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Wallach v. Smith

United States District Court, W.D. New York

July 11, 2017

Mark S. Wallach, Appellant,
David Smith & Jennifer Smith, Appellees.




         In an adversary proceeding brought by Trustee Mark S. Wallach ("Trustee" or "Wallach"), the Bankruptcy Court granted summary judgment to the defendants, David and Jennifer Smith. At stake in this appeal is $700, 000 (plus interest)-the balance remaining on a stock-subscription agreement signed in March 2009, 16 months before NanoDynamics, Inc., the debtor corporation, filed for bankruptcy. Because 11 U.S.C. § 356(c)(2) precludes the bankruptcy trustee from assuming "any executory contract. . . to issue a security of the debtor, " this Court AFFIRMS the decision of the Bankruptcy Court.[1]


         On several occasions, David and Jennifer Smith invested sizeable sums in the technology industry. One beneficiary of those investments was the debtor here, NanoDynamics, Inc., a company engaged in research and development of such commercial applications as cement additives, nano-metal particles, and water-filtration and halloysite products. NanoDynamics sought and received multiple investments from the Smiths-in 2004, 2005, and 2007-at different prices per share.

         In October 2008, NanoDynamics again looked to the Smiths for capital. As it had in the past, NanoDynamics provided the Smiths with a Confidential Private Placement Memorandum ("PPM"), this one offering shares of stock for $5 per share. The PPM apprised prospective investors of the company's financial condition and stated that the "business is dependent upon the proceeds of this Offering to fund our existing obligations and continuing operations." Docket Item 4-22 at 16.[2]

         A short time later, the Smiths invited NanoDynamics representatives to meet with them and other potential investors. Mr. Smith maintains that during this meeting, he privately asked Keith Blakely, then-CEO of NanoDynamics, whether an investment of $2.5 million would be sufficient to take the debtor through to an initial public offering ("IPO"). According to Mr. Smith, Blakely said that it would.

         At about the same time, NanoDynamics was struggling to remain solvent. In fact, the corporation's officers contemplated filing for bankruptcy, and they met with professionals to discuss that possibility. The Smiths were not explicitly informed about that before they signed the contract giving rise to the current dispute. They did, however, receive a First Addendum to the PPM ("First Addendum") in December 2008. The First Addendum addressed the corporation's increased risk of insolvency, stating that NanoDynamics "is overdue in its payment to most vendors" and that "[t]he funds to be raised in this Offering are required if the Company is to continue as a going concern." On March 9, 2009, the Smiths and NanoDynamics signed a stock-subscription agreement ("Agreement") in which the Smiths agreed to purchase 2.5 million shares in NanoDynamics for $1 per share. The first $500, 000 of the subscription price was to be paid upon the Agreement's execution, and the remaining $2 million balance was to be paid by March 31, 2009. NanoDynamics agreed to issue the corresponding stock certificates for the purchased shares within five business days of each payment received.

         The parties did not strictly comply with the dates in the Agreement. Instead, the Smiths invested the initial $500, 000 by April 1, 2009, and they invested an additional $1.3 million over the next few months: $1 million on April 10; $200, 000 on April 20; and $100, 000 on June 8. Within five days of each of these payments, and as provided in the Agreement, NanoDynamics issued the corresponding certificates of stock to the Smiths.

         On July 27, 2009, having received $1.8 million of the $2.5 million that the Smiths agreed to pay, NanoDynamics filed for bankruptcy under Chapter 7 of the United States Bankruptcy Code. BK Docket Item 1.


         After the declaration of bankruptcy, Wallach was appointed trustee, and the debtor filed its schedule of assets. The debtor's schedule included the $700, 000 balance still owing from the Smiths, and the Trustee moved, pursuant to 11 U.S.C. § 365(a), to assume "an unexpired executory contract"-namely, the Agreement. BK Docket Item 109.

         In February 2011, Wallach filed an amended complaint, alleging that the Smiths were liable under the Agreement and N.Y. Bus. Corp. Law § 628(a); were liable for breach of contract; and owed $700, 000 to the bankruptcy estate under 11 U.S.C. § 542. Docket Item 3-8 at 2-3. In response, the Smiths moved to dismiss, AP Docket Items 5, 7, 10, a motion that the Bankruptcy Court denied in May 2011, AP Docket Item 19. About three years later, in March 2014, the defendants filed what would be their final amended answer, raising several affirmative defenses and counterclaims. See Docket Item 3-3. Both sides moved for summary judgment-on March 4, 2014 (Docket Item 4-15), and March 7, 2014 (Docket Item 4-16), respectively-and all responses and replies were filed by August 1, 2014.

         After reviewing the submissions and hearing oral argument, and after issuing an interlocutory decision on the dueling motions, Docket Item 1-2, United States Bankruptcy Judge Michael J. Kaplan granted the defendants' motion for summary judgment and dismissed the complaint in its entirety. Docket Item 1-4. The plaintiffs filed a notice of appeal from the Bankruptcy Court's decisions on December 22, 2015. Docket Item 1. The plaintiff filed its brief in February 2016 (Docket Item 6); the defendants responded in March 2016 (Docket Item 8); and the plaintiff replied in April 2016 (Docket Item 9). This Court held oral argument in February 2017 and reserved decision. Docket Item 16.


         A. Jurisdiction and Standard of Review on ...

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