GENESIS MERCHANT PARTNERS, LP., a Connecticut corporation, Plaintiff,
NERY'S USA, INC., a Nevada corporation, JOHN CATHCART, an individual and COMMERCIAL TARGA, S.A. DE CV., a Mexican corporation, Defendants. NERY'S USA, INC., a Nevada corporation, Counterclaimant,
GENESIS MERCHANT PARTNERS, LP., a Connecticut corporation, Counterdefendant.
STATEMENT OF DECISION PURSUANT TO RULE 52
JEFFREY T. MILLER, District Judge.
On July 18, 2011, Genesis filed suit against Defendants Nascent Wine Company, Inc. ("Nascent"), Commercial Targa ("Targa"), and John Cathcart (together "Defendants") for Nery's' failure to make payments due to Genesis under a $1.85 million promissory note ("Second Note") issued by Nery's and guaranteed by Targa. Nery's issued the Second Note to Nascent in exchange for its purchase of Targa, which Nascent owned at that time. Nascent then assigned the Second Note to Genesis to satisfy its obligation on another promissory note ("First Note") that it had issued to Genesis for $1 million. Genesis asserted three claims against all defendants: (1) breach of contract, (2) unjust enrichment, and (3) and negligent misrepresentation. Genesis also asserted a conversion claim solely against Nery's.
On August 19, 2011, Nery's filed both a third-party complaint against Nascent and a counterclaim against Genesis. The third-party complaint alleges that Nascent failed to disclose pertinent information about Targa's tax debt to the Mexican government prior to the SPA's signing. Nery's claims that the undisclosed debt prevented Targa from obtaining a loan and severely limited its ability to do business. This court granted Genesis' motion to dismiss Nery's' counterclaim on January 6, 2012 because it made no separate factual allegations, was almost identical to the third-party complaint and requested only declaratory relief.
On September 7, 2012, Defendants filed a motion for summary judgment, which this court denied as to the breach of contract and unjust enrichment claims, but granted for the negligent misrepresentation and conversion claims. The court also granted the motion for summary judgment filed on behalf of Defendant Cathcart.
The parties have acknowledged that federal jurisdiction and venue are properly before this court. This Court has diversity jurisdiction of this action pursuant to 28 U.S.C. §1332, and venue exists under 28 U.S.C. §1391(a), (d), and (f). California state substantive law applies to the cause of action alleged in Genesis' Complaint and Nery's third-party complaint.
A five-day trial began on July 24, 2013 and concluded on July 2, 2013, with Genesis insisting that it was entitled to damages and Nery's requesting rescission of its contract purchasing Targa. The court has determined that Nery's request for rescission should be granted, rendering it unnecessary for the court to address Genesis' damage claims.
FINDINGS OF FACT
Genesis is a Delaware Corporation that operates as a private equity or investment fund. As part of its portfolio, Genesis makes loans to businesses.
Nascent, a publicly traded company, owned and operated various food service distributor companies. Between 2006 and 2008, Nascent acquired nine companies, including Commercial Targa, S.A. DE C.V. ("Targa"), a Mexican corporation, in October 2007. Targa was a cheese distribution company in Northern Baja, Mexico, which sold cheese under the brand name "Nery's." The Nery's brand name had been developed over 25 years by a family business in Northern Baja, Mexico. Targa also held three Mexican permits, including a permit to import cigarettes, as well as its "cut-and-wrap" facility and equipment.
When Nascent acquired Targa in 2007, Targa had sales of approximately $7 million with a net profit of $1.2 million with its principal market in Northern Baja. By the latter half of 2008, however, sales were declining and capital was insufficient to push the Nery's brand name nationwide through Mexico. Moreover, the Nery's brand name had been licensed to a Mexican company, Zahava, which in turn was licensed to sell cheese in Mexico. Under the license agreement with Zahava, Targa retained its cut-and-wrap business and would even cut-and-wrap other cheese brought to Targa by Zahava. The agreement was for several years but contingent upon Zahava meeting sales minimums for Nery's brand cheese.
In March 2008, Nascent borrowed $1 million from Genesis for the purpose of buying cheese for Targa. The capital was also to be used for the purpose of taking Nery's brand nationwide. The loan was evidenced by a written promissory note dated March 31, 2008 between Genesis and Nery's, initially for a six month term and then extended to a one-year term with accrued interest and principal due (115%) (the "Nascent Note"). In March 2009, the Nascent note was again modified and extended. The Nascent Note was secured by all assets of Nascent, including Targa and the Nery's brand.
Sandro Piancone was the Chief Executive Officer of Nascent during this general period of time when Nascent was negotiating with Genesis for the Nascent loan. Piancone also became Director General of Targa and responsible for its overall growth. Piancone first met John Cathcart in 2006. At the time, Cathcart was a mergers and acquisitions consultant who Piancone retained in 2007 for the purpose of assisting Nascent with the acquisition of food service and distribution companies. Cathcart was an experienced businessman with over 25 years in the venture capital and business start-up area. Cathcart also had experience with taking companies public as well as in company buyouts and roll-ups. Piancone and Cathcart did not have any contact after Cathcart's 2007 consulting activities until early 2009 when, in the midst of Nascent's financial difficulties, Piancone reached out to Cathcart for assistance. At that point, Cathcart became more involved with Nascent. By May or June 2009, Cathcart met with Piancone and Nascent board members. Piancone suggested that Cathcart become a licensee to market Nery's brand cheese in the U.S. The licensing agreement with Zahava was fully discussed. Piancone and Cathcart agreed to explore Cathcart's purchase of Targa. A letter of intent by Cathcart for a $2 million cash purchase of Targa followed Cathcart's inspection of the Targa facility and review of some financials for 2009. By late 2009, Targa was barely operating at all, and at a loss. Targa's income was approximately $10, 000 to $15, 000 a month with monthly expenses at $25, 000 to $30, 000. It was apparent to Cathcart that Targa could have shut down its facility and continued receiving royalties and/or restart its cut-and-wrap business. Moreover, it appeared to Cathcart that Zahava likely could not meet its sales minimums for Nery's brand cheese, which would terminate the licensing rights for Zahava.
It became Cathcart's intention to acquire Targa after concluding he could deal with Zahava, whether Zahava met sales minimums or not. This decision was based on Cathcart's two to three visits to the Targa plant, Cathcart's discussions with plant manager Christian Alvarez (discussed below), Cathcart's review of the financials which, being unaudited, contained some inconsistencies, and Piancone's representation that there were no more than a few hundred dollars in accounts payable other than the $150, 000 to Ex-Im Bank. Piancone further represented that any accounts payable were stale and not necessary to pay. Piancone also represented to Cathcart that facility back rent would be forgiven by the landlord in lieu of a new rental agreement.
When Cathcart met with Alvarez during one of his plant visits before Cathcart's acquisition of Targa, Alvarez told Cathcart none of the following: That in 2008 to 2009, Targa's revenues were being diverted to other Nascent companies; that Targa's vendors were not getting paid because of this diversion; that taxes and labor expenses were not being paid by Targa for 2009; and that Alvarez was asking Piancone to send checks to pay for these liabilities with the requests being unheeded. Alvarez personally was aware of the approximately $306, 000 in unpaid liabilities separate and apart from approximately $285, 000 in unpaid taxes due to the Mexican government. Meanwhile, none of this information regarding Targa's financial liabilities was communicated to Cathcart by Piancone or Alvarez.
Cathcart, realizing he could not raise cash to pay off Genesis, negotiated with Genesis to keep its loan in place as a part of a new financing structure. Although Cathcart could only raise $300, 000 in operating capital, both he and Genesis agreed it would be sufficient for Nery's to acquire Targa and all its assets from Nascent.
From the beginning, Genesis was informed by Nascent of Cathcart's interest in purchasing Targa and was involved in the negotiations between Nery's and Nascent because Genesis had a security interest in Nascent's assets including Targa. Genesis also knew or should have known, through Nascent and its Portfolio Manager, Tim Doede, that Targa faced a very large rent liability and possible eviction from its facility, that Targa had large tax liabilities pending, and that other significant liabilities and risks existed for Targa.
During the continued negotiations with Nascent and Genesis, Nery's did not offer cash for the Targa stock but instead proposed a $2 million purchase price for the Targa stock, which was determined by Nascent's representations concerning its debt and Targa's accounts payable that consisted only of: (1) what Nascent owed Genesis, which totaled $1, 150, 000; (2) $700, 000 owed by Nascent on two other loans; and (3) no more than $150, 000 in liabilities/accounts payable of Targa at closing. On October 29, 2009, Nery's communicated these terms to Genesis, through Doede.
Nascent's representation that Targa's accounts payable did not exceed $150, 000 was material to Nery's because Nery's would not have executed any contract to purchase Targa if the accounts payable exceeded $150, 000 beyond the few hundred dollars to which Piancone and/or Alvarez had earlier referred. Nery's refused to pledge any security interest to Genesis as part of the proposed purchase terms. As indicated previously, in November 2009, Nery's also informed Genesis, via Doede, that Nery's could only provide $300, 000 of working capital.
In a "Nascent Valuation Memorandum" drafted by Doede and dated January 31, 2010, the following was set forth: "As of the writing of this Valuation, documents that would effectuate the sale of these assets in exchange for the assumption of $2, 000, 000 in liabilities of Nascent are being finalized. Currently, the business of Targa has been stopped due to a lack of working capital to purchase inventory of cheese and cigarettes for distribution in Mexico. [Nery's] is providing $300, 000 of working capital to restart the business... the plan for restarting the Targa business is risky, especially with only $300, 000 of new capital as identified as of the writing of this valuation."
In the "Nascent Valuation Memorandum, " Genesis also recognized that as of January 31, 2010, the amount of the Nascent Note was $1, 100, 000.
On or about February 10, 2010, Nascent and Nery's executed a Stock Purchase Agreement ("SPA") for the purchase of Targa's stock previously reviewed and approved by Genesis and its legal counsel. On or about February 10, 2010, Nascent and Nery's executed a Stock Purchase Agreement ("SPA") for the purchase of Targa's stock, which included the following material terms, representations, and warranties:
In Article I of the SPA, Nascent acknowledged that:
º "Indemnification Acknowledgment" has the meaning set forth in Section 8.3(a)(ii) of the SPA. (SPA at p. 2)
º Nascent, and any other officer or director of the Targa, refers to actual knowledge that would have been obtained "after reasonable due diligence or inquiry in light of the circumstances." Id. at p. 3.
º Nery's was entitled to an exclusive remedy of indemnity for "Losses", including damages, costs, liabilities, losses, judgments, settlements, awards, penalties, fines, legal fees, expert fees, costs of investigation, and enforcement and collection costs. Id.
º A "Material Adverse Effect" on Nery's includes material adverse effects on Nery's' assets, operations, personnel, condition (financial or otherwise) or prospects, or Nery's ability to consummate the transactions contemplated by the SPA. Id.
º A "Welfare Plan" means any other plan or program maintained for past or present Targa employees, "including without any limitation... severance plan... vacation pay... holiday pay... severance... excess benefit, bonus... salary continuation... that are maintained or contributed to by [Targa]."
In Article II of the SPA entitled "Purchase and Sale, " Nascent agreed to transfer the Targa stock to Nery's for a purchase price of $2 million. (Id. at p. 6, ¶2.1, 2.2.) ...