ROBERT E. GERBER, UNITED STATES BANKRUPTCY JUDGE:
In late December 2007, Basell AF S.C.A. (
In the first week of January 2009, less than 13 months later, a financially strapped Lyondell filed a petition for chapter 11 relief in this Court.
In an earlier published decision,
Now shareholder defendants (the
Upon review of the Amended Complaints, the Court determines that the earlier deficiencies identified in the First 12(b)(6) Decision were not satisfactorily cured, and that plausible claims of intent on the part of Lyondell's Board to put assets beyond the reach of Lyondell creditors still have not been sufficiently alleged. Thus the intentional fraudulent transfer claims will be dismissed. The Movants' constructive fraudulent transfer claims contentions are rejected, and those claims survive.
Before the events that are the subject of these actions, Lyondell was a publicly traded chemicals company based in the United States. Lyondell's Board consisted of 10 elected outside directors (the
As alleged in the Revised Complaint, Smith was CFO of Lyondell from 1988-1994; President of Lyondell from 1994 to an unstated date; CEO from 1996 until the time of the Merger, and a director of Lyondell from 1988 until completion of the Merger.
Lyondell's other 10 directors at the time — the Outside Directors — were identified by name in the Revised Complaint, with individual paragraphs which included the length of service of each. Those paragraphs indicate that the Outside Directors had served as such for periods running from less than one year up to twelve years
As noted above, the Court denied the defendants' earlier motion to dismiss the constructive fraudulent transfer claims, but granted it with respect to intentional fraudulent transfer claims. As to the latter, the court noted that the Complaint was "nearly entirely constructive fraudulent transfer focused, and [spoke] of the effect of the LBO, as contrasted to its intent."
The Court then noted, based on earlier authority it cited and common sense, that the intent of a corporation transferring property was derived from the intent of the natural persons in a position to make the necessary decisions on the corporation's
Here, consistent with the Delaware law principle that corporations can merge only with the approval of their boards of directors, the transaction that was the subject of the Trustee's attack had been approved by Lyondell's Board. And thus it was the Board's intent that was critical — based, once again, on the intent of the individuals acting as members of the Board. That could be shown by establishing, with nonconclusory factual allegations, either that enough Board members had the requisite intent on their own, or that Smith or another could cause that number of Board members to form the requisite intent. But the Court did not believe that it could find the requisite Board intent based on imputation of Smith's intent alone. The Court stated:
Thus, the requisite intent could be shown by two means: (1) establishing the intent of a critical mass of Board members who might have that intent on their own, or (2) by establishing that Smith or another, by reason of the ability to control them, had caused the critical mass to form that intent.
Compared to its immediate predecessor, the Revised Complaint contains a fair number of additional allegations, including information on Lyondell's acquisition of an oil refinery in Houston; the process of preparing Lyondell's (financial) "Long Range Plan" and projected earnings; and roles played by Blavatnik and certain senior Basell managers in the Merger. But the Court here focuses only on allegations added to address the deficiencies discussed in the First 12(b)(6) Decision.
First, with respect to the Board as a whole, the Revised Complaint adds allegations as to the Board's knowledge of the inflated financials underpinning the Merger and foreseeable "dire"
Second, the Revised Complaint bolsters earlier allegations with respect to Smith and provides somewhat individualized allegations as to the 10 other directors. The Revised Complaint adds a paragraph with respect to each Board member by name,
Further, the amended allegations expand on Board member Chazen, who was also a Senior Executive Vice President and Chief Financial Officer of Occidental, one of Lyondell's biggest ethylene customer and holder of approximately 8.5% (by November 2006) of Lyondell's stock. It alleges that:
Third, the Revised Complaint adds allegations that Smith dominated the Board's decisions, particularly with respect to the Merger, by failing to disclose to the Board that:
The Complaint also adds allegations reiterating the monetary incentives that Smith, his "inner cadre" of senior managers, and Board members stood to gain from the Merger consideration by an inflated per share price of $48
The standard for evaluating a motion to dismiss under Fed. R. Civ. P. 12(b)(6), made applicable to adversary proceedings pursuant to Fed. R. Bankr.P. 7012, is well established. Although Rule 8(a)(2) generally requires only a "short and plain statement of the claim showing" entitlement to relief, "a plaintiff's obligation to provide the grounds of his entitlement to relief
Further, to survive threshold scrutiny, the plaintiff must state a "claim to relief that is plausible on its face."
Additionally, when a claim is premised on fraud — and claims for intentional fraudulent transfer are in this category
Thus, to support a fraud claim, a complaint must "allege facts that give rise to a `strong inference' of fraudulent intent."
The Court first addresses the principles applicable to the determination of this motion, and then applies those principles to the new allegations that have been put forward here.
For the purposes of this motion, the Court must focus first on what was required to allege the requisite intent, and then, as a separate matter, on the allegations addressing whether and how the Board members came to that intent. The First 12(b)(6) Decision, by reason of the Trustee's focus on Smith and the argument that Smith's intent should be imputed to Lyondell, focused principally on how one gauges the intent of a corporation with an actively functioning Board, and whose intent mattered. But now that it is established that it is the Board's intent that matters, the Court must focus much more on the nature of that intent, as a predicate to evaluating the allegations put forward to establish that intent.
The analysis begins, as it must, with statutory text. Section 548 of the Code provides that the trustee may avoid a transfer or obligation if the debtor "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."
And here the Court must emphasize that the subject of the analysis is an intentional tort — one with an intent to injure others (in this case, creditors), in a particular way: by efforts to "hinder, delay or defraud" them. As a textual analysis matter, the Court interprets those words with the assumption that none should be surplusage, and thus that they refer to different ways to effect the resulting injury. But those words nevertheless take their meaning by the company they keep.
Thus the Court holds that the requisite intent must be consistent with the overall theme of intentional fraudulent transfer law: proscribing intentional actions to injure creditors, by means of placing assets out of the reach of creditors' reach or by other intentional steps to prevent creditors from collecting on their debts or placing obstacles in creditors' way. Other wrongful acts that the Trustee might more easily be able to show — e.g., negligence, other breaches of fiduciary duty, and constructive fraudulent transfers, which have an inevitable adverse effect on creditor needs and concerns — may be seriously prejudicial to creditors, but the creditors' rights rest on other law, not intentional fraudulent transfer law. For that reason, the Court is unwilling to consider intent to commit other wrongful acts as a substitutes for the intent to frustrate legitimate creditor expectations that is the foundation of intentional fraudulent transfer law.
So what kinds of allegations provide the predicate for a finding of that intent?
One means of finding the requisite intent is by reference to its conceptual underpinnings — by focus on what "intent" means. Here we are talking about an intentional tort of a particular nature. Some acts to hinder, delay or defraud are so obvious that they would pass muster under any test — such as the proverbial deeding of the house to one's brother-in-law just after an adverse verdict has come down. And there are others that appropriately should be regarded the same way — as when hindering, delaying or defrauding creditors is the inevitable consequence, as it typically is in Ponzi Scheme cases. By the same token, the requirement for an intentional act requires a standard that does not also capture situations where the consequence — here, loss to creditors — is simply a bad result after the fact, or results from mere negligence. And caselaw requires that courts be wary in relying on facts that are benign in nature, or circumstances that would be applicable to nearly every corporate insider.
For that reason, the Court has considered, and ultimately agrees with, the Movants' point
Although, as the Trustee observes, the bulk of the cases referencing the Restatement involved Ponzi Schemes, this Court, like the ASARCO court,
But as an alternative to the Restatement standard, the Trustee asks this Court to adopt a "natural consequences" standard
In Sentinel, the Seventh Circuit reversed a district court judgment after trial that had declined to find an intentional fraudulent transfer when the debtor had illegally co-mingled customer accounts and pledged customer assets as collateral for a loan used in funding its own proprietary activities — thereby rendering funds permanently unavailable to these customers. The Sentinelcourt found the requisite actual intent to hinder, delay or defraud, basing its conclusion on analysis stating that "Sentinel certainly should have seen this result as a natural consequence of its actions," and that "[i]n our legal system, "every person is presumed to intend the natural consequences of his acts."
Thus the Court sees insufficient basis for concluding that "natural consequences" can be the standard based on the Trustee's second, more expansive, meaning — i.e., as anything other than another way of imposing the Restatement standard. Importantly, the Court can find no instance in which the Restatement standard has been rejected, in this district or elsewhere.
Another means for finding intent is the "badges of fraud" technique. "Badges of Fraud" are facts found in many intentional fraudulent transfer cases that provide a basis for finding intentional fraudulent transfer by means of circumstantial evidence.
"Badges of fraud" factors have been codified in state fraudulent transfer laws, and in caselaw under the Code. The Texas version of the UFTA provides, by way of example:
Caselaw applying the Code's federal equivalent, section 548, likewise identifies factors to consider, though they are somewhat less specific and more abstract.
While "the existence of a badge of fraud is merely circumstantial evidence and does not constitute conclusive proof" of actual fraudulent intent, "the more factors present, the stronger the inference."
Still another means of finding the requisite intent is "Motive and Opportunity" analysis, mentioned by the Court in the First 12(b)(6) Decision, and upon which the Trustee relies.
In the First 12(b)(6) Decision, the Court gave some, but not extensive, attention to the Trustee's Motive and Opportunity argument. The Court observed that judges in this district had applied Motive and Opportunity analysis to intentional fraudulent
Those statements accurately described what Musicland, Adelphia-Bank of America and Madoff said, but the limits on the use of Motive and Opportunity analysis now need to be noted as well. In appropriate cases, Motive and Opportunity analysis may be quite useful in discerning intent (especially in reinforcing conclusions drawn from other indicia of intent), but motive and opportunity may also be found in situations that are totally benign. Entities may have nearly limitless opportunities to move their assets away from the reach of their creditors, and they may sometimes have the motive to do so as well. But it does not necessarily follow that entities would always, or even regularly, act in accordance with that motivation, and the reasons for which they might or not act might have nothing to do with any motivation they might otherwise have.
And in that connection, the Movants note that the Trustee fails to cite any fraudulent transfer case (as contrasted to a securities fraud case) in which the requisite intent was found based solely on motive and opportunity.
Given the repeated mention (if not reliance) on Motive and Opportunity analysis in other cases, the Court is loath to say that Motive and Opportunity analysis will never qualify as a basis for finding intent to hinder, delay or defraud in a fraudulent conveyance case. And thus the Court assumes that Motive and Opportunity doctrine will sometimes provide a basis for drawing the "strong inference" of actual intent to defraud creditors that intentional fraudulent transfer claims require. But in such cases, especially when the allegations of motive and opportunity are not joined by other allegations supporting a finding of intent to injure creditors, the Court believes it must find, by reason of the other caselaw, that the inference of intent drawn from that motive and opportunity be quite strong — and that if there are other motivations that would not be wrongful (or if the motivations are shared by many other corporate insiders), the inference of wrongful intent drawn from the motive and opportunity allegations must outweigh any opposing inferences.
Finally, another potentially applicable basis for finding the requisite intent to injure creditors is recklessness, which is not infrequently a basis for finding the requisite scienter in securities fraud cases. In the First 12(b)(6) Decision, the Court assumed this to be a satisfactory basis for alleging the requisite intent,
But while this Court and the courts that it had cited accurately quoted what the Second Circuit had said in Shields (which was in a securities laws context), and the Musicland and Madoff courts (and then this Court) expressly focused on whether the Shields language should apply in cases involving other than securities fraud (concluding that it should),
It is probably too late in the day to say that the quoted language in G-I Holding, Musicland, Adelphia-Bank of America, and Madoff, and the First 12(b)(6) Decision, all taken from the Shields securities law holding, should no longer be applicable in fraudulent transfer cases. Yet it is still fair to observe that "recklessness" was imported from securities fraud cases into intentional fraudulent transfer cases in the Musicland, Adelphia-Bank of America and Madoff decisions in contexts in which distinctions between recklessness and higher levels of intent would not matter.
But in at least some intentional fraudulent transfer cases, the distinction would matter — because some state fraudulent transfer statutes (like those based on the Uniform Fraudulent Conveyance Act) impose
Thus, while the Court will remain within the confines of its citation of Musicland, Adelphia-Bank of America and Madoff in the First 12(b)(6) Decision,and thus assume the continued validity of recklessness as a potential basis for finding intent, the Court must nevertheless construe the required level of recklessness in a fraudulent transfer case to require allegations of facts "that give rise to a strong inference of fraudulent intent."
The "strong inference" requirement must be imposed to ward off allegations of "fraud by hindsight,"
The Court now considers the sufficiency of the amended pleadings against these standards. Ultimately, it determines that the Trustee failed to fill the gaps that needed to be filled after the First 12(b)(6) Decision. Most importantly, the Trustee has failed to meet the requirements for establishing intent under the Restatement. Nor can the Court find that deficiency remedied by any of the other potential means.
Here the Court examines the allegations of the Complaint to ascertain whether there here are plausible allegations that a "critical mass"
Here the Court can find no allegations supporting an inference that any of the Board members other than Smith and Chazen had any wrongful intent of any type. Nor, for that matter, can the Court find allegations supporting the view that Smith's and Chazen's satisfactorily pleaded dishonesty and greed was accompanied by an actual intent that creditors not be paid, or that they be otherwise hindered in their debt recovery efforts.
The individual allegations as to the Board members (after saying when each was elected to the Board and when each served) say that the Board member "routinely attended" board meetings at which Lyondell's Long Range Plan and other strategic planning for Lyondell was discussed
In fact, allegations of the last type are paradigmatic examples of the practice, condemned by the Supreme Court in Twombly, by which a "formulaic recitation of a cause of action's elements will not do."
In another section of the Revised Complaint,
Nor can the Court conclude find the requisite Board intent by the accepted substitute for actual intent — such as the Restatement's alternate requirement that a loss to creditors be "substantially certain." There may well have been clues available to the Board that could lead Board members to believe that the transaction under consideration was too aggressive, and that losses to creditors were foreseeable. It may also be that before voting in favor of a transaction like the Merger and related LBO, Board members should have sought and obtained more information. But it is quite different to conclude, based on allegations even in the Revised Complaint, that Board members believed at the time of the Merger that leaving creditors unpaid was "substantially certain."
This should hardly be viewed as an endorsement of the degree of care of the Board. The case for more questions from Board members, that might have led to more answers, is very strong. But allegations are lacking that Board members actually knew of the things that the Trustee believes they should have known. As negligent as Board members may have been, there are still no allegations supporting a view that they intentionally wished to do creditors harm, or knew that harm to creditors was substantially certain.
If, notwithstanding the preceding analysis, "Badges of Fraud" supported an inference of an actual intent to hinder, delay or defraud, the Court would allow the Revised Complaint to survive at this point. But here the "Badges of Fraud" do not support such a conclusion, and indeed are notably inapplicable in the case. In the typical Badges of Fraud situation, many or most of the Badges can be found, and here nearly none of them can.
In its discussion of the law above, the Court recognized that Motive and Opportunity analysis could sometimes provide a basis for drawing the "strong inference" of actual intent to defraud creditors that intentional fraudulent transfer claims require. But the Court concluded that when the allegations of motive and opportunity were not joined by other allegations supporting a finding of intent to injure creditors, they would at least normally not suffice. In the relatively rare cases in which they might, the inference of intent drawn from that motive and opportunity would have to be quite strong — and that if there were other motivations that would not be wrongful (or if the motivations were shared by many corporate insiders), the inference of wrongful intent drawn from the motive and opportunity allegations would have to outweigh any opposing inferences.
Here they do not. "Motive" must be understood as a motive to hinder, delay or defraud creditors — not a motive for self-enrichment, which the Court has already held to be insufficient for pleading intent to impair creditors' rights to be repaid.
Similarly, opportunity in the fraudulent transfer context cannot simply mean the ability of an officer to effect an alleged transfer, or of a director to vote to authorize it — because officers and directors always have that ability. If opportunity were satisfied so easily, such a test would be rendered meaningless.
One may legitimately query, then, what kinds of standards for "Motive and Opportunity" would satisfactorily separate conduct that is benign from conduct that is wrongful. And the Court finds the existing caselaw to be less than clear in answering that question. But the Court believes that, at the least, Motive and Opportunity analysis can provide the basis for an intent to hinder, delay or defraud only when it reflects something out of the ordinary — i.e., when the motive and opportunity are coupled with something else, and where the Court can find the "strong inference" of the requisite intent. Here there is nothing else, and the Court need not speculate how Motive and Opportunity analysis might be employed in a stronger case.
For reasons set forth above, the Court assumes that recklessness is still a basis for imposing liability for intentional fraudulent transfer — but believes that if recklessness is to be used as a substitute for actual intent to injure creditors, it must be construed in such a fashion that it embodies "a state of mind approximating actual intent, and not merely a heightened form of negligence."
complaint makes allegations, in conclusory terms, like that in which it is alleged that the Board "knew, or intentionally turned a blind eye," to the fact that the projections grossly overstated the earnings that Lyondell could achieve, were not prepared using data derived from actual performance, and in fact had been fabricated;
Finally, it is important to note the caselaw backdrop against which this Court is ruling, and the difficult burden facing the Trustee. On a motion to dismiss, it is not enough to plead facts that are "merely consistent with a defendant's liability."
Here, there are undisputed extrinsic facts that cut against the inference the Trustee asks the Court to draw. One is that Blavatnik was inputting into the transaction substantial capital and assets of his own; apart from evidencing Blavatnik's own commitment to the transaction under consideration, it provides additional assets available to creditors for repayment. Another is that Lyondell's existing creditors at the time were paid back to a very substantial degree — to the extent of $7 billion.
Similarly, the Trustee here asserts that Board members intended to hinder, delay or defraud the future creditors of Lyondell (or the emerging entity) when Board members (i) did not challenge Smith's inflated projections, (ii) accepted Blavatnik's acquisition offer at $48 per share, and (iii) approved the Merger and the terms of the LBO financing. But there are also competing, non-fraudulent, inferences for the actions of the Board that are entirely reasonable (which competing inferences the Court must evaluate under Tellabs)
Constructive fraudulent transfer doctrine (and ordinary breach of fiduciary duty doctrine) can protect against such things. But intentional fraudulent transfer doctrine covers offenses of a wholly different nature.
In sum, the Trustee has failed to satisfactorily plead factual allegations demonstrating a strong inference of an actual intent to hinder, delay or defraud creditors by a critical mass of Lyondell's board of directors. Accordingly, the claims for intentional fraudulent transfer must be dismissed, this time without leave to amend.
The Movants also assert several additional grounds for dismissal of the state law constructive fraudulent transfer in Fund 1 and Reichman — that:
The Court is unpersuaded by any of these contentions.
The Court agrees with the Movants that the Trustee, in his dual capacities on behalf of the Litigation Trust and the Creditor Trust, is pursuing simultaneous causes of action that are "similar in object and purpose." Obviously, the Trustee seeks to recover the consideration received by Lyondell's former shareholders pursuant to the Merger and related LBO on behalf of each trust, albeit under different legal predicates. Obviously as well, there is an overlap in ownership of the fraudulent transfer claims by both Trusts. While that might be troublesome in other contexts (in which two trusts had conflicting claims, or, especially, where defendants were at risk of a double recovery), the issue is academic here, because the competing intentional fraudulent transfer claims have been dismissed.
There is no longer a basis for dismissal of the constructive fraudulent transfer claims on this ground, if there was.
The second basis for dismissal is somewhat puzzling to the Court. The Movants do not dispute that Lyondell's unsecured creditors
No caselaw or other authority was offered in support of this supposed rule, and if ever adopted it would run contrary to the Code — which permits reorganization plans to "include any other appropriate provision not inconsistent with the applicable provisions of this title,"
There can be no plausible argument that Lyondell's unsecured creditors lack unsatisfied claims, and there likewise can be no plausible argument that the Trustee, as
The Movants further argue that the Creditor Trust lacks standing to bring its constructive fraudulent transfer claims on behalf of the creditors that they once belonged to. That is so, the Movants argue, because standing rested exclusively with the Lyondell bankruptcy estate, and cannot revert back to creditors or their assignee unless there is a dismissal of the bankruptcy case. In support of this contention, the Movants rely on three cases from the 1800's,
The 1800s Cases were decided under the Bankruptcy Act of 1867,
Moreover, the 1800s Cases did not hold that creditors could never have reversionary standing absent a dismissal of the bankruptcy case. To the contrary, while the Supreme Court in Glenny held that the right to sue would lie in the "bankrupt's assignee,"
That is exactly what happened here. The Lyondell debtors elected not to pursue causes of action under section 554 of the Code, and expressly abandoned such right (exclusive or not) in the Plan.
The Plan's mechanism is entirely consistent with the modern Code, which, to state the obvious, supersedes the 1867 Act as the statute that now governs this case. Section 1123(b)(6) provides that a plan "may include any other appropriate provision not inconsistent with the applicable provisions of this title," and this broad language gives flexibility to a debtor and its creditors to include a host of plan provisions to fit the needs of a case. In practice, trusts are often created under chapter 11 plans as a useful tool for giving more time to creditors to pursue recovery from third parties in protracted litigation while allowing for a reorganization and/or interim distributions to creditors before the litigation concludes.
What was done here is also consistent with existing bankruptcy jurisprudence. The estate representative's authority to bring suits for the benefit of creditors is premised on the underlying objective of equality of distribution, and not to flout it.
Finally, the Movants effectively repeat contentions the Court has already rejected. In the First 12(b)(6) Decision, the Court ruled that section 546(e) of the Code did not apply to the claims of the Trustee of the Creditor Trust, on behalf of individual creditors:
Nevertheless, the Movants argue that the constructive fraudulent transfer claims are "barred by the express provisions of § 546(e)" because the Creditor Trust is a "de facto" estate representative since the Creditor Trust was created by a bankruptcy, funded by a bankruptcy, and acts only for bankruptcy creditors.
First (though this is dispositive), while the Court respects the rights of litigants appearing before it to appeal decisions they regard as misguided, the Court has already ruled on this issue. The Court ruled in the First 12(b)(6) Decision that section 546(e) did not apply in this case, for reasons the Court discussed at length. Adding rhetoric that the Creditor Trust was created by assigns from creditors at the end of a bankruptcy case — aside from telling the Court nothing it did not already know — is hardly a basis for reargument.
Additionally, the Movants' contention that a Creditor Trust is a de facto estate representative because the shareholder suits are, "in short, a creature of Chapter 11" is unpersuasive. Of course the suits and the Creditor Trust are products of Chapter 11. But that does not change the fact that the Creditor Trust is an assignee of the Lyondell Debtors' creditors, and are pursuing these suits on behalf of the creditors. The Movants' argument ignores the carefully considered and crafted terms of the Plan establishing a Litigation Trust (which serves as the estate representative) that is separate and distinct from the Creditor Trust, which is the assignee of creditors' rights.
For the reasons set forth above, the Movants' motions:
(emphasis added). Thus in this context, the Trustee must put forward allegations establishing the requisite intent to achieve the consequences — impeding creditor recoveries — and not just to engage in an aggressive transaction that puts creditor recoveries at risk. But as the second clause of § 8A provides, intent to achieve the consequences also may be found if those consequences are "substantially certain" to result from the challenged actions.
See Collier ¶ 548.04.
In re Bear Stearns Cos., Sec., Derivative, & ERISA Litig., 763 F.Supp.2d 423, 499 (S.D.N.Y.2011) (Sweet, J.). Cf. Shemian v. Research In Motion Ltd., 570 Fed.Appx. 32, 35 (2d Cir.2014) (summary order) ("Shemian") (to make out the "strong inference of scienter" required under the PSLRA, the inference of scienter had to be "cogent and at least as compelling as any opposing inference of nonfraudulent intent.").
398 B.R. at 774 n. 7. For its "same standard" conclusion, the Musicland court cited Serova v. Teplen, 2006 U.S. Dist. LEXIS 5781 at *26, 2006 WL 349624, at *8 (S.D.N.Y.Feb. 16, 2006) (Baer, J.) (concluding that the Second Circuit applies PSLRA standards for pleading securities fraud to claims for common law fraud).
Likewise, the Madoff court observed that:
445 B.R. at 222 n. 14.
From these origins, the language first appearing in Shields, quoted supra n. 82, now appears as part of the analysis in the reported fraudulent transfer decisions in G-I Holding (in 2002), Musicland (in 2008), Adelphia-Bank of America (in 2009), Madoff, (in 2011), and the First 12(b)(6) Decision (in 2014).