Taylor v. Rothstein Kass & Co.

• Decision Date: 04 February 2020
• Docket Number: Civil Action No. 3:19-CV-1594-D
• Parties: THOMAS L. TAYLOR III, Plaintiff, v. ROTHSTEIN KASS & COMPANY, PLLC, et al., Defendants.
• Court: U.S. District Court — Northern District of Texas

THOMAS L. TAYLOR III, Plaintiff, v. ROTHSTEIN KASS & COMPANY, PLLC, et al., Defendants.

Civil Action No. 3:19-CV-1594-D

UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF TEXAS DALLAS DIVISION

February 4, 2020

MEMORANDUM OPINION AND ORDER

In this action by Thomas L. Taylor III ("Taylor"), a court-appointed temporary receiver, involving claims for negligence, breach of fiduciary duty, fraud, and fraudulent transfers, defendants Rothstein, Kass & Company, PLLC and Brian Matlock (collectively, "Rothstein Kass") move to dismiss for failure to state a claim on which relief can be granted. For the reasons that follow, the court grants the motion in part and denies it in part and grants Taylor leave to replead.

I

In June 2016 the Securities and Exchange Commission filed a civil enforcement action against Christopher A. Faulkner ("Faulkner"), President and Chief Executive Officer of Breitling Energy Corporation ("BECC"), and others, alleging that Faulkner and his codefendants orchestrated a massive fraudulent scheme through the offer and sale of securities to public investors.¹ This court appointed Taylor as temporary receiver for the estates of Faulkner, BECC, Breitling Oil & Gas Corporation ("BOG"), Breitling Royalties Corporation ("BRC") (collectively, the "Audit Entities"), and their alleged alter egos Crude Energy, LLC, Crude Royalties, LLC, and Patriot Energy, Inc., among others (collectively, with the Audit Entities, the "Breitling Entities").

Between 2011 and 2016, Faulkner used the Breitling Entities to raise approximately $150 million in gross proceeds from investors through the offer and sale of oil and gas-related securities. Faulkner misappropriated approximately $32.8 million of the Breitling Entities' funds through the receipt of transfers and the payment of personal expenses from company bank and credit card accounts. As part of his alleged fraudulent scheme, Faulkner took BOG and BRC public through a reverse merger transaction, wherein BOG and BRC merged into BECC, a publicly-traded entity. In preparation for the reverse merger and related public filings, the Audit Entities engaged Rothstein Kass to audit BOG's and BRC's financial statements for 2011 and 2012. Despite myriad alleged red flags, including materially misleading cost estimates in private placement memoranda, commingling of investor proceeds, overselling of interests in numerous offerings, massive reimbursements to Faulkner, and the absence of internal controls, Rothstein Kass issued an unqualified,"clean" audit opinion regarding the Audit Entities' annual financial statements on April 14, 2014. From December 2013 to February 2016, BECC raised $68.5 million, $18.5 million of which Faulkner misappropriated.

Taylor filed this lawsuit against Rothstein Kass, asserting claims for negligence; aiding, abetting, or participation in breaches of fiduciary duties; aiding, abetting, or participation in Faulkner's fraudulent scheme; and fraudulent transfers. Rothstein Kass moves to dismiss under Fed. R. Civ. P. 12(b)(6), contending that Taylor has failed to state a claim on which relief can be granted. Taylor opposes the motion.

II

Under Rule 12(b)(6), the court evaluates the pleadings by "accept[ing] 'all well-pleaded facts as true, viewing them in the light most favorable to the plaintiff[s].'" In re Katrina Canal Breaches Litig., 495 F.3d 191, 205 (5th Cir. 2007) (quoting Martin K. Eby Constr. Co. v. Dall. Area Rapid Transit, 369 F.3d 464, 467 (5th Cir. 2004)). To survive a motion to dismiss, Taylor must allege enough facts "to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant[s] [are] liable for the misconduct alleged." Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). "The plausibility standard is not akin to a 'probability requirement,' but it asks for more than a sheer possibility that a defendant has acted unlawfully." Id.; see also Twombly, 550 U.S. at 555 ("Factual allegations must be enough to raise a right to relief above the speculative level[.]"). "[W]here the well-pleaded facts donot permit the court to infer more than the mere possibility of misconduct, the complaint has alleged—but it has not 'show[n]'—'that the pleader is entitled to relief.'" Iqbal, 556 U.S. at 679 (quoting Rule 8(a)(2)). Furthermore, under Rule 8(a)(2), a pleading must contain "a short and plain statement of the claim showing that the pleader is entitled to relief." Although "the pleading standard Rule 8 announces does not require 'detailed factual allegations,'" it demands more than "labels and conclusions." Iqbal, 556 U.S. at 678 (quoting Twombly, 550 U.S. at 555). And "a formulaic recitation of the elements of a cause of action will not do." Id. (quoting Twombly, 550 U.S. at 555).

III

The court begins with Rothstein Kass's contention that Taylor's negligence and gross negligence claims are time-barred.

A

Limitations is an affirmative defense. See Rule 8(c)(1). To obtain a Rule 12(b)(6) dismissal based on an affirmative defense, the "successful affirmative defense [must] appear[] clearly on the face of the pleadings." Cochran v. Astrue, 2011 WL 5604024, at *1 (N.D. Tex. Nov. 17, 2011) (Fitzwater, C.J.) (alterations added) (quoting Clark v. Amoco Prod. Co., 794 F.2d 967, 970 (5th Cir. 1986)). In other words, Rothstein Kass is not entitled to dismissal under Rule 12(b)(6) unless Taylor has "pleaded [him]self out of court by admitting to all of the elements of the defense." Id. (quoting Sivertson v. Clinton, 2011 WL 4100958, at *3 (N.D. Tex. Sept. 14, 2011) (Fitzwater, C.J.)).

Under Texas law, the statute of limitations for negligence actions is two years. SeeTex. Civ. Prac. & Rem. Code Ann. § 16.003(a) (West 2017). The "limitations period begins to run when 'the claimant discovers or should have discovered through the exercise of reasonable care and diligence the facts establishing the elements of his cause of action.'" Janvey ex rel. Sharp Capital, Inc. v. Thompson & Knight LLP, 2003 WL 21640573, at *3 (N.D. Tex. July 8, 2003) (Lynn, J.) (quoting FDIC v. Shrader & York, 991 F.2d 216, 221 (5th Cir. 1993)); see also SC & E Admin. Servs., Inc. v. Deloitte, 2006 WL 6747974, at *7 (W.D. Tex. July 25, 2006) (holding that the discovery rule applies to professional negligence claims against auditors). But if a wrongdoing corporate officer's knowledge of the facts giving rise to the negligence claim is imputed to the corporation, the claim accrues when the officer acquires such knowledge. See, e.g., Thompson & Knight LLP, 2003 WL 21640573, at *3 ("[T]o hold that [the receiver's] claim . . . [is] barred by the statute of limitations, the Court would have to hold (1) that [the officer] discovered . . . the facts giving rise to these claims; (2) that [the officer's] knowledge is imputed to [the corporation]; and (3) that certain exceptions . . . do not apply.").

B

Relying on FDIC v. Ernst & Young, 967 F.2d 166, 170-71 (5th Cir. 1992), Rothstein Kass contends that Faulkner's knowledge should be imputed to the Breitling Entities because Taylor's allegations demonstrate that Faulkner conducted a fraud on behalf ofthe corporation by raising approximately $150 million in gross proceeds, only a portion of which he used to fund his lavish lifestyle. Because Rothstein Kass resigned from the engagement with the Breitling Entities in June 2014, Rothstein Kass asserts that the two-year statute of limitationsfor Taylor's negligence claims had already expired by June 2016, over one year before the court's August 14, 2017 order tolling any applicable statute of limitations.

Taylor responds that dismissal based on an imputation theory is not appropriate at the pleading stage. He also contends that Faulkner's knowledge should not be imputed to the Breitling Entities. Relying on Janvey v. Democratic Senatorial Campaign Committee, Inc., 712 F.3d 185, 193 (5th Cir. 2013), Taylor maintains that the knowledge of a controlling principal who is engaged in fraud is not imputed to the subordinate entities and that those entities' claims cannot accrue until a receiver is appointed. Further, Taylor asserts that Faulkner acted adversely to the Breitling Entities because he "use[d] and caus[ed] said entities to engage in fraud and violate securities laws and then loot[ed] the entities of the ill-gotten gains." P. Resp. 5. Taylor also invokes the adverse domination doctrine, contending that the statute of limitations must be tolled where the wrongdoing directors constitute a majority of the board and the majority's wrongdoing was intentional.

Rothstein Kass replies that the imputation doctrine is not so limited because it has been applied in contexts when claims have been made against alleged wrongdoers. Rothstein Kass also asserts that adverse domination is inapplicable because, in its view, the doctrine only tolls limitations for claims against wrongdoers who are adversaries in the action, and it is further limited to claims against corporate officers and directors, not auditors.

C

The court holds that Rothstein Kass is not entitled to dismissal based on the statute of limitations because it is not clear from the face of the pleadings that Faulkner's knowledgeshould be imputed to the Breitling Entities. Although "the general rule [is] that courts are to impute an officer/director's knowledge to the corporation" so long as "the officer/director is acting on the corporation's behalf[,] . . . there is an exception to imputation." Askanase v. Fatjo, 130 F.3d 657, 666 (5th Cir. 1997) (citing Ernst & Young, 967 F.2d at 171). Where a "plaintiff can show that the officer/director was acting adversely to the corporation and entirely for his own or another's purpose, the limitations will be tolled." Id. (citing Shrader & York, 991 F.2d at 222). Courts have refused to impute the knowledge of principals to...