Industrial Technology Ventures, L.P. v. Pleasant T. Rowland Revocable Trust et al
Filing
151
DECISION AND ORDER denying 134 Motion for Summary Judgment; granting in part and denying in part 136 Motion for Summary Judgment; and denying 138 Motion for Summary Judgment consistent with this Decision and Order. Signed by Hon. Michael A. Telesca on 4/28/15. (JMC)
UNITED STATES DISTRICT COURT
WESTERN DISTRICT OF NEW YORK
____________________________________
INDUSTRIAL TECHNOLOGY
VENTURES LP,
Plaintiff,
DECISION & ORDER
-vs-
08-CV-6227T
PLEASANT T. ROWLAND REVOCABLE
TRUST, W. JEROME FRAUTSCHI LIVING
TRUST, W. JEROME FRAUTSCHI, and
DIANE C. CREEL,
Defendants.
____________________________________
INTRODUCTION
Plaintiff Industrial Technology Ventures LP (“ITV”), a Georgia Limited
Partnership, brings this diversity action against Defendants Pleasant T.
Rowland Revocable Trust, W. Jerome Frautschi Living Trust, (collectively
“the Trusts”), W. Jerome Frautschi individually, and Diane C. Creel,
claiming that the defendants violated the Securities Exchange Act of 1934
(“Exchange Act”) and committed various State law torts in connection with
the financing and eventual sale of a company known as Ecovation (“the
Company”), a start-up wastewater treatment technology company located
in Rochester, New York.
Specifically, ITV, which had invested in
Ecovation, claims that Creel, the CEO, Chairman of the Board, and
President of Ecovation, at all relevant times, inter alia, conspired with the
defendant Trusts, who had also invested in Ecovation and had guaranteed
several loans made to Ecovation, to enrich themselves at the expense of
other investors in the Company. ITV alleges that the defendant Trusts took
advantage of Ecovation’s need for capital, and with Creel’s assistance,
obtained control of the Company by providing loan guarantees to the
Company. In doing so, ITV contends that the defendants acted at the
expense of the Company’s remaining shareholders, whose investments
were severely diluted as a result of defendants’ alleged conduct.
ITV
claims, inter alia, that the defendants fraudulently induced ITV and other
shareholders to sell a substantial number of shares in the Company for an
unreasonably low price in light of the material facts known only to the
defendants at the time of the sale, and intentionally withheld from ITV and
other shareholders.
Plaintiff alleges ten counts against the defendant including claims of:
(1) breach of fiduciary duty against Creel and Frautschi; (2) breach of
fiduciary duty against the Trusts; (3) lender liability for breach of fiduciary
duty against the Trusts; (4) aiding and abetting breach of fiduciary duty
against Frautschi and the Trusts; (5) unjust enrichment against the Trusts;
2
(6) two separate claims of tortious interference with business relationships
against the Trusts and against Creel; (7) securities fraud against all
Defendants; (8) common law fraud against all Defendants; and (9) civil
conspiracy against all Defendants. Dkt. No. 116.
Currently pending before the Court are three motions for summary
judgment filed by all four defendants.1
Individual defendants Creel and
Frautschi have each filed motions seeking summary judgment against ITV
on all counts pending against them. Dkt. Nos. 134, 138. The defendant
Trusts have filed a joint motion for summary judgment against ITV asking
that the complaint against the trusts be dismissed in its entirety.
Dkt.
No. 136. For the reasons stated below, the Trusts’ motions are granted in
part and denied in part, and the individual defendants’ motions are denied.
BACKGROUND
The following facts are drawn from the parties’ voluminous Rule 56
statements,2 and will be summarized in their most abbreviated form. As is
1
By Order dated April 23, 2015, this action was transferred to the Honorable Michael A.
Telesca.
2
The Court notes that Plaintiff ITV’s Rule 56 submissions run afoul of Local Rule 56(a)(3), which
requires valid citations to admissible evidence, essentially “inviting this Court to peruse a
haystack looking for needles.” Fernandez v. DeLeno, 71 F.Supp.2d 224, 227 (S.D.N.Y. 1999).
While the Court notes the deficiency in ITV’s opposition, this Court has “broad discretion to
determine whether to overlook a party's failure to comply with local rules.” D.H. Blair & Co., Inc.
v. Gottdiener, 462 F.3d 95. 108 n.2 (2d Cir. 2006) (internal quotation marks omitted) (citations
omitted). Therefore, the Court in its discretion will overlook ITV’s non-compliance with the Local
Rules on this occasion, but Plaintiff’s counsel is reminded to comply with Local Rule 56 in future
filings with the Court.
3
required, they are viewed in the light most favorable to ITV, as the nonmoving party.
I.
The Parties
Plaintiff ITV is a venture capital firm that invests in emerging
businesses.
In 2002, Ecovation, a start-up Company engaged in the
business of wastewater treatment, was seeking capital to expand its
business. ITV invested in Ecovation, and as part of its agreement to invest
in the Company, ITV appointed one of its managers, Edward Wilson
(“Wilson”) to became a member of the Board of Directors of Ecovation.
Several other investors also invested in Ecovation at that time. Sterling
Venture Partners, L.P. (“Sterling”), a private equity fund, invested in the
Company and appointed Eric Becker (“Becker”) to sit on Ecovation’s
Board. As owners of preferred stock, ITV and Sterling (the “Institutional
Investors”) enjoyed, in addition to the right to designate Board members,
liquidation preferences, and rights of first refusal on future equity.
In
September, 2002, Evocation filed an Amended Certificate of Incorporation
that created and defined the rights associated with Series A preferred
stock.
Pleasant Rowland and her husband, defendant Jerome Frautschi, also
invested in Ecovation through their trusts, the Pleasant T. Rowland
4
Revocable Trust and the W. Jerome Frautschi Living Trust. In addition to
investing in Ecovation, the Trusts also guaranteed significant loans made
to Ecovation. Defendant W. Jerome Frautschi also became a member of
the Board of Directors of Ecovation.
In 2003, Ecovation hired Diane Creel (“Creel”), former Chairman and
CEO of Earth Tech, another business in the environmental engineering
sector, to serve as Ecovation’s CEO, President, and Chair of the Board of
Directors. Pursuant to her employment agreement, Creel was to serve for
a period of two years with an automatic renewal for an additional two years.
Creel testified that she came to Ecovation seeking “an opportunity for me to
try to build another company . . . . So I went from 9,000 employees to 11,
flying around on private jets to riding in coach, having a driver in L.A. to
driving my own SUV through the snow in Rochester to have that
opportunity to try to grow another business.” Pl. Ex. 5 (Creel Dep.) 28-32.
Creel’s compensation package included an annual salary of $435,000
along with a potential annual bonus and 1.2 million common stock options
at $.95 per share. Under the terms of her employment agreement, the
Compensation Committee of the Board of Directors had discretion over
Creel’s compensation and bonus.
5
Frautschi, Rowland, nor any of their agents had met Creel before she
became CEO of Ecovation. Creel, however, had other professional
relationships connecting her to Frautschi and other Board members.
II.
Evocation’s Existing and Proposed Lines of Credit
In 2002, the Company faced serious funding problems. It had raised
some capital by issuing shares of Series A stock in 2002 and 2004, and
also obtained a $4 million line of credit from U.S. Bank that was guaranteed
by Frautschi. However, the Series A equity raise and the U.S. Bank loan
were not sufficient to sustain the Company’s rapid growth.
Ecovation considered entering into a $30 million financing agreement
with Newcourt Capital U.S.A., Inc. (“CIT”) in 2004. CIT provided the
Company with proposed terms, but the negotiations did not result in a
formal agreement. At that point the Trusts intervened and offered a loan to
Ecovation with similar terms, and the Board authorized management to
negotiate a formal loan agreement with the Trusts based on those terms.
The Trusts’ Line of Credit (“Trusts’ LOC”) included a $6 million tangible
net worth covenant to provide assurance that the Company could repay the
loan. The loan agreement provided, among other things, that Creel would
remain full-time President of the Company. Should Creel leave Ecovation
for any reason, the Trusts would have the ability to immediately terminate
6
the loan. See Def. Ex. 83, §5.1. (“[A]ll notes shall be immediately pre-paid
upon a change of control of the Borrower.”) The final loan agreement also
provided the Trusts with warrants to purchase common stock for $.50 per
share in addition to any interest on any outstanding balance on the line of
credit.
On June 30, 2004, Ecovation entered into the Trusts’ LOC, which had a
maturity date of December 31, 2006, and which provided Ecovation with
the ability to borrow up to $30 million if it remained in compliance with the
agreement. Frautschi joined the Board shortly after the execution of the
Trusts’ LOC.
The Trusts’ LOC’s Adjusted Tangible Net Worth covenant (the same as
the one proposed by CIT) required the Company to maintain an adjusted
net worth of $6 million in order to avoid default. Creel testified that she
didn’t get “overly concerned about” whether the Company would meet the
net worth requirement because she thought it could be met. Creel Dep. at
321-22.
Ecovation breached this covenant by July of 2005, about one year
later. By Written Consent, the parties agreed that the Trusts would receive
500,000 shares of common stock at a price of $0.01 per share in exchange
7
for a waiver by the Trusts of the Company’s breach of the Adjusted
Tangible Net Worth Covenant through December 31, 2005.
In the meantime, the Board charged Creel with investigating financing
options to cure the Company’s default in the fall of 2005. Creel advised the
Board in December, 2005, that the two companies interested in a possible
acquisition of Ecovation, 3M and Veolia, would not entertain and/or commit
to a proposal at that time. On December 21, the Board unanimously voted
to retain J.P. Morgan to pursue a sale or refinancing of the Company.
Thus, when the debt alternatives did not come to fruition, Creel again
presented the Board with a proposal from the Trusts extending the existing
waiver to June 30, 2006, this time in exchange for converting the warrants
to purchase shares of common stock into warrants to purchase Series A
stock for $.50 per share. Creel urged the Board to accept the proposal, and
the Board followed her recommendation, entering into a First Amendment
and Waiver Agreement (“Waiver Agreement”) with the Trusts on January 1,
2006. The Waiver Agreement shortened the life of the loan by six months,
and provided the Trusts with regular business reports, the right to review
any and all proposed design-build financing contracts as well as the
opportunity to fund or not fund any design-build financing contract. During
the Waiver Agreement negotiations, Frautschi resigned from the Board in
8
November, 2005, based on his concern that “there might be a possible
conflict in that we had a major commitment in the financing of Ecovation.”
Pl. Ex. 8 (Frautschi Dep.) 60. Frautschi then negotiated and ultimately was
granted a release and waiver of liability relating to his Board position as a
condition of the extension of the waiver. His seat was then filled by
Creighton “Kim” Early (“Early”), a former colleague of Creel’s from Earth
Tech on December 15, 2005. Creel continued to assure the Board that
“06/30 will not be an issue.” Pl. Ex. 62.
III.
Competing Term Sheets
By April 2006, the Board began internal financing discussions, which
involved the proposal of a bridge loan by Becker, Sterling’s representative.
Unbeknownst to Becker, the Trusts expressed to Creel a dislike for Sterling
and the Institutional Investors in general.
On June 1, 2006, Creel reported to the Board that the sale process
had failed, and requested a formal proposal for the potential bridge loan.
She shared this information with the Trusts, and apprised them of
Ecovation’s financing needs.
The Institutional Investors submitted a term sheet outlining the terms
of a proposed financing vehicle for Ecovation (“the Investor Term Sheet” or
“ITS”), on June 14, 2006. Among other things, the ITS proposed an
9
$18 million bridge loan that was convertible into equity in order to finance
operations and customer contracts while the Company finalized an even
larger equity financing with existing and outside investors. At the time the
ITS was submitted, Ecovation had already drawn more than $24 million on
the Trusts’ Line of Credit, and the June 30, 2006 maturity date was only
two weeks away.
Two days later, Creel discussed the ITS with the Trusts’
representative, but not with Frautschi or Rowland. Creel finally met with
Frautschi and Rowland on June 19, 2006. During that meeting, the Trusts
expressed willingness to negotiate a line of credit of $50 million under
terms similar to the existing Line of Credit that was set to expire on
June 30, 2006. Creel then informed the Board on June 20, 2006, six days
after the ITS was submitted, that the Trusts would submit an amended term
sheet in a few days. Creel’s handwritten notes of her discussion with Board
member Early on June 20, 2006, regarding the Trusts’ alternative proposal
indicate, “accept this agreement – [indecipherable] foreclose.” Pl. Ex. 20.
On June 22, 2006, the Trusts submitted a competing proposal to the
Investor Term Sheet (“Trusts’ Term Sheet” or “TTS”), which provided for a
$50 million Line of Credit. The number of warrants demanded by the Trusts
was based on, and was in the same ratio as the warrant coverage
10
contained in the ITS. The Trusts’ Term Sheet also provided that the Board
of Directors would increase from seven directors to eleven, and that Creel’s
compensation matters would be subject to review and approval by the
Trusts.
According to ITV, Creel and the Trusts had begun strategizing an
exclusive financing agreement months earlier. In support of this fact,
Plaintiff submits a worksheet from a Microsoft Excel workbook entitled,
“Term Sheet Analysis,” dated June 14, 2006. Pl. Ex. 31 (analysis of the
impact on stock ownership if the Trusts received 51% of outstanding
Series A stock). Additionally, it submits an affidavit from a computer
science and data forensics analysis that concludes that four documents,
including Plaintiff’s Exhibit 31, were created as early as April 20, 2006. Pl.
Ex. 106. The Defendants submit contradicting evidence in the form of a
sworn declaration by Ken Garcia (“Garcia”), CFO of Ecovation, stating that
the document was not created until after the Company received the Trusts’
Term Sheet on June 22, 2006. Garcia Decl. ¶¶ 30-31. Defendants further
maintain that the specific contents of Plaintiff’s Exhibit 31 were input on
June 27, 2006. The spreadsheet indicates that the Trusts requested the
same ratio of warrants for Series A Preferred Stock to debt that the other
11
Institutional Investors requested in their June 14, 2006 term sheet. Def.
Exs. 34 & 37.
According to Becker, the Trusts, through Creel, had threatened to
foreclose on the Line of Credit and accelerate the outstanding debt if the
Board did not accept their proposal. Pl. Ex. 3 (Becker Dep.) at 56-57.
Likewise, Wilson testified that the Board “had a few days until the lender
was to foreclose . . . . I mean, there was no alternative. There was no other
option than accept the term sheet.” Pl. Ex. 16 (Wilson Dep.) at 316-17.
Becker and Wilson also testified that Creel threatened to quit the Company
if the Trusts’ term sheet was not accepted, and the Trusts threatened to
foreclose if Creel quit. Becker Dep. at 103-04; Wilson Dep. at 320. The
other four directors, including Early, all executed sworn declarations that
uniformly state that no threats of foreclosure were ever communicated. Call
Decl. ¶¶ 16-18; Early Decl. ¶¶ 17-19; Patchen Decl. ¶¶ 15-17; Slocum
Decl. ¶¶ 18-19.
The Investor Term Sheet was then withdrawn on June 23, 2006.
Board member David Patchen testified that “the [investor] term sheet had
been withdrawn so the Company had no other alternative.” Pl. Ex. 12
(Patchen Dep.) 229-30. According to Paul DiBella of ITV, “[o]ur support in
withdrawing that - - we were not at a point in time to be playing chicken . . .
12
. We were under the threat of foreclosure, and I certainly understand what
it means to take a zero, and that’s what we were being faced with.” Pl.
Ex. 6 (DiBella Dep.) at 191-93. An emergency conference of the Board was
held on June 24, 2006, to vote on the TTS. With only one proposal on the
table, Ecovation’s Board ultimately voted to accept the Trusts’ Term Sheet.
IV.
Outside Financing
After the Company executed the Waiver Agreement, Michael DeRosa
(“DeRosa”) of Element Partners (“Element”), a venture capital fund,
contacted Creel in June, 2006, expressing interest in leading and
organizing a round of financing. DeRosa had previously been affiliated with
ITV and was involved with ITV’s investment in Ecovation, serving as an
observer to the Board of Directors. At that time he did not make a formal
offer of financing to Ecovation, nor was a term sheet prepared by Element
Partners. DeRosa testified, however, that Element was willing to prepare a
term sheet and prepared to move quickly. Pl. Ex. 17 ¶ 16; Pl. Ex. 20.
Without any feedback from Creel, DeRosa believed the Company “just kind
of went cold on us.” Def. Ex. 5 (DeRosa Dep.) at 173-75.
On June 18, 2006, Wilson inquired about the status of the ITS and
reminded Creel about DeRosa’s proposal.
13
Some weeks later, Creel ended up speaking with DeRosa regarding
Element’s proposal. On June 20 or 23, Ecovation CFO Ken Garcia sent
DeRosa a non-disclosure agreement that DeRosa returned on June 23,
2006, after the Investor Term Sheet had already been withdrawn.
V.
Creel’s Compensation; Second Amended Line of Credit
After the Board approved the TTS, the Trusts agreed not to foreclose on
the line of credit on June 30, 2006, while a formal loan agreement was
developed in July. At the same time, Creel was negotiating an amended
employment agreement and a formal employee retention plan with the
Compensation Committee that would guarantee her a multi-million dollar
payout at the sale of the Company. Creel shared information relating to
these negotiations with the Trusts’ representatives.
In a memorandum dated July 14, 2006, the Compensation
Committee recommended that the Board approve certain compensation
actions with regard to Creel, Garcia, and other Ecovation employees, and
generally reflected the agreement reached between Creel and the
Compensation Committee.
The memorandum was submitted on
Ecovation’s letterhead. According to Wilson, he “didn’t consider it to be in
the best interest of all the shareholders.” Wilson Dep. 525. Nonetheless, he
voted to submit the agreement to the Board for approval because “[t]his
14
was the best we could do to satisfy her so that this financial arrangement
could close.” Id. at 524. The Board approved the amended employment
agreement, which was executed on July 24, 2006. On the same date that
the Company entered into the amended employment agreement with
Creel, Ecovation also entered into the Second Amendment to the Line of
Credit3 with the Trusts.
The Trusts requested that Rick Kollauf (“Kollauf”), their personal
financial advisor, take one of the four new positions on the Board and
permitted Creel to fill the other three positions. While the Amended Line of
Credit Agreement made clear that any matters relating to Creel’s
compensation had to be approved by independent directors and subject to
review and approval by the Board, the Trusts now had four additional
designees on the Board in addition to Creel and Early.
Soon after the Company executed the amended employment
agreement and Amended Line of Credit, Wilson resigned from the
Compensation Committee, stating “because the credit agreement contains
a covenant that gives lender approval authority for all issues regarding
employee incentive pay and retention compensation and more specifically
all compensation matters related to you, the committee no longer has
3
The Second Amendment to the Line of Credit contained the principal terms in the Trusts’ Term
Sheet, including the ability to designate four representatives to the Board of Directors.
15
relevance.” Pl. Ex. 58. He goes on to state that “[g]etting the Company
funded was in the best interest of all the shareholders and the
compensation committee did what was necessary to facilitate closure of the
transaction.” Id. Following Wilson’s resignation, and, with Board approval,
the Compensation Committee was restructured and Kollauf became Chair
on August 25, 2006.
In 2007, Ecovation hired an independent consultant, Frederic W.
Cook & Co. (“Cook”), to make recommendations to the Board regarding an
employee retention and compensation plan that had been proposed by
management. Pl. Ex. 121. A draft of the Cook report recommended a
change to the portion of Creel’s employment agreement relating to a
severance payment upon a change of control of the Company that would
have also deprived her of certain vested contractual rights that she had
obtained previously through a Board vote. As a result, Creel contacted
Kollauf, now head of the Compensation Committee, to ask Cook to remove
that recommendation from its report as outside of the report’s scope.
After reviewing the proposed draft, Creel contacted Cook by e-mail
on January 30, 2007:
Right now I am entitled contracturally [sic] to the severance and
one third of the IRP. I have extended my tenure contractually to
the Company through a sale in exchange for these issues in my
contract. This was done as a favor to the [Trusts], otherwise
16
we wouldn’t have a funded functional company. If I have to
work two years for a buyer to get IRP or severance, we can
void the contract I signed agreeing to stay and I will go now.
When I do go, the Company is obligated to pay back the debt,
which it cannot do and basically would be bankrupt if I did
leave.
Bottom, bottom line, I am not giving up severance and the
Company can’t let me because voiding my contract creates a
falling house of cards.
Pl. Ex. 122.
Cook removed the recommendation from its report before it was
finalized and presented to the Compensation committee. Def. Ex. 346.
VI.
IDFA Conference and Sale of Ecovation
Following the execution of the Second Amendment to the Line of
Credit and the resulting shift in Board control, Becker asked Frautschi
whether the Trusts would consider purchasing all of Sterling’s shares in
September, 2006. The Trusts declined.
Several months later, Creel and another Ecovation executive, Daniel
Hagen (“Hagen”), attended an industry conference presented by the
International Dairy Food Association (“IDFA”) in Orlando, Florida from
January 15-17, 2007. There, Creel and Hagen briefly met with
representatives from Ecolab, a company that had been identified by
J.P. Morgan as a potential purchaser in the previous sale attempt in May of
17
2006, and a “joint marketing alliance” was discussed. Creel Dep. at
1020-21; Hagen Aff. ¶ 3.
On January 18, Creel flew from Florida to Madison, Wisconsin, to
meet with the Trusts. Shortly thereafter, Frautschi contacted Becker with an
offer to purchase all of Sterling’s stock, which Becker accepted. Frautschi
also came in contact with Wilson, who agreed to sell Fratuschi two-thirds of
ITV’s stock. No written stock purchase agreement, representations, or
warranties were made, and the sale concluded quickly on January 30,
2007.
Six months later, Creel advised the Board that Ecovation may receive
a preemptive offer for the Company. According to Creel, there was no
discussion with Ecolab about a potential acquisition until a meeting in
Minneapolis on May 15, 2007. Creel Dep. at 1020.
Ecolab ultimately purchased Ecovation for $210 million on February 5,
2008.
DISCUSSION
I.
Summary Judgment Standard
Summary judgment may not be granted unless “the pleadings,
depositions, answers to interrogatories, and admissions on file, together
with the affidavits, if any, show that there is no genuine issue as to any
18
material fact and that the moving party is entitled to a judgment as a matter
of law.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247 (1986). A party
seeking summary judgment bears the burden of establishing that no
genuine issue of material fact exists. See Adickes v. S.H. Kress & Co., 398
U.S. 144, 157 (1970). “[T]he movant must make a prima facie showing that
the standard for obtaining summary judgment has been satisfied.”
11 Moore's Federal Practice 56.11[1] [a] (Matthew Bender 3d ed.). “In
moving for summary judgment against a party who will bear the ultimate
burden of proof at trial, the movant may satisfy this burden by pointing to
an absence of evidence to support an essential element of the nonmoving
party's claim.” Gummo v. Village of Depew, 75 F.3d 98, 107 (2d Cir. 1996)
(citing Celotex Corp. v. Catrett, 477 U.S. 317, 322–23 (1986)), cert. denied,
517 U.S. 1190 (1996).
The burden then shifts to the non-moving party to demonstrate
specific facts showing that there is a genuine issue for trial. Anderson, 477
U.S. at 250. To do this, the non-moving party must present evidence
sufficient to support a jury verdict in its favor. Id. at 249. “[F]actual issues
created solely by an affidavit crafted to oppose a summary judgment
motion are not ‘genuine’ issues for trial.” Hayes v. N.Y. City Dep't of Corr.,
84 F.3d 614, 619 (2d Cir. 1996). Summary judgment is appropriate only
19
where, “after drawing all reasonable inferences in favor of the party against
whom summary judgment is sought, no reasonable trier of fact could find in
favor of the nonmoving party.” Leon v. Murphy, 988 F.2d 303, 308 (2d Cir.
1993). The parties may only carry their respective burdens by producing
evidentiary proof in admissible form. Fed.R.Civ.P. 56(c)(1). The underlying
facts contained in affidavits, attached exhibits, and depositions, must be
viewed in the light most favorable to the non-moving party. U.S. v. Diebold,
Inc., 369 U.S. 654, 655 (1962).
II.
Pending Motions
Plaintiff alleges ten counts against the various Defendants in its Second
Amended Complaint. Dkt. No. 116. For the sake of clarity, the issues
contained in Defendants' Motions for Summary Judgment shall be grouped
together and decided based upon the similarity of the claims: (1) breach of
fiduciary duty and aiding and abetting; (2) lender liability; (3) unjust
enrichment; (4) tortious interference; and (5) fraud and civil conspiracy.
A. Breach of Fiduciary Duty
Plaintiff claims, in Count I, that Creel and Frautschi breached their
fiduciary duties to the Board and shareholders when: (1) Creel
recommended to the Board that the Company accept the Waiver Extension
and the Trusts’ Term Sheet; (2) Creel intentionally delayed action with
20
respect to the Investor Term Sheet, which would have saved the Company
from foreclosure and prevented the Trusts from diluting the value of the
Institutional Investors’ shares; (3) Creel failed to renegotiate the terms of
the Waiver Extension and Trusts’ Term Sheet, with the Trusts at armslength; and (4) when Frautschi worked with Creel to induce the Board to
accept the Waiver extension under unfavorable terms, while he was a
member of the Board. 2nd Am. Compl., ¶¶ 136-37. ITV further alleges, in
Count II, that the Trusts, as control shareholders, breached their fiduciary
duties by colluding with Creel to compel the Board to accept the Waiver
Extension and TTS under the threat of foreclosure and agreeing to set
Creel’s compensation package in exchange for her assistance in securing
acceptance of the Waiver Extension and TTS. 2nd Am. Compl., ¶¶ 143-44.
1. Breach of Fiduciary Duty Claims
The parties agree that Delaware law applies to the breach-offiduciary-duty and related aiding and abetting counts.4 See Creel Mem. 16,
Fratuschi Mem. 11, Trusts’ Mem. 11, e.g., ITV Mem. 40; see generally,
The elements of breach of fiduciary duty claim under Delaware law
are: “(1) that the fiduciary duty exists and (2) that the fiduciary breached
that duty.” In re Tropicana Entm't, LLC, 520 B.R. 455, 470 (Bankr. D. Del.
4
The parties do not specifically address choice of law with regard to the remaining Counts;
however, both sets of briefings are in agreement in applying New York law to Counts III through
X.
21
2014) (citing York Lingings v. Roach, No. 16622–NC, 1999 WL 608850, *2
(Del. Ch. July 28, 1999)). “For a fiduciary duty to exist, there must first be a
fiduciary relationship.” Id. Under Delaware law, a director is a fiduciary of a
corporation. Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.
1993). It is undisputed that Creel and Frautschi owed fiduciary duties to
Ecovation.
With regard to shareholder liability, a controlling shareholder owes
fiduciary duties to other shareholders. In re Primedia, Inc. Derivative Litig.,
910 A.2d 248, 257 (Del. Ch. 2007) (citing Kahn v. Lynch Commc'n Sys.,
Inc., 638 A.2d 1110, 1113–14 (Del. 1994)).
A controlling shareholder
exists when the shareholder: “(1) owns more than 50% of the voting power
of a corporation; or (2) exercises control over the business and affairs of
the corporation.” Feldman v. Cutaia, 956 A.2d 644, 657 (Del. Ch. 2007)
(internal quotation omitted), aff'd, 951 A.2d 727 (Del. 2008). Bare
allegations that the subject shareholder possesses the “potential ability to
exercise control” are insufficient. Primedia, 910 A.2d at 257. And, although
a plaintiff need not demonstrate that the subject shareholder “oversaw the
day-to-day operations” of the corporation, “[a]llegations of control over the
particular transaction at issue are enough.” Id. ITV has submitted evidence
that the Trusts had influence over Creel, and that Creel and the Trusts
22
were sharing information and/or collaborating such that the Trusts’ gained
control over the business affairs of Ecovation, or, at the very least, control
over the June, 2006, financing process. Moreover, factual issues exist as to
whether the Trusts’ involvement with Company caused it to enter into the
challenged transactions.
With regard to ITV’s breach of fiduciary duty claims, the following issues
of fact preclude summary judgment in favor of Defendants: (1) whether
Creel intentionally delayed the financing process in order to obtain Board
approval of the Trusts’ Term Sheet; (2) whether the Trusts threatened to
foreclose on the Line of Credit in order to gain approval by the Board of the
TTS; (3) whether Creel failed to pursue financing sources as alternatives to
the Trusts’ LOC per the Board’s direction; (4) whether Creel withheld
information from the Board regarding outside investors, specifically,
DeRosa and Element Partners; (5) whether Frautschi and the Trusts
concealed from the Board their intentions with respect to foreclosure on the
LOC and their involvement in future capital raises for the Company; and
(6) whether Frautschi and the Trusts promised Creel that they would
improve her compensation if she assisted the Trusts in getting their
financing proposals approved.
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Defendants’ motions for summary judgment dismissing Counts I and
II of the Second Amended Complaint are denied.
2.
Aiding/Abetting
ITV also brings claims against Frautschi and the Trusts for aiding and
abetting Creel’s breaches of her fiduciary duties. Specifically, ITV claims
that Frautschi and the Trusts had actual knowledge that Creel breached
her duty to the Institutional Investors, and provided substantial assistance
in doing so. 2nd Am. Compl., ¶¶ 157-59.
Under Delaware law, to recover on a claim for aiding and abetting
another's breach of fiduciary duty, a plaintiff must prove four elements:
“(I) the existence of a fiduciary relationship, (ii) a breach of the fiduciary's
duty, (iii) knowing participation in the breach by the non-fiduciary
defendants, and (iv) damages proximately caused by the breach.”
In re Rural Metro Corp. S'holders Litig., 88 A.3d 54, 80 (Del. Ch. 2014)
(citing Malpiede v. Townson, 780 A.2d 1075, 1096 (Del. 2001)).
The Trusts and Frautschi move for summary judgment dismissing
ITV’s claim on the grounds that there is no evidence that Creel breached a
fiduciary duty and that the remaining Defendants did not knowingly
participate in any breach committed by Creel. Trusts’ Br. 35-36; Frautschi
Br. 12-16. These arguments must be rejected, as ITV has submitted
24
evidence establishing some collusive efforts between the Defendants,
discussed supra in Section II (A)(1), creating material issues of fact with
regard to the level of participation the Trusts and Frautschi had in their
dealings with Creel and, in turn, the Board. See, e.g., Gotham Partners,
L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160, 172 (Del. 2002)
(holding that aiding and abetting a breach of fiduciary duty requires a
showing of an underlying breach in the fiduciary duty). For the same
reasons, Defendants have failed to prove the non-existence of an issue of
fact as to Frautschi’s or the Trusts’ knowledge of the alleged breach.
Because Defendants’ motions for dismissal of the underlying breach
of fiduciary duty claims have already been denied, the Court must also
deny their motions on the aiding and abetting claims.
As a result, Defendants’ motions for summary judgment dismissing
Count IV of the Second Amended Complaint is denied.
B. Lender Liability
Plaintiff contends that the Trusts, as lenders to the Company, owed a
fiduciary duty to the other shareholders, including ITV, and breached that
duty by abusing their control over the Company to dilute the investments of
ITV and the other Institutional Investors. 2nd Am. Compl., ¶¶ 149-54.
25
The elements of such a claim for lender liability are set forth in the
case of In re KDI Holdings, Inc., 277 B.R. 493 (Bankr. S.D.N.Y. 1999). As
stated therein:
Lender liability is established by application of the
instrumentality doctrine, which requires: (1) Control, not mere
majority or complete stock control, but complete domination,
not only of finances, but of policy and business practice in
respect to the transaction attacked so that the corporate entity
as to this transaction had at the time no separate mind, will or
existence of its own; and (2) Such control must have been used
by the defendant to commit fraud or worse, to perpetrate the
violation of a statutory or other positive legal duty, or a
dishonest and unjust act in contravention of plaintiff's legal
rights; and (3) The aforesaid control and breach of duty must
proximately cause the injury or unjust loss complained of.
277 B.R. at 515-16 (quotation and citations omitted).
To establish lender liability through the use of the instrumentality
doctrine in the context of a creditor-debtor relationship, “courts require a
strong showing that the creditor assumed actual, participatory and total
control of the debtor. Merely taking an active part in the management of the
debtor corporation does not automatically constitute control....” Krivo
Indust. Supply Co. v. Nat’l Distillers and Chem. Corp., 483 F.2d 1098, 1105
(5th Cir. 1973), reh'g denied, 490 F.2d 916 (5th Cir. 1974). See also Nat’l
Westminster Bank USA v. Century Healthcare Corp., 885 F.Supp. 601, 603
(S.D.N.Y. 1995).
26
[L]ender liability is predicated on an unmistakable showing that
the subservient corporation in reality has no separate,
independent existence of its own and was being used to further
the purposes of the dominant corporation. Suggestions by a
major lender for a defaulted debtor, even when coupled with a
threat of the exercise of its legal rights if the debtor does not
comply, are both commonplace and completely proper.
Westminster, 885 F. Supp. at 603.
Because there is a genuine issue of fact as to whether the Trusts
colluded with Creel to gain control over Ecovation’s business affairs,
generally and, with respect to the June 2006 transaction, whether the
Trusts leveraged the threat of foreclosure to leave the Board without a
viable alternative, Defendants’ motion for summary judgment dismissing
Count III alleging lender liability is denied.
C. Tortious Interference
In Counts VI and VII, ITV alleges that ITV developed a business
relationship with Ecovation of which the Trusts and Creel had knowledge,
and interfered with that relationship when they delayed acting upon, and
then ultimately rejected the Investor Term Sheet.
2nd Am. Compl.,
¶¶ 169-74. As a result, ITV was unable to make further investments in the
Company, and the Board’s acceptance of the Trusts’ Term Sheet severely
diluted the value of the shares owned by ITV. Id., ¶ 175. Plaintiff advances
similar claims with regard to Defendants’ alleged interference with its rights
27
under the Amended Certificate of Incorporation, which provided certain
rights of first refusal. Id., ¶ 179-183.
Under New York law, the elements of a claim for tortious interference
with prospective business relations are (1) business relations with a third
party; (2) the defendant's interference with those business relations; (3) the
defendant acted with the sole purpose of harming the plaintiff or used
dishonest, unfair, or improper means; and (4) injury to the business
relationship. Nadel v. Play–By–Play Toys & Novelties, 208 F.3d 368, 382
(2d Cir. 2000).
Defendants move for summary judgment dismissing ITV’s tortious
interference claims because: (1) the Trusts and Creel were not strangers to
the business relationships at issue; (2) ITV failed to adduce evidence of
wrongful means; and (3) ITV failed to adduce evidence that the Trusts
interfered with ITV’s rights under an Amended Certificate of Incorporation.
Generally, “a claim for tortious interference will lie only against a
stranger who improperly interferes with a contract between two contracting
parties.” IMG Fragrance Brands, LLC v. Houbigant, Inc., 679 F. Supp.2d
395, 407 (S.D.N.Y. 2009). For a successful tortious interference with
contract claim, defendant must be a third party in relation to the contract,
“that is, he or she may not be a party to the contract at issue.”
28
In re MF Global Holdings, No. 11 Civ. 7866(VM) 2014 WL 667481, at *20
(S.D.N.Y. Feb. 11, 2014); see also Roselink Investors, L.L.C. v. Shenkman,
386 F.Supp.2d 209, 228 (S.D.N.Y. 2004) (citing Finley v. Giacobbe,
79 F.3d 1285, 1295 (2d Cir. 1996)). It is clear that the claim “‘must be
based on a non-party improperly interfering with a contract between two
contracting parties,’ and cannot be based on the actions of a director or
officer in his official capacity.” Rockland Exposition, Inc. v. Alliance of Auto.
Serv. Providers, 894 F.Supp.2d 288, 336–37 (S.D.N.Y. 2012) (quoting
Scuderi v. Springer, No. 03 Civ. 2098 (RO), 2004 WL 2711048, at *2
(S.D.N.Y. Nov. 29, 2004) (emphasis in original)). “A corporate officer or
director, when acting within the scope of his or her authority, ‘is not a third
party vis-a-vis the corporation and as such cannot interfere with [the
corporation's] own contract.’” Conocophillips v. 261 East Merrick Rd. Corp.,
428 F.Supp.2d 111, 122 (E.D.N.Y. 2006) (quoting Roselink Investors, 386
F.Supp.2d at 228); see also Murtha v. Yonkers Child Care Ass'n, Inc.,
45 N.Y.2d 913, 914 (1978) (stating that a “director of a corporation is not
personally liable to one who has contracted with the corporation on the
theory of inducing a breach of contract, merely due to the fact that, while
acting for the corporation, he has made decisions and taken steps that
resulted in the corporation's promise being broken”). Thus, “[a] corporate
29
officer or director generally cannot be liable for tortiously interfering with a
contract between the corporation and a third party.” Roselink Investors, 386
F. Supp.2d at 228 (internal quotation omitted).
Despite this general rule, “a narrow exception exists for officers
acting wholly outside the scope of their authority for purely personal gain.”
IMG Fragrance, 679 F.Supp.2d at 407–08 (citing Scuderi, 2004 WL
2711048, at *2 (additional citations omitted)). To hold corporate officers
personally liable, “plaintiff must establish (1) that defendants' acts were
taken outside the scope of their employment; or (2) that defendants
personally profited from their acts.” G.D. Searle & Co. v. Medicore
Commc'ns, Inc., 843 F. Supp. 895, 911 (S.D.N.Y. 1994) (citations omitted).
With respect to Creel, ITV has submitted evidence that she acted for
her own personal gain to secure a larger compensation package. Summary
judgment is therefore denied with regard to claims made against Creel in
Counts VI and VII.
The claims against the Trusts, however, for alleged tortious
interference with business relationships must fail as a matter of law insofar
as the evidence shows that Trusts were required parties to both the
Investor Term Sheet and the Amended Certificate. No reasonable factfinder could conclude that the Trusts were outsiders or third parties for
30
purposes of ITV’s tortious interference with contract claims. Koret, Inc. v
Christian Dior, S.A., 161 A.D.2d 156, 554 N.Y.S.2d 867 (1st Dept. 1990)
(corporate parent had a right to interfere with the contract of its subsidiary
in order to protect its economic interests); Kassover v. Prism Venture
Partners, LLC, 53 A.D.3d 444 (1st Dept. 2008) (no tortious interference with
contract claim where plaintiffs were express third-party beneficiaries under
a merger agreement with right to enforce its terms); see generally, Winicki
v City of Olean, 203 A.D.2d 893, 611 N.Y.S.2d 379 (4th Dept. 1994)
(“Plaintiffs cannot state a claim for tortious interference against one of the
contracting parties.”) Counts VI and VII as they relate to the Trusts are
therefore dismissed.
D. Unjust Enrichment
ITV claims that under the circumstances alleged above, the Trusts were
unjustly enriched when they obtained valuable shares and liquidation
preferences in the Company for an unreasonably low price and that the
shares owned by ITV in Ecovation were diluted as a result. 2nd Am. Compl.,
¶¶ 164-65.
To prevail on a claim of unjust enrichment, “a party must show that
(1) the other party was enriched, (2) at that party's expense, and (3) that it
is against equity and good conscience to permit the other party to retain
31
what is sought to be recovered.” Green v. Beer, 06 Civ. 4156, 2007 WL
576089 at *2 (S.D.N.Y. Feb. 22, 2007) (internal quotations and citations
omitted); see also Cruz v. McAneney, 31 A.D.3d 54, 59 (2d Dept. 2006).
The Trusts argue that ITV’s unjust enrichment claim cannot proceed
because it is duplicative of ITV’s tort claims. Trusts’ Mem. 35. Plaintiff has
made clear that its unjust enrichment claim was pled in the alternative.
ITV Mem. 78. Moreover, triable issues of fact exist as to each element of
ITV’s unjust enrichment claim. Among other things, Plaintiff has presented
evidence that the Trusts received millions of warrants to purchase enough
stock to own a majority of the outstanding Series A Preferred Stock in
Ecovation for $0.01 per share; that ITV and the Institutional Investors
withdrew their term sheet and thus did not participate in the June 2006
financing; and that the Trusts’ Term Sheet was the only term sheet
available for the Board to review, which provided the Trusts with the
exclusive right to purchase the penny Series A stock. Dismissal of ITV’s
unjust enrichment claim is therefore denied.
E. Fraud and Civil Conspiracy
Counts VIII through X advance claims of securities fraud, common law
fraud, and civil conspiracy arising out of the Defendants’ alleged
concealment of the existence of discussions between Ecovation and
32
Ecolab at the IDFA Conference in January 2007, before the Trusts’
purchase of ITV’s stock the very same month. 2nd Am. Compl., ¶¶ 188-197,
202-206, 211-213.
Common law fraud in New York requires: “(1) a misrepresentation or
omission of material fact; (2) which the defendant knew to be false;
(3) which the defendant made with the intention of inducing reliance;
(4) upon which plaintiff reasonably relied; and (5) which caused injury to
plaintiff.” In re Optimal U.S. Litigation, 813 F.Supp.2d 351, 381 (S.D.N.Y.
2011). “The elements of fraud under New York law are essentially the
same as those for a claim of securities fraud under Section 10(b) and
Rule 10b–5.” Serova v. Teplen, No. 05 Civ. 6748(HB), 2006 WL 349624, at
*8 (S.D.N.Y. Feb. 16, 2006).5
Plaintiff has adduced evidence that Ecolab may have been identified as
a potential buyer in January 2007, if not earlier, and that a discussion of
either a joint marketing venture or an acquisition or both took place at the
5
In the securities fraud context, materiality is a mixed question of both law and fact. Press
v. Chemical Inv. Servs. Corp., 166 F.3d 529, 538 (2d Cir.1999), and the Supreme Court has
cautioned that “[t]he determination [of materiality] requires delicate assessments of the inferences
a reasonable shareholder would draw from a given set of facts and the significance of those
inferences to him, and these assessments are peculiarly one for the trier of fact.” TSC Indus. v.
Northway, 426 U.S. 438, 450 (1976); accord RMED Int'l v. Sloan’s Supermarkets., 185 F.Supp.2d
389 400 (S.D.N.Y. 2002) (“[S]ummary judgment is only appropriate in a 10b–5 action on the
grounds of immateriality where the alleged misstatements or omissions are so obviously
unimportant to a reasonable investor that reasonable minds could not differ on the question of their
importance.”) (citations and internal quotation marks omitted).
33
IDFA Conference between representatives of Ecolab and Ecovation. It is
undisputed that Creel then flew to Wisconsin to meet with the Trusts the
day following the IDFA Conference. The existence of such merger
negotiations could lead a reasonable juror to conclude that the Trusts
became motivated to purchase ITV’s stock, after previously refusing, upon
their learning of a potential sale.
Likewise, a reasonable juror could
conclude from the record evidence that ITV reasonably relied on Creel’s
representations to the Board regarding the status of the sale process and
on Frautschi’s alleged statement concerning the Trusts’ long-term exit
horizon in determining whether to sell its stock.
In sum, genuine issues of material fact exist as to whether Ecolab
and Ecovation started merger discussions at the IDFA Conference;
whether those discussions were withheld from ITV and the Board; and
whether those discussions influenced Frautschi’s decision to purchase
stock from Sterling and ITV. Accordingly, I deny Defendants’ motions for
summary judgment with respect to Counts VIII and IX of the Plaintiff’s
Complaint.
Finally, Plaintiff brings a conspiracy claim against Defendants, who
seek summary judgment on the basis that the law does not recognize a
34
stand-alone cause of action for civil conspiracy. See Creel Mem. 37,
Frautschi Mem. 40, Trusts’ Mem. 35; 2nd Am. Compl., ¶¶ 211-15.
It is true that “New York does not recognize an independent tort of
conspiracy” and liability can only be available based on the establishment
of “an independent underlying tort.” Dell's Maraschino Cherries Co. v.
Shoreline Fruit Growers, Inc., No. 10–CV–3789, 2012 WL 3537009, at *17
(E.D.N.Y. Aug. 14, 2012) (quoting Kirch v. Liberty Media Corp., 449 F.3d
388, 402 (2d Cir. 2006)). Here, however, Plaintiff’s civil conspiracy claims
are derivative of its underlying claims for fraud, which survive summary
judgment. In this regard, Defendants’ motion is denied as to Count X of the
Second Amended Complaint.
III. Summary
The proof, although heavily circumstantial, gives rise to the following
issues of fact: whether Creel was providing the Trusts with material
information while withholding the same from the Board; whether the Board
was improperly influenced by the Trusts, through Creel, in voting on the
financing and other agreements; whether the Trusts had Creel threaten the
board with foreclosure in order to gain approval of their term sheet; and
whether Creel actively sought alternative financing and/or a buyer for
Ecovation. These issues of fact pervade nearly every claim advanced by
35
ITV, except where specifically stated in the above analysis, rendering
summary judgment wholly inappropriate. See Trident Intern. Ltd. v. Am.
Steamship Owners Mut. Protection, No. 05 Civ. 3947, 2008 WL 2909389,
at *4 (S.D.N.Y. July 24, 2008) (“Based upon a review of the parties'
arguments, their respective (and voluminous) 56.1 statements, and the
competing affidavits issued in support of these cross-motions, it is apparent
to the Court that summary judgment is wholly inappropriate in this case.
Significant and genuine issues of material fact permeate every aspect of
this dispute.”); see also, generally 11 Moore's Federal Practice, § 56.41
[3][d] (Matthew Bender 3d ed.) (“The trial court has the right to exercise its
discretion to deny a motion for summary judgment, even if it determines
that a party is entitled to it, if, in the court's opinion, the case would benefit
from a full hearing.”) I find that to be the case here. The record, containing
hundreds of exhibits spanning thousands pages (a good percentage of
which was filed under seal), is replete with signs of collusiveness between
Creel and the Trusts. The Defendants are alleged to have created a
tortious path leading to multi-million dollar benefit for only a select number
of stockholders in Ecovation, based upon, among other things, a failure of
fiduciary responsibility. In this regard, Plaintiff ITV has raised sufficient
issues of material fact to warrant a trial.
36
CONCLUSION
The Trusts’ motion for summary judgment, Dkt. No. 136, is granted
as to Counts VI and VII of the Second Amended Complaint, and denied as
to the remaining causes of action. The motions for summary judgment by
Defendants Creel, Dkt. No. 134, and Frautschi, Dkt. No. 138, are denied in
their entirety as there exists genuine issues of material fact to be
determined at trial. Accordingly, the following Counts remain pending:
As to the Trusts, Counts II (Breach of Fiduciary Duty), III (Lender
Liability), IV (Aiding and Abetting), V (Unjust Enrichment), VIII
(Securities Fraud), IX (Common Law Fraud), and X (Civil
Conspiracy);
As to Creel, Counts I (Breach of Fiduciary Duty), VI and VII (Tortious
Interference), VIII (Securities Fraud), IX (Common Law Fraud), and X
(Civil Conspiracy); and
As to Frautschi, Counts I (Breach of Fiduciary Duty), IV (Aiding and
Abetting), VIII (Securities Fraud), XI (Common Law Fraud), and X
(Civil Conspiracy).
ALL OF THE ABOVE IS SO ORDERED.
S/Michael A. Telesca
MICHAEL A. TELESCA
United States District Judge
Dated:
Rochester, New York
April 28, 2015
37
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