Martin Lanz Zaslansky v. FZ Holdings US, Inc.

• Court: Court of Chancery of Delaware
• Decided: February 8, 2022
• Docket: C.A. No. 2021-0168-KSJM
• Status: Published

Opinion

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

MARTIN LANZ ZASLANSKY and ) ROBERTA ZASLANSKY FAMILY ) TRUST, ) ) Petitioners, ) ) v. ) C.A. No. 2021-0168-KSJM ) FZ HOLDINGS US, INC., ) ) Respondent. )

ORDER RESOLVING RESPONDENT’S MOTION TO DISMISS AND PETITIONERS’ CROSS-MOTION FOR PARTIAL SUMMARY JUDGMENT

1. The petitioners, Martin Lanz Zaslansky and a trust named for his wife, the

Roberta Zaslansky Family Trust (the “Trust” and, collectively, “Petitioners”), are current

noteholders of FZ Holdings US, Inc. (“Respondent” or the “Company”), a Delaware

corporation.1

2. In 2018, Hemang Mehta and Nevil Shah (the “Principals”) formed the

Company to produce and sell video game figurines. Around that time, Mitesh Lakhani, the

managing partner of Raisol Capital LLC (“Raisol”), approached Zaslansky about investing

in the Company. The petition alleges that Lakhani “has a historical relationship with the

Principals,” but the nature of that relationship is unclear.2

1 Unless otherwise stated, the facts are drawn from Petitioners’ Verified Petition for Breach of Contract & for the Appointment of a Receiver to a Delaware Corporporation Pursuant to 8 Del. C. § 291, C.A. No. 2021-0168-KSJM, Docket (“Dkt.”) 21 (the “Amended Petition” or “Am. Pet.”). 2 Id. ¶ 53. 3. On July 31, 2018, the Trust and the Company executed a convertible

promissory note (“Note 1”) for $250,000 in principal with 8% interest per annum.3 Under

Note 1, the Company was obligated to pay the outstanding principal amount and any unpaid

interest on July 31, 2020, unless the Company defaulted earlier.

4. On March 1, 2019, Zaslansky and the Company executed a convertible

promissory note (“Note 2” and, together with Note 1, the “Notes”) for an additional

$25,000 in principal with 8% interest per annum.4 Under Note 2, the Company was

obligated to pay the outstanding principal amount and any unpaid interest on March 1,

2020, unless the Company defaulted earlier.

5. Each Note provides that the “Company agrees to pay on demand all of the

losses, costs, and expenses (including, without limitation, attorneys’ fees and

disbursements) which the Holder incurs in connection with enforcement of this Note, or

the protection or preservation of the Holder’s rights under this Note, whether by judicial

proceeding or otherwise.”5

6. The Company has struggled financially. According to its balance sheet as of

March 31, 2021, its assets were worth $469,302.63, its liabilities totaled $2,313,866.59,

and its net income was negative $49,871.60.6

3 See Am. Pet. Ex. A (Note 1). 4 See Am. Pet. Ex. B (Note 2). 5 Note 1 § 15; Note 2 § 15. 6 See Am. Pet. Ex. E (“March 31, 2021 Balance Sheet”).

2 7. On October 29, 2020, each Petitioner served a notice of default on the

Company for failing to repay the outstanding principal and interest due under the Notes by

their maturity dates.7

8. Despite this failure to timely repay its noteholders, the Company has partially

repaid debt owed to its Principals. In support of this allegation, Petitioners point to the

Company’s balance sheet as of September 30, 2019, which reflects a debt to

“Founder/Affiliates” of $316,237.37.8 The Company’s later balance sheet indicates that a

debt due to “Owner” decreased from $207,384.48 as of December 31, 2020, to $194,761.94

as of March 31, 2021.9 Similarly, a debt owed to “Sunrise,” which the Principals are

alleged to own or control, appeared to decrease during the same time period.10

9. In a similar vein, the Principals are alleged to have commingled personal debt

with Company debt. The Company’s balance sheets indicate that it repaid a debt to Raisol

in the amount of $90,000 between September 30, 2019, and December 31, 2020.11

According to Petitioners, however, the Company was never indebted to Raisol, as these

7 See Am. Pet. Ex. C (Trust Notice), Ex. D (Zaslansky Notice). 8 See Am. Pet. Ex. J (“September 30, 2019 Balance Sheet”). 9 See March 31, 2021 Balance Sheet. 10 See Am. Pet. Ex. L (December 31, 2019 Balance Sheet) (reflecting $237,222.42 due to Sunrise), Ex. M (June 30, 2020 Balance Sheet) (reflecting $216,931.42 due to Sunrise), March 31, 2021 Balance Sheet (reflecting $207,337.42 due to Sunrise). According to Petitioners, the Principals own or control SCP PTF Investment Vehicle LLC, which does business as Sunrise Capital Partners. Petitioners allege that the entity referred to as “Sunrise” on the balance sheets is this entity. 11 See September 30, 2019 Balance Sheet, March 31, 2021 Balance Sheet. The balance sheets for periods after September 30, 2019, refer to debt owed to “Raisol Consulting,” which Petitioners allege is the same entity as Raisol.

3 balance sheet entries refer to a loan from Raisol to Sunrise Capital Partners that the

Principals had guaranteed.12

10. As a further cause for concern, Petitioners allege that the Principals are

running a parallel company with a similar business model called Minted Labs, Inc. This

company also produces video game figurines, but they are less expensive than the

Company’s and are not custom-made. The Principals did not disclose the existence of

Minted Labs to Petitioners, who learned about it from Lakhani in early 2020. When

pressed for information, the Principals admitted that they and a Company employee have

worked for both companies, which allegedly operate out of the same office building.

11. Petitioners filed this action on February 25, 2021, and they amended their

petition on August 20, 2021. In Counts I and II of the Amended Petition, each Petitioner

claims that Respondent breached their respective Note and seeks damages and an

accounting from 2018 to the present. In Count III, Petitioners request the appointment of

a receiver under 8 Del. C. § 291.

12. On September 3, 2021, Respondent moved to dismiss Counts I and II under

Court of Chancery Rule 12(b)(1) for lack of subject matter jurisdiction and Count III under

Rule 12(b)(6) for failure to state a claim.13 Petitioners cross-moved for partial summary

12 See Am. Pet. Ex. K (Promissory Note & Guaranty). The guaranty was for a $50,000 loan, so it is not clear how that might have morphed into a $90,000 debt on the Company’s balance sheet. The inconsistency is not shocking, however, as none of the Company’s financials appear to have been prepared in accordance with Generally Accepted Accounting Principles. 13 See Dkt. 22.

4 judgment on Counts I and II on October 15, 2021. 14 The motions were fully briefed as of

December 7, 2021,15 and the court held oral argument on December 21, 2021.16

13. Respondent took an unusual position in briefing. Respondent conceded that

the court has subject matter jurisdiction over Count III but argued that Count III fails to

state a claim. Respondent further argued that Counts I and II are purely legal claims that

fall outside of this court’s limited jurisdiction. In Respondent’s view, the court should

dismiss Counts I and II without prejudice and transfer them to the Superior Court because

of the defects in Count III.17 That is a common enough argument. The atypical part is that,

if this court denies Respondent’s motion to dismiss Count III and decides to assert

jurisdiction over Counts I and II, Respondent does not contest entry of judgment in

Petitioners’ favor on the first two counts.18 Because Respondent’s motion and the fate of

Counts I and II hinge on its arguments as to Count III, this analysis focuses there.

14. Respondent has moved to dismiss Count III for appointment of a receiver

under 8 Del. C. § 291 under Court of Chancery Rule 12(b)(6). Under Rule 12(b)(6), “the

14 See Dkt. 26. 15 See Dkt. 25 (Resp’t’s Opening MTD Br.); Dkt. 27 (Pet’rs’ Combined Answering MTD Br. & Opening PMSJ Br.); Dkt. 34 (Resp’t’s Combined Reply MTD Br. & Answering PMSJ Br.); Dkt. 38 (Pet’rs’ Reply PMSJ Br.). 16 See Dkt. 43 (“Oral Arg. Tr.”). 17 See Resp’t’s Opening MTD Br. at 12–13. 18 See Resp’t’s Combined Reply MTD Br. & Answering PMSJ Br. at 3 (stating that Respondent does “not contest the entry of judgment on Counts I and II”); Oral Arg. Tr. at 5:18–21 (stating that “to the extent the Court does determine that it should exercise jurisdiction over the debt claims, [Respondent does] not contest entry of judgment on those claims”).

5 governing pleading standard in Delaware to survive a motion to dismiss is reasonable

‘conceivability.’”19 The court must “accept all well-pleaded factual allegations in the

[c]omplaint as true . . . , draw all reasonable inferences in favor of the plaintiff, and deny

the motion unless the plaintiff could not recover under any reasonably conceivable set of

circumstances susceptible of proof.”20 The court, however, need not “accept conclusory

allegations unsupported by specific facts or . . . draw unreasonable inferences in favor of

the non-moving party.”21

15. Under 8 Del. C. § 291, a creditor or stockholder can petition this court to

appoint a receiver “of and for” an insolvent corporation.22 The power to appoint “a receiver

lies within the sole discretion of the Court.”23 In reviewing the petition, “[t]he Court

applies an ‘insolvency plus’ standard to determine whether to appoint a receiver under

Section 291.”24 That standard requires the court to determine two things: (i) that the

corporation is insolvent and (ii) that appointment of a “neutral third party” is necessary “to

19 Cent. Mortg. Co. v. Morgan Stanley Mortg. Cap. Hldgs. LLC, 27 A.3d 531, 537 (Del. 2011). 20 Id. at 536 (citing Savor, Inc. v. FMR Corp., 812 A.2d 894, 896–97 (Del. 2002)). 21 Price v. E.I. DuPont de Nemours & Co., Inc., 26 A.3d 162, 166 (Del. 2011) (citing Clinton v. Enter. Rent-A-Car Co., 977 A.2d 892, 895 (Del. 2009)), overruled on other grounds by Ramsey v. Ga. S. Univ. Advanced Dev. Ctr., 189 A.3d 1255 (Del. 2018). 22 8 Del. C. § 291. 23 Banet v. Fonds de Régulation et de Contrôle Café Cacao, 2009 WL 529207, at *3 (Del. Ch. Feb. 18, 2009) (citation omitted). 24 In re Geneius Biotech., Inc., 2017 WL 6209593, at *5 (Del. Ch. Dec. 8, 2017) (quoting Ross Hldg. & Mgmt. Co. v. Advance Realty Gp., LLC, 2010 WL 3448227, at *5 (Del. Ch. Sept. 2, 2010)).

6 protect the insolvent corporation’s creditors or shareholders by showing some benefit that

such an appointment would produce or some harm it could avoid.”25

16. To plead insolvency, Petitioners must allege that Respondent has either: “1)

‘a deficiency of assets below liabilities with no reasonable prospect that the business can

be successfully continued in the face thereof,’ or 2) ‘an inability to meet maturing

obligations as they fall due in the ordinary course of business.’”26

17. Petitioners allege, and the Company’s balance sheet demonstrates, that the

Company’s liabilities equaled nearly five times its assets as of March 31, 2021, and the

Company had a negative net income. This court has held that similar facts demonstrate

insolvency under the balance sheet test.27 Petitioners have thus met the first test for

insolvency. Because Petitioners have clearly met their pleading burden under the first test,

this analysis does not reach their arguments under the second test.

18. The “plus” factor of the insolvency-plus test requires that Petitioners plead

facts to show “there exist ‘special circumstances’ where ‘some real beneficial purpose will

be served’” by the appointment of a receiver.28 To satisfy this standard, Petitioners must

plead “the necessity of a neutral third party [i] ‘to protect the insolvent corporation’s

25 Id. (cleaned up). 26 Prod. Res. Gp., L.L.C. v. NCT Gp. Inc., 863 A.2d 772, 782 (Del. Ch. 2004) (quoting Siple v. S & K Plumbing & Heating, Inc., 1982 WL 8789, at *2 (Del. Ch. Apr. 13, 1982)). 27 See id. at 783 (holding that insolvency was adequately pled under the balance sheet test where the respondent’s liabilities were nearly five times its assets and it consistently suffered large operating losses). 28 Pope Invs. LLC v. Benda Pharm., Inc., 2010 WL 5233015, at *6 (Del. Ch. Dec. 15, 2010) (quoting Banet, 2009 WL 529207, at *3).

7 creditors or shareholders by showing some benefit that such an appointment would produce

or some harm it could avoid,’ and [ii] the ‘potential benefits must outweigh any potential

harm that appointment of a receiver could cause.’”29

19. Petitioners allege that the Principals “have caused the Company to repay

other creditors in part or full ahead of Petitioners and other noteholders, and have

commingled their own debt with debt of the Company.”30 The creditors being repaid ahead

of Petitioners are alleged to be the Principals and their affiliates.31 As for commingling,

Petitioners allege that Respondent has recorded the “personal debt of the Principals and of

Sunrise Capital Partners . . . as Company debt.”32 On top of this, Petitioners allege that

Respondent has continued to “secure[] more convertible debt.”33

20. Petitioners also allege that the Principals have used Respondent’s money and

resources to operate a parallel company, Minted Labs, which Petitioners allege operates in

the Company’s building and uses a Company employee.34 Petitioners have no interest in

Minted Labs and allege they and other noteholders were not informed about its existence

until early 2020.35

29 Geneius, 2017 WL 6209593, at *5 (quoting Badii ex rel. Badii v. Metro. Hospice, Inc., 2012 WL 764961, at *7, *10 (Del. Ch. Mar. 12, 2012) (internal quotation marks and footnotes omitted)). 30 Am. Pet. ¶ 46. 31 See id. ¶ 49. 32 Id. ¶ 52. 33 Id. ¶ 32. 34 See id. ¶¶ 56–57. 35 See id. ¶ 58.

8 21. In response to Petitioners’ plus-factor allegations, Respondent first argues

that Petitioners’ claims are not well-pled, pointing out that the Amended Petition uses the

phrase “upon information and belief” more than twenty times. Respondent cites several

cases in which this court found such allegations insufficient to state a claim.36

22. While the phrase “upon information and belief” appears with some frequency

in the Amended Petition, this decision need not rely on those allegations alone. Petitioners

have provided support for their allegations with specific facts and attached exhibits from

which the court is able to draw reasonable inferences.37 Indeed, Respondent’s own

financial records attached to and incorporated by reference into the Amended Petition

render the allegations about growing convertible debt, paying off insiders, and satisfying

insiders’ personal obligations reasonably conceivable.38 In addition, the Amended Petition

alleges that “[w]hen pressed for information [about Minted Labs], the Principals conceded

that they and an employee of the Company have worked for both companies.” 39 This

situation is thus distinguishable from Respondent’s cited cases.40

36 See Resp’t’s Opening MTD Br. at 8–10; Oral Arg. Tr. at 7:4–8:10. 37 See Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 860 A.2d 312, 320 (Del. 2004) (holding that the trial court erred by considering documents “neither attached to, nor incorporated by reference into, the complaint”). 38 Compare September 30, 2019 Balance Sheet (showing $850,000 in convertible debt, $316,237.37 due to “Founder/Affiliates,” and $90,000 due to “Raisol Capital”), with March 31, 2021 Balance Sheet (showing $1,100,000 in convertible debt, $194,761.94 due to “Owner,” and $0 due to “Raisol”). 39 Am. Pet. ¶ 58. 40 See DG BF, LLC v. Ray, 2021 WL 776742, at *27 (Del. Ch. Mar. 1, 2021) (dismissing claims based on information and belief that the nominal defendant was undercapitalized and being used as the individual defendants’ personal piggy bank because the allegations 9 23. Aside from its “information and belief” argument, Respondent contends that

the only inference to be drawn from Respondent’s failure to repay its debts allegations is

that “Petitioners desire (exigently) to be moved ‘ahead’ in the line of partial or full debt

payments that are actually being made by FZ Holdings.”41 Respondent further contends

that “unspecified ‘concerns’” about a parallel company “do[] not support a reasonable

inference of any exigent circumstance warranting a receiver.”42 Finally, Respondent insists

that appointing a receiver for the Company would have the effect of liquidating a

corporation that is only valuable as a going concern, which would destroy its value and

prevent any meaningful distribution to creditors.43

24. Respondent’s arguments again fall short. Taking Petitioners’ allegations as

true and drawing all reasonable inferences in their favor, as the court must at this stage,

were “limited” and “conclusory”); Neurvana Med., LLC v. Balt USA, LLC, 2020 WL 949917, at *23 (Del. Ch. Feb. 27, 2020) (refusing to accept as true an allegation made upon information and belief where the allegation was unsupported by well-pled facts in the complaint); O’Gara v. Coleman, 2020 WL 752070, at *6 (Del. Ch. Feb. 14, 2020) (same); Griffin Corp. Servs., LLC v. Jacobs, 2005 WL 2000775, at *6 (Del. Ch. Aug. 11, 2005) (same). 41 Resp’t’s Opening MTD Br. at 9 (emphasis in original). 42 Id. 43 See Resp’t’s Combined Reply MTD Br. & Answering PMSJ Br. at 2; Oral Arg. Tr. at 4:4–12, 6:4–11. Respondent cites to Keystone Fuel Oil, Inc. v. Del-Way Petroleum, Co., for the proposition that “a receiver is normally a remedy of an auxiliary nature incidental to primary relief bottomed upon fraud or inequitable conduct under the given circumstances, and the appointment of a receiver should not be the sole object of a suit.” 1977 WL 2572, at *2 (Del. Ch. June 16, 1977). That portion of the decision, which was on a different procedural posture, “cited to two cases in which a petitioner sought the appointment of a receiver pendente lite for a solvent company and invoked this court’s general equitable authority, not the statutory authority granted by § 291,” and thus is inapposite. Prod. Res., 863 A.2d at 785.

10 Respondent’s continued debt financing, selective repayment of current debts, lackadaisical

approach to bookkeeping, and commingling of personal and Company debts has the

potential to harm Petitioners, other current noteholders, and any future creditors that the

Company may attract. A receiver could prevent or alleviate this harm. And a receiver need

not necessarily liquidate the insolvent corporation’s assets to do so. Rather, a receiver is

broadly empowered to do all that “may be necessary or proper” in the name of the

corporation.44 If Petitioners prove their claims, it remains to be seen what powers will be

necessary and proper for the receiver to do what is in the best interests of the Company. At

this stage, the question is whether it is reasonably conceivable that the appointment of a

neutral third party is necessary to protect the Company’s creditors. It is. Petitioners have

thus adequately pled the plus factor.

25. For the foregoing reasons, Respondent’s motion to dismiss Count III

pursuant to Rule 12(b)(6) is DENIED.

26. Respondent has moved to dismiss Counts I and II under Rule 12(b)(1),

arguing that they are legal claims falling outside of this court’s limited jurisdiction.45 Under

the “clean-up doctrine,” however, this court may exercise “ancillary jurisdiction ‘to resolve

purely legal causes of action that are before it as part of the same controversy over which

the Court originally had subject matter jurisdiction in order to avoid piecemeal

44 8 Del. C. § 291. 45 See Resp’t’s Opening MTD Br. at 10–13.

11 litigation.’”46 The court has found that Count III under 8 Del. C. § 291 is well-pled; that

claim indisputably gives rise to subject matter jurisdiction over this action, allowing the

court to exercise subject matter jurisdiction over Counts I and II under the clean-up

doctrine. Accordingly, Respondent’s motion to dismiss Counts I and II pursuant to Rule

12(b)(1) is DENIED.

27. The court has denied Respondent’s motion to dismiss Count III for failure to

state a claim and held that the exercise of jurisdiction over Counts I and II is appropriate.

Per Respondent’s stipulation described above, Petitioners’ motion for partial summary

judgment as to Counts I and II is GRANTED.

28. The parties shall confer on a form of Order memorializing this ruling as to

Counts I and II and on a schedule for litigating Count III.

/s/ Kathaleen St. J. McCormick Chancellor Kathaleen St. J. McCormick Dated: February 8, 2022

46 FirstString Rsch., Inc. v. JSS Med. Rsch. Inc., 2021 WL 2182829, at *6 (Del. Ch. May 28, 2021) (quoting Kraft v. WisdomTree Invs., Inc., 145 A.3d 969, 974 (Del. Ch. 2016)).