Martin Lanz Zaslansky v. FZ Holdings US, Inc.

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
MARTIN LANZ ZASLANSKY and )
ROBERTA ZASLANSKY FAMILY )
TRUST, )
)
Petitioners, )
)
v. ) C.A. No. 2021-0168-KSJM
)
FZ HOLDINGS US, INC., )
)
Respondent. )
ORDER RESOLVING RESPONDENT’S MOTION TO DISMISS AND PETITIONERS’
CROSS-MOTION FOR PARTIAL SUMMARY JUDGMENT
1. The petitioners, Martin Lanz Zaslansky and a trust named for his wife, the
Roberta Zaslansky Family Trust (the “Trust” and, collectively, “Petitioners”), are current
noteholders of FZ Holdings US, Inc. (“Respondent” or the “Company”), a Delaware
corporation.1
2. In 2018, Hemang Mehta and Nevil Shah (the “Principals”) formed the
Company to produce and sell video game figurines. Around that time, Mitesh Lakhani, the
managing partner of Raisol Capital LLC (“Raisol”), approached Zaslansky about investing
in the Company. The petition alleges that Lakhani “has a historical relationship with the
Principals,” but the nature of that relationship is unclear.2
1
Unless otherwise stated, the facts are drawn from Petitioners’ Verified Petition for Breach
of Contract & for the Appointment of a Receiver to a Delaware Corporporation Pursuant
to 8 Del. C. § 291, C.A. No. 2021-0168-KSJM, Docket (“Dkt.”) 21 (the “Amended
Petition” or “Am. Pet.”).
2
Id. ¶ 53.
3. On July 31, 2018, the Trust and the Company executed a convertible
promissory note (“Note 1”) for $250,000 in principal with 8% interest per annum.3 Under
Note 1, the Company was obligated to pay the outstanding principal amount and any unpaid
interest on July 31, 2020, unless the Company defaulted earlier.
4. On March 1, 2019, Zaslansky and the Company executed a convertible
promissory note (“Note 2” and, together with Note 1, the “Notes”) for an additional
$25,000 in principal with 8% interest per annum.4 Under Note 2, the Company was
obligated to pay the outstanding principal amount and any unpaid interest on March 1,
2020, unless the Company defaulted earlier.
5. Each Note provides that the “Company agrees to pay on demand all of the
losses, costs, and expenses (including, without limitation, attorneys’ fees and
disbursements) which the Holder incurs in connection with enforcement of this Note, or
the protection or preservation of the Holder’s rights under this Note, whether by judicial
proceeding or otherwise.”5
6. The Company has struggled financially. According to its balance sheet as of
March 31, 2021, its assets were worth $469,302.63, its liabilities totaled $2,313,866.59,
and its net income was negative $49,871.60.6
3
See Am. Pet. Ex. A (Note 1).
4
See Am. Pet. Ex. B (Note 2).
5
Note 1 § 15; Note 2 § 15.
6
See Am. Pet. Ex. E (“March 31, 2021 Balance Sheet”).
2
7. On October 29, 2020, each Petitioner served a notice of default on the
Company for failing to repay the outstanding principal and interest due under the Notes by
their maturity dates.7
8. Despite this failure to timely repay its noteholders, the Company has partially
repaid debt owed to its Principals. In support of this allegation, Petitioners point to the
Company’s balance sheet as of September 30, 2019, which reflects a debt to
“Founder/Affiliates” of $316,237.37.8 The Company’s later balance sheet indicates that a
debt due to “Owner” decreased from $207,384.48 as of December 31, 2020, to $194,761.94
as of March 31, 2021.9 Similarly, a debt owed to “Sunrise,” which the Principals are
alleged to own or control, appeared to decrease during the same time period.10
9. In a similar vein, the Principals are alleged to have commingled personal debt
with Company debt. The Company’s balance sheets indicate that it repaid a debt to Raisol
in the amount of $90,000 between September 30, 2019, and December 31, 2020.11
According to Petitioners, however, the Company was never indebted to Raisol, as these
7
See Am. Pet. Ex. C (Trust Notice), Ex. D (Zaslansky Notice).
8
See Am. Pet. Ex. J (“September 30, 2019 Balance Sheet”).
9
See March 31, 2021 Balance Sheet.
10
See Am. Pet. Ex. L (December 31, 2019 Balance Sheet) (reflecting $237,222.42 due to
Sunrise), Ex. M (June 30, 2020 Balance Sheet) (reflecting $216,931.42 due to Sunrise),
March 31, 2021 Balance Sheet (reflecting $207,337.42 due to Sunrise). According to
Petitioners, the Principals own or control SCP PTF Investment Vehicle LLC, which does
business as Sunrise Capital Partners. Petitioners allege that the entity referred to as
“Sunrise” on the balance sheets is this entity.
11
See September 30, 2019 Balance Sheet, March 31, 2021 Balance Sheet. The balance
sheets for periods after September 30, 2019, refer to debt owed to “Raisol Consulting,”
which Petitioners allege is the same entity as Raisol.
3
balance sheet entries refer to a loan from Raisol to Sunrise Capital Partners that the
Principals had guaranteed.12
10. As a further cause for concern, Petitioners allege that the Principals are
running a parallel company with a similar business model called Minted Labs, Inc. This
company also produces video game figurines, but they are less expensive than the
Company’s and are not custom-made. The Principals did not disclose the existence of
Minted Labs to Petitioners, who learned about it from Lakhani in early 2020. When
pressed for information, the Principals admitted that they and a Company employee have
worked for both companies, which allegedly operate out of the same office building.
11. Petitioners filed this action on February 25, 2021, and they amended their
petition on August 20, 2021. In Counts I and II of the Amended Petition, each Petitioner
claims that Respondent breached their respective Note and seeks damages and an
accounting from 2018 to the present. In Count III, Petitioners request the appointment of
a receiver under 8 Del. C. § 291.
12. On September 3, 2021, Respondent moved to dismiss Counts I and II under
Court of Chancery Rule 12(b)(1) for lack of subject matter jurisdiction and Count III under
Rule 12(b)(6) for failure to state a claim.13 Petitioners cross-moved for partial summary
12
See Am. Pet. Ex. K (Promissory Note & Guaranty). The guaranty was for a $50,000
loan, so it is not clear how that might have morphed into a $90,000 debt on the Company’s
balance sheet. The inconsistency is not shocking, however, as none of the Company’s
financials appear to have been prepared in accordance with Generally Accepted
Accounting Principles.
13
See Dkt. 22.
4
judgment on Counts I and II on October 15, 2021. 14 The motions were fully briefed as of
December 7, 2021,15 and the court held oral argument on December 21, 2021.16
13. Respondent took an unusual position in briefing. Respondent conceded that
the court has subject matter jurisdiction over Count III but argued that Count III fails to
state a claim. Respondent further argued that Counts I and II are purely legal claims that
fall outside of this court’s limited jurisdiction. In Respondent’s view, the court should
dismiss Counts I and II without prejudice and transfer them to the Superior Court because
of the defects in Count III.17 That is a common enough argument. The atypical part is that,
if this court denies Respondent’s motion to dismiss Count III and decides to assert
jurisdiction over Counts I and II, Respondent does not contest entry of judgment in
Petitioners’ favor on the first two counts.18 Because Respondent’s motion and the fate of
Counts I and II hinge on its arguments as to Count III, this analysis focuses there.
14. Respondent has moved to dismiss Count III for appointment of a receiver
under 8 Del. C. § 291 under Court of Chancery Rule 12(b)(6). Under Rule 12(b)(6), “the
14
See Dkt. 26.
15
See Dkt. 25 (Resp’t’s Opening MTD Br.); Dkt. 27 (Pet’rs’ Combined Answering MTD
Br. & Opening PMSJ Br.); Dkt. 34 (Resp’t’s Combined Reply MTD Br. & Answering
PMSJ Br.); Dkt. 38 (Pet’rs’ Reply PMSJ Br.).
16
See Dkt. 43 (“Oral Arg. Tr.”).
17
See Resp’t’s Opening MTD Br. at 12–13.
18
See Resp’t’s Combined Reply MTD Br. & Answering PMSJ Br. at 3 (stating that
Respondent does “not contest the entry of judgment on Counts I and II”); Oral Arg. Tr. at
5:18–21 (stating that “to the extent the Court does determine that it should exercise
jurisdiction over the debt claims, [Respondent does] not contest entry of judgment on those
claims”).
5
governing pleading standard in Delaware to survive a motion to dismiss is reasonable
‘conceivability.’”19 The court must “accept all well-pleaded factual allegations in the
[c]omplaint as true . . . , draw all reasonable inferences in favor of the plaintiff, and deny
the motion unless the plaintiff could not recover under any reasonably conceivable set of
circumstances susceptible of proof.”20 The court, however, need not “accept conclusory
allegations unsupported by specific facts or . . . draw unreasonable inferences in favor of
the non-moving party.”21
15. Under 8 Del. C. § 291, a creditor or stockholder can petition this court to
appoint a receiver “of and for” an insolvent corporation.22 The power to appoint “a receiver
lies within the sole discretion of the Court.”23 In reviewing the petition, “[t]he Court
applies an ‘insolvency plus’ standard to determine whether to appoint a receiver under
Section 291.”24 That standard requires the court to determine two things: (i) that the
corporation is insolvent and (ii) that appointment of a “neutral third party” is necessary “to
19
Cent. Mortg. Co. v. Morgan Stanley Mortg. Cap. Hldgs. LLC, 27 A.3d 531, 537 (Del.
2011).
20
Id. at 536 (citing Savor, Inc. v. FMR Corp., 812 A.2d 894, 896–97 (Del. 2002)).
21
Price v. E.I. DuPont de Nemours & Co., Inc., 26 A.3d 162, 166 (Del. 2011) (citing
Clinton v. Enter. Rent-A-Car Co., 977 A.2d 892, 895 (Del. 2009)), overruled on other
grounds by Ramsey v. Ga. S. Univ. Advanced Dev. Ctr., 189 A.3d 1255 (Del. 2018).
22
8 Del. C. § 291.
23
Banet v. Fonds de Régulation et de Contrôle Café Cacao, 2009 WL 529207, at *3 (Del.
Ch. Feb. 18, 2009) (citation omitted).
24
In re Geneius Biotech., Inc., 2017 WL 6209593, at *5 (Del. Ch. Dec. 8, 2017) (quoting
Ross Hldg. & Mgmt. Co. v. Advance Realty Gp., LLC, 2010 WL 3448227, at *5 (Del. Ch.
Sept. 2, 2010)).
6
protect the insolvent corporation’s creditors or shareholders by showing some benefit that
such an appointment would produce or some harm it could avoid.”25
16. To plead insolvency, Petitioners must allege that Respondent has either: “1)
‘a deficiency of assets below liabilities with no reasonable prospect that the business can
be successfully continued in the face thereof,’ or 2) ‘an inability to meet maturing
obligations as they fall due in the ordinary course of business.’”26
17. Petitioners allege, and the Company’s balance sheet demonstrates, that the
Company’s liabilities equaled nearly five times its assets as of March 31, 2021, and the
Company had a negative net income. This court has held that similar facts demonstrate
insolvency under the balance sheet test.27 Petitioners have thus met the first test for
insolvency. Because Petitioners have clearly met their pleading burden under the first test,
this analysis does not reach their arguments under the second test.
18. The “plus” factor of the insolvency-plus test requires that Petitioners plead
facts to show “there exist ‘special circumstances’ where ‘some real beneficial purpose will
be served’” by the appointment of a receiver.28 To satisfy this standard, Petitioners must
plead “the necessity of a neutral third party [i] ‘to protect the insolvent corporation’s
25
Id. (cleaned up).
26
Prod. Res. Gp., L.L.C. v. NCT Gp. Inc., 863 A.2d 772, 782 (Del. Ch. 2004) (quoting
Siple v. S & K Plumbing & Heating, Inc., 1982 WL 8789, at *2 (Del. Ch. Apr. 13, 1982)).
27
See id. at 783 (holding that insolvency was adequately pled under the balance sheet test
where the respondent’s liabilities were nearly five times its assets and it consistently
suffered large operating losses).
28
Pope Invs. LLC v. Benda Pharm., Inc., 2010 WL 5233015, at *6 (Del. Ch. Dec. 15, 2010)
(quoting Banet, 2009 WL 529207, at *3).
7
creditors or shareholders by showing some benefit that such an appointment would produce
or some harm it could avoid,’ and [ii] the ‘potential benefits must outweigh any potential
harm that appointment of a receiver could cause.’”29
19. Petitioners allege that the Principals “have caused the Company to repay
other creditors in part or full ahead of Petitioners and other noteholders, and have
commingled their own debt with debt of the Company.”30 The creditors being repaid ahead
of Petitioners are alleged to be the Principals and their affiliates.31 As for commingling,
Petitioners allege that Respondent has recorded the “personal debt of the Principals and of
Sunrise Capital Partners . . . as Company debt.”32 On top of this, Petitioners allege that
Respondent has continued to “secure[] more convertible debt.”33
20. Petitioners also allege that the Principals have used Respondent’s money and
resources to operate a parallel company, Minted Labs, which Petitioners allege operates in
the Company’s building and uses a Company employee.34 Petitioners have no interest in
Minted Labs and allege they and other noteholders were not informed about its existence
until early 2020.35
29
Geneius, 2017 WL 6209593, at *5 (quoting Badii ex rel. Badii v. Metro. Hospice, Inc.,
2012 WL 764961, at *7, *10 (Del. Ch. Mar. 12, 2012) (internal quotation marks and
footnotes omitted)).
30
Am. Pet. ¶ 46.
31
See id. ¶ 49.
32
Id. ¶ 52.
33
Id. ¶ 32.
34
See id. ¶¶ 56–57.
35
See id. ¶ 58.
8
21. In response to Petitioners’ plus-factor allegations, Respondent first argues
that Petitioners’ claims are not well-pled, pointing out that the Amended Petition uses the
phrase “upon information and belief” more than twenty times. Respondent cites several
cases in which this court found such allegations insufficient to state a claim.36
22. While the phrase “upon information and belief” appears with some frequency
in the Amended Petition, this decision need not rely on those allegations alone. Petitioners
have provided support for their allegations with specific facts and attached exhibits from
which the court is able to draw reasonable inferences.37 Indeed, Respondent’s own
financial records attached to and incorporated by reference into the Amended Petition
render the allegations about growing convertible debt, paying off insiders, and satisfying
insiders’ personal obligations reasonably conceivable.38 In addition, the Amended Petition
alleges that “[w]hen pressed for information [about Minted Labs], the Principals conceded
that they and an employee of the Company have worked for both companies.” 39 This
situation is thus distinguishable from Respondent’s cited cases.40
36
See Resp’t’s Opening MTD Br. at 8–10; Oral Arg. Tr. at 7:4–8:10.
37
See Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 860 A.2d 312, 320 (Del. 2004) (holding
that the trial court erred by considering documents “neither attached to, nor incorporated
by reference into, the complaint”).
38
Compare September 30, 2019 Balance Sheet (showing $850,000 in convertible debt,
$316,237.37 due to “Founder/Affiliates,” and $90,000 due to “Raisol Capital”), with March
31, 2021 Balance Sheet (showing $1,100,000 in convertible debt, $194,761.94 due to
“Owner,” and $0 due to “Raisol”).
39
Am. Pet. ¶ 58.
40
See DG BF, LLC v. Ray, 2021 WL 776742, at *27 (Del. Ch. Mar. 1, 2021) (dismissing
claims based on information and belief that the nominal defendant was undercapitalized
and being used as the individual defendants’ personal piggy bank because the allegations
9
23. Aside from its “information and belief” argument, Respondent contends that
the only inference to be drawn from Respondent’s failure to repay its debts allegations is
that “Petitioners desire (exigently) to be moved ‘ahead’ in the line of partial or full debt
payments that are actually being made by FZ Holdings.”41 Respondent further contends
that “unspecified ‘concerns’” about a parallel company “do[] not support a reasonable
inference of any exigent circumstance warranting a receiver.”42 Finally, Respondent insists
that appointing a receiver for the Company would have the effect of liquidating a
corporation that is only valuable as a going concern, which would destroy its value and
prevent any meaningful distribution to creditors.43
24. Respondent’s arguments again fall short. Taking Petitioners’ allegations as
true and drawing all reasonable inferences in their favor, as the court must at this stage,
were “limited” and “conclusory”); Neurvana Med., LLC v. Balt USA, LLC, 2020 WL
949917, at *23 (Del. Ch. Feb. 27, 2020) (refusing to accept as true an allegation made upon
information and belief where the allegation was unsupported by well-pled facts in the
complaint); O’Gara v. Coleman, 2020 WL 752070, at *6 (Del. Ch. Feb. 14, 2020) (same);
Griffin Corp. Servs., LLC v. Jacobs, 2005 WL 2000775, at *6 (Del. Ch. Aug. 11, 2005)
(same).
41
Resp’t’s Opening MTD Br. at 9 (emphasis in original).
42
Id.43
See Resp’t’s Combined Reply MTD Br. & Answering PMSJ Br. at 2; Oral Arg. Tr. at
4:4–12, 6:4–11. Respondent cites to Keystone Fuel Oil, Inc. v. Del-Way Petroleum, Co.,
for the proposition that “a receiver is normally a remedy of an auxiliary nature incidental
to primary relief bottomed upon fraud or inequitable conduct under the given
circumstances, and the appointment of a receiver should not be the sole object of a suit.”
1977 WL 2572, at *2 (Del. Ch. June 16, 1977). That portion of the decision, which was
on a different procedural posture, “cited to two cases in which a petitioner sought the
appointment of a receiver pendente lite for a solvent company and invoked this court’s
general equitable authority, not the statutory authority granted by § 291,” and thus is
inapposite. Prod. Res., 863 A.2d at 785.
10
Respondent’s continued debt financing, selective repayment of current debts, lackadaisical
approach to bookkeeping, and commingling of personal and Company debts has the
potential to harm Petitioners, other current noteholders, and any future creditors that the
Company may attract. A receiver could prevent or alleviate this harm. And a receiver need
not necessarily liquidate the insolvent corporation’s assets to do so. Rather, a receiver is
broadly empowered to do all that “may be necessary or proper” in the name of the
corporation.44 If Petitioners prove their claims, it remains to be seen what powers will be
necessary and proper for the receiver to do what is in the best interests of the Company. At
this stage, the question is whether it is reasonably conceivable that the appointment of a
neutral third party is necessary to protect the Company’s creditors. It is. Petitioners have
thus adequately pled the plus factor.
25. For the foregoing reasons, Respondent’s motion to dismiss Count III
pursuant to Rule 12(b)(6) is DENIED.
26. Respondent has moved to dismiss Counts I and II under Rule 12(b)(1),
arguing that they are legal claims falling outside of this court’s limited jurisdiction.45 Under
the “clean-up doctrine,” however, this court may exercise “ancillary jurisdiction ‘to resolve
purely legal causes of action that are before it as part of the same controversy over which
the Court originally had subject matter jurisdiction in order to avoid piecemeal
44
8 Del. C. § 291.
45
See Resp’t’s Opening MTD Br. at 10–13.
11
litigation.’”46 The court has found that Count III under 8 Del. C. § 291 is well-pled; that
claim indisputably gives rise to subject matter jurisdiction over this action, allowing the
court to exercise subject matter jurisdiction over Counts I and II under the clean-up
doctrine. Accordingly, Respondent’s motion to dismiss Counts I and II pursuant to Rule
12(b)(1) is DENIED.
27. The court has denied Respondent’s motion to dismiss Count III for failure to
state a claim and held that the exercise of jurisdiction over Counts I and II is appropriate.
Per Respondent’s stipulation described above, Petitioners’ motion for partial summary
judgment as to Counts I and II is GRANTED.
28. The parties shall confer on a form of Order memorializing this ruling as to
Counts I and II and on a schedule for litigating Count III.
/s/ Kathaleen St. J. McCormick
Chancellor Kathaleen St. J. McCormick
Dated: February 8, 2022
46
FirstString Rsch., Inc. v. JSS Med. Rsch. Inc., 2021 WL 2182829, at *6 (Del. Ch. May
28, 2021) (quoting Kraft v. WisdomTree Invs., Inc., 145 A.3d 969, 974 (Del. Ch. 2016)).
12