An investor group is suing Innovative Industrial Properties (IIP) (NYSE: IIPR) for not doing proper due diligence in its Kings Garden investment.
Investor Michael Mallozzi originally sued IIP in April 2022, when the Blue Orca Capital report came out. He was then joined by investors Alejandro Handal and Stephen Forrester.
They are claiming IIP mislead investors, was incompetent, and broke securities laws.
In December, IIP asked the court to dismiss the case, but the latest brief asks the court to deny that request to dismiss because IIP was aware that Kings Garden was a Ponzi scheme while telling investors everything was OK.
Kings Garden Deal
In April 2019, IIP entered into a sale-leaseback transaction with California-based Kings Garden, led by its CEO and Chairman Michael King. Between 2019-2021, IIPR purchased six properties from Kings Garden at prices far higher than Kings Garden had paid for the properties.
In total, IIP invested approximately $150 million into Kings Garden cannabis farms, which accounted for up to 10% of IIP’s rental revenues. The company also spent money to build out the facilities for Kings Garden.
At the heart of the lawsuit, the investors claim that IIP didn’t do the due diligence that it claimed it had. Specifically, the case states that a simple background check would have uncovered that Swiss American Investment Corporation, one of Kings Garden’s investors, filed a suit alleging that Kings Garden had not paid out promised quarterly dividends.
It also points out “irregular” transactions involving millions of dollars between Kings Garden and its managing directors, multiple related-party transactions between Kings Garden and entities its managing members owned or controlled, and that there was “self-dealing … and a lack of transparency around its financial affairs.”
The court brief also stated, “King had already been involved with 32 lawsuits before January 2019, already had felony charges, and had already changed his name. The information from which IIPR eventually concluded that Kings Garden was a Ponzi scheme with organized crime ties was available in early 2019 with just a few keystrokes.”
Instead, IIP continued to tell investors that Kings Garden was in good shape – up until IIP sued it for lack of payment. At that point, the company said it actually suspected Kings Garden was not being honest.
The investors argue that IIP can’t have it both ways, claiming in one lawsuit that Kings Garden lied to them, but in another lawsuit said they had no idea Kings Garden was lying.
The case uses IIP’s own language saying that it sends its due diligence team to check on construction projects and verifies invoices. But, the lawsuit claims, it wasn’t doing any of that.
“Two of those projects, the San Bernardino and 19th Street properties, had allowances for up to a total of $76.4 million in ‘Draw Requests.’” the suit said. “At the end of the Class Period, IIPR stated that it had paid $49 million dollars in Draw Requests to Kings Garden for work that had never been performed, due to forged Draw Requests and invoices.”
For example, an electrical invoice appeared to be cobbled together with mismatched fonts and text boxes that were added to an old invoice. That document was from an electric company previously owned by Kings Garden’s vice president of operations.
The lawsuit also brings up an April 2022 report by the activist short-seller Blue Orca that wrote about IIP’s exposure to Kings Garden. The case says that instead of addressing the issues raised by Orca, IIP said that Orca didn’t understand commercial real estate or the cannabis industry.
In the company’s May 2022 earnings call, IIP continued to sing the praises of Kings Garden, saying, “Michael King and his team have one of the best reputations for product quality and consistency and perhaps the single largest cannabis market in the world.”
Just a few weeks later though, the court filing claims that IIP realized the problems. In July 2022, it told investors that Kings Garden had quit paying rent and in August filed a lawsuit against the company for fraud calling it a Ponzi scheme.