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Heritage Handoff Holdings, LLC v. Fontanella

United States District Court, D. Delaware

March 6, 2019

HERITAGE HANDOFF HOLDINGS, LLC, Plaintiff,
v.
RONALD FONTANELLA, Defendant.

          John A. Sensing, POTTER ANDERSON & CORROON LLP, Wilmington, DE; Dylan P. Kletter & Kelsey D. Bond, BROWN RUDNICK LLP, Hartford, CT. Attorneys for Plaintiff.

          Dominick T. Gattuso & Aaron M. Nelson, HEYMAN ENERIO GATTUSO & HIRZEL LLP, Wilmington, DE; Marc J. Kurzman & Peter M. Nolin, CARMODY TORRANCE SANDAK & HENNESSEY LLP, Stamford, CT; Damian K. Gunningsmith, CARMODY TORRANCE SANDAK & HENNESSEY LLP, New Haven, CT. Attorneys for Defendant.

          MEMORANDUM OPINION

          ANDREWS, U.S DISTRICT JUDGE

         At issue in this case is the July 31, 2015 sale of Rex Forge ("Rex") from Ronald Fontanella to Heritage Handoff Holdings, LLC ("Heritage"). Rex manufactures forged steel parts, primarily for the automotive industry. Prior to the sale, Mr. Fontanella served as CFO, CEO, and owner of Rex. (D.I. 157-60 ("Tr.") at 14:4-15). CounterPoint Capital Partners ("CounterPoint") and Carlin Capital ("Carlin") formed Heritage, a Delaware LLC, for the purpose of purchasing Rex. (Tr. 420:7-15). The Stock Purchase Agreement ("SPA") embodies the Parties' final deal regarding the sale. (PX 4).

         Heritage brought this action on August 10, 2016 alleging breach of contract, securities fraud under Section 10(b) of the Exchange Act, common law fraud, and violation of the Connecticut Unfair Trade Practices Act. (D.I. 1 at ¶¶ 66-94). Mr. Fontanella counterclaimed seeking reformation of the SPA and alleging breach of contract. (D.I. 135 at CC ¶¶ 48-69). I held a four-day bench trial on August 13-16, 2018. The Parties have since fully briefed the issues addressed at trial and provided me with joint proposed post-trial findings of fact. (D.I. 168, 169, 170, 172, 173, 174, 175).

         I. Background

         Rex manufactures forged steel components for automotive industry customers. It is considered a "Tier 2" parts supplier. (Tr. 55:15-25). Rex ships its forgings to Tier 1 suppliers such as Dana and Hendrickson for additional processing. (Tr. 54:7-12). Tier 1 suppliers provide parts to Original Equipment Manufacturers ("OEMs") such as Ford or Toyota. (Tr. 54:18-55:10). OEMs monitor Tier 1 and Tier 2 suppliers. (Tr. 395:24-396:7).

         As of the signing of the SPA on July 31, 2015 ("Closing"), Rex did not have a diverse customer base-80 percent of Rex's business was concentrated in four Dana locations. (Tr. 15:14-18, 48:22-49:9). Rex's second largest customer was Hendrickson. (Tr. 135:15-20). Heritage recognized the high customer concentration as a potential risk. (Tr. 709:7-21). During diligence, it made repeated inquiries to Mr. Fontanella about Rex's relationship with Dana. (Tr. 433:14-17). Heritage wanted to know "everything" Mr. Fontanella knew about Rex's customer relationships before Closing. (PX 89).

         Mr. Fontanella consistently represented to Heritage that Rex's relationship with Dana was good. (Tr. 423:9-13, 708:8-15). It was not. During the relevant period, Rex received scorecards from Dana which consistently ranked Rex's quality as "poor" or "bad." (Tr. 290:8-17, 373:1-374:18, 399:9-15; PX 193). The scorecards were not available to the general public. (Tr. 522:3-8). Rex was also receiving daily phone calls from Dana, receiving urgent complaint emails from Dana, and undergoing regular onsite visits from Dana. (Tr. 60:7-16; PX 32; PX 33; PX 40). In May 2015, two senior Dana executives visited Rex to tell Mr. Fontanella in person that Dana was cancelling parts and sending them to a competitor. (Tr. 81:13-20, 350:25-351:17). A customer moving parts to a competitor was an exceedingly uncommon occurrence with only one other identified instance in nineteen years. (Tr. 87:16-25, 297:10-12). Mr. Fontanella did not disclose any of these issues to Heritage.

         During diligence, Heritage sought to speak with someone from Dana to verify the stability of its relationship with Rex. (Tr. 436:15-18). Mr. Fontanella was not helpful and initially claimed he did not know to whom Heritage could talk. (Tr. 436:19-437:13). Mr. Fontanella eventually arranged a call with Dana employee Philip Alber during which Heritage presented itself as a consultant. (Tr. 437:23-24, 438:13-21). Mr. Alber had a high regard for Rex and had a good relationship with the company. (Tr. 1025:23-1026:22). However, Mr. Alber was a lower level employee and was not involved in Dana's purchasing decisions or quality issues. (Tr. 437:25-438:9, 931:23-932:3).

         During the same period, Hendrickson was decreasing its volume of purchases of part number D-2700 ("the Spider"). (Tr. 123:9-13; 300:25-301:9). The Spider was Rex's highest revenue part. (Tr. 136:17-23; PX 196). Mr. Fontanella did not disclose any issues with Hendrickson to Heritage prior to Closing. (Tr. 115:4-9; PX 9).

         Press cells are Rex's primary equipment. They have designations ranging from Press 42 to Press 52. (Tr. 151:15-17, 427:13-21). The press cells consist of a main press, a trim press, an induction heater, a conveyor, and cooling towers. (Tr. 151:18-152:13, 633:6-9). If any part of the press cell breaks down, the entire press cell is inoperable. (Tr. 633:11-15). At Closing, much of Rex's equipment was at least half a century old and had encountered "hard use." (DX 71 at HERITAGE4771-88). Heritage was aware that two of the presses were out of service at Closing. (PX5 at REX24271).

         Prior to Closing, Rex handled most maintenance in-house. (Tr. 158:2-6). It employed a full-time maintenance manager who managed six or seven employees. (Tr. 187:8-13). Rex's capital expenditures ranged from $650, 000 to $700, 000 per year between 2008 and 2013. (PX 7 at HERITAGE50). Pursuant to SPA § 2.24(a)(iv), Rex disclosed to Heritage each capital expenditure incurred during the diligence period that was greater than $25, 000. (PX 5 at REX24317-18).

         During diligence, Heritage had access to Rex's maintenance records, had access to Rex's employees, and toured Rex's facilities on numerous occasions. (Tr. 608:8-11, 688:25-689:6, 743:25-744:21, 745:9-20). Heritage also obtained an appraisal report from Great American. (DX 71). The report disclosed the equipment was in "fair" condition, which meant that the equipment "may require repair or refurbishment soon; appears to have seen extensive service; may be aged, have suffered hard use or may be visually unattractive to potential buyers." (Id. at HERITAGE4771-88). Heritage recognized that, due to the age and condition of the equipment, "unexpected significant capital expenditures could be required to maintain or repair the forging press and hammers." (DX 95 at HERITAGE655).

         At Closing, Heritage agreed to pay $12 million for Rex. (PX 4). Heritage paid Mr. Fontanella $8, 393, 065 in cash, which was reduced in March 2016 to $7, 886, 065 by certain net working capital adjustments, and a $2, 500, 000 Note, which was payable to Mr. Fontanella over the next five years. (PX 107; DX 137). Under the Note, Heritage and Rex agreed to pay Mr. Fontanella $79, 538 quarterly, for twenty quarters, with the remaining balance due on July 31, 2020. (PX 4 at REX24364). These payments are subject to certain set-off rights under Section 6.6 of the SPA and certain environmental funding provisions under Exhibit B to the SPA. (Id.).

         Post-Closing, Rex's maintenance department changed dramatically. The long-term maintenance director and the electrician left the company. (Tr. 248:14-249:22, 511:19-512:1). Between Closing and June 2016, the Director of Manufacturing and Engineering, another long-term Rex employee who ultimately left the company, supervised maintenance. (Tr. 306:25-307:1). In June 2016, Rex promoted a recently hired employee to handle maintenance. (Tr. 627:19-628:2). Moreover, Rex did not have a preventive maintenance plan. (Tr. 938:20-24, 944:3-7). Rather, Heritage ran the equipment until it needed to be repaired. (Tr. 685:4-17). Indeed, even with known mechanical problems and no skilled in-house maintenance department, Heritage ran some equipment until it failed. (Tr. 689:7-690:7).

         In October 2015, Plaintiff defaulted on its loan agreement with Wells Fargo. (Tr. 729:18-730:1; PX 105).

         II. Plaintiff's Fraud Claims

         A. Legal Standard

         In Delaware, to establish a common law fraud claim a plaintiff must prove: (1) a false representation by the defendant; (2) the defendant's knowledge of or reckless indifference to the falsity of the representation; (3) the defendant's intent to induce the plaintiff to act; (4) the plaintiffs actions taken in justifiable reliance on the false representation; and (5) damages stemming from the plaintiffs reliance. Stephenson v. Capano Dev., Inc., 462 A.2d 1069, 1074 (Del. 1983). A finding of fraud does not require finding an overt misrepresentation. Fraud can occur "through deliberate concealment of material facts, or by silence in the face of a duty to speak." Id.

         Federal securities fraud is similar to Delaware common law fraud. To establish a claim of federal securities fraud a plaintiff must prove: (1) the sale of a security from the defendant to the plaintiff; (2) a false representation or omission of material fact by the defendant; (3) the defendant's intent to deceive, manipulate, or defraud (often referred to as scienter); (4) the plaintiffs actions were taken in justifiable reliance on the defendant's representation or omission; and (5) damages stemming from the plaintiffs reliance. Institutional Inv 'rs Grp. v. Avaya, Inc., 564 F.3d 242, 251 (3d Cir. 2009).

         B. Relevant Factual Findings

         1. Dana was Rex's largest customer at Closing, accounting for 80% of Rex's business. (Tr. 49:7-9).

         2. In May 2015, Dana representatives Vyas Harsh and Phil Molyet informed Mr. Fontanella that Dana was moving parts from Rex. (Tr. 81:13-23, 350:25-351:17).

         3. Sometime prior to July 8, Hendrickson informed Mr. Fontanella that it was delaying orders of the Spider from Rex. (Tr. 123:3-13).

         4. Mr. Fontanella learned on June 8, 2015 that Rex was losing Dana's Toyota Tacoma program, Part #5002961. (Tr. 99:2-6; PX 56).

         5. Mr. Fontanella did not inform Heritage of lost parts prior to Closing. (Tr. 124:10-125:25, 1068:6-25).

         6. Heritage knew it was purchasing an old business with 1950s era equipment. (Tr. 516:9-16; PX 7 at HERITAGE25).

         7. Heritage was aware that older equipment may unexpectedly require large capital expenditures for repairs. (DX 71 at HERITAGE4756).

         8. Heritage was on notice that the equipment was in "fair working order." (Id.). This meant that it "[m]ay require repair or refurbishment soon" and may have "suffered hard use." GW. atHERITAGE4771).

         9. Heritage changed the maintenance regime immediately after Closing. (Tr. 247:18-248:22).

         C. Discussion

         Plaintiff argues that Mr. Fontanella committed fraud via representations or material omissions he made related to (1) Rex's customers and (2) Rex's equipment. I will consider each set of representations in turn. First, however, I will address Mr. Fontanella's defenses to the fraud claims.

         1. Mr. Fontanella's Affirmative Defenses

         Defendant argues that Plaintiff contractually waived its right to rely on any extra-contractual representation made by Mr. Fontanella. It bases its argument on "anti-reliance" provisions of the Parties' pre-negotiation Confidentiality Agreement and of the SPA.

         The relevant provision of the Confidentiality Agreement precludes Heritage from bringing a claim based on the Evaluation Material provided to it by the investment banking firm Sperry, Mitchell & Company, LLC:

You understand that none of the Company's directors, officers, employees, agents, or representatives have made or make any representation or warranty, express or implied, as to the accuracy or completeness of the Evaluation Material. You agree that none of the Company's directors, officers, employees, agents, or representatives shall have any liability to you or any other person resulting from the use or content of the Evaluation Material.

(DX 4 at SPM3583). The SPA's integration clause, Section 7.5, preserves the obligations imposed by the Confidentiality Agreement:

This Agreement and the Related Agreements constitute the entire agreement between and among the parties hereto and thereto with respect to their collective subject matter and supersede all other prior agreements and understandings, both written and oral, among or between any of such parties with respect to the collective subject matter hereof and thereof; provided, this Agreement shall not supersede any existing confidentiality agreements between or among the parties, all of which continue in effect in accordance with their terms.

         (PX 4). The SPA also contains a provision, Section 2.28, which expressly disclaims extra-contractual statements made by Defendant. (Id.). That section provides:

Except for the representations and warranties contained in Section 2 of this Agreement (including the related portions of the Shareholder Disclosure Schedule), the Shareholder, the Company and/or any other Person has not made or does not make any other express or implied representation, either written or oral, on behalf of the Shareholder or the Company (including any representation or warranty as to the accuracy or completeness of any information regarding the Company furnished or made available to Purchaser and its representatives, or in any form in expectation of the transactions contemplated thereby), or as to the future revenue, profitability or success of the Company, or any representation arising from statute or otherwise in law.

(Id.).

         Delaware courts enforce clear anti-reliance provisions. See Prairie Capital III, L.P. v. Double E Holding Corp., 132 A.3d 35, 50 (Del. Ch. 2015); Abry Partners V, L.P. v. F & WAcq. LLC, 891 A.2d 1032, 1057 (Del. Ch. 2006). However, an enforceable anti-reliance provision must contain a promise by the plaintiff that it did not rely on extra-contractual statements. Abry Partners, 891 A.2d at 1059. "If parties fail to include unambiguous anti-reliance language, they will not be able to escape responsibility for their own fraudulent representations made outside of the agreement's four corners." Id.

         The SPA does not contain unambiguous anti-reliance language. Though Defendant disclaimed extra-contractual representations, Plaintiff did not affirmatively promise not to rely on such representations. Thus, under Delaware law, SPA§ 2.28 is not an anti-reliance provision. Therefore, it does not prevent Heritage from successfully asserting a fraud claim based on extra-contractual representations.

         Although the Confidentiality Agreement bars Plaintiff from bringing a claim based on the content of the Evaluation Material, it does not bar Plaintiffs fraud claim based on representations made during diligence. Defendant cites RAA Management, LLC v. Savage Sports Holdings, Inc. for the proposition that "[n]on-reliance clauses in a confidentiality agreement are intended to limit or eliminate liability for misrepresentations during the due diligence process." 45 A.3d 107, 119 (Del. 2012). However, Defendant omits the next sentence of that opinion, which states, "The breadth and scope of the non-reliance clauses in a confidentiality agreement are defined by the parties to such preliminary contracts themselves." Id. In RAA Management, the confidentiality agreement provided:

You [RAA] understand and acknowledge that neither the Company [Savage] nor any Company Representative is making any representation or warranty, express or implied, as to the accuracy or completeness of the Evaluation Material or of any other information concerning the Company provided or prepared by or for the Company, and none of the Company nor the Company Representatives, will have any liability to you or any other person resulting from your use of the Evaluation Material or any such other information. Only those representations or warranties that are made to a purchaser in the Sale Agreement when, as and if it is executed, and subject to such limitations and restrictions as may be specified [in] such a Sale Agreement, shall have any legal effect.

Id. at 110 (alterations and emphasis in original). That agreement is distinguishable from the Parties' Confidentiality Agreement in that it bound the plaintiff to rely only on representations made in an eventual contract. It expressly excluded representations made in the materials and during diligence. Here, the Confidentiality Agreement precludes reliance on the Evaluation Materials, but is silent on representations made during due diligence. Thus, the Confidentiality Agreement does not bar Plaintiff from pursuing a Delaware common law fraud claim based on statements and representations made during diligence.[1]

         Defendant next argues that Plaintiffs fraud claim is duplicative of its breach of contract claim and, therefore, improper bootstrapping. Plaintiff addresses this claim in a single footnote. (D.I. 175 at 2 n.2). It argues that every case Defendant cites establishes that a post-Closing lawsuit may assert fraud claims. Its confidence is misplaced. Delaware courts routinely dismiss fraud claims that seek damages which are identical to the damages alleged for a breach of contract claim. EZLinks Golf, LLC v. PCMS Datafit, Inc., 2017 WL 1312209, at *6 n.70 (Del. Super. Ct. Mar. 13, 2017) (collecting cases). Moreover, a plaintiffs request for punitive damages does not sufficiently distinguish the damages claims to allow a fraud claim to stand. Id. at *6. Other than its request for punitive damages, Plaintiff does not distinguish the damages it seeks for each of the claims in this case. (See D.I. 168 at 14-25). Therefore, Defendant is correct that Plaintiff is barred from asserting a fraud claim under Delaware law.[2]

         Accordingly, I will only assess Defendant's liability for federal securities fraud.

         2. Rex's Customers

         Plaintiff has established by a preponderance of the evidence that Mr. Fontanella made false representations and omitted material facts regarding Rex's customers. During the diligence period, Mr. Fontanella failed to disclose complaints and cancellations which he was receiving from customers. (Tr. 61:15-19, 63:24-64:2, 78:20-79:8, 81:13-20, 350:25-351:17). Mr. Fontanella also omitted from the SPA material information regarding the status of Rex's relationship with key customers. At Closing, Dana had removed four parts from Rex, the Toyota Tacoma project was ending, Ford was concerned with Rex, and Hendrickson had indicated it would reduce business. (Tr. 138:10-139:2). Of particular concern, Dana was moving some of its business to Rex's competitor Welland Forge-a lengthy, difficult and expensive process. (Id. at 139:3-5, 406:17-25).

         Despite these issues with key customers, Defendant omitted this information during negotiations and represented that all was well. Mr. Fontanella also falsely represented in Schedule 2.13(a) that any disputes were minor and "have been or will be favorably resolved." (PX 5 at REX24299).

         Defendant looks to Schedule 2.13(a) to relieve him of liability for the inaccurate customer representations he made in the SPA. Schedule 2.13(a) provides:

From time to time in the normal course of business, customers [sic] disputes arise regarding the quality of products sold by the Company and have been or will be favorably resolved. To the Shareholder's knowledge, there are currently no such disputes that could reasonably be anticipated to have a Material Adverse Effect on the Company.

         Specifically, Defendant argues that the "material adverse effect" language renders the representations made in Schedule 2.13(a) accurate.[3] (D.I. 173 at 19-21). The contract defines "material adverse effect" (MAE) as:

any state of facts, change, event, effect, occurrence or circumstance that, individually, or in the aggregate . . . has, has had or could reasonably be expected to have or give rise to, a material adverse effect on (a) the business, financial condition, or operations of the Company ....

         (PX 4 at REX24360). Defendant argues that none of the lost parts, individually or in ...


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