District Court Upholds Private Settlement of 16(b) Claim
A few weeks ago I blogged about a magistrate judge’s recommendation, in a 16(b) action filed by plaintiff’s attorney Daniel Doherty, that the district judge grant summary judgment to the insider, FBC Holdings, on the ground that FBC had previously settled the claim privately, for 30% of the alleged profit, in response to claims asserted by plaintiffs’ attorneys David Lopez and Miriam Tauber. The district judge has now adopted the magistrate’s report and recommendation and granted FBC’s motion, agreeing that the settlement was “fair, reasonable and adequate.”
In its opinion, the district court also addressed the scope of the “debt previously contracted” exemption in Section 16(b). As discussed in my earlier blog, FBC was a ten percent owner of Sphere 3D Corporation, and one of the securities FBC owned was a debenture convertible into Sphere common stock. In March 2018, FBC and Sphere amended the debenture to extend its maturity date, require Sphere to pay an “extension fee” in return, and allow Sphere to pay the extension fee and future interest in either cash or common stock. On four subsequent payment due dates, Sphere paid interest and the extension fee with common stock.
In its settlement negotiations with Mr. Lopez and Ms. Tauber, FBC argued, among other things, that its receipt of the stock was exempt under the “debt previously contracted” exemption. As interpreted by the courts, the exemption requires that the debt exist “independently” of any obligation to transfer the securities. Plaintiff argued that Sphere’s ability to pay fees and interest with stock was part of the same agreement that gave rise to Sphere’s debt obligation, and therefore payments in stock were not independent of the underlying debt obligation. The court did not resolve that issue, agreeing with the magistrate that, to uphold a settlement, all a court has to find is that the insider’s defenses were “strong enough” to justify the issuer’s settlement for less than the full amount of the alleged profit. The court did say, though, that its review of the case law addressing the “debt previously contracted” exemption supports a conclusion that the independence requirement is met if the debt doesn’t arise in connection with an obligation to purchase or sell securities, and here Sphere had no obligation to deliver securities. While not a holding, the language may be useful precedent in analyzing the scope of the exemption.
-Alan Dye, Section16.net March 1, 2021
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