CHRISTOPHER S. SONTCHI, Bankruptcy Judge.
This adversary proceeding arises in the third Chapter 11 bankruptcy of a chain of stores providing automotive parts and services doing business as "Strauss Discount Auto." In 2007, through the plan of reorganization in the second Chapter 11 case, a Japanese company known as "AB7" — through two of its newly-formed subsidiaries — purchased the Strauss business for approximately $45 million. AB7 funded its subsidiaries' purchase of the assets. In its simplest terms, this dispute is over whether, (i) as plaintiffs argue, AB7's funding of ABST (both purchase and after) was or should have been solely a capital contribution/equity infusion by AB7 to its subsidiaries; or, (ii) as AB7 argues, its funding was allowed to be and, in fact, was a combination of debt and capital contribution/equity to its subsidiaries.
The plaintiffs in this case are (i) the reorganized debtor in the third Chapter 11 case known as "ABST"; and (ii) certain creditors in the second Chapter 11 case known as the R & S Plaintiffs. Under the plan of reorganization in the second Chapter 11 case, the R & S Plaintiffs were to receive approximately $45 million from the purchaser. At the time of the filing of the third Chapter 11 case, however, they were still owed approximately $8 million. Under ABST's confirmed plan in this — the third — Chapter 11 case, unsecured creditors, including the R & S Plaintiffs, will share pro rata in the proceeds, if any, of this litigation.
The facts surrounding AB7's purchase of the assets and the provisions of the plan of reorganization in the second Chapter 11 case have given rise to a number of claims asserted by the plaintiffs against AB7 and certain AB7-related officers and directors of the debtor known as the "Individual Defendants." In summary, these claims are:
Count Claim Asserted By Against Alter Ego/Piercing the Veil: 1 Plaintiffs allege that ABST is an alter ego of AB7. ABST & R & S AB7 Plaintiffs Breach of Fiduciary Duties: 2 ABST alleges that the Individual Defendants owed and ABST Individual breached fiduciary duties of loyalty and care to ABST and Defendants its creditors. Avoidance of Fraudulent Transfers: 3 ABST alleges that AB7, through overlapping ABST directors ABST AB7 and AB7's controlling power as an insider, caused ABST to incur loan obligations with the intent to defraud or hinder ABST's creditors. Avoidance of Constructively Fraudulent Transfers: 4 ABST alleges that the loan transactions were "constructively ABST AB7 fraudulent" it was insolvent from its inception and it did not receive reasonably equivalent value for incurring debt owed to AB7.
Avoidance of Preferential Transfers: 5 ABST alleges AB7 received preferential payments. ABST AB7 Recovery of Avoidable Transfers: 6 ABST alleges that it should recover the transfers set ABST AB7 forth in counts 3-5. Declaratory Judgment: 7 ABST alleges it should obtain declaratory judgment invalidating ABST AB7 the loan obligations it incurred in favor of AB7. Recharacterization of Debt to Equity: 8 ABST alleges that the loan obligations it incurred in favor ABST AB7 of AB7 should be recharacterized as equity. Equitable Subordination: 9 ABST alleges that the loan obligations it incurred in favor ABST AB7 of AB7 should be equitably subordinated to the unsecured claims against ABST. Breach of Plan of Reorganization: 10 Plaintiffs allege that the order confirming the plan in the ABST & R & S AB7 second Chapter 11 case required AB7 to fund ABST with Plaintiffs equity, not debt. Plaintiffs further allege that AB7 funded ABST in relevant part with debt, which was a breach of the plan reorganization. Breach of Asset Purchase Agreement: 11 Plaintiffs allege that the asset purchase agreement in the ABST & R & S AB7 second Chapter 11 case (which was executed in connection Plaintiffs with the plan of reorganization) required AB7 to fund ABST with equity, not debt. Plaintiffs further allege that AB7 funded ABST in relevant part with debt, which was a breach of the asset purchase agreement. 122 Tortious Interference with ContractR & S PlaintiffsAllDefendantsFraudulent Inducement: 13 R & S Plaintiffs allege that the Defendants fraudulently R & S Plaintiffs All induced: (i) the R & S Plaintiffs to vote in favor of the Defendants plan in the second Chapter 11 case; and (ii) the bankruptcy court to approve confirmation of that plan. Objection to Proof of AB7's Claim: 14 ABST objects to AB7's claim because ABST's loan obligations ABST AB7 to AB7 that form the basis of the claim should be recharacterized as equity. Disallowance of AB7 Proof of Claim: 15 ABST objects to AB7's claim because ABST's loan obligations ABST AB7 to AB7 that form the basis of the claim were the result of fraudulent and/or preferential transfers.
The defendants have sought to dismiss all of the counts under Federal Bankruptcy Rule 7012(b)(6). Counts 1-3, 5-11 and 14-15 allege facts sufficient to show a plausible claim for relief and, thus, the motion to dismiss those counts will be denied. Counts 4 fails to sufficiently plead a plausible claim and the motion to dismiss will be granted for Count 4. Finally, Count Thirteen, only alleges facts sufficient to show a plausible claim for a part of the relief requested. Thus, the defendants' motion
The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 157 and 1334. Venue is proper in this District pursuant to 28 U.S.C. §§ 1408 and 1409. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2). Except as set forth below, this Court has the judicial power to enter a final order.
Before the Court are two related motions to dismiss
On February 4, 2009, ABST filed a voluntary Chapter 11 petition. No trustee was appointed and ABST continued to operate its business as a debtor-in-possession, pursuant to 11 U.S.C. §§ 1107 and 1108. AB7 filed a proof of claim in the amount of $43,994,044.12 against ABST on May 1, 2009. Plaintiffs commenced this adversary proceeding by filing the Complaint on December 11, 2009. Then, on April 23, 2010, AB7 moved to dismiss the adversary proceeding. One week later, Yukuo Takenaka moved separately to dismiss Counts Two, Twelve, and Thirteen, joining AB7 with respect to the remaining counts.
Meanwhile, the parties were negotiating the terms of the plan of reorganization. This culminated on September 15, 2010, with this Court entering its Findings of Fact and Conclusions of Law and Order Confirming the Fourth Amended Joint Plan of Reorganization Proposed by Autobacs Strauss Inc. and the Official Committee of Unsecured Creditors ("Fourth Amended Joint Plan"). On October 6, 2010, the Fourth Amended Joint Plan of Reorganization became effective. Under the confirmed plan, ABST reorganized its business and continues to operate. Unsecured creditors and the R & S Plaintiffs were classified as classes 3a and 3b respectively. The claimants in both classes will share pro rata in the net proceeds, if any, from this litigation.
From 2000 until May 2, 2007, the "R & S Plaintiffs"
On August 10, 2006, the R & S Plaintiffs filed their own voluntary Chapter 11 petition in the New Jersey Bankruptcy Court.
AB7 is a Japanese corporation with its principal place of business in Japan. It is a multi-billion dollar "total car-life service" company. AB7 buys and sells cars, sells and installs after-market car parts and accessories, and performs various other automotive services.
Autobacs U.S.A. ("ABUSA") is a wholly-owned subsidiary of AB7, which was formed to facilitate the purchase of the Strauss business in the second Chapter 11 case. ABST, in turn, is a wholly-owned subsidiary of ABUSA. Contemporaneously with the filing of ABST's Chapter 11 case in Delaware, ABUSA filed its own Chapter 11 case in the United States Bankruptcy Court for the Central District of California. In that bankruptcy, GRL Capital Advisors LLC purchased 100% of ABST's common stock on June 2, 2009. Glenn Langberg (described further below) is the sole member of GRL Capital Advisors LLC and the chief executive officer ("CEO") of ABST.
ABUSA is not a defendant in this case.
ABST is a Delaware corporation with its principal place of business in South River, New Jersey. It filed a voluntary Chapter 11 petition in Delaware on February 4, 2009. ABST continued as the debtor in possession under 11 U.S.C. §§ 1107 and 1108 in this bankruptcy case. It does business as Strauss Discount Auto and provides after-market automotive parts, accessories, and services in New Jersey, New York, and Pennsylvania. As of the effective date of confirmation of ABST's plan, it was operating approximately 63 stores.
The Fourth Amended Joint Plan was confirmed in this case on September 15, 2010, and became effective on October 6, 2010. ABST continues to do business as a reorganized debtor.
Under the terms of the Fourth Amended Joint Plan, GRL Capital Advisors, LLC's equity in ABST was cancelled. Eighty percent of the new equity in the reorganized company was placed in trust to be distributed pro rata to the debtor's unsecured creditors.
Takenaka Partners LLC ("Takenaka Partners") is a California limited liability company. It provides investment banking and consulting services. In April 2006, AB7 retained Takenaka Partners as it general advisor, financial advisor, and representative.
Kenichi Takeda ("Takeda") is a Japanese citizen. From March 9, 2007 to June 25, 2009, Takeda served as a director of ABST. Takeda is the former chairman of the board of directors at ABST (collectively, the "Board of Directors" and, individually, "ABST Director"). Additionally, he was a director at AB7 from June 28, 2006 to April 30, 2007. He was also the co-chief operation officer ("COO") for AB7. Finally, from April 30, 2007 to June 2009, he was a senior executive merchandising strategy officer at AB7.
Akihiro Yamada ("Yamada") is a Japanese citizen. He was the president of ABST from March 9, 2007 to February 3, 2009. He was also the CEO of ABST and a member of its Board of Directors from March 9, 2007 to June 25, 2009. Yamada is an AB7 employee and a former ABUSA director, and was employed by AB7 while holding his ABST positions.
Hiroyoshi Kojima ("Kojima") is a Japanese citizen. He was the chief financial officer ("CFO") of ABST and a member of its Board of Directors from March 9, 2007 to June 25, 2009. Kojima is an AB7 employee, and was employed by AB7 while holding his ABST positions.
Yukuo Takenaka ("Takenaka") is a citizen of the United States. Takenaka is president and CEO of Takenaka Partners, which, at the time, was serving as a general advisor, financial advisor and representatives of AB7. Takenaka was a member of ABST's Board of Directors from March 9, 2007 to March 4, 2009. During that same period, Takenaka was ABUSA and a European subsidiary of AB7, Autobacs France.
Takenaka represented AB7 during the confirmation process of the R & S Plaintiffs' bankruptcy case.
Takeda, Yamada, Kojima, and Takenaka are collectively referred to as the "Individual Defendants."
According to AB7, Glenn Langberg ("Langberg") previously owned a majority of the equity interests and was CEO of the R & S Plaintiffs. Then, after the purchase
Langberg is the sole member of GRL Capital Advisors, LLC. As described above, that entity purchased 100 percent of the equity interest of ABST on June 12, 2009, through the California bankruptcy proceedings of ABUSA. Langberg is currently (to the Court's most recent knowledge) CEO of ABST. The Plaintiffs consider Langberg one of two disinterested, non-AB7 related members of ABST's Board of Directors.
Joseph Catalano ("Catalano") is a former executive and director of the R & S Plaintiffs and was also an ABST executive and a member of its Board of Directors. The Plaintiffs consider Catalano the second of two disinterested, non-AB7 related members of ABST's Board of Directors.
Takeda, Yamada, Kojima, Takenaka, Langberg, and Catalano constituted ABST's Board of Directors during the relevant period. Takeda, Yamada, and Kojima were directors or otherwise employees of AB7. Takenaka was related to AB7 as a director of its wholly-owned subsidiary, ABUSA, a director of its European subsidiary, Autobacs France, and through the relationship between AB7 and Takenaka Partners (of which he was president and CEO). Langberg and Catalano were non-AB7-related members of ABST's Board of Directors.
Koichi Sumino ("Sumino") is a citizen of Japan. He was director and CEO of AB7 for many years, retiring in June 2008.
Joseph Kim ("Kim") is a vice president of Takenaka Partners. He drafted what is discussed below as the "Three-Year Projection."
The R & S Plaintiffs' market presence in New Jersey, New York, and Pennsylvania intrigued AB7. AB7 first moved (from Japan) into the United States market in August 2003. In 2006, when AB7 sought to increase its international market presence, AB7 viewed the R & S Plaintiffs' East Coast chain of Strauss Discount Auto stores as a possible United States foothold. When the R & S Plaintiffs filed a voluntary Chapter 11 petition on August 10, 2006, AB7 retained Takenaka Partners to investigate and facilitate a potential acquisition. In late August 2006, Takenaka Partners contacted Langberg, proposing AB7's acquisition of the R & S Plaintiffs' assets.
On December 11, 2006, Yamada, an employee of AB7, prepared a business plan for AB7's acquisition of the R & S Plaintiffs' assets. AB7 retained the law firm of Pillsbury Winthrop Shaw Pittman LLP ("Pillsbury"). Pillsbury advised Yamada and Takenaka (who was serving as a financial advisor to AB7), to use ABUSA or a new company wholly-owned by ABUSA to acquire the R & S Plaintiffs' assets. Pillsbury circulated a letter to Yamada, Takenaka, Kim (an employee of Takenaka Partners), and (undisclosed) others on February 6, 2007. This letter described tax considerations and stated that AB7
On February 26, 2007, AB7's board of directors met and agreed to fund the acquisition with $20 million in equity, $33.65 million in long-term loans, and $8 million in short-term loans. Two days later, on February 28, 2007, the AB7 board approved a $23 million loan to acquire the R & S Plaintiffs' assets. Takeda, Kojima, Takenaka, and Sumino approved the $23 million loan.
Moving forward with the acquisition game plan, on March 8, 2007, AB7 incorporated ABST, a new company wholly-owned by ABUSA (ABUSA was in turn wholly-owned by AB7). ABST's certificate of incorporation included an exculpatory provision
AB7's presence became visible on March 26, 2007. The R & S Plaintiffs held a "Vendor Breakfast" to introduce AB7 and to request increases in credit lines and merchandise releases. AB7 announced at that meeting that it would soon acquire the R & S Plaintiffs' assets.
AB7 made a presentation at the meeting discussing how "[i]nventory levels [are] significantly higher at competitive outlets" and that a primary business driver going forward would be expanding merchandise offerings with "[b]roader and [d]eeper [a]ssortments."
Three days later, on March 29, 2007, the R & S Plaintiffs' and AB7 signed an asset purchase agreement (the "R & S APA").
"During negotiations on the proposed R & S Plan, in or about January 2007, AB7
On behalf of the R & S Plaintiffs, attorneys Kenneth A. Rosen, Bruce Buechler, and Eric Horn from Lowenstein Sandler PC ("Lowenstein") filed the R & S Disclosure Statement on March 30, 2007.
In Article VI, Section B, the R & S Disclosure Statement describes the means to implement the plan through the sale of substantially all of the R & S Plaintiffs' assets. Sub-part 3 details the R & S APA's "Purchase Price."
Specifically, the R & S Disclosure Statement provides that "[o]n or prior to the Effective Date, [AB7] will make a
In short, the R & S Disclosure Statement asserts that AB7 will make a "capital contribution" in an amount sufficient to pay the "cash portion of the purchase price plus $10 million of working capital." The total amount due as the "cash portion of the purchase price" was approximately $27,878,470. After adding $10 million for working capital, the aggregate "capital contribution" required from AB7 on or before the Effective Date was $37,878,470.
A three-year projection was annexed to the R & S Disclosure Statement (the "Three-Year Projection").
Drafts of the Three-Year Projection were rejected by Kim because they had shown interest due on existing debt of the
The R & S Plan also provides that "ABST shall not make any dividends or
The language in the R & S APA does not match the language in the R & S Disclosure Statement with respect to the "Purchase Price" and "Payment of Purchase Price." In the R & S Disclosure Statement, the "Purchase Price" and AB7's related financial obligations are included in a two-paragraph long description of "Purchase Price." In contrast, in the R & S APA, the "Purchase Price" is defined in section 3.2
Article IV provides
Essentially, Article IV provides that AB7 has a financial obligation to provide ABST, the buyer, with funds, up to a specified amount on Schedule 4. Schedule 4 lists the "Total Payment as per Article IV of APA" as $38,919,235.
The R & S APA was signed on March 29, 2007, by Langberg, on behalf of the "seller" (the R & S Plaintiffs), by Akihiro Yamada, on behalf of the "buyer" (ABST), and by someone whose signature is illegible on behalf of AB7.
On April 25, 2007, Judge Novalyn L. Winfield held the R & S Confirmation
Also at the R & S Confirmation Hearing, an attorney proffered testimony on behalf of Langberg. Langberg would have testified that the R & S Plaintiffs' business was a "turnkey operation" with "an existing base of approximately 90 stores that are open for business stocked with inventory and with experienced employees who are operating there on a day to day basis. And, therefore, [ABST] would be stepping in ... with a going business that is generating a positive cash flow."
On April 26, 2007, the attorney
AB7's attorney
On April 27, 2007, Judge Winfield signed the R & S Confirmation Order.
The R & S Confirmation Order also states: "[t]he Asset Purchase Agreement between Autobacs/Strauss [ABST] and the Debtors dated as of March 29, 2007 (the `APA') and the transactions contemplated thereby are hereby approved in all respects."
On April 26, 2007, the day between the R & S Confirmation Hearing and issuance of the R & S Confirmation Order, AB7 funded ABST with $43 million. The $43 million was provided to fund the R & S APA closing. Of the $43 million, $20 million was equity, and $23 million was a long term interest bearing loan (the "$23 Million Loan"). The "Loan Agreement" reflecting the $23 Million Loan was signed by Sumino on behalf of AB7, and by Yamada on behalf of ABST. The $23 Million Loan Agreement was never circulated for approval to the full board of ABST Directors. It was never approved by Langberg or Catalano. There are no recorded minutes evidencing an ABST Directors' meeting regarding the $23 Million Loan Agreement, nor does any party suggest that such a meeting was held.
On May 2, 2007, the R & S APA purchase closed. ABST paid $27,878,470.60 to the R & S Plaintiffs. None of the non-AB7-related ABST employees or directors knew that of the $43 million transferred, or that $23 million took the form of a loan.
Over a month after closing, on June 5, 2007, William Drozdowski, ABST's non-AB7-related director of accounting, began to prepare financial statements for ABST in preparation for the first meeting of ABST's Board of Directors. Drozdowski prepared a balance sheet and listed the entire $43 million provided by AB7 as "Contributed Capital." Kojima (ABST CFO and AB7 employee) directed Drozdowski to list $20 million as capital and $23 million as a long-term loan. Drozdowski spoke with Langberg, Catalano, and Paul Dawson,
The Plaintiffs contend that out of the $43 million transferred to ABST, $28 million went right out the door to the R & S Plaintiffs in accordance with the R & S APA. Thus, while $43 million was transferred to ABST, once $28 million was paid out under the plan, ABST was left with $15 million in cash. But, since ABST owed $23 million under the long-term loan, the $15 million in remaining cash was insufficient to cover their liabilities, i.e., they were underwater by $8 million. Therefore, ABST contends it was insolvent immediately.
On July 5, 2007, Kojima (ABST's CFO and an employee of AB7) sent an email to Takeda and other AB7 employees in Japan. The email stated that "[i]n the [R & S] Disclosure Statement [sic] issued by the court in the current Strauss asset purchase there is a phrase that says, `there will be no asset dividends or distributions until the completion of the [ABST] repayment.'... I [Kojima] think I want to temporarily stop payment of interest until the completion of repayment in 2010 because we will avoid the risk of litigation by the wording of the `Disclosure Statement.'"
Non-AB7-related ABST employees, including Langberg, Catalano, Dawson, and Drozdowski, were actively excluded by the AB7-related ABST Directors from making decisions concerning ABST finances.
When ABST's cash was low, Drozdowski or Dawson would inform Kojima that additional funds were needed to continue operating. Kojima would acquire funds from AB7 and tell Drozdowski or Dawson to record the money from AB7 as
The following chart reflects the loan agreements between AB7 and ABST related to the funds provided by AB7 when Drozdowski or Dawson expressed ABST's need for funding. The chart also shows when interest payments and a $10.6 million loan prepayment were made from ABST to AB7.
Loan Payment Total Debt
Debt (ABST Interest Paid (by (by ABST to (ABST owed
Date owed AB7) ABST to AB7) 44 AB7) AB7)
4/26/2007 $23 million $23.0 million
10/11/2007 $2.5 million $25.5 million
11/14/2007 $2 million $27.5 million
12/19/2007 $2.1 million $29.6 million
1/9/2008 $4 million $33.6 million
1/9/2008 ($44,065) $33.6 million
1/10/200845 $4.5 million ($4.5 million) $33.6 million
3/3/2008 $4 million $37.6 million
4/22/2008 ($128,085) $37.6 million
4/22/2008 ($10.6 million) $27.0 million
5/2/2008 $5 million $32.0 million
6/20/2008 $2.6 million $34.6 million
7/8/2008 ($38,864) $34.6 million
7/9/200846 $4 million ($4 million) $34.6 million
Loan Payment Total Debt Debt (ABST Interest Paid (by (by ABST to (ABST owed Date owed AB7) ABST to AB7) 47 AB7) AB7) 7/28/2008 $3.65 million $38.25 million 11/6/200848 $10.65 million ($96,537) ($8.65 million) $40.25 million 12/3/2008 ($17,393) $40.25 million 1/14/2009 ($27,091) $40.25 million
None of the loans in the chart above were presented to the full board of ABST Directors. No ABST Director resolutions or minutes exist discussing or showing approval of them.
The loans on January 10, 2008, November 6, 2008 and December 6, 2008, were all "roll ups" of prior debt. Each roll up took place on the maturity date of prior loans. They allowed ABST to avoid making principal repayments on the due dates.
On April 10, 2008, ABST's auditor
The cash infusion of $12.3 million on April 9, 2008, surprised Drozdowski. He was not consulted, and no one at ABST other than Takeda, Yamada, and Kojima knew about the cash transfer until after the fact.
AB7's concerns regarding ABST's financial condition led AB7 to disseminate its own financial statements when any vendor, finance company, real estate landlord, or anyone else made a credit inquiry about ABST's credit. Takeda, Yamada, and Kojima directed Catalano and other ABST employees to withhold ABST's financials when vendors and suppliers asked for proof of ABST's financial health. ABST employees provided AB7's financial statements in good faith reliance on Takeda,
AB7 required ABST to purchase merchandise on unfavorable terms from AB7 or companies with relationships with AB7. Examples of purchasing problems cited by ABST include:
At many junctures, the two non-AB7-related ABST Directors (Catalano and Langberg) objected to no avail to the AB7-related ABST Directors' actions.
In April 2008, Kojima informed Dawson that ABST would no longer receive a cash infusions from AB7. Dawson suggested approaching a factor to obtain loans based on ABST's inventory. Kojima told Dawson he would confer with Takeda and Yamada, and later returned to tell Dawson not to proceed with a factor because it was "unnecessary."
ABST contends that after AB7-related ABST Directors stopped Dawson from seeking a factor and stopped Langberg and Catalano by refusing to allow the use of inventory as collateral, AB7 then "pulled the plug" on ABST.
On February 2, 2009, AB7 served ABST with a Notice of Event of Default. AB7 declared that all amounts owing under the loan agreements described in the table above were immediately due and payable.
Under New York Insurance Law § 7903, a company, such as ABST, that historically sold (and continues to sell) service contracts has to remain current with its New York State Insurance Department license and registration. After ABST filed for bankruptcy, Yamada received a license and registration renewal notice for selling service contracts. He did not notify anyone and failed to renew the license by the renewal deadline. The license and registration lapsed in New York on February 28, 2009. This subjected ABST to over $250,000 in fines and could cause New York State to suspend ABST's license to sell service contracts.
On May 1, 2009, AB7 filed a proof of claim against ABST's estate for $43,994,044.12. This amount accounted for $42,575,218.47 in unpaid principal and interest on unsecured loans, as well as $1,400,184.72 for AB7's guarantee of an ABST continuing letter of credit with Bank of Tokyo-Mitsubishi UFJ, Ltd.
On May 15, 2009, the R & S Plaintiffs filed a proof of claim against the ABST estate for $8,140,496.67. The R & S Plaintiffs' proof of claim describes the "Purchase Price" from the R & S Plaintiffs' reorganization. They allege they were to receive $45 million and that ABST was to pay a maximum of $19.34 million. Of that $19.34 million, the R & S Plaintiffs received $11,199,503.33. Therefore, the R & S Plaintiffs filed a claim for the difference: $8,140,496.67.
The standard governing a motion under Rule 12(b)(6) is well known.
Plausibility pleading requirements under Rule 8(a) differ from those under Rule 9(b). "Complaints asserting claims for fraud must meet a heightened pleading standard. Federal Rule of Civil Procedure Rule 9(b) requires these complaints to set forth facts with sufficient particularity to apprise the defendant of the charges against him so that he may prepare an adequate answer. To provide fair notice, the complaint must go beyond merely quoting the relevant statute.... Rule 9(b) requires plaintiffs to plead with particularity the `circumstances' of the alleged fraud in order to place the defendants on notice of the precise misconduct with which they are charged, and to safeguard defendants against spurious charges of immoral and fraudulent behavior. It is certainly true that allegations of `date, place or time' fulfill these functions, but nothing in the rule requires them. Plaintiffs are free to use alternative means of injecting precision and some measure of substantiation into their allegations of fraud."
Undercapitalization and insolvency are the most relevant factors in determining "whether the corporation was established to defraud its creditors or [some] other improper purpose such as avoiding the risks known to be attendant to a type of business."
"Undercapitalization" or unreasonably "small capital" is conceptually distinct from "insolvency."
Plaintiffs allege that ABST planned all along to rapidly expand inventory and payroll, and that ABST was grossly undercapitalized from the outset (and therefore at the time of each transfer or obligation). Plaintiffs allege that the $10 million in working capital provided for in the R & S Confirmation Order, without regard to later provided funds, was grossly insufficient relative to ABST's planned rapid expansion. Thus, ABST had unreasonably small capital. Defendants respond by arguing that "the actual facts alleged show that there was no such radical `expansion' — merely restocking of depleting store shelves and a 5.4% staffing increase after emerging from bankruptcy." This is a factual issue that cannot be resolved in the context of the motion to dismiss.
Defendants also argue that ABST had the ability to access credit, citing the loans from AB7 to ABST. Defendants contend that where a debtor has a reasonable belief it can raise money in capital markets, it does not have unreasonably small capital. But Plaintiffs allege that, in reality, AB7 did not have such a belief (and accordingly neither did ABST) as ABST was directed to provide AB7's financial documents whenever creditworthiness was at issue.
The natural inference from the substituted financial documents belies Defendants' contentions that ABST, standing alone, had access to raise money in capital markets. In fact, it implies the opposite. Plaintiffs also allege that avenues to access credit were actively blocked by Defendants' prohibition of granting collateral to potential lenders. The Complaint essentially explains that ABST had no ability to access capital aside from its parent because of the controlling AB7-related ABST Directors. Rather, all it could do was ask Kojima for operational funding for AB7 with hopes that "Mama" would provide. These allegations warrant discovery on the issue of undercapitalization.
The Bankruptcy Code defines a corporation as "insolvent" when it is in a "financial condition such that the sum of such entity's debts is greater than all of such entity's property, at a fair valuation...."
Plaintiffs assert that the $23 Million Loan rendered ABST insolvent from its inception. AB7 does not dispute that ABST was insolvent from inception under
In support of AB7's argument that ABST must be valued solely on a going concern basis, AB7 cites Langberg's testimony, which was proffered at the R & S Confirmation Hearing. There, the R & S Plaintiffs' business was touted as a "turnkey operation" with "an existing base of approximately 90 stores that are open for business stocked with inventory and with experienced employees who are operating there on a day to day basis. And, therefore, [ABST] would be stepping in ... with a going business that is generating a positive cash flow."
There can be no serious contention that the Strauss business that was acquired by AB7 through the R & S APA and R & S Plan was not a going concern. But for purposes of whether a liquidation or going concern analysis is appropriate the question is whether the business was "wholly inoperative, defunct, or dead on its feet" or if liquidation in bankruptcy was clearly imminent on the transfer date. That is a question in this case that cannot be answered on a motion to dismiss.
As mentioned above, AB7 does not dispute that ABST was insolvent from inception under a liquidation analysis. The Defendants do challenge, however, whether ABST has adequately pled that the company was insolvent as a going concern. Defendants correctly characterize plaintiffs' insolvency allegations as being broad and general. Defendants argue that because the Plaintiffs seek to avoid eleven different loan obligations, incurred on eleven different days, along with six payments on six different days, over the course of 20 months, they must allege facts establishing insolvency on each date, rather than in broad stroke.
In response to AB7's argument, Plaintiffs assert that a 12(b)(6) motion is not the appropriate stage for the Court to consider these issues in detail. Given the moving parts, lack of hard data, and the number of different times at which insolvency must be decided for Plaintiffs' various claims, Plaintiffs assert that there are admittedly broad allegations are sufficient for purposes of Rule 12(b)(6).
Moreover, while admitting that the Complaint does not contain the specificity that the Defendants argue is necessary, Plaintiffs argue that its broad assertions are not as broad as argued. Plaintiffs claim they have alleged facts supporting insolvency under both the discounted cash flow analysis and the adjusted balance sheet analysis. But, Plaintiffs do not provide
When it's all said and done, Plaintiffs rely on the old "where there is smoke there is fire" theory of pleading. The Plaintiffs contend that out of the $43 million transferred to ABST, $28 million went right out the door to the R & S Plaintiffs in accordance with the R & S APA. Thus, while $43 million was transferred to ABST, once $28 million was paid out under the plan, ABST was left with $15 million in cash. But, since ABST owed $23 million under the long-term loan, the $15 million in remaining cash was insufficient to cover their liabilities, i.e., they were underwater by $8 million. Therefore, ABST contends it was insolvent immediately.
These allegations are sufficient to survive a motion to dismiss — barely. One certainly cannot deny the math. But many a balance sheet insolvent debtor may be nonetheless solvent as a going concern. Plaintiffs have won the right to take discovery but if they expect to prevail on this point they have much work left to do.
In sum, the Plaintiffs have adequately pled that ABST was insolvent for all relevant periods.
A subsidiary is an alter ego or instrumentality of a parent entity "when `the separate corporate identities ... are a fiction and ... the subsidiary is, in fact, being operated as a department of the parent.'"
Count One is asserted by all Plaintiffs. As a preliminary matter, AB7 argues that the R & S Plaintiffs cannot pursue the alter ego claim for two reasons. First, only ABST can pursue an alter ego claim premised on generalized harms to the debtor. Second, the R & S Plaintiffs have failed to allege any particularized harm. Therefore, AB7 seeks dismissal of the R & S Plaintiffs as parties to Count One. AB7 concedes that ABST can press forward with Count One.
The R & S Plaintiffs counter by arguing that they suffered two particularized harms. First, they filed a claim against ABST's estate for $8,140,496.67. Second, they were fraudulently induced by AB7 and AB7-related ABST Directors to endorse the R & S Plan, which incorporated the R & S APA.
AB7 acknowledges the assertion of the $8 million claim against ABST's estate but
For analyzing alter ego claims, the Third Circuit uses seven factors to determine whether companies are operating as a single economic unit: (a) the subsidiary is undercapitalized; (b) the subsidiary was insolvent at the relevant time; (c) the companies failed to observe corporate formalities;
These factors are not exhaustive, no single factor is dispositive, and some combination is required.
As discussed above, plaintiffs' allegations regarding undercapitalization are sufficient to survive the motion to dismiss.
Similarly, plaintiffs' allegations relating to insolvency are sufficient.
This factor considers "whether corporate records were kept, officers and directors functioned properly, and other corporate formalities were observed."
Plaintiffs allege that:
Defendants argue that the "minimal disregard of corporate formalities alleged in the Complaint does not come close to establishing that [ABST] functioned as an alter ego of AB7." Defendants argue on the merits that neither the by-laws nor other law required ABST Director approval of AB7's loans. Finally, Defendants argue that alleged violations of ABST's accounting rules should be disregarded, since Plaintiffs did "not allege that such rules were ever formally adopted by [ABST's] board."
AB7's arguments on the merits are for another day. This is a motion to dismiss and Plaintiffs have sufficiently alleged the failure of AB7 and ABST to observe corporate formalities.
Plaintiffs make no allegation regarding the non-payment of dividends.
Siphoning suggests "the improper taking of funds that the owner was not legally entitled to receive."
Defendants argue that AB7 put "$75 million net of its own cash into the company" and therefore could not have siphoned money out of ABST. They also argue that Plaintiffs ignore that the $10.6 million loan prepayment and interest payments were "bracketed by significant infusions of larger amounts of both equity and low-interest unsecured debt. The accusation that [ABST] was used to extract value for AB7 is not just inaccurate — on the facts pleaded it is downright surreal."
The defendants' argument that they could not be siphoning cash when they put cash into the company misses the point. Indeed their allegation that they put "net" cash into the company is exactly the point. The question is not what they put in the company, but when they took it out. If the infusions were, in fact, loans, then the insider was siphoning cash by requiring payments to be made under his loan at a time when the company was insolvent.
Defendants argue that the "Complaint does not allege that [ABST's] board failed to maintain minutes of its meetings or other corporate records...."
When a parent corporation exercises significant control over a subsidiary's operations and finances, an inference may arise that Defendants created a façade.
Defendants argue that ABST was a legitimate and separate corporation from AB7, recognized as such by all relevant parties. Defendants argue that AB7 and ABST functioned in a prototypical parent-subsidiary relationship. Moreover, they argue that Plaintiffs only allege that AB7-related ABST Directors managed the daily affairs of ABST, not that AB7 itself managed the affairs of ABST. Defendants argue that wholly-owned subsidiaries may share officers, directors, and employees with their parent, without requiring the court to infer that the subsidiary is a mere instrumentality for the parent and without requiring the court to conclude that those officers and directors were not functioning properly.
Plaintiffs allege that the AB7-related ABST Directors were loyal to AB7 and not acting on behalf of ABST. Plaintiffs point to AB7-related ABST Directors' compensation and health care, showing that each AB7-related ABST Director received the majority of their compensation and their medical benefits from AB7.
For example, Plaintiffs allege:
Plaintiffs' allegations provide facts that suggest AB7-related ABST Directors functioned improperly and used ABST as an instrumentality. "Although some of plaintiffs' allegations ... are consistent with the parent/subsidiary relationship, their other allegations also give rise to the inference that the ... defendants created a façade by exercising significant control over the ... operations, finances" and the ultimate decision to file bankruptcy.
Under all seven elements of the Third Circuit's test, Plaintiffs have sufficiently alleged that AB7 and ABST were a single economic unit.
Taking Plaintiffs allegations as true, this Court could find that AB7 "misdirected funds, exercised crippling control, and purposely siphoned" money from ABST to AB7 for AB7's benefit (even if just as a risk minimization device). As such, Plaintiffs sufficiently allege that AB7 may have perpetrated fraud or injustice, or something similar.
Plaintiffs allege AB7 and ABST were a single economic unit and that AB7 may have perpetrated injustice or something similar. Therefore, the Motion to Dismiss Count One will be denied.
ABST alleges that the Individual Defendants
The Individual Defendants argue that (a) they only owed fiduciary duties to their sole shareholder, AB7; (b) even if fiduciary duties were owed to ABST or others, the duty of care claims must be dismissed because of (b)(i) an exculpatory provision in the ABST certificate of incorporation or (b)(ii) the business judgment rule protections
The Individual Defendants argue that ABST was a solvent, wholly owned subsidiary corporation of AB7. Therefore, ABST's Directors only owed duties to the sole shareholder, AB7. They correctly argue that in the "zone of insolvency" Delaware directors "must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation for the benefit of its shareholder owners."
Insolvency is discussed above. ABST has sufficiently pled insolvency from the time of ABST's inception, without a termination date. Since all of the Individual Defendants' acts fall during a period of insolvency the Individual Defendants owed fiduciary duties to ABST and its creditors.
"The duty of care has been described as the duty to act on an informed basis. To prove a breach of the duty of care, a plaintiff must demonstrate gross negligence. The precise behavior constituting gross negligence varies depending on the context, but in general "a trial court will not find a board to have breached its duty of care unless the directors individually and the board collectively have failed to inform themselves fully and in a deliberate manner."
ABST alleges that the Individual Directors violated their duty of care by:
Additionally, ABST alleges that the ABST Directors had a duty to act created by the bylaws and Accounting Rules and they failed to act in spite of this known duty.
"Litigation involving the duty of care is uncommon since the adoption of section 102(b)(7) of the Delaware General Corporate Law...."
The Individual Defendants argue that the exculpatory clause in ABST's certificate of incorporation
The business judgment rule "creates a presumption in favor of a director-approved
"The duty of loyalty mandates that the best interest of the corporation and its shareholders takes precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the stockholders generally. To prove a breach of the duty of loyalty, plaintiffs must allege facts showing that a self-interested transaction occurred and that the transaction was unfair...."
Alternatively described, the duty of loyalty is "an affirmative obligation to protect and advance the interests of the corporation and mandates that [the director] absolutely refrain from any conduct that would harm the corporation."
"The duty of good faith is a `subsidiary element' of the `fundamental duty of loyalty.' The Delaware Supreme Court has recognized three non-exclusive categories of conduct indicative of a failure to act in good faith. First, a failure to act in good faith may be established when a director `intentionally acts with a purpose other than that of advancing the best interests of the corporation.' Second, a failure to act in good faith may be established when a director `acts with the intent to violate applicable positive law.' Third, a failure to act in good faith may be established when a director `intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.'"
Thus, ABST has pled more than simple common employment to show "interestedness" of the overlapping AB7-related ABST Directors.
The Individual Defendants then attempt to discredit ABST's allegations that the Individual Defendants purchased inventory in a manner that benefitted AB7 and harmed ABST as not extreme enough to support a pleading for the breach of the duty of loyalty. But the Individual Defendants have merely isolated one allegation. Considering ABST's allegations together, the cases that the Individual Defendants cite do not support discrediting ABST's allegations at this stage.
In fact, all of the cases cited by the Individual Defendants are either distinguishable on the facts or, upon inspection, support that the Court deny the Individual Defendants Motion to Dismiss Count Two.
For example, the Individual Defendants point to FDIC v. Sea Pines Co., supposedly to contrast what they view as non-breaching conduct in this case with the "extreme conduct, such as victimizing an insolvent subsidiary for the benefit of its shareholders" that led the court in Sea Pines to deny dismissing a count that pled breach of the duty of loyalty.
Sea Pines stated that the facts in its case were materially indistinguishable from those in the Supreme Court case Koehler v. Black River Falls Iron Co.
The Individual Defendants deny that Plaintiffs sufficiently pled that AB7 was required to provide funding to ABST in return for equity rather than in return for debt. Their denial is unsupported. And, on Plaintiffs' case theory, their claims inhabit a space quite akin to that in Koehler and Sea Pines. According to Plaintiffs, the AB7-related ABST Directors, instead of honestly endeavoring to effect a capital contribution for the benefit of the corporation, raised the structural payout priority of their own debts, to the injury of the creditors and the corporation, in betrayal of their trust. The similarity between the allegations in Koehler in 1862 and those today before this Court are uncanny. The distinguishing conduct they cite to the Court as "extreme" actually tracks the conduct alleged before the Court today.
Thus, ABST has sufficiently pled a breach of the fiduciary duty of loyalty by the Individual Defendants.
Takenaka's Motion argues that, as an outside director, Takenaka was not involved in ABST's day-to-day management. Therefore, he argues he owed no fiduciary duties regarding day-to-day management.
Takenaka cites In re Merck & Co., Inc. Sec., Derivative & "ERISA" Litig. in support of his motion.
The Complaint alleges that Takenaka negotiated the R & S APA deal. Additionally, Takenaka was so involved that he testified through proffer in support of the R & S APA and R & S Plan. Takenaka was not only an outside director, but ABST's vice-president as well. He represented that the R & S APA deal would be done with equity rather than debt. Takenaka
Thus, ABST has sufficiently pled a breach of the fiduciary duties of care and loyalty by Takenaka.
ABST has sufficiently alleged breaches of the fiduciary duty of care and loyalty by the Individual Defendants. Thus, the Court will deny the motions with respect to Count Two.
ABST alleges that AB7, through overlapping ABST directors and AB7's controlling power as an insider, caused ABST to incur loan obligations with the intent to defraud or hinder ABST's creditors.
"Section 548(a)(1) of the Code grants a trustee [or DIP] the power to avoid any transfer by a debtor of an interest in property [or any obligation incurred by the debtor] made within two years before the filing of a bankruptcy petition if the transfer was actually or constructively fraudulent. Under Section 548(a)(1)(A), transfers or obligations incurred by a debtor may be avoided if made with actual intent to hinder, delay or defraud a past or future creditor."
Searching for such circumstantial evidence, courts often look to badges of fraud that include, "but are not limited to: (i) the relationship between the debtor and the transferee; (ii) consideration for the conveyance; (iii) insolvency or indebtedness of the debtors; (iv) how much of the debtor's estate was transferred; (v) reservation of benefits, control or dominion by the debtor over the property transferred; and (vi) secrecy or concealment of the transaction. The presence or absence of any single badge of fraud is not conclusive. The proper inquiry is whether the badges of fraud are present, not whether some factors are absent. Although the presence of a single factor ... may cast suspicion on the transferor's intent, the confluence of several in one transaction generally provides conclusive evidence of an actual intent to defraud. Additionally, a court may consider other factors relevant to the transaction."
ABST argues fraud based on allegations that:
AB7 concedes that the first badge of fraud, the relationship between the debtor and the transferee, is present, and provides circumstantial evidence of actual fraud. AB7 is admittedly an insider as the indirect 100 percent parent of ABST.
ABST argues that loan obligations to AB7, totaling $40,250,000 in principal and $2,258,554.31 in interest, are void.
As discussed above, Plaintiffs' allegations regarding insolvency are sufficient to survive the motion to dismiss.
Neither ABST nor AB7 expressly address this factor. Moreover, the financial documents provided to this Court are insufficient to readily determine the total worth of the estate and the percent of the estate transferred with regard to each transfer. Thus, this prong has not been sufficiently pled by Plaintiffs
Plaintiffs argue that AB7 had dominion and control over the Debtor's financial and operational affairs. Their argument here is unclear, but they appear to be arguing that ABST, as an alter ego of AB7, was one and the same with AB7, and thereby reserved benefits and control with respect to the obligations incurred and payments made. This prong has not been sufficiently pled by Plaintiffs.
AB7 argues that "there is no suggestion that the Loan Obligations or Payments were concealed when they were actually made." AB7 also argues that "[a]t most, the Complaint alleges a failure to affirmatively disclose the $23 Million Loan prior to June 5, 2007, but AB7 was under no duty to disclose the details of its planned funding of [ABST] beyond the $10 million
ABST asserts that the $23 Million Loan, put on the books of ABST as debt, was not disclosed or discussed prior to June 5, 2007, after AB7 had directed ABST to incur the obligation. ABST alleges that Takenaka asserted at the R & S Confirmation Hearing that neither "he nor AB7 is aware of any other arrangement or agreement involving AB7 and ABST or any of its affiliates, employees or principals." This assertion could possibly have created a duty to disclose the details of AB7's planned funding process, supposing ABST and AB7 had already set up a financing arrangement. No such disclosure was made until June 5, 2007. There are no discussions, recorded minutes, votes, or resolutions regarding the $23 Million Loan.
AB7 argues that at the very least, the $10.9 million payment and (aggregated) $17,250,000 in working capital loans were not concealed. However, ABST contends in its Complaint that "[e]ach loan agreement was signed by Sumino on behalf of AB7 and by Yamada on behalf of [ABST] and approved by AB7 and the Individual AB7/ [ABST] Defendants.... None of the loans [were] circulated to the full [ABST] board of directors for approval, or approved by Langberg or Catalano. No [ABST] board resolutions or minutes of meetings exist in which any such loan was approved." If they were not circulated for approval, they were approved in some degree of secrecy.
This prong has been sufficiently pled by Plaintiffs.
Plaintiffs have sufficiently pled four badges of fraud: an insider relationship, insolvency, lack of consideration and secrecy. Therefore, the Court will deny the Motion to Dismiss this count.
In the alternative to pleading that the loan obligations were the result of actual fraud, ABST alleges that the transactions were "constructively fraudulent." More specifically, ABST alleges it was insolvent from inception and it did not receive reasonably equivalent value for incurring the debt owed to AB7.
It is undisputed that the Delaware and New Jersey Fraudulent Transfer Acts track section 548 of the Bankruptcy Code (or vice versa). To establish a constructively fraudulent transfer or obligation, "the plaintiff must show that (a) the debtor made the transfer [or incurred the obligation] without receiving reasonably equivalent value, and (b) [regarding the debtor's financial condition] the debtor was either: (i) insolvent or became insolvent as a result of the transfer; (ii) engaged or [was] about to engage in a business or transaction for which its remaining assets were unreasonably small in relation to the business or transaction; or (iii) intended to incur, or believed or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due."
"The term `reasonably equivalent value' is not defined by the Bankruptcy Code. Congress left to the courts the task of setting forth the scope and meaning of this term, and courts have rejected the application of any fixed mathematical formula to determine reasonable equivalence. As the Third Circuit has noted, `a party receives reasonably equivalent value for what it gives up if it gets roughly the value it gave.' Rather, courts look to the `totality of the circumstances' of the transfer to determine whether `reasonably equivalent' value was given."
Generally, this Court follows a two-step approach, first looking to whether "based on the circumstances that existed at the time of the transfer [or obligation] it was `legitimate and reasonable' to expect some value accruing to the debtor."
AB7 argues that ABST received reasonably equivalent value both when it incurred loan obligations (receiving cash) and when it made payments in principal and interest in favor of AB7 (paying down debt). Plaintiffs argue that the loan obligations are void; therefore, they argue that ABST did not receive reasonably equivalent value when it incurred the loan obligations.
As set forth above, there is a total $40,250,000 in incurred intercompany loan obligations. Excluding roll ups, they are comprised of: (i) $23 million on April 26, 2007; (ii) $2.5 million on October 11, 2007; (iii) $2 million on November 14, 2007; (iv) $2.1 million on December 19, 2007; (v) $4 million on January 9, 2008; (vi) $4 million on March 3, 2008; (vii) $5 million on May 2, 2008; (viii) $2.6 million on June 20, 2008; (ix) $3.65 million on July 29, 2008; and (x) $2 million on November 6, 2008.
ABST received cash (dollar for dollar) equal to the face amount of each loan obligation ABST incurred in favor of AB7. Plaintiffs do not argue that the payment of $23 million to the R & S Plaintiffs under the R & S Plan and R & S APA nor the subsequent cash infusions were not reasonably equivalent value for the assets acquired by AB7. Rather, they argue that they expected to get the cash with no strings or repayment obligations attached. Therefore, the discrepancy is between the expectation (free cash) and the loan obligations (cash with repayment obligations), Plaintiffs argue that discrepancy results in ABST having not received reasonably equivalent value.
There is a total of $10,952,035 in principal and interest payments made on intercompany loans from ABST to AB7. They consist of (i) $44,065 on January 9, 2008; (ii) $128,085 on April 22, 2008; (iii) $10.6
When AB7 provided dollars for debt on a one-to-one ratio, they provided reasonably equivalent value. Thus, regardless of whether the transactions should be characterized as capital contributions or loans, ABST received reasonably equivalent value for the cash. However, they have sufficiently pled that ABST did not receive reasonably equivalent value for costs of incurring the debt, i.e., the principal and interest payments in the amount of $10,952,035.
ABST must also allege that "(b) [regarding the debtor's financial condition] the debtor was either: (i) insolvent or became insolvent as a result of the transfer; (ii) engaged or [was] about to engage in a business or transaction for which its remaining assets were unreasonably small in relation to the business or transaction; or (iii) intended to incur, or believed or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due."
Plaintiffs' allegations regarding insolvency are sufficient to survive the motion to dismiss.
Similarly, Plaintiffs' allegations regarding undercapitalization are sufficient.
The Complaint alleges that AB7 generally did not attempt to collect principal and interest payments on loan obligations when they came due. Rather, the obligations went unpaid and had to be rolled into new loan arrangements. In addition, apart from the $23 Million Loan, ABST required approximately $20 million in additional cash. The clear inference is that ABST was unable to pay its debts as they came due.
There is no dispute that the cash was infused into ABST regardless of whether it was debt or equity. Thus, regardless of whether the transactions should be characterized as capital contributions or loans, ABST received reasonably equivalent value for the cash. However, they have sufficiently pled that ABST did not receive reasonably equivalent value for costs of incurring the debt, i.e., the principal and interest payments in the amount of $10,952,035. In addition, Plaintiffs have sufficiently alleged ABST was insolvent, had unreasonably small capital and was unable to pay its debts as they became due. The Motion to Dismiss Count Four will be granted in part and denied in part as the amount of the claim is limited to $10,952,035.
ABST alleges that six relevant preferential transfers were made to or for the benefit of AB7: (i) $128,085 on April 22, 2008; (ii) $10.6 million on April 22, 2008; (iii) $38,864 on July 8, 2008; (iv) $96,537 on November 6, 2008; (v) $17,393 on December 3, 2008; and (vi) $27,091 on January 14, 2009.
AB7 concedes that payments (v) and (vi) must survive the Motion to Dismiss as they occurred within 90 days of ABST's
Under 11 U.S.C. § 547(b), in order to avoid a prepetition preferential transfer of the debtor's interest in property, ABST must show that the transfer was:
AB7 argues that the Complaint fails to establish a prima facie case for a preferential transfer because ABST failed to allege insolvency at the time the Contested Preference Payments were made. Under § 547(f) of the Bankruptcy Code, ABST is presumed insolvent for the 90-day period prior to February 4, 2009, ABST's Chapter 11 petition date.
AB7 argues that the face of ABST's Complaint establishes the subsequent new value defense for AB7 with respect to $10,863,486 in payments made between April 22, 2008 and November 6, 2008. AB7 argues it provided "money" to ABST, which constitutes "new value."
Section 547(c)(4) of the Bankruptcy Code provides that "[t]he trustee may not avoid under this section a transfer ... to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor ... on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor."
AB7 provides the following chart in support of its new value defense:
New Value Defense Chart Created by AB7
Date Payment New Value Net Preference
4/22/2008 $ 128,085 $ 128,085
4/22/2008 $10,600,000 $10,778,085
5/2/2008 ($5,000,000) $ 5,778,085
6/20/2008 ($2,600,000) $ 3,178,000
7/8/2008 $ 38,864 $ 3,216,949
7/28/2008 ($3,650,000) $0
11/6/2008 $ 96,537 $ 96,537
11/6/2008 ($2,000,000) $0
12/3/2008 $ 17,393 $ 17,393
1/14/2009 $ 27,091 $ 44,484
ABST argues that the subsequent new value defense is inapplicable to a 12(b)(6) motion to dismiss, since it is an affirmative defense that goes to the merits of the complaint, not the sufficiency of the complaint.
ABST sufficiently alleges each element to plead a prima facie preference case. The subsequent new value defense is not properly before the court on this motion to dismiss under Rule 12(b)(6). Therefore, the Court will deny the Motion to Dismiss Count Five.
Count Six seeks to recover transfers avoided under Counts Three, Four, and Five pursuant to section 550 of the Bankruptcy Code. The disposition of this Court is determined by those counts. Thus, the Motion to Dismiss will be granted in part and denied in part as set forth above.
Count Seven seeks a declaratory judgment that recharacterizes the debts owed to AB7 as equity contributions. As this Count is derivative of Count Eight, which survive the Motion to Dismiss, the Motion will be denied as to Count Seven.
Count Eight lies at the heart of the Plaintiffs' theory in this case. Through Count Eight, ABST seeks to recharacterize the loan obligations it incurred in favor of AB7 as equity or capital contributions.
"The law regarding recharacterization is well-settled in this jurisdiction. The Third Circuit has held that the overarching inquiry with respect to recharacterizing debt as equity is whether the parties to the transaction in question intended the loan to be a disguised equity contribution."
The court looks to the "intent of the parties at the time of the transaction, determined not by applying any specific factor, but through a common sense evaluation of the facts and circumstances surrounding a transaction.'"
This Court recently looked to the Sixth Circuit's eleven factor test used in In re AutoStyle Plastics, Inc.
The first factor in AutoStyle is the name given to the instruments. The absence of notes or other instruments of indebtedness is a strong indication that the advances were capital contributions and not loans. In Fidelity Bond and Mortgage Company,
AB7 argues that there is an agreement governing each "loan" that is an "instrument evidencing indebtedness." Each such agreement is titled "Loan Agreement" and uses terms such as "Lender" and "Borrower." AB7 also argues that ABST's Loan Prepayment Application from April 17, 2008, was incorporated by reference in the Complaint and "recounts that [ABST] received from AB7 $41.65 million in long-term and short term loans."
ABST argues first that the labels affixed to the loan agreements and prepayment applications were affixed by AB7, and therefore should be disregarded. Instead, ABST argues, the Court should look to the actual nature of the transaction.
Given the "loan agreements" between "borrower" and "lender," the first factor favors AB7 and weighs against recharacterization.
"The next factor is the presence or absence of a fixed maturity date and schedule of payments. `The absence of a fixed maturity date and a fixed obligation to repay is an indication that the advances were capital contributions and not loans.'"
AB7 argues a fixed maturity date appears in each loan agreement. In the Complaint, ¶ 111 provides a table with the main attributes of each "loan" provided by AB7. Each has a "scheduled repayment date."
ABST argues that the repayment dates were illusory. AB7 never intended to make payment demand or enforce the loans when they came due. ABST alleges that repayment dates were ignored and that loans were rolled up each time principal payments came due.
Specifically, on January 10, 2008, rolled up $4.5 million of loans from October 11,
ABST concedes that one $10.6 million principal payment was made. However, the factual circumstances alleged by ABST surrounding the transfer make the nature of the "prepayment of principal" questionable.
Accordingly, although there are numerous fixed repayment dates stated in the loan agreements, ABST was not regularly required to make principal payments as they came due. Therefore, this factor weighs in favor of recharacterizing the Contested Obligations as equity.
"Another factor in the AutoStyle analysis is the presence or absence of a fixed rate of interest and interest payments. The absence of such is a strong indication that the investment was a capital contribution, rather than a loan."
AB7 argues that in ABST's Complaint a table detailed the applicable interest rates for each loan,
Thus, the third factor favors AB7 and weighs against recharacterization.
"`If the expectation of repayment depends solely on the success of the borrower's business, the transaction has the appearance of a capital contribution.'"
AB7 argues that the loan agreements did not explicitly tie repayment to ABST's business success, and therefore this factor weighs against recharacterization. ABST argues that there was no other source for repayment available for repaying AB7's loans, aside from the earnings and success of ABST. Therefore, ABST concludes that repayment depended solely on ABST's economic success.
AB7 replies that the proper "question is not whether loans were in danger of not being repaid absent success of the business, but whether the lender specifically agreed to tie its right to repayment to such success, indicating an intent to be treated more like an equity owner."
AB7 misapprehends the holding of AutoStyle. The court in AutoStyle does not quote, or even cite, to a "specific provision [of the loan agreement] permitting repayment only out of corporate earnings."
AB7 next cites In re Franklin Equipment in its effort to support its creative proposition that this factor requires a specific provision in the loan agreement permitting repayment only out of corporate earnings.
Lastly, AB7 cites In re Exide Techs., Inc. for support of its specific provision theory.
Without more, AB7's theory is holding some water. However, in Exide, there were yet again two sources of repayment: (1) the earnings of the business and (2) the fully secured interests of the plaintiffs. Therefore, because more than one source of repayment existed, the credit agreement would have to specifically tie repayment to only corporate earnings; otherwise, multiple sources of repayment would exist and the expectation of repayment would not depend solely on the success of the borrower's business.
Unlike in each of those cases, ABST alleges there was one and only one source of repayment available here: the earnings and success of ABST. AB7 concedes that all loans were unsecured and has not suggested an alternative source of repayment existed.
Thus, the fourth factor favors ABST and weighs in favor of recharacterization.
"`Thin or inadequate capitalization is strong evidence that the advances are capital contributions rather than loans.'"
AB7 first argues that ABST failed to plead inadequate capital at the time any particular loan was advanced. Second, AB7 argues that this factor is not determinative.
The Court has already held that ABST has sufficiently pled that it was undercapitalized and insolvent from its inception. ABST also argues that inadequate capitalization is particularly relevant where, as here, advances come from an insider to a subsidiary with a history of unprofitability, where "the substance of the relationship represented a capital contribution designed to prop up the struggling subsidiary."
AB7 replies that undercapitalization is not determinative.
AB7's caution regarding the unhealthy deterrent effect is misplaced. In Hedged-Investments, the Tenth Circuit noted that it had previously rejected "the ... automatic subordination of insider loans [when the borrower corporation was badly undercapitalized] on the grounds that such a fixed rule would discourage owners' efforts to salvage a troubled business."
In fact, the language comes from a footnote that described the shift from "automatic subordination of insider loans [to a badly undercapitalized borrower]," which had previously been the standard for both equitable subordination and recharacterization (under In re Mid-Town Produce Terminal, Inc.)
The Hedged-Investments court shifted the recharacterization inquiry to a thirteen factor examination used in the Eleventh Circuit.
This factor favors ABST and weighs in favor of recharacterization.
"Another factor in the AutoStyle test is the identity of interest between the creditor and the stockholder. `If stockholders make advances in proportion to their respective stock ownership, an equity contribution is indicated. On the other hand, a sharply disproportionate ratio between a stockholder's percentage interest in stock and debt is indicative of bona fide debt. Where there is an exact correlation between the ownership interests of the equity holders and their proportionate share of the alleged loan this evidence
AB7 argues that this factor is probative of intent where there are numerous stockholders, but not in the context of a wholly owned subsidiary. AB7 argues that since "a sole shareholder always makes advances in proportion to its holdings, if this factor is given undue weight it could improperly deter a corporation's 100 percent owner from extending financing to a subsidiary in need."
ABST argues that an exact correlation exists between AB7's ownership interest and its proportionate share of the alleged loan. AB7 indirectly owned 100 percent of the equity of ABST and made 100 percent of the loans. Additionally, ABST argues that the identity of interest factor takes on particular importance where a parent company makes a cash advance to a struggling subsidiary.
AB7 replies, reiterating its argument that a sole shareholder necessarily makes advances in proportion to their equity ownership, and therefore reveals nothing about the parties' intent.
In cases of wholly owned subsidiaries, there is only an exact correlation between the ownership interest of the sole equity holder and the proportionate share of the alleged loan where the equity holder is also the sole lender. There could be numerous lenders involved together in making a single advance. Therefore, AB7's statement is not necessarily true.
Additionally, a parent of a wholly owned subsidiary often trades away control as additional shareholders or lenders join the fray. Where they choose to retain control (or whatever other benefits they see in sole equity ownership and sole lender status) they risk this factor weighing against them in a recharacterization claim.
Moreover, AB7's policy argument fails because it is equally applicable to situations involving numerous shareholders. For example, if this factor was applied to two equity shareholders who each own 50% of the company and contribute 50% of a $1 million loan ($500,000), they could argue that such a pro rata split made business sense, and that giving this factor undue weight in favor of recharacterization would deter a corporation's two fifty-percent owners from extending financing to a subsidiary in need.
ABST alleges an exact correlation between AB7's ownership interest and its proportionate share of the alleged loan, and further alleges that AB7's cash advances were made to a struggling subsidiary. Therefore, the sixth factor favors ABST and weighs in favor of recharacterization.
"Another factor in the AutoStyle test is the presence or absence of security for the advances made under the alleged debt. `The absence of a security for an advance is a strong indication that the advances were capital contributions rather than loans.'"
AB7 concedes that their loans were all completely unsecured. However, AB7 argues that "this factor should have no relevance here where ABST represented
However, the intent to honor a public representation is not mutually exclusive with the intent to make an equity contribution. AB7 cites no legal authority and there is no apparent underlying rationale for jumping to its conclusion.
The seventh factor favors ABST and weighs in favor of recharacterization.
"Yet another factor in the AutoStyle test is the debtor's ability to obtain outside financing. `When there is no evidence of other outside financing, the fact that no reasonable creditor would have acted in the same manner is strong evidence that the advances were capital contributions rather than loans.'"
AB7 argues that ABST failed to allege that any third parties denied ABST requested funding. AB7 misconstrues the inquiry factor this element requires. The proper question is not whether a third party denied ABST funding. As discussed in both Cold Harbor
ABST argues that no outside lender would provide equivalent funding under the same or similar terms that AB7 provided. ABST alleges that the low interest rates,
Of the facts alleged, the most persuasive fact is that AB7 used its own financial statements and precluded ABST from using its financials when dealing with trade creditors and anyone else inquiring about ABST's credit.
This eighth factor favors ABST and weighs in favor of recharacterization.
"Another factor in the AutoStyle test is the extent to which the payments to be made are subordinated to the claims of outside creditors. `Subordination of advances to claims of all other creditors indicates that the advances were capital contributions, not loans.'"
AB7 argues that ABST did not allege the subordination of advances to claims of other creditors. ABST responds that the absence of AB7's demand for payment indicates the obligations to AB7 were subordinated. ABST cites cases that state "the failure to demand repayment of any portion of the principal advances, in conjunction with the failure to charge interest on the advances ... effectively subordinated any existing rights ... for repayment.... This de facto subordination casts additional doubt on the original intention to assert the rights of a bona fide creditor."
AB7 argues that unlike in the cases cited by ABST, AB7 had documented loans, received interest payments, and eventually demanded principal repayment.
This factor favors ABST and weighs in favor of recharacterization.
"Another factor in the AutoStyle test is whether the advances were used to acquire capital assets. `Use of advances to meet the daily operating needs of the corporation, rather than to purchase capital assets, is indicative of bona fide indebtedness.'"
AB7 argues that "[w]hile the initial $23 million loan was advanced for purposes of acquiring the assets of the [R & S] Debtors, this factor should have little relevance where, as part of the same transaction, AB7 also infused $20 million in equity."
ABST emphasizes that the $23 Million Loan was used to purchase the R & S Plaintiffs' assets, which constitute capital assets.
The $23 million, $5 million, and $2 million advances described above allegedly were advanced for purposes of acquiring capital assets. It is of note that ABST does not allege that all advances were used to acquire capital assets. Therefore, this factor favors ABST and weighs in favor of recharacterization.
"Another factor in the AutoStyle test is the presence or absence of a sinking fund to provide repayments."
AB7 does not dispute that no sinking fund existed. Therefore, this factor favors ABST and weighs in favor of recharacterization.
"A factor discussed by the district court in Submicron is the presence or absence of voting rights."
ABST does not allege, nor do the loan agreements appear to grant AB7 rights to vote.
One additional consideration concerning to the court in Cold Harbor was "a troubling lack of formalities."
Applying this Court's decision in Friedman's, the Court is not to base its decision on a mechanical count of factors for and factors against recharacterization. "Rather, the Court is to use its evaluation of the above described factors to make its decision `through a common sense evaluation of the facts and circumstances surrounding a transaction.'"
ABST alleges that the loan obligations it incurred in favor of AB7 should be equitably subordinated to the unsecured claims against ABST
"The Bankruptcy Code provides that a court may `under principles of equitable subordination, subordinate for the purposes of distribution all or part of an allowed claim to all or part of another allowed claim.' Under the Mobile Steel framework,
Courts differentiate between insiders and outsiders when analyzing whether a claimant's conduct was inequitable. Indeed, `[t]he most important factor in determining if a claimant has engaged in inequitable conduct for the purposes of equitable subordination is whether the claimant was an insider or outsider in relation to the debtor at the time of the act.' An insider's conduct is `rigorously scrutinized,' and the plaintiff `bears the burden of presenting material evidence of unfair conduct that the insider claimant then must rebut by proving the fairness of his transactions with the debtor.' The rationale behind the heightened scrutiny of insider conduct is that:
`In circumstances where the plaintiff seeks to equitably subordinate the claim of a fiduciary or insider of the debtor who is also a creditor, the line between the defendant creditor and the debtor is often blurred. The insider creditor is typically in a position to exert control over the debtor. The creditor may also share common management and/or ownership with the debtor. In its efforts to collect its debt, therefore, the creditor may act directly or cause the debtor to act.'
`On the other hand, if the claimant is not an insider, then evidence of more egregious conduct such as fraud, spoliation or overreaching is necessary.'"
"A party may be found to constitute an `insider' for purposes of equitable subordination if the party either (i) meets the statutory definition of insider, or (ii)[is] in a close relationship with the debtor to such an extent as to suggest transactions were not conducted at arm's-length. ABST alleges that AB7 was an insider at all relevant times. AB7 has not disputed insider status. ABST was an indirect
Analyzing AB7 as an insider, AB7's conduct is rigorously scrutinized, and ABST "bears the burden of presenting material evidence of unfair conduct that the insider claimant then must rebut by proving the fairness of his transactions with the debtor."
Again, under the Mobile Steel framework, equitable subordination requires proof of three elements: (a) the defendant engaged in some type of inequitable conduct; (b) the misconduct caused injury to the creditors or conferred an unfair advantage on the defendant; and (c) equitable subordination of the claim is consistent with bankruptcy law. It is also of note that courts recognize that determining whether a creditor's claim should be subordinated is a fact-intensive inquiry which should not necessarily be determined on a motion to dismiss.
General categories of inequitable conduct include, but are not limited to, (i) fraud, illegality, and breach of fiduciary duties; (ii) undercapitalization; and (iii) claimant's use of the debtor as a mere instrumentality or alter ego.
ABST alleges the following constituted fraud, illegality and breach of fiduciary duties:
The bulk of these accusations including undercapitalization and alter ego, have already been discussed and generally favor denying the motion to dismiss. ABST's allegations of illegality under Bankruptcy Code sections 1125(a)(1) and 1129(a)(4), however, have not.
ABST argues that AB7 violated section 1125(a)(1) of the Code when it failed to provide sufficient information in the R & S Disclosure Statement and R & S Plan. AB7 responds that section 1125(a)(1) of the Bankruptcy Code requires sufficient information in the disclosure statement be provided by a plan proponent. AB7 argues that it was not a plan proponent and it neither drafted nor signed the disclosure statement.
Neither AB7 nor ABST cite legal authority regarding obligations under 1125(a)(1). That section of the Bankruptcy Code provides: (1) "adequate information" means information of a kind, and in sufficient detail, as far as is reasonably practicable ... that would enable ... a hypothetical investor of the relevant class to make an informed judgment about the plan...."
The Bankruptcy Code generally prohibits solicitation of an acceptance or rejection from the holder of a claim or interest prior to transmission of the "adequate information" described by § 1125(a)(1).
Plaintiffs also assert that AB7 violated section 1129(a)(4) of the Bankruptcy Code as the $23 Million Loan was not approved by the court. AB7 cites to the statute, the legislative history and court decisions in correctly arguing that section 1129(a)(4) only requires approval of payments made for professional services performed before plan confirmation.
Section 1129(a)(4) provides "(a) The court shall confirm a plan only if all of the following requirements are met: (4) Any payment made or to be made by the proponent, by the debtor, or by a person issuing securities or acquiring property under the plan,
The legislative history to section 1129 indicates that (a)(4) "requires that any payment made or promised by the proponent, the debtor, or person issuing securities or acquiring property under the plan, for services or for costs and expenses in, or in connection with, the case, or in connection with the plan and incident to the case, be disclosed to the court. In addition, any payment made before confirmation must have been reasonable, and any payment to be fixed after confirmation must be subject to the approval of the court as reasonable."
In In re Dallas Stars, L.P., an order was issued that addressed section 1129(a)(4), stating: "U. Payment for services or costs and expenses (11 U.S.C. § 1129(a)(4)). Any payment made or to be made by the Debtors for services or for costs and expenses of the Debtors' professionals in connection with their Chapter 11 Cases, or in connection with the Prepackaged Plan and incident to the Chapter 11 Cases, has been approved by, or is subject to the approval of, the Court as reasonable, thereby satisfying section 1129(a)(4) of the Bankruptcy Code."
Similarly, in In re Stations Holding Co.,
Thus, AB7 correctly concludes that ABST "misapplied Section 1129(a)(4), which requires approval of payments made for professional services performed before plan confirmation, where such payments are made or promised by the debtor, plan proponent, or persons acquiring property or issuing securities under the plan." As a result, ABST has failed to plead any misconduct under section 1129(a)(4).
Nonetheless, the remaining relevant factors support ABST and sufficiently plead that AB7 was engaged in inequitable misconduct.
AB7 argues that the loans it provided permitted ABST to continue functioning, make payments to Class 4 Creditors from the R & S Plan, and pay trade vendors who supplied ABST with inventory. Indeed AB7 argues that every dollar it advanced benefitted ABST at AB7's expense.
ABST alleges that:
These allegations are sufficient to allege harm and unfair advantage.
AB7 argues that as a general unsecured creditor, it should be treated as other general unsecured creditors, especially since all of the general unsecured creditors benefitted from AB7's overall course of conduct. ABST cites section 510(c) of the bankruptcy code for the principle that distribution of assets among similarly situated creditors should be equal. ABST alleges, however, that AB7 is not similarly situated with other general unsecured creditors, however, because it engaged in inequitable unfair conduct that caused harm.
ABST is correct and it has sufficiently pled that equitable subordination would be consistent with the bankruptcy law.
ABST satisfies all three parts of the Mobile Steel test. Therefore, the claim for equitable subordination should not be dismissed. However, sections 1129(a)(4) and 1125(a)(1) are not grounds that support ABST's claim for equitable subordination. The Court will deny the Motion to Dismiss Count Nine (but notes that sections 1129(a)(4) and 1125(a)(1) allegations are unfounded).
The Plaintiffs allege that AB7 was bound by and breached the R & S Plan and R & S Confirmation Order. AB7 argues that it is not bound and, therefore, could not be in breach.
Specifically, AB7 argues it was "not a party to the R & S Plan, did not sign the R & S Disclosure Statement, and is not alleged to have drafted or actively negotiated either document — only to have reviewed them, through counsel, and not objected.... [I]t is not enough to make them `parties' to the documents for contract purposes."
AB7, through its attorney Antonoff, was an active participant in developing the R & S Confirmation Order.
Plaintiffs have sufficiently pled that AB7 was bound to the R & S Plan and R & S Confirmation Order.
In ¶ 20 of the R & S Confirmation Order, Judge Winfield ordered that "[o]n or prior to the Effective Date, Autobacs [AB7] will make a capital contribution to Autobacs/Strauss [ABST] in an amount sufficient to pay the foregoing cash portion of the purchase price plus $10 million of working capital."
Tracking the language of the R & S Confirmation Order, Plaintiffs equate the term "capital contribution" to equity-based financing and assert that a capital contribution cannot be made using debt-based financing. They contend that the "cash portion of the purchase price" due was $27,878,470. Adding together the $27,878,470 cash portion of the purchase price and the $10,000,000 in working capital, the Plaintiffs conclude that, under the express terms of the Confirmation Order, AB7 was required to make a capital contribution to ABST, on or before the Effective Date, in the amount of $37,878,470. Instead, AB7 only provided $20 million in equity-based financing on or before the Effective Date. Therefore, the Plaintiffs conclude that AB7 breached the R & S Plan when it failed to timely provide the difference of $17,878,470 in equity-based financing.
AB7 disputes the meaning of the term "capital contribution." Specifically, AB7 argues that the required "capital contribution" could be made using equity or debt. AB7 concedes that it contributed $20 million in equity and $23 million in debt on or before the effective date, but argues that it thereby provided its required "capital contribution" in full.
In support of this interpretation of "capital contribution," AB7 cites the definition of "capital contribution" found in Black's Law Dictionary: "Funds made available by a shareholder, usu. without an increase in stock holdings."
The Plaintiffs respond by arguing that the definition of the term "contributed capital,"
Turning first to the usage of the term in finance and accounting, the Plaintiffs cite the Dictionary of Finance and Investment Terms, which defines "contributed capital" as "payments made in cash or property to a corporation by its stockholders either to buy capital stock, to pay an assessment on the capital stock, or as a gift."
The Plaintiffs next turn to extensive case law to show that loans and debt are distinct from equity and capital contributions. Numerous cases set up a disjunctive either/or test to determine whether certain financial advances constitute capital contributions on the one hand, or, alternatively, loans. For example, one Supreme Court case held, "[a] corporation must derive its funds from three sources: capital contributions, loans, and profits from operations.... We need not decide whether the funds supplied to petitions ... were capital contributions rather than loans."
The Plaintiffs also cite many binding cases from the Third Circuit that categorically treat financing as a loan (debt) or a capital contribution (equity) in a mutually exclusive way. In In re SubMicron Sys. Corp.,
Based on the foregoing case law and definitional usage of the term "capital contribution," it is at least plausible that use of the term "capital contribution" may have excluded debt. Furthermore, the Plaintiffs assert that, to clear any ambiguity,
AB7 argues that the "unexplained reference to a `capital contribution' [in the R & S Confirmation Order] cannot be deemed to change a fundamental term of the [R & S APA] absent any allegation of a new agreement."
AB7's position assumes that the R & S APA is not informed by the other R & S Plan-related documents (or otherwise) in a way that would require AB7 to use equity rather than debt.
AB7 also argues that the R & S APA controls AB7's obligations. This is distinct from AB7's argument that it is not bound by the R & S Plan-related arguments. Here, AB7 argues that even if it were so bound, it only participated in negotiating and signing the R & S APA, so primacy should be given to that document (the R & S APA) over the R & S Plan and the R & S Disclosure Statement. They must also mean to argue that R & S APA should be given primacy over the R & S Confirmation Order, because of the language in ¶ 20 of the R & S Confirmation Order. AB7 points out that the R & S Confirmation Order provides that the R & S APA "... and the transactions contemplated thereby are hereby approved in all respects."
AB7 is incorrect that the R & S Confirmation Order needs to "explain" its reference to the term "capital contribution," especially merely to survive the Motion to Dismiss.
The R & S APA provides that "[AB7] specifically agrees, for the benefit of Seller and its creditors, to provide Buyer with the funds up to the total amount set forth on Schedule 4, provided, however, that the aggregate amount provided by
The Plaintiffs argue that AB7 breached the R & S APA by failing to fund the total amount listed in Schedule 4 has equity. AB7 concedes that the R & S APA required the use of equity to fund a $10 million investment for working capital. Beyond that $10 million, AB7 argues that the R & S APA was silent as to how AB7 would fund the closing payments enumerated in Schedule 4. Therefore, AB7 concludes, the silence permitted AB7 to fund the Schedule 4 payments with equity or debt, or a combination of both.
The Plaintiffs concede that the R & S APA does not explicitly state on its face, taken alone, that AB7 must provide the entire total amount in Schedule 4 in the form of equity. However, the Plaintiffs contend that in the context of the R & S Plan-related documents, it becomes clear that the R & S APA required the use of equity to fund the total amount from Schedule 4.
AB7 argues that while extrinsic evidence can be used to interpret an ambiguous contract, even New Jersey's "expansive" view of the parol evidence rule bars a party from relying on extrinsic evidence to alter the terms of the contract.
AB7 cites Crystal Palace Gambling Hall, Inc. v. Mark Twain Indus., Inc.
In Crystal Palace, three out of four of the documents were consistent with one another, but the fourth was inconsistent. The court in Crystal Palace stated that "[a]lthough there is a conflict in the terms of several of the documents ... three of the four documents that discuss this matter... the purchase agreement, the confirmation order ... and ... the plan of reorganization, all indicate that the transaction was supposed to [occur in a particular time frame]."
While the R & S Plan-related documents explicitly require a "capital contribution," the R & S APA does not. Similar to Crystal Palace, the case before this Court involves a potential conflict between documents that may give rise to a potential
Regardless, whereas Crystal Palace found "strong support" of intent by comparing multiple documents against each other and searching for consistency, this court need only find it plausible that the R & S APA required a "capital contribution," in light of the surrounding documents. Although the analysis is not purely numerical, three of the four relevant documents in this case explicitly require a capital contribution.
Therefore, the Plaintiffs sufficiently plead a breach of the R & S APA in light of the surrounding documents. Moreover, because the inconsistency gives rise to ambiguity, extrinsic evidence should be allowed to interpret the R & S APA.
R & S Plaintiffs allege that the Defendants fraudulently induced: (i) the R & S Plaintiffs to vote in favor of the plan in the second Chapter 11 case; and (ii) the New Jersey Bankruptcy Court to approve confirmation of that plan.
Plaintiffs' allegations in support of its claim of fraudulent inducement must meet the Rule 9(b) heightened pleading requirements, stating "with particularity the circumstances constituting fraud...."
Under New Jersey law, Plaintiffs must allege five elements to plead common law fraud: (i) a material misrepresentation of a presently existing or past fact; (ii) knowledge or belief by the defendant of the fact's falsity; (iii) an intention that the other person rely on the material misrepresentation; (iv) reasonable reliance thereon; and (v) resulting damages.
The R & S Plaintiffs allege there were five separate material misrepresentations made by AB7.
First, the R & S Plaintiffs allege (wait for it) that AB7 repeatedly represented that it would fund the majority of the cash portion of the purchase price of the R & S Plaintiffs' assets through capital contributions (equity). Nonetheless on February 26, 2007, AB7 held a board of directors'
Plaintiffs identify a number of specific occasions where AB7 misrepresented that the funding will be by capital contribution. For example, ABST alleges that: "(a) During negotiations on the proposed R & S Plan, in or about January 2007, AB7 and Takenaka Partners, through Kim and Takenaka, represented to the principals of R & S Parts and Service, who, acting as the conduit for AB7's information, stated to counsel to the R & S Creditors Committee that the Strauss Discount Auto Purchase would be a full equity deal with the purchase price being funded by capital contributions rather than debt."
This representation was made to the "R & S Principals," which is not the defined term in the Complaint
It is unclear who the relevant principals in or about January 2007 were. Therefore, who made the misrepresentation and the general content of the misrepresentation are properly plead, but "to whom" is not properly plead with the particularity required by Rule 9(b).
Regarding the fact that this was an oral misrepresentations, AB7 argues that the R & S Plaintiffs could not have reasonably relied on it (or any other oral statements) because the R & S APA had an integration clause. For this proposition, AB7 cites two cases, Winoka Vill., Inc. v. Tate
AB7 quotes Winoka Vill. for the proposition that "alleged oral misrepresentations, being contradictory of the undertakings expressly dealt with [in] writing[], are not effectual."
Second, the R & S Plaintiffs identify the Disclosure Statement and R & S Plan as containing misrepresentations effected by AB7. For example, "(b) Exhibit A to the R & S Disclosure Statement that was circulated to all the participants in the R & S Bankruptcy Case was the form of the proposed R & S Plan." The proposed R & S Plan contained the language that "[o]n or prior to the Effective Date, [AB7] will make a capital contribution to Autobacs/Strauss in an amount sufficient to pay the foregoing cash portion of the purchase price plus $10 million of working capital." The R & S Plaintiffs allege that "[b]y agreeing to that language in connection with the R & S Plan, Defendants falsely represented that their intention was to fund the acquisition solely through equity, when, in fact, the AB7 board of directors had already approved" a $23 million loan and other loans "as the mechanism for funding most of the purchase price."
AB7 argues that the R & S Plaintiffs failed to allege that
Third, ABST alleges that "(c) For the same reasons, Defendants falsely represented their intent by agreeing to language at page 38 of the R & S Disclosure Statement that AB7 `will make a capital contribution ... in an amount sufficient to pay the foregoing cash portion of the purchase price....'"
Fourth, ABST alleges "(d) On behalf of AB7, Kim drafted a Three-Year Projection
AB7 argues that the Three-Year Projection prepared by Kim was not a representation that ABST would have no debt.
Fifth, ABST alleges "(e) Takenaka falsely testified on behalf of AB7 and Takenaka Partners at the R & S Confirmation Hearing on April 25, 2007, that `AB7 and ABST' had `no current intention ... to encumber [sic] the assets' and that neither `he nor AB7 is aware of any other
AB7 argues that the "general statement to the New Jersey Bankruptcy Court that he and AB7 were not aware of `any other arrangement involving AB7 and ABST' was not rendered inaccurate (much less fraudulent) simply because AB7 had internally authorized eventual loans to ABST.... The funding approval was merely a ministerial detail of a fully disclosed transaction, not a separate `agreement' requiring disclosure. The AB7 board's February 26, 2007, internal authorization does not evidence an `agreement' with ABST, which was not even created until March 8, 2007."
AB7 said it was unaware of "any other arrangement." "Arrangement" clearly includes preparation. The R & S Plaintiffs alleged that AB7 represented that it was unaware of any other arrangements, besides those disclosed to the New Jersey Court. The New Jersey Court had not been told of the arrangement made by the board of directors, in preparation for lending $23 million to ABST. This clearly constitutes a misrepresentation of a presently existing fact.
ABST also argues that the above representatives were false and misleading in failing to disclose that, by virtue of the $23 Million loan obligation, ABST would be insolvent under the Bankruptcy Code from its inception."
The R & S Plaintiffs also allege that AB7 represented that it would stabilize and strengthen ABST. Specifically, Takenaka proffered that AB7's "business plan for [ABST] is to stabilize the business during the next several months for upwards of 12 months...."
As described above, on February 26, 2007, AB7 held a board of directors' meeting, where the directors approved a funding plan for the R & S APA limited to $20 million in equity. The board-approved funding plan provided for the difference between the Schedule 4 total ($38,919,235) and $20 million to be funded with debt.
AB7 argues that Plaintiffs could not reasonably have relied on any oral representations made during R & S APA negotiations because of the R & S APA's integration clause. AB7 finds the R & S APA clear and unambiguous. However, in light
Plaintiffs allege that as a result of the misrepresentations, creditors (whose interests are now represented by the R & S Plaintiffs) agreed to the R & S Plan, voting for its confirmation. Plaintiffs also allege that the R & S Plaintiffs are owed $8,140,496.67, which is the amount still due under the R & S Plan. Furthermore, Plaintiffs seek compensatory as well as punitive damages. These allegations are sufficient to survive the Motion to Dismiss.
Yamada, Takeda, and Kojima argue correctly that no specific statements, i.e., misrepresentations, are attributed to them. Therefore, the Motion to Dismiss Count Thirteen against Yamada, Takeda, and Kojima in their individual capacity will be dismissed.
Leave to replead is "freely given when justice so requires" and denied when futile.
The Motion to Dismiss the claims against Yamada, Takeda, and Kojima will be granted. The Motion to Dismiss the remaining claims under Count Thirteen will be denied, provided, however, that the motion to dismiss the alleged misrepresentations made to "R & S Principals" will be granted provided however, that the R & S plaintiffs have leave to replead the definition of "R & S Principals."
In Count Fourteen, ABST seeks to disallow AB7's general unsecured claim against ABST because the loans which provide the basis for the claim should be recharacterized as an equity investment.
Count Fourteen is tied to Count Eight: Recharacterization of Debt to Equity. As this Court is not dismissing Count Eight, the Motion to Dismiss Count Fourteen will be denied.
In Count Fifteen ABST seeks to disallow AB7's Proof of Claim to pursuant to Bankruptcy Code § 502(d) based on underlying avoidable transfer claims. Those claims are addressed in Counts Three, Four, and Five. The Court has denied the Motion to Dismiss Counts Three and Five and granted the Motion to Dismiss Count Four However, because Count Three and Count Four overlap somewhat the Court will deny the Motion to Dismiss with respect to Count Fifteen in whole.
"In order for a defendant to be subject to liability for punitive damages, his conduct must be `willful and wantonly reckless or malicious.'"
For the foregoing reasons, the Court will grant in part and deny in part Defendants' Motion to Dismiss and Takenaka's Motion. More specifically:
The Court will enter an order.
