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Alpha Capital Anstalt v. Imaging 3, Inc.

United States District Court, S.D. New York

July 26, 2018

ALPHA CAPITAL ANSTALT and BRIO CAPITAL MASTER FUND, LTD., Plaintiffs,
v.
IMAGING3, INC., Defendant.

          MEMORANDUM OPINION AND ORDER

          GREGORY H. WOODS UNITED STATES DISTRICT JUDGE

         Defendant, Imaging3, Inc., has been through some hard times in recent years-a 2012 bankruptcy, a charge of fraud by the U.S. Securities and Exchange Commission in 2013, continuing “going concern” qualifications in its financial statements through 2017. Nonetheless, Plaintiffs, Alpha Capital Anstalt (“Alpha Capital”) and Brio Capital Master Fund, Ltd. (“Brio Capital”), invested a significant amount of additional capital in the company between April 2015 and March 2017. But after Imaging3 consummated a dilutive financing that Plaintiffs did not approve, Alpha Capital and Brio Capital found their investments trapped in a company that failed to honor its contractual obligations: first by failing to honor Alpha Capital's demand to exercise a warrant, and then by failing to pay its lenders' notes when due. Alpha Capital and Brio Capital brought this case as a result of Imaging3's repeated breaches. Because Imaging3 has clearly violated the terms of its contracts by failing to honor the terms of its warrant agreement and failing to pay Plaintiffs' notes when due, Plaintiffs' motion for summary judgment is GRANTED.

         I. BACKGROUND AND FACTS [1]

         A. Imaging3 and its Rocky Road

         Defendant, Imaging3, Inc. (“Imaging3” or “Defendant”) is a publicly traded company. Imaging3 holds itself out as being in the business of “refurbishment and sale of medical equipment, parts and services to hospitals, surgery centers, research labs, physician offices and veterinarians.” Declaration of Yosef Milgrom, ECF No. 32 (“First Milgrom Decl.”), Ex. 16 at 6 (Imaging 3 Form 10-Q for Period Ended June 30, 2017). The company touts its “proprietary medical technology designed to produce 3D medical diagnostic images in real time.” Id. But at the same time, the company acknowledges that the technology is still in development and that it has not been approved by the federal Food and Drug Administration. Id.

         The company's financial road has been rocky. In 2012, the company filed a petition for a Chapter 11 bankruptcy. See First Milgrom Decl., Ex. 18. One of the plaintiffs in this action, Alpha Capital Anstalt (“Alpha Capital”), was described in documents filed in connection with the bankruptcy as a creditor of Imaging3 at the time of its bankruptcy, as was Brio Capital, L.P. Id.

         In connection with the bankruptcy, Alpha Capital was issued a warrant, dated July 30, 2013. See First Milgrom Decl., Ex. 11 (the “Warrant”); First Pl's 56.1 Statement ¶¶ 21, 23, 28, 29, 30. The Warrant granted Alpha Capital the right to purchase up to 10, 287, 224 shares of Imaging3 stock at a base exercise price of $0.000001 per share. Warrant at 1, 2. The Warrant permitted Alpha Capital to exercise its purchase right at any time until the tenth anniversary of the Warrant by simply delivering a completed exercise notice. Id. at 1.

         Around the same time in 2013, the U.S. Securities and Exchange Commission (the “SEC”) charged the company and its CEO with fraud. Declaration of Yosef Milgrom, ECF No. 38 (“Second Milgrom Decl.”), Ex. C (SEC Press Release dated June 26, 2013). Imaging3 announced the end of its mandatory self-remediation period ordered pursuant to a consent agreement between it and the SEC on July 31, 2017. Second Milgrom Decl., Ex. D (Imaging3 Press Release dated July 31, 2017).

         Imaging3 turned a corner when it emerged from bankruptcy, but its financial road was still not secure. The company's filings with the SEC for fiscal year 2017, for example, all contain “going concern” qualifications. See First Milgrom Decl., Exs. 14, 15, 16, 17. For example, in the company's 10-Q for the quarter ended June 30, 2017, the company stated: “The Company has historically incurred net losses. The continuing losses have adversely affected the liquidity of the Company. In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company's ability to raise additional capital, obtain financing and to succeed in its future operations.” First Milgrom Decl., Ex. 16 at 7.

         B. The Notes and Their Terms

         During the period between April 27, 2015 and March 24, 2017, Imaging3 issued to Alpha Capital a series of seven secured convertible notes (the “Alpha Notes”). Second Pl's 56.1 Statement ¶ 1. During the same period, Imaging3 issued seven secured convertible notes (the “Brio Notes”, and, together with the Alpha Notes, the “Notes”) to Brio Capital Master Fund, Ltd. (“Brio Capital” and, together with Alpha Capital, “Plaintiffs”). Id. ¶ 2. A subset of the Notes were issued pursuant to a Securities Purchase Agreement, dated as of April 27, 2015, among Imaging3, Alpha Capital, Brio Capital, and a number of other investors. Id. ¶¶ 1, 2; First Milgrom Decl., Ex. 9 (the “SPA”).[2]Imaging3, Plaintiffs, and a series of other investors later entered into a Convertible Note Amendment Agreement, dated as of January 5, 2017 (the “January 2017 Amendment Agreement”). First Milgrom Decl., Ex. 10. Pursuant to that agreement, Alpha Capital and Brio Capital agreed to extend the maturity date on the 10% OID Notes that they had previously issued to August 31, 2017. They also agreed to provide additional loans to Imaging3. Those additional advances were also represented by Notes, the maturity date of which was also August 31, 2017.

         The provisions of the Notes that are pertinent to this dispute are uniform. The Notes contain covenants that constrain the operations of Imaging3. In particular, the Notes expressly prohibit Imaging3 from entering “into any financing transactions that contain a conversion price that changes daily or varies based on the current market price of the common stock (a ‘Variable Rate Transaction').” See, e.g., First Milgrom Decl., Ex. 2 (10% OID Note dated April 27, 2015), at § 8(b).

         Each Note also provides its holder the right to participate in any “Qualified Financing.” Id. at § 7(a). The Notes define a “Qualified Financing” by Imaging3 as “an equity or debt financing with the principal purpose of raising capital.” Id. The Notes require Imaging3 to notify Note holders of a Qualified Financing at least ten business days prior to its anticipated closing date. The Notes also obligate Imaging3 to permit the holder of a Note to participate in the Qualified Financing “upon the same terms and conditions (except with respect to purchase price), in such Qualified Financing at a purchase price determined by multiplying the purchase price for participation in the Qualified Financing by 0.90 . . . .” Id.

         Under all of the Notes, an “Event of Default” occurs upon a default in the payment of principal under the Note as and when it becomes payable. See, e.g., id. § 9(a)(i). An “Event of Default” is also triggered by a failure by Imaging3 to comply with covenants in the Note, unless the failure is cured “within the earlier to occur of (A) five (5) Trading Days after notice of such failure sent by the Holder or by any other Holder to the Company and (B) ten (10) Trading Days after the Company has become or should have become aware of such failure . . . .” See, e.g., id. § 9(a)(ii).

         The consequences of an Event of Default are clearly spelled out in each of the Notes. Pursuant to Section 9(b) of each of the Notes, upon an Event of Default, the Note becomes, at the election of its holder, immediately due and payable in cash at the “Mandatory Default Amount.” See, e.g., id. § 9(b); Second Pl's 56.1 Statement ¶ 22. The Notes define the term “Mandatory Default Amount” as follows:

“Mandatory Default Amount” means the sum of (a) the greater of (i) the outstanding principal amount of this Note, plus all accrued and unpaid interest hereon, divided by the Conversion Price on the date the Mandatory Default Amount is either (A) demanded (if demand or notice is required to create an Event of Default) or otherwise due or (B) paid in full, whichever has a lower Conversion Price, multiplied by the VWAP on the date the Mandatory Default Amount is either (x) demanded or otherwise due or (y) paid in full, whichever has a higher VWAP, or (ii) 120% of the outstanding principal amount of this Note, plus 100% of accrued and unpaid interest hereon, and (b) all other amounts, costs, expenses and liquidated damages due in respect of this Note.

         See, e.g., First Milgrom Decl., Ex. 2 at 3; Second Pl's 56.1 Statement ¶ 24. The Notes' interest rate automatically increases to 18% upon the occurrence of an Event of Default. See, e.g., First Milgrom Decl., Ex. 2 at § 9(b).

         C. Imaging3 Hits the Wall

         In May 2017, Imaging3 engaged in a transaction that violated the terms of the Notes. On May 25, 2017, Imaging3 completed the sale (the “Auctus Transaction”) of $500, 000 of Convertible Promissory Notes (the “Auctus Notes”) to Firstfire Global Opportunities Fund, LLC and Auctus Fund, LLC (collectively, the “Auctus Investors”). Second Pl's 56.1 Statement ¶ 3. The Auctus Transaction was a “Variable Rate Transaction, ” as defined in Section 8(b) of the Notes.[3] The Auctus Transaction was a debt financing, the principal purpose of which was to raise capital for Imaging3. Id. ¶¶ 12, 13. It was, therefore, “Qualified Financing, ” as defined in the Notes. In accordance with Section 7 of the Notes, by emails dated May 22, 2017, Alpha Capital and Brio Capital separately notified Imaging3 that, pursuant to the provisions of the Notes, Alpha Capital and Brio Capital each elected to “roll” its Notes into the Auctus Transaction. Id. ¶ 15. Imaging3 refused to honor Plaintiffs' rights of participation. Id.

         On June 6, 2017, Alpha Capital delivered a notice to exercise its rights under the Warrant. First Pl's 56.1 Statement ¶ 22; First Milgrom Decl., Ex. 12. In the notice of exercise, Alpha Capital elected to purchase 10, 286, 433 shares of Imaging3. First Milgrom Decl., Ex. 12. Imaging3 has ...


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