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Cannonball Fund, Ltd. v. Dutchess Capital Management, LLC

Superior Court of Massachusetts, Suffolk, Business Litigation Session

June 13, 2018

CANNONBALL FUND, LTD. et al.
v.
DUTCHESS CAPITAL MANAGEMENT, LLC et al.

          File Date: June 15, 2018

          MEMORANDUM OF DECISION AND ORDER ON DUTCHESS DEFENDANTS’ MOTION FOR SUMMARY JUDGMENT

          Mitchell H. Kaplan, Justice of the Superior Court

          This case is once again before the court on the Dutchess Defendants’[1] motion to dismiss the derivative claims asserted against them by the Cannonball Plaintiffs.[2] In this motion, the Dutchess Defendants argue that the seven volumes of evidentiary material submitted to the court in support of their motion establish that there are no material disputed issues of fact and the Dutchess Defendants are entitled to summary judgment dismissing all remaining claims pending against them under Mass.R.Civ.P. 56. The court disagrees. It finds that there are a number of material disputed factual issues and therefore denies the motion.[1]

         As a result of the numerous dispositive motions filed over the past seven years by these defendants, as well as others-some of whom are no longer parties, there have been numerous previous written opinions issued by this court, as well as an opinion by the Massachusetts Appeals Court (Cannonball Fund, Ltd. v. Duchess Capital Mgmt., 84 Mass.App.Ct. 75 (2013) (Canonball) and an opinion issued by the Grand Court of the Cayman Islands. This court will not repeat the description of the relationships and history among the parties that has been frequently described in those opinions and will assume familiarity with all of them.

         For present purposes, it is sufficient to note that the plaintiffs bring this action derivatively on behalf of Dutchess Private Equities Cayman Fund, Ltd. (Dutchess, Ltd.), a Cayman Islands exempt corporation, and Dutchess Private Equities Fund, L.P. (Dutchess, LP), a Delaware limited partnership. Dutchess, Ltd. and Dutchess, LP were two feeder funds (collectively the Feeder Funds) that fed a master fund, Dutchess Private Equities Fund, Ltd. (the Master Fund), also a Cayman Islands exempt corporation, which made all investments. DCM is a Connecticut LLC whose managing members are the individual defendants: Novielli and Leighton. DCM owns all of the voting shares of Dutchess, Ltd., is the general partner of Dutchess, LP, and is the investment manager for Dutchess, Ltd., Dutchess, LP, and the Master Fund. Dutchess Advisors is also a Connecticut LLC managed by Novielli and Leighton. It was paid by some of the Master Fund’s portfolio companies for allegedly providing various consulting services to them and also owns a majority of the equity in one of the portfolio companies. Smith is (or was) the COO of DCM and Vice President of Dutchess Advisors. Novielli, Leighton, and Smith (the Individual Defendants) were on the boards of a number of the Master Fund’s portfolio companies, as well as owning interests in other entities that provided services to DCM or the portfolio companies.[2]

         The claims that the Dutchess Defendants are seeking to dismiss are: (i) breach of fiduciary duty asserted derivatively on behalf of Dutchess, Ltd. against the Individual Defendants and DCM; and (ii) unjust enrichment against Dutchess Advisors, asserted derivatively on behalf of both Dutchess, Ltd. and Dutchess, LP.

          The court lists below some of the material, disputed issues of fact that preclude the entry of summary judgment dismissing these claims. This list is not intended to be exhaustive, but rather to highlight certain areas in which disputed factual issues exist that must be resolved at trial.

         Breach of Fiduciary Duty-the Individual Defendants

         Because Dutchess, Ltd. is a Cayman Islands corporation, Cayman Islands law determines the fiduciary duties that the Individual Defendants owe to Dutchess, Ltd. Cannonball, 84 Mass.App.Ct. at 93. Under Cayman Islands law a breach of fiduciary duty arises out of failure of the duty of loyalty. The Dutchess Defendants’ Cayman Island law expert expressed the duty as follows: "The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal."

         There are disputed issues of fact regarding whether the Individual Defendants breached their fiduciary duty to Dutchess, Ltd., as defined above.

         Based on an opinion offered by their expert, the defendants assert, as an undisputed fact, that the Master Fund "focused on structured Private Investment in Public Equity ("PIPE") transactions, a form of ‘last resort’ financing pursued by companies with no other financing[3] options." That is what is in the expert report, but that opinion may be rejected by the fact finder. Indeed, the statement does not appear to be reflective of the nature in which many PIPE transactions were employed during the relevant period. See Steinberg, Marc I.; Obi, Emmanuel U. "Examining the Pipeline: A Contemporary Assessment of Private Investments in Public Equity (PIPES)," Univ. of Penn. Journal of Business Law vol. 11, no. 1 (Fall 2008): p. 1-48 (PIPE issuers range in size from small, over-the-counter bulletin board companies to large-cap, NYSE-traded companies. In terms of transaction frequency, PIPES have dramatically increased from the 306 transactions recorded in 1996 to the 1, 454 deals that were closed in 2007. The aggregate PIPE deal value during this same period also has grown from just over $4 billion dollars to a whopping $83 billion dollars-a staggering increase. Although once considered a financing alternative of last resort used mainly by cash-strapped companies or issuers otherwise unable to secure traditional sources of capital, the PIPE market now attracts sophisticated market players"). To the extent that the defendants are using their expert to prove that all investors in Dutchess Ltd. must have known of the Individual Defendants’ and DCM’s high risk investment strategy because of the reference to PIPES in the offering materials, there are disputed factual issues.

         Additionally, Cayman Islands law clearly emphasizes that fiduciaries have obligations of undivided loyalty and are not to profit from their trust. Disclosure of conflicts is essential. There is evidence in the summary judgment record from which a fact finder might conclude that the Individual Defendants did not fully disclose all of the financial relationships between them and the Master Fund and its portfolio companies. The court cannot say as a matter of law that all of the payments flowing to the Individual Defendants by way of compensation for board memberships, consulting fees, contractual fees, redemption of stock, or rents were fully disclosed[4] in the financial statements. It may be that all of these services were fairly compensated and necessary, but that will require factual assessment. The existence, if proved, of payments to the Individual Defendants and companies they control from portfolio companies, is some evidence that investment decisions may have been made for purposes other than maximizing returns to Dutchess, Ltd, especially if any such payments are not adequately disclosed.[3]

          A persistent factual dispute concerns the manner in which the Individual Defendants valued the portfolio companies in the books of account. There is evidence in the summary judgment record that GAAP required the Master and Feeder Funds’ investments in these companies to be reported at "fair value." There is also evidence that these investments were valued at cost in the Funds’ financial statements, until April 1, 2008, when the fair value of investments in several portfolio companies began to be dramatically reduced. While it may be that this was the earliest time that the degradation in value had become apparent, the Individual Defendants were on the boards of these companies and to various extents involved in their management. A finder of fact could conclude that the carrying value of these assets should have been reduced at an earlier time.[4] Additionally, there is evidence that reporting these investments at cost instead of a reduced "fair value" enabled the Individual Defendants to receive increased[5] management fees and to continue to support these companies with additional lending, which had the collateral effect of enabling the portfolio companies to continue to make payments to the ...


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