Delaware Bankruptcy Litigation : Delaware Bankruptcy Lawyer & Attorney : Fox Rothschild Law Firm : Financial Restructuring & Bankruptcy Litigation

Real Mex operates four primary brands of restaurant - El Torito, El Torito Grill, Chevys Fresh Mex and Acapulco Mexican Restaurant.  The first El Torito restaurant opened in 1954, whereas the first Acapulco restaurant started in 1960.  The Chevys restaurants came along in 1986.  In 1970, Real Mex Foods, Inc., began manufacturing and distributing Mexican foods to the Debtors' restaurants and general public.  According to the Debtors, the internal manufacture and distribution of foods improves the company's purchasing power and food quality.  Decl. at *4-5.  At the time of filing for bankruptcy, Real Mex employed approximately 11,000 full and part-time employees.  Id. at 5.

Events Leading to Bankruptcy

Over the last couple of years, we have written about several restaurant chains filing for bankruptcy.  Like the restaurants that filed bankruptcy before it, Real Mex attributes its bankruptcy filing to the overall drop in consumer discretionary spending that began in 2008 and continues to the present.  Decl. at *10.  Fewer customers are coming to Real Mex's restaurants, which in turn reduces overall sales.  In 2008, the company experienced annual revenues of $553 million.  By 2009, revenues dropped to $500 million.  By 2010, revenues dropped again, this time to $478 million.  Decl. at *11.

Although Real Mex blames the recession for its drop in revenues, the company also points to specific factors that have negatively affected profitability.  Many of Debtors' restaurants are located in states that have disproportionately higher unemployment.  Decl. at *11.  Furthermore, the company has experienced higher commodity prices for its food ingredients.  Id.

Objectives in Bankruptcy

In July of this year, Real Mex notified its lenders that it was in default of certain covenants in its loan agreements.  During that same month, Real Mex was able to reach a short term agreement with its lenders whereby they agreed to waive certain covenant defaults.  Decl. at *13.  In August and September, Real Mex entered negotiations with its lenders regarding a restructuring under chapter 11.  Once it was clear that the company could not reach a consensual agreement with all of its lenders regarding a restructuring, Real Mex decided to file for bankruptcy and seek a sale of substantially all of the company's assets under section 363 of the Bankruptcy Code.  Id. at 14.

The Real Mex bankruptcy proceeding is before the Honorable Brendan L. Shannon.  Real Mex is represented by the law firms Milbank, Tweed, Hadley & McCloy LLP and Pachulski Stang Ziehl & Jones LLP.  A copy of Real Mex's Declaration filed with the Bankruptcy Court is available here for review. 

For those readers who are generally unfamiliar with the bankruptcy process, below are some of my prior posts that address common issues that arise in Delaware bankruptcy proceedings: 

Ten Things Every Commercial Landlord Should Know About a Tenant in Bankruptcy;

What to Expect in a Section 341 Meeting of Creditors;

A Closer Look at Chapter 11 Bankruptcy Auctions; and,

Subject Matter Jurisdiction of the Bankruptcy Court.

Jason Cornell is a bankruptcy attorney with the law firm Fox Rothschild LLP.  Jason practices before the United States Bankruptcy Courts for the District of Delaware and District of South Florida.  You can reach Jason at (561) 804 4415 or jcornell@foxrothschild.com

Background

On July 22, 2008, SemCrude and certain of its affiliates (the “Debtors”) filed for bankruptcy under chapter 11. Shortly prior to the Debtors’ bankruptcy filing, a large number of oil producers, including Samson Resources Company, Titan Energy, Inc., Winstar Energy I, L.P. and Loren Gas, Inc. (the “Producers”) sold and delivered millions of dollars worth of oil and gas to the Debtors. The Debtors then transferred some of that oil and gas to J. Aron & Company, BP Oil Supply Company, ConocoPhillips Company and Plains Marketing, L.P. (the “Purchasers”). The Debtors did not pay for any of the oil and gas delivered in the seven weeks before the Petition Date.

Since the Debtors’ bankruptcy filing, a number of oil producers asserted their right to payment based on statutory lien claims and trust theories of recovery. The Purchasers filed a number of declaratory judgment actions seeking declarations of the Court that their settlement with the Debtors has released them of any obligation to the oil producers on account of the oil and gas received from the Debtors. After extensive litigation, the Purchasers have moved for summary judgment in this case, seeking confirmation that the oil producers do not have any rights over the oil and gas which the Debtors sold to the Purchasers. Opinion at *10-11.

The Producers oppose the summary judgment motions, arguing that they are premature given the lack of meaningful discovery regarding the Purchasers' affirmative claims. Opinion at *12. In the alternative to their arguments supporting their motion for a continuance, the Producers argue that the motions for summary judgment should be denied.

Judge Shannon’s Opinion

Similar to Judge Walsh’s DBSI decision, discussed here: Decision in DBSI Delays Motion for Summary Judgment, Judge Shannon begins the Opinion with a discussion of Federal Rule of Civil Procedure (“FRCP”) 56 and motions for summary judgment. Judge Shannon cites to opinions which include Celotex Corp. v. Catrett, 477 U.S. 317 (1986); Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986); Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574 (1986); Pastore v. Bell Tel. Co. of Pa., 24 F.3d 508 (3d Cir. 1994); and Petruzzi’s IGA Supermarkets v. Darling-Del. Co., Inc., 998 F.2d 1224 (3d Cir. 1993). Opinion at *14-16.

Judge Shannon then turns to a discussion of the legal standard for requesting a continuance by quoting Dowling v. City of Philadelphia, 855 F.2d 136, 139 (3d Cir. 1988), which states in part, “[t]he court is obliged to give a party opposing summary judgment an adequate opportunity to obtain discovery.” Opinion at *16. FRCP 56 provides that a court may defer considering a motion for summary judgment if a nonmovant shows that it cannot present the facts essential to its opposition of summary judgment. “For this reason, courts usually grant properly filed Rule 56(f) motions as a matter of course.” Opinion at *17 quoting St. Surin v. V.I. Daily News, Inc., 21 F.3d 1309, 1314 (3d Cir. 1994). In St. Surin, the Third Circuit “stated that the court should resolve a motion requesting a continuance under Rule 56 before proceeding to the merits of a summary judgment motion.” Opinion at *18.

The Producers sought discovery regarding the affirmative defenses raised by the Purchasers, in which the Purchasers argue that they were (1) buyers for value without knowledge of the Continuance Movants’ liens and (2) buyers in the ordinary course. The Producers supported their argument that they were unable to obtain the necessary discovery with an affidavit as required by FRCP 56. Opinion at *23. Judge Shannon thus followed the precedent of the Third Circuit and granted the motion for continuance, continuing the motions for summary judgment “until more meaningful discovery has occurred….” Opinion at *23.

The Bankruptcy Rules and Federal Rules of Civil Procedure provide a number of rules that are meant to even out imbalances of power or information so that litigation is decided in as fair a way as possible. The Delaware judiciary also has shown a preference for allowing parties an opportunity to litigate their claims, so long as they can do so within the bounds of the rules. 

John Bird practices with the law firm Fox Rothschild LLP in Wilmington, Delaware. You can reach John at 302-622-4263, or jbird@foxrothschild.com.

Background

ProxyMed was a Florida corporation that provided services to healthcare companies. It filed for bankruptcy on July 23, 2008, and had a plan of liquidation confirmed on July 15, 2009. In 2002, well before it started having financial troubles, a private investment firm, General Atlantic LLC (“GA”), purchased roughly 28.9 percent of ProxyMed’s stock. As a part of its purchase agreement, GA appointed Braden Kelly (“Kelly”) to ProxyMed’s board of directors.

To summarize a lengthy background, Kelly had represented to ProxyMed that GA would continue to invest in ProxyMed. Opinion at *4-5. Ultimately, however, GA found an opportunity that it decided to pursue instead of continuing to invest in ProxyMed and ceased infusing capital into ProxyMed. Opinion at *6. ProxyMed was unable to secure alternative financing, leading to a liquidity crisis and its bankruptcy.

ProxyMed’s Liquidating Trustee (the “Trustee”) filed a complaint alleging (1) that GA and Kelly (together the “Defendants”) breached their fiduciary duties to ProxyMed and (2) that GA defrauded ProxyMed. GA and Kelly together filed a motion to dismiss under rule 12(b)(6), which was decided by the Opinion.

Judge Shannon’s Opinion

Judge Shannon started his discussion of the requirements of pleading fraud so as to survive a motion to dismiss on *7 of the Opinion. He cites many of the usual cases in an analysis of a motion to dismiss, including Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007), Scheuer v. Rhodes, 416 U.S. 232 (1974), Phillips v. County of Allegheny, 515 F.3d 224, 231 (3d Cir. 2008), Kost v. Kozakiewicz, 1 F.3d 176 (3d Cir. 1993), as well as two cases which discuss the heightened requirements of pleading fraud: Seville Indus. Machinery Corp. v. Southmost Machinery Corp., 742 F.2d 786 (3d Cir. 1984), Official Comm. Of Unsecured Creditors of Fedders North America, Inc. v. Goldman Sachs Credit Partners (Fedders I), 405 B.R. 524 (Bankr. D. Del. 2009).

As provided by Twombly, “on a Rule 12(b)(6) motion, the facts alleged must be taken as true and a complaint may not be dismissed merely because it appears unlikely that the plaintiff can prove those facts or will ultimately prevail on the merits.” Opinion at *7. Additionally, all reasonable inferences are drawn in favor of the plaintiff while legal conclusions are not entitled to a presumption of truth. Opinion at *7. Rule 8(a) of the Federal Rules of Civil Procedure (“FRCP”) mandates that a complaint contain “a short and plain statement of the claim showing that the pleader is entitled to relief” such that the defendant has fair notice of what the claim is and the grounds upon which it rests. Opinion at *7-8. Additionally, because fraud was alleged, the Trustee must meet the elevated pleading requirement of Rule 9(b), which states, “In alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person’s mind may be alleged generally.” Opinion at *8 (citing FRCP 9(b)).

Judge Shannon opined that “It is not a defendant’s fraudulent intent that must be pled with particularity, but the circumstances constituting fraud.” Opinion at *9. Citing Fedders I, he then allowed that the pleading standards are relaxed in the case of a trustee because a trustee “inevitably lacks knowledge concerning acts of fraud previously committed against the debtor, a third party.” Opinion at *9. Regardless of the slight relaxation provided to trustees, Judge Shannon ultimately held that the Trustee's complaint was lacking in the details necessary to show fraud, and thus did not fulfill the requirements of FRCP 9(b).  He thus dismissed the charges of fraud against both Defendants.

 
In addition to his analysis of fraud pleading requirements, Judge Shannon discusses the claimed breach of fiduciary duty, which, thanks to the Chancery Court, is a common theme in Delaware jurisprudence. Additionally, the Opinion provided a detailed discussion of how a choice of law conflict is analyzed under Delaware law. It’s a fairly detailed analysis and provides an excellent template for any lawyer’s analysis and argumentation of the same. Put simply, Delaware choice of law precedent provides that a judge consider how each of the proffered jurisdictions would rule on the "conflict" and only decide which controls if a different outcome would be obtained in each jurisdiction.

John Bird practices with the law firm Fox Rothschild LLP in Wilmington, Delaware. You can reach John at 302-622-4263, or jbird@foxrothschild.com.

Background

WL Homes (the “Debtor”) formed JLH Insurance Corporation (“JLH”) in order to pay insurance claims filed against the Debtor. The Debtor funded JLH with $10 million, which JLH kept in an account at Wachovia. The Debtor then entered into a credit agreement with Wachovia, pledging JLH’s deposit accounts as security. Wayne Stelmar, who was at that time CFO of the Debtor and president of JLH, reaffirmed the Debtor’s obligations to Wachovia in June and July of 2008. Opinion at *4.

The Debtor and several of its affiliates filed for bankruptcy under chapter 11 on February 19, 2009. Shortly thereafter the case converted to chapter 7.  On March 20, 2009, Wachovia commenced an adversary proceeding seeking a declaration that it holds a perfected security interest in the JLH deposit accounts. Wachovia and the Trustee for WL Homes both moved for summary judgment following discovery, which led to this Opinion being issued.

Judge Shannon’s Opinion

After a detailed analysis of the case law surrounding motions for summary judgment, Opinion at *5-8, Judge Shannon examined Wachovia’s security interest under California law. Under California law, a security interest requires that (1) value is given, (2) a valid security agreement is entered and control over the account is given as collateral, and (3) the debtor has rights in the collateral. The Debtors' Trustee did not dispute either of the first two points, Opinion at *9-10, but disputed that WL Homes had the right to control the JLH deposit accounts.

Judge Shannon determined, however, that WL Homes had sufficient rights in the JLH account because of (1) WL Homes’ use and control of the account and (2) JLH’s consent to use the accounts. Opinion at *11. Judge Shannon provides his reasoning for this portion of his decision on pages 11 through 16 of the Opinion. One of Wachovia’s more compelling arguments appears to have been that all seven of the people authorized to manage the JLH account were at the relevant time, officers of WL Homes, and only two of them were also officers of JLH. Opinion at *12.

Additionally, although the signor of the loan documents signed on behalf of WL Homes, he was concurrently the president of JLH. Opinion at *15. Judge Shannon quoted In re Pubs, Inc. of Champaign, 618 F.2d 432 (7th Cir. 1980), for the proposition that “if the president, vice-president or director of a corporation has knowledge or notice of a fact, knowledge or notice of that fact is generally imputed to the corporation.” Opinion at *15. Judge Shannon determined that this knowledge and the apparent authority to act for JLH was binding upon JLH. Opinion at *16. Judge Shannon then granted Wachovia’s motion for summary judgment.

Judge Shannon finishes his decision by ruling on the Trustee’s motion for summary judgment, holding that the Trustee did not carry its burden for the granting of a motion for summary judgment. Opinion at *17-19.

 
The law surrounding agency is complex and most States have developed a broad and complex collection of statutes and precedents to govern nearly any situation in which agency is a factor. Given the stakes of most lawsuits that implicate agency laws, and the variance across States, this is one area of law that should not be argued with intuition, but should only be argued after thorough research and preparation.
 

John Bird practices with the law firm Fox Rothschild LLP in Wilmington, Delaware. You can reach John at 302-622-4263, or jbird@foxrothschild.com.

Background

Donna K. Brady (the “Debtor”) was the principal officer of DK Brady Excavating, Inc. (“DKBE”). As such, she personally guaranteed a credit agreement on behalf of DKBE with Tri Supply and Equipment, Inc. (the ”Plaintiff”). She eventually defaulted under her obligations to the Plaintiff, had a default judgment entered against her in the Plaintiff’s favor, and filed for bankruptcy under chapter 7. Opinion at *1-2.

The Plaintiff initiated the adversary proceeding in which this opinion arose by filing a complaint seeking for an order denying the discharge sought by the Debtor. The Plaintiff made two allegations, one of which survived the motion for summary judgment. This post will focus on the allegation that did not survive the motion for summary judgment. This allegation was that the Debtor violated Delaware’s Construction Trust Statute, 6 Del.C. § 3502, bringing the previously awarded default judgment “within § 523(a)(4), which excepts from discharge a debt incurred by fraud or defalcation while acting in a fiduciary capacity.” Opinion at *2.

The Plaintiff asked the Court to construe Delaware’s Construction Trust Statute broadly to infer that the Debtor owed a fiduciary duty that she violated when she failed to pay the default judgment. Opinion at *5.

Judge Shannon’s Opinion

Judge Shannon started with the regular analysis of the legal standard for a motion to dismiss, including references to Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) and Kost v. Kozakiewicz, 1 F.3d 176 (3d Cir. 1993). Judge Shannon then addressed the legal standard for pleading fraud under § 727 of the Bankruptcy Code which requires a party to “state with particularity the circumstances constituting fraud or mistake.” Opinion at *4. In the Third Circuit, plaintiffs alleging fraud must be able to survive the “enhanced Rule 9 scrutiny” under which all such allegations are reviewed. Opinion at *4-5. But as the fraud claims were not dismissed, they won’t be discussed further in this blog post.

Turning back to the allegations of violating a construction trust, Judge Shannon discussed § 523 of the Bankruptcy Code and cited the Supreme Court in opining “The § 523 exceptions are strictly construed in favor of the debtor and the party asserting non-dischargeability bears the burden to show, by a preponderance of the evidence, that the disputed debt is not dischargeable.” Opinion at *7 (citing Grogan v. Garner, 498 U.S. 279, 287-88 (1991)).

He then turned to federal law in defining “fiduciary” narrowly, used only in the context of technical trust relationship. Federal courts then turn to state law to determine the existence of a technical trust relationship – in this instance, Judge Shannon looked to Delaware’s Construction Trust Statute. Opinion at *7. Delaware’s Construction Trust Statute includes a list of various entities that are considered “contractors” such that the statute would apply to them. Noticeably absent, however, is any mention of officers or directors of contractors. Opinion at *8-9. Judge Shannon summarized his reasoning in this portion of the decision by stating, “if the Delaware legislature intended to include officers and directors within the meaning of ‘contractor,’ it would have done so explicitly." Opinion at *9.

 
This opinion cited heavily to Judge Sontchi’s opinion in Moran v. Crowe (In re Moran), 413 B.R. 168 (Bankr. D. Del. 2009). Treating another judge's opinion as precedent illustrates the remarkable consistency of the Delaware Judiciary. This consistency helps practitioners in this court to know which arguments to avoid, and which to emphasize.

John Bird practices with the law firm Fox Rothschild LLP in Wilmington, Delaware. You can reach John at 302-622-4263, or jbird@foxrothschild.com.

Ascendia's Business

Ascendia manufactures and sells health and beauty products throughout North America and across the globe.  According to the Declaration of Douglas Booth, Ascendia's Chief Restructuring Officer, Ascendia distributes its products through "mass merchants" such as Walmart, Target, Walgreens and Dollar General Stores.  See Booth Decl, pghs. 5-6.  A copy of the Booth Declaration as originally filed with the Delaware Bankruptcy Court is available here for review. 

In 1920, Ascendia started as the Lander Co., Inc., selling cosmetics within the United States.  From 1920 to 1950, Lander Co. grew to thirty brands and four subsidiaries.  In 2003, a private equity firm, Hermes Group, LLC, acquired Lander Co..  Two years later, Hermes merged with Cenuco, Inc..  Following the merger of Hermes and Cenuco, the merged entity changed its name to Ascendia Brands, Inc..  Booth Decl., pghs. 7-8.

Events Leading to Bankruptcy

Starting in early 2008, Ascendia's revenues fell below the company's forecasted projections.  The company attributed the drop in revenue to higher than expected costs and lower than expected sales from the company's "Healing Garden" and "Calgon" line of products.  In addition, and like many other debtors before it, Ascendia points to the overall decline in economic conditions and the negative effect such conditions have had on the company's profitability.  Booth Decl., pghs. 40-41.

Ascendia filed for bankruptcy on August 5, 2008 (review Ascendia's Bankruptcy Petition here).  In the months prior to bankruptcy, Ascendia sustained net operating losses of $7.1 million (June 2008) and $9.2 million (May 2008).  Prior to bankruptcy, Ascendia began discussions with its lenders regarding a possible restructuring of the company or a sale of assets. 

After filing for bankruptcy, Ascendia conducted a sale of assets under section 363 of the Bankruptcy Code.  On November 25, 2008, the Bankruptcy Court approved an asset purchase agreement between Ascendia and Ilex NewCo. LLC.  A copy of the Order approving the sale to Ilex is available here.

Procedural Posture of the Preference Actions

At the time of this post, many of the adversary actions filed by Ascendia do not include Summons.  The Summons often will state the date of the first pretrial status conference scheduled before the Court.  Once a pretrial status conference is scheduled, Plaintiff's counsel may begin to circulate a proposed scheduling order similar to the scheduling order that is often used in this jurisdiction.  A copy of the form scheduling order provided by the Delaware Bankruptcy Court is available here for review. 

The Ascendia bankruptcy proceeding is before the Honorable Brendan L. Shannon of the United States Bankruptcy Court for the District of Delaware.  Plaintiff's counsel is represented by Young Conaway Stargatt & Taylor LLP. 

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Jason Cornell is a bankruptcy attorney with the law firm Fox Rothschild LLP.  Jason practices in Wilmington, Delaware in Fox Rothschild's Financial Services and Litigation departments.  He can be reached at 302 427 5512, or jcornell@foxrothschild.com.

Events Leading to Bankruptcy

Magic Brands' problems began before the 2009 recession.  The company's revenue peaked in 2004 and experienced significant decline in 2006 and 2007.  During this time, several senior managers left the company.  By 2008, Magic Brands had a new president and CFO and quickly began restructuring the company.  It was during Magic Brands' restructuring, however, when the U.S. went into a recession and consumer spending quickly declined.  Magic Brands' restructuring included a  "turn around plan" that sought to eliminate unprofitable stores, many of which were under a master lease with Spirit Master Funding, LLC. 

Objectives in Bankruptcy

Magic Brands and Spirit Master Funding were in negotiations regarding the master lease up to the filing for bankruptcy.  Now that the company is in bankruptcy, the parties intend to seek bankruptcy court approval of an amended master lease that will allow the Debtor to shed unprofitable leases.  In addition to the lease amendment, Magic Brands also plans to seek court approval of an asset purchase agreement for $40 million.  According to the Debtor, if the asset purchase agreement is approved by the Bankruptcy Court, the proceeds from the sale will be sufficient to pay-off both the company's pre and post-petition debt and administrative expenses associated with the bankruptcy filing.

Conclusion

It is possible that the bankruptcy sale will not include seven store locations that fall under the proposed amended master lease with Spirit Master Funding.  If these stores are not included in the 363 sale, the sale price for the Debtor drops from $40 million to $31 million.  Going in to bankruptcy, Magic Brands' prepetition senior secured debt totals approximately $23 million.  Even if the sale price drops to $31 million, the Debtor believes the proceeds will be enough to cover its secured debt and administrative expenses.  However, if the sale includes the seven stores subject to the amended master lease, the Debtor states that the $40 million sale price "should generate sufficient cash to pay unsecured creditors a meaningful dividend."  At this stage, it is not clear what the Debtor means by "meaningful dividend."  What is clear, however, is that unsecured creditors stand to make a better recovery if the sale goes forward at $40 million.

This bankruptcy proceeding is before the Honorable Brendan L. Shannon of the United States Bankruptcy Court for the District of Delaware.  Click here for a copy of Magic Brands' bankruptcy petition.

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Jason Cornell is a bankruptcy attorney in Wilmington, Delaware with the law firm Fox Rothschild LLP. You may reach Jason at 302 427-5512, or jcornell@foxrothschild.com.

Background

Fedders filed for chapter 11 bankruptcy protection in Delaware on August 22, 2007 (the "Petition Date").  Approximately 10 years prior to the Petition Date, Fedders decided to expand its business from residential room air conditioning to commercial HVAC.  To finance its expansion, Fedders incurred substantial secured debt.  Fedders' expansion and additional debt were not a success, though, and by 2007 Fedders had defaulted on its loans.

In March of 2007, Fedders entered in to replacement financing which it intended to use to pay off its prior debt and provide additional cash to finance its operations.  Unfortunately, within two months of entering in to the replacement financing, Fedders was in default once again.  Three months later the company filed for bankruptcy.

Committee's Claim and the Lenders' Response

One of the many claims alleged by the Committee was that Fedders' lenders (the "Lenders") aided and abetted Fedders' directors in breaching its duty of care.  In a prior motion to dismiss, the Lenders succeeded in having all claims dismissed as to them except the claim of aiding and abetting.  Through a separate motion to dismiss, the Lenders now asked the Court to dismiss this final claim.

The Committee claimed that Fedders' directors breached their duty of care in taking on new debt, yet failing to receive a "credible financial assessment" that Fedders could comply with the replacement financing.  According to the Committee, the Lenders aided and abetted the directors in their breach as the Lenders "gave substantial assistance and encouragement to the [directors'] breaches of fiduciary duties."  Opinion at *11.

Court's Analysis

The Court began its analysis by  looking at what is required to prove a breach of a duty of care.  Citing Delaware law, the Court observed that a corporate director generally must commit gross negligence to breach his duty of care.  Cargill, Inc., v. JWH Special Circumstances LLC, 959 A.2d 1096, 1113 (Del. Ch. 2008).  Further, various kinds of behavior can rise to the level of gross negligence, though there is generally a finding that the directors and officers failed to inform themselves "fully and in a deliberate manner."  Opinion at *10, citing Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 368 (Del. 1993). 

Next, the Court looked at the requirements to establish a claim of aiding and abetting a breach of fiduciary duty.  Again relying on Cargill, the Court listed the four requirements for aiding and abetting a breach:  (i.) existence of fiduciary relationship; (ii.) proof of a breach by the fiduciary; (iii.)  proof that a defendant, who is not a fiduciary, knowingly participated in a breach; and (iv.)  a showing that damages to the plaintiff resulted from the concerted action of the fiduciary and the nonfiduciary.  Opinion at *12, citing Cargill, 959 A.2d at 1125. 

In considering the Lenders' Motion to Dismiss, the Court focused on the third prong of the Cargill analysis - whether the Lenders knowingly participated in a breach of a fiduciary's duty.  Opinion at *14.  Here, the Court noted that the loan from the Lenders to the Fedders included a borrowing base calculation based on Fedders' inventories and accounts.  The fact that the loan criteria was based on inventory, the Court found, "undercuts [the Committee's] assumption that Fedders' solvency was or should have been the focus of inquiry by the Lender[s] or the Insider Directors."  Opinion at *12.  Finding that the Committee's complaint did not allege any facts to demonstrate that the Lenders knowingly participated in a breach, the Court granted the Lenders' Motion to Dismiss.  In doing so, the Court found that dismissal was especially appropriate "where the loan documents, on their face, contradict the conclusory allegations made."  Opinion at *14.

Conclusion

The decision in Fedders serves as a reminder of the pleading standard necessary to overcome a challenge under Fed.R.Civ.P. 12(b)(6).  Even more, the decision looks at what is required for a party to aid and abet a fiduciary in breaching a duty of care.  To get past a motion to dismiss, a plaintiff must allege facts sufficient to show that the defendant knowingly participated in the fiduciary's breach of duty. 

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Jason Cornell is a bankruptcy attorney with Fox Rothschild LLP in Wilmington, Delaware.  You can reach Jason at 302 427 5512 or jcornell@foxrothschild.com

Background

In 2006, Elrod Holdings (the "Debtor") filed for chapter 7 liquidation in the United States Bankruptcy Court for the District of Delaware.  The Debtor began its business in 1965 designing, manufacturing and installing spectator seating for motor sport raceways.  In 2005, the Elrod family sold 75% of their stock in the company to a company called Champlain for $35 million.  Champlain paid the Elrods $26 million in cash and the remainder in notes.

Soon after the sale to Champlain, the Debtor's business quickly deteriorated.  By June 2006, the Debtor, Elrods and certain lenders sought to restructure the company's debt.  A few months after the restructuring, Safeco, the Debtor's bonding company, demanded that the Elrods provide personal guarantees before Safeco would issue further bonds on projects for which the Debtor was a contractor.  When the Elrods refused to provide personal guarantees to Safeco, Safeco refused to issue construction bonds, resulting in the Debtor quickly running out of money.

Fraudulent Conveyance Claims

As part of the pre-bankruptcy restructuring, the Elrods agreed to purchase certain equipment from the Debtor and lease the same equipment back to the Debtor.  After the commencement of the bankruptcy proceeding, George Miller, as the chapter 7 trustee, commenced an adversary action alleging that the Elrod's "participated and/or aided and abetted in the [sale leaseback], with the actual intent to hinder, delay, and/or defraud the Debtor's creditors."  In addition to claiming that the sale leaseback was actually fraudulent, the trustee argued that the leaseback of the equipment was constructively fraudulent.

Court's Analysis

Looking first at whether there was "actual intent" for the fraudulent transfer claims, the Court noted (and the parties agreed) that it was the Debtor's intent that was key to determine whether a conveyance was fraudulent, not the intent of the party receiving the conveyance.  The Elrods argued that there was no fraudulent intent on the part of the Debtor.  The chapter 7 trustee, on the other hand, argued that the Elrod's intent to hinder, delay or defraud should be imputed to the Debtor because the Elrods dominated or controlled the Debtor.

In order to decide whether the intent of the Elrods would be imputed to the Debtor, the Court looked at the "intent imputation doctrine" recognized by the United States Bankruptcy Court for the Southern District of New York in Jackson  v. Miskin (In re Adler, Coleman Clearing Corp.), 263 B.R. 406, 445 (S.D.N.Y. 2001)(finding that under "the domination and control rule, the requisite intent derives from a transferee who is in the position to dominate or control the debtor's disposition of his property, a circumstance that section 548(a)(1)(A) anticipates by its provision that the fraudulent conveyance by the debtor may be voluntary or involuntary.")  Applying Adler, the intent of the transferees (the Elrods) can be imputed to the Debtor if (i) the Elrods possessed the requisite intent to hinder, delay or defraud the Debtor's creditors; (ii) the Elrods were in a position to dominate and control the Debtor; and (iii) the Elrod's domination and control related to the Debtor's disposition of its property.

In deciding whether the Elrods had the requisite fraudulent intent, the Court observed that fraudulent intent may be based on circumstantial evidence.  Citing In re Vaniman Int'l Inc., the Court noted that "[a]s a general rule, fraudulent intent is found on the basis of circumstantial evidence because 'fraudulent intent is not susceptible to direct proof.'"  In re Vaniman Int'l Inc., 22 B.R. 166 (Bankr. E.D.N.Y. 1982).  Signs of fraud include evidence of a close relationship among the parties to a transaction, the transaction involves a "secret and hasty transfer" or contains inadequate consideration. 

The Trustee argued that a close relationship did exist between the parties and that the Elrod's refusal to execute the bond agreement evidenced fraud.  For purposes of summary judgment, the Court found that the Trustee had identified some of the "badges of fraud."  Having made this determination, the Court next addressed whether the Elrods were in a position of control.  Here, the Court noted that vicarious intent is an extreme situation that is dependent upon nearly total control of a debtor by the transferee.  A typical case where transferee intent is imputed on the Debtor is one where the transferee is the sole shareholder of the Debtor and has complete control.  The Trustee argued that although the Elrods comprise only a minority of the Debtor's board, they still exercised functional control of the Debtor.  Even so, the Court found that functional control is not enough.  To prevail, the Trustee must show that the Elrods had "formal, legal control as well as functional control." 

After finding that actual intent did not exist, the Court next turned to the Trustee's allegations that the transfer of property was constructively fraudulent.  Here the Court begin its analysis with the rule that whether a transfer conferred "realizable commercial value" was central to deciding whether the transfer at issue was constructively fraudulent.  On this point, the Court found several examples of value provided by the Elrods in the sale leaseback transaction.  First, the Elrods submitted an appraisal showing that the price at which the Elrods purchased the equipment from the Debtor was greater than the actual value of the equipment.  Next, the Elrods introduced evidence that the rental payments from the Debtor to the Elrods were at a below market interest rate that was to the Debtor's benefit.  The Trustee, on the other hand, offered no evidence to show the value provided by the Elrods was less than a reasonably equivalent value.  Based on these findings, the Court granted summary judgment for the Elrods on the Trustee's fraudulent transfer claim.

Conclusion

Under most circumstances, claims alleging fraud must be pled with particularity.  The decision in Elrod shows that a plaintiff alleging fraud must satisfy certain factual thresholds in order to overcome a motion for summary judgment.  Further the decision shows the challenges for plaintiffs who seek to impute the allegedly fraudulent conduct of a third party on to a debtor.

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Jason Cornell is a bankruptcy attorney in the Wilmington, Delaware office of Fox Rothschild LLP.  You may contact Jason at 302 427 5512, or jcornell@foxrothschild.com

Accuride's Business

Accuride and Accuride Canada were formed in 1986 for the purpose of acquiring all of the assets of a division of Firestone.  Two years after formation, Phelps Dodge Corporation purchased Accuride.  One year after Phelps' purchase, Kohlberg Kravis Roberts & Co. acquired a controlling interest in Accuride.  As stated in Accuride's Bankruptcy Declaration, Accuride's stock originally traded on the New York Stock Exchange, however, it was subsequently delisted and now trades in the over-the-counter market.

The Company's Financials

In its Petition for Bankruptcy, Accuride lists its assets at $682 million, against liabilities of $847 million.  Accuride's sales reached $1.4 billion in 2006, however, by 2008 sales were down to $931 million. The company's senior credit facility includes a term loan with a balance of $303 million and a revolving credit facility with a principal balance of $100 million.  In addition to its credit facility, the company issued notes worth $275 million.  According to Accuride's Petition for Bankruptcy, its ten largest unsecured trade creditors are as follows:

1. Matalco Inc. ... $1.1 million
2. Joseph Tryerson ... $804,609
3. Ryerson ... $791,756
4. Gallatin Steel ... $557,663
5. American Colloid ... $323,409
6. PrimeTrade Inc. ... $321,506
7. Anixter Fasteners ... $248,044
8. Foseco Metallurgical $236,594
9. Hydro Aluminum $230,801
10. B&B Metals Processing ... $228,683

Events Leading to Bankruptcy

Accuride is one of several auto parts suppliers that filed for bankruptcy in recent months.  As with other parts manufacturers, Accuride attributes it bankruptcy filing to the global economic downturn.  In its Bankruptcy Declaration, Accuride cites an industry publication that reports a drop in demand for trucking vehicles by 23% in the first half of 2007.  Forecasts predict further declines for 2009.  Given the poor economic outlook for the last three years, Accuride's stock price fell from $16.91 in 2007 to $.36 per share at the time it filed for bankruptcy. 

This bankruptcy proceeding is before the Honorable Brendan L. Shannon.

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Jason Cornell is a bankruptcy attorney in Wilmington, Delaware with the law firm Fox Rothschild LLP.  If you have questions regarding this bankruptcy, or any other Delaware bankruptcy proceeding, you can contact Jason at 302 427-5512, or jcornell@foxrothschild.com.

Debtor's Operations

Freedom Communications' origins go back to 1935 when R.C. Hoiles purchased The Orange County Register.  From its beginnings through 2000, the company purchased newspapers and other publications in the states of Arizona, California, Colorado, Florida, Illinois, Indiana, Missouri, New Mexico, North Carolina, Ohio and Texas.  According to Freedom's Declaration, as of its petition date, the company owns 90 daily or weekly publications and 30 daily newspapers.  In addition to print publications, Freedom also owns eight television stations, most of which are either ABC or CBS affiliates.  Including contractors, Freedom employs over 8,200 individuals.

Debtor's Financials

Freedom lists its assets with a book value of $757 million, against liabilities totaling over $1 billion.  Included in Freedom's debt is its credit agreement of approximately $770 million.  The remaining $306 million in liabilities includes trade claims, contract claims, lease claims, non qualified retirement plan claims and litigation claims.  According to Freedom's Petition for Bankruptcy, the company's ten largest unsecured creditors include:

1. JP Morgan (unsecured loan) ... $770 million
2. Class Action Plaintiffs ... $28.9 million
3. Kingworld Productions, Inc. ... $1.5 million
4. North Pacific Paper ... $1.2 million
5. Bowater America, Inc. ... $753,326
6. Inland Empire Paper ... $590,502
7. SP Newsprint  Co. ... $548,151
8. Vertis Inc. ... $381,416
9. Impression Inks West ... $374,591
10. Abitibi Consolidated Sales ... $356,630

Conclusion

This bankruptcy proceeding is before the Honorable Brendan L. Shannon.  There has been substantial activity in this case within the first 24 hours of the petition date.  Included among the company's "first day" bankruptcy motions is a motion to pay certain critical vendors, a motion seeking administrative claim status of postpetition goods and a motion to establish procedures for the rejection of executory contracts and leases.  (To read a prior post on issues relevant to lease rejection, click here).

Many debtors file for bankruptcy in an effort to sell-off assets under the protection of section 363 of the United States Bankruptcy Code.  Freedom states in its Declaration that it filed for bankruptcy in order to restructure its debt under a plan of reorganization.  To that end, the company intends to file a disclosure statement and plan of reorganization within 45 days from the date it filed for bankruptcy.

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Jason Cornell is a bankruptcy attorney who practices in Wilmington, Delaware with Fox Rothschild LLP.  If you have questions regarding this or any other Delaware bankruptcy proceeding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com.  Fox Rothschild LLP does not represent Freedom Communications Holdings in this bankruptcy proceeding.