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Ginsburg v. ICC Holdings LLC

United States District Court, N.D. Texas, Dallas Division

November 13, 2017

ICC HOLDINGS, LLC, and TIM McGRAW, Defendants. v.



         In this action arising from defendants' alleged misrepresentations and breach of contract in connection with plaintiff Scott Ginsburg's (“Ginsburg's”) investment in defendants' medical marijuana[1] business, defendants move to dismiss under Fed.R.Civ.P. 12(b)(6) and 9(b). For the reasons that follow, the court grants the motion in part and denies it in part and grants Ginsburg leave to replead.


         In December 2015 defendant ICC Holdings, LLC (“ICC”) and its Chief Executive Officer, defendant Tim McGraw (“McGraw”), contacted Ginsburg to solicit funding to support their medical marijuana business.[2] In connection with defendants' solicitation efforts, McGraw sent Ginsburg a Private Placement Memorandum (“PPM”) dated March 2015. The PPM “reasonab[ly] estimate[d] . . . the projected revenue for medical cannabis sales in Illinois” to be $1, 115, 910, 000, and projected that ICC would have earnings before interest, taxes, depreciation, and amortization (“EBITDA”) of $46, 817, 840 in 2016, and $53, 065, 367 in 2017. Ds. App. 14, 29. It also stated, on its financial projections page: “[t]he projections are ‘forward looking statements' and were not prepared with a view to public disclosure or compliance with published guidelines of the commission or any state securities commission. The company advises all prospective investors to pursue their own independent investigation with respect to the projected financial information included.” Id. at 29 (bold font and capitalization omitted).

         Following Ginsburg's receipt of the PPM, he asked McGraw whether ICC would prepare and provide him a copy of audited financial statements. McGraw responded that ICC's bank required audited financial statements and that he would provide copies of them to Ginsburg as they were prepared.[3] Allegedly in reliance on McGraw's representations and the statements in the PPM, Ginsburg loaned ICC $7 million, as evidenced by a January 19, 2016 promissory note (“January Note”) in that same amount, convertible into Class B Units in ICC.

         In February 2016 McGraw and ICC sought additional funding from Ginsburg. In a February 4, 2016 email to Ginsburg, McGraw stated: “[t]he Holland deal is ours now. Revolution [an operating arm of ICC] will take operating control. . . Moral of the story is that we are in the driver[']s seat.” Id. at ¶ 12(d) (alterations in original). McGraw also stated that the so-called “Holland deal” will “make Revolution the largest producer on the planet.”[4] Id. In a February 17, 2016 email, McGraw stated that ICC's projected financials should show Ginsburg “how lucrative being our lead investor on these deals is and how [McGraw] ha[d] structured them so [Ginsburg] [would] get [his] capital back quickly”; that “[w]e will overnight be bigger than GW”; that ICC's patient and facility ramp-up was slower than initially projected because of “decisions made by our Governor in Illinois, ” but that “even so the future is [expletive] bright”; and that ICC “stands alone at the top of cannabis.” Id. ¶ 12(e) (some alterations in original). That same day, ICC's CFO, Jonathan Charak (“Charak”), emailed Ginsburg 3-year forecasted financials reflecting projected EBITDA of negative $1, 452, 781.00 for 2016, but projecting that in 2017, ICC's EBITDA would grow over $4.5 million to $3, 052, 688.00 and that ICC would have a positive net cash flow of $52, 688.00. The 3-year forecast also projected EBITDA growth in 2018 of nearly 700% to $21, 104, 488.00, with positive cash flow of $19, 104, 488.00.

         On February 22, 2016 McGraw stated in an email to Ginsburg that if Ginsburg provided $2, 250, 000 in exchange for another Class B convertible note, McGraw would also give Ginsburg 150, 000 Founders' Units from McGraw's personal holdings. On March 3, 2016 McGraw emailed Ginsburg, stating that ICC needed cash to pay subcontractors that week or they would walk off the job. McGraw stated:

[t]here is HUGE demand for [marijuana extract] and we can make a [expletive] load as soon as we get the final inspection of the labs done. Which if we pay today or tomorrow can be next week. We want more revenue but we are sitting on a pile of money because the labs aren't online.

Id. at ¶ 12(h) (alterations in original). Allegedly in reliance on McGraw's and ICC's statements and projections, Ginsburg executed a second promissory note (“March Note”) in the amount of $3.6 million, convertible into Class B Units in the company. Under the terms of a Funding Disbursement and Interest Reserve Agreement (“Reserve Agreement”), Ginsburg was to “hold back” $1, 260, 000 from the $3.6 million stated value of the March Note, which was to be used to service 12 months of ICC's interest obligations on the $10.6 million combined total of both notes. Although Ginsburg only wired $2, 340, 000 to ICC in March 2016 (not the full $3.6 million), he contends that he never executed the Reserve Agreement and never consented to its terms.

         Ginsburg alleges that he later learned that the statements and projections on which he had relied had no basis in fact “and were, stated mildly, wildly optimistic forecasts.” Id. at ¶ 12(j). Although ICC had projected 2016 EBITDA of $46, 817, 840 on January 6, 2016, ICC emailed Ginsburg on February 17, 2016 (approximately one month after it received $7 million in funding from Ginsburg) forecasting 2016 EBITDA of negative $1, 452, 781.00. These same forecasts (sent halfway through Q1) showed Q1 EBITDA to be estimated at negative $410, 850. Then, on May 16, 2016, after Ginsburg executed the March Note, McGraw emailed Ginsburg providing 5-year projected financials showing the actual Q1 EBITDA to be negative $1, 932, 113-a loss more than $1.5 million greater than the projections provided to Ginsburg halfway through that quarter, when defendants were seeking additional funding from Ginsburg. The May 16, 2016 projected financials also showed revised 2016 EBITDA to be projected at a $4, 885, 755.00 loss, which was three times greater than the projections provided to Ginsburg on February 17, and more than $50 million less than the EBITDA projected in defendants' emailed estimates on January 6, 2016.

         Ginsburg alleges that defendants also materially misrepresented having specialized knowledge about the status of marijuana legalization efforts nationally and internationally, in general, and the status of the Illinois legislature's position and timetable for getting laws changed, which would expand the potential Illinois customer base for medical marijuana usage. Although the PPM stated that “[a]s cannabis gains support for full legalization/recreational use, it is another indication that the industry is set to rapidly expand, providing both investors and operators with unprecedented opportunities, ” such “full legalization” never materialized in Illinois or in the remainder of the United States. Id. ¶ 13(a). In addition, on March 10, 2016, allegedly “amidst discussions between ICC and [Ginsburg] regarding [a] potential second round of funding, ” McGraw stated in an email to Ginsburg that, through ICC's efforts, a law was about to be enacted that would considerably expand the permissible uses for medical marijuana, thus significantly increasing the market and demand for ICC's products.[5] Id. at ¶ 13(b). But neither chronic pain nor Post-Traumatic Stress Disorder was added to the list of permissible uses for treatment by medical marijuana, as McGraw had indicated, nor were the other indicated changes enacted into law.

         Ginsburg alleges that he justifiably relied on the material misrepresentations made by ICC and McGraw when he provided funding to ICC by making loans that could be converted into Class B Units of ICC. He asserts that McGraw and ICC continue to materially mislead potential investors; that, on May 6, 2016, McGraw emailed him an “Investor Presentation” in preparation for the round of Class C Unit-convertible notes and failed to disclose ICC's known risks (e.g., that favorable legislation might not be passed), the probability that such risks would materialize, or the anticipated magnitude of such materialization; and that defendants “continue to display an ongoing pattern of deceit, over-inflation of projected earnings, and under-estimation of known risks.” Id. ¶ 15.

         By letter dated July 6, 2016, Ginsburg made demand upon ICC to bring the debts on the January Note and March Note (collectively, the “Notes”) current by paying the accrued interest, which was due three months after the effective date of each note. Ginsburg alleges that ICC was to have made the interest payments on or before August 4, 2016, but they were not paid. In April 2017 Ginsburg notified ICC that the interest then owing under the Notes exceeded $1, 260, 000 and demanded that ICC bring the Notes current within 20 business days, which ICC failed to do.

         Ginsburg sues McGraw and ICC alleging claims for breach of contract based on ICC's alleged default on the Notes; common law fraud, violation of Tex. Bus. & Com. Code Ann. § 27.01; violation of § 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and Securities and Exchange Commission (“SEC”) Rule 10b-5; violation of § 20 of the Exchange Act, 15 U.S.C. § 78t (as to McGraw only); violation of Tex. Rev. Civ. Stat. Ann. Art. 581-33(A)(2); violation of Tex. Rev. Civ. Stat. Ann. Art. 581-33(F) (as to McGraw only); violation of the Illinois Securities Law of 1953, 815 ILCS 5/12(F), and violation of the Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. § 1962(c).

         McGraw and ICC move to dismiss Ginsburg's fourth amended complaint under Rules 12(b)(6) and 9(b). They contend that because the purpose of the Notes is to fund the cultivation, possession, and sale of marijuana, in violation of federal law, the Notes are void and unenforceable because they contravene public policy. McGraw and ICC also maintain that, even if the Notes are enforceable, the court should dismiss Ginsburg's claims because the fourth amended complaint does not plausibly allege that McGraw and ICC have breached the Notes, made any misrepresentations, or failed to disclose risks, and that the fourth amended complaint fails to state any fraud-based claims with the requisite particularity.

         Ginsburg opposes the motion.


         A “In deciding a Rule 12(b)(6) motion to dismiss, the court evaluates the sufficiency of plaintiff['s] [fourth] amended complaint by accepting all well-pleaded facts as true, viewing them in the light most favorable to the plaintiff.” Bramlett v. Med. Protective Co. of Fort Wayne, Ind., 855 F.Supp.2d 615, 618 (N.D. Tex. 2012) (Fitzwater, C.J.) (internal quotation marks and brackets omitted) (quoting In re Katrina Canal Breaches Litig., 495 F.3d 191, 205 (5th Cir. 2007)). To survive a motion to dismiss under Rule 12(b)(6), plaintiff must plead “enough facts to state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). “A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). “The plausibility standard is not akin to a ‘probability requirement, ' but it asks for more than a sheer possibility that a defendant has acted unlawfully.” Id. (quoting Twombly, 550 U.S. at 556); see also Twombly, 550 U.S. at 555 (“Factual allegations must be enough to raise a right to relief above the speculative level[.]”). “[W]here the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged-but it has not ‘shown'-‘that the pleader is entitled to relief.'” Iqbal, 556 U.S. at 679 (brackets omitted) (quoting Rule 8(a)(2)). “Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice.” Id. at 678

         (citation omitted).

         To obtain a Rule 12(b)(6) dismissal based on an affirmative defense, the “successful affirmative defense [must] appear[] clearly on the face of the pleadings.” Cochran v. Astrue, 2011 WL 5604024, at *1 (N.D. Tex. Nov. 17, 2011) (Fitzwater, C.J.) (quoting Sivertson v. Clinton, 2011 WL 4100958, at *2 (N.D. Tex. Sept. 14, 2011) (Fitzwater, C.J.)). In other words, defendants are not entitled to dismissal under Rule 12(b)(6) based on an affirmative defense unless Ginsburg “‘has pleaded [him]self out of court by admitting to all of the elements of the defense.'” Id. (alteration in original) (quoting Sivertson, 2011 WL 4100958, at *3).


         “Rule 9(b) imposes a heightened pleading standard for fraud claims and requires that a party state with particularity facts supporting each element of fraud.” Turner v. AmericaHomeKey Inc., 2011 WL 3606688, at *2 (N.D. Tex. Aug. 16, 2011) (Fitzwater, C.J.) (citing Benchmark Elecs., Inc. v. J.M. Huber Corp., 343 F.3d 719, 724 (5th Cir. 2003)), aff'd, 514 Fed.Appx. 513 (5th Cir. 2013). “At a minimum, Rule 9(b) requires allegations of the particulars of time, place, and contents of the false representations, as well as the identity of the person making the misrepresentation and what he obtained thereby.” Turner, 2011 WL 3606688, at *2 (quoting Benchmark Elecs., 343 F.3d at 724) (internal quotation marks omitted). More colloquially, plaintiffs must plead the “who, what, when, where, and how” of the fraud. United States ex rel. Williams v. Bell Helicopter Textron, Inc., 417 F.3d 450, 453 (5th Cir. 2005) (quoting United States ex rel. Thompson v. Columbia/HCA Healthcare Corp., 125 F.3d 899, 903 (5th Cir. 1997)). Because Rule 9(b) must be “read in conjunction with [Rule] 8 which requires only a short and plain statement of the claim showing that the pleader is entitled to relief, ” “punctilious pleading detail” is not required. Steiner v. Southmark Corp., 734 F.Supp. 269, 273 (N.D. Tex. 1990) (Fitzwater, J.) (internal quotation marks omitted) (quoting Landry v. Air Line Pilots Ass'n Int'l AFL-CIO, 892 F.2d 1238, 1264 (5th Cir. 1990)). “The court's key concern in assessing a complaint under Rule 9(b) is to determine whether the plaintiff seeks to redress specific wrongs or whether the plaintiff instead seeks the opportunity to search out actionable wrongs.” Garcia v. Boyar & Miller, P.C., 2007 WL 2428572, at *4 (N.D. Tex. Aug. 28, 2007) (Fitzwater, J.) (citation omitted).


         The court begins with Ginsburg's breach of contract claim based on ICC's alleged default on the Notes and defendants' contention that this claim is precluded on the ground that the Notes are void and unenforceable.


         Defendants move to dismiss Ginsburg's breach of contract claim, contending that the Notes are void and unenforceable because their illegal purpose contravenes public policy. They maintain that, under the Federal Controlled Substances Act (“CSA”), marijuana is a Schedule I controlled substance, the use of which is prohibited under any circumstance; that the CSA makes it unlawful to manufacture, distribute, dispense, or possess any controlled substance; that the CSA also makes it illegal to profit from the manufacture or sale of marijuana; that loaning money to support a business cultivating, selling, or distributing marijuana exposes individuals to other federal laws that criminalize aspects of the marijuana business; that Ginsburg has admitted to this court that he invested $10.6 million to support a business that cultivates, sells, and distributes marijuana; and that by investing in ICC to finance the cultivation, possession, and sale of marijuana, Ginsburg has knowingly violated countless Texas and federal drug laws.

         Ginsburg responds that, as part of their effort to obtain funding for ICC, defendants misrepresented that marijuana would soon be legalized in Illinois and nationwide, in large part due to ICC's efforts, and that defendants should not be permitted to benefit from their wrongdoing; that the Notes on their face do not reflect an illegal purpose that is against public policy because the CSA does not prohibit an individual from “profiting” from a business involving controlled substances; that the cases on which defendants rely are factually distinguishable; that the “ultimate object” of the Notes was not to acquire ownership in ICC's marijuana business, but rather for Ginsburg to loan funds to a business and to be repaid with interest from whatever source of funds or proceeds was available to ICC; and that no mention of any illegal purpose exists within the four corners of the Notes, and that the Notes do not identify any purpose for the funds being loaned by Ginsburg to ICC.

         Defendants argue in reply that Ginsburg did not lack knowledge of the business in which he was investing, and that, viewed as a whole, Ginsburg's investment with ICC plainly had as its ultimate object the acquisition of an interest in, and the operation of, a marijuana dispensary; that the parties' agreement included an ownership option in the defendant company, and that whether Ginsburg has as yet exercised that option is irrelevant to the determination that the Notes have an illegal purpose; that the CSA specifically addresses profits derived from controlled substances[6]; and that the Notes indisputably provide capital to, and secure a right to acquisition of, an ownership interest in ICC, and therefore advance an illegal purpose under the CSA.

         B The court must decide as a threshold matter what law to apply in determining the legality of the Notes and their enforceability. “[Q]uestions involving the effect of illegality upon a contract are determined by the law chosen by the parties, if they have made an effective choice.” Restatement (Second) of Conflicts of Laws § 202 cmt. a (1971). In this case, the parties have effectively chosen Illinois law. Each Notes states: “[t]his Note and all actions arising out of or in connection with this Note shall be governed by and construed in accordance with the laws of the State of Illinois, without regard to the conflicts of law provisions.” 2d. Am. Compl. Ex. B at ¶ 7(g); 2d Am. Compl. Ex. C. at ¶ 7(g). The Notes are therefore governed by Illinois law. See Int'l Interests, L.P. v. Hardy, 448 F.3d 303, 306-07(5th Cir. 2006) (stating that “[i]n diversity cases, a federal court must follow the choice of law rules of the forum state, ” and that “[t]he Supreme Court of Texas has recognized that contractual choice of law provisions should generally be enforced.” (citing Mayo v. Hartford Life Ins. Co., 354 F.3d 400, 403 (5th Cir. 2004); DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 677 (Tex. 1990))).

         Where it is alleged that an agreement contravenes a federal statute, however, the court looks to federal law to determine whether the contract is illegal or violates public policy, and, if so, whether the contract is unenforceable as a result. See Kelly v. Kosuga, 358 U.S. 516, 519 (1959) (“the effect of illegality under a federal statute is a matter of federal law”); Sola Elec. Co. v. Jefferson Elec. Co., 317 U.S. 173, 174 (1942) (“When a federal statute condemns an act as unlawful the extent and nature of the legal consequences of the condemnation, though left by the statute to judicial determination, are nevertheless federal questions, the answers to which are to be derived from the statute and the federal policy which it has adopted. To the federal statute and policy, conflicting state law and policy must yield.”); see also N. Ind. Pub. Serv. Co. v. Carbon Cnty. Coal Co., 799 F.2d 265, 273 (7th Cir. 1986) (“NIPSCO”) (“When the statute is federal, federal law determines not only whether the statute was violated but also, if so, and assuming the statute itself is silent on the matter, the effect of the violation on the enforceability of the contract.” (citing cases)); Energy Labs, Inc. v. Edwards Eng'g, Inc., 2015 WL 3504974, at *3 (N.D. Ill. June 2, 2015) (“Since Defendants argue that a federal statute . . . makes its contract with ELI illegal, we must apply federal law to answer both whether the contract violates that statute and whether the contract is enforceable.”).


         Illinois' Compassionate Use of Medical Cannabis Pilot Program Act (“CUA”), 410 Ill. Comp. Stat. Ann. 130/25 (West 2017), which became effective on January 1, 2014, protects patients with debilitating medical conditions, as well as their physicians and providers, from arrest and prosecution, criminal and other penalties, and property forfeiture if the patients engage in the use of medical cannabis. See Ball v. Madigan, 2017 WL 1105447, at *1 (N.D. Ill. Mar. 24, 2017). In addition to setting forth eligibility requirements for patients' use of medical cannabis, the CUA regulates the operation of medical cannabis cultivation centers and dispensaries and provides for the registration (renewable annually) with Illinois' Department of Agriculture and Department of Financial and Professional Regulation of up to 22 cultivation centers[7] and 60 dispensaries. Ball, 2017 WL 1105447, at *1; see also 410 Ill. Comp. Stat. Ann. 130/85 and 130/115. The CUA is effective until July 1, 2020. 410 Ill. Comp. Stat. Ann. 130/220.

         Federal law, however, continues to prohibit use of marijuana, even by medical users. See 21 U.S.C. §§ 812 (controlled substances), 844(a) (penalties); Gonzales v. Raich, 545 U.S. 1, 26-29 (2005) (Congress' plenary power under Commerce Clause includes power to prohibit local cultivation and use of marijuana in compliance with state medicinal use statutes); United States v. Oakland Cannabis Buyers' Coop., 532 U.S. 483, 491-95 (2001) (holding that medical necessity is not a defense to manufacturing and distributing marijuana). Marijuana is a schedule-I controlled substance under the CSA. See 21 U.S.C. § 802(6) (defining controlled substance to include any drug or substance “included in schedule I . . . of part B of this subchapter.”); id. § 812(c), Schedule I at (c)(10). “By classifying marijuana as a Schedule I drug, as opposed to listing it on a lesser schedule, the manufacture, distribution, or possession of marijuana became a criminal offense, with the sole exception being use of the drug as part of a Food and Drug Administration preapproved research study.” Gonzales, 545 U.S. at 14 (citations omitted). The first section of the CSA provides that “[t]he illegal importation, manufacture, distribution, and possession and improper use of controlled substances have a substantial and detrimental effect on the health and general welfare of the American people.” 21 U.S.C. § 801(2). Illinois' enactment of the CUA does not affect the fact that marijuana, including medical marijuana, is prohibited under the CSA. As the Ninth Circuit recently explained in United States v. McIntosh, 833 F.3d 1163 (9th Cir. 2016):

The CSA prohibits the manufacture, distribution, and possession of marijuana. Anyone in any state who possesses, distributes, or manufactures marijuana for medical or recreational purposes (or attempts or conspires to do so) is committing a federal crime. The federal government can prosecute such offenses for up to five years after they occur. See 18 U.S.C. § 3282. Congress currently restricts the government from spending certain funds to prosecute certain individuals. But Congress could restore funding tomorrow, a year from now, or four years from now, and the government could then prosecute individuals who committed offenses while the government lacked funding. Moreover, a new president will be elected soon, and a new administration could shift enforcement priorities to place greater emphasis on prosecuting marijuana offenses.
Nor does any state law “legalize” possession, distribution, or manufacture of marijuana. Under the Supremacy Clause of the Constitution, state laws cannot permit what federal law prohibits. U.S. Const. art VI, cl. 2. Thus, while the CSA remains in effect, states cannot actually authorize the manufacture, distribution, or possession of marijuana. Such activity remains prohibited by federal law.

Id. at 1179 n.5.


         Under federal law, contracts that violate a federal statute on their face are “intrinsically illegal.” NIPSCO, 799 F.2d at 273. For example, express agreements to violate the law are clearly illegal-such as agreements to restrain trade or commit a bank robbery-as are agreements that explicitly contradict a federal statute. See, e.g., Kaiser Steel Corp. v. Mullins, 455 U.S. 72, 78 (1982) (holding that agreement was illegal because it required plaintiff to pay a penalty if it breached a separate agreement to restrain trade). “In addition, even if the contract is not illegal on its face, courts have found contracts inherently illegal where one party must violate a statute or regulation to fulfill its obligations.” Energy Labs, Inc., 2015 WL 3504974, at *3 (citing cases); see also, e.g., D.R. Wilder Mfg. Co. v. Corn Prods. Ref. Co., 236 U.S. 165, 172-73 (1915) (recognizing that if contract is “inherently illegal . . . the also elementary rule that courts will not exert their powers to enforce illegal contracts or to compel wrongdoing” may apply).

         Because illegality of contract is an affirmative defense, defendants cannot secure dismissal of Ginsburg's breach of contract claim under Rule 12(b)(6) based on the illegality of the Notes unless the defense appears clearly on the face of the fourth amended complaint. See Cochran, 2011 WL 5604024, at *1. For at least the following reasons, the court cannot conclude, based on the allegations in the fourth amended complaint, that the Notes are intrinsically illegal.

         “To determine whether a contract violates a federal statute on its face, [the court] compare[s] the four corners of the contract with the language of the statute and related regulations and any interpreting case law.” Energy Labs, Inc., 2015 WL 3504974, at *4 (citing NIPSCO, 799 F.2d at 273). As explained above, the CSA prohibits a person from knowingly or intentionally manufacturing, distributing, dispensing, or possessing with an intent to manufacture, distribute, or dispense, a controlled substance. See 21 U.S.C. § 841(a)(1). On their faces, the Notes do not violate the CSA. Nothing contained in the Notes requires Ginsburg or ICC to manufacture, distribute, dispense, or possess marijuana. In fact, the Notes do not mention marijuana, ICC's business, or how ICC is to obtain the funds to repay its loan obligations. Instead, the Notes simply set forth the terms of Ginsburg's loans to ICC and provide for the repayment of the loans at a certain rate of interest.[8]

         Nor would granting relief in this case require that McGraw or ICC violate the CSA.[9]Ginsburg seeks repayment of the $9, 340, 000 that he loaned ICC, plus interest, attorney's fees, costs, and expenses. Obtaining this relief does not require that ICC manufacture, distribute, dispense, or possess marijuana. See, e.g., Mann v. Gullickson, 2016 WL 6473215, at *7 (N.D. Cal. Nov. 2, 2016) (holding, in case where defendant failed to make payments under contract for sale of consulting business related to marijuana industry, that the court “could grant relief in this case that does not require [defendant] to violate the CSA. [Plaintiff]'s suit seeks [defendant's] full payment for the businesses he sold to her. Mandating that payment does not require [defendant] to possess, cultivate, or distribute marijuana, or to in any other way require her to violate the CSA.”); Energy Labs, Inc., 2015 WL 3504974, at *4 (where enforcement of contract would not necessarily require defendant to violate federal statute, and “by paying for the air conditioning units with non-federal funds, Defendants can fulfill their obligations under the purchase orders without violating [statute], ” contract, as pleaded, was not illegal).[10] In other words, even if the Notes concern an illegal object (i.e., a violation of the CSA), it is possible for the court to enforce the Notes in a way that does not require any party to engage in illegal conduct.


         Defendants argue that “Ginsburg is not entitled to any relief because the stated purpose of his investment and the Notes, admitted by Ginsburg, is to finance the cultivation, possession and dispensing of marijuana, a purpose that is in clear violation of the laws of the United States and the State of Texas.” Ds. Br. 12. But defendants fail to cite any authority in support of their apparent position that, under federal and Texas law, a contract with the purpose of funding an organization that is violating or intends to violate federal law is automatically void or unenforceable.[11]

         Generally, a contract entered into in violation of federal law or public policy is unenforceable. See Kaiser Steel Corp., 455 U.S. at 77 (“There is no statutory code of federal contract law, but our cases leave no doubt that illegal promises will not be enforced in cases controlled by the federal law.”); id. at 83 (“It is also well established . . . that a federal court has a duty to determine whether a contract violates federal law before enforcing it.”). In practice, however, federal courts have taken a more flexible approach to the question of enforceability. See, e.g., Paul Arpin Van Lines, Inc. v. Universal Transp. Servs., Inc., 988 F.2d 288, 290 (1st Cir. 1993) (“This general rule [of not enforcing illegal contracts] . . . is almost as much honored in the breach as in the observance.”); see also Nagel v. ADM Inv'r Servs., Inc., 217 F.3d 436, 440 (7th Cir. 2000) (noting that despite Kaiser Steel's “ringing declaration, many cases continue to treat the defense of illegality to the enforcement of a contract as presumptive rather than absolute, forgiving minor violations and not allowing the defense to be used to confer windfalls.” (citing cases)). “[T]he defense of illegality, being in character if not origins an equitable and remedial doctrine, is not automatic but requires . . . a comparison of the pros and cons of enforcement.” NIPSCO, 799 F.2d at 273. In NIPSCO the Seventh Circuit held that the contract was enforceable, noting that the statute violated was “an anachronism-a regulatory statute on which the sun set long ago.” Id. at 274. In Resolution Trust Corp. v. Home Savings of America, 946 F.2d 93 (8th Cir. 1991), the court observed: “[s]ome federal courts have applied this less-than-absolute rule and have refused to enforce illegal contracts only if the statute or regulation explicitly provides that contracts in violation are void, or if the interest in enforcement clearly outweighs the public policy against enforcement.” Resolution Tr. Corp., 946 F.2d at 96-97 (footnote and citations omitted). More recently, the Ninth Circuit explained that “[n]uanced approaches to the illegal contract defense, taking into account such considerations as the avoidance of windfalls or forfeitures, deterrence of illegal conduct, and relative moral culpability, remain viable in federal court and represent no departure from Kaiser Steel . . . as long as the relief ordered does not mandate illegal conduct.” Bassidji v. Goe, 413 F.3d 928, 937-38 (9th Cir. 2005); see also Energy Labs, Inc., 2015 WL 3504974, at *3 (“[E]ven if a contract is illegal, it is not automatically unenforceable. Under federal law, the illegality of contract defense involves a balancing of the ‘pros and cons of enforcement, ' taking into account the benefits of enforcement ‘that lie in creating stability in contract relations and preserving reasonable expectations' and the ‘costs in forgoing the additional deterrence of behavior forbidden by the statute.'” (citations omitted)); Dervin Corp. v. Banco Bilbao Vizcaya Argentaria, S.A., 2004 WL 1933621, at *3 (S.D.N.Y. Aug. 30, 2004) (“The fact that a contract offends a federal statute or regulation does not, however automatically render it void or unenforceable. Unless the enforcement of a contract would require directing the precise conduct that a statute or regulation makes unlawful, ‘the courts are to be guided by the overriding general policy . . . of preventing people from getting other people's property for nothing when they are purporting to be buying it.'” (citation omitted)).

         Defendants do not address any of the foregoing factors in their motion to dismiss Ginsburg's contract claims. Instead, they appear to posit that, if a contract has an illegal purpose, it is automatically void and unenforceable. But, as explained above, federal courts do not take such a “black-and-white” approach to enforceability. Although the court does not suggest that a contract with the purpose of funding an organization that is violating or intends to violate federal law is necessarily enforceable, or that, in this case, the Notes are themselves enforceable, it concludes at the Rule 12(b)(6) stage that defendants have not established from the face of the fourth amended complaint that the Notes are void and unenforceable.


         Defendants also move to dismiss Ginsburg's contract claim on the basis that he has failed to plead a plausible claim for relief.


         Defendants contend that the Notes and the Reserve Agreement are the operative contracts between the parties; that, under the Reserve Agreement, Ginsburg withheld $1, 260, 000 to service 12 months of interest payments under both Notes, which carried the Notes through to April 26, 2017; and that ICC therefore did not breach its agreement with Ginsburg before May 24, 2017. Defendants next contend that, because Ginsburg demanded additional interest payments from ICC before May 24, 2017, sued ICC for failing to pay this additional interest, and took the position that he never agreed to or executed the Reserve Agreement, even though he admits that he withheld $1, 260, 000 from the amount of the March Note, his conduct constitutes a prior material default under the Notes. According to defendants, “Ginsburg either improperly withheld $1, 260, 000 that was supposed to be paid to ICC or improperly demanded payment of interest that had already been paid and sued ICC for interest that was not owed. Therefore, Ginsburg's prior breach bars his recovery for breach of contract.” Ds. Br. 14.

         Ginsburg responds that he has plausibly alleged all of the elements of a claim for breach of contract; that the fourth amended complaint pleads that the Reserve Agreement represents no more than preliminary negotiations, that Ginsburg never executed the Reserve Agreement or consented to its terms, and that, accordingly, the unsigned Reserve Agreement is unenforceable against Ginsburg and does not excuse ICC from its obligation to make the interest payments required under the Notes; that defendants' prior material breach affirmative defense is not established based on the face of the complaint and the unambiguous terms of the March Note, which contains no promise by Ginsburg to transfer the full $3.6 million, but instead specifies that a lesser amount may be loaned; and that ICC's failure to pay the accrued interest qualifies as a default under the Notes, and Ginsburg's demand that ICC pay what is owed under the Notes is not a prior material breach.


         Under Illinois law, [12] to prove a claim for breach of contract, a plaintiff must establish the following elements: “(1) the existence of a valid and enforceable contract; (2) performance by the plaintiff; (3) breach of contract by the defendant; and (4) resultant injury to the plaintiff.” Catania v. Local 4250/5050 of Commc'ns Workers of Am., 834 N.E.2d 966, 971 (Ill. Ct. App. 2005) (citation omitted). In the fourth amended complaint, Ginsburg alleges that, on March 16, 2016, he executed a promissory note in the amount of $3.6 million, and, pursuant to the Note, transferred $2, 340, 000 to ICC. Ginsburg also asserts that the Notes required ICC to pay accrued interest three months after each Note's effective date; that ICC defaulted by failing to make the interest payments required by the Notes; that he sent a demand letter on July 6, 2016, demanding that the interest be paid to him by August 4, 2016; that he sent a demand letter on April 26, 2017 stating that the interest then owing under the Notes exceeded $1, 260, 000; and ...

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