ROBERT E. GERBER, Bankruptcy Judge.
In this adversary proceeding under the umbrella of the jointly administered chapter 15 cases of foreign debtors ICP Strategic Credit Income Fund Ltd. (the "
For the reasons discussed below, the Court concludes that the Liquidators have (though just barely) alleged claims for primary violations (as that expression is used in aiding and abetting jurisprudence) of breach of fiduciary duties owed to the Funds. But the Liquidators have not done so for fraud or fraudulent trading. The Court further concludes that (assuming that the Liquidators could show substantial assistance by the delivery of routine legal services if DLA Piper provided them knowing that it was doing something wrong) the Liquidators have failed to plausibly allege the "knowledge" prong of the claim for aiding and abetting breaches of fiduciary duty — that DLA Piper knew that it was assisting in a violation of duty. And most obviously, the Liquidators are barred from recovery by the in pari delicto defense under New York's "Wagoner Rule."
Accordingly, each of the claims must be, and is, dismissed.
Under familiar principles, for the purposes of determining this motion to dismiss (and for that purpose only), the Court takes the allegations of the Complaint as true.
The Liquidators allege that DLA Piper aided and abetted fraud and breaches of fiduciary duty committed by the Funds' investment manager
As alleged in the Complaint, Triaxx Funding was a collateralized debt obligation
About half of the Funds' net asset value was invested in Triaxx Funding.
When the value of its residential mortgage-backed securities declined, Triaxx Funding became subject to margin calls from Barclays. But Triaxx Funding did not have sufficient funds to meet the margin calls. This, the Complaint alleges, led the Manager and Priore to seek alternative ways for Triaxx Funding to meet the margin payments — in connection with which the Manager and Priore allegedly "looked to [DLA Piper] for a solution."
The Funds were incorporated in 2005 as exempted limited liability companies under the Cayman Islands Companies Law. The Feeder Fund invested approximately $174 million in the Master Fund, which the Master Fund then invested along with the contributions of its two other shareholders.
About five years after their incorporation, the Funds were put into liquidation proceedings in the Cayman Islands. Shareholders of the Feeder Fund filed a winding-up petition in May 2010. The Cayman Islands Grand Court appointed Hugh Dickson and Stephen Akers as the Joint Official Liquidators of the Feeder Fund, and removed the prior management — the Manager and Priore. A few months later, the Master Fund's shareholders placed the Master Fund too in liquidation. Dickson and Akers again were appointed as Joint Official Liquidators. Later, Saville took Akers' place.
About three years after the Funds entered liquidation in the Caymans, the Liquidators came to this Court seeking recognition of the Funds' Cayman liquidation proceedings as foreign main proceedings under Chapter 15 of the Bankruptcy Code. The Court granted recognition in August 2013.
A few months later, the Funds and the Liquidators commenced this action in New York State Supreme Court. In January 2014, DLA Piper removed the action to the United States District Court for the Southern District of New York.
DLA Piper is a law firm with one of its several offices in New York City. DLA Piper attorney Lucien White ("
Though not named as defendants in this adversary proceeding, the Manager, Priore, Barclays and the Trustee also had roles in connection with the allegations in the Complaint.
The Manager, a Delaware corporation, was based in New York. It was founded by Priore, who was also the Manager's president and chief investment officer. The Manager served as an investment manager and "collateral manager" to both Triaxx Funding and the Funds. Pursuant to an October 2006 Investment Management Agreement with the Master Fund, the Complaint alleges, "[the Manager] owed [the Master Fund] the fiduciary duty to invest [the Master Fund's] assets in good faith and give [the Master Fund] `the benefit of its best judgment and efforts in rendering services'. . . ."
Priore was a director of each of the Funds, owing each fiduciary duties. The Funds also had two independent directors in the Cayman Islands, but these directors, the Complaint alleges, were "unaware of Priore's and the Manager's wrongful acts" due to the Manager's and Priore's concealment of them. If the independent directors had known of the wrongful activity, the Complaint alleges, "they could and would have taken action to stop the fraud on the . . . Funds."
As noted above, Barclays funded Triaxx Funding's purchase of its residential mortgage-backed securities. As discussed below, Barclays accepted payment from the Master Fund (in lieu of Triaxx Funding) on the margin call obligations.
A trustee acting in connection with the transactions that are the subject of the Complaint at issue (the "
At the heart of the Complaint are ten transfers, totaling $36.5 million (the "
Two such documents, referred to in the Complaint (and here) as the "
But the Waiver Letter solved only part of Triaxx Funding's problem; the Trustee also had to accept the payment to Barclays as satisfying Triaxx Funding's payment obligation, thus avoiding the declaration of an event of default. To this end, the Direction Letter was sent by the Manager to the Trustee; it directed the Trustee to consider Triaxx Funding's margin obligation paid as a result of the Master Fund's transfer of funds to Barclays. Upon execution of these letters, Barclays and the Trustee agreed to take part in the Transfers.
With the groundwork for the Transfers in place, the Master Fund transferred $36.5 million to Triaxx Funding, over a period of approximately 11 months, at a time when the Funds had "tens of millions of dollars" in unpaid redemption requests from investors.
In early 2010, some months after the transfers comprising the Transfers, Triaxx Funding defaulted and Barclays foreclosed on its collateral anyway. But the Complaint asserts that had Triaxx Funding defaulted earlier, before the ten Transfers, the Master Fund would not have suffered losses as severely as it did in 2010. Thus, the Complaint alleges, the Transfers exacerbated the loss suffered by the Funds.
The Complaint also alleges that although the Transfers were characterized at the time as having been incident to a loan, such characterizations were false. The Complaint alleges that "as White knew, there was no agreement from Barclays or Triaxx Funding to repay [the Funds] and the only means [the Funds] had to seek repayment was litigation."
DLA Piper's allegedly false description of the Transfers as incident to a loan is alleged to be an important element of DLA Piper's aiding and abetting of Priore's and the Manager's fraud and breaches of fiduciary duty. As set out in the Discussion below, key to these allegations are DLA Piper's knowledge of Priore's and the Manager's alleged wrongdoing, and DLA Piper's knowing and substantial assistance to them. The Complaint's allegations in these respects are discussed in turn below.
As alleged in the Complaint, White knew that the Manager and Priore caused the transfer of the $36.5 million from the Master Fund to Barclays without the Master Fund having an obligation to pay Barclays, and with neither Barclays nor Triaxx Funding
As also alleged in the Complaint, DLA Piper knew not only that Barclays was not obligated to repay the Master Fund, but also that Barclays recognized the impropriety of the Transfers, as evidenced by a Barclays requirement that the Waiver Letter include "claw-back" language, to protect Barclays from claims that it had received a fraudulent conveyance. This language provided, in substance, that Barclays would waive Triaxx Funding's margin payment for only so long as neither the Master Fund nor any other person or entity made a "claw-back" claim against Barclays. Thus, allegedly, DLA Piper knew that the Master Fund could only seek repayment through litigation, and even then would have to battle the express waiver obtained by Barclays.
Further, the Complaint alleges, White knew that even if Triaxx Funding were obligated through litigation or directed by the Manager to repay the Master Fund, Triaxx Funding did not have the liquidity to do so, and White had no reason to believe that Triaxx Funding would ever have such liquidity, whether by way of a margin excess payment from Barclays or otherwise.
The Complaint also alleges, as relevant to DLA Piper's knowledge, that the Master Fund received no interest or fees for the use of its funds to cover Triaxx Funding's margin obligations;
The Complaint also alleges DLA Piper knew that the Transfers "made no commercial sense,"
Finally, in further support of its contentions that DLA Piper had the requisite knowledge, the Complaint makes a number of additional, though conclusory and argumentative, allegations:
The Complaint does not allege that White acted in a role other than as an attorney, but alleges a number of acts that White performed as an attorney that allegedly provided substantial assistance to fraud and breaches of fiduciary duty. In that connection, the Complaint alleges that:
These representations, the Complaint alleges, were made in the process of allegedly "silenc[ing] a potential whistle-blower" — Peter Woroniecki ("
The Complaint also alleges that White made misrepresentations to the SEC during the SEC's investigation of the Manager and Priore, thus assisting the Manager and Priore in concealing their fraudulent scheme. To this end, the Complaint alleges, White told the SEC, among other things, that there was a repayment mechanism embedded in the transactions that included the Transfers, and that he had not "review[ed] any documents relating to [the Master Funds'] authority or ability to. . . . make the loan. . . ."
Finally, the Complaint alleges substantial assistance by reason of DLA Piper's paying itself using the funds DLA Piper allegedly helped misappropriate.
Based on those underlying facts, the Complaint asserts claims in its Count 1 for aiding and abetting breaches of fiduciary duty. It starts with allegations directed at establishing the requisite primary violations, alleging that the Manager and Priore breached their fiduciary duties to the Funds by causing the Master Fund to transfer the $36.5 million to Barclays to cover Triaxx Funding's obligations. In connection with their alleged primary breaches of fiduciary duty, the Complaint also alleges that the Manager and Priore:
Then, the Complaint continues with allegations directed at establishing secondary liability. It alleges that:
Finally, the Complaint alleges, having this "actual knowledge" of the Manager's and Priore's breaches of fiduciary duties, DLA Piper "substantially assisted" the Manager and Priore by effectuating the Transfers as discussed above. In connection with effectuating the Transfers, DLA Piper allegedly created false "loan" documents, "silenced" a whistleblower, and made misrepresentations to the Funds' Administrator.
The Complaint's Count 2 follows in similar fashion, but charging aiding and abetting fraud, as contrasted to breach of fiduciary duty. The Complaint once again starts with allegations directed at establishing the requisite primary violations, alleging that the Manager and Priore defrauded the Funds, on substantially the same grounds that Count 1 alleges that the Manager and Priore breached fiduciary duties owed to the Funds. Only a few words change between Count 1 and Count 2 with respect to this; instead of saying that the Manager and Priore "caused" the Master Fund to transfer $36.5 million to Barclays, Count 2 alleges that the Manager and Priore "misappropriated" $36.5 million from the Funds. And instead of asserting that the funds were used to cover Triaxx Funding's "obligations," Count 2 alleges that the funds were used to pay not only Triaxx Funding's obligations to Barclays, but also interest on Triaxx Funding's notes and other expenses.
Then, once again, the Complaint continues with allegations directed at establishing secondary liability for aiding and abetting fraud. In Count 2, it alleges DLA Piper knew of the Manager's and Priore's alleged fraudulent scheme in ways nearly identically to the way it alleges DLA Piper knew of the Manager's and Priore's breaches of fiduciary duty is alleged in Count 1. It also alleges DLA Piper's "substantial assistance" to the Manager and Priore in ways nearly identical to those by which it alleges them in Count 1.
The Complaint's Count 3 asserts a cause of action under Cayman Companies Law § 147.
Rule 8 applies to complaints generally. Fed. R. Civ. P. 8(a)(2) requires a short and plain statement of the claim showing that the pleader is entitled to relief, in order to give the defendant fair notice of what the claim is and the grounds upon which it rests.
Thus, to survive a motion to dismiss, a complaint must contain "allegations plausibly suggesting (not merely consistent with)" an "entitlement to relief."
"Once a claim has been stated adequately, it may be supported by showing any set of facts consistent with the allegations in the complaint."
Heightened pleading requirements, set forth in Fed. R. Civ. P. 9(b), apply to "any claim that `sounds in fraud,' regardless of whether fraud is an element of claim."
The more stringent standards of Fed. R. Civ. P. 9(b) require a party alleging fraud or mistake to plead "with particularity the circumstances constituting fraud or mistake."
The requisite "strong inference" of fraud may be established either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness.
Choice of law issues arise in four contexts in these cases — with respect to (1) claims for primary violations of breach of fiduciary duty; (2) claims of primary violations of fraud; (3) secondary violations of aiding and abetting breaches of fiduciary duty and fraud; and (4) application of in pari delicto. The Court considers them in turn.
For determinations of primary violations of fiduciary duty, the Court would normally apply the "internal affairs" doctrine. This is a conflict of laws principle recognizing that the law of the state (or other jurisdiction) of incorporation should have the authority to regulate a corporation's internal affairs — i.e., matters peculiar to the relations between the corporation and, as relevant here, its officers and directors.
The Court agrees with the Liquidators' observation that the "internal-affairs doctrine would have this Court look to the law of the state of incorporation, here the Cayman Islands, to analyze the breach of fiduciary duty. . . ."
The law applicable to claims of fraud, by contrast, is determined by reference to choice of law rules governing torts.
Here the parties agree that New York law should apply (or at least they rely on New York law), and the Court sees the interests of New York as predominant with respect to the claims of fraud. To the extent it matters, the Court applies New York law.
Claims of aiding and abetting breaches of fiduciary duty rest in part on underlying primary violations of duty that are subject to the internal affairs doctrine. For that reason, there has been a conflict in the cases as to whether claims for aiding and abetting breaches of fiduciary duty should be decided under the law of the jurisdiction of organization or more traditional tort principles — under which the Court would look to the jurisdiction with the greatest interests in the controversy.
But after analyzing the split of authority on the matter in Adelphia, this Court held (for reasons stated at greater length in that opinion) that the conflicts principles applicable to torts should apply.
Perhaps for those reasons, the parties do not dispute that the claims of aiding and abetting fraud here should be decided under New York law.
The two sides do, however, dispute the jurisdiction whose law should apply to the consideration of DLA Piper's in pari delicto defense. DLA Piper contends that New York law should guide the Court's consideration of in pari delicto and imputation. The Liquidators contend that based on the internal affairs doctrine, Cayman, not New York, law should apply.
But as to each of these issues, the Court agrees with DLA Piper. The Liquidators fail to cite any case in which a court applied the law of the jurisdiction of organization, rather than that with the greatest interests, in making an in pari delicto determination. And this Court has previously done exactly the opposite. In Adelphia, the Court likewise faced issues as to the application of in pari delicto. Choice of law there was important, because under the law of Pennsylvania (the place where the injuries were suffered; where most of the wrongful conduct took place; and which thus had the greatest stake in the controversy), in pari delicto would not be a conclusive bar to recovery. But under Delaware and other states' law, in pari delicto would probably be a defense. This Court utilized interests analysis and then applied Pennsylvania law, not Delaware law, in analyzing the in pari delicto defenses on motions to dismiss.
Similarly, in MagCorp, each of the two injured debtors was a Delaware corporation, but (while the Court applied Delaware law to the claims against insiders based on their alleged breaches of fiduciary duty), in analyzing the claims against the company's counsel, accountants and investment banker, the Court applied the Wagoner Rule — the in pari delicto law of the State of New York.
Finally, but very importantly, "in New York, in pari delicto is an affirmative defense. . . ."
Nor, once it applies interests analysis, can the Court agree that Cayman has a greater interest in the controversy. The Cayman court itself recognized that Counts 1 and 2 of the Complaint "assert[ed] causes of action belonging to the Funds which arose under United States law. . . ."
Thus, once the Court applies interest analysis doctrine, New York has the greater interest in this controversy, and New York Law should apply.
The Complaint's Count 1 charges DLA Piper with aiding and abetting breaches of fiduciary duty by Priore and the Manager. The Court finds that Count 1 — just barely — satisfactorily alleges a primary breach of fiduciary duty. But the remainder of Count 1 (which must plead the requisite knowledge and substantial assistance) fails to pass muster under Fed. R. Civ. Proc. Rule 8 or, especially, Rule 9.
With respect to the requisite primary violation, the Court said the Complaint "just barely" suffices because of the obvious potential defenses that appears in material part from the face of the Complaint. As the Liquidators recognize in their Complaint, "approximately 50% of the . . . Funds' net asset value was invested in Triaxx Funding."
With the benefit of its judicial experience,
The Business Judgment Rule, as it exists under New York law, "bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes."
Likewise, with the benefit of its judicial experience, the Court sees a future causation issue — whether the Funds suffered the losses they did because Triaxx Funding's duty to pay the Funds back was inadequately documented (and that Triaxx Funding, managed by the same Manager, might later contend that it really didn't have a duty to pay the money back), on the one hand, or because Triaxx Funding later lacked the resources to do so, on the other.
For these reasons, the Court has great uncertainty, based on its judicial experience, as to whether the Liquidators could overcome the Business Judgment Rule defense articulated by the New York Court of Appeals in Auerbach,
But even assuming the possibility of a primary violation, and thus a breach, by Priore or the Manager, of fiduciary duty, the Court finds the Liquidators pleading of the requisite knowledge of wrongful conduct on the part of White — and hence DLA Piper — to be inadequate.
Though their Complaint is replete with rhetoric and conclusory allegations (neither of which, under familiar principles, can be credited when determining the adequacy of a complaint), the Liquidators essentially make two points. They contend (1) that the Master Fund's transfers to Barclays on account of Triaxx Funding's margin obligation were done for "no good commercial reason," and (2) that the transfers did not result in loans. Assuming for now, as the Court has just noted it will do, that these allegations might support claims of breach of fiduciary on the part of Priore or the Manager, the allegations that surround them fail adequately to plead that White knew they were doing anything wrong.
With respect to the first, the Liquidators' allegations that White knew that the Transfers "made no commercial sense" and lacked "a good commercial reason"
With respect to the second, there are no allegations supporting the conclusion that White believed that there was no duty on the part of Triaxx Funding to pay the advances back. A belief of that nature would be wholly contrary to what one would expect based on judicial experience and common sense. The Court accepts as satisfactorily pleaded the Liquidators' allegations that limitations in the documents made common ways of documenting a loan impractical or impossible, but it is way too much of a jump to draw from that the conclusion that White never believed there was a loan, or, especially, that he knew of a theft.
Of course, attorneys providing legal services are not immune from claims that they have aided and abetted breaches of fiduciary duty. But to make assert viable claims for such, the plaintiff must show that the attorney knew more than the facts generally surrounding the transaction,
The issues as to the allegations of substantial assistance are close. There are no allegations that White — and hence DLA Piper — had any role in the Transfers other than as counsel performing ordinary legal services. There are no allegations that White proposed using the Funds' money for the margin calls (and indeed the Complaint affirmatively alleges that the Manager and Priore made that decision alone
Thus it is highly debatable whether the legal services that were provided here can be regarded as rising to the level of substantial assistance. Once again, while lawyers are not immune from liability for aiding and abetting wrongful conduct, courts must be wary of regarding the attorney's legal advice, or the attorney's interfacing with others, as substantial assistance in the absence of allegations establishing something more
But ultimately, the Court does not need to decide whether providing these routine legal services rose to the level of providing "substantial assistance" because the requisite knowledge of breach of duty was inadequately pleaded in any event.
The Complaint's Count 2 charges DLA Piper with aiding fraud by Priore and the Manager. Though the Court has found that the Liquidators have alleged, albeit barely, a primary violation of breach of fiduciary duty, they have not done likewise with a claim of fraud, especially with the particularity that Rule 9(b) requires.
Turning first to the primary allegation of fraud, the Court sees a failure to make several of the allegations necessary for a traditional showing of fraud
The Complaint alleges that the Manager and Priore "fraudulently caused" and misrepresented the nature of the payments from the Master Fund to Triaxx Funding. It does so not by particularized facts establishing the existence of an underlying fraud, but by broad and conclusory references to a "fraud," "scheme," "fraudulent scheme," "plan," or a "misappropriation" of funds.
The Complaint does not allege a duty on the part of Priore to make disclosure to the other directors. Nor does it allege a duty on the part of the Manager to bring the Transfers before the Board. The Complaint is especially lacking with respect to the Manager's and Priore's alleged fraudulent intent. No fact or set of facts cited in Count 2 of the Complaint gives rise to an inference, much less a strong inference, fraudulent intent on the part of Priore or the Manager. Nor do the previous 128 paragraphs that are incorporated into Count 2 sufficiently address the intent of the alleged underlying wrongdoers.
The Complaint does, to be sure, assert that:
But apart from their conclusory nature, these allegations do not make out a showing of fraud. They do not even say who was defrauded, and what was concealed.
The expenditure of the $36.5 million may have been ill-advised, and Priore and the Manager could have been conflicted if the alleged motivations for the Transfers — incremental fees and reputation — trumped the motivation to protect the underlying investment. But there are no allegations — especially those with specificity — supporting a claim of related fraud.
The Court further finds the allegations in the Complaint supporting secondary liability on DLA Piper's part for fraud to be equally, if not more, deficient. Once again, the Complaint fails to forth facts underlying the allegation that White knew of a fraud or his participation in one, or supporting the idea that he knew how his assistance was supporting the perpetration of a fraud — a matter that is particularly challenging based on the delivery of legal services.
Though not identical to the claims of aiding and abetting fraud, section 147 of the Cayman Islands Companies Law has overlapping requirements. Like the requirement for establishing a primary violation incident to pleading a claim of aiding and abetting, Section 147 requires a showing that the Funds were "carried on with intent to defraud. . . . or for any fraudulent purpose." The Court has already discussed the failure to satisfactorily allege fraud. And there are no allegations, particularly any meeting Rule 9(b) requirements, establishing the requisite intent to operate the Funds with a "fraudulent purpose."
Thus the Liquidators' Cayman Fraudulent Trading Claim must fail as well.
In its most important — and in some ways, strongest — point, DLA Piper further argues that even if the Liquidators otherwise had satisfactorily pleaded claims for aiding and abetting breach of fiduciary duty or fraud, those claims would have to fail under the doctrine of in pari delicto and the New York version of that doctrine, the Wagoner Rule. The Court agrees.
The in pari delicto doctrine prevents a party from suing others for a wrong in which the party participated or is deemed through imputation to have participated. The doctrine "has been wrought in the inmost texture of [New York] law for at least two centuries."
Here, unless an applicable exception applies, the alleged misconduct is imputed to the Funds, and then imputed to the Foreign Liquidators.
The Liquidators do not dispute that in pari delicto and imputation initially apply. Instead, they urge the Court to rely on the "adverse interest exception" to the in pari delicto defense. The Court turns to that exception now.
Preliminarily, however, the Court notes that the New York Court of Appeals is generally loath to apply exceptions to in pari delicto,
To come within the exception, the agent must have totally abandoned his principal's interests and be acting entirely for his own or another's purposes. The exception cannot be invoked merely because the agent has a conflict of interest or is not acting primarily for his or her principal. As the Kirschner court stated:
Here, taking the Liquidators' allegations as true, there was a benefit to both the insider (Priore) and the corporation (the Funds). The Liquidators argue that Priore and/or the Manager benefited from their conduct because that would protect management fees and their reputations. But here the Funds benefited in a much more major way, and for the most part much more than minimally. While the Court is inclined to agree that interest on the Funds' advance to Triaxx Funding was only a modest benefit, the Funds received a very significant benefit for the very reason the Transfers were made: the Transfers served to prevent Barclays from foreclosing on collateral in which the Funds were heavily invested. The Court is unpersuaded by the Liquidators' contention that avoiding a foreclosure on a default that would have destroyed "approximately 50% of the [] Fund's net asset value"
Since the Funds benefited from the Transfers, the adverse interest exception does not apply.
For that reason, in analyzing Wagoner Rule issues, the Court does not need to consider DLA Piper's reliance on an exception to the exception.
As noted, the adverse interest exception is not applicable here, for reasons the Court just addressed. But because the Manager and Priore were the sole decision-making agents of the Funds, and thus were one and the same with the Funds, their bad acts would be imputable to the funds even if the Adverse Interest Exception were to apply.
The Liquidators argue that the Sole Actor Rule here does not apply because the Funds had innocent investors who assertedly could have stopped the alleged fraud.
Thus the Court concludes that apart from the Liquidators' failure to satisfactorily plead claims for aiding and abetting, DLA Piper must be dismissed, at the pleading stage, under its in pari delicto defense.
Accordingly, DLA Piper's motion to dismiss must be, and is, granted as to all three Counts.
SO ORDERED.
One other concern underlies the Court's decision to find the Liquidators' allegations of a primary violation plausible, albeit barely so. The Liquidators have made arguably separate and stronger contentions, at least impliedly, that even if the Transfers were loans or effectively loans and created indebtedness running from Triaxx Funding to the Master Fund or both of the Funds, repayment of the indebtedness might be made more difficult by competing priority of payments demands on Triaxx Funding, see Cmplt. ¶85, or by limitations in Triaxx Funding's Indenture or other organizational documents such that "Triaxx Funding could not accept a loan from [the Manager] or a [Manager] affiliate," id. at ¶ 44, or "painful mechanics." Id. at ¶ 45. How important such concerns would be is difficult to determine under Rule 12(b)(6).
