United States District Court, D. New Jersey
KEVIN McNULTY, District Judge.
This matter comes before the Court upon the motion of Plaintiff William Klawonn (Docket No. 88) to Set Aside the Order of Magistrate Judge Michael A. Hammer (Docket No. 86) ("Hammer Order"), pursuant to Fed.R.Civ.P. 72(a). Judge Hammer's Order, dated January 29, 2014, denied Plaintiff's request to compel additional discovery from Defendant YA Global, a determination that was intertwined with the merits. I will affirm Judge Hammer's Order and deny this appeal. Because I write primarily for the parties on this discovery issue, I assume familiarity with the facts and background, and my discussion of them will be limited.
A. Factual Overview
Plaintiff Klawonn, a NeoMedia shareholder, asserts claims against Defendants YA Global and nominal Defendant NeoMedia for the disgorgement of short-swing insider trading profits allegedly earned in violation of Section 16(b) of the Securities Exchange Act ("SEA") of 1934, 15 U.S.C. § 78p(b). A 10% beneficial ownership interest triggers liability for short-swing trading, as well as reporting requirements, under Section 16(b) of the SEA. YA Global asserts that it was not subject to Section 16(b) because it was not the beneficial owner of more than 10% of NeoMedia's common stock.
On August 24, 2006, NeoMedia issued to YA Global a $5 Million convertible debenture ("CD" or "debenture") that was convertible to common stock. On December 29, 2006, NeoMedia issued a $2.5 Million debenture to YA Global that was likewise convertible to common stock. In connection with each debenture, the parties entered into an Investor Registration Rights Agreement ("RRA"). Each debenture was subject to a "conversion cap, " which prevented YA Global from exercising its conversion rights to the extent that such exercise would result in YA Global's owning more that 4.99% of NeoMedia's outstanding common stock. The intention of the cap was to prevent YA Global from becoming a beneficial owner of 10% or more of NeoMedia's stock (the threshold of liability for short-swing profits under Section 16(b) of the SEA).
One term of the August 2006 CD was that NeoMedia was to obtain an effective registration of its common stock with the SEC no later than November 22, 2006. Failure to obtain that registration would constitute an "Event of Default." The December 2006 CD similarly required a registration statement by March 27, 2007, on pain of default. The registration deadlines were set forth in the RRAs. It is uncontested that NeoMedia did not meet either deadline.
Failure to meet the registration deadline constituted an Event of Default. The default provision contained a "limitation of conversion, " which provided that, upon an Event of Default, YA Global was relieved of its obligation to comply with the 4.99% conversion caps.
On November 7, 2007, well after the agreed deadline, the SEC issued a Notice of Effectiveness of registration of the relevant shares. NeoMedia and YA Global entered into a waiver agreement, dated December 31, 2008, in which YA Global relinquished its right to further liquidated damages triggered by the prior events of default. At that time, NeoMedia had already paid YA Global at least $1.3 million in liquidated damages for its failure to timely register the shares.
B. The Discovery Dispute
At issue on this appeal is a dispute that "goes to the heart of the case and will determine whether any additional discovery is necessary...." Docket No. 72 ("Joint Status Letter"). The parties do not dispute that the Events of Default (i.e., the failure to meet the deadline for registration) caused the conversion caps to become ineffective. They disagree, however, as to the date, if any, that the period of default ended, a determination that will influence the period for which relevant discovery may be taken.
The dispute centers on the issue of whether NeoMedia's registration of the shares on November 7, 2007, though belated, cured the default and reinstated the conversion caps. If so, YA Global could not after that date become the beneficial owner of more than 10% of the stock, and liability for short swing profits could not attach. If, on the other hand, the default was not cured (or was incurable), the conversion caps would remain dormant. With no conversion caps in place, there would remain a potential for short-swing profit liability after November 7, 2007.
That dispute directly affects the scope of relevant discovery. If the default was cured, and the conversion caps were restored, items such as trading records dating from after November 7, 2007, would not be relevant. If the default was not cured, and the conversion caps were not in place, then tsuch post-November 7, 2007 documents might be relevant. Judge Hammer agreed with YA Global that NeoMedia's November 7, 2007 registration cured the defaults and extinguished its ongoing liability, and he therefore disallowed discovery after that date.
C. Procedural Background
I am not writing on a clean slate in this case, which was reassigned to me. I therefore summarize some of the rulings already entered.
This discovery issue was first raised by the parties in a joint letter dated September 22, 2011 (Docket No. 63) addressed to then-Magistrate Judge Shipp. Judge Shipp directed the parties to seek clarification from Judge Chesler, who was then assigned to this matter. Before Judge Chesler, YA Global argued that the evidence produced to date showed that the period of liability did not last beyond November 7, 2007. Klawonn maintained that the late registration did not cure the default and, therefore, did not reinstate the conversion caps.
On October 27, 2011, Judge Chesler issued an Opinion & Order. Docket No. 65 ("Chesler Opinion 86 Order"). Judge Chesler noted that a prior opinion neither ruled out nor "unconditionally allow[ed] discovery after [November 27, 2007]." Id. at 1. Judge Chesler divided discovery into two phases: (1) "the period up to and including the date of the cure of the default(s) and (2) the period "after the cure of the default(s)." Id. Judge Chesler then posited that the question before the Court was whether discovery should proceed to the second phase, which was a matter to be decided by Magistrate Judge Shipp. The Magistrate Judge was directed to use
procedures subject to his discretion, based on two questions: 1) does the evidence obtained demonstrate that the period during which conversion caps were ineffective ended on a particular date, i.e., November 7, 2007, as asserted in Defendant's briefs in support of their motion to dismiss the Amended Complaint; and 2) if so, does the evidence obtained demonstrate a colorable basis for finding that, as of the date that the conversion caps were ...