Manchester Management Company, LLC et al v. Echo Therapeutics, Inc. et al
Filing
65
OPINION AND ORDER. For the reasons stated in this Opinion, the Echo Defendants' motion for sanctions is DENIED. The Clerk of Court is directed to terminate the motion pending at docket entry 56. SO ORDERED. re: 56 MOTION for Sanctions filed by Michael Goldberg, Shepard Goldberg, Echo Therapeutics, Inc. (Signed by Judge Katherine Polk Failla on 3/14/2018) (rjm)
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
------------------------------------------------------X
:
MANCHESTER MANAGEMENT COMPANY, :
LLC, MANCHESTER ALPHA, L.P., JEB
:
PARTNERS, L.P., in its individual and
:
derivative capacity, JAMES E. BESSER,
:
and DONALD E. BESSER,
:
:
Plaintiffs,
:
:
v.
:
:
:
ECHO THERAPEUTICS, INC., MICHAEL
GOLDBERG, SHEPARD GOLDBERG,
:
:
ALEC GOLDBERG, PLATINUM
:
MANAGEMENT (NY) LLC, MARK
:
NORDLICHT, BERNARD FUCHS, and
MEDICAL TECHNOLOGIES INNOVATION :
ASIA, LTD.,
:
:
Defendants, :
:
:
ECHO THERAPEUTICS, INC.,
:
Nominal Defendant. :
:
------------------------------------------------------ X
USDC SDNY
DOCUMENT
ELECTRONICALLY FILED
DOC #: _________________
DATE FILED: March 14, 2018
______________
16 Civ. 9217 (KPF)
OPINION AND ORDER
KATHERINE POLK FAILLA, District Judge:
On November 29, 2016, Plaintiffs Manchester Management Company,
LLC, Manchester Alpha, L.P., JEB Partners, L.P., James E. Besser, and Donald
Besser (collectively, “Plaintiffs”) filed a complaint in this District along with an
ex parte application for a temporary restraining order (“TRO”). In their
complaint, Plaintiffs claimed that they had been misled in their purchase of
securities in Echo Therapeutics, Inc. (“Echo”); they laid blame for that
deception at the feet of three individuals associated with Echo — cousins
Michael and Shepard Goldberg and Michael’s son Alec (together with Echo, the
“Echo Defendants”) — as well as the hedge fund Platinum Management (NY)
LLC (“Platinum Management”), its co-owners Mark Nordlicht and Bernard
Fuchs (with Platinum Management, the “Platinum Defendants”), and a Chinese
company, Medical Technologies Innovation Asia, Ltd. (“MTIA”) (with the Echo
and Platinum Defendants, “Defendants”). In their request for injunctive relief,
Plaintiffs claimed that a contemplated transaction between Echo and MTIA that
was scheduled to close imminently would result in the improper expropriation
to China of Echo’s intellectual property.
The Court granted the application for a TRO and, after expedited
discovery, convened a two-day-long hearing (the “Hearing”) on Plaintiffs’ motion
for a preliminary injunction on December 8 and 9, 2016. After concluding, on
the concededly incomplete record before it, that Plaintiffs had not met their
burden of demonstrating irreparable harm or a likelihood of success on the
merits, the Court denied Plaintiffs’ motion. Ten days later, before Defendants
responded to the complaint, Plaintiffs voluntarily dismissed their lawsuit
pursuant to Federal Rule of Civil Procedure 41(a)(1)(A)(i).
The Echo Defendants contend that Plaintiffs’ lawsuit was a precipitous —
indeed, vexatious — action, whose ruinous consequences cannot be remedied
merely by its dismissal. In consequence, the Echo Defendants seek sanctions
under the mandatory review provision of the Private Securities Litigation
Reform Act of 1995 (the “PSLRA”), 15 U.S.C. § 78u-4(c)(1), Federal Rule of Civil
Procedure 11, 28 U.S.C. § 1927, and the Court’s inherent power. The Court
2
understands Echo’s frustrations, but cannot find on this record that the
lawsuit was either frivolous or vexatious. Accordingly, and as detailed in the
remainder of this Opinion, the Court denies the Echo Defendants’ motion.
BACKGROUND 1
A.
Factual Background
Because this motion focuses on Plaintiffs’ conduct in this litigation, the
Court will address only briefly the parties’ interactions before November 29,
2016. Echo is a medical device company that focuses on non-invasive
continuous glucose monitoring (“CGM’’) and associated technologies. (Compl.
¶ 1). In or about December 2013, Echo entered into a License, Development
and Commercialization Agreement (the “Licensing Agreement”) with MTIA,
pursuant to which Echo granted MTIA rights to develop, manufacture, market
and distribute Echo’s CGM system in China. (Id. at ¶ 19). 2 To a degree
disputed vigorously by the parties, the Licensing Agreement permitted transfer
1
The facts in this section are drawn from Plaintiffs’ complaint (“Complaint” or “Compl.”
(Dkt. #1)); the affidavits and declarations submitted in connection with this litigation
(cited using the conventions “[Name] PI Decl.” and “[Name] Sanctions Decl.”); and the
transcripts of the hearing on Plaintiffs’ motion for a preliminary injunction (cited using
the convention “Tr.” (Dkt. #44, 48)). For ease of reference, the Echo Defendants’
supporting memorandum is referred to as “Def. Br.” (Dkt. #59); Plaintiffs’ opposition
memorandum as “Pl. Opp.” (Dkt. #61); and the Echo Defendants’ reply memorandum as
“Def. Reply” (Dkt. #63).
2
The parties dispute whether the Licensing Agreement was extant in 2016. (Compare Pl.
Opp. 4-5, with Def. Reply 4-5; see also Tr. 6 (“That is because the licensing amendment
filed with the [Form 8-K] on or about November 23, we have found out is, in fact, based
upon a licensing agreement that was terminated by Echo in or about September
2014.”)). Plaintiffs argue that MTIA had failed to make a required payment; Defendants
rejoin that Echo’s Board of Directors had waived the requirement, though no written
memorialization of this waiver was produced during the Hearing.
3
of certain of Echo’s intellectual property to MTIA, though Echo retained
ownership over such property. (Id.).
Also in December 2013, Echo and several Platinum-related entities
entered into a Securities Purchase Agreement (the “SPA”) for the purchase of
more than 1.8 million shares of Echo stock. (Compl. ¶ 21). Platinum obtained
a seat on Echo’s Board of Directors, and nominated Dr. Michael Goldberg, who
later became Board Chairman in February 2015. (Id. at ¶ 24 n.7). Michael’s
cousin Shepard Goldberg was elected to the Board in June 2014 after a
contentious proxy fight. (Id. at ¶ 25). 3 In September and December of 2014,
various Platinum-related entities infused cash into Echo. (Id. at ¶¶ 27-28, 31).
In January 2016, NASDAQ initiated procedures to delist Echo; stated
reasons included the failure to meet stockholders’ equity requirements and the
failure to hold an annual stockholders’ meeting. (Compl. ¶ 43). In that month,
and then again in May 2016, Plaintiffs purchased a total of $800,000 of Echo’s
10% senior secured convertible notes (the “Notes”) through a Confidential
Private Placement Memorandum (the “PPM”). (Id. at ¶¶ 3, 11-13). As a result
3
According to the Complaint, Alec Goldberg was hired as Manager of Business
Development for Echo in June 2014. (Compl. ¶ 29). The younger Goldberg’s name
came up during the preliminary injunction hearing, though he was not called as a
witness by either side. (See Tr. 235-37, 250-51). But in recounting that fact, the Court
does not adopt the Echo Defendants’ conclusion that the naming of Alec Goldberg as a
Defendant is evidence of the bad faith of Plaintiffs’ lawsuit. (See, e.g., Def. Br. 2 n.3).
As just noted, Alec Goldberg was employed during the relevant time period as Manager
of Business Development at Echo, and he was involved with Michael Goldberg in
reviewing financing offers submitted by Bai Ge of MTIA. (Tr. 235-36). That Alec
Goldberg was not called as a witness demonstrates to this Court only that he was not
deemed probative by either side of the issue of Plaintiffs’ claimed need for preliminary
injunctive relief — not that he was an improper party to the lawsuit.
4
of their purchases, Plaintiffs obtained “a security interest in the assets of Echo,
including, but not limited to, Echo’s intellectual property.” (Id. at ¶ 12).
Plaintiffs observe that various Platinum-related entities were subject to
civil and criminal investigations and/or litigation in 2016. (See, e.g., Compl.
¶¶ 6-10, 45-46). This turmoil, it is alleged, then spread to Echo: “Since in or
about July 2016 to date, Echo has been in a state of constant and acute
financial distress.” (Id. at 48). Echo’s alleged reactions to this distress resulted
in Plaintiffs’ lawsuit.
B.
Procedural Background
1.
The Complaint and the TRO
Plaintiffs filed the Complaint on November 29, 2016. The key factual
assertions were as follows:
As set forth herein, the Platinum Defendants, Echo,
Michael Goldberg (“M. Goldberg”) and Shepard
Goldberg
(‘‘S.
Goldberg”)
made
material
misrepresentations and/or omissions in connection
with Echo’s offer and sale of $6,000,000 of 10% senior
secured convertible notes (the “Notes”), of which
Plaintiffs
purchased
$800,000.
These
misrepresentations and/or omissions occurred through
the means of a Confidential Private Placement
Memorandum (“PPM”). In the PPM, Defendants
intentionally and carefully concealed that Echo’s
business and board of directors were under the direct
and absolute control of the Platinum Defendants in
violation of Federal Securities Laws. Through the
Platinum Defendants’ undisclosed dominion over Echo,
the Defendants have and continue to plunder Echo’s
trade secrets, including its state-of-the-art CGM
technology in violation of the Economic Espionage Act
of 1996 (as amended by the Defend Trade Secrets Act of
2016).
***
5
The Goldberg Defendants, in their positions of control
over Echo’s board of directors, have ensured that the
Platinum Defendants’ instructions to plunder the assets
of Echo were carried out. To this day, the Platinum
Defendants, both directly and through the Goldberg
Defendants, are proceeding to plunder Echo’s trade
secrets by providing them to Defendant Medical
Technologies Innovation Asia, Ltd. (“MTIA”), which has
substantial ties to the Platinum Defendants and the
Goldberg Defendants, the full extent of which is not yet
known.
(Compl. ¶¶ 3, 5). The Complaint alleged ten causes of action, including, as
relevant here, claims under Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934 (the “Exchange Act”), 15 U.S.C. §§ 78j(b) and 78t(a), and Rule 10b5 promulgated thereunder, 17 C.F.R. § 240.10b-5. (Id. at ¶¶ 116-27).
Concurrent with the Complaint, Plaintiffs filed an application for a
temporary restraining order. 4 The TRO application focused in particular on the
possibility that Echo CGM technology — in which Plaintiffs, by dint of their
investment, had an interest — was being improperly transferred out of Echo’s
control and into MTIA’s for little or no consideration. In support of the
application, Plaintiffs included a sworn statement from Thomas Bishop, who
had only a few days earlier left Echo as its Vice President of Operations and
Product Development. (Bishop PI Decl.). Bishop began his affidavit with a
primer on Echo and its CGM technology, including his estimate that “[s]ince
4
The Court finds it curious that the Echo Defendants continue to make much of the ex
parte nature of the TRO application, because the Court understood this issue to have
been resolved at the Hearing. Counsel for Plaintiffs told the Court at the time of the
TRO, and contemporaneous documents confirm, that Echo’s counsel had specifically
disclaimed representation of the company or its representatives in the litigation at the
time of its filing. (See Whelan Sanctions Decl., Ex. D).
6
2007, … Echo has invested, at least, one hundred million dollars
($100,000,000) in CGM technology.” (Id. at ¶ 3). He then recounted a lengthy
history of his interactions with representatives of both Platinum-related entities
and MTIA; Bishop contended that Echo had striven not to provide certain
source code and algorithms to MTIA, reasoning that such material was outside
of the scope of the Licensing Agreement, but that certain individuals had
provided such information, and contemplated providing additional information,
to MTIA for no additional compensation. (See, e.g., id. at ¶¶ 12-21, 30; see also
id. at ¶ 37 (“It is my belief that the Licensing Agreement is a mechanism by
which Platinum Partners, the Goldberg Defendants and MTIA are attempting to
transfer, for little to no cost to MTIA, Echo’s intellectual property that was
developed at a cost of over $100,000,000. The Licensing Agreement did not
provide MTIA with the right to take full access to Echo’s intellectual
property[.]”)). Bishop coupled his IP concerns (which, he claims, were shared
throughout Echo’s R&D team) with concerns that “Platinum Partners, through
M. Goldberg’s long association with the company, may have controlled Echo.”
(Id. at ¶ 23 5; see also id. at ¶ 30 (noting that severance package for outgoing
Echo CEO Scott Hollander “upset everyone in Echo’s R&D team … because it
appeared that Hollander agreed to transfer [Echo intellectual property] to MTIA
for consideration of the Goldbergs agreeing to pay Hollander $420,000 in
severance”)).
5
Platinum Partners Value Arbitrage Fund L.P. was alleged to be the “flagship hedge fund
for Platinum [Management.]” (Compl. ¶ 2).
7
Plaintiff James Besser built on these twin concerns in his own
supporting affidavit. (Besser PI Decl.). After recounting Plaintiffs’ investments
in Echo, Besser catalogued several putative misstatements and material
omissions that, he claimed, made clear that “Platinum had and exercised
complete control and domination over Echo.” (Id. at ¶ 10; see also id. at ¶ 64
(“Plaintiff[s] would never have purchased the Notes and agreed to Platinum
being the Collateral Agent had Plaintiffs known that Platinum (and its officers)
were the undisclosed principals of Echo or had Plaintiffs known the material
and ongoing connections between M. Goldberg and Platinum, none of which
were disclosed in the PPM”)). Besser also described financing offers that
Plaintiffs had made to Echo that, as Besser explained, were “far superior to
that offered by MTIA.” (Id. at ¶ 24; see also id. at ¶ 46 (noting “no legitimate
business purpose” in threat to “shutter” Echo rather than accept financing
from Plaintiffs)). These dealings caused Besser to conclude that “purloining
Echo’s intellectual property rights out from under Echo and to MTIA is the goal
behind Platinum, M. Goldberg, S. Goldberg, and MTIA’s conduct.” (Id. at
¶ 24)). Finally, Besser explained the need for emergent relief: After appearing
to settle its disputes with Plaintiffs in October 2016, Echo unexpectedly
changed course without giving the contractually-required notice and entered
into an amendment with MTIA to the Licensing Agreement — one that Plaintiffs
believed violated the terms of the Notes. (Id. at ¶¶ 58-63).
The Court issued a TRO that same day, and set a hearing on Plaintiffs’
preliminary injunction motion for December 8, 2016. (Dkt. #3). The Court also
8
ordered limited discovery on an expedited basis. (Id.). Thereafter, Plaintiffs
moved for alternate service on MTIA; the Court denied the first application
without prejudice, and granted the second application on December 6, 2016,
two days before the scheduled hearing. (Dkt. #4-7, 13-15, 20).
Also on December 6, the Court received opposition papers from the Echo
Defendants. (Dkt. #21-22). At the end of the day, the Court held a telephonic
conference with counsel for Plaintiffs and counsel for certain of the Platinum
Defendants. (Dkt. #30). Counsel for Mark Nordlicht protested the late
deposition notice received by his client, citing questions of fairness and undue
burden. Counsel suggested that the burden was particularly acute for
Nordlicht because, in the Court’s parlance, he “ha[d] no horse in the TRO race,”
and that indifference evidenced “the degree of control or interest he ha[d] in
these matters.” (Id. at 23). Plaintiffs’ counsel responded, however, that
Plaintiffs had an interest in Nordlicht’s testimony:
[W]e believe Mr. Nordlicht has information and evidence
that would help us establish that burden [of proving
entitlement to continued injunctive relief], because
frankly we believe there is a relationship, a strong
relationship of him being an undisclosed principal and
Platinum being an undisclosed principal, of Mr. Fuchs
being an undisclosed principal, and the information we
want from Mr. Nordlicht goes directly to that issue, and
we think we can establish that on a preliminary
injunction basis, which would support the entirety of
the preliminary injunction.
(Id. at 24). After hearing from the parties, the Court permitted Plaintiffs two
hours of deposition testimony from Nordlicht. (Id. at 26-28).
9
2.
The Preliminary Injunction Hearing
The hearing on Plaintiffs’ application for a preliminary injunction began
on December 8, 2016. In attendance were counsel for, and representatives of,
Plaintiffs and the Echo Defendants, and counsel for Mark Nordlicht. No
representative of MTIA was present.
The Court heard brief introductory statements from the parties. (Tr. 69). Plaintiffs then called six witnesses, beginning with Thomas Bishop, the
former Echo VP of Operations and Product Development. Bishop hewed largely
to the factual assertions he had made in his affidavit, and offered
interpretations of the Licensing Agreement. (See, e.g., id. at 14 (“So I believe
that the [Licensing Agreement] gave MTIA the ability to manufacture the
product and distribute the product, to use it and to further its development,
but it did not include the specific intellectual property that was owned by Echo;
in particular, the algorithms that were developed by Echo that allowed the
signal to be effectively processed.”); see also id. at 77-79 (discussing bases for
concern that Echo would lose control over its intellectual property to MTIA)).
On cross-examination, Bishop was provided with a copy of the Licensing
Agreement, and was directed to the definition of Echo “know-how” — which, in
contrast to Bishop’s earlier testimony, included Echo algorithms. (Tr. 51-57). 6
Bishop was also asked, among other topics, about his understanding of the
6
Bishop explained that his understanding of the Licensing Agreement was influenced by,
and shared by, then-CEO Scott Hollander. (See Tr. 54 (“The decision not to provide the
algorithms was made between myself and a discussion with Scott Hollander who was
the CEO at the time who, we discussed and agreed that our interpretation, it was not
included in the license agreement.”)).
10
royalty rates for MTIA’s use of Echo intellectual property. (Id. at 63-65). And
defense counsel sought Bishop’s acknowledgment that the Licensing
Agreement only restricted Echo’s ability to develop its intellectual property in
China. (Id. at 67-68).
The next witness was former Echo CEO Scott Hollander. Hollander
discussed his interactions with various Platinum representatives, including
Bernard Fuchs and Alice Chen, and with Bai Ge of MTIA. (See, e.g., Tr. 90-98).
Hollander also discussed various efforts, most of which were unsuccessful, to
obtain financing for Echo in 2016. (Id. at 103-12). Current CEO Alan
Schoenbart then testified about the Licensing Agreement (in particular, its
viability vel non in late 2016), and his dealings with MTIA and Platinum. (See,
e.g., id. at 125-27). Schoenbart also pushed back on Plaintiffs’ argument that
their offer was superior to MTIA’s, and opined that a principal stumbling block
to Echo’s ability to obtain necessary financing was Plaintiff James Besser:
There [were] just a lot of complex issues, and the
investors weren’t — the investors, the main investor
that wasn’t agreeing to this was Mr. Besser, and we
couldn’t move forward with our financing. So we did the
bridge in September and tried to, you know, work
through the complexities until it became that the
complexities weren’t going to get worked out, and Mr.
Besser sent a letter, like cease and desist letter, and
here is my terms or something like that, or he had sent
terms, and he was upset we didn’t accept his terms.
(Id. at 141). On cross-examination, Schoenbart related that he had no
concerns that MTIA would act beyond its authority under the Licensing
11
Agreement, or that the Platinum Defendants would misappropriate Echo’s
technology. (Id. at 165-66). 7
Plaintiffs called both Mr. Shepard Goldberg and Dr. Michael Goldberg.
Mr. Goldberg discussed, among other things, conversations with James Besser
concerning the latter’s “wish to participate, his wish to stop the Chinese
partnership from investing.” (Tr. 187). Mr. Goldberg was also shown
numerous emails, including emails from Platinum representatives such as
Mark Nordlicht. (See, e.g., id. at 197-202, 204-07). For his part, Dr. Goldberg
was questioned about the PPM, including restrictions on Echo’s participation
in future financing. (Id. at 215-19). He was also questioned about his prior
affiliation with, and interactions with representatives of, Platinum-related
entities. (Id. at 219-22). Plaintiffs’ counsel and Echo’s counsel pressed
Dr. Goldberg about the ostensible failure of MTIA to comply with its obligations
under the SPA. (Id. at 223-30, 244-45). And Dr. Goldberg testified about the
competing finance proposals presented to Echo in 2016. (Id. at 231-34, 23641; see also id. at 251-53).
The final witness was Plaintiff James Besser. Early in his testimony,
Besser discussed the due diligence he undertook preliminary to Plaintiffs’
investment in Echo. Commenting on snippets of information concerning Echo
that had come out in the testimony of other witnesses, Besser testified that he
7
During his testimony, Schoenbart also explained how the litigation had compromised
Echo’s relationship with MTIA, to the point of rendering it unlikely that the $5 million
financing deal would take place. (Tr. 169-72). In this setting, Schoenbart mentioned a
press release issued by Plaintiffs concerning the TRO two days before the Hearing. (Id.
at 172-75). James Besser was also questioned about the press release. (Id. at 283-84).
12
would not have invested in Echo had he known the information. (See, e.g.,
Tr. 264 (“If, based on the descriptions that I have heard here today, if the
meetings [involving Fuchs, Chen, Echo, and MTIA personnel] were related to
the developmental milestones and the intimate details of the product, that’s far
beyond any kind of involvement that I have ever had with a company.”); see
also id. at 308 (“What I’m objecting to is a pattern of heavy investment in the
day-to-day operation and research activities of the company by affiliates of a
significant investor who appeared to only own 9.9 percent of the voting stock of
the company.”)). Besser also recounted his discussions with Echo
representatives concerning Plaintiffs’ financing proposals in 2016 (e.g., id. at
269-75), and the events that led to the filing of the Complaint (e.g., id. at 27682). On cross-examination, among other things, Besser acknowledged that he
had not read, or had not read with care, certain Echo documents. (Id. at 28489, 297-98, 300-01).
3.
The Court’s Decision
The next day, December 9, 2016, the Court conducted oral argument on
Plaintiffs’ motion. During the Court’s questioning, Plaintiffs’ counsel
commented on the absence of evidence regarding the Platinum Defendants and
MTIA, and went so far as to request an adverse inference from the Court:
Your Honor, that would have been very helpful with
respect to presenting evidence on that issue had Mr.
Fuchs shown up for his deposition, produced
documents pursuant to the order. Had he shown up at
yesterday’s hearing, it would have been helpful and if
MTIA showed up or actually contacted me at all with
13
respect to producing documents or making themselves
available even if it was telephonically for a deposition.
He never contacted me with respect to asking for an
extension [at] any point in time. We know MTIA has
access to a significant amount of funds, just to the
investments they made. We know [MTIA] and Mr. Bai
Ge came to the United States on multiple occasions and
we know he has some proficiency in English. They
never made any attempt to contact us, MTIA or Mr.
Fuchs. I can assure you that would have been a central
focus of this discovery and certainly my questions
yesterday on that issue.
***
With respect to Mr. Fuchs and MTIA’s failure to show, I
think that would have provided significant additional
evidence with respect to the relationship with Platinum.
That failure to show and that failure to produce
documents, I believe an adverse inference can be made
with respect to how Platinum controlled Echo.
(Tr. 338-39, 341). 8
The Court heard brief closing arguments from the parties, and adjourned
for several hours before rendering an oral decision denying the motion. The
8
These sentiments were reiterated in counsel’s summation:
Your Honor, briefly, in closing, again, not to belabor the point, but
we have had the prejudice of not having the ability to have a fully
developed record. We don’t have the ability to have a fully
developed record with, I think, two of the key parties in this case
that would provide a tremendous amount of clarity to the
relationships between MTIA, Echo, and Platinum. It would provide
a tremendous amount of clarity, particularly with Mr. Fuchs,
concerning why he was advocating on Platinum’s behalf for the
transfer of certain technology. And it is because — and with MTIA,
it would have provided a tremendous amount of clarity with respect
to what happened back in 2014 and why that payment wasn’t
made and whether it was something that was agreed upon between
MTIA and Echo that that payment would not have had to have been
made, that it was some type of understanding. That would have
all been very, very powerful information that — who knows what
would have happened had we been able to get that information?
(Tr. 374).
14
Court began, appropriately, by complimenting the parties for their efforts in
such a compressed time frame and by explaining its decision to credit the
testimony of the various witnesses. (Tr. 380-81). It then addressed, and
denied, Plaintiffs’ request for an adverse inference, though it recognized the
reasons why Plaintiffs’ evidentiary record was incomplete. (Id. at 381-82).
The Court then proceeded to consider the standard for preliminary
injunctive relief and found that Plaintiffs had failed to meet their burden,
beginning with the requirement of irreparable harm. The Court found that, at
the time they sought the TRO, Plaintiffs had misperceived that “a
consummation of Amendment No. 2 would result in the expropriation of Echo’s
intellectual property to China with the attendant loss of control over that
property and the possible shutting down of Echo’s U.S. operations.” (Tr. 384).
The Court found, to the contrary, that witnesses on both sides were keen to
preserve the long-term viability of Echo, and that “this dispute really does boil
down to a very stark difference of opinion about the best way to keep Echo
afloat and to get this concededly beneficial technology to market.” (Id. at 38485). It also found that Plaintiffs’ arguments on irreparable harm proceeded
from a “misunderstanding of Echo’s and MTIA’s financing and licensing
obligations,” which it then proceeded to review with the parties. (Id. at 386).
The Court also found that Plaintiffs had failed to prove a likelihood of
success on the merits, although it clarified the scope of its holding:
There were 10 claims for relief in the complaint, but
through today’s conversation, I understand that three
bases in particular are being proffered for injunctive
15
relief: The misappropriation claim; the securities fraud
claim; and the breach of fiduciary duty claim.
Let me be clear. The fact I am finding ultimately the
plaintiffs have not demonstrated likelihood of success
on the merits sufficient to warrant the injunctive relief
they seek is not tantamount to a ruling that their
complaint lacks merit.
(Tr. 387-88). With particular respect to Plaintiffs’ securities fraud claims, the
Court found that “[P]laintiffs have not shown a likelihood of success of their
argument that the business decisions of which plaintiffs now complain are the
product of anything other than the business judgment of the officers and
directors of Echo, faced with some rather trying financial circumstances.” (Id.
at 394).
Reviewing the other factors, the Court found that the balance of
hardships favored Defendants, citing Echo’s precarious financial condition.
(Tr. 396-97). Finally, the Court found that the public interest factor played
“the least prominent role in my calculus.” (Id. at 397). For all of these reasons,
the Court dissolved the temporary restraining order, and left for another day
the scheduling of defense responses to the Complaint. After staying
enforcement of its decision to permit Plaintiffs to consider an emergency appeal
to the Second Circuit, the Court entered an order in line with its oral decision
on December 12, 2016. (Dkt. #29).
4.
The Dismissal and the Motion for Sanctions
On December 15, 2016, the Echo Defendants submitted a letter
requesting a pre-motion conference on their contemplated motion to dismiss.
16
(Dkt. #32). Counsel for Bernard Fuchs submitted a similar letter four days
later. (Dkt. #34).
On December 19, 2016, Plaintiffs filed a notice of voluntary dismissal
without prejudice, pursuant to Rule 41(a)(1)(A)(i). (Dkt. #36-38). Three days
later, on December 22, 2016, counsel for the Echo Defendants sought a premotion conference with the Court to address their belief that a mandatory
sanctions inquiry was warranted under the PSLRA and Rule 11. (Dkt. #39; see
also Dkt. #40 (Plaintiffs’ response)). A conference on the matter was held on
January 10, 2017. (Dkt. #50 (transcript)). At that time, counsel for the Echo
Defendants previewed the bases for their motion:
I would not be making an application under Rule 11. I
would be making an application under the inherent
authority of the Court to review whether actions
brought before it are brought in bad faith or vexatious
or brought with a proper purpose; and, if not, I think
the Court does have that inherent power. I also believe
that the Court has the power to award sanctions under
Section 1927 where an action that lacks a colorable
position is asserted again for vexatious or improper
purposes. So, basically, there are three prongs to the
request for sanctions: the inherent power, Section 1927,
and the PSLRA requirement to consider whether an
action that asserts a securities law violation, whether
that action was brought in accordance with the proper
standard.
(Id. at 4-5). 9
9
Because of the detail with which the Echo Defendants outlined their arguments in the
pre-motion letter and resulting conference, the Court believes that Plaintiffs received
adequate notice of the arguments being made in the motion. For this reason, the Court
rejects Plaintiffs’ arguments concerning violations of Local Rule 7.1(a)(1) and Federal
Rule of Civil Procedure 7. (See Pl. Opp. 13).
17
The Echo Defendants filed their motion papers and supporting
declarations on March 6, 2017. (Dkt. #56-59). Plaintiffs filed their opposition
submissions on April 5, 2017. (Dkt. #60-62). The Echo Defendants filed a
reply brief on April 19, 2017 (Dkt. #63), and a supplemental letter brief on
October 11, 2017 (Dkt. #64).
DISCUSSION
A.
The Court Will Not Impose Sanctions Under the PSLRA
1.
Applicable Law
a.
Sanctions Under Rule 11 Generally
Federal Rule of Civil Procedure 11(b) provides, in relevant part, that
[b]y presenting to the court a pleading, written motion,
or other paper … an attorney … certifies that to the best
of the person’s knowledge, information, and belief,
formed after an inquiry reasonable under the
circumstances:
(1) it is not being presented for any improper purpose,
such as to harass, cause unnecessary delay, or
needlessly increase the cost of litigation;
(2) the claims, defenses, and other legal contentions are
warranted by existing law or by a nonfrivolous
argument for extending, modifying, or reversing existing
law or for establishing new law;
(3) the factual contentions have evidentiary support or,
if specifically so identified, will likely have evidentiary
support after a reasonable opportunity for further
investigation or discovery; and
(4) the denials of factual contentions are warranted on
the evidence or, if specifically so identified, are
reasonably based on belief or a lack of information.
18
Fed. R. Civ. P. 11(b). The rule imposes on attorneys “an affirmative duty to
conduct a reasonable inquiry into the facts and the law before filing.” Bus.
Guides, Inc. v. Chromatic Commc’ns Enters., Inc., 498 U.S. 533, 551 (1991).
The Second Circuit recently offered the following guidance concerning the
imposition of sanctions under Rule 11:
“A pleading, motion or other paper violates Rule 11
either when it has been interposed for any improper
purpose, or where, after reasonable inquiry, a
competent attorney could not form a reasonable belief
that the pleading is well grounded in fact and is
warranted by existing law or a good faith argument for
the extension, modification or reversal of existing law.”
Kropelnicki v. Siegel, 290 F.3d 118, 131 (2d Cir. 2002)
(internal quotation marks omitted). For example, Rule
11 is violated “where it is patently clear that a claim has
absolutely no chance of success under the existing
precedents.” Eastway Constr. Corp. v. City of New York,
762 F.2d 243, 254 (2d Cir. 1985), superseded on other
grounds by rule.
Sorenson v. Wolfson, 683 F. App’x 33, 35 (2d Cir. 2017) (summary order); see
also Star Mark Mgmt., Inc. v. Koon Chun Hing Kee Soy & Sauce Factory, Ltd.,
682 F.3d 170, 177 (2d Cir. 2012) (noting that Rule 11 sanctions for pleadings
are subject to an “objective unreasonableness” standard); cf. Fishoff v. Coty
Inc., 634 F.3d 647, 654 (2d Cir. 2011) (“The fact that a legal theory is a longshot does not necessarily mean it is sanctionable. The operative question is
whether the argument is frivolous, i.e., the legal position has ‘no chance of
success,’ and there is ‘no reasonable argument to extend, modify or reverse the
law as it stands.’” (internal citations omitted)).
Additional restrictions pertain in the context of sanctions imposed for
improper legal (as distinguished from factual) arguments. “Sanctions that
19
involve monetary awards (such as a fine or an award of attorney’s fees) may not
be imposed on a represented party for causing a violation of subdivision (b)(2),
involving frivolous contentions of law. Monetary responsibility for such
violations is more properly placed solely on the party’s attorneys.” Fed. R. Civ.
P. 11, 1993 Advisory Committee Notes. “Whether an attorney’s conduct was
unreasonable should be determined not with the benefit of hindsight, but
rather on the basis of what was objectively reasonable to believe at the time the
pleading, motion or other paper was submitted. Furthermore, all doubts must
be resolved in favor of the signer of the pleading.” In re IPO Secs. Litig., 399 F.
Supp. 2d 369, 371 (S.D.N.Y. 2005) (citations omitted).
b.
Sanctions in Private Securities Actions
In other types of litigation, even where Rule 11 is violated, “sanctions
under Rule 11 are discretionary, not mandatory.” Ipcon Collections LLC v.
Costco Wholesale Corp., 698 F.3d 58, 63 (2d Cir. 2012). Not so in the private
securities litigation context. Instead, the district court is obligated under the
PSLRA in certain circumstances both to consider the plaintiff’s submissions
under Fed. R. Civ. P. 11, and to impose sanctions if violations of that rule are
found:
(1) Mandatory review by court: In any private action
arising under this chapter, upon final adjudication of
the action, the court shall include in the record specific
findings regarding compliance by each party and each
attorney representing any party with each requirement
of Rule 11(b) of the Federal Rules of Civil Procedure as
to any complaint, responsive pleading, or dispositive
motion.
20
(2) Mandatory sanctions: If the court makes a finding
under paragraph (1) that a party or attorney violated
any requirement of Rule 11(b) of the Federal Rules of
Civil Procedure as to any complaint, responsive
pleading, or dispositive motion, the court shall impose
sanctions on such party or attorney in accordance with
Rule 11 of the Federal Rules of Civil Procedure. Prior to
making a finding that any party or attorney has violated
Rule 11 of the Federal Rules of Civil Procedure, the
court shall give such party or attorney notice and an
opportunity to respond.
15 U.S.C. § 78u-4(c)(1)-(2); see also ATSI Commc’ns, Inc. v. Shaar Fund, Ltd.,
579 F.3d 143, 152 (2d Cir. 2009) (“ATSI”); Rombach v. Chang, 355 F.3d 164,
178 (2d Cir. 2004).
“The express congressional purpose” of this provision of the PSLRA is “to
increase the frequency of Rule 11 sanctions in the securities context, and thus
tilt the ‘balance’ toward greater deterrence of frivolous securities claims.” ATSI,
579 F.3d at 152; accord Gurary v. Nu-Tech Bio-Med, Inc., 303 F.3d 212, 219-22
(2d Cir. 2002) (“Gurary III”); Simon DeBartolo Grp., L.P. v. Richard E. Jacobs
Grp., Inc., 186 F.3d 157, 166-67 (2d Cir. 1999). See generally 5A Charles Alan
Wright et al., FEDERAL PRACTICE & PROCEDURE § 1338.1 (3d ed. 2004); William B.
Rubenstein, NEWBERG ON CLASS ACTIONS § 19.28 (5th ed. 2011).
Significantly, however, “[t]he PSLRA … does not in any way purport to
alter the substantive standards for finding a violation of Rule 11, but functions
merely to reduce courts’ discretion in choosing whether to conduct the Rule 11
inquiry at all and whether and how to sanction a party once a violation is
found.” Simon DeBartolo Grp., 186 F.3d at 167.
21
c.
The Presumption for Substantial Violations of Rule 11
What is more, Section 78u-4(c)(3) states a presumption concerning the
appropriate fees to impose and its rebuttal:
(3) Presumption in favor of attorneys’ fees and costs
(A) In general: Subject to subparagraphs (B) and (C), for
purposes of paragraph (2), the court shall adopt a
presumption that the appropriate sanction — (i) for
failure of any responsive pleading or dispositive motion
to comply with any requirement of Rule 11(b) of the
Federal Rules of Civil Procedure is an award to the
opposing party of the reasonable attorneys’ fees and
other expenses incurred as a direct result of the
violation; and (ii) for substantial failure of any complaint
to comply with any requirement of Rule 11(b) of the
Federal Rules of Civil Procedure is an award to the
opposing party of the reasonable attorneys’ fees and
other expenses incurred in the action.
(B) Rebuttal evidence: The presumption described in
subparagraph (A) may be rebutted only upon proof by
the party or attorney against whom sanctions are to be
imposed that — (i) the award of attorneys’ fees and other
expenses will impose an unreasonable burden on that
party or attorney and would be unjust, and the failure
to make such an award would not impose a greater
burden on the party in whose favor sanctions are to be
imposed; or (ii) the violation of Rule 11(b) of the Federal
Rules of Civil Procedure was de minimis.
(C) Sanctions: If the party or attorney against whom
sanctions are to be imposed meets its burden under
subparagraph (B), the court shall award the sanctions
that the court deems appropriate pursuant to Rule 11
of the Federal Rules of Civil Procedure.
15 U.S.C. § 78u-4(c)(3) (emphasis added).
The term “substantial violation” is not defined in the statute. In Gurary
v. Nu-Tech Bio-Med, Inc., 303 F.3d 212 (2d Cir. 2002) (“Gurary III”), the Second
Circuit sought to delimit the term, and, in so doing, to resolve the related
22
issues of “whether a complaint containing both frivolous and nonfrivolous
allegations triggers the statutory presumption, and, if so, whether the presence
of nonfrivolous allegations, by itself, rebuts that presumption[.]” Id. at 219.
After identifying various categories of non-frivolous claims that might appear in
a private securities action, 10 the Second Circuit concluded that “once a
substantial violation is found, the existence of some nonfrivolous claims does
not suffice to rebut the statutory presumption on the ground that full
sanctions would be an unreasonable and unjust burden.” Id. at 222. That led
the Court naturally to define what constituted a “substantial violation” in the
pleading context:
[A] substantial violation occurs whenever the
nonfrivolous claims that are joined with frivolous ones
are insufficiently meritorious to save the complaint as a
whole from being abusive. Under this interpretation,
the district court must examine the qualitative
substance of the nonfrivolous claims in order to assess
whether these claims were, in fact, legitimate filings that
had the potential of prevailing or whether they patently
lacked merit and only narrowly avoided being deemed
frivolous themselves.
Gurary III, 303 F.3d at 222. The Court confirmed, however, that “even if no
substantial failure existed under the PSLRA, partial sanctions might still be
10
See Gurary v. Nu-Tech Bio-Med, Inc., 303 F.3d 212, 220-21 (2d Cir. 2002):
A securities complaint may, however, present frivolous claims
joined with nonfrivolous claims in a wide variety of ways, including
the combination of frivolous claims with [i] valid, winning claims;
[ii] claims lost before a jury but which are meritorious enough to
survive summary dismissal; [iii] claims that, though properly
dismissed at summary judgment because capable of resolution as
a matter of law, presented novel legal issues that could well have
gone in the plaintiff’s favor; and [iv] summarily dismissed claims
that, while not legally frivolous, lack any merit.
23
assessable under ordinary Rule 11 standards to punish not the bringing of the
whole suit, but only of the frivolous claim.” Id.
2.
Discussion
a.
The PSLRA Mandatory Review Provision Is Not
Implicated
To the extent that the Echo Defendants are entitled to sanctions under
Rule 11, it is only by operation of the PSLRA. Rule 11, by its terms, contains a
safe harbor provision, which provides that a motion for sanctions “must not be
filed or be presented to the court if the challenged paper, claim, defense,
contention, or denial is withdrawn or appropriately corrected within 21 days
after service or within another time the court sets.” Fed. R. Civ. P. 11(c)(2).
The Complaint was voluntarily dismissed on December 19, 2016, four days
after the Echo Defendants’ pre-motion letter for sanctions and twenty days
after the Complaint was filed.
The PSLRA omits the safe harbor from its sanctions provision, but
includes, perhaps in its stead, a requirement that the litigation proceed to a
“final adjudication.” That term is not defined in the statute, and the Court now
considers whether Plaintiffs’ entry of a voluntary dismissal without prejudice
qualifies. After reviewing the sparse case law on this issue, the Court adopts
the analysis articulated by Judge Cote in Blaser v. Bessemer Tr. Co., No. 01
Civ. 11599 (DLC), 2002 WL 31359015, at *3 (S.D.N.Y. Oct. 21, 2002), and Unite
Here v. Cintas Corp., 500 F. Supp. 2d 332, 337 (S.D.N.Y. 2007); accord In re
Millennial Media, Inc. Sec. Litig., No. 14 Civ. 7923 (PAE), 2015 WL 3443918, at
*14 n.11 (S.D.N.Y. May 29, 2015). As Judge Cote observed,
24
The PSLRA does not define the term “final adjudication”
and there is little case law on its meaning as it is used
in Section 78u-4(c)(1). “In the absence of [a statutory]
definition,” a court “construe[s] a statutory term in
accordance with its ordinary or natural meaning.” FDIC
v. Meyer, 510 U.S. 471, 476, 114 S. Ct. 996, 127
L.Ed.2d 308 (1994). Black’s Law Dictionary defines
adjudication as “[t]he legal process of resolving a
dispute; the process of judicially deciding a case.”
Black’s Law Dictionary 42 (7th ed. 1999). The American
Heritage Dictionary defines adjudicate as “[t]o hear and
settle (a case) by judicial procedure.” The American
Heritage Dictionary of the English Language 21 (4th ed.
2000). Cf. Sellan v. Kuhlman, 261 F.3d 303, 311 (2d
Cir. 2001) (“When Congress uses a term of art such as
‘adjudicated on the merits’ [in 28 U.S.C.S. § 2254(d)],
we presume that it speaks consistently with the
commonly understood meaning of this term.
‘Adjudicated on the merits’ has a well settled meaning:
a decision finally resolving the parties' claims, with res
judicata effect, that is based on the substance of the
claim advanced, rather than on a procedural, or other,
ground.”). To the extent that plaintiff voluntarily
dismissed her complaint without prejudice pursuant to
Rule 41(a)(1)(i), this dispute has not been “resolv[ed]”
and the Court has not “decid[ed]” the case. Nor has it
“hear[d] and settle[d]” the case. By the plain meaning
of the term, there has been no “adjudication” in this
case, let alone adjudication that is “final.”
Blaser, 2002 WL 31359015, at *3.
Other courts have adopted similar analyses, and this Court finds those
analyses to be persuasive. See, e.g., Hilkene v. WD-40 Co., No. CIV A 04-2253KHV, 2007 WL 470830, at *1 (D. Kan. Feb. 8, 2007) (“The PSLRA does not
define ‘final adjudication,’ but the phrase ordinarily refers to a terminating
decision, such as a verdict, summary judgment or dismissal with prejudice
without leave to amend. … Because the Court dismisses plaintiff's claims
without prejudice and with the opportunity for plaintiff to re-file them in state
25
and/or federal court, the case did not result in a ‘final adjudication.’”
(collecting cases)); see also Great Dynasty Int'l Fin. Holdings Ltd. v. Haiting Li,
No. C-13-1734 EMC, 2014 WL 3381416, at *4-5 (N.D. Cal. July 10, 2014)
(adopting Blaser) (quoting DeMarco v. Depotech Corp., 131 F. Supp. 2d 1185,
1187 (S.D. Cal. 2001), aff'd, 32 F. App’x 260 (9th Cir. 2002) (non-precedential
memorandum order)); cf. In re Cross Media Mktg. Corp. Sec. Litig., 314 F. Supp.
2d 256, 269 (S.D.N.Y. 2004) (“Because this case is dismissed without prejudice
and with leave to re-file, the Court may not have made a ‘final adjudication’
and it may be unnecessary for the Court to rule on the applicability of Rule 11
sanctions at this time.”). 11 Contra Smith v. Smith, 184 F.R.D. 420, 422 (S.D.
Fla. 1998).
The Echo Defendants’ arguments to the contrary pay appropriate
attention to the underlying purposes of the PSLRA, but overlook the
significance of procedural context. What keeps Section 78u-4(c) from being a
strict liability standard is the inclusion of a final adjudication requirement.
However defined, that term means something other than a voluntary dismissal
of a complaint without prejudice a mere twenty days after its filing, even
coupled with a request for injunctive relief. And this case makes plain why
Judge Cote’s reasoning is correct: Plaintiffs filed a ten-count complaint, of
which three involved claims of securities fraud, along with a request for
11
The Echo Defendants’ citation to this decision is somewhat misleading. (Def. Br. 20).
While Judge Patterson in fact conducted a sanctions analysis, he did so only after
making the above-quoted statement that such analysis may be “unnecessary” in the
context of a dismissal with leave to re-file.
26
emergent relief; the Court granted the request, ordered expedited discovery,
and then held a two-day hearing on the propriety of continuing the injunctive
relief. The Court’s decision to dissolve the injunction was, as the parties are
well aware, based on the stringent standards for injunctive relief. (Tr. 383-84).
These standards, as the parties are also well aware, require the Court to
consider not the adequacy of a plaintiff’s pleadings, but rather the evidence
Plaintiffs presented in support of their requested relief. The Court found
simply that that evidence was insufficient. (See id. at 388 (“Let me be clear.
The fact I am finding ultimately the plaintiffs have not demonstrated likelihood
of success on the merits sufficient to warrant the injunctive relief they seek is
not tantamount to a ruling that their complaint lacks merit.”); id. at 393 (“What
I mean is I’m finding insufficient evidence from the plaintiffs of materiality and
scienter.”)). It was not asked, and did not opine, on the adequacy of Plaintiffs’
pleadings.
b.
Plaintiffs’ Complaint Was Not Objectively Unreasonable
Even if mandatory review were applicable, the Court does not find the
“substantial violation” of Rule 11(b) that is a prerequisite for sanctions. In
part, the Court’s implementation of this standard is hampered by issues raised
in the preceding section — in particular, the absence of any challenge to the
adequacy of the Complaint before its voluntary dismissal. Only now do the
Echo Defendants seek this analysis. (See, e.g., Def. Br. 5-6, Def. Reply 1-3).
Plaintiffs’ securities fraud claims were subject to the heightened pleading
requirements of Federal Rule of Civil Procedure 9(b) and the PSLRA, 15 U.S.C.
27
§ 78u-4(b). See, e.g., ATSI, 493 F.3d at 99. As this Court noted in a prior
opinion,
[t]he PSLRA “requires plaintiffs to state with
particularity both the facts constituting the alleged
violation, and the facts evidencing scienter, i.e., the
defendant's intention ‘to deceive, manipulate, or
defraud.’” Tellabs, Inc. v. Makor Issues & Rights, Ltd.,
551 U.S. 308, 313 (2007) (quoting Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 193 & n.12 (1976)) (citing 15
U.S.C. § 78u-4(b)(1), (2)).
To satisfy the scienter
requirement, a complaint must give “rise to a strong
inference that the defendant acted with the required
state of mind.” 15 U.S.C. § 78u-4(b)(2). A “strong
inference” that a defendant acted with scienter is not an
irrefutable inference, though it “must be more than
merely plausible or reasonable[.]” Tellabs, 551 U.S. at
314. It cannot be identified “in a vacuum,” as “[t]he
inquiry is inherently comparative[.]” Id. at 323. A
“strong inference” is an inference that is “cogent and at
least as compelling as any opposing inference one could
draw from the facts alleged.” Id. at 324.
Ong v. Chipotle Mexican Grill, Inc., No. 16 Civ. 141 (KPF), 2017 WL 933108, at
*13 (S.D.N.Y. Mar. 8, 2017).
The Court’s review of the Complaint — conducted only for purposes of
this motion and without meaningful response from Plaintiffs — suggests
deficiencies in pleading reliance and scienter. However, such a finding does
not mandate the issuance of sanctions. Rather, the Second Circuit has
recognized that sanctions under the PSLRA might not be appropriate where a
plaintiff, with leave to amend, would be able to assert a cognizable claim for
securities fraud:
Because we do not believe that the PSLRA was designed
to mandate sanctions in all cases for a complaint that,
if properly pleaded, could state a cognizable claim under
the securities laws, we examine [Plaintiff’s] case to
28
determine whether an amendment could have stated
such a claim.
Had [Plaintiff] been afforded the opportunity to amend
his complaint to allege [the issuer’s CEO’s]
misrepresentations with proper specificity, as he
apparently sought to do, [Plaintiff] could have asserted
a cognizable claim under Rule 10b-5 with respect to his
second two purchases.
Gurary v. Winehouse, 235 F.3d 792, 801-02 (2d Cir. 2000) (“Gurary II”).
On this record, the Court cannot find that Plaintiffs would have been
unable to allege a securities fraud claim with the proper specificity. Here, too,
the Court is careful to distinguish what Plaintiffs could adequately have
pleaded in an amended complaint with what Plaintiffs were able to demonstrate
with truncated discovery at the Hearing. With respect to the Licensing
Agreement, Plaintiffs could have amended the complaint to allege its
termination based on MTIA’s failure to pay the balance due under the SPA.
Similarly, with respect to the undisclosed principal argument, Plaintiffs could
have amended the complaint to argue, as they did at the Hearing, “that [but
for] these material omissions [regarding Platinum], Manchester would never
have entered into the security agreement that defined the collateral
relationship at issue in this litigation and pursuant to which Manchester’s
rights were subordinated to those of MTIA and Platinum.” (Tr. 392).
The Echo Defendants allege additional violations of Rule 11(b) that go
beyond pleading deficiencies. They claim, for example, that Plaintiffs and their
counsel did not exercise appropriate diligence before filing the Complaint. (See
Def. Br. 2-8, 12, 15; Def. Reply 1-3). However, the Court has considered the
29
account from Plaintiffs’ counsel of the investigation that preceded the filing of
the Complaint, and does not find a substantial violation in this regard. (See
Whelan Sanctions Decl.; Pl. Opp. 2). Of note, Plaintiffs had interviewed
Thomas Bishop, Echo’s former VP of Operations and Product Development,
who stated quite clearly in connection with the application for a TRO that “the
Licensing Agreement is a mechanism by which Platinum Partners, the
Goldberg Defendants and MTIA are attempting to transfer, for little to no cost
to MTIA, Echo’s intellectual property that was developed at a cost of over
$100,000,000.” (Bishop PI Decl. ¶ 37). Bishop also expressed concerns, which
he claimed were shared by Echo’s R&D team, that Platinum Partners — the
affiliates of which were by then roiled with allegations of bribery and other
misconduct — “may have controlled Echo.” (Id. at ¶ 23). Bishop reiterated
these concerns during his direct testimony (Tr. 9-48), and though crossexamination may have revealed certain deficiencies in Bishop’s understanding
of the relevant agreements, it did not cause him to recant his earlier testimony.
(See, e.g., id. at 54 (“The decision not to provide the algorithms was made
between myself and a discussion with Scott Hollander who was the CEO at the
time who, we discussed and agreed that our interpretation, it was not included
in the license agreement.”)).
Further corroboration for the allegations in the Complaint was provided
by Keith Krystyniak, Echo’s former Director of Engineering. (Whalen Sanctions
Decl. ¶ 6). Krystyniak confirmed Bishop’s statements that (i) MTIA
representatives had repeatedly insisted on obtaining Echo intellectual property
30
that went beyond the scope of the Licensing Agreement, and (ii) “everyone in
Echo’s Littleton, Massachusetts office believed that MTIA sought to
misappropriate the CGM technology, and that Platinum was enabling MTIA’s
misappropriation.” (Id.).
Plaintiffs’ own representative shared similar views based on firsthand
observations. James Besser related that after Plaintiffs had purchased the
Notes, they learned “that Platinum directly controlled and still controls every
aspect of Echo’s business from financial decisions, appointing and terminating
board members and executives, choice of business partners and vendors and
even, whether Echo was permitted to pay its employees.” (Besser PI Decl. ¶ 9;
see also id. at ¶¶ 32, 64). Besser also recounted various discussions with Echo
management regarding financing proposals, opining that the ones offered by
Plaintiffs were demonstrably superior to those offered by MTIA, and that Echo’s
decision to go with the latter evidenced collusion on the part of MTIA and
Platinum. (See, e.g., id. at ¶¶ 22-28, 33, 37-58). The Court agrees with the
Echo Defendants that Besser should have read with greater care the relevant
agreements. (Def. Br. 12-14). However, this deficiency does not negate
Besser’s account of his dealings with Echo, including: (i) a conversation with
Shepard Goldberg in which the latter indicated that “he would shutter Echo
and terminate all of Echo’s employees” rather than accept Plaintiffs’ offer
(Besser PI Decl. ¶ 45); and (ii) Echo’s entry into, and subsequent violation of,
the standstill agreement with Plaintiffs in October and November 2016 (id. at
¶¶ 58-62).
31
In its discussion of materiality and scienter, the Court explained the
difficulties Plaintiffs confronted as a consequence of the expedited discovery
schedule:
On [materiality], I don't really have a complete sense of
what the meetings with Ms. Chen and Mr. Fuchs
involved. The content, I have a very vague sense. I do
not know about the existence or not of NDAs, nondisclos[ure] agreements. I do not have any indication of
consequent actions by Mr. Fuchs or Ms. Chen, and I
have difficulty on this record finding that this
information is sufficiently material to support a
securities fraud claim for which the appropriate relief is
not damages, but reformation of the agreements.
There is as well a more elemental problem. Even taking
Mr. Besser at his word that he would not have invested
with full knowledge of Platinum's involvement, to state
an actionable claim, I need evidence demonstrating that
Echo and its representatives acted with scienter. I don’t
have it on this record.
(Tr. 393-94).
This Court will not impose sanctions for Plaintiffs’ supposed lack of
diligence on so incomplete a record. As the Court observed, there are key
witnesses from whom the Court did not hear at the Hearing, including
representatives of Platinum Management and MTIA. Because of that, there
remain a number of unanswered questions concerning (i) the interrelationship
between and among various Platinum-related entities, Echo, and MTIA; (ii) the
consequences, if any, of MTIA’s failure to make the payments specified by the
SPA; and (iii) the bona fides of MTIA’s financing proposals. The Court declined
Plaintiffs’ request to draw an adverse inference from the absence of discovery
from MTIA and Platinum (see Tr. 381-82); because this missing evidence would
32
also be probative of the issue of Plaintiffs’ diligence, the Court declines for the
same reasons to impose sanctions on Plaintiffs.
That leaves the portion of Rule 11(b) that proscribes submissions that
are “being presented for any improper purpose, such as to harass, cause
unnecessary delay, or needlessly increase the cost of litigation.” Fed. R. Civ.
P. 11(b)(1). The Echo Defendants claim that Plaintiffs commenced this
litigation for the improper purpose of forcing Echo to accept their financing
proposal, citing as evidence: (i) the Court’s observations during the Hearing
regarding Plaintiffs’ apparent “force-feed[ing]”; (ii) Plaintiffs’ decision to issue a
press release that struck the Court as overly definitive two days prior to the
December 8 hearing; and (iii) Plaintiffs’ representations to the Court in
obtaining the TRO. (See, e.g., Def. Br. 8, 12, 15, 16; Def. Reply 5-7). 12
While Plaintiffs’ conduct was at times more aggressive than the Court
would have preferred, the Court cannot find that the Complaint was filed for an
improper purpose. On the record presented to it, the Court concluded that
“this dispute really does boil down to a very stark difference of opinion about
the best way to keep Echo afloat and to get this concededly beneficial
technology to market” (Tr. 385), and its rejection of Plaintiffs’ arguments of
irreparable harm stemmed, in part, from its belief that these arguments “rest[]
on a misunderstanding of Echo’s and MTIA’s financing and licensing
12
To the extent the latter claim involves materials other than the Complaint, such as the
declarations supporting the TRO request or Plaintiffs’ counsel’s representations to the
Court in connection with Plaintiffs’ requests for emergent relief, such materials are
perhaps better analyzed in the next section. See 15 U.S.C. § 78u-4(c)(1)-(2) (limiting
review to “any complaint, responsive pleading, or dispositive motion”).
33
obligations” (id. at 386). Plaintiffs’ arguments did not carry the day, but
neither did they strike the Court as vexatious.
The Echo Defendants argue otherwise, claiming first that the purpose of
the lawsuit was “to ‘starve out’ the Company so that Plaintiffs could take over
control and force the Company to accept their financing”; they further suggest
that the Court held the same view. (Def. Br. 8-9 & n.12). In its evaluation of
irreparable harm, the Court did observe that Plaintiffs were “content with a
Pyrrhic victory, they’re willing to starve Echo of funding presumably in the
hope that Echo will turn to it for funding.” (Tr. 387). However, that is a far cry
from concluding that the lawsuit was brought for an improper purpose. After
all, Plaintiffs believed — and had reason to believe — that Platinum
Management was improperly directing Echo to transfer its valuable technology,
for insufficient consideration, to MTIA. 13 Were that belief true, Plaintiffs would
have been justified in seeking injunctive relief to prevent that transfer, even at
the expense of depriving Echo of funding from MTIA. The fact remains that
this Court will never know the degree to which Plaintiffs were correct.
The Echo Defendants also cite Plaintiffs’ decision to issue a press release
on December 6, 2016. (Def. Br. 9). The Court has already chastised Plaintiffs
13
Among other things, and as previously noted, Plaintiffs had entered into a standstill
agreement with Echo the preceding month, one provision of which was that “Echo
would not raise any new money unless given 48 hours’ notice to [James] Besser and his
related entities.” (Tr. 154). Echo violated that provision when it “entered into a half a
million dollar bridge loan with an MTIA related entity and then informed us about it
three days” later, on November 21, 2016, approximately one week before this lawsuit
was filed. (Id. at 277-78; see id. at 154-55 (testimony of Schoenbart that Echo did not
provide notice)).
34
for their decision to issue the release, which the Court found to be
insufficiently precise in distinguishing the allegations of the Complaint from
the Court’s decision to grant the TRO. (Tr. 382-83). However, the Court does
not consider the release to be evidence of bad faith. Particularly in light of the
fact that it was issued one week after the TRO application was granted, the
Court accepts Plaintiffs’ explanation that it was issued to counterbalance,
however inartfully, the Form 8-K issued by Echo concerning the lawsuit. (Pl.
Opp. 8-9).
Hindsight being 20/20, the parties and the Court can identify things that
Plaintiffs could have done better when bringing this lawsuit. But the standard
here is one of “substantial violation,” and the Court does not find that the
conduct described in this section amounted to a substantial violation. At the
risk of beating the proverbial dead horse, the Court observes that Plaintiffs’
request for emergent relief failed because of a lack of evidence, and not because
of the frivolity of the allegations in the Complaint. It will not impose sanctions
under the PSLRA.
B.
The Court Will Not Impose Sanctions Under 28 U.S.C. § 1927 or Its
Inherent Power
1.
Applicable Law
As a fallback position, the Echo Defendants request sanctions under 28
U.S.C. § 1927 or the Court’s inherent power. Section 1927 provides in relevant
part that “[a]ny attorney … who so multiplies the proceedings in any case
unreasonably and vexatiously may be required by the court to satisfy
personally the excess costs, expenses, and attorneys’ fees reasonably incurred
35
because of such conduct.” 28 U.S.C. § 1927. The imposition of sanctions
under § 1927 is appropriate only “when there is a finding of conduct
constituting or akin to bad faith.” Sakon v. Andreo, 119 F.3d 109, 114 (2d Cir.
1997). Before reaching such a conclusion, a court “must find clear evidence
that [i] the offending party’s claims were entirely meritless and [ii] the party
acted for improper purposes.” Revson v. Cinque & Cinque P.C., 221 F.3d 71, 79
(2d Cir. 2000).
Similarly, “[i]n order to impose sanctions pursuant to its inherent power,
a district court must find that: [i] the challenged claim was without a colorable
basis and [ii] the claim was brought in bad faith, i.e., motivated by improper
purposes such as harassment or delay.” Enmon v. Prospect Capital Corp., 675
F.3d 138, 143 (2d Cir. 2012) (internal quotation marks omitted). “When a
district court invokes its inherent power to impose attorney’s fees or to punish
behavior by an attorney in ‘the actions that led to the lawsuit ... [or] conduct of
the litigation,’ which actions are taken on behalf of a client, the district court
must make an explicit finding of bad faith.” United States v. Seltzer, 227 F.3d
36, 41-42 (2d Cir. 2000) (quoting Hall v. Cole, 412 U.S. 1, 15 (1973)).
The Second Circuit has “declined to uphold awards [of attorneys’ fees]
under the bad-faith exception absent both clear evidence that the challenged
actions are entirely without color and are taken for reasons of harassment or
delay or for other improper purposes and a high degree of specificity in the
factual findings of the lower courts.” Wilson v. Citigroup, N.A., 702 F.3d 720,
724 (2d Cir. 2012) (internal quotation marks and citations omitted); see also
36
Milltex Indus. Corp. v. Jacquard Lace Co., 55 F.3d 34, 39-40 (2d Cir. 1995)
(reversing sanction because attorney’s actions in representing client were
neither “entirely without color [of legal legitimacy]” nor undertaken with
“improper purposes”).
“[A]n award made under § 1927 must be supported by a finding of bad
faith similar to that necessary to invoke the court’s inherent power.” Oliveri v.
Thompson, 803 F.2d 1265, 1273 (2d Cir. 1986). “[T]he only meaningful
difference between an award made under § 1927 and one made pursuant to
the court’s inherent power is ... that awards under § 1927 are made only
against attorneys or other persons authorized to practice before the courts
while an award made under the court’s inherent power may be made against
an attorney, a party, or both.” Enmon, 675 F.3d at 144 (quoting Oliveri, 803
F.2d at 1273) (internal quotation marks omitted).
2.
Discussion
The Court is no more willing to impose sanctions under either of these
provisions. Plaintiffs’ litigation failed in the short term — in part for reasons
beyond their control — and it was promptly discontinued, but it was not
indefensible, and it was not commenced for an improper purpose. The Court
has addressed most of the Echo Defendants’ sanctions arguments at pages 27
through 35 of this Opinion. It discusses here their contentions that Plaintiffs
misled the Court to obtain the TRO. (See Def. Br. 10-12, 16-17).
The Court does not consider itself to have been misled. On the issue of
the reasons for proceeding ex parte, the Court fully credits Plaintiffs’ counsel’s
37
explanation that Echo’s eventual counsel had, at that time, disclaimed
representation of the company on the matter. (Tr. 383). On the issue of the
arguments for injunctive relief, the Court understands — and finds that
Plaintiffs sincerely believed — in the arguments they made, even if they were
unable to present evidence sufficient to continue the relief. While certain
documents were admissible of multiple or contrary interpretations, Plaintiffs’
discussions with percipient witnesses at Echo, plus James Besser’s own
interactions, gave them grounds to believe that something was amiss with their
investments. The Court was concerned, and expressed concern, that counsel
for Plaintiffs may have understated the hardship of injunctive relief to Echo.
(See Tr. 397 (“I understood on November 29th that preserving the status quo
would not harm the defendants, and what I've heard yesterday suggests or has
caused me to change my views in that regard[.]”)). However, the Court does not
believe any understatement was deliberate, and it considered that fact in
concluding that “the balance of hardships favors defendants” and promptly
dissolving the injunction. (Id.). Finally, to the extent the Echo Defendants
claim consequential damages, the Court cannot accept their arguments in full,
and credits the evidence of alternate causes provided by Plaintiffs. (Whelan
Sanctions Decl., Ex. E). In short, Plaintiffs had a good-faith basis, and proper
motives, for bringing the instant lawsuit, and the Court will not impose
sanctions on them or their counsel.
38
CONCLUSION
For the reasons stated in this Opinion, the Echo Defendants’ motion for
sanctions is DENIED. The Clerk of Court is directed to terminate the motion
pending at docket entry 56.
SO ORDERED.
Dated:
March 14, 2018
New York, New York
__________________________________
KATHERINE POLK FAILLA
United States District Judge
39
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?