309 F. Supp. 3d 100
S.D. Ill.2018Background
- In December 2015 Hudson Bay and CVI (the Funds) entered a PIPE transaction with Patriot National and CEO Steven Mariano involving SPAs, a Rescission & Exchange Agreement (REA), and warrants (Series A & B) with price-adjustment features. A prior NDA limited the Funds' trading before public announcement.
- After public disclosure the stock price dropped; the parties restructured via the REA on December 23, 2015. The Funds later exercised warrants but Patriot refused delivery, citing an FINRA inquiry. The Funds sued for specific performance and breach of contract in April 2016.
- Patriot and Mariano asserted affirmative defenses including fraudulent inducement, market manipulation, and contract repudiation; the court struck the fraud and manipulation defenses for inadequate pleading but allowed breach defenses to stand as denials.
- Defendants then filed counterclaims repeating the earlier dismissed theories (Section 10(b) market manipulation, material misrepresentations/omissions, fraudulent inducement) and breach of contract; Mariano also claimed breach of the implied covenant of good faith and fair dealing.
- The Funds moved to dismiss on procedural grounds (law of the case/leave to amend) and for failure to state claims under Rules 12(b)(6) and 9(b)/PSLRA. The court declined to rule on procedural bar arguments and resolved the claims on the merits.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Procedural bar / law of the case | Funds: counterclaims barred because court previously struck those defenses and Defendants failed to seek leave to amend | Defendants: claims are permissible counterclaims tied to denials and the court should consider them on the merits | Court declined to apply procedural bar; proceeded to merits analysis (no dismissal on procedural grounds) |
| Breach of contract sufficiency | Funds: Defs fail to plead damages and claims are meritless | Defs: plead specific breaches (dates, share amounts borrowed/shorted) showing nonperformance by Funds | Breach claims survive; allegations suffice to state breach and at least nominal damages; leave to assert breach counterclaim allowed |
| Fraud / fraudulent inducement and material misrepresentation (including Section 10(b) theory based on omissions) | Funds: fraud claims are duplicative of contract claims and fail PSLRA/Rule 9(b) particularity requirements | Defs: alleged then-present facts and omissions (intent to borrow/short, actual borrowing) induced the SPA/REA | Dismissed: fraud claims are duplicative of contract claims and/or insufficiently particular; amendment would be futile |
| Market manipulation (Section 10(b)/Rule 10b-5) | Funds: shorting was contractually permitted after disclosure; shorting alone is not manipulation; plaintiffs lack scienter and reliance | Defs: Funds borrowed large share amounts while in possession of MNPI to depress price and obtain more shares under the warrants | Dismissed: Defs failed to plead the requisite "something more" beyond permissible shorting, failed to plead strong inference of scienter, and failed to plead reliance; manipulation claim fails |
Key Cases Cited
- Ashcroft v. Iqbal, 556 U.S. 662 (2009) (plausibility standard for Rule 12(b)(6))
- Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) (pleading must be plausible, not merely possible)
- ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 2007) (standards for pleading market manipulation and applicability of Rule 9(b)/PSLRA)
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) (test for strong inference of scienter)
- Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) (manipulative or deceptive acts under securities laws; examples of manipulative devices)
- Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994) (Section 10(b) liability for manipulative or deceptive acts)
- Luitpold Pharms., Inc. v. Ed. Geistlich Söhne A.G. Für Chemische Industrie, 784 F.3d 78 (2d Cir.) (nominal damages suffice to plead breach of contract)
- CompuDyne Corp. v. Shane, 453 F. Supp. 2d 807 (S.D.N.Y. 2006) (short-selling pre-announcement and naked shorting supported manipulation theory)