AIG SPECIALTY INSURANCE COMPANY v. MCCOLGAN (2022)

MEMORANDUM & ORDER

This case arises from claims that Jude McColgan (“McColgan”) and Rajeev Aggarwal (“Aggarwal”) (collectively, with McColgan, “defendants”) fraudulently induced Upland Software, Inc. (“Upland”) to purchase Char Software, Inc. (“Char”). Both McColgan, who was the Chief Executive Officer (“CEO”) of Char at the time of the transaction, and Aggarwal, a founder, former director, advisor and stockholder of Char, are alleged to have financially benefited from doing so. AIG Specialty Insurance Company (“AIG” or “plaintiff”), as subrogee and assignee of Upland, now seeks to recover the amount Upland allegedly overpaid due to the fraud. Pending before the Court are two motions to dismiss, one from each defendant.

I. Background

In February, 2020, McColgan, as Char CEO, finalized and executed an Agreement and Plan of Merger (“Acquisition Agreement”) with Upland. As part of that Acquisition Agreement, Char provided Upland with a Material Customer list and certified, inter alia:

to the Knowledge of the Company, no party to any Material Contract intends to, terminate, cancel or materially change the terms of, any such Material Contract. The Company (i) has not received any notice, and has no reasonable basis to believe, that any Material Customer shall not continue as a customer of the Company after the Closing or that such customer intends to terminate or materially modify existing Contracts with the Company or to reduce its commitments or purchases thereunder․

As set forth in the Acquisition Agreement,

‘Knowledge’ means, when used with respect to the Company, the actual knowledge of Jude McColgan ․ or the knowledge [he] would have, after due inquiry with respect to the subject matter so qualified with Knowledge.

According to the facts alleged in the complaint, however, McColgan and Aggarwal knew that one of Char's most lucrative customers, ESPN, Inc. (“ESPN”), which was included on the Material Customer list, did not intent to renew its contract with Char.

In December, 2019, Aggarwal had one or more calls with ESPN representatives, including ESPN Senior Product Director Andrew Machado (“Machado”). During those calls, Aggarwal attempted to expand the relationship between the two business but was rebuffed. In fact, as set forth in the complaint, ESPN representatives instead conveyed that ESPN was considering alternatives to Char due to cost. Subsequently, on January 21, 2020, Machado sent an email to Char's Director of Account Management (“the Director”) that ESPN was not going to renew its contract with Char. That same day, the Director notified McColgan via email that ESPN was “a churn risk for this year” and explained that Aggarwal has “alluded” to ESPN considering other partners.

The Director subsequently spoke with Machado to better understand ESPN's decision not to renew its contract with Char. After that conversation, on January 27, 2020, the Director emailed McColgan and others stating that ESPN was “not planning on continuing with [Char] post contract expiration”. McColgan responded, “I continue to hear the opposite.” As set forth in the complaint, McColgan's assertion was intentionally false as McColgan had no basis to believe that ESPN would renew its contract with Char.

Just one day after that email, representatives from Upland spoke with an ESPN representative other than Machado as part of Upland's due diligence process pursuant to the acquisition. During that call, the ESPN representative indicated uncertainty about ESPN's continued relationship with Char. Upland later requested an additional phone call with ESPN to obtain more information about the relationship.

Simultaneously, on January 28, 2020, McColgan and Aggarwal each individually contacted Machado at his personal email account about “providing a reference”. Aggarwal had previously communicated with Machado only through his ESPN email account. McColgan and Aggarwal both spoke with Machado via phone over the course of the day.

A few days later, on January 30, 2020, Machado spoke with Upland representatives about the relationship between ESPN and Char. On that call, Machado stated that ESPN had a large contract with Char and that ESPN was growing rapidly. Machado indicated that ESPN's use of products purchased from Char could decline, but that it would do so because of price rather than functionality or value. Machado allegedly assured Upland that it would be very difficult for ESPN to replace the products Char provided. As set forth in the complaint, McColgan is also alleged to have altered an email reviewed by Upland to allay concerns regarding the relationship between Char and ESPN.

In conjunction with the Acquisition Agreement, AIG and Upland entered a Buyer-Side Representations and Warranties Insurance Policy (“the Policy”). After Upland purchased Char and ESPN ended its relationship with Char, Upland submitted an insurance claim to AIG, alleging that Upland had received notice of ESPN's decision not to renew its contract with Char and that Char had knowledge of that decision before the execution of the Acquisition Agreement. After reviewing the claim, AIG reimbursed Upland more than 5 Million dollars, the amount Upland allegedly overpaid for Char due to the fraud. Both the Acquisition Agreement and the Policy are governed by Delaware law.

AIG, an Illinois corporation with a principal place of business in New York, asserts three causes of action against both defendants, who are residents of Massachusetts: fraudulent inducement, fraud, civil conspiracy. A fourth cause of action, aiding and abetting fraud, is brought only against Aggarwal. This Court's jurisdiction over the matter is based on diversity pursuant to 28 U.S.C. § 1332(a) because AIG and defendants are citizens of different states and the amount in controversy exceeds 5 Million dollars.

II. Motions to Dismiss

A. Legal Standard

To survive a motion under Fed. R. Civ. P. 12(b)(6), the subject pleading must contain sufficient factual matter to state a claim for relief that is actionable as a matter of law and “plausible on its face.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009), (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). A claim is facially plausible if, after accepting as true all non-conclusory factual allegations, the court can draw the reasonable inference that the defendant is liable for the misconduct alleged. Ocasio-Hernandez v. Fortuno-Burset, 640 F.3d 1, 12 (1st Cir. 2011).

When rendering that determination, a court may not look beyond the facts alleged in the complaint, documents incorporated by reference therein and facts susceptible to judicial notice. Haley v. City of Boston, 657 F.3d 39, 46 (1st Cir. 2011). A court also may not disregard properly pled factual allegations even if actual proof of those facts is improbable. Ocasio-Hernandez, 640 F.3d at 12. Rather, the inquiry required focuses on the reasonableness of the inference of liability that the plaintiff is asking the court to draw. Id. at 13. The assessment is holistic: “the complaint should be read as a whole, not parsed piece by piece to determine whether each allegation, in isolation, is plausible”. Hernandez-Cuevas v. Taylor, 723 F.3d 91, 103 (1st Cir. 2013), quoting Ocasio-Hernandez, 640 F.3d at 14.

A more demanding pleading standard is, however, imposed upon claims sounding in fraud. Regarding those claims, a plaintiff “must state with particularity the circumstances constituting” the fraud. Fed. R. Civ. P. 9(b). Particularity requires alleging the “time, place, and content of the alleged misrepresentation with specificity.” SEC v. Tambone, 597 F.3d 436, 442 (1st Cir. 2010) (en banc) (quoting Greebel v. FTP Software, Inc., 194 F.3d 185, 193 (1st Cir. 1999)).

B. McColgan's Pending Motion

i. Right of subrogation

As an initial matter, McColgan asserts that AIG has failed to state a claim upon which relief can be granted because AIG lacks a right of subrogation. In so arguing, McColgan relies on Section 8(c) of the Policy, which states:

The Insurer shall be entitled to subrogate against any Seller only if such payment results from or arises out of a Breach resulting from or arising out of fraud on the part of such Seller.

In the Policy, Breach is defined as a violation of Article III of the Acquisition Agreement. McColgan asserts that the kind of Breach alleged by AIG in the complaint does not meet the requirements of Section 8(c) and, thus, AIG has no right of subrogation.

Setting aside the question of whether the effort to enforce the subrogation limitation of Section 8(c) is an affirmative defense and therefore not properly addressed on a motion to dismiss, that Section does not shield McColgan. Referring to the Acquisition Agreement, the Policy defines a “Seller” as that term is used in Section 8(c), as a stockholder of Char's Capital Stock. According to the complaint, McColgan does not qualify as a “Seller” because he did not own Char's Capital Stock. Thus, Section 8(c) of the Policy does not apply to McColgan and cannot support a claim against him. Section 8(b) of the Policy, however, which is not addressed in McColgan's motion, provides broad subrogation rights to AIG in circumstances beyond those discussed in Section 8(c).

ii. Sufficiency of pleadings

McColgan contends that AIG has failed to state claims for which relief can be granted on any of the four counts set forth in the complaint. The Court considers the sufficiency of the pleadings pertaining to each of those counts in turn.

Regarding the first two counts—for fraud and fraudulent inducement—McColgan argues that AIG: (1) impermissibly relies on extra-contractual statements to bolster those claims in contravention to the language in the Acquisition Agreement which limits the written materials to be relied upon; (2) fails to allege that Upland reasonably relied upon the Material Customer List and (3) is unable to identify any false information contained in the Material Customer List that Char provided to Upland.

Each of those contentions is unavailing. The first is soundly refuted by the requirement of Delaware courts that only express disclaimers of reliance upon extra-contractual statements bar the use of such evidence to allege fraud. See FdG Logistics LLC v. A&R Logistics Holdings, Inc., 131 A.3d 842, 860 (Del. Ch.), aff'd sub nom. A & R Logistics Holdings, Inc. v. FdG Logistics LLC, 148 A.3d 1171 (Del. 2016). There is no such language in the Acquisition Agreement. The language cited by McColgan is instead a standard representations and warranties clause that does not address reliance and is therefore distinguishable from an effective express disclaimer. See Anvil Holding Corp. v. Iron Acquisition Co., No. CIV.A. 7975-VCP, 2013 WL 2249655, at *8 (Del. Ch. May 17, 2013). The second contention is ineffective because AIG has alleged sufficient facts to maintain its claims that McColgan actively sought to mislead Upland regarding Char's relationship with ESPN and to preclude Upland from discovering those falsehoods.

Finally, McColgan's assertion that the Material Customer List provided to Upland did not contain falsehoods and, thus, the claims must be dismissed is preposterous based on the many certifications in the Acquisition Agreement to which McColgan allegedly subscribed. The Material Customer List is far from the only source of alleged falsehoods. McColgan therefore cannot, at this stage of litigation, dispense with either of the first two claims, which have been alleged with sufficient particularity.

AIG has also alleged facts sufficient to maintain counts three and four for civil conspiracy and aiding and abetting fraud. Having found that AIG sufficiently pled fraud and fraudulent inducement, the Court rejects McColgan's preliminary contention that counts three and four must be dismissed because there is no underlying tort. Moreover, although there are no facts set forth that McColgan and Aggarwal communicated directly with one another about the alleged fraud, there is sufficient “circumstantial evidence” linking the two, i.e. the timing of the defendants’ communication with Machado. That connection extends beyond “speculation and innuendo” and is thus sufficient to support the conspiracy claim. See Lipson v. Anesthesia Servs., P.A., 790 A.2d 1261, 1289 (Del. Super. Ct. 2001).

Furthermore, although McColgan correctly notes that agents of a corporation cannot conspire with one another or aid and abet each in torts, see Cornell Glasgow, LLC v. La Grange Props., LLC, 2012 WL 2106945, at *11 (Del. Super. Ct. June 6, 2012), he overlooks the fact that AIG does not allege that Aggarwal was an agent of Char. As set forth in the complaint, this claim falls within the well-charted precedent concerning conspiracies amongst stockholders, such as Aggarwal, and corporate officers, such as McColgan. See Agspring Holdco, LLC v. NGP X US Holdings, L.P., No. CV 2019-0567-AGB, 2020 WL 4355555, at *21 (Del. Ch. July 30, 2020), and cases cited. Moreover, defendant mistakenly relies heavily upon the recent decision of Anschutz Corp. v. Brown Robin Cap., LLC, No. CV 2019-0710-JRS, 2020 WL 3096744, at *17 (Del. Ch. June 11, 2020), re-argument granted, No. CV 2019-0710-JRS, 2020 WL 4249874 (Del. Ch. July 24, 2020), in which the claims dismissed concerned a conspiracy among corporate officers rather than, as here, a corporate officer and a defendant, such as Aggarwal, further removed from the corporate structure.

AIG has therefore proffered sufficient facts to survive McColgan's motion to dismiss.

C. Aggarwal's Pending Motion

i. Right of subrogation

Similar to McColgan, Aggarwal argues that AIG has no subrogation rights to pursue claims against him. Aggarwal relies on Section 5.11 of the Acquisition Agreement which requires that the representation and warranty insurance policy executed in conjunction with the Agreement does

not permit subrogation or any other recovery of any kind of the insurer [i.e., AIG] against any Stockholder [e.g., Aggarwal] ․ under this Agreement.

As a result, Aggarwal contends that Upland waived any right to subrogate claims against Aggarwal.

The problem with that argument is two-fold. First, while Section 5.11 sets forth requirements for the insurance policy, it is the policy itself from which AIG derives its subrogation rights. Thus, by relying exclusively on language in the Acquisition Agreement, Aggarwal asserts, at most, a discrepancy between that Agreement and the subject Policy. Second, both the Acquisition Agreement in Section 8.06(d) and the Policy in Section 8(c) make it clear that AIG may pursue claims of fraud against stockholders, notwithstanding limitations on subrogation rights regarding other kinds of claims. Those provisions, as AIG convincingly submits, do not contradict Section 5.11 because AIG has not brought claims pursuant to the Acquisition Agreement (i.e., “under this Agreement”) but rather claims for fraud. See Cmty. Ass'n Underwriters of Am. v. Rhodes Dev. Grp., Inc., 488 F. App'x 547, 549 (3d Cir. 2012) (“the waiver of subrogation clause only applies to [the non-party to the contract] to the extent that it asserts claims arising under that contract”).

ii. Sufficiency of pleadings

Again, as is the case with McColgan, Aggarwal challenges the sufficiency of the pleadings with which AIG has brought its four claims for relief. At the outset, the Court notes that it has already dispensed with two of Aggarwal's arguments because they are the same as those advanced by McColgan, i.e. (1) that AIG may rely only upon written statements in proving its claims for fraud and fraudulent inducement (not so) and (2) that AIG cannot allege that McColgan and Aggarwal aided and abetted each other in torts because both are agents of the same company (again, not so).

Turning to the contentions specific to Aggarwal, he reasons that the claims for fraud and fraudulent inducement must be dismissed because AIG has failed to allege that Aggarwal himself made any false representations to AIG or that he acted with the requisite scienter. Those arguments do not warrant dismissal, however, in light of relatively recent decisions of Delaware state courts extending liability for fraud such that

a selling stockholder may face liability for representations made by the company if the stockholder either (i) knew that the company's representations were false or (ii) lied to the buyer about those representations.

ChyronHego Corp. v. Wight, No. CV 2017-0548-SG, 2018 WL 3642132, at *10 (Del. Ch. July 31, 2018), and cases cited. Thus, in Prairie Cap. III, L.P. v. Double E Holding Corp., 132 A.3d 35, 60 (Del. Ch. 2015), for example, stockholders were held liable for fraud because they were alleged to have known that representations made by the company in which they held stock were false. Based on that development, AIG has pled, with particularity, “facts and circumstances indicating fraudulent intent,” In re Cabletron Sys., Inc., 311 F.3d 11, 29 (1st. Cir. 2002), sufficient to support the allegations that Aggarwal knew Machado misrepresented the relationship between ESPN and Char to Upland. Accordingly, those claims will not be dismissed.

Aggarwal also claims that AIG failed to plead the essential elements of the conspiracy and aiding and abetting. At the motion to dismiss stage, this Court accepts all plausibly alleged facts as true. AIG has plausibly alleged that Aggarwal knowingly worked in concert with McColgan in advance of the call between Machado and Upland to misrepresent the relationship between Char and ESPN with the goal of inflating the price at which Upland would agree to purchase Char. The allegations supporting that narrative include Aggarwal's detailed knowledge of the business relationship between Char and ESPN, as well as the timing and circumstances of the communications among Aggarwal, McColgan and Machado. Accordingly, AIG has sufficiently pled that Aggarwal conspired with, and aided and abetted, McColgan to commit the fraud alleged. See AeroGlobal Cap. Mgmt., LLC v. Cirrus Indus., Inc., 871 A.2d 428, 437 n.8 (Del. 2005) (“The elements for civil conspiracy under Delaware law are: (1) a confederation or combination of two or more persons; (2) an unlawful act done in furtherance of the conspiracy; and (3) actual damage.”); Wavedivision Holdings, LLC v. Highland Cap. Mgmt. L.P., No. CIV.A. 08C-11-132JOH, 2011 WL 5314507, at *17 (Del. Super. Ct. Nov. 2, 2011), aff'd, 49 A.3d 1168 (Del. 2012) (“Liability for aiding and abetting requires proof of three elements: (1) underlying tortious conduct; (2) knowledge; and (3) substantial assistance.”).

ORDER

For the foregoing reasons, defendants’ motions to dismiss (Docket Nos. 38 and 41) are DENIED.

So ordered.

GORTON, United States District Judge