KLS Diversified Master Fund, L.P. v. McDevitt ( 2022 )

21-1263
KLS Diversified Master Fund, L.P. v. McDevitt
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
SUMMARY ORDER
RULINGS BY SUMMARY ORDER DO NOT HAVE PRECEDENTIAL EFFECT. CITATION TO A SUMMARY
ORDER FILED ON OR AFTER JANUARY 1, 2007, IS PERMITTED AND IS GOVERNED BY FEDERAL RULE OF
APPELLATE PROCEDURE 32.1 AND THIS COURT’S LOCAL RULE 32.1.1. WHEN CITING A SUMMARY ORDER
IN A DOCUMENT FILED WITH THIS COURT, A PARTY MUST CITE EITHER THE FEDERAL APPENDIX OR AN
ELECTRONIC DATABASE (WITH THE NOTATION “SUMMARY ORDER”). A PARTY CITING TO A SUMMARY
ORDER MUST SERVE A COPY OF IT ON ANY PARTY NOT REPRESENTED BY COUNSEL.
1 At a stated term of the United States Court of Appeals for the Second Circuit,
2 held at the Thurgood Marshall United States Courthouse, 40 Foley Square, in the City of
3 New York, on the 13th day of July, two thousand twenty-two.
4
5 PRESENT:
6 MICHAEL H. PARK,
7 STEVEN J. MENASHI,
8 MYRNA PÉREZ,
9 Circuit Judges.
10 _____________________________________
11
12 KLS DIVERSIFIED MASTER FUND, L.P.,
13
14 Plaintiff-Appellee,
15
16 v. 21-1263
17
18 SEAN MCDEVITT,
19
20 Defendant-Appellant.
21 _____________________________________
22
23 FOR DEFENDANT-APPELLANT: CHRISTOPHER J. SEUSING (Michelle M.
24 Arbitrio, Sameer P. Ponkshe, on the brief),
25 Wood Smith Henning & Berman LLP,
26 White Plains, NY.
27
28 FOR PLAINTIFF-APPELLEE: EUGENE R. LICKER (Marjorie Peerce, on the
29 brief), Ballard Spahr LLP, New York, NY.
30
31
32
1 Appeal from a judgment of the United States District Court for the Southern District of
2 New York (Liman, J.).
3 UPON DUE CONSIDERATION, IT IS HEREBY ORDERED, ADJUDGED, AND
4 DECREED that the judgment of the district court is AFFIRMED.
5 Defendant Sean McDevitt was the CEO of Sensei, Inc. (“Sensei”), which operated a
6 healthcare-related “digital engagement platform” and “mobile application.” Short on cash, Sensei
7 entered into an agreement (the “Transaction”) on January 9, 2017 with Plaintiff KLS Diversified
8 Master Fund, L.P. (“KLS”) whereby KLS paid Sensei $2 million in exchange for a $3.33 million
9 convertible promissory note, with a 4% annual coupon and a maturity date of two years from the
10 date of execution.
11 Three documents governed the terms of the Transaction. First, the Note Purchase
12 Agreement provided that KLS would purchase the promissory note from Sensei for $2 million,
13 and Sensei made certain representations and warranties to KLS. Second, the Secured Convertible
14 Promissory Note (“Note”) provided that Sensei would pay the $3.33 million value of the Note plus
15 coupon after two years and that Sensei covenanted to: (1) make to KLS “[a] prompt report of any
16 legal actions pending or threatened in writing against the Company” and (2) “[t]imely file all
17 required tax returns and reports and timely pay all foreign, federal, state, and local taxes.” App’x
18 at 79. Third, McDevitt also signed a Conditional Guaranty, in which he agreed to be “fully and
19 personally liable for the payment and performance of any then remaining obligations of [Sensei]
20 set forth in the Note . . . only in the event” that a “Recourse Event” occurs. App’x at 150. The
21 recourse events relevant to this appeal are: (1) “any intentional or willful failure to disclose a
22 material fact in connection with the issuance of the Note or at any time the Note is outstanding”
2
1 (“Recourse Event A”); and (2) “any material breach of the material terms of the Note . . . directly
2 or indirectly caused by [McDevitt]” (“Recourse Event C”). App’x at 150–51.
3 Sensei failed to pay the $3.33 million principal and accrued interest owed to KLS at the
4 two-year maturity date. KLS thus foreclosed on Sensei’s assets and obtained title to them. KLS
5 then sued McDevitt for a breach of guaranty claim alleging that he was liable for Sensei’s
6 obligations under the Note because he triggered various recourse events in the Conditional
7 Guaranty. The district court granted KLS’s motion for summary judgment as to McDevitt’s
8 liability, finding that: (1) McDevitt triggered Recourse Event A by failing to disclose a litigation
9 threat by Porter Wright Morris & Arthur (“Porter Wright”); and (2) McDevitt triggered Recourse
10 Event C by failing to disclose pending litigation against Sensei by Porter Wright and Jonathan
11 Schwartz, and failing to timely file and pay federal and state taxes. The district court granted in
12 part and denied in part KLS’s motion for summary judgment as to damages, finding that: (1) KLS
13 could recover the full amount due under the Note from McDevitt without offsetting the value of
14 the collateral in KLS’s possession; (2) McDevitt’s claim that the Transaction was unconscionable
15 was waived and failed on the merits; and (3) KLS’s request for attorneys’ fees of 30% of the
16 amount recovered was reasonable. 1 McDevitt appealed. We assume the parties’ familiarity with
17 the underlying facts, the procedural history of the case, and the issues on appeal.
18 “We review the district court’s grant of summary judgment de novo, construing the facts
19 in the light most favorable to the non-moving party and drawing all reasonable inferences in its
20 favor.” Ashley v. City of New York, 992 F.3d 128, 136 (2d Cir. 2021). We also review the court’s
21 interpretation of the Transaction documents de novo. See Compagnie Financiere de CIC et de
1
The only part of KLS’s motion for summary judgment that the court denied was its request for “fees on
fees” or “payment of fees in connection with the collection of attorney’s fees.” Special App’x at 116–17.
3
1 L’Union Europeenne v. Merrill Lynch, Pierce, Fenner & Smith Inc., 188 F.3d 31, 34 (2d Cir.
2 1999).
3 I. Recourse Events
4 Any one Recourse Event is sufficient to establish McDevitt’s liability and therefore to
5 affirm the judgment of the district court. 2 We affirm the district court’s grant of summary
6 judgment on the basis that Sensei’s failure to file and pay taxes on time triggered Recourse Event
7 C, which requires “a material breach of the material terms of the Note . . . directly or indirectly
8 caused by [McDevitt].” App’x at 150–51. 3 Recourse Event C provides an inexhaustive list of
9 terms that are “material,” each of which protected KLS’s investment in Sensei. The Note’s
10 affirmative covenant that Sensei file and pay taxes on time is a material term because, like those
11 terms listed in Recourse Event C, the failure to timely pay taxes can result in penalties, including
12 liens, which affect KLS’s investment.
13 Sensei’s failure to file and pay federal and state taxes on time was also a material breach.
14 Sensei failed to file federal taxes for the first and second quarters of 2018, resulting in about $5,500
15 in late fees and penalties, and it also owed about $44,000 in federal taxes and $4,250 in state taxes
16 halfway through 2018. 4 These liabilities were significant in and of themselves for a cash-strapped
17 company, but they were even more significant as indicia of Sensei’s problems in light of the
18 hundreds of thousands of dollars of back taxes Sensei owed because of its failure to file and pay
2
See App’x at 150 (“[I]n the event any of the following occurs,” “Guarantor shall be fully and personally
liable for the payment and performance of any then remaining obligations of Company set forth in the Note.”
(emphasis added)); App’x at 151 (“Upon the occurrence of a Recourse Event, Guarantor shall pay the Guaranteed
Obligations in full in cash upon demand by Holder.” (emphasis added)).
3
Because we hold that the breach of the tax covenant triggered Recourse Event C, we need not decide whether
the district court properly concluded that McDevitt triggered Recourse Events A and C by failing to disclose the Porter
Wright and Schwartz litigations.
4
McDevitt was replaced as CEO in May 2018.
4
1 taxes before the Transaction. KLS ultimately advanced $570,000 in credit so Sensei could pay off
2 its tax liabilities.
3 McDevitt argues that the tax-related breach was not material because he paid off the state
4 tax liabilities. Even so, Sensei was still liable for the unpaid federal taxes and penalties. McDevitt
5 also argues that because his tax advisor instructed him not to file federal taxes in order to pursue
6 an Offer in Compromise with the IRS, that there was no breach, and even if there was a breach, it
7 was not caused by him. The Note, however, does not provide any exception to the taxes covenant.
8 And McDevitt cannot avoid responsibility by blaming his tax advisor—the tax advisor testified
9 that he did not know about the KLS financing, much less the covenants in the Note, and whatever
10 the tax advisor’s advice, McDevitt had ultimate control over whether and when taxes were filed.
11 In sum, we affirm the district court’s grant of summary judgment to KLS because McDevitt
12 triggered Recourse Event C and is therefore liable to KLS under the Conditional Guaranty.
13 II. Unconscionability
14 The district court found that (1) McDevitt forfeited his unconscionability defense because
15 he failed to raise the argument at the liability stage of summary judgment and instead raised it at
16 the damages stage, and (2) McDevitt contractually waived the argument when he agreed to a broad
17 waiver of defenses in the Conditional Guaranty, which included waiving “any legal or statutory
18 provision or legal or equitable principle of law which would discharge [McDevitt’s] obligations
19 for the Guaranteed Obligations.” 5 App’x at 152–54. McDevitt did not challenge the district
20 court’s finding that he contractually waived the unconscionability defense, and he thus abandoned
5
McDevitt also waived his argument that the value of the collateral that KLS currently possesses should
offset the judgment against him. McDevitt devotes only two sentences to this argument in his briefs and fails to
provide any factual or legal analysis. The issue is thus “not sufficiently argued in the briefs,” and we decline to
consider it. Norton v. Sam’s Club, 145 F.3d 114, 117 (2d Cir. 1998).
5
1 the issue on appeal.
2 In any event, McDevitt’s unconscionability argument fails on the merits. “The doctrine of
3 unconscionability seeks to prevent sophisticated parties with grossly unequal bargaining power
4 from taking advantage of less sophisticated parties.” NML Capital v. Republic of Argentina, 621
5 F.3d 230, 237 (2d Cir. 2010) (citation omitted). “In general, a provision will be deemed
6 unenforceable on unconscionability grounds only where it is both procedurally and substantively
7 unconscionable when made. . . . [T]here are some exceptional cases where a provision of a contract
8 is so outrageous as to warrant holding it unenforceable on the ground of substantive
9 unconscionability alone.” Id. (cleaned up).
10 Here, there was no procedural unconscionability. Even though Sensei was running low on
11 cash and had limited financing options, both parties in the transaction were sophisticated
12 commercial entities represented by counsel who negotiated at arm’s length. See NML Capital, 621
13 F.3d at 237; Westinghouse Elec. Corp. v. N.Y.C. Transit Auth., 623 N.E.2d 531, 535 (N.Y. 1993).
14 The contract was not “so outrageous” that it would be unenforceable on substantive
15 unconscionability alone. NML Capital, 621 F.3d at 237 (citation omitted). Although many of the
16 terms of the Transaction were highly favorable to KLS, they were not unreasonable given the large
17 risk KLS took lending to Sensei. 6 See Westinghouse Elec. Corp., 623 N.E.2d at 535 (“The bedrock
18 of the doctrine of unconscionability is the prevention of oppression and unfair surprise . . . and not
19 of disturbance of allocation of risk.” (cleaned up)).
20 We have considered the remainder of McDevitt’s arguments and find them to be without
6
McDevitt argues on appeal that the Transaction is substantively unconscionable because it violates New
York’s criminal usury laws. McDevitt forfeited this argument because he raised it for the first time on appeal, and we
decline to consider it. See Harrison v. Republic of Sudan, 838 F.3d 86, 96 (2d Cir. 2016) (“It is a well-established
general rule that an appellate court will not consider an issue raised for the first time on appeal.” (cleaned up)).
6
1 merit. 7 Accordingly, we affirm the judgment of the district court.
2 FOR THE COURT:
3 Catherine O’Hagan Wolfe, Clerk of Court
4
7
We reject McDevitt’s argument that the court abused its discretion in its award of attorneys’ fees. McDevitt
contends that the fee award was unreasonable because the number of hours KLS’s counsel billed was inflated. The
court did not abuse its discretion in finding that the number of hours billed was justified given the complexity of the
case and efforts required by counsel. And in any event, the 30% contingency fee that the court awarded was lower
than the fee for the actual time billed.
7