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Investors sue Patriot National, allege breach of private placement


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Investors sue Patriot National, allege breach of private placement

isbeing sued by two investment funds for refusing to hand over stock that itpromised to them in a private placement six months ago.

The suits accuse the Florida-based company of breaking itscontract by withholding a total of 1.6 million shares from CVI Investments Inc.and Hudson Bay Master FundLtd., even though they hold rights to the stock. Patriot Nationalis stalling primarily because its CEO committed to selling more of hiscompany's stock than he actually controls, Hudson Bay alleged in its complaint,and is now unable to follow through on his end of the deal.

The dispute stems from a complex stock and warrant sale thatPatriot National agreed to in December 2015 with CVI Investments, Hudson Bayand a third investor, Alto Opportunity Master Fund. The deal's terms call forPatriot National Chairman, President and CEO Steven Mariano to supply all ofthe stock involved in the transaction, which included the outright sale of 2.5million shares as well as warrants for more shares to be provided later.

Yet when CVI Investments and Hudson Bay notified PatriotNational in early April that they would exercise some of those warrants, thecompany denied the requests. Patriot National cited an ongoing FINRA inquiryinto possible fraudulent activity surrounding the private placement, tellingCVI Investments in a letter that it "will not honor" its requestuntil the inquiry is completed, according to a copy included in court filings.

In their respective lawsuits, CVI Investments and Hudson Baysaid they were not aware of any FINRA investigations, and are not even subjectto regulation by the agency.

FINRA spokeswoman Michelle Ong said in an interview thatwhile the agency does not comment on specific investigations, it does notappear that the private placement falls under FINRA's jurisdiction, since noneof the companies involved are broker/dealers.

Patriot National, in a response filed in court, maintainedthat FINRA's Office of Fraud Detection and Market Intelligence is stillconducting an investigation. Patriot National is doing its own internal reviewas well. The company declined multiple requests for comment about the privateplacement and Mariano's stock commitments.


Patriot National has not publicly acknowledged Mariano'son-paper shortfall, nor has it disclosed in public filings that it faces legalaction connected to the private placement. On a May 13 earnings call, Marianoin response to a question about the deal alluded to "legal action"but said he could not comment on "what's going on there."

However, Hudson Bay believes Patriot National refuses todeliver its shares because Mariano does not control them.

Patriot National's April 8 showed that Mariano hadbeneficial ownership of, at most, nearly 14.8 million of his company's sharesas of March 31. More than 1.3 million of those shares are pledged as collateralfor a 2013 credit agreement with UBS Bank USA, and another 10.5 million arepledged as collateral for a 2015 Fifth Third Bank loan. That leaves just about3 million of Mariano's shares "unencumbered" by ongoing commitments.

But by early April, Patriot National had almost 4.9 millionshares tied to the private placement's series B warrants, all of which would besupplied by Mariano. That created a significant deficit between the amount thatMariano had committed to the various transactions and the amount overwhich he retained control.

"In fact, public filings reveal that the most likelyreason why Mariano has not delivered the Shares as required is that, contraryto his contractual commitment, Mariano does not have sufficient unencumberedShares to meet his delivery obligations to all investors, including HudsonBay," Hudson Bay's complaint said.

The natural next step would be for Patriot National to sueMariano over the shortfall, Hudson Bay said in the filing, since PatriotNational needs to deliver on its commitments to the investors. A clauseincluded in the deal promised that the share and warrant sales would not"conflict with or result in a breach or violation" of Mariano's priorcommitments, as well as that Mariano would always have enough stock on hand tocover his obligations. But Mariano is both the company's top executive and itsmajority shareholder.

"On information and belief, not only has Mariano failedto hold a sufficient number of unencumbered Shares, he has used his dominionand control over Patriot National to ensure that Patriot National does not suehim or otherwise take action to enforce his obligations," the complaintsaid.

CVI Investments did not name Mariano as a defendant in itssuit, but nevertheless accused him of an "erratic and reckless pattern ofconduct" in running the company. It is unclear whether Alto OpportunityMaster Fund, which is run by TenorCapital Management Co. L.P., has filed a suit of its own over thedeal. Tenor Capital COO Daniel Kochav did not return a call requesting comment.

In its court-filed responses, Patriot National denied theallegations included in the two lawsuits and asked the court to dismiss thecomplaints.

Strategic options

CVI Investments and Hudson Bay are not the only ones toquestion the arrangement. Compass Point LLC analyst Ken Billingsley firsthighlighted Mariano's apparent share deficit in an April 8 note to clients,speculating that the imbalance could have prompted Patriot National's suddendecision to explore a sale.

The company announced in February that it would alternatives, and twomonths later said it hired Evercore Group LLC as an adviser and would consider itself.

The shift in strategy came with little warning. PatriotNational was just more than a year removed from an IPO that raised over $100 million, and though its stockstruggled in subsequent months, Mariano touted its potential. The "heavylifting and upfront investments" were finally behind it, he analysts on a Feb. 25earnings call. The company, he said, was now poised for growth.

Four days later, however, Patriot National formed a specialcommittee dedicated to finding "value creation" opportunities.Seeking a sale based on Patriot National's fundamentals seemed curious,Billingsley said in his note, since it would likely mean selling at a bigdiscount to its competitors.

"If the company does explore a sale, we estimate[Patriot National] could be worth between $10 and $15 per share depending onthe speed at which the company pursues a sale," he said, adding that thosevaluations translated to as much as a 50% discount to its peer group. "Onereason the company may be exploring a possible sale is due to a potential issuesurrounding shares pledged by its CEO."

A wider deficit

Mariano's share deficit could be even wider than Hudson Baycalculated in its lawsuit, according to a review conducted by S&P GlobalMarket Intelligence of Billingsley's research and Patriot National's publicfilings.

Patriot National's most recent proxyfiling shows that Mariano held beneficial ownership of about14.6 million shares as of April 6.

The of the privateplacement awarded the three investors series A warrants covering roughly 3.3million Patriot National shares, along with B warrants covering a number ofshares to be determined based on a complicated formula involving PatriotNational's lowest 10-day volume-weighted average stock price over a set period.In essence, the lower Patriot National's share price goes, the more B warrantshares it might have to deliver to the investors.

Patriot National later registered the 3.3 million A warrantshares along with the estimated 4.9 million shares connected to the B warrants.That meant that Mariano could be responsible for more than 8.1 million sharesthrough the investors' full exercise of the A and B warrants.

Adding that commitment to the existing pledges of 11.9million shares to UBS Bank USA and Fifth Third Bank means that Marianoallocated as collateral or tied to warrants almost 20 million Patriot Nationalshares. That total is 5.4 million shares more than the amount that Marianoactually controlled.

"You reach a conclusion that Mariano has overleveragedthis company, based upon what's in the filings," Robert Ansehl, a partnerat law firm White and Williams LLP who specializes in insurance transactionsand regulation, said in an interview. "It's nothing I've seen before."

Court dates have not yet been set for the lawsuits filed byCVI Investments and Hudson Bay, both of which are seeking monetary damages inaddition to the immediate delivery of Patriot National's shares.

Yet if Mariano and Patriot National ultimately do hand overthe shares, it will likely mean giving them up at a steep discount. While theinvestors could pay as much as $10 per Patriot National share when theyexercise their A warrants, the exercise price for the B warrants is just onecent per share.

That means that even if the investors paid the maximumamount for the A warrant shares, they could still end up purchasing Mariano's2.5 million common shares, 3.3 million A warrant shares and 4.9 million Bwarrant shares for a grand total of $62.5 million. That hypotheticalcalculation works out to about $5.88 each for 10.6 million Patriot Nationalshares.

By comparison, Patriot National's open-market stock pricestood at $7.83 as of the May 12 close.