Opinion
C. A. N19C-04-067 MMJ CCLD
04-21-2022
GEN- E, LLC, Plaintiff/Counter-Defendant, v. LOTUS INNOVATIONS, LLC, LOTUS INNOVATIONS FUND, LP, LOTUS INNOVATIONS FUND II GP LLC, GENE HOLDINGS, LLC, LOTUS INNOVATIONS FUND II, L.P., LOTUS INNOVATIONS MANAGEMENT, LLC, HALCYON STRATEGIC PARTNERS, LLC, CHRISTIAN MACK, DAVID ROMAN, PHILIP JONES and OMMID BAVARIAN, Defendants/Counter-Plaintiffs/Third-Party Plaintiffs, v. ST. CLOUD CAPITAL PARTNERS III SBIC, L.P., VIADUCT PARTNERS I, LP, GEN-E HOLDCO, LLC, GEN-E ULTIMATE HOLDINGS, LLC, GEN-E BLOCKER, LLC, and STAR MOUNTAIN DIVERSIFIED SMALL BUSINESS ACCESS FUN II, LP, Third-Party Defendants.
Steven T. Margolin, Esq., Samuel L. Moultrie, Esq., Greenberg Traurig, LLP, Wilmington, DE, John K. Wells, Esq. (argued), Greenberg Traurig, LLP, Boston, MA, Attorneys for Plaintiff John A. Sensing, Esq., Clarissa R. Chenoweth, Esq., Potter Anderson & Corroon LLP, Wilmington, DE, Simon Leen, Esq. (argued), Boies Schiller Flexner LLP, Washington, D.C., John J. Kucera, Esq., Boies Schiller Flexner LLP, Los Angeles, CA, John M. Seaman, Esq., E. Wade Houston, Esq., Abrams & Bayliss LLP, Wilmington, DE, Attorneys for Defendants
Submitted: March 9, 2022
The Motion to Dismiss of Defendants Lotus Innovations Fund II, L.P., Lotus Innovations Management, LLC, Halcyon Strategic Partners, LLC, Christian Mack, David Roman, Philip Jones, and Ommid Bavarian
Steven T. Margolin, Esq., Samuel L. Moultrie, Esq., Greenberg Traurig, LLP, Wilmington, DE, John K. Wells, Esq. (argued), Greenberg Traurig, LLP, Boston, MA, Attorneys for Plaintiff
John A. Sensing, Esq., Clarissa R. Chenoweth, Esq., Potter Anderson & Corroon LLP, Wilmington, DE, Simon Leen, Esq. (argued), Boies Schiller Flexner LLP, Washington, D.C., John J. Kucera, Esq., Boies Schiller Flexner LLP, Los Angeles, CA, John M. Seaman, Esq., E. Wade Houston, Esq., Abrams & Bayliss LLP, Wilmington, DE, Attorneys for Defendants
OPINION
Honorable Mary M. Johnston< Judge
FACTUAL AND PROCEDURAL CONTEXT
Plaintiff Gen-E ("Company") is a software company previously owned or controlled by Defendants. This dispute arises out of the acquisition of gen-E pursuant to an Asset Purchase Agreement ("APA") executed on April 14, 2017.
The Court will use "gen-E" to refer to the Plaintiff before acquisition, and "Gen-E" to refer to Plaintiff in its capacity post acquisition and acting as the company.
Defendants Lotus Innovations Fund, LP., Lotus Innovations, LLC, GenE Holdings, LLC, Lotus Innovations Fund, LP, Lotus Innovations Fund II GP LLC, Lotus Innovations Fund II, L.P., Lotus Innovations Management, LLC and Halcyon Strategic Partners, LLC (collectively "Lotus") are Delaware entities that shared common ownership and/or control of Gen-E and were parties to portions of the Asset Purchase Agreement. Defendants Christian Mack, David Roman, and Philip Jones are the Managing Directors of Lotus Innovations and owners/control persons of the Lotus Entities. Defendant Ommid Bavarian was the Chief Financial Officer for the Lotus Entities and for the Company and is a partner in Fund II.
In November 2016, Plaintiff began discussions with Defendants to purchase gen-E. On February 22, 2017, Plaintiff began due diligence in preparation for the potential transaction. After several months of negotiation, Plaintiff decided to purchase gen-E. The parties executed the APA on April 14, 2017. Plaintiff alleges that within weeks of closing the transaction, Gen-E was faced with significant cash shortages as millions of dollars in expected receivables failed to materialize. By August 17, 2017, the receivables due to Gen-E by B12 Consulting LLC and Charter Communications-key customers-remained unpaid. The withheld payments led to two side letters ("Side Letters"), which contained subsequent agreements among the parties.
On August 21, 2017, the First Side Letter was executed. Lotus and Defendant Jones agreed to provide benefits to Plaintiff beyond what was contemplated in the APA. Lotus agreed to pay Plaintiff on behalf of B12 Consulting LLC and Charter Communications if the customers failed to tender payment to Plaintiff.
On March 13, 2018, the parties executed the Second Side Letter. A disagreement had arisen regarding the parties' respective rights and obligations under the APA and First Side Letter. The parties agreed that Lotus would make payment to Plaintiff. It also was agreed that Defendant Jones would sell products and services on Plaintiff's behalf. By the end of March 2018, Gen-E defaulted on its obligations to its lender, and nearly entered bankruptcy.
On April 5, 2019, Plaintiff brought suit against the original defendants- Lotus Innovations, LLC, Lotus Innovations Fund, LP Lotus Innovations Fund II GP LLC, and genE Holdings-because of alleged material misrepresentations contained in the APA. On January 9, 2020, Plaintiff filed its First Amended Complaint. On March 26, 2021, Plaintiff filed its Second Amended Complaint, adding corporate Defendants Lotus Innovations Fund II, LP, Lotus Innovations Management, LLC, Halycon Strategic Partners, LLC, and individual Defendants Christian Mack, David Roman, Philip Jones, and Ommid Bavarian ("Additional Defendants").
STANDARD OF REVIEW
In a Rule 12(b)(6) Motion to Dismiss, the Court must determine whether the claimant "may recover under any reasonably conceivable set of circumstances susceptible of proof." The Court must accept as true all well-pleaded allegations.Every reasonable factual inference will be drawn in the non-moving party's favor. If the claimant may recover under that standard of review, the Court must deny the Motion to Dismiss.
Spence v. Funk, 396 A.2d 967, 968 (Del.).
Id.
Wilmington Sav. Fund Soc'y, F.S.B. v. Anderson, 2009 WL 597268, at *2 (Del. Super.).
Spence, 396 A.2d at 968.
"Under the present rules of the Superior Court, a cause of action need not be set forth with all the technical exactitude of allegation necessary under the rules of common law pleading. The present rules adopt a system of notice pleading rather than fully informative pleading as was theretofore required. The theory underlying the present rules is that a plaintiff must put a defendant on fair notice in a general way of the cause of action asserted, which shifts to the defendant the burden to determine the details of the cause of action by way of discovery for the purpose of raising legal defenses."
Klien v. Sunbeam Corp., 94 A.2d 385, 391 (Del.), opinion adhered to on reargument, 95 A.2d 460 (1953).
ANALYSIS
Pursuant to 10 Del. C. § 8106: "no action based on a detailed statement of the mutual demands in the nature of debit and credit between parties arising out of contractual or fiduciary relations, no action based on a promise…shall be brought after the expiration of 3 years from the accruing of the cause of such action…."Claims for fraud, arise from a promise. The statute of limitations for fraud is three years.
Van Lake v. Sorin CRM USA, Inc., 2013 WL 1087583, at *6 (Del. Super.).
The limitations period "does not begin to run until evidence of fraud is discovered or could have been discovered had reasonable diligence been exercised." Notice triggering inquiry "is notice of everything to which such inquiry might have led."
Tobacco & Allied Stocks, Inc. v. Transamerica Corp., 143 F.Supp. 323, 329 (D. Del.), aff'd sub nom. Tobacco & A. Stocks v. Transamerica Corp., 244 F.2d 902 (3d Cir. 1957).
Id.
When deciding a motion to dismiss based on a statute of limitations defense, the Court must conduct a three-part analysis, based on the pleadings, to determine whether the claim is time barred. The Court analyzes:
Van Lake, 2013 WL 1087583, at *7.
(1) the date of accrual of the cause of action based on the allegations;
(2) whether the plaintiff has pleaded facts sufficient to create a reasonable inference that the statute of limitations has been tolled; and
(3) assuming a tolling exception has been pleaded adequately, when the plaintiff was on inquiry notice of a claim based on the allegations.
Id.
The statute of limitations runs from the date of accrual, unless the plaintiff demonstrates that a tolling exception applies. Exceptions include fraudulent concealment and inherently unknowable injury. Under the doctrine of inherently unknowable injury, the injury must have been undiscoverable. Where the exception applies, the cause of action only accrues once the plaintiff is on inquiry notice of possible claims.
Certainteed Corp. v. Celotex Corp., 2005 WL 217032, at *7 (Del. Ch.).
Id.
Id.
"Inquiry notice does not require actual discovery of the reason for injury. Rather, it exists when the plaintiff becomes aware of 'facts sufficient to put a person of ordinary intelligence and prudence on inquiry which, if pursued, would lead to the discovery [of injury].'" When tolling the statute of limitations turns on the issue of inquiry notice, "summary judgment is appropriate where there is a 'red flag' that 'clearly and unmistakably' would lead a prudent person to investigate and thereby discover the basis for the cause(s) of action alleged." It is not necessary that the plaintiff be aware of every aspect of the alleged wrongful conduct. "The court should consider whether there were red flags that would have left a prudent person of ordinary intelligence to inquire further." A red flag may be evidenced by sufficient facts that actually create or should create suspicion in the mind of a prudent person of ordinary intelligence.
Id. (quoting Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 860 A.2d 312, 319 (Del.))(internal citation omitted).
Ocimum Biosolutions (India) Ltd. v. AstraZeneca UK Ltd., 2019 WL 6726836, at *8 (Del. Super.), aff'd, 247 A.3d 674 (Del.) (quoting Boerger v. Heiman, 965 A.2d 671, 675 (Del.)).
Id. at *9.
Altenbaugh v. Benchmark Builders, Inc., 2022 WL 176292, at *2 (Del.)
Ocimum, 2019 WL 6726836 at *10.
Plaintiffs are under an obligation to act with reasonable diligence. "[O]nce a plaintiff's suspicions are triggered, [the plaintiff] is expected to act with alacrity to explore those suspicions as well as other possible instances of non-compliance."
Id. at *11.
Additional Defendants argue that there were various "red flags" sufficient to place Plaintiff on inquiry notice. Plaintiff concedes in its Second Amended Complaint that:
(1) after closing, key customers refused to pay amounts that plaintiff had been led to believe were legitimately owed;
(2) within mere weeks of Plaintiff's ownership, the Company was faced with a significant cash shortfall, as millions of dollars in expected receivables failed to materialize; and
(3) the Company failed to generate revenue….the Company defaulted on its obligations to its lender, and it nearly entered bankruptcy in March 2018.Plaintiff was aware the Company was having unanticipated problems with both receivables and revenue, resulting in significant cash shortfall.
Additional Defendants further argue that the Side Letters establish inquiry notice. It is undisputed that the Side Letters are subsequent agreements to the original contract. Additional Defendants allege that both Side Letters were executed because Plaintiff was aware of facts that would later lead to this litigation-which the parties wished to avoid. Specifically, Additional Defendants argue that the First Side Letter was executed after two of Gen-E's largest customers failed to pay Plaintiff amounts due under pre-sale contracts.
Additional Defendants assert that the First Side Letter demonstrates that Plaintiff investigated facts surrounding payment failures. The First Side Letter was executed after two of Plaintiff's largest customers failed to pay Plaintiff amounts due under pre-sale contracts. Plaintiff basis its fraud claims upon these same failed payments.
Additional Defendants also assert that the Second Side Letter demonstrates inquiry notice as of March 13, 2018, at the latest. The Second Side Letter states:
A disagreement has arisen among the Parties as to their respective rights and obligations under the Asset Purchase Agreement and the Prior Side Letter. The Parties now desire to compromise and settle their disputes without admission of liability or fault and for the sole purpose of preventing time-consuming, costly and uncertain dispute resolution proceedings.
Additional Defendants allege that the purpose of the Second Side Letter was to: (1) resolve a dispute over Defendant Jones' involvement in gen-E's business prior to the sale; and (2) resolve a dispute involving Gen-E Holdings and two of its clients. Both disputes are included in the subject of the current litigation. Additional Defendants assert that the Second Side Letter is evidence of both inquiry notice and awareness.
Plaintiff argues that the statute of limitations should be tolled according to the doctrine of fraudulent concealment. Under the doctrine of fraudulent concealment, "the statute of limitations will be tolled if there was an affirmative act of concealment or some misrepresentation that was intended to put a 'plaintiff off the trail of inquiry' until such time as the plaintiff is put on inquiry notice."Plaintiff must allege an affirmative act of concealment by defendants. Where the plaintiff alleges some affirmative act that "either prevented the plaintiff from gaining knowledge of material facts or led the plaintiff away from the truth," the plaintiff bears the burden of pleading facts sufficient to demonstrate application of the tolling doctrine.
Van Lake, 2013 WL 1087583, at *9 (quoting Winner Acceptance Corp. v. Return on Capital Corp., 2008 WL 5352063, at *15 (Del. Ch.)).
Id. at *10 (citing Smith v. Mattia, 2010 WL 412030, at *5 (Del. Ch.)).
Id.
Plaintiff alleges that it presented numerous acts by Additional Defendants that were intended to "put Plaintiff off the trail of inquiry." Plaintiff alleges that the Side Letters contained certain misrepresentations deliberately intended to put Plaintiff "off the scent" of earlier fraud by agreeing to guarantee a receivable that was uncollectable. Specifically, Paragraph 202 of the Second Amended Complaint states:
On August 21, 2017, Lotus agreed to enter into a letter agreement (the "First Side Letter") with the Company. In the First Side Letter, Lotus represented that there existed "certain past due amounts owed to you
by" B12 and Charter, and that "the Customers have collectively acknowledged to Lotus that such Outstanding Customer Payments are due and owing to Purchaser." In other words, Lotus reiterated to Plaintiff the alleged legitimacy and/or collectability of the B12 and Charter receivables. Further, Lotus concealed the illegitimacy of the Charter receivable by falsely representing that Charter had "acknowledged" to Lotus that the receivable was "due and owing." In fact, Charter continued to challenge the invoice and the amount thereof, and had refused to make payment on it.Plaintiff contends that the Side Letters were executed to encourage Gen-E not to investigate the outstanding payments.
Plaintiff further asserts that representations in the APA regarding financial statements were affirmative acts of concealment of the Gen-E's financial condition. Plaintiff argues that these pre-closing representations made by Lotus:
were materially false and misleading, and were known by the Individual Defendants to be false and misleading at the time they were made. As detailed herein, the Individual Defendants were all well aware throughout 2016 that the Company was underreporting ASL to IBM, and underpaying IBM for ASL copies. Indeed, this underreporting and underpayment was the direct result of Lotus's interpretation of the IBM contracts and its attempt to minimize expenses associated with selling OpsCenter. To the extent that Lotus failed to properly account for COGS on the Company's financial statements as presented to Plaintiff, such failure was intentional, or, at the very least, the result of a reckless disregard for the truth.The Second Amended Complaint also alleges misrepresentations and concealment by Additional Defendants regarding gen-E revenues during 2016 and the first quarter of 2017. The APA was executed on April 4, 2017.
Plaintiff contends that it only discovered the "veil of secrecy" after receiving Lotus internal emails. Plaintiff alleges that internal emails are evidence that gen-E's CEO deliberately concealed contract information. The emails contain statements: (1) "that the contract is for internal purposes only;" (2) directing a company salesperson "not to mention" or "send" the contract to anyone outside of Gen-E; and (3) directing that "no one is to contact the customer about this unless it is thru [the Company's CEO] please."
During oral argument, the Court conducted inquiry into when Plaintiff began its investigation of alleged fraud. Counsel declined to address this issue, arguing that this was a question of fact requiring further discovery.
The Court finds that Plaintiff was aware that fraud may have been committed, at the very least, as of the time the investigation into the alleged fraud began. Plaintiff conceded that the investigation took "several years," prior to the filing of the fraud claims. The commencement of running of the statute of limitations period does not extend past the time of inquiry notice, even though there may be other types of fraud alleged or other participants in the fraud identified. So long as inquiry into all facts leading to the alleged fraud is triggered, and no fraudulent concealment is identified, the statute of limitations period begins to run at the time of inquiry notice.
The Court finds that the alleged acts of affirmative concealment by Additional Defendants, occurred before the APA was executed. Thus, the acts alleged occurred before tolling exceptions could apply. The subsequent Side Letters demonstrate that Plaintiff had reason to investigate possible wrongdoing- including fraud and misrepresentation-rather than tolling the statute of limitations.
Plaintiff alleged fraud in multiple pleadings-in the Original Complaint filed on April 5, 2019, and in the First Amended Complaint filed on May 9, 2020. However, it was not until the Second Amended Complaint-filed on March 26, 2021-that Plaintiff added the Additional Defendants. Plaintiff claims that it did not have knowledge of sufficient facts to allege fraud with particularity, until they saw the Lotus emails. However, Gen-E concedes it had access to those same company emails for a significant period before this action was filed. Thus, the Court finds Gen-E's argument regarding lack of knowledge unpersuasive.
The Court finds that Plaintiff was on inquiry notice as of March 13, 2018, at the very latest. The Side Letters were "red flags" that would have led a prudent person of ordinary intelligence to conduct further inquiry. Lotus acknowledges that there were accounting issues, problematic relationships with accounts, slow payments of receivables from Charter and B-12, and outstanding disputes that needed to be resolved. The Side Letters demonstrate Lotus' acknowledgement of issues and overstatement of EBITDA, which are the basis for Plaintiffs' claim for fraudulent concealment.
The Court finds Plaintiff was on inquiry notice of all alleged grounds for fraud claims more than 3 years before the Second Amended Complaint was filed. Thus, the statute of limitations for this action expired as of March 13, 2021.
CONCLUSION
The Court finds that Plaintiff was on inquiry notice as of March 13, 2018. Fraud claims must be brought within the 3-year statute of limitations period. The Second Amended Complaint, including the fraud claims, was filed on March 26, 2021, after the statute of limitations expired.
Plaintiff has not alleged sufficient facts to support a finding that the statute of limitations should be tolled under the doctrine of fraudulent concealment. The Side Letters demonstrate Plaintiff had a reason to investigate, rather than tolling the statute of limitations.
THEREFORE, the Motion to Dismiss of Defendants Lotus Innovations Fund II, L.P., Lotus Innovations Management, LLC, Halcyon Strategic Partners, LLC, Christian Mack, David Roman, Philip Jones, and Ommid Bavarian is hereby GRANTED.
The Court need not address these Defendants' remaining arguments-failure to state a claim for fraud against Defendants individually; the intracorporate conspiracy doctrine as a bar to civil conspiracy and aiding and abetting; and failure to state a claim for unjust enrichment. These issues are moot.
IT IS SO ORDERED.