Lockhart v. Garzella

Decision Date30 April 2021
Docket NumberCase No. 3:19-cv-00405
PartiesM. CHRISTOPHER LOCKHART, et al., Plaintiffs, v. JACK GARZELLA, et al., Defendants.
CourtU.S. District Court — Southern District of Ohio

JUDGE WALTER H. RICE

DECISION AND ENTRY SUSTAINING IN PART AND OVERRULING IN PART DEFENDANTS JOHN BRENT HENRIKSEN AND CFO SOLUTIONS, L.C. D/B/A ADVANCED CFO SOLUTIONS, LLCS' MOTION TO DISMISS (DOC. #21), DEFENDANT JACK GARZELLA'S NOTICE OF JOINDER (DOC. #27) AND DEFENDANT JOHN WOOTTON'S NOTICE OF JOINDER (DOC. #28); DISMISSAL OF COUNT ONE PURSUANT TO RULE 12(b)(6) IS WITHOUT PREJUDICE TO PLAINTIFFS FILING WITHIN 14 DAYS OF THIS DECISION AND ENTRY AN AMENDED COMPLAINT SUBJECT TO THE STRICTURES OF FED. R. CIV. P. 11

Before the Court is a Motion to Dismiss Plaintiffs' Complaint pursuant to Fed. R. Civ. P. 12(b)(1) and Fed. R. Civ. P. 12(b)(6) ("Motion" or "Motion to Dismiss"), filed by Defendants John Brent Henriksen1 ("Henriksen") and CFO Solutions, LC. d/b/a Advanced CFO Solutions, LLC ("Advanced CFO"), Doc. #21. Also before the Court is a "Notice of Joinder," Doc. #27, filed by pro se Defendant Jack Garzella ("Garzella"), and a "Notice of Joinder," Doc. #28, filed by pro seDefendant John Wootton ("Wootton"). Both pro se Defendants incorporate the arguments and authorities cited in the Motion to Dismiss and request dismissal of Plaintiffs' claims against them pursuant to Fed. R. Civ. P. 12(b)(1) and 12(b)(6). Henriksen, Advanced CFO, Garzella and Wootton are collectively referred to as "Defendants."

Plaintiffs, Christopher Lockhart ("Lockhart"), Evan C. Barrett, Greg Bell, Jim Brunke, Julian Castelli, Cybeck Capital VI, LLC, Gary M. Kopacka, Bill Mestdagh, Thomas J. Meyer, Diane R. Meyer, James R. Sever, Donald Slivensky, Donald Slivensky Living Trust, Donald Slivensky as Trustee, Daniel Epperson and Thomas W. Thompson (collectively, "Plaintiffs"), have filed responses opposing the Motion to Dismiss, Doc. #24, and Henriksen and Advanced CFO have filed a reply. Doc. #25. Plaintiffs have filed responses opposing each of the Notices of Joinder filed by Garzella and Wootton, Doc. ##29 and 30.

The matter is ripe for resolution.

I. Background Facts

Flying Software Labs, Inc. ("FSL"), located in Utah, developed and marketed software products designed to assist aviation related activities. Doc. #1, PageID#5.2 Each of the 15 Plaintiffs is alleged to be an "investor in FSL viapromissory notes" or as a shareholder in the company.3 Id., PageID##6 and 7. In addition to being FSL shareholders and/or investors in promissory notes, some of the Plaintiffs are also members of the board of directors or board of advisors. Id. The Complaint alleges that all the investments made by Plaintiffs occurred between October 2016 and October 2017. Id., PageID##10-12.

The Complaint names four Defendants: (1) Defendant Garzella, the CEO and chairman of the board of FSL; (2) Advanced CFO, a Utah limited liability corporation that provided FSL with chief financial officer services on a contract basis; (3) Henriksen, FSL's Chief Financial Officer and an owner and partner of Advanced CFO4; and (4) Wootton, FSL's attorney and corporate secretary. Id., PageID#7. Plaintiffs allege that FSL was under the "complete domination and management" of Garzella and that Advanced CFO, Henriksen and Wootton "aided" him. Id., PageID#5. The Complaint also alleges that Garzella "undertook financing and stock activities that were supported by a series of misstatements" and lies that were "contrary to direction from the Board of Directors governing FSL." Id. As the CEO and chairman of the FSL board, Garzella "engaged in a series of self-dealing, contractual breaches, and other malfeasance." Id. These actions "eventually resulted in FSL's bankruptcy."5 Id.

Plaintiffs allege that in November 2016, approximately one month after some of the Plaintiffs made their first investment in FSL, Defendants negotiated a $400,000 five year secured note ("WBI Note" or "Note") that contained "specific terms." Id., PageID#7. Although FSL's board and Plaintiffs were aware of the Note and its amount, the terms of the Note were material to the operation of FSL and were not disclosed to Plaintiffs. Id., PageID#11. The covenants6 in the WBI Note prohibited FSL from engaging in the following activities: (1) entering into a new secured loan or permitting "any lien or encumbrance on any of its assets;" (2) paying any principal or interest on another promissory note made between it and any its "officers, directors, members, or managers before the WBI Note had been repaid;" (3) paying "any principal or interest on any other debt obligation to anyone who was not an officer, director, member, or manager without first obtaining prior written consent from WBI;" and (4) making "any capital expenditure in an amount greater than $25,000 without WBI's prior written consent." Id., PageID#8.

Plaintiffs allege that "FSL under the control of Defendants Garzella, [Henriksen], Wootton, and Advanced CFO (acting through its agent [Henriksen]), carried on its future business without regard to these covenants." Id., PageID#8. "It violated all of them and did not disclose these material terms to the Board or tofuture investors, including Plaintiffs." Id. Plaintiffs allege that Garzella, without prior written consent from WBI, repaid himself for loans he had made to FSL, repaid a loan to another individual, invested "hundreds of thousands of dollars" in software and negotiated an acquisition in a company that resulted in FSL assuming over $1.3 million of liens. Id., PageID##8-9. Defendants also "purposely withheld information" from the FSL Board that "would have revealed the true financial condition of the company at an earlier date." Id., PageID#13.

Many of the Plaintiffs acquired shares in FSL or became investors in promissory notes at a time when Defendants were violating the covenants of the WBI Note. Plaintiffs allege that the disclosure to them of these covenants and FSL's violation of them would have revealed FSL's "true financial state." Id., PageID##11-12. Having this information about FSL's financial condition would have caused Plaintiffs either to renegotiate the terms of their promissory notes and share purchases or not enter into the transactions with FSL. Id.

In addition to violating certain covenants in the WBI Note, Garzella provided unrealistic sales projections to the Board of Directors, many of whom were investors, falsely stated that FSL's software, its main product, was complete and spent FSL funds on first class air travel at a time when the company was under financial distress.

The "falsehoods, self-dealings, and manipulations" were not discovered by Plaintiff Lockhart, a member of the Board of Directors, as well as a shareholder and promissory note investor, until early 2018. Id., PageID#14. By the time ofPlaintiff Lockhart's discovery, FSL's financial and operational condition were "in such poor shape" that FSL "was liquidated in bankruptcy" and Plaintiffs received "no payment for their investments and shares." Id., PageID#14.

Plaintiffs allege that Henriksen acted as the CFO from 2015 through March 2019, and that from February 2017 through November 2017, he "facilitated the harm Garzella inflicted upon the Plaintiffs." Id., PageID#15. The Complaint alleges that Henriksen "blessed financial statements, pro formas used to gain investment, and other documents sent to WBI and the Board of Directors" yet failed to access the FSL accounting system to verify the accuracy of the documents. Id. The Complaint alleges that had he performed his job as CFO "to the standard expected," Garzella's "self-dealing, regarding loan payment, violation of the WBI Note covenants, and other misuse of funds" would have been discovered "significantly earlier than the first quarter of 2018." Id., PageID#15.

The Complaint alleges that Wootton, along with the other Defendants, allegedly worked to negotiate the Note, carry on FSL's business without regard to the covenants, failed to disclose and "purposefully withheld" information about FSL's financial condition. Id., PageID##7-8 and 14. Along with Garzella, Plaintiffs allege that Wootton asked "the Board to approve a [m]otion allowing Garzella to pay himself from" a contract that was being run through Garzella's separateengineering company "even though he was being paid as an employee of FSL." Id., PageID#13.7

The Complaint alleges four counts against Defendants. Count I alleges federal securities violations under §§ 10(b)8 and 20(a) of the Securities Exchange Act of 1934 ("the Exchange Act"), 15 U.S.C. §§78(b) and 78t(a) and Rule 10b-5 promulgated thereunder by the U.S. Securities and Exchange Commission ("SEC"), 17 C.F.R. §240.106-5 and §§12(a)(2). Doc. # 1, PageID#15. Counts II, III and IV allege state law claims of common law fraud, breach of fiduciary duty and unjust enrichment, respectively. Id., PageID##19, 21 and 23.

The Complaint states that subject matter jurisdiction exists pursuant to 28 U.S.C. §§1331, 1337 and 1332. Plaintiffs' assertion of "complete diversity of citizenship," however, is not supported by the allegations in the Complaint.9 Therefore, the Court exercises jurisdiction, if at all, pursuant to §§ 1331, federal question jurisdiction and/or 1337, commerce and antitrust regulations.

II. Legal Analysis
A. Introduction

Defendants argue that the Complaint should be dismissed pursuant to Fed. R. Civ. P 12(b)(1). They assert that despite Plaintiffs' "artful pleading," under Delaware law the claims are, "in substance," merely "classic derivative claims" that belong to FSL.10 Doc. #21-1, PageID##114, 110 and 111. Minger v. Green, 239 F.3d 793, 799 (6th Cir.2001) ("The Rules require that we not rely solely on labels in a complaint, but that we probe deeper and examine the substance.") (citation omitted)). Defendants contend that because FSL is in bankruptcy, only FSL's Chapter 7 bankruptcy trustee has standing to assert these claims pursuant to 11 U.S.C....

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