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Vista Outdoor Inc. v. Reeves Family Trust

United States District Court, S.D. New York

February 13, 2017



          JED S. RAKOFF, U.S.D.J.

         Why would the executives (and former principals) of a paddle-board division of a sports and recreation company cause the company to make a one-time $60, 500 purchase of one million stickers that the executives themselves immediately attempted to repurchase from the company for approximately $4 million? The answer is that they thereby hoped to stick the company with a $10 million "earnout" payment to the executives, thus netting themselves a cool $6 million. Thanks, however, to the age-old doctrine of good faith and fair dealing, and similar legal protections, in the end it is these executives who are stuck.

         Before the Court are the motions, and cross-motions for summary judgment of plaintiff Vista Outdoor Inc. ("Vista") and defendants Reeves Family Trust, Michelle Wilkens, Jeremy Wilkens, and Kyle Reeves. The crux of the dispute is whether defendants, two of whom were formerly employed by Vista, improperly entered self-dealing transactions to hit profit targets and thereby receive compensation known as an "earnout." Vista blocked the transactions before they could be finalized. For the reasons set forth below, the Court grants partial summary judgment for Vista imposing a declaratory judgment that the attempted transactions were not an appropriate means for Jeremy Wilkens, Michelle Wilkens, and the Reeves Family Trust to generate profits for the purposes of satisfying the earnout (Count I), and holding further that defendants Jeremy Wilkens and Michelle Wilkens breached the implied covenant of good faith and fair dealing by attempting to enter such transactions (Count IV), that Kyle Reeves tortuously interfered with the parties' contract by intentionally procuring the breach by Michelle Wilkens and Jeremy Wilkens (Count V), and that defendants Reeves Family Trust, Michelle Wilkens, and Jeremy Wilkens are in breach of Section 2.5 of the parties' Purchase Agreement (Count VI). The Court also grants partial summary judgment for defendants holding that the Reeves Family Trust did not breach the covenant of good faith and fair dealing, and otherwise grants summary judgment to both sides dismissing the remaining claims and counterclaims.

         Since, collectively, these rulings dispose of all of the claims, this Opinion and Order also directs the parties to submit proposed calculations of prejudgment interest so that final judgment may be promptly entered.

         The basic facts are not in dispute. Plaintiff Vista is a public company specializing in outdoor sports and recreation products. Vista Outdoors's Local Rule 56.1 Statement of Undisputed Material Facts in Support of its Motion for Summary Judgment ("PL's R. 56.1 Statement") at ¶¶ 1-3, ECF No. 73.[1]On July 20, 2015, Vista acquired Jimmy Styks, a manufacturer of stand-up paddle-boards ("SUPs"), cofounded by defendants Kyle Reeves and Jeremy Wilkens. Id. at ¶¶ 40-41. Since defendant Reeves was not personally an owner of Jimmy Styks, he did not sign the agreement memorializing the acquisition (the "Purchase Agreement"). Id. at ¶¶ 42-44, 47-49, 84. Instead, Vista signed the Purchase Agreement with defendants Jeremy Wilkens and Michelle Wilkens, husband and wife, and the Reeves Family Trust, a Canadian irrevocable trust whose sole trustee is defendant Reeves' mother. Id.[2]

         The Purchase Agreement contains what is known as an "earnout, " which defendants concede was designed to allow Vista to "acquire Jimmy Styks by paying the full value of the company in two parts." See Wilkens Decl. at ¶ 11, ECF No. 64; see also Reeves Decl. at ¶ 2, ECF No. 61 ("An earn-out was a significant part of the consideration for the acquisition."). As the Second Circuit has explained, an "earnout permits parties to conclude a merger without first agreeing as to the proper valuation of the target company." Sec. Plans, Inc. v. CUNA Mut. Ins. Soc, 769 F.3d 807, 810 (2d Cir. 2014). Instead, "[t]hrough a contingent payment structure, the parties agree to disagree and defer the ultimate valuation question until a later point in time when the uncertainties with respect to valuation have been resolved." Id.

         Pursuant to this arrangement, Vista paid defendants $40 million at closing, and agreed to pay up to $40 million in additional, contingent consideration if Jimmy Styks met or exceeded targets during the three years after the acquisition. PL's R. 56.1 Statement at ¶¶ 43-44, 47-49, 84. For "year one, " defendants would receive a baseline $1 million payment if gross profits equaled $9, 947, 684, with the potential payout increasing as gross profits rose. Id. at ¶¶ 50-54. The year one earnout reached a maximum of $10 million if gross profits equaled or exceeded $12, 434, 605. Id. The Purchase Agreement further specified that the parties will measure gross profits using "generally accepted accounting principles . . ., as applied by [Vista]." Fortney Decl. Ex. 3 at 5, 7.

         Following acquisition, issues arose as Vista worked to integrate Jimmy Styks into its business. Vista hired defendants Reeves and Wilkens, PL's R. 56.1 Statement at ¶¶ 114-117, but in 2016, Jimmy Styks' two largest customers reduced their anticipated orders. Id. at ¶¶ 154-167. Vista further admits that it did a "poor" job integrating Jimmy Styks into its larger corporate structure, id. at ¶¶ 140-147, but alleges (though it is not undisputed) that defendants Reeves and Wilkens exacerbated these problems by repeatedly taking combative stances with Vista's management in profanity-laden emails. See id. at ¶¶ 124, 150, 153, 349. Regardless, it is undisputed that over the course of year one, it became clear that an earnout payment based on anticipated orders was unlikely. Id. at ¶ 199.

         Accordingly, defendants Reeves and Wilkens developed a plan to "buy" the earnout. Id. at ¶¶ 152, 199, 268. Defendants first considered purchasing a sufficient number of fins, screws, or t-shirts from Jimmy Styks to trigger the payment. Id. at ¶¶ 197-198, 200. They ultimately settled on stickers because they yielded the best profit margin. Id. at ¶¶ 201-203, 226. In April 2016, defendant Reeves placed an order on behalf of (and billable to) Vista for one million stickers, to be rush delivered to Jimmy Styks' California office rather than Vista's distribution center near Kansas City (which was the primary distribution center for Jimmy Styks SUPs). Id. at ¶¶ 205-213, 222-223. Upon learning that the stickers were ready, Reeves then emailed Wilkens stating: "Haha, this is real dude! 60k worth of stickers!!! We are going to go down in the history books . . ." Id. at ¶ 221.[3] Defendant Wilkens later testified that he was "sure" purchasing the stickers "would have raised flags" within Vista, and had hoped that "organic sales" would be sufficient to obtain the earnout payment. Id. at ¶¶ 269-270.

         To the extent that Jimmy Styks had previously distributed stickers to its customers, it had provided them gratis. Id. at ¶¶ 227-230. Nonetheless, on June 22, 2016, seven business days prior to the end of the 2016 earnout period, defendants attempted to purchase from Jimmy Styks approximately 900, 000 stickers at $3.99 or $4.99 per sticker for a total price of just under $4 million. Id. at ¶¶ 244, 251. Specifically, defendant Reeves submitted three purchase orders on behalf of the Reeves Family Trust, even though he was not the trustee and had no authorization, id. at ¶¶ 251-256, and defendant Jeremy Wilkens submitted three purchase orders on his own behalf, id. at ¶ 251.

         Vista, however, blocked the transaction, fired Reeves and Wilkens, and filed a six-count complaint alleging, inter alia, that defendants' attempted sticker purchase breached the implied covenant of good faith and faith dealing (Count IV), and that defendant Reeves tortuously interfered with the Purchase Agreement by causing the other defendants' breach (Count V). Id. at ¶¶ 253, 354-355, 362. Defendants answered with six counterclaims, including that Vista blocked the transaction in bad faith (Counterclaim III) and fired defendants in violation of state and federal whistleblower laws (Counterclaims IV-VI). Id. at ¶ 363. Vista subsequently withdrew Counts II and III of its complaint. See ECF No. 80. Vista now moves the Court to grant summary judgment in its favor on Counts I, IV, V, and VI and to dismiss defendants' counterclaims in their entirety. Defendants cross-move for summary judgment in their favor on Counterclaim III and to dismiss Vista's claims in their entirety.

         The Court begins with whether Vista is entitled to a declaratory judgment that the sticker transactions were not an appropriate means to generate gross profits for the purposes of the earnout because defendants Michelle Wilkens, Jeremy Wilkens, and the Reeves Family Trust attempted to enter the transactions in breach of the implied covenant of good faith and fair dealing (Counts I and IV, respectively). Under New York law, "implicit in every contract is a covenant of good faith and fair dealing which encompasses any promises that a reasonable promisee would understand to be included." N.Y. Univ. v. Continental Ins. Co., 662 N.E.2d 763, 769 (N.Y. 1995) (citations omitted). Pursuant to this principle, "neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract." Sec. Plans, 769 F.3d at 817.

         There is no genuine dispute that the sticker purchase would have defeated the purpose of the earnout. Defendants admit that the earnout is not incentive compensation linked to one year's profits. Instead, it reflects Jimmy Styks' "full value" at the time of the acguisition. See Wilkens Decl. at ¶ 11; Reeves Decl. at ¶ 2. If Jimmy Styks hit certain targets during the three years after the acguisition, Vista agreed to pay up to $40 million on the assumption that the company was more valuable than the parties anticipated. See Sec. Plans, 769 F.3d at 810.

         Reasonable parties would understand that this arrangement makes economic sense only if Jimmy Styks generates its sales in the ordinary course of its business. As noted, for year one, Vista agreed to pay defendants $1 million if gross profits reached $9, 947, 684 and an additional $3.62 in compensation for every $1 in gross profits thereafter (up to a maximum earnout of $10 million). While Vista would technically "lose" $2.62 for every $1 in gross profit over the threshold, Vista in reality would suffer no detriment because the value of Jimmy Styks as a company would increase simultaneously. PI.'s R. 56.1 Statement at ¶¶ 104-106. This is because past profits, when generated in a predictable way, are likely to be repeated as future profits. Id. By artificially increasing Jimmy Styks profit during a critical period following the acquisition, defendants overstated the "full value" of the company and caused Vista to overpay to the tune of $10 million.[4]

         The terms of the Purchase Agreement support this understanding. Section 3.7(c) includes a representation by defendants that Jimmy Styks' "accounts receivable . . . have arisen from bona fide transactions entered ... in the ordinary course of business consistent with past practice (emphasis added)." Accordingly, if defendants had made their $4 million sticker purchase prior to the acquisition, these profits would not have counted toward Jimmy Styks' overall valuation. No reasonable party would believe that such purchases would count after the acquisition, given that they are no more reflective Jimmy Styks' "full value" after the purchase than before. Defendants respond that the sticker transactions are permissible because the profits from the sales would have been recognizable under GAAP. There is no dispute that the Purchase Agreement measures Jimmy Styks' gross profits using "generally accepted accounting principles . . ., as applied by [Vista]." Defendants, however, conflate GAAP with the distinct issue of whether the defendants acted in bad faith by arbitrarily and materially boosting Jimmy Styks' revenue. Cf. United States v. Rigas, 490 F.3d 208, 220 (2d Cir. 2007) (citing United States v. Simon, 425 F.2d 796, 805-06 (2d Cir. 1969)("It has been the long-held view in this Circuit that GAAP neither establishes nor shields guilt in a securities fraud case.")).[5] As defendants' GAAP expert testified, whether a transaction is made in bad faith has no bearing on whether the revenue is recognizable under GAAP. See Fortney Decl. Ex. 176, Ashe Tr. at 253:24-254:12, ECF No. 58. Conversely, compliance with GAAP does not preclude the possibility that a transaction is made in bad faith or otherwise contravenes the purpose of the earnout provision. Id. at 251:13-253:14. Indeed, if it were otherwise, defendants could have entered into transactions that were forbidden by Vista policy - or even illegal - but would still be entitled to their earnout if the transactions would have resulted in GAAP revenue. See id. at 168:17-170:14. No reasonable party would have agreed to such an outcome, and the covenant of good faith and fair dealing is implied by law precisely to prevent such maneuvers.

         Defendants' reliance on Judge Koeltl's recent decision in Vysyaraju v. Mgmt. Health Sols., Inc., No. 12 CIV. 4420 JGK, 2013 WL 4437236 (S.D.N.Y. Aug. 19, 2013) is misplaced. In Vysyaraju, the parties signed a purchase agreement containing an earnout provision and representations that the parties had prepared their pre-closing financial statements in accordance with GAAP, "consistent with past practice." Id. at *3. The agreement further stated that the parties would measure post-closing profits in accordance with GAAP, but did not require adherence to "past practice." Id. at *6. The plaintiff brought suit alleging bad faith after the defendant changed its accounting policies, but the court dismissed the claim, reasoning that the purchase agreement addressed GAAP pre- and post-closing, and "[w]here the parties wanted revenue calculated through procedures other than those provided by GAAP they knew how to do that." Id. at *8.

         Here, unlike in Vysyaraj u, the allegations concern the types of transactions that parties may enter under the Purchase Agreement - not the accounting method used to measure such transactions. Furthermore, while the Purchase Agreement in Section 3.7(c) specifies what types of transactions are permissible pre-closing, it is silent concerning post-closing transactions. The terms of the Purchase Agreement are therefore no bar to Vista's claim because the agreement leaves the issue to the parties' discretion, which is bounded by the covenant of good faith and fair dealing - the subject of the present dispute. See Sec. Plans, 769 F.3d at 818.[6]

         Defendants make two additional points that, while correct, are immaterial. Defendants argue that the Purchase Agreement does not prohibit them from purchasing Jimmy Styks products. Defendants and Counter-Plaintiffs' Memorandum of Law in Support of their Motion for Summary Judgment ("Defs.' Br.") at 18, ECF No. 51.[7] Defendants also add that the agreement allows Reeves and Wilkens to start new product lines. Id. at 4. But there is no evidence that this was what the defendants were about. On the contrary, it is essentially undisputed that they were entering into an artificial set of transactions solely so that they could qualify for their earnout.

         Based on the foregoing, there is no genuine dispute that defendant Jeremy Wilkens, as a company insider who orchestrated the sticker transaction, breached the implied covenant of good faith and fair dealing. There is also no genuine dispute that defendant Michelle Wilkens breached the covenant. While Mrs. Wilkens was not an insider and did not submit purchase orders in her own right, [8] she testified that Mr. Wilkens discussed the sticker scheme with her and asked whether she was "okay with it, " and that she subsequently used her husband to make purchase orders on her behalf for the purpose of "buying the earn-out." See Fortney Decl. Ex. 16 at 138:10-139:10; see also id. ("Q. Did there come a time in 2016 when you and your co-founders decided to place a series of purchase orders with Vista . . . ? A. Yes. Q. When did you decide to place that order? A. When Jeremy [Wilkens] decided to put the [purchase order] in.").[9] Mrs. Wilkens cannot now avoid liability simply because she used her husband to buy the stickers rather than purchasing them herself.[10]

         On the other hand, Vista has not shown that the Reeves Family Trust acted in bad faith. It is undisputed that the trustee, Eleanor Reeves, considers and generally follows the advice of defendant Reeves in carrying out her duties. PI.'s R. 56.1 Statement at ¶ 25. However, Ms. Reeves did not authorize the purchase orders made on behalf of the trust by her son and had no knowledge of the purchase orders at the time they were made. Id. at ΒΆΒΆ 253-255. Vista further blocked the orders before Ms. Reeves could ratify the ...

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