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November 10, 2005.

WHITTIER TRUST COMPANY, as trustee of the Gerald G. Loehr Separate Property Trust, WILLIAM C. JOHNSON, as trustee of The Gerald G. Loehr Separate Property Trust and in his individual capacity, TODD B. LOFTIS, and LINDA LOEHR, Defendants.

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 ("Exchange Act")

  "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 mind.
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).

  1. Loftis

  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 ...

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