Leshinsky v. Wang et al
Filing
138
OPINION & ORDER: For the foregoing reasons, plaintiffs' motion to compel SmartHeat to produce responsive documents held by its subsidiaries is denied. When this dispute arose on January 3, 2014, roughly three and a half months remained until the close of fact discovery on April16, 2014. See Dkt. 76. Accordingly, the parties are directed, by June 20, 2014, to submit a proposed revised case management plan, setting forth a schedule under which merits discovery will conclude no later than September 26, 2014, about three and a half months from the date of this order. (Signed by Judge Paul A. Engelmayer on 6/12/2014) (ajs)
usn: so~y
DOCUMENT
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
------------------------------------------------------------------------)(
STREAM SICA V, DHARANENDRA RAI, and TIEN
CHUNG, Individually and on Behalf of All Others Similarly
Situated,
Plaintiffs,
ELECTRO~ I CALLY
FILED
DOC#:·-----~-=---
DATE FILED:
12 Civ. 6682 (PAE)
OPINION & ORDER
-v-
JAMES JUN WANG, SMARTHEAT, INC., and JOHN
DOES 1-4,
Defendants.
------------------------------------------------------------------------)(
PAUL A. ENGELMAYER, District Judge:
In this putative class action, plaintiffs allege that defendants SmartHeat, Inc.
("SmartHeat") and James Jun Wang violated§ 10(b) ofthe Securities Exchange Act of 1934, 15
U.S.C. § 78j(b), and the United States Securities and Exchange Commission's implementing
rule, 17 C.F .R. § 240.1 Ob-5. During discovery, plaintiffs moved to compel SmartHeat to
produce responsive documents held by its subsidiaries. SmartHeat claimed that such documents
were not within its custody, possession, or control. To resolve that dispute, the Court ordered
discovery as to SmartHeat's access to documents held by its subsidiaries. The parties have now
completed that discovery and briefed the issue. For the reasons that follow, the Court holds that
SmartHeat does not have access to documents held by its subsidiaries. Plaintiffs' motion to
compel is therefore denied.
I.
Background
A. Facts Alleged in the Second Amended Complaint
SmartHeat is a Nevada holding company whose subsidiaries operate primarily in China.
Dkt. 52 (“Second Amended Complaint” or “SAC”) ¶ 31. SmartHeat “designs, manufactures,
and sells clean technology plate heat exchangers and related systems in China.” Id. Its
technology is used in commercial and residential buildings. Id. Wang founded SmartHeat and,
until May 25, 2012, served as its CEO and board chairman. Id. ¶ 29. He remains chairman and
CEO of SmartHeat’s principal subsidiary, SmartHeat Taiyu (Shenyang) Energy Technology Co.,
Ltd. (“Taiyu”), which he founded in 2002. Id. ¶¶ 29–30.
On January 29, 2009, SmartHeat’s stock started trading on the NASDAQ stock exchange.
Id. ¶ 3. That same day, SmartHeat announced that its senior management had entered into a
lock-up agreement that prevented them from selling any shares until 2012. Id. The locked-up
shares represented approximately 61% of SmartHeat’s outstanding common stock. Id. ¶ 53.
That day, SmartHeat issued a press release that quoted Wang as saying, “Our entire senior
management team has voluntarily entered into share lock-ups as a reflection of our great
confidence in the prospect of SmartHeat.” Id. ¶ 49. Throughout 2009, SmartHeat and others
continued to tout the lock-up agreement. Id. ¶¶ 51–54. On January 11, 2010, SmartHeat’s stock
price reached its all-time peak, at $186 per share. Id. ¶ 95.
The SAC alleges two instances in which SmartHeat subsequently failed to disclose new
information that allegedly rendered materially false or misleading its original statements about
the lock-up agreement. First, the SAC alleges, on February 5, 2010, Wang and senior
management entered into a revised lock-up agreement, which stated that the lock-up agreement
had been terminated on January 1, 2010, a month earlier, but did not disclose this revision to
2
shareholders. Id. ¶¶ 6, 13. Second, the SAC alleges, between February 2010 and August 13,
2010, Wang, working through SmartHeat’s counsel, Robert Newman, caused 380,000 locked-up
SmartHeat shares, owned by “SmartHeat insiders,” to be sold for $23 million, again without any
disclosure that shares subject to the previously touted lock-up agreement were being sold. Id.
¶¶ 7, 57–65. The 380,000 shares had been subject to the earlier lock-up agreement, but were
freed from that restriction by the undisclosed February 5, 2010 agreement. Id. ¶ 7.
The SAC alleges that the sales of the 380,000 locked-up shares “put steady downward
pressure on SmartHeat’s stock price,” causing it to drop almost 44 percent between February 24,
2010, and May 3, 2010. Id. ¶ 102. Then, in late 2011, the Financial Industry Regulatory
Authority (FINRA) charged the brokerage company that had executed the sales, First Merger
Capital, Inc., and five of its employees, with failure to report the apparently suspicious sales. Id.
¶ 14. In early 2012, the employees accepted FINRA’s allegations. Id. ¶ 15.
On May 25, 2012, following a two-day meeting of SmartHeat’s board, Wang resigned as
CEO. Id. ¶ 16. He maintained his positions at SmartHeat’s subsidiaries, including as chairman
and CEO of Taiyu, SmartHeat’s principal subsidiary. Id. ¶ 29. At the same time, SmartHeat
obtained a $2 million revolving line of credit with a 1.25% per month interest rate and a 4%
origination fee from a company at which Wang was a principal, Northtech. Id. ¶ 17. The line of
credit was secured by most of SmartHeat’s assets. Id.
On May 30, 2012, SmartHeat reported the results of its May 25, 2012 board meeting. Id.
¶ 18. That same day, NASAQ halted trading in SmartHeat’s shares, seeking information
regarding “the restructuring of [SmartHeat’s] board and management and [SmartHeat’s] entry
into a secured revolving credit facility.” Id. NASDAQ then delisted SmartHeat. Id. ¶ 19. When
trading of SmartHeat’s stock resumed, this time on the pink sheets rather than on the NASDAQ,
3
SmartHeat’s share price fell from $4.04 to $1.30 on the first day. Id. ¶ 20. Between then and the
filing of the SAC, SmartHeat’s stock price traded at between $0.25 and $1.35 per share. Id.
¶ 115.
B. Procedural History Prior to the Instant Dispute
On August 31, 2012, the initial Complaint in this case was filed by putative lead plaintiff
Steve Leshinsky. Dkt. 1. On December 14, 2012, the Court appointed Stream SICAV, an
institutional investment fund incorporated in Luxembourg, to serve as lead plaintiff. Dkt. 18.
Plaintiffs later filed an Amended Complaint and a Second Amended Complaint. Dkt. 22, 52. On
May 8, 2013, SmartHeat moved to dismiss the Second Amended Complaint. Dkt. 54. On July
24, 2013, plaintiffs moved to serve Wang, who lives in China, through SmartHeat’s registered
agent and counsel. Dkt. 66. On October 7, 2013, after briefing, the Court denied defendant’s
motion to dismiss and granted plaintiffs’ motion for alternative service of Wang. Dkt. 70. On
October 21, 2013, the Court revised and approved the parties’ case management plan, under
which fact discovery was to close on April 16, 2014. Dkt. 75–76. On November 7, 2013, the
Clerk of Court issued a certificate of default as to Wang. Dkt. 83.
C. Procedural History of the Instant Dispute
On January 3, 2014, plaintiffs informed the Court that, in response to their requests for
production, SmartHeat had disclaimed any ability to access documents held by its Chinese
subsidiaries, and that, as a result, its entire production consisted of 47 documents, most of them
briefs or exhibits thereto opposing the NASDAQ’s action to delist its shares. Dkt. 84. Plaintiffs
requested an order directing SmartHeat to produce all responsive documents in its possession,
including those held by its subsidiaries. Id.
4
On January 21, 2014, the Court held a telephone conference with the parties and directed
plaintiffs, under Federal Rule of Procedure 30(b)(6), to “notice a deposition of a person at
SmartHeat, Inc. to testify about that company’s processes and practices with respect to the
creation and custody of, and access to, documents including but not limited to the extent to
which SmartHeat, Inc., or its agents, have had access to documents of its subsidiaries.” Dkt. 89.
The Court directed the parties to brief the issue “[i]f, after the deposition, the parties remain in
dispute about the ability of SmartHeat, Inc. to produce the documents that plaintiff has
requested.” Id.
On January 29, 2014, the Court approved plaintiffs’ deposition notice after defendants
challenged its scope. Dkt. 95. On February 24, 2014, plaintiffs deposed Oliver Bialowons, the
President and CEO of SmartHeat. During the deposition, the parties reached an impasse and
requested a telephone conference with the Court. During that conference, the Court clarified the
scope of the deposition and authorized continuation of the deposition by video, as Bialowons, to
the Court’s surprise, had arranged to leave for the airport at 3 p.m, in mid-deposition, to return
home to Germany. See Dkt. 106 Ex. 2 (“Bialowons Dep. I”) at 86–101.
On February 28, 2014, plaintiffs submitted a letter requesting, inter alia, that the Court
grant them seven more hours of deposition time, on the grounds that “the witness’s and counsel’s
misconduct [at the original deposition] made the time Plaintiffs have had essentially valueless.”
Dkt. 106 at 3. On March 7, 2014, defendants replied. Dkt. 109. On March 11, 2014, after
carefully reviewing the deposition transcript and the parties’ filings, the Court concluded that, at
the original deposition, Bialowons had not been prepared to discuss, in a substantive manner,
SmartHeat’s access to documents held by its subsidiaries, and that his preparation appeared to
have been more suited to stonewalling than substantive discussion. Dkt. 111. The Court
5
therefore allowed plaintiffs to depose Bialowons for seven more hours and clarified the topics on
which Bialowons should be prepared to give answers. Id.
On April 3, 2014, Bialowons was deposed again. Dkt. 133 Ex. 1 (“Bialowons Dep. II”).
On April 4, 2014, the Court held a conference with the parties concerning a motion by defense
counsel to withdraw. See Dkt. 117–120. At that conference, the Court learned that SmartHeat
had not completed its document production relevant to the instant discovery dispute. The Court
therefore directed SmartHeat to complete its document production and permitted plaintiffs to reopen their deposition of Bialowons so as to pose questions to him, within the scope of the
deposition notice, regarding the documents to be produced. Dkt. 123. Accordingly, on April 29,
2014, Bialowons was deposed for a third time. Dkt. 133 Ex. 2 (“Bialowons Dep. III”).
On May 6, 2014, plaintiffs submitted their letter brief concerning this discovery dispute.
Dkt. 133 (“Pl. Br.”). On May 9, 2014, SmartHeat replied. Dkt. 134 (“Def. Br.”).
II.
Discussion
Federal Rule of Civil Procedure 34 allows a party to demand documents which are in the
responding party’s “possession, custody or control.” Fed. R. Civ. P. 34(a). Plaintiffs seek to
compel SmartHeat to produce relevant documents within the possession, custody, or control of
SmartHeat’s subsidiaries.
“A basic tenet of American corporate law is that the corporation and its shareholders are
distinct entities.” Dole Food Co. v. Patrickson, 538 U.S. 468, 474 (2003). A corollary is that a
parent corporation is distinct from a separately incorporated subsidiary. Id. at 475 (“A corporate
parent which owns the shares of a subsidiary does not, for that reason alone, own or have legal
title to the assets of the subsidiary. . . . ‘The properties of two corporations are distinct, though
the same shareholders own or control both. A holding corporation does not own the subsidiary’s
6
property.’”) (quoting 1 W. Fletcher, Cyclopedia of the Law of Private Corporations § 31, at 514
(rev. ed. 1999)). Each corporation is a “distinct legal entity, with legal rights, obligations,
powers, and privileges different from those of the natural [or legal] individuals who created it,
who own it, or whom it employs.” Cedric Kushner Promotions, Ltd. v. King, 533 U.S. 158, 163
(2001). Because parent and subsidiary are legally distinct, a document held by a subsidiary is
not within the control of the parent, and therefore a parent cannot be legally obligated at the
threat of sanction to produce it, unless “the intracorporate relationship establishes some legal
right, authority or ability [of the parent] to obtain requested documents on demand.” DeSmeth v.
Samsung Am., Inc., No. 92 Civ. 3710 (LBS) (RLE), 1998 WL 74297, at *9 (S.D.N.Y. Feb. 20,
1998); see also In re Vivendi Universal, S.A. Sec. Litig., No. 02 Civ. 5571 (RJH) (HBP), 2009
WL 8588405, at *3 (S.D.N.Y. July 10, 2009) (“Where documents from a corporation are sought
by way of a subpoena served on an affiliate, the Court must inquire into the nature of the
relationship between the affiliates to determine whether the entity on which the subpoena was
served has the practical ability to obtain the documents from the affiliate.”).
In determining a parent’s control over a subsidiary in this context, district courts in this
Circuit consider “[1] the degree of ownership and control exercised by the parent over the
subsidiary, [2] a showing that the two entities operate as one, [3] demonstrated access to
documents in the ordinary course of business, and [4] an agency relationship.” DeSmeth, 1998
WL 74297, at *9; accord In re Vivendi, 2009 WL 8588405, at *3; In re Ski Train Fire of Nov.
11, 2000 Kaprun Austria, MDL 1428 (SAS) (THK), 2006 WL 1328259, at *5 (S.D.N.Y. May
16, 2006); Dietrich v. Bauer, No. 95 Civ. 7051 (RWS), 2000 WL 1171132, at *3 (S.D.N.Y. Aug.
16, 2000), affirmed in part and clarified in part on reconsideration, 198 F.R.D. 397 (S.D.N.Y.
2001); cf. Gerling Int’l Ins. Co. v. C.I.R., 839 F.2d 131, 140 (3d Cir. 1988) (“Where the litigating
7
corporation is the parent of the corporation possessing the records, courts have found the
requisite control where ‘a subsidiary corporation acts as a direct instrumentality of and in direct
cooperation with its parent corporation, and where the properties and affairs of the two [were]
. . . inextricably confused as to a particular transaction.’”) (quoting Acme Precision Products,
Inc. v. American Alloys Corp., 422 F.2d 1395, 1398 (8th Cir. 1970)). This inquiry is “often
highly fact-specific,” 8A Charles Alan Wright, Arthur R. Miller & Richard L. Marcus, Federal
Practice and Procedure § 2210 (3d ed), and the burden of proof falls on the party seeking
discovery, see In re Vivendi, 2009 WL 8588405, at *3; S.E.C. v. Credit Bancorp, Ltd., 194
F.R.D. 469, 472 (S.D.N.Y. 2000); Golden Trade S.r.L. v. Lee Apparel Co., 143 F.R.D. 514, 525
n.7 (S.D.N.Y. 1992).
A.
SmartHeat’s Degree of Ownership and Control over its Subsidiaries
The first factor in determining whether SmartHeat has control over documents in the
custody of its subsidiaries is the degree of ownership and control that SmartHeat exercises over
its subsidiaries.
SmartHeat acknowledges that it indirectly owns whole or controlling shares in nine
subsidiaries.1 See Def. Br. Ex. A (showing that SmartHeat wholly owns two Nevada
corporations, and that these corporations (1) wholly own three Chinese subsidiaries and one
German subsidiary, (2) own controlling shares in five Chinese subsidiaries, and (3) own a 30.6%
share in one Chinese company). Mere ownership by a parent, however, is not a decisive factor,
but merely one factor among several. See In re Vivendi, 2009 WL 8588405, at *3 (“[A]lthough
there is no dispute that SGBT is a wholly owned subsidiary of SG, that fact is not controlling in
this Circuit.”); In re Ski Train, 64 Fed. R. Serv. 3d 594, at *6 (a parent’s “complete ownership”
1
Plaintiffs do not specify from which subsidiaries they seek to compel production.
8
of its subsidiary “suggests that the first factor in the parent-subsidiary control test tips in
Plaintiffs’ favor”); Motorola Credit Corp. v. Uzan, No. 02 Civ. 666 JSR, 2013 WL 6098388, at
*3 (S.D.N.Y. Nov. 20, 2013) (“This pragmatic approach to understanding ‘control’ will often
result in a finding that a parent corporation has, practically speaking, sufficient control over its
subsidiaries to require that it search them in compliance with a subpoena served on the parent.”)
(emphases added). Plaintiffs do not cite any cases from this District holding that ownership of
whole or controlling shares establishes, by itself, a parent’s control over its subsidiary for the
purpose of Rule 34; rather, the cases plaintiffs cite, and indeed all cases from this District of
which this Court is aware, engage in a factual inquiry into practical control, of which ownership
is but one part. Gerling, which plaintiffs cite for the proposition that “[a] parent always controls
a subsidiary,” Pl. Br. 5, does not so hold. Instead, Gerling notes that two district court cases
from the late 1970s adopted this per se approach, although Gerling itself appears to adopt the
more common, multi-factor approach. 839 F.2d at 140–41.
Significantly, as to the degree of ownership and control factor, SmartHeat appears in
practice to exert little, if any, control over its subsidiaries. Bialowons testified that SmartHeat
cannot participate in its subsidiaries’ decision-making. Bialowons Dep. III at 29. SmartHeat
cannot, according to its CEO, prevent its subsidiaries from, for example, buying or selling a
factory. Id. And SmartHeat appears to do little, if anything, to monitor its subsidiaries’ activities
or to independently verify the financial information they provide as inputs to SmartHeat’s
consolidated financial statements. See Bialowons Dep. II at 23–29, 56–60, 65–67. SmartHeat
does not prepare its own financial statements. Nor, apparently, does it receive any of its
subsidiaries’ individual financial statements—instead, it receives its consolidated financial
statements in near-final form from its outside counsel, after its American accounting firm has
9
prepared the financial statements based on translated versions of documents provided by the
subsidiaries’ Chinese accounting firm. Id. at 23–29, 37; Pl. Br. Ex. 8. Bialowons testified that
he has no need to see financial documents from SmartHeat’s subsidiaries; he needs only the
ultimate financial information. Bialowons Dep. II at 21.
Plaintiffs point to only one episode in which SmartHeat exerted control over its
subsidiaries: In 2010, “SmartHeat caused its subsidiaries to create an internal audit department,
and retained a third-party internal audit firm, ShineWing, to assess its subsidiaries’ internal
control over financial reporting.” Pl. Br. 2 (citing SmartHeat Letter to SEC, Feb. 3, 2012).2 But
this limited instance of control, which occurred four years ago, little changes the overall picture
of SmartHeat’s limited authority over its subsidiaries.
In sum, while SmartHeat’s ownership of its subsidiaries is a factor favoring plaintiffs in
their bid for the foreign subsidiaries’ documents, the lack of any track record in which SmartHeat
has actually exerted control points in the opposite direction. It undermines plaintiffs’ claims that
SmartHeat has the legal authority or practical ability to obtain documents at will from its
subsidiaries.
B.
Whether SmartHeat and its Subsidiaries Operate as One
The second factor is whether SmartHeat and its subsidiaries operate as one entity, i.e.,
whether their day-to-day operations are substantially in common with each other. See In re
Vivendi, 2009 WL 8588405, at *4. A parent and subsidiary may be said to operate as one entity
if, for example, “they shared employees, shared facilities, shared office space and utilized
common practices and forms.” Id.
2
Available at
http://www.sec.gov/Archives/edgar/data/1384135/000118518512000170/filename1.htm.
10
As to this point, the facts point in both directions, but mostly favor SmartHeat. To begin
with, SmartHeat has very little in the way of activities; by definition there is little it can do, or
does, in concert with its subsidiaries. SmartHeat is a holding company. SmartHeat 2013 10-K,
at 1.3 It has no material assets other than the ownership interests of its subsidiaries, which
manufacture, sell, and service plate heat exchangers. Id. at 1, 13, 30. SmartHeat’s activities
appear to consist entirely of holding board meetings, keeping board minutes, making filings with
the SEC, and ensuring that these filings are truthful. Bialowons Dep. II at 56–60, 123–24, 133.
SmartHeat attests that it has no employees, see Bialowons Dep. II at 66–67, a position
that plaintiffs do not dispute, see Pl. Br. 3, and thus it cannot share employees with its
subsidiaries. That said, certain critical SmartHeat personnel either are, or were, also associated
with the subsidiaries. SmartHeat’s acting chief accountant and principal financial officer,
Yingkai Wang, is also the financial manager of SmartHeat’s subsidiaries. Id. at 70–71; Pl. Br.
Ex. 10; SmartHeat 2013 10-K, at 42. SmartHeat’s Corporate Secretary, Jane (Huajun) Ai, also
works for SmartHeat’s subsidiaries; she is not paid by SmartHeat. Bialowons Dep. II at 170.
Additionally, James Jun Wang, SmartHeat’s founder and former Chairman, President and CEO,
is no longer associated with SmartHeat, but is now the general manager of SmartHeat’s Chinese
subsidiaries. SmartHeat 2013 10-K, at 17. However, Bialowons, SmartHeat’s current President
and CEO, has no affiliation with its subsidiaries.
SmartHeat also has no office, Bialowons Dep. II at 99, and therefore cannot share one
with its subsidiaries. Bialowons performs his SmartHeat work from wherever he is located at the
moment; he never works from SmartHeat’s subsidiaries’ offices. Id. SmartHeat does share a
3
Available at
http://www.sec.gov/Archives/edgar/data/1384135/000118518514000958/smartheat10k123113.ht
m.
11
miniscule facility with its principal subsidiary: It has a drawer or binder in that subsidiary’s
office, in which SmartHeat keeps its corporate minutes. Pl. Br. 3 n.9 (citing Bialowons Dep. II
at 107)4 (drawer); Bialowons Dep. III at 81 (binder).
In sum, there is little commonality between SmartHeat’s day-to-day operations and the
day-to-day operations of its subsidiaries. SmartHeat engages in a few, formalistic corporate
activities—board meetings and regulatory filings—while its subsidiaries manufacture, sell, and
service plate heat exchangers. See SmartHeat 2013 10-K at 1. SmartHeat is certainly dependent
on its subsidiaries, as evidenced by the joint roles of Yingkai Wang and Jane (Huajun) Ai and by
the fact that SmartHeat’s sole physical manifestation—the drawer or binder in which it keeps its
corporate minutes—is in its principal subsidiary’s office. But that dependence does not make
SmartHeat the alter ego of its subsidiaries; on the contrary, SmartHeat and its subsidiaries appear
to respect the corporate form. If anything, SmartHeat appears to be unusually distinct from its
subsidiaries, as illustrated by its apparent inability to affect its subsidiaries’ decision-making and
its lack of independent oversight over its subsidiaries’ finances.
In arguing that SmartHeat and its subsidiaries operate as one, and that SmartHeat is its
subsidiaries’ alter ego, plaintiffs assert that nearly all of SmartHeat’s activities are in essence
performed by its subsidiaries, in that SmartHeat does little more than file documents with the
SEC, and those are drafted by the employees of SmartHeat’s subsidiaries, whom SmartHeat does
not pay. Pl. Br. 6. But that is not entirely so. To be sure, Yingkai Wang, SmartHeat’s acting
chief accountant, is apparently employed only by its subsidiaries; and he does sign SmartHeat’s
regulatory filings, and perhaps has some role in their preparation, although plaintiffs’ letter brief
4
Neither party provided this portion of the Bialowons deposition to the Court. However,
SmartHeat has not contested plaintiffs’ representation that Bialowons testified that SmartHeat
keeps its corporate minutes in a drawer in the office of its principal subsidiary; accordingly, the
Court assumes that this is an accurate representation of Bialowons’s testimony.
12
does not explain that role with any clarity. However, SmartHeat’s audits, and the preparation of
its financial statements, are conducted by an outside accounting firm, which SmartHeat pays and
which, as plaintiffs concede, is SmartHeat’s agent. Bialowons Dep. II at 28, 97; Pl. Br. 4, 6.
SmartHeat’s activities are not, therefore, performed entirely by its subsidiaries; some are
performed by subsidiaries, but others, perhaps the bulk, are performed by its outside agents.
Moreover, in asserting conclusorily that “SmartHeat and its subsidiaries ‘operate as one’ and
SmartHeat is its subsidiaries’ alter ego,” Pl. Br. 6, plaintiffs conflate all of these subsidiaries.
Plaintiffs do not commit as to whether they view SmartHeat as the alter ego of one particular
subsidiary, or, somehow, of each of its nine subsidiaries; and, if the latter, whether the nine
subsidiaries are therefore alter egos of each other.
Finally, as to this factor, even if the Court were persuaded that SmartHeat is the alter ego
of one or more of its subsidiaries, that finding would not yield the conclusion that the documents
of SmartHeat’s subsidiaries are within SmartHeat’s control. In the standard case in which a
discovery dispute turns on the relationship between a parent and a subsidiary, the parent’s
control over the subsidiary’s documents is established in part by showing that the subsidiary is
the alter ago of the parent. But this case does not present that scenario. Here, even accepting
plaintiffs’ claim as true, the parent is the alter ego of the subsidiary, not vice versa.
Plaintiffs have therefore not shown that SmartHeat and its subsidiaries operate as one
entity or are each others’ alter egos. This lack of unity weighs against a finding that SmartHeat
has the legal authority or practical ability to demand documents from its subsidiaries.
C.
SmartHeat’s Access to its Subsidiaries’ Documents in the Ordinary Course
of Business
The third relevant factor is whether SmartHeat has access, in the ordinary course of
business, to its subsidiaries’ documents. See In re Vivendi, 2009 WL 8588405, at *3 (“Where
13
the corporations in issue have a parent-subsidiary relationship, ‘access and ability to obtain
documents have been found where documents ordinarily flow freely between parent and
subsidiary.’”) (quoting Linde v. Arab Bank, plc, 262 F.R.D. 136, 2009 WL 1456573, at *2
(E.D.N.Y. May 22, 2009)).
Even according to plaintiffs, however, SmartHeat’s present access to its subsidiaries’
documents in the ordinary course of business is close to nil:
SmartHeat employs [ ] a cumbersome process to obtain any information or
documents from its subsidiaries; the information or documents have to be
provided to SmartHeat’s Chinese auditors, Evertrust CPA, who provided it to
Diligency, Inc., who provided it to SmartHeat’s US auditors, Goldman Kurland
Mohidin, LLP, who provided it to SmartHeat’s counsel Robert Newman, who
provided it to SmartHeat. Any request for information would have to go
backwards through the same process (the “Process”).
...
Mr. Bialowons is not aware of any situations in which the process was followed
in reverse. Mr. Bialowons testified that SmartHeat’s consolidated financial
statements are prepared through the Process. . . . If SmartHeat needs any more
information, it must request it through the Process. It has not received any other
information than SmartHeat’s financial information.
Pl. Br. 3–4 (citing Bialowons Dep. II at 22–32, 151–52; Pl. Br. Ex. 8).
Seeking to minimize the significance of SmartHeat’s present paltry access to its
subsidiaries’ documents, plaintiffs argue that this is a recent development. They argue that, until
defendant Wang resigned as SmartHeat CEO on May 25, 2012, SmartHeat had regular access to
its subsidiaries’ documents, and that Wang’s resignation should not be taken to have genuinely
inhibited SmartHeat’s access to such documents. Pl. Br. 6. But plaintiffs have not established
that SmartHeat ever had regular access to its subsidiaries’ documents. Plaintiffs identify only
two instances in which SmartHeat ostensibly sought documents from its subsidiaries, but on
close review, it is clear that in neither case did SmartHeat actually do so. First, on August 11,
14
2011, SmartHeat’s outside counsel requested copies of any emails that the four insiders who had
allegedly sold locked-up shares had sent to SmartHeat or Wang regarding the sales of the lockedup shares. Id. at 2 (citing Pl. Br. Ex. 5). But that request was directed at documents held by
SmartHeat and its then-CEO Wang; it was not directed at documents held by SmartHeat’s
subsidiaries. Second, on January 13, 2012, Arnold Staloff, one of SmartHeat’s U.S. directors,
asked Wang and Rhett Wang for their “analysis of the valuation” of “the two companies that
were recently acquired” by SmartHeat, to be used in determining the ratio of a reverse stock
split. Id. (citing Pl. Br. Ex. 3). Again, that request also was not directed at the subsidiaries or at
documents held by them; it sought assessments from two SmartHeat-affiliated persons: James
Jun Wang, an officer of SmartHeat, and Rhett Wang, also apparently an officer of SmartHeat.
See Pl. Br. Ex. 3 (addressed in part to “rhettwang@smartheatinc.com”); id. Ex. 6 (email dated
June 21, 2011 in which Rhett Wang’s signature block reads “VP Strategic Development . . .
Email: RhettWang@smartheatinc.com”). Plaintiffs themselves characterize this email as one in
which “SmartHeat’s US director casually sought financial information directly from its CEO.”
Pl. Br. 2 (emphasis added).
Plaintiffs also argue that “SmartHeat’s agents, its auditors, continue to have access to
information from SmartHeat’s subsidiaries.” Id. at 6. But plaintiffs do not cite evidence of this.
They fail to establish that SmartHeat’s auditors—as opposed to SmartHeat’s subsidiaries’
auditors—have access to financial statements of the subsidiaries. Bialowons testified that he did
not know—and the record does not otherwise make clear—at what point in that process the
subsidiaries’ financial statements are rolled up into the consolidated form in which SmartHeat
receives them. Bialowons Dep. II at 25–27.
15
The evidence before the Court reveals that SmartHeat has at best very limited and
tenuous access to any documents of its subsidiaries, and plaintiffs have not adduced any
evidence that this is a recent phenomenon. SmartHeat’s lack of access counsels against a finding
that documents held by SmartHeat’s subsidiaries are within SmartHeat’s control.
D.
Agency Relationship
Plaintiffs only half-heartedly argue that SmartHeat and its subsidiaries have an agency
relationship. They point to one instance in which SmartHeat proposed to sign a joint
development agreement with the Stanton Group, a Massachusetts company, even though the
work would be conducted by SmartHeat’s subsidiaries. Pl. Br. 2 (citing Pl. Br. Ex. 6 and
Bialowons Dep. III at 79). At most, this shows that SmartHeat was confident that, had it entered
into the joint development agreement, it could secure the agreement of its subsidiaries to perform
the work set out in that agreement. However, nothing in the Stanton Group email chain indicates
that SmartHeat ever represented that it was acting as the agent of one of its subsidiaries, such that
it could bind a subsidiary contractually.
After carefully reviewing the record evidence, the Court concludes that plaintiffs have
not met their burden of showing that SmartHeat has the “legal right, authority or ability” to
obtain documents from its subsidiaries on demand. DeSmeth, 1998 WL 74297, at *9.
SmartHeat owns majority shares in its subsidiaries, but in practice it does not actually control
them, engage in substantial common operations with them, regularly obtain documents from
them, or contractually bind them. SmartHeat therefore does not control documents merely
because its subsidiaries have those documents in their custody, possession, or control.5
5
SmartHeat also states, based on a questionnaire propounded to 19 employees of the
subsidiaries, that its subsidiaries do not have any responsive documents in their custody,
possession, or control. Def. Br. 5 (citing Def. Br. Ex. C). Absent a sworn affidavit stating that
16
CONCLUSION
For the foregoing reasons, plaintiffs' motion to compel SmartHeat to produce responsive
documents held by its subsidiaries is denied.
When this dispute arose on January 3, 2014, roughly three and a half months remained
until the close of fact discovery on April16, 2014. See Dkt. 76. Accordingly, the parties are
directed, by June 20, 2014, to submit a proposed revised case management plan, setting forth a
schedule under which merits discovery will conclude no later than September 26, 2014, about
three and a half months from the date of this order.
Pa;!A~n~e~
SO ORDERED.
United States District Judge
Dated: June 12, 2014
New York, New York
an identified person has performed a defined search for responsive documents, the Court is
skeptical of this representation. However, because the Court holds that documents held by
SmartHeat's subsidiaries are not within SmartHeat's control, the Court need not rely on
SmartHeat's representation as to the existence of such documents.
17
Disclaimer: Justia Dockets & Filings provides public litigation records from the federal appellate and district courts. These filings and docket sheets should not be considered findings of fact or liability, nor do they necessarily reflect the view of Justia.
Why Is My Information Online?