United States District Court, S.D. New York
For CMF Investments, Inc., Plaintiff: Faun Marie Phillipson, Jonathan Craig Uretsky, Phillipson & Uretsky, LLP, New York, NY.
Darrell Palmer, Defendant, Pro se, Law Offices of Darrell Palmer, Solana Beach, CA.
OPINION & ORDER
VALERIE CAPRONI, United States District Judge.
By outward appearances, this is a routine contract case. Plaintiff CMF Investments, Inc. (" CMF" or " Plaintiff") and Defendant Darrell Palmer (" Palmer" or " Defendant") entered into a Stock Purchase Agreement (the " SPA"), dated December 14, 2012, for the sale of ten million shares of Spare Backup, Inc. (" SPBU"), a thinly-traded " penny stock, " in exchange for a $10, 000 cash payment. Pl. Ex. 1. When Plaintiff only received four million shares of SPBU after the time for performance had expired, it brought this breach of contract action seeking specific performance with regards to the additional six million shares or, alternatively, damages equal to the market value of those shares on January 22, 2013. Compl. ¶ ¶ 34-49. Plaintiff touts the sanctity of contract and argues that it was at all times ready willing and able to uphold its end of the bargain and pay for the shares when they were delivered. CMF claims that Palmer breached the contract when he failed to deliver the remaining six million shares. Tr. 178, 190-91. Palmer, in contrast, professes to be baffled by the lawsuit because he claims he was merely an accommodation party for a deal between CMF and the CEO of SPBU (whom Palmer claims was the real party in interest of the deal with CMF). Def. Mem. at 1-2 (Dkt. 50). According to Palmer, he did not complete the transaction because both parties told him the deal had been called off. Def. Ex. 5. Despite email traffic that reflects a meeting of the minds that the contract had been terminated and that the four million shares that had been transferred would be returned to Palmer, see Def. Ex. 6, Plaintiff argues that termination was not effective because it did not comply with the formalities of termination set forth in the contract, Tr. 180, 196-97.
The Court held a one-day bench trial on May 16, 2014, and heard testimony from Carla Hohenhouse, the sole officer and shareholder of CMF, Tr. 4-115, and Palmer, Tr. 116-176. During oral argument, Plaintiff's counsel conceded the obvious: there may have been more to the overall deal than what appeared on the face of the contract. Nevertheless, he argued that facts extraneous to the contract between CMF and Palmer were irrelevant because the contract was signed and enforceable. Tr. 180-83. The Court disagrees. Plaintiff's testimonial attempts to provide a legitimate explanation for dubious communications between herself and Perle were not credible, see Tr. 56-59, and the Court will not provide judicial imprimatur to an arrangement the goal of which the Court, as the trier of fact, finds was unlawful. Judgment is therefore entered for Defendant. Pursuant to Rule 52(a) of the Federal Rules of Civil Procedure, the Court makes the following findings of fact and conclusions of law.
I. LEGAL STANDARD
CMF claims that Palmer breached the SPA by not delivering ten million shares of SPBU to CMF's brokerage account within ten business days of the date the SPA was executed. Palmer claims that his performance was excused because the parties agreed to terminate the agreement in email exchanges between December 24 and 26, 2012. Alternatively, Palmer claims that the SPA is unenforceable against him because it was a cog in a scheme designed to achieve an improper purpose. Def. Proposed Findings of Fact at 1 (" Palmer Brief, " Dkt. 42).
To prevail on a claim for breach of contract under New York law, which the parties specified governs the SPA, CMF must establish " (1) the existence of an agreement, (2) adequate performance of the contract by the plaintiff, (3) breach of contract by the defendant, and (4) damages." Harsco Corp. v. Segui, 91 F.3d 337, 348 (2d Cir. 1996). The parties do not dispute the existence of the SPA or that Palmer did not tender full performance of his obligation under the SPA. It is also undisputed that CMF did not tender full performance either. It partially performed in a way that was directly proportionate to Palmer's performance. Oddly, the partial performance by CMF occurred after CMF had agreed, in a December 26, 2012, email to Palmer, to return the shares CMF had received. Def. Ex. 9. CMF argues, however, that it revoked its agreement to unwind and that the agreement to unwind was not enforceable because it did not comply with the formal requirements of the SPA, Pl. Post-Trial Mem. at 5. CMF also attests that it was at all times ready and willing to complete its performance -- but only after Palmer fully performed. As for damages, CMF claims that it would have sold the remaining shares of stock covered by the SPA for a significant profit, and seeks damages measured by the market price during the period immediately after the shares were to be delivered.
Even if Plaintiff had met its burden of proving that the agreement was not terminated, that CMF adequately performed its obligations under the contract, that Defendant breached the contract, and damages, however, a contract is unenforceable under New York law if the finder of fact concludes that the agreement was made " with corruption and fraud contemplated as its purpose." Dodge v. Richmond, 10 A.D.2d 4, 16, 196 N.Y.S.2d 477 (1st Dep't 1960), aff'd, 8 N.Y.2d 829, 168 N.E.2d 531, 203 N.Y.S.2d 90 (1960). It is well-settled that illegal agreements are void. Stone v. Freeman, 298 N.Y. 268, 271, 82 N.E.2d 571 (1948) (" It is the settled law of this State . . . that a party to an illegal contract cannot ask a court of law to help him carry out his illegal object . . . ."). " [E]ven where a contract is not itself unlawful, the bargain may still be illegal [and unenforceable] under New York law if it is closely connected with an unlawful act." United States v. Bonanno Organized Crime Family of La Cosa Nostra, 879 F.2d 20, 28 (2d Cir. 1989) (citing Contemporary Mission, Inc. v. Bonded Mailings, Inc., 671 F.2d 81 (2d Cir. 1981)). But " [c]onnection is a matter of degree, " and " [t]here must be at least a direct connection between the illegal transaction and the obligation sued upon." McConnell v. Commonwealth Pictures Corp., 7 N.Y.2d 465, 471, 166 N.E.2d 494, 199 N.Y.S.2d 483 (1960). Because strong public policy favors freedom of contract, illegalities that are merely incidental to the contract sued on will not void the entire agreement. New England Mutual Life Ins. Co. v. Caruso, 73 N.Y.2d 74, 81-82, 535 N.E.2d 270, 538 N.Y.S.2d 217 (1989); McConnell, 7 N.Y.2d at 471. When " the illegality is central to or a dominant part of the plaintiff's whole course of conduct in performance of the contract, " however, the plaintiff cannot recover because the courthouse doors are closed " to those who sue to collect the rewards of corruption." McConnell, 7 N.Y.2d at 469, 471.
II. FINDINGS OF FACT
CMF has been operating as an investment company since 2005, investing primarily in convertible promissory notes and convertible debentures. Tr. 35. In June 2012, Hohenhouse was introduced to Cery Perle,  the CEO of SPBU, by David Miller, an investor with an investing strategy similar to CMF. Tr. 39, 44. Between June and November 2012, Hohenhouse and Perle discussed CMF purchasing shares of SPBU through a private stock purchase agreement, with the shares originating from converted debentures rather than from the open market. Tr. 39-40. Hohenhouse testified that Perle was seeking buyers like CMF for the sole purpose of ridding old debt from SPBU's balance sheet and compensating holders of old debt for the amounts due to them. According to Hohenhouse, when she heard of SBPU's debt converting activity her investment savvy alerted her to a profitable opportunity. Tr. 36. The Court does not credit Hohenhouse's explanation on this point. The explanation simply cannot be squared with the contemporaneous email traffic between Hohenhouse and Perle, Def. Ex. 11, or with the overall economics of the transaction.
The SPA at issue here is the third such agreement CMF attempted to consummate to acquire shares of SPBU; Hohenhouse testified that the first two fell through because Perle " disappeared" before the agreements could be executed. Tr. 39-40. Palmer, an attorney who had done legal work for Perle and SPBU, was the holder of some of SPBU's " old debt, " including the convertible debentures that were converted to the shares that he contracted to sell. Tr. 73, 117-18; Pl. Ex. 1 at 1. On December 14, 2012, Hohenhouse and Darrell Palmer signed the SPA and agreed that Hohenhouse would pay Palmer $10, 000 in exchange for 10 million shares of SPBU. Pl. Ex. 1 at 1. Palmer would obtain the shares by converting two convertible debentures, each with a face value of $5, 000, into shares of SPBU common stock. Consistent with Palmer's position that Perle was the real party in interest, Perle was an additional signatory to the SPA, which purported to be between CMF and Palmer, and Perle took an active role in negotiating the transaction with Hohenhouse. Pl. Ex. 1 at 6; Tr. 42-43. Palmer played virtually no role. Tr. 42-43. The Court credits Palmer's testimony that he was an accommodation party for a transaction that was between CMF and Perle. See Tr. 137-38, 146-48, 170; Palmer Brief at 1.
Palmer testified that SPBU owed him approximately $1 million in legal fees, which he had been carrying largely in the form of convertible debentures for over a year. Tr. 117-18, 135-36. He testified that he was uneasy converting the debentures and selling the shares himself on the open market given his relationship with SPBU as its former counsel, but he was in need of " Christmas cash." Tr. 128, 173. Perle reported to Palmer that this transaction had been sanctioned by James Schneider, another of Perle's attorneys who specialized in advising small companies on SEC and stock-related matters. Tr. 172-73, 207. That assurance assuaged Palmer's concern with regards to selling his shares in a private transaction. Tr. 172-73, 207. According to evidence introduced by Plaintiff, SPBU was trading for approximately $0.019/share when the SPA was executed. See Pl. Ex. 8. Thus, on the open market, Palmer's shares were worth approximately $190, 000, compared to the $10, 000 he would be paid under the SPA. Nevertheless, and notwithstanding the substantial debt allegedly due him from SPBU, Palmer signed the SPA negotiated between Perle and Hohenhouse and agreed to sell stock that he purportedly owned free and clear at a discount of approximately 95%.
The SPA provided that Palmer would deliver the shares to CMF within ten business days of December 14, 2012. Pl. Ex. 1 at 2. Hohenhouse testified that her brokerage firm would not deposit shares into her account without an attorney's opinion, inter alia, that the shares had been properly issued and paid for. Tr. 19, 44-45. On December 17, 2012, Hohenhouse sent her attorney a package of documents to obtain his opinion regarding the shares of SPBU; her attorney then sent his opinion along with the documentation to the brokerage firm as proof that CMF had legal title to the shares. Tr. 44-45. One of the documents Hohenhouse sent her attorney was a photocopy of a check made payable to Palmer in the amount of $10, 000, purportedly proving payment-in-full for the shares. Tr. 19, 46. Hohenhouse testified that the check was never actually delivered to Palmer, a fact she did not disclose to her attorney. Tr. 46. Hohenhouse testified that she did not send Palmer the check because Perle (not Palmer) instructed her to pay for the shares with a wire transfer. Tr. 19, 50-51. The brokerage firm deposited four million shares of SPBU into CMF's account on December 24, 2012, before CMF had paid for them, based on Hohenhouse's false representation to her attorney (and the brokerage firm) that the $10, 000 check was payment for the shares. Tr. 22, 49, 50, 53. Hohenhouse testified that she told Perle " from the beginning" that she would not pay for the shares until they were in CMF's brokerage account, despite her full knowledge that her brokerage firm required the shares to be paid for prior to deposit. Tr. 48-49.
The plan went off the rails when the balance of the ten million shares did not " hit" CMF's account by the date Perle indicated they would, and Hohenhouse saw an email from Perle to David Miller stating that Perle did not " DWAC" the remaining six million shares as he had promised. See Def. Ex. 11. The email traffic that followed made it clear that Perle, not Palmer, was the real party in interest; that, pursuant to her agreement with Perle, Hohenhouse had two compatriots waiting in the wings to take action relative to the shares once she received them; and that, whatever this transaction really was about, it had nothing to do with getting old debt off of SPBU's balance sheet.
On December 24, when the six million shares from the second debenture had not been deposited into CMF's brokerage account, Hohenhouse emailed Perle -- NOT Palmer -- to raise concerns. She wrote:
Cery, The last time we spoke you said both dwacs would be done today. Only one hit. YOU said, when both hit then I could do the wire. I don't wire until stock hits. Now you see why. I will immediately pull the plug and don't you EVER contact me again. I have held these guys off and kept them from making money for two weeks waiting for you to get your [act] together . . . . You put 4 million shares in my account and expect me to wire you 10, 000 and you want to be paid in full but yet you rip me on the number of shares . . . . Go find somebody else to work your deal.
E-mail from Carla Hohenhouse to Cery Perle (Dec. 24, 2012 at 20:01:06) (Def. Ex. 11 at 9). Hohenhouse testified that the " guys" she referred to were two people who posted on message boards whom she knew only through Internet monikers. Tr. 80. She testified that, as a favor to Perle, she intended to pay them around $200 to post to an investment forum when SPBU made some unspecified announcement, because Perle was concerned the news would be overlooked by investors due to the holiday season. Tr. 57-58, 75-77, 80-81. Hohenhouse testified that her " guys'" planned activity had nothing to do with her reasons for purchasing SPBU stock. Tr. 58.
Further email confirmed that Perle was the real party in interest to the transaction with CMF. Approximately 40 minutes after Hohenhouse's first email, apparently having received an email from David Miller at Harllon Holdings in the interim, Hohenhouse emailed Perle again:
I told you I had everything under control. I told you that letting the guys go on Thursday was not a problem. We discussed payment and you agreed that ...