Walnut Private Equity Fund, L.P. v. Argo Tea, Inc.

Decision Date02 December 2011
Docket NumberCase No.: 1:11-cv-770
PartiesWalnut Private Equity Fund, L.P., Plaintiff, and Hauser Capital Partners, LLC, et al Intervening Plaintiffs, v. Argo Tea, Inc., et al, Defendants.
CourtU.S. District Court — Southern District of Ohio

Judge Michael R. Barrett

OPINION & ORDER

This matter is before the Court on the following sets of pending motions. First, there are the motions of Defendants Mosaix Venture, L.P., Glen Tullman, and Stanley Nitzberg (the "Mosaix Defendants"). These include their Motion to Dissolve Temporary Restraining Order (Doc. 13)1 ; Motion for Reconsideration of the State Court's October 31, 2011 Order (Doc. 16) and; Motion to Dismiss or in the Alternative, Motion to Transfer (Doc. 17). Second, are the motions of Defendant Argo Tea, Inc. and Arsen Avakian (the "Argo Defendants"). These include their Motion to Dissolve Temporary Restraining Order (Doc. 14) and; Motion to Dismiss, or, in the Alternative, to Transfer(Doc. 15). Plaintiff Walnut Private Equity Fund, L.P. ("Walnut") filed the final pending motion: Motion to Extend Temporary Restraining Order and Set Hearing on Preliminary and Permanent Injunctive Relief (Doc. 25).2

The issues presented in these motions came before the Court for a hearing held on November 28, 2011 (the "Hearing"). The date of the Hearing was set by agreement of all the parties. (See 11/08/2011 Docket Entry.) Any and all arguments the parties intended to make on the above motions were made in their present filings and at the Hearing. Accordingly, the Court deems that each of the above motions have been briefed, argued, and are fully ripe for decision. If the parties believe the Court is incorrect here, they may freely advise the Court as such.

Plaintiff's Complaint (Doc. 2) requests declaratory judgment and preliminary and permanent injunctive relief relative to Defendants' plan that would allegedly "destroy[ ] dividend, redemption, veto and election rights attendant to plaintiff's Preferred Series C shares, in violation of Argo Tea, Inc.'s corporate charter." (Doc. 2 ¶ 1.) In other words, Walnut seeks to stop Defendants from carrying out a stock recapitalization plan that would eliminate certain rights it has by virtue of the preferred stock it holds in Argo Tea, Inc. (See Doc. 2 ¶ 1.) The Intervening Plaintiffs, Hauser Capital Partners, LLC, and Hauser Tysoe, LLC (the "Intervening Plaintiffs"), have also filed a Complaint (Doc. 6), which makes the same allegations. The Intervening Plaintiffs seek to restrain Defendants from carrying out a plan that would allegedly breach Argo Tea Inc.'s articles of incorporation and thereby destroy the Intervening Plaintiffs' rights as preferred stockholders. (Doc. 6 ¶ 1.) The Court's rulings are all summarized below.

I. Background

On October 5, 2011, Walnut, individually and derivatively on behalf of Argo Tea, Inc. ("Argo"), filed its Complaint in the Court of Common Pleas for Hamilton County, Ohio. Walnut seeks to enjoin a proposed plan for recapitalization through an exchange offer (the "Plan"). The Plan, as detailed in a memorandum sent to Argo's Board of Directors on September 28, 2011, (the "September Memorandum") (Doc. 31 -1) seeks to convert all outstanding classes of preferred stock into a new class of Series A Preferred Stock. (Doc. 31-1, 1.) As the September Memorandum states, one of Argo's directors proposed the Plan, and certain holders of current preferred stock "have indicated their support." (Doc. 31-1, 1.)

Specifically, the Plan proposes a multi-step transaction. First, Argo's Board of Directors (the "Board") would approve the Plan and would propose an amendment to Argo's Fifth Amended and Restated Certificate of Incorporation (the "Certificate") to authorize a new class of preferred stock—the Series A Preferred Stock. Second, the holders of currently outstanding preferred stock would exercise a "mandatory conversion" right, as detailed in the Certificate. Section 5.1(b) of the Certificate states that upon "vote or written consent of the holders of at least sixty-seven percent (67%) of the then outstanding shares of Preferred Stock . . . all outstanding shares of Preferred Stock shall automatically be converted into shares of Common Stock . . . ." (Doc. 2-1, 27.) Thus, upon such a vote, all outstanding shares of preferred stock would be converted into common stock. Third, a majority of stockholders would approve the Board's proposed amendment to the Certificate authorizing the new class of preferred stock (the Series A Preferred Stock). In the final step, the holders of the newly issuedcommon stock (issued in step two to replace the cancelled preferred stock) would be given the right to exchange their newly acquired common shares for shares of the newly created Series A Preferred Stock. (Doc. 31-1, 2.)

The Plan would have several effects. First and most obviously, all of the rights, preferences, and characteristics of the currently outstanding preferred stock would be eliminated. (Doc. 31-1, 1.) As the September Memorandum states, "the results from a mandatory conversion would . . . come at the price to the preferred stockholders relinquishing all of the substantial economic and other benefits, which were negotiated in connection with their initial investments . . . ." (Doc. 31-1, 2.) The current holders of the preferred stock would receive the newly issued Series A Preferred Stock in exchange, but the benefits of that new preferred stock would offer "more limited rights than currently exist in certain classes of the preferred stock . . . ." (Doc. 31-1, 2.) Second, the Plan would improve Argo's "ability to secure additional capital financings under more favorable terms, while also substantially improving the incentive award structure in place for its common shareholders." (Doc. 31-1, 2.) In other words, as stated by Argo's attorney at the Hearing, the Plan would encourage $10 to $15 million in new investment and would allow the company to grow and to incentivize its officers appropriately. Overall, it is alleged that the Plan would "result in significant benefits to the Company." (Doc. 31-1, 1.) Finally, the Plan changes the makeup of the Board. The Plan states that once the Certificate is amended (as proposed by the Board in step one), and approved by the stockholders (in step three), the current Board directors who serve as designees of the preferred stock holders "would step down and would be replaced." (Doc. 31-1, 3.) As the September Memorandum concludes, "By precipitatingan early mandatory conversion, Board governance will be streamlined and strengthened, certain consent and veto rights generally applicable to activities undertaken by the Board or the broader investor base would be removed, and the participating preferred and other economic benefits currently held by the certain classes of preferred stock would be eliminated, resulting in a clearer path to additional financing and strategic opportunities." (Doc. 31-1, 3.)

Plaintiffs maintain that any benefits to Argo would come at the expense of their investment, which is considerable given that Walnut owns $3.65 million of Series C Preferred Stock and the Intervening Plaintiffs own $1 million of Series C Preferred Stock and $300,000 of Series D Preferred Stock. (Doc. 2 ¶ 12; Doc. 6 ¶¶ 10, 15.) Furthermore, the current Series C Preferred Stock grants Plaintiffs unique rights. These rights include "guaranteed cumulative dividends," "veto rights over any conversion of preferred shares into common stock and over other specified actions," "the right to have Argo redeem Plaintiff's Series C Stock in 2014," and, "the right to designate two directors." (Doc. 2 ¶ 13.) Additionally, Plaintiff Walnut holds a particular right written into Section 3.3.1 of the Certificate—Argo's articles of incorporation. (Doc. 2 ¶ 14.) This "veto right" states that Walnut must consent to any action that would "alter or change the rights, preferences or privileges of the Series C Preferred Stock, directly or indirectly, by merger, consolidation, conversion transaction or otherwise." (Doc. 2-1, 12.) Plaintiffs maintain that Defendants' Plan "ignores plaintiff's veto right and would violate the provisions of Argo's certificate of incorporation." (Doc. 2 ¶ 16; see also Doc. 6 ¶ 17.)

On October 5, 2011, the same day Argo's Board was scheduled to meet, Walnutobtained an ex parte temporary restraining order ("TRO") in the state court. (See Doc. 16-1, 8-9.) The state court ruled as follows: "Walnut will be irreparably harmed in the event that the defendants are permitted to proceed with their Recapitalization Plan"; "Walnut has demonstrated a substantial likelihood that it will prevail on its claims"; "the Recapitalization Plan could eliminate certain rights that Walnut has as a preferred shareholder, the value of which would be impossible to determine," and; "the defendants will not be harmed by a temporary order that preserves the status quo pending an adjudication of the respective rights of the parties." (Doc. 16-1, 8.) The state court specifically ordered as follows:

A. The defendants are hereby prohibited and enjoined from any vote, action, or consent to attempt to convert the preferred stock of Argo into common stock under Section 5.1 of Argo's certificate of incorporation;
B. The defendants are hereby prohibited and enjoined from approving an amendment to Argo's certificate of incorporation to create a new class of preferred stock; and
C. The defendants are hereby prohibited and enjoined from authorizing any proposed exchange of new preferred stock for common stock.

(Doc. 16-1, 8-9.)

On October 13, 2011, Walnut filed a motion to extend the TRO. The state court granted that motion and extended the TRO through October 31, 2011, the same date the court scheduled the matter for hearing. (Doc. 14, 2-3; Doc. 16-1.) In the meantime, the Argo Defendants and the Mosaix Defendants filed motions to dismiss both complaints based on the lack of subject-matter jurisdiction,...

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