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New York District Court Denies In Part And Grants In Part Motion To Dismiss Class Action Against Agriculture Company
08/08/2023On July 21, 2023, Judge Lewis J. Liman of the United States District Court for the Southern District of New York granted in part and denied in part a motion to dismiss a putative securities class action alleging that an agriculture company (the “Company”) and certain of its officers (the “Individual Defendants”) violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 thereunder. In Re Appharvest Sec. Litig., No. 21-cv-7985 (LJL), 2023 BL 261952 (S.D.N.Y. July 31, 2023). Plaintiffs alleged that defendants made misleading statements about the impact of the Covid-19 pandemic on quality control, training, yield, and employee attrition at the Company’s main plant.
The Company is a domestic producer of fruits and vegetables and grows all of its crops indoors using Controlled Environment Agriculture (“CEA”) technology. The Company’s common stock and warrants began trading on the NASDAQ on February 1, 2021. According to the operative complaint (the “complaint”), at the beginning of 2020, the Company had approximately 20 employees, but by April 9, 2021, the Company’s CEO announced that it had hired approximately 550 employees. Plaintiffs further alleged that in March 2019, the Company entered into a ten-year agreement with the largest producer and distributor (the “Distributor”) of greenhouse grown produce in North America, making the Distributor the Company’s exclusive marketing and distribution partner for the Company’s products produced at its main plant. Plaintiffs further alleged that the Distributor was required under the agreement to purchase all of the Company’s products that received a grade of USDA Grade No. 1 under the Company’s internal grading standard.
Relying on the purported statements of several confidential witnesses (“CWs”), the complaint alleged that between the first harvest in January 2021 and the end of the putative class period on August 10, 2021, the Company suffered various productivity challenges. Specifically, the Company allegedly suffered waste, damage, and poor quality at its main plant, and one CW allegedly estimated that up to 50% of the Company’s crop was wasted in its first growing season due to disease, insects, and damage caused by employees. The CWs purportedly attributed the waste in large part to the Company’s failure to train its employees adequately. Plaintiffs further alleged through purported CW statements that the Company’s “piece rate” bonus structure, which entitled employees to be paid more for meeting productivity goals, resulted in lower yield and quality, because it caused employees to work too fast, resulting in damage to certain crops.
Plaintiffs also alleged that CWs maintained that the Company’s main production facility was plagued by significant attrition and churn caused by worker dissatisfaction with increasing hours. The employee churn and turnover was allegedly exacerbated in part by personnel absence caused by the Covid-19 pandemic. According to plaintiffs, employee turnover resulted in the Company’s failure to maintain its goal of having 500 employees at its main plant. By its 2021 Q2 Earnings Call, Individual Defendants allegedly admitted that the Company’s workforce had fallen to 400 people, or by 20%. The Company allegedly undertook several remedial measures during the putative class period, including hiring and firing executives. The complaint further alleged that Individual Defendants had knowledge of the Company’s problems because of the time they spent at the Company’s main plant and because of frequent leadership meetings during the Company’s “toughest times.” Individual Defendants also allegedly provided productivity forecasts for each growing season under their distribution agreement “on a weekly, and possibly daily, basis.” The complaint further alleged that, during the putative class period, defendants made numerous allegedly false and/or misleading statements about the Company’s performance, in that they misrepresented or failed to disclose the operational problems occurring at the Company.
Following the Company’s 2021 Q2 earnings call, in which it allegedly disclosed the myriad issues and discussed potential remedial measures, the Company’s stock fell approximately 29%, and the Company’s warrant price fell approximately 44%. Plaintiffs filed suit on September 24, 2021. Defendants moved to dismiss, arguing that plaintiffs had not sufficiently pled falsity, scienter, or loss causation.
Turning first to the issue of scienter, the Court found that the allegations in the complaint did not give rise to a strong inference that Individual Defendants possessed the requisite scienter prior to the end of Q1 2021. The Court noted that these allegations, which were based on Individual Defendants’ attendance at weekly forecast meetings and informal calls, were insufficiently particular to support an inference of scienter because the complaint failed to state when exactly these meetings started, and failed to explain how the alleged information discussed during those meetings throughout the entire putative class period contradicted defendants’ public statements, as is required to show scienter. The Court also rejected plaintiffs’ argument that statements by Individual Defendants’ that “‘everyone knew what everyone else knew’ regarding fundamental financial data,” and other statements holding themselves out as knowledgeable about the Company were insufficient to support an inference of scienter because plaintiffs did not plead with particularity that any senior leader, prior to the end of Q1 2021, had contemporaneous knowledge about fundamental financial data that was contrary to any public statements, and the complaint also did not explain why the CW was in a position to know exactly what each senior leader knew. Similarly, the Court also found that the allegations concerning the CEO’s visits to the Company’s main plant, “while supporting the inference that [he] may have had some limited knowledge concerning labor issues and waste,” were insufficiently particular to establish scienter for any particular statement. The Court rejected plaintiffs’ claim that defendants’ regular receipt and access to productivity, labor, and quality reports, the timing of the COO’s demotion, or defendants’ statements about operational and labor shortfalls, supported a strong inference of scienter.
However, the Court found that additional allegations concerning the “toughest times” in the post-Q1 2021 period did raise a compelling inference of scienter with respect to two of Individual Defendants (the CFO and President). In particular, the Court found that purported statements from a CW supported an inference that the CFO and President “participated in numerous meetings during which the problems with hiring, productivity, turnover, and [the Company’s] underperformance relative to its forecasts were discussed,” and that “during this period, [the CFO and President] were part of a process to reforecast to lower estimated production due to quality issues and substantial rejections by [the Distributor] and were part of leadership meetings to keep an eye on productivity issues.” The Court emphasized that this strong inference of scienter was further bolstered by the core operations doctrine, because during the putative class period, the Company’s only open facility and source of revenue was the main plant. The Court further noted, however, that the CEO did not attend any of the alleged meetings, nor was he involved in the process of reforecasting to lower estimated production, and thus there was no inference of scienter with respect to him.
The Court next found that the forward-looking statements that defendants claimed were protected under the PSLRA safe harbor contained non-forward looking elements that were severable, and therefore actionable. For example, in the Company’s May 17 press release, after reiterating its full-year 2021 outlook of net sales, the Company alleged stated that “[w]e are pleased by our fast start to the year, the encouraging operating and financial performance . . . and our team’s ability to scale the business . . . .” The Court noted that although the portion of this statement concerning the Company’s net sales outlook was a forward-looking statement protected by the PSLRA, other portions contained representations that provided specific information about the current or past situation of the Company. And although the Court dismissed some of the alleged statements as inactionable statements of opinion, it declined to dismiss other statements as inactionable puffery. Similarly, while the Court agreed with defendants that some of the allegations by CWs could not be supported by their testimony (for example, that the Company prepared forecasts during the putative class period, and that Individual Defendants knew about the Company’s productivity challenges), it held that other allegations (including that the Company prepared projections with details such as yield, sales, and costs during the time that one CW was employed as support for the inference that they prepared similar projections during the putative class period) were supported.
The Court likewise found that some of the alleged statements at issue were false or misleading, including statements about the impact Covid-19 related staffing issues had on the Company’s ability to meet its financial projections. However, the Court also held that certain other alleged statements, including statements in the risk disclosures that the Company “had not experienced material financial impacts due to the pandemic” and statements portraying the labor issues caused by COVID-19 as merely a risk rather than something that had already happened, were not actionable.
Finally, the Court rejected defendants’ claim that plaintiffs failed to plead loss causation, holding that “[p]laintiff[s] adequately allege loss causation through allegations that the market reacted negatively to corrective disclosures of the alleged fraud.”
Having found that plaintiffs sufficiently pled certain primary Section 10(b) violations, the Court declined to dismiss plaintiffs’ Section 20(a) claim.
