Afp Mfg. Corp. v. Afp Imaging Corp.

AFP MANUFACTURING CORPORATION, Plaintiff, v. AFP IMAGING CORPORATION, BIOWAVEINNOVATIONS, LLC, and R. SCOTT JONES, Defendants.

No. 17-CV-03292 (NSR)

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

FILED: July 6, 2018

July 5, 2018

OPINION & ORDER

NELSON S. ROMÁN, United States District Judge

Plaintiff AFP Manufacturing Corporation ("Plaintiff" or "Manufacturing") commenced this action against Defendants AFP Imaging Corporation ("Imaging"), BioWave Innovations ("BioWave") and R. Scott Jones ("Jones") (collectively the "Defendants") asserting claims sounding in breach of contract, fraud, and unjust enrichment, and seeking attorneys' fees. Before this Court is Defendants' motion to dismiss Plaintiff's Complaint, pursuant to Federal Rule of Civil Procedure 12(b)(6). For the following reasons, Defendants' motion is GRANTED in part and DENIED in part.

BACKGROUND

I. Facts Alleged

The facts that follow are derived from the Complaint as well as any "documents attached to the complaint as an exhibit or incorporated in it by reference,"¹ and they are accepted as truefor the purposes of this motion. See Carlin v. Davidson Fink LLP, 852 F.3d 207 (2d Cir. 2017). In light of the extensive facts in this case, exclusively those facts that are relevant to this motion are discussed below.

A. The Parties

Plaintiff is a Georgia corporation whose principle owners are Craig and Susan Brummers (hereafter referred to collectively as the "Brummers") (Compl. ¶ 1, ECF No. 1.) Defendant Imaging is a Georgia Corporation founded in 1978 as a manufacturer of x-ray film processing equipment for medical, dental, veterinary, and industrial uses. (Id. ¶ 14.) Jones is the CEO of Imaging and a resident of Connecticut (Id. ¶ 11.) He is also the principal member of BioWave, which is the majority owner of Imaging and is a Connecticut corporation (Id. ¶¶ 10-11, 16.)

In early 2016, the Brummers entered into negotiations with Jones to purchase all of Imaging's assets and, to that end, incorporated Manufacturing to serve as the acquirer of Imaging's assets (Id. ¶¶ 15, 18.)

B. The Asset Purchase Agreement

On June 10, 2016, the parties executed an Asset Purchase Agreement (hereafter, "APA") between Manufacturing, as buyer, and Imaging and BioWave, as sellers. (Id. ¶ 19.) The APA provided that Manufacturing would purchase Imaging's assets effective June 27, 2016 for $1 million, in the form of $850,000 cash at closing and a promissory note for $150,000 payable to Imaging over ten years, with payments to begin 24 months after closing. (Id.) The APA alsoentitled Manufacturing and the Brummers to execute a due diligence review before the sale took effect. (Id. ¶ 20.) In this review, the Brummers considered Imaging's balance sheets, income statements, aging statements for accounts payable and receivable, tax filings, and data detailing Imaging's materials costs, pricing practices, inventory holdings, and other key financial information, which Jones claimed to have taken directly from the company's internal database. (Id. ¶ 21.)

Additionally, Imaging and BioWave provided certain covenants, representations, and warranties in the APA, a number of which are at issue here, including:

a. All information, documents and copies of documents provided to Purchaser pursuant hereto, including those provided in connection with Purchaser's due diligence request, are, to the best of Seller's knowledge and ability to reasonably construct proforma [sic] financials, true, complete and accurate in all material respects;

b. All seller financial statements provided or to be provided to Purchaser in connection with this transaction were prepared consistently from period to period and fairly present, to the best of Seller's knowledge, the financial position and results of operations of Seller's Processor Business;

c. The Purchased Assets include all assets, properties, contracts, permits or other items that are of material importance to the ongoing operation of Seller's Processor Business; and

d. Until the Closing or earlier termination of the [APA], except with the Purchaser's written consent, Seller will conduct its business only in the ordinary course . . . and will not . . . enter into or assume any contractual commitments other than in the ordinary course of business.

(Id. ¶ 22.) Defendants also agreed that Imaging would "cause its corporate name to change within 180 days of closing, or such time as reasonably practicable thereafter, so that it will no longer contain the name 'AFP Imaging' or anything substantially similar." (Id. ¶ 23.)

Finally, the APA contains an express Georgia choice of law provision and entitles the prevailing party to recover its attorneys' fees in all litigation arising from or relating to the APA. (Id. ¶¶ 24, 33.)

C. Defendants' Alleged Breaches of the APA

Manufacturing completed the purchase and took possession of Imaging's assets on June 27, 2016, financing the cash portion of the purchase price by taking out an $850,000 Wells Fargo Veterans loan backed by the U.S. Small Business Administration ("SBA"). (Id. ¶ 25.)

Plaintiff maintains that, after the purchase, it became aware of a number of breaches of the APA by Defendants.

i. False Due Diligence Documentation

First, Plaintiff contends that, in the course of the pre-purchase due diligence review, Defendants provided documentation that was intentionally false in multiple respects in order to induce Plaintiff to enter into the APA. (Id. ¶ 16.) For instance, Defendants represented that Imaging's Materials Cost of Goods Sold ("Materials COGS") amounted to 19.4% of its gross sales. (Id. ¶ 28.) After the sale closed, however, Manufacturing determined that the Materials COGS more closely approximated 38% of Imaging's gross sales. (Id. ¶ 29.) This discrepancy resulted from Defendants' out-of-date materials prices as well as their omission of necessary components from the "Bill of Materials," or the list enumerating the parts that were required to build, and determine the price of, Imaging's products (Id. ¶¶ 30-31.)

Plaintiff further alleges that Defendants' price quotations for some of the parts included in the Bill of Materials were based on massive pre-orders designed to generate bulk discounts that would look appealing in due diligence but would in fact tie up working capital (Id. ¶ 35.) Forexample, Imaging's top-selling product required a component called a "7 Gallon Tank with Lid." (Id. ¶ 36.) Upon taking control of the business, Manufacturing discovered that the price data provided by Defendants for these tanks depended on an order for 480 units even though the company needed only 100 units per year. (Id.) When Manufacturing attempted to reduce the order from a nearly five-year supply (480 tanks) to a six-month supply (50 tanks), the supplier insisted on delivering—and being paid for—all 480 tanks within a six-month period. (Id. ¶ 37.)

Defendants' proforma income statements also misrepresented the sales discounts that Imaging provided its customers—estimating that they amounted to 0.5% of Imaging's annual gross sales. (Id. ¶ 42.) However, a review of Imaging's historical discount data conducted by Manufacturing after the sale revealed that Imaging's discount rate was approximately 23% of its annual gross sales—46 times higher than the rate previously represented by Defendants. (Id. ¶ 42.) Overall, these hidden consumer discounts, along with the aforementioned inconsistencies and undisclosed costs, reduced Manufacturing's net profitability to zero. (Id. ¶ 43.)

ii. Materially Misstated Supplier Payment Terms

Plaintiff also contends that Defendants materially misstated supplier payment terms when they provided an "Aging Summary" for accounts payable, which stated that Imaging "enjoyed generous payment terms from its suppliers." (Id. ¶ 44.) For instance, while the Aging Summary stated that one of Imaging's three largest suppliers, Star-Glo, permitted Imaging "90+ days" to pay each invoice, almost all of Imaging's suppliers (including Star-Glo) required that Imaging pay for each order in advance with cash. (Id. ¶¶ 45-46.)

Moreover, because the parties' non-disclosure agreement barred the Brummers from speaking with Imaging's customers or suppliers before the sale, the Brummers did not discover this material discrepancy in payment terms until after the sale was completed. (Id. ¶ 47.)

iii. Materially Misstated Inventory Levels

Plaintiff further states that Defendants provided intentionally inaccurate balance sheets to Plaintiff in the course of due diligence (Id. ¶¶ 49-51.) After Plaintiff gained control of Defendants' company, however, it found that the actual inventory levels were much lower than the levels included in Defendants' documentation. (Id. ¶ 51.) Additionally, a number of the parts that were in stock were obsolete, which necessitated large write-offs. (Id. ¶ 54.)

iv. Falsified Inventory Recount

When there were repeated inventory shortfalls after the sale, the parties agreed to an inventory recount (Id. ¶ 56.) Following the recount, the new inventory numbers were entered into the company's online tracking system, which corroborated that the total inventory value met the minimum threshold required by the APA. (Id. ¶ 57.) Yet, Manufacturing's supplies continued to fall short of the updated numbers that the physical recount produced. (Id. ¶ 59.) Manufacturing then requested that Imaging provide it with the original document on which the physical inventory had been recorded. (Id. ¶ 60.) Imaging failed to produce the original document, claiming that Jones substituted it with a "cleaned-up" printed document. (Id. ¶ 61.) When Plaintiff asked Jones for the original record, Jones responded that he had misplaced it. (Id. ¶ 62.) As a result, no accurate record of the inventory exists. (Id. ¶ 63.)

v. Data Tampering

Plaintiff additionally contends that Defendants engaged in data tampering following the sale. Among the assets that Manufacturing acquired as part of the sale was a computer server containing...