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Commitments and contingencies
 9 Months Ended
Sep. 30, 2012
Commitments and contingencies [Abstract]  
Commitments and contingencies

10. Commitments and contingencies

Guarantees and Indemnifications — In the ordinary course of its business, the Company makes certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. The Company, as permitted under Delaware law and in accordance with its Bylaws, indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer or director is or was serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum amount of potential future indemnification is unlimited; however, the Company has a director and officer insurance policy that may enable it to recover a portion of any future amounts paid. The Company believes the fair value of these indemnification agreements is minimal. The Company has not recorded any liability for these indemnities in the accompanying condensed consolidated balance sheets. However, the Company accrues for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is probable and the amount can be reasonably estimated.

Litigation — The Company is subject to legal proceedings and claims which arise in the ordinary course of its business. As of the date hereof, the Company believes that the final disposition of such matters will not have a material adverse effect on the financial position, results of operations or cash flows of the Company. The Company maintains liability insurance coverage to protect the Company’s assets from losses arising out of or involving activities associated with ongoing and normal business operations. In accordance with ASC 450 Contingencies, the Company records a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated.

The Securities Action. Beginning January 31, 2011, several complaints were filed in the U.S. District Court for the Central District of California against us and four of our officers – Alfred E. Mann, Hakan S. Edstrom, Dr. Peter C. Richardson (a former officer) and Matthew J. Pfeffer – on behalf of certain purchasers of our common stock. The complaints include claims asserted under Sections 10(b) and 20(a) of the Exchange Act and have been brought as purported shareholder class actions. In general, the complaints allege that the defendants violated federal securities laws by making materially false and misleading statements regarding our business and prospects for AFREZZA, thereby artificially inflating the price of the Company’s common stock. The U.S. District Court for the Central District of California has consolidated the pending actions for all purposes and appointed lead counsel. The consolidated action is referred to as the Securities Action.

On July 23, 2012, the Company, while continuing to deny all allegations of wrongdoing or liability whatsoever arising out of the Securities Action, and without in any way admitting fault or liability, entered into a stipulation of settlement to resolve the Securities Action. The current and former officers and directors named as individual defendants in the consolidated lawsuits have also entered into the stipulation of settlement which remains subject to preliminary and final approval by the US. District Court.

Subject to final approval of the settlement by the U.S. District Court and notice to potential class members, and in exchange for a release of all claims by the class members, among others, and a dismissal of the consolidated lawsuits, the Company has agreed (i) to cause the Company’s insurers to pay class members and their attorneys a total of $16.0 million; and (ii) to issue class members and their attorneys 2,777,778 shares of the Company’s common stock. The Company has also agreed that if the consolidated closing bid price for the Company’s common stock is below $1.00 per share on the date the U.S. District Court enters an order of final judgment, then the Company will issue class members and their attorneys an additional 1,000,000 shares of its common stock. Following final approval of the settlement by the U.S. District Court, the shares will be issued pursuant to an exemption from registration provided by Section 3(a)(10) of the Securities Act of 1933, as amended. On September 12, 2012, the U.S. District Court preliminarily approved the settlement and scheduled a final approval hearing for December 17, 2012.

The Derivative Actions. Beginning in February 2011, several shareholder derivative complaints were filed in the Superior Court of California for the County of Los Angeles and in the U.S. District Court for the Central District of California against all of the Company’s directors and certain of its officers. The complaints in the shareholder derivative actions allege breaches of fiduciary duties by the defendants and other violations of law. In general, the complaints allege that the defendants caused or allowed for the dissemination of materially false and misleading statements regarding its business and prospects for AFREZZA, thereby artificially inflating the price of its common stock. The Superior Court of California for the County of Los Angeles has consolidated the actions pending before it and appointed lead counsel. The consolidated state derivative actions are referred to as the State Derivative Action. The U.S. District Court for the Central District of California has also consolidated the derivative actions pending before it. The consolidated federal derivative actions are referred to as the Federal Derivative Action. The State Derivative Action and the Federal Derivative Action are collectively referred to as the Derivative Actions.

On August 3, 2012, the Company, while continuing to deny all allegations of wrongdoing or liability whatsoever arising out of the Derivative Actions and without in any way admitting fault or liability, entered into a stipulation of settlement to resolve the Derivative Action. Subject to preliminary and final approval of the settlement by the U.S. District Court and notice to shareholders, and in an exchange for a release of all claims by the plaintiffs, among others, and a dismissal of the Derivative Actions, the Company has agreed (i) to adopt certain corporate governance measures, (ii) to cause the Company’s insurers to pay the plaintiffs’ attorneys a total of $800,000, and (iii) to issue plaintiffs’ attorneys 225,000 shares of the Company’s common stock. Following final approval of the settlement by the U.S. District Court, the shares will be issued pursuant to an exemption from registration provided by Section 3(a)(10) of the Securities Act of 1933, as amended. On September 12, 2012, the U.S. District Court preliminarily approved the settlement. A final approval hearing is scheduled for November 19, 2012.

As a result of settlement discussions with the plaintiffs taking place in the latter part of the quarter ended June 30, 2012 and entering into the stipulation of settlement for the Securities Action on July 23, 2012 and for the Derivative Action on August 3, 2012, the Company determined that the liabilities pertaining to both the securities and derivative lawsuits were probable as of June 30, 2012. The Company’s financial statements as of and for the three months ended June 30, 2012 reflect the following accruals:

 

  (i) Cash consideration. The Company recorded a current liability of $16.8 million under “Accrued expense and other current liabilities” and a corresponding current asset under “Prepaid expenses and other current asset” to reflect a receivable from the Company’s insurers. The Company has determined that the collectability of the receivable from the insurers is probable. The cash obligation resulted in no charge to the Company’s Condensed Consolidated Statements of Operations for the period.

 

  (ii) Stock consideration. The Company recorded a charge to “General and administrative” expenses and an estimated current liability under “Accrued expense and other current liabilities” of $7.7 million representing the estimated fair value of the 3,002,778 common shares to be issued in the aggregate subject to court approval.

 

  (iii) Additional stock consideration. The Company concluded that the contingent obligation to issue an additional 1,000,000 shares of its common stock, as defined in the stipulation of settlement agreement for the Securities Action, met the definition of a derivative instrument in accordance with ASC 815 Derivatives and Hedging. The Company estimated the fair value of the derivative instrument using the Monte Carlo simulation model to forecast the contingent obligation applying probabilities that the stock price will be lower than $1.00 based on the following assumptions: expected volatility of 60%, risk free interest rate of 0.16% and final judgment dates ranging from four to six months. As a result, the Company estimated the fair value of this contingent obligation to be immaterial.

As of September 30, 2012, the Company estimated the aggregate fair value of the stock consideration at $8.6 million and recognized an increase in the contingent liability of $901,000 during the quarter ended September 30, 2012. During the quarter ended September 30, 2012, the Company remeasured the additional stock consideration using the Monte Carlo simulation model to forecast the contingent obligation applying probabilities that the stock price will be lower than $1.00 based on the following assumptions: expected volatility of 54%, risk free interest rate of 0.1% and final judgment date on or before December 31, 2012. As a result, the Company estimated the fair value of this contingent obligation related to the additional stock consideration to be immaterial.