SIDNEY A. FITZWATER, District Judge.
In this action arising from defendants' alleged misrepresentations and breach of contract in connection with plaintiff Scott Ginsburg's ("Ginsburg's") investment in defendants' medical marijuana
In December 2015 defendant ICC Holdings, LLC ("ICC") and its Chief Executive Officer, defendant Tim McGraw ("McGraw"), contacted Ginsburg to solicit funding to support their medical marijuana business.
Following Ginsburg's receipt of the PPM, he asked McGraw whether ICC would prepare and provide him a copy of audited financial statements. McGraw responded that ICC's bank required audited financial statements and that he would provide copies of them to Ginsburg as they were prepared.
In February 2016 McGraw and ICC sought additional funding from Ginsburg. In a February 4, 2016 email to Ginsburg, McGraw stated: "[t]he Holland deal is ours now. Revolution [an operating arm of ICC] will take operating control. . . Moral of the story is that we are in the driver[']s seat." Id. at ¶ 12(d) (alterations in original). McGraw also stated that the so-called "Holland deal" will "make Revolution the largest producer on the planet."
On February 22, 2016 McGraw stated in an email to Ginsburg that if Ginsburg provided $2,250,000 in exchange for another Class B convertible note, McGraw would also give Ginsburg 150,000 Founders' Units from McGraw's personal holdings. On March 3, 2016 McGraw emailed Ginsburg, stating that ICC needed cash to pay subcontractors that week or they would walk off the job. McGraw stated:
Id. at ¶ 12(h) (alterations in original). Allegedly in reliance on McGraw's and ICC's statements and projections, Ginsburg executed a second promissory note ("March Note") in the amount of $3.6 million, convertible into Class B Units in the company. Under the terms of a Funding Disbursement and Interest Reserve Agreement ("Reserve Agreement"), Ginsburg was to "hold back" $1,260,000 from the $3.6 million stated value of the March Note, which was to be used to service 12 months of ICC's interest obligations on the $10.6 million combined total of both notes. Although Ginsburg only wired $2,340,000 to ICC in March 2016 (not the full $3.6 million), he contends that he never executed the Reserve Agreement and never consented to its terms.
Ginsburg alleges that he later learned that the statements and projections on which he had relied had no basis in fact "and were, stated mildly, wildly optimistic forecasts." Id. at ¶ 12(j). Although ICC had projected 2016 EBITDA of $46,817,840 on January 6, 2016, ICC emailed Ginsburg on February 17, 2016 (approximately one month after it received $7 million in funding from Ginsburg) forecasting 2016 EBITDA of negative $1,452,781.00. These same forecasts (sent halfway through Q1) showed Q1 EBITDA to be estimated at negative $410,850. Then, on May 16, 2016, after Ginsburg executed the March Note, McGraw emailed Ginsburg providing 5-year projected financials showing the actual Q1 EBITDA to be negative $1,932,113—a loss more than $1.5 million greater than the projections provided to Ginsburg halfway through that quarter, when defendants were seeking additional funding from Ginsburg. The May 16, 2016 projected financials also showed revised 2016 EBITDA to be projected at a $4,885,755.00 loss, which was three times greater than the projections provided to Ginsburg on February 17, and more than $50 million less than the EBITDA projected in defendants' emailed estimates on January 6, 2016.
Ginsburg alleges that defendants also materially misrepresented having specialized knowledge about the status of marijuana legalization efforts nationally and internationally, in general, and the status of the Illinois legislature's position and timetable for getting laws changed, which would expand the potential Illinois customer base for medical marijuana usage. Although the PPM stated that "[a]s cannabis gains support for full legalization/recreational use, it is another indication that the industry is set to rapidly expand, providing both investors and operators with unprecedented opportunities," such "full legalization" never materialized in Illinois or in the remainder of the United States. Id. ¶ 13(a). In addition, on March 10, 2016, allegedly "amidst discussions between ICC and [Ginsburg] regarding [a] potential second round of funding," McGraw stated in an email to Ginsburg that, through ICC's efforts, a law was about to be enacted that would considerably expand the permissible uses for medical marijuana, thus significantly increasing the market and demand for ICC's products.
Ginsburg alleges that he justifiably relied on the material misrepresentations made by ICC and McGraw when he provided funding to ICC by making loans that could be converted into Class B Units of ICC. He asserts that McGraw and ICC continue to materially mislead potential investors; that, on May 6, 2016, McGraw emailed him an "Investor Presentation" in preparation for the round of Class C Unit-convertible notes and failed to disclose ICC's known risks (e.g., that favorable legislation might not be passed), the probability that such risks would materialize, or the anticipated magnitude of such materialization; and that defendants "continue to display an ongoing pattern of deceit, over-inflation of projected earnings, and under-estimation of known risks." Id. ¶ 15.
By letter dated July 6, 2016, Ginsburg made demand upon ICC to bring the debts on the January Note and March Note (collectively, the "Notes") current by paying the accrued interest, which was due three months after the effective date of each note. Ginsburg alleges that ICC was to have made the interest payments on or before August 4, 2016, but they were not paid. In April 2017 Ginsburg notified ICC that the interest then owing under the Notes exceeded $1,260,000 and demanded that ICC bring the Notes current within 20 business days, which ICC failed to do.
Ginsburg sues McGraw and ICC alleging claims for breach of contract based on ICC's alleged default on the Notes; common law fraud, violation of Tex. Bus. & Com. Code Ann. § 27.01; violation of § 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Securities and Exchange Commission ("SEC") Rule 10b-5; violation of § 20 of the Exchange Act, 15 U.S.C. § 78t (as to McGraw only); violation of Tex. Rev. Civ. Stat. Ann. Art. 581-33(A)(2); violation of Tex. Rev. Civ. Stat. Ann. Art. 581-33(F) (as to McGraw only); violation of the Illinois Securities Law of 1953, 815 ILCS 5/12(F), and violation of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1962(c).
McGraw and ICC move to dismiss Ginsburg's fourth amended complaint under Rules 12(b)(6) and 9(b). They contend that because the purpose of the Notes is to fund the cultivation, possession, and sale of marijuana, in violation of federal law, the Notes are void and unenforceable because they contravene public policy. McGraw and ICC also maintain that, even if the Notes are enforceable, the court should dismiss Ginsburg's claims because the fourth amended complaint does not plausibly allege that McGraw and ICC have breached the Notes, made any misrepresentations, or failed to disclose risks, and that the fourth amended complaint fails to state any fraud-based claims with the requisite particularity. Ginsburg opposes the motion.
"In deciding a Rule 12(b)(6) motion to dismiss, the court evaluates the sufficiency of plaintiff['s] [fourth] amended complaint by accepting all well-pleaded facts as true, viewing them in the light most favorable to the plaintiff." Bramlett v. Med. Protective Co. of Fort Wayne, Ind., 855 F.Supp.2d 615, 618 (N.D. Tex. 2012) (Fitzwater, C.J.) (internal quotation marks and brackets omitted) (quoting In re Katrina Canal Breaches Litig., 495 F.3d 191, 205 (5th Cir. 2007)). To survive a motion to dismiss under Rule 12(b)(6), plaintiff must plead "enough facts to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). "The plausibility standard is not akin to a `probability requirement,' but it asks for more than a sheer possibility that a defendant has acted unlawfully." Id. (quoting Twombly, 550 U.S. at 556); see also Twombly, 550 U.S. at 555 ("Factual allegations must be enough to raise a right to relief above the speculative level[.]"). "[W]here the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged—but it has not `shown'—`that the pleader is entitled to relief.'" Iqbal, 556 U.S. at 679 (brackets omitted) (quoting Rule 8(a)(2)). "Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice." Id. at 678 (citation omitted).
To obtain a Rule 12(b)(6) dismissal based on an affirmative defense, the "successful affirmative defense [must] appear[] clearly on the face of the pleadings." Cochran v. Astrue, 2011 WL 5604024, at *1 (N.D. Tex. Nov. 17, 2011) (Fitzwater, C.J.) (quoting Sivertson v. Clinton, 2011 WL 4100958, at *2 (N.D. Tex. Sept. 14, 2011) (Fitzwater, C.J.)). In other words, defendants are not entitled to dismissal under Rule 12(b)(6) based on an affirmative defense unless Ginsburg "`has pleaded [him]self out of court by admitting to all of the elements of the defense.'" Id. (alteration in original) (quoting Sivertson, 2011 WL 4100958, at *3).
"Rule 9(b) imposes a heightened pleading standard for fraud claims and requires that a party state with particularity facts supporting each element of fraud." Turner v. AmericaHomeKey Inc., 2011 WL 3606688, at *2 (N.D. Tex. Aug. 16, 2011) (Fitzwater, C.J.) (citing Benchmark Elecs., Inc. v. J.M. Huber Corp., 343 F.3d 719, 724 (5th Cir. 2003)), aff'd, 514 Fed. Appx. 513 (5th Cir. 2013). "At a minimum, Rule 9(b) requires allegations of the particulars of time, place, and contents of the false representations, as well as the identity of the person making the misrepresentation and what he obtained thereby." Turner, 2011 WL 3606688, at *2 (quoting Benchmark Elecs., 343 F.3d at 724) (internal quotation marks omitted). More colloquially, plaintiffs must plead the "who, what, when, where, and how" of the fraud. United States ex rel. Williams v. Bell Helicopter Textron, Inc., 417 F.3d 450, 453 (5th Cir. 2005) (quoting United States ex rel. Thompson v. Columbia/HCA Healthcare Corp., 125 F.3d 899, 903 (5th Cir. 1997)). Because Rule 9(b) must be "read in conjunction with [Rule] 8 which requires only a short and plain statement of the claim showing that the pleader is entitled to relief," "punctilious pleading detail" is not required. Steiner v. Southmark Corp., 734 F.Supp. 269, 273 (N.D. Tex. 1990) (Fitzwater, J.) (internal quotation marks omitted) (quoting Landry v. Air Line Pilots Ass'n Int'l AFL-CIO, 892 F.2d 1238, 1264 (5th Cir. 1990)). "The court's key concern in assessing a complaint under Rule 9(b) is to determine whether the plaintiff seeks to redress specific wrongs or whether the plaintiff instead seeks the opportunity to search out actionable wrongs." Garcia v. Boyar & Miller, P.C., 2007 WL 2428572, at *4 (N.D. Tex. Aug. 28, 2007) (Fitzwater, J.) (citation omitted).
The court begins with Ginsburg's breach of contract claim based on ICC's alleged default on the Notes and defendants' contention that this claim is precluded on the ground that the Notes are void and unenforceable.
Defendants move to dismiss Ginsburg's breach of contract claim, contending that the Notes are void and unenforceable because their illegal purpose contravenes public policy. They maintain that, under the Federal Controlled Substances Act ("CSA"), marijuana is a Schedule I controlled substance, the use of which is prohibited under any circumstance; that the CSA makes it unlawful to manufacture, distribute, dispense, or possess any controlled substance; that the CSA also makes it illegal to profit from the manufacture or sale of marijuana; that loaning money to support a business cultivating, selling, or distributing marijuana exposes individuals to other federal laws that criminalize aspects of the marijuana business; that Ginsburg has admitted to this court that he invested $10.6 million to support a business that cultivates, sells, and distributes marijuana; and that by investing in ICC to finance the cultivation, possession, and sale of marijuana, Ginsburg has knowingly violated countless Texas and federal drug laws.
Ginsburg responds that, as part of their effort to obtain funding for ICC, defendants misrepresented that marijuana would soon be legalized in Illinois and nationwide, in large part due to ICC's efforts, and that defendants should not be permitted to benefit from their wrongdoing; that the Notes on their face do not reflect an illegal purpose that is against public policy because the CSA does not prohibit an individual from "profiting" from a business involving controlled substances; that the cases on which defendants rely are factually distinguishable; that the "ultimate object" of the Notes was not to acquire ownership in ICC's marijuana business, but rather for Ginsburg to loan funds to a business and to be repaid with interest from whatever source of funds or proceeds was available to ICC; and that no mention of any illegal purpose exists within the four corners of the Notes, and that the Notes do not identify any purpose for the funds being loaned by Ginsburg to ICC.
Defendants argue in reply that Ginsburg did not lack knowledge of the business in which he was investing, and that, viewed as a whole, Ginsburg's investment with ICC plainly had as its ultimate object the acquisition of an interest in, and the operation of, a marijuana dispensary; that the parties' agreement included an ownership option in the defendant company, and that whether Ginsburg has as yet exercised that option is irrelevant to the determination that the Notes have an illegal purpose; that the CSA specifically addresses profits derived from controlled substances
The court must decide as a threshold matter what law to apply in determining the legality of the Notes and their enforceability. "[Q]uestions involving the effect of illegality upon a contract are determined by the law chosen by the parties, if they have made an effective choice." Restatement (Second) of Conflicts of Laws § 202 cmt. a (1971). In this case, the parties have effectively chosen Illinois law. Each Notes states: "[t]his Note and all actions arising out of or in connection with this Note shall be governed by and construed in accordance with the laws of the State of Illinois, without regard to the conflicts of law provisions." 2d. Am. Compl. Ex. B at ¶ 7(g); 2d Am. Compl. Ex. C. at ¶ 7(g). The Notes are therefore governed by Illinois law. See Int'l Interests, L.P. v. Hardy, 448 F.3d 303, 306-07 (5th Cir. 2006) (stating that "[i]n diversity cases, a federal court must follow the choice of law rules of the forum state," and that "[t]he Supreme Court of Texas has recognized that contractual choice of law provisions should generally be enforced." (citing Mayo v. Hartford Life Ins. Co., 354 F.3d 400, 403 (5th Cir. 2004); DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 677 (Tex. 1990))).
Where it is alleged that an agreement contravenes a federal statute, however, the court looks to federal law to determine whether the contract is illegal or violates public policy, and, if so, whether the contract is unenforceable as a result. See Kelly v. Kosuga, 358 U.S. 516, 519 (1959) ("the effect of illegality under a federal statute is a matter of federal law"); Sola Elec. Co. v. Jefferson Elec. Co., 317 U.S. 173, 174 (1942) ("When a federal statute condemns an act as unlawful the extent and nature of the legal consequences of the condemnation, though left by the statute to judicial determination, are nevertheless federal questions, the answers to which are to be derived from the statute and the federal policy which it has adopted. To the federal statute and policy, conflicting state law and policy must yield."); see also N. Ind. Pub. Serv. Co. v. Carbon Cnty. Coal Co., 799 F.2d 265, 273 (7th Cir. 1986) ("NIPSCO") ("When the statute is federal, federal law determines not only whether the statute was violated but also, if so, and assuming the statute itself is silent on the matter, the effect of the violation on the enforceability of the contract." (citing cases)); Energy Labs, Inc. v. Edwards Eng'g, Inc., 2015 WL 3504974, at *3 (N.D. Ill. June 2, 2015) ("Since Defendants argue that a federal statute . . . makes its contract with ELI illegal, we must apply federal law to answer both whether the contract violates that statute and whether the contract is enforceable.").
Illinois' Compassionate Use of Medical Cannabis Pilot Program Act ("CUA"), 410 Ill. Comp. Stat. Ann. 130/25 (West 2017), which became effective on January 1, 2014, protects patients with debilitating medical conditions, as well as their physicians and providers, from arrest and prosecution, criminal and other penalties, and property forfeiture if the patients engage in the use of medical cannabis. See Ball v. Madigan, 2017 WL 1105447, at *1 (N.D. Ill. Mar. 24, 2017). In addition to setting forth eligibility requirements for patients' use of medical cannabis, the CUA regulates the operation of medical cannabis cultivation centers and dispensaries and provides for the registration (renewable annually) with Illinois' Department of Agriculture and Department of Financial and Professional Regulation of up to 22 cultivation centers
Federal law, however, continues to prohibit use of marijuana, even by medical users. See 21 U.S.C. §§ 812 (controlled substances), 844(a) (penalties); Gonzales v. Raich, 545 U.S. 1, 26-29 (2005) (Congress' plenary power under Commerce Clause includes power to prohibit local cultivation and use of marijuana in compliance with state medicinal use statutes); United States v. Oakland Cannabis Buyers' Coop., 532 U.S. 483, 491-95 (2001) (holding that medical necessity is not a defense to manufacturing and distributing marijuana). Marijuana is a schedule-I controlled substance under the CSA. See 21 U.S.C. § 802(6) (defining controlled substance to include any drug or substance "included in schedule I . . . of part B of this subchapter."); id. § 812(c), Schedule I at (c)(10). "By classifying marijuana as a Schedule I drug, as opposed to listing it on a lesser schedule, the manufacture, distribution, or possession of marijuana became a criminal offense, with the sole exception being use of the drug as part of a Food and Drug Administration preapproved research study." Gonzales, 545 U.S. at 14 (citations omitted). The first section of the CSA provides that "[t]he illegal importation, manufacture, distribution, and possession and improper use of controlled substances have a substantial and detrimental effect on the health and general welfare of the American people." 21 U.S.C. § 801(2). Illinois' enactment of the CUA does not affect the fact that marijuana, including medical marijuana, is prohibited under the CSA. As the Ninth Circuit recently explained in United States v. McIntosh, 833 F.3d 1163 (9th Cir. 2016):
Id. at 1179 n.5.
Under federal law, contracts that violate a federal statute on their face are "intrinsically illegal." NIPSCO, 799 F.2d at 273. For example, express agreements to violate the law are clearly illegal—such as agreements to restrain trade or commit a bank robbery—as are agreements that explicitly contradict a federal statute. See, e.g., Kaiser Steel Corp. v. Mullins, 455 U.S. 72, 78 (1982) (holding that agreement was illegal because it required plaintiff to pay a penalty if it breached a separate agreement to restrain trade). "In addition, even if the contract is not illegal on its face, courts have found contracts inherently illegal where one party must violate a statute or regulation to fulfill its obligations." Energy Labs, Inc., 2015 WL 3504974, at *3 (citing cases); see also, e.g., D.R. Wilder Mfg. Co. v. Corn Prods. Ref. Co., 236 U.S. 165, 172-73 (1915) (recognizing that if contract is "inherently illegal . . . the also elementary rule that courts will not exert their powers to enforce illegal contracts or to compel wrongdoing" may apply).
Because illegality of contract is an affirmative defense, defendants cannot secure dismissal of Ginsburg's breach of contract claim under Rule 12(b)(6) based on the illegality of the Notes unless the defense appears clearly on the face of the fourth amended complaint. See Cochran, 2011 WL 5604024, at *1. For at least the following reasons, the court cannot conclude, based on the allegations in the fourth amended complaint, that the Notes are intrinsically illegal.
"To determine whether a contract violates a federal statute on its face, [the court] compare[s] the four corners of the contract with the language of the statute and related regulations and any interpreting case law." Energy Labs, Inc., 2015 WL 3504974, at *4 (citing NIPSCO, 799 F.2d at 273). As explained above, the CSA prohibits a person from knowingly or intentionally manufacturing, distributing, dispensing, or possessing with an intent to manufacture, distribute, or dispense, a controlled substance. See 21 U.S.C. § 841(a)(1). On their faces, the Notes do not violate the CSA. Nothing contained in the Notes requires Ginsburg or ICC to manufacture, distribute, dispense, or possess marijuana. In fact, the Notes do not mention marijuana, ICC's business, or how ICC is to obtain the funds to repay its loan obligations. Instead, the Notes simply set forth the terms of Ginsburg's loans to ICC and provide for the repayment of the loans at a certain rate of interest.
Nor would granting relief in this case require that McGraw or ICC violate the CSA.
Defendants argue that "Ginsburg is not entitled to any relief because the stated purpose of his investment and the Notes, admitted by Ginsburg, is to finance the cultivation, possession and dispensing of marijuana, a purpose that is in clear violation of the laws of the United States and the State of Texas." Ds. Br. 12. But defendants fail to cite any authority in support of their apparent position that, under federal and Texas law, a contract with the purpose of funding an organization that is violating or intends to violate federal law is automatically void or unenforceable.
Generally, a contract entered into in violation of federal law or public policy is unenforceable. See Kaiser Steel Corp., 455 U.S. at 77 ("There is no statutory code of federal contract law, but our cases leave no doubt that illegal promises will not be enforced in cases controlled by the federal law."); id. at 83 ("It is also well established . . . that a federal court has a duty to determine whether a contract violates federal law before enforcing it."). In practice, however, federal courts have taken a more flexible approach to the question of enforceability. See, e.g., Paul Arpin Van Lines, Inc. v. Universal Transp. Servs., Inc., 988 F.2d 288, 290 (1st Cir. 1993) ("This general rule [of not enforcing illegal contracts] . . . is almost as much honored in the breach as in the observance."); see also Nagel v. ADM Inv'r Servs., Inc., 217 F.3d 436, 440 (7th Cir. 2000) (noting that despite Kaiser Steel's "ringing declaration, many cases continue to treat the defense of illegality to the enforcement of a contract as presumptive rather than absolute, forgiving minor violations and not allowing the defense to be used to confer windfalls." (citing cases)). "[T]he defense of illegality, being in character if not origins an equitable and remedial doctrine, is not automatic but requires. . . a comparison of the pros and cons of enforcement." NIPSCO, 799 F.2d at 273. In NIPSCO the Seventh Circuit held that the contract was enforceable, noting that the statute violated was "an anachronism—a regulatory statute on which the sun set long ago." Id. at 274. In Resolution Trust Corp. v. Home Savings of America, 946 F.2d 93 (8th Cir. 1991), the court observed: "[s]ome federal courts have applied this less-than-absolute rule and have refused to enforce illegal contracts only if the statute or regulation explicitly provides that contracts in violation are void, or if the interest in enforcement clearly outweighs the public policy against enforcement." Resolution Tr. Corp., 946 F.2d at 96-97 (footnote and citations omitted). More recently, the Ninth Circuit explained that "[n]uanced approaches to the illegal contract defense, taking into account such considerations as the avoidance of windfalls or forfeitures, deterrence of illegal conduct, and relative moral culpability, remain viable in federal court and represent no departure from Kaiser Steel . . . as long as the relief ordered does not mandate illegal conduct." Bassidji v. Goe, 413 F.3d 928, 937-38 (9th Cir. 2005); see also Energy Labs, Inc., 2015 WL 3504974, at *3 ("[E]ven if a contract is illegal, it is not automatically unenforceable. Under federal law, the illegality of contract defense involves a balancing of the `pros and cons of enforcement,' taking into account the benefits of enforcement `that lie in creating stability in contract relations and preserving reasonable expectations' and the `costs in forgoing the additional deterrence of behavior forbidden by the statute.'" (citations omitted)); Dervin Corp. v. Banco Bilbao Vizcaya Argentaria, S.A., 2004 WL 1933621, at *3 (S.D.N.Y. Aug. 30, 2004) ("The fact that a contract offends a federal statute or regulation does not, however automatically render it void or unenforceable. Unless the enforcement of a contract would require directing the precise conduct that a statute or regulation makes unlawful, `the courts are to be guided by the overriding general policy . . . of preventing people from getting other people's property for nothing when they are purporting to be buying it.'" (citation omitted)).
Defendants do not address any of the foregoing factors in their motion to dismiss Ginsburg's contract claims. Instead, they appear to posit that, if a contract has an illegal purpose, it is automatically void and unenforceable. But, as explained above, federal courts do not take such a "black-and-white" approach to enforceability. Although the court does not suggest that a contract with the purpose of funding an organization that is violating or intends to violate federal law is necessarily enforceable, or that, in this case, the Notes are themselves enforceable, it concludes at the Rule 12(b)(6) stage that defendants have not established from the face of the fourth amended complaint that the Notes are void and unenforceable.
Defendants also move to dismiss Ginsburg's contract claim on the basis that he has failed to plead a plausible claim for relief.
Defendants contend that the Notes and the Reserve Agreement are the operative contracts between the parties; that, under the Reserve Agreement, Ginsburg withheld $1,260,000 to service 12 months of interest payments under both Notes, which carried the Notes through to April 26, 2017; and that ICC therefore did not breach its agreement with Ginsburg before May 24, 2017. Defendants next contend that, because Ginsburg demanded additional interest payments from ICC before May 24, 2017, sued ICC for failing to pay this additional interest, and took the position that he never agreed to or executed the Reserve Agreement, even though he admits that he withheld $1,260,000 from the amount of the March Note, his conduct constitutes a prior material default under the Notes. According to defendants, "Ginsburg either improperly withheld $1,260,000 that was supposed to be paid to ICC or improperly demanded payment of interest that had already been paid and sued ICC for interest that was not owed. Therefore, Ginsburg's prior breach bars his recovery for breach of contract." Ds. Br. 14.
Ginsburg responds that he has plausibly alleged all of the elements of a claim for breach of contract; that the fourth amended complaint pleads that the Reserve Agreement represents no more than preliminary negotiations, that Ginsburg never executed the Reserve Agreement or consented to its terms, and that, accordingly, the unsigned Reserve Agreement is unenforceable against Ginsburg and does not excuse ICC from its obligation to make the interest payments required under the Notes; that defendants' prior material breach affirmative defense is not established based on the face of the complaint and the unambiguous terms of the March Note, which contains no promise by Ginsburg to transfer the full $3.6 million, but instead specifies that a lesser amount may be loaned; and that ICC's failure to pay the accrued interest qualifies as a default under the Notes, and Ginsburg's demand that ICC pay what is owed under the Notes is not a prior material breach.
Under Illinois law,
Defendants contend that, under the Reserve Agreement, Ginsburg was to withhold $1,260,000 to service 12 months of interest payments under both Notes, and that, accordingly, ICC did not breach the Note. Ginsburg alleges, however, that he never agreed to, or signed, the Reserve Agreement. He asserts that
4th Am. Compl. ¶ 17 (citation omitted). Because, at the motion to dismiss stage, the court must accept all well-pleaded facts as true and draw all reasonable inferences in Ginsburg's favor, the court cannot dismiss Ginsburg's breach of contract claim on the basis of a Reserve Agreement that Ginsburg alleges he never agreed to or signed.
Nor can the court dismiss Ginsburg's claim on the theory that his withholding $1,260,000 constituted a prior material breach of the Notes that now bars him from recovering. It is true that, under Illinois law, "the rule is well-settled that a party cannot sue for breach of contract without alleging and proving that he himself substantially complied with all the material terms of the agreement." George F. Mueller & Sons, Inc. v. N. Ill. Gas Co., 336 N.E.2d 185, 189 (Ill. Ct. App. 1975). The court cannot conclude, however, based on the allegations in the fourth amended complaint, that Ginsburg did not substantially comply with the material terms of the Notes. At the very least, defendants do not contend that Ginsburg failed to substantially comply with all of the material terms of the January Note. Accordingly, Ginsburg has at least pleaded a plausible claim based on ICC's breach of the January Note. And because the fourth amended complaint does not resolve the question whether Ginsburg materially breached the March Note, the court concludes that this issue must be resolved on summary judgment motion or at trial.
Accordingly, the court denies defendants' motion under Rule 12(b)(6) to dismiss Ginsburg's breach of contract claim.
The court next considers Ginsburg's fraud claims, beginning with his claim for common law fraud.
In ¶ 20 of the fourth amended complaint, Ginsburg alleges a claim for common law fraud. Under Texas law,
Choe v. Bank of Am., N.A., 2013 WL 3196571, at *5 (N.D. Tex. June 25, 2013) (Fitzwater, C.J.) (quoting Fluorine On Call, Ltd. v. Fluorogas Ltd., 380 F.3d 849, 858 (5th Cir. 2004) (citations omitted) (Texas law)), aff'd, 605 Fed. Appx. 316 (5th Cir. 2015). Defendants move to dismiss Ginsburg's common law fraud claim on the basis that he has failed to meet the particularity requirement of Rule 9(b), has pleaded representations of future estimates or projections, not past or existing facts, and has not plausibly alleged that defendants knew that any representation was false or reckless at the time it was made.
Ginsburg responds that the misrepresentations on which he bases his fraud claims are set forth in ¶ 12 of the fourth amended complaint; that an expression of an opinion as to the occurrence of a future event may constitute fraud if the speaker purports to have special knowledge of facts that will occur or exist in the future, or if the opinion or prediction is based on or buttressed with false facts; that defendants' material misrepresentations regarding the financial status, performance, and viability of ICC are actionable because they were based on, or buttressed with, false facts (or, at a minimum, lacked any reasonable factual basis when made); that the massive discrepancy in defendants' financial predictions before they received funds from Ginsburg and after they received funds demonstrates that the projections were either false when made or that McGraw had no reasonable basis to believe that his statements were true when he made them; that defendants' misrepresentations were based on their having one-sided knowledge of the facts underlying those statements; that McGraw had exclusive access to ICC's financial dealings and records and thus had superior knowledge of ICC's status and operations; that McGraw represented that he had "superior knowledge" regarding the status of medical cannabis legislation and ICC's role in those efforts; and that Ginsburg was not in a position to access or evaluate the same information to which defendants had access and to make his own interpretation thereof.
Defendants contend that Ginsburg has not pleaded that they made any prediction or representation known to be false when it was made. As a general matter, "[p]ure expressions of opinion are not representations of material fact, and thus cannot provide a basis for a fraud claim." Italian Cowboy Partners, Ltd. v. Prudential Ins. Co. of Am., 341 S.W.3d 323, 337-38 (Tex. 2011). Moreover, "[b]ecause a prediction, or statement about the future, is essentially an expression of opinion, future predictions are generally not actionable." Hoffman v. L&M Arts, 838 F.3d 568, 579 (5th Cir. 2016) (brackets, citation, and internal quotation marks omitted). Accordingly, "[t]he generally accepted rule in Texas jurisprudence is that future predictions and opinions, especially those regarding the future profitability of a business, cannot form a basis for fraud as a matter of law." Zar v. Omni Indus., Inc., 813 F.2d 689, 693 (5th Cir. 1987) (citations omitted); see also Guevara v. Lackner, 447 S.W.3d 566, 577 (Tex. App. 2014, no pet.) ("Predictions and opinions regarding the future profitability of a business generally cannot form a basis for a claim of fraud."); Fry v. Farm & Ranch Healthcare, Inc., 2007 WL 4355055, at *3 (Tex. App. Dec. 13, 2007, no pet.) (mem. op.) ("Predictions and opinions regarding the future profitability of a business generally cannot form a basis for a claim of fraud."); Lloyd v. Junkin, 75 S.W.2d 712, 714 (Tex. Civ. App. 1934, no writ) (holding that because "that which lies in the future cannot be a matter of certain knowledge," representations as to future value, productiveness, efficiency, or expected earnings or profits "must be taken and understood as mere expressions of opinion, and therefore their nonfulfillment cannot be treated as fraud"); Nat'l Newspaper Enters. v. Chitwood, 68 S.W.2d 264, 267 (Tex. Civ. App. 1934, writ dism'd) ("We do not question the proposition of law that a statement of the belief of the future earnings of a business, necessarily based more or less upon guesswork, cannot be made the basis for a charge of fraud, or for awarding damages.").
There are two recognized exceptions, however, to this general rule. First, "[a]n opinion may constitute fraud if the speaker has knowledge of its falsity." Trenholm v. Ratcliff, 646 S.W.2d 927, 930 (Tex. 1983). Second, "[a]n expression of an opinion as to the happening of a future event may also constitute fraud where the speaker purports to have special knowledge of facts that will occur or exist in the future." Id (citations omitted); see also Italian Cowboy Partners, 341 S.W.3d at 338 ("Special or one-sided knowledge may help lead to the conclusion that a statement is one of fact, not opinion.").
Ginsburg limits his fraud claims to the alleged misrepresentations pleaded in ¶ 12 of the fourth amended complaint. In ¶ 12(a), Ginsburg alleges that "[p]er the PPM, provided by McGraw to Plaintiff on January 6, 2016, ICC stated (on p. 13) that estimated annual revenue for medical cannabis sales in Illinois in that time period would be $1,115,910,000; and projected (on p. 28) that the Company would have EBITDA in 2016 of $46,817,840, and more in 2017." 4th Am. Compl. ¶ 12(a). He alleges in ¶ 12(f) that, on February 17, 2016, ICC's CFO
To the extent Ginsburg bases his common law fraud claim on ICC's statement in the PPM that $1,115,910,000 was a "reasonable estimate of the projected revenue for medical cannabis sales in Illinois,"
Similarly, the financial projections contained in the PPM (which the PPM itself identifies as "forward looking statements") and Charak's February 17, 2016 email, are predictions regarding ICC's future profitability, and, as such, do not constitute material misstatements of fact.
The court concludes that the following statements (assuming arguendo that they are not subject to dismissal on the basis that they are vague statements of corporate optimism or "puffery,"
Ginsburg's remaining allegations in support of his fraud claim fail because he has not pleaded that ICC or McGraw made the alleged misstatements with knowledge that they were false or without knowledge of their truth. The fourth amended complaint alleges that, in early January 2016, McGraw assured Ginsburg that ICC's bank required audited financial statements and that he would provide copies to Ginsburg as they were prepared, but later, when McGraw requested detailed month-end and quarter-end financial statements, McGraw responded in a June 2016 email that Ginsburg was not entitled to have access to quarterly, monthly, or detailed financial statements, and that defendants "do not have audited financials if that's what you need." 4th Am. Compl. ¶ 12(b). Ginsburg does not allege that, when McGraw represented that ICC's bank required audited financial statements and that he would provide Ginsburg copies, McGraw either knew this statement was false or made this statement without knowledge of its truth. Ginsburg also asserts that McGraw stated in a February 4, 2016 email "[t]he Holland deal is ours now. Revolution [an operating arm of ICC] will take operating control. . . . Moral of the story is we are in the driver[']s seat." Id. ¶ 12(d). Assuming arguendo that McGraw's statement is a representation of existing facts (as opposed to a prediction about a future event), Ginsburg does not allege that, when McGraw made this statement, he knew that the Holland had not been (or would not be) finalized, or that he made this statement without knowledge of its truth.
In sum, with respect to each alleged misstatement that Ginsburg pleads in support of his fraud claim,
The court next considers Ginsburg's claims brought under the Exchange Act. In ¶ 22 of the fourth amended complaint, Ginsburg alleges a claim for fraud in connection with the purchase or sale of securities, in violation of § 10(b) the Exchange Act and Rule 10b-5. In ¶ 23, Ginsburg alleges that McGraw is liable under § 20 of the Exchange Act, 15 U.S.C. § 78t, as a person who controls ICC.
Section 10(b) and Rule 10b-5 "prohibit making any material misstatement or omission in connection with the purchase or sale of any security." Ludlow v. BP, P.L.C., 800 F.3d 674, 681 (5th Cir. 2015)(quoting Halliburton Co. v. Erica P. John Fund, Inc., ___U.S. ___, 134 S.Ct. 2398, 2408 (2014)). To recover under § 10(b) and Rule 10b-5, plaintiff must prove: "(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation." Halliburton Co., 134 S.Ct. at 2407 (citations and internal quotation marks omitted). Claims under § 10(b) and Rule 10b-5 are subject to the heightened pleading requirements of Rule 9(b) and the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-4(b). Milano v. Perot Sys. Corp., 2006 WL 929325, at *3 (N.D. Tex. Mar. 31, 2006) (Fitzwater, J.) (citing R2 Invs. LDC v. Phillips, 401 F.3d 638, 641 (5th Cir. 2005)).
Defendants move to dismiss Ginsburg's Exchange Act claims, contending for the following reasons that he has failed to meet the stringent pleading requirements of Rule 9(b) and the PSLRA for his federal and state securities law claims: Ginsburg has failed to plead, with the rigorous level of particularity required by Rule 9(b) and the PSLRA, that defendants acted with the required scienter to violate the federal securities laws; the fourth amended complaint does not allege any facts to support a strong inference that any defendant knew that a statement was false when made, or acted with severely reckless disregard about the veracity of any statement, because Ginsburg has identified only a series of optimistic projections about ICC's future that ultimately failed to come true; Ginsburg has failed to identify, with the particularity required by the PSLRA, any statement alleged to be misleading and the reasons why the statement is misleading; Ginsburg has failed to identify any actionable material misrepresentation because each of the misrepresentations on which he bases his claims is merely an estimate or predictive statement relating to ICC's future performance; Ginsburg alleges no particularized facts to support that the projections or predictive statements were false when made, defendants did not believe the statements to be true when made, the projections or predictive statements lacked any reasonable basis, or defendants knew of undisclosed facts that would seriously undermine the accuracy of the statements; and the PPM disclaims reliance, discloses all material risks and that material may be omitted, expressly states that the projections are "forward-looking," and admonishes potential investors to perform their own investigation and due diligence.
Ginsburg responds by arguing, inter alia, that his allegations demonstrate that defendants "(1) did not genuinely believe that their statements to Plaintiff were true; (2) had no reasonable basis to believe that their statements were true; and (3) possessed superior knowledge of the Company's financial operations and overall viability, and thus were aware of facts undermining their statements and projections." P. Br. 13. He also contends that he has not merely alleged that ICC's projected profits were not realized; instead, he asserts that defendants never intended to realize the projected profits and knew their financial projections were completely unrealistic. Regarding scienter, Ginsburg contends that defendants' "misstatements and omissions were made in the context of discussions wherein Defendants were seeking millions of dollars from Plaintiff to provide funding for ICC by means of convertible promissory notes," and the "inference that Defendants' misstatements were made with scienter is at least as strong as any other inference that could be made from the facts stated in the Complaint." P. Br. 19.
Largely for the reasons explained above, see supra § V(C), the court holds that, to the extent Ginsburg bases his Exchange Act claims on statements reflecting defendants' personal opinions, beliefs about the future, or projections of future performance—including, inter alia, ICC's financial projections and predictions about its expected profits and the status of the market—Ginsburg has failed to plead an actionable misstatement of fact.
"[P]rojections of future performance not worded as guarantees are generally not actionable under the federal securities laws." Krim v. BancTexas Grp., Inc., 989 F.2d 1435, 1446 (5th Cir. 1993). Nonetheless, while predictive statements are typically not actionable, "a defendant does not place itself beyond the reach of the securities laws merely by disclosing information that is predictive in nature. . . . [W]hether liability is imposed depends on whether the predictive statement was `false' when it was made." Isquith v. Middle S. Utils. Inc., 847 F.2d 186, 203 (5th Cir. 1988); see also In re BP p.l.c. Sec. Litig., 852 F.Supp.2d 767, 790 (S.D. Tex. 2012) ("Statements that are predictive in nature are actionable only if they were false when made." (citing Shushany v. Allwaste, Inc., 992 F.2d 517, 524 (5th Cir. 1993)); In re Franklin Bank Corp. Sec. Litig., 782 F.Supp.2d 364, 386 (S.D. Tex. 2011) ("Projections of future performance generally are not actionable under the securities laws, unless they were false when made."). "A statement of belief is a factual misstatement actionable under Section 10(b) if (1) the statement is not actually believed, (2) there is no reasonable basis for the belief, or (3) the speaker is aware of undisclosed facts tending seriously to undermine the statement's accuracy." Spitzberg v. Hous. Am. Energy Corp., 758 F.3d 676, 691, n.24 (5th Cir. 2014) (quoting Reese v. Malone, 747 F.3d 557, 579 (9th Cir. 2014)); see also Rubinstein v. Collins, 20 F.3d 160, 166 (5th Cir. 1994) ("[A] predictive statement is one that contains at least three factual assertions that may be actionable: 1) The speaker genuinely believes the statement is accurate; 2) there is a reasonable basis for that belief; and 3) the speaker is unaware of any undisclosed facts that would tend seriously to undermine the accuracy of the statement.").
Setting aside the conclusory allegation in the fourth amended complaint that defendants' "statements and projections had no basis in fact and were, stated mildly, wildly optimistic forecasts," 4th Am. Compl. ¶ 12(j), Ginsburg has not plausibly alleged that any of the projections or predictive statements was false when made; that defendants did not actually believe the statements to be true when made; that the projections or predictive statements lacked any reasonable basis; or that defendants knew of undisclosed facts that would seriously undermine the accuracy of the statements. Accordingly, the court concludes that Ginsburg's Exchange Act claims based on defendants' opinions, projections, or predictive statements must be dismissed.
Moreover, Ginsburg's Exchange Act claims must be dismissed for the additional reason that Ginsburg has failed to plead specific facts establishing a strong inference of scienter.
Scienter is a required element of any securities fraud action. Nathenson v. Zonagen Inc., 267 F.3d 400, 406-07 (5th Cir. 2001). Scienter consists of "an intent to deceive, manipulate, or defraud or that severe recklessness in which the danger of misleading buyers or sellers is either known to the defendant or is so obvious that the defendant must have been aware of it." R2 Invs. LDC, 401 F.3d at 643 (citation omitted). "[P]laintiffs may establish scienter by demonstrating either intent or severe recklessness." Fin. Acquisition Partners LP v. Blackwell, 440 F.3d 278, 287 (5th Cir. 2006) (emphasis omitted); see Southland Sec. Corp. v. INSpire Ins. Sols., Inc., 365 F.3d 353, 365 (5th Cir. 2004) ("[T]he . . . state of mind requirement is severe recklessness or actual knowledge.").
The standards for pleading scienter are governed by the PSLRA. "The PSLRA pleading standard for scienter is especially challenging for plaintiffs." Plotkin v. IP Axess Inc., 407 F.3d 690, 696 (5th Cir. 2005). "[T]o survive a motion to dismiss a securities-fraud action, plaintiffs must, inter alia, plead specific facts establishing a strong inference of scienter." Fin. Acquisition Partners, 440 F.3d at 287 (citing Nathenson, 267 F.3d at 407). "To qualify as `strong' within the intendment of § 21D(b)(2) . . . an inference of scienter must be more than merely plausible or reasonable—it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 314 (2007). To allege scienter based on defendant's conscious conduct, "a plaintiff must plead strong circumstantial evidence of misbehavior." Mortensen v. AmeriCredit Corp., 123 F.Supp.2d 1018, 1025 (N.D. Tex. 2000) (Fitzwater, J.), aff'd, 240 F.3d 1073 (5th Cir. 2000). To plead scienter based on recklessness, a plaintiff must demonstrate "an extreme departure from the standard of ordinary care . . . that present[s] a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it." Owens v. Jastrow, 789 F.3d 529, 536 (5th Cir. 2015) (quoting Abrams v. Baker Hughes Inc., 292 F.3d 424, 430 (5th Cir. 2002)).
In deciding defendants' motion to dismiss, the court "accept[s] the facts alleged in the plaintiffs' complaint as true and constru[es] their allegations in the light most favorable to them." Goldstein v. MCI WorldCom, 340 F.3d 238, 244 (5th Cir. 2003) (citing Abrams, 292 F.3d at 430). The court does not, however, "`strain to find inferences favorable to the plaintiff[].'" Id. (quoting Westfall v. Miller, 77 F.3d 868, 870 (5th Cir. 1996)). "Nor [does the court] accept conclusory allegations, unwarranted deductions, or legal conclusions." Southland Sec. Corp., 365 F.3d at 361 (citing Nathenson, 267 F.3d at 406).
Even when construed in the light most favorable to Ginsburg, the fourth amended complaint does little more than allege that defendants made "wildly optimistic forecasts," 4th Am. Compl. ¶ 12(j), and did not accurately predict what their financial results (or the market for medical marijuana in Illinois) would be. "[C]ompany officials should not," however, "be held responsible for failure to foresee future events." Abrams, 292 F.3d at 433 (approving Second Circuit's observation in Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000)). No allegation in the fourth amended complaint supports an inference, much less a "strong inference," that defendants knew or should have known that there was no basis for predicting the forecasted financials included in the PPM or Charak's February 17, 2016 email, that ICC would be highly profitable, that Ginsburg would get his capital back "quickly," that ICC would finalize the "Holland deal," that Revolution would be the largest producer of medical marijuana, or that production would start as soon as final inspection of the labs was completed. As currently pleaded, this is a classic case of alleging "fraud by hindsight," which is insufficient to plead a plausible claim. See, e.g., Lormand v. US Unwired, Inc., 565 F.3d 228, 254 (5th Cir. 2009) (defining "fraud by hindsight" as the case where "a plaintiff alleges that the fact that something turned out badly must mean defendant knew earlier that it would turn out badly," or where "there is no contemporaneous evidence at all that defendants knew earlier what they chose not to disclose until later"); Rosenzweig v. Azurix Corp., 332 F.3d 854, 867-68 (5th Cir. 2003) (affirming dismissal of securities fraud class action where certain factual underpinnings on which plaintiffs relied were hindsight assessments of defendants' performance); Fitzpatrick v. Uni-Pixel, Inc., 35 F.Supp.3d 813, 827 (S.D. Tex. 2014) ("In hindsight, the forecasts that defendants made on February 26, 2013, thus turned out to be incorrect; but incorrectness alone does not mean that the February 26, [2013], forecasts are actionable."). As defendants argue in their reply,
Ds. Reply 9. Business misjudgments alone are not fraud. See Melder v. Morris, 27 F.3d 1097, 1101 n.8 (5th Cir. 1994).
Accordingly, because Ginsburg has failed to satisfy the PSLRA pleading requirement of a strong inference of scienter, the court concludes that Ginsburg has failed to plausibly allege his claims under the Exchange Act, and it grants defendants' motion to dismiss these claims.
Ginsburg seeks to hold McGraw liable under § 20 of the Exchange Act, 15 U.S.C. § 78t, as a person who controls ICC. Because Ginsburg has not plausibly alleged a § 10(b) or Rule 10b-5 violation, his control person claim against McGraw fails as well. See Southland Sec. Corp., 365 F.3d at 383 ("Control person liability is secondary only and cannot exist in the absence of a primary violation." (citing Lovelace v. Software Spectrum Inc., 78 F.3d 1015, 1021 n.8 (5th Cir. 1996)). Accordingly, the court grants defendants' motion to dismiss Ginsburg's claim brought under § 20 of the Exchange Act.
Ginsburg sues both defendants under the Texas Securities Act ("TSA"), Tex. Rev. Civ. Stat. Ann. Art. 581-33(A)(2), and brings a claim against McGraw under Tex. Rev. Civ. Stat. Ann. Art. 581-33(F) as a person who controls ICC. Defendants move to dismiss these claims, contending that Ginsburg has failed to plead that defendants made any prediction or representation known to be false when it was made.
Article 581-33 of the TSA provides, in pertinent part:
Tex. Rev. Civ. Stat. Ann. Art. 581-33(A)(2). Article 581-33(A) differs in significant respects from § 10(b) and from common law fraud in that it does not require reliance by the purchaser on the seller's material misrepresentation or omission. Granader v. McBee, 23 F.3d 120, 123 (5th Cir. 1994); Weatherly v. Deloitte & Touche, 905 S.W.2d 642, 649 (Tex. App. 1995, writ dism'd w.o.j.) ("An omission or misrepresentation is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding to invest. An investor is not required to prove that he would have acted differently but for the omission or misrepresentation. . . . [T]he focus under the Texas Securities Act is on the conduct of the seller or issuer of securities, i.e., whether they made a material misrepresentation, not on the conduct of individual buyers."). Nor does the plaintiff have to demonstrate scienter under the TSA (although courts have held that intent or scienter is an element of a claim under Art. 581-33 for an untrue promise of future performance). SeeDorsey v. Portfolio Equities, Inc., 540 F.3d 333, 33-44 (5th Cir. 2008).
As with the common law fraud and Exchange Act claims discussed above, "statements of opinion, including opinions about a security's value, are generally not actionable under [the TSA]." Murphy v. Reynolds, 2011 WL 4502523, at *8 (Tex. App. Sept. 29, 2011, no pet.) (mem. op.); see also Tex. Capital Sec., Inc. v. Sandefer, 58 S.W.3d 760, 776 (Tex. App. 2001, pet. denied) (noting that predictions of increased share prices generally do not amount to actionable misrepresentations); Paull v. Capital Res. Mgmt., Inc., 987 S.W.2d 214, 218-19 (Tex. App. 1999, pet. denied) (holding that characterization of investment as "low risk" and prediction of "large revenues for a long time" were statements of opinion that were not actionable under fraud provision of TSA where investors had equal access to information on which opinions were based). Moreover, "[b]ecause the [TSA] is so similar to the federal [Exchange Act], Texas courts look to decisions of the federal courts to aid in the interpretation of the [TSA]." Grotjohn Precise Connexiones Int'l, S.A. v. JEM Fin., Inc., 12 S.W.3d 859, 868 (Tex. App. 2000, no pet.).
To the extent Ginsburg bases his TSA claims on statements reflecting defendants' personal opinions, beliefs about the future, or projections of future performance, the court concludes, for the reasons explained above, see supra §§ V(C)-(E) and VI(B), that Ginsburg has failed to plausibly plead that defendants made an "untrue statement of material fact," as required by the TSA. With respect, however, to defendants' alleged misrepresentations of existing facts—for example, McGraw's verbal assurances that ICC's bank required audited financial statements and his statement that "[t]he Holland deal is ours now," 4th Am. Compl. ¶ 12(d) (alteration in original) (to the extent this statement expresses the existing fact that the "Holland deal" is complete, as opposed to predicting that the "Holland deal" will be finalized)—because scienter is not a required element of Ginsburg's TSA claims, and because defendants do not move to dismiss these claims on any other ground, the court denies defendants' motion to dismiss Ginsburg's TSA claim based on these allegations.
Ginsburg brings a claim for statutory fraud under Texas law, alleging that defendants violated Tex. Bus. & Com. Code. Ann. § 27.01.
Defendants move to dismiss this claim, contending that § 27.01 does not apply as a matter of law because Ginsburg has not pleaded that there has been an actual conveyance of stock (the Notes only gave Ginsburg the option to convert any outstanding principal owed under the Notes into Class B units). They also maintain that the plain language of § 27.01 requires a false representation of a past or existing fact or a false promise, does not give rise to a cause of action for fraud by omission, and that, to the extent Ginsburg's claim for statutory fraud is based on alleged omissions, it should be dismissed.
Ginsburg responds that contracts to convey stock—like the Notes in the present case—qualify as "transactions" under § 27.01, and that the contrary authority on which defendants rely is outdated or inapplicable; that defendants' argument that § 27.01 does not support a cause of action for fraud by omission is equally flawed; and that the fourth amended complaint specifies that Ginsburg's claim for statutory fraud is based on defendants' false representations designed to induce him to execute the convertible Notes, and because defendants undoubtedly knew of the falsity of their representations and failed to disclose that falsity in order to reap the benefits of Ginsburg's funding, the statute is satisfied and defendants are potentially liable for exemplary damages under § 27.01(d).
To establish a statutory fraud claim, a plaintiff must prove: (1) a transaction involving real estate or stock; (2) during the transaction, the other party made a false representation of fact, made a false promise, or benefited by not disclosing that a third party's representation was false; (3) the false representation or promise was made for the purpose of inducing the party to enter into a contract; (4) the party relied on the false representation or promise by entering into the contract; and (5) the reliance caused the party injury. Tex. Bus. & Com. Code Ann. § 27.01. Thus a viable claim for statutory fraud must relate to "a transaction involving real estate or stock in a corporation." Id.
Ginn v. NCI Bldg. Sys., Inc., 472 S.W.3d 802, 823 (Tex. App. 2015, no pet.) (quoting Evans v. Wilkins, 2001 WL 1340356, at *3 (Tex. App. 2001, no pet.) (not designated for publication)); see also U.S. Quest Ltd. v. Kimmons, 228 F.3d 399, 406 (5th Cir. 2000) ("Section 27.01(a) also applies only to situations where there is an actual conveyance of the stock, and not to situations where there is merely a breach of contract to convey stock." (citing Stanfield v. O'Boyle, 462 S.W.2d 270, 271 (Tex. 1971)); Tex. Commerce Bank Reagan v. Lebco Constructors, Inc., 865 S.W.2d 68, 82 (Tex. App. 1993, writ denied) ("Texas courts have not interpreted section 27.01 that broadly."). "In o[th]er words, the contract must cause stock to be conveyed." Ginn, 472 S.W.3d at 823 (citing cases). "A transaction occurs when there is a sale or a contract to sell real estate or stock between the parties." Id. (citing Burleson State Bank v. Plunkett, 27 S.W.3d 605, 611 (Tex. App. 2000, pet. denied); Nolan v. Bettis, 577 S.W.2d 551, 556 (Tex. Civ. App. 1979, writ ref'd n.r.e.)).
Ginsburg neither alleges nor argues in his brief that defendants actually conveyed any ICC stock. He instead maintains that the cases defendants cite in support of their argument are "outdated" because they pre-date the 1983 amendments to the statute. P. Br. 17. Ginsburg contends that
P. Br. 17 (some citations omitted). Ginsburg cites to no binding authority, however, in support of this position. Numerous cases, including the Fifth Circuit's decision in U.S. Quest, post-date the 1983 amendments to § 27.01 and hold that an actual conveyance of stock must occur in order for there to be an actionable claim under the statute. See, e.g., U.S. Quest, 228 F.3d at 406 ("Section 27.01(a) also applies only to situations where there is an actual conveyance of the stock, and not to situations where there is merely a breach of contract to convey stock."); Zhang v. Monroe, 2017 WL 108311, at *8 (E.D. Tex. Jan. 11, 2017) (same); Ginn, 472 S.W.3d at 823 ("Courts have `strictly' interpreted this requirement, holding that for fraud in a transaction to be actionable under section 27.01, the contract must `actually effect the conveyance' of real estate or stock between the parties, and it `cannot merely be tangentially related or a means for facilitating a conveyance' of real estate or stock." (citations omitted)).
In the single case on which Ginsburg relies, Tukua Investments, LLC v. Spenst, 413 S.W.3d 786, 796 (Tex. App. 2013, pet. denied), a Texas court of appeals held that a contract to convey real estate constitutes a "transaction" under § 27.01 even if an actual conveyance of real estate does not occur. But even assuming arguendo that it is sufficient for purposes of a claim under § 27.01 to allege a contract to convey stock (rather than an actual conveyance of stock), Ginsburg has not pleaded, as he argues in his brief, that the Notes in this case are "contracts to convey stock." P. Br. 17. In the fourth amended complaint, Ginsburg alleges that he "loaned ICC $7,000,000 as evidenced by a Promissory Note in that same amount, convertible into Class B Units in the Company," 4th Am. Compl. ¶ 12(c), and that he "executed a Promissory Note in the stated amount of $3,600,000 . . . which Note is convertible into Class B Units in the Company," id. ¶ 12(i). The convertible Notes in this case are analogous to the unvested stock options courts have held to be insufficient to support a claim under § 27.01. See, e.g., Ginn, 472 S.W.3d at 823 ("when an agreement only grants unvested stock, it does not constitute a transfer or conveyance of stock that implicates section 27.01."); Stephanz v. Laird, 846 S.W.2d 895, 905 (Tex. App. 1993, writ denied) (holding that § 27.01 did not apply when plaintiff had not met certain conditions precedent in order for the stock options to begin vesting). They did not purport to convey stock or even promise a conveyance in the future. They merely gave Ginsburg the option, at some later point, of converting ICC promissory notes (i.e., ICC debt owed to Ginsburg) into ICC Class B Units (i.e., shares of ICC stock). Because Ginsburg has not plausibly pleaded that there was a contract for the sale of stock, the court grants defendants' motion to dismiss his § 27.01 claim.
Ginsburg alleges that defendants are liable for violating the Illinois Securities Law of 1953, 815 ILCS 5/12(F).
In their motion to dismiss, defendants contend that Ginsburg's fraud-based claims—presumably including his claim under the Illinois Securities Law—fail as a matter of law. They do not, however, identify any particular pleading defect concerning Ginsburg's claim under the Illinois Securities Law. Instead, they generally describe the perceived pleading defects in Ginsburg's "federal and state securities law claims," Ds. Br. 16; contend that the elements of a claim under Section 5/12(F) of the Illinois Securities Law "largely mirror" the fraud provisions of SEC Rule 10b-5, id.; and state that the Illinois courts look to federal securities fraud case law in interpreting those sections of the Illinois Securities Law. Essentially, defendants state that the pleading is insufficient, and they shift the burden to the court to determine why. The court declines to shoulder this obligation.
Accordingly, although the pleading defects that the court has identified above with respect to Ginsburg's other fraud-based claims cast some doubt on whether the fourth amended complaint plausibly pleads a claim under the Illinois Securities Law of 1953, the court declines to dismiss this claim in light of defendants' failure to point to any specific deficiency. Defendants' motion to dismiss Ginsburg's claim for violation of the Illinois Securities Law of 1953 is therefore denied.
Finally, the court addresses Ginsburg's civil RICO claim.
RICO makes it unlawful "for any person employed by or associated with any enterprise engaged in, or the activities of which affect, interstate or foreign commerce, to conduct or participate, directly or indirectly, in the conduct of such enterprise's affairs through a pattern of racketeering activity[.]" 18 U.S.C. § 1962(c). "`Reduced to their simplest terms, the essential elements of a [civil] RICO claim are: (1) a person who engages in (2) a pattern of racketeering activity (3) connected to the acquisition, establishment, conduct, or control of an enterprise.'" Orthoflex, Inc. v. ThermoTek, Inc., 2012 WL 2864510, at *2 (N.D. Tex. July 12, 2012) (Fitzwater, C.J.) (quoting Larrew v. Barnes, 2002 WL 32130462, at *1 n.1 (N.D. Tex. Aug. 27, 2002) (Kaplan, J.), rec. adopted, 2002 WL 32130462 (N.D. Tex. Sept. 17, 2002) (Fitzwater, J.)), appeal docketed, No. 16-11381 (5th Cir. Sept. 16, 2016).
"Section 1961(1)(B) defines `racketeering activity' according to whether it constitutes `any act which is indictable' under several specified sections of title 18 of the United States Code, [two] of which [are] mail fraud [and wire fraud]." TruGreen Landcare, L.L.C. v. Scott, 512 F.Supp.2d 613, 623 (N.D. Tex. 2007) (Fitzwater, J.) (citations omitted). "To establish a pattern of racketeering activity, [plaintiff] must allege (1) the predicate acts of racketeering activity, and (2) a pattern of such acts." Orthoflex, Inc., 2012 WL 2864510, at * 2 (citing In re Burzynski, 989 F.2d 733, 742 (5th Cir. 1993)). A pattern of racketeering activity includes two or more acts of racketeering activity. See 18 U.S.C. § 1961(5). "[A] `pattern' requires both that the acts are `related' to each other and that they have `continuity.'" Burzynski, 989 F.2d at 742. "It is this factor of continuity plus relationship which combines to produce a pattern." H.J. Inc. v. Nw. Bell Tel. Co., 492 U.S. 229, 239 (1989) (citation omitted). Predicate acts are related if they "have the same or similar purposes, results, participants, victims, or methods of commission, or otherwise are interrelated by distinguishing characteristics and are not isolated events." Id. at 240 (citations omitted). Continuity requires that the related acts "constitute or threaten long-term criminal activity." Burzynski, 989 F.2d at 742 (citing H.J. Inc., 492 U.S. at 239). Continuity can be proved by "a closed period of repeated conduct, or . . . past conduct that by its nature projects into the future with a threat of repetition." H.J. Inc., 492 U.S. at 241. "A closed period of conduct may be demonstrated `by proving a series of related predicates extending over a substantial period of time,'" while "[a]n open period of conduct involves the establishment of `a threat of continued racketeering activity.'" Word of Faith World Outreach Ctr. Church, Inc. v. Sawyer, 90 F.3d 118, 122 (5th Cir. 1996) (citing H.J. Inc., 492 U.S. at 242).
Defendants move to dismiss Ginsburg's civil RICO claim, contending that Ginsburg "has wholly failed to plead any of the elements necessary to state a claim for RICO in his one-paragraph claim," Ds. Br. 23; that Ginsburg's fraud allegations subsumed within the RICO claim do not meet the heightened pleading standard of Rule 9(b); that under the PSLRA, conduct that would have been actionable as fraud in the purchase or sale of securities cannot constitute an actionable predicate act under RICO; that Ginsburg does not plead sufficient facts to show a predicate act, a pattern of racketeering activity, or an enterprise; and that Ginsburg does not plead facts to distinguish between the persons engaged and the alleged RICO enterprise.
Ginsburg responds that he has sufficiently pleaded that ICC is an enterprise engaged in or affecting interstate commerce due to ICC's interstate activities involving the sale and purchase of securities; that he had pleaded that McGraw is a person associated with (and distinct from) ICC due to McGraw's role as the sole owner of one of ICC's two members; that he has alleged a clear pattern of racketeering activity by alleging that McGraw committed two or more related acts of mail fraud, wire fraud, and/or fraud in the sale of securities by fraudulently obtaining funding from him on January 19, 2016 and again on March 16, 2016; that "McGraw's on-going pattern of deceit, over-inflation of projected earnings, and under-estimation of known risks in his effort to obtain funding for ICC demonstrate a clear threat of continued racketeering activity," P. Br. 24; and that the fourth amended complaint adequately pleads a legally sufficient nexus between McGraw, ICC, and the racketeering activity.
The court concludes that the fourth amended complaint fails to state a plausible civil RICO claim against defendants because it does not adequately plead a pattern of racketeering activity.
Although the court is in part granting defendants' motion to dismiss, it will permit Ginsburg to replead.
First, as the court explained in In re American Airlines, Inc., Privacy Litigation, 370 F.Supp.2d 552 (N.D. Tex. 2005) (Fitzwater, J.), "`district courts often afford plaintiffs at least one opportunity to cure pleading deficiencies before dismissing a case, unless it is clear that the defects are incurable or the plaintiffs advise the court that they are unwilling or unable to amend in a manner that will avoid dismissal.'" Id. at 567-68 (quoting Great Plains Tr. Co. v. Morgan Stanley Dean Witter & Co., 313 F.3d 305, 329 (5th Cir. 2002)). There is no indication that the defects in the fourth amended complaint are in all respects incurable,
Second, "[t]his court's approach in cases decided under the PSLRA has been to allow plaintiffs at least one opportunity to replead after the court has filed an opinion identifying defects in a complaint." Town of Davie Police Pension Plan v. Pier 1 Imports, Inc., ___ F.Supp.3d ___, 2017 WL 3437215, at *25 (N.D. Tex. Aug. 10, 2017) (Fitzwater, J.).
Third, although Ginsburg is on his fourth amended complaint, the court considers this memorandum opinion and order to be the first that alerts him to the court's conclusions about the deficiencies in his complaint and his first opportunity to cure the deficiencies that the court has identified.
The court therefore grants Ginsburg 28 days from the date this memorandum opinion and order is filed to file a fifth amended complaint.
Accordingly, for the reasons explained, defendants' motion to dismiss is granted in part and denied in part, and Ginsburg is granted leave to replead.
