Kartoon Studios, Inc. 10-Q

ITEM 1. LEGAL PROCEEDINGS. As of September 30, 2022, there were no material pending legal proceedings to which the Company is a party or as to which any of its property is subject other than described below. As previously disclosed, the Company, its Chief Executive Officer Andy Heyward, and its Chief Financial Officer Robert Denton were named as defendants in a putative class action lawsuit filed in the U.S. District Court for the Central District of California and styled In re Genius Brands International, Inc. Securities Litigation , Master File No. 2:20-cv-07457 DSF (RAOx). Lead plaintiffs alleged generally that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) by issuing allegedly false or misleading statements about the Company, initially over an alleged class period running from March into early July 2020. Plaintiffs sought unspecified damages on behalf of the alleged class of persons who invested in the Company’s common stock during the alleged class period. Defendants moved to dismiss lead plaintiffs’ amended complaint; and in a decision issued on August 30, 2021, the Court dismissed the amended complaint but granted lead plaintiffs a further opportunity to plead a claim. On September 27, 2021, lead plaintiffs filed a second amended complaint, naming the same defendants. The new complaint alleged again that the Company made numerous false or misleading statements about the Company’s business and business prospects, this time over an expanded alleged class period that extended into March 2021; they again alleged that these misstatements violated Section 10(b) and 20(a) of the Exchange Act. Lead plaintiffs again sought unspecified damages on behalf of an alleged class of persons who invested in the Company’s common stock during the expanded alleged class period. In November 2021, defendants filed a motion to dismiss the second amended complaint. On July 15, 2022, the Court issued a decision dismissing the second amended complaint in its entirety and with prejudice. On August 12, 2022, lead plaintiffs filed a notice of appeal to the United States Court of Appeals for the Ninth Circuit. Briefing of the appeal is expected to be extended into early 2023. The Company cannot predict the outcome of that appeal or the timing of a decision on it. Related to the securities class action, the Company’s directors (other than Dr. Cynthia Turner-Graham), together with Messrs. Heyward and Denton and former director Michael Klein, have been named as defendants in several putative stockholder derivative lawsuits. As previously disclosed, these include a consolidated proceeding pending in the U.S. District Court for the Central District of California and styled In re Genius Brands Stockholder Derivative Litigation , Case No. 2:20-cv-08277 DSF (RAOx); an action filed in the Los Angeles County Superior Court captioned Ly, etc. v. Heyward, et al ., Case No. 20STCV44611; and an additional case pending in the U.S. District Court for the District of Nevada, styled Miceli, etc. v. Heyward, et al ., Case No. 3:21-cv-00132-MMD-WGC. While the allegations and legal claims vary somewhat among the derivative actions, they all generally allege that the defendants breached fiduciary duties owed to the Company. The plaintiffs, all alleged stockholders of the Company, purport to sue on behalf and for the benefit of the Company. Accordingly, the derivative plaintiffs seek no recovery from the Company. Instead, as a stockholder derivative action, the Company is named as a nominal defendant. Pursuant to agreements among the parties, the courts in all of the derivative lawsuits have stayed proceedings pending the outcome of the securities class action. The Company cannot predict the impact of the securities class action’s dismissal on the shareholder derivative lawsuits. The Company is also a nominal defendant in an action filed in January 2022 in the U.S. District Court for the Southern District of New York and styled Todd Augenbaum v. Anson Investments Master Fund LP, et al ., Case No. 1:22-cv-00249 VM. The action, which again purports to be brought on behalf and for the benefit of the Company, seeks the recovery under Section 16(b) of the Exchange Act of supposed short-swing profits allegedly realized by roughly a dozen persons and entities that participated as investors in certain of the Company’s private placements of securities in 2020. Plaintiff Augenbaum, who purports to be a Company stockholder, filed his lawsuit after issuing a demand to the Company’s Board of Directors asking that the Company sue the investor defendants. The Company rejected the demand, and Mr. Augenbaum sued a few weeks later, as Section 16(b) permits him to do. No Company officer or director is among the defendants. The defendant investors in the action requested and received court permission to file a motion to dismiss the action. The motion was filed in July 2022, and the plaintiff has opposed it. Thereafter, the Court ordered additional briefing on the motion, which is currently scheduled to conclude in mid-November 2022. There is otherwise no current activity in the case. The Company cannot predict the outcome of the motion to dismiss, the timing of court action on the requests, or the outcome of the lawsuit more generally. While the Company again notes that plaintiff seeks no relief against the Company, several of the defendant investors have made demands on the Company that it indemnify their costs of defending the action, invoking provisions in the agreements by which the investors acquired Company securities. 58 On January 18, 2022, the Company was named as a defendant in a lawsuit filed in the Supreme Court of the State of New York, County of New York styled Harold Chizick and Jennifer Chizick v. Genius Brands International, Inc., ChizComm Ltd ., Index No. 650278/2022, alleging: (1) breach of employment agreement, (2) breach of duty of good faith, (3) constructive dismissal, (4) indemnification, (5) violation of the Employment Standards Act 2000 of Ontario, and (6) defamation. On February 25, 2022, the Company filed a motion to dismiss on the ground that venue is improper. In response, plaintiffs’ counsel has advised that they will be amending their complaint to address the arguments in the Company’s venue motion. Plaintiffs filed an amended complaint on March 17, 2022, adding a claim for reformation of the plaintiffs’ employment agreements to address the Company’s lack of venue argument and a claim for breach of escrow agreement regarding alleged release of shares held in escrow pursuant to the parties’ Purchase and Sale Agreement (the “PSA”). On April 25, 2022, the Company filed a motion for partial dismissal of the plaintiffs’ amended complaint seeking (1) dismissal of the plaintiffs’ claims for indemnification and defamation and (2) a stay of plaintiffs’ claim for breach of escrow agreement pending the required arbitration of this claim. At the hearing on this motion to dismiss on June 14, 2022, the Company was successful in having (1) the indemnification claim dismissed with prejudice and (2) the claim for breach of escrow agreement stayed pending arbitration of this claim before the American Arbitration Association (“AAA”). On June 3, 2022, plaintiffs commenced their AAA arbitration proceeding regarding their claim for breach of escrow agreement by filing an arbitration demand. On June 6, 2022, plaintiffs filed a request for emergency relief in the AAA proceeding seeking a mandatory injunction to release the Company shares held in escrow pending indemnification claims under the terms of the PSA. The Company opposed this emergency relief request on multiple grounds (including, without limitation, the lack of any irreparable harm, the adequacy of money damages and the Company’s indemnification claim applicable to the escrowed shares) and the hearing on this emergency relief request occurred at the AAA offices in New York on June 24, 2022. On October 3, 2022, the parties reached a full and complete settlement of the New York state action and the AAA arbitration proceeding and both proceedings have been dismissed with prejudice. In all of the above-mentioned active proceedings, the Company has denied and continues to deny any wrongdoing and intends to defend the claims vigorously. The Company maintains a program of directors’ and officers’ liability insurance that, subject to the insurers’ reservations of rights, has offset a portion of the costs of defending the securities class action litigation, and that the Company expects will afford coverage for some costs of the other shareholder litigation should any of those cases proceed.