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THAYER/PATRICOF EDUCATION FUNDING, L.L.C. v. PRYOR RESOURCES

April 23, 2002

THAYER/PATRICOF EDUCATION FUNDING, L.L.C., AND THAYER/PATRICOF EDUCATION HOLDINGS, L.L.C. PLAINTIFFS,
V.
PRYOR RESOURCES, INC., FRED H. PRYOR, PHILIP R. LOVE, AND MICHAEL B. HAYS, DEFENDANTS.



The opinion of the court was delivered by: John D. Bates, United States District Court Judge.

    MEMORANDUM OPINION
Thayer/Patricof Education Holdings, L.L.C. and Thayer/Patricof Education Funding, L.L.C. (collectively "Thayer") bring this action raising claims of breach of contract, misrepresentation, fraud, and federal and state securities violations in connection with the purchase of 80 percent of the stock of defendant Pryor Resources, Inc. ("Pryor Resources" or "the Company"). Thayer purchased the controlling share of the Company from defendants Fred H. Pryor, Philip R. Love, and Michael B. Hays ("defendants") through a Recapitalization Agreement ("the Agreement") executed on January 25, 1999 at Thayer's offices in Washington, D.C. The individual defendants are three former owners and directors of the Company who, after the sale, still retained a 20 percent stake in the Company's stock.*fn1
In early 2001, the former controller of the Company allegedly confessed that he had been forcing entries in the Company's books. Thayer entered discussions with the defendants to determine the extent of financial problems with the Company, and eventually threatened suit. After settlement negotiations broke down, on July 3, 2002, Thayer sent a notice of intent to sue defendants and the Company for indemnification pursuant to the Recapitalization Agreement. Complaint at ¶ 56. Hours later, defendants filed suit in the United States District Court for the District of Kansas, claiming that Thayer breached the Recapitalization Agreement by attempting to circumvent the remedies provision in it. The Kansas action challenges Thayer's right to issue the claim letters, seeks to limit Thayer's recovery, and attacks Thayer's theories of recovery.
This action commenced two weeks later. Thayer claims that the defendants "cooked the Company's books" and "forced" accounting entries in its general ledger in an effort to inflate the value of the company prior to the sale to Thayer. Complaint at ¶¶ 2, 17-18. Thayer alleges that this "scheme was undertaken with the knowledge, consent, and participation of Defendants Pryor, Love, and Hays by, at a minimum, their willful and reckless blindness to the fraud. . . ." Id. at ¶ 21. Thayer seeks rescission of the Agreement, restitution of an alleged $100 million loss from the purchase of the Company, and punitive damages.

BACKGROUND

Pryor Resources, located in Overland Park, Kansas, conducts educational and career training seminars throughout the country built around the well-known Fred Pryor Seminars, and also publishes related catalogues, books, tapes, and various electronic and e-commerce media. Complaint at ¶¶ 13-14. Before the sale to Thayer, Fred Pryor was the Chairman of the Board, Philip Love was President and Chief Executive Officer, and Michael Hays was Vice-President of the Company. Love Affidavit at ¶ 3. In the fall of 1998, at the height of the Internet boom, Thayer began considering an investment in the Company. Complaint at ¶ 34. Before the sale, defendants Pryor, Love, and Hays owned all of the shares of capitol stock in the Company. Id. at ¶ 35. Pryor and Love both live in Kansas City, Missouri, and Hays lives in the Kansas suburbs of Kansas City. Id. at ¶¶ 10-12.
Thayer is a venture capital group incorporated in Delaware and located in Washington, D.C. Id. at ¶ 8. Several Thayer directors live in Washington, including Jeffrey Goodman, Christopher Temple, and Frederick Malek; two Thayer directors, George Jenkins and Salem Schuckman, live in Pennsylvania and New York, respectively. See Defendants' Motion, Ex. 6.
On January 25, 1999, Thayer and the defendants executed the Recapitalization Agreement with Thayer purchasing 717 shares of the Company stock for $65,805,514. Agreement at p. 1, B. Thayer also assumed most of the company's liabilities, thus providing an overall total investment of more than $83 million in exchange for roughly 80 percent of the Company. Complaint at ¶ 4. The purchase gave Thayer control of the Board of Directors, leaving Pryor, Love, and Hays as minority shareholders. The Agreement was signed and executed in a closing at Thayer's offices in Washington, D.C. where $80 million in cash and securities was exchanged for the Company's stock. Temple Declaration at ¶ 3. The sale was thus negotiated, consummated and finalized in Washington.
Thayer retained Ernst & Young to perform a due diligence review of the Company's financial accounts and to certify the working capital; that was done from November 1998 through January 1999. Love Aff. at ¶ 19. Thayer claims that defendants warranted that the Company's finances were complete and accurate, and that in making the purchase it relied on representations defendants made during the negotiation and sale of the Company and on the 1996 and 1997 financial statements attached to the Recapitalization Agreement.*fn2 Thayer claims that those representations were false and that the defendants "walked out of Washington with $80 million based on their misrepresentations." Plaintiffs' Opposition at 7. Thayer alleges that, as directors and officers of the Company, defendants either intentionally misrepresented the Company's value or were grossly negligent in allowing such representations to be made.
After closing on the sale, Thayer again hired Ernst & Young to complete a final audit of the new Company's assets and liabilities, and to prepare an Audited Closing Balance Sheet. This audit did not find any discrepancies in the Company's finances. Since the purchase, Thayer has been in control of the Company, making the day-to-day decisions.
On February 26, 2001 — more than two years after the sale of the Company to Thayer — Michael Biritz, the Company's controller, allegedly informed the Company's chief financial officer, Jim Anderson, that from 1996 through 2000 he had been "forcing" entries on the Company's general ledger because information from the Company's proprietary seminar registration software system failed to balance. See Defendants' Motion, Ex. 3 ("2/28/01 Conversation with Mike Biritz"). Four audits had failed to detect these financial problems, two by Ernst & Young after Thayer purchased the Company and two by Baird, Kurtz & Dobson ("BKD"), the local accounting firm that audited the Company's financial statements in 1996 and 1997. Redler Affidavit at ¶ 6.*fn3
Thayer conducted a lengthy investigation in the spring of 2001 after Biritz came forward, although defendants claim that the investigation failed to uncover any fraud by them. On March 29, 2001, Thayer sent defendants a demand letter seeking indemnification. Thayer claimed in the letter that the Company's financial statements grossly overstated amounts for prepaid expenses and profitability, understated tax liabilities, and thus did not fairly represent the true financial position of the Company.
On June 27, 2001, counsel for defendants sent a letter to Thayer's counsel offering a $5 million settlement. On July 3, 2001, Thayer faxed a letter to defendants rejecting the offer as grossly inadequate, and stating that the requisite notice under the Agreement had been provided and Thayer was ready to sue. Later that afternoon, defendants filed their complaint in the District of Kansas. See Fred Pryor, et al. v. Thayer/Patricof Education Holdings, L.L.C., et al., 01-CV-2327-GTV (D.Kan.) (hereinafter "Kansas Complaint"). Thayer filed this suit two weeks later on July 18, 2001. The Complaint in this Court alleges that the 1996, 1997, and 1998 financial statements did not represent the true financial health of the Company. Complaint at ¶¶ 29-31. Thayer claims that the financial statements overstated prepaid postage assets by more than $21 million. Id. at ¶ 44. Thayer alleges that defendants conducted a scheme to overstate earnings before interest, taxes, depreciation and amortization ("EBITDA"), and that the Company overstated its revenues by $11.2 million and overstated EBITDA by 100 percent. Id. at ¶¶ 29-31. According to Thayer, the Company's overall net worth from 1996 through 1998 was misstated by more than $23 million. Id. at ¶ 33.
Defendants seek declaratory judgments to limit damages to $15 million and to declare that Thayer breached a number of provisions in the Agreement. Id. at ¶¶ 66-71. They also seek recovery of $2 million they invested in the Company after Thayer took over, allegedly in reliance on Thayer and Ernst & Young's audits for 1999 and 2000. Id. at ¶¶ 35-37. Defendants claim that their investment has been lost, and that Thayer and its directors breached their fiduciary duty to defendants, the minority shareholders.

ANALYSIS

I. Defendants' Motion to Dismiss

Defendants raise three issues supporting either dismissal or transfer. The heart of their argument is the request to transfer this case to Kansas, which is addressed in Section II below. Defendants also move to dismiss for improper venue and failure to join indispensable parties. The Court will address those issues first.

Defendants claim that the District of Columbia is not the proper venue for this action, arguing that most of the operative events giving rise to Thayer's claims did not occur here. Under 28 U.S.C. § 1391(b)(2), however, venue is proper in any "judicial district in which a substantial part of the events or omissions giving rise to the claim occurred." While defendants correctly assert that the financial statements were prepared and audited in Kansas, and that many of the witnesses and documents are in Kansas, it nonetheless remains the case that the parties negotiated the purchase in the District of Columbia, the defendants made essential oral and written representations here, the parties signed and executed the Recapitalization Agreement at issue here, and the exchange of cash and securities for Company stock occurred here. Thayer's Complaint is, at its core, based on the negotiation and execution of the Agreement, which occurred in the District of Columbia. It is impossible, therefore, to avoid the conclusion that a "substantial part" of the relevant events occurred here.
Moreover, Thayer correctly notes that four of the 17 counts asserted in its Complaint are brought pursuant to the Securities Exchange Act of 1934. Under that Act's liberal venue provision, an action may be brought in any district where one or more violations of the Act occurred, as well as in the district where the defendant is found, or in any district where the defendant has transacted business. 15 U.S.C. § 78aa; see also Poling v. Farrah, 131 F. Supp.2d 191, 193 (D.D.C. 2001) (venue proper not only in the district where the defendant is found or transacts business, but in any district where the transaction constituting the violation occurred; a non-resident defendant's phone calls into the District of Columbia ...

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