Opinion
SUCV20173878BLS2
07-16-2018
Michael MOGAVERO et al. v. ELEPHANT BIOTECHNOLOGIES, INC. et al.
UNPUBLISHED OPINION
OPINION
Janet L. Sanders, Justice of the Superior Court
This is an action that arises from plaintiffs’ involvement in a startup business aimed at developing a sanitizing spray product called Elephant. Plaintiffs claim that they were misled about the business and made substantial investments in it based on the defendants’ false representations. The defendants in turn claim that the plaintiffs (together with third-party defendants) engaged in conduct which was harmful to the business and in breach of their fiduciary and contractual obligations. Now before the Court are: a) Defendants’ Motion to Dismiss the Second Amended Complaint; and b) Plaintiffs’ Motion to Dismiss Counts IV and VI of the Amended Counterclaim and Third-Party Complaint. This Court concludes that each motion is allowed in part and denied in part.
BACKGROUND
The Second Amended Complaint (the Complaint) contains the following allegations, assumed as true for purposes of the defendants’ motion. In or around March 2016, plaintiff Michael Mogavero was introduced to the defendants Loutfi Kachouh and his wife Gina Bandar-Kachouh. The Kachouhs described for Mogavero a spray they were developing through their company, the Elephant Corporation (Elephant), and the success they had had in obtaining a patent on it. Relying on these representations, Mogavero, through a company that he owned, plaintiff MCC Global Ventures, LLC (MCC), invested a total of $500,000 in Elephant and in return, received shares of stock equal to a 34 percent ownership in the business. In addition, Mogavero personally loaned the Kachouhs a total of $125,000, secured by a promissory note and a pledge agreement. Mogavero subsequently learned that the Kachouhs’ representations about the business were false and that the Kachouhs had misappropriated money from Elephant’s accounts for their own personal use. In addition, the loan that Mogavero made has not been repaid.
Subsequent pleadings in this case contain a different spelling for the individual defendants, dropping the "h" from their last names.
Counts One and Two of the Complaint, asserted against the Kachouhs personally, allege fraud and negligent misrepresentation. Count Three alleges that the Kachouhs aided and abetted each other to commit fraud and misappropriate the plaintiffs’ investment. Count Four alleges that both the Kachouhs and Elephant breached their fiduciary duties to Mogavero and MCC. Count Five purports to be a derivative claim asserted on behalf of Elephant against the Kachouhs alleging conversion, corporate waste, and mismanagement. Counts Six and Seven, brought against all defendants, allege a breach of contract and a violation of Chapter 93A.
In response to these claims, defendants asserted a counterclaim and also brought in additional parties. That counterclaim was amended on May 18, 2018 and is the subject of plaintiffs’ partial Motion to Dismiss. Attached to the Amended Counterclaim and Third-Party Complaint (the Counterclaim) are various exhibits purporting to document the investment relationship between the parties. In support of their Motion to Dismiss plaintiffs’ Complaint, the defendants rely on the allegations made in the Counterclaim, together with these exhibits. This would contravene Rule 12(b)(6), however, which requires that this Court assess the sufficiency of the Complaint based solely on the allegations contained therein. This Court nevertheless summarizes the allegations in the Counterclaim since they are relevant to the plaintiffs’ Motion to Dismiss.
This motion was filed in violation of the Business Litigation Session’s procedural order regarding partially dispositive motions. Because this was not recognized until the date of the hearing, this Court allowed the parties to proceed. The motion is nevertheless a good example of why such partially dispositive motions should first be discussed with opposing counsel and with the court before they are filed.
According to the Counterclaim, Mogavero is a director of Elephant, and MCC (not Mogavero) is a shareholder. Both of the Kachouhs are directors. The Counterclaim alleges that Mogavero and MCC induced Elephant into retaining third-party defendant Inventure Labs, LLC (Inventure) and to hire third-party defendant James Clare as Elephant’s chief executive officer. Mogavero and MCC failed to disclose to Elephant that Mogavero and Clare had a financial interest in Inventure. Mogavero also caused Elephant to make distributions of corporate funds to Inventure without the approval or knowledge of Gina Bandar-Kachouh. Thereafter, Mogavero and Inventure (together with the individual third-party defendants) used Elephant’s trade secrets and intellectual property to develop a competing product.
Plaintiffs’ Motion to Dismiss is aimed only at Counts IV and VI of the Counterclaim. Count IV alleges that Mogavero, MCC, Inventure, Clare, and third-party defendant Stan Petrov breached their fiduciary obligations to Elephant. Count VI alleges that Mogavero and MCC (together with third-party defendants) entered into a "series of contracts" with Elephant and the Kachouhs and thereafter, breached their obligations under those contracts and have been "unjustly enriched to the detriment of Elephant."
DISCUSSION
Before arguments on the instant motions and then at the hearing on these motions, the parties made certain concessions as to some of their positions. For example, plaintiffs had originally argued in support of their motion that Elephant was a foreign corporation which could not bring suit here in Massachusetts; defendants made a similar argument as to MCC. The parties now agree that both Elephant and MCC are registered to do business here, however. As to defendants’ motion, plaintiffs concede that there is no cognizable claim against Elephant for breach of fiduciary duty in Count Four, since a corporation does not owe such a duty to its shareholders. Plaintiffs also conceded at the motion hearing that Mogavero was not himself a shareholder in Elephant but a director only; the Kachouhs thus did not owe any fiduciary duty to him. Accordingly, that portion of Count Four of the Complaint that is asserted against Elephant must be dismissed for failure to state a claim. The only plaintiff on that Count is MCC, since Mogavero, as a non-shareholder, has no basis to claim breach of fiduciary duty. Finally, defendants are no longer pressing their argument that Count Six of the Complaint, alleging breach of contract, should be dismissed.
As to those issues that remain in dispute, this Court rules as follows.
A. Defendants’ Motion to Dismiss
In scattershot fashion, defendants make a plethora of arguments as to why plaintiffs fail to state a claim upon which relief may be granted. Several of these arguments rely on documents attached not to the Complaint, but to the Counterclaim and to the defendants’ memorandum. To consider materials beyond the four corners of the Complaint itself would not be appropriate at this early stage in the case, however, where it is not at all clear which of these documents would apply to the issues in contention. See Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002) (where a document is not attached to the complaint or explicitly incorporated by reference, a "plaintiff’s reliance on the terms and effect of a document in drafting the complaint is a necessary prerequisite to the court’s consideration of the document on a dismissal motion; mere notice or possession [of a document] is not enough" (emphasis in original) ). Other arguments advanced by the defendants ignore the legal standard applicable to a motion brought under Rule 12(b)(6), which is that I must accept as true all factual allegations contained in the Complaint and draw all reasonable inferences in favor of the plaintiffs. Greenleaf Arms Realty Trust I, LLC v. New Boston Fund, Inc., 81 Mass.App.Ct. 282, 288-93 (2012) (reversing lower court’s allowance of Rule 12(b)(6) motion in case alleging fraud and breach of fiduciary duty). Thus, for example, an argument that the plaintiffs have not demonstrated that they were sufficiently damaged is unpersuasive, given the factual nature of this issue and the applicable legal standard.
This is not a mere technicality. There are several agreements, and this Court cannot determine, from reading the Complaint alone, which of these documents (if any) forms the basis for any of plaintiffs’ claims or are important to them. Indeed, the plaintiffs’ principal claim stems from certain oral representations allegedly made by the Kachouhs before any contract was entered into.
Two of defendants’ arguments do merit some discussion. The first is aimed at those counts of the Complaint alleging fraud and misrepresentation. Defendants assert that the disclaimer clauses in certain of agreements essentially bar these claims. But see fn.3, supra . Not every agreement relevant to this dispute has a disclaimer clause, however. Moreover, if the agreement does have a provision regarding representations, it is not as broad as defendants contend. Finally and perhaps most important, it is well settled that a party to a contract cannot use an exculpatory or merger provision as shelter against a claim of deceit. Greenleaf Arms Realty Trust I, LLC v. New Boston, Inc., 81 Mass.App.Ct. at 288-89, and cases cited therein. As the Supreme Judicial Court has noted: "[i]n obedience to the demands of a larger public policy[,] the law long ago abandoned the position that a contract must be held sacred regardless of the fraud of one of the parties in procuring it." Bates v. Southgate, 308 Mass. 170, 182-83 (1941). It is true that a disclaimer clause may be enough to bar a claim based on negligent misrepresentation as alleged in Count Two of the Complaint, but until the Court has a clearer picture of which agreements are applicable to this dispute, it would be premature to dismiss even that count at this juncture.
The second argument that warrants consideration is whether plaintiffs have satisfied the requirements necessary to bring a derivative claim, as asserted in Count V. A derivative action is a suit in equity, the purpose of which is to "place in the hands of the individual shareholder a means to protect the interests of the corporation from the misfeasance and malfeasance of ‘faithless directors and managers.’ " Kamen v. Kemper Financial Services, Inc., 500 U.S. 90, 95 (1991) (Kamen ), quoting Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548 (1949). "To prevent abuse of this remedy, however, equity courts established as a precondition ‘for the suit’ that the shareholder demonstrate ‘that the corporation itself has refused to proceed after suitable demand, unless excused by extraordinary conditions.’ " Kamen, 500 U.S. at 95-96, quoting Ross v. Bernhard, 396 U.S. 531, 534 (1970). This requirement is accommodated by Rule 23.1 of the Massachusetts Rules of Civil Procedure, which states that the Complaint must allege "with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority ... and the reasons for his failure to obtain the action or for not making the effort." Because the function of the demand doctrine is a matter of substance and because Elephant is a Delaware corporation, this Court looks to Delaware substantive law to determine what is required to satisfy the demand rule. Kamen, 500 U.S. at 108-09; Johnston v. Box, 453 Mass. 569, 578 (2009) (affirming dismissal of derivative claim for failure to satisfy Delaware law’s demand requirements).
Notably, the Rule also requires that the Complaint be verified, which it is not.
It is a "cardinal precept" of Delaware law that directors, rather than shareholders, manage the business and affairs of a corporation, and that includes decisions regarding whether to initiate or pursue a lawsuit on the corporation’s behalf. Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984). To preserve this managerial freedom, Delaware requires that a shareholder may not institute a derivative action unless he can demonstrate "either that the board wrongfully refused the plaintiff’s pre-suit demand to initiate the suit or, if no demand was made, that such a demand would be futile ..." White v. Panic, 783 A.2d 543, 550 (Del. 2001); Spiegel v. Buntrock, 571 A.2d 767, 773 (Del. 1990). In the instant case, the Complaint falls well short of showing that a demand on Elephant’s board was made or that such demand, if it had been made, would have been futile.
The Complaint alleges only that Mogavero in the spring of 2016 questioned the Kachouhs about various expenditures and that prior to initiating litigation, he "made numerous attempts to resolve these issues with the defendants ..." ¶ 32 of Complaint. This included numerous emails and in-person communications with Loutfi Kachouh, in which Mogavero demanded that Kachouh return the money or take other action. "These attempts were futile as would have been any others because the Kachouhs are the majority shareholders of Elephant Corporation." ¶ 32 of Complaint. The Complaint does not allege that Loutfi Kachouh was a director at the time Mogavero raised these questions. Even if he was, however, this is not sufficient to show that Mogavero (acting on behalf of MCC as shareholder) made a demand on Elephant’s Board of Directors. Indeed, nowhere in the Complaint are the identity of Board members revealed, much less that a demand was made on the Board as a whole.
Since the Complaint does not demonstrate that a demand was made, then it is incumbent on the plaintiffs to allege particularized facts creating a reasonable doubt that, at the time the Complaint was filed, "the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand." Postorivo v. AG Paintball Holdings, Inc., 2008 WL 553205, at *7 (Del.Ch. 2008), applying test set forth in Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993). See In re Sonus Networks, Inc. Derivative Litigation, 2004 WL 2341395 at *4 (Mass.Super.Ct. Sept. 27, 2004) (Van Gestel, J.) (generalized allegations reflecting poor supervision over financial statements by board members failed to excuse demand). Here, the Complaint alleges only that a demand would have been futile because the Kachouhs are majority shareholders of the corporation. There are no particularized allegations to suggest that the Board members, however, were incapable of exercising their business judgment in connection with the specific wrongdoing alleged in the Complaint. Accordingly, Count Five must be dismissed.
B. Plaintiffs’ Partial Motion to Dismiss
This motion is aimed at two counts of the Counterclaim, Count IV and Count VI. In determining the legal sufficiency of these counts, this Court admits to having some difficulty deciphering the Counterclaim overall. For example, the Counterclaim alleges that Inventure (apparently with Mogavero’s assistance) improperly used Elephant’s confidential information but then alludes to a settlement agreement entered into between Elephant and Inventure, which the Counterclaim then asserts is void. It describes alleged misconduct of Clare and third-party defendant Petrov, but says little or nothing about why Mogavero and MCC should be held liable for this misconduct. The specific counts that are the subject of the Motion do little to clarify things, simply incorporating by reference the disjointed and confusing factual allegations that precede them. This Court understands its obligation to read the Counterclaim generously. Still, Rule 12(b)(6) does impose some obligation on the party asserting the claim to present more than labels and conclusions and to show an entitlement to relief that is more than just speculative. Iannacchino v. Ford Motor Co., 451 Mass. 623, 636 (2008). This Court concludes that at least as to MCC, the defendants (as the plaintiffs-in-counterclaim) have failed to meet that standard.
Count IV of the Counterclaim alleges that Mogavero and MCC (together with third-party defendants Inventure, Clare, and Petrov) breached their fiduciary obligations to Elephant. In their memorandum offered in support of their motion, plaintiffs make clear that they are not seeking to dismiss this Count as to Mogavero in his capacity as a director of Elephant. They are seeking to dismiss this Count, however, as to MCC since MCC is not a director but only a minority shareholder. In support of this position, plaintiffs argue that whatever duties that MCC had to Elephant are limited to those set forth in certain agreements, attached to the Counterclaim as Exhibits B, C, and D. Each of those contracts states that the rights and obligations of the parties shall be governed by Delaware law. In contrast to Massachusetts law, Delaware law does not impose a heightened fiduciary duty on shareholders of a close corporation. See Harrison v. NetCentric Corp., 433 Mass. 465, 472 (2001), citing Riblet Prods. Corp. v. Nagy, 683 A.2d 37, 39 (Del. 1996). See also Nixon v. Blackwell, 626 A.2d, 1366, 1380-81 (Del. 1993 (declining "to fashion a special judicially-created rule for minority investors"). As a shareholder in Elephant, MCC may have certain contractual responsibilities, but no claim for breach of fiduciary duty lies. Accordingly, plaintiffs’ Motion as to Count IV is allowed as to MCC but denied as to Mogavero.
Defense counsel appeared to concede as much at the motion hearing.
As to Count VI, this is framed as a count for "unjust enrichment" or promissory estoppel. That count explicitly relies on what it describes as a "series of contracts" that the Kachouhs and/or Elephant entered into with Mogavero, MCC, and the third-party defendants. Plaintiffs quite properly point out that this doctrine would apply only if there were no contract; if a contract governs the relationship between the parties, there is no basis for this equitable claim. Quite apart from that, however, this Court fails to see how the allegations in the Counterclaim support the conclusion that MCC (as opposed to Mogavero) was unjustly enriched. That is, the Counterclaim fails to explain in any coherent way how MCC received some benefit which it was not entitled to receive, much less that MCC made any promises on which defendants relied to their detriment. Accordingly, this Court agrees with the plaintiffs that, at least as to MCC, this Count too must be dismissed.
This is not to say that the claim against Mogavero is a strong one. Because Count IV of the Counterclaim survives as to Mogavero, however, he remains in the case as a defendant-in-counterclaim even if Count VI were dismissed, so ruling now on this claim will not narrow the issues or limit the scope of discovery. Moreover, this is the kind of claim that would be better decided on a more complete factual record.
CONCLUSION AND ORDER
For all the foregoing reasons, the Plaintiffs’ Motion to Dismiss Count IV and Count VI of the Counterclaim is ALLOWED as to MCC but DENIED as to Mogavero.
As to Defendants’ Motion to Dismiss the Second Amended Complaint (Docket # 32) it is DENIED as to Counts One, Two, Three, Six, and Seven. It is ALLOWED as to Count Five and as to so much of Count Four that is asserted against defendant Elephant, the plaintiff on that count being MCC only.