United States District Court, W.D. New York
DECISION & ORDER
MICHAEL A. TELESCA, District Judge.
Plaintiff Industrial Technology Ventures LP ("ITV"), a Georgia Limited Partnership, brings this diversity action against Defendants Pleasant T. Rowland Revocable Trust, W. Jerome Frautschi Living Trust, (collectively "the Trusts"), W. Jerome Frautschi individually, and Diane C. Creel, claiming that the defendants violated the Securities Exchange Act of 1934 ("Exchange Act") and committed various State law torts in connection with the financing and eventual sale of a company known as Ecovation ("the Company"), a start-up wastewater treatment technology company located in Rochester, New York. Specifically, ITV, which had invested in Ecovation, claims that Creel, the CEO, Chairman of the Board, and President of Ecovation, at all relevant times, inter alia, conspired with the defendant Trusts, who had also invested in Ecovation and had guaranteed several loans made to Ecovation, to enrich themselves at the expense of other investors in the Company. ITV alleges that the defendant Trusts took advantage of Ecovation's need for capital, and with Creel's assistance, obtained control of the Company by providing loan guarantees to the Company. In doing so, ITV contends that the defendants acted at the expense of the Company's remaining shareholders, whose investments were severely diluted as a result of defendants' alleged conduct. ITV claims, inter alia, that the defendants fraudulently induced ITV and other shareholders to sell a substantial number of shares in the Company for an unreasonably low price in light of the material facts known only to the defendants at the time of the sale, and intentionally withheld from ITV and other shareholders.
Plaintiff alleges ten counts against the defendant including claims of: (1) breach of fiduciary duty against Creel and Frautschi; (2) breach of fiduciary duty against the Trusts; (3) lender liability for breach of fiduciary duty against the Trusts; (4) aiding and abetting breach of fiduciary duty against Frautschi and the Trusts; (5) unjust enrichment against the Trusts; (6) two separate claims of tortious interference with business relationships against the Trusts and against Creel; (7) securities fraud against all Defendants; (8) common law fraud against all Defendants; and (9) civil conspiracy against all Defendants. Dkt. No. 116.
Currently pending before the Court are three motions for summary judgment filed by all four defendants. Individual defendants Creel and Frautschi have each filed motions seeking summary judgment against ITV on all counts pending against them. Dkt. Nos. 134, 138. The defendant Trusts have filed a joint motion for summary judgment against ITV asking that the complaint against the trusts be dismissed in its entirety. Dkt. No. 136. For the reasons stated below, the Trusts' motions are granted in part and denied in part, and the individual defendants' motions are denied.
The following facts are drawn from the parties' voluminous Rule 56 statements,  and will be summarized in their most abbreviated form. As is required, they are viewed in the light most favorable to ITV, as the nonmoving party.
I. The Parties
Plaintiff ITV is a venture capital firm that invests in emerging businesses. In 2002, Ecovation, a start-up Company engaged in the business of wastewater treatment, was seeking capital to expand its business. ITV invested in Ecovation, and as part of its agreement to invest in the Company, ITV appointed one of its managers, Edward Wilson ("Wilson") to became a member of the Board of Directors of Ecovation. Several other investors also invested in Ecovation at that time. Sterling Venture Partners, L.P. ("Sterling"), a private equity fund, invested in the Company and appointed Eric Becker ("Becker") to sit on Ecovation's Board. As owners of preferred stock, ITV and Sterling (the "Institutional Investors") enjoyed, in addition to the right to designate Board members, liquidation preferences, and rights of first refusal on future equity. In September, 2002, Evocation filed an Amended Certificate of Incorporation that created and defined the rights associated with Series A preferred stock.
Pleasant Rowland and her husband, defendant Jerome Frautschi, also invested in Ecovation through their trusts, the Pleasant T. Rowland Revocable Trust and the W. Jerome Frautschi Living Trust. In addition to investing in Ecovation, the Trusts also guaranteed significant loans made to Ecovation. Defendant W. Jerome Frautschi also became a member of the Board of Directors of Ecovation.
In 2003, Ecovation hired Diane Creel ("Creel"), former Chairman and CEO of Earth Tech, another business in the environmental engineering sector, to serve as Ecovation's CEO, President, and Chair of the Board of Directors. Pursuant to her employment agreement, Creel was to serve for a period of two years with an automatic renewal for an additional two years. Creel testified that she came to Ecovation seeking "an opportunity for me to try to build another company.... So I went from 9, 000 employees to 11, flying around on private jets to riding in coach, having a driver in L.A. to driving my own SUV through the snow in Rochester to have that opportunity to try to grow another business." Pl. Ex. 5 (Creel Dep.) 28-32.
Creel's compensation package included an annual salary of $435, 000 along with a potential annual bonus and 1.2 million common stock options at $.95 per share. Under the terms of her employment agreement, the Compensation Committee of the Board of Directors had discretion over Creel's compensation and bonus.
Frautschi, Rowland, nor any of their agents had met Creel before she became CEO of Ecovation. Creel, however, had other professional relationships connecting her to Frautschi and other Board members.
II. Evocation's Existing and Proposed Lines of Credit
In 2002, the Company faced serious funding problems. It had raised some capital by issuing shares of Series A stock in 2002 and 2004, and also obtained a $4 million line of credit from U.S. Bank that was guaranteed by Frautschi. However, the Series A equity raise and the U.S. Bank loan were not sufficient to sustain the Company's rapid growth.
Ecovation considered entering into a $30 million financing agreement with Newcourt Capital U.S.A., Inc. ("CIT") in 2004. CIT provided the Company with proposed terms, but the negotiations did not result in a formal agreement. At that point the Trusts intervened and offered a loan to Ecovation with similar terms, and the Board authorized management to negotiate a formal loan agreement with the Trusts based on those terms.
The Trusts' Line of Credit ("Trusts' LOC") included a $6 million tangible net worth covenant to provide assurance that the Company could repay the loan. The loan agreement provided, among other things, that Creel would remain full-time President of the Company. Should Creel leave Ecovation for any reason, the Trusts would have the ability to immediately terminate the loan. See Def. Ex. 83, §5.1. ("[A]ll notes shall be immediately pre-paid upon a change of control of the Borrower.") The final loan agreement also provided the Trusts with warrants to purchase common stock for $.50 per share in addition to any interest on any outstanding balance on the line of credit.
On June 30, 2004, Ecovation entered into the Trusts' LOC, which had a maturity date of December 31, 2006, and which provided Ecovation with the ability to borrow up to $30 million if it remained in compliance with the agreement. Frautschi joined the Board shortly after the execution of the Trusts' LOC.
The Trusts' LOC's Adjusted Tangible Net Worth covenant (the same as the one proposed by CIT) required the Company to maintain an adjusted net worth of $6 million in order to avoid default. Creel testified that she didn't get "overly concerned about" whether the Company would meet the net worth requirement because she thought it could be met. Creel Dep. at 321-22.
Ecovation breached this covenant by July of 2005, about one year later. By Written Consent, the parties agreed that the Trusts would receive 500, 000 shares of common stock at a price of $0.01 per share in exchange for a waiver by the Trusts of the Company's breach of the Adjusted Tangible Net Worth Covenant through December 31, 2005.
In the meantime, the Board charged Creel with investigating financing options to cure the Company's default in the fall of 2005. Creel advised the Board in December, 2005, that the two companies interested in a possible acquisition of Ecovation, 3M and Veolia, would not entertain and/or commit to a proposal at that time. On December 21, the Board unanimously voted to retain J.P. Morgan to pursue a sale or refinancing of the Company.
Thus, when the debt alternatives did not come to fruition, Creel again presented the Board with a proposal from the Trusts extending the existing waiver to June 30, 2006, this time in exchange for converting the warrants to purchase shares of common stock into warrants to purchase Series A stock for $.50 per share. Creel urged the Board to accept the proposal, and the Board followed her recommendation, entering into a First Amendment and Waiver Agreement ("Waiver Agreement") with the Trusts on January 1, 2006. The Waiver Agreement shortened the life of the loan by six months, and provided the Trusts with regular business reports, the right to review any and all proposed design-build financing contracts as well as the opportunity to fund or not fund any design-build financing contract. During the Waiver Agreement negotiations, Frautschi resigned from the Board in November, 2005, based on his concern that "there might be a possible conflict in that we had a major commitment in the financing of Ecovation." Pl. Ex. 8 (Frautschi Dep.) 60. Frautschi then negotiated and ultimately was granted a release and waiver of liability relating to his Board position as a condition of the extension of the waiver. His seat was then filled by Creighton "Kim" Early ("Early"), a former colleague of Creel's from Earth Tech on December 15, 2005. Creel continued to assure the Board that "06/30 will not be an issue." Pl. Ex. 62.
III. Competing Term Sheets
By April 2006, the Board began internal financing discussions, which involved the proposal of a bridge loan by Becker, Sterling's representative. Unbeknownst to Becker, the Trusts expressed to Creel a dislike for Sterling and the Institutional Investors in general.
On June 1, 2006, Creel reported to the Board that the sale process had failed, and requested a formal proposal for the potential bridge loan. She shared this information with the Trusts, and apprised them of Ecovation's financing needs.
The Institutional Investors submitted a term sheet outlining the terms of a proposed financing vehicle for Ecovation ("the Investor Term Sheet" or "ITS"), on June 14, 2006. Among other things, the ITS proposed an $18 million bridge loan that was convertible into equity in order to finance operations and customer contracts while the Company finalized an even larger equity financing with existing and outside investors. At the time the ITS was submitted, Ecovation had already drawn more than $24 million on the Trusts' Line of Credit, and the June 30, 2006 maturity date was only two weeks away.
Two days later, Creel discussed the ITS with the Trusts' representative, but not with Frautschi or Rowland. Creel finally met with Frautschi and Rowland on June 19, 2006. During that meeting, the Trusts expressed willingness to negotiate a line of credit of $50 million under terms similar to the existing Line of Credit that was set to expire on June 30, 2006. Creel then informed the Board on June 20, 2006, six days after the ITS was submitted, that the Trusts would submit an amended term sheet in a few days. Creel's handwritten notes of her discussion with Board member Early on June 20, 2006, regarding the Trusts' alternative proposal indicate, "accept this agreement - [indecipherable] foreclose." Pl. Ex. 20.
On June 22, 2006, the Trusts submitted a competing proposal to the Investor Term Sheet ("Trusts' Term Sheet" or "TTS"), which provided for a $50 million Line of Credit. The number of warrants demanded by the Trusts was based on, and was in the same ratio as the warrant coverage contained in the ITS. The Trusts' Term Sheet also provided that the Board of Directors would increase from seven directors to eleven, and that Creel's compensation matters would be subject to review and approval by the Trusts.
According to ITV, Creel and the Trusts had begun strategizing an exclusive financing agreement months earlier. In support of this fact, Plaintiff submits a worksheet from a Microsoft Excel workbook entitled, "Term Sheet Analysis, " dated June 14, 2006. Pl. Ex. 31 (analysis of the impact on stock ownership if the Trusts received 51% of outstanding Series A stock). Additionally, it submits an affidavit from a computer science and data forensics analysis that concludes that four documents, including Plaintiff's Exhibit 31, were created as early as April 20, 2006. Pl. Ex. 106. The Defendants submit contradicting evidence in the form of a sworn declaration by Ken Garcia ("Garcia"), CFO of Ecovation, stating that the document was not created until after the Company received the Trusts' Term Sheet on June 22, 2006. Garcia Decl. ¶¶ 30-31. Defendants further maintain that the specific contents of Plaintiff's Exhibit 31 were input on June 27, 2006. The spreadsheet indicates that the Trusts requested the same ratio of warrants for Series A Preferred Stock to debt that the other Institutional Investors requested in their June 14, 2006 term sheet. Def. Exs. 34 & 37.
According to Becker, the Trusts, through Creel, had threatened to foreclose on the Line of Credit and accelerate the outstanding debt if the Board did not accept their proposal. Pl. Ex. 3 (Becker Dep.) at 56-57. Likewise, Wilson testified that the Board "had a few days until the lender was to foreclose.... I mean, there was no alternative. There was no other option than accept the term sheet." Pl. Ex. 16 (Wilson Dep.) at 316-17. Becker and Wilson also testified that Creel threatened to quit the Company if the Trusts' term sheet was not accepted, and the Trusts threatened to foreclose if Creel quit. Becker Dep. at 103-04; Wilson Dep. at 320. The other four directors, including Early, all executed sworn declarations that uniformly state that no threats of foreclosure were ever communicated. Call Decl. ¶¶ 16-18; Early Decl. ¶¶ 17-19; Patchen Decl. ¶¶ 15-17; Slocum Decl. ¶¶ 18-19.
The Investor Term Sheet was then withdrawn on June 23, 2006. Board member David Patchen testified that "the [investor] term sheet had been withdrawn so the Company had no other alternative." Pl. Ex. 12 (Patchen Dep.) 229-30. According to Paul DiBella of ITV, "[o]ur support in withdrawing that - we were not at a point in time to be playing chicken.... We were under the threat of foreclosure, and I certainly understand what it means to take a zero, and that's what we were being faced with." Pl. Ex. 6 (DiBella Dep.) at 191-93. An emergency conference of the Board was ...