Chapel Invs., Inc. v. Cherubim Interests, Inc.

• Decision Date: 14 April 2016
• Docket Number: Civil Action No. 4:16–CV–00172–O
• Citation: 177 F.Supp.3d 981
• Parties: Chapel Investments, Inc., Plaintiff, v. Cherubim Interests, Inc., Defendant.
• Court: U.S. District Court — Northern District of Texas

177 F.Supp.3d 981

Chapel Investments, Inc., Plaintiff,

v.Cherubim Interests, Inc., Defendant.

Civil Action No. 4:16–CV–00172–O

United States District Court, N.D. Texas, Fort Worth Division.

Signed April 14, 2016

Jesse Z. Weiss, Ryan Shelton, Hohmann, Brophy & Shelton, PLLC, Austin, TX, for Plaintiff.

Marcus C. Marsden, Jr., The Colaneri Firm, P.C., Arlington, TX, for Defendant.

ORDER

Reed O'Connor

, UNITED STATES DISTRICT JUDGE

The Joint Motion for Approval of Stipulation of Settlement of All Claims (Doc. 7) (the “Motion”) of Plaintiff Chapel Investments, Inc. (“Plaintiff”) and Cherubim Interests, Inc. (“Defendant”) came on for hearing on April 14, 2016 before the Honorable Reed O'Connor, U.S. District Judge. The Court having been presented with a Stipulation of Settlement of all Claims (the “Stipulation,” Exhibit 1 to the Motion) between Plaintiff and Defendant, considered the Motion and Stipulation, the Declaration of Patrick Johnson (“Johnson Decl.,” Exhibit 2 to the Motion), and arguments of counsel, conducting a hearing on the Motion, and good cause appearing therefor, the Court grants the Motion for the reasons explained below.

Jurisdiction and Venue

This Court has subject matter jurisdiction over this proceeding pursuant to 28 U.S.C. § 1332(a)(2)

because there is complete diversity of citizenship between Plaintiff, a Belize international business company, and Defendant, a Nevada corporation, and Plaintiff seeks damages in excess of $75,000. Complaint, Doc 1. Venue is proper in this Court pursuant to 28 U.S.C. § 1391(b)(1) because Defendant's headquarters is within this district. Complaint.

Findings of Fact

Plaintiff alleges that defendant Cherubim Interests, Inc. (“Defendant”), a public company, owes Plaintiff a debt in the amount of $100,000.00 plus interest. See Complaint, Doc. 1. Plaintiff and Defendant have reached agreement as to all terms of settlement of this action. See Stipulation for Settlement, Exhibit 1. (the “Stipulation”). Because the parties have agreed to settle Plaintiff's claims against Defendant in exchange for the issuance of unregistered shares of Defendant's stock to Plaintiff, Court approval is required under Section 3(a)(10) of the Securities Act of 1933 (the “Securities Act”), 15 U.S.C. § 77c(a)(10)

.

As discussed below, Section 3(a)(10) is an exception to the securities laws for settlements that are approved by a court. The exception applies if the court determines that the settlement is fair, following a hearing on the terms and conditions of the proposed exchange, at which the person to receive the stock has the right to appear. In this case, the only person to receive shares from the Section 3(a)(10) exchange is Plaintiff, who, together with Defendant, asks the Court for approval of the terms of the Stipulation for Settlement, filed concurrently herewith.

A. The Parties

Plaintiff is a sophisticated offshore institutional investor, highly experienced in the business of buying and selling securities, including multiple transactions such as that proposed here. See Stipulation, Exhibit 1, p.6, ¶ 12(a). Plaintiff is the holder of an outstanding loan to Defendant in the principal amount of $100,000.00 (the “Claim”) plus interest, attorney fees, and costs. See Complaint, Doc. 1. The underlying documentation supporting the Claim is attached as an exhibit to the Complaint. See Complaint, Doc. 1, Exhibit 1. Plaintiff and its U.S. representatives have utilized their knowledge, sophistication, and experience in business and financial matters, and have fully evaluated the merits and risks of entering into the Stipulation. See Stipulation, Exhibit 1, pp.6–7, ¶ 12(b). Plaintiff is able to bear the economic risk of entering into the Stipulation and is able to afford a complete loss of its investment. See Stipulation, Exhibit 1, p.7, ¶ 12(c).

While fully aware of the significant risks of exchanging debt for the common stock of a small public company in financial difficulty, Plaintiff is willing to accept that risk provided that Defendant abides by the terms of the Stipulation. If Defendant is successful and its business performs well, there is the potential for Plaintiff to fully recoup its investment and possibly generate a substantial return.

Defendant is a real estate investment company based in Bedford, Texas, that invests in commercial buildings and single and multifamily housing. See Declaration of Patrick Johnson, (“Johnson Decl.”), Exhibit 2, ¶ 3. Defendant's stock is publicly traded on the OTC Pink marketplace under the ticker symbol “CHIT.” Defendant is a very small company, with a market capitalization well under a million dollars, and a current stock price of only $0.0001 per share. Like many micro-cap public companies whose shares trade on the over-the-counter market, trading in Defendant's stock is volatile and unpredictable. See Johnson Decl., Exhibit 2, ¶ 8. Over the last year, the trading price and volume for Defendant's stock have fluctuated substantially. See Johnson Decl., Exhibit 2, Ex. A (chart of Defendant's trading price and volume over the prior year).

Defendant concedes that the Claim held by Plaintiff is bona fide outstanding, and that Defendant is obligated to pay the full amount of the Claim without counterclaim or right of offset. See Johnson Decl., Exhibit 2, ¶ 5. Defendant's board of directors has determined that the terms of the Stipulation are fair to Defendant, and in the best interests of its stockholders. See Johnson Decl., Exhibit 2, ¶ 10.

B. The Terms of the Stipulation

The parties and their attorneys and investment advisors have worked cooperatively together to structure an advantageous settlement. See Motion at 3. The proposed Stipulation has benefits and risks for each party. See id. Because of its low stock price and the relative size of the debt, Defendant may have to issue a large number of its shares to satisfy the Claim. See id. However, the Stipulation will allow Defendant to remove debt from its balance sheet and avoid a judgment it cannot afford by paying Plaintiff in stock instead of cash. See id. at 3–4. Existing shareholders will be better off owning a lower percentage of an entity with an improved chance to continue as a going concern, than their existing percentage of a corporation that may be forced into bankruptcy or out of business. See id. The proposed exchange of debt for equity is therefore highly accretive, and beneficial to the overall enterprise and its stakeholders. See id. at 4.

Plaintiff will bear significant investment risk by agreeing to the Stipulation. Motion at 4. Plaintiff is agreeing to exchange debt, which has a liquidation preference above all equity, for common stock which sits at the bottom of the capitalization table. See id. Plaintiff's ability to recoup cash will be entirely dependent on its ability to sell the shares it receives in an uncertain and illiquid market. See id. However, the Stipulation will provide Plaintiff with at least the opportunity to recoup its full investment and earn a return, possibly even a high return, particularly if Defendant's stock price increases. See id. Plaintiff will receive a number of shares that are currently priced at more than the Claim amount which, in theory, it should be able to sell for more than the amount of the Claim. See Stipulation, Exhibit 1, ¶ 6. The Stipulation also contains a pricing adjustment formula over a defined period, which provides for a high degree of theoretical protection. See Stipulation, Exhibit 1, ¶¶ 6–10. If Defendant's stock price declines over time, it will be required to issue Plaintiff more shares. Id. However, in the real word, it may be difficult and perhaps impossible for Plaintiff to sell enough shares at any price to recoup its investment. As an equity investor, Plaintiff's return will be wholly dependent on the market for Defendant's stock. See Motion at 4.

The parties have agreed to settle the claims in this action in exchange for issuance of Defendant's stock to Plaintiff, subject to obtaining the Court approval required by Section 3(a)(10) of the Securities Act of 1933, as amended, 15 U.S.C. § 77c(a)(10)

, and the comparable provision of Nevada state “blue sky” law, Nevada Revised Statutes § 90.280(6)(c). The Court's approval of the proposed settlement is necessary because the settlement involves Defendant paying Plaintiff with unregistered shares of Defendant's common stock. As discussed further below, the Securities Act and its Nevada equivalent provide for an exemption to an issuer's registration requirement in certain situations, including where, as here, a court determines that the settlement is fair. See

Oceana Capitol Grp. Ltd. v. Red Giant Entertainment, Inc., No. 3:15–cv–428, 150 F.Supp.3d 1219, 1221–22, 2015 WL 9239767, at *2 (D.Nev. Dec. 17, 2015) ; ScripsAmerica, Inc. v. Ironridge Global LLC, 56 F.Supp.3d 1121, 1132, fn. 16 (C.D.Cal.2014) ; see also Johnson Decl., ¶ 9.

Each party has stipulated that the terms of the proposed settlement are fair and reasonable, no party has objected, and indeed Plaintiff and Defendant jointly ask that the stipulation be approved by the Court.

Conclusions of Law

A. The Proposed Settlement is Fair

Section 3(a)(10) provides that, “any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests” is exempt from application of the federal securities laws, “where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court.” 15 U.S.C. § 77c(a)(10)

.

The statute is routinely taken advantage of by public companies to settle outstanding debts in exchange for stock. See Oceana Capitol, 150 F.Supp.3d at 1223, 2015 WL 9239767, at *3

(“The Section 3(a)(10) exemption is often used to effectuate settlements of claims against public company defendants.”); ScripsAmerica, 56...