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RSMCFH, LLC v. Fareharbor Holdings, Inc.

United States District Court, D. Hawaii

February 13, 2019

RSMCFH, LLC, a Hawaii limited liability company, Plaintiff,
FAREHARBOR HOLDINGS, INC., a Delaware corporation, Defendant.



         Before the Court is Defendant FareHarbor Holdings, Inc.'s (“Defendant”) Motion to Dismiss Pursuant to Rule 12(b)(6) (“Motion”), filed on November 16, 2018.[1] [Dkt. no. 20.] Plaintiff RSMCFH, LLC (“Plaintiff”) filed its memorandum in opposition on December 14, 2018, and Defendant filed its reply on December 21, 2018. [Dkt. nos. 23, 24.] This matter came on for hearing on January 7, 2019. Defendant's Motion is hereby granted in part and denied in part for the reasons set forth below.


         This action for securities violations arises out of Plaintiff's multi-million dollar investment in Defendant, which “is a local activities and experiences booking software provider.” [Dkt. no. 1 (complaint filed September 14, 2018 (“Complaint”)) at ¶ 11.] In December 2016, Defendant's representative approached Plaintiff about investing in Defendant and meetings took place several times from December 5 to 23, 2016. During these meetings, Defendant's officers - Lawrence Hester, Zachary Hester, and Max Valverde - represented that Defendant's existing preferred investors had already invested $3 million, and Defendant was seeking a $5 million investment from Plaintiff, in exchange for preferred stock. [Id. at ¶ 13.]

         Before making the investment, Plaintiff asked for certain information, including information about Defendant's capitalization. [Id. at ¶ 14.] Plaintiff specifically requested “all material information about the capital structure of [Defendant], including but not limited to the various percentages of common and preferred securities held in the Company.” [Id.] Roy Pfund, one of Plaintiff's members, made several requests for this information, including a December 2016 oral request to Mr. Valverde, Defendant's Chief Commercial Officer, and a January 4, 2017 email request. [Id.] In response, Mr. Valverde disclosed the $3 million invested by those who held Defendant's Series A preferred shares. No. other preferred securities were disclosed. [Id. at ¶ 15.] Based on these representations, Plaintiff was prepared to invest in Defendant. [Id. at ¶ 16.]

         In anticipation of Plaintiff's investment, Defendant adopted a Second Amended and Restated Certificate of Incorporation, authorizing the issuance of 1, 600, 000 shares of Series B Preferred Shares (“Certificate of Incorporation”). [Id. at ¶ 17.] This was the first time Defendant issued Series B Preferred Shares. [Id.] On January 5, 2017, Plaintiff executed a Subscription Agreement, agreeing to purchase 1, 594, 652 of the Series B Preferred Shares at $3.1354 per share, for a total of $4, 999, 999.46. [Id. at ¶ 19.] Plaintiff alleges it had no reason to believe Defendant had any other Series B Preferred Shareholders or that any other person had similar rights. Defendant represented in the Subscription Agreement that it had given Plaintiff access to all information that was both reasonably available to Defendant and responsive to Plaintiff's request for information. Plaintiff argues that, based on Defendant's representations, it believed Defendant had disclosed all relevant capitalization information. [Id. at ¶¶ 19-20.]

         On April 17, 2018, Defendant entered into an Agreement and Plan of Merger (“Merger Agreement”) in which Booking Holdings Inc. (“Booking”) agreed to purchase Plaintiff (“Booking Acquisition”), and the merger closed in May 2018. Plaintiff argues the Booking Acquisition was a “Liquidation Event” under the Certificate of Incorporation, which triggered Plaintiff's right to be paid “Liquidation Proceeds.” [Id. at ¶ 22.] The Merger Agreement provided that all shares of stock in Defendant, including Plaintiff's, would be cancelled and converted into a right to a cash payment, the amount of which depended on the number and type of shares held. [Id.]

         Plaintiff received a copy of the Merger Agreement, which stated that, on a date before Plaintiff made its investment, Defendant issued: one group of warrants that the Merger Agreement referred to as the “Costella Warrants”; and another group referred to as the “Series A-2 Preferred Warrants” (“A-2 Warrants” and collectively “Warrants”). The Warrants were sold for an aggregate total of $124, 791.01. [Id. at ¶ 23.] According to Plaintiff, “the effect of the Costella Warrants was (1) to dilute Plaintiff's percentage ownership interest in [Defendant]; and (2) reduce the amount available for distribution to Plaintiff from the liquidation proceeds by diverting substantial amounts to the holder(s) of the Costella Warrants.” [Id.] Plaintiff asserts that, but for the Costella Warrants, more than $7 million of additional liquidation proceeds from the Booking Acquisition would have been available to Plaintiff and Defendant's other shareholders. [Id.] Plaintiff also alleges the A-2 Warrants diverted more proceeds of the Booking Acquisition away from Plaintiff and Defendant's other shareholders. Plaintiff alleges the holders of the Warrants effectively paid less than $0.05 per share for their investments in Defendant. [Id.]

         Plaintiff asserts the Warrants and their terms should have been disclosed to Plaintiff in response to Plaintiff's pre-investment requests for information about Defendant's capitalization. According to Plaintiff, Defendant did not make this information available to Plaintiff, and Defendant deliberately concealed them from Plaintiff before Plaintiff's investment. [Id. at ¶ 24.]

         Once Plaintiff learned about the Warrants, it made repeated demands to Defendant and Booking for documents regarding the merger and the Warrants, but these requests were refused. [Id. at ¶ 28.] The Series B Liquidation Proceeds are now due and owing to Plaintiff. [Id. at ¶ 30.] Defendant and Booking have informed Plaintiff that it is entitled to receive more than $10 million for its shares, but Plaintiff contends that amount is insufficient. [Id. at ¶ 29.]

         The Complaint alleges the following claims: Defendant's misrepresentations regarding its capitalization and its concealment of the Warrants and their terms violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5 (“Count I”); fraud (“Count II”); a claim that Defendant breached the Subscription Agreement and the Certificate of Incorporation (“Count III”); and violation of the Hawai`i Uniform Securities Act, Haw. Rev. Stat. §§ 485A-501 and 485A-509 (“Count IV”).

         Defendant now urges dismissal of Plaintiff's claims in the Complaint and asserts the dismissal should be with prejudice.


         I. Consideration of Materials Beyond the Pleadings

         Defendant submitted two exhibits in support of the Motion: a series of emails between Mr. Valverde, Mr. Pfund, and others from December 19, 2016 to January 5, 2017; [Motion, Decl. of Laura A. Kelly in Supp. of Motion (“Kelly Decl.”), Exh. A;] and the Subscription Agreement, [id., Exh. B]. As a general rule, this Court's scope of review in considering a Fed.R.Civ.P. 12(b)(6) motion to dismiss is limited to the allegations in the complaint. See Khoja v. Orexigen Therapeutics, Inc., 899 F.3d 988, 998 (9th Cir. 2018), cert. petition docketed, No. 18-1010 (Feb. 4, 2019). If the district court considers materials beyond the pleadings, “the 12(b)(6) motion converts into a motion for summary judgment under [Fed. R. Civ. P.] 56, ” and “both parties must have the opportunity ‘to present all the material that is pertinent to the motion.'” Id. (quoting Fed.R.Civ.P. 12(d)). However, a district court can consider materials beyond the pleadings without converting the motion to dismiss into a motion for summary judgment if either the incorporation by reference doctrine or Fed.R.Evid. 201 judicial notice applies. Id.

         Defendant argues both the emails and the Subscription Agreement have been incorporated by reference into the Complaint.

[I]ncorporation-by-reference is a judicially created doctrine that treats certain documents as though they are part of the complaint itself. The doctrine prevents plaintiffs from selecting only portions of documents that support their claims, while omitting portions of those very documents that weaken - or doom - their claims. Parrino v. FHP, Inc., 146 F.3d 699, 706 (9th Cir. 1998), superseded by statute on other grounds as recognized in Abrego Abrego v. Dow Chem. Co., 443 F.3d 676, 681-82 (9th Cir. 2006) (observing “the policy concern underlying the rule: Preventing plaintiffs from surviving a Rule 12(b)(6) motion by deliberately omitting references to documents upon which their claims are based”).
Although the doctrine is straightforward in its purpose, it is not always easy to apply. In Ritchie, we said that a defendant may seek to incorporate a document into the complaint “if the plaintiff refers extensively to the document or the document forms the basis of the plaintiff's claim.” [United States v.] Ritchie, 342 F.3d [903, ] 907 [(9th Cir. 2003)]. How “extensively” must the complaint refer to the document? This court has held that “the mere mention of the existence of a document is insufficient to incorporate the contents of a document” under Ritchie. Coto Settlement v. Eisenberg, 593 F.3d 1031, 1038 (9th Cir. 2010) (citing Ritchie, 342 F.3d at 908-09). . . .

Id. at 1002. Plaintiff does not dispute Defendant's position that Exhibit B - the Subscription Agreement - is incorporated by reference in the Complaint. See Mem. in Opp. at 28 n.5. This Court concludes that the Subscription Agreement is incorporated by reference into the Complaint because it is both referred to extensively in the Complaint and it forms the basis for Plaintiff's claims. See, e.g., Complaint at ¶ 41; id. at ΒΆΒΆ 44-49. The Subscription Agreement will ...

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