Law360 Covers Shareholder Dilution Lawsuit in Delaware

Law360 Covers Shareholder Dilution Lawsuit in Delaware

By Darcy Reddan, Law360, Friday, May 18, 2018 – The co-founder and an early investor of Energy Efficient Equity Inc., a company that provides financing for energy and water savings home improvements, have filed a suit against a venture capital fund and its officers alleging the company used a $5 million loan to push them out, according a complaint made public Friday in Delaware state court.

E3 co-founder Jonathan Urdan and William Woodward, an investor who contributed $790,000 to launch the company, allege venture capital firm WR Capital Partners LLC, WR E3 Holdings LLC and key administrators Henri Talerman, Frank E. Walsh III and Bradley D. Kynal engaged in a scheme in which a $5 million revolving credit facility was extended to E3 that ultimately diluted their shares and pushed them out of the company.

“WR Capital was secretly plotting to dilute plaintiffs and take over their company. Had they known its true intent, plaintiffs never would have done business with WR Capital,” the complaint states.

According to the complaint, the May 2016 transaction saw E3 receive the $5 million credit facility in exchange for repayment at 10 percent interest per year, with Urdan and Woodward pledging their own stock and notes as collateral, shares of series B preferred stock and a large block of warrants that could be converted to stock, as well as veto rights over corporate transactions with specific penalties in the event E3 defaults on the loan.

Urdan and Woodward allege that the structure of the deal meant that the more E3 drew from the credit facility, the more warrants — equity — WR Capital would acquire. The loan also included an option for WR Capital to extend an additional $3 million in exchange for 379,034 warrants, equaling 3 percent ownership of E3.

The complaint alleges that following the deal, Urdan and Woodward became aware the company would need more capital than the loan provided and began seeking new investors.

In early 2017, a larger company sought to buy E3 for $15 million, four times the amount invested so far. WR Capital exercised its right under the lending agreement and vetoed the transaction, which the complaint labels as a deliberate effort to “starve E3 so it could acquire more ownership of the company when it was desperate and had no other options, then sell the company.”

As WR Capital increased its control, the complaint alleges that it terminated CEO and co-founder Kevin Kurka without complying with E3 bylaws.

WR Capital then selected Bradley D. Kynal as the new CEO, a move Urdan and Woodward contend it did not have the power to do. The complaint identifies Kynal as Walsh’s golfing partner and notes that he was given 12 percent equity.

By June 2017, WR Capital held 35 percent of E3 stock and had half of the board seats after Kurka’s termination. Combined with Kynal’s ownership stake, WR Capital held nearly half of the company’s stock, according to the complaint.

Urdan and Woodward allege that WR Capital then used the termination of Kurka as a way to threaten to call an event of default under the loan agreement, pushing for the deal to be renegotiated.

The renegotiated deal saw WR Capital exercise its $3 million option in exchange for majority control of the board and millions of new warrants, notably 8,524,478 warrants for the same credit extension that originally called for 379,034 under the original deal.

The complaint says this conduct is “a textbook case of self-dealing,” noting the firm did not look for other investors that may have provided more appropriate valuation for the equity.

The complaint goes on to allege that WR Capital captured more equity through a bridge to the loan in 2018 that called for a $2.5 million credit facility to be issued that secured millions of additional shares for the defendants.

The complaint redacts the majority of the conduct relating to the bridge but notes that the transaction was a lopsided exchange that saw millions of shares distributed despite only $500,000 being provided upfront.

Urdan and Woodward seek damages believed to be in excess of $10 million for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, fraudulent inducement, fraudulent concealment, breach of contract, unjust enrichment and breach of implied covenant of good faith and fair dealing.

“This case is about the abuse of minority shareholders and we look forward to our day in court,” Daniel S. Miller, counsel for Urdan and Woodward, told Law360 on Friday.

Representatives for WR Capital declined to comment on Friday.

The plaintiffs are represented by Elena C. Norman and Benjamin M. Potts of Young Conaway Stargatt & Taylor LLP and Louis R. Miller, Daniel S. Miller and Jeffery B. White of Miller Barondess LLP.

Counsel information for the defendants was not immediately available Friday.

The case is Urdan et al. v. WR Capital Partners LLC et al., case number 2018-0343-TMR, in the Court of Chancery of the State of Delaware.