In a decision signed September 21, 2017 in an adversary proceeding related to the Boomerang Systems bankruptcy (case 15-11729), Judge Walrath of the Delaware Bankruptcy Court denied a defendants FRCP 12(b)(6) motion to dismiss a preference complaint. Judge Walrath’s opinion is available here (the “Opinion”).

Judge Walrath first provided the requirements for a preference action to survive a motion to dismiss.  Quoting Stanziale v. DMJ Gas-Mktg. Consultants, LLC (In re Tri-Valley Corp.), Adv. No. 14-50446 (MFW), 2015 WL 110074, at *2 (Bankr. D. Del. Jan. 7, 2015), Judge Walrath stated that “to satisfy Rule 8, the complaint must identify each alleged preferential transfer by the date of the transfer, the name of the debtor/transferor, the name of the transferee, and the amount transferred.”  Opinion at *5.

In this case, Gavin Solmonese, LLC, the liquidating trustee of Boomerang Systems (the “Liquidating Trustee”), filed a preference action that is, in Delaware, a fairly routine pleading.  In its complaint, the Liquidating Trustee alleged the amount, date, and method of payment made by the Debtors to the Defendant.  Judge Walrath held that “this allegation is sufficient to allege a preferential transfer.”  Opinion at *6.

The Defendant asserted its affirmative defenses as grounds for dismissal of the complaint.  However, as the Court held, “these defenses are not grounds to dismiss the action under Rule 12.”  Opinion at *6.  A 12(b)(6) dismissal requires a deficiency in the plaintiff’s pleading.

Avoidance actions are painful for defendants – particularly when they are innocent actors.  But the innocence of a preference defendant is not a defense.  The only defenses available are those provided by statute – 11 U.S.C. § 547(c). We have provided an overview of these defenses in our short booklet A Preference Reference.

In a 28 page opinion released November 25, 2014 in the Tropicana Entertainment bankruptcy (Bank. D. Del. 08-10856), Judge Carey of the Delaware Bankruptcy Court provided an opinion regarding a defendant’s motion to dismiss an amended complaint.  Judge Carey granted the majority of the motion to dismiss, denying a second request for leave to amend because “The Trustee has now had ample opportunity to present a properly pled complaint.”  This ruling illustrates the importance of providing all the necessary details and required allegations in a complaint, particularly if the Court has already provided you with one “do-over”.  Judge Carey’s opinion is available here (the “Opinion”).

Background

Pursuant to the confirmed plans in the Tropicana bankruptcy cases, Lightsway Litigation Services, LLC was appointed as the trustee of a Litigation Trust (the “Trustee”) tasked with pursuing claims against insiders of the Debtors. On February 17, 2010, the Trustee filed a complaint against Yung, Wimar, Columbia and others asserting claims for breach of fiduciary obligations, breach of contract, breach of the implied covenant of fair dealing, and equitable subordination. The defendants filed a motion to dismiss the complaint and, after a hearing, the Court entered an Order denying the motions to dismiss, but directing the Trustee to file an amended complaint.  On February 9, 2011, the Trustee filed the First Amended Complaint against Yung, Wimar and Columbia (the “Defendants”).  Opinion at *3.

The Defendants filed another motion to dismiss.  After briefing and oral argument, the Court entered the Opinion and corresponding Order granting the motion in part and denying it in part.

Judge Carey’s Ruling

While the amended complaint contains five claims, all of which are addressed in the motion to dismiss and the Opinion, the only claim this post will discuss is the Trustee’s amended claim that “[Defendant] Yung breached fiduciary duties owed to the Debtors based upon his equity ownership and control of the management, operation, and finances of the Debtors.”  Opinion at *17 (internal quotations omitted).

This section of the Opinion spans pages 17-21, providing a detailed analysis of who is owed fiduciary duties, and when.  Beginning when a company is healthy, and all duties are owed to the equity holders, in this case the parent company, and ending when a company is distressed and all duties are owed to the creditors, at the individual company level.  As stated by the Court, “[t]he solvency or insolvency of the corporation determines which constituency has the right to pursue a derivative claim based on a breach of fiduciary obligation.”  Opinion at *20.

Citing the Delaware Chancery Court’s decision Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 792 (Del. Ch. 2004), the Opinion states that “To meet the burden of pleading insolvency, a plaintiff must plead facts showing that the debtor-corporation has either 1) a deficiency of assets below liabilities with no reasonable prospect that the business can be successfully continued in the fact thereof, or 2) an inability to meet maturing obligations as they fall due in the ordinary course of business.”  Opinion at *20-21.  In this case, the Trustee failed to plead specific facts, alleging only that “[the Defendant’s] misconduct propelled the Debtors into insolvency, which ultimately led to the filing of the bankruptcy cases in the Spring of 2008.”  Opinion at *20.

While there is no doubt that the Debtors filed for bankruptcy, “[the complaint contains] no facts to provide a basis from which [the Court] can infer whether any or all of the Debtors were insolvent or when insolvency occurred.”  Opinion at *21.  And although the Defendants did not raise insolvency in their motion to dismiss the original complaint, the Defendants are not required to defend against claims that were not included in the complaint.  This led to the Court’s ruling that “The Trustee has now had ample opportunity to present a properly pled complaint. The request for leave to again amend the complaint is denied.”  Opinion at *21.

In this case, the failures of the Trustee in crafting a complaint that satisfied the standards of the Delaware Bankruptcy Court, even with two bites at the apple, led to the Court’s dismissal of a cause of action that could have resulted in significant damage awards for the Trustee.  If you read no other parts of this decision, make sure to carefully review pages 17-21 before filing any amended complaints in the Delaware Bankruptcy Court.

Summary

In a straight-forward 9 page decision signed May 1, 2012, Judge Walrath of the Delaware Bankruptcy Court granted a defendant’s motion to dismiss a preference complaint, but granted the plaintiff leave to amend. Judge Walrath’s opinion is available here (the “Opinion”).  Numerous posts on this blog discuss other opinions issued by the Delaware Bankruptcy Court dealing with preference payments, as can be seen here. PREFERENCE OPINION POSTS.

Additionally, this opinion is very similar to that discussed in this prior post: Decision in Everything But Water, LLC Requires Preference Claimants to Identify Transferees Specifically in Granting Motion to Dismiss.

Background

The Debtors are comprised of two entities, Ultimate Acquisition Partners, LP and CC Retail. They operated under the name “Ultimate Electronics” and all checks were cut using this name, rather than identifying which Debtor was acting. Opinion at *2. Several payments were made to various creditors, including Mitsubishi Digital Electronics America, Inc. d/b/a Mitsubishi Digital Electronics (“Mitsubishi”) within the 90 day period before the Debtors filed for bankruptcy.

The Debtors filed for bankruptcy on January 26, 2011, and the Court converted the cases to chapter 7 and appointed the Trustee, Alfred T. Giuliano, on May 3, 2011. Mitsubishi filed several claims in the bankruptcy, including general unsecured claims, administrative claims, and 503(b)(9) claims. Opinion at *2. On July 19, 2011, the Trustee filed a complaint against Mitsubishi for recovery of any preference payments. On October 19, 2011, Mitsubishi filed the motion to dismiss that is decided by this Opinion.

The motion to dismiss argues that the Trustee is required to identify which of the two Debtors made the payments that the Trustee now seeks to avoid. Opinion at 4-5. Failing this, Mitsubishi argued, the complaint must be dismissed. Opinion at *4.

Judge Walrath’s Opinion

Judge Walrath’s analysis of the standard of review for a 12(b)(6) motion could be a cut/paste of the Everything But Water opinion mentioned above, citing the same authorities for the same principles. Jumping then, to Mitsubishi’s argument for dismissal: The Trustee fails to identify the transferor as required by Miller v. Mitsubishi Digital Elecs. Am. Inc. (In re Tweeter Opco), 452 B.R. 150 (Bankr. D. Del. 2011) and In re Valley Media, Inc., 288 B.R. 189, (Bankr. D. Del. 2003). Opinion at *4. Judge Walrath agreed with Mitsubishi and granted the motion to dismiss. Opinion at *5.

The Trustee’s complaint also argued that Mitsubishi’s claims and administrative expense claims, filed in the Ultimate Acquisition bankruptcy case, should be disallowed pursuant to 11 U.S.C. § 502(d). Opinion at *5-6. Section 502(d) provides that “the court shall disallow any claim of any entity from which” a transfer is avoidable “unless such entity or transferee has paid the amount, or turned over any such property, for which such entity or transferee is liable…” 11 U.S.C. § 502(d). However, because the Trustee’s preference complaint was dismissed, his 502 claim was not applicable and would also be dismissed. Opinion at *8.

Recent opinions published by the judges in the Delaware Bankruptcy Court seem to indicate that they are becoming more strict in their interpretation of pleading requirements, but generously allowing plaintiffs to amend insufficient complaints. Regardless of which side of a preference action you are on, knowledge of the ever changing local rules and precedents is vital to successful litigation or settlement.

Summary

In an 11 page decision signed June 30, 2011, Judge Walrath of the Delaware Bankruptcy Court granted a motion to dismiss, holding that a preference complaint must clearly identify the alleged preference transferee. Judge Walrath’s opinion is available here (the “Opinion”).  A number of decisions on motions to dismiss under Federal Rule of Civil Procedure 12(b)(6) have been released recently. If you’d like to review some of these rulings, the following blog posts provide a solid start:

Decision in Tweeter Opco Once Again Reminds Trustees of the Specificity Requirement in Pleading Preference Actions

Decision in Crucible Materials Requires Preference Claims to Contain More Than Just Recitations of the Code

Decision in DBSI Inc., Holds that the “Particularity” Requirement of F.R.C.P. 12(b)(6) and 9(b) was Satisfied, Notwithstanding the Number of Alleged Fraudulent Transfers

Background

Everything But Water, LLC (the “Debtor”) and certain of its affiliates filed for bankruptcy under chapter 11 on February 25, 2009. The case was converted to chapter 7 and Montague Claybrook was appointed as the trustee (the “Trustee”) on July 30, 2009. The Trustee filed a complaint against JDH Management (“JDH”) and various affiliates of Bear Stearns in which he asserted claims for preferential and fraudulent transfers. In response, JDH filed a motion to dismiss for failure to state a claim under FRCP 12(b)(6), arguing both that JDH did not have a relationship with the Bear Stearns entities that would create a liability and that the Trustee failed to adequately state a claim. The Opinion was written in response to JDH’s motion.

Judge Walrath’s Opinion

Judge Walrath’s legal analysis begins with a discussion of the standard for ruling on motions under FRCP 12(b)(6). She cites the usual suspects, including Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009); Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007); Fowler v. UPMC Shadyside, 578 F.3d 203 (3d Cir. 2009); and Kost v. Kozakiewicz, 1 F.3d 176 (3d Cir. 1993). Opinion at *4-5. Judge Walrath then turns to JDH’s assertion that it has no affiliation with the Bear Stearns entities in question. Because the Court must accept the non-moving party’s factual allegations as true in considering a motion to dismiss, Judge Walrath had to accept the Trustee’s allegations that JDH was affiliated with the Bear Stearns entities in question. Opinion at *6.

Judge Walrath then moved to an analysis of the preferential and fraudulent transfer claims. She cited In re Valley Media, Inc., 288 B.R. 189, 192 (Bankr. D. Del. 2003) in opining that “to survive a motion to dismiss a claim for avoidance of a preferential transfer, the Plaintiff must plead the following: (a) an identification of the nature and amount of each antecedent debt and (b) an identification of each alleged preference transfer by (i) date, (ii) name of debtor/transferor, (iii) name of transferee and (iv) the amount of the transfer.” Opinion at *6. Judge Walrath held that “the Trustee’s Complaint is deficient because it contains no information regarding who received any of the transfers.” Thus, the “Trustee does not meet the pleading requirements for preferential transfers.” Opinion at *8. Judge Walrath also states that the “Trustee’s Complaint fails to plead properly a claim for avoidance of fraudulent transfers for the same reason….” Opinion at *9. Because of the deficiencies in the complaint, Judge Walrath grants the motion to dismiss, but in an effort to preserve fairness given the technicality of the reason for dismissal, she explicitly allows the Trustee to file an amended complaint. Opinion at *11.

In some situations, minor mistakes are all that it takes to leave a filing vulnerable to a motion to dismiss under FRCP 12(b)(6). Recent opinions published by the judges in the Delaware Bankruptcy Court seem to indicate that they are becoming more strict in their interpretation of pleading requirements. Regardless of which side of a preference action you are on, knowledge of the ever changing local rules and precedents is vital to successful litigation, or settlement.

Summary

In a 23 page decision signed July 15, 2011, Judge Walsh of the Delaware Bankruptcy Court denied a motion to allow a plaintiff to file an amended complaint, holding that the amended complaint was too deficient to survive a motion to dismiss and therefore would not be allowed. Judge Walsh’s opinion is available here (the “Opinion”).

Background

Following Fruehauf Trailer Corporation’s (the “Debtor”) bankruptcy and subsequent confirmation of its plan in September 1998, Chriss Street (“Street”) was appointed as the trustee of the Debtor’s liquidating trust. He served in this capacity until August 2005, when he resigned and was succeeded by Daniel Harrow (“Harrow”). While there was extensive litigation between Street and Harrow, this post will only discuss those portions of the litigation that led directly to the issuance of the Opinion.

In July 2007, Street filed a complaint (the “Original Complaint”) against Harrow in California State Court. The case was removed to federal court, where Harrow filed an answer denying all material allegations. The case was then transferred to the District Court of Delaware, then referred to the Bankruptcy Court as a core proceeding. The case lay dormant until July 12, 2010, when Street filed an amended complaint. Eight days later, Street filed a second amended complaint. The Court struck both amended complaints, because Street filed them without Harrow’s consent or Court approval, in violation of Rule 15 of the Federal Rules of Civil Procedure (“FRCP”). On September 8, 14, and 24, 2010, Street filed three identical motions to amend the Original Complaint, pursuant to Rule 15. Street appended a proposed amended complaint (the “Amended Complaint”) to these motions. Opinion at *2-3.

To summarize, the Original Complaint, filed 2 years after Street resigned, was eleven pages long and listed 26 defendants, 25 of which were “John Does” while the Amended Complaint, filed 5 years after Street’s resignation, was 126 pages and listed 16 defendants. Opinion at *7-8. The Opinion was written in response to Street’s motion to allow (the “Motion”) him to amend his complaint.

Judge Walsh’s Opinion

Judge Walsh begins his discussion of the Motion by quoting FRCP 15, which provides that “a party may amend its pleading only with the opposing party’s written consent or the court’s leave” and that “[t]he court should freely give leave when justice so requires.” Opinion at *8. Judge Walsh then quotes several opinions that define the extent to which an amendment should be allowed. These include: Foman v. Davis, 371 U.S. 178 (1962); Dole v. Arco Chem. Co., 921 F.2d 484 (3d Cir. 1990); Johnson v. Geico Cas. Co., 673 F.Supp.2d 244 (D. Del. 2009); and Koken v. GPC Int’l, Inc., 443 F.Supp.2d 631 (D. Del. 2006). Opinion at *8-9. In summation of the flaws in the Amended Complaint, Judge Walsh opines that “the Proposed Amended Complaint fails to state a claim upon which relief may be granted” and it “fails to meet the pleading requirements of Rule 9(b) … and alleges causes of action that are time barred.” Opinion at *9.

Judge Walsh then proceeds to identify general flaws within several counts of the Amended Complaint, including: (1) Failing to Plead Fraud with Particularity, at *9-12; and (2) Time-Barred by the Statute of Limitations, at *12-15. Judge Walsh then discusses each of the 22 counts of the Amended Complaint before ultimately concluding that “all twenty-two counts contained in Street’s Proposed Amended Complaint fail to state a claim upon which relief may be granted,” at which point he denies the Motion. Opinion at *23.

While FRCP 15 and Third Circuit precedent provide that leave to amend should be liberally granted, it is by no means a certainty. For this reason, it is vital to determine the appropriate defendants and fully research any relevant laws, particularly statutes of limitation, prior to filing a complaint.

Summary

In his first published opinion since returning from a well-deserved vacation, Judge Sontchi of the Delaware Bankruptcy Court ruled that facially plausible allegations are sufficient to protect a complaint, which sought to recharacterize another party’s bankruptcy claims, from being dismissed pursuant to Federal Rule of Civil Procedure (“FRCP”) 12(b)(6). Judge Sontchi’s opinion is available here (the “Opinion”).  For the principles of an analysis under FRCP 12(b)(6), please review the posts listed below:

Decision in Tweeter Opco Once Again Reminds Trustees of the Specificity Requirement in Pleading Preference Actions

Decision in Crucible Materials Requires Preference Claims to Contain More Than Just Recitations of the Code

Decision in DBSI Inc., Holds that the “Particularity” Requirement of F.R.C.P. 12(b)(6) and 9(b) was Satisfied, Notwithstanding the Number of Alleged Fraudulent Transfers

Background

In July 2006, Friedman’s Inc. (the “Debtor”) purchased the jewelry chain Crescent following Crescent’s descent into bankruptcy. In order to make this purchase, the Debtor issued an unsecured promissory note (the “Note”) to its shareholders in exchange for their funding of just over $22 million. Opinion at *3-4. The funding was provided to the Debtor by each of its shareholders on a pro rata basis, and was to accrue interest at 8% per annum, with no fixed dates for payment. Following a tax rebate paid to the Debtor in December 2006, the interest on the Note could have been paid in full, but was not. Rather, interest was never paid on the Note. Opinion at *4-5. In January 2008, the Debtor was pushed into an involuntary bankruptcy, which the Court later converted to a voluntary chapter 11 case.

Thereafter, the shareholders who contributed to the Debtor in exchange for the Note filed a claim for its value, including interest. The Debtor filed a complaint objecting to the general unsecured claims of Goldman Sachs Credit Partners L.P., Plainfield Direct Inc., Ramius Value and Opportunity Master Fund Ltd, Parche, LLC and Cadence Master Fund Ltd. (collectively, the “Defendants”) and sought to recharacterize them as equity. The Defendants filed a motion to dismiss the complaint under FRCP 12(b)(6) for failure to state a claim. It was this motion that gave rise to the Opinion.

The Defendants argue that the funding was intended to be a loan and not equity. Opinion at *6. This is evidenced, they argue, by the Debtor’s consideration, and rejection, of raising equity to pay for the acquisition. Opinion at *20. The Debtors allege that the details of the transaction, including the pro rata contribution by the shareholders, the deferred interest payments, the below market interest rate, unpaid interest even when monies were available, and the basis of the contribution being subordinated unsecured, all are indicative of an equity transaction rather than a debt transaction. Opinion at *2.

Judge Sontchi’s Opinion

Judge Sontchi’s legal analysis begins with the standard explanation of the requirements to grant a motion to dismiss under FRCP 12(b)(6) – explained in our previous posts (see the links above). He then moved to a discussion of Third Circuit recharacterization precedent, which focuses on “whether the parties called an instrument one thing when in fact they intended it as something else. That intent may be inferred from what the parties say in their contracts, from what they do through their actions, and from the economic reality of the surrounding circumstances.” Opinion at *9 quoting Cohen v. KB Mezzanine Fund II, LP (In re SubMicron Sys. Corp.), 432 F.3d 448, 456 (3d Cir. 2006).

Judge Sontchi then went through the following factors to determine what the intent of the parties was in providing the financing at issue: (1) Names Given to the Instruments, if any, Evidencing the Indebtedness, at *12; (2) Presence or Absence of a Fixed Maturity Date and Schedule of Payments, at *13; (3) No Fixed Rate of Interest and Interest Payments, at *14; (4) Repayment Dependent on Success, at *15; (5) Inadequacy of Capitalization, at *16; (6) Identity of Interests Between Creditor and Stockholder, at *16; (7) Security, if any, for the Advances, at *17; (8) Ability to Obtain Financing From Outside Lending Institutions, at *17; (9) Extent to Which the Advances Were Subordinated to the Claim of Outside Creditors, at *18; (10) The Extent to Which the Advances Were Used to Acquire Capital Assets, at *18; (11) Presence or Absence of a Sinking Fund, at *19; (12) Presence or Absence of Voting Rights, at *19.

Judge Sontchi is clear to note that the Court does not base its decision on the mechanical exercise of tallying how many of the above factors weigh in favor of determining the funding is equity vs. how many weigh in favor of determining the funding to be debt. He does, however provide the score: Equity 7, Debt 3 and Neither 2. Opinion at *21. In reaching his ultimate decision to deny the motion to dismiss, Judge Sontchi points out that the Defendants may win at trial, but deciding a motion to dismiss requires the judge to take all allegations in the Complaint as true. In this instance, he determined that the Plaintiff alleged sufficient facts that an evidentiary record is necessary for the Court to make a final decision on how to characterize the funding. Opinion at *21-22.

Motions to Dismiss serve a gatekeeping function in court, ensuring that time is not spent developing a factual record when no legal wrong has been committed. Considering that most legal actions are resolved through settlement, it is important to keep in mind that a complaint which survives a motion to dismiss is going to be much more expensive to settle.

Summary

In a 12 page decision signed July 6, 2011, Judge Walrath of the Delaware Bankruptcy Court granted a motion to dismiss, holding that a complaint that sets forth only conclusory allegations parroting the statutory language of the Bankruptcy Code is insufficient. Judge Walrath’s opinion is available here (the “Opinion”).

Background

Crucible Materials Corporation (“Crucible”) produced steel products, primarily for automotive manufacturers. Following the disruption in the American auto industry, Crucible filed for bankruptcy. Judge Walrath confirmed the plan of reorganization of Crucible and certain of its affiliates (the “Debtors”) on August 26, 2010.  At the same time, Richard D. Caruso was appointed Litigation Trustee (the “Trustee”).

On November 8, 2010, the Trustee filed an adversary proceeding (the “Complaint”) against The Lenick Company (the “Defendant”) to avoid transfers pursuant to section 547 (“Count 1″), to avoid fraudulent conveyances pursuant to section 548 (“Count 2″), to recover post-petition transfers pursuant to section 549 (“Count 3″), to recover property transferred pursuant to section 550 (“Count 4″), and to disallow any claims the Defendant may have pursuant to section 502 (“Count 5″). On January 12, 2011, the Defendant moved to dismiss the complaint pursuant to Rule 12(b)(6). Counts 2 and 3 were withdrawn by the Trustee and the Defendant withdrew its motion regarding the same two counts.

In its motion to dismiss, the Defendant argued that the Trustee’s failure to include proof of the transfers and the lack of detail concerning the transfers made the complaint insufficient to provide notice of what transfers the Trustee sought to avoid. Opinion at *6. Rather, the Defendant argued that “the Trustee simply asserts the elements of section 547(b) and relies on legal conclusions rather than factual assertions.” Opinion at *7. The details that the Trustee included were: the name of the transferee, check numbers, check amounts, invoice dates, invoice numbers, and the clear dates of the transfers. Id. The Trustee argued that this was sufficient detail to put the Defendant on notice and survive the motion to dismiss.

Judge Walrath’s Opinion

Judge Walrath’s legal analysis begins with a fairly standard analysis of the requirements of a motion to dismiss under Federal Rules of Civil Procedure (“FRCP”) 12(b)(6). A pair of posts discussing opinions that detail the requirements of a motion to dismiss are below:

Decision in Tweeter Opco Once Again Reminds Trustees of the Specificity Requirement in Pleading Preference Actions

Decision in DBSI Inc., Holds that the “Particularity” Requirement of F.R.C.P. 12(b)(6) and 9(b) was Satisfied, Notwithstanding the Number of Alleged Fraudulent Transfers

Following her summary of the precedent surrounding a motion to dismiss, Judge Walrath turned to a discussion of each of the three counts remaining in the Complaint. In examining the motion to dismiss Count 1, Judge Walrath held that the Trustee must identify the transferor by name (which debtor received the transfer), and must include information detailing the nature of the antecedent debt. Without any proof of an antecedent debt or creditor/debtor relationship, the complaint fails. Opinion at *8-10. Judge Walrath continued by acknowledging that Count 4 is derivative of Count 1, and the failure of Count 1 necessarily requires Count 4 to likewise be dismissed. Opinion at *10-11. Similarly, Count 5 is derivative of Count 1, and would also be dismissed. Opinion at *11.

Judge Walrath concluded by quoting FRCP 15(a), which states that “leave to amend shall be freely given when justice so requires.” Opinion at *12. Because the Defendant provided no reasons why leave to amend should not be granted, Judge Walrath determined that justice would best be served by granting the requested leave to amend. Id.

When arguing for a dismissal of a complaint, never forget to include argument as to why the plaintiff should not be granted leave to amend. Some attorneys may think that a mention of FRCP 15 will give their opponent the idea to argue for amendment. However, failing to argue that leave should not be granted means that any argument to the contrary by opposing counsel, almost guarantees that leave to amend will be granted.

Summary

In a 10 page decision signed May 5, 2011, Judge Walsh of the Delaware Bankruptcy Court denied a motion to dismiss and held that the plaintiff Litigation Trustee satisfied the “particularity” requirements of Federal Rules of Civil Procedure 12(b)(6) and 9(b), despite having his complaint allege that each transfer within a 13 page list of transfers was fraudulent.  Judge Walsh’s opinion is available here (the “Opinion”).

Background

DBSI and certain of its affiliates filed for bankruptcy on November 6, 2008. A plan of liquidation was confirmed October 26, 2010, and a Litigation Trust was formed. The Litigation Trustee was given the power to pursue the Debtors’ causes of action, including bringing lawsuits to recover preference payments and fraudulent transfers.

The Litigation Trustee brought a claim against certain DBSI insiders, including Douglas L. Swenson, alleging fraudulent transfers were made to these insiders prior to DBSI’s bankruptcy. Opinion at *2. As part of a 208 page complaint, the Litigation Trustee includes a list of transfers that is 13 pages long, each of which the Trustee alleges were fraudulently made as part of “the Insiders elaborate pyramid or ‘Ponzi’ scheme…” Opinion at *3.

The defendants moved to dismiss the complaint, arguing that Federal Rules of Civil Procedure 12(b)(6) and 9(b) require a complaint to allege with particularity the specific facts that would support a claim. Essentially, the defendants argue that each specific transfer must be addressed by the complaint. Opinion at *4.

Judge Walsh’s Opinion

Judge Walsh’s Opinion was issued following the defendants’ motion to dismiss, so he viewed all facts in the light most favorable to the Trustee.  As judges often do when addressing motions to dismiss, Judge Walsh cited Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 557 (2007) for the proposition that the factual allegations need only establish “plausible grounds” for a claim in order to survive a motion to dismiss. Opinion at *6. Additionally, Judge Walsh cited Pardo v. Gonzaba (In re APF Co.), 308 B.R. 183, 188 (Bankr. D. Del. 2004) in opining that “Rule 9’s requirements, however, are relaxed in the bankruptcy context, particularly in cases such as the present in which a trustee has been appointed.” Opinion at *6-7.

In this case, the Litigation Trustee identified a large number of transfers and pleaded that certain “badges of fraud” were indicative of fraudulent intent. The badges of fraud alleged therein were: (1) the relationship between the debtor and the transferee; (2) consideration for the conveyance; (3) insolvency or indebtedness of the debtors; (4) how much of the debtor’s estate was transferred; (5) reservation of benefits, control or dominion by the debtor over the property transferred; and (6) secrecy or concealment of the transaction. Opinion at *8.

The purpose of a pleading is to set forth the facts with particularity to apprise the defendant fairly of the charges made against it so that it can prepare an adequate answer. Opinion at *7. In this case, the Litigation Trustee alleged that each transfer to Swenson from all DBSI entities were fraudulent, and the Litigation Trustee identified what he intended to prove in order to substantiate his claim of fraud.  Judge Walsh found the Litigation Trustee’s pleading sufficient and held that because the “Trustee has adequately pleaded badges of fraud and has specifically identified every transfer made to Swenson, I will deny the motion [to dismiss].” Opinion at *10.

Just because the size of a fraudulent scheme is broad and sweeping, doesn’t necessarily make the allegations related thereto broad and sweeping. Opinion at *9. And don’t forget that when there is a lawyer on the “wrong side” of a lawsuit, there is almost always a lawyer on the “right side.”

Introduction

In January of this year, Judge Brendan L. Shannon of the United States Bankruptcy Court for the District of Delaware issued a decision addressing whether a debtor’s lenders had aided and abetted the directors of debtor, Fedders North America, Inc. (“Fedders”), in breaching their duty of care (read the Fedders’ Decision here).  The aiding and abetting claim was one of several claims brought through an adversary action filed by the Official Committee of Unsecured Creditors (the “Committee”).  The Committee’s complaint asserted sixteen causes of action against Fedders’ lenders.  Of the sixteen, the only claim before the Court in the January decision was the one alleging the lenders aided and abetted Fedders’ officers in their breach of the duty of care.  This post will look at the facts that gave rise to the Committee’s claims against the lenders, as well as the Court’s analysis in resolving the Committee’s claims.

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.