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STAFFORD v. CYBER DYNE LIQUIDATING CORPORATION

September 2, 2005.

JOHN S. STAFFORD, III, an individual, and DAVID W. LOBDELL, an individual, Plaintiff,
v.
CYBER DYNE LIQUIDATING CORPORATION, a Delaware corporation, a/k/a CYBER DYNE LIQUIDATION CORPORATION; WEINTRAUB DILLON, PC, a California professional corporation; RICHARD A. WEINTRAUB, an individual; TIMOTHY P. DILLON, an individual; CARL LOVEGREN, an individual; and MICHAEL O'HAGAN, an individual, Defendants.



The opinion of the court was delivered by: WILLIAM HAYES, District Judge

ORDER GRANTING DEFENDANTS' SPECIAL MOTIONS TO STRIKE

[Doc. No.'s 12; 17; 22]

Defendants Timothy P. Dillon, Richard A. Weintraub, Weintraub Dillon P.C. and Michael O'Hagan (collectively "Defendants") each move to strike Plaintiffs' complaint, pursuant to California Code of Civil Procedure 425.16. Plaintiffs John S. Stafford and David W. Lobdell (collectively, "Plaintiffs") oppose Defendants' motions. On August 4, 2005, the Court held a hearing on Defendants' motions and now issues the following order. I. Factual Background

  This malicious prosecution action brought by Plaintiffs John S. Stafford III ("Stafford") and David W. Lobdell ("Lobdell") arises out of a failed state court lawsuit brought by the Defendants in this action. The underlying case concerned a complex series of transactions involving the acquisition of certain corporate assets owned by All Optical Networks ("AON") by one of AON's directors. The Defendants in this case were the plaintiff, officers of the plaintiff and attorneys for the plaintiff in the underlying action. After three rounds of amended complaints, several depositions, and extensive motion practice the underlying case was voluntarily dismissed. Thereafter, Plaintiffs instituted the instant action.

  A. AON Networks

  AON was a company specializing in the development of optical technology to facilitate the routing and transfer of data. Weintraub Declaration in Support of Special Mot. to Strike ("Weintraub Decl No. 1."), ¶ 16. AON was formed in or about September 2000. Id. at ¶ 9. According to Defendants, at its formation, AON was worth approximately $21 million dollars. Id. at ¶ 19. AON was an off-shoot of a company named Cyber Dyne Computer Corporation ("Cyber Dyne"). According to Defendants, in 2000 Cyber Dyne transferred all of its intellectual property to AON in exchange for approximately 16 million shares of AON stock. Id. at ¶ 9. Defendants contend that after the transfer, Cyber Dyne owned nearly 77% of the outstanding AON stock. Id. at ¶ 20. In conjunction with the transfer, the Cyber Dyne shareholders created a liquidating trust (the "CDC Trust") to hold the AON stock, and avoid certain negative tax consequences related to the transaction. Id. at ¶ 11. The trustee for the CDC Trust was a Delaware corporation named the Cyber Dyne Liquidating Corporation (the "Trustee").

  Defendant Richard Weintraub ("Weintraub") declares that he performed various legal services for some of the CDC Trust beneficiaries and through that work he learned about AON, its technology, its value and the CDC Trust percentage ownership in the AON stock. Id. at ¶¶ 6-21. B. The July 2002 CDC Trust Beneficiary Meeting & The Comp-Optics Transaction

  According to Defendant Weintraub, in or around July 2002, Weintraub was contacted by a CDC Trust beneficiary and was invited to attend a beneficiary meeting where the keynote speaker was Michael Lee ("Lee"), who at the time was an AON director and a CDC Trust beneficiary. Id. at ¶¶ 26-27. Defendant Weintraub attended the meeting and learned that the percentage interest of the CDC Trust in AON had been "diluted" to approximately less than 50%. Id. at ¶ 28. According to Defendant Weintraub, he learned that AON had been issuing preferred stock to finance the company's operations and that John S. Stafford III's ("Stafford") was purchasing most of that stock. Id. at ¶ 28. In addition, Defendant Weintraub declares that at the meeting he learned that AON was in the "pre-production" process of developing a new product called OC192, a potential new version of AON's "Metro Scout" product. However, he also learned that AON was running out of money and that it needed approximately 3 million dollars to fund "the fabrication of the OC192 product and continue AON's day-to-day operations." Id. at ¶ 29.

  Defendant Weintraub declares that at the meeting, many of the CDC Trust beneficiaries were concerned and "many of the beneficiaries did not understand how a company that just a year ago was valued in excess of 21 million dollars could now be on the verge of bankruptcy." Id. at ¶ 30. According to Defendant Weintraub, several beneficiaries approached Mr. Lee and requested "that he put together a private placement memorandum ("PPM") so that they could try to raise the necessary capital to sustain AON." Id. at ¶ 30. Defendant Weintraub believed that David Lobdell ("Lobdell"), then Senior Vice President of Administration & Legal Affairs of AON, would prepare the PPM. Id. at ¶¶ 18, 31. However, according to Defendant Weintraub, Lobdell did not provide the requested documents to raise money for AON until two months after the meeting. Id. at ¶ 32. In Defendant Weintraub's view this was an excessive amount of time to prepare the documents, in light of AON's precarious financial condition. Further, following the preparation of the documents by Lobdell, the beneficiaries were given only three weeks to obtain three million dollars in funding. Id. at ¶ 32. Mr. Weintraub declares that: The foregoing facts led me to believe that AON had no intention of allowing its beneficiaries to raise funding in order to sustain the company. Rather, it appeared that the goal of the company and some of its directors, including but not limited to Mr. Lobdell, was simply to dissolve the corporation and allow Mr. Stafford to purchase the AON assets below market value.

 Id. at ¶ 32.

  In or around October 2002, Defendant Weintraub was contacted by either Mr. Lee or Bob Yukes ("Yukes"), both of whom were directors of the Trustee at the time. Id. at ¶ 33. Either Mr. Lee or Mr. Yukes requested Defendant Weintraub "look over documents concerning the proposed acquisition of certain AON assets by a company called Comp-Optics," a company wholly owned by Mr. Stafford. Id. at ¶ 33. Defendant Weintraub declares that he learned that a letter of intent ("LOI") between Comp-Optics and AON had been approved by the AON board, but that Mr. Lee was objecting to the formal terms of the transaction that were contained in the final Asset Purchase Agreement ("APA"). Id. at ¶¶ 34, 40-44.

  Plaintiffs' view of the Comp-Optics Transaction, not surprisingly, differs from Defendants. Plaintiffs assert that all members of the AON board knew that Stafford owned Comp-Optics and that at the time of the sale AON was in dire financial straits. Plaintiffs also argue that after diligently trying to finance AON and considering other strategic options, the AON board determined that its best option was to accept an offer from Comp-Optics to purchase the HPIC assets. Pursuant to the APA, Comp-Optics purchased all of the HPIC assets and paid AON $400,000 in cash and assumed $112,000 in liabilities. Stafford also released a security interest he held in the HPIC assets in order for the HPIC assets to be sold to Comp-Optics.

  C. Weintraub's Investigation

  In reviewing the Comp-Optics' LOI and the APA, Mr. Weintraub declares that he noticed that the transaction was between AON and one its directors, Mr. Stafford. Id. at ¶ 35. Further, Defendant Weintraub declares that terms of the LOI required AON to sell "the entirety of its assets for only $501,000." Id. at ¶ 36. According to Defendant Weintraub, the $501,000 amount was comprised of a $500,000 contract price for the purchase of the HPIC assets and an option to buy the remaining AON assets, such as Metro Scout, for $1,000. Id. at ¶ 36. The LOI also contained a covenant not to sue Mr. Stafford. Id. at ¶ 37.*fn1 Defendant Weintraub also learned that the LOI contained a license agreement that would allow Comp-Optics to use all of the technology of AON in the development and production of the HPIC assets. Id. at ¶ 38. According to Defendant Weintraub, that license meant that Mr. Stafford had the legal right to use all of AON's "intellectual property which, of course, diminished such property's value to other potential investors or purchasers." Id. at ¶ 38.

  Between October 2002 and November 2002, Defendant Weintraub exchanged email messages and reviewed (and/or assisted in drafting) certain letters by Mr. Lee to the AON board regarding the LOI. Mr. Lee's letters raised objections to the final terms and conditions contained in the Asset Purchase Agreement. In or around November 2002, Defendant Weintraub began representation of another company named Interphotonics in its attempt to purchase the remaining AON assets. Id. at ¶ 47. Defendant Weintraub declares that he had the "express written consent of the director of the Trustee for the CDC Trust" to represent Interphotonics. Id. at ¶ 47.

  In or around March 2003, Ed Sullivan*fn2 and Defendant O'Hagan contacted Defendant Weintraub. Id. at ¶ 50. Defendant Weintraub declares that he knew that Mr. Sullivan was a CDC Trust beneficiary and also a founder of Cyber Dyne. Id. at ¶ 47. Further, Defendant Weintraub declares that he knew that Defendant O'Hagan was a former Chief Technical Officer of AON, a CDC Trust beneficiary and the director of the Trustee for the CDC Trust. Id. at ¶ 49. Following a discussion with Mr. Sullivan and Defendant O'Hagan, Defendant Weintraub declares that he investigated the Comp-Optics transaction further. Id. at ¶ 50.

  According to Defendant Weintraub, through the course of his investigation he learned that the HPIC assets had "tremendous implications for national security." Id. at ¶ 54. Specifically, in the context of nuclear warfare, the HPIC technology could enable computer and communication infrastructure to withstand an electro magnetic pulse emitted during a nuclear explosion. Id. at ¶ 54. HPIC technology relies on light, rather than electrons, and therefore would not be effected by an electro-magnetic pulse. Id. at ¶ 54. Defendant Weintraub declares that he "learned that the Department of Defense was very interested in this technology." Id. at ¶ 54.

  During his investigation, Defendant Weintraub also declares that he learned that Stafford's offer to the AON board required a decision by the board in roughly one day. Id. at ¶ 66. Defendant Weintraub also learned of objections to the transaction made by Mr. Lee and Peter Sahagan at various board meetings. Id. at ¶¶ 65-67.

  D. The Underlying Lawsuit

  Eventually, on October 17, 2003, the Trustee filed a lawsuit captioned Cyber Dyne Liquidating Corporation v. All Optical Networks, Inc. et al., Case No. GIC 819673, in the Superior Court of California in and for the County of San Diego ("the underlying suit" or "underlying action"). At the time of the filing of the underlying suit, Defendant O'Hagan was the director and officer of the Trustee. Defendants Weintraub, Timothy P. Dillon ("Dillon"), and Weintraub Dillon P.C. (collectively "the attorney defendants") were counsel to the Trustee in the underlying action. The named defendants in the underlying action were former and then current officers and directors of AON.

  The Trustee alleged that AON's officers and directors breached their fiduciary duties to the AON stockholders. Specifically, the Trustee asserted causes of action for (1) breach of duty of loyalty in violation of Delaware Corporations Code § 144(a); (2) breach of duty of care; (3) breach of duty of good faith; (4) unauthorized sale of all or substantially all assets in violation of Delaware Corporations Code § 271; (5) unauthorized dissolution; (6) breach of duty to disclose in business transactions; (7) fraudulent concealment; (8) breach of a fiduciary's duty to disclose; (9) intentional misrepresentation; and (10) negligent misrepresentation. In later amended complaints the plaintiffs added causes of action for civil conspiracy, aiding and abetting breach of fiduciary duty and fraud, and unfair business practices.

  The causes of action in the underlying action arose out of two categories of transactions. The first category involved Stafford's investment in AON. The plaintiffs in the underlying action alleged that Stafford conspired with the other defendants in the underlying action to allow Stafford to purchase a majority of the AON stock at below fair value in order to loot the company one year later. Defendant Weintraub Dillon P.C. and Richard A. Weintraub's Notice of Lodgment ("DNOL") Ex. Y [Third Amended Complaint ("TAC"), ¶¶ 23-58]. The second transaction involved AON's sale of its "HPIC" assets in October 2002 to Comp-Optics. Id. at ¶¶ 59-117.

  The defendants in the underlying action brought a demurrer to the original complaint. On March 22, 2004, the Trustee filed a first amended complaint. DNOL, Ex. T. On March 29, 2004, Defendant O'Hagan was replaced as director of the Trustee by Carl Lovegren ("Lovegren"), a CDC Trust beneficiary. Weintraub Decl. No. 1, ¶ 93. The defendants demurred to the first amended complaint. On July 15, 2004, the Honorable Jay M. Bloom issued an order "sustaining and overruling demurrers." DNOL, Ex. U. Judge Bloom ruled that "Plaintiffs [in the underlying action] have not sufficiently alleged that demand on the corporation's Board of Directors would have been futile." DNOL, Ex. U, p. 1. In addition, Judge Bloom ruled:
[P]laintiffs have alleged only that the demand would have been futile as to only 3 out of 9 directors. Since this is not a majority of the board, they have not pled facts to create a reasonable doubt that a majority of the directors were disinterested and independent. They also have not pled facts to suggest a reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment. As such, the demand futility requirement has not been met and the demurrers are sustained.
Id. at pp. 3-4. Judge Bloom overruled the demurrer to the twelfth cause of action for aiding and abetting breach of fiduciary duty and fraud, holding that "Comp-Optics, as a non-fiduciary, may be liable for aiding and abetting a fiduciary's breach." Id. at p. 5. The court also granted plaintiffs leave to amend their complaint.

  On August 5, 2004, the Trustee filed a second amended complaint. Defendants again demurred. On November 2, 2004, Judge Bloom issued an order (1) overruling the demurrer filed by Comp-Optics to the sixth cause of action, (2) sustaining with leave to amend the demurrer to the ninth cause of action, (3) and sustaining without leave to amend the demurrer to the eleventh cause of action. DNOL, Ex. X, p. 1. E. The Depositions of Dr. O'Hagan & Michael Lee

  Following the filing of the demurrer to the second amended complaint, on October 26, 2004, defendants deposed Mr. Lee.*fn3 Mr. Lee testified that although he voted in favor of the Term Sheet for the sale of assets from AON to ...


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