RUSS KENDIG, Bankruptcy Judge.
On March 24, 2015, Defendant David A. Schwab filed a motion for summary judgment. Defendants Jerry A. Schwab and Donna L. Schwab also filed summary judgment motions and joined David Schwab's motion. Plaintiff filed a consolidated response in opposition, to which Defendants replied. Following submission of Plaintiff's sur-reply, the court took the matter under advisement.
The court's jurisdiction of this adversary is premised in 28 U.S.C. § 1334 and United States District Court for the Northern District of Ohio's general order of reference, Order 2012-7, dated April 4, 2012. This is a core proceeding under 28 U.S.C. § 157(b)(2)(F), (H), and (O). Venue is appropriate pursuant to 28 U.S.C. § 1409.
This opinion is not intended for publication or citation. The availability of this opinion, in electronic or printed form, is not the result of a direct submission by the court.
Plaintiff John B. Pidcock
Schwab Industries was a family owned concrete business headquartered in Dover, Ohio and also operating in Florida. Its facilities included ready-mix plants in both Ohio and Florida, an Ohio block plant, and an Ohio distribution terminal. Its assets also included a deep water port in the Gulf of Mexico and an orange grove
As a result of the economic downturn in the late 2000s, Debtors' sales declined and, coupled with the inability to obtain additional financing, led to a bankruptcy filing on February 28, 2010. Debtors were unable to secure postpetition financing to permit reorganization. When the secured lenders allowed only limited use of cash collateral, Debtors were forced into a quick liquidation of their assets via a bankruptcy auction procedure. Cement Resources, LLC
Plaintiff's claims in this case primarily concern Defendants' actions during the sale process. He claims that Defendants were engaged in demanding and negotiating side agreements which resulted in elevating their personal interests over Debtors' and creditors' interests, resulting in a diminution in the sale value of the business that harmed the estate.
Defendants moved the court for summary judgment, primarily challenging Plaintiff's claims based on res judicata. Federal Rule of Civil Procedure 56, adopted into bankruptcy practice by Federal Rule of Bankruptcy Procedure 7056, governs motions for summary judgment. The court is instructed to "grant summary judgment if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed.R.Civ.Pro. 56(a). The moving party initially must prove that there are no genuine issues of material fact.
There is no dispute that Defendants acted behind the scenes to extract personal financial benefits through the sale. Although the specific terms were not fully disclosed to the court prior to the sale, various constituencies in the case were aware that self-dealing was afoot. For example, unsigned minutes from an April 30, 2010 board meeting state that "Mr. Oscar [Debtors' counsel] also advised the Board that he had informed counsel for each of the Bank Group and the Committee that the Schwab family was having discussions with Atlas/Garmark concerning additional arrangements between them if the transaction were to be consummated." (Pl.'s Ex. 2, p. 4, ECF No. 246-1) In an April 30, 2010 email, Attorney Hammer, counsel for the Committee, references the negotiations. (Defs.' Ex. HHH, ECF No. 222-12) In a May 6, 2010 email, Plaintiff specifically asked the chief restructuring officer, Larry Goddard,
The negotiations were also referenced in the revised bid procedures motion. (M. Rev. Bidding Proc. Order, Main Case ECF Nos. 344 and 346) In footnote five of the bid procedure motion, Debtors disclosed that
(M. for a Rev. Bidding Proc. Order p. 10, fn. 5, Main Case ECF No. 344) The proposed deal was quite lucrative for Defendants: in exchange for a $3 million contribution, Defendants would receive a fifteen percent (15%) equity stake in Cement Resources; David Schwab received a four-year employment offer valued at $1.2 million; and Jerry and Donna were to receive $150,000 in consulting fees for a period of three years.
The potential impact of these negotiations was not lost on other parties. The Official Committee of Unsecured Creditors ("Committee") objected to the bid procedures motion and appointment of Cement Resources as stalking horse bidder, querying
(Obj. of Off. Comm. of Unsecured Creds., Main Case ECF No. 378) (emphasis original) There are logical suggestions that the side agreement caused the Schwabs to vote in favor of Cement Resources as the stalking horse bidder in spite of a bid from Oldcastle that was valued at $5.5 million greater than the Cement Resources bid.
In spite of the Committee's misgivings about Defendants' motivations, following a hearing on the motion, the parties submitted an agreed order, stating "[t]he objections of the Committee of Unsecured Creditors and [other creditor] are resolved. (Ag. Order Approving Rev. Bidding Proc. ¶ 8, Main Case ECF No. 406)
What developed from Defendants' attempts to personally profit from the sale with side agreements was a pay-to-play environment, acknowledged Oldcastle, the eventual winning bidder and purchaser. Upon questioning of Oldcastle during the sale hearing, Mr. Rosenblatt, an attorney for Oldcastle, revealed that
(Transcript of Hearing held 5/28/10 at 60:7-18, Main Case ECF No. 1118) Oldcastle met with Jerry, Donna and David individually and eventually offered an earn-out package valued in the neighborhood of $7 million. (Pl.'s Ex. 80, ECF No. 246-4; Pl.'s Ex. 100, ECF No. 246-5) Key terms included five year employment for David Schwab at $300,000 per year with a thirty percent (30%) bonus potential; Jerry and Donna Schwab maintaining director positions for five years with compensation of $150,000 per year; and an option to participate in "future performance of the business, via a one-time payment at the end of five years." (
Concerns about Defendants' self-dealing and self-interest were also specifically raised during the sale process. The Committee renewed its charges about self-dealing. Paragraph three of its objection calls the Cement Resources bid "suspect," stating "Debtors' insiders have a strong incentive to support the Cement Resources bid notwithstanding the fact that it may cause significant harm to unsecured creditors, and that their business judgment is hopelessly conflicted." (Obj. of Off. Comm. of Unsec. Creds. ¶ 3, Main Case ECF No. 434) The Committee called the sale a sub rosa plan and identified other issues in the sale. (Id. at ¶¶ 4-5)
At the start of the sale hearing, the court was informed that Debtors' board, consisting of Jerry, Donna, David and Mary Lynn, were two-to-one in favor of the Oldcastle bid. (Pl.'s Ex. 4, ECF No. 246-1) Jerry and Mary Lynn voted in favor of the bid, David voted against, and Donna abstained. Later in the hearing, however, the court learned that the board took another vote, resulting in a 2-2 tie when Donna voted against Oldcastle. (Pl.'s Ex. 5, ECF No. 246-1) It is not entirely clear why Donna changed her vote, but the draft meeting minutes prepared by Debtors' counsel indicate her vote changed after she took a telephone call from Ed Fletcher, partner with Atlas Holdings LLC. (Pl.'s Ex. 5, ECF 246-1; Pl.'s Ex. 32, ECF No 246-2) She later testified that she just felt uncomfortable after the first vote. (Dep. of Donna Schwab 295:10-297:15, ECF No. 212-1)
As a direct result of the above, the court specifically inquired about the "continuing involvement of any insider with respect to either the Oldcastle deal or the Cement Resources deal?" (Tr. From 5/28/10 hearing, 48:17-29, Main Case ECF No. 1118) Debtors' counsel advised the court that there had been discussions with both Oldcastle and Cement Resources for some continued involvement by one or more of the Schwabs. (
(
In spite of advice from Debtors' counsel to disclose the details of any side agreements, full disclosure was not forthcoming. It is plainly obvious that at least Donna Schwab was unwilling to divulge information on the agreements with the other constituencies involved in the case. (Pl.'s Ex. 109 and 111, ECF No. 246-6)
Ultimately, the sale of Debtors' assets to Oldcastle was approved and an order entered on May 28, 2010. The sale order contained not only findings that the sale was made in good faith and that the purchase price was fair and reasonable, but also findings that dealt directly with Debtors' conduct during the sale process. Examples include:
(Order Auth. Sale ¶ 14, Main Case ECF No. 455)
(
(
The side agreements may have impacted the sale in a variety of ways. First, they could have decreased the amount of the stalking horse bid. There are suggestions in the record that Cement Resources was tapped out and the deal was too expensive. (Pl.'s Ex. 35, ECF 246-2; Pl.'s Ex. 36, ECF 246-2) Were it not for the side agreement, Cement Resources may have been able to pour more money toward the asset purchase rather than direct money toward the individual agreements, thereby providing a larger return to the estate. And the indications are Oldcastle's bid did not exceed its willing purchase price, leaving the firm impression money remained on the table. (Dayko Dep. 136:25-137:1, ECF No. 211-1) How the agreements may have impacted other interested parties is a great unknown. Other interested parties may have reacted in any number of ways, including withdrawal, if they came to the same conclusion as Mr. Rosenblatt of Oldcastle that the deal was rigged unless you paid the Schwabs.
Defendants argue that Plaintiff's claim, which is based on self-dealing and self-interest, is barred by res judicata because Plaintiff twice raised related issues during the sale process and twice entered into agreed orders, thereby foreclosing this action. With res judicata, "a final judgment on the merits bars further claims by parties or their privies based on the same cause of action."
Four elements must be established for res judicata to apply: (1) a final decision on the merits by a court of competent jurisdiction, (2) a subsequent action between the same parties or their privies, (3) an issue in the subsequent action which was litigated or should have been litigated in the prior action, and (4) an identity of the causes of action."
The parties do not dispute the first element. A sale order is a final order, thereby satisfying the first requirement for application of res judicata.
Plaintiff does not challenge Defendants' statement that Defendants were parties or privies to the sale order. During the sale process, Plaintiff was acting as a financial advisor to Committee. He now occupies the role of Creditor Trustee of the Creditor Trust, the vehicle used for the benefit of the unsecured creditors. Consequently, his current role is the equivalent of the role previously occupied by the Debtor or Committee, both of which were parties to the sale order. There is no question that privity exists between the two, binding Plaintiff to the sale order.
In a similar but not identical vein, Debtors, not Defendants, were the actual parties to the sale order. Defendants, as shareholders and directors, were the decision-makers for Debtors and also were personally affected by the sale order. The relationship between the two warrants additional exploration.
In order to promote finality of a chapter 11 plan confirmation order, the Sixth Circuit was willing to view "party" expansively.
Although this court is dealing with a sale order, not a confirmation order, similar principles are applicable. While the sale disposed of the bulk of Debtors' assets, it also effectively disposed of Defendants' equity interests and cemented the limited return to creditors. In order to protect the sale process and the purchaser, finality of the sale order is essential.
Defendants also claim that they were in privity with Debtors by virtue of their position as officers. The court is not in complete agreement. Defendants have cited the general rule but ignore that
The parties disagree on the third element, whether the present claim was or should have been litigated during the course of the sale process. When the two causes of action `arose from the same transaction, or series of transactions. . . . [the latter action] should have been litigated in the earlier action.'
Most of the leading Sixth Circuit cases discussing res judicata and bankruptcy involve claims brought after the bankruptcy case in a different forum.
Procedurally, this case presents a varying fact pattern from the cases referenced above because all the litigation has occurred in the same underlying bankruptcy case and no one challenges that the breach of fiduciary claim is not related.
The inquiry turns to whether this claim should have been brought during the sale process. This consideration has received less attention by the Sixth Circuit than the former consideration. The determination is not simple. On one hand, it seems preposterous to argue that a breach of fiduciary duty claim should have been litigated against Defendants during the truncated sale process. In this case, Debtors were still operating as a going concern, which is optimal for sale value. However, the secured lenders were pushing for a quick sale by limiting funding for continued operations. Additionally, Cement Resources, the stalking horse bidder, was also aggressively seeking a quick sale. Under these time constraints, full litigation of a breach of fiduciary claim was nearly impossible while preserving the sale.
Plaintiff argues bringing the claim was impossible due to Defendants' affirmative concealment of the breadth of the negotiations with both Cement Resources and Oldcastle. Under
For the purposes of this argument, the court is going to operate on the assumption that Defendants did have a duty to disclose their negotiations and did not do so. As a result, the question becomes whether Plaintiff, or his predecessor, had sufficient information or exercised reasonable diligence with the information available. On this point, the court cannot find in Plaintiff's favor.
Defendants' negotiations with Cement Resources were clearly known by parties to the sale process. The court will not restate all the facts outlined above in detail but will highlight key examples. In an email dated April 30, 2015, an attorney for the Committee sent an email that stated "the Schwabs apparently are also negotiating the terms of a go-forward agreement for them with Atlas." (Defs.' Ex. HHH, ECF No. 222-12) Approximately one week later, Plaintiff sent an email acknowledging his awareness that Defendants were negotiating for management agreements and equity. (Pl.'s Ex. 40, ECF No. 246-3) The negotiations were also referenced in pleadings filed with the court and was part of the foundation for the Committee's objection to appointment of Cement Resources as the stalking horse bidder. (M. Rev. Bidding Proc. Order, Main Case ECF Nos. 344 and 346; Obj. of Off. Comm. of Unsecured Creds., Main Case ECF No. 378). The Committee objection was ultimately resolved. (Ag. Order Approving Rev. Bidding Proc. ¶ 8, Main Case ECF No. 406)
The
Although the side agreements with Oldcastle were not as open, several parties were aware of their existence. Most damning for Plaintiff is his own admission he knew, around May 21, 2010, that the Schwabs had been communicating with Oldcastle about side agreements:
(Depo. of John B. Pidcock, pp. ECF 207-1, pp. 109;21-110:10). His testimony indicates that he inquired about the specifics of the deal, which no one divulged:
(
Other disclosures were also made. During the sale hearing, Oldcastle revealed that
(Transcript of Hearing held 5/28/10 at 60:7-18, Main Case ECF No. 1118) An attorney for Debtors, Daniel DeMarco, also generally indicated, without citation to a specific event, the banks and Committee were made aware of the negotiations. (Depo. of Daniel A. DeMarco at 9:7-11:15, ECF No. 214-1)
The sum of the above leads the court to the inescapable conclusion that the negotiations with Oldcastle were not concealed. Although the specific terms were not known, there is no indication that anyone pressed the issue or made diligent efforts to ascertain the terms. The court cannot find that affirmative concealment bars application of res judicata, nor that concealment was a bar to bringing these claims earlier in this case.
Since affirmative concealment does not bar res judicata, the court returns to the question of whether Plaintiff should have brought these claims during the sale process. In discussing the finality prong of res judicata, the Sixth Circuit acknowledged that "with the execution of the sale order the debtor's assets are judicially sold and no further litigation can be brought regarding those assets without forcing the court to undo the sale, an action of the very kind res judicata seeks to prohibit."
While the above tends against application of res judicata, the problem for Plaintiff is that the Sixth Circuit takes finality of the sale order earnestly. When subsequent claims attempt to denigrate the sale order, the Sixth Circuit has not been favorable in its consideration of the later claims. In
Regarding the final element, Plaintiff argues that this court's decision in a related adversary,
Here, Debtors and Defendants were directly and intimately involved in the sale process and were parties to the sale order. The claims now asserted by Plaintiff were raised two times during the sale process and withdrawn. Specific findings in the sale order negate the alleged harm now claimed. While the exact specifics of the side deals may not have been known, there was sufficient information to put the Committee and Plaintiff on notice and provoke additional inquiry. Failure to pursue full disclosure may have been a calculated, strategic decision to allow the assets to be sold while the business was operating and the fire was hot rather than risk any devaluation a delay may have wrought. (Order Auth. Sale ¶ 21, Main Case ECF No. 21) Regardless, to the extent the present claim was not actually litigated during the sale process, the overlap in the findings supporting the sale order, including findings that the process generated the best price for the assets and the sale was fair and reasonable, and the allegations of this complaint suggesting Defendants' actions harmed the sale process, create an identity between the causes of action for res judicata purposes. The court finds the fourth element is satisfied.
This decision is not without moral unease. The court in no way seeks to condone the actions of Defendants. Plaintiff set forth a compelling argument that Defendants' focus was not on what was in Debtors' best interests and acted with little regard for the unsecured creditors and with great regard for themselves. However, the court does note that the unsecured creditors were represented during the sale process and signed the sale order. Their objections were either resolved or withdrawn.
This decision is not intended to be a green light for directors and/or shareholders to elevate their interests over those of a bankrupt corporation. However, on the facts of this case, where Defendants' actions were not fully concealed, and the court issued a sale order contravening the damages alleged by Plaintiff, the court is without authorization to revisit the sale order.
The application of res judicata to the sale process arose from concern that sales needed to be final. Buyers would not pay a fair price if they needed to be concerned with endless litigation about the merits or finality of the terms or the title to what was purchased. The easiest way to deal with this valid concern was to carry over the tried and true precedent of res judicata and apply it to sale orders.
The problem is that it is an uncomfortable fit. An ox cart is a means of transporting a load, but it is not a desirable means of transporting any load from Ohio to California. Similarly, res judicata is a means of protecting a sale order, but it creates undesirable effects in the process.
Application of res judicata grew from courts making logical argument by analogy. A bankruptcy sale order needs to be protected and is like other court orders, therefore it should be protected like other court orders applying res judicata. Things should be treated similarly because they are similar, but not identically because they are not the same. The analogy works to the extent things are similar but not to the extent they are different. Argument by analogy's inherent strength is its inherent weakness. Brothers have similarities. The three Alou brothers were all good enough to make it from the Dominican Republic to the major leagues, but only one could hit with power. It gets even tougher with Cain and Abel. Analogies are never perfect.
The problem is that res judicata precedent has, to this point in time, been driven like a truck through a vegetable stand in an action movie. There has been no recognition of the inherent procedural differences between bankruptcy sale orders and general civil litigation orders. Perhaps more importantly there has been nearly no recognition of the inherent functional differences between bankruptcy sale orders and general civil litigation orders.
The procedural differences are relatively obvious. Orders at the end of a trial occur following months or years of discovery and motions and then days or weeks of trial. In the Schwab Industries sale, the real guts of the legal process transacted in hours at the courthouse on one day. There was definitely a great deal of legal activity in the preceding months, but there had been little understanding about the scope of self-dealing and zero formal discovery. It appears that the revelation by Oldcastle's president that he felt the need to pay the Schwabs in order for Oldcastle's bid to be considered was made the first time at the hearing. There was no way this could be fully investigated, or investigated at all, as the participants passed a melting ice cube around the courtroom with the lender refusing to extend the operating life of Debtors.
The functional differences between a general civil litigation order and a bankruptcy sale order appear not only to be less obvious, but perhaps entirely misunderstood. The goal, or function, of the application of res judicata is normally set out as protecting the purchaser by protecting title via defending the integrity of the order. No one can doubt res judicata's effectiveness in protecting purchasers in the sale order context. It has done very well in this regard and bankruptcy sale orders are viewed as the gold standard for acquisition risk management.
The problem is that defending the purchaser is an intermediate goal and only one of several intermediate goals. The ultimate goal, which is to say the functional end of the sale process, is to maximize value. Put in Canton, Ohio terms: How do we get the most money?
Protecting purchasers' title is one way of getting the most money. Buyers will be willing to pay top dollar if they know that the path ahead is free of litigation and other questions. So the function of buyer protection is merely an intermediate goal of the ultimate goal: to get the most money.
Achieving the ultimate goal requires the courts to recognize that there are other intermediate goals in addition to buyer protection that must be considered. Another intermediate goal is honesty. There can be little doubt that honest and fair proceedings produce the most money for several reasons, not the least of which is that all are encouraged to participate, secure in the knowledge that the playing field is level. Second, additional funds may be added to the purchase price if not consumed by payoffs.
Holding those responsible for the cost of their dishonesty would not require disturbing the purchaser's title pursuant to the sale order. The sale need not be set aside and the purchaser need not be disturbed nor his warranties impacted. It would merely mean that those who participated in dishonest conduct could be sued for damages. Slavish devotion to res judicata, recognizing no exceptions or limitations, operates as an overcompensating shield for misbehaving owners by providing a "Get Out of Jail Free" card no matter their conduct.
One piece of evidence stands out as particularly damning and makes it clear that millions of dollars was paid as baksheesh just to get the Schwabs out of the way. As of February 12, 2014, the Schwabs stated that they had received the monies due and payable under their agreements with Oldcastle in spite of being "barred from the business properties formerly known as Schwab Industries, Inc. . . . [and] representatives of Oldcastle advised [them] that they were not authorized to enter onto any of the Ready Mix Concrete business operations . . . [and] since June 2010, Oldcastle has not identified `any specific duties' for any one of the aforementioned Schwabs." (Pl.'s Ex. 100, pp. 22-23, ECF No. 246-5)
But the precedent is what it is. There are no broad exceptions, nor even many narrow ones, and the court is obligated to follow precedent. Bankruptcy judges are more like bus drivers than ship captains, who sit up top and make the rules. We sit up front and take orders.
A separate order granting Defendants' motions for summary judgment will be entered immediately.
