Fraudulent Joinder of Non-Diverse Nevada Defendant Does not Destroy Federal Diversity Jurisdiction
Posted by: Mark Albright on Mon, Dec 14, 2015Share this post
REPLY IN SUPPORT OF MOTION TO STRIKE
A transfer agent is defined in NRS 348.240 to mean “the treasurer or similar official of the issuer, a corporate or other trustee, registrar, paying agent, other corporate agent, or other person acting as an agent for, among possibly other duties, the transfer and registration of public securities.” (Emphasis added). NRS 348.430 allows a corporate issuer to appoint a “transfer agent” in Nevada for the sale and transfer of publicly traded shares. With respect to the appointment of a transfer agent, NRS 348.430 provides: “None of the persons designated [as a transfer agent] … need have an office or do business within this state.” The appointment may be “for such term as may be agreed, including for so long as an issue may be outstanding, corporate or other authenticating trustees, registrars, paying agents, other transfer agents or other agents that specify their rights, compensations and duties.”
When there is a dispute between various parties as to who is entitled to a transfer of certain corporate shares, the law is clear that transfer agents (who merely transfer and register public securities) are not “parties in interest” but are “merely nominal or formal parties or are not parties properly joined but are parties fraudulently joined,” and thus their citizenship in the forum state will not prevent removal.” See, Pesch v. First City Bank of Dallas, 637 F.Supp. 1530 (N.D. Texas 1986). Thus, the court in Pesch concluded that the Texas transfer agent was merely a nominal or a formal party to the Illinois action against a Swiss defendant. Since the transfer agent had been improperly or fraudulently joined in the action, the court concluded that the state court action was properly removed and denied the motion to remand.
The court in Pesch explained that the plaintiff was confusing “the existence of a cause of action [against the transfer agent] with the availability of a satisfactory remedy.” Id. at 1538. The court noted that nowhere in the complaint does the plaintiff even intimate that “the transfer agent had done anything for which it could be liable in a Texas court.” Id. at 1538. Nowhere in the complaint did the plaintiff Pesch allege that the transfer agent had done anything wrongful. Indeed, he could not have so alleged because the transfer agent was acting according to the law. The court went on to hold that the transfer agent (and indeed the corporate issuer in the Pesch case) were “nothing more than neutral bystanders to a battle between Pesch and CDB.” Id. at 1539. Since there was no possibility of any cause of action existing against the transfer agent, the court held that they were fraudulently joined, that there was complete diversity and that removal was proper. Likewise, in the instant case, the transfer agents are nothing more than neutral bystanders to a dispute between the issuer (Players Network, Inc.) and the stock purchasers (the named Defendants other than the transfer agents).
This Pesche rationale is also applicable in this case to Nevada resident transfer agents, Empire Stock Transfer, Inc., a Nevada corporation (hereinafter “Empire”), and Pacific Stock Transfer Company, a Nevada corporation (hereinafter “Pacific”). Empire and Pacific (former transfer agents of Plaintiff), were sued years after they had been released of their duties, and they are no longer currently serving as the corporate transfer agent of the issuer, Plaintiff Players Network. The law is clear that because transfer agents are subject to any order entered by a court of competent jurisdiction entering a temporary restraining order or order of permanent injunction prohibiting the transfer of shares or stock of the issuer, they are not necessary parties, and their “citizenship in the forum state will not prevent removal.” Id. at 1533. There is no clam for relief against the transfer agents. Rather, they are named here solely for convenience in the event of service of a TRO or permanent injunction prohibiting the transfer of the shares. They need not be named parties in the dispute between the real parties in interest, and do not affect diversity of jurisdiction.
The court in Pesch explained that the question whether joinder is fraudulent arises with “the requirement of 28 USC 1441(b) that there be diversity of citizenship among the parties to the action who are ‘properly joined.’” Id. at 1537.
As the court wisely indicated in Pesch, there is a difference between the existence of a “cause of action” on the one hand, and the availability of a “remedy” (in other words injunctive relief), on the other hand. Since a TRO or injunction can simply be served on a transfer agent, they are not deemed indispensable parties.
In other words, just because a stake holder can be served with a TRO does not mean that it is also liable for a cause of action. The court in Pesch also relied on Kearney v. Dollar, 111 F.Supp. 738 (D. Del 1953) wherein the District Court held that even the corporation whose shares were the subject of an ownership dispute (in other words the corporate issuer) was not a necessary or indispensable party, but was instead only a nominal and formal party, because the only connection it had with the controversy was that it was enjoined from transferring the shares to anyone other than the parties to the suit. Id. at 744. Similarly, in the Pesch decision, even the issuer was not deemed to be a mandatory party, much less the transfer agent. Thus, the court in Pesch summarized its holding as follows:
This court holds that where, as here, a corporation and its transfer agent are joined in defendants (1) only to prevent their transferring and re-registering shares of the corporation’s stock, to which adverse ownership claims have been made by others, and (2) to obtain a judgment directing them to surrender the shares and pertinent stock powers to the plaintiff, and for no other substantive purpose, such defendants are merely nominal or formal parties whose presence does not preclude removal.
Id. at 153. (Emphasis added).
One of the leading cases on the subject, also relied upon by the court in Pesch, is the United States Supreme Court in Salem Trust Co. v.. Manufacturers’ Finance Co.., 44 S. Ct. 266, 264 U.S. 182 (1924). This case involved a dispute between plaintiff, a citizen of Massachusetts, and the defendant, a citizen of Delaware. The funds in dispute were being held by a second defendant, a trust company, International Trust Company, also a citizen of Massachusetts. The case was removed from the state to federal court. Plaintiff moved to remand, asserting that the International Trust Company was a necessary party to the suit and that the case was improperly removed because the plaintiff and the trust company were citizens of the same state. The motion to remand was denied. The case was tried in the district court and dismissed. On appeal, the United States Supreme Court explained that jurisdiction was proper in the federal court in any suit brought in a state court which is wholly between citizens of different states and which can be determined as between them, such that a defendant interested in the controversy may remove the suit to the proper district court of the United States. The court then explained as follows regarding unnecessary parties:
District Courts have jurisdiction if all of the parties on the one side are of citizenship diverse to those on the other side. Jurisdiction cannot be defeated by joining formal or unnecessary parties. The right of removal depends upon the case disclosed by the pleadings when the petition therefore is filed. . . . [I]t is not affected by the fact that one of the defendants is a citizen of a the same state as the plaintiff if that defendant is not an indispensable party to the controversy between plaintiff and defendant who are citizens of different states. . . . This suit involves a controversy between the petitioner, a citizen of Massachusetts, and the respondent the Finance Company, a citizen of Delaware, which can be determined without affecting any interest of the other respondent, the International Trust Company, a citizen of Massachusetts. . . . It has no interest in the controversy between the petitioner and the other respondent. Its only obligation is to pay over the amount deposited with it when it is ascertained which of the other parties is entitled to it. On the question of jurisdiction, an unnecessary and dispensable party, will not be considered.
44 S. Ct. at 267. (Emphasis added).
Likewise, in the case at bar, the Plaintiff has a dispute with various purchasers of its stock subject to convertible bond debentures or convertible notes. The controversy is solely between the Plaintiff and the stock purchasers. There is no claim for relief directly against any of the transfer agents whose only obligation is to transfer the shares once it has been ascertained by the court which of the other parties is entitled to the shares. Since the transfer agents are unnecessary and dispensable parties, they are not to be considered in determining diversity of citizenship for purposes of federal diversity jurisdiction. As noted by the United States Supreme Court in the Salem Trust case, “no cause of action exists against the International Trust Company because it has not been determined which of the other parties is entitled to payment. The District Court has jurisdiction. The motion to remand was rightly denied.” 44 S. Ct. at 268.
The instant case is closely analogous with an escrow case or interpleader case. For example, in Cramer v. Phoenix Mut. Life Ins. Co. of Hartford, Conn., 91 F.2d 141 (8th Cir. 1937), the Eighth Circuit Court of Appeals explained the impact of a custodian or disinterested stakeholder in federal diversity cases:
In no real sense is it [a stakeholder] a party to the litigation. This is in line with the rule generally recognized where federal jurisdiction rests upon diversity of citizenship, that “a custodian or stakeholder of property is usually held to be a merely nominal party whose citizenship does not affect the question of federal jurisdiction. See, Federal Reserve Bank v. Omaha National Bank, 45 F.2d 511, 514 (8th Cir. (C.C.A. 8)).” (Emphasis added)).
Id. at 146. The key test was summarized by the court in Pesch as follows: “The test whether or not a defendant is a nominal party is whether his role in the lawsuit is that of depository or stakeholder. Id. 637 F. Supp. at 1536.
Judge Philip M. Pro of the Nevada District Court similarly explained that interpleader is a doctrine “which enables a disinterested stakeholder such as an insurance company or escrow holder, to deposit with the clerk of the court funds to which various claimants may seek inconsistent rights…. All various claimants are joined through the interpleader action and may then litigate among themselves their respective claims to the funds at issue. Once the claimants have been joined, the disinterested stakeholder may then be dismissed from the suit.” Nevada Eighty–Eight, Inc. v. Title Ins. Co. of Minn., 753 F.Supp. 1516, 1527 (D.Nev 1990). (Emphasis added).
Hence, both Pacific and Empire, fraudulently added as resident Defendants to destroy jurisdiction, should be either stricken as defendants or ignored for purposes of determining federal diversity jurisdiction. The Plaintiff failed to address the Empire/Pacific fraudulent joinder issues in its opposition and instead focused on an advisory opinion from the Financial Institutions Division and on Nevada state statutes with respect to licensing and/or high interest rate loans. These legal theories are irrelevant at this stage of the proceedings when considering a Motion to Strike and Motion to Remand. The Nevada advisory opinion attached to Plaintiff’s opposition has to do with a brick and mortar company located in Nevada with Nevada employees who would be providing regular loans by financing credit sales to Nevada purchasers at their Nevada stores by their Nevada employees. That is a far cry from a New York private equity venture capital firm without a website receiving occasional telephone calls from a Nevada company asking that funds be wired to Nevada as part of a purchase agreement of stock, whereby the debt can later be converted into shares of stock in the seller entity. The undersigned’s conversations with the Nevada Financial Institutions Division indicate that this issue has never come up before and their initial impressions are that the statutory scheme for consumer protection loans would indeed not apply to a stock purchase agreement involving convertible debenture notes and purchase agreements, even if a convertible note was part of the sophisticated financial arrangements documented in the Stock Purchase Agreement. In other words, even though the court is not now addressing the merits of the defenses, it is significant that the underlying transaction is a stock purchase agreement that includes the purchase of a Note. See, Securities Purchase Agreement attached hereto as Exhibit “A,” and by this reference made a part hereof.
This was a Securities Purchase Agreement
Venture Capital investments are generally made as cash in exchange for shares and often an active role in the invested company. Venture capital differs from traditional financing sources, according to the SBA U.S. Small Business Administration website at https://www.sba.gov/content/venture-capital in that venture capital typically:
1. Focuses on young, high-growth companies
2. Invests equity capital, rather than debt
3. Takes higher risks in exchange for potential higher returns
4. Has a longer investment horizon than traditional lender financing
5. Actively monitors portfolio companies via board participation, strategic marketing, governance, and capital structure.
The SBA article notes on its website that successful long-term growth for most businesses is dependent upon the availability of equity capital. However, lenders generally require some equity cushion or security/collateral before they will lend money to a small business (a traditional loan or debt financing). Hence, a lack of equity limits the debt financing available to businesses. Additionally, debt financing requires the ability of the young company to service the debt by making current or monthly interest payments. These funds are then not available to help grow the new business.
On the other hand, Venture Capital provides businesses with a financial cushion in exchange for stock: of course the issuer needs to keep in mind that equity providers have the last call against the company’s assets. In view of this lower priority and usual lack of a current payment requirement, equity providers (as compared to debt financing through loans) require a higher rate of return on investment than lenders receive. Here, the interest rate set forth in the Note was only 8%. The Note is merely the mechanism contained in the Securities Purchase Agreement for the stock seller to avoid the eventual conversion rights of the stock purchaser under SEC rules.
Venture capital for new and emerging business typically comes from high net worth individuals known as “angel investors” and/or venture capital firms. These investors (rather than lenders) usually provide capital unsecured by assets to young, private companies with the potential for rapid growth. This type of investing (purchasing/investing in stock) inherently (as compared to simply making a secured loan) carries a high degree of risk. Venture capital is long-term or “patient capital” that allows companies the time to mature into profitable organizations without the need of monthly interest payments or putting up collateral as security. tps://www.sba.gov/content/venture-capital.
In summary, equity capital is money raised by a business in exchange for shares of ownership in the company. Ownership is represented by owning shares of stock outright or having the right to convert other financial instruments into stock of that private company. Id. The fact that a note is utilized in the Securities Purchase Agreement arguably does make the transaction a hybrid – part loan and part equity purchase. Nevada has never construed such a securities purchase agreement as requiring a lending license.
Venture capital is a type of private equity. Venture Capital, Wikipedia, and the typical capital investment occurs in the interest of generating a return through an eventual exit event, such as an IPO or the trade or sale of the company. Id. A convertible note is a hybrid, part debt and part equity, where it functions as debt, until some point in the future, when it may convert to equity at some predefined terms. Convertible debt is typically obtained from the same angel investors and venture capitalists that fund equity deals and is usually used for smaller rounds of financing at the early stages of a company’s life. See, Forbes, Comparing Debt vs Convertibles, http://www.forbes.com/sites#/sites/georgedeeb/2014/03/19/comparing-equity-vs-debt-vs-convertibles-for-startup-financings/
NRS § 355.265 (2013) defines Venture Capital as follows: Venture capital means equity, near-equity and seed capital financing, including, without limitation, early stage research and development capital for start-up enterprises, and other equity, near-equity or seed capital for growth and expansion of entrepreneurial enterprises.”
There is no evidence in the statute, case law or elsewhere that venture capital stock purchase agreements (even if a part of the purchase agreement contains a convertible note to satisfy certain SEC requirements), somehow trigger state lending requirements or state lending statutes. This was a stock purchase agreement which merely contained a note as a method for the seller of the shares to avoid the purchaser’s conversion rights.
STATEMENT OF FACTS FROM SETH KRAMER
REGARDING THE SECURITIES PURCHASE AGREEMENT
In his affidavit attached hereto as Exhibit “B,” and by this reference incorporated herein, Defendant Seth Kramer explains as follows regarding the underlying transaction:
1. I am over the age of eighteen years and have personal knowledge of the matters set forth herein, and am competent and willing to testify in court to the same if necessary.
2. I am one of the Defendants named in the within action, the Managing Director of Defendants Asher Enterprises, Inc. (“Asher”) and Vis Vires Group Inc. (“VVG”), and the President of KBM Worldwide, Inc. (“KBM”), and as such am fully familiar with all the facts and circumstances related and submit this Affidavit in support of Defendants’ Reply Brief regarding Defendants’ Motion to Strike Fraudulently Named Defendants in the Amended Complaint; and Motion to Dismiss or in the Alternative to Transfer Venue to New York.
3. The Corporate Defendants make investments in small cap public companies, thereby providing funds to entities, which would otherwise be unable to obtain such financing to continue to operate their respective businesses. As part and parcel of these investments, the Corporate Defendants advanced money to these companies and in exchange receive inter alia Convertible Promissory Notes (the “Note”), Securities Purchase Agreements, Letters of Instruction and Authorization (“TA Letter”) executed by the companies and their transfer agents, Corporate Resolutions authorizing the investments, Officer’s Certificates further verifying the transactions, and Disbursement Authorizations directing the payment of the proceeds.
4. In substantially all of these investment instances, the public companies are insolvent by application of either accepted definition (a) the liabilities exceed the assets or (b) the companies are incapable of meeting their current expenses as they become due. These companies rely heavily on investments, in order to acquire the necessary funds to maintain operations.
5. At the inception of these investments, the investor relies heavily on the Note (“Securities”), which, in pertinent part, permits the investor to exercise its conversion rights by converting the debt in whole or in part to equity (common stock of the issuer). It is unusual at best that these public companies have the wherewithal to repay the Note in cash, and accordingly both parties at the time of the transaction anticipate that repayment will occur by utilization of the conversion process.
6. In order for the court to make an informed decision on the merits of this matter, it is essential that the court be given a general background in these types of investments, along with a brief history of the dealings between the Plaintiff and the Corporate Defendants.
7. In order for companies to issue free trading stock (unrestricted stock), the shares to be traded must have been authorized as a result of a Registration Statement or fall under one of the exemptions to registration. In transactions of this type, the Note, which constitutes Securities under Rule 44 of the Securities Act of 1933, is the exemption relied upon by the investor. Rule 144 is a “safe harbor” and enables the investor to obtain unregistered stock utilizing the conversion process provided that the Securities have been held for a period of six (6) months (the tacking period) from the date that the Note is fully funded. This conversion process affords the investor an opportunity to obtain repayment of his investment.
8. Additionally, in order for the investor to obtain the benefits of Rule 144, during the first year after the Note is fully funded, the issuer must be current in its basic filing obligations to the Securities and Exchange Commission (“SEC”), to wit: quarterly (10-Qs) and annual reports (10-Ks).
9. Investments of this nature are of high risk: (1) since the investor initially is prevented from obtaining free trading stock until the expiration of the tacking period; (2) the issuer must be current in its basic filing obligations; and (3) the issuer for a myriad of reasons could be delisted from its exchange or trading of its stock suspended by the SEC.
10. In an attempt to provide the investor with a degree of assurance, that there will be sufficient shares of common stock available to accommodate the investor’s Notices of Conversion prior to the funding of the Note, the issuer furnishes to the investor a TA Letter [Transfer Agent Letter] signed by both the company and its transfer agent, whereby, among other things, a share reserve is established by the transfer agent for the investor’s benefit. The amount of shares which are set aside by the transfer agent are enumerated in the TA Letter to avoid any misunderstanding in the future.
11. For the court’s information, a transfer agent acts as the custodian and keeper of records for an issuer concerning the number of shares authorized, issued and outstanding and also maintains a list of the names of the shareholders for the company’s benefit. Usually there exists a written contract between the company and the transfer agent and the compensation received by the transfer agent is paid by the company. Simply stated, the transfer agent is an agent of the company.
12. The Notes generally contain a right of prepayment in order to accommodate the company, the purpose of which is to afford the company during the first 180 days after funding an opportunity to prepay the investment at a premium. The schedule of prepayment and the premium to be paid increases as the investor’s opportunity to exercise its conversion rights approaches.
13. With respect to the specifics of the transaction, involving the Corporate Defendants, the Note provides in pertinent part the method of calculation of the conversion price to be utilized by the investor at the time that a Notice of Conversion is issued. Each Note has a specified per annum interest rate of eight (8%) percent. In order for the investor to achieve a reasonable return on its investment, the conversion price to be utilized is a discount to the market price. This discount is intended to protect the investor against market price fluctuation during the tacking period. Simply stated, the price of the company’s shares becomes less important to the investor, since the investor’s conversion price is the bid price less discount, at the time of conversion.
Of course, these issues go to the merits and can be addressed by the court another day, after a resolution of the federal diversity issues.
REPLY IN SUPPORT OF MOTION TO DISMISS
OR TRANSFER TO NEW YORK
/ / /
/ / /
York, Case No. CV 15 6226, entitled Vis Vires Group, Inc. v. Players Network, Inc. and Mark Bradley.
DATED this _____ December, 2015.
ALBRIGHT, STODDARD, WARNICK &
G. MARK ALBRIGHT, ESQ.
Nevada Bar No. 1394
WILLIAM H. STODDARD, SR., ESQ.
Nevada Bar No. 1477
801 South Rancho Drive, Suite D-4
Las Vegas, Nevada 89106
Attorney for Defendants Vis Vires Group, Inc.;
KBM Worldwide, Inc., Asher Enterprises, Inc.;
Seth Kramer and Curt Kramer
About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah. Our firm’s practice includes a strong emphasis on personal injury accidents. Call us at 702-384-7111.
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