Warren David Yu v. GSM Nation, LLC

• Court: Court of Chancery of Delaware
• Decided: July 7, 2017
• Docket: 12293-VCMR
• Status: Published

Opinion

COURT OF CHANCERY OF THE STATE OF DELAWARE

TAMIKA R. MONTGOMERY-REEVES Leonard Williams Justice Center VICE CHANCELLOR 500 N. King Street, Suite 11400 Wilmington, Delaware 19801-3734

Date Submitted: May 18, 2017 Date Decided: July 7, 2017

Larry R. Wood, Jr., Esquire John P. DiTomo, Esquire Adam V. Orlacchio, Esquire Alexandra M. Cumings, Esquire Blank Rome LLP Morris, Nichols, Arsht & Tunnell LLP 1201 North Market Street, Suite 800 1201 North Market Street, 16th Floor Wilmington, DE 19801 Wilmington, DE 19899

Michael Busenkell, Esquire Blake Rohrbacher, Esquire Margaret F. England, Esquire Susan M. Hannigan, Esquire Gellert Scali Busenkell & Brown, LLC Richards, Layton & Finger, P.A. 1201 North Orange Street, Suite 300 One Rodney Square Wilmington, DE 19801 920 North King Street Wilmington, DE 19801

RE: Warren David Yu v. GSM Nation, LLC et al., Civil Action No. 12293-VCMR

Dear Counsel:

This letter opinion resolves Defendants’ motion to dismiss. Defendants move

to dismiss for lack of subject matter jurisdiction because, in their view, the complaint

merely seeks to collect a debt, and damages provide an adequate remedy at law.

They also move to dismiss for failure to state a claim, and Defendant Ahmed Khattak

moves to dismiss for lack of personal jurisdiction. Because, when viewed

holistically, the complaint does not assert any equitable claims and an adequate Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 2 of 15

remedy exists at law, the motion to dismiss for lack of subject matter jurisdiction is

granted.

I. BACKGROUND

The facts outlined in this letter opinion derive from Plaintiff’s Verified

Amended Complaint (the “Complaint”).

A. Facts

Defendant GSM Nation, LLC (“GSM”) is a Delaware limited liability

company in the mobile phone retail and wholesale business. Defendant Ahmed

Khattak is the chief executive officer, co-founder, and manager of GSM and owns

85% of the GSM units. Junaid Shams is the other co-founder of GSM. Shams was

acquainted with Plaintiff David Warren Yu through medical studies at the George

Washington University before Yu loaned money to GSM in the series of transactions

that gave rise to this case.

Defendant US Mobile Inc. was a Delaware corporation that was merged with

and into Defendant US Mobile LLC, a Delaware limited liability company, on July

1, 2015. Khattak also allegedly controls US Mobile LLC. Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 3 of 15

Khattak and Shams founded GSM in 2010, and since then, the company has

allegedly experienced “tremendous growth.”1 In 2011, GSM was featured in Forbes

magazine and listed among Businessweek’s 25 most promising companies.

In mid-2012, GSM sought to expand further by developing a mobile virtual

network operator (“MVNO”), which would allow GSM to provide cellular service

plans to its customers. But GSM was cash strapped at the time. Shams, at Khattak’s

request, approached Yu for the purpose of soliciting loans to GSM, and Khattak

allegedly represented to Yu that GSM needed capital to launch an MVNO. In

October 2012, GSM provided Yu with a prospectus that included the plan to form

an MVNO as a division of GSM.

From February 2013 through September 2014, Yu loaned $3,500,000 to GSM

under a series of 16 separate loan agreements (the “Loan Agreements”) bearing 12%

simple interest, payable monthly. Yu was entitled to call the loans at any time with

60 days’ notice.

GSM paid Yu the required monthly interest payments and employed

personnel to develop MVNO capabilities. The Complaint also alleges that Khattak

paid himself “a draw” of $10,000 to $15,000 per month from GSM while Yu was

1 Compl. ¶ 14. Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 4 of 15

making loans to the company. Additionally, Khattak used $5,000 from GSM each

month to cover his personal living expenses. And the Complaint asserts that Khattak

“tried to buy a luxury car using a cashier’s check from GSM,”2 but it does not allege

that Khattak was successful in buying the car or when he made the attempt.

In April 2013, GSM released an MVNO business plan, which stated in part

that the MVNO GSM was developing would be a part of GSM. But Yu alleges that

instead of completing the MVNO development process within GSM, Khattak

applied to the Federal Communications Commission (the “FCC”) on behalf of US

Mobile LLC for permissions related to becoming an MVNO. US Mobile LLC

sought the right from the FCC to provide global resale services between the United

States and points abroad. Yu alleges that, as a result, US Mobile LLC, not GSM,

became an MVNO. Yu also asserts on information and belief that Khattak caused

GSM to purchase cellular phones and transfer them to US Mobile LLC for no

consideration, but the Complaint does not allege when this transfer occurred.

GSM paid Yu the required interest payments under the Loan Agreements until

January 2016 when GSM’s interest check was returned for insufficient funds.

GSM’s February 2016 interest check also was returned for insufficient funds. On

2 Id. ¶ 47. Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 5 of 15

February 17, 2016, Yu made a demand for full payment of the debt pursuant to the

Loan Agreements. But GSM allegedly responded that “given the current state of the

business, GSM is not able to repay or service the loan.”3 GSM provided Yu with a

GSM income statement dated December 4, 2015, which showed a net loss of

$812,257, and a GSM balance sheet dated January 31, 2016, which showed total

assets of $112,730.27 and total liabilities of $4,403,083.35.

B. This Litigation

On May 3, 2016, Yu filed the original complaint in this action, and on July

26, 2016, he filed the Complaint at issue in this motion. Count I of the Complaint

alleges a breach of contract claim against GSM for failure to repay the loans. Count

II is a claim for fraudulent inducement against GSM and Khattak in connection with

the Loan Agreements because GSM and Khattak allegedly represented that an

MVNO would be developed within GSM. Count III alleges equitable fraud against

GSM and Khattak for the same conduct. Count IV is a fraudulent transfer claim

against GSM, Khattak, US Mobile LLC, and US Mobile Inc. Count V alleges unjust

enrichment against GSM, Khattak, US Mobile LLC, and US Mobile Inc., and count

VI seeks to pierce the corporate veils of GSM, US Mobile LLC, and US Mobile Inc.

3 Id. ¶ 80. Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 6 of 15

under an alter ego theory of liability against Khattak. Further, Yu’s prayer for relief

requests “equitable rescission” of the loan agreements, “reformation,” a

“constructive trust” voiding the transfers from GSM to US Mobile LLC, and an

“equitable accounting.”

On August 9, 2016, Defendants GSM, US Mobile Inc., and US Mobile LLC

moved to dismiss the Complaint for lack of subject matter jurisdiction. Defendant

Khattak moved to dismiss for lack of personal jurisdiction, and all Defendants

moved to dismiss for failure to state a claim. Yu asserts that his claims for equitable

fraud and unjust enrichment are equitable claims. And he argues that his claims for

fraudulent transfer and fraudulent inducement seek equitable remedies such that the

Court of Chancery has subject matter jurisdiction. Yu contends that the Court has

jurisdiction over his breach of contract claim pursuant to the “clean-up” doctrine.4

The Court heard oral argument on the motions on May 18, 2017. This opinion

resolves the pending motions to dismiss.

II. ANALYSIS

GSM, US Mobile Inc., and US Mobile LLC move to dismiss the Complaint

for lack of subject matter jurisdiction. They argue that the Complaint merely uses

4 Pl.’s Answering Br. to GSM Mot. to Dismiss 13 n.1. Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 7 of 15

traditionally equitable words but does not actually bring equitable claims or seek

equitable remedies. The Court of Chancery will grant a Rule 12(b)(1) motion to

dismiss “if it appears from the record that the Court does not have jurisdiction over

the claim.”5 The Court of Chancery is a court of limited jurisdiction. Section 342

of Title 10 of the Delaware Code states that “[t]he Court of Chancery shall not have

jurisdiction to determine any matter wherein sufficient remedy may be had by

common law, or statute, before any other court or jurisdiction of this State.” 6 This

Court acquires subject matter jurisdiction over a case “in only three ways: (1) the

invocation of an equitable right; (2) the request for an equitable remedy when there

is no adequate remedy at law; or (3) a statutory delegation of subject matter

jurisdiction.”7

5 Medek v. Medek, 2008 WL 4261017, at *3 (Del. Ch. Sept. 10, 2008). 6 10 Del. C. § 342. 7 Hillsboro Energy, LLC v. Secure Energy, Inc., 2008 WL 4561227, at *1 (Del. Ch. Oct. 3, 2008) (quoting Medek v. Medek, 2008 WL 4261017, at *3 (Del. Ch. Sept. 10, 2008)) (internal quotation marks omitted). Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 8 of 15

“When a party challenges this Court’s subject matter jurisdiction over a

particular case, the ‘[C]ourt must review the allegations of the complaint as a whole

to determine the true nature of the claim.’”8 As former Chancellor Allen observed:

Chancery jurisdiction is not conferred by the incantation of magic words. Neither the artful use nor the wholesale invocation of familiar chancery terms in a complaint will excuse the court . . . from a realistic assessment of the nature of the wrong alleged and the remedy available in order to determine whether a legal remedy is available and fully adequate. If a realistic evaluation leads to the conclusion that an adequate remedy is available, this court, in conformity with the command of Section 342 of Title 10 of the Delaware Code, will not accept jurisdiction over the matter.9

“[E]quity will take a practical view of the complaint, and will not permit a suit to be

brought in Chancery where a complete legal remedy otherwise exists but where the

plaintiff has prayed for some type of traditional equitable relief as a kind of formulaic

‘open sesame’”10 to equity jurisdiction.

8 Hillsboro Energy, 2008 WL 4561227, at *1 (quoting Christiana Town Ctr., LLC v. New Castle Ctr., 2003 WL 21314499, at *3 (Del. Ch. June 6, 2003)). 9 McMahon v. New Castle Assocs., 532 A.2d 601, 603 (Del. Ch. 1987). 10 Int’l Bus. Machines Corp. v. Comdisco, Inc., 602 A.2d 74, 78 (Del. Ch. 1991). Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 9 of 15

A. Alter Ego Liability

Count VI of Yu’s Complaint asserts that Khattak is subject to personal liability

under an alter ego or veil piercing theory, which is an equitable claim.11 Yu alleges

that GSM, US Mobile Inc., and US Mobile LLC are alter egos of Khattak because

Khattak paid himself compensation from GSM both in cash and through other fringe

benefits such as the rent on an apartment. The Complaint also alleges on information

and belief that GSM and US Mobile LLC were undercapitalized “[a]t the time of

GSM’s transfer of resources and assets to US Mobile, if not before.”12 And Yu

asserts that US Mobile LLC was formed for the purpose of fraudulently transferring

assets from GSM to an entity that did not owe a debt to Yu.

“Persuading a Delaware court to disregard the corporate entity is a difficult

task.”13 “In order to state a cognizable claim to pierce the corporate veil of [a

corporation], plaintiffs must allege facts that, if taken as true, demonstrate the

Officers’ and/or the Parents’ complete domination and control of the

11 Sonne v. Sacks, 314 A.2d 194, 197 (Del. 1973) (“[P]iercing the corporate veil may be done only in the Court of Chancery . . . .”). 12 Compl. ¶¶ 141-42. 13 Wallace ex rel. Cencom Cable Income P’rs II, Inc., L.P. v. Wood, 752 A.2d 1175, 1183 (Del. Ch. 1999) (quoting Harco Nat. Ins. Co. v. Green Farms, Inc., 1989 WL 110537, at *4 (Del. Ch. Sept. 19, 1989)) (internal quotation marks omitted). Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 10 of 15

[corporation].”14 “Piercing the corporate veil under the alter ego theory ‘requires

that the corporate structure cause fraud or similar injustice.’ Effectively, the

corporation must be a sham and exist for no other purpose than as a vehicle for

fraud.”15

Yu does not allege that Khattak commingled funds with GSM or US Mobile

LLC or that those entities failed to observe other corporate formalities such that they

are sham entities. In contrast, Yu alleges that GSM, not Khattak, conducted a

successful mobile phone sales business for at least five years.16 GSM was named as

one of Businessweek’s 25 most promising businesses. And GSM serviced Yu’s loan

in compliance with the Loan Agreements from February 2013 through December

2015 before it defaulted. Khattak did not even approach Yu to solicit his investment

in GSM. Rather, Shams, the other co-founder of GSM, was Yu’s initial point of

contact.17 GSM allegedly is insolvent now, but the Complaint includes no non-

conclusory allegations that it was inadequately capitalized from February 2013 when

14 Id. at 1183-84. 15 Id. at 1184 (quoting Outokumpu Eng’g Enters., Inc. v. Kvaerner EnviroPower, Inc., 685 A.2d 724, 729 (Del. Super. Ct. 1996)). 16 E.g., Compl. ¶¶ 12-13. 17 Id. ¶ 17. Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 11 of 15

Yu provided the first loan to January 2016 when GSM first failed to service the loan.

US Mobile LLC also allegedly conducts a legitimate operating business and has at

least applied for MVNO-related permission from the FCC. And the Complaint does

not allege any specific transfer of assets from GSM to US Mobile LLC that could

support the inference that US Mobile LLC was formed for a fraudulent purpose.18

The alter ego liability claim is merely an attempt to bootstrap a legal claim into the

Court of Chancery’s jurisdiction through the “invocation of familiar chancery

terms.”19 That attempt cannot succeed.

B. Equitable Fraud

Count III of the Complaint alleges a claim for equitable fraud, which Yu

asserts forms a sufficient basis for this Court’s equitable jurisdiction. GSM moves

to dismiss count III for lack of subject matter jurisdiction and argues that the

equitable fraud claim was pled as a pretext to gain access to the Court of Chancery.

The Court of Chancery has “exclusive, rather than concurrent, jurisdiction over”

18 The Complaint merely asserts on information and belief that Khattak caused GSM to purchase cellular phones and transfer them to US Mobile LLC for no consideration, but the Complaint does not provide any details regarding the alleged transfer. 19 McMahon v. New Castle Assocs., 532 A.2d 601, 603 (Del. Ch. 1987). Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 12 of 15

actions for “equitable fraud.”20 As such, a properly pled claim for “equitable fraud

must be pursued exclusively in the Court of Chancery.”21 Equitable fraud requires

the same elements as common law fraud, except scienter.22 Instead, a special

relationship must exist between the parties “such as some form of fiduciary

relationship or other similar circumstances, which common law fraud does not

require.”23

Aside from the title “equitable fraud,” the Complaint alleges no basis for an

equitable fraud claim. No facts in the Complaint suggest that GSM or Khattak owed

a fiduciary or similar duty to Yu. Absent any facts regarding an essential element

of a claim for equitable fraud, the equitable fraud claim cannot be a basis for

invoking this Court’s jurisdiction.24

20 Mark Fox Gp., Inc. v. E.I. duPont de Nemours & Co., 2003 WL 21524886, at *5 (Del. Ch. July 2, 2003). Equitable fraud is also referred to as “negligent or innocent misrepresentation.” Id. at *5 n.15. 21 Id. at *5. 22 Narrowstep, Inc. v. Onstream Media Corp., 2010 WL 5422405, at *13 (Del. Ch. Dec. 22, 2010). 23 Id. 24 See Mark Fox Gp., 2003 WL 21524886, at *6 (dismissing an equitable fraud claim for lack of subject matter jurisdiction without reaching the pending Rule 12(b)(6) motion to dismiss). Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 13 of 15

C. Unjust Enrichment

Yu also brings an unjust enrichment claim in count V of the Complaint and

argues that such a claim is an equitable claim sufficient to invoke the jurisdiction of

the Court of Chancery. But the Delaware Supreme Court held in Crosse v. BCBSD,

Inc. that when unjust enrichment is “an off-the-contract theory of recovery that

accompanies . . . breach of contract allegations,” the claim is “legal, not equitable.”25

Yu primarily seeks to collect a debt that is governed by the Loan Agreements

through his unjust enrichment claim. Pleading such a claim as “unjust enrichment”

is not sufficient to invoke equity jurisdiction where unjust enrichment is an

alternative to breach of contract. Count V, thus, does not allege an equitable claim.

D. Equitable Remedies

In addition to nominally pleading equitable claims, Yu attempts to invoke

equity jurisdiction by seeking equitable remedies. The Complaint requests a

constructive trust, rescission, reformation, and an equitable accounting. But the

primary remedy Yu seeks—and the remedy that will make him whole—is money

damages in the amount owed on his debt. Assuming Yu succeeds on the merits of

his claims, he can obtain that remedy against GSM under the Loan Agreements or

25 Crosse v. BCBSD, Inc., 836 A.2d 492, 496-97 (Del. 2003). Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 14 of 15

against US Mobile LLC as the transferee of a fraudulent transfer.26 Neither the

Complaint nor the briefing suggests any reason why a Superior Court judgment

against GSM and US Mobile LLC would not provide a full, fair, and complete

remedy to Yu.

While the Complaint alleges that GSM is insolvent, it does not allege that US

Mobile LLC is unable to pay a judgment. And it does not allege that specific assets

were transferred to US Mobile LLC such that an avoidance of the transfer would be

a better remedy. Instead, the Complaint alleges that Yu loaned cash to GSM, which

GSM used to fund the development of MVNO capabilities. Subsequently, US

Mobile LLC rather than GSM applied to the FCC for MVNO-related permissions.

The Complaint also alleges that on information and belief, GSM transferred cellular

phones to US Mobile LLC for no consideration. But the Complaint does not allege

when that transfer occurred or how many phones were transferred. Those allegations

do not provide a basis for this Court to avoid a transfer of assets or grant a

constructive trust. Rather, they suggest that a monetary judgment is Yu’s best

26 See 6 Del. C. § 1307(a)(2) (“In an action for relief against a transfer or obligation under this chapter, a creditor, subject to the limitations in § 1308 of this title, may obtain . . . [a]n attachment or other provisional remedy against the asset transferred or other property of the transferee in accordance with the procedure prescribed by applicable law . . . .”). Warren David Yu v. GSM Nation, LLC et al. C.A. No. 12293-VCMR July 7, 2017 Page 15 of 15

remedy to collect the debt he is owed. While the Complaint includes the “magic

words” of certain equitable remedies in an attempt to invoke equity jurisdiction, the

Superior Court can grant a full, fair, and complete remedy. Thus, this Court lacks

subject matter jurisdiction over Yu’s claims.27

III. CONCLUSION

For these reasons, Defendants’ Rule 12(b)(1) motion to dismiss for lack of

subject matter jurisdiction is granted. This case will be dismissed if Plaintiff does

not transfer the case to the Superior Court within 60 days pursuant to 10 Del. C. §

1902.

IT IS SO ORDERED.

Sincerely,

/s/Tamika Montgomery-Reeves Vice Chancellor

27 Because this Court lacks subject matter jurisdiction, I do not consider Defendants’ arguments under Rule 12(b)(2) and 12(b)(6).