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Great Hill Equity Partners IV, LP v. Sig Growth Equity Fund I, LLLP

Court of Chancery of Delaware

November 26, 2014

GREAT HILL EQUITY PARTNERS IV, LP, GREAT HILL INVESTORS LLC, FREMONT HOLDCO, INC., and BLUESNAP, INC. (F/K/A PLIMUS), Plaintiffs,
v.
SIG GROWTH EQUITY FUND I, LLLP, SIG GROWTH EQUITY MANAGEMENT, LLC, AMIR GOLDMAN, JONATHAN KLAHR, HAGAI TAL, TOMER HERZOG, DANIEL KLEINBERG, IRIT SEGAL ITSHAYEK, DONORS CAPITAL FUND, INC., and KIDS CONNECT CHARITABLE FUND, Defendants.

Date Submitted: August 13, 2014

Gregory V. Varallo, Rudolf Koch, and Robert L. Burns, of Richards, Layton & Finger, P.A., Wilmington, Delaware; of Counsel: Stephen D. Poss, Kathryn L. Alessi, and Adam Slutsky, of Goodwin Procter LLP, Boston, Massachusetts, Attorneys for Plaintiffs.

David J. Margules, of Ballard Spahr LLP, Wilmington, Delaware; of Counsel: M. Norman Goldberger, Laura E. Krabill, and William B. Igoe, of Ballard Spahr LLP, Philadelphia, Pennsylvania, Attorneys for Defendants SIG Growth Equity Management, LLC, SIG Growth Equity Fund I, LLLP, Amir Goldman, Jonathan Klahr, Donors Capital Fund, Inc., Kids Connect Charitable Fund, Daniel Kleinberg, and Tomer Herzog; Peter N. Flocos, of K&L Gates LLP, New York, New York, Attorneys for Defendants Daniel Kleinberg and Tomer Herzog.

David S. Eagle and Sean M. Brennecke, of Klehr Harrison Harvey Branzburg LLP, Wilmington, Delaware; of Counsel: Michael K. Coran, of Klehr Harrison Harvey Branzburg LLP, Philadelphia, Pennsylvania, Attorneys for Defendants Hagai Tal and Irit Segal Itshayek.

MEMORANDUM OPINION

Glasscock, Vice Chancellor

This matter involves certain Defendants' motion to dismiss claims against them, arising from the Plaintiffs' purchase of Plimus, a company in the business of facilitating payment to sellers of goods online. Plimus's business model was dependent on its relationship with entities that facilitated payment from buyers— notably Paymentech and PayPal, with which the majority of Plimus's revenue was associated. The Amended Complaint alleges that the Plimus executives who negotiated the contract made fraudulent misrepresentations in connection with the sale, withholding the information that Plimus's relationship with Paymentech had been terminated by Paymentech, and that its relationship with PayPal was also about to be terminated. As a result of this fraud, argue Plaintiffs, they paid for what they believed was a thriving company but got a near-moribund operation instead. The Plaintiffs seek contractual damages as well as recovery from two executives who negotiated the contract, based on fraud. The latter claims are not the subject of this motion to dismiss, and I assume for purposes of this motion that the complaint adequately pleads fraud against these two executives.

The Amended Complaint also seeks to recover against four members of the board of directors, a major Plimus investor, and that investor's registered agent, which served as the stockholders' representative, for fraud and/or for conspiring with and aiding and abetting the executives in their fraudulent acts, in addition to claims for indemnification and unjust enrichment. The Plaintiffs also seek to recover from two other investors for indemnification and/or unjust enrichment. These Defendants move to dismiss under Rule 12(b)(6), alleging, among other things, failure to plead fraud with specificity as required under Chancery Rule 9. For the reasons that follow, these Moving Defendants' Motion is largely denied.

I. BACKGROUND FACTS

A. The Parties and Business

Plimus[1] is an e-commerce payment processing business incorporated in California, with its principal place of business in Waltham, Massachusetts.[2]Plimus provides online tools, including a payment clearance platform, to its clients, sellers of online goods and digital content including video games, music, and software.[3] Through this platform, Plimus acts as a payment intermediary between its clients and purchasers of its clients' electronic wares and services.[4] Online sellers typically use Plimus because they "lack the business experience necessary to fulfill the payment-processing function themselves, lack the infrastructure or scale to do so, or both."[5]

To deliver its payment platform, Plimus also acts as an intermediary between its clients and payment processors that "deal directly with the major credit card companies, " such as PayPal, Inc. ("PayPal").[6] In the Plaintiffs' words:

For transactions where a consumer of Plimus's clients chooses to use a credit card, the payment processor serves as an intermediary between the credit card association and Plimus, who in turn acts [as] an intermediary between Plimus's clients and the payment processor, to process the credit card payment.[7]

Consequently, Plimus's relationships with payment processors are critical to its business model.[8] These relationships are explored in further detail below.

Prior to its acquisition, Plimus was a private company, with a five-member board of directors and a relatively concentrated ownership structure.[9] Defendant SIG Growth Equity Fund I, LLLP ("SIG Fund"), a Delaware limited liability limited partnership with its principal place of business in Pennsylvania, was Plimus's largest stockholder.[10] Defendant SIG Growth Equity Management, LLC ("SIG Management, " and collectively with SIG Fund, "SIG") is a Delaware limited liability company also based in Pennsylvania.[11] SIG Management is SIG Fund's authorized agent and, as described in further detail below, signed the merger agreement as representative of the Company's stockholders.[12]

At the time of the merger, SIG Fund held 7, 957, 977 shares of Plimus Series A Preferred Stock.[13] In connection with its large holding of Plimus stock, SIG designated two members to the Plimus board, Defendants Amir Goldman and Jonathan Klahr.[14] Goldman, a Managing Director at SIG Management, also served on the board of Susquehanna Growth Equity ("SGE"), the U.S.-based private equity division of the Susquehanna International Group.[15] Klahr, in addition to serving on Plimus's board, also served as a director of SIG Management and SGE.[16] Because of Goldman's position with SIG Management, and both Goldman's and Klahr's involvement with SGE, the Amended Complaint contends that these individuals directed SIG's actions.[17]

Plimus's co-founders, Defendants Tomer Herzog and Daniel Kleinberg, each owned 4, 723, 957 shares of Plimus common stock—a collective 44% ownership stake in the Company.[18] Herzog and Kleinberg also served on the Plimus board, and Herzog additionally served as the President of Plimus.[19]

Prior to closing, Plimus's CEO was Defendant Hagai Tal, who also sat on the board and owned 881, 500 shares of Plimus common stock.[20] Defendant Irit Segal Itshayek served as Plimus's Vice President of Financial Strategy and Payment Solutions.[21]

Other stockholders of Plimus, prior to the closing, included Defendant Donors Capital Fund, Inc. ("Donors Capital"), a Maryland corporation that owned 1, 449, 000 shares of Plimus's Series A Preferred Stock, and Defendant Kids Connect Charitable Fund ("Kids Connect"), a Virginia corporation that owned 351, 000 shares of Series A Preferred Stock.[22]

B. The Merger

In late 2010, Plimus's board and SIG decided to explore a possible sale of the Company.[23] Perkins Coie, the Company's outside legal counsel, stepped in to advise on the sale; the Company also retained investment banking firm Raymond James.[24] In connection with the sales process, Plimus and its investment bankers prepared a sales document entitled "Confidential Information Memorandum."[25]This Memorandum contained detailed information about Plimus's business model, leadership, historical successes, and financial projections and prospects, among other things.[26]

Among those companies interested in acquiring Plimus were Great Hill Equity Partners IV, LP, a Delaware limited partnership headquartered in Boston, and Great Hill Investors LLC, a Massachusetts limited liability company also headquartered in Boston (collectively, "Great Hill"). In early February 2011, Great Hill signed a non-disclosure agreement with the Company, [27] and in late February, Plimus sent Great Hill the Confidential Information Memorandum.[28]Great Hill also received access to the data room set up by Plimus to facilitate information sharing with prospective bidders.[29]

On May 18, 2011, Great Hill submitted a bid letter to Plimus, indicating that it valued the Company at approximately $115 million.[30] On May 26, Great Hill and Plimus entered into a letter agreement outlining the basic terms of a potential acquisition (the "Letter Agreement").[31] The Letter Agreement reiterated that Great Hill valued the Company at $115 million, and granted Great Hill an exclusivity period in which the parties could negotiate the terms of a definitive agreement.[32]During the negotiation process, Great Hill, aided by counsel and its expert due diligence consultants, including PricewaterhouseCoopers LLP, engaged in extensive due diligence, involving, among other things, exchanges of written questions and responses as well as face-to-face meetings and telephone conversations between Great Hill representatives and Plimus management. [33]

The Plaintiffs claim that the individual Defendants were actively involved in this sales process. The Amended Complaint alleges that Goldman and Klahr attended board meetings and received a variety of information about the Company in connection with their director roles and "through SIG's information rights as a major stockholder in Plimus;" they both also had access to the data room.[34]Additionally, the Plaintiffs allege that Herzog and Kleinberg were "active participants in Plimus's business and the sales process;" during the sales process, both of these co-founders "sought and obtained access to the materials in the data room; repeatedly requested and received regular written updates from the Company's investment banker and management concerning the sales process; and participated in regular telephonic meetings with Tal, SIG directors Goldman and Klahr, and Raymond James concerning the sales process."[35]

Following extensive negotiations and diligence, Great Hill contracted to acquire Plimus for $115 million through merger entities Fremont Holdco, Inc. ("Fremont"), a Delaware corporation based in Massachusetts, and its wholly-owned subsidiary Fremont Merger Sub, Inc.[36] On August 3, 2011, Fremont, Fremont Merger Sub, Inc., Plimus, SIG Management, and certain "Effective Time Holders" (as explained below[37]) entered into an Agreement and Plan of Merger (the "Original Merger Agreement"). On September 29, an Amended Agreement and Plan of Merger (the "Amended Merger Agreement"), with substantially the same terms, was executed among Fremont, Fremont Merger Sub, Inc., Plimus, SIG Management, Herzog, Kleinberg, Tal, and SIG Fund.[38] While Fremont Holdco, Fremont Merger Sub, Inc., and Plimus are bound by the entire Amended Merger Agreement, Herzog, Kleinberg, Tal, and SIG Fund only signed the Amended Merger Agreement in connection with Section 5.06—the Agreement's non- compete, non-solicit, and confidentiality provisions.[39] Further, SIG Management, which executed the Amended Merger Agreement on behalf of the Effective Time Holders as Stockholders' Representative, only entered into certain sections of the Amended Merger Agreement.[40]

The parties closed the merger on September 29, 2011. The Plaintiffs allege that, in connection with the transaction, SIG Fund received over $50.17 million, Donors Capital received over $9 million, Kids Connect received over $2.2 million, Herzog and Kleinberg each received over $21.1 million, and Tal received over $5.2 million.[41]

C. Plimus's Payment Processing Relationships

The current dispute between the parties revolves around material information that was allegedly withheld from the Plaintiffs during the sales process, concerning the status and cause of Plimus's deteriorating relationships with its major payment processors. The Amended Complaint explains that Plimus's relationships with payment processors are critical to its payment platform. As a May 2010 PowerPoint presentation prepared by Company management and sent to Great Hill on August 29, 2011—after the parties entered into the Original Merger Agreement—noted, Plimus's relationships with payment processors were "one of the most significant and material relationships our company has."[42] This presentation further reiterated that "[w]ithout these relationships our business cannot exist. They are our gateway to all credit card issuers and additional payment methods outside the U.S."[43] As of early 2011, Plimus had agreements with several payment processors, including "key payment processor" Paymentech, LLC ("Paymentech") and PayPal, "Plimus's most important payment processor."[44]However, the Plaintiffs allege that, unbeknownst to them, these integral business relationships were in disrepair leading up to the merger—Paymentech already having unilaterally terminated its agreement prior to the merger's closing and PayPal preparing to do the same eight days after the closing—due to Plimus's violations of contractual terms and the credit card association rules, as described below.

1. Paymentech

Prior to Great Hill's acquisition of Plimus, Paymentech was one of Plimus's "key payment processor[s]."[45] On February 4, 2011, however, Paul Hankins, Paymentech's Associate General Counsel and Vice President, notified Plimus that Paymentech intended to terminate the parties' processing agreements on May 5, 2011.[46] This notice provided that:

Paymentech has previously informed Plimus, on multiple occasions, of Plimus' breach of the Agreements. Those breaches include, without limitation, submitting cross border transactions from countries which Paymentech has no license, acting as an aggregator without a license to do so, and violations of Association rules regarding the unauthorized sale of Intellectual Property (as defined by the Associations). As you are also aware, Plimus has failed to cure such breaches for a period of time in excess of 30 days.[47]

On February 9, David Romano, a Paymentech account executive, sent an email to Tal and Segal Itshayek urging Plimus to "cease all activity for any (and all) client, vendor, supplier, author, sponsored merchant, etc. in India immediately, " and warning that "[p]otential fines could be in the millions of dollars."[48] On February 11, 2011, Tal sent a letter to Hankins, noting that Paymentech's "sudden termination puts an unreasonable stress on several aspects of our business for which we need to make transition [sic]."[49] Tal, on behalf of Plimus, requested a two-month extension, such that the relationship would not be terminated until July 5, 2011.[50] On February 14, in his response to Tal, Hankins agreed to postpone the termination until June 20, 2011, to give Plimus the opportunity to transition to a new provider, but conditioned the extension on Plimus being compliant with "merchant agreements and association rules."[51] Hankins's letter noted that Plimus was, at that time, still not in compliance with the processing agreements, as had been expressed in his previous February 4, 2011 letter.[52]

The Plaintiffs allege that because Plimus "continued to violate the Agreements and Association Rules, " Paymentech rescinded its extension on March 1, 2011 and stated its intent to terminate the parties' agreements as of March 7, 2011.[53] Despite providing a March 7 termination date, however, on March 3, Roger Hart, Paymentech's General Counsel, wrote to Tal that Paymentech would extend the termination date to March 21, 2011.[54] In his letter, though, "Hart warned Plimus to 'immediately and permanently cease submitting to Paymentech any transactions representing new sales.'"[55] Hart further conveyed that Plimus would be liable for any fines or penalties associated with Plimus transactions that were levied by the credit card companies, including those "substantial fines" that "MasterCard has indicated it intends to impose . . . against Paymentech for Plimus' noncompliance with MasterCard rules."[56]

On March 7, Goldman emailed Tal and requested correspondence between Plimus and Paymentech "to be sure we [i.e., SIG, Goldman, and Klahr] are up to speed on that here."[57] Tal responded to Goldman's request on or around March 18.[58] On March 20, Klahr emailed Tal, requesting that he provide the same correspondence to Herzog and Kleinberg, "who, with Tal, Goldman and Klahr, comprised the entirety of Plimus's five-member Board of Directors;" Klahr also noted that he and Goldman had "questions we would like to ask [Perkins Coie] about the deal and also about Paymentech."[59] Meanwhile, on March 18, Plimus's counsel at Perkins Coie had sent an email to Paymentech's General Counsel, copying Goldman, Klahr and Tal, informing Paymentech that Perkins Coie had "been retained by [Plimus] to represent it in connection with Paymentech's unilateral termination of the agreements between Plimus and Paymentech and the attendant winding down process."[60] Plimus counsel also expressed that the withholding of funds by Paymentech in connection with the termination "has and will continue to have a detrimental effect on Plimus' business—especially during this time of intensive transition."[61]

The Plaintiffs allege that on March 21, 2011, per Paymentech's General Counsel's notice, Paymentech terminated its relationship with Plimus.[62] The following day, "Klahr forwarded to Herzog and Kleinberg the Company's correspondence with Paymentech, including Perkins Coie's March 18 letter to Paymentech."[63] Through a separate email, Klahr requested that Herzog and Kleinberg provide him a time they could speak by telephone.[64] The Plaintiffs believe that "at least Klahr, Herzog and Kleinberg spoke by telephone on March 22 regarding Paymentech's termination of the Plimus relationship."[65]

2. PayPal

According to the Plaintiffs, by the time of the merger, the same problems that led to the termination of the Paymentech relationship were already destroying Plimus's even more important relationship with PayPal. Leading up to the merger, the Plaintiffs allege, PayPal served as the Company's "most important payment processor."[66] In the third quarter of 2011, for instance, PayPal processed approximately 66% of Plimus's total payments.[67] Through its agreement with PayPal, Plimus could offer to its clients "the PayPal payment mechanism, "[68] which includes both PayPal credit card payment processing services and the PayPal Wallet, an e-commerce payment mechanism with 132 million users in 133 countries.[69] The Plaintiffs describe the symbiotic business relationship between Plimus and PayPal as follows:

Plimus maintained several of its own PayPal accounts, which functioned as master accounts. Plimus then assigned its clients individual sub-accounts organized underneath Plimus's master accounts. Because those clients maintained sub-accounts to Plimus's master accounts, rather than separate accounts of their own directly with PayPal, Plimus was able to deduct and add monies to those sub-accounts and fully administer its clients' sales with no legwork necessary by those clients—one of the reasons the clients sought Plimus as a business partner.[70]

Beginning in June 2011, however—shortly after the Company's relationship with Paymentech had been terminated—the relationship between Plimus and PayPal became similarly strained by Plimus's violations of the credit card association rules and related breaches of the parties' agreements. The Plaintiffs claim that "[t]he same inability or unwillingness of the Defendants to comply with the chargeback rules and other card association rules that led to the March 2011 Paymentech termination soon led to a crisis with PayPal."[71] In fact, the Plaintiffs claim, rather than attempt to remedy the underlying breaches and "[d]espite Paymentech's March 2011 termination of Plimus due to Plimus's repeated breaches of the Paymentech agreement and the card association rules due to excessive chargebacks, in April 2011 Tal caused Plimus to take on numerous new high risk clients."[72]

a. The MasterCard BRAM Program

MasterCard has developed a business risk-monitoring program, the Business Risk Assessment & Mitigation Programs (the "BRAM Program"),

whereby MasterCard monitors and enforces compliance with its rules and regulations by sellers and seeks to identify transactions that may cause legal, risk, and regulatory problems to the MasterCard brand. Through the program, MasterCard also monitors sellers who it knows have a history of violations, and further monitors those entities choosing to do business with such sellers.[73]

According to the Amended Complaint, violations of the BRAM Program are taken "extremely serious[ly]" within the payment processing industry, as they "can often result in MasterCard terminating its relationships with a credit card payment processor or MasterCard ordering a credit card payment processor to cease doing business with sellers and entities related to those sellers."[74] Under this Program,

MasterCard retains sole discretion to terminate its relationship with a credit card payment processor in the event of a BRAM violation. . . . MasterCard may also impose significant fines, fees, or penalties for participation tied to BRAM violations upon payment processors who pass on such fees to Plimus and similar entities.[75]

The Company, as a result of its contractual relationship with PayPal, was subject to the rules and regulations promulgated by MasterCard, including the BRAM Program; Plimus was also prohibited from engaging in any business activity resulting in fraudulent transactions.[76] According to the Amended Complaint, "Plimus's relationship with PayPal was preconditioned on Plimus's compliance with the MasterCard BRAM program, and PayPal retained the right to terminate that relationship based on any violations of that program."[77]

b. Plimus's June 2011 BRAM Violation

On June 16, 2011, three months after Paymentech terminated its relationship with Plimus, the Plaintiffs allege that Rick Lancaster, a PayPal employee who managed Plimus's account, contacted Segal Itshayek by phone, notifying her that one of Plimus's clients had "violated the MasterCard BRAM program's prohibitions against fraudulent get-rich-quick schemes."[78] The same day, allegedly "immediately recogniz[ing] the ramifications of the June 2011 BRAM Violation, " Plimus's COO emailed Segal Itshayek that "[w]e don't want the word to spread out, "[79] and Plimus's Assi Itshayek[80] and Tal emailed Klahr and Goldman to schedule a conference call "to put adjustments to the agreement that in my eyes have [a] material financial impact."[81] Goldman responded that he and SIG's in-house counsel would participate in the call.[82] The evening of June 16, at 11:34 p.m., Tal emailed a PayPal contact, requesting a call.[83]

On June 17, Segal Itshayek sent Lancaster a letter that stated:
Following our conversation yesterday, I would like to inform you, on behalf of Plimus, the account "[Client Y]" was suspended yesterday and is being terminated from our system. . . . In addition, we have launched an internal investigation to determine if we have any similar "get rich quick" scheme accounts that will require suspension as well. We will update you on the results of this investigation early next week.[84]

On June 23, Lancaster requested a status update on Plimus's investigation.[85] Segal Itshayek responded that most of the get-rich-quick clients had already been suspended, but that "[t]here are a few that we are still investigating and most probably finalize [sic] our conclusions by the end of this week."[86] In total, Plimus terminated sixteen other accounts as a result of its internal investigation.[87] According to the Plaintiffs, Tal and Segal Itshayek communicated this information regarding the termination of clients to Great Hill in June 2011, including the representation that "Plimus did not need to terminate any additional clients due to excessive chargeback ratios, and that the termination of this small group of clients fixed the problem."[88] The Amended Complaint alleges that "[d]uring this period of back-and-forth between Plimus and PayPal, Tal and SIG were communicating by telephone, including an eighteen-minute call on June 22, a sixteen-minute call on June 26, and a fifteen-minute call on June 28."[89]

As a result of Plimus's client's violation, PayPal charged Plimus a $200, 000 fine, passing on the fine MasterCard had charged PayPal for breaching its brand integrity rules.[90] Segal Itshayek became aware of the fine on September 22, 2011.[91] The Amended Complaint contends that "[t]he fine was clearly recognized by several of the [] Defendants as a major problem, " and that "[d]uring the two-day period following PayPal's notification of the fine . . . Tal emailed Goldman to call him, and Tal (and others at Plimus) exchanged at least seven phone calls with SIG, including Klahr."[92]

c. August 2011 BRAM/Aggregation Violation

The Plaintiffs contend that concurrent with Plimus's June 2011 BRAM violation, PayPal began expressing concern that Plimus was also violating another of MasterCard's BRAM rules by acting as an aggregator, instead of a reseller.[93] To be acting as an aggregator, which is prohibited by the BRAM Program, meant that "Plimus was using its own merchant account in an unauthorized manner to aggregate and process transactions for its clients, rather than acting as a reseller by purchasing is clients' products and re-selling those products to end-users."[94] On June 21, Lancaster, PayPal's account representative for Plimus, informed Segal Itshayek that:

PayPal needs to obtain a letter from you outlining the business model for Plimus that we can provide to the Card Association. In that letter you need to explain why you are not aggregating and how you purchase the product from the merchant and resell it to the end user.[95]

Segal Itshayek responded later that day.[96] In August 2011, PayPal communicated to Segal Itshayek and Plimus employee Jason Edge that MasterCard considered Plimus in violation of its aggregation rules, and was levying a $500, 000 fine against the ...


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