November 23, 2020
A recent Law 360 story by Rachel O’Brien, “Judge Nixes Suit For Crypto Co. Investor’s $728K Atty Fees,” reports that a New York federal judge tossed a lawsuit by an alleged pump-and-dump scheme mastermind asking for his attorney fees to be paid by a cryptocurrency company involved in the alleged scheme, ordering the man to pay the company's fees instead. While Barry Honig and his business GRQ Consultants Inc. point to indemnification clauses in agreements with Riot Blockchain as proof that his legal fees should be paid, U.S. District Judge Naomi Reice Buchwald said the clauses say the opposite.
Honig, at one time the largest shareholder in Riot Blockchain, spearheaded a $27 million pump-and-dump scheme involving 10 individuals and 10 associated corporate entities, the U.S. Securities and Exchange Commission alleged in September 2018. Honig and others, including former Teva Pharmaceutical Industries Ltd. chairman Phillip Frost and Riot Blockchain CEO John O'Rourke, manipulated stock prices in three microcap companies and left investors holding "virtually worthless shares," the SEC said.
In July 2019, Honig settled the SEC claims without admitted any wrongdoing, submitting to an injunction barring him from future violations of federal securities laws, a penny stock ban and further restrictions. Honig was named in several other suits, including in five shareholder derivative actions which alleged Riot, its directors and officers and Honig violated securities laws, and that Honig bought stock from Riot to gain "control" over the company so he could violate the securities laws.
A February 2018 class action from shareholder Creighton Takata in New Jersey federal court alleged that Honig's purchase of securities was part of a "fraudulent scheme consisting of misrepresentations, omissions, and actions that deceived the investing public in violation of securities laws." He called those allegations "a house of cards" in his October 2019 motion to dismiss, which was granted in April because the shareholders didn't show how the defendants violated anti-fraud provisions of federal securities law, the judge said then.
In the case tossed, Honig had argued that the security purchase agreements he entered into with Riot in 2017 to buy convertible promissory notes and common stock purchase warrants guaranteed that if Honig was a defendant in a lawsuit, Riot would pay his legal fees. The indemnification clauses in the agreements, Honig argued in the April suit, meant Riot must pay the $728,000 attorney fees he incurred fighting securities fraud allegations by the SEC and in class actions.
Riot argued that Honig's claim fails because Riot isn't obligated to pay when the litigation is connected with actions "based upon ... any violations by [Honig] of securities laws or any conduct by [Honig] which constitutes fraud, gross negligence, willful misconduct or malfeasance by [Honig]." But Honig said the carveout in the indemnification clause only applies to actual securities violations, and since some of the lawsuits are ongoing, he's entitled to advancement of legal costs.
Judge Reice Buchwald agreed with Riot that "the allegations of the underlying action — not the merits of the action — govern Riot's obligations." Since it's the nature of the allegations that trigger the obligation to indemnify, the clauses clearly side with Riot, Judge Reice Buchwald said. "If there were any ambiguity, which there is not, about when the obligation to indemnify is determined (and thus whether allegations or merits control), the next sentence of Section 4.8 confirms the court's conclusion," she said. She pointed to the section that states if an action is brought wherein the indemnity clause might be implemented, Honig must notify Riot in writing and Riot "shall have the right to assume the defense thereof with counsel of its own choosing reasonably acceptable to [Honig]."
"The logic of Section 4.8's structure is apparent," the judge said. "The first sentence informs the parties as to whether indemnification is required. If and when those conditions are satisfied, Honig would notify Riot, which then has the option to assume the defense. The provision presupposes that the parties can determine, prior to that notice, whether an obligation to indemnify exists."
Judge Reice Buchwald also granted Riot's motion that Honig pay its reasonable attorney fees for this action. Scott Carlton of Paul Hastings LLP, counsel for Riot Blockchain, told Law360 in a statement, "We are pleased with the court's careful consideration in this matter, including the awarding of attorneys' fees for Riot Blockchain as the prevailing party."