:ase 3:07-cv-01429-j document 128 filed 04/18/2008 page 1...
Post on 09-Oct-2020
1 Views
Preview:
TRANSCRIPT
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
:ase 3:07-cv-01429-J Document 128
ALAN W. SPARER (No. 104921)MARC HABER (No. 192981)JAMES S. NABWANGU (No. 236601)LAW OFFICES OF ALAN W. SPARER100 Pine Street, 33rd FloorSan Francisco, California 94111-5128Telephone: 415/217-7300Facsimile: 415/217-7307
,sparerlaw.comasparer,namhaberg,sparerlaw.comjnabwangu(c sparerlaw.com
Attorneys for PlaintiffsMICHAEL B. ESHELMAN, D.D.S.; PETERF. SILCHER, D.D.S.; and LORI I. SILCHER
Filed 04/18/2008 Page 1 of 19
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
SAN FRANCISCO DIVISION
MICHAEL B. ESHELMAN, D.D.S.; PETER F. No. C 07 1429 JSWSILCHER, D.D.S.; and LORI I. SILCHER,
Plaintiffs,Action Filed: March 12, 2007
V.
ORTHOCLEAR HOLDINGS, INC. a BritishVirgin Islands Company ; ORTHOCLEAR,INC., a Delaware Corporation ; MUHAMMADZIAULLAH CHISHTI, an individual;HUAFENG "CHARLES" WEN, an individual;PETER RIEPENHAUSEN, an individual;ARTHUR T. TAYLOR, an individual;SAIYED ATIQ RAZA, an individual;CHRISTOPHER KAWAJA, an individual;PATRICIA HUMELL SEIFERT, an individual;JOSEPH BREELAND, an individual;MUDASSAR RATHORE, an individual;PAUL BADAWI, an individual; 3iTECHNOLOGY PARTNERS III, LP, aLimited Partnership ; and DOES 1 through 25,inclusive,
PLAINTIFFS' OPPOSITION TODEFENDANT 3i'S MOTION TO DISMISSTHIRD AMENDED COMPLAINT
Date: May 16, 2008Time: 9:00 a.m.Judge: Hon. Jeffrey S. WhiteCourtroom: 2, 17th FloorTrial Date: Not Set
Defendants.
PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 2 of 19
1 TABLE OF CONTENTS
2
INTRODUCTION AND SUMMARY OF ARGUMENT iv3
4 STATEMENT OF RELEVANT FACTS 1
5 ARGUMENT 3
6 I. PLAINTIFFS MEET THE REQUIREMENTS FORMAINTAINING A DERIVATIVE CLAIM. 3
7
8 II. THE REPURCHASE OF 3i'S SHARES WAS MADE ULTRAVIRES.
9III. PLAINTIFFS SUFFICIENTLY HAVE PLED CLAIMS FOR
10 BREACH OF FIDUCIARY DUTY AND INTENTIONAL 9
11 AND NEGLIGENT MISREPRESENTATION.
12 A. Badawi ' s Role In The Align Settlement. 9
13 B. Badawi ' s Self-Dealing With Confidential Information. 11
14 IV. PLAINTIFFS ADEQUATELY HAVE PLED RELIANCE. 13
15 CONCLUSION 14
16
17
18
19
20
21
22
23
24
25
26
27
28
-i-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
,ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 3 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
TABLE OF AUTHORITIES
CASES
Abrons v. Maree, 911 A.2d 805 (Del. Ch. 2006)
Argiropoulos v. Kopp, No CCB-06-0769, 2007 U.S. Dist. LEXIS 22351(D. Md. Mar. 26, 2007)
Balin v. Amerimar Realty Co., No. 12896, 1996 Del. Ch. LEXIS 146 (Del.Ch. Nov. 15, 1996)
Deckert v. Independence Shares Corp., 311 U. S. 282 (1940)
De La Fuente v. FDIC, 332 F.3d 1208 (9th Cir. 2003)
Foss v. Harbottle, 2 Hare 461 (Eng. 1843)
Heilbrunn v. Hanover Equities Corp., 259 F. Supp. 936 (S.D.N.Y. 1966)
In re BP P.l.c. Deriv. Litig., 507 F. Supp. 2d 302 (S.D.N.Y. 2007)
In re Focus Media Inc., 3 87 F.3 d 1077 (9th Cir. 2004)
In re Hansen Natural Corp. Sec. Litig., 527 F. Supp. 2d 1142
(C.D. Cal. 2007)
In re Levi Strauss & Co. Sec. Litig., 527 F. Supp. 2d 965 (N.D. Cal. 2007)
In re PNB Holding Co. S'holders Litig., No. 28-N, 2006 Del. Ch. LEXIS158 (Del. Ch. Aug. 18, 2006)
In re Prudential Ins. Co. Deriv. Litig., 659 A.2d 961, 973 (N.J. Ch. 1995)
Kaster v. Modification Sys., Inc., 731 F.2d 1014 (2d Cir. 1984)
Larson v Dumke, 900 F. 2d 1363 (9th Cir 1990)
Lewis v. Sporck, 612 F. Supp. 1316 (N.D. Cal. 1985)
Malone v. Brincat, 722 A.2d 5 (Del. 1998)
Neubauer v. Goldfarb, 108 Cal. App. 4th 47 (2003)
Rademacher v. Russ, 131 F. Supp. 50 (D. Minn. 1955)
Remillard Brick Co. v. Remillard-Dandini Co., 109 Cal. App. 2d 405
(1952)
Seghers v. Thompson, No. 06 Civ. 308 (RMB) (KNF), 2006 U.S. Dist.LEXIS 71103 (S.D.N.Y. Sept. 27, 2006)
-ii-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT
PAGE(S)
9
3
3,4
13
9
4, 5
4
4
13
3
12
9
7
6
4
6
9
9
4
9
4
C 07 1429 JSW
,ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 4 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
Stoner v. Walsh, 772 F. Supp. 790 (S.D.N.Y. 1991)
Walczak v. EPL Prolong, Inc., 198 F.3d 725 (9th Cir. 1999)
Zarowitz v. BankAmeirca Corp., 866 F.2d 1164 (9th Cir 1989)
STATUTES & RULES
Cal. Corp. Code §309(a)
Fed. R. Civ. P. 23.1
OTHER
BVI Business Companies Act) §60
§61
§62
§121
§ 184C(1)(a)
§ 184C(2)(a)-(e)
§2116
-iii-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT
7
13
4
9
6
7, 8
7, 8
7, 8
3
4, 5
5
3
C 07 1429 JSW
,ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 5 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
INTRODUCTION AND SUMMARY OF ARGUMENT
This is an opposition to Defendants 3i's and Badawi's Motion to Dismiss Plaintiffs' Third
Amended Complaint. Defendants argue that Plaintiffs' derivative action belongs to OrthoClear,
the payment to 3i was mandated by OrthoClear's Articles and Memoranda, and that Plaintiffs
have not pled their claims against Badawi with particularity. In addition, Defendants 3i and
Badawi, OrthoClear and Seifert all have argued that Plaintiffs cannot maintain a derivative action
and Plaintiffs' respond to all of their various arguments here.
Plaintiffs' claims are not antagonistic to the Class or OrthoClear and if successful would
even benefit remaining shareholders. Plaintiffs meet the requirements of bringing a derivative
action under BVI law and also have shown that demand would be futile given the inherent
conflicts of interest created by the 3i-OrthoClear settlement. Plaintiffs also seek leave to amend
to submit missing verifications. See Section I. The repurchase of 3i's shares was ultra vires and
also violated BVI law. 3i's argument rests on a clear misstatement of the Memorandum and
Articles of Association. See Section II. Based on Badawi's role in using insider information
gained on OrthoClear's board regarding the settlement with Align to force a quick settlement by
OrthoClear's and 3i's claims, Plaintiffs have stated claims for breach of fiduciary duty and
intentional and negligent misrepresentation. Even if the inadequate, incomplete and misleading
statements made on behalf of the Board in its solicitation of shareholder approval were not
deliberate, they were negligent and breached fiduciary duties owed to the remaining
shareholders. See Section III. Finally, contrary to Defendants' assertions, Plaintiffs have pled
sufficiently that they relied on Defendants' misstatements, and what they would have done absent
the misrepresentations . See Section IV.
PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
,ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 6 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
STATEMENT OF RELEVANT FACTS
On September 28, 2006, less than two months before the scheduled ITC hearing,
OrthoClear suddenly announced in a shareholder letter signed by Defendant Patricia Seifert that
it had reached a settlement with Align "to discontinue, worldwide, all design, manufacture,
marketing and sales of removable dental aligners," and would cease accepting patients and
transfer its intellectual property to Align. Third Amended Complaint ("TAC") ¶170.
The letter asserted that OrthoClear would receive $10 million for these concessions, and
another $10 million conditional on shareholders ' approval of the cessation of operations. Id. It
omitted the following information required as part of a full and accurate solicitation for
shareholder approval : that the settlement with Align would constitute a deemed liquidation of
OrthoClear; that given the Company ' s debts and financial position the $20 million would not
leave any substantial payment for the A, B and C Preferred Shareholders; that during the
preceding 2 years the Company had not accurately represented to investors the cost or risks of the
litigation with Align ("Align Litigation") or the conflicts between OrthoClear's technology and
Align ' s patents; that the individual directors and officers were securing immunity from suit for
infringement and theft of trade secrets as an important part of the settlement; and that approval of
three-fourths of each class of shares was required to authorize the Company's actions . Id. ¶¶171-
72, 179.
In response to shareholder questions about the settlement approval they had been asked to
give, OrthoClear sent a letter dated October 2, 2006 asserting that : ( 1) it was necessary to settle
because of increasing litigation costs ; (2) it was necessary to settle because ITC staff attorneys
had suggested an interpretation of one patent that increased the risk of an exclusion order
prohibiting OrthoClear from importing aligners ; (3) the settlement terms did not require
OrthoClear to "cease operations or to dissolve"; (4) no final decision had been made about the
approach to take, but "our goal is to maximize investor return "; (5) the "exact amount" of money
that may be returned to shareholders in each class "has not yet been determined and cannot be
determined unless and until there is an actual liquidation ." Id. ¶¶177-79.
-1-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
,ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 7 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
Badawi, as the 3i Board member and Class D Preferred share representative, knew or
should have known that the September 28 and October 2 letters, sent to shareholders to obtain
their approval of the Board's decision to settle with Align and related Board actions, contained
information that was incomplete, inadequate, misleading and/or false.
The settlement between Align and OrthoClear, approved by the shareholders in reliance
upon Defendants' misrepresentations, became effective October 6, 2006. TAC ¶181. Badawi
resigned from OrthoClear the same day. See 3i's Motion to Dismiss Third Amended Complaint
("3i MTD") at 2. 3i immediately demanded a return of its investment. TAC ¶179(f). When
OrthoClear demurred, 3i threatened litigation on grounds that apparently included OrthoClear's
misrepresentations regarding the Align Litigation. See Joint Case Management Conference
Statement ("Joint CMC") at 4. The parties engaged in negotiations which were kept secret from
the other investors. TAC ¶184. The negotiations resulted in a payment to 3i of substantially all
the funds it had invested. TAC ¶10; 3i MTD at 2. When that payment was announced in a letter
dated March 8, 2007 from OrthoClear signed by Chishti, it continued to reassure shareholders
that the Company was still in the process of determining what it could pay in liquidation and
telling the shareholders to be patient. TAC ¶¶187, 189.
3i has waived the confidentiality of its agreement with OrthoClear by selectively
disclosing portions which support its arguments and omitting those that do not. The settlement
agreement between 3i and OrthoClear provides that: OrthoClear will repurchase 3i's shares and
warrants for $8.5 million; defend and indemnify 3i from any litigation such as this class action
lawsuit up to an additional $1.5 million;' and aid 3i in any way to avoid being sued. In
consideration for these benefits, 3i granted OrthoClear and its directors and officers a full release
of claims.
No shareholder approval was sought or obtained for this agreement as required under BVI
law. No Board resolutions were passed making any finding that this Agreement was in the
interest of the Company and/or its shareholders.
1This is no $ 1.5 million windfall for A, B and C Preferred Shareholders.
-2-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
,ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 8 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
ARGUMENT
1.
PLAINTIFFS MEET THE REQUIREMENTS FORMAINTAINING A DERIVATIVE CLAIM.
Defendants in their three separate briefs offer a laundry list of largely duplicative reasons
why Plaintiffs should not be allowed to bring their claims derivatively for breach of fiduciary
duty (Count Five), for violation of BVI Business Companies Act Section 121 (Count Six), and
for violation of BVI Business Companies Act Section 2116 (Count Seven) to recover funds paid
to 3i.
First, Defendants argue that the TAC was not verified as it should have been.
OrthoClear's Motion To Dismiss Third Amended Complaint ("OC MTD") at 9; Seifert's Motion
To Dismiss Third Amended Complaint ("Seifert MTD") at 11. Although the original complaint
was verified, the TAC was not, and Plaintiffs respectfully request leave to submit the missing
verifications . See In re Hansen Natural Corp. Sec. Litig., 527 F. Supp . 2d 1142, 1163 (C.D. Cal.
2007) (Dismissal without leave to amend is improper unless it is clear that the complaint could
not be saved by any amendment).
Second, Defendants claim that Plaintiffs' economic interests are antagonistic to the
interests of the other shareholders of the Company, and therefore they cannot act derivatively.
The cases cited are inapposite. OC MTD at 9; Seifert MTD at 11-12. In Argiropoulos v. Kopp,
No CCB-06-0769, 2007 U.S. Dist. LEXIS 22351 (D. Md. Mar. 26, 2007), plaintiff was pursuing
individual claims to recover debts from the defunct corporation in clear competition with the
other plaintiff shareholders. Id. at *25. Here, the representative Plaintiffs seek recovery on
behalf of all shareholders other than Defendants, and the only shareholders who would not
benefit are those who have already settled by waiving all claims against Defendants . See Balin v.
Amerimar Realty Co., No. 12896 , 1996 Del. Ch . LEXIS 146, at * 10-* 11 (Del . Ch. Nov. 15,
1996) (shareholder can represent both a class and a derivative action where plaintiff seeks a
remedy for the benefit of all shareholders , not for himself alone ; and where individual claims do
-3-PUS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
,ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 9 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
not preclude a recovery by the corporation on the derivative claims).
The other cases cited by Defendants are equally unhelpful. In Zarowitz v. BankAmerica
Corp., 866 F .2d 1164 (9th Cir 1989), the plaintiff sought to block two settlements that would
have benefited other plaintiffs but have an adverse effect on his damages action for wrongful
termination . In Larson v Dumke, 900 F.2d 1363, 1368 (9th Cir 1990), the court allowed the
plaintiff to remain the shareholder representative despite his individual claims because (as here)
"if the derivative claim is proved, the damages accrued to the corporation would benefit minority
shareholders."
Without any authority, Defendants also argue that there is economic antagonism between
the Company ' s claim and the shareholders' claim , because they compete for the same pool of
money . OC MTD at 9-10; Seifert MTD at 11-12. That is incorrect, since many of the
shareholder claims are covered by D&O insurance . In any event, since OrthoClear is not an
ongoing concern, the Company's and Plaintiffs ' interest in recovering funds are the same: to
compensate the remaining shareholders for their loss. When Plaintiffs ' claims are satisfied, there
is no need for further efforts on behalf of the Company. Courts have long held that Plaintiffs
may bring an action for rescission jointly with derivative claims . See Rademacher v. Russ, 131
F. Supp . 50, 52-53 (D. Minn . 1955) (denying motion to dismiss and allowing restitution and
derivative claims to proceed jointly); Heilbrunn v. Hanover Equities Corp., 259 F . Supp. 936,
939 (S .D.N.Y. 1966) (denying motion to dismiss where plaintiffs brought class action claim
based on fraud, claims for rescission and derivative claim).
Third, Defendants argue that the claims do not meet the conditions for bringing a
derivative action under BVI law. 3i MTD at 4-5; OC MTD at 10-11. The BVI law which
authorizes derivative actions became effective only on January 1, 2006, and there are no cases
interpreting it.2 Section 184C(1)(a) of the BVI Business Companies Act authorizes shareholders
2For that reason Defendants citations to Foss v. Harbottle, 2 Hare 461 (Eng. 1843), andSeghers v. Thompson, No. 06 Civ. 308 (PNM) (KNF), 2006 U. S. Dist . LEXIS 71103 (S.D.N.Y.Sept . 27, 2006), are unavailing. Both rely on English common law which was superseded by theenactment of BVI Companies Act Section 184C. We note that even English common lawrecognizes and allows derivative actions in certain circumstances . See In re BP P./.c. Deriv.Litig., 507 F. Supp . 2d 302, 311 (S.D.N.Y. 2007). English law prescribes two exceptions to the
-4-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
e 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 10 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
to "bring proceedings in the name and on behalf of' the company, subject to certain conditions,
which never have been interpreted. On their face they are satisfied. The shareholders must be
acting in good faith. Id. § 184C(2)(a). They are. The action must take into account the "views of
the company's directors on commercial matters." Id. §184C(2)(b). There is no commercial
matter at stake in this particular derivative action. The court is also directed to consider "whether
the proceedings are likely to succeed;" and "the costs of the proceedings in relation to the relief
likely to be obtained." Id. § 184C(2)(c), (d). Since the case is proceeding on a contingent fee
basis, the cost or success is not an issue for the Company, and in any event most of the same
costs would be incurred in bringing the non-derivative claims. The potential benefit to the
Company and its shareholders is in excess of $8.5 million.3 The final test is "whether an
alternative remedy to the derivative claim is available. Id. § 184C(2)(e). This Court has ruled as
a matter of law that none are available to shareholders.
Although there is apparently no requirement of demand or demand futility under BVI
law, Defendants reach for it as another obstacle to this proceeding. However, it is clear that in
this case demand is futile under any reasonable standard. The facts show that the D&O
Defendants and Badawi: failed to disclose the reasons for the settlement with Align; mislead
shareholders to induce them to approve the settlement; failed to disclose to shareholders the
allegations made against the Company by 3i and the terms of the settlement with 3i; and falsely
induced Plaintiffs not to take action while they secretly negotiated the settlement and substantial
payment to 3i. TAC ¶200.4 In addition, since 3i has waived the confidentiality of its Settlement
Foss v. Harbottle rule that are applicable here: (1) where the alleged wrong is ultra vires, (2)where the validity of the transaction is dependent upon approval by a majority of shareholdersgreater than a simple majority.
3In addition to the $8.5 million paid 3i under its settlement agreement with OrthoClear, italso can be assumed that OrthoClear is paying 3i under the agreement's secret indemnityprovision-a poison pill designed to deter any A, B or C shareholder from suing 3i.
4Badawi's actions are similar if not identical to those of Atiq Raza, who alsomisappropriated inside information about the settlement for his own benefit. On January 22,2008, Raza settled SEC charges for fraud and insider trading by agreeing to pay nearly $3 millionin disgorgement and penalties, and agreeing to be barred from serving as an officer or director ofany public company for five years. TAC ¶172.
-5-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
e 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 11 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
Agreement with OrthoClear and the D&O Defendants, Plaintiffs can now disclose that in return
for the $8.5 million payment to 3i (and indemnification obligations of up to another $1.5
million), the D&O Defendants were granted full releases from claims that 3i had against them
individually, including the very misrepresentation claims that Plaintiffs allege in this case.
Even under the cases upon which 3i relies, this is sufficient to demonstrate demand
futility. In Lewis v. Sporck, the court noted that allegations of "approval of corporate action"
together with evidence of "`self-interest or other indication of bias"' adequately would
demonstrate demand futility. 612 F. Supp. 1316, 1322 (N.D. Cal. 1985) (quoting Greenspun v.
Del. E. Webb Corp., 634 F.2d 1204, 1210 (9th Cir. 1980)). Bias, in turn, requires allegations that
"the act benefited the directors personally at the expense of the corporation." Id. (citing In re
KauffmanMut. FundActions, 479 F.2d 257, 265 (1st Cir. 1973)). This is precisely what
Plaintiffs have alleged. The demand futility allegations are not (as 3i claims) merely that the
D&O Defendants "approved" of the alleged wrongdoing, "would have to sue themselves" and
that they are named as defendants. 3i MTD at 5. Through this lawsuit, the D&O Defendants
stand accused of giving away corporate assets when threatened with claims of misrepresentation
and in order to buy immunity from 3i. The D&O Defendants put their own interests ahead of the
interests of the company and cannot now legitimately be expected to act disinterestedly on behalf
of the shareholders.
More than being prevented from acting on behalf of the Company by their own self-
interest, OrthoClear, at this point, is incapable of instituting this action on its own behalf. TAC
¶200. It simply does not have the resources or even the structural capacity to do so. The federal
rules require only that the complaint "state with particularity ... the reasons for not obtaining the
action or not making the effort." Fed. R. Civ. P. 23.1. Whether a particular demand would be
"futile" "useless" or "unavailing" "depends on the circumstances of the individual case and is
within the discretion of the district court." Kaster v. Modification Sys., Inc., 731 F.2d 1014, 1018
(2d Cir. 1984) (citing Lewis v. Graves, 701 F.2d 245, 248 (2d Cir. 1983)). Here, OrthoClear has
wound down its affairs and does not have a management in place to direct litigation against the
-6-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
e 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 12 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
D&O Defendants, Badawi and 3i. OrthoClear has only one employee, an in-house attorney. It
has no regularly functioning officers or other management. What little assets are remaining in
the Company are going towards defending the D&O Defendants, and (perhaps), indemnifying 3i
and Badawi.
In fact, other than the D&O Defendants' own funds, the only remaining source for
recovery for the shareholders is the directors' and officers' liability insurance that the Company
purchased for them. TAC ¶200. However, such policies now typically exclude coverage for any
action brought directly by a company against its own board of directors and officers, under a
"insured versus insured exclusion." In conjunction with OrthoClear's precarious financial
situation and indemnity obligation to 3i, such an exclusion makes it practically impossible for
D&O Defendants to institute an action on behalf of OrthoClear. The cases cited by 3i (3i MTD
at 6), which hold only that an "insured versus insured exclusion" standing alone is insufficient
basis for demand futility, are therefore inapposite. In re Prudential Ins. Co. Deriv. Litig., 659
A.2d 961, 973 (N.J. Ch. 1995) (rejecting a blanket rule that an exclusion by itself makes demand
futile, but noting that such an exclusion "might decrease the likelihood that demand will be
accepted"); Stoner v. Walsh, 772 F. Supp. 790, 805 (S.D.N.Y. 1991) (rejecting "assertion that the
exclusion automatically renders a board member `interested ... "') (emphasis added).
H.
THE REPURCHASE OF 3i'S SHARES WAS MADEULTRA VIRES.
3i insists that it was entitled to the payment pursuant to its liquidation preference
expressed in Section 12 of the Memorandum of Association. 3i MTD at 7-8. However,
Section 12 is irrelevant because both it and OrthoClear concede that the payment made was not
part of a liquidation process, but pursuant to a "settlement agreement" in which OrthoClear
acquired 3i's shares. 3i's Motion To Dismiss Second Amended Complaint at 3; OC MTD at 11.
Share repurchases are not governed by Section 12, but Section 18 of OrthoClear's Articles of
Association and Sections 60, 61 and 62 of the BVI Business Companies Act. Request For
-7-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
e 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 13 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
Judicial Notice In Opposition To Defendants' Motions To Dismiss Third Amended Complaint;
Declaration Of James S. Nabwangu In Opposition To Motions To Dismiss Third Amended
Complaint Ex. C. Those sections were not complied with. TAC ¶193.
Article 18 of OrthoClear's Articles of Association empowers the Company's directors to
repurchase shares from less than all shareholders only under limited conditions. See Declaration
of Joseph V. Mauch In Support Of OrthoClear's Motion To Dismiss Third Amended Complaint
Ex. A (Article 18 of Defendant OrthoClear's Articles of Association). Defendant 3i claims that
under Section 9 of the Memorandum, 3i needed only a writing from the Company for a share
repurchase to be valid. Section 9 is qualified, however, by the provisions of the Company's
Articles. Section 9 of the Memorandum states that "[s]ubject as otherwise provided in the
Articles, ... the Preference Shares shall not be entitled or subject to redemption or repurchase by
the company except ... as otherwise agreed to in writing by the Company ...." Id. (emphasis
added). This reference plainly requires the terms of a repurchase to satisfy the Articles of
Association. Article 18(a) makes any repurchase subject to Sections 60, 61 and 62 of the BVI
Business Companies Act.
Those Sections of the Companies Act prohibit repurchase of less than all of the shares of
the company (as occurred here) unless the shareholders approve of the purchase or the Directors
pass a resolution "stating that, in their opinion, (a) the ... acquisition is to the benefit of the
remaining shareholders ; and (b) the terms of the offer and the consideration offered for the shares
are fair and reasonable to the company and to the remaining shareholders." See Declaration of
James S. Nabwangu In Opposition to Defendants ' Motions To Dismiss Third Amended
Complaint Ex. B (BVI Bus . Cos. Act §§60, 61 ). The shareholders did not approve the purchase
(TAC ¶190), and the Directors never passed such a resolution, nor could they have done so given
its effect on the Company and the remaining shareholders . TAC ¶193 . Accordingly , the TAC
adequately alleges that the repurchase of 3i' s Series D Preferred Shares violated the OrthoClear
Memorandum and Articles of Association, and justifies a constructive trust.
-8-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
A. Badawi' s Role In The Align Settlement.
Defendants falsely claim that Badawi cannot be sued for breach of fiduciary duty based
on the payment from OrthoClear to 3i because it was entered into after Badawi left the Board. 3i
MTD at 10. Their agreement fails for the reasons stated below.
First, Badawi had a duty to act honestly and in good faith with a view to the best interests
of OrthoClear and all its shareholders . Cal. Corp. Code §309(a). Second, Directors have a
fiduciary duty to shareholders to exercise due care, good faith and loyalty when requesting
shareholder action . See, e.g., Malone v. Brincat, 722 A. 2d 5, 10 - 11 (Del . 1998). Inaccurate
information in the context of director statements to shareholders in conjunction with a request for
shareholder action "may be the result of a violation of the fiduciary duties of care, loyalty or
good faith," and directors are required to supply shareholders with " all information that is
material to the action being requested and to provide a balanced, truthful account of all matters
disclosed in the communications with shareholders ." Id. at 11-12; Abrons v. Maree, 911 A.2d
805, 812 (Del. Ch . 2006) (same); In re PNB Holding Co. S'holders Litig., No. 28-N, 2006 Del.
Ch. LEXIS 158, at *56 (Del. Ch. Aug. 18 , 2006) (same).5
Accordingly, Defendant Badawi's liability for breach of fiduciary duty is premised on his
role leading up to the final payment, which began while he was on the Board of OrthoClear, and
5See also De La Fuente v. FDIC, 332 F.3d 1208 , 1222 (9th Cir . 2003 ) (duty of candorrequires fiduciaries to disclose "all material information relevant to corporate decisions fromwhich they may derive a personal benefit") (citation and internal quotation marks omitted);Neubauer v. Goldfarb, 108 Cal . App. 4th 47, 62 (2003) ("[D]irectors and majority shareholdersowe a fiduciary duty to minority shareholders which requires complete candor in disclosing fullyall of the facts and circumstances surrounding a transaction") (citation and internal quotationmarks omitted); Remillard Brick Co. v. Remillard-Dandini Co., 109 Cal. App. 2d 405, 420(1952) (director "cannot utilize his inside information and his strategic position for his ownpreferment," and "cannot use his power for his personal advantage and to the detriment of thestockholders and creditors no matter how absolute in terms that power may be and no matter howmeticulous he is to satisfy technical requirements").
-9-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
e 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 15 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
included among other points: misrepresenting the terms of the Align settlement to shareholders;
failing to disclose that 3i intended immediately to seek a return of its funds, and failing to
disclose that 3i would be the exclusive shareholder beneficiary of the proposed settlement. TAC
¶179. Thus, the claims against Badawi relate directly to the actions he took and failed to take at
the time he was a director when OrthoClear settled with Align and solicited shareholder approval
of the Board's action. Badawi cannot immunize his unlawful course of conduct by resigning as a
director in the middle of it. The fact that 3i was not able to obtain the payment until after Badawi
resigned does not cure the breach of fiduciary duty while he was a director.
Finally, it is clear that the September 28 and October 2 letters misstated the reasons for
and consequences of the Align settlement, and were designed to lull shareholders into inaction.
Instead of disclosing the financial and business impact of the settlement, OrthoClear instead
concealed that it needed a three-fourths vote of each class of shares to consummate the settlement
and transfer its patents . TAC at ¶179(d). The letter also falsely suggested that the only question
for shareholder decision was whether or not to agree to abandon OrthoClear's operations outside
the United States in return for a second $ 10 million, bringing the total settlement to $20 million.
TAC ¶170.
The October 2 letter stated falsely that: (1) it was necessary to settle because of
increasing litigation costs (OrthoClear hadjust raised $10 million from 3i tofund litigation
costs); (2) it was necessary to settle because ITC staff attorneys had suggested an interpretation
of one patent that increased the risk of an exclusion order prohibiting OrthoClear from importing
aligners into the United States (Six months prior, Seifert had said the ITC decision would not
affect OrthoClear's ability to operate in the U.S.); (3) the settlement terms did not require
OrthoClear to "cease operations or to dissolve" (3i asserted at the time that the Align settlement
was a "deemed liquidation" (3i MTD at 1)); (4) no final decision had been made about the
approach to take, but "our goal is to maximize investor return" (implyingfalsely that the
settlement would leave the Company in afinancial position to do other than liquidate); (5) the
"exact amount" of money that may be returned to shareholders in each class "has not yet been
-10-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
e 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 16 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
determined and cannot be determined unless and until there is an actual liquidation" (apparently
a precept not applicable to 3i, since OrthoClear was able to determine what could be returned to
3i within a matter ofmonths and before any other distribution). TAC ¶¶176-79 (emphasis
added). Neither letter, as Defendants wish, states that the solicitation was for approval of an
effective "deemed" liquidation of OrthoClear, which is Defendants' justification for its secret
payment to 3i.
B. Badawi 's Self-Dealing With Confidential Information.
Defendants 3i and Badawi deny that they used information gained by Badawi's presence
on the Board to further the interests of 3i. 3i was able to extract a "settlement" from OrthoClear
of millions of dollars, long before any of the other investor, and months before any formal
liquidation of the company. Indeed, no liquidation yet has taken place. See TAC ¶¶180, 187; see
n.4, supra. In addition, 3i was able to obtain an indemnification from OrthoClear for a sum of up
to $1.5 million, making the settlement worth its entire investment. 3i and Badawi only have
recently disclosed that the payment it received from OrthoClear represented a settlement of
"other potential claims." See Joint CMC at 4. In connection with this disclosure, 3i disclosed for
the first time that at the time it invested in August 2006, OrthoClear misrepresented to 3i that no
basis for Align's claims existed, and failed to disclose the advanced stage ofsuch claims. Id. at
3-4. 3i now wants to distance itself from its CMC statement, and have it both ways. For
instance, 3i and Badawi argue that their settlement, which includes "other potential claims," is
"neither remarkable nor untoward." 3i MTD at 11-12. At the same time, they claim that the
sudden shuttering of OrthoClear would make any reasonable investor claim fraud. Id. at 12.
The reality is that Badawi participated in Board meetings where the reasons for the Align
settlement were discussed. He also participated in seeking shareholder approval of the Align
settlement and knew that other investors were being told that no distributions would be made
before a final decision to liquidate was announced-a promise Badawi had no intention of
honoring. See 3i MTD at 12. Badawi now explains that his swift departure from the Board after
the Align settlement was an effort to avoid "any potential conflict of interest" so 3i could press
-11-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
e 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 17 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
its claims . See 3i MTD at 12.
Badawi's sudden departure from the Board, the size of the settlement (obtained by 3i
through secret negotiations), and how rapidly it was obtained, all evidence Badawi's breach of
fiduciary duty by using information for his own benefit and the benefit of 3i. Where, but from a
Board member privy to the problems in the ITC proceeding and settlement discussions with
Align, and the Board discussions of the Company's finances and future plans could 3i have
obtained the information it used to immediately demand and extract a 100% settlement from
OrthoClear? Meanwhile, other shareholders were misled into waiting for the Company's next
steps.
The same allegations that state a claim for breach of fiduciary duty also give rise to State
common law claims for intentional and negligent misrepresentation resulting from the
September-October 2006 solicitation for approval of the Align settlement, and related
misrepresentations and omissions regarding the distribution of the proceeds.6 Even if the
inadequate, incomplete and misleading statements made on behalf of the Board in its solicitation
of shareholder approval were not deliberate but merely negligent, the letters caused shareholders
to stand by while 3i secretly obtained the bulk of the available funds to satisfy investor claims.
Defendants wrongly assume that Plaintiffs must plead the negligent misrepresentation claim with
particularity under Federal Rule of Civil Procedure 9(b). First, generally, only fraud claims must
be plead with particularity. Second, "` [w]here averments of fraud are made in a claim in which
fraud is not an element, an inadequate averment of fraud does not mean that no claim has been
stated. The proper route is to disregard averments of fraud not meeting Rule 9(b)'s standard and
then ask whether a claim has been stated."' In re Levi Strauss & Co. Sec. Litig., 527 F. Supp. 2d
965, 979 (N.D. Cal. 2007) (quoting In re Daou Sys. Inc. Sec. Litig., 411 F.3d 1006, 1027 (9th Cir.
2005)). Without the allegations of intentional fraud, Plaintiffs' allegations support a claim of
6Plaintiffs' SAC mistakenly omitted Badawi from the negligence cause of action, and theCourt's prior order did not address Plainffs' claims of negligent misrepresentation againstBadawi. See 1/18/08 Order Granting Motions to Dismiss ("1/18/08 Order") at 13-16.Accordingly, Plaintiffs amended the TAC to ensure Defendant Badawi was on notice of thisclaim.
-12-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
e 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 18 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
I negligent misrepresentation.
IV.
PLAINTIFFS ADEQUATELY HAVE PLED RELIANCE.
The Court held that Plaintiffs needed to plead reliance (1/18/08 Order at 11), and
Plaintiffs have done so. The TAC alleges that had Plaintiffs known the facts that were concealed
or omitted, they would not have voted to approve the settlement with Align, and would have
taken immediate steps to hold Defendants accountable. TAC ¶180. This is not a holders claim,
and selling shares was not one of Plaintiffs' options. Plaintiffs raised questions at the time the
first letter was sent announcing the settlement, leading to a second letter that contained
misinformation and omitted information available to the Company about the financial impact of
the proposed settlement payment from Align.
Had investors been told the true state of affairs in October 2006 at the time they were
asked to approve the settlement, they could have protected their rights by promptly filing an
action against OrthoClear, which effectively would have prevented distributions such as occurred
with 3i until all claims against OrthoClear were sorted out. See, e.g., Deckert v. Independence
Shares Corp., 311 U.S. 282, 288 (1940) (violation of Securities Act Section 12 states a claim for
equitable relief); Walczak v. EPL Prolong, Inc., 198 F.3d 725, 730 (9th Cir. 1999) (injunction
available against shareholder distributions where Plaintiffs seek equitable relief); see also In re
Focus Media Inc., 387 F.3 d 1077 (9th Cir. 2004).
-13-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
e 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 19 of 19
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
Attorneys for Plaintiffs MICHAEL B. ESHELMAN,D.D.S.; PETER F. SILCHER, D.D.S.; and LORI I.SILCHER
-14-
CONCLUSION
For all the reasons set forth above, Defendants' Motion to Dismiss should be DENIED.
DATED: April 18, 2008 Respectfully submitted,
LAW OFFICES OF ALAN W. SPARER
By: /s/
ALAN W. SPARER
PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW
top related