Baker v. Goldman Sachs & Co.

• Court: U.S. District Court — District of Massachusetts
• Writing for the Court: Saris
• Citation: Baker v. Goldman Sachs & Co., 656 F.Supp.2d 226 (D. Mass. 2009)
• Decision Date: 15 September 2009
• Docket Number: Civil Action No. 09-10053-PBS.
• Parties: Janet BAKER, et al., Plaintiffs, v. GOLDMAN SACHS & CO., et al., Defendants.

656 F.Supp.2d 226

Janet BAKER, et al., Plaintiffs, v. GOLDMAN SACHS & CO., et al., Defendants.

Civil Action No. 09-10053-PBS.

United States District Court, D. Massachusetts.

September 15, 2009.

COPYRIGHT MATERIAL OMITTED

Terence K. Ankner, The Law offices of Partridge, Ankner & Horstmann, LLP, Boston, MA, Alan K. Cotler, Steven T. Voigt, Joan A. Yue, Reed Smith, LLP, Philadelphia, PA, for Plaintiffs.

John D. Donovan, Jr., Matthew L. McGinnis, Annmarie A. Tenn, Ropes & Gray LLP, Boston, MA, for Defendants.

MEMORANDUM AND ORDER

SARIS, District Judge.

This case arises out of the merger of Dragon Systems, Inc. ("Dragon") into Lernout & Hauspie Speech Products N.V. and its subsidiary (collectively "L & H") on June 7, 2000. Within months of the merger, the public disclosure of an accounting fraud scheme at L & H rendered L & H's stock worthless, and ultimately led L & H to file for bankruptcy on November 29, 2000.

Plaintiffs Janet and James Baker, the founders and controlling shareholders of Dragon, allege that defendant Goldman Sachs & Co. ("Goldman")¹ is liable to them for breach of contract and common law duties because it negligently advised Dragon to merge with L & H without engaging in adequate investigation of the value of L &H.²

Defendants move to dismiss all claims. After a hearing, the motion is ALLOWED in part and DENIED in part.

II. FACTUAL BACKGROUND

When all reasonable inferences are drawn in favor of the non-moving party, the complaint alleges the following facts, many of which are disputed.

1. Dragon's "Golden Eggs"

Founded in 1982, Dragon revolutionized the area of speech recognition technology. Compl. ¶ 8. In the late 1990s, "Dragon had an extensive research and development pipeline for future products and opportunities — Dragon's `golden eggs.'" Pl.'s Mem. at 3. In order to effectively develop this technology, Dragon began to consider a merger with another company. At this time, Dragon's founders, Janet and James Baker, owned 51 percent of its stock. Compl. ¶¶ 2, 4. James Baker served for many years as Dragon's Chairman and Chief Executive Officer. His wife, Janet Baker, served as Dragon's President and succeeded him as Chairman and CEO. Id. ¶ 3. Janet Baker was a member of Dragon's Board of Directors at the time of Goldman's engagement and through the closing of the Dragon merger with L & H on June 7, 2000. Id.

2. Dragon Bait — The 1999 Engagement Letter

In the fall of 1999, L & H approached Dragon about a merger. At the time, Dragon was also discussing a potential merger with Visteon, a subsidiary of Ford. At this time, Dragon was valued at no less than $600 million. Compl. ¶ 12. In November 1999, Dragon decided to engage Goldman as its financial advisor. In its pitch to Dragon's Board of Directors, and to Janet Baker, Goldman promoted its experience expertise in investment banking, high reputation for professionalism, international resources, and the "real value" Goldman would add "in maximizing transaction value and negotiating definitive agreements." Id. ¶ 14. Goldman knew that Dragon was a privately held corporation, that the Bakers were the founders and majority owners, and that any transaction would require the Bakers' approval. Id. ¶ 15.

On December 8, 1999, Ellen Chamberlain, Dragon's Chief Financial Officer, signed an Engagement Agreement on behalf of Dragon. Id. ¶ 16. The agreement was addressed to Chamberlain, Janet Baker and Donald Waite, the Executive Vice President and Chief Administrative Officer of Seagate Technology, Inc. ("Seagate"), which held shares of Dragon stock. Neither Baker nor Waite were addressed in their representative capacity. With a salutation that reads "Ladies and Gentleman," the agreement provides:

We are pleased to confirm the arrangements under which Goldman, Sachs & Co. ("Goldman Sachs") is exclusively engaged by Dragon Systems, Inc. (the "Company") as financial advisor in connection with the possible sale of all or a portion of the Company.

During the term of our engagement, we will provide you with financial advice and assistance in connection with this potential transaction, which may include performing valuation analyses, searching for a purchaser acceptable to you, coordinating visits of potential purchasers and assisting you in negotiating the financial aspects of the transaction.

Compl. Ex. B at 1 (emphasis added). Under the agreement, Dragon would be paying Goldman's fee. Significantly, it also provided:

Please note that any written or oral advice provided by Goldman Sachs in connection with our engagement is exclusively for the information of the Board of Directors and senior management of the Company, and may not be disclosed to any third party or circulated or referred to publicly without our prior written consent.

Compl. Ex. B at 4.

Annex A of the Engagement Agreement ("Annex A") which governs possible derivative actions, states,

The Company, Seagate Technology, and Janet M. Baker also agree that neither Goldman Sachs nor any of such affiliates, partners, directors, agents, employees or controlling persons shall have any liability to the Company, Seagate Technology, Inc., Janet M. Baker or any person asserting claims on behalf of or in right of the Company in connection with or as a result of either our agreement or any matter referred to in this letter except to the extent that any losses, claims, damages, liabilities, or expenses incurred by the Company result from the gross negligence, willful misconduct or bad faith of Goldman Sachs in performing the services that are the subject of this letter.

Janet Baker and Donald L. Waite signed as stockholders "agreeing only as the fifth sentence of Annex A." Annex A also provides that the letter agreement shall be construed under New York law. See Compl. Ex. B, Annex A.

A follow-up letter dated March 31, 2000 referred to the "engagement letter dated December 2, 1999 between" Goldman and Dragon. Again, Waite and Baker signed as shareholders "agreeing only to the fifth sentence of Annex A." Compl. Ex. C.

3. The Deal with L&H

Early in the negotiations, the consideration L&H offered for Dragon was an equal mix of cash and stock. Compl. ¶¶ 34, 36. This changed at a critical meeting between Dragon and L & H on March 8, 2000, where L & H informed Dragon and the Bakers that, in light of another merger/acquisition deal with Dictaphone in which L & H was involved, L & H would have to change the offer for the Dragon merger to all stock with no cash component. Id. ¶ 36. In plaintiff's view, this change in the structure of the deal should have signaled to Goldman that L & H could not raise the amount of cash needed for a mixed stock and cash transaction. Plaintiffs believe that this was a significant red flag that L & H's stock was not worth its trading price. Id. ¶ 42.

4. Goldman's Prior Investigation of L & H

In 1998, Goldman undertook an analysis of L & H on behalf of another client, GE Capital, that was considering an investment of $25 million or less in L & H. Through this investigation, Goldman learned that at least one of L & H's strategic partners was "related" to L & H. Compl. ¶¶ 41, 44, 77. L & H's strategic partners were companies that supposedly developed translation capabilities for numerous languages and dialects around the world and then licensed or sold this technology to L & H. Id. ¶¶ 74-75. Goldman's 1998 investigation revealed that one of these partners, Flanders Language Valley (FLV), which was represented as a "third party investment entity," was in fact closely related to L & H. The founders of L & H, Jo Lernout and Pol Hauspie, resigned from the board of FLV "due to the conflicts of interest that had become apparent." Id. ¶ 77. Plaintiffs believed this should have served as another warning sign for Goldman.

As part of its evaluation of L & H's financial health for GE Capital, Goldman contacted at least two L & H customers. Id. ¶¶ 89, 91. Furthermore, Goldman devised various strategies for GE Capital to "hedge some of the stock price risk" with its investment. Id. ¶ 41.

By contrast, during its engagement by Dragon, Goldman did not contact L & H's customers to determine whether they were in fact customers of L & H or to understand their relationships with L & H. Id. ¶ 88. Goldman also represented to Dragon that L & H's stock value was not an open issue or concern. Id. ¶ 61.

5. Goldman's Due Diligence Obligations

On December 14, 1999, Goldman sent the Bakers and others a copy of "Due Diligence Questions" regarding L & H that included the following issues of inquiry: financial information from 1996 through December 1999, organic sales growth, assets and liabilities, major customers and their contracts, research and development budgets, and the manner of L & H's integration of its acquisitions into its business. Compl. ¶ 45. On December 16 and 17, 1999, Goldman submitted two memoranda, which compared and contrasted possible acquisitions of Dragon by L & H and Visteon. Id. ¶¶ 46, 52. The December 17 memorandum also included a "Merger Analysis" stating Goldman's various estimates for revenue and debt for a combined company if L & H purchased Dragon with "100% Stock," "100% Cash", or "50% Stock/50% Cash." Id. ¶ 52. The plaintiffs' complaint alleges that when Goldman provided these calculations to the Bakers and Dragon's Board of Directors, it had not done any of the necessary investigation, research, review, or analysis. Id.

In addition, Goldman was uniquely positioned to investigate, research, review and analyze L & H's Asian growth and revenues, a significant factor in Dragon's consideration of the merger deal, because Goldman had offices in Singapore and South Korea, where L & H's Asian growth was concentrated. Compl. ¶ 67. Nevertheless, Goldman allegedly did not investigate the critical area of L & H's Asian growth and revenues, or that it conducted such a negligent analysis that it failed to discover what a Wall Street Journal reporter learned with only a few...