United States District Court, D. Delaware
AJZN, INC. A California corporation, formerly known as AERIELLE, INC., Plaintiff,
DONALD YU, AERIELLE, LLC, GREAT AMERICAN LIFE INSURANCE COMPANY, AERIELLE TECHNOLOGIES, INC., AERIELLE IP HOLDINGS, LLC, and AERIELLE ACQUISITIONS CORPORATION, Defendants.
GREGORY M. SLEET, District Judge.
The plaintiff, AJZN, Inc. ("AJZN") filed this lawsuit against Defendants Donald Yu, Aerielle, LLC, Great American Life Insurance Company, Aerielle Technologies, Inc., Aerielle Acquisitions Corporation, and Aerielle IP Holdings, LLC (collectively, "the defendants") on June 28, 2012. (D.I. 1.) The Complaint raises a number of claims relating to corporate transactions.
The defendants filed a motion to dismiss for failure to state a claim on April 15, 2013. (D.I. 38.) For the reasons stated below, the defendants' motion is granted as to Counts 1, 2, 3, 4, 5, 7, and 10 (in part), and denied as to Counts 6, 8, 9, 10 (in part), and 11.
AJZN, formerly known as Aerielle, Inc., is incorporated and has its principal place of business in Santa Clara County, California. (D.I. 36 at ¶ 2.) Defendant Donald Yu ("Yu") is an individual who, upon belief, resides in Santa Clara County, California. ( Id. at ¶ 3.) Defendant Aerielle, LLC ("Aerielle") is a Delaware-organized limited liability company with its principal place of business in California. ( Id. at ¶ 4.) Defendant Great American Life Insurance Company ("GALIC") is incorporated and has its principal place of business in Ohio. ( Id. at ¶ 5.) It is believed to be the sole member of Aerielle. ( Id. at ¶¶ 4-5.) Defendant Aerielle Technologies, Inc. ("ATI") is incorporated in California, with its principal place of business there. ( Id. at ¶ 6.) Defendant Aerielle Acquisition Corporation ("AAC") is a Delaware corporation, whose principal place of business is also in California, and upon belief, was formed and controlled by Yu. ( Id. at ¶ 7.) Defendant Aerielle IP Holdings, LLC ("AIPH") is an Ohio-organized limited liability company and GALIC was the sole member of AIPH. ( Id. at ¶ 8.)
AJZN was founded in 2004 by Arthur Cohen, who held numerous patents, trademarks and a copyright primarily in wireless audio and internet radio technology (collectively, the "Intellectual Property"). ( Id. at ¶ 12.) As the sole shareholder of ATI from 2007 through 2009, AJZN assigned almost all of its Intellectual Property to ATI. ( Id. ) On September 17, 2007, AJZN entered into a Senior Secured Note Purchase Agreement (the "Note Purchase Agreement") with GALIC, whereby AJZN, as the borrower, incurred debt obligations to GALIC, while GALIC procured a security interest in substantially all of AJZN's assets. ( Id. at ¶ 13.) In January 2009, AJZN received approximately $1.5 million for settlement of a patent lawsuit. ( Id. at ¶ 14.) GALIC demanded the settlement proceeds be paid directly to it in accordance with the Note Purchase Agreement. ( Id. ) In lieu of immediate payment from the settlement funds, GALIC insisted AJZN appoint Yu as CEO of AJZN. ( Id. ) AJZN obliged and Yu became its CEO in February 2009. ( Id. )
GALIC formed Aerielle in February 2009, with Yu acting as CEO. ( Id. at ¶ 15.) On April 10, 2009, AJZN entered into an Asset Purchase Agreement with Aerielle in which AJZN sold substantially all of its assets and its 100% interest ownership in ATI to Aerielle in exchange for the assumption of certain debt and a warrant (the "Warrant"). ( Id. at ¶ 16.) The Warrant gave AJZN the option, after April 10, 2010, to acquire up to 12, 000 membership units of Aerielle. ( Id. ) The Warrant was to further compensate AJZN for its assets, which were purportedly worth more than the amount of debt assumed by Aerielle. ( Id. ) As part of this transaction, AJZN entered into other agreements, including a Confidential Mutual Release and a Settlement Agreement (the "Release"). ( Id. at ¶ 17.)
In May 2010, AJZN attempted to exercise its rights under the Warrant by notifying the Aerielle board. ( Id. at ¶ 20.) It was informed the necessary paperwork would be provided. ( Id. ) On June 21, 2010, Cohen followed up with a written request for the necessary paperwork. ( Id. at ¶ 21.) Aerielle again failed to respond. ( Id. ) In October 2010, GALIC representatives met with Cohen to discuss AJZN's interest in Aerielle and requested to terminate the Warrant in exchange for an Earnout Agreement, which would pay AJZN a percentage of gross revenues, generated by ATI, if ATI merged with Aerielle. ( Id. at ¶¶ 22-23.) AJZN declined the offer. ( Id. at ¶ 24.)
Effective December 31, 2010, Aerielle transferred substantially all of its assets, including those acquired from AJZN, and its shares of ATI to AAC, which was owned and controlled by Yu. ( Id. at ¶ 25.) As part of the transfer, AJZN received an earnout (the "Earnout") similar to the Eamout Agreement previously proposed and rejected. ( Id. ) The Eamout was contoured as a percentage interest in a "Revenue Participation Agreement, " issued by AAC to Aerielle and capped the maximum payment at $1.5 million. ( Id. ) Aerielle sent AJZN notice of the Eamout; but AJZN never received a copy of the Revenue Participation Agreement. ( Id. ) AJZN continued voicing its objections to the Eamout, which defendants did not acknowledge. ( Id. ) The Eamout ultimately failed to generate any revenue for AJZN. ( Id. at ¶ 26.)
Count 1 - Violation of Securities Exchange Act of 1934 and Rule lOb-5 against Yu; Aerielle, LLC; and GALIC
FED. R. CIV. P. 9(b) requires circumstances of fraud be described with particularity to provide notice to a defendant of the specific misconduct charged. Seville Indus. Machinery Corp. v. Southmost Machinery Corp., 742 F.2d 786, 791 (3d Cir. 1984). Allegations of "date, place or time" to fulfill the particularity requirement of Rule 9(b) are not required. Id. "Plaintiffs are free to use alternative means of injecting precision and some measure of substantiation into their allegations of fraud." Id. When substantive information lies within another party's control, a plaintiff may plead based on information and belief, "but only ifthe pleading sets forth the specific facts upon which the belief is reasonably based." Brinkmeier v. BIC Corp., 733 F.Supp.2d 552, 559 (D. Del. 2010). In satisfying Rule 9(b), in conjunction with Rule 8(a)(2),  "the requirement of particularity... does not entail an exhaustive cataloging of facts but only sufficient factual specificity to provide assurance that plaintiff has investigated... the alleged fraud and reasonably believes that a wrong has occurred." Temple v. Haft, F.R.D. 49, 53 (D. Del. 1976).
The heightened pleading requirement of Section 78u-4(b) of the Private Securities Litigation Reform Act (the "PSLRA"), however, imposes an additional layer of factual particularity superseding the standard of Rule 9(b). In re Rockefeller Ctr. Props., Inc. Sec. Litig., 311 F.3d 198, 215-18 (3d Cir. 2002). Section 78u-4(b)(1) requires securities fraud be pled to (1) specify each statement alleged as misleading; (2) provide the reason why the statement is misleading; and (3) if an allegation regarding the statement or omission is made on information and belief, state with particularity all facts on which the belief is formed. 15 U.S.C. § 78u-4(b)(1). According to Section 78u-4(b)(2), a plaintiff must "state with particularity facts giving rise to a strong inference" of the defendant's scienter. 15 U.S.C. § 78u-4(b)(2). Allegations of securities fraud must therefore resemble "the first paragraph of any newspaper story" and set out the "who, what, when, where and how" of the events at issue. In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1422 (3d Cir. 1997).
Section 10(b) of the Securities Exchange Act of 1934 provides it is unlawful to:
use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so based registered, or any securities-based swap agreement... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
15 U.S.C. § 78j(b). Additionally, Rule 10b-5 states:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
17 C.F.R. § 240.10b-5. In order to state a claim under § 10(b) and Rule 10b-5, a plaintiff must establish: "(I) a material misrepresentation (or omission); (2) scienter, i.e., a wrongful state of mind; (3) a connection with the purchase or sale of a security; (4) reliance...; (5) economic loss; and (6) loss causation, ' i.e., a causal connection between the material representation and the loss." City of Roseville Employees' Retirement Sys. v. Horizon Lines, Inc., 713 F.Supp.2d 378, 386 (D. Del. 2010) (quoting Dura Pharms, Inc. v. Broudo, 544 U.S. 336, 341-42 (2005)).
Under the heightened pleading standard of the PSLRA, claims under § 10(b) and Rule 10b-5 must initially "specify each allegedly misleading statement, why the statement was misleading, and, if an allegation is made on information and belief, all facts supporting that belief with particularity." Id. at 386 (quoting Inst'l Investors Group v. Avaya, Inc., 564 F.3d 242, 252-53 (3d Cir. 2009)). Therefore, a plaintiff "must identify either false statements or statements rendered misleading by omission." Van Roy v. Sakhr Software Co., C.A. No. 11-863-LPS, 2014 WL 3367275, at *6 (D. Del. July 8, 2014) (emphasis added). Only material misstatements and omitted facts that a reasonable investor would find important in making an investment decision are actionable. Id. (citing TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)); see also In re Burlington, 114 F.3d at 1425.
The complaint must also "state with particularity facts giving rise to a strong inference that the defendant acted with" scienter. Horizon Lines, 713 F.Supp.2d at 386 (quoting 15 U.S.C. § 78u-4(b)(2)). Scienter is a "mental state embracing intent to deceive, manipulate, or defraud" which requires "a knowing or reckless state of mind." Avaya, 564 F.3d at 252 (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n.12, (1976)). Recklessness means "an extreme departure from the standards of ordinary care presenting a danger of misleading buyers or sellers, when the defendant either knows about this danger or the danger is so obvious the defendant should have been aware of it." OpenGate Capital Group, LLC v. Thermo Fisher Scientific, Inc., C.A. No. 13-1475-GMS, 2014 WL 3367675, at *6 (D. Del. July 8, 2014). The facts alleged are viewed collectively and not scrutinized in isolation as to whether a strong inference of scienter exists. Horizon Lines, 713 F.Supp.2d at 386 (citing Tellabs, Inc. v. Makar Issues & Rights, Ltd., U.S. 308, 322 (2007)). This strong inference may be established "either by alleging facts to show that defendants had both motive and opportunity to commit fraud, or by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Oran v. Stafford, 226 F.3d 275, 288-89 (3d Cir. 2000). "Cobbling together a litany of inadequate allegations does not render those allegations particularized in accordance with... the PSLRA." Horizon Lines, 713 F.Supp.2d at 386 (quoting Cal. Pub. Employees' Ret. Sys. v. Chubb Corp., 394 F.3d 126, 155 (3d Cir. 2004)).
Reliance is adequately pled by "alleging... [a plaintiff] was aware of a company's statement and engaged in a relevant transaction... based on that specific misrepresentation." OpenGate, 2014 WL, 3367675, at *7 (quoting Erica P. John Fund, Inc. v. Halliburton Co., 131 S.Ct. 2179, 2185 (2011)). Courts evaluate the facts surrounding a plaintiffs decision and "a sophisticated purchaser may reasonably rely on the honesty of those with whom he deals in the absence of knowledge that his trust is misplaced." Id. (citing Halliburton, 131 S.Ct. at 2186; EP Medsystems, Inc. v. EchoCath, Inc., 235 F.3d 865, 883 (3d Cir. 2000)).
Under § 20(a) of the Securities Exchange Act, liability may be found when a defendant exercised control over a "controlled person" who violated § 10(b). Snowstorm Acquisition Corp. v. Tecumseh Products Co., 739 F.Supp.2d 686, 707 (D. Del. 2010) (citing Avaya, 564 F.3d at 252). Section 20(a) states:
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action. 15 U.S.C. § 78t(a). Control means "the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise." Snowstorm Acquisition Corp., 739 F.Supp.2d at 707 (quoting 17 C.F.R. § 240.12b-2). Therefore, a plaintiff must prove "not only that one person controlled another person, but also that the controlled person' is liable under the Act." Id. (quoting In re Alpharma Inc. Sec. Litig., 372 F.3d 137, 153 (3d Cir. 2004)). Under § 20(a), "secondary liability cannot be found... unless it can be shown that the defendant was a culpable participant in the fraud." Id. (quoting In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 284 n.16 (3d Cir. 2006)). Additionally, the PSLRA requires that a § 20(a) claim state with particularity the circumstances of the defendant's control of the primary violator and the defendant's culpability as a controlling person. In re Digital Island Sec. Litig., 223 F.Supp.2d 546, 561 (D. Del. 2002).
AJZN alleges at the time of its purchase of the Warrant, Aerielle, Yu, and GALIC, knew and concealed that the Warrant was worthless and would never be honored, and it was induced by defendants to transfer its assets to Aerielle, who then transferred the assets to other entities owned and controlled by Yu and GALIC, eliminating AJZN's interest in Aerielle. ( Id. at ¶¶ 18, 29-31.) Damages resulted from the transfer of AJZN's interest in ATI to Aerielle for the worthless Warrant. ( Id. at ¶¶ 30, 32.) AJZN relies heavily on The Wharf (Holdings) Ltd v. United Int'l Holdings, Inc., 532 U.S. 588 (2001), where the Supreme Court affirmed that the defendant's material misrepresentation occurred when it secretly intended to never honor the plaintiffs option to purchase stock. (D.I. 40 at 10-11) (citing 532 U.S. at 590, 596-97); see also Tracinda Corp. v. DaimlerChrysler AG, 197 F.Supp.2d 42, 60 (D. Del. 2002) ("[T]he making of a promise with no intent to fulfill that promise, coupled with a later refusal to fulfill that promise, constitutes a misstatement.") ( Id. at 8.)
AJZN argues scienter is evidenced by Yu's use of Aerielle funds to pay for personal expenses, the issuance of large payments from Aerielle to Yu and his daughter, the payment of third-party bills, and the refusal to honor AJZN's request to exercise its rights under the Warrant and obtain its interest in Aerielle. ( Id. at 11-13.)
Defendants maintain dismissal is warranted in absence of any alleged specific statements or misrepresentations about the Warrant. (D.I. 38 at 13.) Regarding scienter, they note the facts purportedly supporting a secret intention not to honor the Warrant when issued occurred after the Warrant was signed by both parties. (D.I. 41 at 5) (citing D.I. 40 at 9-10). Defendants further argue Wharf is not applicable because that litigation began before the 1995 effective date of the PSLRA, and did not apply the heightened pleading requirements. ( Id. ) (citing United Int'l Holdings, Inc. v. Wharf (Holdings) Ltd., 210 F.3d 1207, 1219 (10th Cir. 2000)). They assert AJZN contorts a breach of contract claim into a securities fraud claim, and fails to address certain necessary elements. ( Id. at 13-14.)
AJZN does not assert a securities fraud claim because it fails to specifically plead that it was induced to enter into the Asset Purchase Agreement with Aerielle based on the defendants' misrepresentation of a statement made or omission of a material fact. AJZN fails to identify any statement by the defendants. AJZN's reliance on Wharf and Tracinda is misplaced. In Wharf, the court's analysis did not apply the heightened provisions of the PSLRA. In Tracinda, the plaintiff adequately pled the first element of a § 10(b) claim because it identified a specific statement by the defendant before execution of the agreement, and a later statement which supported the misleading nature of the first. 197 F.Supp.2d at 49, 59-60. Here, since AJZN failed to allege with any specificity a misrepresentation or an omission of a material fact by the defendants, the first element is not satisfied.
By failing to meet the initial element, AJZN does not sufficiently allege the second element of scienter. Under the PSLRA, "any private securities complaint alleging the defendant made a false or misleading statement must... state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Avaya, 564 F.3d at 253 (quoting Tellabs, Inc., 551 U.S. at 321). AJZN relies on the totality of the facts in the complaint to support an inference of scienter. Absent identifying any material statement or misrepresentation by defendants which was relied upon by AJZN in entering the Asset Purchase Agreement, there is no sci enter.
Because AJZN fails to adequately plead securities fraud under § 10(b) and Rule 10b-5, and consequently, cannot allege a violation of § 20(a), Count 1 is dismissed.
Count 2 - Violation of California Corporations Code §§ 25401 and 25501 against Yu, Aerielle, and GALIC
Section 25401 of the California Corporations Code provides:
It is unlawful for any person, in connection with the offer, sale, or purchase of a security, directly or indirectly, to do any of the following:
(a) Employ a devise, scheme, or artifice to defraud.
(b) Make an untrue statement of material fact or omit to state a material fact necessary to make the statement made, in light of the circumstances under which they were made, not misleading.
(c) Engage in an act, practice, or course of business that operates or would operate as a fraud or deceit upon another person.
CAL. CORP. CODE § 25401. Further, § 25501 states:
Any person who violates Section 25401 shall be liable to the person who purchases a security from him or sells a security to him, who may sue either for rescission or for damages (if the plaintiff or the defendant, as the case may be, no longer owns the security), unless the defendant proves that the plaintiff knew the facts concerning the untruth or omission or that the defendant exercised reasonable care and did not know (or if he had exercised reasonable care would not have known) of the untruth or omission....
CAL. CORP. CODE § 25501. Since these claims involve fraud, the circumstances must be pled with particularity. Jackson v. Fischer, 931 F.Supp.2d 1049, 1058 (N.D. Cal. 2013) (referencing FED. R. CIV. P. 9(b)). Falsity must be pled with specificity, including the "time, place, and specific content of the false representations as well as the identities of the parties to the misrepresentations." Id. (quoting Swartz v. KPMG LLP, 476 F.3d 756, 764 (9th Cir.)). Liability under § 25401 attaches when a buyer or a seller of a security makes "an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading." Id. (quoting CAL. CORP. CODE § 25401). Section 25401 does not apply to cases of "simple nondisclosure." Id. (citing Lynch v. Cook, 196 Cal.Rptr. 544, 554 (Cal.Ct.App. 1983)). Failure to allege facts of a defendant's material misstatement or omission in connection with the sale of securities warrants dismissal. See Jackson, 931 F.Supp.2d at 1065 (dismissal of securities fraud claims under §§ 25401 and 25501 where the same allegations were used for § 10(b) and Rule 10b-5 claims, which failed to specify that defendants made any false statement or omission in the sale of the securities).
When a violation of § 25401 is adequately plead, liability attaches under § 25501 if privity is established and demonstrates "liability is limited to the actual or literal seller or purchaser" of the security. Rich v. Shrader, No. 09-CV-0652, 2010 WL 3717373, at *22 (S.D. Cal. Sept. 17, 2010); see also In re Diasonics Sec. Litig., 599 F.Supp. 447, 548-49 (C.D. Cal. 1984) (noting a blanket allegation does not satisfy strict privity requirement to each defendant); see also SEC v. Seaboard Corp., 677 F.2d 1289, 1296 (9th Cir. 1982) (dismissed state securities fraud claim because liability can only be limited to the "actual sellers" of the security).
Similar to the allegations in Count 1, Count 2 relates to the sale of the Warrant, and asserts that §§ 25401 and 25501 were violated by offering or selling a security through written and oral communications that included untrue statements of material fact or omitted material facts. (D.I. at ¶ 35.) Since defendants did not intend to allow the Warrant to be exercised and omitted and misrepresented their intention, AJZN maintains their conduct was a material element for inducing it to acquire the Warrant. ( Id. at ¶¶ 18, 36.) AJZN seeks the difference between the equity value ...