On March 13, 2015, the United States District Court for the District of Delaware, in the case of Walnut Creek Mining Company v. Cascade Investment, LLC, Civ. No. 14-738-LPS (In re Optim Energy, LLC, Bankr. Case No. 14-10262-BLS), affirmed an order of the United States Bankruptcy Court for the District of Delaware which denied derivative standing to the debtor’s largest unsecured creditor, Walnut Creek Mining Company (“Walnut Creek”). Walnut Creek had sought to file an adversary proceeding seeking to recharacterize or subordinate Cascade Investment, LLC’s (“Cascade”) secured debt. Cascade had guaranteed the debtor’s debt to Wells Fargo. When the debtor breached the agreement, Cascade paid Wells, and, by virtue of a reimbursement agreement with the debtor, became a secured creditor of the debtor.
In considering Walnut Creek’s motion for derivative standing below, the Bankruptcy Court had determined that Walnut Creek’s complaint had failed as a matter of law to state claims against Cascade. On appeal to the USDC, Walnut Creek claimed that the Bankruptcy Court had failed to consider certain factual allegations that supported the complaint. Cascade countered that the Bankruptcy Court had properly rejected the factual allegations in the proposed complaint and noted further that the expiration of the “challenge period” set forth in the final DIP order should foreclose the filing of any action to challenge Cascade’s prepetition debt. The USDC reviewed the Bankruptcy Court’s findings of fact for clear error and exercised plenary review over questions of law.
First the USDC confirmed that derivative standing requires a party to show three elements: (1) a colorable claim, (2) the trustee’s unjustifiable refusal to pursue the claim, and (3) the permission of the bankruptcy court to initiate the action. Below, the Bankruptcy Court had dismissed Walnut Creek’s motion because the Court found that the complaint did not articulate a colorable claim for recharacterization or equitable subordination. The USDC reviewed these findings de novo.
The USDC found that Walnut Creek’s allegation of inadequate capitalization of the debtor was “insufficient, standing alone, to state a claim for recharacterization.” Further, even with the additional allegations made by Walnut Creek to the extent that a prudent lender would not have guaranteed the debtor’s obligations to Wells Fargo, the USDC said that had “no impact on Cascade’s and the debtor’s intention at the time of the transaction. In short, the Cascade guarantee was required by Wells Fargo as a condition of the extension of the credit facility to the Debtor. While perhaps it might have been imprudent for Cascade to guarantee the debtor’s debt, it did not impact Cascade’s and the debtor’s intent at the time of the transaction for this to be a debt transaction and not a capital infusion.
Moreover, the USDC was not impressed that the debtor and Cascade had treated transactions in 2010 and 2011 as equity transactions. “How the Debtor and Cascade treated two transactions in 2010 and 2011 has no probative value as to their intent as of the time they entered into the Reimbursement Guaranty in 2007.”
Addressing Walnut Creek’s claim of equitable subordination, the USDC did not find any inequitable conduct on the part of Cascade. Noting Walnut Creek’s argument that “the inequitableness of the June 1, 2007 transaction was that Cascade designed the transaction to prioritize its interest ‘senior to trade creditors’ and ‘ahead of other bona fide creditors of the business,’ the Court was unpersuaded. “This merely describes the mechanics of secured versus unsecured lending.” Moreover, the Court observed, “[T]here is no dispute that Cascade actually bound itself as a guarantor to … Wells Fargo . . . , and – upon the Debtor’s default – actually paid the amount outstanding on that debt.”
As a result of the findings that Walnut Creek’s complaint failed to state claims for equitable subordination and recharacterization, the USDC affirmed the Bankruptcy Court’s order dismissing Walnut Creek’s motion for derivative standing. The USDC did not address Cascade’s additional defense that expiration of the DIP Order’s challenge period would also have precluded the filing of the adversary action.