Summary
In Netwolves Corp. v. Sullivan, 2001 WL 492463 (S.D.N.Y. 2001), the court was not asked to freeze the assets of the defendant.
Summary of this case from Newby v. Enron CorporationOpinion
00 Civ. 8943 (AGS), 00 Civ. 9628 (AGS)
May 9, 2001
OPINION AND ORDER
These actions, which are related, arise out of the merger of Sales Management and Consulting, Inc. ("SMCI") and TSG Global Education Web, Inc. ("TSG"). Certain defendants in action 00 Civ. 8943 (AGS) (the "Netwolves Action") have moved to dismiss the complaint in that action for lack of subject matter jurisdiction, pursuant to Fed.R.Civ.P. 12 (b)(1). Certain defendants in action 00 Civ. 9628 (AGS) (the "Sullivan Action") have moved to dismiss the complaint in that action for failure to bring compulsory counterclaims, pursuant to Fed.R.Civ.P. 13(a). Plaintiffs in the Sullivan Action have moved by order to show cause for a preliminary injunction, pursuant to Fed.R.Civ.P. 65, requiring Netwolves Corporation ("Netwolves") and its president, Walter M. Groteke, Jr., to instruct Netwolves' counsel to issue certain opinion letters concerning the sale of Netwolves stock. For the reasons set forth below, the Rule 12(b)(1) motion is granted, the Rule 13(a) motion is denied, and the Rule 65 motion is granted.
I. THE PARTIES
Netwolves is a New York corporation with its principal place of business in Melville, New York. (Verified Am. Compl. in the Netwolves Action ("Netwolves Am. Compl.") ¶ 2; Compl. in the Sullivan Action ("Sullivan Compl.") ¶ 11.) TSG is a Delaware corporation with its principal place of business in Guilford, Connecticut. (Netwolves Am. Compl. ¶ 3; Sullivan Compl. ¶ 16.) ProCare Automotive Solutions, Inc. ("ProCare") is an Ohio corporation with its principal place of business in Independence, Ohio. (Netwolves Am. Compl. ¶ 4.) David H. Sullivan, Martin E. Cunningham, Ronald B. Collins, and John J. Phelan are all Connecticut residents. (Netwolves Am. Compl. ¶¶ 5-6, 8-9; Sullivan Compl. ¶¶ 6-9.) Daniel J. Molloy is a New Jersey resident. (Netwolves Am. Compl. ¶ 7; Sullivan Compl. ¶ 10.) Walter M. Groteke, Jr. and Peter C. Castle are New York residents. (Sullivan Compl. ¶¶ 12, 14.) Daniel G. Stephens is a Florida resident. (Sullivan Compl. ¶ 13.) Alan Blackman is a dual citizen of the United States and New Zealand, whose place of residence is unknown. (Sullivan Compl. ¶ 15.)
II. THE FACTS
A. The Merger
Prior to July 7, 1999, Messrs. Sullivan, Cunningham, Collins, Phelan and Molloy (collectively the "Sullivan Parties") together owned SMCI. (Netwolves Am. Compl. ¶ 3; Sullivan Compl. ¶¶ 6-10.) SMCI was in the business of providing training and consulting services to businesses in certain automotive and gasoline-related industries. (Netwolves Am. Compl. ¶ 13; Sullivan Compl. ¶ 17.) SMCI offered many of its services through in-person seminars conducted at various locations throughout the United States. (Sullivan Compl. ¶ 18.) During the late 1990s, SMCI became interested in offering its services via the Internet. ( Id. ¶ 19; Netwolves Am. Compl. ¶ 14.)
Netwolves manufactures and sells certain Internet technology or products. (Netwolves Am. Compl. ¶ 2; Sullivan Compl. ¶¶ 25-27.) During the last quarter of 1998, representatives of Netwolves and SMCI began discussing the possibility of working together to advance their mutual interests. (Netwolves Am. Compl. ¶ 14; Sullivan Compl. ¶ 28.) The parties disagree as to what was said during these negotiations, what was not said, and the truth or relevance of what was said or not said. ( Compare, e.g., Netwolves Am. Compl. ¶ 14 with Sullivan Compl. ¶¶ 28-46.) What is not disputed is that, as a result of the negotiations, the parties agreed to merge SMCI into a Netwolves subsidiary created specifically for this transaction, TSG. (Netwolves Am. Compl. ¶¶ 3, 14; Sullivan Compl. ¶ 47.)
Under the terms of the merger agreement, dated July 7, 1999, the Sullivan Parties received 180,000 shares of Netwolves common stock in exchange for all of the stock of SMCI. (Netwolves Am. Compl. ¶ 15; Sullivan Compl. ¶ 49.) The Netwolves stock received by the Sullivan Parties was not registered with the Securities and Exchange Commission (the "SEC") and could not be sold for 18 months. (Aff. of David H. Sullivan in Support of Application for Order to Show Cause ("Sullivan OTSC Aff.") ¶¶ 6-7, Ex. A § 2.26, Ex. B.) SMCI and TSG then merged, with TSG being the surviving corporation. (Netwolves Am. Compl. ¶ 3; Sullivan Compl. ¶ 50.) Concurrently, and in connection with the merger, the Sullivan Parties acquired approximately 3% of the common stock of TSG. (Netwolves Am. Compl. ¶ 3; Sullivan Compl. ¶ 51.) The remaining 97% of TSG's common stock is owned by Netwolves. (Netwolves Am. Compl. ¶ 3; Mem. of Law, in Opp. to Pls.' Mot to Dismiss the Am. Compl. for Lack of Subject Matter Jurisdiction ("Netwolves 12(b)(1) Mem.") at 5.) At the same time and in connection with the merger, Mr. Sullivan received 250,000 shares of TSG preferred stock (convertible into Netwolves stock) as compensation for certain sums owed him by SMCI. (Sullivan Compl. ¶ 51; Sullivan OTSC Aff. ¶ 8.) Mr. Sullivan converted the TSG preferred stock into Netwolves common stock in January 2000. (Sullivan OTSC Aff. ¶ 8-9.)
In addition, the Sullivan Parties and Netwolves entered into a shareholders agreement at the time of the merger. Among other things, the agreement set forth certain terms relating to the management of TSG and obligated Netwolves to make capital contributions to TSG of as much as $4,700,000. (Netwolves Am. Compl. ¶ 16; Sullivan Compl. ¶ 52.) In the shareholders agreement, Netwolves and the Sullivan Parties agreed that TSG would have a five-member board of directors, with three directors designated by Netwolves and two directors designated by the Sullivan Parties. (Netwolves Am. Compl. ¶ 17; Sullivan Compl. ¶ 52.) Finally, the Sullivan Parties entered into employment agreements with TSG. (Sullivan Compl. ¶ 55.)
B. TSG Post-Merger
Beyond the basic facts discussed above, the parties submit very different versions of the facts.
1. Netwolves' Account
According to Netwolves, during the time of the merger negotiations between Netwolves and SMCI, Mr. Sullivan was also negotiating a transaction between ProCare, a company in which he held a controlling interest, and BP Amoco. (Netwolves Am. Compl. ¶ 18.) After the SMCI-TSG merger was effected, Mr. Sullivan concluded the ProCare-BP Amoco transaction, an opportunity which allegedly belonged to TSG. ( Id. ¶¶ 19-20.) Thereafter, in violation of his employment agreement with TSG, Mr. Sullivan performed various services for ProCare. In addition, in exchange for participation or equity interests in ProCare, the other Sullivan Parties also performed various services for ProCare, in violation of their respective employment agreements with TSG. ( Id. ¶¶ 21-24.) When Netwolves personnel, including the Netwolves-designated directors of TSG, learned of the ProCare-BP Amoco transaction in August 1999, they required the Sullivan Parties to reaffirm, and abide by, the terms of their respective employment contracts. Messrs. Cunningham, Collins, Molloy, and Phelan were also required to divest themselves of any equity interests in ProCare. ( Id. ¶ 25.) Nonetheless, the Sullivan Parties continued to perform services for ProCare, in violation of their employment agreements with TSG. ( Id. ¶ 26.) The Sullivan Parties also permitted ProCare, and other companies in which Mr. Sullivan held ownership interests (the "Sullivan Companies"), to use TSG's personnel, facilities, equipment, and utility services. ProCare and the Sullivan Companies also charged certain operating expenses to TSG. ( Id. ¶¶ 26-27.) ProCare and the Sullivan Companies were also permitted by the Sullivan Parties to use certain proprietary information or technology owned by TSG or Netwolves. ( Id. ¶ 27.) All of this was actively concealed by the Sullivan Parties and the unnamed "Jane and John Doe" defendants, who, among other things, falsified and destroyed business records to cover their tracks. ( Id. ¶ 28.)
From the SMCI-TSG merger forwards, Netwolves claims, TSG has experienced substantial operating losses and exhausted the capital provided by Netwolves. ( Id. ¶ 30.) On or about November 14, 2000, Netwolves notified TSG that Netwolves would cease to voluntarily provide additional capital to TSG unless TSG's board adopted and implemented a plan to alter TSG's operations in certain ways. ( Id. ¶ 31.) A special TSG board of directors meeting was scheduled, but the two Sullivan-designated directors refused to attend. ( Id. ¶¶ 31-32.) Without at least one of those two directors, the board lacked a quorum. ( Id. ¶ 11.) Nonetheless, the three Netwolves-designated directors purported to adopt certain changes in TSG's business. (Netwolves Am. Compl. ¶ 31.) The Sullivan Parties refused to implement the resolutions passed by the three Netwolves-designated directors, and threatened to sabotage TSG's operations. ( Id. ¶¶ 32-33.)
2. The Sullivan Parties' Account
Not surprisingly, the Sullivan Parties have a very different view of events since the merger. The Sullivan Parties assert that, sometime after the SMCI-TSG merger, they discovered, and Netwolves admitted, that Netwolves' Internet products could not perform in the manner represented by Netwolves personnel during the merger negotiations. (Sullivan Compl. ¶¶ 56-72.) In fact, some of the Internet products or technologies did not, and do not, exist. ( Id.) The Sullivan Parties also discovered that certain transactions described by Netwolves during the merger negotiations were neither planned nor anticipated. ( Id. ¶ 73.) Mr. Groteke and Mr. Stephens also are alleged to have violated a representation to the Sullivan Parties by selling shares of Netwolves stock during the time that the Sullivan Parties were restricted from selling their shares. ( Id. ¶ 74.) Netwolves and its personnel also failed to provide the Sullivan Parties with operational control of TSG. Instead, Netwolves forced TSG to relinquish control of TSG's books and records, and sought to undermine TSG's existence as a separate corporation. ( Id. ¶¶ 77-78.) Netwolves also attempted to misuse TSG's financial information for Netwolves' own purposes. ( Id. ¶¶ 79-80.) In August 2000, Netwolves sought to cause TSG to abandon its own business activities and focus instead on selling one of Netwolves' Internet products. ( Id.) In November 2000, after learning that the Sullivan Parties had retained counsel, Netwolves terminated all of TSG's employees, terminated funding of TSG, and terminated TSG's operations. As part of these efforts, Netwolves, among other things, stopped payment on certain payroll checks. ( Id. ¶¶ 82-83.)
III. PROCEDURAL POSTURE
On November 22, 2000, Netwolves and TSG filed the Netwolves Action. On December 13, 2000, the Sullivan Parties wrote to the Court seeking leave to serve a motion to dismiss the complaint. The Court lacked subject matter jurisdiction, the Sullivan Parties argued, because TSG has its principal place of business in Connecticut, where Messrs. Sullivan, Cunningham, Phelan, and Collins all reside. (Letter from Brian C. Wille to the Court dated Dec. 13, 2000.) On December 14, 2000, Netwolves filed its amended complaint, styling the litigation as a derivative action, with TSG aligned as a nominal defendant. (Netwolves Am. Compl.) The amended complaint asserts claims for, among other things, misappropriation of corporate assets and opportunities, breach of fiduciary duty, breach of contract, conversion, and unjust enrichment. ( Id. ¶¶ 36-73.) On December 19, 2000, the Sullivan Parties filed the Sullivan Action. (Sullivan Compl.) The complaint asserts claims for, among other things, violations of the Securities Exchange Act of 1934 and the regulations promulgated thereunder, fraud, and breach of contract. ( Id. ¶¶ 84-114.)
On January 22, 2001, the Sullivan Parties moved to dismiss the Netwolves Action, pursuant to Rule 12(b)(1). They contend that the Court lacks subject matter jurisdiction because TSG should be realigned as a plaintiff, thereby eliminating diversity of citizenship. (Mem. of Law. in Supp. of Defs.' Mot. to Dismiss the Am. Compl. for Lack of Subject Matter Jurisdiction ("Sullivan 12(b)(1) Mem.") at 10-18.) Also on January 22, 2001, ProCare joined in the Sullivan Parties' motion. (ProCare Mem. of Law. in Supp. of Mot. to Dismiss the Am. Compl.) On March 1, 2001, Netwolves moved to dismiss the Sullivan Action, pursuant to Rule 13(a). Netwolves argues that the Sullivan Action consists of compulsory counterclaims that were required to be asserted in the Netwolves Action. (Mem. of Law in Supp. of Defs.' Mot. to Dismiss the Compl. Pursuant to Fed.R.Civ.P. 13(a) ("Netwolves 13(a) Mem.") at 6-10.) On April 6, 2001, the Sullivan Parties brought, by order to show cause, a motion for a preliminary injunction. They seek an injunction compelling Netwolves and Mr. Groteke, as president of Netwolves, to instruct Netwolves' counsel to issue an opinion letter stating that the Netwolves stock held by the Sullivan Parties may be sold. Such an opinion letter is necessary for compliance with applicable laws and regulations because the stock is unregistered. (Mem. of Law in Supp. of Application for Order to Show Cause ("Sullivan OTSC Mem.").) On April 12, 2001, the Court held a conference on the order to show cause and set a briefing schedule for the injunction motion. All three motions are now fully briefed. The Court will consider each in turn.
IV. THE RULE 12(B)(1) MOTION
The issue here is whether there is complete diversity of citizenship, such that this Court has subject matter jurisdiction. On the facts alleged, the presence or absence of diversity turns upon whether TSG is aligned as a plaintiff or a defendant. The Court finds, as set forth below, that TSG is properly aligned as a plaintiff. Accordingly, the Court concludes that it must dismiss the Netwolves Action pursuant to Rule 12(b)(1).
Subject matter jurisdiction in the Netwolves Action is alleged under 28 U.S.C. § 1332. (Netwolves Am. Compl. ¶ 11.) Section 1332(a) provides, in pertinent part, that, "[t]he district courts shall have original jurisdiction of all civil actions where the matter in controversy exceeds the sum or value of $75,000, exclusive of interest and costs, and is between . . . citizens of different states. . . ." 28 U.S.C. § 1332 (a)(1). It is well established that this section requires "complete diversity," i.e. that no plaintiff be a citizen of the same state as any defendant. See Doctor's Associates, Inc. v. Distajo, 66 F.3d 438, 445 (2d Cir. 1995) (citing, inter alia, Strawbridge v. Curtiss, 7 U.S. (3 Cranch) 267, 267, 2 L.Ed. 435 (1806), overruled on other grounds, 43 U.S. (2 How.) 497, 555, 11 L.Ed. 353 (1844)). The Sullivan Parties and Procare do not dispute that the amount in controversy in the Netwolves Action exceeds $75,000. Rather, they argue that there is an absence of complete diversity. (Sullivan 12(b)(1) Mem. at 10-18.)
As noted above, four of the Sullivan Parties are citizens of Connecticut and one is a citizen of New Jersey. See supra p. 3. As for the corporate parties, § 1332(c) provides, in pertinent part, that, "a corporation shall be deemed to be a citizen of any State by which it has been incorporated and of the State where it has its principal place of business. . . ." 28 U.S.C. § 1332 (c)(1). Under that section, Netwolves is a citizen of New York, ProCare is a citizen of Ohio, and TSG is a citizen of both Delaware and Connecticut. See supra pp. 2-3. Accordingly, complete diversity exists if, and only if, TSG and the four Sullivan Parties who reside in Connecticut are aligned on the same side of the controversy.
How then to align TSG? The general rule in shareholders' derivative actions is that the corporation is properly aligned as a plaintiff because the corporation is the real party in interest. Duffey v. D.C. Wheeler, 820 F.2d 1161, 1163 (11th Cir. 1987) (citing Koster v. Lumbermens Mutual Casualty Co., 330 U.S. 518, 522-23, 67 S.Ct. 828, 831, 91 L. Ed. 1067 (1947)); Cohen v. Heussinger, No. 89 Civ. 6941 (SS), 1994 WL 240378, at *2 (S.D.N.Y. May 26, 1994) (citing Duffey); ZB Holdings, Inc. v. White, 144 F.R.D. 42, 45 (S.D.N.Y. 1992) (same). There is an exception to the general rule, however, for those situations in which aligning the corporation as a plaintiff would not provide a "real collision" of interests. Smith v. Sperling, 354 U.S. 91, 97, 77 S.Ct. 1112, 1116, 1 L.Ed.2d 1205 (1957); Cohen, 1994 WL 240378, at *2 (citing Sperling); ZB Holdings, 144 F.R.D. at 45 (same). "In other words, `the final alignment of the parties should reflect the actual antagonisms between the plaintiffs, the corporation, and the directors.'" ZB Holdings, 144 F.R.D. at 45 (quoting Liddy v. Urbanek, 707 F.2d 1222, 1224 (11th Cir. 1983)). "Whenever the management refuses to take action to undo a business transaction or whenever . . . it so solidly approves it that any demand to rescind would be futile, antagonism is evident." Sperling, 354 U.S. at 97, 77 S.Ct. at 1115-1116, 1 L.Ed.2d 1205. Whether antagonism is evident "is a practical not a mechanical determination and is resolved by the pleadings and the nature of the dispute." Id. at 97, 77 S.Ct. at 1116, 1 L. Ed.2d 1205.
Netwolves alleges in its amended complaint, in pertinent part, that:
TSG is properly named as a nominal defendant herein because defendants Cunningham and Sullivan and the three directors of TSG designated by the plaintiff Netwolves, who collectively comprise the five member board of directors of TSG, are so divided in interest respecting the management of the affairs of TSG that the vote ostensibly required for this action by the Board of Directors cannot be obtained because of the provision in TSG's bylaws that four directors are required to be present to constitute a quorum for the transaction of business. . . .
(Netwolves Am. Compl. ¶ 11.) According to Netwolves, this division of interest, combined with the allegations of wrongdoing by the Sullivan Parties and the refusal of Mr. Cunningham and Mr. Sullivan to attend board meetings, shows that TSG is antagonistic to this lawsuit. (Netwolves 12(b)(1) Mem. at 11-15.) The Sullivan Parties, on the other hand, argue that the amended complaint alleges only deadlock, not antagonism, and that deadlock does not justify applying the Sperling exception and naming the corporation as a defendant. (Sullivan 12(b)(1) Mem. at 13-16.)
Sperling and subsequent cases that have found antagonism involved situations where a majority of the corporation's management have either refused to consent to the derivative action or would clearly refuse if asked. In Sperling, for example, the plaintiff charged that the corporation had wasted assets by entering into contracts for the benefit of the son-in-law of one of the corporation's directors. 354 U.S. at 92, 77 S.Ct. at 1113. All or a majority of the directors had allegedly approved the contracts in question, 354 U.S. at 92, 77 S.Ct. at 1113; the Supreme Court concluded that demand on the board would be futile, demonstrating antagonism. 354 U.S. at 97, 77 S.Ct. at 1115-16. In the companion case to Sperling, Swanson v. Traer, 354 U.S. 114, 77 S.Ct. 1116, 1 L.Ed.2d 1221 (1957), the Supreme Court found antagonism where the plaintiffs alleged in the complaint that they had made demand on the directors to bring suit, but the board refused. 354 U.S. at 115-16, 77 S.Ct. at 1117-18. Similarly, in Rogers v. Valentine, 426 F.2d 1361, 1363 (2d Cir. 1970), the Second Circuit found antagonism where the board had refused a demand to bring suit on behalf of the corporation and further demand would have been futile. In ZB Holdings, the court found antagonism where the complaint alleged fraud and misrepresentation against the "controlling shareholders or dominant officials of the corporation." 144 F.R.D. at 46; see also Reilly Mortgage Corp. v. Mount Vernon Savings Loan Ass'n, 568 F. Supp. 1067, 1073 (E.D. Va. 1983) (antagonism found where "[t]he complaint alleges that the corporation's controllers failed to remedy improper activities, failed to permit stockholders' efforts to compel remedies, and uniformly approved activities to both the corporation's and the stockholders' detriment.)
Netwolves cites (Netwolves 12(b)(1) Mem. at 11) Mukamal v. Occidental Petroleum Co, No. 67 Civ. 3291 (ELP), 1976 U.S. Dist. LEXIS 13246 (S.D.N.Y. Sept. 14, 1976) for the proposition that the "pivotal fact" in Sperling and its companion case was that "the complaint alleged personal conflicts of interest and wrongdoing on the part of some managers of the corporation." Id. at *8 (emphasis added). This Court believes that the allegation of conflicts of interest or wrongdoing on the part of a majority of the managers is the key point. Cf. Sperling, 354 U.S. at 92, 77 S.Ct. at 1113 (all or a majority of the directors had approved the transactions at issue). Where only a minority of managers is accused, the majority can vote to have the corporation sue that minority, and no antagonism exists. See, e.g., Nejmanowski v. Nejmanowski, 841 F. Supp. 864 (C.D. III. 1994).
In contrast, antagonism has generally not been found where the corporation does not, would not, or cannot express opposition to the initiation of the lawsuit. For example, in Lewis v. Odell, 503 F.2d 445 (2d Cir. 1974), the plaintiff alleged that a director of the corporation had used inside information to benefit himself. Due to a lack of diversity, plaintiff sought to amend the complaint. In the interim, however, the corporation had gone into bankruptcy. At the time plaintiff sought amendment, the corporation was being run by bankruptcy trustees. The Second Circuit ruled that, at the time of the amendment, there was no antagonism because the trustees had not refused a demand for litigation, were not accused of any wrongdoing, and reserved their right to take over the litigation. Id. at 446-47; see also Liddy, 707 F.2d at 1224-25 (no antagonism where plaintiff was controlling official and 50% shareholder); Nejmanowski v. Nejmanowski, 841 F. Supp. 864 (C.D. Ill. 1994) (no antagonism where plaintiff and one of the other two directors favored the lawsuit and could have caused corporation to sue third director); Taylor v. Swirnow, 80 F.R.D. 79 (D. Md. 1978) (no antagonism where trustee of bankrupt corporation did not oppose suit, plaintiffs controlled majority of stock, and defendants were not in control of corporation at time of suit).
In Kartub v. Optical Fashions, 158 F. Supp. 757 (S.D.N.Y. 1958), Judge Edelstein found no antagonism where one director had died and the other two had resigned. The court ruled that, where the corporation was unable to act, it could not be considered antagonistic such that there was a collision of interests between the plaintiff and the corporation. Id. at 758-59. Absent a collision of interests, the general rule of aligning the corporation as a plaintiff applied. Id. at 759.
The rationale of Kartub has been applied to cases where the corporation cannot act for itself due to a deadlock between shareholders. In Duffey, for example, plaintiff owned 17.5% of the corporation's stock and defendant owned 77.5%. Those two individuals were the corporation's only directors. The corporation's by-laws required a quorum of 85% of the stock for a shareholders meeting. 820 F.2d at 1162. Since the corporation was deadlocked between plaintiff and defendant, the Eleventh Circuit found that the corporation was not "`actively antagonistic'" to plaintiff's lawsuit, such that the corporation should be aligned as a defendant. Id. at 1163 (quoting Swanson). In Cohen, then-District Judge Sotomayor ruled that there was no antagonism where plaintiff and defendant each owned half of the corporation and plaintiff did not allege that defendant controlled the corporation. 1994 WL 240378, at *2. A similar result was reached in Gibson v. BoPar Dock Co., 780 F. Supp. 371 (W.D. Va. 1991). There, the court found no antagonism because the plaintiff and others who favored the litigation had the ability to take control of the corporation. Id. at 374. In the alternative, the court found that, if plaintiff and her allies could not take control, the shareholders of the corporation were evenly divided and deadlocked. As a result, the corporation was not actively opposed to the litigation, but simply unable to act. Id. at 375.
Under the precedents outlined above, the facts alleged here show that TSG should be aligned as a plaintiff. The amended complaint in the Netwolves Action alleges that Netwolves designates 3 out of 5 TSG directors and owns 97% of TSG's common stock. The Sullivan Parties designate 2 TSG directors and own only 3% of TSG's common stock. See supra pp. 4-5. Even though the amended complaint alleges causes of action against two TSG directors, if the question of whether to sue the Sullivan Parties was to be put to a vote, TSG's management, i.e. its board of directors, would obviously vote to litigate. These facts distinguish the Netwolves Action from cases such as Sperling and ZB Holdings, in which a majority of the corporation's management was accused of wrongdoing and would have opposed litigation.
Given the facts alleged here, and the persuasive reasoning set forth in Nejmanowski, 841 F. Supp. at 866, the Court believes that TSG's board of directors is the management" of TSG for the purposes of determining whether TSG is hostile to the Netwolves Action.
Netwolves alleges, however, that it cannot put the question to a vote because the two Sullivan-designated TSG directors, Mr. Sullivan and Mr. Cunningham, refuse to attend board meetings, thereby preventing the presence of a quorum. (Netwolves Am. Compl. ¶ 11, 31-32.) Netwolves claims this constitutes antagonism on the the part of the corporation. (Netwolves 12(b)(1) Mem. at 12-15.) The Court finds, however, that this is not antagonism, but deadlock. Based on the facts in the amended complaint, the corporation would not vote against this action; it simply cannot vote. As noted above, a corporation that cannot act, a deadlocked corporation, is not considered "actively antagonistic" to a lawsuit, within the meaning of Sperling and Swanson, because the corporation has not refused to sue, and will not clearly refuse to sue if it becomes able to render a decision. See, e.g., Duffey, 820 F.2d at 1162-63; Cohen, 1994 WL 240378, at *2. Absent active antagonism, courts apply the general rule that a corporation is aligned as a plaintiff in a derivative action.
In seeking a finding of antagonism, Netwolves cites two cases that seemingly found antagonism where co-equal shareholders were opposed to each other: Ono v. Itoyama, 884 F. Supp. 892 (D.N.J. 1995), aff'd 79 F.3d 1138 (3d Cir. 1996) (table without opinion) and Sonn v. Korein, No. 88 Civ. 1014 (CSH), 1988 WL 52838 (S.D.N.Y. 1988). (Netwolves 12 (b)(1) Mem. at 13-14, 18-19.) In Ono, plaintiff and defendant each owned 50% of the corporation's stock. Plaintiff and defendant were also the corporation's only directors. 884 F. Supp. at 893. The complaint specifically alleged, however, that defendant had taken control of the corporation through a pattern of fraud and extortion. Id. at 900. Plaintiff alleged that defendant had caused both plaintiff and the corporation to become financially dependent on him and then threatened to cut off financial support if plaintiff did not acquiesce to defendant's sexual demands. Id. at 894. Plaintiff had further alleged that defendant had obtained title to the corporation-owned apartment in which plaintiff lived and then evicted plaintiff. Id. Based upon these allegations of fraudulent and extortionate conduct, and the resulting domination of the corporation by defendant, the court distinguished Duffey, Cohen, and Gibson. It concluded that the corporation was not neutral or deadlocked, but was antagonistic to plaintiff's lawsuit. The amended complaint in the Netwolves Action contains no allegations that would support a finding that the Sullivan Parties dominated TSG, such that TSG is antagonistic to the Netwolves Action. Ono is thus distinguishable from the Netwolves Action.
Sonn is somewhat more favorable to Netwolves. In that case, the court ruled that "[blecause the complaint alleges that one of the two general partners has harmed the Partnership, and that partner's assent would be necessary before any action to redress the alleged harm could be undertaken, I find that the requisite antagonism exists in this case." 1988 WL 52838. As to Sonn, however, the court subsequently granted reargument and, in so doing, specifically cited the decisions in Lewis and Kartub, stating that the issue was whether the facts of Sonn were analogous to the facts of Lewis or Kartub. Sonn v. Korein, No. 88 Civ. 1014 (CSH), 1988 WL 100221 (Sept. 21, 1988). The decision on reargument is neither published nor available on Westlaw or Lexis. The only other available decision in that case holds that the action must be dismissed because, whether the partnership was a plaintiff or a defendant, complete diversity was absent under a then-new Supreme Court decision concerning the citizenship of partnerships. Sonn v. Korein, No. 88 Civ. 1014 (CSH), 1990 WL 80045 (S.D.N.Y. June 6, 1990). Thus, the decision relied upon by Netwolves may no longer be good law. To the extent it is still good law, this Court believes Sonn is distinguishable because, unlike Sonn, this is not a case in which the defendants' votes are required for the corporation to sue. Here, the corporation simply needs the defendants to appear at a board meeting so that there will be a quorum. Moreover, to the extent Sonn is not distinguishable, the Court adopts the position of Judge Sotomayor in Cohen. Absent evidence of hostility to the litigation, such as refusal of a demand for suit (as in Swanson) or approval by a majority of directors of the challenged actions (as in Sperling), this Court finds that the general rule of aligning the corporation as a plaintiff applies. Here the general rule applies because the allegations of the amended complaint show that, but for the present deadlock, the corporation would approve the lawsuit. Cf. Dowd v. Front Range Mines, Inc., 242 F. Supp. 591, 593 (D. Colo. 1965). This Court finds, as judges of this District have held in Kartub and Cohen, that the inability to vote on whether to oppose or support a lawsuit is not, by itself, sufficient to warrant a finding of antagonism under Sperling or Swanson. Such an inability to act is, however, the most that Netwolves has alleged here.
For the reasons set forth above, this Court finds that TSG is not actively antagonistic to this lawsuit, and so should be aligned as a plaintiff. With TSG aligned as a plaintiff, there is not complete diversity because a plaintiff and several defendants are all citizens of Connecticut. Accordingly, this Court lacks subject matter jurisdiction over the Netwolves Action and, therefore, grants the Sullivan Parties' and ProCare's motion to dismiss pursuant to Rule 12(b)(1).
V. THE RULE 13(A) MOTION
The issue as to whether the Sullivan Parties were obligated to assert their claims as counterclaims against Netwolves, TSG, and Messrs. Groteke, Stephens, Castle, and Blackman in the Netwolves Action, rather than in the separately-filed Sullivan Action, is moot for the reason that the Court has granted the motion to dismiss the Netwolves Action for lack of subject matter jurisdiction. Accordingly, Netwolves' motion to dismiss the Sullivan Action pursuant to Rule 13(a) is denied.
VI. THE RULE 65 MOTION
The issue here is whether the Sullivan Parties meet the standard for a preliminary injunction. For the reasons set forth below, the Court finds both a clear entitlement to the requested relief and a showing of irreparable harm if the relief is not granted; accordingly, the Sullivan Parties are entitled to a preliminary injunction.
As described above, each of the Sullivan Parties received certain shares of Netwolves stock in connection with the SMCI-TSG merger. See supra pp. 4, 5. After these actions were filed, and after the 18-month holding period imposed by the merger agreement expired in January 2001, the Sullivan Parties retained Prudential Securities to sell some of their Netwolves shares. (Sullivan OTSC Aff. ¶ 10.) The stock certificates representing those shares all bear a legend indicating that the shares are not registered with the SEC and may not be sold, transferred or assigned without SEC registration or an opinion of Netwolves' counsel. ( Id. Ex. B.) Because the shares in question have never been registered with the SEC. Prudential sought opinion letters from Netwolves' counsel stating that the shares could be sold legally. (Sullivan OTSC Aff. ¶¶ 11, 15; Aff. of Melinda O'Donnell dated Apr. 17, 2001 ("O'Donnell Aff.") Ex. A.) Netwolves counsel refused to provide the opinion letters. (Aff. of Edward S. Wactlar dated Apr. 18, 2001, Ex. A.) The Sullivan Parties now seek an injunction compelling Netwolves and its president to instruct Netwolves' counsel to provide the opinion letters required for the sale of the Sullivan Parties' Netwolves stock.
To obtain a preliminary injunction, a party ordinarily must show "(a) that it will suffer irreparable harm in the absence of an injunction and (b) either (i) a likelihood of success on the merits or (ii) sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly in the movant's favor." Tom Doherty Assocs., Inc. v. Saban Entm't, Inc., 60 F.3d 27, 33 (2d Cir. 1995). However, where the injunction would alter, rather than preserve, the status quo, the party seeking the injunction must meet a higher standard. Id. at 33-34. Specifically, with respect to the second prong of the injunction standard, the movant must make a "clear showing that [it] is entitled to the relief requested." Id. at 34. Here, the Sullivan Parties must meet the higher standard because the injunction they request would alter the status quo. At present, the Sullivan Parties hold Netwolves stock that they are unable to sell. The injunction would compel Netwolves to provide opinions of counsel that would permit the Sullivan Parties to sell that stock. Such a sale would, by definition, mean that the Sullivan Parties no longer held the stock, thereby altering the present state of affairs. Accordingly, to obtain the requested injunction, the Sullivan Parties must show a clear entitlement to the opinions of counsel and that they will be irreparably harmed if they do not receive those opinions.
Netwolves argues that, under the Supreme Court's decision in Grupo Mexicano de Desarrollo, S.A. v. Alliance Bond Fund, Inc., 527 U.S. 308, 119 S.Ct. 1961, 144 L.Ed.2d 319 (1999), the Court lacks the authority to issue the requested injunction. (Netwolves OTSC Mem. at 11-12.) "The issue, in Grupo Mexicano, was "whether, in an action for money damages, a United States District Court has the power to issue a preliminary injunction preventing the defendant from transferring assets in which no lien or equitable interest is claimed.'" Traffix, Inc. v. Talk.com Holding Corp., No. 00 Civ. 9802 (AKH), 2001 U.S. Dist. LEXIS 1200, at *6 (S.D.N.Y. Feb. 13. 2001) (quoting Grupo Mexicano, 527 U.S. at 310). Grupo Mexicano and Traffix are entirely inapplicable here because the Sullivan Parties do not seek an injunction concerning any assets of any defendant in the Sullivan Action; the injunction concerns the Sullivan Parties' own assets. Accordingly, the Court may grant the injunction if it is warranted.
A. Clear Showing of Entitlement
Netwolves does not dispute that, under N.Y. U.C.C. § 8401, an issuer is obligated to provide an opinion of counsel unless it has reasonable grounds for refusing to do so. Rather, Netwolves claims that it has two reasonable grounds for refusing the Sullivan Parties' request for the opinion of counsel. (Mem. of Law. in Opp. to Pls.' Application for an Order to Show Cause Regarding the Issuance of Opinion Letters Authorizing the Transfer of Netwolves Stock ("Netwolves OTSC Mem.") at 17-24. First, Netwolves contends that it was entitled to withhold the opinion because Netwolves had a claim in the Netwolves Action for rescission of the stock. (Netwolves OTSC Mem. at 17-18.) Whatever the legal merits of this position, the Court has dismissed the Netwolves Action for lack of subject matter jurisdiction. See supra Section IV. As a result, there is now no pending claim for rescission.
Netwolves' second argument is that the intended sales of stock are impermissible under SEC Rule 144, 17 C.F.R. § 230.144. Specifically, Netwolves argues that the Sullivan Parties are subject to the aggregation rule of Rule 144(e)(3)(vi). (Netwolves OTSC Mem. at 18-24.) Rule 144 "is designed to prohibit the creation of public markets in securities of issuers concerning which adequate current information is not available to the public." 17 C.F.R. § 230.144, Preliminary Note. Where sufficient information is available, however, "the rule permits the public sale in ordinary trading transactions of limited amounts of securities owned . . . by persons who have acquired restricted securities of the issuer." Id. Restricted securities are defined, in relevant part, as "[slecurities acquired directly or indirectly from the issuer . . . in a transaction . . . not involving any public offering." 17 C.F.R. § 230.144 (a)(3)(i). The Sullivan Parties' stock meets this definition because the shares were acquired from the issuer, Netwolves, as part of the SMCI-TSG merger, which did not involve a public offering of any securities. See supra pp. 4-5.
Under Rule 144, several requirements must be met for a sale of restricted securities. First, there must be "adequate current public information" about the issuer. 17 C.F.R. § 230.144 (c). This requirement is met because Netwolves has been subject to the reporting requirements of section 13 of the Securities Exchange Act of 1934 since at least June 2000. (Aff. of Caroline Rule in Supp. of Application for Order to Show Cause ("Rule OTSC Aff.") Ex. E.) Second, the securities must have been held for at least one year. 17 C.F.R. § 230.144 (d). This requirement is met because the Sullivan Parties have held their Netwolves stock since at least January 24, 2000. (Sullivan OTSC Aff. ¶ 9, Ex. B.) It is undisputed that the Sullivan Parties also have met the requirements of selling in "brokers' transactions" as defined in the Securities Act of 1933 and Rule 144(g), 17 C.F.R. § 230.144 (f). It is also undisputed that the Sullivan Parties have filed a notice of the proposed sale, 17 C.F.R. § 230.144 (h), and have a bona fide intention to sell. 17 C.F.R. § 230.144 (i).
At issue here are the limitations on the amount of securities that may be sold. 17 C.F.R. § 230.144 (e). Netwolves claims that the Sullivan Parties are required to aggregate their sales for purposes of determining the applicable limitations, pursuant to Rule 144(e)(3)(vi). (Netwolves OTSC Mem. at 18-20.) Since Prudential Securities requested that Netwolves' counsel opine that the Sullivan Parties are not required to aggregate their sales, Netwolves argues that it was not required to have its counsel issue any opinion of counsel. ( Id. at 18-24.) Even assuming that the Sullivan Parties are subject to the aggregation requirements of Rule 144(e)(3)(vi), however, that does not entitle Netwolves to deny any opinion of counsel. If the Sullivan Parties are subject to the aggregation requirements of Rule 144(e)(3)(vi). that simply means that the maximum number of shares they may collectively sell within any three-month period is limited under Rule 144(e). 17 C.F.R. § 230.144 (e). The Sullivan Parties are clearly entitled to sell up to that limit. Id. Even if Netwolves' counsel cannot provide precisely the opinion that Prudential Securities requested, it can provide an opinion letter stating that the Sullivan Parties may sell their stock subject to any applicable quantity limitations imposed by Rule 144(e). Given their entitlement to sell, subject to any applicable limitations, the Sullivan Parties are clearly entitled to such an opinion.
B. Irreparable Harm
If the Sullivan Parties do not receive the injunctive relief they seek, and so do not receive an opinion of counsel enabling them to sell their stock, they claim that they may ultimately be unable to recover any value for the stock. (Sullivan OTSC Mem. at 17-19.) Normally this type of injury is not considered irreparable, as it may be remedied by an award of monetary damages. However, where the defendant is insolvent, or may become insolvent during the pendency of the litigation, monetary injury is deemed irreparable because the plaintiff may never be able to recover damages. See, e.g., Federated Strategic Income Fund v. Mechala Group Jamaica Ltd., No. 99 Civ. 10517 (HB), 1999 WL 993648, at *8 (S.D.N.Y. Nov. 2, 1999); Catherines v. Copytele, Inc., 602 F. Supp. 1019, 1027 (E.D.N.Y. 1985).
Here, the Sullivan Parties have presented evidence that from its inception in February 1998 to the present, Netwolves has never shown a profit. (Rule OTSC Aff. Exs. E, F.) From June 30, 2000 to December 31, 2000 (the last period for which financial information was submitted to the Court), Netwolves' identifiable assets fell by almost 50%, from $25,543,130 to $13,869,710. (Rule OTSC Aff. Ex. F at 6.) Netwolves' cash and cash equivalents also fell by almost half during the latter half of 2000, from $20,200,000 to $10,600,000. ( Id. at 13.) During the same six-month period, Netwolves had an operating loss of $11,772,438 and revenues of $1,023,831. ( Id. at 6.) As of December 31, 2000, Netwolves had an accumulated deficit of $42,648,753. ( Id. at 1.) Other information in the company's SEC filings also show that Netwolves faces serious financial difficulties, despite management's positive projections. ( See generally Rule OTSC Aff. Exs. E, F.) In addition, the price of Netwolves stock has dropped dramatically. In July 1999, shortly after the SMCI-TSG merger, Netwolves stock was trading at or about $30.00 a share. (Reply Aff. of Caroline Rule in Further Supp. of Application for Order to Show Cause Ex. C.) Today, according to information obtained by the Court from the New York Times' website, http://www.nyt.com, Netwolves stock is trading at approximately $3.00 a share. ( See printouts attached as Appendix 1.) This is down from a high within the last year of almost $12.00. ( See id.) The stock is also down approximately 50% from the time the Sullivan Parties requested the opinions of counsel. (Rule OTSC Aff. Ex. B; Aff. of Peter Castle dated Apr. 20, 2001, Ex. B.) While there has clearly been some fluctuation in the price of Netwolves stock, there is no question that the stock has significantly decreased in value. In circumstances similar to these, courts have found that the defendant may become insolvent during the pendency of the litigation, and that monetary injury is, therefore, irreparable. See Catherines, 602 F. Supp. at 1027; Shearson Lehman Hutton Holdings, Inc. v. Coated Sales, Inc., 697 F. Supp. 639, 642 (S.D.N.Y. 1988) (Leval, J.). Accordingly, the Court finds that the Sullivan Parties have shown irreparable injury.
Netwolves argues that there can be no irreparable harm because the Sullivan Parties delayed in seeking an injunction. According to Netwolves, approximately six weeks elapsed between the time Netwolves' counsel refused to issue the opinion letter and the date the Sullivan Parties initiated the Rule 65 motion. (Netwolves OTSC Mem. at 15-16.) The Court does not believe that any such delay negates a finding of irreparable injury. Six weeks is not an unreasonable time for the Sullivan Parties to have investigated the legal merits of this motion, investigated Netwolves' financial condition, and drafted their moving papers. In addition, any alleged delay did not prejudice or harm Netwolves in any manner.
For the reasons set forth above, the Sullivan Parties have demonstrated irreparable injury and clear entitlement to the relief they request, at least in so far as they seek an opinion of counsel permitting them to sell their stock subject to any applicable quantity limitations in Rule 144. Accordingly, Netwolves and Mr. Groteke, as Netwolves' president, are hereby enjoined to instruct Netwolves' counsel without delay to issue an opinion letter permitting Messrs. Sullivan, Cunningham, Collins, Phelan, and Molloy to sell their Netwolves stock subject to any applicable restrictions in Rule 144(e). As security, pursuant to Rule 65(c), Messrs. Sullivan, Cunningham, Collins, Phelan, and Molloy are hereby ordered to deposit the proceeds of any sale(s) of Netwolves stock into escrow with their legal counsel in New York City. Such proceeds shall remain in escrow with such attorneys until such time as the Court orders otherwise.
VII. CONCLUSION
For the reasons set forth above, the motion by the Sullivan Parties and ProCare to dismiss the Netwolves Action pursuant to Fed.R.Civ.P. 12 (b)(1) is granted; the motion by Netwolves to dismiss the Sullivan Action pursuant to Fed.R.Civ.P. 13(a) is denied; and the motion by the Sullivan Parties for a preliminary injunction pursuant to Fed.R.Civ.P. 65 is granted to the extent set forth above. The Clerk of the Court is directed to close the file in 00 Civ. 8943 (AGS).
SO ORDERED.