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Higher Education Management Group, Inc. v. Mathews

Court of Chancery of Delaware

November 3, 2014

HIGHER EDUCATION MANAGEMENT GROUP, INC. and PATRICK SPADA, derivatively, and on behalf of ASPEN GROUP, INC., Plaintiffs,
v.
MICHAEL MATHEWS, JOHN SCHEIBELHOFFER, MICHAEL D'ANTON, C. JAMES JENSEN, DAVID E. PASI, SANFORD RICH, PAUL SCHNEIER, and DAVID GARRITY, Defendants, and ASPEN GROUP, INC., Nominal Defendant.

Submitted: July 15, 2014

Seth D. Rigrodsky, Esq., Brian D. Long, Esq., Gina M. Serra, Esq., RIGRODSKY & LONG, P.A., Wilmington, Delaware; Jeffrey M. Norton, Esq., Roy Shimon, Esq., NEWMAN FERARA LLP, New York, New York; Attorneys for Plaintiffs.

Kathleen M. Miller, Esq., SMITH, KATZENSTEIN & JENKINS LLP, Wilmington, Delaware; Steven M. Kaplan, Esq., Eric S. Schaer, Esq., KAPLAN KRAVET & VOGEL P.C., New York, New York; Attorneys for Defendants.

MEMORANDUM OPINION

PARSONS, Vice Chancellor.

This is primarily a derivative action for breach of the duty of loyalty. The plaintiffs are shareholders of Aspen Group, Inc. ("Aspen Group"), and the defendants are the directors and the former CFO of that company. Aspen Group acquired Aspen University, an online educational institution whose former CEO is a plaintiff, Patrick Spada. The plaintiffs allege that the defendants, in an attempt to mislead educational accreditors, concocted a story that Spada had taken loans from Aspen University while he was CEO. They allege further that certain defendants then pressured the plaintiffs to corroborate the existence of the loans to bolster the company's position for the accreditation inspection. The plaintiffs maintain that there were never any loans, and they charge the defendants with breaching their fiduciary duties by making material misrepresentations in SEC filings and other documents. The plaintiffs also allege that the current CEO of Aspen Group and the rest of the defendants wasted corporate assets and wrongfully diluted the plaintiffs' combined equity stake in Aspen through an improper transfer or issuance of certain stock and convertible warrants. The plaintiffs assert that the former CFO of Aspen Group aided and abetted those alleged fiduciary breaches.

The defendants have moved to dismiss under Rule 12(b)(6) for failure to state a claim and Rule 23.1 for failure to plead adequately demand futility. This Memorandum Opinion constitutes my ruling on the defendants' motion to dismiss. Having considered the preliminary record before me and the arguments presented by counsel on July 15, 2014, I conclude that, as to the claim for breach of fiduciary duty, the plaintiffs have failed to plead adequately that demand upon the board would have been futile. I therefore dismiss the claim for breach of fiduciary duty on that basis. As to the allegations of corporate waste, I find that the plaintiffs have failed to state a claim upon which relief can be granted with respect to the challenged marketing costs and have failed to plead sufficiently that demand would have been futile for the claims regarding the CEO's spending. Regarding the plaintiffs' equity dilution claim, I have determined that the plaintiffs do not have standing to bring a claim regarding the disputed shares of the company's stock because that stock existed before the plaintiffs owned an interest in the company. I further find that the plaintiffs have failed to state a claim with respect to the warrants in question. Lastly, because the plaintiffs have not adequately pled a predicate breach of fiduciary duty, I conclude that they fail to state a claim upon which relief can be granted with respect to the allegation that the former CFO aided and abetted the alleged breaches of fiduciary duties. Thus, I grant defendants' motion to dismiss.

I. BACKGROUND[1]

A. Parties

Plaintiffs in this case are Higher Education Management Group, Inc. ("HEMG"), a Nevada corporation, and Patrick Spada (collectively, "Plaintiffs"). All issues surround the alleged actions of Aspen Group, Inc. ("Aspen Group"), a publicly traded Delaware corporation. Defendants Michael Mathews, John Scheibelhoffer, Michael D'Anton, C. James Jensen, David E. Pasi, Stanford Rich, and Paul Schneier (collectively, the "Director Defendants") serve on the board of Aspen Group. Defendant Mathews serves as CEO and chairman. Defendant David Garrity was the CFO and later an Executive Vice President of Aspen Group from June 2011 until October 31, 2013. Plaintiff Spada, who owns and controls HEMG, is the former CEO and chairman of Aspen University, which is now a subsidiary of Aspen Group. In the aggregate, Plaintiffs hold 8.5% of Aspen Group's stock, making them collectively its second largest shareholder.

Spada founded Aspen University, an online educational institution, in 2003. In May 2011, Aspen University merged with Education Growth Corporation, a company controlled by Mathews. Aspen University was the surviving entity, with Mathews replacing Spada as CEO. In September 2011, Spada resigned from the Aspen University Board and Mathews replaced him as Chairman.

In March 2012, Aspen University was acquired by Aspen Group. Aspen Group originally was a Florida public corporation with a different name, but it reincorporated in Delaware in February 2012. Under the terms of the March 2012 merger, Aspen University became a wholly owned subsidiary of Aspen Group, and its board members were appointed to the Aspen Group board of directors. All of the Director Defendants except Rich were directors of Aspen University before the merger, and all Director Defendants became directors of Aspen Group after the merger. Aspen University is accredited by the Distance Education and Training Council ("DETC") and as such is eligible to receive Title IV funding from the United States Department of Education ("DOE").[2] To maintain its accreditation and, thus, its Title IV funding, Aspen University must submit documents and financial statements to both the DOE and the DETC to show financial stability.

B. The Characterization of Certain Disputed Cash Transfers

Plaintiffs' breach of fiduciary duty claim stems from a disputed transfer of $2, 195, 084 between Aspen University and HEMG, and how that transaction or series of transactions was reported in SEC filings and accounting statements. In its March 19, 2012 Form 8-K filing, Aspen Group stated that as of "December 31, 2011, [Aspen Group] included as an asset a loan receivable of $2, 209, 960 from HEMG."[3] Specifically, the Form 8-K stated that:

In connection with the audit of Aspen's financial statements for 2010-2011, Aspen discovered in November 2011 that HEMG had borrowed $2, 195, 084 from it from 2005 to 2010 without Board of Directors authority. Aspen has been unable to reach any agreement with Mr. Spada concerning repayment and is considering its options.[4]

In addition, "in order to secure the repayment of that debt, " Defendants Mathews, D'Anton, and Scheibelhoffer pledged their shares of Aspen Group stock as collateral.[5] Aspen Group made similar statements in numerous subsequent SEC filings, which are quoted at length in the Complaint.[6]

On April 13, 2012, the SEC Division of Corporate Finance issued a letter to Garrity seeking more information with regard to the purported "loan"[7] and why Aspen Group had recorded it as a secured receivable asset in its accounting statements. The SEC disputed the characterization of the alleged transaction as a secured loan between HEMG and Aspen Group, stating "the amounts related to improper cash advances should have been recorded as a loss due to misappropriation of assets rather than as a receivable."[8] Defendants, through Garrity, defended Aspen Group's right to list the alleged loan as a receivable.

Aspen Group, in an August 20, 2012 Form 10-Q, reported that: "On August 16, 2012, following a series of discussions with the Staff of the SEC, the [Aspen Group] Board approved a write-off of this receivable, " i.e., the Loan.[9] Aspen Group also released Mathews, D'Anton, and Scheibelhoffer from their pledge of shares as collateral. Aspen Group further disclosed that it:

Amend[ed] and restat[ed] in its entirety the [Aspen Group] Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2012 filed on May 15, 2012 (the "Initial 10-Q"). This report was necessary to reflect a restatement relating to the write-off of a loan receivable of approximately $2.2 million owed by a corporation which is believed to still be controlled by Aspen's former Chairman.[10]

In a Form 8-K also filed on August 20, Aspen Group additionally disclosed that it would revise its March 31, 2012 financial statements. On August 30, 2012, the SEC issued another letter to Garrity asking Aspen Group to "clearly indicate that the [August 20 Form 8-K] restatement relates to the correction of an error."[11] In response, Aspen Group, on September 21, 2012, amended its August 2012 Form 8-K to clarify that it had made "an error in the accounting for a loan receivable of approximately $2.2 million owed by a corporation which is believed to still be controlled by Aspen Group's former Chairman."[12]

In its SEC filings, Aspen Group has continued to describe the transaction that led to the write-off as an "unauthorized loan, " discovered by a November 2011 audit (the "Audit ").[13] Since the September 21, 2012 Amended 8-K/A, the SEC has not advised Aspen Group that it has any issues with the way that Aspen Group is accounting for the Loan, i.e., as a write-off and not as a receivable.

Plaintiffs vehemently deny that any transfer of money ever occurred, and allege that Aspen Group had actual knowledge that no loan had occurred, even when it was reporting the Loan in its SEC filings. Plaintiffs offer three theories to support these allegations. First, Plaintiffs allege that Defendants have no documentation to prove the existence of the Loan, because Plaintiffs' counsel asked for documentation but never received anything. Second, Plaintiffs argue that, even if the Loan existed, the Defendant Directors were aware of a September 16, 2011 release (the "Release") between Aspen Group and Plaintiffs that released all payment obligations. Third, Plaintiffs aver that each of the Director Defendants knew that the Loan was a fabrication.

Plaintiffs make identical claims that each director approached Spada, asking him to sign two documents. One, an IRS Form 1099-Misc, allegedly would have acknowledged that the Loan existed, and the other would have released Spada and HEMG from any debt obligations arising from the Loan. According to the Complaint, the Director Defendants wanted Spada to sign these documents to bolster Aspen Group's financial statements for the accreditation process.

The Complaint also describes a December 11, 2011 meeting between Spada and two Aspen Group board members that purportedly evidences Aspen Group's actual knowledge that there was no Loan. Plaintiffs allege that, on December 11, Spada met with Mathews, Scheibelhoffer, and Ken Mathiesonheld in New York City.[14] At this meeting, Defendants Mathews and Scheibelhoffer allegedly attempted to coerce Spada to corroborate the existence of the Loan. Spada had subsequent conversations with Mathiesonheld and Mathews on February 4, 2012, where each allegedly tried again to convince Spada to acknowledge the Loan. Lastly, on July 25, 2012, [15] Aspen Group's counsel sent a letter to Plaintiffs' counsel, on which he copied Mathews and Garrity, detailing the SEC's insistence that Aspen Group change the Loan from an asset to a write-off on its balance sheet and urging Plaintiffs to corroborate the Loan's existence. These communications, according to Plaintiffs, support a reasonable inference that the Director Defendants knew that the Loan never ...


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