration award, the trustee alleges, were “contrary to the exercise of sounds business judgment.” Ji should have acted to preserve “the company’s limited assets” but instead “expedited” the payment of the dividend “in conscious disregard of the known material risks.”
The dividend transferred “a significant portion” of Sorrento’s “most significant assets” — an equity interest in Scilex Holding Company that — out of the company and to Sorrento’s shareholders, “for no consideration,” the trustee alleges. Sorrento held an approximate 96 percent ownership interest in Scilex prior to the dividend, which transferred “approximately 48 percent of Sorrento’s ownership interest in Scilex (76 million common shares) to Sorrento’s shareholders.”
“Spiraling toward bankruptcy, Sorrento’s lack of capital, diminished value, and inability to obtain financing was swept under the rug, just so Ji and his fellow defendants could participate in the first dividend in the company’s history,” the suit alleges.
The trustee alleges that all of the defendants except for Janda simultaneously held positions at Scilex at the time the dividend issued.
The case has been assigned to Judge Christopher M. Lopez.
Weinhoffer is also represented by David Kellam Jr., Hannah Syburg and Adam Skrzecz of McKool Smith.
Counsel for the defendants had not filed an appearance as of Friday afternoon.
The case number for the adversary proceeding is 25-03596. The case number for Sorrento Therapeutics’ bankruptcy is 23-90085.