Cornerworld Corporation v. Timmer et al

Filing 106

OPINION ; signed by Judge Robert Holmes Bell (Judge Robert Holmes Bell, kcb)

C o r n e r w o r l d Corporation v. Timmer et al

D o c . 106

UNITED STATES DISTRICT COURT F O R THE WESTERN DISTRICT OF MICHIGAN S O U T H E R N DIVISION

C O R N E R W O R L D CORPORATION, P l a in tif f , F ile No. 1:09-CV-1124 v. H O N . ROBERT HOLMES BELL N E D TIMMER, D e f e n d a n t. / OPINION O n September 10, 2010, the Special Master filed his First Dispute Resolution R e c o m m e n d a tio n , recommending that the Court make certain findings regarding the reloc atio n of switching equipment and the compensation of Plaintiff's chief financial officer. (D k t No. 96, Recommendation.) This matter is before the Court on Defendant Ned Timmer's o b je c tio n s to the Recommendation and his incorporated motion for preliminary injunction. (D k t. No. 99, Obj.). Plaintiff CornerWorld has filed a response to those objections and the m o tio n for preliminary injunction. (Dkt. No. 104.) For the reasons that follow, the Court a d o p ts the Special Master's recommendation in part and denies Defendant's motion for p re lim in a ry injunction. A. Relocation of Switching Equipment D e f en d a n t Ned Timmer contends that CornerWorld defaulted under the Transaction D o c u m e n ts by moving switching equipment to Texas. The Special Master recommended that

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th e Court make a finding that Plaintiff's relocation of the switching equipment from M ic h ig a n to Texas is not an event of default. The Special Master further recommended that th e Court expand the preliminary injunction to prohibit Defendant from taking any action to p re v e n t the relocation of the switching equipment. D e f en d a n t objects to both the process used and the recommendations made by the S p ec ial Master. Defendant also requests the Court to schedule a hearing and to enter a p re lim in a ry injunction enjoining Plaintiff from moving the switching equipment from M ic h ig a n to Texas. Defendant's procedural objection is based on his contention that the Special Master c o n su lted with Plaintiff and its experts, but failed to consult with Defendant about the costs a n d risks of moving the equipment before entering his recommendation with respect to the sw itch in g equipment. Defendant contends that this procedure was unfair and put him at a g re a t disadvantage. Defendant does not contend that he had no opportunity to present his position to the S p e c i a l Master. Rather, Defendant complains that he did not have an opportunity to address th e Special Master after the Special Master consulted with Plaintiff's engineers. Defendant co n tend s that he should have had an opportunity to rebut the analyses offered by Plaintiff's e n g in e e rs regarding the costs and risks associated with moving the switches to Texas. The Court appointed the Special Master to serve as arbiter of issues involving c o m p l ia n c e with the transaction documents pending trial in accordance with the parties'

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a g re e m e n t. (Dkt. No. 25, Pl.'s Br. re Sp. Master; Dkt. No. 29, Def.'s Br. re Sp. Master;Dkt. N o . 43, Order Appointing Sp. Master.) The Court did not specify the procedures to be f o llo w e d by the Special Master. The Court relies on the Special Master to undertake such in v e stig a tio n s and to utilize such procedures as he deems necessary. Even if Defendant was d e n ie d an opportunity to rebut Plaintiff's evidence, Defendant can bring those matters to the C o u rt's attention through his objections to the Recommendation, as he has done here. This p ro c e s s as a whole is not unfair. Defendant also objects to the Special Master's recommended finding that removal of th e switching equipment to Texas is not an event of default under the Debenture. Defendant c o n te n d s that moving the equipment would have a material adverse effect both on the e n f o rc e ab ility of the Transaction Documents and on the operations of S-Squared, LLC and T 2 TV, LLC, the subsidiary companies.1 D e f e n d a n t contends that moving the switching equipment will have a materially a d v e rs e effect on the enforceability of the transaction documents because the switching

The Secured Debenture defines an event of default to include any event "that has, or c o u ld reasonably be expected to have, a Material Adverse Effect." (Dkt. No. 8, Ex. 2, Sec. D e b . § 6(a)(x).) "Material Adverse Effect" is defined to include: an effect that results in or causes, or could reasonably be expected to result in or cause, a material adverse effect on (a) the legality, validity or e n fo r c e a b ility of any Transaction Document, (b) the results of operations, asse ts, business or condition (financial or otherwise) of the Issuers and the S u b s id ia r ie s, taken as a whole . . . . Id . at § 1 (emphasis added.) 3

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e q u ip m e n t represents a significant portion of the value of the collateral, and moving the e q u ip m e n t would have a materially adverse effect on Defendant's ability to enforce his rights a n d remedies under the Secured Debenture. Specifically, Defendant points out that moving th e equipment eliminates Defendant's ability to resell the business as a turn-key operation, a n d hampers Defendant's ability to repossess the equipment in the event of a default. The Special Master found: (1) that there was no provision in any of the operative sa les documents that prohibits the equipment from being moved out of Michigan; (2) that, h a d the parties intended moving the collateral to be an event of default, they would have in c lu d e d it in the transaction documents because, based on his experience, such prohibitions a re standard boiler plate provisions in security agreements; and (3) that despite some in c o n v e n ie n c e, Defendant's security interest in the equipment continues to be enforceable. B a se d upon these findings, the Special Master concluded that Defendant failed to meet his b u rd e n of proving that moving the equipment was a materially adverse event. Defendant has n o t challenged these findings. Defendant nevertheless objects to the Special Master's c o n c lu s io n s based on his contention that the Special Master failed to consider the impact that m o v in g the equipment would have on the enforceability of his security agreements. Contrary to Defendant's assertions, the Special Master did consider the impact of m o v in g the equipment on the enforceability of the security agreements. The Special Master s p e c if ic a lly acknowledged that repossession may be more inconvenient, but noted that the D e b e n tu re does not provide that a default results from a material "inconvenience" in

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e x e rc is in g the secured party's rights and remedies under the Debenture. Because Defendant s o ld the businesses to a Texas operation and did not insert any language in the sales d o c u m e n ts requiring that the businesses or the equipment stay in Holland, it is reasonable to f in d that the movement of the equipment to Texas is not an event of default. Defendant has n o t alerted the Court to any language in the transaction documents that would support a f in d in g of default based upon the inconvenience of repossession. The Court finds nothing in Defendant's response that would cast doubt on the Special Master's legal conclusion that m o v in g the equipment is not a "materially adverse event" under the enforceability prong of th e Secured Debenture's definition of "Material Adverse Effect." Defendant also contends that moving the switching equipment would have a m a te ria lly adverse effect on the operations of the subsidiary companies. First, Defendant c h a llen g e s the Special Master's finding that moving the switching equipment will generate a cost savings. Defendant has presented evidence that, despite the more beneficial terms of th e XO Communications lease, CornerWorld is still obligated to pay on a three-year lease in H o lla n d that commenced in February, 2009. (Dkt. No. 100, Ex. 12, Lease.) A lth o u g h the Court is not privy to all of the facts and figures considered by the S p e c ia l Master, its is beyond dispute that the Special Master was aware of the Holland lease. T h e Special Master specifically noted that the projected annual savings took into c o n sid e ra tio n the rent which continues to be paid on the building in Holland. (R e c o m m e n d a t io n 4.) Plaintiff has presented evidence that the cost savings estimate was

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b a se d not only on a lower rent at XO, but also on a personnel reduction at the Holland facility a n d future savings when CornerWorld exercises its option under the lease agreement to p u rch ase the Holland facility. (Dkt. No. 104, Beck Aff. ¶ 4.) Second, Defendant contends that moving the primary switch creates a considerable r is k to operations because, during the time that the primary switch is being moved to Texas, S - S q u a re d will be operating with only the back-up or "lab" switch. Defendant has presented e v id e n c e that, unlike the primary switch which has two hard drives, the lab switch has only a single hard drive. Accordingly, if there is a failure in the back-up switch hard drive, he c o n te n d s that the entirety of the switching capacity would go down. (Timmer Aff. ¶¶ 8-9.) D e f e n d a n t has also presented evidence that the switches provide dial tone service to tele p h o n e customers of T2 Communications, LLC, and he is not aware of how CornerWorld w ill provide uninterrupted dial tone service to customers in Holland for calls, including 911 ca lls, from Texas. (Timmer Aff. ¶¶ 100-11.) In response to Defendant's objections regarding risks to operations during the switch, P lain tiff has presented evidence that the back-up switch, which was never operational in H o lla n d , is being made fully operational in Texas. (Beck Aff. ¶¶ 6-7.) Accordingly, in the e v e n t of a technical breakdown, there will be redundancy in both personnel and equipment. (Id . at ¶ 7.) "CornerWorld has incorporated a detailed, phased migration plan whereby both lo c a tio n s will run simultaneously until full migration to the lab switch as been completed." (Id . at ¶ 8.) Plaintiff has also presented evidence that after the lab and primary switches have

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b e e n moved to Texas, equipment will remain in Holland to provide the T2 Communications, L L C dial tone service and allow for the ability o make 911 emergency service calls. (Id. at ¶ 9.) While Defendant may disagree with CornerWorld's business decisions, there is n o th i n g in the record to suggest that CornerWorld's decision to move the equipment was m a d e lightly, that it was not motivated by a determination of what was in the best interest of C o rn e rW o rld and the subsidiary companies, or that it will create substantial risk to o p e ra tio n s . The Court finds nothing in Defendant's objections that would cast doubt on the S p e c i a l Master's legal conclusion that moving the equipment is not a materially adverse e v e n t that would support a finding of default under the operations prong of the Secured D e b e n tu re 's definition of "Material Adverse Effect." The Court will accordingly adopt the S p e c ia l Master's recommended finding that moving the switches from Michigan to Texas is not an event of default under the Secured Debenture. Because the Court has made this f in d in g , the Court finds no need to enter a preliminary injunction prohibiting Defendant from ta k in g any action to prevent the relocation. The Court is satisfied that Defendant understands th a t any resort to self-help tactics to prevent conduct that the Court has determined does not c o n s titu te a default would amount to contempt of court. B. Request for Preliminary Injunction D ef en d an t has requested the Court to schedule a hearing to enter a preliminary in ju n c tio n enjoining Plaintiff from moving the switching equipment to Texas, and requiring

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P la in tif f to return any collateral that has already been moved. The Court declines to do so. T h e Court has appointed the Special Master to oversee compliance with the transaction d o c u m e n ts pending trial. Although Defendant has expressed concern that the Special M a ste r's Recommendation operates as a recommendation of summary judgment on the issues b e f o re him, Defendant's concerns are unfounded. The Court is relying on the Special Master to serve as arbitrator of possible disputes between the parties pending trial. The Special M a s te r 's recommended findings are preliminary findings that either support or defeat a p a r ty' s request for a preliminary injunctive relief. They do not replace a trial on the merits: T h e purpose of a preliminary injunction is merely to preserve the relative p o sitio n s of the parties until a trial on the merits can be held. Given this lim ite d purpose, and given the haste that is often necessary if those positions a re to be preserved, a preliminary injunction is customarily granted on the b a sis of procedures that are less formal and evidence that is less complete than in a trial on the merits. A party thus is not required to prove his case in full at a preliminary-injunction hearing, and the findings of fact and conclusions of la w made by a court granting a preliminary injunction are not binding at trial o n the merits. Univ. of Texas v. Camenisch, 451 U.S. 390, 395 (1981) (citations omitted). Based on the Special Master's findings, the Court concludes that entry of a p re lim in a ry injunction enjoining CornerWorld from moving the switching equipment is not w a rra n te d . To the extent Defendant seeks preliminary injunctive relief based on other a lle g e d defaults, those are matters that should be brought first before the Special Master who is tasked with arbitrating disputes between the parties relating to compliance with the

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B u y/S e ll Agreements and Transaction Documents and the on-going operation of C o rn e rW o rld and its subsidiaries pending trial. (Dkt. No. 43, Order Appointing Sp. Master.) C . Compensation of Chief Financial Officer C o rn e rW o rld 's Board of Directors has voted to offer its Chief Financial Officer, V. C h a se McCrea, a salary increase and a grant of stock options. Defendant has refused to to c o n se n t to the employment agreement. The Secured Debenture prohibits Plaintiff from in c re a sin g the compensation payable to any officers or members of senior management " w ith o u t the approval of Cornerworld's Board of Directors and the consent of Holder [ T im m e r], which consent shall not be unreasonably withheld." (Dkt. No. 8, Ex. 2, Sec. Deb. § 5(f)). The Special Master has recommended that the Court make a finding that Defendant ac ted unreasonably in voting to disapprove the amended employment contract with Plaintiff's C h ie f Financial Officer. The Special Master further recommended that the Court expand the p re lim in a ry injunction to require Defendant's consent to the proposed contract. Defendant objects to this recommendation. Defendant contends that as a Board M e m b e r he is required under Nevada Revised Statute 78.138(4)(a)2 to consider the best in ter e sts of creditors, of which he is one. Defendant also contends that he was uncomfortable w ith offering the raise because Mr. McCrea, as CFO, did not provide financial information o r a partial payment as required by the Earn Out Agreement, did not timely provide sufficient

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Plaintiff CornerWorld is a Nevada corporation. (Dkt. No. 1, Compl. ¶ 1.) 9

f in a n c ia l information for purposes of evaluating Plaintiff's 2010-2011 budget, and has not p ro v id e d a plan for increasing revenue. Although Defendant, as a board member, is permitted to consider the interests of c re d ito rs ,3 he may not do so to the exclusion of his primary fiduciary duty to the corporation. B o a rd members are required to consider the best interests of the corporation. See Nev. Rev. S tat.§ 78.138 (West) ("Directors and officers, in deciding upon matters of business, are p re su m e d to act in good faith, on an informed basis and with a view to the interests of the c o rp o ra tio n ." ). The transcript of the Board meeting reveals that Defendant was complimentary of Mr. M c C re a , but voted against the raise because he had an interest as a creditor in being paid. T h e Special Master found, based on the transcript, that Defendant's refusal to approve the c o n tra c t with Mr. McCrea was based upon self-interest and not on the best interests of C o rn e rW o rl d . The Special Master's factual finding is supported by the transcript. There is no ev iden ce that Defendant raised any concerns about Mr. McCrea to the Board. Defendant's s o le expressed concern was about whether he was going to be paid. From the beginning of th is case the Court has observed Defendant's single-minded focus on his rights in the event o f default, rather than on the success of the businesses he sold. He has failed to consider Nevada law provides that "Directors and officers, in exercising their respective p o w e rs with a view to the interests of the corporation, may consider: (a) The interests of the c o rp o ra tio n 's employees, suppliers, creditors and customers." Nev. Rev. Stat. § 78.138 (W e s t) (emphasis added). 10
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w h a t the businesses need to do to succeed. The Court will accordingly adopt the Special M a ste r's finding that Defendant acted unreasonably in voting to disapprove the employment c o n tra c t with Mr. McCrea. In light of the Court's determination that Defendant acted u n r e a so n a b l y in withholding his consent, the Board may offer Mr. McCrea the salary increase w ith o u t obtaining Defendant's consent. In light of this finding, the Court observes no need to expand the preliminary injunction to require Defendant's consent to the proposed contract. A n order consistent with this opinion will be entered.

Dated: October 6, 2010

/s/ Robert Holmes Bell ROBERT HOLMES BELL UNITED STATES DISTRICT JUDGE

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