DUNCAN W. KEIR, Bankruptcy Judge.
Before the court is the Defendants' Joint Motion to Dismiss First Amended Complaint (the "Motion to Dismiss"). Defendants filed a joint Motion to Dismiss
The court finds that it has jurisdiction over this matter pursuant to 28 U.S.C. § 1334.
Plaintiff is the Chapter 11 Trustee for four related Debtor entities (i) TMST, Inc. f/k/a Thornburg Mortgage, Inc. ("TMST"), (ii) TMST Home Loans, Inc. f/k/a Thornburg Mortgage Home Loans, Inc. ("TMHL"); (iii) TMST Hedging Strategies, Inc. f/k/a Thornburg Mortgage Hedging Strategies, Inc., and (iv) TMST Acquisition Subsidiary, Inc. f/k/a Thornburg Acquisition Subsidiary, Inc. (collectively, "Debtors"). The Debtor entities filed bankruptcy under chapter 11 of the Bankruptcy Code on May 1, 2009 (the "Petition Date"). Prior to filing, the Debtors' business consisted of several entities, TMST being the largest and only publically traded entity
At the outset of the bankruptcy cases, Debtors acted as debtors in possession with the rights and powers so provided by Section 1107(a). Upon motion to appoint chapter 11 trustee filed by the United States Trustee and after a trial thereupon, the court ordered the appointment of a Chapter 11 trustee. Joel Sher was appointed chapter 11 trustee on October 28, 2009 in the bankruptcy cases of all related Debtors, except for Adfitech (for which the request had been voluntarily withdrawn by the United States Trustee).
The adversary proceeding now before the court was initiated by the filing of a 21-count complaint on April 30, 2011,
In the lengthy complaint Plaintiff outlines a series of events involving the Debtors and Defendants leading first to the execution of restructuring agreements, then to releases, forbearance agreements and eventually to the Debtors' chapter 11 bankruptcy filings.
The Amended Complaint alleges the following. TMST financed its acquisition of mortgage backed securities ("MBS") by entering into financing agreements with investment and securities firms.
TMST's primary source of income derived from the net of the interest income earned on the MBS and the costs of the repurchase transactions.
Under the repurchase agreements TMST retained the beneficial economic ownership of the MBS including the right to receive the principal and interest collected on the mortgages underlying the MBS.
TMHL was in the business of originating, acquiring, securitizing and servicing residential mortgage loans.
Beginning in 2008 one or more of the Defendants, citing a sudden decline in value
On February 28, 2008 prior to the markets opening, TMST issued its 2007 10-K.
TMST began negotiations with Defendants to restructure its debts during the second week of March 2008 under the pressure of continuing margin calls.
Despite the additional capital raised and the respite period envisioned by the Override Agreement, Debtors continued to experience liquidity deficiencies due to the Defendants' downgrades of the MBS.
During the following months, Plaintiff alleges that Defendants continued to make aggressive margin calls. As TMST began to dispute the Defendants' rights to both haircuts and margin payments, Plaintiff alleges that Defendants threatened liquidation and demanded additional payments from the liquidation fund.
On December 12, 2008, TMST, TMHL, TMHS and Defendants entered into an Amended and Restated Override Agreement (the "Amended Override Agreement").
Following the execution of the Amended Override Agreement, Debtors and Defendants negotiated an extension of the March 16, 2009 maturity date while discussing the Debtors' longterm restructuring plans. During the time period of these discussions, Debtors allege that some Defendants (Citi and UBS) continued to take a position of refusal regarding any extension in what Debtors describe as an exercise of "leverage and control" over Debtors.
In the last week of March 2009 and under pressure from Defendants allegedly threatening to terminate their agreements with Debtors and exercise their rights in collateral, Debtors made a public disclosure that they would be filing Chapter 11 bankruptcy cases.
The Amended Complaint seeks (A) avoidance under Section 548(a)(1)(B) (constructive fraud) of the Override Agreement and Amended Override Agreement and transfers associated therewith (Counts 1, 9, 2, and 11, respectively), March Forbearance Agreements (Count 17), and Second Releases (Count 21) (collectively, the "Bankruptcy Code Constructive Fraud Counts"); (B) avoidance under Section 544(b) and state law constructive fraud of the Override Agreement and Amended Override Agreement and transfers associated therewith (Counts 4, 13, 5, and 15, respectively), March Forbearance Agreements (Count 19) and Second Releases (Count 23) (collectively, the "State Law Constructive Fraud Counts"); (C) avoidance under Section 548(a)(1)(A)(actual fraud) of the Override Agreement transfers (Count 3) and Amended Override Agreement and transfers associated therewith (Counts 8 and 10, respectively), March Forbearance Agreements (Count 16), and Second Releases (Count 20) (collectively, the "Bankruptcy Law Actual Fraud Counts"); (D) avoidance under Section 544(b) and state law actual fraud of the Override Agreement Transfers (Count 6), Amended Override Agreement and related transfers (Counts 12 and 14, respectively), March Forbearance Agreements (Count 18) and Second Releases (Count 22) (collectively the "State Law Actual Fraud Counts"); (E) avoidance as preferential transfers under Section 547(b) of the Override Agreement Transfers (Count 24), the Amended Override Agreement Transfers (Count 25) and Second Releases (Count 26) (collectively the "Preference Counts"); (F) Breach of the Override Agreement under state law (Count 7) (the "Override Breach Count"); (G) Breach of the Repurchase Agreements and Turnover (Count 27) (the "Breach of Repurchase Agreement Count"); (H) rescission of named agreements due to duress and/or coercion (Count 28) (the "Duress Count"); (I) equitable
The Bankruptcy Law Constructive Fraud Counts seek avoidance pursuant to Section 548(a)(1)(B) of the Override Agreement and the Amended Override Agreement, transfers made pursuant to those two agreements, the Forbearance Agreement, and the Second Releases. Defendants initially argue that all the Bankruptcy Law Constructive Fraud Counts must be dismissed because the transactions sought to be avoided are protected transactions under the safe harbor provisions of Section 546. Defendants contend that dismissal at this early stage of the case and before discovery is appropriate and necessary to promote the purposes of the safe harbor provisions in creating market stability.
Section 548(a)(1)(B) sets forth the grounds for avoidance under the bankruptcy laws for constructively fraudulent transfers. It provides:
First the court addresses the defense raised under the safe harbor provisions of Section 546. Defendants argue that as to the Bankruptcy Law Fraudulent Conveyance Counts, any and all transfers made under the various agreements are protected from the reach of Section 548(a)(1)(B) by the safe harbors provided under Section 546(e)(g).
The Section 546 safe harbors provide as follows:
These safe harbor provisions require that transfers otherwise avoidable as constructively fraudulent under Section 548(a)(1)(B) or state law (applying Section 544)
Defendants argue that the agreements between the parties fit squarely within the definitions provided by the Bankruptcy Code and emphasize that case law supports a finding that the safe harbor provisions are to be interpreted broadly. Plaintiff defends against application of the safe harbor provisions by arguing that the swap agreements were never true swap agreements and although at one point in time the original Master Purchase Agreements may have qualified under the Bankruptcy Code's definition of repurchase agreement, the subsequent agreements and transactions between the parties were so contrary to the original agreements that they lost all indicia of being protected transfers. In response to the Plaintiff's argument that the safe harbor provisions would not apply because the original nature of the agreements was transformed by subsequent conduct, Defendants argue both factually that the agreements did not transform and legally that in applying the safe harbor provisions the court need only consider the original agreement and whether it qualifies under the applicable definition.
The court finds that the Bankruptcy Law Constructive Fraud Counts must be dismissed pursuant to Section 546(e), (f) and (g). Each of the agreements, transfers and parties qualify under one or more of the safe harbor provisions.
Case law is replete with descriptions of the purpose of the safe harbor provisions in promoting stability in the financial markets. See e.g., In re National Gas Distributors, LLC, 556 F.3d 247, 252-53 (4th Cir. 2009); Kaiser Steel Corp. v. Charles Schwab & Co., Inc., 913 F.2d 846, 849 (10th Cir.1990) (quoting H.R. Rep. 97-420, at 2 (1982), 1982 U.S.C.C.A.N. 583). In furtherance of this stated purpose of protecting markets as opposed to merely certain agreements, Congress provided in Section 546(e)-(g) broad, inclusive provisions describing the protected transactions and the definitions of certain terms provided in the safe harbor provisions are defined in Section 101 and are themselves expansive.
In their Motion to Dismiss, Defendants contend that all subject transfers were made by or to each Defendant and that each of them meets the definition of either "repo participant" or "swap participant" as required in assuming the safe harbor protections of Section 546(f) and (g). Those terms are defined in Sections 101(46)
Having found that each of the Defendants qualifies under the definition of the types of entities intended to be protected by the safe harbor provisions, the court turns to the determination of whether each of the transfers was the type of payment specified or was made in connection with the type of contract included within the safe harbor provisions. Defendants argue that each transfer qualifies and was "in connection with" a repurchase agreement (Section 546(f)), a swap agreement (Section 546(g)), or a securities contract (Section 546(e)).
As to the payments made pursuant to the Override Agreement on account of and to Defendants holding debt arising from repurchase transactions referred to in the Amended Complaint,
Section 101(47) (in applicable part) provides the definition of "repurchase agreement" (and reverse repurchase agreements) as follows:
In Bevill, Bresler & Schulman Asset Mgmt. Corp. v. Spencer S & L Ass'n, 878 F.2d 742 (3d Cir.1989), the United States Court of Appeals for the Third Circuit described a two part inquiry as to whether an agreement was a standard repurchase or reverse-repurchase agreement under the Section 101 definition. The court wrote:
Id. at 743. See also American Home Mortgage Inv. Corp. v. Lehman Bros. Inc. (In re American Home Mortgage, Holdings, Inc.), 388 B.R. 69, 77-78 (Bankr. D.Del.2008). Applying this Bevill analysis, the court finds that the Master Repurchase Agreements entered into between Debtors and Defendants herein created repurchase and reverse-repurchase agreements as contemplated under the bankruptcy safe harbor protections.
Plaintiff does not contend that the Master Repurchase Agreements were not repurchase agreements as described by the bankruptcy statute. However, Plaintiff argues that the subsequent agreements between the parties transformed the initial agreements in such a way as to remove them from the definition of repurchase agreements, thus eliminating the safe harbor protections. For example, citing Section 101(47) and the requirement that repurchase transaction be completed not later than a year from the purchase date, Plaintiff points to the sections in the Override Agreement, Amended Override Agreement and March Forbearance Agreements which extended the maturity dates beyond the one-year date set forth in the original agreements.
Ultimately, because the court finds the original agreements to be repurchase agreements and finds a solid nexus between the workout agreements and the original agreements, each of the challenged transfers meets the definition and intention of being "in connection with" a repurchase agreement. See Securities Inv. Protection Corp. v. Bernard L. Madoff Inv. Securities, LLC (In re Madoff), 505 B.R. 135, 144 (S.D.N.Y.2013) (finding the language "in connection with" in Section 546(g) should be given a broad interpretation of being "related to such an agreement.").
Plaintiff does not renew the transformation argument with respect to the swap agreements with Defendants RBS PLC, Greenwich Capital and CSI, but instead argues that the swap agreements (and reverse swap agreements) never met the
Section 101(53B) sets forth the definition:
The term "swap agreement" —
The definition itself contains broad language ("any agreement or transaction that is similar to any other agreement or transaction referred to in this paragraph") as recognized by the Court in In re National Gas Distributors, LLC, 556 F.3d at 253. That court explained that "[t]he current definition of `swap agreement' is now extremely broad, covering several dozen enumerated contracts and transactions, as well as combinations of them, options on them, and similar contracts or transactions." Id.
The agreements at issue in this case require cash payments to be exchanged between the parties based upon an index calculation.
Madoff, 505 B.R. at 138 fn. 1 (citation omitted).
Plaintiff argues that the back-to-back nature of the swap transactions require a finding that they were not true swap agreements and were mere credit support. The court does not find that the Plaintiff's argument is persuasive. The agreements followed the customary ISDA forms and contained the characteristics common with swaps. The Plaintiff's challenge based on his characterization of the purpose of the swaps as credit support does not remove the transactions from the definition provided in the Bankruptcy Code or the protections provided those transactions. Indeed, as held by the Madoff court, infusing an analysis of the debtor's intent into the determination of whether a transaction qualifies for safe harbor
The court further finds that the Bankruptcy Law Constructive Fraud Counts are subject to dismissal based on the Defendants' alternative ground of failure to adequately state a cause of action under Federal Rule of Civil Procedure 12(b)(6),
Id. at 545, 127 S.Ct. at 1964-65 (citations omitted). The Court further elaborated in Ashcroft v. Iqbal, 556 U.S. 662, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) that the review of a complaint upon a motion to dismiss for failure to state a cause of action is "context-specific" and acknowledged that courts must use their "judicial experience and common sense...." Id. at 679, 129 S.Ct. at 1950.
Counts 1 and 9 of the Amended Complaint are distinguishable from the other Bankruptcy Constructive Fraud Counts because Plaintiff seeks avoidance of the Override Agreement and Amended Override Agreement (as opposed to the transfers thereunder). Plaintiff avers that each of the agreements represents an incurrence of obligation that is avoidable under Sections 548(a)(1)(B) and 550 of the Code. These Counts do not attempt to avoid any particular undertaking by Debtors under the agreements as an obligation for purposes of the application of the avoidance statute but instead attempt to broadly label the entire agreement as "obligations."
Although both "transfers" and "obligations" are expressly avoidable under Section 548, the Bankruptcy Code only provides a definition for "transfers." The statute reads:
The term "transfer" means —
11 U.S.C. § 101(54). See also MacMenamin's Grill Ltd. v. Mooney, et al. (In re MacMenamin's Grill Ltd.), 450 B.R. 414, 429 (Bankr.S.D.N.Y.2011). The effect of a transfer of a debtor's interest in property is a depletion of the assets of the debtor, where there is no receipt by the debtor of reasonable equivalent value. The effect of an obligation incurred by a debtor is to increase the liabilities and hence potential claims against the assets of the debtor thus diluting the recovery opportunities of other claims, unless the debtor receives reasonably equivalent value. The word "obligation" does not apply so broadly as to include any agreement entered into that does neither.
The attempt by Plaintiff to exclude the agreements from the safe harbor provisions and as a remedy, in effect, tear up the Override Agreement and Amended Override Agreement by labeling the whole as an incurrence of an "obligation" as the term appears in Section 548(a)(1)(B) is not supportable under the statute offered by Plaintiff for that purpose. The court finds
Furthermore, by Counts 2 and 11 Plaintiff argues that Section 548(a)(1)(B) requires avoidance of enumerated payments made to the Defendants based on an assertion that due to the Override Agreement Transfers and Amended Override Agreement Transfers Debtors were insolvent, left with insufficient capital, and left without sufficient liquidity to pay debts incurred or intended to be incurred. Plaintiff further avers that Debtors did not receive reasonably equivalent value for the transfers. This last (and legally essential) averment is challenged by Defendants. They argue that the payments made in accordance with the Override Agreement and Amended Override Agreement were on account of antecedent debts and the reduction of those debts by application of the payments received constitutes reasonably equivalent value as a matter of law.
Plaintiff disputes that statement of law, citing Official Comm. of Unsecured Creditors v. Wachovia Bank (In re Heilig-Meyers Co.), 297 B.R. 46, 52 (Bankr. E.D.Va.2003), and further argues that the margin calls which precipitated the Override Agreement and payments made thereunder were wrongfully demanded by Defendants. Plaintiff does not aver in the Amended Complaint that the payments were not applied to the indebtedness arising from the financing transactions and repayment/repurchase obligations incurred by Debtors. The Plaintiff's assertion of wrongful margin calls appears to allege that the demands for partial pay down or further securitizations were wrongful demands based on the method of valuing the underlying securities and not diversion of the payments to other than repayment of obligations outstanding. The court finds that to the extent the transfers asserted to be avoidable under Section 548(a)(1)(B) as constructive fraudulent transfers reduced debts owed by Debtors under the various financing arrangements preexisting the Override Agreement, the constructive fraud counts would fail even if not protected by the safe harbor provisions.
In summary, the court finds that all Bankruptcy Law Constructive Fraud Counts must be dismissed because each and every transfer alleged in these counts is protected by the safe harbor protections of Section 546(e)-(g) and further as to Counts 1, 2, 9 and 11, that they fail to state a cause of action.
Defendants seek dismissal of the State Law Constructive Fraud Counts based on the safe harbor provisions of Section 546 and for a failure to state a cause of action as to Counts 4, 5, and 15. The court's analysis regarding the applicability of the safe harbor provisions to the Bankruptcy Law Constructive Fraud Counts
Because Section 546 does not provide a safe harbor from transactions otherwise avoidable under Section 548 due to actual fraud, the grounds for dismissal raised by Defendants for the Bankruptcy Law Actual Fraud Counts are based solely on their contention that Plaintiff has failed to allege the requisite fraudulent intent and the lack of requisite badges of fraud.
Section 548(a)(1)(A) sets forth the grounds for avoidance of a transfer
For each count brought pursuant to Section 548(a)(1)(A) in the Amended Complaint, Plaintiff states that the transfers were made with an actual intent to hinder, delay and/or defraud the Debtors' creditors and that the intent can be "inferred from, among other things, the traditional badges of fraud surrounding the Debtors' entry into the [Agreement]." Plaintiff alleges that Defendants caused Debtors to enter into the underlying transactions and effectuate the transfers and that Defendants exercised dominance or control over Debtors to the detriment of the Debtors' other creditors.
Defendants argue that the court must dismiss the actual fraud counts because the Plaintiff's use of imputation of intent to defraud is not adequately pled because it fails to rise to the level of control necessary to meet the dismissal standard. The court disagrees. The Amended Complaint contains repeated allegations that Defendants individually and collectively dominated and controlled the Debtors' resources and disposition of assets. The court finds that with the exception of Count 8,
Defendants seek dismissal of the five State Law Actual Fraud Counts based upon their argument that the safe harbor provisions extend even to actual fraud counts brought under State law by Section 544(b) and that only avoidance actions based on actual fraud brought pursuant to Section 548(a)(1)(A) are excluded from the safe harbor protections. Defendants further argue that the State Law Actual Fraud Counts should be dismissed because Plaintiff has failed to sufficiently allege the requisite fraudulent intent and badges of fraud.
The court agrees with the Defendants' argument that the safe harbors in Section 546 prevent avoidance actions based on state law actual fraud claims. The plain language of the Section 546(e)-(g) safe harbors include actions brought pursuant to Section 544.
In Count 24, Plaintiff seeks to avoid as preferential transfers, payments made to named defendants within one year prior to the Petition Date pursuant to Section 547. Plaintiff alleges that these transfers, listed in paragraph 406 of Amended Complaint, were made pursuant to the terms of the Override Agreement. Plaintiff alleges that because the recipient Defendants were insiders of the Debtors as defined in Section 101(31), the transfers that occurred outside the 90-day period immediately prior to the Petition Date are also avoidable. Similarly in Counts 25 and 26, Plaintiff seeks to avoid transfers made pursuant to the Amended Override Agreement (Count 25) and the Second Releases (Count 26) upon the same asserted application of Section 547.
In the Motion to Dismiss Defendants argue that these preference avoidance counts must be dismissed by reason of the application of any of several stated defenses. Defendants assert that the complained of transfers are protected against avoidance by the safe harbor provisions under Section 546. In addition, Defendants state that the facts asserted in the Amended Complaint fail to state a claim because the pleaded facts are insufficient to support a finding that the Defendants were insiders of the Debtors at the time of the transfer. Defendants also argue that the Amended Complaint fails to allege facts that would satisfy the requirements of Section 547(b)(5).
As to the Defendants' arguments concerning the allegation of insider and of
Count 7 is the Plaintiff's cause of action for breach of the Override Agreement. The pleaded facts include allegations that Defendants breached agreements contained in the Override Agreement to remit 80% of interest from the MBS and instead impounded 100% of those funds for their own benefit.
Defendants, in the Motion to Dismiss, argue that this court must dismiss this count as a matter of law based upon releases contained in the subsequently executed Amended Override Agreement, March Forbearance Agreements and a Termination and Purchase Agreement. Defendants also argue that Count 7 is barred by the alleged ratification by TMST arising from its execution of the Amended Override Agreement, that TMST waived any asserted cause of action for breach, and that any such action is barred as a result of the court's February 22, 2012 ruling in Credit Suisse Securities (USA) LLC v. TMST, Inc. (f/k/a Thornburg Mortgage, Inc.), et al, Adversary Proceeding Case No. 09-574.
The Amended Override Agreement and some of the Forbearance Agreements contain general releases which if enforceable would bar the Plaintiff's action for breach of the Override Agreement. However, in Counts 10 and 16, Plaintiff seeks to avoid transfers that occurred under the Amended Override Agreement and the Forbearance Agreements upon an allegation that those agreements were the result of actual fraud. Releases of a cause of action can effectuate a transfer of the cause of action to the benefit of the released party. Thus, if Plaintiff succeeds in proving his actual fraud based avoidance, the releases will not be enforceable.
In addition, the Plaintiff's allegations include assertions that Defendants acted in bad faith and with intent to destroy TMST. If the agreements containing the releases were entered into by Defendants with the actual intent (of Defendants) to not fulfill obligations imposed upon the Defendants, such may invalidate the releases as having been obtained through fraudulent misrepresentation.
The court finds that collateral estoppel does not bar this Count. The ruling to which Defendants cite was not upon the same issue but rather was made in the context of a challenge to the security interests of the defendant therein. For these reasons Count 7 will not be dismissed.
Similar to the Plaintiff's stated cause of action in Count 7, Count 27 alleges breach of agreement. Under Count 27, the alleged breached agreements are Repurchase Agreements and the Forbearance Agreements. The Amended Complaint alleges that Defendants wrongfully valued the repurchase collateral when liquidating the collateral and crediting the collateral value to the loan obligations. Citing Sections 559 and 562 of the Bankruptcy Code, Plaintiff asserts that any excess
In the Motion to Dismiss, Defendants argue that Plaintiff fails to plead facts demonstrating breach of the method of valuation set forth in the agreements and instead asserts only bald conclusions. Pointing to the agreements, Defendants assert that the documents specifically authorize the liquidation of the collateral, and in some agreements, a valuation in the "sole discretion" of the lending party. However the court must disagree with the Defendants' characterization of Count 27 of the Complaint as to the sufficiency of the facts asserted. The Amended Complaint includes sufficient detail as to the alleged rights of Debtors to a reasonable exercise of the "sole discretion" as to valuation and an allegation that such a reasonable valuation would have yielded excesses in amounts over those which were credited. Nor does a review of the cited agreements defeat the Plaintiff's theory of law. At this stage of the adversary proceeding, Count 27 is sufficient in pleaded fact and legal basis to survive the Defendants' Motion to Dismiss.
Plaintiff seeks to invalidate and render unenforceable the Override Agreement, Amended Override Agreement, First Releases, March Forbearance Agreement, Second Releases, (the "Challenged Agreements") and the obligations and transfers related thereto and to rescind the Override Agreement, Amended Override Agreement, and March Forbearance Agreements because of coercion or duress. Defendants seek dismissal of this count asserting that the Amended Complaint fails to plead facts which form a plausible basis for the requested relief.
The elements of duress or coercion applicable to this count are uncontested. Defendants must have made a threat to do an unlawful injury resulting in Debtors being compelled or forced to agree to a contract or release. The wrongful threat must have precluded the Debtors from exercising free will. See Interpharm, Inc. v. Wells Fargo Bank, N.A., 2010 WL 1257300, at *6 (S.D.N.Y. March 31, 2010). The exercise of legal rights by a party or rights asserted under a good faith interpretation of a contract do not support a finding of abuse or coercion. See Cooper Dev. Co. v. Friedman, 1994 WL 62846, at *4 (S.D.N.Y. Feb. 22, 1994). Here, Defendants argue that the facts pled by Plaintiff are solely exercises by Defendants of their rights under the Challenged Agreements.
However, the Defendants' characterization of the pleaded facts as reciting only lawful exercise of contractual rights is inaccurate. The Amended Complaint specifically asserts that after TMST's issuance of a 10-K report in March of 2008, Defendants improperly made inflated margin calls for more than $600 Million. These allegedly unlawful calls were made at a time during which Defendants knew that TMST had a liquidity crisis.
Defendants contest the Plaintiff's assertions that Debtors had no free will, pointing to alternatives such as a suit by Debtors to enforce the repurchase agreements, or an earlier bankruptcy filing. However, free will is precluded if irreparable harm would be suffered should the threat be carried out and circumstances permit no other alternative to the agreement. See KiSKA Const. Corp. U.S. v. G & G Steel, Inc., 2005 WL 1225944, at *4-5 (S.D.N.Y. May 20, 2005). At this stage of this litigation, the court has no basis in fact to determine whether the economic distress alleged to have resulted from the alleged improper margin calls could have been adequately remedied by either litigation or an earlier bankruptcy filing.
Similarly, Plaintiff asserts that Defendants wrongfully breached the Override Agreement and caused continuing economic duress leading to Debtors' entry into the Amended Override Agreement
Defendants also point to applicable New York law requiring a timely repudiation of an agreement obtained by duress. However, as argued by Plaintiff, continuing duress delays the requirement of repudiation. See Sosnoff v. Carter, 165 A.D.2d 486, 492, 568 N.Y.S.2d 43 (N.Y.App.Div. 1991). The facts alleged by Plaintiff rise to a plausible basis (when viewed most favorably to Plaintiff) that such continuing economic duress may have existed as a result of the continuing alleged wrongful acts and demands by Defendants. Thus, the court concludes that the Amended Complaint should not be dismissed as to Count 28.
In Count 29 Plaintiff requests that the court order the claims of Defendants be subordinated to all other allowed claims based upon equity as authorized by Section 510(c).
Official Committee of Unsecured Creditors of Sunbeam Corporation, et al. v. Morgan Stanley & Co., Inc., et al. (In re Sunbeam Corp.), 284 B.R. 355, 363 (Bankr.S.D.N.Y. 2002) (quoting In re 80 Nassau Assocs. v. Crossland Fed. Sav. Bank (In re 80 Nassau Assocs.), 169 B.R. 832, 837 n. 3 (Bankr.S.D.N.Y.1994)).
[T]he fundamental aim of equitable subordination is to undo or offset any inequity in the claim position of a creditor that will produce injustice or unfairness to other creditors in terms of the bankruptcy results. 9281 Shore Road Owners Corp. v. Seminole Realty Co. (In re 9281 Shore Road Owners Corp.), 187 B.R. 837, 853 (E.D.N.Y.1995) (quoting In re Kansas City Journal-Post Co., 144 F.2d 791, 800 (8th Cir.1944)). While Congress did not define inequitable conduct in the context of Section 510(c), courts have developed three requirements for the application of equitable subordination:
The Bank of New York v. Epic Resorts-Palm Springs Marquis Villas, LLC, et al. (In re Epic Capital Corp.), 307 B.R. 767, 772 (D.Del.2004) (citations omitted).
Furthermore, courts uniformly hold that a higher burden of proof is required of the party seeking equitable subordination if the respondent is not an insider of the debtor. As to a non-insider, the plaintiff must show that the defendant engaged in egregious conduct, such as fraud, spoilation or overreaching. Id. In the instant case Plaintiff argues that the facts pleaded in the Amended Complaint demonstrate that Defendants were insiders of the Debtors. In the alternative Plaintiff asserts that even if not found to be insiders, the alleged conduct of Defendants rises to the level of egregious conduct and therefore justifies equitable subordination.
The definition of an insider set forth in Section 101(31) includes "a person in control of the debtor." 11 U.S.C. § 101(31)(B)(iii). The definition defines by example and as such is not an exclusive listing of the circumstances under which the insider status is to be applied.
However, where a finding of insider status is sought based upon alleged control of the debtor by the defendant, mere pressure or influence upon the debtor is insufficient. Stratton v. Equitable Bank, N.A., 104 B.R. 713, 732 (D.Md.1989). Instead,
It may be difficult for Plaintiff to prove by evidence either the degree of control necessary for a finding that Defendants were insiders, or absent such a finding, to prove that the Defendants' conduct was sufficiently egregious to shock the conscience of the court. Nonetheless, the court, in determining whether to dismiss this count, must look to the pleaded facts, giving all reasonable inferences that might be drawn from those facts in favor of Plaintiff. Plaintiff pleads a series of events that could be described as wrongful acts by Defendants that placed Debtors in serious financial peril. If wrongful margin calls placed Debtors in perilous straits, the Plaintiff's pleaded facts then paint a picture of duplicitous deal-making by Defendants that resulted in the remaining investment value of Debtor being liquidated through the raising of new equity to pay down the debts of Defendants. When coupled with the alleged subsequent breaches by Defendants of the forbearances promised, the permissible inferences are certainly sufficient to plausibly raise a basis for equitable subordination. Certainly such inferences include that the value remaining in TMST for other creditors was significantly diminished by the Defendant's taking of the liquidity fund. In denying the Motion to Dismiss as to this count, the court again cautions that the burden upon Plaintiff is significant as to proof of the level of misconduct that would justify the extraordinary remedy of equitable subordination.
In Count 30, Plaintiff requests that the claims of Defendants be disallowed on equitable grounds. The Motion to Dismiss argues that equitable disallowance of a claim is not authorized by the Bankruptcy Code and therefore the court must dismiss this count as a matter of law.
Section 502 provides that a claim for which a proof of claim is properly filed shall be allowed unless an objection is filed and one of the specific grounds enumerated in Section 502(b) apply to the claim.
Courts addressing equitable disallowance in written opinions have reached conflicting decisions as to whether the court may disallow a claim upon such basis. In Adelphia Communications Corp., et al. v. Bank of America, N.A., et al. (In re Adelphia Communications Corp.), 365 B.R. 24, 72-75 (Bankr.S.D.N.Y.) (Gerber, J.), the court denied a motion to dismiss concluding that equitable disallowance is
To the contrary the same court, in the more recent case of Harbinger Capital Partners LLC, et al. v. Ergen, et al. (In re LightSquared, Inc.), 504 B.R. 321, 342-44 (Bankr.S.D.N.Y.2013) (Chapman, J.), concluded that equitable disallowance is not a permitted basis for disallowing a claim. This court has neither been apprised of nor found any binding precedent upon this issue in an opinion of either the United States Court of Appeals for the Fourth Circuit or the United States Supreme Court.
While acknowledging the different views of learned judges on the issue, this court concludes that the analysis in the LightSquared opinion is correct and that analysis is adopted herein. Without limitation of that adoption, this court finds that it is Section 502, not Section 510, that provides the statutory law as to allowance and disallowance of claims. Under Section 502, properly filed claims (and in Chapter 11 cases scheduled claims that are not scheduled as disputed, contingent or unliquidated)
LightSquared, 504 B.R. at 336 (footnote omitted) (citing 11 U.S.C. §§ 1129(a)(3), 1126(e) and 28 U.S.C. § 1412).
Section 510(c) does not add to the permissible grounds for disallowance. It provides that the court may subordinate an allowed claim under principles of equitable subordination.
LightSquared, 504 B.R. at 337 (quoting Pepper v. Litton, 308 U.S. at 310-12, 60 S.Ct. at 238). The court added by footnote:
Id. at 337 n. 20.
The Supreme Court has made it clear that bankruptcy courts cannot rely upon equitable powers to reach results not consistent with the provisions of the Code. See Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988). This precept is reiterated by the Supreme Court in the recent decision in Law v. Siegel, ___ U.S. ___, 134 S.Ct. 1188, 188 L.Ed.2d 146 (2014). In that case, the trustee sought to surcharge a debtor's exemption due to debtor's misconduct. In reversing the lower court's granting of the surcharge, the Supreme Court quoted from the Ahlers opinion: "We have long held that `whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of' the Bankruptcy Code." Id. at ___, 134 S.Ct. at 1195 (quoting Ahlers, 485 U.S. at 206, 108 S.Ct. at 969).
Although acknowledging that the bankruptcy court may have inherent power to sanction "abusive litigation practices," neither that power nor Section 105 permits the court to override explicit mandates in other sections of the Bankruptcy Code. In addition to remarking that the Bankruptcy Code provided specific "not to say mind-numbingly detailed-enumeration of exemptions and exceptions to those exemptions...," the Supreme Court found that courts were not allowed to create additional exceptions.
Like the exceptions to exemptions discussed in Siegel, In Section 502(b) the Code provides specific grounds for disallowance of claims that do not include equitable disallowance. Here also the court may not add to listed grounds where the statute makes clear that the list is exclusive and not merely examples. Accordingly, Count 30 of the Amended Complaint must be dismissed under Rule 12(b)(6) for failure to state a claim upon which relief can be granted.
In Count 31 Plaintiff requests that the court disallow the Defendants' claims in the bankruptcy case pursuant to Section 502(d).
Because the court has not dismissed all avoidance counts as urged by Defendants, the count states a plausible cause of action for recovery and dismissal of Count 31 must be denied.
In addition to participating as co-movants in the Motion to Dismiss, defendants Citigroup Global Inc. and Citi Global LTD, filed a Supplemental Memorandum applicable to only those defendants.
As to Citigroup Global Inc., the Supplemental Memorandum argues that in all the transactions referred to by Plaintiff in the Amended Complaint, Citigroup Global Inc. acted as a named agent for a disclosed principal and therefore it is not legally the actor responsible for the performance or lack thereof. Plaintiff counters this assertion by pointing out that he has averred that Citigroup Global Inc. was the recipient of certain transfers that Plaintiff now seeks to avoid in certain counts of the Amended Complaint. Without discovery, Plaintiff argues it cannot be determined whether there is proof that Citigroup Global Inc. should not be held to be an initial transferee as that term is used in determining liability for avoided transfers.
The Court agrees with Plaintiff as to only those counts seeking to avoid transfers which are not being dismissed as to all defendants for the reasons set forth herein before. Accordingly, in addition to the dismissal of counts as to all Defendants set forth herein above, Counts 7, 27-29 and 31 of the Amended Complaint shall be dismissed as to Citigroup Global Inc. only.
As to Citi Global LTD, the Supplemental Memorandum argues that the Plaintiff's characterizations of the duties placed upon this defendant in the Global Masters Lending Agreement were by the language of that agreement not duties of Citi Global LTD but instead TMST. Further it is argued that the CGML Forbearance agreement sets forth an agreed upon valuation of the Citi Global LTD securities which standard the Amended Complaint does not allege Citi Global LTD violated. Finally the Supplemental Memorandum avers that English law must govern these agreements with Citi Global LTD and under that applicable law an implied covenant of good faith and fair dealing does not arise. In his response to the Supplemental Memorandum, Plaintiff makes no argument as to Citi Global LTD's request that Count 27 of the Complaint be dismissed as against it.
For the reasons stated in the Supplemental Memorandum, the court agrees that as to Defendant Citi Global LTD, Count 27 shall be dismissed.
The court having found that the Amended Complaint should be dismissed in part, an Order effectuating the court's decision will be entered herewith.
Declaration of Douglas K. Mayer in Support of Defendants' Joint Motion to Dismiss, Exhibit A (Credit Suisse Repurchase Agreement) § 19(a).
Plaintiff also contends that the MBS were transformed to non-protected agreements upon their downgrade from AAA and AA ratings. This argument fails primarily because of the court's holding that the agreements also meet the definition of the repurchase agreements by virtue of being "interests in mortgage related securities or mortgage loans" which definition does not depend on a rating to qualify.
