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Carter v. Urban Service Systems Corp.

United States District Court, District of Columbia

August 13, 2018

RICHARD CARTER et al., Plaintiffs,
v.
URBAN SERVICE SYSTEMS CORPORATION et al., Defendants.

          MEMORANDUM OPINION

          RANDOLPH D. MOSS UNITED STATES DISTRICT JUDGE.

         This case raises the question whether a party to a stock purchase agreement and corresponding promissory note and security agreement may decline to make payments due under those agreements based on a defense of fraudulent inducement, while simultaneously affirming the stock purchase agreement and treating the acquired stock as his own. As explained below, the Court concludes that, at least in the circumstances of this case, he may not do so, and that his remedy for fraudulent inducement lies, if at all, in an action for damages.

         The parties to this action are Plaintiffs Richard and Jonita Carter, who were the sole shareholders in Urban Service Systems Corporation (“Urban Systems”) prior to the transaction at issue, and Defendants Urban Systems and William Keating. In 2016, the Carters decided to retire, and they agreed to sell their interest in Urban Systems to Keating. But because Keating lacked the funds to purchase the company outright, the sale was made, in effect, on credit. Richard Carter returned all of his shares to Urban Systems in exchange for a promise, secured by those shares, that Urban Systems would make monthly payments to him over a period of almost five years, for a total of $1, 032, 246. Jonita Carter also returned most of her shares to Urban Systems on similar terms requiring monthly payments totaling $137, 175, and she sold her remaining shares to Keating in return for a promise, again secured by the corresponding shares, that Keating would pay her $68, 579, plus interest, over a similar period of time. Pursuant to these agreements, Keating would become the sole shareholder in Urban Systems; Urban Systems would pay the Carters the bulk of the purchase price from the company's profits over a period of about five years; and Keating would acquire the company, along with its new debt to the Carters, for $68, 579. In theory, all would gain from the transaction. The Carters would receive $1, 238, 000 for the company, and Keating would acquire the company for a relatively modest upfront amount.

         That theory, however, turned on the assumption that the company would earn a substantial profit on its sole contract, which was with the District of Columbia Water and Sewer Authority (“D.C. Water”). When it failed to do so, the company and Keating stopped making the required payments to the Carters. The Carters, in response, eventually notified Urban Systems and Keating that they were in default under the promissory notes, and the Carters exercised their rights under the security agreements to demand the return of their shares. When Urban Systems and Keating failed to cure their defaults or to return the stock, the Carters commenced this action. Subsequently, they moved for a preliminary injunction, seeking to compel Urban Systems and Keating to return their shares.

         With the agreement of the parties, the Court consolidated Plaintiffs' motion for a preliminary injunction with briefing and argument on summary judgment, set a further briefing schedule, and held a hearing on the consolidated motions. Urban Systems and Keating answered the Carters' motions, and Keating filed counterclaims against the Carters alleging fraudulent inducement and negligent misrepresentation. Neither Urban Systems nor Keating disputes the Carters' allegations of nonpayment of the amounts specified in the payment schedules. They do, however, dispute that Plaintiffs are entitled to relief, arguing that Richard Carter fraudulently induced Keating to enter into the transaction by misrepresenting the profitability of Urban Systems' D.C. Water contract. According to Keating, he is the injured party; neither he nor Urban Systems should be required to return the shares; and the Carters are liable to him for compensatory damages. Finally, Urban Systems and Keating contend that, in any event, the entry of a preliminary injunction or summary judgment is premature because they have not yet had the opportunity to conduct discovery relating to their fraudulent inducement and negligent misrepresentation defenses.

         As explained below, the Court agrees that it is premature to resolve Keating's counterclaims. That does not mean, however, that it is premature to decide whether the Carters are entitled to the return of their shares under the promissory notes and security agreements. Those agreements are clear: The promissory notes are payable “without offset, ” and, in the event of a default, Urban Systems and Keating agreed to return the shares to the Carters. To be sure, fraudulent inducement may, at times, provide a basis for rescinding a contract. But the party asserting fraudulent inducement must elect either to rescind the contract-which, here, would result, among other things, in the return of the shares to the Carters-or to affirm the contract and to sue for damages. Although Keating would like to have it both ways, he is not entitled to do so; he cannot affirm the portion of the contract that grants him ownership of Urban Systems, while disaffirming the portion that requires that he and Urban Systems make monthly payments to the Carters. Having continued to exercise control of Urban Systems to this day, his sole recourse is to return the shares, as required by the agreements, and then, if appropriate, to sue for damages.

         The Court will, accordingly, grant partial summary judgment in favor of Plaintiffs and deny Plaintiffs' motion for a preliminary injunction as moot.

         I. BACKGROUND

         For purposes of resolving Plaintiffs' motion for partial summary judgment, the Court takes “the facts in the record and all reasonable inferences derived therefrom in the light most favorable” to Defendants. Coleman v. Duke, 867 F.3d 204, 209 (D.C. Cir. 2017) (quoting Al-Saffy v. Vilsack, 827 F.3d 85, 89 (D.C. Cir. 2016)).

         A. Negotiations

         Plaintiffs Richard and Jonita Carter are the former owners and operators of Urban Systems, a waste collection, disposal, and processing company. Dkt. 11-18 at 2 (Carter Decl. ¶ 3). In February 2016, Richard Carter (hereinafter “Carter”) proposed to sell Urban Systems to Defendant William Keating, Dkt. 20 at 113-14, who had served as President of the company from 2005 to 2013, id. at 85. Because Keating lacked the capital to purchase the company outright, Carter suggested that Urban Systems fund the bulk of the purchase price from the company's future profits on its contract with D.C. Water. Id. at 114 (“[Carter] said that the [company's] contract would . . . pay the cost of the purchase and still have some profit remaining.”). That contract-known as the Grit Contract-dated back to approximately 2005 and was Urban Systems' sole existing contract (and source of revenue) at the time of the negotiations and sale. Id. at 13, 63-64; Dkt. 14-1 at 1 (Keating Decl. ¶¶ 3-5).

         Under the Grit Contract, Urban Systems disposed of heavy solid materials-or “grit”- removed from wastewater on behalf of D.C. Water. Id. (Keating Decl. ¶ 3); Dkt. 20 at 12-13. The company picked up the grit from D.C. Water's wastewater treatment plant and transported it to a disposal site, and, in return, received a per-ton fee. Dkt. 20 at 74. Given the nature of the contract, however, both the revenue and costs were subject to fluctuation. Id. at 18. Because Urban Systems was paid on a per-ton basis, the revenue varied based on the amount of grit generated each month. Id. at 74. Likewise, Urban Systems' costs-and, in particular, its disposal costs-also varied. Id. at 28. As Eunice Liu, the company's former comptroller, explained, different disposal sites charged different amounts; those that are further away from the District of Columbia charged less for disposal, but travel to those more distant sites resulted in larger transportation costs. See Id. at 95. Urban Systems negotiated separate per-ton disposal rates with the various disposal sites. Id. at 88.

         According to Keating, when Carter proposed in February 2016 that Keating purchase Urban Systems, Carter represented that the Grit Contract would generate sufficient profits to cover the purchase price, while still leaving some return for Keating. Id. at 114; Dkt. 14-1 at 1 (Keating Decl. ¶ 5) (“Mr. Carter represented to me that he would submit . . . a bid for the [c]ontract at sufficient profit margins to enable the [c]ompany to pay him approximately $1 million in monthly increments of approximately $20, 000 over a period of approximately five years.”). Carter backed this representation up with a spreadsheet, which he asked Liu to send to Keating, “reflect[ing] the expenses and . . . [profit] margins associated with servicing the [c]ontract.” Id. at 2 (Keating Decl. ¶ 11). The spreadsheet, which is captioned “Grit Hauling Cost Proposal, ” includes a separate page for each of the five years of the contract. See Dkt. 17-1. Each page includes a series of costs, including driver wages, payroll taxes, fringe benefits, fuel, registration, insurance, repairs, and maintenance. Dkt. 17-1 at 2-6. Most significantly, the spreadsheet reflects the proposed weekly, monthly, and annual disposal costs at an initial rate of $18.50 per ton and growing by approximately 3% each year of the contract. Id.; Dkt. 20 at 28. The projected disposal cost was, by far, the largest cost included in the spreadsheet, and the profitability of the contract turned on managing that significant cost. See Dkt. 17-1 at 2-6; Dkt. 20 at 28 (“Th[e] [landfill rate] is the single most [important] line item in bidding this contract in order for it to be profitable.”); id. at 93 (explaining that the $18.50 per ton landfill rate indicated that “th[e] contract [would] be very profitable”). Notably, the spreadsheet also projected that an alternative disposal site would charge $55.00 per ton, Dkt. 17-1 at 2-4, and Carter conceded in his testimony that the Grit Contract would be a losing proposition at that rate, Dkt. 20 at 77. The spreadsheet, however, projected that all of the grit would go to the less expensive site, known as the King & Queen Landfill. See Dkt. 17-1 at 2-6; Dkt. 20 at 77, 123.

         Carter and Keating had several follow-up meetings at which they negotiated the terms of the sale. During one meeting in March 2016, Keating presented Carter with his own spreadsheet of projected costs and revenue, which “reflected [the profit] margins [from] the spreadsheet Mr. Carter had Eunice Liu send to [Keating], along with additional details and assumptions, ” and Keating “asked [Carter] to confirm . . . the accuracy of the cost assumptions and revenue margins.” Dkt. 14-1 at 3 (Keating Decl. ¶¶ 15-16). In their conversations about that spreadsheet, Carter did not “at any point tell” Keating “that the costs that he assumed . . . were inaccurate.” Dkt. 20 at 71. By April 2016, Carter and Keating reached an agreement for the sale of Urban Systems. Dkt. 11-18 at 3 (Carter Decl. ¶ 4).

         B. Agreements

         The sale of Urban Systems was accomplished through a series of agreements. The first agreement-the Stock Purchase and Redemption Agreement (“Purchase Agreement”)-set forth the overall structure and terms of the transaction. Dkt. 11-3. Under that agreement, Urban Systems redeemed all of Richard Carter's shares in exchange for a promise to pay him $1, 032, 246, and it redeemed roughly two-thirds of Jonita Carter's shares in exchange for a promise to pay her $137, 175. Id. at 3. Keating, in turn, agreed to purchase Jonita's remaining shares, representing all of the outstanding post-acquisition shares of the company, in exchange for a promise to pay her an additional $68, 579. Id. at 2-4. To ensure payment of the agreed-upon amounts, Urban Systems further agreed to execute a note promising to pay Richard Carter the principal amount of $1, 032, 246, and to execute a second note promising to pay Jonita Carter the principal amount of $137, 175. Id. at 3. The company also agreed to grant the Carters security interests in their respective redeemed shares as collateral for those payments and to enter into corresponding security agreements. Id. at 3-4. Keating, likewise, agreed to enter a note promising to pay Jonita Carter the principal amount of $68, 579, to grant her a security interest in the shares he acquired under the agreement, and to enter into a corresponding security agreement. Id. at 3.

         The Purchase Agreement also specified the source of funding for the amounts payable under the promissory notes and provided a further guarantee of payment. Recognizing that the Grit Contract was the company's sole source of revenue, the agreement specified that the payments due under the promissory notes would come from the revenue generated by the Grit Contract and that Urban Systems would establish an escrow account “with its primary banking institution to ensure that the appropriate amount of payments under the [Grit] contract [were] deposited into a separate account for [the Carters] to cover the [p]romissory [n]ote [p]ayments.” Id. at 4. Finally, the parties also included an integration clause in the Purchase Agreement specifying that “all of the promises, agreements, conditions, understandings, covenants, warranties and representations among the parties” were reflected in the agreement to the exclusion of any “prior agreements or understandings.” Id. at 8. The parties entered into a separate agreement establishing the escrow account and requiring Urban Systems to deposit “approximately $900, 000” into the account annually. Dkt. 11-13; see also Dkt. 11-18 at 5 (Carter Decl. ¶ 17).

         Each of the three promissory notes (“Promissory Notes”) took a similar form. Under the first, Urban Systems agreed to pay Richard Carter $1, 032, 246 plus interest, Dkt. 11-4 at 2; under the second, Urban Systems agreed to pay Jonita Carter $137, 175 plus interest, Dkt. 11-5 at 2; and under the third, Keating promised to pay Jonita Carter $68, 579 plus interest, Dkt. 11-6 at 2. Each provided for 58 consecutive monthly payments of principal and interest; each further reflected the same security interests granted in the Purchase Agreement; each included an acceleration clause in case of default; and each included the following language:

This Note is payable without offset, and is subject to no other terms, conditions, defenses or offsets. No. setoffs or counterclaims shall be asserted or brought by the Maker or any other party at any time liable hereunder in any suit or action for the collection of any sum due hereunder.

Dkt. 11-4 at 2, 4; Dkt. 11-5 at 2, 4; Dkt. 11-6 at 2, 4. An amortization schedule, reflecting the required payments of principal and interest, was attached to each note. Dkt. 11-4 at 6-8; Dkt. 11-5 at 6-8; Dkt. 11-6 at 6-8. The parties later agreed to modify the amortization schedules in minor respects. See Dkt. 11-7; Dkt. 11-8; Dkt. 11-9.

         The three security agreements (“Security Agreements”) also took a similar form. Under the first, Urban Systems granted Richard Carter a security interest in the shares the company redeemed from him and specified that, “[i]n the event of [d]efault, ” the company would “issue to [Richard Carter] the 59, 951 shares of” the company's stock. Dkt. 11-10 at 2. Under the second, Urban Systems granted Jonita Carter a security interest in the shares it redeemed from her and specified that, “[i]n the event of [d]efault, ” the company would “issue to [Jonita Carter] 7, 967 shares of” the company's stock. Dkt. 11-11 at 2. And, under the third, Keating granted Jonita Carter a security interest in (1) the shares that she transferred to him, (2) “all earnings attributable to th[ose] shares, ” and (3) “all proceeds attributable to the [s]hares.” Dkt. 11-12 at 2.

         C. Post-Agreement Events

         The parties anticipated that the profits Urban Systems would earn on the Grit Contract would be sufficient to pay the Carters the amounts due under the agreements described above. According to Keating, however, that expectation-and, in Keating's view, Carter's representations about the profitability of the contract-did not meet with reality. The parties differ about why this came to pass, but, for purposes of the Carters' motion for summary judgment, the Court must accept Keating's version of events. He points to a variety of factors.

         First, Keating asserts that the wage, payroll tax, and employee benefit cost projections set forth in the spreadsheet that Carter gave him were inaccurate because they accounted for only one driver, even though “[i]t t[ook] two to three people to make the contract work to the satisfaction of D.C. Water.” Dkt. 20 at 119. Previously, Carter had used personnel from his other company, Carter & Carter Inc., to “supervis[e] and assist[] on the Urban contract, ” but that labor cost was not reported in the spreadsheet. Id. at 144. Keating testified that he needed to spend “double” the amount projected in the spreadsheet on wages-about $140, 000 in wages per year-in addition to incurring increased payroll taxes and benefits. Id. at 120-21.

         Second, Keating contends that delivering the services required under the Grit Contract required more equipment than the company owned, resulting in additional expenses that were not included in the spreadsheet. When Keating acquired Urban Systems, it owned one vehicle, but, according to Keating, the company needed two vehicles to deliver the required services-“one that's running” and “one as a backup.” Id. at 121-22; see also Id. at 143 (“We needed additional equipment, because the equipment we had wasn't sufficient to do the job.”). This, in turn, raised the company's insurance costs. Id. at 121-22. The equipment that Urban Systems did have, moreover, was ...


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