On January 22, 2018, in an adversary proceeding arising within the Haggen bankruptcy (Adv. No. 16-51204), Judge Gross of the Delaware Bankruptcy Court issued a ruling against the Plaintiff, denying the relief requested in the complaint and dismissing the adversary proceeding. Judge Gross’s opinion is available here (the “Opinion”).

The Committee filed an adversary proceeding with a 78 count, 145 page Complaint making numerous allegations including, but not limited to, fraudulent transfers, breach of fiduciary duties, and unjust enrichment.  The Defendants’ answer spanned 184 pages, denying the numerous allegations and laying out the groundwork for the intense legal battle that followed.  Accordingly, it came as no surprise that the trial lasted five days and Judge Gross’s Opinion was 162 pages.

This Opinion follows on the heels of motions for summary judgment, which were previously discussed in this blog post:  In Fact Intensive Issues, You Need a Trial to Provide the Court With the Facts.

As one could presume based on Judge Gross’s affable nature, both in the courtroom, in the public sphere, and in his rulings, Judge Gross has crafted this Opinion in a manner that clearly guides the reader through each issue and includes an easily understood summary.  Judge Gross held that the Defendants were not so cavalier in planning and effecting the Project that they were grossly negligent nor that there was anything inherently wrong with the OpCo-PropCo structure.

“The Project failed but not because the Defendants did not care if it succeeded. Moreover, it is not uncommon for parties who are planning a transaction to make certain that they are protected in the event the transaction fails. Such protection from adverse results is one of the reasons for forming a corporation or other entity – to limit personal liability.

It is unnerving that the Project failed in a matter of months and certainly the Court had questions about how it happened. It turns out that the people in charge, the Individual Defendants, to some degree were not prepared. They were not, however, grossly negligent and they certainly meant for Haggen, Holdings and the OpCo to succeed. The Committee made a strong case but, at the end of the day failed to establish gross negligence or self-dealing or the existence of any fraudulent transfers. The Committee did establish that the leases between Spirit and GIG, and the OpCo’s, were above the market rate, but there is no liability. The Committee failed however, to establish the remaining counts of the Complaint.”

Opinion at *3.  Judge Gross then cites to the Delaware Chancery Court for the proposition that “to allege that a corporation has suffered a loss as a result of a lawful transaction, within the corporation’s powers, authorized by a corporate fiduciary acting in a good faith pursuit of corporate purposes, does not state a claim for relief against that fiduciary no matter how foolish the investment may appear in retrospect.”  Opinion at *4 (quoting Gagliardi v. TriFoods Int’l, Inc., 683 A. 2d 1049, 1052 (Del. Ch. 1996)).

This case arose from a buyout that was structured with separate entities having separate roles.  The property owning entities have been successful – real estate is, after all, booming.  The operating entities, however, have struggled like a large number of other retailers.  Retail bankruptcy cases are at an all-time high and rents are higher than ever.  As Judge Gross recognized in the Opinion, the corporate structure is meant to provide down-side protection to equity holders.  In this instance (pending any possible appeals), the corporate form appears to have operated precisely as intended.

In a decision signed October 4, 2017 in an adversary proceeding arising within the Haggens bankruptcy (HH Liquidation, LLC, et al., case 16-51204), Judge Gross of the Delaware Bankruptcy Court denied a motion for summary judgment, holding that he Court and needs to see evidence at trial of why and how the Debtor failed while a related entity was flush with cash. Judge Gross’s opinion is available here (the “Opinion”).

By way of history, the Haggen family started operating a grocery in 1933, growing to operate thirty stores and a pharmacy by 2011.  In late 2014, the Safeway / Albertsons merger occurred, which required them to sell 146 stores.  In February 2015, Haggen (thanks in large part to the direction of Comvest Partners, a private equity firm who had purchased 80% of Haggen’s equity) purchased the 146 former Albertsons locations.  With a signature, Haggens grew to a size that was approximately 600% larger than it had ever been.  It is my opinion that growth at this pace either succeeds fantastically, or fails fantastically.  Unfortunately, this is a bankruptcy court opinion – so it’s clear this wasn’t a fantastic success.

Haggens split the acquisition into multiple pieces, segregating the operating and real property assets in different entities.  Those which held real property I will refer to collectively as PropCos, and those which operated stores and leased the real property for such a purpose I will refer to collectively as OpCos.  For those who have not followed the Haggens bankruptcy, it is important to recognize that OpCos were placed into bankruptcy and the PropCos were not.

The plaintiff in the adversary proceeding argued that the debtor and non-debtor related entities should be substantively consolidated and that the OpCos and PropCos were liable for fraudulent transfer.  Without consolidation or a fraudulent transfer ruling, the PropCos creditors will receive 100% of their claims while OpCos unsecured creditors will receive 0%.  If the plaintiffs are successful in their claims, the PropCos creditors and the OpCos creditors would all receive approximately 20% of their claims.  Opinion at *7.

Judge Gross was not sympathetic to the Debtors’ opining that:

Comvest created Holdings, the OpCo Entities and the PropCo Entities and formed them to hold separate assets. The OpCo Entities held operational assets and leased property from the PropCo  Entities which held the real property. Then, in a matter of a few months the OpCo Entities were bankrupt and are unable to pay unsecured creditors anything while the PropCo Entities are flush with money.  The Court and the OpCo Entities’ creditors need to see evidence at trial of why and how this happened.

Opinion at *7-8.  Of particular note, Judge Gross made repeated references to the Mervyn’s decision,  In re Mervyn’s Holdings, LLC, 426 B.R. 488 (Bankr. D. Del. 2010).  “In Mervyn’s, like here, the owner of real property (Target Corporation) sold its interest in Mervyn’s, LLC to a group of private equity firms who spun off real estate leaving the operational portion of Mervyn’s, LLC undercapitalized and paying rent to the real estate holding entity.”  Opinion at *9.  I have found that when a judge on the Bankruptcy Court makes repeated reference to another decision, particularly when it is a decision of that very judge, litigants should make every effort to differentiate, or analogize, the instant case.  The repeated reference to Mervyn’s by Judge Gross provides a clear picture of the issues he will need answered by the litigants here.  It’s his opinion, I’d expect it to be the first and last thing out of both litigants’ mouths.