On 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.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.