:ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 1 ...securities.stanford.edu/filings-documents/1037/OHI_01/...interest ofthe Companyand/orits shareholders. 1This is no $1.5

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:ase 3:07-cv-01429-J Document 128

ALAN W. SPARER (No. 104921)MARC HABER (No. 192981)JAMES S. NABWANGU (No. 236601)LAW OFFICES OF ALAN W. SPARER100 Pine Street, 33rd FloorSan Francisco, California 94111-5128Telephone: 415/217-7300Facsimile: 415/217-7307

,sparerlaw.comasparer,namhaberg,sparerlaw.comjnabwangu(c sparerlaw.com

Attorneys for PlaintiffsMICHAEL B. ESHELMAN, D.D.S.; PETERF. SILCHER, D.D.S.; and LORI I. SILCHER

Filed 04/18/2008 Page 1 of 19

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN FRANCISCO DIVISION

MICHAEL B. ESHELMAN, D.D.S.; PETER F. No. C 07 1429 JSWSILCHER, D.D.S.; and LORI I. SILCHER,

Plaintiffs,Action Filed: March 12, 2007

V.

ORTHOCLEAR HOLDINGS, INC. a BritishVirgin Islands Company ; ORTHOCLEAR,INC., a Delaware Corporation ; MUHAMMADZIAULLAH CHISHTI, an individual;HUAFENG "CHARLES" WEN, an individual;PETER RIEPENHAUSEN, an individual;ARTHUR T. TAYLOR, an individual;SAIYED ATIQ RAZA, an individual;CHRISTOPHER KAWAJA, an individual;PATRICIA HUMELL SEIFERT, an individual;JOSEPH BREELAND, an individual;MUDASSAR RATHORE, an individual;PAUL BADAWI, an individual; 3iTECHNOLOGY PARTNERS III, LP, aLimited Partnership ; and DOES 1 through 25,inclusive,

PLAINTIFFS' OPPOSITION TODEFENDANT 3i'S MOTION TO DISMISSTHIRD AMENDED COMPLAINT

Date: May 16, 2008Time: 9:00 a.m.Judge: Hon. Jeffrey S. WhiteCourtroom: 2, 17th FloorTrial Date: Not Set

Defendants.

PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW

ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 2 of 19

1 TABLE OF CONTENTS

2

INTRODUCTION AND SUMMARY OF ARGUMENT iv3

4 STATEMENT OF RELEVANT FACTS 1

5 ARGUMENT 3

6 I. PLAINTIFFS MEET THE REQUIREMENTS FORMAINTAINING A DERIVATIVE CLAIM. 3

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8 II. THE REPURCHASE OF 3i'S SHARES WAS MADE ULTRAVIRES.

9III. PLAINTIFFS SUFFICIENTLY HAVE PLED CLAIMS FOR

10 BREACH OF FIDUCIARY DUTY AND INTENTIONAL 9

11 AND NEGLIGENT MISREPRESENTATION.

12 A. Badawi ' s Role In The Align Settlement. 9

13 B. Badawi ' s Self-Dealing With Confidential Information. 11

14 IV. PLAINTIFFS ADEQUATELY HAVE PLED RELIANCE. 13

15 CONCLUSION 14

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-i-PLFS OPP TO 3i'S MTD THIRD AMENDED COMPLAINT C 07 1429 JSW

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TABLE OF AUTHORITIES

CASES

Abrons v. Maree, 911 A.2d 805 (Del. Ch. 2006)

Argiropoulos v. Kopp, No CCB-06-0769, 2007 U.S. Dist. LEXIS 22351(D. Md. Mar. 26, 2007)

Balin v. Amerimar Realty Co., No. 12896, 1996 Del. Ch. LEXIS 146 (Del.Ch. Nov. 15, 1996)

Deckert v. Independence Shares Corp., 311 U. S. 282 (1940)

De La Fuente v. FDIC, 332 F.3d 1208 (9th Cir. 2003)

Foss v. Harbottle, 2 Hare 461 (Eng. 1843)

Heilbrunn v. Hanover Equities Corp., 259 F. Supp. 936 (S.D.N.Y. 1966)

In re BP P.l.c. Deriv. Litig., 507 F. Supp. 2d 302 (S.D.N.Y. 2007)

In re Focus Media Inc., 3 87 F.3 d 1077 (9th Cir. 2004)

In re Hansen Natural Corp. Sec. Litig., 527 F. Supp. 2d 1142

(C.D. Cal. 2007)

In re Levi Strauss & Co. Sec. Litig., 527 F. Supp. 2d 965 (N.D. Cal. 2007)

In re PNB Holding Co. S'holders Litig., No. 28-N, 2006 Del. Ch. LEXIS158 (Del. Ch. Aug. 18, 2006)

In re Prudential Ins. Co. Deriv. Litig., 659 A.2d 961, 973 (N.J. Ch. 1995)

Kaster v. Modification Sys., Inc., 731 F.2d 1014 (2d Cir. 1984)

Larson v Dumke, 900 F. 2d 1363 (9th Cir 1990)

Lewis v. Sporck, 612 F. Supp. 1316 (N.D. Cal. 1985)

Malone v. Brincat, 722 A.2d 5 (Del. 1998)

Neubauer v. Goldfarb, 108 Cal. App. 4th 47 (2003)

Rademacher v. Russ, 131 F. Supp. 50 (D. Minn. 1955)

Remillard Brick Co. v. Remillard-Dandini Co., 109 Cal. App. 2d 405

(1952)

Seghers v. Thompson, No. 06 Civ. 308 (RMB) (KNF), 2006 U.S. Dist.LEXIS 71103 (S.D.N.Y. Sept. 27, 2006)

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Stoner v. Walsh, 772 F. Supp. 790 (S.D.N.Y. 1991)

Walczak v. EPL Prolong, Inc., 198 F.3d 725 (9th Cir. 1999)

Zarowitz v. BankAmeirca Corp., 866 F.2d 1164 (9th Cir 1989)

STATUTES & RULES

Cal. Corp. Code §309(a)

Fed. R. Civ. P. 23.1

OTHER

BVI Business Companies Act) §60

§61

§62

§121

§ 184C(1)(a)

§ 184C(2)(a)-(e)

§2116

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INTRODUCTION AND SUMMARY OF ARGUMENT

This is an opposition to Defendants 3i's and Badawi's Motion to Dismiss Plaintiffs' Third

Amended Complaint. Defendants argue that Plaintiffs' derivative action belongs to OrthoClear,

the payment to 3i was mandated by OrthoClear's Articles and Memoranda, and that Plaintiffs

have not pled their claims against Badawi with particularity. In addition, Defendants 3i and

Badawi, OrthoClear and Seifert all have argued that Plaintiffs cannot maintain a derivative action

and Plaintiffs' respond to all of their various arguments here.

Plaintiffs' claims are not antagonistic to the Class or OrthoClear and if successful would

even benefit remaining shareholders. Plaintiffs meet the requirements of bringing a derivative

action under BVI law and also have shown that demand would be futile given the inherent

conflicts of interest created by the 3i-OrthoClear settlement. Plaintiffs also seek leave to amend

to submit missing verifications. See Section I. The repurchase of 3i's shares was ultra vires and

also violated BVI law. 3i's argument rests on a clear misstatement of the Memorandum and

Articles of Association. See Section II. Based on Badawi's role in using insider information

gained on OrthoClear's board regarding the settlement with Align to force a quick settlement by

OrthoClear's and 3i's claims, Plaintiffs have stated claims for breach of fiduciary duty and

intentional and negligent misrepresentation. Even if the inadequate, incomplete and misleading

statements made on behalf of the Board in its solicitation of shareholder approval were not

deliberate, they were negligent and breached fiduciary duties owed to the remaining

shareholders. See Section III. Finally, contrary to Defendants' assertions, Plaintiffs have pled

sufficiently that they relied on Defendants' misstatements, and what they would have done absent

the misrepresentations . See Section IV.



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STATEMENT OF RELEVANT FACTS

On September 28, 2006, less than two months before the scheduled ITC hearing,

OrthoClear suddenly announced in a shareholder letter signed by Defendant Patricia Seifert that

it had reached a settlement with Align "to discontinue, worldwide, all design, manufacture,

marketing and sales of removable dental aligners," and would cease accepting patients and

transfer its intellectual property to Align. Third Amended Complaint ("TAC") ¶170.

The letter asserted that OrthoClear would receive $10 million for these concessions, and

another $10 million conditional on shareholders ' approval of the cessation of operations. Id. It

omitted the following information required as part of a full and accurate solicitation for

shareholder approval : that the settlement with Align would constitute a deemed liquidation of

OrthoClear; that given the Company ' s debts and financial position the $20 million would not

leave any substantial payment for the A, B and C Preferred Shareholders; that during the

preceding 2 years the Company had not accurately represented to investors the cost or risks of the

litigation with Align ("Align Litigation") or the conflicts between OrthoClear's technology and

Align ' s patents; that the individual directors and officers were securing immunity from suit for

infringement and theft of trade secrets as an important part of the settlement; and that approval of

three-fourths of each class of shares was required to authorize the Company's actions . Id. ¶¶171-

72, 179.

In response to shareholder questions about the settlement approval they had been asked to

give, OrthoClear sent a letter dated October 2, 2006 asserting that : ( 1) it was necessary to settle

because of increasing litigation costs ; (2) it was necessary to settle because ITC staff attorneys

had suggested an interpretation of one patent that increased the risk of an exclusion order

prohibiting OrthoClear from importing aligners ; (3) the settlement terms did not require

OrthoClear to "cease operations or to dissolve"; (4) no final decision had been made about the

approach to take, but "our goal is to maximize investor return "; (5) the "exact amount" of money

that may be returned to shareholders in each class "has not yet been determined and cannot be

determined unless and until there is an actual liquidation ." Id. ¶¶177-79.

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Badawi, as the 3i Board member and Class D Preferred share representative, knew or

should have known that the September 28 and October 2 letters, sent to shareholders to obtain

their approval of the Board's decision to settle with Align and related Board actions, contained

information that was incomplete, inadequate, misleading and/or false.

The settlement between Align and OrthoClear, approved by the shareholders in reliance

upon Defendants' misrepresentations, became effective October 6, 2006. TAC ¶181. Badawi

resigned from OrthoClear the same day. See 3i's Motion to Dismiss Third Amended Complaint

("3i MTD") at 2. 3i immediately demanded a return of its investment. TAC ¶179(f). When

OrthoClear demurred, 3i threatened litigation on grounds that apparently included OrthoClear's

misrepresentations regarding the Align Litigation. See Joint Case Management Conference

Statement ("Joint CMC") at 4. The parties engaged in negotiations which were kept secret from

the other investors. TAC ¶184. The negotiations resulted in a payment to 3i of substantially all

the funds it had invested. TAC ¶10; 3i MTD at 2. When that payment was announced in a letter

dated March 8, 2007 from OrthoClear signed by Chishti, it continued to reassure shareholders

that the Company was still in the process of determining what it could pay in liquidation and

telling the shareholders to be patient. TAC ¶¶187, 189.

3i has waived the confidentiality of its agreement with OrthoClear by selectively

disclosing portions which support its arguments and omitting those that do not. The settlement

agreement between 3i and OrthoClear provides that: OrthoClear will repurchase 3i's shares and

warrants for $8.5 million; defend and indemnify 3i from any litigation such as this class action

lawsuit up to an additional $1.5 million;' and aid 3i in any way to avoid being sued. In

consideration for these benefits, 3i granted OrthoClear and its directors and officers a full release

of claims.

No shareholder approval was sought or obtained for this agreement as required under BVI

law. No Board resolutions were passed making any finding that this Agreement was in the

interest of the Company and/or its shareholders.

1This is no $ 1.5 million windfall for A, B and C Preferred Shareholders.



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ARGUMENT

1.

PLAINTIFFS MEET THE REQUIREMENTS FORMAINTAINING A DERIVATIVE CLAIM.

Defendants in their three separate briefs offer a laundry list of largely duplicative reasons

why Plaintiffs should not be allowed to bring their claims derivatively for breach of fiduciary

duty (Count Five), for violation of BVI Business Companies Act Section 121 (Count Six), and

for violation of BVI Business Companies Act Section 2116 (Count Seven) to recover funds paid

to 3i.

First, Defendants argue that the TAC was not verified as it should have been.

OrthoClear's Motion To Dismiss Third Amended Complaint ("OC MTD") at 9; Seifert's Motion

To Dismiss Third Amended Complaint ("Seifert MTD") at 11. Although the original complaint

was verified, the TAC was not, and Plaintiffs respectfully request leave to submit the missing

verifications . See In re Hansen Natural Corp. Sec. Litig., 527 F. Supp . 2d 1142, 1163 (C.D. Cal.

2007) (Dismissal without leave to amend is improper unless it is clear that the complaint could

not be saved by any amendment).

Second, Defendants claim that Plaintiffs' economic interests are antagonistic to the

interests of the other shareholders of the Company, and therefore they cannot act derivatively.

The cases cited are inapposite. OC MTD at 9; Seifert MTD at 11-12. In Argiropoulos v. Kopp,

No CCB-06-0769, 2007 U.S. Dist. LEXIS 22351 (D. Md. Mar. 26, 2007), plaintiff was pursuing

individual claims to recover debts from the defunct corporation in clear competition with the

other plaintiff shareholders. Id. at *25. Here, the representative Plaintiffs seek recovery on

behalf of all shareholders other than Defendants, and the only shareholders who would not

benefit are those who have already settled by waiving all claims against Defendants . See Balin v.

Amerimar Realty Co., No. 12896 , 1996 Del. Ch . LEXIS 146, at * 10-* 11 (Del . Ch. Nov. 15,

1996) (shareholder can represent both a class and a derivative action where plaintiff seeks a

remedy for the benefit of all shareholders , not for himself alone ; and where individual claims do

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not preclude a recovery by the corporation on the derivative claims).

The other cases cited by Defendants are equally unhelpful. In Zarowitz v. BankAmerica

Corp., 866 F .2d 1164 (9th Cir 1989), the plaintiff sought to block two settlements that would

have benefited other plaintiffs but have an adverse effect on his damages action for wrongful

termination . In Larson v Dumke, 900 F.2d 1363, 1368 (9th Cir 1990), the court allowed the

plaintiff to remain the shareholder representative despite his individual claims because (as here)

"if the derivative claim is proved, the damages accrued to the corporation would benefit minority

shareholders."

Without any authority, Defendants also argue that there is economic antagonism between

the Company ' s claim and the shareholders' claim , because they compete for the same pool of

money . OC MTD at 9-10; Seifert MTD at 11-12. That is incorrect, since many of the

shareholder claims are covered by D&O insurance . In any event, since OrthoClear is not an

ongoing concern, the Company's and Plaintiffs ' interest in recovering funds are the same: to

compensate the remaining shareholders for their loss. When Plaintiffs ' claims are satisfied, there

is no need for further efforts on behalf of the Company. Courts have long held that Plaintiffs

may bring an action for rescission jointly with derivative claims . See Rademacher v. Russ, 131

F. Supp . 50, 52-53 (D. Minn . 1955) (denying motion to dismiss and allowing restitution and

derivative claims to proceed jointly); Heilbrunn v. Hanover Equities Corp., 259 F . Supp. 936,

939 (S .D.N.Y. 1966) (denying motion to dismiss where plaintiffs brought class action claim

based on fraud, claims for rescission and derivative claim).

Third, Defendants argue that the claims do not meet the conditions for bringing a

derivative action under BVI law. 3i MTD at 4-5; OC MTD at 10-11. The BVI law which

authorizes derivative actions became effective only on January 1, 2006, and there are no cases

interpreting it.2 Section 184C(1)(a) of the BVI Business Companies Act authorizes shareholders

2For that reason Defendants citations to Foss v. Harbottle, 2 Hare 461 (Eng. 1843), andSeghers v. Thompson, No. 06 Civ. 308 (PNM) (KNF), 2006 U. S. Dist . LEXIS 71103 (S.D.N.Y.Sept . 27, 2006), are unavailing. Both rely on English common law which was superseded by theenactment of BVI Companies Act Section 184C. We note that even English common lawrecognizes and allows derivative actions in certain circumstances . See In re BP P./.c. Deriv.Litig., 507 F. Supp . 2d 302, 311 (S.D.N.Y. 2007). English law prescribes two exceptions to the


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to "bring proceedings in the name and on behalf of' the company, subject to certain conditions,

which never have been interpreted. On their face they are satisfied. The shareholders must be

acting in good faith. Id. § 184C(2)(a). They are. The action must take into account the "views of

the company's directors on commercial matters." Id. §184C(2)(b). There is no commercial

matter at stake in this particular derivative action. The court is also directed to consider "whether

the proceedings are likely to succeed;" and "the costs of the proceedings in relation to the relief

likely to be obtained." Id. § 184C(2)(c), (d). Since the case is proceeding on a contingent fee

basis, the cost or success is not an issue for the Company, and in any event most of the same

costs would be incurred in bringing the non-derivative claims. The potential benefit to the

Company and its shareholders is in excess of $8.5 million.3 The final test is "whether an

alternative remedy to the derivative claim is available. Id. § 184C(2)(e). This Court has ruled as

a matter of law that none are available to shareholders.

Although there is apparently no requirement of demand or demand futility under BVI

law, Defendants reach for it as another obstacle to this proceeding. However, it is clear that in

this case demand is futile under any reasonable standard. The facts show that the D&O

Defendants and Badawi: failed to disclose the reasons for the settlement with Align; mislead

shareholders to induce them to approve the settlement; failed to disclose to shareholders the

allegations made against the Company by 3i and the terms of the settlement with 3i; and falsely

induced Plaintiffs not to take action while they secretly negotiated the settlement and substantial

payment to 3i. TAC ¶200.4 In addition, since 3i has waived the confidentiality of its Settlement

Foss v. Harbottle rule that are applicable here: (1) where the alleged wrong is ultra vires, (2)where the validity of the transaction is dependent upon approval by a majority of shareholdersgreater than a simple majority.

3In addition to the $8.5 million paid 3i under its settlement agreement with OrthoClear, italso can be assumed that OrthoClear is paying 3i under the agreement's secret indemnityprovision-a poison pill designed to deter any A, B or C shareholder from suing 3i.

4Badawi's actions are similar if not identical to those of Atiq Raza, who alsomisappropriated inside information about the settlement for his own benefit. On January 22,2008, Raza settled SEC charges for fraud and insider trading by agreeing to pay nearly $3 millionin disgorgement and penalties, and agreeing to be barred from serving as an officer or director ofany public company for five years. TAC ¶172.



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Agreement with OrthoClear and the D&O Defendants, Plaintiffs can now disclose that in return

for the $8.5 million payment to 3i (and indemnification obligations of up to another $1.5

million), the D&O Defendants were granted full releases from claims that 3i had against them

individually, including the very misrepresentation claims that Plaintiffs allege in this case.

Even under the cases upon which 3i relies, this is sufficient to demonstrate demand

futility. In Lewis v. Sporck, the court noted that allegations of "approval of corporate action"

together with evidence of "`self-interest or other indication of bias"' adequately would

demonstrate demand futility. 612 F. Supp. 1316, 1322 (N.D. Cal. 1985) (quoting Greenspun v.

Del. E. Webb Corp., 634 F.2d 1204, 1210 (9th Cir. 1980)). Bias, in turn, requires allegations that

"the act benefited the directors personally at the expense of the corporation." Id. (citing In re

KauffmanMut. FundActions, 479 F.2d 257, 265 (1st Cir. 1973)). This is precisely what

Plaintiffs have alleged. The demand futility allegations are not (as 3i claims) merely that the

D&O Defendants "approved" of the alleged wrongdoing, "would have to sue themselves" and

that they are named as defendants. 3i MTD at 5. Through this lawsuit, the D&O Defendants

stand accused of giving away corporate assets when threatened with claims of misrepresentation

and in order to buy immunity from 3i. The D&O Defendants put their own interests ahead of the

interests of the company and cannot now legitimately be expected to act disinterestedly on behalf

of the shareholders.

More than being prevented from acting on behalf of the Company by their own self-

interest, OrthoClear, at this point, is incapable of instituting this action on its own behalf. TAC

¶200. It simply does not have the resources or even the structural capacity to do so. The federal

rules require only that the complaint "state with particularity ... the reasons for not obtaining the

action or not making the effort." Fed. R. Civ. P. 23.1. Whether a particular demand would be

"futile" "useless" or "unavailing" "depends on the circumstances of the individual case and is

within the discretion of the district court." Kaster v. Modification Sys., Inc., 731 F.2d 1014, 1018

(2d Cir. 1984) (citing Lewis v. Graves, 701 F.2d 245, 248 (2d Cir. 1983)). Here, OrthoClear has

wound down its affairs and does not have a management in place to direct litigation against the



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D&O Defendants, Badawi and 3i. OrthoClear has only one employee, an in-house attorney. It

has no regularly functioning officers or other management. What little assets are remaining in

the Company are going towards defending the D&O Defendants, and (perhaps), indemnifying 3i

and Badawi.

In fact, other than the D&O Defendants' own funds, the only remaining source for

recovery for the shareholders is the directors' and officers' liability insurance that the Company

purchased for them. TAC ¶200. However, such policies now typically exclude coverage for any

action brought directly by a company against its own board of directors and officers, under a

"insured versus insured exclusion." In conjunction with OrthoClear's precarious financial

situation and indemnity obligation to 3i, such an exclusion makes it practically impossible for

D&O Defendants to institute an action on behalf of OrthoClear. The cases cited by 3i (3i MTD

at 6), which hold only that an "insured versus insured exclusion" standing alone is insufficient

basis for demand futility, are therefore inapposite. In re Prudential Ins. Co. Deriv. Litig., 659

A.2d 961, 973 (N.J. Ch. 1995) (rejecting a blanket rule that an exclusion by itself makes demand

futile, but noting that such an exclusion "might decrease the likelihood that demand will be

accepted"); Stoner v. Walsh, 772 F. Supp. 790, 805 (S.D.N.Y. 1991) (rejecting "assertion that the

exclusion automatically renders a board member `interested ... "') (emphasis added).

H.

THE REPURCHASE OF 3i'S SHARES WAS MADEULTRA VIRES.

3i insists that it was entitled to the payment pursuant to its liquidation preference

expressed in Section 12 of the Memorandum of Association. 3i MTD at 7-8. However,

Section 12 is irrelevant because both it and OrthoClear concede that the payment made was not

part of a liquidation process, but pursuant to a "settlement agreement" in which OrthoClear

acquired 3i's shares. 3i's Motion To Dismiss Second Amended Complaint at 3; OC MTD at 11.

Share repurchases are not governed by Section 12, but Section 18 of OrthoClear's Articles of

Association and Sections 60, 61 and 62 of the BVI Business Companies Act. Request For



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Judicial Notice In Opposition To Defendants' Motions To Dismiss Third Amended Complaint;

Declaration Of James S. Nabwangu In Opposition To Motions To Dismiss Third Amended

Complaint Ex. C. Those sections were not complied with. TAC ¶193.

Article 18 of OrthoClear's Articles of Association empowers the Company's directors to

repurchase shares from less than all shareholders only under limited conditions. See Declaration

of Joseph V. Mauch In Support Of OrthoClear's Motion To Dismiss Third Amended Complaint

Ex. A (Article 18 of Defendant OrthoClear's Articles of Association). Defendant 3i claims that

under Section 9 of the Memorandum, 3i needed only a writing from the Company for a share

repurchase to be valid. Section 9 is qualified, however, by the provisions of the Company's

Articles. Section 9 of the Memorandum states that "[s]ubject as otherwise provided in the

Articles, ... the Preference Shares shall not be entitled or subject to redemption or repurchase by

the company except ... as otherwise agreed to in writing by the Company ...." Id. (emphasis

added). This reference plainly requires the terms of a repurchase to satisfy the Articles of

Association. Article 18(a) makes any repurchase subject to Sections 60, 61 and 62 of the BVI

Business Companies Act.

Those Sections of the Companies Act prohibit repurchase of less than all of the shares of

the company (as occurred here) unless the shareholders approve of the purchase or the Directors

pass a resolution "stating that, in their opinion, (a) the ... acquisition is to the benefit of the

remaining shareholders ; and (b) the terms of the offer and the consideration offered for the shares

are fair and reasonable to the company and to the remaining shareholders." See Declaration of

James S. Nabwangu In Opposition to Defendants ' Motions To Dismiss Third Amended

Complaint Ex. B (BVI Bus . Cos. Act §§60, 61 ). The shareholders did not approve the purchase

(TAC ¶190), and the Directors never passed such a resolution, nor could they have done so given

its effect on the Company and the remaining shareholders . TAC ¶193 . Accordingly , the TAC

adequately alleges that the repurchase of 3i' s Series D Preferred Shares violated the OrthoClear

Memorandum and Articles of Association, and justifies a constructive trust.


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A. Badawi' s Role In The Align Settlement.

Defendants falsely claim that Badawi cannot be sued for breach of fiduciary duty based

on the payment from OrthoClear to 3i because it was entered into after Badawi left the Board. 3i

MTD at 10. Their agreement fails for the reasons stated below.

First, Badawi had a duty to act honestly and in good faith with a view to the best interests

of OrthoClear and all its shareholders . Cal. Corp. Code §309(a). Second, Directors have a

fiduciary duty to shareholders to exercise due care, good faith and loyalty when requesting

shareholder action . See, e.g., Malone v. Brincat, 722 A. 2d 5, 10 - 11 (Del . 1998). Inaccurate

information in the context of director statements to shareholders in conjunction with a request for

shareholder action "may be the result of a violation of the fiduciary duties of care, loyalty or

good faith," and directors are required to supply shareholders with " all information that is

material to the action being requested and to provide a balanced, truthful account of all matters

disclosed in the communications with shareholders ." Id. at 11-12; Abrons v. Maree, 911 A.2d

805, 812 (Del. Ch . 2006) (same); In re PNB Holding Co. S'holders Litig., No. 28-N, 2006 Del.

Ch. LEXIS 158, at *56 (Del. Ch. Aug. 18 , 2006) (same).5

Accordingly, Defendant Badawi's liability for breach of fiduciary duty is premised on his

role leading up to the final payment, which began while he was on the Board of OrthoClear, and

5See also De La Fuente v. FDIC, 332 F.3d 1208 , 1222 (9th Cir . 2003 ) (duty of candorrequires fiduciaries to disclose "all material information relevant to corporate decisions fromwhich they may derive a personal benefit") (citation and internal quotation marks omitted);Neubauer v. Goldfarb, 108 Cal . App. 4th 47, 62 (2003) ("[D]irectors and majority shareholdersowe a fiduciary duty to minority shareholders which requires complete candor in disclosing fullyall of the facts and circumstances surrounding a transaction") (citation and internal quotationmarks omitted); Remillard Brick Co. v. Remillard-Dandini Co., 109 Cal. App. 2d 405, 420(1952) (director "cannot utilize his inside information and his strategic position for his ownpreferment," and "cannot use his power for his personal advantage and to the detriment of thestockholders and creditors no matter how absolute in terms that power may be and no matter howmeticulous he is to satisfy technical requirements").



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included among other points: misrepresenting the terms of the Align settlement to shareholders;

failing to disclose that 3i intended immediately to seek a return of its funds, and failing to

disclose that 3i would be the exclusive shareholder beneficiary of the proposed settlement. TAC

¶179. Thus, the claims against Badawi relate directly to the actions he took and failed to take at

the time he was a director when OrthoClear settled with Align and solicited shareholder approval

of the Board's action. Badawi cannot immunize his unlawful course of conduct by resigning as a

director in the middle of it. The fact that 3i was not able to obtain the payment until after Badawi

resigned does not cure the breach of fiduciary duty while he was a director.

Finally, it is clear that the September 28 and October 2 letters misstated the reasons for

and consequences of the Align settlement, and were designed to lull shareholders into inaction.

Instead of disclosing the financial and business impact of the settlement, OrthoClear instead

concealed that it needed a three-fourths vote of each class of shares to consummate the settlement

and transfer its patents . TAC at ¶179(d). The letter also falsely suggested that the only question

for shareholder decision was whether or not to agree to abandon OrthoClear's operations outside

the United States in return for a second $ 10 million, bringing the total settlement to $20 million.

TAC ¶170.

The October 2 letter stated falsely that: (1) it was necessary to settle because of

increasing litigation costs (OrthoClear hadjust raised $10 million from 3i tofund litigation

costs); (2) it was necessary to settle because ITC staff attorneys had suggested an interpretation

of one patent that increased the risk of an exclusion order prohibiting OrthoClear from importing

aligners into the United States (Six months prior, Seifert had said the ITC decision would not

affect OrthoClear's ability to operate in the U.S.); (3) the settlement terms did not require

OrthoClear to "cease operations or to dissolve" (3i asserted at the time that the Align settlement

was a "deemed liquidation" (3i MTD at 1)); (4) no final decision had been made about the

approach to take, but "our goal is to maximize investor return" (implyingfalsely that the

settlement would leave the Company in afinancial position to do other than liquidate); (5) the

"exact amount" of money that may be returned to shareholders in each class "has not yet been



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determined and cannot be determined unless and until there is an actual liquidation" (apparently

a precept not applicable to 3i, since OrthoClear was able to determine what could be returned to

3i within a matter ofmonths and before any other distribution). TAC ¶¶176-79 (emphasis

added). Neither letter, as Defendants wish, states that the solicitation was for approval of an

effective "deemed" liquidation of OrthoClear, which is Defendants' justification for its secret

payment to 3i.

B. Badawi 's Self-Dealing With Confidential Information.

Defendants 3i and Badawi deny that they used information gained by Badawi's presence

on the Board to further the interests of 3i. 3i was able to extract a "settlement" from OrthoClear

of millions of dollars, long before any of the other investor, and months before any formal

liquidation of the company. Indeed, no liquidation yet has taken place. See TAC ¶¶180, 187; see

n.4, supra. In addition, 3i was able to obtain an indemnification from OrthoClear for a sum of up

to $1.5 million, making the settlement worth its entire investment. 3i and Badawi only have

recently disclosed that the payment it received from OrthoClear represented a settlement of

"other potential claims." See Joint CMC at 4. In connection with this disclosure, 3i disclosed for

the first time that at the time it invested in August 2006, OrthoClear misrepresented to 3i that no

basis for Align's claims existed, and failed to disclose the advanced stage ofsuch claims. Id. at

3-4. 3i now wants to distance itself from its CMC statement, and have it both ways. For

instance, 3i and Badawi argue that their settlement, which includes "other potential claims," is

"neither remarkable nor untoward." 3i MTD at 11-12. At the same time, they claim that the

sudden shuttering of OrthoClear would make any reasonable investor claim fraud. Id. at 12.

The reality is that Badawi participated in Board meetings where the reasons for the Align

settlement were discussed. He also participated in seeking shareholder approval of the Align

settlement and knew that other investors were being told that no distributions would be made

before a final decision to liquidate was announced-a promise Badawi had no intention of

honoring. See 3i MTD at 12. Badawi now explains that his swift departure from the Board after

the Align settlement was an effort to avoid "any potential conflict of interest" so 3i could press



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its claims . See 3i MTD at 12.

Badawi's sudden departure from the Board, the size of the settlement (obtained by 3i

through secret negotiations), and how rapidly it was obtained, all evidence Badawi's breach of

fiduciary duty by using information for his own benefit and the benefit of 3i. Where, but from a

Board member privy to the problems in the ITC proceeding and settlement discussions with

Align, and the Board discussions of the Company's finances and future plans could 3i have

obtained the information it used to immediately demand and extract a 100% settlement from

OrthoClear? Meanwhile, other shareholders were misled into waiting for the Company's next

steps.

The same allegations that state a claim for breach of fiduciary duty also give rise to State

common law claims for intentional and negligent misrepresentation resulting from the

September-October 2006 solicitation for approval of the Align settlement, and related

misrepresentations and omissions regarding the distribution of the proceeds.6 Even if the

inadequate, incomplete and misleading statements made on behalf of the Board in its solicitation

of shareholder approval were not deliberate but merely negligent, the letters caused shareholders

to stand by while 3i secretly obtained the bulk of the available funds to satisfy investor claims.

Defendants wrongly assume that Plaintiffs must plead the negligent misrepresentation claim with

particularity under Federal Rule of Civil Procedure 9(b). First, generally, only fraud claims must

be plead with particularity. Second, "` [w]here averments of fraud are made in a claim in which

fraud is not an element, an inadequate averment of fraud does not mean that no claim has been

stated. The proper route is to disregard averments of fraud not meeting Rule 9(b)'s standard and

then ask whether a claim has been stated."' In re Levi Strauss & Co. Sec. Litig., 527 F. Supp. 2d

965, 979 (N.D. Cal. 2007) (quoting In re Daou Sys. Inc. Sec. Litig., 411 F.3d 1006, 1027 (9th Cir.

2005)). Without the allegations of intentional fraud, Plaintiffs' allegations support a claim of

6Plaintiffs' SAC mistakenly omitted Badawi from the negligence cause of action, and theCourt's prior order did not address Plainffs' claims of negligent misrepresentation againstBadawi. See 1/18/08 Order Granting Motions to Dismiss ("1/18/08 Order") at 13-16.Accordingly, Plaintiffs amended the TAC to ensure Defendant Badawi was on notice of thisclaim.



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I negligent misrepresentation.

IV.

PLAINTIFFS ADEQUATELY HAVE PLED RELIANCE.

The Court held that Plaintiffs needed to plead reliance (1/18/08 Order at 11), and

Plaintiffs have done so. The TAC alleges that had Plaintiffs known the facts that were concealed

or omitted, they would not have voted to approve the settlement with Align, and would have

taken immediate steps to hold Defendants accountable. TAC ¶180. This is not a holders claim,

and selling shares was not one of Plaintiffs' options. Plaintiffs raised questions at the time the

first letter was sent announcing the settlement, leading to a second letter that contained

misinformation and omitted information available to the Company about the financial impact of

the proposed settlement payment from Align.

Had investors been told the true state of affairs in October 2006 at the time they were

asked to approve the settlement, they could have protected their rights by promptly filing an

action against OrthoClear, which effectively would have prevented distributions such as occurred

with 3i until all claims against OrthoClear were sorted out. See, e.g., Deckert v. Independence

Shares Corp., 311 U.S. 282, 288 (1940) (violation of Securities Act Section 12 states a claim for

equitable relief); Walczak v. EPL Prolong, Inc., 198 F.3d 725, 730 (9th Cir. 1999) (injunction

available against shareholder distributions where Plaintiffs seek equitable relief); see also In re

Focus Media Inc., 387 F.3 d 1077 (9th Cir. 2004).



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Attorneys for Plaintiffs MICHAEL B. ESHELMAN,D.D.S.; PETER F. SILCHER, D.D.S.; and LORI I.SILCHER

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CONCLUSION

For all the reasons set forth above, Defendants' Motion to Dismiss should be DENIED.

DATED: April 18, 2008 Respectfully submitted,

LAW OFFICES OF ALAN W. SPARER

By: /s/

ALAN W. SPARER


Documents

:ase 3:07-cv-01429-J Document 128 Filed 04/18/2008 Page 1 ...securities.stanford.edu/filings-documents/1037/OHI_01/...interest ofthe Companyand/orits shareholders. 1This is no $1.5