Genuine Issues Of Material Fact Preclude Summary Judgment On Recharacterization And Equitable Subordination Claims.
Official Unsecured Creditors’ Committee of Broadstripe, LLC v. Capital Management, L.P. (In re Broadstripe, LLC), Case No. 09-10006 (CSS), Adv. No. 09-50966 (CSS) (September 2, 2010) (J. Sontchi)
On January 2, 2009 (the “Petition Date”), Broadstripe commenced its Chapter 11 cases by filing voluntary petitions for relief. Sometime thereafter, the Official Unsecured Creditors’ Committee (“OUCC”) filed the instant Complaint in which it sought relief from Highland Capital (“Highland”) under twelve theories. The Complaint centered around two events: (1) Highland’s objection to the Wave Sale, pursuant to which WaveDivision Holdings, LLC (“Wave”) committed to purchase two of Broadstripe’s three systems for $157 million; and (2) Highland’s alleged representation that it would finance the James Cable Asset Purchase Agreement (the “James Cable APA”) – pursuant to which Broadstripe, which represented in the James Cable APA that it had the financial capacity to consummate the sale, would purchase substantially all of James Cable’s assets for a purchase price to be determined later – and its subsequent refusal and failure to do so.
On September 2, 2010, the Court issued a memorandum opinion containing its findings of fact and conclusions of law with respect to its May 3, 2010 order denying Highland’s motion for summary judgment as to Counts One (recharacterization), Two (equitable subordination), Four (breach of duty of care), Five (breach of duty of loyalty), Six (aiding and abetting breach of duty of care), Seven (aiding and abetting breach of duty of loyalty), Eight (preference claims related to First Liens), Nine (preference claims related to Second Liens), Eleven (recovery of avoidance actions), and Twelve (disallowance of Highland’s claims pursuant to § 502(d)) and granting the motion with respect to Count Three (alter ego).
Count One: Recharacterization
The Committee argued that Highland’s $65 million claim should be recharacterized as equity because Highland’s monetary contributions were primarily made to gain control over the company, not as a loan. Because the determination of recharacterization with respect to a lender who contributes funds to a struggling company “lie[s] in facts that confer context case-by-case,” the Court held that summary judgment was inappropriate as to Count One.
Count Two: Equitable Subordination
The Court denied summary judgment on count two because genuine issues existed concerning the period of time during which Highland was an insider, the inequitable conduct at issue, and any potential harm resulting therefrom. The Bankruptcy Code provides that a court may “under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim” if three elements are met: (1) the defendant engaged in some type of inequitable conduct; (2) the misconduct caused injury to the creditors or conferred an unfair advantage on the defendant; and (3) equitable subordination of the claim is consistent with bankruptcy law.
A defendant’s status as an insider is a vital factor in the analysis because the actions of insiders are closely scrutinized. The Court concluded that Highland was a statutory insider from October 26, 2006 through the present and that issues of material fact existed as to whether Highland was a non-statutory insider prior to that time.
Further, the Court determined that genuine issues existed as to whether Highland acted inequitably with respect to objecting to a sale of a portion of Broadstripe’s business and with regard to the James Cable APA, at which time Highland was a statutory insider and purportedly made representations that it would finance the deal, only to back out later when it determined that the purchase was not a sound business move. Finally, triable issues of fact concerning the harm resulting from this inequitable conduct arose from Highland’s alleged misconduct giving rise to exposure to litigation which had accumulated $3 million in legal fees and over $100 million in claims against the estate, which may have driven the debtors to bankruptcy, as well as risking Broadstripe’s reputation.
Claims Three Through Seven: State Law Claims
Claims Three through Seven concerned state law causes of action such as alter ego, breach of the duty of care, breach of the duty of loyalty, and others. The Court denied summary judgment as to all of these claims except the alter ego claim, which the Court remarked was supported by evidence more appropriately categorized under breach of fiduciary and which failed to establish genuine issues concerning whether Broadstripe and Highland were a single economic entity.
Claims Eight through Ten: Preference Claims
The Committee brought claims against the Highland defendants seeking the recovery of allegedly preferential transfers in the amount of approximately $9.4 million with respect to the First Lien Investments and $1.63 million with respect to the Second Lien Investments. Highland responded that: (1) only some of the Highland defendants were insiders, making the one-year preference period applicable only to those defendants and the ninety-day period applicable to all others; and (2) that Highland did not receive any more than it would have in a liquidation because the First Lien Transfers were fully secured. The Court held that genuine issues existed regarding whether the First Lien Investments were fully secured, whether the First Lien Debt was going to be equitably subordinated (per above), and whether the First Lien and Second Lien Investments were made in the ordinary course of business according to ordinary business terms.
Claim Twelve: § 502(d) Disallowance
Pending a determination of whether preferential transfers occurred and whether certain claims should be subordinated or recharacterized, the Court refused to determine whether Highland’s claims should be disallowed under § 502(d).
