Delaware Business Bankruptcy Report: Morris James LLP Lawyers and Attorneys

Stanziale v. Pepper Hamilton LLP (In re Student Finance Corp.), No. 04-1551 (JJF), 2007 WL 2936195 (D. Del. Oct. 5, 2007) (Judge Joseph J. Farnan, Jr.)

In this adversary proceeding in the United States District Court for the District of Delaware, certain defendants moved to strike damages claims alleged by the trustee of the estate of Student Finance Corporation.  The Court granted the motion, finding that the trustee failed to provide fair notice of these damages claims, as required under Fed. R. Civ. P. 8(a) (made applicable to this adversary proceeding by Fed. R. Bankr. P. 7008(a)). 

In this adversary proceeding in which the trustee of Student Finance Corporation (“SFC”) asserted, inter alia, fraudulent transfer and preference claims against defendants Pamela Bashore Gagne, Robert L. Bast, the Brennan Family Trusts, and W. Roderick Gagne as trustee of the Brennan Family Trusts (collectively, the “Family Defendants”), the Family Defendants moved to strike certain damage claims. The trustee raised the damage claims in his initial disclosures. The damages allegedly arose from (1) the asserted overpayment of loan commitment fees paid by SFC to the Family Defendants during the period from 1999 through 2001, and (2) stock redemption payments in the total amount of approximately $7 million made by SFC to the Family Defendants during the period from February 2000 through January 2001.

This adversary proceeding was commenced on December 22, 2004, and, thereafter, the District Court withdrew the reference, and granted defendants’ motion to dismiss various counts, including those for deepening insolvency, negligent misrepresentation, aiding and abetting a breach of fiduciary duty, civil conspiracy and turnover of estate property. The trustee then amended his complaint. At the time that the Court wrote this opinion, only two causes of action remained – the fraudulent transfer and preference claims. The Family Defendants contended that they did not receive fair notice of the damage claims, as required under Fed. R. Civ. P. 8(a). The question at the center of this motion was whether the remaining causes of action were encompassed by the damages asserted in the initial disclosures.

The trustee contended that the Family Defendants had notice of the transactions from the start of the lawsuit. The Court disagreed. In the factual background sections of the amended complaint preceding the surviving claims, the trustee described certain transactions that the Family Defendants allegedly entered into with SFC, but did not describe the transactions giving rise to the damages claims at issue. The trustee contended that the transactions were discussed elsewhere in the complaint in the context of the dismissed counts, and applied to the remaining counts because of incorporation clauses. The Court dismissed this argument as “empty formalism.” The Court noted that not every transaction described elsewhere in the complaint related to the surviving claims, and also noted that the trustee misquoted his own complaint in advancing his argument, by contending that the fraudulent conveyance claim related to “transactions,” when the actual complaint only cited a single transaction, which was unrelated to the damage claims at issue. Likewise, a reading of the preference count did not reveal any intention to include the loan commitment or stock redemption payments. Therefore, the Court concluded that the fraudulent conveyance and preference counts did not give the Family Defendants fair notice of the claims at issue.

The trustee next contended that the Family Defendants’ answer and affirmative defenses were “stated broadly enough to cover the claims at issue.” The Court rejected this argument too, as the burden is on the plaintiff to state his claim. The question is not whether the defendant might appear to be aware of the claims.

The trustee also contended that his responses to certain of the Family Defendants’ interrogatories and his expert reports provided sufficient notice of the claims at issue. However, those responses, which went to the issue of damages were stated in general terms, and were inadequate to put the Family Defendants on notice. Moreover, the trustee served the expert reports and interrogatory responses after the close of discovery, by agreement between the parties. The Court noted, however, that an extension of time to answer discovery does not open the door for the plaintiff to assert new claims at that late date. The Court also noted that an expert report is not a pleading, and is not a vehicle for asserting new claims.

Last, the Family Defendants asserted that permitting the trustee to go forward with these new claims would prejudice them because it would require that discovery be re-opened. The Court agreed, finding it would prejudice the Family Defendants to require them to defend against these damage claims at this late date.

Therefore, the Court granted the motion to strike the damage claims, but denied, without discussion, the Family Defendants’ request for costs.

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OHC Liquidation Trust v. Discovery Re (In re Oakwood Homes Corp.), C.A. No. 06-436-JJF, 2007 WL 2071730 (D. Del. July 17, 2007) (Judge Joseph J. Farnan, Jr.)

The OHC Liquidation Trust, as liquidating trust for the estate of Oakwood Homes Corporation, filed an adversary proceeding in the United States Bankruptcy Court for the District of Delaware against Discovery Re and United States Fidelity & Guaranty Company, asserting seven claims arising under the Bankruptcy Code and contract law. Thereafter, the defendants filed a motion to dismiss, which the Bankruptcy Court granted as to the claims based on the Bankruptcy Code. The surviving claims were for (i) breach of contract, (ii) breach of implied covenant of good and faith and fair dealing, and (iii) unjust enrichment. By a decision dated July 11, 2006, the Bankruptcy Court held that these remaining claims constituted a core proceeding. Thereafter, the defendants filed a motion seeking to withdraw the reference.

The basis for the motion was that the remaining claims were all state law claims, and that mandatory withdrawal under 28 U.S.C. § 157(d) was required. Alternatively, the defendants argued for permissive withdrawal because the adversary proceeding was commenced after confirmation of the Oakwood Homes plan, and for reasons of judicial economy.

The District Court rejected the defendants’ argument for mandatory withdrawal, finding that it is only required where the action requires a “substantial and material” consideration of a federal statute outside the Bankruptcy Code. Because the adversary proceeding concerned only state law claims, mandatory withdrawal was not warranted.

The District Court also rejected the defendants’ request based on permissive withdrawal, noting that there is a presumption that bankruptcy proceedings shall proceed in bankruptcy court. The Third Circuit, in In re Pruitt, 910 F.2d 1160, 1168 (3d Cir. 1990) articulated five factors for determining whether permissive withdrawal is warranted: (i) promoting uniformity of bankruptcy administration; (ii) reducing forum shopping and confusion; (iii) fostering economical use of debtor/creditor resources; (iv) expediting the bankruptcy process, and (v) timing of the request for withdrawal. Considering these factors, the District Court stated that the Bankruptcy Court had already ruled on the defendants’ motion to dismiss and had conducted discovery. Also, this was a core proceeding that would affect the structure of debtor-creditor rights in the Oakwood Homes bankruptcy case. Finally, the District Court found that letting the adversary proceeding remain in the Bankruptcy Court would diminish the risk of forum shopping and promote consistent administration of the estate.

Accordingly, the District Court denied the defendants’ motion to withdraw the reference.

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Hayes v. Genesis Health Ventures, Inc. (In re Genesis Health Ventures, Inc.), Civ. A. No. 06-397 (JJF), Case No. 00-2692 (PJW), 2007 WL 211209 (D. Del. Jan. 26, 2007) (Judge Joseph J. Farnan, Jr.)

The appellant filed a notice of appeal from an order of the Bankruptcy Court imposing sanctions against the appellant. However, although the notice of appeal was dated eight days after the date of entry of the order, it was not filed until fifteen days after the date of entry of the order appealed from. Because the ten day deadline to file a notice of appeal under Federal Rule of Bankruptcy Procedure 8002(a) was jurisdictional, the District Court found that it lacked jurisdiction to adjudicate the appeal.

Appellant James J. Hayes filed a number of motions and pleadings in the bankruptcy case of Genesis Health Ventures, Inc. The debtors sought, and the court entered on May 15, 2006, an order imposing sanctions against Hayes in connection with the filings. On May 30, 2006, Hayes filed a notice of appeal of the bankruptcy court’s order. The debtors filed a motion to dismiss Hayes’ appeal, contending that his notice of appeal was untimely under Fed. R. Bankr. P. 8002.

Under Rule 8002(a), a “Notice of Appeal shall be filed within the clerk within 10 days of the date of entry of the judgment, order or decree appealed from.” Rule 8002 is jurisdictional, and the court cannot waive it. The order appealed from was entered on May 15, 2006. Because, under the Federal Rules of Bankruptcy Procedure, intervening Saturdays and Sundays are included when calculating the ten-day time period for filing a notice of appeal, the notice of appeal in this matter was to be filed no later than May 25, 2006. However, Hayes’ notice of appeal was filed on May 30, 2006, although dated May 23, 2006.

Although Hayes acted pro so, the Court held that the Supreme Court’s holding in Houston v. Lack, which provides that the date indicated on filings by pro se prisoners is presumptively the date of filing, did not extend to this case. There was no indication in the record that Hayes was incarcerated. In addition, Hayes did not file a motion to extend the time to file the notice of appeal under Rule 8002(c). Accordingly, the court held that the appeal was untimely, and that the court lacked jurisdiction to adjudicate the appeal.

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In re Aurora Foods, Inc., C.A. No. 04-166 (GMS), 2006 WL 3747306 (D. Del. Dec. 19, 2006) (Judge Gregory M. Sleet)

W Top Hat, Ltd. was one of several lenders entering into a credit agreement with the Aurora Foods Inc. debtors prior to Aurora’s bankruptcy. The credit agreement was modified several times prior to the bankruptcy. W Top Hat commenced an adversary proceeding against the debtors, contending that the final pre-petition modification to the credit agreement was improperly made. The bankruptcy court granted the debtors’ motion to dismiss the adversary proceeding. W Top Hat also objected to confirmation of the debtors’ plan, contending that the debtors failed to make required payments under the credit agreement. The bankruptcy court overruled W Top Hat’s objection, and confirmed the plan.

W Top Hat appealed both the dismissal of the adversary proceeding and the decisions overruling its objection to the confirmation order. Those appeals were consolidated on W Top Hat’s motion.

On November 1, 1999, the debtors entered into a credit agreement with various lenders, including W Top Hat. According to section 10.6A of the credit agreement, modifications or amendments thereto could only be made with the written consent of the “Requisite Lenders,” provided, however, that any modifications or amendments decreasing the amount of fees payable could only be made by the written consent of all lenders.

On June 27, 2002, the credit agreement was amended to allow the debtors additional time to make certain principal payments under the agreement, as well as to impose an excess leverage fee. The excess leverage fee would be imposed if the debtor failed to make the required payment by September 30, 2003, or committed other events of default.

On February 21, 2003, the credit agreement was amended again. This amendment increased the excess leverage fee and added an asset sale fee. This fee required the same payment to each of the lenders if the debtors failed to meet certain increased targets of proceeds received from asset sales.

On October 13, 2003, the debtors entered into a further amendment to the credit agreement with a majority of the lenders; W Top Hat, however, was not a party to that negotiation and amendment. This amendment combined the excess leverage fee and the asset sale fee into one “Excess Leverage and Asset Sale Fee,” thereby reducing the aggregate amount of each fee. The combined fee was also capped at $15 million if payment of all principal, interest, and fees was paid to the senior secured lenders by March 31, 2004.

The debtors filed voluntary Chapter 11 petitions on December 8, 2003, and proposed a plan shortly thereafter. W Top Hat objected to the plan, arguing that the October 2003 Amendment was improperly entered into without W Top Hat’s participation and consent as it required the consent of all lenders, not just the Requisite Lenders, and that W Top Hat was entitled to a full share of the excess leverage fee. The bankruptcy court overruled the objection, holding that October 2003 Amendment was controlling, and that it limited the payments of fees occurring under the plan before March 31, 2004.

The debtors argued that the appeal should be dismissed because of equitable mootness, citing the Third Circuit’s 1996 In re Continental Airlines opinion, which provided that an appeal could be dismissed, even though some relief could be granted, when granting that relief would be inequitable. The court rejected this argument, finding that although the debtors’ plan was substantially consummated, W Top Hat sought a payment of $6.85 million out of total assets of some $930 million. Accordingly, if W Top Hat were to prevail, having to make this payment would be unlikely to cause the plan of reorganization to unravel. The court then, having decided that the appeal could proceed, addressed the merits of W Top Hat’s appeal.

The main issue in the appeal as to both the plan objection and adversary proceeding was whether section 10.6A of the credit agreement controlled, or whether the October 2003 Amendment controlled. The district court agreed with the bankruptcy court’s conclusion that this decision concerned which provision was specific, and which was general, bearing in mind that no provision should be rendered meaningless. Analyzing this question under the applicable New York law, the bankruptcy court had concluded that the provisions could be read together, with the specific provisions of the October 2003 Amendment trumping the general provisions of section 10.6A of the credit agreement. Under this reading, the general language of the credit agreement did not apply to the Excess Leverage and Asset Sale Fee governed by the October 2003 Amendment. The district court upheld this reading.

The district court also upheld the bankruptcy court’s finding that the prior course of performance among the parties showed that they understood that the credit agreement could be modified by a majority of the lenders, as opposed to all the lenders.

The district court also reviewed W Top Hat’s contention that the bankruptcy plan violated the best interests test of 11 U.S.C. § 1129(a)(7), and found it meritless. Having decided that the October 2003 Amendment controlled as between W Top Hat and the debtors, the district court agreed with the bankruptcy court that the creditors would do as well under the plan as they would have in a hypothetical Chapter 7 liquidation.

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In re Stone & Webster, Inc., 354 B.R. 686 (D. Del. 2006) (Judge Sue L. Robinson)

This was a case of contract interpretation and choice of law issues, in connection with a determination of damages owed by a guarantor to a lender. The lender argued that the law to be applied was the Bankruptcy Code and Delaware law, because of the venue of the case; the guarantor argued in favor of the Saudi Arabian law selected in the underlying credit agreement. The court found that New York law, the law chosen in the guaranty, applied.

After receiving a six million dollar judgment, the plaintiff, Saudi American Bank (“SAMBA”) claimed entitlement to prejudgment interest under Delaware law. SAMBA claimed that a guaranty and credit agreement (on which the underlying judgment was based) both provided that interest was to be paid but did not apply an applicable interest rate. The Delaware legal rate of interest that would have been applicable was 11%.

The defendant claimed that Saudi Arabian law governed the credit agreement and guaranty as well as a Payment Letter executed between the parties. The credit agreement contained a choice of law provision which expressly provided that Saudi Arabian law governed the agreement. The Payment Letter contained no choice of law provision but, because the agreement was executed in Saudi Arabia, and payment was to incur in Saudi Arabia, the defendant claimed that the Payment Letter also was governed by Saudi Arabian law. Finally, though the guaranty expressly stated that it was to be governed by New York law, the defendant argued that the guaranty was derivative of the rights granted under the credit agreement and Payment Letter and thus Saudi Arabian law should apply to the guaranty as well.

Noting that the parties did not dispute that the guaranty allowed SAMBA to recover its interest and expenses incurred in enforcing SAMBA’s rights under the guaranty, the court likewise held that the issue of whether SAMBA was entitled to prejudgment interest could be determined expressly under the guaranty without reference to the Payment Letter or the credit agreement.

The court held that the guaranty was to be governed solely by New York law. The court noted that it was obligated to apply the conflict of laws rules of the state of Delaware, the state in which the court was sitting. Under Delaware law, express choice of law provisions are generally given effect absent some jurisdiction having a materially greater interest in the subject matter. The court found that Delaware, as the site of the bankruptcy, had “some, albeit diminimus,” interest in the matter. However, the interest that Delaware might have was not a materially greater interest than the state of New York. Consequentially, the court determined that New York law should apply to the calculation of prejudgment interest under the guaranty. The court also believed that the application of New York’s rate was more equitable than applying the Delaware rate, which was higher.

UPDATE:  In connection with the decision above, the District Court ordered SAMBA to provide an accounting of the attorneys' fees it was seeking to recover.  SAMBA provided an itemization of some $2.1 million in fees and an additional $195,000 in expenses.  However, SAMBA conceded that it was unable to account for and carve out all the fees related to the grant of summary judgment and that associated litigation.  SAMBA argued that much litigation arose out of the same facts and that it was therefore unable to (and should not be required to) break out its accounting directly related to the Shaw litigation.  The Court disagreed and, in its February 13, 2007 Memorandum Opinion and Order awarded SAMBA $345,714.50 in fees and no expenses.  The $345,714.50 was the amount identified by plaintiff as being attributable solely to the recovery action against Shaw.

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Magten Asset Mngmnt. Corp. v. Northwestern Corp. (In re Northwestern Corp.), 352 B.R. 32 (D. Del. 2006) (Judge Joseph J. Farnan, Jr.)

The appellant, a creditor in the debtors’ bankruptcy case, appealed from a Bankruptcy Court decision denying approval under Federal Rule of Bankruptcy Procedure 9019 of the appellant’s motion to approve a global settlement of litigation and claims with the debtors. The District Court affirmed the Bankruptcy Court decision, holding that the express terms of the settlement agreement required that it be approved by the Court prior to becoming effective, and that the settlement agreement could not be approved because it was inconsistent with the debtors’ plan of reorganization. Because the plan had been substantially consummated, it could not be amended.

Appellant Magten Asset Management Corporation, a creditor of the debtors, appealed from an order of the Bankruptcy Court denying appellants’ motion under Federal Rule of Bankruptcy Procedure 9019 seeking approval of a global compromise and settlement with the debtors of litigation and claims among the parties in the debtors’ Chapter 11 case.

The appellant contended that the Bankruptcy Court erred in concluding that the settlement agreement negotiated by appellant and the debtors was not a binding contract upon its execution. First, the appellant contended that, because the debtors’ plan of reorganization had already been confirmed, 11 U.S.C. § 363 no longer applied, and the settlement agreement did not require the approval of the Bankruptcy Court to be effective. The appellant also contended that the plain language of the settlement agreement showed that it was meant to be binding upon execution, and did not require Bankruptcy Court approval to be effective. The appellant had only filed the 9019 motion because the Bankruptcy Court ordered it to do so.

The appellant also contended that the Bankruptcy Court erred in concluding that the settlement agreement was inconsistent with the debtors’ plan of reorganization because, it alleged, the debtors drafted both the plan and the settlement agreement and represented to the Bankruptcy Court that the settlement agreement was consistent with the terms of the Plan. Finally, the appellant also contended that the settlement agreement provided the non-accepting holders of the Series A 8.45% Quarterly Income Preferred Securities, of which the appellant was one, with a recovery that was less than the amount that QUIPS holders would receive under their Class 9 treatment under the plan, and, therefore, an amendment to the plan was not required to implement the settlement agreement.

The debtors countered that they still believed a settlement of the instant litigation would have been in the best interests of the estate, but that they could not pursue the settlement agreement with the appellant once objections were filed by representatives of the Class 7 and Class 9 claimants. Because of the objections, the debtors contended that the settlement agreement required the approval of the Bankruptcy Court, as well as the execution of additional documents to become effective. The debtors also contended that the terms of the settlement agreement were inconsistent with the plan, because the plan gives non-accepting QUIPS holders the option of either (1) accepting the Plan and receiving a Class 8(b) distribution, or (2) rejecting the Plan and receiving only a Class 9 claim. The Debtors contended that the proposed settlement agreement would have provided non-accepting QUIPS holders with both types of recoveries. Therefore, amendment of the plan or the consent of the Class 7 and Class 9 claimants was required. However, the debtors pointed out that the plan had been confirmed and substantially consummated by the debtors, and therefore, amendment to the plan was not feasible.

The District Court affirmed the Bankruptcy Court’s decision. First, the District Court reviewed the settlement agreement, and determined that the express terms of the settlement agreement required that it be approved by the Bankruptcy Court, and that an order be entered, before the settlement agreement could be implemented. Accordingly, the Court rejected the appellant’s arguments that section 363 and the debtors’ reorganized status obviated the need for Bankruptcy Court approval.

Next, the Court considered the appellant’s contentions regarding harmony between the plan and the settlement agreement. Under the Plan, QUIPS holders could select one of two options; they could either select Option 1, which was a pro rata share of 505,591 shares of new common stock, plus warrants exercisable for an additional 2.3% of new common stock, or Option 2, which was a pro rata share of recoveries, if any, upon resolution of the QUIPS litigation.

The plan also provided that, to the extent shares allocated to Class 8(b) claimants were not distributed to Option 2 holders, those shares were to be distributed to Class 7 and Class 9 claimants. However, the settlement agreement diluted the distributions to which Class 7 and Class 9 claimants are entitled, and conflicted with the plan’s disbursement scheme, by providing QUIPS holders electing Option 2 with the full amount of stock set aside for them in the disputed claims reserve and the stock they would have received if they elected Option 1, stock which was to be divided among the Class 7 and Class 9 claimants. Therefore, an amendment to the Plan would have been necessary for the settlement agreement to be consistent with the plan. However, such an amendment was not feasible because the plan had been substantially consummated, and in any event, such an amendment would have been opposed on behalf of Class 7 and Class 9 claimants. Accordingly, the District Court concluded that the Bankruptcy Court's decision to deny the appellants’ Rule 9019 motion was not erroneous.

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