Cohen v. Northwestern Growth Corp.

• Decision Date: 19 August 2005
• Docket Number: No. Civ. 04-4043.,Civ. 04-4043.
• Citation: 385 F.Supp.2d 935
• Parties: Brad COHEN; Wilson Dolde; Charles R. Durham; Harvey Everest; Duane Floyd; Linda Rafferty; Wells Richards; Samuel Sklaroff; Waren Soberg; and Curt S. Tomlinson, Plaintiffs, v. NORTHWESTERN GROWTH CORPORATION; Exp@nets, Inc., f/k/a Communications Systems USA, Inc., n/k/a Netexit, Inc.; Merle D. Lewis; Richard Hylland; Daniel K. Newell; and Avaya, Inc., Defendants.
• Court: U.S. District Court — District of South Dakota

385 F.Supp.2d 935

Brad COHEN; Wilson Dolde; Charles R. Durham; Harvey Everest; Duane Floyd; Linda Rafferty; Wells Richards; Samuel Sklaroff; Waren Soberg; and Curt S. Tomlinson, Plaintiffs, v. NORTHWESTERN GROWTH CORPORATION; Exp@nets, Inc., f/k/a Communications Systems USA, Inc., n/k/a Netexit, Inc.; Merle D. Lewis; Richard Hylland; Daniel K. Newell; and Avaya, Inc., Defendants.

No. Civ. 04-4043.

United States District Court, D. South Dakota, Southern Division.

August 19, 2005.

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Curtis D. Smith, Moss & Barnett, Minneapolis, MN, John Patrick Peterson, Johnson, Eklund, Nicholson & Peterson, Sioux Falls, SD, for Plaintiffs.

Christopher Wayne Madsen, Thomas John Welk, Boyce Greenfield Pashby & Welk, LLP, Sioux Falls, SD, Ellen E. Bonacorsi, Louis F. Bonacorsi, Bryan Cave, LLP, St. Louis, MO, for Defendants.

MEMORANDUM OPINION AND ORDER

PIERSOL, Chief Judge.

Pending before the Court are Northwestern Growth Corporation's Motion to Dismiss, Doc. 41, Merle D. Lewis and Daniel K. Newell's Motion to Dismiss, Doc. 36 and Richard Hylland's Motion to Dismiss, Doc. 44. Avaya, Inc., filed a joinder in the motions to dismiss, Doc. 51. Defendants have also filed a Request for Judicial Notice Doc. 38, in support of their motions to dismiss. The motions have been fully briefed and will be decided based upon the written record in this case.

BACKGROUND

Plaintiffs are former business owners who sold their companies to Exp@nets, Inc., n/k/a Netexit, Inc. ("Exp@nets"), in 1998 and 1999 in exchange for both cash and restricted Exp@nets' stock. At the time of the sales, Exp@nets was a privately held company, but the Plaintiffs were solicited to sell their companies to Exp@nets with the representations that the Defendants intended to pursue an initial public offering ("IPO") within a few months of Plaintiffs' sales to Exp@nets. The IPO never happened.

Northwestern Growth Corporation ("NGC") is a wholly owned subsidiary of Northwestern Corporation ("Northwestern"). The principal place of business for both NGC and Northwestern is Sioux Falls, South Dakota. Exp@nets is a Delaware corporation with its principal place of business in Colorado. Defendant Merle D. Lewis ("Lewis") served as the Chairman of the Board and Chief Executive Officer ("CEO") of Northwestern and NGC. He also served as the Chairman of the Board of Exp@nets. Defendant Richard Hylland ("Hylland") was the Vice Chairman of the Board of Directors of Exp@nets, the President and Chief Operating Officer of Northwestern (from May 1998) and the Vice Chairman of NGC. Hylland also served as the CEO of NGC (January 1998 through May 1998) and President and Chief Operating Officer of NGC (September 1994 through January 1998). Defendant Daniel K. Newell ("Newell") was the Vice President Finance for Northwestern (from 1995 to 1999), the Senior Vice President of Finances for Northwestern (from May 1999), and the Chief Financial Officer of Northwestern (July 1999). Newell also served as the Vice President (1995 to 1998), President, Managing Director and CEO of NGC (from May 1998). The remaining Defendant, Avaya, Inc., purchased substantially all of the assets and assumed certain liabilities of Exp@nets on October 30, 2003. Thus, Avaya is the successor in interest to the business and liabilities of Exp@nets.

Northwestern created NGC in 1994 to pursue and manage non-utility investments and development activities for Northwestern, focusing in the energy, energy equipment and energy services industries. In late 1997, the Board of Directors of Northwestern and NGC, including Defendants Lewis, Hylland and Newell, authorized the creation of Communications Systems USA ("CSUSA") to pursue a national "inter-connect" business to provide telephone hardware, software and wiring services to other businesses. CSUSA was incorporated in the State of Delaware on January 27, 1998. In February 1999, CSUSA's name was changed to Exp@nets.

Exp@nets purchased the stock of 26 local inter-connect companies, including those owned and operated by Plaintiffs. NGC owned a controlling percentage of Exp@nets' stock and each stockholder of an acquired company became a minority shareholder of Exp@nets. The consideration paid for each company was comprised of a combination of cash and Exp@nets' stock. Although the percentages of cash and stock varied amongst the Plaintiffs, it was approximately 50 percent cash and 50 percent stock. Plaintiffs contend that they sold their companies after receiving representations from Exp@nets that an IPO of Exp@nets' stock would occur imminently, and Plaintiffs would receive substantial additional cash compensation when they sold their Exp@nets' stock, receiving far more than if they sold their companies strictly for cash. Plaintiffs further contend the Exp@nets' stock only had value if Exp@nets conducted the IPO.

Despite the representations of an imminent IPO, Plaintiffs allege that Defendants did not intend to make an IPO of Exp@nets' stock. Rather, Plaintiffs alleged Defendants intended to keep Exp@nets as a subsidiary of Northwestern Corporation and use Exp@nets' revenues to bolster Northwestern's stock price. Additionally, Defendants Lewis, Newell and Hylland are alleged to have unjustly enriched themselves through a private equity company.

An IPO of Exp@nets' never occurred. In Northwestern's Quarterly Report of August 14, 2003, it reported that Northwestern had started a process to sell its interest in Exp@nets. Northwestern then filed for Chapter 11 bankruptcy on September 14, 2003. Exp@nets, n/k/a Netexit, Inc., filed for Chapter 11 bankruptcy on May 4, 2004. Avaya purchased substantially all of the assets of Exp@nets. None of the consideration received in the sale of Exp@nets' assets to Avaya was distributed to Exp@nets' minority shareholders, nor to any of the Plaintiffs, nor retained by Exp@nets. As a result of the methods used to sell the assets of Exp@nets, and the manner in which the proceeds were distributed, the Exp@nets' stock owned by the minority shareholders, including Plaintiffs, is now worthless. Plaintiffs allege they were defrauded out of approximately $20 million as a result of the Defendants' conduct and the events described above.

Damages are sought under federal securities laws and state securities laws, as well as under common law theories. Plaintiffs bring this action to redress alleged violations of the provisions of § 12(a)(2) of the Securities Act of 1933, 15 U.S.C. § 771(a)(2) ("Securities Act") (Count I), §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) ("Exchange Act"), Rule 10b-5 promulgated thereunder by the United States Securities and Exchange Commission ("SEC"), 17 C.F.R. § 240.10b-5 ("Rule 10b-5") (Count III), as well as under state securities laws (Counts V through IX) and common law theories of fraud (Counts II) and breach of fiduciary duty (Counts X and XI). Count IV is entitled "Rescission of Consideration Received in Form of Exp@nets Stock," which is an election of remedies rather than a separate cause of action.

Although Defendants have filed separate motions to dismiss the Amended Complaint, they have also incorporated into their briefs arguments contained in the briefs filed by the other Defendants. The Motions to Dismiss are filed pursuant to Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure, as well as the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4, et seq. ("Reform Act").

NGC contends that the only reason it is named as a defendant in this action is because of its corporate relationship with Exp@nets, as all the claims against NGC are derivative of the Plaintiffs' allegations against Exp@nets. Thus, NGC maintains it cannot be held liable as a parent company of Exp@nets for any wrongdoing by its subsidiary. In addition to claiming that none of the nine causes of action against NGC are sufficiently pled, NGC contends that Plaintiffs have failed to tie any of the claims to NGC. NGC further argues that the only misstatement specifically attributed to NGC relates to a future occurrence, an Exp@nets' IPO, which cannot provide the basis for any securities fraud liability. Finally, most of Plaintiffs' claims against NGC are time-barred.

Lewis and Newell filed a joint Motion to Dismiss. They contend that the Amended Complaint should be dismissed on the following grounds. The federal and state securities fraud claims in Counts I, III, V, VI, VII, VIII and IX are barred by the applicable statutes of limitation and repose. Count II, alleging common law fraud, lacks particularity and is not cognizable under South Dakota law because it is based upon representations regarding a possible future event and the oral representations are directly contradicted by a written contract. The remaining two claims in Counts X and XI, alleging breaches of fiduciary duties, are derivative claims that only the Exp@nets' bankruptcy trustee may prosecute.

Hylland seeks dismissal of all counts in the Amended Complaint on the following grounds. The claim under Section 10(b) of the Exchange Act and Rule 10b-5 are barred by the statute of limitations and it fails to meet the heightened pleading requirements of the Reform Act and Rule 9(b) because Plaintiffs do not plead fraud and scienter with particularity. Plaintiffs' claim is based on a single oral representation allegedly made by Hylland to one Plaintiff regarding a future IPO that was directly contradicted by the parties' written contract. As to the common law fraudulent inducement claim, including a request for rescission of the contracts, Plaintiffs have failed to plead fraud with particularity as required by Rule 9(b) and failed to state a claim. The breach of fiduciary duty claims fail because they are derivative claims, which may only be brought by Exp@nets' bankruptcy trustee. The Section 12(a)(2) claim under the Securities Act and state securities act claims are barred...