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Pet Quarters, Inc. v. Badian

March 30, 2007



I. Introduction

Before the Court is defendants Markham Holdings Limited's and James David Hassan's Motion to Dismiss (doc. #85). Plaintiff Pet Quarters, Inc., has responded and opposes the Motion. For the reasons set forth below, the motion is GRANTED IN PART AND DENIED IN PART.

II. Background

Pet Quarters is a corporation organized and existing under the laws of the State of Arkansas, with its principal place of business in Arkansas. Pet Quarters supplies pet food and other pet supplies to consumers and professionals through the Internet and mail order catalogs.

In early 1999, Pet Quarters began to look for capital funding sources to help aid in the growth of its business.*fn1

During this search, Pet Quarters was introduced to defendant Ladenburg Thalmann and Company, a capital investment firm. Following a series of conversations and referrals, Ladenburg introduced Pet Quarters to defendant Thomas Badian. Pet Quarters eventually entered into three financing arrangements with Badian and his investment companies.

On February 23, 2000, Pet Quarters entered into a common stock and warrants purchase agreement ("the Agreement") with Amro International ("Amro") and Markham Holdings Limited ("Markham"), both Badian investors. Under the Agreement, Pet Quarters sold 619,047 shares of its common stock to Amro and 95,238 shares to Markham, for a total of less than $1.5 million. The Agreement contained repricing provisions under which Amro and Markham could demand additional shares of stock in the event the share price fell over a defined period of time.*fn2 Hassan signed the Agreement on behalf of Markham.

On March 15, 2000, Pet Quarters entered into an equity line of credit with Splendid Rock Holdings ("Splendid Rock"), another Badian investor. Pet Quarters could periodically draw on the line of credit in exchange for shares of common stock, issued at a discount to market price.

On May 2, 2000, Pet Quarters entered into a loan agreement with Amro in the amount of $1 million. The loan was made subject to the terms and conditions of a convertible debenture, which allowed Amro to convert any outstanding principal into shares of Pet Quarters' common stock after a certain period of time. By March 2001, Pet Quarters' stock was trading at pennies per share, down from a high of more than six dollars on September 1, 1999.

On July 21, 2004, Pet Quarters filed this action against thirteen named defendants, alleging their involvement in a scheme to defraud Pet Quarters and to manipulate downward the price of its securities in violation of federal and state laws. In general, Pet Quarters alleges that the defendants are seasoned practioners of a "death spiral" funding scheme in which they provide financing to a target company and proceed to aggressively short-sell its stock in the hope that such short sales will drive down the price of the target company's securities. Pet Quarters accuses Markham and Hassan of participating in this "death spiral" scheme to manipulate the price of Pet Quarters' stock.

The Complaint sets forth nine claims against both defendants: (1) violation of § 10 of the Securities Exchange Act of 1934 and SEC Rule 10b-5 (Counts I & II), (2) violation of sections 23-42-507 and 23-42-508 of the Arkansas Code Annotated (Count III), (3) common law fraud (Count IV), (4) aiding and abetting breach of fiduciary duty (Count VI), (5) prima facie tort (Count VII), (6) constructive fraud (Count IX), (7) civil conspiracy (Count XII), (8) tortious interference with contracts (Count XIII), and (9) disgorgement and restitution under the Exchange Act (Count XVI). The Complaint sets forth one claim against Markham for negligent misrepresentation (Count XV). In addition, the Complaint sets forth a claim against Hassan for control person liability under § 20A of the Exchange Act (Count XIV). Markham and Hassan move to dismiss the Complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure for failure to state a claim, under Rule 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA") for failure to plead fraud with sufficient particularity, and under Rule 12(b)(2) for lack of personal jurisdiction over Hassan.*fn3

III. Discussion

A. Standard of Review

When considering a motion to dismiss under Rule 12(b)(6), the Court must assume that all facts alleged in the complaint are true and construe the complaint in a light most favorable to the plaintiff. Coleman v. Watt, 40 F.3d 255, 258 (8th Cir. 1994). The court should grant the motion only if the plaintiff can prove no set of facts that would entitle them to relief. Id. However, the court is free to reject "legal conclusions, unsupported conclusions, unwarranted inferences and sweeping legal conclusions cast in the form of factual allegations." Varner v. Peterson Farms, 371 F.3d 1011, 1015 (8th Cir. 2004).

Rule 9(b) of the Federal Rules of Civil Procedure provides a heightened standard of pleading when a plaintiff alleges fraud or mistake. "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed. R. Civ. P. 9(b). Conclusory allegations that a defendant's conduct was fraudulent and deceptive are insufficient to satisfy Rule 9(b). Commercial Prop. Investments, Inc. v. Quality Inns Intern., Inc., 61 F.3d 639, 644 (8th Cir. 1995).

B. Personal Jurisdiction Over Hassan

The Court must first address Hassan's personal jurisdiction argument. Hassan argues he does not have sufficient contacts with the United States to establish personal jurisdiction over him. In order to survive a motion to dismiss for lack of personal jurisdiction, the plaintiff must make a prima facie showing that the Court has personal jurisdiction over the defendant. Epps v. Stewart Info. Services Corp., 327 F.3d 642, 647 (8th Cir. 2003). The plaintiff bears the burden of proof of whether jurisdiction exists. Id. The Court must view the evidence in a light most favorable to the plaintiff and resolve all factual conflicts in favor of the plaintiff. Digi-Tel Holdings, Inc. v. Proteq Telecomm., Ltd., 89 F.3d 519, 522 (8th Cir. 1996).

The parties seem to combine their personal jurisdiction analysis with a control person analysis, suggesting that if the Court concludes Hassan is a control person the Court has jurisdiction over him. Although not cited by either party, this analysis is similar to San Mateo County Transit Dist. v. Dearman, Fitzgerald & Roberts, Inc., 979 F.2d 1356 (9th Cir. 1992). In that case, the court held that personal jurisdiction exists if "the ...

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