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Clark v. Davenport

Court of Chancery of Delaware

July 18, 2019

KENNETH E. CLARK, Plaintiff,
v.
CHESTER C. DAVENPORT, CECE DAVENPORT BERKOWITZ, COREY DAVENPORT, ROBERT L. REISLEY, JONATHAN FOTOS, GEORGETOWN BASHO INVESTORS, LLC, and ADAM J. WRAY, Defendants.

          Date Submitted: May 2, 2019

          Robert A. Penza, Christina M. Belitz, POLSINELLI PC, Wilmington, Delaware; Attorneys for Plaintiff Kenneth E. Clark.

          Andrew D. Cordo, F. Troupe Mickler IV, Hayley M. Lenahan, ASHBY & GEDDES, P.A., Wilmington, Delaware; Attorneys for Defendant Adam J. Wray.

          David A. Felice, BAILEY & GLASSER, LLP, Wilmington, Delaware; Attorneys for Defendant Corey Davenport.

          MEMORANDUM OPINION

          LASTER, V.C.

         The plaintiff sued seven defendants for inducing him to make three investments in a failed enterprise. Three of the defendants defaulted. Two settled. The remaining two moved to dismiss the complaint pursuant to Rule 12(b)(6) for failing to state a claim on which relief can be granted. One of the two remaining defendants moved for dismissal pursuant to Rule 12(b)(2), contending that this court lacks personal jurisdiction over him. The Rule 12(b)(6) motions are granted in part. The Rule 12(b)(2) motion is denied.

         I. FACTUAL BACKGROUND

         The facts are drawn from the amended complaint and the documents it incorporates by reference. At this stage of the proceeding, the complaint's allegations are assumed to be true, and the plaintiff receives the benefit of all reasonable inferences.

         A. Basho And Georgetown

         Founded in 2008, Basho Technologies, Inc. ("Basho" or the "Company") was a privately held Delaware corporation. Basho specialized in distributed-systems database software, which enables large companies to store and manage massive amounts of data using cloud-based applications. By late 2013, many large businesses, including over one third of the Fortune 50, were using Basho's software. According to industry analysts, Basho fell within a small cluster of companies best positioned to exploit this rapidly expanding market segment.

         Along the way, Basho attracted the interest of defendant Chester Davenport, a wealthy and successful attorney. The defendants in this case include two other members of the Davenport family: Corey Davenport, Chester's son, and CeCe Davenport Berkowitz, Chester's daughter. For clarity, this decision refers to the Davenports by their first names.

         Chester controlled non-party Georgetown Partners LLC and used it to make private-equity-style investments. Both Corey and CeCe are employees of Georgetown.

         In February 2011, Georgetown invested in Basho through defendant Georgetown Basho Investors, LLC, a special purpose vehicle that Chester also controlled. For simplicity, this decision does not distinguish between Georgetown and the special purpose vehicle.

         Georgetown purchased shares of Basho's Series D preferred stock and obtained the right to designate a member of Basho's board of directors (the "Board"). Georgetown designated Chester. In June 2012, Georgetown purchased shares of Basho's Series F preferred stock and received the right to designate a second member of the Board. Georgetown designated defendant Robert Reisley, an associate and confidante of Chester's who was a member and officer of Georgetown.

         The Series F preferred stock carried blocking rights that prevented Basho from raising equity capital without the consent of holders of a majority of the Series F shares. As the holder of a majority of the Series F shares, Georgetown controlled the blocking rights.

         B. Chester Takes Control.

         Chester wanted to force a near-term sale of Basho. He anticipated that Basho would soon need additional capital. He planned to use Georgetown's blocking rights to foreclose third-party financing options, thereby forcing Basho into a cash crisis. Basho eventually would turn to Georgetown, and Chester would insist on full control as the price for keeping Basho afloat. Once in control, Chester would achieve a near-term sale.

         Consistent with this plan, Georgetown blocked Basho from pursuing attractive financing proposals from third parties. After failing to raise capital from other sources, Basho turned to Georgetown. Rather than investing equity, Georgetown provided Basho with a secured loan that authorized monthly draws of up to $1.5 million and a maximum credit limit of $7.5 million.

         The loan was only a short-term financing solution, and Basho's management team expected to need more funding by the end of 2013. During 2013, Basho attempted to raise equity from outside investors, but Georgetown interfered with the process. Basho's CEO resigned in frustration.

         Having cut off Basho's other financing options and with the loan coming due, Georgetown presented Basho with an offer to lead a Series G round that would raise a total of $25 million. Georgetown would fund $10 million, but only $2.5 million would be new money. The remaining $7.5 million would come from converting amounts due under the secured loan. Georgetown had not yet lined up any other investors to participate in the round. Georgetown wanted to close its part of the deal, then go into the market to find investors.

         The terms of the Series G round were onerous. Among other things, the shares gave Georgetown control over 65% of Basho's voting power. Georgetown also would receive the right to designate four of seven directors. But without other options, Basho accepted.

         The initial closing took place on January 23, 2014 (the "Series G Financing"). Immediately after closing, Georgetown added defendant Jonathan Fotos to the Board. He was a Georgetown employee and beholden to Chester. The Georgetown designees- Chester, Reisley, and Fotos-then led the Board through a series of resolutions that the non-Georgetown directors had never seen before, much less discussed. One resolution appointed Chester as Executive Chairman. Another established an Executive Committee with the power to exercise all of the Board's authority. Its members were Chester, Reisley, and whoever became Basho's CEO. The Board approved all of the resolutions.

         Effective March 10, 2014, Chester and Reisley hired defendant Adam Wray to serve as Basho's CEO. Wray also became a director and member of the Executive Committee. Although Wray had experience working at technology firms, including as a CEO, he was underqualified to lead Basho. Chester and Reisley nevertheless provided Wray with a lavish compensation package that was out of step with market terms.

         After hiring Wray, the Executive Committee continued to manage Basho. The Board did not convene a formal meeting for months. During this period, numerous key personnel left the Company.

         C. Insider Transactions With Chester's Affiliates

         Basho continued to need money. Davenport and his Georgetown colleagues thought they would be able to find investors to fill out the remaining $15 million for the Series G Financing, but they had little success. The punitive terms of the Series G Financing sparked concern, and every investor who had previously shown interest in Basho declined to participate. By mid-March 2014, Georgetown had managed to raise only $67, 500 from other investors.

         To keep Basho going, Georgetown exercised warrants it had received in the Series G Financing and paid $1.8 million for additional Series G shares. The date for exercising the warrants had passed, but the Executive Committee extended it for Georgetown.

         Chester next paid an individual in China to refer investors to Basho. Those efforts led to additional purchases of Series G shares totaling $2.5 million.

         Georgetown next engaged two investment banks to place the Series G shares. They failed to generate any interest.

         After that, Chester resorted to funding Basho with insider loans. In April 2014, the Executive Committee approved a $650, 000 loan from Georgetown. In June, the Executive Committee approved a loan of $1.5 million from Newport Beach Investors, LLC ("Newport"), another entity that Chester controlled. In August, the Executive Committee approved a second loan from Newport, this time in the amount of $250, 000. In September, the Executive Committee approved a third loan from Newport, this time in the amount of $400, 000.

         Basho's difficulties in raising capital signaled to its business partners that it was distressed. As a result, Basho lost significant strategic relationships, including with companies such as Cluster Technologies, NEC, Xyratex Ltd., Seagate Technology LLC, EMC Corporation, and Akamai Technologies, Inc.

         D. Clark's October 2014 Investment

         In October 2014, Chester telephoned plaintiff Kenneth Clark about investing in Basho. Clark was the founder and chairman of First Guaranty Mortgage Company, a residential mortgage lender licensed in forty-four states. Clark had met Chester in 1988 when First Guaranty merged with a savings and loan association that Chester partly owned. Clark and Chester stayed in contact over the years, and Clark considered Chester a friend.

         For his part, Chester knew that Clark was in the process of selling First Guaranty to a private equity firm, which meant Clark would have cash to deploy. Chester also knew that Clark was not a professional investor and did not have any particular knowledge about Basho or its industry.

         During a call with Clark on October 2, 2014, Chester spoke positively about Basho. After the call, he sent Clark an email that attached an "Executive Summary." The email contained positive statements about Basho, the state of its business, and the market in which it operated. The email did not mention other highly material facts about the difficulties that Basho had encountered and the ongoing problems it faced.

         For example, Chester told Clark, "We have not raised capital from the [sic] Venture Capital. Most of the capital has been raised By [sic] the insiders in the Company." Although technically true, Chester failed to mention that Basho had tried to raise money from venture capital funds and failed miserably, or that the money raised from insiders included repeated, emergency cash injections from Chester and his affiliates. By omitting the negative information, Chester implied that Basho had not yet sought venture capital due to the high level of participation by Basho's insiders and their confidence in Basho.

         Chester also told Clark that as a result of the Series G Financing, Georgetown "became the controlling shareholder of the Company and has 5 of the 7 board seats." Chester conveyed this message as part of his pitch that there was "a new sheriff in town" who would take Basho to the next level. Chester's statement was deceptive because Georgetown had been exercising control over Basho since before the Series G Financing, which would have undermined the "new sheriff in town" narrative.

         Chester also represented in his October email: "We only have $8M of the G shares that remain to be sold. We are offering those shares first to family and friends of GTP's Limited Partners." This was deceptive. Georgetown was not offering the Series G shares first to friends and family. Chester contacted Clark only after exhausting his other options.

         Chester even represented to Clark that Basho had "engaged Benchmark, a New York investment banking firm to sell $50M-$60M of new securities valuing Basho closer to the Values being given our competitors" and that he expected "the value of Basho will be set in a range of $500M to $600M." Benchmark never set a value for Basho in this range. Given Basho's condition at the time, Chester could not have reasonably expected that Basho would receive that valuation.

         The complaint details other positive statements in Chester's email that were similarly misleading. In each case, Chester omitted closely related and highly material negative information that was necessary to put the positive statement in context.

         The Executive Summary also contained false and misleading disclosures about Wray. For example, it stated that "Wray is a cloud enterprise technology entrepreneur and executive with more than 20 years of experience," but cloud technologies did not become a market segment until approximately 2009, and Wray had never been a cloud enterprise technology "entrepreneur."

         Wray's bio also claimed that he had

led a variety of companies at different stages, holding positions of CEO, president, GM and product management. Most recently, Wray served as the CEO and president of Tier 3, where he led the company through nearly $20 million in funding from venture capitalists and grew the company from a startup to an eight figure annual run-rate ($10M) before selling the company to CenturyLink for several hundred million dollars.

         Elsewhere, the Executive Summary represented that Wray and Basho CTO Dave McCrory had "led VC-backed companies to successful M&A exits." These statements were false. Wray did not sell Tier 3 to CenturyLink. In fact, Wray admitted under oath in another proceeding that Tier 3 replaced him as CEO in October 2012 and that his successor accomplished the sale over a year later. Wray had not led any VC-backed companies to a successful M&A exit.

         The complaint alleges that after speaking with Clark and sending this email, "Chester put Clark in contact with Wray." The complaint pleads a series of negative facts that Clark was not told. It then alleges that "Wray did not provide Clark with any of this material Basho history. On the contrary, Wray corroborated everything Chester had said, and reinforced the message that Basho was postured for imminent success."

         Based on his communications with Chester and Wray, Clark decided to invest. In making his decision, Clark took into account his years of friendship with Chester and the fact that Chester had always seemed to act honestly. He trusted Chester and believed that he was receiving an inside view of Basho from the people who controlled it. Precisely because Chester controlled Basho, Clark thought Basho was an ideal opportunity for a passive investment, enabling him to focus on the sale of his mortgage-lending business.

         On October 28, 2014, Clark invested $2 million in Basho in return for Series G shares (the "October 2014 Investment"). Clark documented the investment by executing a signature page to Basho's Series G Senior Participating Preferred Stock Purchase Agreement.

         E. Clark's December 2014 Investment

         In December 2014, Chester again approached Clark and urged him to make an additional investment in Basho. Wray also communicated with Clark about the investment. Together, they claimed that (i) at least three investment funds were clamoring to fill out the Series G round but that Chester was stalling them to facilitate investments by friends like Clark, (ii) other investors in New York were considering the shares but Chester wanted Clark to buy them, (iii) an aggressive ramp-up of Basho's booking was expected for 2015, (iv) Basho was close to claiming the dominant position in its market by the end of 2015, and (v) Basho was on the verge of an enormously beneficial strategic partnership with IBM.

         During these discussions, Wray represented to Clark that Basho expected to achieve $32 million in bookings for 2015. Wray also represented that Basho was uniquely positioned to achieve a strategic partnership with IBM because IBM owned The Weather Company, an existing Basho client. According to Wray, Basho expected to announce its strategic partnership with IBM on February 22, 2015, at the IBM Interconnect Conference.

         Neither Chester nor Wray identified any of the serious problems that Basho faced. They did not disclose any of the negative information that they had failed to disclose in connection with the October 2014 Investment, nor did they disclose additional problematic events that had taken place in the interim. Most notably, they never disclosed that an outside director and co-founder of Basho (Earl Galleher) had filed a complaint seeking books and records based on detailed allegations of serious fiduciary misconduct by Chester and Georgetown.

         In reliance on Chester and Wray's sanitized representations, Clark invested another $500, 000 in Basho. In exchange, he received additional Series G shares (the "December 2014 Investment").

         F. Clark's March 2016 Investment

         Fifteen months passed between the December 2014 Investment and Clark's next investment. During the intervening period, Basho completed the Series G round. The final investment came from the Business Development Corporation of America ("BDCA"), which invested $2 million of equity and loaned Basho $10 million in March 2015. But even after the BDCA investment, Basho's financial condition continued to deteriorate. In June 2015, the outside director and co-founder who had filed the books-and-records action (Galleher) circulated a detailed memorandum expressing serious concerns about Basho and requesting immediate Board action. In October 2015, Galleher circulated another detailed memorandum raising additional concerns.

         During this period, Clark did not receive any meaningful information about Basho's situation. His principal contacts were Chester and Wray, but they did not disclose the hardships Basho was facing, nor did they tell him about Galleher's claims. For his part, Clark did not pay significant attention to Basho, both because he trusted Chester, and because he was still focused on selling his mortgage business. That transaction closed in October 2015.

         From time to time, Clark did check in with Chester and Wray. For example, on February 17, 2016, Clark contacted Wray for an update. During their efforts to schedule a call, Wray cited a conflict because of meeting with Raytheon regarding a "large gov pursuit we've been chosen for." Clark responded that Raytheon sounded like "huge upside potential" and asked if "[e]verything [was] going well?" Wray wrote back:

Yes, everything's going great. The position we've staked out in IoT and Time Series is really starting to take hold w/ IBM, Cisco and others, including Akamai, Juniper and Wind River.
On the Raytheon pursuit, it will be huge. We've been chosen by their Solipsys division to be the standard going forward for their DB over Oracle. That means we're being baked into over 20 massive gov pursuits that they have w/ countries from U.S. to Quatar [sic], plus becoming foundational to review existing clients for change out in next cycle. We should see some rather large upside this yr out of Raytheon, and growth to only continue from there (side note, their interest and review of our technology brought Lockheed Martin ...

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