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Brining v. Donavan

Superior Court of Massachusetts, Suffolk, Business Litigation Session

September 14, 2017

Jennifer Brining, Individually and as Trustee of the Jennifer Brining Living Trust and for the Benefit of Sendlater, Inc., in a Derivative Capacity
v.
John J. Donavan et al

          MEMORANDUM OF DECISION AND ORDER ON DEFENDANTS' MOTION TO DISMISS

          Mitchell H. Kaplan, Justice

         INTRODUCTION

         This case is before the Court on the nominal defendant Sendlater, Inc.'s (Sendlater) motion to dismiss. The exact nature of the motion to dismiss is complicated by the unusual procedural history of this case which informs the basis for the motion that Sendlater has filed.

         The plaintiff, Jennifer Brining, is a shareholder in Sendlater, a corporation established under the laws of Vermont in 2014. Although she is by far the largest investor in Sendlater, having invested approximately $1.3 million of the approximately $2.5 million invested in the company, she is a minority shareholder owning only just over 11% of the company, as of May 2017.[1] She originally filed her complaint asserting only direct claims against the defendants who are John J. Donovan and two companies that he or his wife control (collectively, for simplicity, Donovan). In general, Brining alleged that nearly all of the money invested in Sendlater was taken by Donovan, then a Director and effectively the manager of Sendlater, and used for his personal affairs, not for the benefit of Sendlater. She asserted various causes of action based on that conduct. At a hearing on requests for preliminary relief convened in November 2016, the court (Liebensparger, J.) commented that the claims asserted by Brining appeared to be claims for corporate waste, which were claims that belonged to Sendlater and not to an individual investor. Apparently prompted by this remark, on November 30, 2016, Brining's attorney sent counsel for Sendlater a Mass.R.Civ.P. 23.1 demand letter demanding that Sendlater's board of directors (the Board) cause the company to bring suit against Donovan. On December 13, 2016, Brining amended her complaint to allege that a demand had been sent, but the Board had not responded.[2]

         During additional hearings held in early 2017 to address discovery disputes and requests for protective orders, the court ruled that while the form of the demand sent to the Board was unusual, it was adequate to inform the Board of the allegedly wrongful actions undertaken by Donovan and to request action to redress this conduct. Moreover, Sendlater, through counsel, advised the court that Donovan had been removed from the Board, no longer had any control over Sendlater's funds, and the Board had retained AlixPartners LLP to conduct an independent investigation of the transactions between Donovan and Sendlater. Therefore, it appears that the Board treated Brining's attorney's demand as a formal demand requiring investigation and response.

         The Vermont statute authorizing derivative proceedings (11A V.S.A. § 7.40) provides little guidance concerning how much time a board of directors may have to respond to a shareholder demand, nor does there exist and case law interpreting it. Nonetheless, the court concluded that under Vermont law a board must be given adequate time to investigate such a demand. See § 7.40(b) (" Whether or not a demand for action was made, if the corporation commences an investigation of the charges made in the demand or complaint, the court may stay any proceeding until the investigation is completed" ). Further, as noted above, the Board had already retained a well-known forensic accounting firm to investigate, and it required adequate time to complete its work.

         In the interim, the court decided motions to dismiss the Amended Complaint. It held that all of Brining's direct claims against Donovan had to be dismissed for failure to state a claim on which relief could be granted, as well as certain of the derivative claims.[3] In consequence, by the end of April 2017, the only claims still pending in this action were derivative claims in the name of the nominal defendant Sendlater against Donovan for fraud, breach of fiduciary duty, and unjust enrichment.

         At a hearing convened on April 26, 2017, Sendlater's counsel reported that AlixPartners had completed its report on April 18, 2017 and the Board had met to consider Brining's demand on April 20, 2017. The Board then consisted of three members, none of whom appeared to have been Board members at the time that the demand was sent: John Rose, Nadir-Yohan Zohar (who became president of Sendlater effective February 1, 2017), and Bhaskar Panigrahi. The court was presented with minutes of the Board's meeting which reflected that the Board received a presentation from AlixPartners, discussed the law suit, and then voted as follows: " Regarding the allegations in the Demand and the Plaintiff's Amended Complaint that pertain to Professor John Donovan, the Board resolves that it is not in the best interests of Sendlater to pursue legal action against Professor Donovan at any point now or in the future, or to permit claims to be pursued on its behalf." Counsel explained that based upon the Board's vote, Sendlater would be filing a motion to dismiss the remaining derivative claims. A schedule for service of the motion and an opposition was adopted. Oral argument on the motion was held on August 8, 2017.

         ADDITIONAL FACTS

         A few additional facts help to place the pending motion in context. Sendlater is an internet based company still very much in the development phase. A detailed understanding of its proposed business operation is unnecessary for the resolution of this case. In brief, it appears that in 2013, Romano and Nancy Formichella conceived of an internet based enterprise that would arrange for cards, gifts and other items to be delivered over extended periods, presumably to family and friends, even after the sender had died. To generate income, partnerships could be developed with retailers, florists, greeting card companies and other relevant businesses. The Formichellas lived in Vermont and sought counsel from a Vermont lawyer who introduced them to Donovan.[4] The lawyer incorporated Sendlater in Vermont, although its physical location became Donovan's residence in Hamilton, Massachusetts. Donovan also became a director and the president of Sendlater. The Formichellas sought investments in Sendlater from their friends, one of whom was Brining who invested through a trust that she controlled. As noted above, it is alleged that nearly all of the funds raised for the benefit of Sendlater passed to accounts in the name of Donovan or businesses controlled by him or his wife. This led Brining to file her original complaint.

         THE ALIXPARTNERS REPORT

         AlixPartners is a nationally recognized forensic accounting firm. It was first retained by Sendlater in connection with Brining's motions for preliminary relief filed in November 2016. While Donovan used AlixPartner's preliminary analysis of his transactions with Sendlater to oppose Brining's motions, the court (Liebensparger, J.) found that it actually supported Brining's contentions that Donovan had misused corporate assets: " I point specifically to the report of [AlixPartners] in which it . . . found that the Donovans expended nearly $580,000 for non-business reasons out of the corporation. He balanced that off with what he said may be, but he hasn't been able to determine or hasn't been able to confirm that the Donovans contributed more than the $580,000 back to the corporation." After the Brining demand was made, AlixPartners was retained to undertake a more thorough analysis of these transactions. As noted above, its conclusions were set out in an April 18, 2017 report to the Board (the Report).

         The Report notes that until December 2016, Sendlater had essentially no internal controls. Not only did it not prepare financial statements, it did not even record transactions. It did not have any procedures for approving expenses or determining that related party transactions were for fair value.

         Through the end of February 2017, a group of companies that the Report identifies as the " Sendlater Entities" had received funds of $2,995,706 and distributed $2,846,276. However, the Report (i) defines the Sendlater Entities as including SecureNet and SIL Holdings; and (ii) states that SecureNet is owned by Donovan's wife and SIL Holdings is owned by Donovan and both those entities engage in some transactions unrelated to the business of Sendlater. In consequence, identifying the gross funds in and out of the " Sendlater Entities" during the period in question is of limited utility in determining financial improprieties related to the misuse of funds intended to further Sendlater's business plan.

         In any event, of the incoming funds, $2,521,801 were invested in Sendlater in return for Sendlater stock. Neither Donovan, his wife, nor any of their entities invested any cash in Sendlater.

         The Report concludes that Donovan loaned " Sendlater Entities" $202,074; however, those loans were documented by notes apparently generated and signed by Zohar on March 30, 2017, although the money was lent on earlier dates. There is no explanation as to why Zohar would sign loan documents for loans made before he was President and what he reviewed to confirm the amounts, sources, and uses of the funds. Donovan also claimed to have made direct payment of Sendlater's legal expenses of nearly $40,000 in November 2016, but that appears to be related to the claims asserted against him in this case. The cash and expenses paid to or on behalf of Sendlater by Donovan appear to have come from loans to Donovan from two individuals: Will Graylin and Bill Wheaton. However, these loans have a very peculiar feature. They appear to be convertible into Sendlater stock at the option of the lenders. It is unclear how Sendlater would account for a loan to Donovan that Graylin and/or Wheaton could convert into stock to be issued by Sendlater?

         The Report states that another entity controlled by Donovan leased three properties or parts of properties located in Vermont, Massachusetts, and South Carolina to Sendlater. The Report does not explain why all three locations were necessary for Sendlater's operations. The total lease obligations to the Donovan related entity were, in the aggregate, $363,970, but, according to the Report, " the estimated value of the lease agreements" to Sendlater was only $192,206. The court has been unable to determine if all, or part, of these lease obligations were paid, although the Report refers to some payments to the Donovan entity.

         Another unusual transaction described in the Report was Donovan's loan of Sendlater shares owned or controlled by him to Sendlater on February 1, 2017. These shares were valued at 28 cents a share, based on the amount paid to Sendlater for the shares by two individual investors on January 31, 2017. There is no indication that this share price was the result of arm's length negotiation or any formal appraisal of the value of Sendlater. The Report does not explain why it was a prudent business decision for Sendlater to borrow shares from Donovan for these transactions instead of simply issuing shares to these new investors.

         The Report concludes that of the $2,846,276 disbursed by Donovan on behalf of the Sendlater Entities: (i) $1,274,506 " appear to be related to the business activities of Sendlater" ; (ii) $800,018 are not related to any Sendlater business activity; and (iii) $771,552 of disbursements " cannot be determined based on the scope of work performed." Moreover, of the $1,274,506 described as apparently related to business activities, $601,063 was paid to a company called Savior Labs for website development and other related services. However, Savior Labs is owned by Paul Parisi who was also an employee of one or more Sendlater Entities. Savior Labs also provided services for Donovan personally. The Report explains that: " Based on the nature (services) and lack of documentation for the work performed by Savior Labs, I was unable to assess the value of services provided to [Sendlater]."

         The Report concluded with the following " general observations regarding the documents provided to [AlixPartners] and relied upon for ...


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