Elysium & CDXC: The Contract Claims
[In which we examine the breach of contract claims and discover that Elysium may be on MUCH weaker ground than we had previously assumed]
The following analysis is based on these documents, attached to ChromaDex's First Amended Complaint, which you can read for yourself and thus draw your own conclusions:
Pterostilbene Supply Agreement (Part 1 and Part 2) (Exhibit C)
Our attention has so far been focused on the parties' tort claims (fraud, trade secrets, etc.) because those are relatively high stakes, and because they are teed up first for resolution (because they are (very) susceptible to motions to dismiss).
I have previously assumed that the competing contract claims would probably result in some kind of "split the difference" financial settlement -- because both sides' claims sound plausible -- but that was without seriously analyzing the claims and the text of the contracts.
Now let's dig deeper.
I have also said that if this dispute gets reduced to a mere breach of contract case then Elysium is in a bad position because they took delivery of a lot of product and they are going to have to pay at least something for it, so there is a limited upside for Elysium (especially after factoring in the cost of litigation).
AND I have said that Elysium's position is MUCH worse if Elysium's tort claims are dismissed but any ChromaDex tort claim survives, because then Elysium will have limited upside but significant downside risk. And I have said that looks to me like the most likely outcome.
There is, however, a third REALLY bad scenario for Elysium, and that is if ChromaDex's tort and contract claims survive, but Elysium itself does not have a winning claim EVEN for a contract breach. If this scenario comes to pass, then you can choose your favorite armageddon-like metaphor and apply it to Elysium's former business.
The reason we have not yet seriously considered this possibility is because both parties seem to have presented very straightforward breach of contract claims, roughly along these lines:
ChromaDex says: "We delivered product, and you did not pay."
Elysium says: "You promised to give us the lowest price, but we caught you red-handed giving someone else a lower price."
They could both be true. So if you take both claims at face value, we have competing contract breaches and the resolution would most likely involve some kind of reduced price or setoff.
But now I am going to suggest that there is a real possibility that this entire dispute is a big mistake and ChromaDex did not breach any contract.
Caveat: We can't know for sure until we learn which customers received what prices for what products and why those transactions were (or were not) subject to the Most Favored Nations Clause, which will require some evidence and testimony.
But when we look at the actual contract language, there is reason to believe that Elysium does not have an open-and-shut case on their breach of contract claims.
So let's start with the Most Favored Nation clause, Niagen Supply Agreement Section 3.1. It reads:
"If ChromaDex supplies Niagen (or a substantially similar product) to a Third Party at a price that is lower than that at which Niagen is supplied to Elysium Health under this Agreement, then the price of Niagen supplied under this Agreement shall be revised to such Third Party price with effect from the date of the applicable sale to such Third Party and ChromaDex shall promptly provide Elysium Health with any refund or credits thereby created; provided Elysium Health purchases equal volumes or higher volumes than the Third Party. For the sake of clarity, this Section does not apply to inter-Affiliate transfers."
What that says is that ChromaDex promises to give Elysium as good a price as anyone else, with a few conditions.
One condition is that the the promise only applies if Elysium purchases equal or higher volumes than the third party.
Another condition is that the sales in question not be among "Affiliates," which are defined as companies with shared ownership.
Another condition (or a limit) is that the low-price privilege only goes back as far as the date of the sale at the lower price, not all the way to the beginning of the relationship.
We have been assuming that Elysium is ChromaDex's biggest customer, that the price Elysium discovered in the spreadsheet was a price in the distant past, and that the sales excluded from the spreadsheet were not transfers among affiliates of ChromaDex or each other.
These don't seem like foolish assumptions, but they are assumptions, and as we'll see in a moment it isn't THAT hard to think of scenarios where they might be false assumptions.
Excluded Products. But first, there are additional exclusions in the contract that might also be relevant: "Excluded Products" and "Excluded Fields." If the spreadsheet prices were related to excluded products or fields, then presumably those sales would not trigger the MFN provision, because those sales were excluded from the purview of the contract.
So what are the excluded products? Section 1.5 of the Supply Agreement says that the excluded products are: "Topical skincare or cosmetic products, and any and all dietary supplements in the form of a melt (melting or dissolving tablet delivery system."
MORE Excluded Products: However, the February 2016 Amendment to the contract expanded the definition of "Excluded Products" to also include:
1. The combination of Niagen with Choline and/or Betaine and/or DMG (unless it is a multi-vitamin);
2. The combination of Niagen with collagen
3. Nano Niagen, and
4. Finished products with Methyl Donor claims
I have no idea what those things are, and we have no idea whether any of the prices that Elysium saw on the spreadsheet involved these kinds of products or not. But if they did involve excluded products, that would be the foundation of a decent argument that the MFN clause was not triggered.
Even More Excluded Products? This same February 2016 Amendment also allows ChromaDex in its sole discretion to add additional products to this exclusion list upon written notice to Elysium. We do not know whether additional products were added to the list, but it is possible.
And then there are the excluded fields. Section 1.6 of the Supply Agreement says, "'Excluded Field' means the doctor channel and the multi-level-marketing channel." What is the "Field" from which doctor and multi-level channels are excluded? Section 1.7 says it is the sale of dietary supplements in the US and Canada. So the contract governs the sale of dietary supplements in the US and Canada, but not via the doctor channel and the multi-level marketing channel.
These defined terms "Excluded Product" and "Excluded Field" are not well-incorporated into the primary agreement, but they seem to evidence that some types of products were excluded from the deal entirely, and that Elysium's channel exclusivity could be limited in some respects, too.
So here are some possible circumstances in which ChromaDex could have been selling Niagen to another distributor at a lower price but might not have violated the MFN clause:
1. If the other distributor, like Thorne, were taking a higher quantity than Elysium was taking during some specific time period at the time of the deal
2. If the other distributor were using the Niagen in something other than a dietary supplement
3. If the other distributor's price had not yet gone into effect (e.g., it was an agreed future price)
4. If the other distributor had not actually made a past purchase at the indicated price
5. If the other distributor were carrying a product including Betaine/DMG, Nano Niagen, or a Methyl Donor, whatever any of that means
6. Or possibly if the sale were for a similar product in an excluded channel, like to doctors or multi-level marketers (not really sure about this one).
Now the reason I have gone into some detail on this contractual language is because the idea that ChromaDex was not even in breach of the contract is not merely idle speculation on my part. It is exactly what ChromaDex is preparing to argue. Here is what ChromaDex said on page 5 of its First Amended Complaint:
"On the June 30 Call, the parties discussed Elysium's concerns and the appropriate pricing of NIAGEN for the orders Elysium wished to place."
BUT, in ChromaDex's response to Elysium's motion to dismiss, ChromaDex provides additional detail about that conversation:
"The MFN provision is only triggered if Elysium 'purchases equal volumes or higher volumes than' any of ChromaDex’s other customers as measured over a period of time. (FAC Ex. A § 3.1; Mot. at 4.) ChromaDex explained why the MFN clause was not triggered and believed the issue was resolved when Elysium did not advance the issue further."
This language suggests that ChromaDex believed that someone else was buying more than Elysium was, but as we have seen there are a number of reasons why the MFN clause might not have been triggered. We don't know what ChromaDex told Elysium, and we don't know what ChromaDex will tell the Court if this litigation continues, but there could be good reason to believe that ChromaDex lacked fraudulent intent when it masked some of the data in the spreadsheet (if ChromaDex in good faith believed that the MFN clause was not triggered). Morever, if ChromaDex CORRECTLY determined that the MFN clause was not triggered, then ChromaDex did not even breach the contract!
There are two related issues remaining, though, so let's go through the contractual language that governs them. The first is Elysium's breach of contract claim based on ChromaDex's allegedly encouraging other suppliers to combine Niagen and Resveratrol. The second is Elysium's suggestion that it was unfairly required to pay trademark royalty fees
Alleged Pterostilbene Contract Breach.
Elysium says that ChromaDex improperly encouraged the sale of a combination of Niagen and Resveratrol, which would breach the Amended Agreement (Section 3.11.3) if Resveratrol were "substantially similar" to pTerostilbene.
The exact language says that ChromaDex may not create or allow the creation of "any products containing both Niagen and pTeroPure (or any ingredients that are substantially similar thereto.)"
Previously I have mocked Elysium's claim on the grounds that pTerostilbene and Resveratrol are obviously substantially different, not substantially similar. Hydrogen Peroxide and Water are substantially similar chemically -- one just has an extra Oxygen molecule -- but one is toxic and the other is vital. Same thing with Carbon Dioxide and Carbon Monoxide. Just adding an oxygen molecule turns something that everyone exhales into a deadly gas. And don't even get me going about Hydrogen and Helium -- one tiny proton could have spared everyone on the Hindenburg. Hydrogen and Helium are astonishingly similar in composition -- but different in their properties -- one explodes and the other doesn't. It's just common sense that Pterostilbene and Resveratrol are different like that -- they have different properties, and those differences are legally and commercially significant -- you can read articles about it -- even if they have some chemical similarities.
But if common sense isn't good enough, the February 2016 Amendment actually addresses this issue in clear language. Section 1.16:
"'pTeroPure' shall mean the novel and proprietary ingredient Ptersostilbene."
In other words, the prohibition against combining Niagen with pTeroPure prohibits combining Niagen with a substance substantially similar to the novel and proprietary ingredient Pterostilbene." If the words "novel" and "proprietary" are to be given effect, then resveratrol, which is neither novel nor proprietary, would obviously be excluded and not "substantially similar."
The Trademark License and Royalty Agreement
Elysium has carried on extensively about the unfairness of their having to pay royalties on ChromaDex's trademarks that they never used, and Elysium has parlayed this complaint into a strange Patent Misuse claim. I call it strange because this isn't a patent infringement case, and ChromaDex has done nothing wrong by including very routine intellectual property use requirements along with the its patent license.
But ChromaDex has a different and interesting response to Elysium, which is basically that Elysium is misinterpreting the Trademark License and Royalty Agreement.
According to ChromaDex, the agreement is not about royalties for the trademarks. It is a single agreement that covers two different things: (1) Permitted Trademark Use and (2) Royalties on the Sale of Niagen.
If you read the Trademark License and Royalty agreement (Exhibit D) you will see clearly that the contract is governing two unrelated things. First, there is a lengthy session governing trademark use (Sections 1-7). Then there is another lengthy session detailing royalties due on sales. The continuation clause (Section 14.1) even treats the two sections differently, with the trademark obligations mostly not surviving termination, but the royalty obligations mostly surviving.
There is no suggestion anywhere in the text that the royalty payments have anything to do with the trademarks. Instead, the royalty payments are clearly and exclusively tied to sales. Moreover, they are tied to sales in an intricate way that is exactly consistent with ChromaDex's explanation. Specifically, the royalty steps up if Elysium purchased the Niagen at less than the maximum agreed amount. In other words, the royalty agreement appears to be a means of lowering Elysium's upfront cost and then picking up the revenue on the back-end as deferred compensation once Elysium had made actual sales. The royalty amount is even to some extent dependent on how much price of a discount Elysium had received up front -- a lower up front price would correspond to a higher royalty.
So if you actually read the contract, Elysium's trademark claim appears to be as fabricated and unsubstantiated as its claim that combining Niagen and Resveratrol is the same as combining Niagen and pTeroPure. Neither makes sense to me. Again, we won't know for sure until we see more facts, but ChromaDex's claim that Elysium owes it the entire amount is not far-fetched and may turn out to be true. By contrast, Elysium's contact claims are looking to me almost as dicey as its tort claims.