The opinion of the court was delivered by: HAROLD BAER JR., District Judge
Plaintiffs JHW Greentree Capital, L.P. and TMI Integrated
Holdings Corp. (collectively, "Greentree") brought this action
against defendants Whittier Trust Company ("Whittier"), William
C. Johnson ("Johnson"), Todd B. Loftis ("Loftis") and Linda Loehr
alleging, inter alia: securities fraud in violation of sections
10(b) and 20(a) of the Securities and Exchange Act of 1934;
common law fraud; negligent misrepresentation; unjust enrichment;
rescission; and indemnity. All of plaintiffs' claims arise out
Greentree's acquisition of Tools & Metals, Inc. ("TMI"), a
privately held corporation owned by Loftis and the Gerald G.
Loehr Separate Property Trust (the "Loehr Trust" or the "Trust").
Defendants now move to dismiss the complaint pursuant to Rules
12(b)(6) and 9(b) of the Federal Rules of Civil Procedure, as
well as the Private Securities Litigation Reform Act of 1995
("PSLRA"). For the reasons set forth below, defendants' motion to
dismiss is GRANTED in part and DENIED in part.
TMI is a corporation that supplies industrial cutting tools and
related services to, primarily, the Lockheed Martin Corporation
("Lockheed"). (Compl. ¶ 7). On March 30, 2004, Greentree acquired
all of TMI's stock pursuant to an Agreement and Plan of Merger
("Merger Agreement"). (Id.) Prior to the acquisition, 90% of
TMI's stock had been controlled by the Loehr Trust. (Id. ¶ 8). The Loehr Trust was established by the
late Gerald Loehr, the former owner of TMI, for the benefit of
his wife and children. (Id. ¶¶ 8, 66). Prior to the sale, the
remainder of TMI's stock was controlled by Loftis, TMI's CEO from
1997 until December 2004. (Id. ¶ 10). Defendant Linda Loehr,
Gerald's widow, was a member of TMI's board of directors from
1997 until the acquisition by Greentree. (Id. ¶ 12). Linda Loehr
is also the lifetime beneficiary of the Loehr Trust. (Id.)
Defendant Johnson was a member of TMI's board from 1997 until the
merger, and is a co-trustee of the Loehr Trust. (Id. ¶
9).*fn1 Johnson is also married to Sharon Loehr Johnson,
Gerald Loehr's daughter and a remainderman of the Loehr Trust.
(Id.) Whittier, a private trust company, is co-trustee of the
Loehr Trust. (Id. ¶ 8).
On October 4, 2004, just over six months after purchasing TMI
for approximately $24 million, Greentree was alerted by the
Internal Revenue Service of an investigation into its acquisition
of TMI. (Id. ¶¶ 4,51). Shortly thereafter, Greentree was informed
by Loftis, who remained CEO of TMI following the acquisition,
that TMI was the subject of a federal criminal investigation for
allegedly defrauding Lockheed, a government contractor. (Id. ¶
52). After initiating its own internal investigation, Greentree
learned that, beginning in 1998, Loftis had been creating false
vendor invoices to conceal TMI's true costs and profit margins
from Lockheed in order to inflate Lockheed's payments to TMI.
(Id. ¶ 53). Plaintiffs allege that, due to the ongoing
investigation into TMI's billing practices, TMI's credit lines
and bank account have been frozen, its ability to win new
business has been severely impaired, and it is facing potential
debarment as a government contractor. (Id. ¶¶ 74, 77). Thus,
Greentree alleges that its shares of TMI are "essentially
worthless." (Id. ¶ 72).
Plaintiffs allege that the defendants intentionally misled them
with regard to TMI's financial stability. Specifically,
plaintiffs allege that, prior to the merger, Loftis made repeated
representations regarding TMI's relationship with Lockheed that
Loftis knew to be false. (See, e.g. Compl. ¶ 29). Plaintiffs
also allege that various representations regarding TMI's billing
practices contained in the Merger Agreement, which was authorized
by TMI's board of directors and signed by Loftis, Johnson and
Whittier, were knowingly false. (Id. ¶¶ 41-43).
Plaintiffs allege that Loftis orchestrated the fraud at TMI,
and that Johnson and Linda Loehr were aware of TMI's fraudulent
billing practices. In 1997 John Andrew Loehr, a former CEO of TMI
and Gerald Loehr's son, sued his father and TMI in state court in
California for wrongful termination (the "California action"). (Compl ¶ 66;
Declaration of Andrew L. Morrison, Esq., dated May 26, 2005, Ex.
B). In his suit, John Andrew Loehr alleged that his father,
Loftis, and other TMI employees were involved in an ongoing
scheme to defraud the government through the administration of
the Lockheed contract. (Compl. ¶ 66). When Gerald Loehr died in
1997, Johnson and Linda Loehr were substituted as defendants in
the California action. (Compl. ¶ 69). Plaintiffs allege that John
Andrew Loehr reported TMI's fraudulent activities to various
members of TMI's board, including Johnson and Linda Loehr, "on
multiple occasions, but each time Linda Loehr and Johnson
willfully ignored the reports." (Compl. ¶ 68). Plaintiffs allege
that, in response to Andrew Loehr's allegations, Linda Loehr told
him to "`mind [his] own business[,]'" and Johnson "demanded
proof." (Compl. ¶ 68). The California action settled in 1998.
(Compl. ¶ 70). Plaintiffs allege that "neither Johnson nor Loehr
took any steps to investigate John Andrew Loehr's allegations or
stop the underlying misconduct against Lockheed." (Id.)
When ruling on a motion to dismiss pursuant to Rule 12(b)(6) of
the Federal Rules of Civil Procedure, the Court must construe all
factual allegations in the complaint in favor of the non-moving
party. See Krimstock v. Kelly, 306 F.3d 40, 47-48 (2d Cir.
2002). The Court's consideration is normally limited to facts
alleged in the complaint, documents appended to the complaint or
incorporated in the complaint by reference, and to matters of
which judicial notice may be taken. See Allen v.
WestPoint-Pepperell, Inc., 945 F.2d 40, 44 (2d Cir.
1991).*fn2 A motion to dismiss should not be granted "unless
it appears beyond doubt that the plaintiff can prove no set of
facts in support of his claim which would entitle him to relief."
Shakur v. Selsky, 391 F.3d 106, 112 (2d Cir. 2004) (quoting
Conley v. Gibson, 355 U.S. 41, 45-46 (1957)). When a complaint
alleges fraud, "Rule 9(b) requires that allegations of fraud be
pleaded with particularity." Harsco Corp. v. Segui,
91 F.3d 337, 347 (2d Cir. 1996). This means that the complaint "must (1)
detail the statements (or omissions) that the plaintiff contends
are fraudulent, (2) identify the speaker, (3) state where and
when the statements (or omissions) were made, and (4) explain why
the statements (or omissions) are fraudulent. Id. A. Section 10(b) of the Securities and Exchange Act of 1934
"To state a cause of action under section 10(b) and Rule 10b-5,
a plaintiff must plead that the defendant made a false statement
or omitted a material fact [in connection with the purchase or
sale of securities], with scienter, and that plaintiff's reliance
on defendant's action caused plaintiff injury." Kalnit v.
Eichler, 264 F.3d 131
, 138 (2d Cir. 2000) (internal quotation
omitted). "The requisite state of mind, or scienter, in an action
under section 10(b) and Rule 10b-5 that the plaintiff must
allege is an intent to deceive, manipulate or defraud." Id.
(internal quotation omitted). The PSLRA imposed heightened
pleading requirements for securities fraud actions. Id. The
PSLRA provides that:
In any private action . . . in which the plaintiff
may recover money damages only on proof that the
defendant acted with a particular state of mind, the
complaint shall, with respect to each act or omission
alleged to violate this chapter, state with
particularity facts giving rise to a strong inference
that the defendant acted with the required state of
15 U.S.C. § 78u-4(b)(2).
To establish fraudulent intent, a plaintiff may either allege
facts showing "that defendants had both motive and opportunity to
commit fraud" or allege "facts that constitute strong
circumstantial evidence of conscious misbehavior or
recklessness." Kalnit, 264 F.3d at 138 (internal quotation
omitted). A plaintiff may establish the requisite strong
inference of scienter by alleging that the defendants: "(1)
benefited in a concrete and personal way from the purported fraud
. . .; (2) engaged in deliberately illegal behavior . . .; (3)
knew facts or had access to information suggesting that their
public statements were not accurate . . .; or (4) failed to check
information they had a duty to monitor." Novak v. Kasaks,
216 F.3d 300, 311 (2d Cir. 2000).
Plaintiffs allege numerous specific and intentional
misrepresentations by Loftis. Loftis argues that plaintiffs'
section 10(b) claim should be dismissed because plaintiffs fail
to allege fraud with adequate particularity. While plaintiffs
aver that the defendants collectively perpetrated a fraud by
concealing TMI's billing irregularities, the complaint is rife
with specific allegations that detail Loftis' role. (See, e.g.
Compl. ¶¶ 58 "Greentree learned through its investigation that Loftis. . . . submitted forged and fictitious
third-party vendor invoices to Lockheed").
Johnson and Loftis argue that the integration clause in the
Merger Agreement bars any claim for fraud based on
representations not contained within the Merger Agreement itself.
The integration clause disclaims reliance on any representations
or promises not set forth in the Merger Agreement. (Compl. Ex. A,
§ 13.10). Defendants are correct that the integration clause
limits plaintiffs claims for fraud to those representations
contained in the Merger Agreement. See In re Vivendi
Universal, S.A. Securities Litigation, 02 Civ. 5571, 2004 WL
876050, *4 (S.D.N.Y. April 22, 2004) (finding that integration
clause bars plaintiffs from relying on extra-contractual
representations not contained in merger agreement to support
fraud claim). However, here the integration clause does not bar
plaintiffs from pursuing fraud claims relating to false
statements or omissions contained within the Merger Agreement
itself. Id. Loftis signed the Merger Agreement, which contained
several misrepresentations. (See Compl. ¶ 42 sellers represent
that "TMI [is] not `in violation of any terms or conditions' of
the Lockheed contract" (quoting Merger Agreement § 4.10(b)).
Defendants also argue that the exclusivity clause contained in
the Merger Agreement limits plaintiff to indemnification for any
breaches of the representations contained in the Merger
Agreement. The exclusivity clause provides that indemnification
shall be the sole remedy for any misrepresentation arising out of
the Merger Agreement, except for claims of fraud. (Compl., Ex.
A § 11.05). Thus, plaintiffs' fraud claims are not barred by the
exclusivity clause. See also In re Vivendi, 2004 WL 876050, *
11 (where "a warranty provided by a contract makes
representations as to present facts, such facts are extraneous to
the contract" and may give rise to a claim for fraud).
In addition, plaintiffs have adequately alleged reasonable
reliance. Johnson and Loftis argue that plaintiffs should have
discovered John Andrew Loehr's prior allegations of fraud at TMI
since they were made in the context of a public lawsuit. However,
it is unrealistic to expect a party to a transaction, even a
sophisticated private equity firm, to scour the dockets of every
court in the nation for closed actions involving an acquisition
target. Plaintiffs allege that they were the victim of a
concerted and prolonged effort to disguise TMI's fraudulent
billing practices. Plaintiffs have sufficiently alleged that they
reasonably relied on the representations contained in the Merger
Agreement. Loftis also argues that the representations giving rise to
plaintiffs' allegations of fraud concerned future events, and
therefore cannot be the basis of an action for fraud. I disagree.
An examination of the representations themselves proves
otherwise. (See Compl. ¶ 42 "`all invoices and claims for
payment . . . submitted by' TMI to Lockheed . . . `were current,
accurate and complete in all material respects as of their
submission date(s)' at all times during the three year period
prior to the date of the Agreement" (quoting Merger Agreement, §
4.10)). This is clearly a representation concerning a present
fact, rather than a promise of future action.
Thus, Plaintiffs allege that Loftis repeatedly assured
Greentree of TMI's fiscal health, and made representations to
that effect in the Merger Agreement, while personally
perpetrating a criminal fraud upon Lockheed. These ...