NYSA Series Trust v. ESPSCO Syracuse, LLC: Court Dismisses Complaint Alleging Section 10(b) Violation

In NYSA Series Trust v. ESPSCO Syracuse, LLC, No. 5:14-CV-1089, 2015 BL 2727 (N.D.N.Y. Feb. 3, 2015), the United States District Court for the Northern District of New York dismissed fraudulent misrepresentation claims with prejudice, holding twenty-two purchasers of debt securities (“Plaintiffs”) failed to offer anything more than conclusory allegations in support of their claims. The court also held, even if adequately pled, the claim was barred by the statute of limitations.

According to the allegations, Patrick Dessein, Dr. Brett Greenky, Dr. Seth Greenky, and Dr. Glenn Axelrod served as founders and managing members of ESPSCO Syracuse, LLC (“ESPSCO” and collectively with the listed individuals “Defendants”) to raise funds for an affiliated entity known as Syracuse Packaging International, LLC (“SPI”). ESPSCO sought funds by offering $1,700,000 in notes to accredited investors, including Plaintiff, in a private offering.  On January 1, 2012, ESPSCO defaulted on its obligation to pay interest on the notes, and SPI failed to honor its obligation as guarantor.

Plaintiffs filed suit, alleging, along with state law claims, that Defendants violated Section 10(b) of the Securities Exchange Act of 1934 by making fraudulent misrepresentations in the offering materials used in connection with the sale of the notes. Plaintiffs asserted misrepresentations or omissions regarding (1) the adequacy of the minimum investment amount to fund the proposed operation of ESPSCO; (2) the fact that funds would be “diverted” to SPI; and (3) the adequacy of SPI’s capitalization for purposes of guaranteeing the investment. Defendants filed a motion to dismiss for failure to state a claim.

 Section 10(b) forbids the making of any untrue statement of a material fact or the omission of any material fact necessary to not be misleading. To state a claim for securities fraud under Section 10(b), a plaintiff must allege: (1) a material misrepresentation or omission; (2) scienter; (3) a connection to the purchase or sale of a security; (4) reliance upon the misrepresentation; (5) economic loss; and (6) a causal connection between the misrepresentation or omission and economic loss.

 Plaintiffs argued the statement, “[a] minimum amount of $200,000 shall be required to be raised in order for the Company to complete a closing hereunder,” falsely suggested that the amount would be sufficient to fund ESPSCO’s operations for a reasonable period of time. The court disagreed. The court reasoned the statement did not speak to the adequacy of funding for ESPSCO’s operations, much less guarantee stability for any period of time. Rather, the materials simply explained that $200,000 was required before the closing could occur.

Second, Plaintiffs asserted that language providing for the use of proceeds in the offering “(a) to acquire the accounts receivables of SPI for factoring, (b) to enter into a commercial loan with SPI, and (c) for general operating expenses of the Company” was misleading because it implied that the highest priority for proceeds was acquiring the SPI accounts receivable for factoring. Plaintiffs also asserted the provision failed to advise them of ESPSCO’s ability to divert the proceeds to SPI. The court rejected this argument, finding the provision did not prioritize how the proceeds would be used and the second enumerated use specifically anticipated diverting SPI funds through a commercial loan.

Finally, Plaintiffs asserted that  language in the offering materials was misleading because it created an implication SPI was  capitalized sufficiently to unconditionally guarantee the “punctual payment” of the notes. See Offering Materials (“If the Company fails to make any payment when due under the notes, the sole remedy of the noteholders will be limited to proceeding against SPI to recover full payment thereon.”). The court disagreed, explaining that this statement merely identified SPI as guarantor and provided for the sole remedy in the event payment was not made, rather than promising an unconditional guarantee. The court also noted the “Form of Guaranty” explicitly stated it was a “guaranty of payment,” not a “guaranty of collection.”

In sum, the United States District Court for the Northern District of New York found nothing but conclusory allegations, which were belied by the language of the documents. Accordingly, the court dismissed the complaint with prejudice and dismissed the remaining state claims without prejudice for a lack of jurisdiction.

The primary materials for this post can be found on the DU Corporate Governance website

David Stone