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In re Xethanol Corp. Derivative Litigation

August 16, 2007

IN RE XETHANOL CORPORATION DERIVATIVE LITIGATION


The opinion of the court was delivered by: Hon. Harold Baer, Jr., District Judge*fn1

THIS DOCUMENT RELATES TO: All Actions

OPINION & ORDER

Plaintiffs Marco E. Radnuz, August Russ, and Katherine Fay-Hammonds (collectively "Plaintiffs") bring this putative shareholders' derivative action against Lawrence S. Bellone ("Bellone"), Christopher D'Arnaud-Taylor ("Taylor"), Jeffrey S. Langberg ("Langberg"), Richard Ditoro ("Ditoro"), David R. Ames ("Ames"), William P. Behrens ("Behrens") (collectively the "Individual Defendants"), and nominal defendant Xethanol Corporation ("Xethanol" or the "Company") (collectively, "Defendants"). Plaintiffs allege derivative claims for breach of fiduciary duty, misappropriation of information, contribution and indemnification.*fn2

Defendants move to dismiss Plaintiffs' derivative claims with prejudice pursuant to Fed. R. Civ. P. 12(b)(6) and Fed. R. Civ. P. 23.1. Because Plaintiffs' Amended Consolidated Derivative Complaint ("Am. Compl." or "Amended Complaint") does not meet the demand requirements of Fed. R. Civ. P. 23.1, I dismiss it in its entirety.

I. FACTUAL BACKGROUND

The following facts are taken from Plaintiffs' Amended Complaint and must be taken as true for purposes of the pending motion to dismiss. Plaintiffs Marco E. Radnuz, August Russ, and Katherine Fay-Hammonds were shareholders of Xethanol during the period of alleged wrongdoing, and continue to hold shares in the Company. Plaintiffs are respectively citizens of Canada, Ohio and Florida.

Nominal Defendant Xethanol Corporation is a Delaware corporation with its principal place of business in New York, New York. All individual Defendants are citizens or residents of the State of New York. Defendant Taylor was Chairman, Chief Executive Officer and President of the Company until late August 2006. Defendant Langberg is a former director of the Xethanol Board. Defendant Bellone, during the period of alleged wrongdoing, was Chief Financial Officer, and has held this position since April 5, 2005. Defendant Ditoro has been a member of the Board of Directors of the Company since September 7, 2006. Defendant Ames has been a member of the Board of Directors of the Company since October 1, 2006, and has been the Company's Chief Executive Officer and President since November 9, 2006. Defendant Behrens has been a member of the Board of Directors of the Company since October 1, 2006.

Xethanol was incorporated in Delaware on January 24, 2000 ("Old Xethanol") to capitalize on the growing market for ethanol, a clean burning and renewable fuel that is a primary gasoline additive. On February 2, 2005, Old Xethanol entered into a reverse merger with Zen Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Zen Pottery Equipment, Inc. ("Zen"), a publicly traded Colorado corporation. Following the merger, Zen reincorporated from the State of Colorado to the State of Delaware and changed its corporate name to Xethanol Corporation.

While ethanol is traditionally produced from corn, Xethanol's business strategy isto produce ethanol from biomass (generally post-industrial food or paper production waste). Investors focused on this distinction because biomass, unlike corn, has zero or negative cost. According to Plaintiffs, Defendants stated that the Company would follow a three-stage business model during the purported class period, January 31st through August 6th of 2006: (1) self-sustain on revenues produced from traditional corn ethanol production, (2) raise money from public and private investors, and (3) commercialize biomass ethanol production. Am. Compl. ¶¶ 4, 5.

In August 2006, ShareSleuth.com, a forensics securities investigations website, published a widely circulated report that was highly critical of Xethanol and its management. Among other things, the report "revealed" that (1) there was little evidence that Xethanol had produced sufficient amounts of ethanol from biomass to support its claim that it could achieve near-term commercialization, (2) substantial related party transactions had not been disclosed, including the fact that many of the Company's early investors had been disciplined by regulatory agencies and that Defendant Taylor, Chairman, CEO and President of the Company during the Class Period, had fabricated portions of his resume.

Plaintiffs allege that Defendants knowingly misrepresented material facts as to the state of its facilities and of Xethanol's ability to commercialize production of ethanol from biomass in Defendants' 2005 10-KSB SEC report and in press releases. Specifically, Plaintiffs contend that Xethanol misrepresented the true status of Permeate, one of Xethanol's ethanol production plants. For example, Plaintiffs cite Xethanol's February 27, 2006 press release, which implied that both of Xethanol's Iowa facilities were operational. Am. Compl. ¶ 42 ("In Iowa, Xethanol owns two ethanol production facilities, where it is deploying [proprietary biotechnologies to extract and ferment the sugars trapped in biomass waste concentrations]."). Plaintiffs, however, allege that instead, Permeate "lay abandoned and neglected with no current water or sewer service and no employees working at the site." Am. Compl. ¶ 9.

The Amended Complaint states that Defendants also knowingly misrepresented Xethanol's ability to commercialize the production of ethanol from biomass waste and that Xethanol's announcements of joint ventures*fn3 and strategic alliances to develop and execute business outside of the Iowa corn-belt region were misleading. Plaintiffs assert that these announcements, made throughout the period of alleged wrongdoing, "served to support investors' belief that the Company was operating according to plan, and was already reaching its second stage of development." Am. Compl. ¶ 36.

Further, Plaintiffs allege that Defendants claimed in their 2005 SEC filing to use a complex system of internal disclosure controls and procedures, which, combined with their positive statements about the Company, bolstered investor confidence. Am. Compl. ¶¶ 7, 53-55. Plaintiffs contend, however, that Xethanol operated unethically and did not disclose relationships with initial investors who "had alarming records of stock fraud, market manipulation, breach of fiduciary duty, and shareholder abuse." Am. Compl. ¶ 9.*fn4

Plaintiffs assert that a demand on Xethanol's Board would be futile because at the time the Complaint was filed, the board was comprised of interested, named defendants who face a substantial likelihood of personal liability as a result of this action, the board is incapable of suing itself, the alleged acts are incapable of ratification, and demand on the thousands of shareholders would be impracticable. Am. Compl. ΒΆΒΆ 125, 126. To the Court's knowledge, the only related ...


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