Lee v. McDowell

Lee v. McDowell, 2022 NCBC 28.

STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE

SUPERIOR COURT DIVISION

MECKLENBURG COUNTY 19 CVS 17741

KEITH LEE and YOUNG KWON

(individually and derivatively on behalf

of rFactr, Inc.),

Plaintiffs,

ORDER AND OPINION ON

v.

DEFENDANT/THIRD-PARTY

PLAINTIFF CHRIS MCDOWELL’S

CHRIS MCDOWELL; CHRIS LAU; and

AND DEFENDANTS/THIRD-PARTY

ROBERT DUNN,

PLAINTIFFS CHRIS LAU AND

ROBERT DUNN’S MOTIONS FOR

Defendants,

SUMMARY JUDGMENT

and

RFACTR, INC.,

Nominal Defendant.

CHRIS MCDOWELL,

Third-Party Plaintiff,

v.

RICHARD BRASSER and GREG

GENTNER,

Third-Party

Defendants.

CHRIS LAU and ROBERT DUNN,

Third-Party Plaintiffs,

v.

RICHARD BRASSER and GREG

GENTNER,

Third-Party

Defendants.

1. THIS MATTER is before the Court upon Defendant/Third-Party Plaintiff

Chris McDowell’s (“McDowell”) Motion for Summary Judgment (“McDowell’s

Motion”), (ECF No. 109), and Defendants/Third-Party Plaintiffs Chris Lau (“Lau”)

and Robert Dunn’s (“Dunn”) (together, with McDowell, “Defendants”) Motion for

Summary Judgment (“Lau and Dunn’s Motion”), (ECF No. 118), (together, the

“Motions”), pursuant to Rule 56 of the North Carolina Rules of Civil Procedure

(“Rule(s)”) in the above-captioned case.

2. Having considered the Motions and the briefs, exhibits, and affidavits in

support of and in opposition to the Motions, the arguments of counsel at the hearing

on the Motions, and other appropriate matters of record, the Court GRANTS in part

and DENIES in part the Motions as set forth below.

Moore & Van Allen PLLC, by Christopher Donald Tomlinson and

William M. Butler, for Plaintiffs Young Kwon and Keith Lee.

James, McElroy & Diehl, P.A., by John R. Buric, for Nominal Defendant

rFactr, Inc.

Troutman Pepper Hamilton Sanders LLP, by William J. Farley,

Mackenzie Willow-Johnson, and Kiran H. Mehta, for Defendants and

Third-Party Plaintiffs Robert Dunn and Chris Lau.

Rosenwood, Rose, & Litwak, PLLC, by Erik M. Rosenwood and Carl J.

Burchette, for Defendant and Third-Party Plaintiff Chris McDowell.

Lincoln Derr PLLC, by Phoebe Norton Coddington and Sara R. Lincoln,

for Third-Party Defendants Richard Brasser and Greg Gentner.

Bledsoe, Chief Judge.

I.

FACTUAL AND PROCEDURAL BACKGROUND

3. “The Court does not make findings of fact on motions for summary

judgment; rather, the Court summarizes material facts it considers to be

uncontested.” McGuire v. Lord Corp., 2021 NCBC LEXIS 4, at *3 (N.C. Super. Ct.

Jan. 19, 2021).

4. This case arises from the demise of Nominal Defendant rFactr, Inc. (“rFactr”

or the “Company”), a North Carolina corporation that operated as a business-to-

business sales technology and strategy company that helped sales organizations use

social media to improve sales. All Plaintiffs and Defendants invested in rFactr and

subsequently lost the total value of their investments. Defendants each served on

the rFactr Board of Directors (the “Board”) sometime between 2015 and the present.

5. Plaintiffs allege that while on the Board, Defendants failed to oversee and

monitor rFactr’s finances and operations and, in particular, to take action to prevent

rFactr’s Chief Executive Officer, Third-Party Defendant Richard Brasser (“Brasser”),

and Chief Operating Officer, Third-Party Defendant Greg Gentner (“Gentner”), from

engaging in corporate mismanagement and malfeasance, which caused Plaintiffs to

suffer their investment losses. Separately, Plaintiffs allege that McDowell is liable

for inducing them to invest in rFactr without disclosing certain material information

about the Company as well as that the Company would compensate him if Plaintiffs

chose to invest.

A. The Creation of rFactr

6. In 2000, Brasser founded an interactive golf and marketing company called

Targeted Golf Solutions, Inc. (“Targeted Golf”) and thereafter served as its President

and Chief Executive Officer. 1 Gentner joined Brasser at Targeted Golf in 2004 as the

company’s Vice President and Chief Operating Officer. 2 Targeted Golf incurred

certain liabilities early in its existence, including a $400,000 loan from Baker Clark,

a venture capital firm, 3 and, in February 2007, a $175,000 line of credit with Main

Street Bank. 4

7. In 2008, Brasser changed the company’s name to The Targeted Group, Inc.

(“Targeted Group”) and focused the business on interactive social media marketing.5

Targeted Group’s investors included McDowell, a colleague and friend of Brasser’s. 6

McDowell met Brasser in the early 2000s through mutual friends, and their families

often saw each other socially. 7 According to Brasser, McDowell made a “preferred

security and equity investment” in Targeted Group in an amount between $50,000

1 (Dep. Richard Brasser, dated Nov. 2, 2021, at 14:14–19 [hereinafter “Brasser Dep.”], ECF

No. 114.3; Aff. William J. Farley, III Supp. Defs. Chris Lau and Robert Dunn’s Mot. Summ.

J., Ex. B [hereinafter “rFactr Search Results”], ECF No. 114.2.)

2 (Brasser Dep. 14:15–23, 18:15–17, ECF No. 114.3.)

3 (Brasser Dep. 222:19–28:15, ECF No. 114.3.)

4 (Brasser Dep. 22:15, ECF No. 114.3; Aff. William M. Butler, Dep. Ex. 59, ECF No. 124.23.)

5 (Brasser Dep. 15:7–12, ECF No. 114.3.)

6 (Dep. James Christopher McDowell, dated Apr. 23, 2021, at 17:10–18:5, 24:19–25:10

[hereinafter “McDowell Dep.”], ECF No. 103.3; McDowell Dep. 33:21–34:3, ECF No. 125.6;

Brasser Dep. 29:18–20, ECF No. 125.1.)

7 (McDowell Dep. 32:16–33:9, ECF No. 103.3.)

and $75,000, acted as the representative of the preferred shareholders of Targeted

Group, and was “intimately involved” with the company on a weekly basis. 8

8. In 2013, Brasser changed Targeted Group’s name to rFactr and began

promoting its “social sales solution” to other companies. 9 The newly rebranded rFactr

was a continuation of the entity formerly known as Targeted Group and remained

subject to the outstanding debts incurred when the Company operated under that

name. 10 Targeted Group’s equity investors, including McDowell, 11 also retained their

investments in the renamed company. 12

B. Plaintiffs Invest in rFactr

9. In approximately January 2014, Brasser and McDowell agreed that

McDowell would be paid a fee of 10% of all investments he successfully solicited in

rFactr. 13 This agreement eventually took the form of a Consulting Agreement

executed by McDowell and rFactr in June or July 2014 under which McDowell agreed

to provide financial consulting and business development services to the Company in

8 (Brasser Dep. 29:2–30:1, ECF No. 125.1.)

9 (Brasser Dep. 16:21, ECF No. 114.3; Aff. William J. Farley, III Supp. Defs. Chris Lau and

Robert Dunn’s Mot. Summ. J., Ex. J [hereinafter “Articles of Restatement of Targeted

Group”], ECF No. 114.10; rFactr Search Results.)

10On 30 May 2013, Targeted Group filed its Fourth Amended and Restated Articles of

Incorporation that included the name change to rFactr. (Articles of Restatement of Targeted

Group.)

11 (Aff. Erik M. Rosewood, Ex. 4 [hereinafter “Brasser Production”], ECF No. 103.4.)

12 (Brasser Dep. 226:1–27:1, ECF No. 114.3.)

13 (Brasser Dep. 33:24–39:1, ECF No. 125.1.)

exchange for this compensation. 14 The Consulting Agreement was modified in

August 2014 to limit McDowell’s services to financial consulting. 15

10. McDowell’s primary employment in 2014 was as an investment broker

selling bonds, 16 and his clients included Plaintiffs’ employers. 17 Plaintiffs are both

sophisticated, experienced investment and finance professionals working in New

York City 18 and worked with McDowell on behalf of their respective employers at that

time. 19

11. McDowell first discussed his investment in rFactr with Plaintiffs in early

2014. 20 During this discussion, McDowell told Plaintiffs that he had personally

14 (Aff. Carl J. Burchette, Ex. 2 at 11 [hereinafter “McDowell Consulting Agreement”], ECF

No. 127.2.)

15 (McDowell Consulting Agreement 8.) While McDowell does not dispute the existence of

the Consulting Agreement, he asserts that he never signed it. (McDowell Dep. 102:4–8, ECF

No. 125.6.)

16 (Dep. Young Kwon, dated May 10, 2021, at 12:5–8 [hereinafter “Kwon Dep.”], ECF No.

125.3; Dep. Keith Lee, dated May 11, 2021, at 12:1–13, 15:9–13 [hereinafter “Lee Dep.”], ECF

No. 125.5; Lee Dep. 12:1–13, ECF No. 103.1.)

17 (Kwon Dep. 12:5–13:1, ECF No. 125.3; Lee Dep. 15:9–13, ECF No. 125.5.)

18 (Kwon Dep. 9:2–22, ECF No. 103.1; Lee Dep. 10:13–12:16, ECF No. 103.2.) Kwon’s prior

experience included three years as an investment banker at Morgan Stanley, six years

leading the commercial real estate group at a Japanese insurance company, three years as a

planning manager at JP Morgan, six years at Apollo Global Management as head of “CMDS

and ADS trading,” and founder of Atalaya Capital Management, a commercial real estate

business. (Kwon Dep. 9:2–22; ECF No. 103.1.) Lee’s prior experience included running a

trading desk and participating in the sales force at UBS and later working for H/2 Capital

Partners, a hedge fund. (Lee Dep. 10:13–12:16, ECF No. 103.2.)

19As of spring 2014, Kwon worked for Apollo Global Management, Lee worked for H/2

Capital, and McDowell worked for Amherst Securities Group. (Kwon Dep. 12:1–20, ECF No.

125.3; Lee Dep. 14:1–17, 15:9–13, ECF No. 125.5.)

20 (McDowell Dep. 33:21–34:3, ECF No. 125.6; Brasser Dep. 29:18–20, ECF No. 125.1.)

invested in rFactr and was “actively involved in management oversight” of the

Company. 21 As a result of McDowell’s representations, Plaintiffs took an interest in

the Company. McDowell thereafter provided Plaintiffs with some written materials

describing the nature of the Company and offered to arrange a meeting for Plaintiffs

with Brasser. 22 McDowell did not mention then or later that rFactr, through Brasser,

had promised to pay him a fee for each new investor McDowell induced to invest in

the Company.

12. According to Plaintiffs and Brasser, McDowell introduced Plaintiffs to

Brasser at a dinner in New York City in early March 2014. 23 At the dinner, Kwon

“asked [Brasser] a bunch of questions . . . about his track record, about the business

plan, what the management team comprised of, the Board of Directors, and then what

the exit might be.” 24 Brasser “answered all those questions.” 25 Plaintiffs assert,

21 (McDowell Dep. 54:10–15, ECF No. 125.6; Lee Dep. 21:9–11, ECF No. 125.5.)

22 (McDowell Dep. 72:20–22, ECF No. 125.6; Aff. William M. Butler, Dep. Ex. 22, ECF No.

124.16; Aff. William M. Butler, Dep. Ex. 23, ECF No. 124.17.)

23 (See Lee Dep. 211:13–12:1, ECF No. 125.5; Kwon Dep. 21:12–24:6, ECF No. 125.3; Brasser

Dep. 102:5–23, ECF No. 125.1.) While Plaintiffs have asserted that this dinner occurred on

6 March 2014, McDowell has offered evidence that suggests that he was not at a dinner on

that date, (Aff. Chris McDowell, Ex. A, ECF No. 102.1; Brasser Production 0002113 (“I am

looking forward to meeting you and Young for dinner. It is too bad that McDowell can’t join

us[.]”)). Responding to McDowell’s evidence, Plaintiffs have testified that while a dinner

meeting with Brasser and McDowell most definitely occurred, the date of the meeting might

have been shortly before or after 6 March 2014. (Lee Dep. 29:21–30:1, ECF No. 103.2.)

Because the Court must view the evidence in the light most favorable to Plaintiffs, for

purposes of the Motions, the Court takes as fact that a meeting between Plaintiffs, Brasser,

and McDowell occurred in early March 2014.

24 (Kwon Dep. 22:2–6, ECF No. 103.1.)

25 (Kwon Dep. 22:7, ECF No. 103.1.)

however, that Brasser made three statements at this dinner that McDowell knew

were false yet did not correct: (i) that rFactr was a new company; (ii) that investments

in rFactr would serve as bridge financing specifically to support anticipated new

subscription demand; and (iii) that the Company would be cash flow positive in six

months. 26

13. Plaintiffs aver that thereafter McDowell assured them of the good

reputations of Brasser and Gentner, as well as rFactr’s prospects for the future and

its potential profitability. 27 They also testified that McDowell told them that he

would act as an intermediary to Brasser regarding rFactr. 28

14. Despite McDowell’s offer to intervene, Plaintiffs engaged in direct

communications with Brasser and Gentner about their potential investments

between the initial dinner in early March and the closing on Plaintiffs’ investments

in late March and April. 29 During this roughly one-month period, Plaintiffs

communicated with Brasser and Gentner and discussed investment timelines, the

amounts of their investments, the purchase agreement, and the Company’s financial

26 (Resp. Opp’n Defs.’ Mots. Summ. J. 4, 24 [hereinafter “Resp.”], ECF No. 125; Lee Dep.

28:19–29:7, ECF No. 125.5; Kwon Dep. 214:1–17, ECF No. 125.3; Verified Am. Compl. ¶23

[hereinafter “Am. Compl.”], ECF No. 10.) Plaintiffs also assert that Brasser stated that the

investment opportunity was open to friends and family with a “near-term exit opportunity”

and that investors would be treated like family and friends. (Resp. 4, 24; Am. Compl. ¶ 22.)

27 (Lee Dep. 31:16–18, 203:15–17, ECF No. 125.5; Kwon Dep. 28:14–25, ECF No. 125.3.)

28 (Kwon Dep. 30:2–11, ECF No. 103.1.)

29 (Lee Dep. 33:4–18, ECF No. 103.2; Kwon Dep. 25:4–25, ECF No. 103.1.)

information. 30 Brasser arranged a webcast so that Plaintiffs could see and

understand how rFactr’s software worked. 31 Gentner also sent financial statements

to Lee via email on 26 March 2014 that allegedly included a “Proforma Spreadsheet

for 2014” as well as audited financial statements covering 2011 and 2012. 32 Gentner

described the audited financial statements as “from our 2013 Qualified Business

Valuation filing for the State of North Carolina” and reported to Lee that “[o]ur post-

valuation at the end of our Preferred Seed Round was $13.25 million.” 33

15. The 2011 and 2012 audited financial statements were titled “The Targeted

Group, Inc. Statements of Financial Condition” in bold on the top of each page and

included detailed information regarding the company’s financial status in those

years. 34 The statements reflected Targeted Group’s total assets and liabilities,

stockholders’ deficit, net sales, gross profit, other income and expense, cash flows, and

balance sheets for 2011 and 2012 and identified the company’s total 2012 year-end

30 (Brasser Production 0002141–43, 0002152–54, 0002181–84, 0002189–92; Kwon Dep.

25:11–26:7, ECF No. 103.1.)

31 (Kwon Dep. 25:16–18, ECF No. 103.1.)

32 (Aff. Erik M. Rosenwood, Ex. 5 at 00000205, 0000209–20 [hereinafter “Pls.’ Production”],

ECF No. 103.5; Lee Dep. 213:20–14:19, ECF No. 125.5; Lee Dep. 33:4–18, ECF No. 103.2;

Kwon Dep. 26:1–6, ECF No. 103.1.) Although Gentner states in his March 26 email to Lee

that the “Proforma Spreadsheet for 2014” is attached and Plaintiffs have not denied receiving

it, it does not appear to the Court that the spreadsheet itself has been made a part of the

record (it is not at the exhibit cited in McDowell’s brief (Exhibit 5 of the Rosenwood

Affidavit)). As a result, the Court does not base its conclusions in this Order and Opinion on

the contents of the spreadsheet since that evidence is not before the Court.

33 (Pls.’ Production 0000205.)

34 (Pls.’ Production 0000209–20.)

liabilities as $3,247,387, which included long-term debt of $1,400,500. 35 The

statements also showed that Targeted Group had a net operating loss of $1,101,571

for 2012. 36

16. In addition, the statements contained a section describing the history of

Targeted Group, including that the company previously operated as Targeted Golf. 37

While not mentioning rFactr by name, the financial statements described Targeted

Group’s business in terms equally applicable to rFactr:

The Company provides a software platform to create successful and

sustainable social media solutions by empowering organizations to

connect and deepen their most important relationships. The

company provides social media solutions by delivering dynamic,

branding social media solutions that include customized Saas

solutions including its proprietary Enterprise Social Media

Management Software (SMMS). 38

17. Shortly after receiving this information from Brasser and Gentner, each

Plaintiff purchased convertible promissory notes issued by rFactr. 39 Kwon purchased

a single note on 19 March 2014 in the amount of $300,000, 40 and Lee purchased two

35 (Pls.’ Production 0000209–20.)

36 (Pls.’ Production 0000212, 0000214.)

37 (Pls.’ Production 0000216.)

38 (Pls.’ Production 0000216.)

39 (Am. Compl. ¶ 29.)

40 (Am. Compl. ¶ 31; Brasser Production 0185335.)

notes, the first on 4 April 2014 in the amount of $250,000 41 and the second on 19

March 2015 in the amount of $50,000. 42

18. Each Plaintiff signed a written purchase agreement to effect these

investments, representing in each agreement as follows:

Purchasers have reviewed the representations concerning the Company

contained in this Agreement, and such other information regarding the

Company and its business, operations, market potential, capitalization,

financial condition and prospects, and all other matters deemed relevant

by Purchasers. The Company has also made available to the Purchasers

the opportunity to ask questions of, and receive answers from, the

Company concerning the terms and conditions of these Notes and to

obtain any additional information, to the extent that the Company

possesses such information, and can acquire it without unreasonable

effort or expense. 43

19. After Plaintiffs purchased their notes, McDowell made a second equity

investment in rFactr on 24 July 2014 in the amount of $25,000. 44

C. McDowell and Dunn Join the Board

20. McDowell joined rFactr’s Board in March 2015 at roughly the same time Lee

made his second investment in the Company. 45 Soon thereafter, on 9 June 2015,

41 (Am. Compl. ¶ 30; Brasser Production 0185335.)

42 (Am. Compl. ¶ 30; Brasser Production 0185335.) At the time of Plaintiffs’ investments in

rFactr, Kwon estimated that the failure rate for angel investments like rFactr was “90

percent” because they are “highly speculative.” (Kwon Dep. 31:18–25; see also Lee Dep.

33:23–34:2 (“I think the failure rates are pretty high.”).)

43 (Pls.’ Production 0000200, at Convertible Note Purchase Agreement 3.5; Am. Compl. ¶ 32.)

44 (Brasser Production 0185335.)

45 (McDowell Dep. 112:7–20, 114:12–22, ECF No. 125.6.)

McDowell made a third equity investment in rFactr, again in the amount of

$25,000. 46 McDowell remained on rFactr’s Board until the end of 2017. 47

21. Dunn joined the Board in April 2015 and served as a board member until

July 2017. 48 Neither McDowell nor Dunn were employed by rFactr, but each received

rFactr stock options as compensation for their service on the Board. 49 Brasser and

Gentner were rFactr’s only other board members until June 2017. 50

22. According to McDowell and Dunn, Brasser and Gentner engaged in a

pattern of mismanagement and malfeasance throughout McDowell’s and Dunn’s

board service that significantly impeded McDowell’s and Dunn’s ability to monitor

the Company’s operations and performance. This conduct included Brasser’s and

Gentner’s repeated (i) practice of providing McDowell and Dunn inconsistent and

incomplete information about the Company; 51 (ii) refusal to provide McDowell and

Dunn important financial information about the Company, including information

about Brasser’s and Gentner’s compensation; 52 and (iii) refusal to consider or

46 (Brasser Production 0185335.)

47 (McDowell Dep. 112:7–20, 114:12–22, ECF No. 125.6.)

48 (Dep. Robert Dunn, dated Apr. 21, 2021, at 26:20–23 [hereinafter “Dunn Dep.”], ECF No.

125.2.)

49 (See Dunn Dep. 20:23–21:3, 99:25–100:3, ECF 114.6; McDowell Dep. 97:16–98:8, ECF No.

103.3.)

50 (Aff. William M. Butler, Dep. Ex. 25, ECF No. 124.18.)

51(McDowell Dep. 117:16–19, ECF No. 103.3; Aff. William M. Butler, Dep. Ex. 13 at

000005159, ECF No. 124.10.)

52 (Dunn Dep. 42:3–10, 62:16–18, ECF 114.6; McDowell Dep. 179:6–80:7, ECF No. 103.3;

Brasser Production 0193747.)

implement any changes suggested by McDowell and Dunn, including, in particular,

to address concerns about the Company’s lack of recordkeeping and reporting

controls. 53

23. Despite Brasser’s and Gentner’s persistent lack of cooperation, McDowell

and Dunn did succeed in obtaining certain information from them, including (i) at a

board meeting in September or October 2015, a cash flow statement for the period 1

January 2015 through 30 September 2015; 54 and (ii) in the summer of 2015,

compensation information for all rFactr employees, including for Brasser ($330,000

base compensation) and Gentner ($230,000 base compensation). 55

24. Collectively, these documents showed that Brasser’s and Gentner’s

compensation consumed a substantial percentage of the Company’s total revenues. 56

Early on, McDowell and Dunn considered Brasser’s and Gentner’s compensation to

be excessive, particularly in light of rFactr’s small size and declining prospects, and

therefore took measures to try to reduce their pay. 57 These efforts included Dunn’s

53 (Aff. William M. Butler, Dep. Ex. 3 [hereinafter “26 May 2017 Email”], ECF No. 124.3.)

54 (Aff. William J. Farley, III Supp. Defs. Chris Lau and Robert Dunn’s Mot. Summ. J., Ex.

M at 000003563–68 [hereinafter “2015 Financial Documents and Compensation”], ECF No.

114.13.)

55 (2015 Financial Documents and Compensation 000003559; McDowell Dep. 117:10–15, ECF

No. 125.6.) These documents can also be found at Aff. William M. Butler, Dep. Ex. 7, ECF

No. 124.6.

56 (See 2015 Financial Documents and Compensation 000003555–68.)

57(Dunn Dep. 69:2–71:23, ECF No. 114.6; McDowell Dep. 118:4–21:1, ECF No. 103.3;

McDowell Dep. 135:21–36:6, ECF No. 125.6; 2015 Financial Documents and Compensation

000003502; Aff. William M. Butler, Dep Ex. 6, ECF No. 124.5; Aff. William M. Butler, Dep.

Ex. 14 [hereinafter “29 March 2017 Emails”], ECF No. 124.11.)

consultation with an executive compensation expert, 58 who advised that reasonable

compensation for similarly situated executives should be no more than $75,000 to

$100,000, 59 and McDowell’s and Dunn’s repeated insistence to Brasser and Gentner

that they agree to a reduction in their compensation.

25. McDowell’s and Dunn’s efforts appeared to have borne fruit when Brasser

and Gentner agreed to reduce their compensation if rFactr was not at least cash flow

neutral by the end of the third quarter of 2015. 60 When rFactr failed to meet this

milestone, however, Brasser and Gentner refused to make the agreed-upon

compensation reduction, 61 and Brasser grew angry and refused to speak to McDowell

and Dunn when they complained to him about reneging on his agreement. 62 Brasser

and Gentner thereafter continued to pay themselves compensation that McDowell

and Dunn considered excessive.

26. Some months later, in October 2015, Brasser proposed a reduction in his

base compensation to $230,000, provided that he receive a 10% commission for any

sales he made and a revenue share of 7.5% if rFactr had gross revenues over

58 (Resp. 18; Chris Lau and Robert Dunn’s Mem. Supp. Mot. Summ. J. 18 [hereinafter “Lau

and Dunn Br.”], ECF No. 117; Def./Third-Party Pl. Chris McDowell’s Br. Supp. Mot. Summ.

J. 26–27 [hereinafter “McDowell Br.”], ECF No. 107; see 2015 Financial Documents and

Compensation 000003503–07.)

59 (Resp. 18; Lau and Dunn Br. 18; McDowell Br. 26–27; see 2015 Financial Documents and

Compensation 000003504.)

60 (McDowell Dep. 118:4–19:3, ECF No. 103.3.)

61 (McDowell Dep. 119:10–20, ECF No. 103.3.)

62 (McDowell Dep. 119:10–19:20, ECF No. 103.3.)

$300,000. 63 McDowell and Dunn comprised a majority of the disinterested board

members eligible to vote on Brasser’s and Gentner’s compensation64 and rejected

Brasser’s proposal, deeming it not in the Company’s best interest. 65 Thereafter,

Brasser and Gentner continued to pay themselves compensation that McDowell and

Dunn considered excessive, until 2016, when Brasser and Gentner elected not to cash

a few of their compensation checks due to the Company’s declining cash reserves. 66

27. In January 2017, rFactr published to its investors an Investor Update

reporting $1.2 million in 2016 revenues. 67 On 17 February 2017, Dunn emailed

McDowell, pointing out that the Investor Update described an inappropriately

optimistic forecast as a “run-rate,” an error that Dunn attributed to Brasser’s and

Gentner’s “lack [of] business acumen” or their attempt to misrepresent the financials

of rFactr. 68 Dunn challenged Brasser and Gentner on the error, but neither Dunn,

McDowell, nor the Board notified the Company’s investors about the mistake. 69

63 (Aff. William J. Farley, III Supp. Defs. Chris Lau and Robert Dunn’s Mot. Summ. J., Ex.

O, ECF No. 114.15.)

64 (See Aff. William J. Farley, III Supp. Defs. Chris Lau and Robert Dunn’s Mot. Summ. J.,

Ex. L at 6 [hereinafter “rFactr Bylaws”], ECF No. 114.12.)

65 (Aff. William J. Farley, III Supp. Defs. Chris Lau and Robert Dunn’s Mot. Summ. J., Ex.

P, ECF No. 114.16.)

66 (Brasser Dep. 88:23–89:14, ECF No. 114.3.)

67 (Dunn Dep. 124:1–25:11, ECF No. 125.2; Aff. William M. Butler, Dep. Ex. 15 [hereinafter

“2017 Investor Update and Emails”], ECF No. 124.12; Aff. William M. Butler, Dep. Ex. 17

[hereinafter “Dunn Resignation Emails”], ECF No. 124.13.)

68 (Dunn Dep. 115:3–20, ECF No. 125.2; 2017 Investor Update and Emails.)

69 (Dunn Dep. 115:21–16:8, ECF No. 125.2.)

28. On 2 May 2017, Plaintiffs, through counsel, sent a letter to Brasser

requesting financial statements and other documents from rFactr. 70 Gentner

provided the requested information the following month. 71 Dunn quickly noticed

discrepancies between the June 2017 financials and the numbers reported in the

Investor Update. Most significantly, while rFactr had reported $1.2 million in 2016

revenues in the Investor Update, the June 2017 financials stated that rFactr’s 2016

revenues were only $546,000—less than half of those reported to investors just five

months before. 72

29. Matters soon got worse. At a board meeting on 12 June 2017, Brasser and

Gentner revealed to McDowell and Dunn for the first time that rFactr had

systematically failed to pay payroll taxes to the IRS from September 2014 through

June 2016 and that rFactr owed the IRS over $900,000 in unpaid taxes, interest, and

penalties as a result, a huge liability for a company of rFactr’s size and revenues. 73

McDowell and Dunn promptly advised the Company’s other investors about rFactr’s

tax liability. 74

70 (Aff. William J. Farley, III Supp. Defs. Chris Lau and Robert Dunn’s Mot. Summ. J., Ex.

S, ECF No. 114.19.)

71 (Aff. William M. Butler, Dep. Ex. 41, ECF No. 124.21.)

72 (Dunn Dep. 115:6–16:24; 2017 Investor Update and Emails; Dunn Resignation Emails.)

73 (Aff. William J. Farley, III Supp. Defs. Chris Lau and Robert Dunn’s Mot. Summ. J., Ex. X

at 0000422 [hereinafter “2017 Board Minutes”], ECF No. 114.24; Aff. William M. Butler, Dep.

Ex. 32 at 0000422 [hereinafter “2017 Board Minutes”], ECF No. 124.19; Brasser Dep. 121:14–

18, ECF No. 114.3; Dunn Resignation Emails; Aff. William J. Farley, III Supp. Defs. Chris

Lau and Robert Dunn’s Mot. Summ. J., Ex. V, ECF No. 114.22.)

74 (Kwon Dep. 80:20–25, ECF No. 114.4.)

30. Three days later, on 15 June 2017, the Board responded to these revelations

by voting to add a fifth board seat and inviting Lau to serve on the Board. 75 Lau was

an obvious choice because he had invested nearly $2 million in rFactr and had

occasionally participated in board calls since 2015. 76 In light of rFactr’s tax liability,

Dunn, McDowell, and Lau were doubtful that rFactr could survive and placed the

blame for the Company’s demise squarely on Brasser and Gentner. 77 Brasser soon

left his position as Chief Executive Officer to focus on driving the Company’s sales

and revenue growth but remained on the Board. 78

31. The five-person board structure did not last long. Dunn left the Board on

29 June 2017, citing the discrepancy in rFactr’s 2016 revenues, the Company’s large,

undisclosed tax liability, and the misstated run-rate in the Investor Update as

reasons for his resignation. 79 His board seat was not filled.

32. At this point, rFactr had limited cash reserves and was unable to pay its

employees or vendors. The Company was also unsuccessful in courting new

investors. 80 In an effort to chart a path forward, the Board considered various other

75 (2017 Board Minutes 0000423.)

76 (2017 Board Minutes 0000423, 0000424; Dep. Luen H. Lau, dated May 6, 2021, at 43:15–

45:3 [hereinafter “Lau Dep.”], ECF No. 114.8.)

77 (Aff. William M. Butler, Dep. Ex. 18, ECF No. 124.14.)

78 (2017 Board Minutes 0000423, 0000424; Aff. William J. Farley, III Supp. Defs. Chris Lau

and Robert Dunn’s Mot. Summ. J., Ex. Y, ECF No. 114.25.)

79 (Dunn Resignation Emails.)

80 (Brasser Dep. 237:8–11, 240:8–10, 242:7–43:3, ECF No. 114.3; Aff. William J. Farley, III

Supp. Defs. Chris Lau and Robert Dunn’s Mot. Summ. J., Ex. W, ECF No. 114.23; Brasser

Dep. 90:21–91:23, ECF No. 125.1.)

options, including a potential sale to McDowell and Lau that was never

consummated, 81 and a sale of assets to a digital customer engagement platform called

Grapevine6. 82

33. The proposed Grapevine6 transaction required rFactr to pay Grapevine6 a

cash deposit of $200,000, which would be forfeited if a deal was not timely

completed. 83 McDowell and Lau ultimately caused rFactr to reject the sale to

Grapevine6, at least in part because they believed that the tax write-offs resulting

from rFactr’s failure would be more valuable for the Company’s investors than the

contemplated sale to Grapevine6. 84 After Brasser and Gentner pointed out that not

all investors would be able to benefit from such write-offs, Lau acknowledged that

rejecting the sale on that basis was a mistake. 85 Though the proposed sale to

Grapevine6 was rejected, Brasser successfully negotiated a revenue-share deal with

Grapevine6 through which Grapevine6 hired rFactr’s employees (other than Brasser

and Gentner) and took over rFactr’s revenue source. 86 rFactr is no longer an

operating entity.

81 (Lau Dep. 189:25–92:2, ECF No. 125.4; Brasser Dep. 270:16–71:24, ECF No. 125.1.)

82 (Lau 189:10–20, ECF No. 125.4; 2017 Board Minutes 0000432; Aff. William J. Farley, III

Supp. Defs. Chris Lau and Robert Dunn’s Mot. Summ. J., Ex. BB [hereinafter “Grapevine6

Letter of Intent”], ECF No. 114.28; Brasser Dep. 91:2–7, ECF No. 125.1.)

83 (Grapevine6 Letter of Intent 4.)

84 (2017 Board Minutes 0000434.)

85 (2017 Board Minutes 0000435; Brasser Dep. 95:7–96:14, ECF No. 125.1.)

86 (Brasser Dep. 198:14–200:2, 236:3–8, ECF No. 114.3.)

D. Procedural History

34. Lee and Kwon filed this action on 6 September 2019, 87 asserting derivative

claims against McDowell, Dunn, and Lau for breach of fiduciary duty, as well as

individual claims against McDowell for breach of fiduciary duty; constructive fraud;

and securities fraud pursuant to N.C.G.S. § 78A-56(a) (“NCSA”), section 10(b) of the

Exchange Act, and Rule 10b-5. 88

35. Defendants filed the Motions on 17 December 2022, and after full briefing,

the Court held a hearing on the Motions on 16 February 2022 (the “Hearing”), at

which all parties were represented by counsel. The Motions are now ripe for

resolution.

II.

LEGAL STANDARD

36. “Summary judgment is appropriate ‘if the pleadings, depositions, answers

to interrogatories, and admissions on file, together with the affidavits, if any, show

that there is no genuine issue as to any material fact and that any party is entitled

to a judgment as a matter of law.’ ” Da Silva v. WakeMed, 375 N.C. 1, 10 (2020)

(quoting N.C. R. Civ. P. 56(c)). “An issue is ‘genuine’ if it can be proven by substantial

evidence and a fact is ‘material’ if it would constitute or irrevocably establish any

material element of a claim or a defense.” Lowe v. Bradford, 305 N.C. 366, 369 (1982).

87 (Compl., ECF No. 3.)

88 (Am. Compl. ¶¶ 90–120.)

37. “The summary judgment standard requires the trial court to construe

evidence in the light most favorable to the nonmoving party.” Draughon v. Evening

Star Holiness Church of Dunn, 374 N.C. 479, 482 (2020). Accordingly, the Court will

“draw all reasonable inferences in favor of plaintiffs.” Barger v. McCoy Hillard &

Parks, 346 N.C. 650, 662 (1997).

38. “[T]he party moving for summary judgment ultimately has the burden of

establishing the lack of any triable issue of fact.” Pembee Mfg. Corp. v. Cape Fear

Constr. Co., 313 N.C. 488, 491 (1985). “The showing required for summary judgment

may be accomplished by proving an essential element of the opposing party’s claim

does not exist, cannot be proven at trial, or would be barred by an affirmative defense,

or by showing through discovery that the opposing party cannot produce evidence to

support an essential element of her claim.” Dobson v. Harris, 352 N.C. 77, 83 (2000)

(internal citations omitted). “If the movant demonstrates the absence of a genuine

issue of material fact, the burden shifts to the nonmovant to present specific facts

which establish the presence of a genuine factual dispute for trial.” In re Will of

Jones, 362 N.C. 569, 573 (2008). “Nevertheless, if there is any question as to the

weight of evidence summary judgment should be denied.” Id. (cleaned up).

III.

ANALYSIS

A. Derivative Claims for Breach of Fiduciary Duty

39. Plaintiffs have asserted derivative claims against McDowell, Dunn, and Lau

for breach of the fiduciary duties they owe as directors of rFactr, alleging that (i)

McDowell and Dunn failed to adequately monitor and oversee rFactr; (ii) McDowell

and Dunn failed to prevent the payment of excessive compensation to Brasser and

Gentner; 89 and (iii) McDowell and Lau engaged in improper self-dealing by rejecting

the sale of rFactr to Grapevine6 in November 2017. 90

40. Defendants seek dismissal of each of Plaintiffs’ claims, contending that the

undisputed evidence establishes that (i) McDowell and Dunn met their duty of care

by taking reasonable measures in good faith to stay informed about rFactr’s business;

(ii) McDowell’s and Dunn’s decisions concerning Brasser’s and Gentner’s

compensation were made in good faith and are protected by the business judgment

rule; and (iii) McDowell’s and Lau’s rejection of the Grapevine6 transaction was not

improper self-dealing, and regardless, the rejection did not harm rFactr because

rFactr lacked sufficient funds to meet Grapevine6’s non-negotiable deal terms. 91

89 While Plaintiffs appear to argue that Lau may be liable for failing to obtain financial

records and to reduce Brasser’s and Gentner’s compensation, by the time Lau joined the

Board in June 2017, it is undisputed that McDowell, Dunn, and Lau had obtained up-to-date

financial information from rFactr, (2017 Board Minutes 00000422), and Brasser and Gentner

were no longer accepting compensation due to rFactr’s financial troubles, (2017 Board

Minutes 00000426). As a result, the Court concludes that to the extent Plaintiffs’ derivative

claims arising from Defendants’ alleged failure to monitor and oversee the Company’s

operations or prevent the payment of excessive compensation are asserted against Lau, those

claims should be, and therefore are, hereby dismissed for failure to offer evidence sufficient

to sustain their claim under Rule 56.

90 (Resp. 13–22.)

91 (McDowell Br. 27–29; Lau and Dunn Br. 16–21.)

1. Claims Based on Duty to Monitor and Duty of Oversight

41. The Court first considers Plaintiffs’ derivative claims against McDowell and

Dunn for breach of fiduciary duty based on their alleged failure to monitor and

oversee rFactr and its operations.

42. A director of a North Carolina corporation is required to perform his or her

duties “(1) [i]n good faith; (2) [w]ith the care an ordinarily prudent person in a like

position would exercise under similar circumstances; and (3) [i]n a manner he [or she]

reasonably believes to be in the best interests of the corporation.” N.C.G.S. § 55-8-

30(a). To assess whether a director has met this standard, a reviewing court must

examine “the care (1) an ordinarily prudent person, (2) in a like position, (3) would

exercise under similar circumstances, and (4) whether the officer or director acted in

a manner he reasonably believed to be in the best interests of the corporation.” State

v. Custard, 2010 NCBC LEXIS 9, at *55 (N.C. Super. Ct. Mar. 19, 2010). Importantly,

“[this] standard of conduct is subject to review under the business judgment rule.”

Id.

43. The North Carolina courts offer limited guidance concerning a director’s

duty to monitor and oversee the corporation’s business affairs. Former Business

Court Judge Ben Tennille’s 2010 decision in Custard is the most thoroughgoing and

is helpful here. Id. at *65–70. In that case, Judge Tennille relied heavily upon

Delaware law. Id. at *48 (noting that “North Carolina courts have frequently looked

to the well-developed case law of corporate governance in Delaware for guidance”).

This Court, too, concludes that Delaware law provides important and useful guidance

in assessing a director’s duty to monitor and duty of oversight under North Carolina

law and will consult relevant decisions from the Delaware courts in considering the

Motions. See, e.g., Reynolds Am. Inc. v. Third Motion Equities Master Fund Ltd., 379

N.C. 524, 528 (2021) (electing to “borrow freely” from Delaware decisions in judicial

appraisal action); Corwin v. Brit. Am. Tobacco PLC, 371 N.C. 605, 613 (2018) (relying

on Delaware decisions to decide voting power issues in shareholder suit).

44. The starting point under Delaware law—as it was for Judge Tennille in

Custard—is the Delaware Chancery Court’s decision in In re Caremark Int’l Inc.

Derivative Litig., 698 A.2d 959, 967 (Del. Ch. 1996). In Caremark, the Chancery

Court held as follows:

Generally where a claim of directorial liability for corporate loss is

predicated upon ignorance of liability creating activities within the

corporation . . . only a sustained or systematic failure of the board to

exercise oversight––such as an utter failure to attempt to assure a

reasonable information and reporting system exists––will establish the

lack of good faith that is a necessary condition to liability.

Caremark, 698 A.2d at 971.

45. The Delaware Supreme Court subsequently embraced the Chancery Court’s

Caremark holding in Stone v. Ritter, 911 A.2d 362, 365 (Del. 2006), stating that:

Caremark articulates the necessary conditions predicate for director

oversight liability: (a) the directors utterly failed to implement any

reporting or information system or controls; or (b) having implemented

such a system or controls, consciously failed to monitor or oversee its

operations thus disabling themselves from being informed of risks or

problems requiring their attention. In either case, imposition of liability

requires a showing that the directors knew that they were not

discharging their fiduciary obligations. Where directors fail to act in the

face of a known duty to act, thereby demonstrating a conscious disregard

for their responsibilities, they breach their duty of loyalty by failing to

discharge that fiduciary obligation in good faith.

46. Most recently, the Delaware Supreme Court has described a director’s

Caremark duties as follows:

As with any other disinterested business judgment, directors have great

discretion to design context—and industry—specific approaches tailored

to their companies’ businesses and resources. But Caremark does have

a bottom-line requirement that is important: the board must make a

good faith effort—i.e., try—to put in place a reasonable board-level

system of monitoring and reporting. Thus, our case law gives deference

to boards and has dismissed Caremark cases even when illegal or

harmful company activities escaped detection, when the plaintiffs have

been unable to plead that the board failed to make the required good

faith effort to put a reasonable compliance and reporting system in

place.

Marchand v. Barnhill, 212 A.3d 805, 821 (Del. 2019) (footnote omitted).

47. Given the minimal burden the Caremark standard imposes on directors to

satisfy their duty of loyalty to the corporation, both the Delaware Chancery Court

and the Delaware Supreme Court have noted that “a Caremark claim is ‘possibly the

most difficult theory in corporation law upon which a plaintiff might hope to win a

judgment.’ ” City of Birmingham Ret. & Relief Sys. v. Good, 177 A.3d 47, 55 (Del.

2017) (quoting with approval Caremark, 698 A.2d at 967). McDowell and Dunn

contend that they satisfied this minimal burden here, and the Court agrees.

48. First, it is undisputed that McDowell and Dunn made numerous requests

for information during the time they were on the Board 92 and that they were able to

obtain a Company cash flow statement and information regarding Brasser’s and

92 (Brasser Production 0193747; Dunn Dep. 41:10–19, ECF No. 114.6; Brasser Dep. 50:15–

25, ECF No. 114.3; Aff. William M. Butler, Dep. Ex. 2, ECF No. 124.2.)

Gentner’s compensation. 93 Rather than evidence an indifference to or a conscious

disregard of their duties as board members as Plaintiffs suggest, McDowell’s and

Dunn’s repeated requests reflect a good faith attempt to monitor and oversee the

Company.

49. In addition, while it is undisputed that there was no board-level system of

monitoring and reporting at rFactr, the Court is mindful that a director’s Caremark

duties must be “judged in the context in which they occur.” Custard, 2010 NCBC

LEXIS 9, at *51. Here, rFactr was a small, heavily indebted startup company, and

McDowell and Dunn served on a four-member board with the Company’s founders

and chief executive officers, Brasser and Gentner. The evidence is undisputed that

McDowell and Dunn made repeated informal requests to Brasser and Gentner to

implement a system of recordkeeping and reporting for directors and shareholders,

but Brasser and Gentner consistently refused. 94 Because the Company’s bylaws

required majority consent for board action, 95 McDowell and Dunn could not impose

such a reporting system over the other board members’ objections. Even though

McDowell and Dunn were ultimately unsuccessful due to Brasser’s and Gentner’s

opposition, the Court cannot conclude in these circumstances that McDowell and

Dunn failed to “try [ ] to put in place a reasonable board-level system of monitoring

93(Dunn Dep. 41:10–19, ECF No. 114.6; Brasser Dep. 50:15–25, ECF No. 114.3; 2015

Financial Documents and Compensation 000003555–68.)

94 (See, e.g., 26 May 2017 Email.)

95 (rFactr Bylaws 6.)

and reporting,” Marchand, 212 A.3d at 821, or “utter[ly] fail[ed] to attempt to assure

a reasonable information and reporting system exists,” Caremark, 698 A.2d at 971.

50. Plaintiffs nonetheless argue that McDowell and Dunn should have done

more—and indeed they certainly could have made a formal request for board action,

proposed and voted for a board resolution, taken legal action, resigned in protest, or

taken other measures to advocate for a reporting system. But Caremark does not

require that directors do very much to meet their duty of loyalty in this context—they

simply must do something. And here, in the context of this board and this company,

to require McDowell and Dunn to initiate futile formal action to satisfy their duties

under Caremark would place form over substance and would be inconsistent with

both North Carolina and Delaware precedent. See, e.g., Custard, 2010 NCBC LEXIS

9, at *50–51 (noting that “every analysis of fiduciary conduct is contextual in nature,

and the contexts in which fiduciary duties are applied are constantly changing”); see

also, e.g., In re Citigroup Inc. S’holder Litig., 964 A.2d 106, 123 (Del. Ch. 2009) (“[T]o

establish oversight liability a plaintiff must show that the directors knew they were

not discharging their fiduciary obligations or that the directors demonstrated a

conscious disregard for their responsibilities such as by failing to act in the face of a

known duty to act.” (emphasis omitted)).

51. In sum, the undisputed facts show that McDowell and Dunn were not

disengaged, acquiescent, or blindly compliant directors. Rather, they were regularly

requesting financial information but were stymied by the two other members of the

Board who had an equal vote under the bylaws. While McDowell and Dunn certainly

could have taken other and perhaps more productive action, in this context,

Caremark does not require that they do more. Cf., e.g., ATR–Kim Eng Fin. Corp. v.

Araneta, No. 489–N, 2006 Del. Ch. LEXIS 215, at *75 (Del. Ch. Dec. 21, 2006) (finding

that independent board members breached their fiduciary duties after “they entirely

deferred to [a majority shareholder board member] in matters relating to the

[company]”). Thus, the Court concludes that Plaintiffs’ derivative claims based on

McDowell’s and Dunn’s alleged breach of their fiduciary duty to monitor and oversee

the Company should be dismissed.

2. Claims Based on Payment of Excessive Compensation

52. The Court next considers Plaintiffs’ claims for breach of fiduciary duty based

on Defendants’ alleged failure to prevent the payment of excessive compensation to

Brasser and Gentner. Plaintiffs contend that McDowell and Dunn consistently

recognized that Brasser’s and Gentner’s compensation was plainly excessive 96 yet

elected not to reduce either officer’s compensation despite their ability to do so as the

majority of the disinterested directors eligible to vote on the compensation paid to

these executives. 97

96 Indeed, Dunn stated in October 2015 that “[t]here is no question in my mind that the

comp[ensation] is excessive for this company given its weak positions and performance,”

(2015 Financial Documents and Compensation 000003502), and that “the salaries are

outrageous relative to revenue and cashflow especially as they endanger the very survival of

the company,” (Aff. William M. Butler, Dep Ex. 6, ECF No. 124.5). He later stated that

Brasser’s and Gentner’s compensation “cannot in good faith, business acumen, and in

accordance with our fiduciary responsibilities continue indefinitely.” (29 March 2017

Emails.) McDowell testified similarly, stating that he and Dunn were “horrified” at the level

of compensation paid to Brasser and Gentner, (McDowell Dep. 135:21–36:6, ECF No. 125.6),

and admitting that Brasser’s management did not reflect “a rational approach to things,”

(McDowell Dep. 153:13–54:6, ECF No. 125.6).

97 (Resp. 18–19.)

53. McDowell and Dunn move to dismiss, arguing that their decisions

concerning Brasser’s and Gentner’s compensation involved the careful exercise of

business judgment—one in which they balanced the compensation that the struggling

company could afford to pay against the need to pay compensation sufficient to retain

Brasser and Gentner, executives whose knowledge, experience, and abilities were

critical to the Company’s survival. 98 McDowell and Dunn contend that, on these

undisputed facts, their actions should be protected by the business judgment rule as

a matter of law.

54. A director’s standard of care is described in N.C.G.S. § 55-8-30 as follows:

[a] director shall discharge the director’s duties as a director, including

the director’s duties as a member of a committee or subcommittee, in

accordance with all of the following: (1) In good faith. (2) With the care

an ordinarily prudent person in a like position would exercise under

similar circumstances. (3) In a manner the director reasonably believes

to be in the best interests of the corporation.

55. The business judgment rule has been described as “an extension of the

fundamental principle that the management of the business and affairs of a

corporation is entrusted to its directors as the duly elected and authorized

representatives of the shareholders.” Russell M. Robinson, II, Robinson on North

Carolina Corporation Law § 14.06 (rev. 7th ed. 2006). The rule creates

an initial evidentiary presumption that in making a decision the

directors acted with due care (i.e., on an informed basis) and in good

faith in the honest belief that their action was in the best interest of the

corporation, and second, absent rebuttal of the initial presumption, a

powerful substantive presumption that a decision by a loyal and

98 (Lau and Dunn Br. 18–19; Chris Lau and Robert Dunn’s Reply to Pls.’ Mem. Opp’n Mot.

Summ. J. 6–8 [hereinafter “Lau and Dunn Reply”], ECF No. 131; McDowell Br. 28–29.)

informed board will not be overturned by a court unless it cannot be

attributed to any rational business purpose.

Custard, 2010 NCBC LEXIS 9, at *56–57 (quoting id.). As a result, “[t]he rule

precludes a court from unreasonably reviewing or interfering with managerial

decisions by [the board], thus allowing directors to be risk takers without being made

subject to judicial second guessing.” Robinson on North Carolina Corporation Law §

14.06.

56. As previously explained by Judge Tennille:

Absent proof of bad faith, conflict of interest, or disloyalty, the business

decisions of officers and directors will not be second-guessed if they are

“the product of a rational process,” and the officers and directors “availed

themselves of all material and reasonably available information” and

honestly believed they were acting in the best interest of the corporation.

[Citigroup, 964 A.2d at 124] (citation and footnote omitted). [The

business judgment rule] “is predicated on concepts of gross negligence.”

Id.

Custard, 2010 NCBC LEXIS 9, at *58.

57. Under North Carolina law, directors “are not, as a rule, responsible for mere

errors of judgment, nor for slight omissions from which the loss complained of could

not have reasonably resulted.” N.C. Corp. Com. v. Harnett Cnty. Tr. Co., 192 N.C.

246, 248 (1926). Nevertheless, “[e]vidence that a [director] was inattentive,

uninformed, acted in bad faith, or made a decision that is unreasonable may be

considered in determining that the business judgment rule does not apply to protect

alleged misdeeds.” Emrich Enters. v. Hornwood, Inc., 2022 NCBC LEXIS 19, at *45–

46 (N.C. Super. Ct. Feb. 15, 2022) (applying the business judgment rule to the actions

of managers). A reviewing court’s focus must be on the process undertaken by the

board, not the content of the decision made. Custard, 2010 NCBC LEXIS 9, at *57

(citing Caremark, 698 A.2d at 967–68).

58. Board decisions that approve compensation amounting to corporate waste

are not protected by the business judgment rule. See Ehmann v. Medflow, Inc.

(Ehmann I), 2017 NCBC LEXIS 88, at *58 (N.C. Super. Ct. Sept. 26, 2017) (citing

Grimes v. Donald, 673 A.2d 1207, 1215 (Del. 1996), overruled in part on other grounds

by Brehm v. Eisner, 746 A.2d 244 (Del. 2000)). “[W]aste entails an exchange of

corporate assets for consideration so disproportionately small as to lie beyond the

range at which any reasonable person might be willing to trade.” Ehmann v.

Medflow, Inc. (Ehmann II), 2020 NCBC LEXIS 46, at *62 (N.C. Super. Ct. Apr. 9,

2020) (quoting Krieger v. Johnson, 2014 NCBC LEXIS 13, at *22 (N.C. Super. Ct. Apr.

30, 2014)). Even where a contract reflects “some consideration,” there may still be a

finding of waste “if the value of the compensation to be paid is so out of all proportion

to the value of the services which the beneficiary would be expected to render that no

reasonable person would consider that the corporation would receive a quid pro quo.”

Ehmann II, 2020 NCBC LEXIS 46, at *63 (cleaned up). “A claim of waste will arise

only in the rare, ‘unconscionable case where directors irrationally squander or give

away corporate assets.’ ” Brehm v. Eisner (In re Walt Disney Co. Derivative Litig.),

906 A.2d 27, 74 (Del. 2006); see Ehmann II, 2020 NCBC LEXIS 46, at *63.

59. Here, McDowell and Dunn have acknowledged that they were “horrified” by

the “outrageous” and “excessive” compensation paid to Brasser and Gentner, and the

evidence is undisputed that the expert consulted by Dunn advised that Brasser’s

compensation, in particular, was 3 to 4.5 times higher than was typically paid to

executives of similarly situated companies. 99 At the same time, McDowell has

acknowledged that he considered Brasser “untrustworthy,” 100 that Brasser provided

information to the Board that he found “absolutely not useful” and “was basically just

lies,” 101 and that Brasser had engaged in conduct with Gentner that caused McDowell

to question “for years” whether Brasser and Gentner were acting with willful

malfeasance. 102 Ultimately, McDowell declared in June 2017 that “[Brasser] [was]

destroying this company for his own gain and [Gentner] is a willing accomplice.” 103

60. In the face of this evidence, and despite their decision not to take formal

action to reduce either executive’s pay even though they comprised a majority of the

disinterested directors entitled to vote on each executive’s compensation, McDowell

and Dunn argue that they are entitled to judgment as a matter of law because they

exercised reasonable business judgment in rejecting Brasser’s proposal to reduce his

salary and in addressing Brasser’s and Gentner’s compensation through informal

means. 104 McDowell and Dunn contend that Brasser and Gentner knew the most

about rFactr’s products, operations, and sales and that had they acted on their

99 (Resp. 18; Lau and Dunn Br. 18; McDowell Br. 26–27; see 2015 Financial Documents and

Compensation 000003504.)

100 (McDowell Dep. 121:2–12, ECF No. 125.6.)

101 (McDowell Dep. 177:11–78:3, ECF No. 125.6.)

102 (McDowell Dep. 190:12–21, ECF No. 125.6.)

103 (Aff. William M. Butler, Dep. Ex. 18, ECF No. 124.14.)

104 (See Lau and Dunn Br. 18–19; Lau and Dunn Reply 6–8; McDowell Br. 28–29.)

threats to leave the Company should they find their compensation unsatisfactory, the

Company was likely to fail, causing all investors to lose the full value of their

investments. 105 McDowell and Dunn assert that after learning of Brasser’s and

Gentner’s excessive compensation in late 2015 and failing in their first confrontation

with the pair regarding compensation, 106 they decided to reject Brasser’s proposed

compensation reduction and not to impose a compensation reduction through other

formal, confrontational action. Instead, they argue that they prudently sought to

convince Brasser and Gentner to accept less pay through informal persuasion, hoping

to convince them to reduce their drain on the Company’s cash while at the same time

motivating each to stay at the Company. 107

61. The issue thus posed is whether McDowell’s and Dunn’s rejection of

Brasser’s proposed compensation reduction and asserted strategy of informal action

to reduce excessive compensation is protected by the business judgment rule as a

matter of law when the undisputed evidence shows that McDowell and Dunn (i) knew

Brasser’s and Gentner’s compensation was clearly excessive, (ii) harbored strong

suspicions that the pair was engaging in willful malfeasance to the Company’s great

detriment, and (iii) had the authority to impose a compensation reduction through

formal board action but elected not to do so.

105 (Lau and Dunn Br. 18–19; Lau and Dunn Reply 7; Dunn Dep. 86:15–87:3, 88:1–5, ECF

No. 114.6.)

106 (2015 Financial Documents and Compensation 000003502, 000003559; McDowell Dep.

117:19–22, ECF No. 125.6.)

107 (McDowell Dep. 120:8–21:1, ECF No. 125.6; Dunn Dep. 87:8–19, 88:1–5, 99:4–100:7, ECF

No. 114.6; Aff. William M. Butler, Dep. Ex. 13, ECF No. 124.10.)

62. After careful review, the Court concludes that this record creates an issue of

fact as to whether McDowell and Dunn engaged in a rational process to address

Brasser’s and Gentner’s excessive compensation, see Custard, 2010 NCBC LEXIS 9,

at *58 (requiring a director’s decision to be the “product of a rational process” for

business judgment rule protection), or whether, by their lack of formal action, they

unreasonably permitted the waste of rFactr’s corporate assets, see Ehmann II, 2020

NCBC LEXIS 46, at *63. As such, the Court concludes that McDowell’s and Dunn’s

Motions should be denied on these claims alleging a breach of fiduciary duty in

connection with Brasser’s and Gentner’s compensation.

3. Duty of Loyalty and the Grapevine6 Deal

63. Plaintiffs also contend that McDowell and Lau breached their fiduciary

duties as directors by causing rFactr to reject a potential sale of rFactr to Grapevine6

to further their own financial gain at the Company’s expense. For support, Plaintiffs

point to minutes from rFactr’s 16 December 2017 board meeting reflecting that

although McDowell and Lau “made the decision to cancel the deal with Grapevine

because investors have more value with a tax write-off of 25% than in any deal going

forward,” Lau admitted that “this was a mistake” after Brasser and Gentner advised

that “not all investors have write-offs for capital gains, so this decision unfairly causes

real damages to a number of investors.” 108 Plaintiffs also point to Lau’s

108 (Resp. 21; 2017 Board Minutes 0000434–35.)

acknowledgement that he and McDowell were contemplating a purchase of rFactr at

the same time rFactr was negotiating a possible sale to Grapevine6. 109

64. McDowell and Lau argue that their actions are protected by the business

judgment rule and, in any event, offer undisputed evidence that Grapevine6 required

a $200,000 deposit to proceed to contract, which rFactr could not afford to pay. 110 As

a result, McDowell and Lau contend that even if they breached their fiduciary duty

to the Company, rFactr was not injured because no transaction with Grapevine6 was

ever possible. 111

65. Under North Carolina law, the duty of loyalty requires that “a fiduciary

must strive to advance the best interests of the corporation.” Seraph Garrison, LLC

v. Garrison, No. COA14-1166, 2016 N.C. App. LEXIS 1376, at *8 (N.C. App. Apr. 19,

2016) (citing In re The Walt Disney Co. Derivative Litig., No. 15452, 2004 Del. Ch.

LEXIS 132, at *5 n.49 (Del. Ch. Sept. 10, 2004)). “This requirement prohibits the

director from using the director’s position for personal gain to the detriment of the

corporation or its shareholders.” Robinson on North Carolina Corporation Law §

14.04; see Maurer v. SlickEdit, Inc., 2006 NCBC 1, at *56–57 (N.C. Super. Ct. Feb. 3,

2006) (“[W]here . . . a director proposes corporate action for which she has a personal

interest or agenda, there exists a duty of loyalty and a duty of candor to the

corporation and the other directors to disclose the personal interest.”). “Under a duty

109 (Resp. 22; Lau Dep. 189:25–92:2, ECF No. 125.4.)

110 (Lau and Dunn Br. 20; Lau and Dunn Reply 2–3; see McDowell Br. 28.)

111 (Lau and Dunn Br. 20; Lau and Dunn Reply 3; see McDowell Br. 28.)

of loyalty, a director is not only required to avoid conflicts of interest but also to (1)

act in the best interests of those to whom a fiduciary duty is owed and (2) try in good

faith to perform her duties with care.” Custard, 2010 NCBC LEXIS 9, at *52. The

business judgment rule only protects directors for “(1) an advertent business decision

(2) made by disinterested directors (3) within the scope of their authority (4) in good

faith (5) with reasonable care and (6) not for their own self-interests.” Robinson on

North Carolina Corporation Law § 14.06.

66. Here, Plaintiffs have offered substantial evidence that McDowell and Lau

were not disinterested and were acting to further their own self-interests in the

Grapevine6 transaction. As a result, the Court cannot conclude, as McDowell and

Lau urge, that the business judgment rule protects their actions as a matter of law

under the standard imposed by Rule 56. Accordingly, the Court must deny

Defendants’ Motions on this ground.

67. McDowell and Lau’s contention that their alleged breach did not cause

rFactr injury, however, has more traction. Not only have Plaintiffs failed to offer

evidence that the Grapevine6 transaction could have or would have resulted in a sale

benefitting rFactr had McDowell and Lau not rejected it, but the undisputed evidence

also shows that rFactr did not have the necessary funds and had not procured

investors or lenders interested in providing the necessary funds to permit the sale

process to go forward in earnest with Grapevine6. In these circumstances—where

there is no evidence permitting the inference that a sale to Grapevine6 could have

been possible but for McDowell and Lau’s self-dealing—Plaintiffs have failed to show

that McDowell’s and Lau’s alleged breach of fiduciary duty has caused injury to

rFactr. As such, Plaintiffs have failed to offer evidence of a necessary element of their

claim. See, e.g., Panzino v. Map Mgmt. of Charlotte LLC, 2021 NCBC LEXIS 13, at

*4 (N.C. Super. Ct. Feb. 12, 2021) (“To state a claim for breach of fiduciary duty, the

plaintiff must plead the existence of a fiduciary duty, a breach of that duty, and injury

proximately caused by the breach.”); see also, e.g., Meiselman v. Meiselman, 309 N.C.

279, 310 (1983) (recognizing that “the ability, financial or otherwise, of the

corporation to take advantage of [a corporate] opportunity” is relevant in the inquiry

of whether a corporate opportunity was usurped).

68. Based on the above, the Court concludes that Plaintiffs’ claims for breach of

fiduciary duty against McDowell and Lau arising from their actions in connection

with rFactr’s potential sale to Grapevine6 must be dismissed. 112

B. Individual Claims Against McDowell

69. Plaintiffs’ direct claims against McDowell for breach of fiduciary duty,

constructive fraud, and securities fraud all stem from McDowell’s alleged failure to

correct three representations Plaintiffs allege Brasser made to them in McDowell’s

112 Defendants argue more broadly that Plaintiffs have failed to offer evidence from which a

reasonable factfinder could conclude that any actions of Defendants caused rFactr’s

insolvency and Plaintiffs’ loss of their investments, contending that rFactr’s IRS tax liability

and its resulting collapse after disclosure of the IRS tax liens are the cause of Plaintiffs’ loss.

(McDowell Br. 25–28; Lau and Dunn Br. 23; McDowell Reply 13–14; Lau and Dunn Reply 9–

11.) The Court is not persuaded that such a conclusion is compelled as a matter of law under

Rule 56. Not only is “[p]roximate cause . . . ordinarily a question of fact for the jury,” Williams

v. Carolina Power & Light Co., 296 N.C. 400, 403 (1979) (cleaned up), but “[t]he Court should

only decide issues of proximate cause in those cases where reasonable minds could not differ

as to the foreseeability of injury,” In re Southeastern Eye Center–Pending Matters, 2019

NCBC LEXIS 29, at *178 (N.C. Super. Ct. May 7, 2019). Plaintiffs have offered sufficient

evidence of proximate cause to permit reasonable minds to differ here.

presence to induce Plaintiffs to purchase promissory notes in rFactr: (i) that rFactr

was a new company; (ii) that Plaintiffs’ investments would be used as bridge

financing to support a new subscription demand; and (iii) that rFactr would be cash

flow positive in six months. 113 Plaintiffs also allege that McDowell failed to disclose

that he would be paid a finder’s fee if Plaintiffs purchased rFactr’s promissory

notes. 114

70. McDowell moves to dismiss these claims, contending that the undisputed

evidence establishes as a matter of law that he did not owe Plaintiffs a fiduciary duty,

that he did not make any affirmative misrepresentations, and that he did not have a

duty to correct Brasser’s alleged misrepresentations or to disclose any compensation

he received for soliciting Plaintiffs’ investments.

1. Breach of Fiduciary Duty and Constructive Fraud

71. Plaintiffs argue that McDowell owed them a fiduciary duty because he

introduced them to Brasser, vouched for Brasser and rFactr, solicited their

investments by forwarding to them information about rFactr, represented that he

was “actively involved in management oversight” of rFactr, and otherwise induced

them to purchase rFactr’s promissory notes. 115

72. “To establish a claim for breach of fiduciary duty, a plaintiff must show that:

(1) the defendant owed the plaintiff a fiduciary duty; (2) the defendant breached that

113 (Am. Compl. ¶¶ 23–24.)

114 (Am. Compl. ¶ 27.)

115 (Resp. 23–24.)

fiduciary duty; and (3) the breach of fiduciary duty was a proximate cause of injury

to the plaintiff.” Sykes v. Health Network Sols., Inc., 372 N.C. 326, 339 (2019).

73. “For a breach of fiduciary duty to exist, there must first be a fiduciary

relationship between the parties.” King v. Bryant, 369 N.C. 451, 464 (2017) (quoting

Dalton v. Camp, 353 N.C. 647, 651 (2001)). “[A] fiduciary relationship is generally

described as arising when ‘there has been a special confidence reposed in one who in

equity and good conscience is bound to act in good faith and with due regard to the

interests of the one reposing confidence.’ ” Dallaire v. Bank of Am., N.A., 367 N.C.

363, 367 (2014) (quoting Green v. Freeman, 367 N.C. 136, 141 (2013)). “North

Carolina recognizes two types of fiduciary relationships: de jure, or those imposed by

operation of law, and de facto, or those arising from the particular facts and

circumstances constituting and surrounding the relationship.” Hager v. Smithfield

E. Health Holdings, LLC, 264 N.C. App. 350, 355 (2019).

74. As an initial matter, Plaintiffs conceded at the Hearing that McDowell does

not owe Plaintiffs a de jure fiduciary duty based on his role as a broker. 116 This

concession is supported by undisputed evidence establishing that McDowell was not

a personal broker to Plaintiffs, including Plaintiffs’ admissions that they never

entered a brokerage contract with McDowell or paid him for services related to their

purchase of rFactr promissory notes. 117

116 (Feb. 16, 2022 Hr’g Tr. 78:24–79:1 [hereinafter “Tr.”], ECF No. 140.)

117 (Kwon Dep. 13:4–14:10, ECF No. 103.1; Lee Dep. 15:14–16:2, ECF No. 103.2.)

75. Instead, Plaintiffs base their fiduciary duty claims on their alleged de facto

fiduciary relationship with McDowell. However, “[t]he standard for finding a de facto

fiduciary relationship is a demanding one: ‘Only when one party figuratively holds

all the cards—all the financial power or technical information, for example—have

North Carolina courts found that the special circumstance of a fiduciary relationship

has arisen.’ ” Lockerman v. S. River Elec. Membership Corp., 250 N.C. App. 631, 636

(2016) (quoting S.N.R. Mgmt. Corp. v. Danube Partners 141, LLC, 189 N.C. App. 601,

613 (2008)).

76. Rather than address this standard, Plaintiffs argue that McDowell owed

them a de facto fiduciary duty under the “special duty” exception recognized by our

Supreme Court in Barger v. McCoy Hillard & Parks, 346 N.C. 650 (1997). 118 But

Plaintiffs misunderstand the concept of “special duty” as used in Barger. As Judge

Adam M. Conrad of this Court has explained:

[The phrase “special duty” in Barger] comes from precedents dealing

with the distinction between individual and derivative suits. Our courts

have held that “a shareholder may maintain an individual action

against a third party for an injury that directly affects the shareholder,

even if the corporation also has a cause of action arising from the same

wrong, if the shareholder can show that the wrongdoer owed him a

special duty.” Barger, 346 N.C. at 658–59. A fiduciary duty is an

example of a special duty. So is a contractual duty. Other special

duties—including “when the wrongful actions of a party induced an

individual to become a shareholder”—are neither fiduciary nor

contractual, or at least not necessarily so. Id. at 659; see also Howell v.

Fisher, 49 N.C. App. 488, 498 (1980).

118 (Resp. 23.)

Kixsports, LLC v. Munn, 2021 NCBC LEXIS 32, at *37–38 (N.C. Super. Ct. Apr. 1,

2021).

77. Applying these principles here, the Court concludes that Plaintiffs have

failed to offer evidence from which a reasonable factfinder could conclude that

McDowell owed them a fiduciary duty. In particular, even if McDowell’s activities

created a special duty under Barger, Plaintiffs have failed to show that any special

duty he owed was a fiduciary one. Plaintiffs have neither argued nor offered evidence

that McDowell “held all the cards” in his relationship with Plaintiffs or controlled all

the information Plaintiffs could or did consider in making their investments in rFactr.

78. To the contrary, not only were Plaintiffs experienced, highly sophisticated

investors and finance professionals who had ample opportunity after the March 2014

dinner to conduct any necessary due diligence prior to making their investments, 119

but the undisputed evidence also shows that they frequently communicated with

Brasser and Gentner about rFactr and its finances and operations while they were

considering whether to invest. 120

79. At most, the undisputed evidence shows that McDowell was a source of

information to Plaintiffs, not the central and controlling figure in their investment

decision-making. Indeed, Kwon testified that he was satisfied to invest without

receiving certain information he had requested from Brasser because he did not want

119 (Kwon Dep. 9:2–22, ECF No. 103.1; Lee Dep. 10:13–12:16, ECF No. 103.2.)

120 (Kwon Dep. 25:4–18, ECF No. 103.1; Kwon Dep. 30:2–11, ECF No. 125.3; Lee Dep. 33:4–

13, ECF No. 103.2.)

to miss out on investing in this round of financing. 121 In these circumstances, a

fiduciary relationship with McDowell has not been shown to exist. 122 See, e.g., Howell

v. Heafner, 2020 NCBC LEXIS 105, at *39 (N.C. Super. Ct. Sept. 11, 2020) (finding a

de facto fiduciary relationship did not exist where investors failed to show that they

“were unable to request and receive more time to consider the [investment]

paperwork had they chosen to do so, ask questions about the [documents’] provisions

prior to signing, or hold back their signatures until any concerns were satisfied”).

Because Plaintiffs’ claims for breach of fiduciary duty and constructive fraud both

depend upon the existence of a fiduciary relationship, those claims must therefore be

dismissed with prejudice. 123

2. Securities Fraud Pursuant to N.C.G.S. § 78A-56(a), Section 10(b) of the

Exchange Act, and Rule 10b-5

80. Plaintiffs have asserted a claim against McDowell for securities fraud under

the NCSA and the United States Exchange Act for allegedly making material

omissions of fact by failing to disclose his finder’s fee and the falsity of Brasser’s

121 (Kwon Dep. 32:3–16, ECF No. 103.1.)

122 Because the Court has determined that McDowell did not have a fiduciary relationship

with Plaintiffs, he did not have a fiduciary duty to disclose that he would receive

compensation if they chose to invest. As discussed below, however, the Court concludes that

McDowell did have a duty to disclose that information under non-fiduciary principles of

North Carolina law.

123 See, e.g., Panzino, 2021 NCBC LEXIS 13, at *4 (“Constructive fraud and breach of

fiduciary duty are distinct claims with overlapping elements. To state a claim for breach of

fiduciary duty, the plaintiff must plead the existence of a fiduciary duty, a breach of that

duty, and injury proximately caused by the breach. Constructive fraud requires, as an

additional element, that the defendant sought to benefit himself through the breach.”)

(citations omitted)).

alleged March 2014 misrepresentations in inducing them to purchase rFactr

promissory notes. 124 McDowell seeks dismissal, contending that Plaintiffs’ claims are

barred by the applicable statute of limitations and, in any event, are unsupported by

any evidence. 125

a. Statute of Limitations

81. The statute of limitations for securities fraud actions is governed by

N.C.G.S. § 78A-56(f):

(f) . . . No person may sue under this section for any other violation of

this Chapter more than three years after the person discovers facts

constituting the violation, but in any case no later than five years after

the sale or contract of sale, except that if a person who may be liable

under this section engages in any fraudulent or deceitful act that conceals

the violation or induces the person to forgo or postpone commencing an

action based upon the violation, the suit may be commenced not later

than three years after the person discovers or should have discovered

that the act was fraudulent or deceitful.

(emphasis added).

82. McDowell argues that Plaintiffs’ claim is time-barred because Plaintiffs

made their relevant investments in March and April 2014 and did not commence this

124 (See Am. Compl. ¶¶107–15.) The parties appear to agree that McDowell need not be the

owner of a security to face liability under the NCSA. Indeed, our appellate courts have held

that “one who ‘successfully solicit[ed] the purchase [of a security], motivated at least in part

by a desire to serve his own financial interests or those of the securities owner,’ ” may be

subject to primary liability under North Carolina securities law. State v. Williams, 98 N.C.

App. 274, 279 (1990) (first alteration in original) (quoting Pinter v. Dahl, 486 U.S. 647 (1988));

see also Skoog v. Harbert Priv. Equity Fund, II, LLC, 2013 NCBC LEXIS 17, at *12 (N.C.

Super. Ct. Mar. 25, 2013) (describing how primary liability is not restricted to the owner of a

security).

125 McDowell argues without opposition from Plaintiffs that there is no evidence showing that

he was involved in Lee’s second investment in 2015. (McDowell Br. 24–25.) Accordingly, the

Court hereby dismisses Plaintiffs’ securities claim against McDowell to the extent it is based

on Lee’s second investment.

action until over five years later in November 2019. 126 McDowell argues further that

Brasser’s testimony permits a reasonable factfinder to conclude that Plaintiffs were

aware of McDowell’s fee no later than eighteen months after Plaintiffs’ notes were

purchased. 127

83. In response, Plaintiffs contend that their claims are within the three-year

tolling period under section 78A-56(f) because McDowell “knowingly concealed

material information, and failed to correct material misstatements, which ultimately

induced Plaintiffs’ investments in rFactr.” 128 Plaintiffs assert that they were first

made aware that McDowell concealed both the falsity of Brasser’s March 2014

representations and his own compensation for inducing their investments when

counsel compelled the disclosure of rFactr’s financials “at the earliest . . . in June

2017,” rendering the November 2019 filing timely. 129 Because the parties offer

conflicting evidence concerning when Plaintiffs learned of McDowell’s alleged

concealment, the Court concludes that McDowell has not carried his burden to show

that the securities claim is time-barred as a matter of law. Accordingly, the Court

will deny McDowell’s Motion on statute of limitations grounds.

126 (McDowell Br. 23–24.)

127 (Tr. 112:7–13:12.)

128 (Resp. 25.)

129 (Resp. 26; Kwon Dep. 51:19–25, ECF No. 125.3.)

b. Section 78A-56(a)(1) 130

84. Under section 78A-56(a)(1), “[a]ny person who[ ] [o]ffers or sells a security

in violation of [N.C.]G.S. . . 78A-8(3)” is subject to civil liability. 131 As provided in

N.C.G.S § 78A-8(3): “It is unlawful for any person, in connection with the offer, sale

or purchase of any security, directly or indirectly: . . . (3) To engage in any act,

practice, or course of business which operates or would operate as a fraud or deceit

upon any person.”

85. North Carolina courts have found that section 78A-56(a)(1) corresponds to

“federal actions based upon Rule 10b-5 of Section 10(b) of the Securities Act of 1934.”

Piazza v. Kirkbride, 246 N.C. App. 576, 598 (2016); see Saw Plastic, LLC v. Sturrus,

2017 NCBC LEXIS 76, at *26 (N.C. Super. Ct. Aug. 25, 2017). This Court has

previously summarized the elements for a claim under these provisions as follows:

[T]he elements of a cause of action under Rule 10b-5[, and § 78A-

56(a)(1)] include: (1) the making of a false statement or omission of

material fact or the use of a fraudulent device in connection with the

130 Plaintiffs appear to invoke both subsections of 78A-56(a) by broadly arguing that

McDowell “knowingly concealed material information, and failed to correct material

misstatements,” (Resp. 25), citing both section 78A-56, (Am. Compl. 16), and Rule 10b-5, (Am.

Compl. 16), in the Amended Complaint. See Atkinson v. Lackey, 2015 NCBC LEXIS 21, at

*16 (N.C. Super. Ct. Feb. 27, 2015) (“Through N.C.G.S. §§ 78A-56(a)(1) and 78A-56(a)(2), the

NCSA ‘delineates two different pathways to primary liability.’ ” (quoting NNN Durham Office

Portfolio 1, LLC v. Highwoods Realty Ltd. P’ship, 2013 NCBC 12, at *29 (N.C. Super. Ct. Feb.

19, 2013))).

131 While the Court recognizes that one who sends an email containing misrepresentations

may be liable under section 78A-56(a)(1) as “employ[ing] any device, scheme, or artifice to

defraud” or “engag[ing] in any act, practice, or course of business which operates or would

operate as a fraud or deceit upon any person[,]” see Lorenzo v. SEC, 139 S. Ct. 1094, 1100

(2019), the evidence here shows only that McDowell forwarded a slide deck describing

rFactr’s product to Lee, (Aff. William M. Butler, Dep. Ex. 22, ECF No. 124.16), and Plaintiffs

do not allege that the slide deck contained any misrepresentations or false information.

purchase or sale of any security; (2) made with scienter; (3) upon which

the purchaser justifiably relies; and (4) proximate causation.

Saw Plastic, LLC, 2017 NCBC LEXIS 76, at *26 (citation omitted). Further, “[a]n

action under [N.C.]G.S. § 78A-56(a)(1) ‘sounds in fraud, comparable to common law

fraud’ and ‘must include allegations and proof typical of common law fraud claims.’ ”

Id. (quoting NNN Durham Office Portfolio 1, LLC, 2013 NCBC LEXIS 12, at *30); see

also Brown v. Secor, 2020 NCBC LEXIS 134, at *29 (N.C. Super. Ct. Nov. 13, 2020)

(finding that the Court’s rulings as they relate to fraud “apply equally” to a claim

under section 78A-56(a)(1)).

86. To prevail on an omission-based securities fraud claim, as Plaintiffs assert

here, a plaintiff must allege:

(1) “the relationship [between plaintiff and defendant] giving rise to the

duty to speak;” (2) the event that triggered the duty to speak or the

general time period over which the relationship arose and the fraud

occurred; (3) “the general content of the information that was withheld

and the reason for its materiality;” (4) the identity of those under a duty

who failed to make such disclosures; (5) what the defendant gained from

withholding the information; (6) why the plaintiff’s reliance on the

omission was reasonable and detrimental; and (7) the damages the fraud

caused the plaintiff.

Island Beyond, LLC v. Prime Cap. Grp., LLC, 2013 NCBC LEXIS 48, at *18–19 (N.C.

Super. Ct. Oct. 30, 2013) (alteration in original) (quoting Lawrence v. UMLIC-Five

Corp., 2007 NCBC LEXIS 20, at *9 (N.C. Super. Ct. June 18, 2007)). Nevertheless,

“North Carolina courts have been loath to impose an obligation of disclosure on

commercial parties engaged in business negotiations.” Daniel Grp., Inc. v. Am. Sales

& Mktg., 2016 NCBC LEXIS 112, at *23 (N.C. Super. Ct. Dec. 15, 2016).

87. Under North Carolina law, a duty to disclose arises when:

(1) a fiduciary relationship exists between the parties to the transaction;

(2) there is no fiduciary relationship and a party has taken affirmative

steps to conceal material facts from the other; or (3) there is no fiduciary

relationship and one party has knowledge of a latent defect in the

subject matter of the negotiations about which the other party is both

ignorant and unable to discover through reasonable diligence.

In re Southeastern Eye Center–Pending Matters, 2019 NCBC LEXIS 29, at *54–55

(cleaned up) (quoting Hardin v. KCS Int’l, Inc., 199 N.C. App. 687, 696 (2009)). For

ease of reference, the Court will refer to these three circumstances as “Scenario 1,”

“Scenario 2,” and “Scenario 3.”

88. Here, Plaintiffs argue that “McDowell knowingly concealed material

information, and failed to correct material misstatements,” thereby inducing

Plaintiffs to invest in rFactr. 132

89. To begin, and as discussed above, McDowell did not owe Plaintiffs a

fiduciary duty. As a result, McDowell does not have a duty to disclose under Scenario

1.

90. Next, Plaintiffs do not allege and have failed to offer any evidence that

McDowell had a duty to disclose under Scenario 2. Rather than offer evidence of

required “affirmative acts,” Plaintiffs center their allegations and arguments on

McDowell’s failure to correct Brasser’s representations and to disclose his fee. They

identify McDowell’s silence as their only evidentiary support for their claim. This is

insufficient under North Carolina law to establish a duty to disclose under Scenario

2. See, e.g., Merrell v. Smith, 2020 NCBC LEXIS 93, at *29–30 (N.C. Super. Ct. Dec.

132 (Resp. 25.)

22, 2020) (affirmative acts giving rise to a duty to disclose included defendant giving

information to others but not plaintiffs, omitting material information from emails,

and concealing information while processing plaintiffs’ stock transfer forms);

Vitaform, Inc. v. Aeroflow, Inc., 2020 NCBC LEXIS 132, at *32 (N.C. Super. Ct. Nov.

4, 2020) (finding affirmative steps where defendants entered into business with

plaintiff, made representations to plaintiff, and requested trade secret information

from plaintiff to compete against plaintiff); Tillery Envtl. LLC v. A&D Holdings, Inc.,

2018 NCBC LEXIS 13, at *24–26 (N.C. Super. Ct. Feb. 9, 2018) (finding duty to

disclose where defendant took action “calculated to prevent discovery”); Shaw v. Gee,

2016 NCBC LEXIS 103, at *11–12 (N.C. Super. Ct. Dec. 21, 2016) (requisite

affirmative acts included instructing others not to disclose information and making

false assurances); see also United States v. Colton, 231 F.3d 890, 901 (4th Cir. 2000)

(“What is essential is proof of a ‘scheme or artifice to defraud,’ which can be shown by

deceptive acts or contrivances intended to hide information, mislead, avoid suspicion,

or avert further inquiry into a material matter.”); Parsons v. Hornblower & Weeks-

Hemphill, Noyes, 447 F. Supp. 482, 490 (M.D.N.C. 1977) (“We find nothing in Rule

10b-5 that purports to impose liability on anyone whose conduct consists solely of

inaction.” (quoting Wessel v. Buhler, 437 F.2d 279, 283 (9th Cir. 1971))).

91. Finally, Plaintiffs have also failed to offer evidence to show that McDowell

had a duty to disclose under Scenario 3.

92. First, as to Brasser’s alleged representation that rFactr was a new company,

the undisputed evidence shows that Plaintiffs could have learned the truth of rFactr’s

corporate status and history with reasonable diligence. Gentner advised Lee that the

Company’s audited financial statements were “from our 2013 Qualified Business

Valuation filing for the State of North Carolina,” 133 indicating that the statements

were rFactr’s, and those statements reflected that the Company had been in business

for a number of years. And although Plaintiffs argue that they reasonably believed

that the “Targeted Group” reflected in the financial statements was a holding

company, not rFactr itself, 134 Lee acknowledged that the Company’s use of the name

“Targeted Golf Group” would have compelled Plaintiffs to make reasonable

inquiry. 135 Nonetheless, it is undisputed that “Targeted Golf” is referenced by name

three times in the financial statements, 136 yet Plaintiffs failed to conduct any inquiry

to confirm their assumption.

93. In any event, a simple search of public filings on the North Carolina

Secretary of State website would have readily revealed that rFactr was an existing,

but renamed, company. 137 Plaintiffs’ failure to take even this basic step when they

had ample time to do so in these circumstances precludes their assertion that they

acted with reasonable diligence under North Carolina law. See, e.g., Hudson-Cole

Dev. Corp. v. Beemer, 132 N.C. App. 341, 346 (1999) (concluding that there was no

133 (Pls.’ Production 0000205 (emphasis added).)

134 (Resp. 4 n.10.)

135 (Lee Dep. 214:11–13, ECF No. 125.5.)

136 (Pls.’ Production 0000216.)

137 (rFactr Search Results.)

reasonable reliance where the party failed to review public records); Brown, 2020

NCBC LEXIS 134, at *19 (concluding plaintiff’s reliance on defendant’s alleged

misrepresentation was unreasonable when plaintiff had the opportunity to review

public records but failed to do so); Island Beyond, LLC, 2013 NCBC LEXIS 48, at *21

(determining that the plaintiffs did not demonstrate reasonable reliance where they

did not allege that they were prevented from accessing public records and the public

records would have shown the information that the defendants failed to disclose);

Crockett Cap. Corp. v. Inland Am. Winston Hotels, Inc., 2011 NCBC LEXIS 7, at *72

(N.C. Super. Ct. Feb. 28, 2011) (finding reliance was not reasonable when the party

did not review documents in its possession or conduct a title search).

94. In addition, Plaintiffs do not allege or offer evidence that Brasser or Gentner

took any action to prevent their inquiry into rFactr’s status as a new company or that

Plaintiffs had insufficient time to investigate the matter. To the contrary, the

undisputed evidence shows that Plaintiffs were provided with sufficient time and

access to Brasser and Gentner to ask questions, seek information, and otherwise

conduct due diligence for nearly a month before making their investments in

rFactr. 138 Brasser and Gentner provided Plaintiffs with written answers to the

questions Plaintiffs posed to them by email as well as audited financial statements,

and Brasser also spoke with Kwon by telephone. 139 Moreover, Plaintiffs attested in

138 (Lee Dep. 33:4–18, ECF No. 103.2; Kwon Dep. 25:4–25, ECF No. 103.1; Brasser Production

0002141–43, 0002152–54, 0002181–84, 0002189–92; Pls.’ Production 0000209–20.)

139 (Lee Dep. 33:4–18, ECF No. 103.2; Kwon Dep. 25:4–26:06, ECF No. 103.1; Brasser

Production 0002141–43, 0002152–54, 0002181–84, 0002189–92; Pls.’ Production 0000209–

20.)

their purchase agreements that, prior to making their investments, they had

“reviewed . . . [the] information regarding the Company and its business, operations,

market potential, capitalization, financial condition and prospects, and all other

matters [they] deemed relevant,” 140 yet Plaintiffs made no inquiry on this issue, one

they now claim was critical to their investment decision.

95. Because the undisputed evidence shows that Plaintiffs failed to make any

reasonable attempt to confirm their belief that rFactr was a new company, the Court

concludes as a matter of law that Plaintiffs have failed to show that McDowell had a

duty to disclose Brasser’s alleged misrepresentations under Scenario 3. See, e.g.,

Hardin, 199 N.C. App. at 697 (“When the parties deal at arms length and one party

has full opportunity to make inquiry but neglects to do so and the other party resorted

to no artifice which was reasonably calculated to induce the purchaser to forego

investigation action in deceit will not lie.” (cleaned up)).

96. Plaintiffs’ claims based on Brasser’s statements that rFactr would be

profitable in six months and that Plaintiffs’ investments would be utilized for

subscription demand fare no better. Plaintiffs rely for their support on Brasser’s

testimony that McDowell was “intimately involved” in Targeted Group 141—from

which they argue McDowell knew or should have known both statements were false.

The Court cannot conclude, however, that a reasonable factfinder may permissibly

infer from that alleged “intimate involvement” that McDowell knew at the time of

140 (Pls.’ Production 0000200; Aff. William J. Farley, III Supp. Defs. Chris Lau and Robert

Dunn’s Mot. Summ. J., Ex. K at 0000200, ECF No. 114.11; Am. Compl. ¶ 32.)

141 (Resp. 24; Brasser Dep. 29:23–24, ECF No. 125.1.)

Plaintiffs’ investments in 2014—when he was not yet a member of the Board—that

rFactr would not be cash flow positive in six months or that the Company had

contrary intentions for the proceeds of Plaintiffs’ investments. Indeed, Brasser

testified that he believed in February 2015 that rFactr could be profitable or cash

flow neutral in six months, 142 and it is undisputed that McDowell invested in rFactr

in July 2014 and again in June 2015. 143 Viewing this evidence in the light most

favorable to Plaintiffs, a reasonable factfinder could not reasonably conclude that

McDowell was aware that Brasser had misrepresented material information

regarding rFactr’s profitability to Plaintiffs and other investors in March 2014.

97. Accordingly, the Court concludes that McDowell’s Motion should be granted

to the extent Plaintiffs’ securities claims are based on McDowell’s failure to correct

Brasser’s three alleged misrepresentations.

98. The Court reaches a different conclusion, however, concerning McDowell’s

alleged failure to disclose that he would receive compensation should Plaintiffs invest

in the Company. Plaintiffs have offered evidence that McDowell was aware that he

would receive compensation if Plaintiffs invested, told Plaintiffs about his investment

in rFactr, and knew that Plaintiffs thereafter became interested in investing in the

Company. 144 Plaintiffs have also offered evidence that McDowell then arranged for

142 (Brasser Dep. 134:9–24, ECF No. 128.2.)

143 (Brasser Production 0185335.)

144 (Brasser Dep. 33:24–39:1, ECF No. 125.1; see Lee Dep. 202:14–03:9, ECF No. 125.5; Kwon

Dep. 24:10–15, ECF No. 125.3.)

Plaintiffs to meet Brasser, 145 sent investment materials to Plaintiffs, 146 and vouched

for Brasser and rFactr, 147 all without disclosing that he would be compensated if

Plaintiffs invested in the Company. 148

99. Although Plaintiffs could have inquired whether McDowell would receive a

fee for their investments, the record evidence does not compel the conclusion that a

reasonable investor should have made inquiry of McDowell about a possible fee for

obtaining their investment or otherwise suspected that McDowell would be paid

should they choose to invest. See Bucci v. Burns, 2020 NCBC LEXIS 79, at *26 (N.C.

Super. Ct. June 30, 2020) (finding a jury issue where plaintiffs had no reason to

suspect the falsity of a statement about non-public information). Since Plaintiffs have

averred that they would not have invested in rFactr had they known that McDowell

would be paid if he induced their investments, 149 the Court concludes that, based on

this record, McDowell’s Motion must fail as to this aspect of Plaintiffs’ securities

claims.

100. Based on the foregoing, therefore, the Court concludes that McDowell is

entitled to summary judgment on Plaintiffs’ securities fraud claims under section

145 (Brasser Production 0002113; Kwon Dep. 24:10–15, ECF No. 103.1.)

146 (Aff. William M. Butler, Dep. Ex. 22, ECF No. 124.16; Aff. William M. Butler, Dep. Ex. 23,

ECF No. 124.17.)

147 (Lee Dep. 31:16–18, 203:15–17, ECF No. 125.5; Kwon Dep. 28:14–25, ECF No. 125.3.)

148 (Kwon Dep. 51:17–24, ECF No. 125.3; Lee Dep. 204:5–7, ECF No. 125.5; Brasser Dep.

39:2–40:20, ECF No. 125.1.)

149 (Am. Compl. ¶¶ 26–27, 93, 113.)

78A-56(a)(1) and Rule 10b-5 to the extent they are based on McDowell’s failure to

correct Brasser’s alleged misrepresentations, but that McDowell’s Motion should be

denied to the extent Plaintiffs’ claims are based on McDowell’s alleged failure to

disclose that he would receive compensation should Plaintiffs invest in rFactr.

c. Section 78A-56(a)(2)

101. The Court next considers Plaintiffs’ claims against McDowell pursuant to

section 78A-56(a)(2).

102. Under section 78A-56(a)(2), civil liability will be imposed on

[A]ny person who[ ] . . . [o]ffers or sells a security by means of any untrue

statement of a material fact or any omission to state a material fact

necessary in order to make the statements made, in the light of the

circumstances under which they were made, not misleading (the

purchaser not knowing of the untruth or omission), and who does not

sustain the burden of proof that he did not know, and in the exercise of

reasonable care could not have known, of the untruth or omission[.]

103. “Section 56(a)(2) parallels § 12(a)(2) of the Federal Securities Act of 1933,

and ‘cases construing § 12[a](2) should be considered when interpreting § 78A-

56[(a)(2)].’ ” Skoog, 2013 NCBC LEXIS 17, at *14 (alterations in original) (quoting

Venturtech II, L.P. v. Deloitte Haskins & Sells, 790 F. Supp. 576, 588 (E.D.N.C. 1992)).

The section “is more akin to a negligence standard than intentional fraud[,]” Austin

v. Regal Inv. Advisors, LLC, 2018 NCBC LEXIS 3, at *42 (N.C. Super. Ct. Jan. 8,

2018), and “does not additionally require proof of scienter or justifiable reliance[,]”

NNN Durham Office Portfolio 1, LLC, 2013 NCBC 12, at *37.

104. There is “no general duty of disclosure imposed by either federal or North

Carolina securities laws[,]” Skoog, 2013 NCBC LEXIS 17, at *15, and disclosure is

required “only when necessary ‘to make . . . statements made, in the light of the

circumstances under which they were made, not misleading.’ ” Matrixx Initiatives,

Inc. v. Siracusano, 563 U.S. 27, 44 (2011) (citing 17 C.F.R. § 240.10b-5(b)).

Accordingly, when there is no other duty to speak, “[a]n omission must be tied to an

affirmative statement[.]” Skoog, 2013 NCBC LEXIS 17, at *15 (applying this

consideration to section 78A-56(a)(2) claims); see NNN Durham Office Portfolio 1,

LLC, 2013 NCBC 12, at *36 (noting that section 78A-56(a)(2) does not have a general

duty of disclosure and requires an affirmative statement “[l]ike § 56(a)(1)”); Ragsdale

v. Kennedy, 286 N.C. 130, 139 (1974) (“The rule is that even though a vendor may

have no duty to speak under the circumstances, nevertheless if he does assume to

speak he must make a full and fair disclosure as to the matters he discusses.”).

105. Applying these principles here, and because the Court concludes, as

discussed above, that McDowell did not have a duty to disclose that Brasser’s alleged

misrepresentations were false, Plaintiffs’ claims under section 78A-56(a)(2) may only

succeed if McDowell’s omission can be tied to an affirmative statement, made by

McDowell, that was misleading in the circumstances. See, e.g., Aldridge v. Metro.

Life Ins. Co., 2019 NCBC LEXIS 116, at *119 (N.C. Super. Ct. Dec. 31, 2019) (“[O]nly

where a seller elects to make a statement regarding a security does the NCSA require

that the statement contain sufficient material information to not be misleading.”); see

also Worley v. Moore, 2018 NCBC LEXIS 114, at *20–21 (N.C. Super. Ct. Nov. 2, 2018)

(finding that the defendant could not be liable under section 78A-56(b) or section 78A-

8(2) and had no duty to speak where the plaintiff did not assert that the affirmative

statements were made by the defendant).

106. Plaintiffs’ claims under section 78A-56(a)(2), however, are based on

Brasser’s alleged misrepresentations, not McDowell’s. 150 Although federal courts

suggest that omission claims may be based on statements by another if they are

adopted or attributed to the defendant, see e.g., In re First Union Corp. Sec. Litig.,

128 F. Supp. 2d 871, 889 (W.D.N.C. 2001), there is no evidence of record—certainly

no affirmative acts—from which a reasonable factfinder could conclude that

McDowell adopted Brasser’s statements as his own.

107. As a result, the Court concludes that to the extent that Plaintiffs’ claims

against McDowell under section 78A-56(a)(2) are based on Brasser’s alleged

misrepresentations, those claims must be dismissed. 151

108. The Court again reaches a contrary conclusion under this section concerning

Plaintiffs’ claims to the extent they are based on McDowell’s failure to disclose his

fee, and for the same reasons discussed above.

109. Accordingly, the Court concludes that Plaintiffs’ claims under section 78A-

56(a)(2) should be dismissed to the extent they are based on Brasser’s alleged

misrepresentations, but that McDowell’s Motion should be denied to the extent those

150 (Am. Compl. ¶ 23; Resp. 25.)

151 Plaintiffs plead at paragraph 110 of the Verified Amended Complaint that “McDowell was

involved in and materially aided rFactr’s sale of the Notes.” (Am. Compl. ¶ 110.) Plaintiffs,

however, have not offered evidence or arguments supporting any claim for “aiding and

abetting” liability under section 78A-56(c)(2) and thus, to the extent Plaintiffs assert a claim

on that theory, that claim is hereby dismissed.

claims are based on McDowell’s failure to disclose that he would receive compensation

in the event Plaintiffs invested in the Company.

V.

CONCLUSION

110. WHEREFORE, for the reasons set forth above, the Court hereby ORDERS

as follows:

a. The Court GRANTS the Motions as to Plaintiffs’ derivative claims for

breach of fiduciary duty based on a duty of oversight and a duty to monitor

and those claims are hereby dismissed with prejudice.

b. The Court GRANTS the Motions as to Plaintiffs’ derivative claims for

breach of fiduciary duty against Lau based on alleged excessive

compensation and those claims are hereby dismissed with prejudice.

c. The Court DENIES the Motions as to Plaintiffs’ derivative claims for

breach of fiduciary duty against McDowell and Dunn based on alleged

excessive compensation and those claims shall proceed to trial.

d. The Court GRANTS the Motions as to Plaintiffs’ derivative claims for

breach of fiduciary duty based on the duty of loyalty regarding rFactr’s

potential sale to Grapevine6 and those claims are hereby dismissed with

prejudice.

e. The Court GRANTS McDowell’s Motion as to Plaintiffs’ individual claims

for breach of fiduciary duty and constructive fraud and those claims are

hereby dismissed with prejudice.

f. The Court GRANTS McDowell’s Motion as to Plaintiffs’ individual claims

for securities fraud based on McDowell’s failure to correct Brasser’s

alleged misrepresentations and those claims are hereby dismissed with

prejudice.

g. The Court DENIES McDowell’s Motion as to Plaintiffs’ individual claims

for securities fraud (i) to the extent McDowell’s Motion is based on statute

of limitations grounds, and (ii) as to McDowell’s failure to disclose that he

would receive compensation if Plaintiffs invested in the Company, and

those claims shall proceed to trial, except that to the extent those claims

are based on Lee’s purchase of a $50,000 rFactr promissory note on 19

March 2015, those claims are hereby dismissed with prejudice.

SO ORDERED, this the 26th day of May, 2022.

/s/ Louis A. Bledsoe, III

Louis A. Bledsoe, III

Chief Business Court Judge