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Pinnacle Ventures LLC v. Bertelsmann Education Services, LLC

United States District Court, N.D. California, San Jose Division

August 6, 2019




         This action arises from a dispute between investors in third party HotChalk, Inc. (“HotChalk”), a privately held corporation that provides education technology and services. Plaintiffs are Pinnacle Ventures LLC, a private venture capital firm that provides debt and equity financing to early stage companies, and two of its funds, Pinnacle Ventures Debt Fund III, L.P. and Pinnacle IV, L.P. (collectively, “Pinnacle”). Pinnacle provided debt financing to HotChalk beginning in 2014 and received warrants to purchase HotChalk stock. Defendant Bertelsmann Education Services LLC (“BES”) provided additional financing in 2015 and 2018. Pinnacle alleges that BES took effective control of HotChalk in 2015 and used fraudulent and unlawful means to deprive Pinnacle of the value of its investments, first by preventing Pinnacle from participating in the 2015 financing round and then by diluting the value of Pinnacle's warrants in the 2018 transaction. Plaintiff sues BES for fraud and related state law claims.

         BES has filed a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6), seeking dismissal of Claims 1-5 of the first amended complaint (“FAC”) only to the extent those claims are based on the 2015 transaction. Pinnacle argues that because Claims 1-5 are based on BES's conduct in both 2015 and 2018, BES in essence seeks partial dismissal of each claim. Pinnacle contends that Rule 12(b)(6) does not provide a mechanism for dismissing part of a claim, and that in any event the FAC's allegations regarding BES's 2015 conduct are adequate to state a claim. The Court has considered the briefing and the arguments presented at the hearing on August 1, 2019. For the reasons discussed below, the motion to dismiss is DENIED.

         I. BACKGROUND [1]

         Pinnacle was introduced to HotChalk in 2014. FAC ¶ 22, ECF 59-4. HotChalk was an established start-up expected to generate nearly $ XXXXX in revenue in 2014. Id. XXXXX Id.

         Pinnacle Transactions

         Pinnacle and HotChalk entered into two Loan and Security Agreements in 2014 and early 2015, under which Pinnacle provided debt financing totaling $ XXXXX . FAC ¶¶ 23, 25, 27. As part of those transactions, Pinnacle obtained warrants giving it the right to purchase more than two million shares of HotChalk at an exercise price of $ XXXXX . FAC ¶¶ 24, 26.

         2015 BES Transaction

         On August 5, 2015, HotChalk circulated term sheets for an equity deal with BES, a division of a large German conglomerate. FAC ¶ 29. The deal had three primary components: (1) HotChalk would acquire Synergis, a BES subsidiary, through merger; (2) BES would make an $ XXXXX equity investment in HotChalk; and (3) BES would make a $ XXXXX secondary purchase of shares from existing HotChalk shareholders to bring its post-acquisition, post-investment stake in HotChalk to a total of XXXXX . FAC ¶ 29. Because HotChalk's share price had increased substantially since Pinnacle obtained its HotChalk warrants, Pinnacle stood to make millions of dollars by selling the HotChalk shares underlying its warrants. FAC ¶ 30.

         “[O]n or around August 5, 2015, HotChalk's CFO Toth informed a Pinnacle principal that Pinnacle would be able to sell ‘up to 100%' of its warrants to BES.” FAC 32. “On August 13, 2015, Toth again confirmed that Pinnacle could sell all of its warrants to BES and that Pinnacle could do so ‘without too much fuss,' including without first taking the technical step of formally exercising the warrants to purchase the underlying shares before selling them.” Id. Mr. Toth's statements “could only have come on authority of BES given that it was BES that would be purchasing the warrants.” FAC ¶ 33. Because Pinnacle understood that its ability to sell 100% of its warrants as part of BES's direct purchase of HotChalk shares was secure, Pinnacle did not consider any other opportunities that might have been available with respect to its warrants. Id.

         On Friday, October 16, 2015, “Toth called a Pinnacle principal to inform Pinnacle that it would not be able to sell its warrants (or the underlying shares) to BES at all, as Pinnacle had been promised it could do.” FAC ¶ 34. Mr. Toth's statement “could only have come at the direction of BES - the purchaser of HotChalk shares in the transaction.” Id. On Monday, October 19, 2015, Pinnacle emailed HotChalk's CEO to express both disappointment and hope that a solution could be found. FAC ¶ 35. Nothing came of that email, and BES's November 9, 2015 Offer to Purchase required that sellers in the tender offer own HotChalk shares as of October 20, 2015. FAC ¶ 36. The Offer to Purchase precluded sale of warrants in lieu of the underlying shares. Id. Pinnacle had not been informed that it needed to exercise its warrants by October 20, 2015 to sell to BES in the tender offer. Id. Pinnacle therefore was unable to participate in “even the economically inferior, prorated tender offer portion of the transaction.”[2] Id. BES instead acquired HotChalk shares from other large holders, ending up owning approximately XXXXX of HotChalk's equity and taking effective control of HotChalk. FAC ¶¶ 37-40.

         2018 BES Transaction

         Once it had control of HotChalk, BES changed the company's business strategy. FAC ¶ 41. Instead of pursuing strong revenue growth, HotChalk focused on aggressive cost reduction. Id. When Pinnacle expressed concern, BES assured Pinnacle that HotChalk's valuation in the next financing round would be higher than in the last financing round. FAC ¶ 42. In reliance on BES's representations, Pinnacle consented to allow HotChalk to restructure its debt multiple times and amended its own loan agreements to extend the period in which HotChalk had to make payments. FAC ¶ 43. Pinnacle also agreed to fund an additional $ XXXXX loan tranche for the benefit of HotChalk and its controlling shareholder, BES. FAC ¶ 44.

         Meanwhile, BES deliberately dragged its feet on obtaining additional necessary financing, putting HotChalk in a precarious position. FAC ¶ 46. BES thereafter was able to force a financing transaction which benefitted BES at the expense of Pinnacle and other stakeholders in HotChalk. FAC ¶¶ 47-48. In January 2018, Pinnacle received a term sheet for a new transaction that would increase BES's equity interest in HotChalk from XXXXX FAC ¶ 49. At the same time, Pinnacle's warrants were converted on a XXXXX basis, meaning that ...

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