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Underwood v. Benefit Express Services, LLC

United States District Court, D. Delaware

December 28, 2018

TROY UNDERWOOD and TRANSCEND TECHNOLOGIES GROUP, INC., Plaintiffs,
v.
BENEFIT EXPRESS SERVICES, LLC; LLR EQUITY PARTNERS IV, L.P.; LLR EQUITY PARTNERS PARALLEL IV, LP. MICHAEL STERNKLAR; SCOTT EVANS, Defendants. BENEFIT EXPRESS SERVICES, LLC, Counterclaim-Plaintiff,
v.
TROY UNDERWOOD and TRANSCEND TECHNOLOGIES GROUP, INC., Counterclaim-Defendants

          REPORT AND RECOMMENDATION

          Mary Pat Thynge Chief U.S. Magistrate Judge

         I. INTRODUCTION

         This matter arises from plaintiffs' Troy Underwood and Transcend Technologies Group, Inc.'s (collectively, "Plaintiffs") First Amended Complaint against defendants Benefit Express Services, LLC; LLR Equity Partners, IV, L.P., LLR Equity Partners j Parallel IV, L.P., Michael Sternklar, and Scott Evans (collectively, "Defendants"). The initial complaint was filed on March 5, 2018 against Benefit Express, Services, LLC. The First Amended Complaint was filed on May 21, 2018 against Benefit Express Services, LLC, LLR Equity Partners, IV, L.P., LLR Equity Partners Parallel IV, LP. Michael Sternklar and Scott Evans. The First Amended Complaint alleges that certain of Defendants made false representations that were relied upon by Plaintiffs, and alleges breach of contract claims against Defendants. On June 26, 2018, Defendants filed a partial motion to dismiss Counts I, II, and III of the First Amended Complaint, which is pending before the court.

         This Report and Recommendation addresses whether Plaintiffs adequately pled their allegations of fraud, aiding and abetting fraud, and negligent misrepresentation. For the reasons stated below, it is recommended that Defendants' partial motion to dismiss be granted as to Count II, and denied as to Counts I and III.

         II. BACKGROUND

         A. Parties

         Plaintiff Troy Underwood is a citizen of the State of Nevada, residing in Reno. Plaintiff Transcend Technologies Group, Inc. is a California corporation with its principal place of business in Sacramento County, California.

         Defendant Benefit Express Services, LLC, is an Illinois limited liability company with its principal place of business in Schaumberg, Illinois. Defendants LLR Equity Partners IV, L.P. and LLR Equity Partners Parallel IV, L.P. are Delaware limited partnerships with their principal places of business in Philadelphia, Pennsylvania. Defendant Michael Sternklar is Chief Executive Officer and Chairman of Defendant Benefit Express Services, LLC Defendant Scott Evans is Chief Product Officer of Benefit Express Services, LLC.

         B. Background

         Underwood founded Transcend Technologies Group, Inc. in 2002.[1] In 2007, Transcend Technologies Group, Inc. began doing business as BenefitsCONNECT[2]BenefitsCONNECT is an online benefits enrollment and administration system that connects employer groups, insurance carriers, third party administrators, payroll vendors, and brokers.[3] In addition to managing BenefitsCONNECT, Underwood was working on a new venture named Aurora, which would function as an employee benefits agency.[4] In 2015, Aurora entered into a licensing agreement with BenefitsCONNECT that would give Aurora the right to use the BenefitsCONNECT: source code (the "Source Code") on its own platform, once that platform became operational.[5]

         In 2016, Plaintiffs and Defendants began negotiating a potential sale of BenefitsCONNECT to Benefit Express Services, LLC ("Benefit Express").[6] During negotiations and due diligence, Underwood worked closely with Sternklar regarding the transaction.[7] An asset purchase agreement was executed on August 4, 2016 (the "APA") between Plaintiffs and Benefit Express.[8] Per the APA, Plaintiffs agreed to sell all assets of BenefitsCONNECT to Benefit Express, including all intellectual property and source coding.[9] On the same day the parties entered into the APA, and per Defendants' request, Underwood terminated the licensing agreement between Aurora and BenefitsCONNECT.[10]

         On May 21, 2018, Plaintiffs filed their First Amended Complaint against Defendants for alleged fraud, negligent misrepresentation and breach of contract.[11]Count I alleges fraud against Sternklar and Benefit Express.[12] Count II avers claims of aiding and abetting fraud against LLR Equity Partners IV, L.P. and LLR Equity Partners-Parallel IV, L.P. (collectively, "LLR") and Evans.[13] Count III asserts negligent misrepresentation against Sternklar and Benefit Express.[14] Count IV alleges breach of contract against Benefit Express, and Count V avers breach of the covenant of good faith and fair dealing against Benefit Express.[15]

         Plaintiffs allege Sternklar misrepresented via an oral promise that he would license the Source Code to Underwood for use in the Aurora venture after the sale! of BenefitsCONNECT to Benefit Express.[16] Approximately three weeks after the APA was executed, Plaintiffs contend Sternklar informed Underwood that he had "changed his mind" and would not execute a renewed licensing agreement with Plaintiffs.[17] Plaintiffs allege that their reliance on this oral promise resulted in their agreement to a lower sale price and the termination of the licensing agreement between Aurora and BenefitsCONNECT.[18] Plaintiffs further maintain Defendants are breaching their agreement by withholding a $2.9 million payment due to Plaintiffs under the APA.[19]

         On June 25, 2018, Defendants filed the instant partial motion to dismiss Counts I, II and III of the First Amended Complaint pursuant to Fed.R.Civ.P. 9 and 12(b)(6).[20]Defendants allege Plaintiffs' fraud and misrepresentation claims are insufficient in light of the APA's integration clause, and Plaintiffs failed to sufficiently plead the elements of the aiding and abetting fraud claim.[21]

         III. STANDARD OF REVIEW

         A. Fed.R.Civ.P. 12(b)(6)

         Fed. R. Civ. P. 12(b)(6) governs a motion to dismiss a complaint for failure to state a claim upon which relief can be granted. The purpose of a motion under Rule 12(b)(6) is to test the sufficiency of the complaint, not to resolve disputed facts or decide the merits of the case.[22] "The issue is not whether a plaintiff will ultimately prevail, but whether the claimant is entitled to offer evidence to support the claims."[23] A motion to dismiss may be granted only if, after "accepting all well-pleaded allegations in the complaint as true, and viewing them in the light most favorable to the plaintiff, plaintiff is not entitled to relief."[24] While the court draws all reasonable factual inferences in the light most favorable to a plaintiff, it rejects unsupported allegations, "bald assertions," and "legal conclusions."[25]

         To survive a motion to dismiss, a plaintiffs factual allegations must be sufficient to "raise a right to relief above the speculative level. . . ."[26] Plaintiffs are therefore required to provide the grounds of their entitlement to relief beyond mere labels and conclusions.[27] A claim must allege, "enough facts to state a claim to relief that is plausible on its face."[28] A claim has facial plausibility when a plaintiff pleads factual content sufficient for the court to draw the reasonable inference that the defendant; i-liable for the misconduct alleged.[29] Once stated adequately, a claim may be supported by showing any set of facts consistent with the allegations in the complaint.[30] Courts generally consider only the allegations contained in the complaint, exhibits attached to the complaint, and matters of public record when reviewing a motion to dismiss.[31]

         B. Fed. Rule Civ. P. 9(b)

         Federal Rule of Civil Procedure 9(b) requires that "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting [the] fraud or mistake."[32] In doing so, "[m]alice, intent, knowledge, and other conditions of a person's mind may be alleged generally."[33] The purpose of this heightened standard is "to place the defendants on notice of the precise misconduct with which they are charged, and to safeguard defendants against spurious charges of immoral and fraudulent behavior."[34]

         IV. ANALYSIS

         A. Count I - Fraud Against Sternklar and Benefit Express

         The elements of a fraud claim under Delaware law are as follows:

(1) Defendant made a false representation, usually one of fact; (2) Defendant knew or believed that the representation was false, or was made with reckless indifference to the truth; (3) Defendant intended to induce Plaintiff to act or to refrain from acting; (4) Plaintiff's action or inaction was taken in justifiable reliance upon the representation; and (5) there was damage to Plaintiff as a result of such reliance.[35]
Plaintiffs allege that Sternklar made an intentional false oral promise that Plaintiffs would be able to license back the Source Code after the APA was executed when Defendants had no intention of doing so.[36] Specifically, Plaintiffs allege Sterhklar promised that if Plaintiffs terminated the licensing agreement between Aurora and BenefitsCONNECT prior to the execution of the APA, after the sale, Benefit Express would license the Source Code back to Plaintiffs for use in the Aurora venture, as long as Plaintiffs retained no ownership rights and Aurora did not compete with Benefits Express.[37]

         Plaintiffs further allege that Sternklar knowingly made this false promise with the intent of inducing Plaintiffs to cancel the licensing agreement with BenefitsCONNECT and to sell BenefitsCONNECT for a lower price.[38] Plaintiffs contend they reasonably relied on these false misrepresentations and promises when they entered into the APA with Defendants, and maintain they would not have sold BenefitsCONNECT to Defendants, particularly at the amount they did, and would not have terminated the licensing agreement had they known they would not be able to license back the Source Code after execution of the APA.[39]

         Defendants allege that Plaintiffs cannot maintain a fraud claim because as a party represented by counsel, they could not have reasonably relied on any oral promises that were not memorialized in the heavily negotiated APA.[40] Defendants point to the integration clause and other language in the APA to show that the parties expressly agreed that the APA contained all of the terms of the sale of BenefitsCONNECT to Benefit Express, and such terms could only be modified in a writing, signed by both parties.[41]

         Defendants further assert that (assuming solely for the purpose of this motion that the allegation of the existence of Sternklar's oral statement is true) Plaintiffs do not sufficiently plead that Sternklar, at the time the alleged oral promise was made, knew the statement to be false, since it is alleged that Sternklar simply "changed his mind" about licensing the Source Code to Plaintiffs after the APA was executed.[42]

         Assuming for the purposes of this motion that Plaintiffs' allegations are true Plaintiffs have adequately pled enough facts and specificity with respect to a fraud claim. While Delaware courts generally "disfavor allegations of fraud when the underlying utterances take the form of unfulfilled promises of future performance," a complaint that alleges facts with sufficient particularity may "support a reasonable inference that Defendants made promises they had no intention of keeping when they made them."[43] Further, it is recognized that "less particularity is required when the facts lie more in the knowledge of the opposing party than of the pleading party:"[44]

         Delaware courts have held that integration clauses may not preclude a plaintiff's reasonable reliance on a fraudulent misrepresentation.[45] Whether Plaintiffs' reliance on the oral statement was reasonable given the integration clause of the APA is a question of fact that is "generally not suitable for resolution on a motion to dismiss."[46]

         Here, Plaintiffs provide enough facts for an inference that Sternklar had motivation to make the statements alleged in order to gain an advantage in negotiation of the APA. Further, since Sternklar alone made the statements about the Source Code both before and after the execution of the APA, the facts lie more within the knowledge of Defendants.

         Therefore, this court recommends that the partial motion to dismiss as to Count be denied.

         B. Count II - Aiding and Abetting Fraud Against LLR an Scott Evans

         Under Delaware law, to prove a claim of aiding and abetting, Plaintiffs must demonstrate that "(1) a wrongful act was committed; (2) the defendant had knowledge of the act; and (3) the defendant knowingly and substantially participated in ...


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