DocketNumber: No. 11 Civ. 3005 (LAK)
Citation Numbers: 483 B.R. 63
Judges: Kaplan
Filed Date: 11/7/2012
Status: Precedential
Modified Date: 10/17/2022
MEMORANDUM OPINION
This is an action brought by the trustee of the CRC Litigation Trust (the “Trustee”), an entity created by the bankruptcy court to pursue claims on behalf of the bankrupt estate of Chem Rx Corporation (“CRC” or the “Company”), to avoid and recover transfers, and for other relief, in connection with a 2007 leveraged buyout of CRC’s predecessor in interest. It is brought under Sections 544(b) and 550 of the Bankruptcy Code and the New York Debtor & Creditor Law.
Facts
Defendant Jerry Silva founded B.J.K. Inc, a New York corporation doing business as Chem Rx
On October 26, 2007, the Silvas, Chem Rx’s principal shareholders,
The second amended complaint (“SAC”) alleges that the LBO consisted of two parts: (1) the sale of the Silvas’ stock, pursuant to a Stock Purchase Agreement (“SPA”), to Paramount, and (2) the financing for that stock purchase, which was provided pursuant to credit agreements into which Paramount entered to effectuate the LBO.
The Trustee claims that the Silvas, in order to secure the loans to CRC, prepared documents — which were presented to prospective lenders — that misstated Chem Rx’s historical financial performance and “proffered unreasonable future projections for [CRC] based on false financial data.”
In the year following the LBO, CRC violated its loan covenants and was in default on its obligations.
The Silvas argue that all of the Trustee’s claims are barred by the securities settlement payment safe-harbor provision of the federal Bankruptcy Code, 11 U.S.C. § 546(e), and, in any event, are not adequately pleaded.
Discussion
I. The Standard
To survive a Rule 12(b)(6) motion, a plaintiff must plead sufficient facts “to state a claim to relief that is plausible on its face.”
II. Avoidance of the Transfer
Section 544(b) of the Bankruptcy Code allows a trustee to “avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding any unsecured claim....”
“Notwithstanding section[ ] 544 ... of this title, the trustee may not avoid a transfer that is a ... settlement payment, as defined in section 101 or 741 of this title, made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, or that is a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract, as defined in section 741(7).... ”31
The Bankruptcy Code defines a “securities contract” as a “contract for the purchase, sale or loan of a security,”
The fundamental issue thus is whether the payments made to the Silvas as part of the LBO fit within the language of the statute and courts’ understanding of what constitutes a settlement payment. Several circuit courts have held that a “payment made for shares during an LBO is obviously”
A number of courts indeed have held that, in order for a payment in a securities transaction to constitute a “settlement payment” for purposes of Section 546(e), it must travel through the “settlement payment system,” in which a financial intermediary — generally a securities clearing house — takes title to and a beneficial interest in the securities.
The Trustee contends that Enron cannot be expanded to apply to situations such as this one, in which the funds were transferred directly to the Silvas’ banks and did not “pass[j through a clearinghouse or [similar] intermediary,”
The Silvas counter that the payments they received for their stock were “settlement payments” — payments “made to complete a securities transaction,”
Defendants are correct. The plain language of Section 546(e),
The Trustee nevertheless argues that the transaction here — “[a] wire transfer from the company to five Defendants”— implicates none of the concerns cited by the Second Circuit in Enron, i.e., that undoing the payments would substantially and negatively affect the financial markets.
Every circuit court but one to address this argument has rejected it, holding instead that Section 546(e) is “not limited to publicly traded securities but also extends to transactions, such as the leveraged buyout at issue here, involving privately held securities.”
Finally, the Trustee’s contention that the safe harbor should not apply here because upsetting this LBO would not disrupt financial markets is at war with the Second Circuit’s rationale for rejecting a different argument advanced in Enron. In that case, the plaintiff contended that the payments there at issue were not “settlement payments” on the theory that the payments were not “similar payments] commonly used in the securities trade” within the meaning of Section 741(8) of the Bankruptcy Code. The Court of Appeals rejected the argument because it was unwilling to construe the statute to “make application of the safe harbor in every case depend on a factual determination regarding the commonness of a given transaction.”
Given the plain language of the statute, the circuit courts’ agreement that it should be construed broadly, and the Second Circuit’s decision in Enron, the Court determines that the payments made in exchange for the Silvas’ stock were settlement payments and are protected from avoidance by Section 546(e).
Count One is dismissed.
III. Common Law Claims
In addition to seeking to set aside the allegedly fraudulent transfers, the Trustee seeks damages for breach of fiduciary duty and aiding and abetting a breach of fiduciary duty, as well as recovery on an unjust enrichment theory.
The Silvas argue that the Trustee’s common law claims are. “mere attempts at artful pleading to evade Section 546(e), are preempted by the statute, and should be dismissed.”
A. The Unjust Enrichment Claim
The SAC alleges that the “defendants were substantially enriched by their receipt of money transfers from the LBO Transaction, while the Company suffered substantial harm as a result of the LBO Transaction.”
The Supremacy Clause of the United States Constitution provides that federal law “shall be the supreme Law of the Land ... any Thing in the Constitution or Laws of any State to the contrary notwithstanding.”
The Trustee’s claim for unjust enrichment is preempted by Section 546(e). The unjust enrichment claim “seeks to recover the same payments ... held ... unavoidable under § 546(e).”
B. The Remaining Common Law Claims
The Silvas contend that the claims for breaches of fiduciary duty and aiding
Having dismissed the only claim based in federal law, however, the Court declines to exercise jurisdiction over the remaining common law claims. The claims for breach of fiduciary duty (Count 2) and aiding and abetting breach of fiduciary duty (Count 3 and Count 4) thus are dismissed without prejudice.
Conclusion
Defendants’ motion to dismiss the action [DI 41] is granted in all respects. The dismissal of Counts One and Five is on the merits. The dismissal of the remaining claims is for lack of subject matter jurisdiction. The Clerk shall enter judgment and close the ease.
SO ORDERED.
. DI 15, Ex. A.
. SAC ¶ 15.
. Id. ¶ 9.
. Id. ¶ 10.
. Id. ¶ 11.
. Id. ¶ 17.
. DI 41, Ex. 1 at ¶ 2; SAC ¶ 17.
. SAC ¶ 18.
. Id. ¶ 17; DI 15, Ex. A, at 1; see also DI 22 Exs. 2, 3.
. Id. ¶ 19.
. DI 15, Exs. 2, 3.
. SAC ¶ 20.
. DI 22, at 5. For example, the Trustee claims the Silvas misstated Chem Rx’s reserve for bad debt expense, which was in fact "grossly inadequate” to support the debt levels to be incurred. Id. Indeed "[o]nly a few months after the LBO Transaction closed, the Company was forced to revise its bad debt allowance by nearly threefold to account more accurately for the collectability of debts.” Id.
. Id. at 6.
. SAC ¶¶ 36, 41.
. Id. ¶ 19.
. SAC ¶¶ 45-48. The SAC alleges also that, following the LBO, "Jerry and Steven Silva wasted the Company's limited cash by deciding to improve their personal standing in the community by embarking on a charitable giving spree,” donating nearly $4 million in charity during years when CRC suffered massive losses. Id. at ¶ 55.
. Id. ¶¶ 58, 59.
. Id. ¶¶58, 59.
. Id. ¶¶ 60-68.
. Id.n 69-92.
. Id.n 93-103.
. Id. ¶¶ 104-108.
. See DI 41.
. Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007).
. Ashcroft v. Iqbal, 556 U.S. 662, 663, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (citing Twombly, 550 U.S. at 556, 127 S.Ct. 1955).
. Allaire Corp. v. Okumus, 433 F.3d 248, 249-50 (2d Cir.2006) (internal quotation marks and citation omitted).
. ATSI Commc’ns Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir.2007).
. 11 U.S.C. § 544(b)(1). Moreover, the Trustee's claim that the payments made to the Silvas as part of the LBO "were made with actual intent to defraud creditors,” SAC ¶ 63, is subject to the heightened pleading requirement of Rule 9(b). For the reasons discussed below, however, the Court need not determine whether the Trustee has adequately pleaded its claim.
. N.Y. Debt. & Cred. Law § 278.
. 11 U.S.C. § 546(e).
. 11 U.S.C. § 741(7)(A)(I).
. 11 U.S.C. § 741(8).
. Lowenschuss v. Resorts Int'l, Inc., 181 F.3d 505, 515 (3d Cir.1999); In re Kaiser Steel Corp., 952 F.2d 1230, 1240 (10th Cir.1991).
. Resorts, 181 F.3d at 516.
. 11 U.S.C. § 741(8); see also Kaiser Steel, 952 F.2d 1230, 1239-40; QSI Holdings, 571 F.3d at 549-550; Plassein, 590 F.3d at 258.
. DI 22, at 11.
. See Munford, Inc. v. Valuation Research Corp., 98 F.3d 604, 610 (11th Cir.1996).
.651 F.3d 329, 338 (2d Cir.2011). Enron involved Enron’s redemption of commercial paper from individual noteholders, which occurred through a clearing agency. The clearing agency, however, did not take title to or a beneficial interest in the securities during the course of the transaction. Enron argued that the transactions were not "settlement payments” and the safe harbor did not apply because the clearing agency merely “acted as a conduit and recordkeeper.” Enron, 651 F.3d at 339. The court disagreed, noting that Section "546(e) applies to settlement payments made by or to (or for the benefit of) a number of participants in the financial markets. It would appear inconsistent with this language for courts to limit the safe harbor circuitously by interpreting the definition of ‘settlement payment’ to exclude payments that do not involve a financial intermediary that takes title to the securities during the course of the transaction.” Regardless of whether a financial intermediary took a beneficial interest in the securities, the court noted, undoing Enron’s redemption payments would "have a substantial and ... negative effect on the financial markets.” Id.
. Id. (citing In re Plassein Int’l Corp., 590 F.3d 252, 257-59 (3d Cir.2009); In re QSI Holdings, Inc., 571 F.3d 545, 549-50 (6th Cir.2009); Contemporary Indus. Corp. v. Frost, 564 F.3d 981, 986 (8th Cir.2009)).
. Enron, 651 F.3d at 338 (footnote omitted).
. DI 22, at 12.
. Id. at 18.
. Resorts Int’l, 181 F.3d at 515.
. The Silvas cite the SPA, which is a public document and is incorporated by reference into and relied upon in the complaint, see SAC ¶¶ 17, 19, n.3, to show that the payments were made to the Silvas’ banks. Indeed, the SPA provides that payments to the sellers were to be made "by wire transfer ... to bank accounts designated in writing by the Sellers.” DI 15 Ex. A at A-l; DI 15, at 13-14.
. 11 U.S.C. § 546(e).
. 11 U.S.C. § 101(22).
. "[T]he trastee may not avoid a transfer that is a ... settlement payment ... made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, [or] financial institution.” 11 U.S.C. § 546(e).
. In re Resorts Int’l, Inc., at 515-16 (3d Cir.1999) ("The general thrust of Kaiser Steel ... is that the term 'settlement payment’ is a broad one that includes almost all securities transactions.”).
. See, e.g., QSI Holdings, 571 F.3d at 548 (bank acted as exchange agent); Contemporary Indus. Crop v. Frost, 564 F.3d 981, 986 (8th Cir.2009) (bank served as escrow agent); Kaiser Steel Corp., 952 F.2d at 1235-36 (bank acted as disbursing agent); In re Hechinger Inv. Co. of Delaware, 274 B.R. 71, 88 (D.Del.2002) (same).
. In re Plassein Int’l Corp., 590 F.3d 252, 258 (3d Cir.2009) (rejecting argument that "settlement payments must travel through the settlement system”).
. DI 22, at 13.
. QSI Holdings, 571 F.3d at 547; see also Frost, 564 F.3d at 986; Plassein, 590 F.3d at 258-59.
. Plassein, 590 F.3d at 255; see also In re Hechinger Inv. Co. of Delaware, 274 B.R. 71, 76 (D.Del.2002) (applying § 546(e) to LBOs in which shareholders who received payments for their stock consisted of a single family).
. Contemporary Indus., 564 F.3d at 987.
. Id. at 336.
. Id.
. DI 15, at 15.
. DI 15, at 16.
. SAC ¶ 106.
. Id. at ¶ 108.
. U.S. Const, art. VI, cl. 2.
. Cipollone v. Liggett Group, Inc., 505 U.S. 504, 516, 112 S.Ct. 2608, 120 L.Ed.2d 407 (1992) (quoting Fidelity Fed. Sav. & Loan Assn. v. de la Cuesta, 458 U.S. 141, 153, 102 S.Ct. 3014, 73 L.Ed.2d 664 (1982)).
. Contemporary Indus., 564 F.3d at 988 (dismissing unjust enrichment and illegal and/or excessive shareholder distributions claims because "[a]llowing recovery on these claims would render the § 546(e) exemption meaningless, and would wholly frustrate the purpose behind that section.”).
. In re Hechinger, 274 B.R. at 96; see also Contemporary Indus., 564 F.3d at 988. In one case has a court in this circuit declined to find a claim for unjust enrichment preempted by § 546(e). See In re Lehman Bros. Holdings Inc., 469 B.R. 415, 450 (Bankr.S.D.N.Y.2012). In Lehman, however, Magistrate Judge Peck made clear that "[the Lehman bankruptcy] litigation is different” from Hechinger and Contemporary Industries, where the "unjust enrichment claims were identical to the plaintiffs’ constructively fraudulent transfer claims under the Bankruptcy Code and also were based upon the same facts as these constructive fraud claims.... [By contrast,] [t]he claims that [plaintiff] argues should be preempted by federal bankruptcy law are unlike classic avoidance claims for constructively fraudulent transfers. Instead, these claims have more in common with claims grounded in actual fraudulent intent.” Id. In this case, like in Hechinger and Contemporary Industries, the Trustee alleges that "[a]ll defendants were substantially enriched by their receipt of money transfers from the LBO transaction”— the exact allegations that underlie its attempt to avoid the transfer under the Bankruptcy Code. Compare SAC ¶¶ 63-66 with ¶ 106.
. DI 24, at 5.
. In re Hechinger, 274 B.R. at 89 n. 8 ("Whereas the remedy for a fraudulent transfer claim is avoidance of the transfer and recovery from the transferee, the remedy for breach of fiduciary duty claim is a money judgment against the directors and their aiders and abettors.”).
. Carnegie-Mellon Univ. v. Cohill, 484 U.S. 343, 108 S.Ct. 614, 98 L.Ed.2d 720 (1988) ("when the federal-law claims have dropped out of the lawsuit in its early stages and only state-law claims remain, the federal court should decline the exercise of jurisdiction by dismissing the case without prejudice.”); United Mine Workers of Am. v. Gibbs, 383 U.S. 715, 726, 86 S.Ct. 1130, 16 L.Ed.2d 218 (1966) ("Certainly, if the federal claims are dismissed before trial, even though not insubstantial in a jurisdictional sense, the state claims should be dismissed as well.”).