Urdan v. WR Capital Partners, LLC
| Decision Date | 19 August 2019 |
| Docket Number | C.A. No. 2018-0343-JTL |
| Parties | JONATHAN URDAN and WILLIAM WOODWARD, Plaintiffs, v. WR CAPITAL PARTNERS, LLC, a Delaware limited liability company, WR E3 HOLDINGS, LLC, a Delaware limited liability company, HENRI TALERMAN, FRANK E WALSH III, and BRADLEY D. KNYAL, Defendants, and ENERGY EFFICIENT EQUITY, INC., a Delaware corporation, Nominal Defendant. |
| Court | Court of Chancery of Delaware |
Elena C. Norman, Benjamin M. Potts, YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Louis R. Miller, Daniel S. Miller, Jeffery B. White, MILLER BARONDESS, LLP, Los Angeles, California; Counsel for Plaintiffs.
Kenneth J. Nachbar, Alexandra M. Cumings, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Counsel for Defendants.
LASTER, V.C.
A co-founder of a company and one of its early investors sued a private equity fund, its affiliates, and the two fund principals who served on the company's board of directors. The plaintiffs allege that after loaning the company funds and gaining representation on the board, the defendants used the rights they secured in the loan agreement to cut off the company's other financing options. Once the company was desperate for capital, the defendants extracted onerous terms that solidified the defendants' control. They then proceeded to dilute the plaintiffs through interested transactions.
The defendants moved to dismiss the complaint. They point out that after filing suit, the plaintiffs sold their shares. They contend that the plaintiffs thereby lost the ability to assert derivative claims. The same principle would foreclose the plaintiffs' ability to assert direct claims. The only remaining claims are for fraud and unjust enrichment, and the defendants contend that the complaint fails to plead the elements of these claims.
This decision agrees with the defendants. The motion to dismiss is granted.
The facts are drawn from the plaintiffs' complaint and the documents that are integral to the pleading. At this stage of the proceedings, the complaint's allegations are assumed to be true, and the plaintiffs receive the benefit of all reasonable inferences.
In 2014, plaintiff Jonathan Urdan and non-party Kevin Kurka co-founded Energy Efficient Equity, Inc. (the "Company"), which is a Delaware corporation operating in the property-assessed, clean-energy ("PACE") financing industry. In a PACE financing arrangement, a financial intermediary like the Company partners with a local municipalityto loan homeowners money for energy-saving improvements, and the homeowners repay the loans through additional tax assessments added to their property tax bills. The municipality authorizes the financial intermediary to assess the value of the improvements and collect the property taxes. The municipality also authorizes the financial intermediary to issue bonds backed by the property tax assessments. The financial intermediary uses proceeds from the bond issuances to fund the loans to homeowners.
The PACE financing industry is still young. California was the first state to approve PACE financing for home improvements in 2008, and although over thirty states have established PACE programs, almost all of the PACE volume is currently concentrated in California and Florida. In most states, PACE financing is also available for commercial properties, but this market largely remains untapped. As one of a limited number of firms operating in a high-potential industry, the Company had significant prospects for growth.
From the Company's founding until May 31, 2016, the members of the Company's board of directors (the "Board") were Urdan, Kurka, and plaintiff William Woodward, who was the Company's first outside investor. Urdan acted as president and CFO, and Kurka acted as CEO.
From the Company's founding until May 31, 2016, Urdan, Kurka, and Woodward owned 100% of the Company's equity. The following table summarizes the Company's capitalization as of May 30, 2016, with separate accounts for each person summed together. Stockholder Common Stock Series A Preferred Convertible Debt Fully Diluted Kurka 1,710,000 0 0 1,710,000 Urdan 1,710,000 80,000 170,000 1,960,000 Woodward 400,000 100,000 170,000 670,000 TOTAL 3,820,000 180,000 340,000 4,340,000
Defendant WR Capital Partners, LLC is a private equity fund based in Morristown, New Jersey. Defendants Henri Talerman and Frank E. Walsh III manage the fund, which invests in companies with valuations between $50 million and $500 million.
In early 2016, Talerman and Walsh approached Urdan, Kurka, and Woodward about investing in the Company. They touted their background and expertise in small-cap investing and stressed that they approached investing as a partnership with management. Walsh assured Urdan that if WR Capital invested in the Company, they would be "working together as partners." Compl. ¶ 51. The WR Capital website likewise represented that "[a]ll private investments are made in cooperation with management and directors of the portfolio company." Compl. ¶ 49.
With the assistance of counsel, the Company negotiated with WR Capital over the terms of a financing (the "2016 Financing"). On May 31, 2016, the 2016 Financing closed.
The centerpiece of the 2016 Financing was a loan agreement between the Company and WR E3 Holdings, LLC ("WR Sub"), a wholly owned subsidiary of WR Capital (the "Loan Agreement"). The Loan Agreement provided the Company with a revolving credit line of $5 million, which the Company could draw on in increments of at least $100,000. Drawn amounts would accrue interest at 10% per annum. As security for the loan, Urdan,Kurka, and Woodward granted WR Capital a first priority security interest in all of their holdings of Company stock, both common and preferred.
Section 5 of the Loan Agreement, titled "Negative Covenants," identified fifteen categories of actions that the Company could not take without the prior written consent of WR Sub. The list included raising capital from outside investors and engaging in significant corporate transactions.
Section 7.1 of the Loan Agreement, titled "Events of Default," identified twelve events that would entitle WR Sub to declare outstanding draws on the credit facility immediately due and payable. The list included either Urdan or Kurka being terminated for cause, using that term as defined in their respective employment agreements.
As additional consideration for the Loan Agreement, the Company issued a warrant to WR Sub that authorized the purchase of up to 2,307,000 shares of Company common stock at $0.01 per share, exercisable in proportion to the level of draws on the credit facility. If fully exercised, the shares issued pursuant to the warrant would represent 31% of the Company's fully diluted equity. Section 1.2 of the Loan Agreement included an option for WR Sub to increase the size of the credit facility by up to $3 million, which WR Sub could exercise in its "sole discretion." If WR Sub elected to exercise this option, then the number of shares covered by the warrant would increase by 1% for each $1 million of additional credit. If WR Sub exercised the option in full, then it would receive the right to purchase an additional 379,034 shares. That would bring the total number of shares available under the warrant to 2,686,034 shares, representing 34% of the Company's fully diluted equity.
The plaintiffs allege that the term sheet for the 2016 Financing made clear that the 379,034 shares that WR Sub would receive if it exercised its option to provide another $3 million of capital established an upper bound on the amount of equity that WR Capital and its affiliates would receive for that amount of incremental financing. The plaintiffs allege that they negotiated this point because they did not want WR Capital to be able to take advantage of the Company if it required more capital.
As part of the 2016 Financing, the Company and WR Sub entered into a third agreement pursuant to which WR Sub paid $500,000 to acquire 301,979 shares of Series B Preferred Stock, reflecting a price of $1.65 per share. The Series B Preferred Stock was convertible into common stock.
As part of the 2016 Financing, the Board was expanded to five seats, and WR Sub received the right to appoint two members of the Board. WR Sub appointed Talerman and Walsh.
Also in May 2016, a wholly owned subsidiary of the Company borrowed $75 million from Oaktree Capital Management (respectively, the "Oaktree Loan" and "Oaktree"). The Oaktree Loan was secured by all of the assets of the Company, and Oaktree also received a pledge of all of the plaintiffs' stock and WR Sub's stock.
The following table summarizes the Company's capitalization after the 2016 Financing, assuming the Company drew all of $5 million authorized by the Loan Agreement, with separate accounts for each person summed together. Stockholder Common Stock Series A Pref. Series B Pref. Warrants Convertible Debt Fully Diluted Kurka 1,710,000 0 0 0 0 1,710,000 Urdan 1,710,000 132,199 0 0 170,000 2,012,199 Woodward 400,000 165,249 0 0 170,000 735,249 WR Capital 0 0 301,979 2,307,033 0 2,609,012 Oaktree 0 0 0 395,311 0 395,311 TOTAL 3,820,000 297,448 301,979 2,702,344 340,000 7,461,771
In early 2017, WR Capital issued "New Governance and Operating Procedures" that specified how Kurka, the Company's CEO, was to conduct business. Compl. ¶ 71. WR Capital refused to approve any additional draws under the Loan Agreement until Kurka signed the document and agreed to abide by it. In an email dated March 25, 2017, Walsh confirmed to Urdan that WR Capital would not approve draws until Kurka signed, stating: "Consistent with our discussions last week we will not consider funding this [credit draw] until [Kurka] signs the ...
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