Strategic Diversity, Inc. v. Alchemix Corp.

• Decision Date: 20 January 2012
• Docket Number: 10–16404.,Nos. 10–15256,s. 10–15256
• Citation: 666 F.3d 1197,12 Cal. Daily Op. Serv. 802,2012 Daily Journal D.A.R. 824
• Parties: STRATEGIC DIVERSITY, INC., a Massachusetts corporation and Kenneth P. Weiss, an unmarried man, Plaintiffs–Appellants, v. ALCHEMIX CORPORATION, an Arizona corporation; Robert R. Horton, husband; Cheryl Halota Horton, wife; Medici Associates, LLC, a Delaware limited liability company, Defendants–Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

12 Cal. Daily Op. Serv. 802

2012 Daily Journal D.A.R. 824

666 F.3d 1197

STRATEGIC DIVERSITY, INC., a Massachusetts corporation and Kenneth P. Weiss, an unmarried man, Plaintiffs–Appellants,

v.ALCHEMIX CORPORATION, an Arizona corporation; Robert R. Horton, husband; Cheryl Halota Horton, wife; Medici Associates, LLC, a Delaware limited liability company, Defendants–Appellees.

Nos. 10–15256

10–16404.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted July 20, 2011.Filed Jan. 20, 2012.

James O. Ehinger, Jennings, Strouss & Salmon, P.L.C., Phoenix, AZ, for the appellants.

Stephen W. Tully, Gordon & Rees LLP, Phoenix, AZ, for the appellees.

Appeal from the United States District Court for the District of Arizona, G. Murray Snow, District Judge, Presiding. D.C. No. 2:07–cv–00929–GMS.Before: PROCTER HUG, JR. and JOHNNIE B. RAWLINSON, Circuit Judges, and JED S. RAKOFF, Senior District Judge.^*Opinion by Judge HUG; Concurrence by Judge RAWLINSON.

ORDER

The Opinion filed December 2, 2011, slip op. 20613, is withdrawn. It may not be cited as precedent by or to this court or any district court of the Ninth Circuit. Appellees' petition for panel rehearing is DENIED.

OPINION

HUG, Senior Circuit Judge:

This appeal concerns the maintenance of a suit for rescission under section 10(b) of the Securities and Exchange Act of 1934 by plaintiffs-appellants Kenneth Weiss and his wholly-owned corporation Strategic Diversity, Inc. The district court granted summary judgment to defendants-appellees Robert Horton, Alchemix Corporation, and Medici Associates on all claims and awarded the defendants attorneys' fees. We affirm in part, reverse in part, vacate the attorneys' fee award, and remand.

I. Background

A. The Initial Investment

In April 2001, Kenneth P. Weiss met Robert Horton. Weiss expressed interest in investing in Horton's alternative fuels start-up company, Alchemix Corporation. At the direction of his accountant, Weiss set up Strategic Diversity, Inc., (“Strategic”) to handle his investments. In Strategic's first venture, Weiss sought to invest $500,000 in Alchemix and requested certain collateral to secure his investment. Approximately two weeks later, the parties arrived at an agreement.

In a seven-page agreement signed on July 2, 2001, Strategic agreed to invest $500,000 in Alchemix. The agreement incorporated the following: (1) a convertible promissory note (“Note”) in the amount of $500,000.00; (2) security interests in Alchemix's patents and intellectual property rights; and (3) a warrant which included a provision that ensured capitalization of the company could not exceed 40 million shares (“Warrant”).

The Note was to be paid after five years at an interest rate of ten percent per year compounded monthly. Under the terms of the Note, Weiss had the option of converting the Note to 250,000 shares of stock at a price of $2 or such price as offered to other investors. Alchemix had the ability to prepay the Note after one year if three conditions were met: (1) Alchemix had to give Strategic 30 days advance written notice; (2) Alchemix had to pay a prepayment penalty of $10,000; and (3) during the 30 day notice period, Alchemix had to give Strategic the option to convert the Note into 250,000 shares of Alchemix stock at $2 per share or any lower price offered to other investors.

While the agreement did not guarantee Weiss a seat on the Board, it stated that Alchemix “shall immediately undertake its best efforts ... to elect Weiss ... and retain [him] in such Board position at least until such time as the [Note] ... [has] been satisfied or converted pursuant to the terms delineated therein.” Weiss obtained his seat on the Board shortly after his investment was made.

As part of the loan, Weiss also obtained secured interests in Alchemix's property in certain patents and protection in the form of anti-dilution provisions.

B. Alchemix Needs Further Investment

In May 2002, Alchemix needed money. To that end, Alchemix entered into negotiations with the Alchemix Funding Group (“AFG”). AFG was an investment group independent of Alchemix, but the group included members of Alchemix's Board. Horton claims that Weiss was a member of AFG, but Weiss denies this assertion.

Throughout the month, AFG and Alchemix negotiated the terms of an agreement. AFG would loan Alchemix approximately $3 million, but it required certain terms on its loan. Those terms, however, conflicted with Strategic's then-held rights. To get the loan from AFG, Alchemix (and AFG) would need Strategic to make concessions. Weiss testified that his goal was to see that Alchemix succeed, and he believed that securing this line of funding would help Alchemix. Weiss agreed to make certain concessions; however, not surprisingly, he sought to be compensated for them. He negotiated with Alchemix and AFG to find an acceptable outcome for all.

The negotiations culminated in a June 5, 2002 letter from Strategic to Alchemix. In that letter, Weiss, on behalf of Strategic, wrote that he understood Alchemix was seeking funding from AFG in the amount of three million dollars. He indicated that he intended to be an investor in AFG and that his agreement to waive Strategic's rights was “contingent upon my investment in [AFG].” Weiss then noted that he would agree to waive Strategic's rights on certain terms. Specifically, he stood ready to waive anti-dilution provisions, increase the amount of capitalized shares, and release his security interests in Alchemix patents in exchange for a $250,000 investment in Alchemix (500,000 shares at $0.50 per share).

As part of the proposed AFG loan agreement, AFG was to initially supply $1.5 million to Alchemix. A portion of that money, $560,000, was to be paid to Strategic in order to remove Strategic's security interests in Alchemix property. Once collateral requirements were in order, AFG would supply another $1.8 million, bringing its total investment in Alchemix to $3.3 million.

C. Western Oil Sands

However, the AFG–Alchemix transaction never took place because in the midst of those negotiations, Horton received welcome news for Alchemix. On June 17, 2002, a Canadian company, Western Oil Sands (“Western”), indicated its interest in a potentially larger investment in Alchemix than AFG was willing to offer. Western sent a “Memorandum of Understanding” (“Western Memo”) to Horton. According to the Western Memo, Western was to make an initial investment of $3 million and had the option to continue investment if certain conditions were met. The potential investment was up to $36 million.

The next day, on June 18, 2002, Horton canceled the negotiations with AFG. He faxed a copy of the Western Memo to members of the Alchemix Board, including Weiss who received the document.

Sometime after the Western proposal and the circulated Western Memo, Weiss asserts that Horton misrepresented the nature of the Western investment. Weiss testified that he and Horton were “on the phone fairly often” and that “Bob Horton told me that they [Western] were investing $30 million and that the various concessions that I made were, from my personal point of view, contingent on and related directly to that kind of investment.” Weiss also claims that he inquired as to whether there were “any adverse facts or circumstances” that would affect his decision and that Horton did not offer any comments.

Because Weiss was busy with other matters, including travel outside the country, Arthur Hagopian, executive assistant to Weiss and a corporate officer of Strategic, handled the “day-to-day discussions with Alchemix' and Horton's representative.” Hagopian had one conversation with Horton regarding Weiss's resignation from the Board, but all other discussions were with Richard Armstrong, Alchemix's CFO. Horton stated that Armstrong would be the person “shifting the paper” on any such transaction.

Hagopian describes his discussions with Armstrong as a “single transaction” that would involve the “replacement” of Strategic's loan with an equity holding. Armstrong, however, testified in his deposition that he did not recall the transaction. Hagopian stated that Armstrong had opened discussions by claiming that a number of concessions were needed to “clear the way” for a “new investor.” The new concessions for the Western investment included the following: prepayment of the Note; relinquishment of Weiss's Board seat; waiver of Strategic's non-dilution rights; and waiver of Strategic's right to make further loans to Alchemix. Hagopian stated that Armstrong proposed that an equivalent investment in Alchemix stock would be provided at a discounted price in exchange for these concessions. Hagopian and Armstrong negotiated the price of the stock, ultimately arriving at a “discount” price of $1 per share. Armstrong told Hagopian that the 250,000 shares would not originate from Alchemix but rather from Horton's family's holdings in Medici Associates.

In the midst of the Weiss and Horton negotiations, Western made its first $3 million investment in Alchemix, pursuant to the terms in the Western Memo.

On June 27, 2002, Strategic accepted prepayment of the Note with interest and penalties totaling $560,531. In consideration of the prepayment, Strategic (1) waived the thirty day notice, (2) waived Strategic's right to loan an additional $500,000 to Alchemix, and (3) modified the Warrant to allow capitalization of up to 45 million shares. Although the document accepting prepayment of the Note itself makes no reference to the right to purchase Alchemix shares at $1 per share, Weiss produced a sheet with wiring instructions for the payment that also includes the following statement: “Please do not transfer this payment until you send a note stating, ‘Strategic Diversity and/or Kenneth P. Weiss shall have the right to purchase up to 500,000 shares of Alchemix Corp. at $1 a share directly from Robert Horton.’ ” Hagopian also wrote to Armstrong that if there were issues with...