Madhu v. Socure Inc.

Background

Sunil Madhu founded Socure Inc. and, when he left the company in February 2019, held options to purchase nearly 10 million shares. The options came from two awards: 6,758,421 shares at $0.07 per share and 3,221,211 shares at $0.11 per share. The governing agreements required Madhu to provide an exercise notice stating the number of shares and to pay the total exercise price. The agreements stated that an option was exercised when Socure received the completed notice and payment.

In May 2021, Socure’s board had approved a $1.98-per-share valuation. Madhu later sought to exercise his options using that valuation, in part to reduce tax consequences. Socure told him in October 2021 that the valuation was only valid for six months and that the company expected to have a better understanding of the stock’s value in two or three weeks. Socure also had a term sheet for an investment in preferred stock at $16 per share. Madhu tried to exercise through Carta on October 11, 2021, but alleged that Socure had disabled the site’s exercise function. He sent exercise forms and checks by overnight delivery on October 26; the package reached Socure on October 28. He later attempted another exercise through Carta, which displayed the value as “price in flux.”

Madhu’s amended complaint asserted claims for specific performance, declaratory judgment, breach of contract, and breach of the implied covenant of good faith and fair dealing. Socure moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint plausibly states a claim for relief.

Breach-of-Contract Claims

The court held that Madhu plausibly alleged that Socure breached Section 2.18 of the Omnibus Incentive Plan. That provision defined “Fair Market Value” and, because Socure’s shares were not publicly traded, required the value to be determined by the company’s compensation committee in good faith and consistently with the federal tax rules identified in the plan. Madhu alleged that he sought to exercise his options in October 2021 and that Socure failed to determine the fair market value during that month. The court concluded that the alleged additional tax liability was sufficient at the pleading stage to allege damages.

The court did not find a plausible claim under Section 6.04 based on Socure’s refusal to let Madhu exercise through Carta on October 11. Madhu did not adequately allege that Socure’s compensation committee had established or approved Carta as an exercise method. He also did not allege that he made the required cash payment or used an alternative payment method permitted by the committee on that date.

The court did not accept Madhu’s position that he had validly exercised his options on October 4 or October 11. On October 4, he alleged only that he told Socure of his intent to proceed. On October 11, he alleged that he attempted to exercise through Carta but could not do so. The court stated that the agreements required precise compliance, including notice and payment.

Declaratory Judgment

The court granted dismissal of Madhu’s declaratory-judgment claim. Madhu sought declarations that he had exercised the options on October 4 or October 11, that Socure had no right to refuse to issue the shares or conduct a valuation, and that the board had not determined—or had not acted in good faith in determining—that the shares were worth $16 per share.

The court concluded that the complaint itself did not support a declaration that Madhu had exercised the options on either earlier date because it did not allege that he had sent the required notice and payment then. The court also concluded that the requested declarations concerned past events and that the contract claims would address the same issues, so declaratory relief would serve no useful purpose. The court allowed Madhu to amend this claim because it could not conclude that amendment would be futile.

Implied Covenant of Good Faith and Fair Dealing

The court treated Madhu’s two implied-covenant claims separately. It found that his claim based on alleged delays and efforts to prevent him from exercising the options was adequately pleaded, although marginal. Madhu alleged that Socure officers gave him incorrect information and used statements about the valuation’s expiration and a future valuation to delay his exercise. Viewed in Madhu’s favor at the motion-to-dismiss stage, those allegations plausibly suggested that the officers acted to frustrate the agreement’s purpose.

The court granted dismissal of Madhu’s claim based on Socure’s refusal to allow transfer of some options to a gift trust. The option agreements expressly prohibited lifetime transfers, and the court held that the implied covenant could not be used to override or rewrite that express term. The court also denied leave to amend this claim because amendment would be futile.

Disposition

The court granted Socure’s motion to dismiss as to Madhu’s second cause of action, for declaratory judgment, and fifth cause of action, for breach of the implied covenant of good faith and fair dealing. It denied the remainder of Socure’s motion. Madhu was granted fourteen days to file and serve an amended complaint addressing the deficiencies in the declaratory-judgment claim, but he was not permitted to replead the gift-trust claim. The opinion did not decide the proper tax treatment of the proposed transaction.