Michaelson v. Farmer et al
Filing
38
AMENDED OPINION. Signed by Judge Joseph E. Irenas on 3/7/2012. (lih)
UNITED STATES DISTRICT COURT
DISTRICT OF DELAWARE
Chapter 11
In re:
Case No. 11-10160 (KG)
APPLESEED’S INTERMEDIATE
HOLDINGS, LLC, et al,
Debtors
______________________________
HONORABLE JOSEPH E. IRENAS
ROBERT N. MICHAELSON, as
Trustee of the Appleseed’s
Litigation Trust,
CIVIL ACTION NO. 11-807
(JEI/KMW)
Plaintiff,
AMENDED OPINION
v.
JEFFREY D. FARMER, et al.,
Defendants.
APPEARANCES:
DRINKER BIDDLE & REATH LLP
Howard A. Cohen
1100 North Market Street
Suite 1000
Wilmington, DE 19801
and
COOLEY LLP
Jay R. Indyke
Cathy Hershcopf
Richard S. Kanowitz
1114 Avenue of the Americas
New York, NY 10036
Counsel for Plaintiff
BLANK ROME LLP
Elizabeth A. Sloan and Ian Comisky
1201 North Market Street
Suite 800
Wilmington, DE 19801
Counsel for Defendants Jeffrey D. Farmer, Bradford J.
1
Farmer, Brent Bostwick, and Vito Kowalchuk
RICHARDS, LAYTON & FINGER, PA
Drew Gerard Sloan, Robert J. Stearn, Jr. and Mark David Collins
One Rodney Square
920 N. King Street
Wilmington, DE 19801
and
MILBANK, TWEED, HADLEY & McCLOY LLP
Robert Jay Moore and Linda Dakin-Grimm
601 S. Figueroa Street, 30th Floor
Los Angeles, Ca 90017
and
MILBANK, TWEED, HADLEY & McCLOY LLP
Sander Bak and Andrew W. Robertson
1 Chase Manhattan Plaza
New York, NY 10005
Counsel for Golden Gate Defendants (Defined below)
MORRIS JAMES LLP
Carl N. Kunz, III
500 Delaware Avenue, Suite 1500
P.O. Box 2306
Wilmington, DE 19899
Counsel for Defendant Karinn Kelly
PEPPER HAMILTON, LLP
David M. Fournier
1313 market Street, Suite 5100
P.O. Box 1709
Wilmington, DE 19899
Counsel for Defendants Webster Capital Founders Fund LP,
Wester II LLC and Webster III LLC
IRENAS, Senior District Judge, sitting by designation:
Plaintiff Michaelson brings claims as Trustee of the
Appleseed Litigation Trust formed pursuant to a Chapter 11
reorganization.
The claims revolve around a complicated
financial transaction, which allegedly caused Appleseed
Intermediate Holdings LLC and affiliated debtors (collectively
2
“Debtors”)1 to become insolvent.
Presently before the Court,
each Defendant moves to dismiss or partially dismiss.
19, 21, 23, 25)
(Dkt. Nos.
In addition, Plaintiff moves to seal certain
portions of his answering brief.
(Dkt. No. 32)
I.
On January 19, 2011, the Debtors filed voluntary Chapter 11
petitions in Bankruptcy Court.
On April 14, 2011, the Bankruptcy
Court confirmed the Joint Plan of Reorganization of Appleseed’s
Intermediate Holdings LLC and its Debtor Affiliates Pursuant to
Chapter 11 of the Bankruptcy Code (the “Plan”).
Certain claims,
however, were transferred to the Appleseed’s Litigation Trust.
The Trustee, Robert Michaelson, has the exclusive right,
authority and standing to investigate and prosecute those claims.
The instant dispute revolves around an acquisition and dividend
recapitalization allegedly orchestrated by the Private Equity
1
The Debtors are Appleseed’s Intermediate Holdings LLC, Inc.
(“Appleseed’s Intermediate”); Appleseed’s Acquisition, Inc.; Appleseed’s
Holdings, Inc.; Arizona Mail Order Company, Inc.; Bedford Fair Apparel, Inc.;
Blair Credit Services Corporation; Blair Factoring Company; Blair Holdings,
Inc.; Blair International Holdings, Inc.; Blair LLC; Blair Payroll, LLC;
Draper’s & Damon’s Acquisition LLC; Draper’s * Damon’s LLC; Fairview
Advertising LLC; Gold Violin LLC; Haband Acquisition LLC; Haband Company LLC
(“Haband”); Haband Oaks, LP; Haband Online, LLC; Haband Operations, LLC;
Johnny Appleseed’s, Inc.; Linen Source Acquisition LLC; LM&B Catalog, Inc.;
Monterey Bay Clothing Company, Inc.; Norm Thompson Outfitters, Inc.; NTO
Acquisition Corporation; Orchard Brands Insurance Agency LLC; and Wintersilks,
LLC.
3
Parties (hereinafter “PE Parties”)2 in 2007 that caused the
Debtors’ insolvency.
At the time of the transaction, Appleseed’s Intermediate was
a wholly owned subsidiary of Orchard Brands Corporation (formerly
known as Appleseed’s Topco, Inc.) (hereinafter “Orchard Brands”),
which, in turn, was a wholly owned subsidiary of Orchard Brands
Topco LLC.
Investment funds managed by Golden Gate, specifically
all series of Catalog Holdings, owned a 68.4% stake in Orchard
Brands Topco and, therefore, indirectly owned the Debtors.
(See
Compl. ¶ 14-15, 49)
On January 23, 2007, BLR Acquisition Corporation, an entity
formed by Golden Gate, and Orchard Brands, entered into a merger
agreement with Blair Corporation (“Blair”).
(Id. at ¶ 50)
Blair’s shareholders were paid $42.50 a share for a total merger
price of approximately $158 million.
(Id.)
The Blair acquisition was a leveraged buyout.
(Id. at ¶ 51)
In other words, the PE Parties borrowed funds secured by Blair’s
assets to finance the transaction.
2
However, the PE parties did
The PE Parties are made up of the following entities: Golden Gate
Private Equity, Inc. (together with affiliated investment funds, “Golden
Gate”); Golden Gate Capital Management II, LLC; GGC Administration, LLC;
Orchard Brands Corporations (formally known as Appleseed’s Topco, Inc.);
Orchard Brands Topco LLC; Catalog Holdings, LLC; Catalog Holdings, LLC Series B (Draper’s); Catalog Holdings, LLC - Series C (Appleseed’s); Catalog
Holdings, LLC - Series D (NTO); Catalog Holdings, LLC - Series E (Haband);
Golden Gate Capital Investment Fund II, LP; Golden Gate Capital Investment
Fund II (AI), LP; Golden Gate Capital Associates II-QP, LLC; Golden Gate
Capital Associates II-AI, LLC; CCG AV, LLC; CCG AV, LLC - Series C (GGC CoInvest); CCG AV, LLC - Series I (Bain); CCG AC, LLC - Series K (K&E); CCG AC,
LLC - Series K.
4
not merely borrow $158 million to finance the LBO, but instead
used the transaction to facilitate a dividend recapitalization.
(Id. at ¶ 52)
The dividend recapitalization would allow the PE
Parties to realize an immediate return on investment without
selling their equity stake by causing a wholly owned subsidiary
to pay a large dividend up the corporate structure.
(Id. at ¶
53)
To finance the transaction, the PE Parties engaged American
Capital Strategies, Inc. and UBS Securities LLC (collectively
“Lenders”) to secure $710 million of senior credit facilities
(“Senior Credit Facilities”).
(Id. at ¶ 54)
PE Parties offered all of the Debtors’ assets.
As collateral, the
(Id.)
To garner support for the loans, the PE Parties allegedly
knowingly calculated unreasonably optimistic financial
projections.
(Id. at ¶¶ 114-128)
Potential lenders received
glowing growth projections, but internally, the PE Parties
estimated that the levels of sustainable debt for Blair and the
Debtors were far more conservative.
(Id.)
These inflated
projections allowed the PE Parties to secure a larger loan and,
therefore, a larger dividend.
The PE Parties then gave the inflated projections to Duff &
Phelps, LLC to secure a third party solvency opinion.
129)
(Id. at ¶
Plaintiff alleges that the Duff & Phelps projections made
unreasonable comparisons and relied upon faulty factual
5
assumptions provided by the PE Parties. (Id. at ¶¶ 129, 143)
Although Duff & Phelps opined that Orchard Brands would remain
solvent, Duff & Phelps gave no opinion regarding the solvency of
Appleseed’s Intermediate or its subsidiaries - the companies
immediately affected by the issuance of the dividend.
(Id. at ¶
132)
After securing the financing, the PE Parties selected Haband
Company LLC (“Haband”), a wholly owned subsidiary of Appleseed
Intermediate, to pay the dividend.
(Id. at ¶¶ 52, 59)
On April
26, 2007, the day before Haband’s board met to declare the
dividend, the PE Parties replaced two of Haband’s directors with
Joshua Olshansky, managing director of Golden Gate, and T. Neale
Attenborough, a director and officer of Orchard Brands.
¶ 58)
(Id. at
The replacement directors were allegedly insiders because
they had a financial interest in the dividend.
(Id.)
At the meeting of April 27, 2007, the Haband directors
unanimously approved the $310 million dividend to be paid to
Appleseed’s Intermediate, which Appleseed’s Intermediate would
pay to Orchard Brands.
(Id. at ¶ 59)
In turn, Orchard Brands
would pay the dividend to certain preferred shareholders
6
including Minority Shareholder Defendants3 and Catalog Holdings.4
(See Tr. Oral Arg., Feb. 22, 2012)
Catalog Holdings, funds
managed by Golden Gate, disbursed the dividend to private equity
investors.
(Id.)
Immediately following the meeting, the Haband directors were
reinstated.
(Compl. ¶ 64)
Plaintiff alleges that the
temporarily replaced directors would not have voted for the
dividend had they not been replaced.
(Id. at ¶ 65)
On April 30, 2007, the transaction closed.
(Id. at ¶ 67)
Of the $650 million of newly acquired funds (other funds were
advanced or available in cash), $310 million went to the
dividend, $158 went to Blair’s shareholders, and $138 million
paid off existing debt.
(Id. at ¶ 72)
Relatively small
remaining sums were used to pay transaction and financing fees.
(Id.)
According to data contained in the Closing Sources & Uses,
the Lenders transferred the loan proceeds directly to the
beneficiaries.
(Id. at Ex. A)
In other words, the parties
bypassed the administrative hassle of transferring the dividend
through each corporate rung of the ladder.
(Id.)
3
These Defendants include Jeffrey D. Farmer, Bradford J. Farmer, Brent
Bostwick, Karinn Kelly, Vito Kowalchuk, Charles Slaughter (personally and in
his capactity as Trustee of the Charles Lewis Slaughter Trust), Christian
Feuer, Geralynn Madonna, and Jim Brewster.
4
At oral argument, the parties expressed some confusion as to whether
the dividend ultimately reached Orchard Brands Topco before disbursement. The
distinction is not dispositive to these Motions. The Court merely notes here
that these are facts that should not be in dispute.
7
On April 30, 2007, the PE Parties used their domination and
control to require the Debtors to enter into an advisory
agreement in which the Debtors paid large “advisory fees” to the
PE Parties.
(Id. at ¶ 81)
The Debtors were required to pay
these fees regardless of whether they received financial or
consulting services in exchange.
(Id. at ¶ 83)
Although the
Debtors were not required to pay the fees if it would cause a
default, the Debtors made fee payments just months before
declaring bankruptcy.
(Id. at ¶ 81)
Shortly after the 2007 transaction, the Debtors could not
afford payments on the loans.
(Id. at ¶ 112)
In order to avoid
default, the Debtors used the Payment In Kind (“PIK”) feature of
the loan agreements, which allowed the Debtors to add missed
payments to the principal.
(Id.)
Had it not been for this
feature, the Debtors would have declared bankruptcy earlier.
(Id.)
On June 8, 2007, Standard & Poor’s Rating Services (“S&P”)
issued high risk credit ratings to the Debtors and the Senior
Credit Facilities.
(Id. at ¶ 148)
S&P specifically noted the
highly leveraged capital structure and other elements of the 2007
transaction as the main cause for the rating.
(Id.)
The Debtors own audited balance sheet over the calendar year
of 2007 showed equity of $95 million before the transaction and a
deficit of $279 million afterwards.
8
(Id. at ¶¶ 155-56)
Although
assets increased, liabilities increased faster.
(Id.)
Indeed,
the $310 million dividend accounts for a substantial portion of
the decline in the Debtors’ net worth.
(Id. at ¶ 160)
The lack
of liquidity due to the dividend made the Debtors more vulnerable
to unexpected challenges, including the recession.5
(Id. at ¶
167)
On April 27, 2011, Michaelson filed this adversary
proceeding in Bankruptcy Court.
On December 15, 2011, this Court
withdrew the reference to Bankruptcy Court.
Each Defendant now
moves to dismiss pursuant to Fed.R.Civ.P. 12(b)(6) made
applicable to this adversary proceeding pursuant to Bankr.R.
7012(b).
II.
Federal Rule of Civil Procedure 12(b)(6) provides that a
court may dismiss a complaint “for failure to state a claim upon
which relief can be granted.”
In order to survive a motion to
dismiss, a complaint must allege facts that raise a right to
relief above the speculative level.
Bell Atlantic Corp. v.
Twombly, 550 U.S. 544, 555 (2007); see also Fed. R. Civ. P.
8(a)(2).
5
Although Defendants blame the Debtors’ insolvency on the recession,
Plaintiff alleges that the 2007 transaction caused the Debtors’ insolvency.
At this stage in the litigation, the Court may not look beyond the Complaint
to infer that the recession, and not the transaction, caused the Debtors’
insolvency.
9
While a court must accept as true all allegations in the
plaintiff’s complaint, and view them in the light most favorable
to the plaintiff, Phillips v. County of Allegheny, 515 F.3d 224,
231 (3d Cir. 2008), a court is not required to accept sweeping
legal conclusions cast in the form of factual allegations,
unwarranted inferences, or unsupported conclusions.
Morse v.
Lower Merion Sch. Dist., 132 F.3d 902, 906 (3d Cir. 1997).
The
complaint must state sufficient facts to show that the legal
allegations are not simply possible, but plausible.
515 F.3d at 234.
Phillips,
“A claim has facial plausibility when the
plaintiff pleads factual content that allows the court to draw
the reasonable inference that the defendant is liable for the
misconduct alleged.”
Ashcroft v. Iqbal, 566 U.S. 662, 129 S.Ct.
1937, 1949 (2009).
When evaluating a Rule 12(b)(6) motion to dismiss, the Court
considers “only the allegations in the complaint, exhibits
attached to the complaint, matters of public record, and
documents that form the basis of a claim.”
Lum v. Bank of
America, 361 F.3d 217, 221 n.3 (3d Cir. 2004).
A document that
forms the basis of a claim is one that is “integral to or
explicitly relied upon in the complaint.”
Id. (quoting In re
Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1426 (3d Cir.
1997)).
For claims of fraud, “a party must state with particularity
10
the circumstances constituting fraud.”
Fed.R.Civ.P. 9(b);
Bankr.R. 7009 (adopting Rule 9 for adversary proceedings).
“Rule
9(b) exists to insure adequate notice so that defendants can
intelligently respond.”
Illinois Nat. Ins. Co. v. Wyndham
Worldwide Operations, Inc., 653 F.3d 225, 233 (3d Cir. 2011).
Defendants should be able to “answer, engage in discovery, and
move for summary judgment.”
Id.
Although trustees are generally afforded some leeway because
they lack personal knowledge, a complaint must do more than
merely identify the allegedly fraudulent transaction.
Walker v.
Posteur (In re Aphton Corp.), 423 B.R. 76, 85 (Bankr.D.Del.
2010).
To adequately allege fraudulent intent in the absence of
direct evidence, a plaintiff may plead circumstantial evidence,
or badges of fraud, that permit the inference of fraudulent
intent.
See Zazzali v. Swenson (In re DBSI, Inc.), 2011 WL
1810632, *2 (Bankr.D.Del. 2011).
The parties do not dispute that the heightened pleading
standard applies to allegations of actual fraud.
With regard to
the allegations of constructive fraud, however, courts are split.
See, e.g., OHC Liq. Trust v. Nucor Corp. (In re Oakwood Homes
Corp.), 325 B.R. 696, 698 (Bankr.D.Del. 2005) (“There is no
question that Rule 9(b) applies to adversary proceedings in
bankruptcy which include a claim for relief under §§ 544 or 548,
whether it is based upon actual or constructive fraud.”); but see
11
Charys Liq. Trust v. McMahan Sec. Co., L.P. (In re Charys Holding
Co., Inc.), 443 B.R. 628, 632 n.2 (Bankr.D.Del. 2010)
(“Plaintiffs’ constructive fraudulent transfer claims are
governed by Rules 8 and 12(b)(6) and not the heightened Rule 9(b)
pleading standard.”)
Because the distinction does not change the
result in this case, the Court will apply the heightened pleading
standards of Rule 9(b) to allegations of both actual and
constructive fraud.
III.
The Complaint alleges sixteen Counts.
Not all Defendants,
however, have moved to dismiss the same Counts on the same
grounds.
The FBK Defendants,6 and Defendant Kelly by joinder,
move to dismiss Counts I-IV (avoidance of fraudulent transfers as
to the dividend) and Count XI (corporate waste).
The Golden Gate
Defendants,7 move to dismiss: (1) Counts I-IV; (2) Counts V-VIII
(avoidance of fraudulent transfers as to the transaction and
advisory fees); and, (3) Counts IX-XII (state law claims for
breach of fiduciary duty, aiding and abetting a breach of
6
The FBK Defendants are comprised of minority shareholders of Orchard
Brands: Jeffrey Farmer, Bradford Farmer, Brent Bostwick, and Vito Kowalchuk.
7
The Golden Gate Defendants are all PE Parties (except the Webster
Defendants defined infra) as well as Stefan Kaluzny and Joshua Olshansky (comanaging directors of Golden Gate and directors of Orchard Brands) and Jim
Brewster and Geralynn Madonna (minority shareholders of the PE Parties).
12
fiduciary duty, corporate waste, and conspiracy).8
Defendants advance several arguments in support of
dismissing the fraudulent transfer claims (Counts I-VIII).
The
Court will first address those arguments then proceed to the
state law claims.
Lastly, the Court will address Plaintiff’s
Motion to Seal.
A.
Relevant to this case, “the trustee may avoid any transfer
of an interest of the debtor in property or any obligation
incurred by the debtor that is voidable under applicable law by a
creditor holding an unsecured claim.”
11 U.S.C. § 544(b)(1).
Defendants make several arguments for dismissal based on this
statutory language and several arguments based on related
statutory requirements.
See, e.g., 11 U.S.C. §§ 546(e),
550(a)(2).
1.
First, Defendants argue that there was no “interest of the
Debtors in property” because the Senior Credit Facilities
8
The FBK and Golden Gate Defendants have filed their own Motions to
Dismiss. The FBK Defendants join Part II of the Golden Gate Defendants’
Motion, Karinn Kelly joins both Motions and Defendants Webster Capital
Founders’ Fund, LP, Webster II, LLC, Webster III, LLC (PE Party Defendants,
collectively hereinafter “Webster Defendants”), and Charles Slaughter join the
Golden Gate Defendants’ Motion only.
13
required Debtors to pay the dividend.9
544(b)(1).
See 11 U.S.C. §
In other words, Debtors did not have control over the
funds because they were legally required to pay the dividend.10
Defendants note that shortly after signing the loan instruments,
the Lenders wired funds directly to Orchard Brands.
Therefore,
Haband and Appleseed Intermediate never took possession of the
funds.
In support of this argument, Defendants have attached the
loan agreements to the Motion.
Generally, Courts may not
consider extraneous documents in deciding a motion to dismiss for
failure to state a claim.
One exception is when the document is
explicitly relied upon in the complaint.
9
See Angstadt v. Midd-
All Defendants have joined this argument.
10
Defendants primarily rely on non-binding and inapposite case law
surrounding the Eleventh Circuit’s control test. See 3V Capital Master Fund
Ltd. V. Official Comm. Of Unsecured Creditors of TOUSA, Inc. (In re TOUSA),
444 B.R. 613, 648 (S.D.Fla. 2011) (citing Tolz v. Barnett Bank of S. Fla. (In
re Safe-T-Brake of S. Fla., Inc.), 162 B.R. 259, 365 (Bankr.S.D.Fla. 1993).
There, a parent transferred newly borrowed funds to a subsidiary for the
express purpose of repaying existing debt. The Court held that the subsidiary
did not have an interest in property because: (1) the subsidiary could not
designate the beneficiary of the funds, and (2) the subsidiary could not
actually disburse the funds to that party. In so holding, the Court noted
that “[t]o conclude otherwise would confer on the Committee a windfall at the
expense of a valid antecedent lender who was innocent of any intent to
diminish the assets of the debtor.” Id. at 648.
First, TOUSA does not control the outcome here because the Third Circuit
has not adopted the control test. Second, this case is inapposite because it
involves a subsidiary paying a dividend up the corporate ladder resulting in
insolvency - not a parent using a subsidiary as a conduit to pay off existing
debt as in TOUSA. Third, were this Court to apply the control test, the
elements have been satisfied: (1) Haband’s board voted to approve the
dividend, (2) only Haband can issue or disburse its own dividend. Finally,
the policy behind the holding of TOUSA is wholly inapplicable to this case.
Defendants were not innocent antecedent lenders, but allegedly self-interested
owners that sacrificed subsidiaries to enrich themselves.
14
West Sch. Dist., 377 F.3d 338, 342 (3d Cir. 2004).
Here, Plaintiff mentions and relies upon the Senior Credit
Facilities throughout the Complaint.
(See, e.g., Compl. ¶¶ 54,
90-113); see also In re Burlington Coat Factory Sec. Litig., 114
F.3d 1410, 1426 (3d Cir. 1997) (“Plaintiffs cannot prevent a
court from looking at the texts of the documents on which its
claim is based by failing to attach or explicitly cite them.”).
Plaintiff’s Complaint cites liberally to the Senior Credit
Facilities and, therefore, will be considered on this Motion to
Dismiss.
(See Compl. ¶¶ 54, 90-113)
The Senior Credit Facilities, however, provide little
support for Defendants’ argument.
An interest of the debtor in
property encompasses “that property that would have been part of
the estate had it not been transferred before the commencement of
bankruptcy proceedings.”
See Begier v. I.R.S., 496 U.S. 53, 58
(1990) (interpreting the similarly phrased statutory antecedent
to interest of the debtor in property broadly).
Had Appleseed Intermediate and its subsidiaries decided not
to issue the dividend, Debtors would have retained the loan
proceeds and the money would have been property of the estate.
Although the Golden Gate Defendants argue that the Lenders would
not have issued the loans absent payment of the dividend, see Tr.
Oral Arg., Feb. 22, 2012, the argument has no merit.
The
Lenders’ loans would have been in a stronger position if the
15
Debtors had more working capital.
Even if the ambiguous Senior
Credit Facilities would technically have been in default were
Haband not to pay the dividend, any rational creditor would have
forgiven default to obtain a stronger financial position for
free.11
Moreover, although Defendants received the dividend directly
from the Lenders, Haband issued the dividend.
(See Compl. Ex. A)
If, as the Golden Gate Defendants argue, Haband had no choice but
to issue the dividend, then Golden Gate would not have allegedly
temporarily replaced Haband’s directors to ensure board approval.
It truly defies logic to argue that Haband did not have an
interest in property in the $310 million dividend Haband itself
issued.12
As alleged, the PE Parties diverted nearly half of the loan
proceeds to themselves, which left the Debtors teetering on the
brink of insolvency.
It would be paradoxical to allow the PE
Parties to offer Debtors’ property as collateral, abscond with
the proceeds of the loan in the form of a dividend, and yet
11
Although payment of the dividend was arguably required by Section
3.12, the payment of the dividend was not a condition precedent to securing
the loans. Decl. Sander Bak Ex. 2, $335,000,000 Credit Agreement § 3.12. The
dividend did arguably breach a condition precedent under Section 4.02(b),
however, which requires that “at the time of and immediately after giving
effect to such Credit Extension and the application of the proceeds thereof,
no Default shall have occurred and be continuing on such date.” Id. at §
4.02(b). Plaintiff alleges that the dividend caused the Debtors to become
insolvent. The Golden Gate Defendants’ argument that certain clauses of the
Senior Credit Facilities should be read in isolation to relieve Debtors of an
interest in property is unpersuasive.
12
Perhaps this reason accounts for the dearth of case law on the issue.
16
declare that the Debtors had no interest in property.
Accordingly, the Motion to Dismiss will be denied with respect to
the argument that there was no interest of the debtor in
property.
2.
Second, FBK Defendants argue that Plaintiffs have failed to
allege facts sufficient to demonstrate that the transfers are
“voidable under applicable law.”
11 U.S.C. § 544(b)(1).
Although no applicable law is specifically alleged in the
Complaint, the parties have briefed the Delaware Uniform
Fraudulent Transfer Act (“DUFTA”).13
A transfer is fraudulent
under the DUFTA if the debtor made the transfer or incurred the
obligation:
(1) With actual intent to hinder, delay or defraud any
creditor of the debtor; or
(2) Without receiving a reasonably equivalent value in
exchange for the transfer or obligation, and the debtor:
a. Was engaged or was about to engage in a business
or a transaction for which the remaining assets of
the debtor were unreasonably small in relation to
the business or transaction; or
b. Intended to incur, or believed or reasonably
should have believed that the debtor would incur,
debts beyond the debtor's ability to pay as they
became due.
6 Del.C. § 1304(a).
The Statute lists several nonexclusive
factors, or badges of fraud, to facilitate an analysis of actual
13
The Parties have preserved future conflict of law challenges.
17
intent.14
The FBK Defendants argue for dismissal of both the
actual and constructive fraudulent transfer claims.
a.
Claims of actual fraud are analyzed under the first
subsection.
See 6 Del.C. § 1304(a)(1).
The FBK Defendants argue
that Plaintiff has failed to allege that both parties to the
transaction had actual intent.
Alternatively, the FBK Defendants
argue that Plaintiff has not alleged sufficient badges of fraud
to establish actual intent because any allegations are directed
only to the Golden Gate Defendants.
First, this argument misconstrues the plain language of the
statute.
A transfer is fraudulent “if the debtor made the
transfer or incurred the obligation with actual intent to hinder,
delay or defraud any creditor of the debtor.”
1304(a).
6 Del.C. §
The only relevant intent is that of the debtor.
See,
e.g., Charys Liq. Trust, 2010 WL 2774852, *4 (analyzing only the
Debtor’s intent for the purposes of the actual fraudulent
transfer claims).
To require both parties to the transaction to
have actual intent, as FBK Defendants argue, would benefit the
ignorant transferee to the detriment of other creditors.
14
Examples include whether the transfer was to an insider, the debtor
was insolvent or became insolvent shortly after the transfer was made, or the
transfer occurred shortly before a substantial debt was incurred. See, e.g.,
6 Del.C. §§ 1304(b)(1), (9), (10).
18
Second, Plaintiff specifically identifies four badges of
fraud to establish actual fraudulent intent:
(i) the transfer was to an insider as the Debtors were
directly or indirectly owned and/or controlled by [PE
Parties]; (ii) the transfer of the Dividends to [Orchard
Brands] and its shareholders occurred at the same time
when substantial new debts were incurred; (iii) the
Debtors received no value or consideration in exchange
for the transfer of the Dividends; and (iv) the Debtors
were or became insolvent at the time of the 2007
Transaction and the transfer of the Dividends.
(Compl. ¶ 179)
The Complaint offers myriad factual allegations
to support these statements.
See Charys Liq. Trust, 2010 WL
2774852, *5 (denying motion to dismiss where plaintiff alleged
four badges of fraud to show debtor’s actual fraudulent intent).
Here, Plaintiff adequately alleges four badges of fraud,
which permits the inference of actual fraudulent intent.
Therefore, the Motion will be denied as it pertains to
establishing actual fraudulent intent.
b.
Constructive fraud is analyzed under the second subsection.
See 6 Del.C. § 1304(a)(2).
The FBK Defendants argue that
Plaintiff’s allegations indicate that Debtors received reasonably
equivalent value for the dividends.
In support of this argument,
the FBK Defendants note that a significant portion of the
distributed funds were labeled “Return of Capital.”
B)
(Compl. Ex.
Moreover, at oral argument, FBK Defendants argued that the
19
purchase of shares provided reasonably equivalent value for the
dividends.15
However, Defendants have not persuaded the Court that a
voluntarily disbursed dividend to preferred shareholders, even if
some of the payments are a return of capital, constitutes
reasonably equivalent value.16
Defendants do not suggest that
Debtors were otherwise required to return the capital, or that
the total funds each Defendant received were reasonably
equivalent to the return of capital.17
Accordingly, the Motion
will be denied as to the reasonably equivalent value argument.
3.
Third, to establish a fraudulent transfer claim, Plaintiff
15
The Court need not address this argument both because it was not
raised in the original Motion and it is premature. See OR v. Hunter, 2012 WL
259411, *2 n.2 (D.N.J. 2012). The terms of the preferred stock have not been
included in the pleadings. Thus, the Court has no basis to determine whether
the dividend was mandatory or discretionary. Under common stock, for example,
a company is not required to pay a dividend. The purchase price of the stock,
therefore, could not conceivably be labeled a reasonably equivalent exchange
for a dividend the company has no obligation to pay.
16
Defendants support this argument by citing to Ponzi scheme cases where
investors were able to retain transfers to the extent of their initial
investments when they withdrew prior to the investment firm declaring
bankruptcy. See, e.g., Sec. Investor Protection Corp. v. Bernard L. Madoff
Investment Sec., LLC, 424 B.R. 122, aff’d 2011 U.S. App. Lexis 16884 (2d Cir.
2011). Those cases differ significantly, however, from the payment of a
voluntary dividend.
17
In their Reply, the FBK Defendants slightly modify their argument.
Instead of seeking dismissal of the entire distribution, they seek only
dismissal of the fraudulent transfer claims as it applies to the return of
capital. This argument will be disregard because it was raised for the first
time in the Reply. See Hunter, 2012 WL 259411, *2 n.2. The Court notes
again, however, that the Ponzi scheme cases FBK Defendants rely upon shed
little light on the instant dispute.
20
must identify a “creditor holding an unsecured claim that is
allowable under section 502 of this title or that is not
allowable only under section 502(e) of this title.”
544(b)(1).
11 U.S.C. §
The FBK Defendants argue that Plaintiff has failed to
identify an unsecured creditor.
The argument misreads the
Complaint.
Plaintiff has identified four types of unsecured creditors
that existed at the time of the transfer: vendors, landlords,
suppliers, and lenders.
(See Compl. ¶ 175)
Plaintiff need not
identify a specific unsecured creditor by name, address and phone
number even under heightened pleading standards.
See Zazzali,
2011 WL 607442, *5 (citing Pardo v. Avanti Corp. Health Sys.,
Inc. (In re APF Co.), 274 B.R. 634, 639 (Bankr.D.Del. 2001)).
The argument has no merit and the Motion will be denied as to
this argument.
4.
Fourth, the FBK Defendants argue that Plaintiff has failed
to satisfy the terms of § 550(a)(2), which states that the
trustee may recover the value of property avoided under § 544
from “any immediate or mediate transferee of such initial
transferee.”
11 U.S.C. § 550(a)(2).
The FBK Defendants argue
that this Court must view each part of the transaction
individually and may not “collapse” the transaction.
21
According
to this logic, the FBK Defendants received funds from non-Debtor
Orchard Brands - as opposed to Debtor Appleseed Intermediate and this fact supposedly prevents the Trustee from avoiding the
transfer.18
The argument has no basis in law.
A plain reading of § 550(a)(2) permits recovery from
immediate or mediate transferees of an interest of the Debtors in
property.
The Complaint alleges that Debtor Haband paid the
dividend to Appleseed’s Intermediate who paid the dividend to
Orchard Brands who, in turn, disbursed the dividend to Defendants
as preferred shareholders.
Appleseed’s Intermediate is the
initial transferee, Orchard Brands is the immediate transferee
and all other recipients are mediate transferees.
See ETS
Payphones, Inc. v. AT&T Universal Card (In re PSA, Inc.), 335
B.R. 580, 586 (Bankr.D.Del. 2005) (illustrating the application
of the statute).
The FBK Defendants can easily ascertain their
transferee status from the allegations of the Complaint.
Plaintiff has no obligation to apply the statute for Defendants.
As a result, the Court need not reach the issue of whether the
transaction should be collapsed and the Motion will be denied.
5.
Finally, FBK Defendants argue an exception to the trustee’s
18
The FBK Defendants do not argue that they are a good faith transferee
within the meaning of § 550(b)(2).
22
avoidance powers.
Notwithstanding § 544, “the trustee may not
avoid a transfer that is a . . . settlement payment . . . [made
by or to] a financial institution.”
11 U.S.C. § 546(e).
A
settlement payment is any payment commonly used in the securities
trade.
See 11 U.S.C. § 741(8).
The FBK Defendants argue that
the dividend was a settlement payment within the meaning of §
546(e).
Although the Third Circuit has held that a payment for
shares during a leveraged buyout is a settlement payment, see
Lowenschuss v. Resorts Int’l, Inc. (In re Resorts Int’l, Inc.),
181 F.3d 505, 515-16 (3d Cir. 1999), those transactions involved
security exchanges.
The necessary implication is that both
parties exchanged some value.
Here, by contrast, the dividend transaction was not an
exchange, but a one-way payment.
(9th ed. 2009).19
See BLACK ’S LAW DICTIONARY 547
As alleged, Debtors received nothing in
exchange for the dividend.
While the Blair leveraged buyout may
fall within the meaning of a settlement payment, the Blair
acquisition cannot be conflated with the payment of the dividend.
In other words, even if § 546(e) were to apply to the Blair
acquisition in this multifaceted transaction, the dividend would
19
Dividend- A portion of a company’s earnings or profits distributed pro
rata to its shareholders, usu. in the form of cash or additional shares. Id.
Ironically, the transaction at issue in this case was not financed with
earnings or profits, but borrowed funds. The transaction’s label, of course,
is not dispositive to these Motions.
23
not automatically be exempt as well.
See Mervyn’s LLC v. Lubert-
Adler Group IV, LLC (In re Mervyn’s Holdings, LLC), 426 B.R. 488,
500 (Bankr.D.Del. 2010) (Defendant’s “attempt to have this Court
apply section 546(e) to a single conveyance within the entire
transaction is not persuasive . . . The other transactions to
this sale do not fall within the parameters of section 546(e).”).
Having dispensed with each argument to dismiss the actual
and constructive fraudulent transfer claims, the Motions to
Dismiss will be denied with respect to Counts I-VIII as to all
Defendants.
B.
Turning to the state law claims, all Defendants argue that
the statute of limitations bars Counts IX-XII.
Defendants argue,
and Plaintiff does not dispute, that the claims are subject to a
three year statute of limitations under Delaware law.
Del. C. § 8106.
See 10
On the face of the Complaint, however, nearly
four years elapsed between April 30, 2007, the latest possible
date of accrual, and April 27, 2011, the date Plaintiff filed the
Complaint.
In response, Plaintiff argues that the statute of
limitations should be equitably tolled.
Ordinarily, the statute of limitations is an affirmative
defense to be raised in responsive pleadings.
See Worldcom, Inc.
v. Graphnet, Inc., 343 F.3d 651, 657 (3d Cir. 2003) (citing
24
Robinson v. Johnson, 313 F.3d 128, 135 (3d Cir. 2002) (an
exception arises “only if the time alleged in the statement of a
claim shows that the cause of action has not been brought within
the statute of limitations.”) (emphasis omitted).
However, where
more information is needed to establish the applicability of the
affirmative defense, resolution of the issue in a pre-answer
motion to dismiss is premature.
Id.
Here, Defendants correctly note that the statute of
limitations would bar Plaintiff’s state law claims on the face of
the Complaint.
Nevertheless, Plaintiff argues that the statute
of limitations should be equitably tolled.
To invoke the
exception, Plaintiff would have to establish: (1) a fiduciary
relationship; (2) actionable or fraudulent self-dealing; and (3)
lack of inquiry notice.
See End of the Road Trust v. Terex Corp.
(In re Freuhauf Trailer Corp.), 250 B.R. 168, 193 (Bankr.D.Del.
2000).
Without so holding, the Complaint appears to establish the
first two elements.20
Defendants take particular issue, however,
with the third element - inquiry notice.21
Of particular
20
At this stage of the litigation, it is unclear whether Plaintiff will
be able to establish that each Defendant was in a fiduciary relationship with
the Debtors.
21
The parties disagree whether creditors, debtors, or both must be on
inquiry notice to satisfy the statute. The Court need not resolve that
dispute for the purposes of the instant Motion. The Court merely notes that
if the Debtors are required to have inquiry notice, then there arises a
seemingly anomalous situation where the Debtors would be expected to sue their
parent company to toll the statute of limitations.
25
importance to the resolution of this issue is whether the PIK
feature of the loan delayed inquiry notice.
Although Plaintiff
alleges that Debtors were insolvent as a result of the dividend,
Debtors were able to stave off bankruptcy for several years.
Missed loan payments were simply added to the principal to avoid
default.
This feature may have caused both Debtors and creditors
to lack inquiry notice.
Nevertheless, at this stage of the litigation, the record is
not sufficiently developed to determine the applicability of
equitable tolling.
It would be unfair to require Plaintiff to
plead facts sufficient to account for every affirmative defense
and exception thereto in the Complaint.
The Court offers no
opinion as to the merits of a future statute of limitations
argument.
Accordingly, the Motion will be denied without
prejudice to renew the statute of limitations argument in the
future.
C.
Finally, the FBK Defendants argue that Plaintiff has failed
to adequately plead corporate waste (Count XI) because Debtors
received at least some consideration.
To establish the claim,
Plaintiff must show “an exchange of corporate assets for
consideration so disproportionately small as to lie beyond the
range at which any reasonable person might be willing to trade.”
26
Weiss v. Swanson, 948 A.2d 433, 450 (Del.Ch. 2008).
transfer is in effect a gift.”
263 (Del. 2000).
“Such a
Brehm v. Eisner, 746 A.2d 244,
Corporate waste claims are reserved only for
the “rare unconscionable case where directors irrationally
squander or give away corporate assets.”
Binks v. DSL.net, Inc.,
2010 WL 1713629, * 12 (Del.Ch. 2010).
Here, Plaintiff alleges that the PE Parties caused Debtors
to issue a dividend financed by loans collateralized with
Debtors’ assets.
Plaintiff further alleges that Debtors received
no benefit from the transaction.
(E.g., Compl. ¶¶ 2, 260)
Indeed, the dividend, by definition, provided no substantial
benefit to the corporation, but instead benefitted the
shareholders.
Although the Debtors received approximately $650
million pursuant to the Senior Credit Facilities, Defendants
appropriated a large portion of the funds for themselves while
returning no value to the corporation.22
Accordingly, the Motion
will be denied.23
D.
22
Ironically, it was the FBK Defendants that argued that the transaction
could not be collapsed in the context of § 544. Now, the FBK Defendants wish
to view the same transaction as a whole to establish that Debtors received at
least some consideration.
23
For the first time in their Reply, the FBK Defendants argue that only
fiduciaries may be liable for claims of corporate waste. The Court will not
address this untimely argument. The Court notes, however, that to avoid
dismissal upon future Motion, Plaintiff may need to amend the Complaint.
27
Before this Court granted FBK Defendants’ Motion to Withdraw
the Reference, the Bankruptcy Court granted various parties’
motions to file papers under seal.
Only Plaintiff’s Motion to
Seal remains.
Although this adversary proceeding is being litigated in
District Court, “[t]he Bankruptcy Rules and Forms govern
procedure in cases under Title 11 of the United States Code.”
Bankr.R. 1001.
The Federal Rules of Civil Procedure “apply to
bankruptcy proceedings to the extent provided by the Federal
Rules of Bankruptcy Procedure.”
Fed.R.Civ.P. 81(a)(2).
Bankruptcy Rule 7026 expressly makes Fed.R.Civ.P. 26 applicable
to this proceeding.
Fed.R.Civ.P. 26(c) provides that “[t]he court may, for good
cause, issue an order to protect a party or person from
annoyance, embarrassment, oppression, or undue burden or
expense.”
Good cause may be established “on a showing that
disclosure will work a clearly defined and serious injury to the
party seeking closure.
specificity.”
The injury must be shown with
Pansy v. Borough of Stroudburg, 23 F.3d 772, 786
(3d Cir. 1994) (quoting Publicker Indus., Inc. v. Cohen, 733 F.2d
1059, 1071 (3d Cir. 1984).
Plaintiff must show good cause
notwithstanding the parties’ confidentiality agreements.
786.
Id. at
Any previous application of § 107(b) or Bankr.R. 9018 to
this adversary proceeding - rules that do not require a showing
28
of good cause - was erroneous.
Here, Plaintiff has applied for an order sealing his brief
wholesale, but makes no attempt to establish good cause.
This
application falls well short of the specificity a good cause
showing requires.
After review of the documents in this case,
the Court has not discovered any sensitive material, such as
trade secrets, that would commonly satisfy the good cause
standard.
Accordingly, Plaintiff’s Motion to Seal will be denied
and all prior orders sealing documents in this adversary
proceeding will be vacated.24
IV.
For the foregoing reasons the Motion to Dismiss will be
denied.
Dated: 3/7/12
/s/ Joseph E. Irenas
JOSEPH E. IRENAS, S.U.S.D.J
24
The parties have leave to file future motions to seal or renew prior
applications. Such motions shall clearly identify each document to be sealed
and the reasons good cause can be shown.
29
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