Opinion
603098/07.
Decided September 19, 2008.
Plaintiffs: THOMAS J. FLEMING, (Olshan Grundman Frome Rosenzweig Wolosky LLP).
Defendants: DARRYLL A. BUFORD, (Fox Rothschild, LLP).
Plaintiffs, AJW Partners, LLC, AJW Offshore, LTD, AJW Qualified Partners, LLC, New Millennium Capital Partners II, LLC, and AJW Master Fund, LTD (collectively "AJW") moves this Court for: (1) a preliminary injunction (Seq. 001), pursuant to CPLR § 6301, directing defendant Cyberlux Corporation ("Cyberlux") to transfer to AJW more than 26,000,000 shares of stock for their sale in the public market, with any proceeds to be held in escrow pending further order of this Court; and (2)to dismiss (Seq. 002), pursuant to CPLR § 3211(a)(1) and (a)(7), Cyberlux's counterclaims 1 through 3, and 5 through 9. Both motions are consolidated for disposition.
Background
AJW are investors that loaned over $6 million to Cyberlux over a three year period. Cyberlux is a Nevada corporation which designs, manufactures and sells light emitting diode (LED) lighting systems. Cyberlux's common stock is registered with the United States Securities and Exchange Commission (SEC) and its shares are traded publicly.
In September 2004, the parties entered into Securities Purchase Agreements (the "Agreements") whereby Cyberlux issued callable Secured Convertible Notes (the "Notes") to AJW in the aggregate principal amount of $1,500,000. Additionally, between April 2005 and July 2007, AJW purchased Notes from Cyberlux worth approximately $4.62 million.
In addition to the Agreements, the Notes also set forth conditions, rights, and obligations of the parties.
Under the Notes, AJW has the right to convert the outstanding principal amount into common stock by submitting notices of conversion to Cyberlux.
On August 10, 2007, AJW delivered notices of conversion in the amount of 23,563,213 shares at $.0008 per share. On February 7, 2008, AJW delivered notices of conversion converting 3 million shares at .005 per share. Cyberlux has failed to honor either notice.
AJW filed an action asserting claims, among others, for breach of contract. Cyberlux filed counterclaims for fraud, negligent misrepresentation, breach of fiduciary duty, breach of contract, breach of implied covenant of good faith and fair dealing, conversion, declaratory judgment on the issue of usury, and for an injunction.
Preliminary Injunction
AJW seeks a preliminary injunction directing Cyberlux to honor its contractual obligation to deliver shares of stock to AJW to be sold in the marketplace, with proceeds to be held in escrow pending further direction by this Court.
In order to be entitled to a preliminary injunction, a movant must clearly demonstrate (1) a likelihood of success on the merits, (2) irreparable injury absent granting of the preliminary injunction, and (3) a balancing of the equities in the movant's favor. St. Paul Fire Marine Ins. Co. v York Claims Serv., 308 AD2d 347 (1st Dept 2003).
Considering arguendo that AJW can satisfy the first and third requirements for a preliminary injunction, it does not persuade this Court that the potential for irreparable harm without an injunction is present.
Citing unpublished Federal case law, AJW contends that the potential for irreparable harm is established by Cyberlux's "woeful financial performance," making it unlikely that Cyberlux will have access to financial resources to pay a judgment at the conclusion of this litigation. See Alpha Capital Aktiengesellschaft v Advanced Viral Research Corp., 2003 WL 328302 (SDNY 2003).
In Alpha Capital, the Southern District granted an injunction based on the reasoning that "irreparable harm exists where nothing in the record suggests that a defendant will be able to pay a judgment." Id at 2. However, in Alpha Capital, defendant's own registration statement stated that it had no source of product revenue, and that it anticipated that its deficit ($46,364,951), would only increase. Further, defendant's registration statement indicated that it may never be able to sell its product commercially. On this basis, that court determined that the plaintiff had demonstrated irreparable harm.
In this case, Cyberlux's situation, although not ideal, is clearly distinguishable from the defendant in Alpha Capital. First, Cyberlux has a viable product that it has the ability to sell and has sold. According to the Mark D. Schmidt Affidavit, Cyberlux's President and Chief Operating Officer, Cyberlux has contracted with the US Air Force for night-vision lighting systems worth approximately $8 million. Further, Cyberlux has product orders from the Nation Guard worth approximately $663,000. Therefore, Cyberlux, although is currently operating at a loss, it cannot be adequately shown, as AJW suggests, that Cyberlux is approaching insolvency [see Castle Creek Technology Partners, LLC v Cellpoint, Inc., 2002 WL 31958696 (SDNY 2001) (a company's potential insolvency can constitute irreparable harm)], or that there is a "substantial likelihood that defendant will not be able to satisfy a judgment at the conclusion of this case." Alpha Capital at 5. Therefore, AJW fails to satisfy that it will suffer irreparable harm, and the motion for preliminary injunction must be denied.
Motion to Dismiss
"Dismissal under CPLR 3211(a)(1) is warranted only if the documentary evidence submitted conclusively established a defense to the asserted claims as a matter of law.'" Leon v Martinez, 84 NY2d 83, 88 (1994).
When assessing the adequacy of a complaint on a motion to dismiss pursuant to CPLR 3211(a)(7), a court must afford the pleadings a liberal construction, accept the allegations of the complaint as true, and provide the plaintiff "the benefit of every possible favorable inference." Id. at 87-88. Whether a plaintiff can ultimately establish its allegations is not part of the calculus in determining a motion to dismiss. Id. The motion must be denied if from the pleadings' four corners "factual allegations are discerned which taken together manifest any cause of action cognizable at law." 511 W. 232nd Owners Corp. v Jennifer Realty Co., 98 NY2d 144, 152 (2002), quoting Guggenheimer v Ginzburg, 43 NY2d 268, 275 (1977). First Counterclaim — Fraud
The elements required for a fraud cause of action are "representation of a material existing fact, falsity, scienter, deception and injury." New York Univ. v Cont'l Ins. Co., 87 NY2d 308, 318 (1995).
Cyberlux alleges that AJW "materially misrepresented that they would act in good faith and not employ fraudulent means for self-gain in its execution of the transactions agreement." Answer ¶ 56. Here, such a misrepresentation is not a basis for a fraud claim. The Court of Appeals has held that general allegations that a defendant entered into a contract while lacking the intent to perform it are insufficient to state a cause of action for fraud. Id at 318.
Furthermore, a claim of fraudulent inducement of a contract is defectively pled if the acts alleged to constitute fraud "do not arise from circumstances extraneous to, and not constituting elements of, the contract, and therefore do not represent the breach of a legal duty independent of the contract." Baker v Norman, 226 AD2d 301, 304 (1st Dept), appeal dismissed, 88 NY2d 1040 (1996). Here, substantially all of Cyberlux's fraud allegations are derived directly from the terms of the Agreements. For example, Cyberlux's allegations that AJW agreed to negotiate in good faith, not to sell Cyberlux stock short, and to limit conversions to no more than 4.99% of the outstanding shares of Cyberlux's common stock, are all provisions of the Agreements.
The answer does allege that AJW "repeatedly assured" Cyberlux that it would be a long-term investor. Answer ¶ 27. However, this allegation does not meet the requirement of specificity as set forth in CPLR 3016. Therefore, this counterclaim must be dismissed.
Second Third Counterclaims
Defendant's second counterclaim is for negligent misrepresentation and the third, breach of fiduciary duty. Both are dismissed for failure to state a claim. CPLR 3211(a)(7).
Cyberlux must plead that there is a fiduciary or other special relationship with AJW in order to sustain a cause of action for negligent misrepresentation or breach of fiduciary duty. M. Bailey v Gray Siefert Co., Inc., 300 AD2d 258 (1st Dept 2002). Here, no such allegation is set forth to support the claim for negligent misrepresentation. See Answer ¶¶ 60-64.
As to breach of fiduciary duty, contrary to the allegations, no relation of confidence or trust arises when parties deal in arm's length transactions. CIBC Bank Trust Co. (Cayman) Ltd. v Credit Lyonnais, 270 AD2d 138, 139 (1st Dept 2000) (affirming the dismissal of a breach of fiduciary duty claim where the parties represented in the contracts that each "is a sophisticated institutional investor" that "has acted in the capacity of an arm's-length contractual counter-party and not as [the other's] financial advisor or fiduciary"). Here, the Agreements clearly state that "no buyer is acting as a financial advisor or fiduciary to the Company (or in any similar capacity) with respect to this agreement and the transactions contemplated hereby. . ." Agreements, Section 3(o). Therefore, in light of the plain contractual language disavowing a fiduciary relationship, the counterclaim for breach of fiduciary duty must be dismissed.
Fifth Counterclaim
The fifth counterclaim is for breach of contract. Cyberlux alleges that in violation of the Notes, AJW converted shares representing more than 4.99% of the total outstanding shares of stock. See Section 1.1, Callable Secured Convertible Note, April 22, 2005. However, this allegation is belied by the language in the Notes and Cyberlux's own SEC filing of December 21, 2004.
The Notes set forth in relevant part that:
". . .in no event shall the Holder [AJW] be entitled to convert any portion of this Note in excess of that portion of this Note upon conversion of which the sum of (1) the number of shares of Common Stock beneficially owned by the Holder and its affiliates. . .and (2) the number of shares of Common Stock issuable upon the conversion of the portion of this Note. . . [that] would result in beneficial ownership by the Holder and its affiliates of more than 4.99% of the outstanding shares of Common Stock. . ."
Cyberlux clarifies this provision in an SEC filing as follows:
"Although the investors [AJW] may not convert their secured convertible notes and/or exercise their warrants if such conversion or exercise would cause them to own more than 4.9% of our [Cyberlux] outstanding common stock, this restriction does not prevent the investors from converting the rest of their holdings. In this way, the investors could sell more than this limit while never holding more than this limit. There is no upper limit on the number of shares that may be issued. . ." Cyberlux SEC Filing, December 21, 2004.
As stated above, the limitation of 4.99% is applicable only to AJW's ownership of shares at any one given time. Given this explanation and clear understanding of the provision submitted to the SEC, signed by Donald Evans as Chairman of the Board of Cyberlux, this counterclaim for breach of contract is dismissed (documentary evidence).
Further, it should be noted that Cyberlux fails to allege that AJW owned more than 4.99% of shares of common stock at any one given time.
Sixth Counterclaim
Cyberlux's sixth counterclaim for breach of contract alleges that AJW made "false, fraudulent, misleading representations to induce" Cyberlux to hire Mr. Gelmon, a financial consultant. When Mr. Gelmon allegedly failed to produce alternative financing for Cyberlux, as was the purpose of his hiring, Cyberlux alleges a breach of contract on the part of AJW.
Nowhere in the answer or the briefs does Cyberlux point to any contract involving Gelmon, between the parties or otherwise. Therefore, in the absence of alleging the existence of an enforceable contract, Cyberlux fails to state a claim for breach of contract. See Maldonado v Olympia Mechanical Piping Heating Corp. , 8 AD3d 348, 350 (2nd Dept 2004) (holding that in order to state a claim for breach of contract, the provisions of the contract upon which the claim is based must be alleged). Seventh Counterclaim
Cyberlux's seventh counterclaim asserts that AJW breached the implied duty of good faith and fair dealing by its intentional unlawful violation of federal securities laws, Securities Purchase Agreements, Notes, and other agreements" collectively characterized as AJW's "self-dealings."
Implicit in every contract is a promise of good faith and fair dealing, which is breached when a party acts in a manner that, although not expressly forbidden by any contractual provision, would deprive the other party of the right to receive the benefits under their agreement. Skillgames, LLC v Brody , 1 AD3d 247 (1st Dept 2003). However, where the claims made under the covenant of good faith and fair dealing are duplicative of the breach of contact claims, they will be dismissed. See Parker East 67th Associates, L.P., v Minister, Elders and Deacons of Reformed Protestant Dutch Church of City of New York, 301 AD2d 453, 454 (1st Dept), appeal denied, 100 NY2d 502 (2003).
Cyberlux has not alleged any facts different from its breach of contract claim, and therefore cannot sustain a cause of action for breach of good faith and fair dealing.
Eighth Counterclaim
Cyberlux's eighth cause of action is for conversion. Cyberlux alleges that through AJW's acquisition of over 4.99% of shares of Cyberlux common stock, it is liable for conversion. In light of the dismissal of the fifth counterclaim above, this counterclaim is dismissed as academic. Cyberlux has not alleged that AJW unlawfully owned more than 4.99% of outstanding shares of common stock at any given time.
Ninth Counterclaim
Defendant's ninth counterclaim alleges that the Agreements violate New York's usury laws because once the Notes were converted into Cyberlux shares, they violated the criminal usury statute. Criminal Usury is violated as follows:
"A person is guilty of criminal usury in the second degree when, not being authorized or permitted by law to do so, he knowingly charges, takes or receives any money or other property as interest on the loan or forbearance of any money or other property, at a rate exceeding twenty-five per centum per annum or the equivalent rate for a longer or shorter period." New York Penal Law § 190.40.
First, contrary to the allegation set forth in the answer, the Agreements (as well as the Notes) are not in violation of the usury statute on its face. Answer at ¶ 94. The Notes state that Cyberlux is to repay the amount borrowed plus "interest on the unpaid principal balance at the rate of 10%. . .per annum." Consequently, "where the rate of interest on the face of the note, as here, is not in excess of the legal rate at the time of the loan. . ." usurious intent must be asserted. Freitas v Geddes Sav. And Loan Ass'n, 63 NY2d 254 (1984). Cyberlux fails to allege that AJW intentionally charged an interest rate in violation of the usury statute.
Second, because the answer raises the affirmative defense of usury (see Answer, Fourteenth Affirmative Defense), a counterclaim for the same relief must be dismissed. See April M's Enterprises, Inc. v Scott, 178 AD2d 572 (2d Dept 1991).
Accordingly, it is
ORDERED that plaintiff's motion for a preliminary injunction is denied; and it is further
ORDERED that plaintiff's motion to dismiss defendant's counterclaims is granted in its entirety; and it is further
ORDERED that the remainder of the action shall continue.