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Industrial Technology Ventures LP v. Pleasant T. Rowland Revocable Trust

February 23, 2010

INDUSTRIAL TECHNOLOGY VENTURES LP, PLAINTIFF,
v.
PLEASANT T. ROWLAND REVOCABLE TRUST, W. JEROME FRAUTSCHI LIVING TRUST, W. JEROME FRAUTSCHI, AND DIANE C. CREEL, DEFENDANTS.



The opinion of the court was delivered by: Charles J. Siragusa United States District Judge

DECISION and ORDER

INTRODUCTION

This diversity lawsuit alleging unjust enrichment, tortious interference with business relationships, common law fraud, civil conspiracy and violations of the Securities Exchange Act of 1934 is before the Court on motions to dismiss filed by Pleasant T. Rowland Revocable Trust, W. Jerome Frautschi Living Trust (collectively the "Trusts") (Docket No. 5), W. Jerome Frautschi ("Frautschi") (Docket No. 7) and Diane C. Creel ("Creel") (Docket No. 10). For the reasons stated below, the motions are granted in part and denied in part.

BACKGROUND

The Court accepts the factual allegations in the first amended complaint (Docket No. 4) as true for the purpose of considering the motions to dismiss. In general, Plaintiff, Industrial Technology Ventures, L.P. ("ITV"), a Georgia limited partnership, alleges that

[t]his action arises out of an unlawful scheme among the Defendants to take advantage and control of the Company when the Company was in need of capital. The Defendants acted at the expense of the Company's shareholders, including lTV, whose investments in the Company were severely diluted as a result of the Defendants' unlawful conduct. The Defendants also fraudulently induced lTV, and other shareholders, to sell a substantial number of shares in the Company for an unreasonably low price in light of material facts known to Defendants at the time of the sale, but intentionally withheld from lTV, and other shareholders.

(First Am. Compl. ¶ 3.) The Trusts are both citizens of Wisconsin, as is Frautschi. Creel is a citizen of New York, with an address in Rochester. ITV alleges that Defendants committed tortious acts inside and outside of New York and that such acts had an effect in New York. (First Am. Compl. ¶¶ 10 & 11.)

ITV invested in AnAeorobics, Inc. ("AnAerobics" or "the Company"), a company later known as Ecovation, Inc.*fn1 Prior to September 2002, AnAerobics had maintained a four million dollar line of credit with U.S. Bank, which was facilitated and guaranteed by the Trusts. In September 2002, AnAerobics issued Series A Preferred Stock, which ITV purchased pursuant to a Stock Purchase Agreement, a Voting Agreement and an Investor Rights Agreement, all of which are attached to the first amended complaint. ITV made four investments in AnAerobics by purchasing a total of 17.8% of the Series A Preferred stock as of March 2004. ITV purchased 4,681,422 shares of stock at $0.95 per share for a total investment of $4,447,351.57. Under the Voting Agreement, ITV designated Edward Wilson ("Wilson") to the AnAerobics's board of directors. ITV encouraged other institutions to invest in AnAerobics as well. Sterling Venture Partners, L.P., invested, and designated Eric Becker ("Becker") to the board.

The Trusts*fn2 also bought Series A Preferred stock and designated Frautschi to represent them on the board. Defendant Creel became chief executive officer ("CEO") of AnAerobics on May 19, 2003.

In June 2004, AnAerobics wanted to raise additional capital to fund its growth and the board of directors agreed to increase AnAerobics' line of credit to $30 million. AnAerobics entered into a Line of Credit agreement with the Trusts in which the Trusts would be provided with warrants to purchase 2,355,438 shares of AnAerobics Common Stock at a price of $0.50 per share. The Line of Credit agreement also included a provision that was carried over from the prior four million dollar line of credit-it required AnAerobics to maintain a minimum net worth in order to avoid default.

By 2005, AnAerobic had quickly expanded and was experiencing cash flow problems. It was also in default under the minimum net worth provision of the line of credit. Accordingly, the board of directors realized the need to raise additional capital. The Trusts offered to temporarily waive the minimum net worth provision until the end of 2005 in exchange for receiving 500,000 shares of Common Stock with a nominal price of $0.01 per share. The board accepted the offer, and encouraged CEO Creel to actively investigate available options for obtaining additional capital. In late 2005, Creel reported to the board on her discussions with other companies that had expressed an interest in purchasing AnAerobics, however, her discussions did not result in a completed sale. Consequently, the board authorized Creel to negotiate with the Trusts for an additional extension of the waiver of the minimum net worth provision. During these discussions, Frautschi left the room, since his position with the Trusts put him in conflict with AnAerobics.

ITV alleges that pursuant to his scheme with Creel, Frautschi resigned from the board of directors in November 2005. According to ITV, Creel, who wanted a more lucrative compensation package from AnAerobics, then worked with Frautschi to manipulate AnAerobics's need for an extension of the waiver. She did so by convincing the board to accept an extension of the waiver "under extremely unfavorable terms to other shareholders, including ITV." (First Am. Compl. ¶ 36.) In return, ITV alleges that Creel was promised more compensation once the Trusts controlled AnAerobics. Creel agreed with Frautschi to demand that the board release Frautschi from all liability associated with his duties on the board in exchange for an extension of the waiver.

On January 25, 2006, Creel presented the terms she had negotiated with Frautschi and recommended that the board release Frautschi from liability in exchange for a further extension of the waiver. The board requested that Creel attempt to negotiate better terms "and to thoroughly analyze all the potential repercussions of releasing Frautschi from liability as a Board member." (First Am. Compl. ¶ 40.)

On February 10, 2006, Creel reported to the board that the Trusts' demands were unwavering-that the Trusts would extend the waiver to June 30, 2006, only if the board released Frautschi from liability. Further, the Trusts wanted AnAerobics to cancel the common stock warrants the Trusts held, and replace them with warrants to purchase Series A Preferred stock at a price of $0.50 per share. Because Creel was, according to ITV, scheming with the Trusts and Frautschi, she recommended that the board accept the terms, ignoring other sources of capital that were available to AnAerobics on more favorable terms. Relying on Creel's recommendation, the board accepted the terms. In the Spring of 2006, "Creel's demands for a more lucrative compensation package from the Company became more frequent." (First Am. Compl. ¶ 45.)

In April 2006, Creel informed the board that the thirty million dollar line of credit would be insufficient to support AnAerobics' planned growth, and that AnAerobics was still in violation of the minimum net worth requirement, the waiver of which was due to expire on June 30, 2006. The board hired JP Morgan to identify a summary of prospective buyers for AnAerobics. Among those identified by JP Morgan was Ecolab, which subsequently did not express any interest in purchasing AnAerobics.

In a June 1, 2006, board meeting, Creel told the board that AnAerobics needed an additional ten to twelve million dollars to continue operations through the end of the year and avoid default under the minimum net worth requirement of the line of credit. Creel asked ITV and the other Institutional Investors*fn3 to submit a term sheet describing their proposed funding, and that she would show the term sheet to the Trusts and report to the board on the financing before the expiration of the waiver. The Institutional Investors submitted a term sheet on June 14, 2006, that provided enough capital to raise AnAerobic's net worth above the minimum net worth requirement in the line of credit, and allowed for pro rata share participation by all the investors in AnAerobics, including the Trusts, "and was consistent with the Right of First Refusal provision of the Investor Rights Agreement." (First Am. Compl. ¶ 51.) Creel delayed taking action on the term sheet and never entered into arms-length discussions with the Trusts about it. Instead, Creel waited until days before the wavier expiration and met with the board to explain that the Trusts would not accept the term sheet terms, and presented the board with a "take it or leave it" term sheet from the Trusts. The Trusts' terms would increase the line of credit to about fifty million dollars, would require AnAerobics to issue warrants allowing the Trusts to purchase an additional 12,204,474 shares of Series A Preferred stock at $0.01 per share (a value in excess of $26 million), and would change the exercise price on the prior warrant for Class A shares from $0.50 to $0.01 per share. ITV's analysis of the Trusts' terms were that,

[o]nly the Lenders were permitted to participate in this financing even though the Institutional Investors were eager to be involved. By couching the financing in debt rather than equity, the Lenders sought to circumvent the anti-dilution provisions in the Amended Certificate and the Right of First Refusal provision in the Investor Rights Agreement by denying the Institutional Investors their right to purchase their pro rata share of the stock issued in connection with this financing. (First Am. Compl. ¶ 57.) In addition, the Trusts wanted to expand the board of directors to eleven members, with the additional four members to be designated by the Trusts. Finally, the Trusts insisted that Creel's compensation be left to the sole discretion of the Trusts. Faced with the threat of foreclosure upon the expiration of the minimum net worth provision, on June 24, 2006, the board voted unanimously to accept the Trusts' conditions.

The Trusts now held a controlling interest in AnAerobics, despite not having to invest any additional cash in AnAerobics. Their Series A stock ownership rose from 23.7% in 2002 to over 50% in June 2006. "Through the First Series A Warrants, the Series A Conversion and the Second Series A Warrants, the Lenders had obtained a priority liquidation preference in excess of $30 million. The Lenders would eventually receive in excess of $40 million upon the sale of the Company in exchange for these shares alone." (First Am. Compl. ¶ 62.)

Creel threatened to leave AnAerobics if her compensation was not increased. Since the Trusts' loan was not finalized until July 2006, her threats were made to the compensation committee of the board of directors, which included two directors designated by the Institutional Investors. Creel also told the compensation committee that if she left AnAerobics, the Trusts would withdraw their financing under the terms they presented to the board. Becker, one of the members of the compensation committee, vehemently opposed Creel's demands for increased compensation, and went to the Trusts to discuss Creel's demand. The Trusts told Becker to give Creel the compensation package she wanted, and the board, concerned about foreclosure of AnAerobics, agreed to Creel's demands. Wilson resigned from the compensation committee in July, and Creel worked with the Trusts to remove Becker from the compensation committee and the board of directors on October 24, 2006.

In mid-January 2007, Dan Hagen ("Hagen"), an AnAerobics representative, attended an industry conference and was approached by an Ecolab representative who expressed "a vigorous interest" in purchasing AnAerobics. Hagen contacted AnAerobics' former chief financial officer, and that individual instructed Hagen to tell Creel about the contact with Ecolab. Hagen did so, but ITV alleges that Creel, pursuant to her scheme with the Trusts, never informed the board when she engaged in secret negotiations with Ecolab for the sale of AnAerobics. Creel did, however, inform the Trusts about her negotiations. The Trusts then began to solicit the shares of Series A Preferred stock held by ITV and the other Institutional Investors. The trusts explained to the Institutional Investors that the sale of shares must happen quickly. ITV agreed to sell its shares if the Trusts envisioned a time horizon with AnAerobics exceeding two to three years. The Trusts told ITV that they "envisioned a longer time horizon in the Company than lTV and Sterling." (First Am. Compl. ¶ 87.) Frustrated with the Trusts' control of AnAerobics, on January 29, 2007, ITV agreed with the terms Frautschi, acting for the Trusts, submitted in a letter, and sold two-thirds of its shares to the Trusts. Six months later, AnAerobics was sold to Ecolab for $210,000,000, gaining a $40,000,000 profit for the Trusts, and costing ITV about $9,000,000 in losses.

ITV brings ten causes of action against Defendants:

I. Breach of fiduciary duty against Creel and Frautschi

II. Breach of fiduciary duty against the Trusts

III. Lender liability for breach of fiduciary duty against the Trusts

IV. Aiding and abetting breach of fiduciary duty against Frautschi and the Trusts

V. Unjust enrichment against the Trusts and Creel

VI. Tortious interference with business relationships against the Trusts and Creel

VII. Tortious interference with business relationships against the Trusts and Creel

VIII. Securities fraud against the Trusts, Frautschi and Creel

IX. Common law fraud against the Trusts, Frautschi and Creel

X. Civil conspiracy against the Trusts, Frautschi and Creel

STANDARDS OF LAW

The U.S. Supreme Court, in Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007), clarified the standard to be applied to a 12(b)(6) motion:

Federal Rule of Civil Procedure 8(a)(2) requires only a short and plain statement of the claim showing that the pleader is entitled to relief, in order to give the defendant fair notice of what the claim is and the grounds upon which it rests. While a complaint attacked by a Rule 12(b)(6) motion to dismiss does not need detailed factual allegations, a Plaintiff's obligation to provide the grounds of his entitlement to relief requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do. Factual allegations must be enough to ...


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