In re Hexo Corp. Sec. Litig.

524 F.Supp.3d 283

IN RE HEXO CORP. SECURITIES LITIGATION

19 Civ. 10965 (NRB)

United States District Court, S.D. New York.

Signed March 8, 2021

MEMORANDUM AND ORDER

NAOMI REICE BUCHWALD, UNITED STATES DISTRICT JUDGE

Before the Court is defendants’ joint motion to dismiss plaintiffs’ First Amended Class Action Complaint ("FAC"). ECF No. 96. In the FAC, lead plaintiffs Timothy Sweeney and John Medley ("plaintiffs") bring claims under Sections 11, 12(a)(2), and 15 of the 1933 Securities Act ("Securities Act"), Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 ("Exchange Act"), and Rule 10b-5 as promulgated under the Exchange Act.

Plaintiffs are a putative class of individuals and entities that purchased or otherwise acquired HEXO securities between January 23, 2019 and March 30, 2020 (the "Class Period") on the New York Stock Exchange ("NYSE") or the NYSE American exchange, including through or traceable to HEXO's initial public offering ("IPO") on January 25, 2019. Plaintiffs’ claims are asserted against each defendant as follows:

Defendant(s) Role1 Securities Exchange Defined Terms Applicable to
Act Act Defendants
Claim(s) Claim(s)
Asserted Asserted
  HEXO Corp.       Corporation         Sections       Section      Securities Act Defendant
  ("HEXO")                             11,            10(b)
                                       12(a)(2),      and Rule     Exchange Act Defendant2 15             10b-5
  Sebastian        HEXO's              Sections       Section      Securities Act Individual
  St. Louis        president, CEO,     11,            10(b)        Defendant
                   director, and       12(a)(2),      and Rule
                   co-founder          15             10b-5;       Securities Act Defendant
                                                      Section
                                                      20(a)        Exchange Act Individual
                                                                   Defendant
                                                                   Exchange Act Defendant
  Adam Miron       Co-founder and      Sections                    Securities Act Individual
                   HEXO director       11,                         Defendant
                   until July 18,      12(a)(2)
                   2019                15                          Securities Act Defendant
  Michael          HEXO director       Sections                    Securities Act Individual
  Munzar           and chairman        11,                         Defendant
                                       12(a)(2)
                                       15                          Securities Act Defendant
  Jason Ewart      HEXO director       Sections                    Securities Act Individual
                                       11,                         Defendant
                                       12(a)(2)
                                       15                          Securities Act Defendant
  Vincent          HEXO director       Sections                    Securities Act Individual
  Chiara                               11,                         Defendant
                                       12(a)(2)
                                       15                          Securities Act Defendant
  Nathalie         HEXO director       Sections                    Securities Act Individual
  Bourque          until February      11,                         Defendant
                   6, 2020             12(a)(2)
                                       15                          Securities Act Defendant
  Ed Chaplin       HEXO's CFO          Sections       Section      Securities Act Individual
                   until April 30,     11,            10(b)        Defendant
                   2019                12(a)(2),      and Rule
                                       15             10b-5,       Securities Act Defendant
                                                      Section
                                                      20(a)        Exchange Act Individual
                                                                   Defendant
                                                                   Exchange Act Defendant
  Steve            Vice President,                    Section      Exchange Act Individual
  Burwash          Strategic                          10(b)        Defendant
                   Finance; HEXO's                    and Rule
                   interim CFO,                       10b-5;       Exchange Act Defendant
                   May 1-28, 2019;                    Section
                   CFO, Oct. 5,                       20(a)
                   2019 through
                   Class Period
  Michael          HEXO's CFO from                    Section      Exchange Act Individual
  Monahan          May 28 —                           10(b)        Defendant
                   October 4, 2019                    and Rule
                                                      10b-5,       Exchange Act Defendant
                                                      Section
                                                      20(a)
  Underwriter                          Sections                    Securities Act Defendants
  Defendants3 11,
                                       12(a)(2)

[Editor's Note: The preceding image contains the references for footnotes^{1 ,2 ,3} ].

For the reasons set forth below, the Court grants defendants’ motion to dismiss in its entirety.

I. Background ⁴

This lawsuit arises from HEXO's collapse during the year-and-a-half following Canada's legalization of adult-use recreational cannabis on October 17, 2018 ("Legalization"). HEXO, a Quebec-based cannabis supplier, FAC ¶¶ 1, 81, anticipated that the Legalization would create a new market and increase demand for its products, and engaged in a number of actions in order to capitalize on the anticipated growth in demand. First, HEXO entered into supply agreements with major Canadian cannabis dispensaries, including Quebec's government-run dispensary, Société Québécoise du Canabis (the "SQDC"). The "SQDC Agreement," entered into between HEXO and the SQDC, contained a "take-or-pay" provision, which provided that the SQDC would either order or pay for a certain amount of product from HEXO in the first year following Legalization. Second, between December 2018 and January 2019, HEXO circulated a registration statement and a prospectus, and in January 2019, conducted an IPO. Third, HEXO invested in new greenhouse facilities in order to meet the anticipated growth in demand by acquiring Newstrike, another cannabis company.

Unfortunately for HEXO, demand for cannabis — in particular, by the SQDC — fell far short of expectations, and this was reflected in HEXO's performance. Following a series of setbacks suffered by HEXO, plaintiffs brought this suit, asserting Securities Act and Exchange Act claims against HEXO, individual directors and officers of HEXO, and underwriters of the IPO. Central to plaintiffs’ federal securities claims are (a) the SQDC Agreement; (b) HEXO's offering prospectus; and (c) HEXO's acquisition of Newstrike, each of which are described in greater detail below.

A. October 2018: SQDC Agreement

Canada legalized adult-use recreational cannabis on October 17, 2018. FAC ¶ 86. In Quebec, the recreational cannabis market is controlled by the government-run cannabis dispensary, the SQDC. On April 11, 2018, in anticipation of the increased demand for its product following Legalization, HEXO entered into a five-year supply agreement with the SQDC, the SQDC Agreement, to become the preferred supplier of the SQDC, which had an option to renew for a sixth year.⁵ FAC ¶¶ 13, 82.

The SQDC Agreement provided, in relevant part, that the SQDC would purchase from HEXO 20,000 kilograms of cannabis during the first year after Legalization, i.e., October 17, 2018 through October 17, 2019 ("Purchase Obligation"). FAC ¶¶ 13, 84. This provision was subject to a "take-or-pay ("ToP") feature," which allows a supplier to collect payment even if the purchaser does not fulfill its contractual purchase obligation. Declaration of Todd Batson ("Batson Decl."), ECF No. 115, Ex. 4 at 16.⁶ Based on the Purchase Obligation, using a price of $5.45⁷ per gram – the price for cannabis at the time — plaintiffs estimate that the SQDC Agreement should have generated over $100 million in revenues for HEXO in the first year following Legalization. FAC ¶¶ 13, 86. Per the SQDC Agreement, in the second and third years that cannabis was legal, the SQDC was expected to purchase from HEXO volumes of 35,000 kilograms and 45,000 kilograms respectively (however the second and third years were not governed by a ToP provision). FAC ¶¶ 13, 84. Purchase volumes for the final two years of the contract would be based on the volumes in the first three years. FAC ¶¶ 13, 84.

B. December 2018 - January 2019: Initial Public Offering & Prospectus

Two months after Legalization, on December 20, 2018, in anticipation of its IPO, HEXO filed a Registration Statement on Form F-10⁸ with the SEC (the "Registration Statement"), which was signed by the Securities Act Individual Defendants. FAC ¶ 90. The Registration Statement registered $600 million worth of HEXO shares for trading on the Toronto Stock Exchange and NYSE American Exchange. Id.

On January 25, 2019, HEXO filed a prospectus with the SEC (the "Prospectus"), which incorporated the Registration Statement, and which stated that HEXO would conduct an IPO of 7.7 million shares (which ultimately amounted to 8.8 million shares including the underwriters’ over-allotment). FAC ¶¶ 15, 92. The shares were to be listed in the United States on the NYSE American exchange at $5.15 per share. FAC ¶ 15.⁹ The IPO was underwritten by the Underwriter Defendants. FAC ¶ 184.

The Prospectus described the SQDC Agreement, providing details about the SQDC's...