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Apace Communications, Ltd. v. Burke

November 16, 2007


The opinion of the court was delivered by: David G. Larimer United States District Judge


Plaintiffs Apace Communications, Ltd. ("Apace") and Rakesh Aggarwal have commenced this action against thirteen defendants, alleging that they were fraudulently induced to invest in a company named NetSetGo (sometimes referred to in the complaint as "the Company"). Plaintiffs allege that as a result of defendants' misrepresentations concerning NetSetGo's financial health, Apace lost millions of dollars that it had invested in NetSetGo. Jurisdiction is premised on diversity of citizenship under 28 U.S.C. § 1332.*fn1

Nine defendants have moved to dismiss the complaint for failure to state a claim upon which relief can be granted, pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. After these motions were filed, plaintiffs filed a motion for leave to amend the complaint. For the reasons that follow, defendants' motions are granted, and plaintiffs' motion is denied, but plaintiffs are granted leave to file a further motion seeking leave to amend, with a new proposed amended complaint.


The following facts are taken from the complaint. NetSetGo was founded in 1999 by defendants Jeffrey Burke and David Klein as a "full-service e-commerce and internet service provider for small and mid-sized companies." Complaint ¶ 21. Plaintiff Apace is a British Virgin Islands corporation with its principal place of business in the United States. It was formed in 1999 "as a vehicle to invest in other businesses." Complaint ¶ 7. Plaintiff Aggarwal is a citizen of Singapore and an officer of Apace.

The 37-page complaint alleges, at some length if not in great detail, that Apace was fraudulently induced by defendants to invest millions of dollars in NetSetGo, over a period of several years beginning in March 2001. Although NetSetGo had initially experienced rapid growth after its founding, by 2001 it was in debt and in need of additional capital to meet its obligations. Defendants allegedly sought to obtain that capital from Apace.

Plaintiffs allege that in March 2001, "Apace was approached by representatives of NetSetGo to invest in the Company." Complaint ¶ 22. Burke, Klein "and others of the Company" represented to Aggarwal and Apace that NetSetGo was in far better financial shape than it actually was, and that NetSetGo simply needed additional capital to expand its operations.

According to the complaint, several other defendants, such as Steven and Lori Levine ("the Levines") and Cephas Capital Partners, LP ("Cephas"), who were secured creditors of NetSetGo, also allegedly participated in the fraud, by seeking to "draw[] Apace into investing millions of dollars in NetSetGo while concealing the Company's poor financial condition and prospects." Complaint ¶ 31. These defendants' purpose in doing so was simply to protect their own interests, by using the funds provided by Apace to protect defendants' previously-made investments in, and loans to, NetSetGo.

Despite having millions of dollars to invest in other companies, Apace allegedly "had limited experience in investing generally, and NetSetGo was its first U.S. financial transaction." Complaint ¶ 29. Apace was also not represented by an attorney during any of these discussions or events, but only by Aggarwal, who, it is claimed, was also something of a novice at investing. See Complaint ¶ 63 ("Apace was ... unrepresented by counsel in its negotiations and contract preparations with representatives of the Company").

Again, according to the complaint, in reliance on defendants' various misrepresentations, Apace agreed to a series of "investments" in NetSetGo, including $500,000 in March 2001 in exchange for NetSetGo stock, Complaint ¶ 32, and an additional investment of $5.5 million in April 2001. Complaint ¶¶ 35, 36. In exchange for the latter investment, Apace received 62% of the outstanding common stock in NetSetGo, and Aggarwal was given a position on NetSetGo's Board of Directors.

In October 2001, "defendants" persuaded Apace to loan NetSetGo an additional $2.5 million, in exchange for a security interest in NetSetGo's assets. Complaint ¶ 47. Defendants never drafted or filed a security agreement, though, and allegedly never intended to give Apace any security interest (which would have been meaningless anyway, since Apace's right to repayment would have been subordinated to other defendants' interests).

In early 2002, defendants began making plans to establish a successor company to NetSetGo, and to transfer all of NetSetGo's assets to the successor company. This was allegedly spurred in part by defendants' realization that the Apace well was running dry; in February 2002, defendants had unsuccessfully attempted to persuade Apace to invest an additional $1.1 million in NetSetGo, and in October 2002, Apace indicated that it was unwilling to make further investments in NetSetGo unless Cephas and the Levines did the same.

The complaint alleges that defendants' plans came to fruition in December 2002, when NetSetGo's assets were purchased at a foreclosure sale by the sole bidder, "NSG Acquisition Corp.," a company allegedly owned by the secured creditors of NetSetGo. Later that month, NSG Acquisition Corp. filed an amended certificate of incorporation renaming it "Cephire Corp." Defendant Michael Benedict, who had been the Chief Operating Officer of NetSetGo, was listed as President of Cephire, and Cephas and Steven Levine were listed as secured creditors of Cephire.

Complaint ¶¶ 60, 61. Cephire essentially ran the same business as NetSetGo had, using the same employees, equipment and suppliers. Complaint ¶ 62. Apace has never recovered any of its investments in NetSetGo. Complaint ¶ 60.

The complaint asserts eight causes of action: (1) fraud against all defendants; (2) aiding and abetting fraud against Cephas, Jeffrey Holmes (a managing director and partner of Cephas), Clint Campbell (also a managing director and partner of Cephas), and the Levines; (3) constructive fraud against all defendants; (4) negligent misrepresentation against all defendants; (5) breach of fiduciary duty against Burke, Klein and Benedict, by virtue of their superior knowledge of NetSetGo's financial condition vis-a-vis plaintiffs; (6) breach of fiduciary duty by Burke and Klein as directors of NetSetGo; (7) fraudulent conveyance against Benedict, Cephas, Holmes, Campbell, and the Levines; and (8) successor liability against the Levines, Cephas and Cephire.


On June 18, 2007, plaintiffs filed a 51-page amended complaint (Dkt. #51), and a motion for leave to amend the complaint (Dkt. #52). At that point, seven defendants, none of whom had answered the complaint, had filed motions to dismiss the complaint. Plaintiffs thus filed the amended complaint as of right as to those defendants, and sought leave to amend as to the remaining defendants, who had answered the complaint. See Barksdale v. King, 699 F.2d 744, 747 (5th Cir. 1983) (where some but not all defendants have answered, plaintiff may amend, as of course, claims asserted solely against non-answering defendants); Pemrick v. Stracher, No. 92 CV 959, 2005 WL 2921621, at *3 (E.D.N.Y. Nov. 4, 2005) (same).

The amended complaint asserts essentially the same claims as the original complaint, but adds one defendant, Timothy Beers (who has not yet appeared in this action), drops defendants Hyde and Grainger, see n. 1, supra, and adds two claims. The first is a claim for damages to Aggarwal's reputation, and is asserted against the Levines, Empire Beef Co., Inc. ("Empire," which is a corporation allegedly under the direction and management of Steven Levine), Cephas, Benedict, Klein, Burke, Holmes and Campbell.*fn2 The second is a breach of contract claim against Levine, Empire, Cephas, Benedict, Campbell and Beers, based on an alter ego theory, i.e., that those defendants' treatment of NetSetGo as a mere instrumentality for their own private business renders them liable for NetSetGo's alleged breach of the loan agreement between it and Apace.

As stated, a number of motions to dismiss are also pending. Defendants Klein, the Levines, Cephas, Holmes and Campbell have filed pre-answer motions to dismiss for failure to state a claim upon which relief can be granted, pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. Defendant Burke has answered the complaint, and has also filed a post-answer motion to dismiss under Rule 12(b)(6), which I treat as a motion for judgment on the pleadings pursuant to Rule 12(c). See MacDonald v. Grace Church Seattle, 457 F.3d 1079, 1081 (9th Cir. 2006); Byrne v. Nezhat, 261 F.3d 1075, 1096 n. 46 (11th Cir. 2001); Lanigan ...

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