Court: District Court, E.D. Michigan; July 26, 2017; Federal District Court
Atlas Technologies, LLC has filed a lawsuit against former officers Jesse Levine and Julius Levine, as well as the Julius S. Levine Revocable Trust, alleging misappropriation of funds, fraud, and self-dealing. The complaint comprises fourteen counts, which the defendants seek to dismiss based on a 2011 LLC agreement and Delaware law, asserting that they govern the case. The court clarifies that Michigan law applies to the tort claims and that the LLC agreement is not central to the plaintiffs' claims. Consequently, except for one fraud count and one statutory count, the court finds sufficient grounds for the remaining claims.
Jesse Levine, who became CEO in January 2012, is accused of exploiting financial difficulties that began in 2011 to gain control over Atlas. He allegedly breached fiduciary duties and violated the company's "Declaration of Business Principles," which prohibits personal profit from business transactions, outside competitive activities, and conflicts of interest. Despite the Levines' misconduct beginning at their appointments, Atlas claims it only became aware of these violations in March 2016. The Levines are accused of diverting funds to their unrelated entities, including real estate ventures and automated parking garages. Jesse's attempts to shut down Atlas's operations ultimately led to his removal as CEO on March 16, 2016, after these actions were uncovered.
The plaintiff alleges that the defendants engaged in various fraudulent and improper activities, including diverting a significant portion of a lawsuit settlement with General Motors into a secret bank account, transferring funds from this account to the Levine Trust, and charging the company credit fees even after a loan was repaid. They also invoiced Atlas for legal expenses and charges incurred by unrelated entities, added employees to Atlas's payroll who worked for these unrelated entities, misused company credit cards for personal expenses, and withdrew over $240,000 in petty cash for personal benefit. Additionally, they charged rent for a Chicago office not used for Atlas business and misappropriated a returned security deposit. After the Levines' separation from Atlas, they allegedly filed fraudulent UCC financing statements against Atlas's assets, causing ongoing damage despite the statements being terminated by the State of Michigan.
Atlas filed its initial complaint on August 25, 2016, followed by amended complaints alleging multiple counts, including fraud, silent fraud, conversion, unjust enrichment, breach of fiduciary duty, and negligent misrepresentation, among others. Specific counts target different defendants, with some counts directed at Jesse and Julius, others at the Levine Trust, and a few solely at Jesse. On September 20, 2016, Atlas sought a preliminary injunction to prevent further UCC filings by the defendants. A stipulation was reached to expunge the fraudulent statements, and the court subsequently prohibited further filings against Atlas. The defendants filed motions to dismiss the case, which were based on Federal Rule of Civil Procedure 12(b)(6), allowing them to challenge the legal sufficiency of the allegations while viewing them in the light most favorable to the plaintiff.
To survive a motion to dismiss, plaintiffs must present sufficient factual matter that, when accepted as true, establishes a plausible claim for relief, surpassing mere possibilities but not requiring a probable entitlement. The court must accept pleaded facts as true, while disregarding bare assertions that do not provide adequate support. The key inquiry is whether a reasonable inference of liability can be drawn from the allegations.
In this case, the defendants submitted several exhibits, including a 2011 LLC Agreement, which the plaintiffs claim was fraudulently induced. The court evaluates the motion under Rule 12(b)(6) based on the pleadings and documents directly referenced or integral to the claims. The court finds that the 2011 LLC Agreement is not integral to the plaintiffs' claims, which primarily allege breaches of fiduciary duties by specific officers and various tort and statutory claims. Although the defendants argue the document is central to the claims, the court disagrees, stating that the agreement is primarily relevant to the fraud claim and does not affect the sufficiency of the complaint. The court emphasizes that the motion's focus is on the pleadings, not on documents that are central to the defendants' defenses.
In Wysocki v. IBM, the defendant countered the plaintiff's claim under the Uniformed Services Employment and Reemployment Rights Act with a signed general release, which waived the plaintiff’s claims against IBM. The court of appeals ruled that the district court could not consider this release without converting the motion to dismiss into a motion for summary judgment, as the release was outside the pleadings (607 F.3d at 1104). The defendants referenced Hensley Manufacturing v. ProPride, Inc. to argue for consideration of the 2011 LLC Agreement, but this was incorrect. Hensley established that a district court cannot consider matters beyond the complaint when reviewing a motion to dismiss (579 F.3d at 613).
The plaintiffs argued that the 2011 LLC Agreement contradicts their allegations, as it purports to absolve Jesse and Julius from fiduciary duties central to their claims. Defendants cited KSR International Co. v. Delphi Automotive System, LLC to support their position that the court could consider the agreement even if it contradicted the complaint. However, KSR is distinguishable because it involved a breach of contract claim with the contract extensively discussed in the complaint, whereas the current case involves allegations of breach of fiduciary duties and torts without any mention of the 2011 Agreement other than related to alleged fraud.
Concerns regarding the authenticity of the 2011 LLC Agreement were raised, noting discrepancies in the signature page and its sole signature from Jesse in various capacities. While the defendants claimed the agreement was enforceable under Delaware’s Limited Liability Act despite lacking another signature from an Atlas representative, the legitimacy of the agreement remains in question, warranting further discovery to analyze its provenance and enforceability.
The defendants have failed to establish that the 2011 LLC Agreement or the Fee Agreement are pivotal to the plaintiffs' claims, rendering them irrelevant to the motion to dismiss. The defendants' assertions that the 2011 Agreement protects them from the plaintiffs' tort and fiduciary duty claims do not affect the validity of the plaintiffs' claims for relief. A dispute exists regarding the applicable state law, with defendants favoring Delaware law due to Atlas being a Delaware LLC, while plaintiffs assert that Michigan law governs based on the current operating agreement. The plaintiffs' claims are categorized into tort and unjust enrichment (Counts I-V, IX, XII, XIII), breach of fiduciary duty (Counts VI-VIII, XIV), and UCC financing statement claims (Counts X, XI), with no dispute that the UCC claims are governed by Michigan law.
There is no choice of law provision presented to the Court, and the plaintiffs' claim for Michigan law's application based on the LLC agreement lacks relevance. According to Michigan law, the organization and internal affairs of a foreign LLC are governed by the laws of its state of incorporation, which in this case is Delaware. This means Delaware law applies to breach of fiduciary duty claims. However, Michigan law governs the plaintiffs' tort claims. When facing a choice-of-law issue, a federal court applies the forum state's choice-of-law rules. Under Michigan's rules, there is a presumption favoring Michigan law unless a rational basis exists to apply another state’s law. To assess if such a basis exists, Michigan courts conduct a two-step analysis: first, determining if any foreign state has an interest in its law being applied, and second, evaluating if Michigan's interests outweigh that of the foreign state. If a significant interest from another state is found, Michigan law may yield to that state's law if Michigan's interest is minimal.
The "interests analysis" replaces Michigan's outdated lex loci delicti doctrine, which applied the law of the state where a tort occurred. The plaintiff incorrectly relies on this doctrine despite Michigan favoring the interests analysis. Although Delaware, where Atlas is organized, has some interest in applying its laws, Michigan has a greater interest due to the alleged tort and unjust enrichment claims occurring within its borders, as well as the plaintiff's principal place of business and the defendants' citizenship. Therefore, Michigan law governs these claims, while Delaware law applies to fiduciary duty claims related to Atlas's internal affairs.
In Count VII, the plaintiff alleges violations of Michigan’s Limited Liability Company Act, specifically regarding a manager's duties, which pertains to Delaware law for internal matters. This claim fails as it relies on a Michigan statute. In Count VIII, the defendants assert it should be dismissed based on Delaware law but provide no supporting authority, resulting in waiver of this argument. The relevant Delaware statute prohibits limiting liability for bad faith violations of the implied covenant of good faith, which the plaintiff alleges the defendants committed.
In Count III, the plaintiff claims fraudulent inducement to enter the 2011 LLC Agreement, contending that the defendants' failure to disclose their intent to defraud would have prevented the agreement. To succeed in a fraud claim, six elements must be established: a material false representation, knowledge of its falsity, intention for the plaintiff to rely on it, actual reliance by the plaintiff, and resultant damages. Fraud in the inducement renders the contract voidable at the defrauded party's discretion.
When alleging fraud in a federal complaint, a party must meet the heightened standard of specificity required by Fed. R. Civ. P. 9(b). This includes detailing the fraudulent statements, identifying the speaker, specifying when and where the statements were made, and explaining their fraudulent nature (Bennett v. MIS Corp., 607 F.3d 1076). Additionally, the plaintiff must identify the misrepresentation relied upon, the fraudulent scheme, the intent behind the fraud, and the resulting injury (Coffey v. Foamex L.P., 2 F.3d 157). The plaintiff's complaint was insufficient because it failed to identify any specific representation relied upon, the individual who made the statements, or details regarding the timing and location of these statements. The only allegation made was that the defendants omitted information about using the LLC Agreement improperly, which does not satisfy Rule 9(b)’s requirements.
The defendants also argued that the plaintiffs' tort claims were barred by the economic loss doctrine, which prevents a party to a contract from raising tort claims that are indistinguishable from breach of contract claims (Detroit Edison Co. v. NABCO, Inc., 35 F.3d 236). This doctrine, established in Hart v. Ludwig, holds that tort liability claims cannot prevail when the parties' relationship is solely governed by a contract. It distinguishes contractual claims from tort actions meant to address unforeseen injuries due to actions violating separate legal duties (Neibarger v. Universal Cooperatives, Inc., 439 Mich. 512). The Michigan Court of Appeals emphasized the importance of this distinction to maintain the integrity of commercial transactions and ensure that tort remedies do not overshadow contractual remedies. The doctrine is founded on the rationale that parties should anticipate potential losses and negotiate terms accordingly, thereby limiting the need for tort claims when contractual expectations are not met (Detroit Edison Co. v. NABCO, Inc., 35 F.3d 240).
Under Michigan law, the existence of a contract does not necessarily bar tort claims if the legal duty violated by the defendant is distinct from the contractual obligations. The Sixth Circuit, in Tyson v. Sterling Rental, Inc., clarified that tort claims, such as fraud in the inducement, can be pursued even when a contract is in place, particularly when pre-contractual misconduct undermines negotiation fairness. In Tyson, it was determined that a dealership's duty regarding the wrongful exercise of dominion over a vehicle was based on tort principles rather than the sales contract. The court emphasized that plaintiffs’ tort claims, especially concerning fraud, are valid if the alleged tortious conduct was not foreseeable under the contract.
The defendants contested the sufficiency of the claims against the Levine Trust, arguing that the second amended complaint engaged in "group pleading," where misconduct is not attributed to specific individuals. Under Hoover v. Langston Equipment Associates, Inc., plaintiffs must identify which defendant made specific fraudulent statements, as collective references fail to meet the specificity requirements of Rule 9(b). While group pleading is insufficient, courts must also consider the simplicity policy of Rule 8 when addressing motions to dismiss for lack of specificity. Thus, Rule 9(b) should be interpreted alongside Rule 8, ensuring a balance between detail and clarity in pleadings.
Rule 9 aims to provide defendants with specific notice of alleged misconduct, enhancing the clarity of claims without reinstating formal pleading requirements. The essential criterion is whether the complaint adequately informs defendants about the misrepresentation, enabling them to respond effectively to fraud allegations. The second amended complaint, consisting of 256 paragraphs, details a fraudulent scheme involving Jesse and Julius, executives of Atlas. It outlines how they misappropriated funds from a GM settlement, misused Atlas resources, employed individuals for unrelated ventures, and concealed funds in the Levine Trust. These detailed allegations suffice for relevant discovery and adequately inform the defendants of their alleged misconduct.
The defendants contend that many claims fall under Delaware law, which has a three-year statute of limitations, rendering them untimely. Conversely, the plaintiff asserts that Michigan law applies, which has a six-year statute of limitations, and claims are timely since they became aware of the alleged wrongdoing in late 2015. Allegations of wrongdoing began in late 2011, with the complaint filed on August 25, 2016, making claims under Michigan law timely. Under Delaware law, breach of fiduciary duty claims generally must be filed within three years, but exceptions exist for fraudulent concealment and equitable tolling. The plaintiff alleges that the defendants engaged in fraudulent concealment by opening a secret bank account, misleading Atlas employees, and concealing self-dealing activities, which may toll the statute of limitations.
Atlas became aware of a secret account in 2015, triggering an investigation that revealed additional alleged misconduct by the defendants. This concealment and the plaintiff's reliance on the defendants' fiduciary competence toll the statute of limitations for the fiduciary claims, allowing the claims to proceed under both Michigan and Delaware law. The defendants contend that damages in Counts X (Breach of Mich. Comp. Laws. 440.9501) and XI (Tortious Interference) are speculative, as they are contingent on business outcomes, which the plaintiff disputes, asserting that the allegations are not speculative and include incurred costs related to challenging fraudulent UCC filings.
The case referenced, Hemlock Semiconductor Corp. v. Kyocera Corp., involved a breach of contract claim dismissed due to speculation regarding third-party actions, differing from the current tort and statutory violation claims. Under Michigan law, a debtor may seek relief if a fraudulent financing statement is filed. The plaintiff alleges that the defendants filed such statements, which were later expunged, resulting in damages, including costs to challenge these statements. The plaintiff's claims under section 440.9501(7) are plausible, entitling them to seek damages associated with the fraudulent filings. Additionally, the plaintiff presents a plausible claim for tortious interference with economic expectancy, requiring proof of a valid business relationship and the defendant's knowledge of it.
To establish a claim for tortious interference under Michigan law, a plaintiff must demonstrate: (iii) intentional interference that results in the termination of a business relationship or expectancy, and (iv) actual damages stemming from that interference. A valid business expectancy requires more than a subjective expectation; it must represent a reasonable likelihood of entering into a business relationship, not mere wishful thinking. In the case of Lucas v. Monroe County, the Sixth Circuit found that the plaintiffs had provided sufficient evidence of wrongful conduct by the sheriff's department that hindered their ability to enter into business relationships. In the current case, the plaintiff, Atlas, alleges it was excluded from bidding opportunities with a large customer due to a lowered credit score resulting from allegedly fraudulent financing statements. The court notes that plausibility in pleading requires more than a mere possibility of relief, but less than probable entitlement. Atlas's claims, when viewed favorably, present a plausible case for tortious interference with a business expectancy. However, the plaintiff failed to plead fraud in the inducement with the requisite specificity, leading to the dismissal of Count III. Additionally, Count VII, which relies on Michigan law regarding the duties owed by the defendant manager, is also dismissed. The remaining claims, based on the pleadings and considered documents, are deemed plausible. The court grants in part and denies in part the defendants' motion to dismiss, dismissing Counts III and VII while allowing other counts to proceed. A subsequent status conference is scheduled for August 7, 2017.
