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Davis v. Gutierrez

United States District Court, D. New Hampshire

March 27, 2018

Eugene I. Davis, as Trustee Of the GTAT Litigation Trust, the Duly authorized successor to GT Advanced Technologies Inc., et al.
v.
Thomas Gutierrez and Daniel W. Squiller

          MEMORANDUM OPINION

          JOSEPH N. LA LANTE UNITED STATES DISTRICT JUDGE.

         This case involves the actions (and lack thereof) of two former corporate officers of the New Hampshire-based GT Advanced Technologies, Inc. (“GTAT”), a now-bankrupt manufacturer of materials for consumer electronics. The plaintiff[1] alleges that the two former officers, Thomas Gutierrez and Daniel Squiller, misled GTAT's board of directors regarding the technological and economic feasibility of its venture with Apple, Inc., in which GTAT was to manufacture sapphire for potential use by Apple to make its smartphone touch-screens more impervious to ruinous damage.

         Broadly speaking, the plaintiff asserts that the defendants knew or should have known that the agreement with Apple (“Apple Agreement”) was doomed to fail, misled and concealed their knowledge from GTAT's board of directors to get the board to approve the deal, and then reaped substantial profits before GTAT collapsed into bankruptcy less than one year after entering into the agreement. The plaintiff's complaint asserts four claims against both defendants: Breach of the Fiduciary Duty of Care (Count 1); Breach of the Fiduciary Duty of Loyalty (Count 2); Corporate Waste (Count 3); and Equitable Subordination (Count 5). It also asserts two claims against Gutierrez only: Breach of Contract (Count 4); and “Objection to Claims” (Count 6), as well as one claim against Squiller only: “Objection to Claims” (Count 7).

         The defendants have moved to dismiss all claims in the complaint[2] other than the breach of contract claim asserted against Gutierrez in Count 4.[3] They contend that all of the claims are subject to the heightened pleading standard of Federal Rule of Civil Procedure 9(b) because they all “sound in fraud” and assert that the plaintiff has pled none of his claims with the requisite particularity. They further argue that even if Rule 9(b) does not apply, the plaintiff's claims should still be dismissed because they fail under the more lenient pleading standard of Federal Rule of Civil Procedure 8(a). The court held oral argument on March 20, 2018. After review of the defendants' motion, the plaintiff's objection, the defendants' reply, and the parties' exhibits, and after consideration of oral argument, the court denies the defendants' motion in its entirety.

         I. Background

         The court culls the following facts from the complaint, from information contained in documents on which the complaint relies and which are central to the plaintiff's claims, and from publically filed documents. See Curran v. Cousins, 509 F.3d 36, 44 (1st Cir. 2007) (in determining the sufficiency of the complaint under Rule 12(b)(6), the court may consider “documents central to plaintiffs' claim [and] . . . documents sufficiently referred to in the complaint.” (internal quotation omitted)).

         A. GTAT and sapphire

         Prior to 2010, GTAT -- then known as GT Solar International, Inc. -- manufactured furnaces and other equipment used to make components for the solar power industry. As that industry weakened and GTAT's revenues declined, GTAT began producing sapphire crystal growth equipment in mid-2010. Sapphire, one of the hardest substances on Earth, is generally scratch and chemical resistant, transparent and durable. It is typically used in light-emitting diodes (LEDs), light sources for large outdoor displays, and general illumination for lamps, architectural lighting, and retail displays. Although it is naturally occurring, sapphire can also be synthetically manufactured in “advanced sapphire crystallization furnaces” (“ASC furnaces” or “furnaces”), which heat component compounds to temperatures in excess of 3000 degrees Fahrenheit.

         After acquiring other companies with experience in the sapphire industry, GTAT began to design and produce ASC furnaces, which it sold to third parties to produce sapphire.[4]By the end of 2012, GTAT's sapphire business was primarily related to manufacturing and selling furnaces, rather than production of sapphire, though GTAT continued to produce sapphire in limited quantities. After an initial increase in revenue from its furnace production and sales, however, GTAT's revenues and income declined sharply in the fiscal years ending December 31, 2012 and at the start of 2013. This income decline was reflected in falling stock prices. GTAT's stock price fell from $16.51 per share in early July 2011 to $2.94 per share in early January 2013. In light of GTAT's struggles, neither Gutierrez, GTAT's president and chief executive officer, nor Squiller, GTAT's chief operating officer, received a performance-based bonus at the end of 2012.

         With GTAT's business struggling, Gutierrez and Squiller shifted the company's focus to another market: smartphones. Gutierrez and Squiller believed that sapphire's strength, transparency, and durability made it an ideal material to replace the glass screens used in most smartphones. At that time, however, sapphire use had been limited to smaller phone components, such as camera lenses, because of the high cost of producing large enough amounts of sapphire of sufficient quality. To produce synthetic sapphire of high quality, various compounds are heated to extreme temperatures in ASC furnaces, which, over a period of weeks, grow large crystal logs of sapphire called “boules”. These boules, if of sufficient quality, are fabricated and separated into wafers for use in other products.

         In order to lower costs and produce the most affordable high-quality sapphire material, manufacturers attempt to make the largest boules possible. By early-2013, the maximum boule size that any manufacturer (in this case, GTAT) had been able to produce was 115 kg. According to GTAT, it took roughly three years (from March 2010 to early 2013) to increase the maximum boule size from 85 kg to 115 kg. However, it was understood that much larger boules were necessary to justify cost-effective production of sapphire for smartphone display screen production.

         B. Negotiations with Apple

         In early 2013, Gutierrez and Squiller learned that Apple was considering incorporating sapphire display screens into its new iPhone 6 that was to be unveiled in late-2014. Both men made a presentation at Apple's headquarters regarding GTAT's developments in sapphire production at that time.

         Over the next several months, Gutierrez and Squiller had numerous meetings with Apple executives, during which they pitched GTAT as capable of partnering with Apple. In other words, although GTAT had primarily been a manufacturer and marketer of ASC furnaces rather than a producer of sapphire, Gutierrez and Squiller pitched GTAT as being able to produce and supply Apple with a significant quantity of sapphire in any venture involving iPhone screens.

         In late-May 2013, Gutierrez and Squiller proposed a plan to Apple in which GTAT would sell 875 furnaces to Apple, install them at an Apple-owned facility, and manage the entire sapphire production process at the facility. They proposed an aggressive sapphire production schedule, including producing 145 kg boules by late-2013 and 165 kg boules by early-2014.[4]

         A few weeks later, Apple informed GTAT that the new iPhone 6 would have a larger display screen than originally anticipated. Members of the GTAT team who were working with Gutierrez and Squiller on the proposed Apple venture informed them that the change would require a significant increase in either the size of the sapphire boules GTAT would need to produce or the number of furnaces that Apple would need to purchase. Either change would involve a large increase in the cost to Apple. Gutierrez and Squiller instructed the GTAT team to figure out a way to limit the cost increase of the deal to Apple to no more than 20% in order to keep the deal enticing to Apple and best any deal that might be proposed by a competitor.

         On June 19, 2013, Gutierrez and Squiller met with Apple executives again. In light of the larger screen size on the iPhone 6, they proposed increasing both the number of furnaces GTAT would supply to Apple (from 875 to 910)[5] and the size of the sapphire boules GTAT would produce. Specifically, Gutierrez and Squiller proposed producing 165 kg boules in January 2014 and 260 kg boules in June 2014. When Apple expressed doubts about GTAT's ability to produce 260 kg boules, particularly those that would yield enough usable sapphire, Gutierrez agreed to “link approximately $200M of the [ASC furnace] purchase price to this milestone putting our money where our mouth is.”[6]

         C. GTAT's internal team expresses reservations

         Throughout the summer of 2013, various members of the GTAT team that were involved with the Apple venture expressed to Gutierrez and Squiller their reservations about the parameters of the proposed deal. For example, Dr. Christine Richardson, the head of research and development for GTAT, told Squiller that GTAT's chances of successfully growing 260 kg boules by June 2014 was just a four on a scale of one to ten.

         In late June 2013, James Zahler, another member of GTAT's research and development team, expressed reservations to both defendants about needing to produce a 260 kg boule within one year. Zahler noted that a 225 kg boule was already “uncharted territory” and that a 260 kg boule would increase the “technical risk” beyond what he was comfortable with.[7]

         On June 26, 2013, Gene Skayne, GTAT's Vice President of Finance, emailed Squiller and Paul Matthews, a GTAT product manager, questioning GTAT's cost models regarding the feasibility of the company producing massive quantities of sapphire on an expedited schedule in a cost-effective manner. Skayne expressed concern over the aggressive utilization rates[8] used in GTAT's models, which had started at 90% but which Gutierrez and Squiller had pushed to 98%. Skayne noted that the change “is very aggressive and I don't see how we get there.”[9]Zahler similarly noted at one point that the 98% utilization rate was just “wishful thinking.”[10]

         Skayne's June 26 email also questioned the models' use of a 4% failed run rate.[11] Skayne noted that GTAT's experience in one of its plants was a failed run rate of about 10% - 12% even for much smaller boules, and that previous models for the Apple project had used an 8% rate. Skayne asked “what has changed?”[12]

         The following day, Skayne emailed Squiller again questioning the updated models for the Apple project:

I had a call today with [GTAT's internal] team where we discussed changes made to the assumptions I referenced below . . . changing failed runs from 8% to 4%, going from 165 kg boule to 240 kg boule, etc. It seems like the driving force behind these changes is [Gutierrez's] aversion to showing the need for more than 1000 furnaces for the 70K screen project. While I understand the need to take an aggressive position to make sure we get this business, we need to be aware of the risks we are taking and work over the coming months to mitigate those risks. . . . I don't want us all to look stupid next year if we can't get anywhere near the targets agreed with the customer. We've set a very high bar for ourselves here and need to make sure we deliver.[13]

         Squiller responded that both he and Gutierrez were aware of the increased risks, and noted that “Apple has a box we are trying to get into to make the program viable.”[14]

         D. Apple changes the terms of the deal

         In late-August or early-September 2013, Apple suddenly changed course and proposed entirely different terms to Gutierrez and Squiller. Under Apple's revised proposal, rather than Apple purchasing fewer than 1, 000 ASC furnaces from GTAT and having GTAT manage the production of sapphire, GTAT would: (a) itself purchase more than 2, 000 furnaces to manufacture 250, 000 iPhone screens per day using “prepayments” from Apple (at that time, GTAT had sold and installed fewer than 600 furnaces in its entire history);[15] (b) install those furnaces in a large, yet-to-be constructed facility located in Mesa, Arizona, which GTAT would lease from Apple, and (c) produce sapphire boules “on an expedited basis, in staggering volumes, and of unprecedented size and quality.”[16] Specifically, with regard to the production of sapphire boules, rather than the already optimistic goal of producing a 260 kg boule by June 2014, Apple proposed that GTAT produce (a) a 262 kg boule by January 6, 2014, (b) 21 such boules by February 1, 2014, (c) 806 such boules by March 31, 2014, and (d) 5, 301 such boules by June 30, 2014. GTAT's failure to adhere to the aggressive schedule would force it to pay significant liquidated damages penalties.

         In addition to these terms, GTAT would need to bear the cost of more than 700 personnel, utilities, insurance, and raw materials for the Arizona facility. GTAT would also be required to grant Apple a security interest in the furnaces. Finally, Apple was under no obligation to purchase any sapphire from GTAT, even though GTAT was not allowed to sell its sapphire to any other entity. In other words, under Apple's proposal, GTAT would only realize a profit if (a) the company was able to produce massive amounts of sapphire that Apple valued in excess of the prepayments it had transferred to GTAT and (b) Apple agreed to purchase the sapphire in an amount exceeding the prepayments. Squiller would later describe Apple's sudden revision of the terms of the proposed venture “after months of extensive negotiations over price and related terms” as “a classic bait and switch.”[17]

         E. GTAT's internal team raises concerns about revised terms

         GTAT's internal team's skepticism about the terms of the proposed Apple venture grew stronger after Apple provided the new parameters of the deal. In mid-September 2013, Zahler informed Squiller that GTAT's efforts to produce quality sapphire boules larger than 115 kg were not going well, as larger boules had lower or only “sporadic” quality performance.[18]Richardson felt the “timeline was crazy” while Zahler described it as “just bonkers.”[19] As for Matthews, he felt that the new terms represented a “paradigm shift, ”[20] and that Gutierrez's and Squiller's push to make the deal work caused GTAT's internal models to “drift[] further and further away from what [GTAT] had data to support was doable.”[21]

         Matthews expressed concern to Squiller over the increasing yield rate included with GTAT's revised cost models, which had increased from 44% in June 2013 to 57% in August.[22] Matthews was particularly troubled because Apple had not yet given GTAT the final specifications for the screens to be manufactured and, therefore, Matthews felt like the projection, which seemed much too aggressive in any case, was largely guesswork. Eventually, when GTAT received the final specifications from Apple, Matthews raised further concerns with Squiller, as those specifications should have reduced the expected yield rate, but instead the cost models used by Gutierrez and Squiller showed an increased yield rate. Squiller responded that the team felt like Matthews “was resisting the change” and he urged Matthews to “play along with the requests that were being made.”[23] According to Matthews, however, neither he nor the other members of the GTAT team believed the projected yield numbers could possibly be attained.

         In September 2013, Richard Gaynor, GTAT's chief financial officer, also expressed concern about the 57% yield rate being used in the models when GTAT's historic yield rate ranged from 30% to 40%. When Gaynor asked Skayne if GTAT's goals under the Apple Agreement were “supported by actual experiences, ” Skayne replied that the yield numbers simply kept rising and that Squiller had agreed with Apple that it could be done.[24]

         Gutierrez and/or Squiller made additional changes to the underlying assumptions in GTAT's cost models to make Apple's revised proposed terms seem workable from GTAT's perspective. For example, GTAT's early models used an “excess capacity” multiplier between 5% - 15%.[25] GTAT's final model used just a 3% excess capacity multiplier. Similarly, Gutierrez and Squiller simply adopted Apple's proposed fabrication costs and assumptions[26] into GTAT's models, despite being informed by GTAT's team “that Apple's information was unrealistic.”[27] When the GTAT team expressed these concerns to Squiller, he ignored them and simply directed them to use Apple's information.

         F. GTAT board considers and ultimately approves the Apple Agreement

         In September 2013, Gutierrez conceded privately that GTAT had “gotten sucked in” and that the Apple deal “sucks.”[28]Nevertheless, because he and Squiller had failed to explore other potential business partners throughout 2013, Gutierrez acknowledged that not entering the agreement with Apple meant “a lot of cost reduction” for GTAT, including cuts to his and Squiller's salaries.[29] Around the same time, Squiller similarly acknowledged that GTAT's “economics were already on the edge” and “failure likely means bankruptcy of the company.”[30]

         Nevertheless, Gutierrez and Squiller continued to recommend the Apple deal to GTAT's board of directors. In September, Gutierrez represented to the board that GTAT had been “treated as a valued partner” throughout the negotiation process with Apple.[31] On October 22, 2013, Gutierrez described GTAT as having made “very significant progress” with negotiations and stated that the company had secured several key concessions from Apple, including contract provisions regarding “warranties, liquidated damages, treatment of intellectual property and to a more limited extent the economics of the deal for GTAT.”[32] In addition, Gutierrez assured the board that GTAT's internal cost models which showed that the production schedule was feasible were based on “conservative” assumptions.[33]

         The plaintiff alleges that in reality, however, little if any of this was true. As Squiller later described, after Apple had proposed revised terms in late-August or early-September 2013, “[w]hat ensued was anything but an arm's-length negotiation. Apple simply dictated the terms and conditions of the deal to GTAT.”[34] And, as discussed supra, the plaintiff alleges that the assumptions underlying the models were far from conservative, and in fact were so aggressive that they were unattainable.

         On October 28, 2013, Gutierrez recommended to GTAT's board of directors that they approve the Apple Agreement, stating that management “had deemed the transaction to be in the best interest of the Company.”[35] That same day, the board of directors voted to approve the Agreement.

         The Apple Agreement approved by the board contained terms similar, if not identical, to those Apple proposed in late-August or early-September 2013. Specifically, the Agreement called for Apple and GTAT to jointly develop a facility in Mesa, Arizona, where GTAT, employing over 700 people and using more than 2000 ASC furnaces, would manufacture sapphire exclusively for Apple. Rather than its past practice of selling the furnaces, GTAT would own and operate them. In addition, Apple was to provide GTAT with a “prepayment” of approximately $578 million to be paid in installments, which GTAT was to repay over five years, starting in 2015.

         G. Defendants profit from the Apple Agreement

         Not surprisingly, shortly after the Apple Agreement was announced, GTAT's stock price skyrocketed. In response, on December 16, 2013, Gutierrez entered into a Rule 10b5-1 plan.[36]Between December 16, 2013 and March 13, 2014, Gutierrez sold 343, 625 shares of GTAT's stock under the plan. Gutierrez also sold an additional 90, 000 shares on the open market outside of the plan, and he exercised his option on another 100, 000 shares.

         On March 14, 2014, Gutierrez entered into another Rule 10b5-1 plan. Pursuant to this second plan, Gutierrez sold an additional 264, 248 shares of GTAT stock and exercised his option on 100, 000 more shares. In total, Gutierrez sold nearly 50% of his holdings in GTAT stock after the Apple deal for about $10.5 million. Squiller, meanwhile, sold approximately 12% of his holdings in GTAT stock (121, 190 shares) after the Apple Agreement for about $2 million.[37]

         In addition, both Gutierrez and Squiller received large cash bonuses after GTAT entered into the Apple Agreement. In late-2013, Gutierrez received a $1.25 million bonus and Squiller received a $772, 500 bonus.

         I. GTAT immediately fails to perform under the Apple Agreement

         GTAT quickly fell behind its targets under the Apple Agreement. Early attempts to successfully produce a 262 kg sapphire boule failed. In November 2013, four of the five 262 kg boules GTAT produced were unusable, and the fifth yielded just 43 mm of usable sapphire, well below the necessary yield rate. By December 2013, GTAT was already four weeks behind schedule, and attempts to create usable 262 kg sapphire boules continued to fail.

         By June 2014, after repeated delays and failures to adhere to the production schedule in the Apple Agreement, Gutierrez met with Apple to “fall on his sword, ” and noted several problems with GTAT's attempts to meet the parameters of the deal, nearly all of which were identified by the GTAT team before entering into the Apple Agreement.[38] Shortly thereafter, GTAT abandoned its attempts to produce a 262 kg sapphire boule, and instead tried to comply with the other terms of the Apple Agreement by producing smaller boules.

         In addition, the Arizona facility encountered significant delays and additional costs. The facility required 350 more employees than what was originally estimated, and it was considered a “highly contaminated environment” because of the ongoing construction work.[39]

         In August or September 2014, GTAT attempted to renegotiate the Apple Agreement. Apple expressed a willingness to make some of GTAT's proposed concessions. But it was not close to enough to preserve the viability of their arrangement from GTAT's perspective.

         J. Apple unveiling and GTAT's financial collapse

         On September 9, 2014, Apple unveiled the iPhone 6. During the iPhone 6 launch, Apple announced that the new phone would have a display produced from ion-strengthened glass, a product manufactured by GTAT's competitor. Within two days of the announcement, GTAT's stock price fell more than 25% on heavy trading volume.

         On October 6, 2014, GTAT filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code, owing $1.3 billion to its creditors. GTAT's bankruptcy announcement significantly diminished the value of the company. On the day of the announcement, the price of GTAT stock fell from $11.06 per share to $0.80 per share on the heaviest trading volume in the history of the company. The NASDAQ immediately suspended trading of the company's common stock, and GTAT was formally delisted shortly thereafter.

         Apple withheld its final scheduled prepayment of $138 million because of GTAT's failure to perform. Thus, GTAT received a total of $439 million from Apple in prepayments under the Agreement. GTAT spent more than twice that amount -- approximately $900 million -- just to try to meet its obligations under the Agreement.

         II. Analysis

         As mentioned above, the plaintiff asserts four claims against both defendants: Breach of the Fiduciary Duty of Care (Count 1); Breach of the Fiduciary Duty of Loyalty (Count 2); Corporate Waste (Count 3); and Equitable Subordination (Count 5). He also asserts two claims against Gutierrez only: Breach of Contract (Count 4); and “Objection to Claims” (Count 6), as well as one claim against Squiller only: “Objection to Claims” (Count 7).

         The parties disagree over whether the claims are subject to the heightened pleading standard of Federal Rule of Civil Procedure 9(b) or the more lenient pleading standard of Rule 8(a). The defendants argue that Rule 9(b) applies to all of the plaintiff's claims, while the plaintiff contends that Rule 9(b) does not apply to any of his claims.

         As discussed infra, because portions of the plaintiff's breach of fiduciary duty claims are grounded in fraud, those portions of the claims are subject to Rule 9(b)'s heightened pleading standard. The factual allegations in the plaintiff's complaint, however, easily clear that bar.

         A. Heightened pleading standard

Rule 9(b) provides that, “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.” The defendants contend that although the complaint does not allege a claim for fraud per se, all of the plaintiff's claims are “grounded in . . . averments of fraud, ” and therefore are subject to Rule 9(b)'s rigorous pleading standards. The plaintiff counters that his claims remain plausible absent allegations of fraud and are therefore not subject to Rule 9(b)'s heightened pleading requirements.

         First, although the parties, and in particular the defendants, argue over whether Rule 9(b) applies to every claim asserted in the complaint, the rule plainly does not apply to Counts 3, 5, 6, or 7. Although a claim for corporate waste, Count 3, may be based on allegations of fraud and therefore subject to Rule 9(b), see, e.g., Stern v. Gen. Elec. Co., 924 F.2d 472, 477 (2d Cir. 1991), that is not the basis of the corporate waste claim in this case.[40] Rather, the plaintiff's corporate waste claim is based on allegations that in light of the defendants' knowledge about the infeasibility of the Apple venture, no person of ordinary, sound judgment could conclude that the venture was in GTAT's best interest.[41] At most, such a claim alleges that the defendants acted in bad faith, which does not implicate Rule 9(b). Stern, 924 F.2d at 477 (noting that in the context of a corporate waste claim, “[u]nlike allegations of fraud, . . . an allegation of bad faith would not need to be supported by particular factual statements”). In addition, the defendants' arguments as to why the plaintiff's equitable subordination and set-off claims, Counts 5, 6, and 7, should be dismissed are procedural, rather than ...


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