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.

On May 8, 2017, Judge Gross ruled on a Motion to Compel Production of Documents in the Haggen bankruptcy.  Judge Gross’ opinion (the “Opinion”) addresses the conflict when a party is acting on another’s behalf and that entity claims “the oldest of the common law privileges”.  Opinion at *5.  A copy of the Opinion is available here.

In the Haggen bankruptcy, the Committee, the Debtors and the Defendants entered into stipulations granting the Committee derivative standing to bring an adversary proceeding against Defendants.  The Committee served discovery on the Debtors and the Debtors withheld nearly 1,000 documents on the basis of attorney-client privilege and attorney work-product doctrine.  The issue is as stated by Judge Gross: “[T]he Committee is acting on behalf of the Debtors. Yet it does not have access to all of Debtors’ documents which are or may be relevant to the matters it raises in the Complaint.”  Opinion at *5.

In the Opinion, Judge Gross analyzed three key precedents related to the issue of whether the Committee, acting in place of the conflicted Debtors, could obtain discovery from the Debtors:  Teleglobe Communications v. BCE, Inc. (In re Teleglobe Communications Corp.), 493 F. 3d 345 (3d Cir. 2007); Garner v. Wolfinbarger, 403 F. 2d 1093 (5th Cir. 1970) (“Garner”); and Commodity Futures Trading Comm’n v. Weintraub, 471 U.S. 343 (1985) (“Weintraub”).

Judge Gross’s analysis under Weintraub begins on page 6.  He concludes that “the Committee, suing on behalf of the Debtors, does not have access to privileged documents. The foregoing is true even though the Debtors are not operating and the Committee’s recovery, if any, may be on behalf of the estate as a whole. Weintraub therefore applies to chapter 7 trustees but not to Committees.”  Opinion at *8-9.

The discussion of Garner begins on page 9.  Judge Gross determined that if the Committee could show “cause” as to why the attorney-client privilege should be breached.  However, the finding of Garner was limited by Teleglobe.  The Teleglobe discussion begins on page 10.  In Teleglobe, the Third Circuit “added to the joint representation issue this: were the debtors insolvent or in the zone of insolvency when the privileged communication occurred?”  Opinion at *11.  Judge Gross ends his discussion of piercing the attorney-client privilege by denying the relief sought and stating that “If Debtors were insolvent at the time of the communications, the Committee must prove that they were. Perhaps the Committee will be able to prove insolvency at a later date but for now the Committee raises only conjecture and no proof.”  Opinion at *12.

To summarize, Judge Gross concludes that “Weintraub does not apply to the Committee but only to chapter 7 trustees; that Garner affords relief but only on a finding of insolvency; and that it is Teleglobe which requires insolvency without which there is no fiduciary duty owed to creditors.”  Opinion at *13

Judge Gross very quickly reviewed the arguments on the work-product doctrine, finding that as described by the Debtors and Defendants, documents withheld on the basis of the work product doctrine shall be produced, subject to the Debtors proving that they prepared the withheld documents in anticipation of litigation.  Opinion at *13.