The opinion of the court was delivered by: Pitman, United States Magistrate Judge
This action arises out of attempts by defendant Deer Creek Fund LLC ("Deer Creek"), a shareholder of plaintiff Technest Holdings, Inc. ("Technest"), to sell unregistered shares of Technest stock pursuant to Rule 144 in February 2006.
Technest commenced this action seeking, inter alia, to enjoin Deer Creek from selling its Technest shares. Deer Creek asserted various counterclaims. Technest's claims against Deer Creek were amicably resolved by a settlement in April 2006. Remaining in this action are Deer Creek's counterclaims against Technest for tortious interference with prospective economic advantage, breach of the implied covenant of good faith and fair dealing, and breach of the duty to process the transfer of stock. Deer Creek seeks damages in the amount of $543,342.19 plus interest. Technest contends that Deer Creek is not entitled to damages, and that even if it were, those damages would have to be reduced because Deer Creek has failed to mitigate its damages.
The parties consented to my exercising plenary jurisdiction over this matter pursuant to 28 U.S.C. § 636(c), and the matter was tried before me, without a jury, on April 8 and 9, 2008. Based on the testimony and other evidence offered at trial and the parties' pre- and post-trial submissions, I make the following findings of fact and conclusions of law.
1. Technest is a public company whose stock is traded on the "over-the-counter" market. Technest is in the business of developing security technologies (Witness Statement of Gino Pereira, dated Jan. 25, 2007, ("Pereira Stmnt."), ¶¶ 1, 2; Stipulated Facts*fn1 ¶ 3).
2. Technest is incorporated under the laws of Nevada and has its principal place of business in Boston, Massachusetts (Joint Pre-Trial Order, dated January 9, 2007, ("Pre-Trial Order"), at 4).
3. Suzette O'Connor is Co-General Counsel of Technest (Witness Statement of Suzette O'Connor, dated Jan. 25, 2007, ("O'Connor Stmnt."), ¶ 1).
4. Gino Pereira is the Chief Financial Officer of Technest and a member of Technest's Board of Directors (Pereira Stmnt. ¶ 1).
5. Deer Creek is a private investment fund and a New York limited liability company. No member of Deer Creek is a resident of Nevada or of Massachusetts (Pre-Trial Order at 4).
6. Marc Sharinn and Col Wrynn created and now manage Deer Creek (Witness Statement of Marc Sharinn, dated Jan. 9, 2007, ("Sharinn Stmnt."), ¶¶ 6, 8, 9).
7. On February 14, 2005 Deer Creek and a number of other investors acquired Technest securities through a private placement. At that time Deer Creek invested $500,000.00 in Technest (Stipulated Facts ¶¶ 5, 6).
8. In exchange for its investment, Deer Creek, along with the other investors, received "units" consisting of various classes of shares of Technest stock and warrants to purchase additional shares pursuant to a "Securities Purchase Agreement" (Stipulated Facts ¶ 7). Deer Creek received 114,942 "units," each consisting of one share of Technest's Series B Preferred Stock, one share of Technest's Series C Preferred Stock, and one warrant to purchase 211.8 shares of Technest's common stock. The Series C Preferred Stock was convertible, "on certain terms and conditions," into shares of Technest's common stock (Stipulated Facts ¶¶ 8, 9, 10; Sharinn Stmnt ¶¶ 12, 13).
9. On January 19, 2006, Deer Creek converted its Series C Preferred Stock into 114,942 shares of Technest's common stock, which could be traded over the counter. Deer Creek also exercised its rights under the warrant to acquire an additional 52,053 shares of Technest's common stock, giving Deer Creek a total of 166,995 shares of Technest's common stock (Stipulated Facts ¶¶ 11, 13; Sharinn Stmnt. ¶¶ 14, 15).
10. The Securities Purchase Agreement ("SPA"), dated February 14, 2005, governed the "units" acquired at that time by Deer Creek and the other investors, as well as the common stock Deer Creek subsequently acquired. Section 16 of the SPA, entitled "Entire Agreement," provided:
This Agreement (including the attachments hereto) contains the entire agreement of the parties with respect to the subject matter hereof and supercedes and is in full substitution for any and all prior oral or written agreements and understandings between them related to such subject matter, and no party hereto shall be liable or bound to the other party hereto in any manner with respect to such subject matter by any representations, indemnities, covenants or agreements except as specifically set forth herein (SPA, annexed as PX 1 & DX P, § 16).
11. The SPA was signed by Technest and Deer Creek (SPA at 16, 17).
12. The parties also executed a Registration Rights Agreement as an attachment to the SPA (Registration Rights Agreement, annexed as PX 2 & DX Q, ("RRA"); Stipulated Facts ¶ 16; Tr. at 118).
13. The RRA provided that "[o]n or prior to each Filing Date, the Company shall prepare and file with the [SEC] a 'Shelf' Registration Statement covering the resale of the Registrable Securities on such Filing Date for an offering to be made on a continuous basis pursuant to Rule 415" (RRA ¶ 2). The "Filing Date" referred to in the RRA was May 2, 2005 (Stipulated Facts ¶¶ 18, 19; Sharinn Stmnt. ¶¶ 21, 22).
14. The RRA defines "Registration Statement" as "the registration statements required to be filed hereunder, including (in each case) the Prospectus, amendments and supplements to such registration statement or Prospectus, including pre- and post-effective amendments, all exhibits thereto, and all material incorporated by reference or deemed incorporated by reference in such registration statement" (RRA at 2; Stipulated Facts ¶ 22).
15. Technest did not file a registration statement by the May 2, 2005 "Filing Date" because it did not have the resources to do so at that time (Tr. at 348-49). Rather, Technest filed a registration statement on November 22, 2005; the registration statement did not became effective until February or March 2007 (Tr. at 349-50).
16. In the event Technest failed to obtain an effective registration statements by the "Filing Date," Section 2(b) of the RRA provided for liquidated damages, stating, in pertinent part,
[i]f (i) a Registration Statement is not filed on or prior to its Filing Date, or (ii) a Registration Statement filed or required to be filed hereunder is not declared effective by the Commission by its Effectiveness Date, . . . then, on each such Event Date*fn2 and every monthly anniversary thereof until the applicable Event is cured, the Company shall pay to each Holder an amount in cash (or shares of Common Stock . . .), as liquidated damages. (RRA § 2(b)).
17. Section 2 of the RRA was amended on September 30, 2005 to provide that liquidated damages would be paid only in shares of Technest common stock "valued at 90% of the average of the trailing 5 trading days' closing prices before payment" (RRA Amendment No. 1, annexed as PX 3; Stipulated Facts ¶ 25).
18. The RRA also provided:
[i]n connection with the sales of Registrable Securities pursuant to a Registration Statement, each Holder agrees as follows: Each Holder shall not, and shall cause all persons to whom such Holder may transfer Registrable Securities not to, sell more than 25% of the Registrable Securities acquired by such Holder pursuant to the Purchase Agreement in any period of 20 consecutive trading days (RRA § 4(c); Stipulated Facts ¶ 21; Sharinn Stmnt ¶ 26).
19. Under Section 5 of the Securities Act of 1933 ("Securities Act"), all sales of securities must be made pursuant to a registration statement or qualify for an exemption from the registration requirement. 15 U.S.C. § 77e(a).
20. Securities Act Rule 144 ("Rule 144") provides an exemption from the registration requirement. The principal requirements of Rule 144 are that the securities must have been held by the purported seller for at least one year; the number of shares to be sold during any three-month period cannot exceed the greater of one percent of the outstanding shares in that same class or of the average weekly trading volume during the preceding month for a share class as listed on an exchange; and a notice must be filed with the SEC for sales to exceed 500 shares or $10,000 in total transactions in any three-month period.
S.E.C. v. Universal Exp., Inc., 475 F. Supp.2d 412, 431-32 (S.D.N.Y. 2007).
21. Neither the SPA nor the RRA contained any provisions limiting the number of shares Deer Creek could sell under Rule 144 or in the absence of a registration statement.
C. Deer Creek Attempts to Sell Its Technest Shares
22. As of February 15, 2006, Rule 144(e) permitted Deer Creek to sell up to 157,163 of its Technest shares in any 90 day period notwithstanding the absence of an effective registration statement (Stipulated Facts ¶¶ 29, 30; Sharinn Stmnt. ¶¶ 20, 24; see 17 C.F.R. § 230.144(e)). At that time Technest was a thinly traded company, and its stock was traded "over-the-counter" with a quoted price of $10.85 per share (Stipulated Facts ¶¶ 31-33).
23. On or about February 13, 2006, Deer Creek entered into discussions with Erik Brous, a licensed securities broker at Axiom Capital Management, Inc. ("Axiom"), concerning Axiom's selling 157,163 of Deer Creek's Technest shares to certain customers as a block transaction after the Rule 144 one-year holding period expired on February 15 (Sharinn Stmnt. ¶¶ 54-57; Tr. at 5-7, 53).
24. On February 13, 2006 and the following days, Brous, who was experienced in brokering block trades, contacted several "relationship accounts" that he believed would be interested in purchasing a block of Technest stock at approximately $7.00 per share (Tr. at 7-10, 13-14). Among these were Howard Fischer of Basso Capital, Chris Casey of Night Capital, LP, Yoav Roth of SRG Capital, Rich Abbe of Iroquois Capital, LP, Jim Andrew of "ACC" and Sean Deson of Baytree Capital (DX O; DX N; DX M; DX S; Tr. at 24-25, 27; Brous Dep. at 35, 53, 60, 61). Brous' discussions with these potential purchasers can be summarized as follows:
a. When Brous informed Fischer on February 14 that Axiom had 180,000 shares of Technest stock available for a block trade at $7.00 per share, Fischer requested that Brous keep him informed (DX N).
b. After Brous informed Casey on February 21 that Axiom's clearing broker was "cleaning up the stock" and that the trade could be done within the next day, Casey instructed Brous to complete Night Capital's purchase of $100,000 worth of Deer Creek's Technest shares at $7.15 per share (DX M; Tr. at 8).
c. Roth of SRG Capital also expressed interest in purchasing a block of Technest shares, and on February 21 Brous informed Roth that Axiom might have shares available for SRG (DX S; Tr. at 26-27).
d. On February 21 Brous informed Abbe that there were about 50,000 shares of Technest available at $7.10 per share, and Abbe requested that Brous contact Iroquois Capital's "trader" (Tr. at 27).
e. On February 21, 2006, Jim Andrew indicated to Brous that ACC might not purchase Deer Creek's Technest shares unless ACC could find a buyer for the shares from ACC (Tr. at 24-25).
f. Though Deson had expressed interest in purchasing a block of Technest shares, on February 22 Brous was still not sure how interested Deson was (DX O; Tr. at 28).
25. Brous testified that by February 22, 2006, there was sufficient interest from prospective buyers to complete a sale of Deer Creek's 157,163 shares of Technest common stock (Tr. at 10, 47-49; DX V; DX W). He had a specific order from Night Capital and believed other interested buyers were just waiting for him to tell them how many shares were available (Tr. at 49).
26. Axiom expected to cross the trades at $7.05 per share; Axiom would charge Deer Creek $.10 per share, giving Deer Creek a net of $6.95 per share (DX W).
27. On February 22, 2006, in anticipation of the sale, Deer Creek opened an account with Axiom into which it deposited its Technest stock (PX 14; Sharinn Stmnt. ¶ 60; Martino Dep. at 10-11; Sharinn Dep. at 67).
28. Though the prospective buyers did not formally commit to purchasing Deer Creek's Technest stock, (Tr. at 18-19; DX M; DX N; DX O; DX W; Martino Dep. at 101), and Deer Creek was not formally bound to sell it, (Tr. at 23-24; Martino Dep. at 101), Axiom typically relies on similarly informal arrangements with sellers and purchasers when it brokers transactions (Tr. at 55).
D. Technest's Reaction to Deer Creek's Intention to Sell
29. Prior to February 15, 2006, Technest was aware that investors who had purchased stock in connection with the February 15, 2005 offering would, on February 15, 2006, be able to sell those shares pursuant to Rule 144 (Tr. at 92; O'Connor Dep. at 41).
30. Technest was concerned about having a large volume of its stock enter the market at that time, as such sales would depress Technest's stock price (Tr. at 93; Pereira Stmnt. ¶ 15). Technest was concerned about the price of its stock because Technest was seeking, among other things, to be registered on the NASDAQ (O'Connor Stmnt. ¶ 6; Tr. at 93-94), and registry on the NASDAQ requires a "healthy" stock price (Tr. at 93).
31. On February 15, 2006, Robert Tarini, Technest's Chief Executive Officer, instructed O'Conner to advise him of any requests to sell Technest stock "in the coming weeks" (Tr. at 94; DX F). That same day, O'Connor informed Tarini and Pereira that she had been in communication with a broker for Deer Creek, that Deer Creek wanted to sell its 166,995 shares of common stock,*fn3 and that the broker advised her that it would not participate in a sale until Technest filed its quarterly report (DX H).
32. Technest subsequently called between three and ten "company meetings and discussions to establish what [Technest's] belief was" concerning how the volume restrictions in section 4(c) of the RRA would apply to Deer Creek's intended sales (Tr. at 331, 346, 354).
33. O'Connor was not employed by Technest in February 2005, when the SPA and RRA were executed; she testified that in February 2006, she spoke with her co-general counsel and other employees at those meetings to understand Technest's intentions when the SPA and RRA were drafted (Tr. at 170-71).
34. On or about February 21, 2006, Deer Creek's counsel informed O'Connor that Deer Creek was planning to sell its Technest shares without regard to the volume restrictions described in section 4(c) of the RRA (O'Connor Stmnt. ¶ 2).
35. Later that day, O'Connor sent an email to Deer Creek and the other investors who purchased stock on February 15, 2005 stating, in pertinent part,
In connection with sales of your common stock of Technest Holdings, Inc., we wanted to confirm that you were aware of the selling restriction set forth in the Registration Rights Agreement . . . . We also wanted to confirm your awareness of the volume restrictions under Rule 144 promulgated under the Securities Act of 1933, as amended, for companies traded on the Over-the-Counter Bulletin Board.
Section 4(c) of the Registration Rights Agreement provides the following selling restriction: Each holder shall not, and shall not cause all persons to whom such Holder may transfer Registrable Securities not to, sell more than 25% of the Registrable Securities acquired by such Holder pursuant to the Securities Purchase Agreement dated February 14,2005 (the "Purchase Agreement") in any period of 20 consecutive trading days. The term Registrable Securities includes, among other things, those shares of common stock issued upon conversion of Technest's Series C Preferred Stock, those shares of Common stock issued upon exercise of warrants issued pursuant to the Purchase Agreement and shares issued as payment of partial liquidated damages. In order to manage compliance with this restriction, we are requesting that each holder limit their sales of common stock to a daily amount of 1.25% of their Registrable Securities. Therefore, we are asking that you sell no more than 3,130 shares per day (subject to Rule 144(e)) based on your total Registrable Securities being 250,426 (O'Connor Stmnt. ¶¶ 4, 5; DX K ("Restrictions Email")).
E. Technest's Communications with Axiom
36. On February 23, 2006, Axiom's president, Mark Martino, contacted O'Connor by telephone, informed her he was a broker for Deer Creek and inquired whether any restrictions would apply to Deer Creek's proposed sale of Technest shares (Tr. at 56-58, 97; Martino Dep. at 72).
37. O'Connor then forwarded the Restrictions Email to Martino and to the staff of Bear Sterns, Axiom's clearing broker (Tr. at 98, 262; Martino Dep. at 72).
38. Later that day, O'Connor told Martino that the restrictions contained in section 4(c) of the RRA would apply to Deer Creek's proposed sale (Tr. at 58-59). Martino informed O'Connor that Axiom was in a position to sell 157,163 shares, and asked O'Connor what would happen if Deer Creek and Axiom sold more than the 3,100 shares allowable under section 4(c) of the RRA. O'Connor told Martino that Technest would not remove the restrictive legends on more than 3,100 of the shares, thereby effectively preventing Axiom from concluding the trades (Tr. at 59, 63, 73-74; Martino Dep. at 74).
F. Axiom Withdraws From the Block Sale
39. After the foregoing discussions with Technest, Axiom decided not to sell Deer Creek's block of approximately 157,163 shares of Technest stock because there was too much risk involved -- if Technest removed the legends from only 3,130 of those shares, Axiom would be compelled to purchase unrestricted shares in the market place to close the transaction, potentially leaving Axiom with a large receivable from Deer Creek (Tr. at 61-62; Martino Dep. at 74-75).
40. Martino testified that but for O'Connor's February 23 representations concerning the volume restrictions in the RRA and Technest's representations that it would not remove the legends from more than 3,100 shares per day, Axiom would have completed the sale of 157,163 shares for approximately $7.00 per share (Tr. at 62-63).
41. Brous subsequently informed the prospective buyers that the sale of Deer Creek's Technest shares could not be a block trade into the open market. Rather, it would have to be a private sale, with the buyers subject to a number of restrictions on the resale of the stock (Tr. at 29-30; PX 34).
42. Axiom did not inquire of the buyers whether they would be willing to purchase restricted Technest shares through a private sale because Martino and Brous were confident that the buyers would not be interested in such a transaction, and that if such a sale ...