Zazzali v. Hirschler Fleischer P.C. et al
MEMORANDUM OPINION re motions to dismiss. Signed by Judge Leonard P. Stark on 8/21/12. (ntl)
IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF DELAWARE
JAMES R. ZAZZALI, as trustee for the
DBSI Estate Litigation Trust and as Trustee
for the DBSI Private Actions Trust,
C.A. No. 11-614-LPS
HIRSCHLER FLEISCHER, P.C. and JOHN
Natasha M. Songonuga, Esq., GIBBONS P.C., Wilmington, DE;
Brian J. McMahon, Esq., E. Evans Wohlfarth, Jr., Esq., Debra A. Clifford, Esq., GIBBONS P.C.,
Attorneys for Plaintiff.
James W. Semple, Esq. & Jody C. Barillare, Esq., MORRIS JAMES LLP, Wilmington, DE;
Dennis J. Quinn, Esq., Andrew J. Morris, Esq., Zachary G. Williams, Esq., CARR MALONEY
P.C., Washington, DC.
Attorneys for Defendant.
August 21, 2012
STARK, U.S. District Judge:
Pending before the Court are a Motion to Dismiss for Lack of Subject Matter Jurisdiction
(D.I. 10) and a Motion to Dismiss for Failure to State a Claim (D.I. 11) filed by defendant
Hirschler Fleischer P.C. ("Defendant"). For the reasons discussed below, the Court will deny
Defendant's Motion to Dismiss for Lack of Subject Matter Jurisdiction and grant Defendant's
Motion to Dismiss for Failure to State a Claim.
DBSI, Inc. and related entities (collectively, "DBSI"), all of whom are Idaho real estate
investment entities, filed bankruptcy petitions in the United State Bankruptcy Court for the
District of Delaware (the "Bankruptcy Court") beginning on November 6, 2008. (D.I. 1 ~~ 4, 6)
By Order dated October 26, 2010, the Bankruptcy Court confirmed the Second Amended Joint
Chapter 11 Plan ofLiquidation Filed by the Chapter 11 Trustee and the Official Committee of
Unsecured Creditors ("the Plan"). (Id.
10) The Plan created two trusts: the DBSI Estate
Litigation Trust ("EL T") and the DBSI Private Actions Trust ("PAT"). (Id.) The ELT holds the
claims ofthe consolidated bankruptcy estate ofthe DBSI debtor entities, while the PAT holds the
claims of creditors and equity interests holders of DBSI who chose to assign their claims. (Id.)
The Bankruptcy Court appointed James R. Zazzali ("Zazzali" or "Plaintiff' or "Trustee") as the
trustee for the ELT and the PAT. (Id.
The Court is not making any findings of fact. Instead, at this point, the Court must take
as true all well-pleaded factual allegations in the complaint.
DBSI's Investment Structure
From 2004 to 2008, DBSI and its affiliates "presented to the world an illusion of a
monolith of wealth, competence, and power." (Id. ,-r 1) In Private Placement Memoranda
("PPMs") 2 drafted by Defendant, investors were informed that DBSI was a successful real estate
holding company with a history of successful and sophisticated real estate ventures, in which no
investor had ever lost money. (ld. ,-r,-r 1, 28-30)
DBSI sold tax-advantage instruments called "1 031 Exchanges," named after the section
of the Internal Revenue Code authorizing these investments. (Id. ,-r 25) Through the 1031
Exchanges, DBSI investors obtained "tenant-in-common" ("TIC") interests in commercial real
estate properties. (ld.) DBSI structured its TIC syndications using a master lease arrangement
under which the TIC property was leased to a DBSI affiliate master lessor and then subleased to a
tenant. (ld. ,-r,-r 31, 33, 83) DBSI guaranteed that rent from sublessees would be paid to TIC
investors. (ld. ,-r 83) Rent payments from sublessees did not cover both the rent owed to TIC
investors and the debt service; consequently, the operation of the underlying properties could not
support DBSI's obligations. (ld. ,-r 98) As the TIC syndication business failed, DBSI raised
capital from new TIC syndications of properties purchased for sums exceeding the market value
of the properties. (ld.) DBSI's TIC syndication guarantees were sold on the representation that
DBSI had substantial value, even as newly raised investors' funds were being used to pay off
existing investors. (Id.)
Additionally, DBSI created Accountable Reserves. (ld. ,-r,-r 32, 35) In its PPMs, DBSI
"A PPM is an offering document that sets forth the details and terms of investments
offered to the public." (D.I. 1 ,-r 27)
informed investors that it would set aside five percent of investors' funds to pay the costs of
maintaining the properties and these funds would be kept in the Accountable Reserves. (!d.~ 37)
DBSI informed investors that any amount oftheir invested funds not used for property
maintenance would be returned to the TIC owners.
37; see id., Ex. B) Only
approximately $18 million of the Accountable Reserves funds were used as represented, whereas
$82 million of Accountable Reserves were spent for unauthorized purposes, including
misappropriation by DBSI executives. (!d.
In the fall of 2008, "the world learned" that DBSI was running an elaborate Ponzi
Defendant's Involvement with DBSJ
At all times relevant to the Complaint, Defendant served as legal counsel to DBSI. (!d.
28) Defendant advised DBSI on creation of the master lease structure and various § 1031
91) From 2004 until2006, Defendant drafted all of the PPMs used by DBSI in
connection with their TIC syndications and provided material and substantial advice to DBSI
regarding the drafting ofPPMs. (!d.
28-29) After 2006, DBSI continued to use language
drafted and/or reviewed by Defendant in subsequent PPMs. (!d.
78) The allegedly misleading
language that Defendant drafted included statements that DBSI would use Accountable Reserves
only for specified purposes, as well as false statements about DBSI's net worth, loan-to-loan
value ratios, and related financial disclosures. (!d.
44, 60, 68, 76, 87; see also id., Ex. A; id.,
Ex. B; id., Ex. C)
On July 11,2011, the Trustee filed a complaint, on behalfofthe ELT and PAT, against
Defendant and John Does 1-10 for their role in the DBSI fraud. (See D.l. 1 and, hereinafter,
"Complaint") In the Complaint, the Trustee asserts fifteen counts on behalf of one or both of the
trusts. 3 On behalf ofboth trusts, the Trustee asserts the following claims: violation of the
Racketeer Influenced and Corrupt Organizations ("RICO") Act, 18 U.S.C. § 1961 et. seq. and
violation of the Idaho RICO statute, IDAHO CODE § 18-708(c) (Count 1), and conspiracy to
violate the federal and Idaho RICO statutes (Count 2). On behalf of the ELT, the Trustee asserts
the following claims: professional malpractice (Count 3), aiding and abetting breach of fiduciary
duty owed to DBSI (Count 4), and avoidance and recovery of actual and constructive fraudulent
transfers (Counts 9-15). On behalf of the PAT, the Trustee asserts the following claims: aiding
and abetting fraud (Count 5), civil conspiracy (Count 6), aiding and abetting breach of fiduciary
duty owed to owners of reserve funds (Count 7), and aiding and abetting breach of fiduciary duty
owed to creditors (Count 8).
On October 7, 2011, Defendant filed the pending motions to dismiss. (See D.l. 10; D.l.
11) The parties completed briefing on the pending motions on January 13, 2012. (See D.l. 27;
D.I. 28) The Court held oral argument on June 6, 2012. See Mot. Hr'g Tr., June 6, 2012
(hereinafter "Tr. ").
After the hearing, the Court ordered supplemental briefing regarding (1) what notice, if
any, Defendant received regarding the DBSI bankruptcy, confirmation of the Second Amended
Joint Chapter 11 Plan of Liquidation, and the possibility that Defendant might be subject to suit;
and (2) the applicability and impact of equitable mootness on the issues pending before the
The Complaint initially included a count for disallowance, however, this claim was
dismissed without prejudice on January 9, 2012. (See D.l. 26)
Court. (See D.I. 34) The parties completed this supplemental briefing on June 20, 2012. (See
D.I. 38; D.I. 39)
Motion to Dismiss for Lack of Standin~:
"A motion to dismiss for want of standing is ... properly brought pursuant to Rule
12(b)(1), because standing is a jurisdictional matter. Pursuant to Rule 12(b)(1), the Court must
accept as true all material allegations set forth in the complaint, and must construe those facts in
favor of the nonmoving party." Ballentine v. United States, 486 F.3d 806, 810 (3d Cir. 2007)
(internal citations omitted); see also Steel Co. v. Citi:zensfor a Better Env't, 523 U.S. 83, 102
( 1998) (noting that standing is "threshold jurisdictional question"). A court may grant a motion
to dismiss for lack of standing only if, after, "accepting all well-pleaded allegations in the
complaint as true, and viewing them in the light most favorable to plaintiff, plaintiff is not
entitled to relief." Mao v. Aetna, Inc., 221 F.3d 472,481-82 (3d Cir. 2000) (internal quotation
There are three requirements for Article III standing: (1) injury in fact, which means an
invasion of a legally protected interest that is (a) concrete and particularized and (b) actual or
imminent, not conjectural or hypothetical; (2) a causal connection between the injury and the
challenged conduct, which means that the injury fairly can be traced to the challenged action of
the defendant and has not resulted from the independent action of some third party not before the
court; and (3) a likelihood that the injury will be redressed by a favorable decision, which means
that the prospect of obtaining relief from the injury as a result of a favorable ruling is not too
speculative. See Lujan v. Defenders ofWildlife, 504 U.S. 555, 560-61 (1992).
In addition to establishing Article III standing, a party must establish "prudential
standing." See Elk Grove Unified Sch. Dist. v. Newton, 542 U.S. 1, 11-12 (2004); Twp. of
Lyndhurst v. Priceline.com Inc., 657 F.3d 148, 154 (3d Cir. 2011). Prudential standing embraces
the following principles:
(1) the plaintiff generally must assert his own legal rights and
interests, and cannot rest his claim to relief on the legal rights or
interests of third parties; (2) even when the plaintiffhas alleged
reasonable injury sufficient to meet the requirements of Article III,
the federal courts will not adjudicate abstract questions of wide
public significance which amount to generalized grievances
pervasively shared and most appropriately addressed in the
representative branches; and (3) the pl:aintiffs complaint must fall
within the zone of interests to be protected or regulated by the
statute or constitutional guarantee in question.
Trump Hotels & Casino Resorts, Inc. v. Mirage Resorts, Inc., 140 F.3d 478, 485 (3d Cir. 1998)
(internal quotation marks and citations omitted).
The party invoking federal jurisdiction has the burden to establish standing to sue. See
Lujan, 504 U.S. at 561. Each of the standing requirements "must be supported in the same way
as any other matter on which the plaintiff bears the burden of proof, i.e., with the manner and
degree of evidence required at the successive stages of the litigation." !d. "At the pleading stage,
general factual allegations of injury resulting from the defendant's conduct may suffice, for on a
motion to dismiss we presum[e] that general allegations embrace those specific facts that are
necessary to support the claim." !d. (internal quotation marks omitted). "When ruling on a
motion to dismiss for lack of standing, federal courts may consider affidavits and other factual
materials in the record." Nat'! Ass 'n of State Utility Consumer Advocates v. F. C. C., 457 F.3d
1238, 1251 (11th Cir. 2006).
Motion to Dismiss for Failure to State a Claim
Evaluating a motion to dismiss under Federal Rule of Civil Procedure 12(b)( 6) requires
the Court to accept as true all material allegations of the complaint. See Spruill v. Gillis, 372
F .3d 218, 223 (3d Cir. 2004 ). "The issue is not whether a plaintiff will ultimately prevail but
whether the claimant is entitled to offer evidence to support the claims." In re Burlington Coat
Factory Sees. Litig., 114 F.3d 1410, 1420 (3d Cir. 1997) (internal quotation marks omitted).
Thus, the Court may grant such a motion to dismiss only if, after "accepting all well-pleaded
allegations in the complaint as true, and viewing them in the light most favorable to plaintiff,
plaintiff is not entitled to relief." Maio, 221 F.3d at 481-82 (internal quotation marks omitted).
However, "[t]o survive a motion to dismiss, a civil plaintiff must allege facts that 'raise a
right to relief above the speculative level on the assumption that the allegations in the complaint
are true (even if doubtful in fact)."' Victaulic Co. v. Tieman, 499 F.3d 227,234 (3d Cir. 2007)
(quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 127 S. Ct. 1955, 1965 (2007)). While
heightened fact pleading is not required, "enough facts to state a claim to relief that is plausible
on its face" must be alleged. Twombly, 127 S. Ct. at 1974. At bottom, "[t]he complaint must
state enough facts to raise a reasonable expectation that discovery will reveal evidence of [each]
necessary element" of a plaintiffs claim. Wilkerson v. New Media Tech. Charter Sch. Inc., 522
F.3d 315, 321 (3d Cir. 2008) (internal quotation marks omitted). Nor is the Court obligated to
accept as true "bald assertions," Morse v. Lower Merion Sch. Dist., 132 F.3d 902, 906 (3d Cir.
1997) (internal quotation marks omitted), "unsupported conclusions and unwarranted
inferences," Schuylkill Energy Resources, Inc. v. Pennsylvania Power & Light Co., 113 F.3d 405,
417 (3d Cir. 1997), or allegations that are "self-evidently false," Nami v. Fauver, 82 F.3d 63, 69
(3d Cir. 1996).
Equitable Doctrines Impactin2 Defendant's Standin2 Challen2e
The Trustee asserts that Defendant's standing challenge is untimely because Defendant
did not object to confirmation of the Plan or appointment of the Trustee during the DBSI
bankruptcy proceeding. (See D .I. 20 at 15-19) Specifically, the Trustee contends that
Defendant's standing challenge is barred by the doctrines of equitable mootness, res judicata, and
collateral estoppel. The Court disagrees.
"The doctrine of equitable mootness provides that an appeal should be dismissed as moot
when, even though effective relief could conceivably be fashioned, implementation of that relief
would be inequitable." In re SemCrude, L.P., 456 Fed. Appx. 167, 169 (3d Cir. Jan. 3, 2012)
(internal quotation marks omitted). The determination of whether an appeal is equitably moot
requires discretionary balancing of the following equitable and prudential factors:
(1) whether the reorganized plan has been substantially
consummated, (2) whether a stay has been obtained, (3) whether
the relief requested would affect the rights of parties not before the
Court, (4) whether the relief requested would affect the success of
the plan, and (5) the public policy of affording finality of
In re Continental Airlines, 91 F.3d 553, 560 (3d Cir. 1996) (en bane).
The Court concludes Defendant's standing challenge is not "equitably moot." As
Defendant emphasizes, the instant action is not an appeal from confirmation of a plan of
reorganization - thus, it unclear whether the doctrine of equitable mootness is even applicable
here. 4 Additionally, the Court has an obligation at all times to evaluate whether it has
jurisdiction over the action before it, and Defendant's challenge to the Trustee's standing in the
instant action relates to the Court's jurisdiction. See UPS Worldwide Forwarding, Inc. v. US.
Postal Service, 66 F .3d 621, 626 (3d Cir. 1995) ("[S]tanding implicates federal jurisdiction.").
Finally, to the extent that equitable mootness applies to Defendant's standing challenge, it is an
equitable doctrine. Under the circumstances presented here, the Court will exercise its discretion
to consider Defendant's standing challenge, particularly as it is unclear whether Defendant had
any meaningful opportunity or ability to raise this challenge in any prior proceeding.
The Court concludes that Defendant's standing challenge is not barred by the doctrine of
res judicata. Res judicata, or claim preclusion, prevents a party from asserting claims that were
or could have been brought in a prior proceeding. See In re Mullarkey, 536 F.3d 215, 225 (3d
Cir. 2008); see also In re Szostek, 886 F.2d 1405, 1408 (3d Cir. 1989) ("[A] confirmation order
is res judicata as to all issues decided or which could have been decided at the hearing on
confirmation."). However, Defendant was not a party to the bankruptcy proceeding (or in privity
with a party), and res judicata only applies if "there has been (1) a final judgment on the merits in
a prior suit involving (2) the same claim and (3) the same parties or their privies." In re
Montgomery Ward, LLC, 634 F.3d 732, 736-37 (3d Cir. 2011) (internal quotation marks
Defendant, who at the time of Plan confirmation was merely a potential future defendant
in a litigation involving the bankruptcy estate, likely lacks standing to appeal the confirmed Plan.
See Travelers Ins. Co. v. H.K. Porter Co., 45 F.3d 737, 741-42 (3d Cir. 1995) (stating that one
must have direct and immediate "pecuniary interest" in bankruptcy in order to have standing to
appeal plan confirmation, and noting that one who is merely "potential defendant" in future
litigation lacks standing to appeal).
omitted). As Defendant observes, Plaintiff "cites no case suggesting that a third party to the plan
must intervene at the time of plan confirmation to litigate the issue of standing in a future
adversarial proceeding that trustee might or might not file against that third party." D.I. 28 at 9;
see also In re Resorts Int'l, Inc., 372 F.3d 154, 169-71 (3d Cir. 2004) (holding that,
notwithstanding provisions of confirmed reorganization plan, bankruptcy court lacked
jurisdiction over malpractice claim brought by trustee against accounting firm); Rutherford
Hosp., Inc. v. RNH P 'ship, 168 F.3d 693, 699 (4th Cir. 1999) ("[A] bankruptcy court's
jurisdiction does not extend to property that is not part of a debtor's estate."). Thus, the doctrine
of res judicata is inapplicable.
The Court concludes that Defendant's standing challenge is not barred by the doctrine of
collateral estoppel. Collateral estoppel precludes a party from re-litigating an issue if, among
other requirements, "the identical issue was decided in a prior adjudication" and "the party
against whom the bar is asserted was a party or in privity with a party to the prior adjudication."
Del. River Port Auth. v. Fraternal Order ofPolice, 290 F .3d 567, 573 n.1 0 (3d Cir. 2002).
Defendant was not a party to the DBSI bankruptcy proceeding or in privity with a party. Thus,
the doctrine of collateral estoppel is inapplicable.
Motion to Dismiss for Lack of Subject Matter Jurisdiction5
As a threshold matter, the Trustee must establish that it has standing to assert claims on
behalf of assigning investors or creditors. See Marion v. TDIInc., 591 F .3d 13 7, 147 (3d Cir.
It is undisputed that the Trustee has standing to pursue all claims asserted on behalf of
the ELT. (See D.I. 12 at 1) Thus, the following discussion is limited to whether the Trustee has
standing to assert claims on behalf of the PAT.
2010) ("[S]tanding, because it implicates a federal court's authority to hear a case, must be
addressed as a threshold matter."). Defendant contends the Trustee does not have standing for
two reasons: (1) the Complaint fails to adequately allege Article III standing, and (2) the Trustee
lacks authority to pursue the assigned claims. The Court finds each of these arguments
unpersuasive. Accordingly, the Court will deny Plaintiffs Motion to Dismiss for Lack of
Subject Matter Jurisdiction.
The Court concludes that Plaintiff has adequately alleged Article III standing. First,
Plaintiffhas adequately alleged that the investors suffered injury in fact: loss of money invested
in DBSI. (See D.l. 1 ~~ 3-4, 133-34, 138-39, 145, 160, 164, 174, 185) Second, Plaintiffhas
adequately alleged a causal connection between the investors' injuries- being defrauded by
DBSI and losing money on investments- and Defendant's conduct in drafting the allegedly
misleading PPMs. (See id.
22, 26, 27) Defendant's contention that it is "impossible to say
whether any assigning investor- much less all of them- relied on a relevant PPM" (D.I. 12 at 7)
is unpersuasive, as the Complaint explicitly states that "[i]nvestors must certify that they have
read and relied upon the PPM." (D.I. 1 ~ 27; Tr. at 17-18)6 Finally, Plaintiffhas alleged that the
relief requested - compensatory and punitive damages - will redress the injury the investors have
Although the Complaint does not explicitly list the dates on which the investors invested
with DBSI, the Complaint alleges that the "pattern of fraud on investors ... continued from at
least 2004 to November 2008." (D.I. 1 ~ 128) During this same time frame, the Complaint
alleges that the PPMs contained false and misleading language drafted by Defendant. (See id.
~~ 29, 78; see also id., Ex. A (showing dates ofPPMs)) Thus, the Court draws the reasonable
inference that the investors invested between 2004-2008. If discovery reveals that the Trustee is
asserting claims on behalf of investors who invested outside of the 2004-2008 period, then
Defendant may re-assert its Article III standing challenge.
sustained. (See id.
134, 139,160, 175, 185)
Trustee's Authority to Pursue Assiened Claims
Defendant contends that the Trustee is subject to the Bankruptcy Code even when acting
as trustee of the PAT. (D .I. 12 at 12) Under the Bankruptcy Code, a trustee is authorized to act
only for the benefit of the estate. (ld. at 7, 13) Thus, according to Defendant, when the Trustee
brings claims on behalf of individual investors and creditors - as the Trustee purports to do for
all claims asserted on behalf of the PAT -the Trustee is exceeding its authority under the
Bankruptcy Code. (Id. at 14-15)
The Trustee responds that it has authority to bring claims on behalf of the PAT. (D .I. 20
at 11) The Trustee contends that a post-bankruptcy trustee who is not asserting claims on behalf
of the estate is entitled, like any assignee, to bring claims on behalf of assigning creditors. (!d. at
7-8) In essence, the Trustee is arguing that the Bankruptcy Code is not relevant to an assessment
of its authority to pursue claims on behalf of the PAT.
The Court concludes that the Trustee has standing to pursue claims on behalf of assigning
creditors. As an assignee, the Trustee has standing to assert the injury in fact suffered by the
assignors. 7 See Vt. Agency ofNatural Res. v. United States ex ref. Stevens, 529 U.S. 765, 774
(2000); Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co. ("Lafferty"), 267 F.3d
340, 360-61 (3d Cir. 2001). Defendants have failed to persuade the Court that the Trustee, when
acting on behalf of the PAT, should be treated any differently than any other assignee. 8
Contrary to Defendant's assertion, nothing in 11 U.S.C. § 1123 prevents a party from
assigning its claims to a trustee.
Indeed, numerous other courts have held that a private action trustee has standing to
pursue claims on behalf of assigning parties. See, e.g., Kirschner v. Bennett, 648 F. Supp. 2d
In support of its argument that the Trustee lacks standing, Defendant primarily relies on
three cases: Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416 (1972); Williams v. Cal.
1st Bank, 859 F.2d 664 (9th Cir. 1988); and Trenwick Am. Litig. Trust v. Ernst & Young, LLP,
906 A.2d 168 (Del. Ch. 2006). Caplin and Williams addressed the issue of standing of a
bankruptcy trustee. 9 See Caplin, 406 U.S. at 416 ("The sole issue in this case is whether
petitioner, the trustee in reorganization ... has standing ... to assert, on behalf of persons
holding debentures issued by Webb & Knapp, claims of misconduct by an indenture trustee.");
Williams, 859 F.2d at 665 (stating trustee asserting claims was "trustee in bankruptcy"). Thus,
these cases are not applicable to the issue currently before the Court - whether a private action
trustee post plan confirmation has standing to bring claims on behalf of assigning creditors. 10
See Grede v. Bank ofNY Mellon, 598 F.3d 899, 902 (7th Cir. 201 0) (holding that Caplin did not
apply to post plan confirmation private action trustee, because "[a]lthough the terms ofthe
Bankruptcy Code govern the permissible duties of a trustee in bankruptcy, the terms of the plan
of reorganization (and of the trust instrument) govern the permissible duties of a trustee after
bankruptcy") (emphasis in original); Semi-Tech Litig. LLC v. Bankers Trust Co., 272 F. Supp. 2d
319, 323-24 (S.D.N.Y. 2003) (distinguishing Caplin and Williams and holding that post
525, 533 n.l2 (S.D.N.Y. 2009) (opining that private action trustee had standing to pursue claims
on behalf of assigning parties who were injured by corporate fraud of bankrupt corporation).
~otably, Caplin did not even involve the assignment of claims. See Semi-Tech Litig.
LLC v. Bankers Trust Co., 272 F. Supp. 2d 319, 323 (S.D.N.Y. 2003) ("Caplin is distinguishable
from this case in that the debenture holders there, in contrast to the situation here, had not
assigned their claims to the trustee.").
°For the same reason, the Third Circuit's ruling in Lafferty is inapplicable to the present
situation; Lafferty involved a pre-plan confirmation trustee. See 267 F.3d at 344-48; see also D.I.
12 at 11.
confirmation bankruptcy trustee has standing to bring claims assigned by creditors under
confirmed bankruptcy plan). Trenwick is likewise distinguishable, as it involved a litigation trust
and did not involve the assignment of creditors' claims to a private action trust. See 906 A.2d at
While Defendant concedes that the Trustee is not a Chapter 11 bankruptcy trustee such
that the Bankruptcy Code automatically governs the scope of the Trustee's rights and duties (see
Tr. at 96), Defendant argues that the rationale underlying the Supreme Court's decision in Caplin
presents compelling reasons why the limitations of the Bankruptcy Code should apply to a post
plan confirmation private actions trustee. In Caplin, the Supreme Court relied on several
grounds for its holding: (1) statutory federal bankruptcy law does not permit a bankruptcy trustee
to assert claims on behalf of third parties, (2) under the doctrines of in pari delicto and
subrogation the debtor may have to reimburse the defendant for any recovery by the trustee on
behalf of the creditors, and (3) allowing a bankruptcy trustee to sue on behalf of creditors could
create a risk of inconsistent judgments if creditors choose to sue on their own.
The concerns underlying the holding in Caplin are inapplicable to the present situation.
First, unlike the bankruptcy trustee in Caplin, who derived authority from the bankruptcy code,
Zazzali, acting as trustee for the PAT, derives authority from the Private Actions Trust
Agreement and the individual assignment of claims from each of the beneficiaries of the PAT.
Second, the Third Circuit has stated that the doctrine of in pari delicto is not a standing issue.
See Marion, 591 F.3d at 149 ("[T]he in pari delicto issue is separate from that of standing.");
Chancellor Strine's statement that Caplin's holding that a bankruptcy trustee does not
having standing to pursue claims of creditors would apply even to a post plan confirmation
trustee, see Trenwick, 906 A.2d at 191, does not alter the Court's conclusion.
Lafferty, 267 F .3d at 346 ("An analysis of standing does not include an analysis of equitable
defenses, such as in pari delicto."). Additionally, any potential subrogation issues would not
involve the PAT or Zazzali, but rather would involve post-confirmation liquidating trusts, which
are not parties to this litigation and for which Zazzali is not the trustee. (D.I. 20 at 12) Finally,
Caplin's concerns about inconsistent judgments are unwarranted in the present context, where
creditors who have opted to assign their claims to the Trustee are barred from pursuing these
claims on their own. See Sanford Inv. Co. v. Ahlstrom Mach. Holdings, Inc., 198 F.3d 415,425
(3d Cir. 1999) (holding that assignor of claims does not have standing to pursue claims it
Defendant also asserts that the Trustee should be barred from bringing claims on behalf
ofboth the ELT and PAT due to potential conflicts of interests between the estate as a whole and
the individual creditors. (See D.I. 12 at 15-18) The Trustee, in its dual role as trustee for the
ELT and PAT, has the single aim of maximizing the funds available to claimants. See In re Best
Craft Gen. Contr. & Design Cabinet, Inc., 239 B.R. 462, 468 (Bankr. E.D.N.Y. 1999) ("[T]he
Trustee and [creditor] ... hold the parallel interest of maximizing the estate through a recovery
[in litigation]."). While the Court recognizes the potential for competing interests between the
assigned investor claims and the estate's interest, this alone is insufficient to prevent Zazzali
from serving as trustee for both the ELT and PAT, as Zazzali must act in accord with the
fiduciary duties he owes both to the estate and to the assigning creditors. Further, a Trust
Oversight Committee must approve any action involving a situation where there may be
competing interests between the ELT and PAT. See Tr. at 75-76; see also generally Kotrosits v.
GATX Corp. Non-Contributory Pension Plan for Salaried Emps., 757 F. Supp. 1434, 1455 (E.D.
Pa. 1991 ), rev 'don other grounds, 970 F .3d 1165 (3d Cir. 1992) ("[T]he federal judiciary
recognizes that trustees are often called on to balance the competing interests of different
beneficiaries."). Thus, the Court concludes that Zazzali does not lack standing due to the
potential for conflicts of interest.
Motion to Dismiss for Failure to State a Claim
Applicable Pleadin& Standards
In evaluating the Motion to Dismiss for Failure to State a Claim, the Trustee contends
that Federal Rule of Civil Procedure 9(b)' s pleading standard - requiring a plaintiff to plead
fraud with particularity - should be relaxed, as the Trustee - a third party outsider to the
fraudulent conduct- must plead fraud based on second-hand knowledge and without the benefit
ofinformation from the estate and its creditorsY (See D.I. 24 at 6-7; Tr. at 96) Defendant
contends that the Court should hold the Trustee to the same pleading standards as any other
plaintiff. (See D.I. 27 at 2-3; Tr. at 32-33)
The Court concludes that the Trustee is not entitled to a lax pleading standard. While the
Court recognizes there are certain cases where a trustee is at a disadvantage with respect to
pleading allegations with the particularity required by Rule 9, due to lack of access to
information, 13 this is not one of those situations. Here, the Trustee had the benefit of a three
The Trustee concedes that cases applying a lax pleading standard to a bankruptcy trustee
are not binding on this Court, as the Trustee is not acting as a bankruptcy trustee; however, the
Trustee argues that these cases are applicable by analogy. (Tr. at 96)
See, e.g., Hassett v. Zimmerman (In re O.P.M. Leasing Servs., Inc.), 32 B.R. 199,203
(Bankr. S.D.N.Y.) ("This liberality is required because it is often the Trustee, a third party
outsider to the fraudulent transaction, that must plead fraud on secondhand knowledge for the
benefit of the estate and all of its creditors."); see also generally Craftmatic Sec. Litig. v.
Kraftsow, 890 F .2d 628, 645 (3d Cir. 1989) ("Particularly in cases of corporate fraud, plaintiffs
million dollar investigation into the DBSI fraud, which involved interviewing sixty-one
witnesses and resulted in a detailed, 369-page report listing the examiner's findings of fact and
conclusions. (See Tr. at 9) 14 This is not a situation in which a lax pleading standard should
apply. See Trenwick, 906 A.2d at 211 (refusing to apply lax pleading standard where "[t]he
Litigation Trust ha[ d] far more access to information than the typical plaintiff').
Counts One throu2h Four as Asserted on Behalf of the ELT
Counts One through Four of the Complaint assert damages claims that originally
belonged to the debtors. (See D.I. 1 ~~ 110-154) These claims passed from the debtors to the
bankruptcy estate pursuant to 11 U.S.C. § 541(a). See 11 U.S.C. § 541(a) (stating "bankruptcy
estate" is created to receive "the interests of the debtor[ s]"). Thus, the bankruptcy estate "stands
in the shoes of the debtors." Lafferty, 267 F.3d at 354. Pursuant to the Plan, the claims of the
bankruptcy estate passed to the ELT. (See D.I. 1 ~ 10) Therefore, the ELT stands in the shoes of
the debtors and is subject to the same defenses that could have been asserted against the
cannot be expected to have personal knowledge ofthe details of corporate internal affairs. Thus,
courts have relaxed the rule when factual information is peculiarly within the defendant's
knowledge or control.") (internal citations omitted).
The Court does not rely on the merits of the examiner's investigative report in reaching
its conclusions on the pending motions. However, both parties stated they had no objection to
the Court looking at the examiner's report to assess what background information the Trustee
had before filing this lawsuit. (See Tr. at 6, 61)
The Court's discussion here is limited to the ELT as the doctrine of in pari delicto does
not apply to claims asserted on behalf of the PAT, as the Trustee does not "stand in the shoes of
the debtors" for claims brought on behalf of private parties. Defendant asserts that the Trustee
should be estopped from arguing that it is not a bankruptcy trustee when asserting claims on
behalf of the PAT based on the arguments that the Trustee made in connection with the Motion
to Dismiss for Lack of Subject Matter Jurisdiction. (D.I. 27 at 5) However, the Court finds
Defendant contends that one of the defenses that could have been asserted against the
debtors (and, consequently, which now maybe asserted against the Trustee) is the defense of in
pari delicto. Under the doctrine of in pari delicto, a plaintiff is barred from asserting a claim if
the plaintiff participated in the wrongdoing that was a substantial cause of the alleged damages.
See Lafferty, 267 F .3d at 354; see also Am. Int '1 Grp., Inc. Consol. Derivative Litig. ("AIG "), 976
A.2d 872, 882-83 (Del. Ch. 2009).
The Court concludes that the doctrine of in pari delicto bars the Trustee from asserting
Counts One through Four on behalf of the ELT. 16 Here, the Complaint alleges that the entire
DBSI structure was fraudulent (D.I. 1 ~~ 3, 22, 24) and that DBSI became "nothing more than"
an elaborate "Ponzi scheme to defraud investors" (/d.
26). This scheme encompassed all of the
DBSI entities, which allegedly operated as a single enterprise.
111, 119) DBSI and its
related debtor entities played an essential role in the fraudulent scheme by distributing
misleading PPMs and misappropriating investor funds.
50, 52, 93)
The alleged wrongful conduct of officers and directors ofDBSI is imputed to DBSI.
Defendant's argument unpersuasive as the Trustee did not argue that it was actually a bankruptcy
trustee when acting on behalf of the PAT; rather, the Trustee argued there that the Court should
apply the bankruptcy code to the Trustee. (See Tr. at 96) Thus, the Trustee's current positionthat it is not a bankruptcy trustee - is not "irreconcilably inconsistent" with its earlier position.
See Montrose Med. Grp. Participation Sav. Plan v. Bulger, 243 F.3d 773, 780-81 (3d Cir. 2001)
(listing requirements for invoking judicial estoppel as including that party has "taken two
positions that are irreconcilably inconsistent").
The Trustee's assertion that the Court cannot apply the doctrine of in pari delicto on a
motion to dismiss (D.I. 24 at 21) is without merit. See, e.g., Lafferty, 267 F.3d at 360 (affirming
district court's dismissal of claims due to application of doctrine of in pari delicto); see also
Collins &Aikman Corp. v. Stockman, 2010 WL 184074 (D. Del. Jan. 19, 2010), adopted by 2010
WL 1687795 (D. Del. Apr. 26, 2010) (dismissing claims based on application of in pari delicto);
see also generally Leveto v. Lapina, 258 F.3d 156, 161 (3d Cir. 2001) ("[A] complaint may be
subject to dismissal under Rule 12(b)(6) when an affirmative defense ... appears on its face.").
Imputation is a matter of state law. See Lafferty, 267 F.3d at 358. Delaware, Idaho, and Virginia
-the three states whose laws potentially may cover the present causes of action 17 - all apply the
rule that management's misconduct in the course of employment is imputed to the corporation. 18
The Trustee's argument that the adverse-interest exception to imputation applies here is
unpersuasive. (See D.I. 24 at 21-23) The adverse-interest exception is a narrow exception that
applies only where the fraud is entirely adverse to the corporation's interest, such that the actor
has completely abandoned the corporation's interests. 19 The Complaint indicates that the fraud
conferred a benefit on DBSI in the form of bringing in more than $100 million of revenue to
DBSI, some of which was used for "general corporate purposes."20 (D.I. 1 ,-r,-r 48, 50) While the
decision of the insiders to steal this money may have harmed the corporation, this does not alter
Neither party has briefed the applicability of any other state's laws with respect to this
issue. Thus, the Court will presume, without deciding, that either Delaware, Idaho, or Virginia
law is applicable.
See In re AIG, 976 A.2d at 881-82, 887 (applying Delaware law and imputing alleged
fraudulent conduct of AIG officers to corporation); Allen Realty Corp. v. Holbert, 318 S.E.2d
592, 597 (Va. 1984) (stating that, under Virginia law, "a principal is liable for negligent acts that
its agent commits within the scope ofhis employment"); Williams v. Cont'l Life & Accident Co.,
593 P.2d 708, 709-10 (Idaho 1979) (applying imputation rules set out in RESTATEMENT
(SECOND) OF AGENCY).
See In re AIG, 976 A.2d at 891 (applying Delaware law); Allen Realty Corp., 318
S.E.2d at 594-95 (applying Virginia law). Idaho courts have not specifically addressed the scope
of the adverse-interest exception, but Idaho relies on the RESTATEMENT (SECOND) OF AGENCY in
imputation cases, see Cont'l Life & Accident Co., 592 P.2d at 709-10, and the Restatement
provides that the exception applies only where "the agent is secretly acting adversely to the
principle and entirely for his own or another's purpose." RESTATEMENT (SECOND) OF AGENCY
§ 282 (1958).
°Courts have held that when a corporation receives funds from its investors this is a
benefit, even if the corporation received the funds through illegal or inappropriate acts of its
officers. See, e.g., In re CitX Corp., Inc., 448 F.3d 672, 677-78 (3d Cir. 2006) (holding that,
although officers misused incoming cash, cash paid to corporation constituted benefit).
the fact that the insiders still conferred some benefit on DBSI. See Kirschner v. KPMG LLP, 938
N.E.2d 941,953 (N.Y. 2010) ("Even where the insiders' fraud can be said to have caused the
company's ultimate bankruptcy, it does not follow that the insiders 'totally abandoned' the
company."). Thus, the Court concludes that the DBSI insiders' conduct was not entirely adverse
to DBSI's interests.
Plaintiffs contention that in pari delicto cannot apply to its claims because Defendant is
alleged to be an insider is unavailing, as only those who actually control the corporation are
considered "insiders" for this purpose. See OHC Liquidation Trust v. Credit Suisse First Boston,
340 B.R. 510, 536 (Bankr. D. Del. 2006) (stating that insiders are "fiduciaries ... and de facto
controllers ofthe Debtors"); Official Comm. of Unsecured Creditors v. Shapiro, 2001 WL
1468250, at *1 (E.D. Pa. Nov. 16, 2001) ("Unlike outside consultants and advisors, insiders
exercise control over a corporation and should not benefit from in pari delicto, which is an
equitable defense.") (emphasis added). The Complaint contains no allegations that Defendant
controlled the corporation. Thus, there is no basis from which the Court may draw a reasonable
inference that an outside law firm which drafted fraudulent PPMs was in de facto control of
DBSI or had become an insider.
Counts 1 and 2: RICO Claims Asserted on Behalf of PAT
Count One of the Complaint asserts a claim for violation of the federal RICO statute, 18
U.S.C. § 1962(c), and the Idaho RICO statute, IDAHO CODE§ 18-7804(c). (See D.I. 1 ~~ 110134) Count Two of the Complaint asserts a claim for conspiracy to violate these provisions.
"In order to plead a violation of RICO, [a] plaintiff must allege that the defendant
conducted an enterprise through a pattern of racketeering activity." Lum v. Bank ofAm., 361
F.3d 217, 223 (3d Cir. 2004). To plead a RICO conspiracy, a plaintiff must allege "knowing
agreement to facilitate a scheme which includes the operation or management of a RICO
enterprise." In reIns. Brokerage Antitrust Litig., 618 F.3d 300, 373 (3d. Cir. 2010). The
elements for violation of the companion Idaho RICO statute have been interpreted to be the same
as those required under federal law. See Mannos v. Moss, 155 P.3d 1166, 1174-75 (Idaho 2007)
(dismissing claim under Idaho RICO statute citing United States Supreme Court's interpretation
offederal RICO statute); see also State v. Nunez, 981 P.2d 738, 742 (Idaho 1999) (stating that in
order to prove violation of Idaho RICO statute, plaintiff must prove existence of "enterprise"
connected to "patten of racketeering activity").
The Court concludes that the Complaint fails to adequately plead a violation of the
federal or Idaho RICO statutes because (1) the securities fraud exception bars these claims,
(2) the Complaint fails to adequately plead the requisite elements of the underlying racketeering
activity of mail fraud or wire fraud, and (3) the Complaint fails to adequately plead that
Defendant conducted a RICO enterprise.
Securities Fraud Exception
Pursuant to the securities fraud exception to RICO, "no person may rely upon any
conduct that would have been actionable as fraud in the purchase or sale of securities to establish
a violation of section 1962." 18 U.S.C. § 1962(c). The facts pled in the Complaint establish that
the RICO enterprises were created to carry out fraud in connection with the sale of securities.
The Complaint alleges that the enterprises were created "for the purpose of carrying on a
fraudulent Ponzi scheme and to cheat investors .... " (D.I. 1 'if121) In order to carry out this
Ponzi scheme, the Complaint alleges that the members of the enterprise used PPMs to defraud
investors into buying TIC syndications. (See id.
22, 28, 30-31, 125) The Complaint explicitly
alleges that the TIC syndications were sold by a "securities" corporation. (See id.
the Trustee admits that it "has alleged ... that the TIC interests are in fact securities."21 (See D.I.
24 at 26 n.13) The Trustee's contention that the corporate insiders were looting the corporation
(see id. at 27) does not alter the fact that the conduct giving rise to the RICO claim was the sale
of securities based on PPMs which contained false information. Likewise, the Trustee's
assertion that the underlying conduct involved Account Reserves - which are not securities - is
irrelevant, as the conduct in which Defendant participated was the drafting ofPPMs for the sale
of TIC securities; it is this conduct which Plaintiff alleges constitutes the pattern of racketeering
activity and serves as the basis for the mail and wire fraud predicate acts. (See D.I. 1 ~~ 125-26,
128, 131-32) Thus, the securities fraud exception bars the Trustee's RICO claims.
The Complaint fails to adequately allege with sufficient particularity the underlying
racketeering acts of mail or wire fraud. 22 Mail and wire fraud require "(1) the defendant's
knowing and willful participation in a scheme or artifice to defraud, (2) with the specific intent
to defraud, and (3) the use of mails or interstate wire communications in furtherance of the
The fact that Defendant provided an opinion letter stating that the TIC interests were not
securities does not alter the Court's analysis. This opinion letter is not integral to, relied on, or
even mentioned in the Complaint and, thus, is outside the scope of what the Court can consider
on a motion to dismiss. See Angstadt v. Midd-West Sch. Dist., 377 F.3d 338, 342 (3d Cir. 2004).
Contrary to Defendant's assertion (see D.I. 23 at 20-21), mail fraud and wire fraud are
predicate acts under Idaho law. See IDAHO CODE Ann. § 18-7803(a) (listing "[f]raudulent
practices" and "fraud generally" as predicate acts for Idaho Racketeering Statute).
scheme." United States v. McGeehan, 584 F.3d 560, 565 (3d Cir. 2009), vacated on other
grounds, 625 F.3d 159 (3d Cir. 2010) (emphasis added). The elements ofmail and wire fraud
must be pled with "particularity." See FED. R. CIV. P. 9(b); see also Lum, 361 F.3d at 223-24.
The Complaint's recitation of allegations that Defendant had "knowledge" and "knew"
(see D.I. 1 ~~ 45, 60, 79, 87, 93, 128, 143, 144, 159) of the DBSI's fraudulent scheme are
insufficient to adequately plead knowledge. See Iqbal, 556 U.S. 662,678 (2009) ("Threadbare
recitals of the elements of a cause of action, supported by mere conclusory statements, do not
suffice."). The Court concludes that the Complaint does not contain factual allegations from
which Defendant's knowing participation in the fraudulent scheme can be inferred.
The facts alleged in the Complaint indicate that Defendant - a "preeminent firm in the
field of syndicating 1031 exchanges"- performed specialized legal work for DBSI by drafting
PPMs, which were used to defraud investors. (See id.
26, 28-30, 41, 45) The Complaint
contains no information that gives rise to a reasonable inference that Defendant was aware of or
was on notice that the DBSI entities were running a Ponzi scheme; in fact, the Complaint alleges
that DBSI "presented to the world the illusion of a monolith ofwealth." (Id.
1) Further, the
Complaint contains no allegation that Defendant was paid more than its customary fee for the
legal services it provided or gained any improper benefit from DBSI's fraud. (See Tr. at 96)
While the Complaint does allege that various corporate insiders met to discuss the cash-flow
problems ofDBSI and the fraudulent scheme, it indicates that Defendant did not attend these
meetings. (See D.I. 1 ~ 105)
The Trustee contends that there were "red flags" which put Defendant on notice of
DBSI's fraud and which give rise to an inference of knowledge. (See Tr. at 95 (stating "[t]he
economics of the TIC transactions were so wi[ldly] improbable based on generally accepted
econometrics, the cap rate, that they would establish knowledge as to a number of things ....
[These] are red flags")) However, there are no factual allegations in the Complaint that support
the Trustee's contention. Thus, the Trustee's RICO claim fails, as it does not adequately plead
knowing and willful participation in the underlying racketeering activities.
Conductin2 a RICO Enterprise
The Complaint fails to adequately allege that Defendant "conduct[ ed] or participate[ d],
directly or indirectly, in the conduct of' the RICO enterprise. 18 U.S.C. § 18-7804(c); see also
IDAHO CODE § 18-7804(c). The United States Supreme Court explained the "conduct"
requirement in Reeves v. Ernst & Young, 507 U.S. 170, 178-79 (1993), and held that mere
participation in the enterprise is not sufficient; rather, the defendant must "have some part in
directing" the affairs of the enterprise. I d. at 178-79. The Third Circuit has applied Reeves to
dismiss claims against an outside professional where there is no indication that the third-party
professional directed the affairs ofthe alleged RICO enterprise. See Univ. ofMd. v. Peat,
Marwick, Main & Co., 996 F.2d 1534, 1539-40 (3d Cir. 1993) (dismissing RICO claim against
accounting firm for failure to adequately plead that defendant conducted RICO enterprise,
reasoning "[i]t cannot be said that by merely performing what are generic financial and related
services to [a] company, even if they are later found to be deficient, an accounting firm has
opened itself up to liability under the federal racketeering statute").
While the Complaint formulaically recites that Defendant was in "control" of the RICO
enterprise, this threadbare recital of "control" is insufficient, as the Complaint fails to plead any
facts demonstrating that Defendant was in control. See Iqbal, 556 U.S. at 678. The Complaint
merely alleges that Defendant provided routine legal services - drafting PPMs for a corporation.
(See D.I. 1 ~ 28) Thus, like in Peat, here it cannot be said that, by merely performing routine
legal services, Defendant is liable for a RICO violation.
Further, as previously discussed, the Complaint does not contain adequate facts to support
an inference that Defendant had knowledge of illegal aims of the enterprise and, without such
knowledge, Defendant could not conduct a RICO enterprise. See United States v. Urban, 404
F.3d 754, 770 (3d Cir. 2005) (stating conducting ofRICO enterprise does not require that
defendant "hold a managerial position within an enterprise, but [that defendant must] knowingly
further the illegal aims of the enterprise by carrying out the directives of those in control")
Conspiracy to Commit RICO Claims
Based on the Court's conclusion that the Complaint fails to adequately state a claim for
violations of the federal and Idaho RICO statutes, it follows that the Complaint also fails to state
a claim for conspiracy to violate these statutes. See Zavala v. Wal Mart Stores, Inc.,_ F.3d _ ,
2012 WL 3217522 (3d Cir. 2012) (affirming dismissal of RICO and conspiracy to commit RICO
claims because complaint did not adequately allege predicate acts required for RICO claim); see
also Binary Semantics Ltd. v. Minitab, Inc., 2008 WL 763575, at *5 (M.D. Pa. Mar. 20, 2008)
(stating that RICO conspiracy claim "necessarily fails due to failure to state a claim under
Count 5: Aidine and Abettine Fraud
Count 5 ofthe Complaint alleges aiding and abetting fraud. (See D.I. 1 ~~ 155-160) As
an initial matter, the parties dispute which state's law governs this claim. The Trustee contends
that it is unclear which law will govern as there were investors who were defrauded throughout
the United States; however, in its briefing, the Trustee analyzes this count exclusively under
Delaware law. (See D.I. 24 at 19) Defendant asserts that a claim for aiding and abetting fraud
would be governed by Delaware, Idaho, or Virginia law- to the extent that these states recognize
a cause of action for aiding and abetting fraud. (D.I. 23 at 24)
The Court will defer making a choice oflaw determination until there is development of a
more complete factual record. See Graboffv. The Collern Firm, 2010 WL 4456923, at *8 (E.D.
Pa. Nov. 8, 201 0) ("Due to the complexity of this analysis, when confronted with a choice of law
issue at the motion to dismiss stage, courts within the Third Circuit have concluded that it is
more appropriate to address the issue at a later stage in the proceedings."). The Court will
presume, without deciding, that either Idaho or Delaware law applies to this count as these are
the states' laws specifically addressed by the parties in their briefing. 23
In order to state a claim for aiding and abetting fraud under either Idaho or Delaware law,
the plaintiff must allege that defendant had knowledge of the underlying fraud. 24 As previously
Defendant also raised the possibility of Virginia law, but correctly noted that Virginia
does not recognize a cause of action for aiding and abetting fraud. See Meadow Ltd. P 'ship v.
Heritage Sav. & Loan Assn., 639 F. Supp. 643,653-54 (E.D. Va. 1986). Although Defendant
contends that Idaho does not recognize the tort of aiding and abetting fraud, Defendant failed to
cite any authority in support of this assertion. See D.I. 23 at 24; see also 0 'Banion v. Select
Portfolio Servs., Inc., 2010 WL 3834055, at *5 n.8 (D. Idaho Aug. 13, 2010) ("[T]he Court will
assume that Idaho law would recognize a tort for aiding and abetting fraud.").
See O'Banion, 2010 WL 3834055, at *5 n.8 ("[T]he plaintiff must allege and prove in
addition to the perpetration of the underlying fraud that there was knowledge of this fraud on the
part of the aider and abettor; there was substantial assistance by the aider and abetter in the
achievement of the fraud; and that damages to the plaintiff were proximately caused thereby.")
(Idaho law); Brug v. Enstar Grp., Inc., 755 F. Supp. 1247, 1256 (D. Del. 1991) ("[A] plaintiff
must demonstrate that: (1) a wrongful act was committed, (2) the defendant had knowledge of
the act, and (3) the defendant knowingly and substantially participated in or provided substantial
discussed, Plaintiff has failed to plead facts giving rise to an inference that Defendant had
knowledge ofDBSI's fraudulent scheme. Accordingly, Count 5 will be dismissed.
Count 6: Civil Conspiracy
Count 6 of the Complaint alleges that Defendant engaged in civil conspiracy. (See D.I. 1
161-64) The parties dispute which law applies to Count 6. (Compare D.I. 23 at 24-25
(discussing adequacy of pleading under Idaho and Virginia law) with D .I. 24 at 16 (discussing
adequacy of pleading under Idaho law)) The Court will presume, without deciding, that either
Idaho or Virginia law applies.
In order to plead a claim for civil conspiracy under either Idaho or Virginia law, the
plaintiff must allege that there was an agreement to pursue an unlawful objective. 25 The
Complaint fails to adequately allege an agreement between Defendant and the DBSI corporate
The Complaint contains the following allegations regarding an agreement:
An agreement was formed between the Insiders and Hirschler
Fleischer at the time ofHirschler Fleischer's retention. By drafting
intentionally misleading and opaque language throughout the
various PPMs, one can easily infer Hirschler Fleischer agreed to
assist the Insiders in their scheme to defraud thousands of
assistance for the wrongful act.") (Delaware law).
See Taylor v. McNichols, 243 P.3d 642, 660 (Idaho 2010) ("A civil conspiracy that
gives rise to legal remedies exists only if there is an agreement between two or more to
accomplish an unlawful objective in an unlawful manner."); Lesner Pointe Condo. Ass 'n, Inc. v.
Harbour Point Bldg. Corp., 2002 WL 32182354, at *18 (Va. Cir. Ct. Apr. 10, 2002) ("A valid
cause of action for civil conspiracy must allege an agreement between two or more persons to
accomplish an unlawful purpose or to accomplish a lawful purpose by unlawful means, resulting
in damage to the plaintiff.") (internal quotation marks omitted).
(D.I. 1 ~ 30)
The wrongs alleged herein were the product of agreement among
or a confederation among the Insiders and Hirschler Fleischer
during a period beginning no later than 2004 through in or about
2008 with the common objective of accomplishing the wrongs
alleged, including, but not limited to, misleading investors.
These threadbare recitals of an agreement, supported by mere conclusory statements, are
insufficient to satisfy the Trustee's pleading burden. See Iqbal, 556 U.S. at 678; see also
Twombly, 550 U.S. at 557 (noting that "naked assertion of conspiracy ... gets the complaint
close to stating a claim, but without some further factual enhancement it stops short of the line
between possibility and plausibility of entitlement to relief') (internal quotation marks omitted).
Contrary to the Trustee's assertion, the Court cannot "easily infer" that there was an agreement to
defraud. As already explained, the Complaint fails to adequately allege that Defendant had
knowledge ofDBSI's fraud. Without knowledge of the fraud or any facts indicating that
Defendant actually agreed to enter into a conspiracy, the mere allegation that Defendant drafted
PPMs containing misleading information is not sufficient to give rise to a plausible inference that
Defendants agreed to commit fraud. See generally Twombly, 550 U.S. at 556-57 ("Without
more, parallel conduct does not suggest conspiracy, and a conclusory allegation of agreement at
some unidentified point does not supply facts adequate to show illegality."). 26
Count Seven: Aidin& and Abettin& Breach of Fiduciary Duty/Breach of Trust
Count Seven of the Complaint alleges that Defendant aided and abetted the directors and
Based on the Court's conclusion that Plaintiff has failed to adequately allege an
agreement, the Court will not address Defendant's additional argument that an attorney cannot
conspire with a client under Idaho or Virginia law. (See D.I. 23 at 25)
officers ofDBSI in breaching their fiduciary duties owed to investors. (See D.I. 1 ,-r,-r 165-75)
Again, the parties dispute what law governs this claim. (Compare D.I. 23 at 26 (wherein
Defendant's assert that Delaware law applies) with D.I. 24 at 28-29 (wherein Plaintiff argues for
application of either Delaware, Idaho, or Virginia law)) At this phase of the litigation, the Court
presumes, without deciding, that either Delaware, Idaho, or Virginia law governs this claim.
In order to state a claim for breach of fiduciary duty under Delaware law, a Plaintiff must
show "(1) the existence of a fiduciary relationship, (2) a breach ofthe fiduciary's duty, and (3) a
knowing participation in that breach by [the alleged aider and abettor]." In re Santa Fe Pac.
Corp. Shareholder Litig., 669 A.2d 59, 72 (Del. 1995). The elements are substantially similar
under Idaho and Virginia law. 27
The Complaint fails to adequately allege "knowing participation" in the DBSI insiders'
breach of fiduciary duty. The Complaint's allegations that Defendant provided legal services that
were common in the industry, without more, does not support an inference that Defendant
"knowingly participated" in DBSI's fraudulent scheme. See Morgan v. Cash, 2010 WL
2803746, at *4-*8 (Del. Ch. July 16, 2010) (determining that complaint alleging third-party
professional engaged in "routine" practices for corporation failed to state claim for aiding and
abetting where there was a lack of facts pled "suggesting how and why" third-party used its
See State ofIdaho, Dept. ofFin. v. Tenney, 858 P.2d 782, 788 (Idaho App. 1993)
(listing required elements of: ( 1) the existence of an independent primary wrong; (2) actual
knowledge by the alleged aider and abettor of the wrong and ofhis or her role in furthering it;
and (3) substantial assistance in the wrong); AvalonBay Cmty., Inc. v. Willden, 2009 WL
2431571, at * 11 (E.D. Va. Aug. 7, 2009) ("Virginia law allows a third party to be liable for
another party's breach of fiduciary duty when that third party knowingly participated in the
breach ... [and] affirmatively aid[ ed] the breach with the requisite mens rea, or culpable state of
position to aid and abet). Count Seven's formulaic recitation of the knowledge requirement"Hirschler Fleischer knowingly and substantially participated in the aforementioned breaches of
fiduciary duty by the Insiders" (D.I. 1 ~ 174)- is insufficient to state a claim. See Iqbal, 556 U.S.
at 678. 28
and Abettin~ Breach of Fiduciary Duty
Count Eight of the Complaint alleges that the officers and directors ofDBSI breached
fiduciary duties owed to DBSI's creditors and were aided and abetted by Defendant. (See D.I. 1
176-85) This count fails for the same reason discussed above in connection with Count 7-
namely, the Complaint fails to allege "knowing participation" in the DBSI nsiders' breach of
fiduciary duty. The Trustee's contention that, based upon "the numerous and glaring
misstatements in the PPMs, Hirschler Fleischer must have known that the Insiders were
committing fraud and breaching their fiduciary duties to the TIC investors" (!d.
unsupported, as the Trustee has failed to plead any fact giving rise to a reasonable inference that
Defendant was aware that the PPMs did not contain factually accurate financial information. 29
Based on the Court's conclusion that Count 7 fails to state a claim upon which relief can
be granted due to failure to adequately allege knowing participation in the principal's breach of
fiduciary duty, the Court will not address Defendant's additional argument that Delaware law
does not recognize fiduciary duties flowing from corporate officers to investors. (See D.I. 23 at
Based on the Court's conclusion that Count 8 fails to state a claim upon which relief can
be granted due to failure to adequately allege knowing participation in the principal's breach of
fiduciary duty, the Court will not address Defendant's additional argument that Delaware law
does not recognize fiduciary duties flowing from corporate officers to investors. (See D.I. 23 at
Count Nine: Avoidance and Recovery
of Two Year Transfers as Actual Fraudulent Transfers
Count Nine of the Complaint seeks to recover damages in the form of payments made to
Defendant totaling $225,442.69. (See D.I. 1 ~~ 186-191; see also id., Ex. D) Count Nine is
brought pursuant to 11 U.S.C. § 548(a)(1)(A), which permits a trustee to avoid a transfer withing
two years of the bankruptcy petition date if"the debtor voluntarily or involuntarily ... made such
transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to
which the debtor was or became ... indebted" (emphasis added).
The Complaint fails to adequately allege intent to defraud. Other than merely identifying
the alleged fraudulent transfers in exhibit D attached to the Complaint, Count Nine fails to allege
with any specificity facts or other supporting information which would establish the fraudulent
nature of these transactions. 30 Rather, Count Nine merely provides a recitation of the statutory
requirements. This is insufficient as a matter oflaw. See In re Oakwood Homes Corp., 325 B.R.
696, 699 (Bankr. D. Del. 2005) (dismissing claim for fraudulent conveyance and avoidance
0plaintiffs argument that the Complaint pleads several "badges of fraud" sufficient to
show the transferor's intent to defraud is unavailing. (See D.I. 24 at 30) The "badges of fraud,"
which serve as circumstantial evidence of fraudulent intent, are: (1) the relationship between
transferor and transferee; (2) the consideration for the transfer; (3) the insolvency of the
transferor; and (4) the concealment or secrecy of the transaction. See In re Fedders N. Am., Inc.,
405 B.R. 527, 545 (Bankr. D. Del. 2009). Besides insolvency- which Plaintiff has adequately
alleged (see D.I. 1 ~~ 94-109)- Plaintiffhas failed to allege facts supporting any of the other
badges of fraud. Specifically, as previously discussed, the Complaint fails to adequately allege
knowledge of the fraudulent scheme on behalf of Defendant and, thus, the relationship between
Defendant and DBSI is alleged to be a typical attorney-client relationship. (See id. ~ 141)
Additionally, the Complaint does not allege that Defendant received anything outside of its
ordinary legal fees for drafting the PPMs and advising DBSI, and thus the second badge of fraud
is not present. Finally, the Complaint does not plead any facts indicating or giving rise to an
inference that the attorney-client relationship between Defendant and DBSI (or Defendant's role
in drafting the PPMs) was kept secret.
where complaint merely recited statutory elements and attached exhibit showing information
regarding alleged fraudulent transfers); see also In re Brown Schools, 368 B.R. 394, 403-04
(Bankr. D. Del. 2007) (dismissing§ 548(a)(1)(A) claim that sought to avoid payment of fees to
law firm because complaint failed to "allege enough facts from which the Court [could] conclude
that the payment was" made with required intent).
Count 10: Avoidance and Recovery of Constructively Fraudulent Transfers
Count Ten seeks avoidance based on 11 U.S.C. § 548(a)(l)(B), which permits a
bankruptcy trustee to avoid a transfer made within two years of the petition date if certain
conditions are met and the debtor "received less than a reasonably equivalent value in exchange"
for the transfer made. (See D.I. 1 ~~ 192-96)
The Complaint fails to adequately allege that DBSI received less than a reasonably
equivalent value in exchange for the amount of money it paid Defendant. The Complaint merely
recites the statutory elements of this claim, pleading no facts to support this claim or that give
rise to an inference that Defendant received less than a reasonably equivalent value. Thus, Count
10 fails to adequately plead a claim for avoidance. See In re USDigital, Inc., 443 B.R. 22, 39
(Bankr. D. Del. 2011) (dismissing avoidance claim because complaint "fail[ed] to provide any
factual allegations supporting the assertion that [debtor] did not receive reasonably equivalent
Count 11: Avoidance and Recovery of the
Four Year Transfers as Actual Fraudulent Transfers
Count Eleven seeks to recover all payments made to Defendant during the four years
proceeding the petition date, a total of $831,890.76. Plaintiff alleges that it is entitled to relief
pursuant to Idaho Code§ 55-913(1)(A), which contains the same operative language as 11
U.S.C. § 548(a)(1)(A), the provision underlying Count Nine. See IDAHO CODE§ 55-913(1)(A)
(requiring that debtor made transfer or incurred obligation "[w]ith actual intent to hinder, delay,
or defraud any creditor ofthe debtor").
This claim fails for the same reasons listed above in conjunction with Count Nine namely, the Complaint fails to adequately allege intent to defraud and merely recites the requisite
statutory elements for this claim without pleading any facts to support it.
Count 12: Avoidance and Recovery of the
Four Year Transfers as Constructively Fraudulent Transfers
Count Twelve seeks to recover all payments made to Defendant during the four years
preceding the petition date. (See D.I. 1 ,-r,-r 205-13) Plaintiff alleges that it is entitled to relief
under Idaho Code§ 55-913(1)(b), which parallels 11 U.S.C. § 548(a)(1)(B), the basis for Count
Ten. See IDAHO CODE§ 55-913(1)(b) (requiring that debtor made transfer or incurred obligation
"[w]ithout receiving a reasonably equivalent value in exchange for the transfer or obligation").
This claim fails for the same reasons listed above in conjunction with Count Tennamely, the Complaint fails to adequately allege that DBSI did not receive a reasonably
equivalent value in exchange for Defendant's legal services and the Complaint merely recites the
requisite statutory elements for this claim without pleading any facts to support it.
Count 13: Avoidance and Recovery of the
Four Year Transfers as Constructively Fraudulent Transfers
Count Thirteen seeks avoidance of four years of transfers made to Defendant pursuant to
Idaho Code§ 55-914(1). (See D.I. 1 ,-r,-r 214-220) Section 55-914(1) of the Idaho Code parallels
the language of the statutes quoted in conjunction with Counts Ten and Twelve. See IDAHO
CODE§ 55-914(1) (permitting avoidance of transfers made "without receiving reasonably
equivalent value in exchange")Y
Thus, Count Thirteen fails for the same reasons listed above in conjunction with Counts
Ten and Twelve- namely, the Complaint fails to adequately allege that DBSI did not receive a
reasonably equivalent value in exchange for Defendant's legal services and the Complaint merely
recites the requisite statutory elements for this claim without pleading any facts to support it.
Count 14: Transfers in Fraud of Creditors
Count Fourteen seeks to recover all payments made to Defendant during the four years
prior to the petition date pursuant to Idaho Code § 55-906, which has the same operative
language as the provisions that are the basis of Counts Nine and Eleven. (See D.l. 1 ~~ 221-230)
Thus, Count Fourteen fails to adequately plead a claim for the same reasons listed above
in conjunction with Counts Nine and Eleven- namely, the Complaint fails to adequately allege
intent to defraud and merely recites the requisite statutory elements for this claim without
pleading any facts to support it.
Count 15: Preferential Transfers
In Count Fifteen, the Trustee seeks to avoid all preferential transfers, as defined in 11
U.S.C. § 547, that DBSI made to Defendant. (See id.
231-243) Pursuant to 11 U.S.C.
§ 547(b)(4)(A), the Trustee can avoid certain preferential transfers only if they were made "on or
within 90 days before the date of the filing of the petition." Here, the Complaint fails to establish
that DBSI made any payments to Defendant "on or within 90 days before the filing of the
The Idaho Code provision of Count Twelve addressed transfers to "present and future
creditors" whereas the Idaho Code provision cited in Count Thirteen addresses transfers to
petition" in this case. Thus, Count Fifteen fails to adequately state a claim.
Leave to Amend
At the hearing, the Trustee requested leave to amend the Complaint with respect to any
counts that the Court dismissed. (See Tr. at 124) Defendant opposes Plaintiffs request for leave
to amend. (See Tr. at 124-25)
"[I]fa complaint is vulnerable to 12(b)(6) dismissal, a district court must permit a
curative amendment, unless an amendment would be inequitable or futile." Phillips v. Cnty. of
Allegheny, 515 F.3d 224, 236 (3d Cir. 2008). The Court will grant Plaintiffs request for leave to
amend Counts Five through Fifteen, as Plaintiffmaybe able to add factual allegations regarding
knowledge; hence, under the circumstances, amendment of these claims is neither futile nor
inequitable. However, the Court will deny Plaintiffs request for leave to amend with respect to
Counts One through Four, as the Court concludes that amendment of these counts would be
futile. Counts One through Four asserted on behalf of the ELT are barred by the doctrine of in
pari delicto. Counts One and Two, which plead RICO claims on behalfofthe PAT, are barred
by the securities fraud exception and have numerous pleading deficiencies which cannot be cured
For the reasons discussed above, the Court will deny Defendant's Motion to Dismiss for
Lack of Subject Matter Jurisdiction and will grant Defendant's Motion to Dismiss for Failure to
State a Claim. Plaintiff will be given leave to amend Counts Five through Fifteen of the