Court: United States Bankruptcy Court, S.D. New York; April 20, 2010; Us Bankruptcy; United States Bankruptcy Court
HydroGen, L.L.C. (the "Debtor"), an Ohio limited liability company and a subsidiary of HydroGen Corporation, filed for Chapter 11 bankruptcy on October 22, 2008. The Official Committee of Unsecured Creditors (the "Committee") initiated an adversary proceeding to challenge pre-petition transfers of compensation to the Debtor's and Parent's officers and directors, seeking to hold them accountable for potential liabilities. The Committee was granted the standing to pursue these claims following a May 7, 2009 order, and filed an amended complaint on May 12, 2009, which included ten causes of action: breach of fiduciary duty, aiding and abetting breach of fiduciary duty, avoidance of constructive fraudulent transfers (under sections 548(a)(1)(B) and 544(b) of the Bankruptcy Code), unjust enrichment, breach of employment agreements, deepening insolvency, equitable subordination, objection to claims against the estate, and avoidance of preferential transfers (under sections 547 and 550). Defendants Dr. Leo Blomen and Blomenco B.V. filed a motion to dismiss the entire amended complaint, while Defendant John Freeh sought to dismiss only specific claims. The Court will assume the truth of factual allegations in the amended complaint while excluding unsubstantiated legal conclusions. The Debtor, which began operations in November 2001, faced severe cash shortages by December 31, 2007, with only $8.1 million available. The Defendants were allegedly aware of the Debtor’s financial distress and the urgent need for substantial capital to sustain operations and preserve company value.
Defendants allowed the Debtor to operate under the false assumption of unlimited financing despite knowing the lack of prospects for additional funds after December 31, 2007. Rather than adjusting the Debtor's business plan, Defendants planned to increase spending and engaged in unspecified transactions that were detrimental to the Debtor's financial health, resulting in insolvency and significant financial harm. They allegedly imposed additional debts beyond the Debtor's capacity to pay and authorized substantial bonus payments totaling $410,652.92 to six Defendants, along with other unspecified compensation, which the Committee deemed excessive. These actions indicated that the Defendants prioritized their self-interests over the Debtor's and its creditors’ interests, despite being aware of the Debtor's insolvency throughout the relevant period.
Regarding the legal standards for a Rule 12(b)(6) motion to dismiss, the court must accept the complaint's factual allegations as true and draw reasonable inferences in favor of the plaintiff. The court may consider documents referenced in the complaint, those relied upon by the plaintiff, and facts subject to judicial notice. A complaint must present enough factual matter to surpass a speculative level to survive a motion to dismiss, aligning with recent Supreme Court rulings that require more than a mere formulaic recitation of claims. Rule 8(a)(2) mandates a short and plain statement demonstrating entitlement to relief, emphasizing the necessity for specific circumstances and events supporting the claim.
A complaint must include more than bare assertions to withstand a motion to dismiss under Rule 12(b)(6); it needs to present plausible claims for relief, as established in Twombly and Iqbal. Courts are not obligated to accept legal conclusions framed as factual allegations. The standard for plausibility requires consideration of judicial experience and common sense, aiming to filter out meritless cases before discovery. The Committee alleges that the Defendants, as former officers and directors of the Debtor, breached their fiduciary duties by allowing excessive spending, accumulating debt, and paying themselves high compensation, thus harming the Debtor and its creditors.
Before evaluating the sufficiency of the breach of fiduciary duty claim, the applicable state law must be determined. Bankruptcy courts should apply the forum state's choice-of-law rules unless federal policy dictates otherwise. The internal affairs doctrine governs disputes involving corporate issues, requiring that such matters be adjudicated according to the law of the corporation's state of incorporation. This principle, upheld in New York, ensures certainty and protects the expectations of parties involved. Breach of fiduciary duty claims against corporate officers or directors are governed by the law of the state of incorporation, as established in various precedents. The internal affairs doctrine also applies to limited liability companies, supporting the application of the law of incorporation in related disputes.
Ohio law governs the breach-of-fiduciary-duty claim against Defendants due to the Debtor being an Ohio-incorporated limited liability company. Under Ohio law, a breach-of-fiduciary-duty claim requires: 1) the existence of a fiduciary duty; 2) a failure to fulfill that duty; and 3) a resulting injury. To withstand a motion to dismiss, the Amended Complaint must present sufficient factual support for each element, moving beyond mere speculation. It is recognized in Ohio that corporate directors and officers have fiduciary responsibilities towards their corporation, as codified in Ohio Revised Code Section 1701.59. While the fiduciary duty of corporate officers is based on common law, it is clear that those Defendants who served as officers or directors of the Debtor owe a fiduciary duty during their tenure. However, directors of a parent corporation typically do not owe fiduciary duties to a wholly-owned subsidiary.
The Amended Complaint lacks clarity regarding the specific relationships between each Defendant and the Debtor or Parent. It does assert that Dr. Blomen and other individual Defendants served as directors or officers of the Debtor between 2001 and 2008, establishing a possible fiduciary duty during that time. Nevertheless, it fails to clarify whether this duty was in effect between late 2007 and the Petition Date, the period of alleged fiduciary violations. Consequently, the Court finds the Committee has not sufficiently pled the first element of the fiduciary duty claim.
The claim against Dr. Blomen fails to meet the pleading standards necessary for a breach of fiduciary duty, as the Amended Complaint lacks specific factual allegations to support the claim. General assertions about unspecified transactions and obligations do not satisfy the requirements outlined in Federal Rule of Civil Procedure 8(a). While the complaint mentions the amount of bonuses paid to Dr. Blomen, it classifies these payments as excessive and made in bad faith without providing the necessary factual context, rendering the claim speculative under Twombly standards.
In contrast, other cited cases demonstrated sufficient pleading where specific events and misconduct were detailed, highlighting the inadequacy of the current allegations. Furthermore, the claim of aiding and abetting breaches of fiduciary duty lacks detailed factual support, and there is ambiguity regarding the applicable law, with potential jurisdictional implications due to the Debtor's incorporation in Ohio versus its operational presence in New York and Pennsylvania. The court intends to conduct a choice-of-law analysis before deciding on the Rule 12(b)(6) motion related to the aiding and abetting claim, given the significant legal differences among the jurisdictions involved.
Some courts have applied the internal affairs doctrine to aiding and abetting claims related to breach of fiduciary duty, aligning these claims with the corporation's internal matters. In cases like BBS Norwalk One, Inc. v. Raccolta, Inc., courts found that aiding and abetting claims mirror breach of fiduciary duty claims. Conversely, other courts, such as in Solow v. Stone, have treated aiding and abetting as tort claims, applying tort conflicts of laws principles instead. This distinction is important since if the internal affairs doctrine applies, the law of Ohio, the Debtor's state of incorporation, would govern the aiding and abetting claim. However, under tort conflicts principles, the law of the place where the tort occurred—typically where economic losses were sustained—would be determinative. In cases involving aiding and abetting claims, economic losses are generally considered to occur at the corporation's principal place of business, which for the Debtor is New York.
The application of Ohio law complicates matters further, as it remains uncertain whether Ohio recognizes aiding and abetting liability. The Sixth Circuit has noted ambiguity regarding common law claims for aiding and abetting tortious conduct in Ohio. Only one case explicitly recognizes such liability, relying on a Supreme Court of Ohio case that suggested the adoption of section 876(b) of the Restatement (Second) of Torts, which outlines the concert of action theory.
Liability for harm to a third party due to another's tortious conduct arises when one knows the other's actions breach a duty and provides substantial assistance or encouragement. While one court has suggested that the Ohio Supreme Court would recognize aiding and abetting liability based on the Restatement (Second) of Torts, this position remains unconfirmed as the Ohio Supreme Court has not addressed the matter. Other Sixth Circuit courts acknowledge the issue as unsettled in Ohio. Aiding and abetting liability in Ohio would require proof of (1) knowledge of the primary party's breach of duty and (2) substantial assistance or encouragement in the tortious act. The Amended Complaint fails to adequately plead these elements, presenting only a vague assertion of aiding and abetting without necessary factual support. Therefore, the aiding and abetting claim would likely fail under Ohio law.
Conversely, New York law clearly recognizes aiding and abetting breach of fiduciary duty, requiring (1) a breach of fiduciary duty, (2) that the defendant knowingly induced or participated in the breach, and (3) that the plaintiff suffered damages. Since the breach-of-fiduciary-duty claim was previously deemed inadequately pled, the aiding and abetting claim also fails to meet the required elements under New York law. Consequently, the aiding and abetting claim is insufficiently pled under both Ohio and New York law, which are the potential governing laws in this context.
The Court determined that it need not choose between competing choice-of-law principles, as the aiding and abetting claim does not survive dismissal regardless of which state law is applied. The Amended Complaint failed to sufficiently allege a claim for aiding and abetting breach of fiduciary duty, leading to the granting of Dr. Blomen’s and Blomenco B.V.’s motion to dismiss that claim.
Regarding constructive fraudulent transfers under section 548(a)(1)(B) of the Code, the Committee seeks to avoid bonuses and compensation received by Defendants in the two years prior to the Petition Date. To establish a successful claim, the Amended Complaint must show that: 1) the Debtor transferred property, 2) the Debtor was insolvent or became insolvent due to the transfer, and 3) the Debtor received less than reasonably equivalent value for the transfer. The Court found that the Amended Complaint presented only a formulaic recitation of these elements without adequate factual support, particularly lacking evidence that the Debtor did not receive reasonably equivalent value. Consequently, the Court dismissed the Committee's section 548(a)(1)(B) claim.
Additionally, the Amended Complaint alleges that the bonuses and compensation received by Defendants constitute constructive fraudulent transfers under section 544(b) of the Code and applicable state law. The specific state law applicable to this claim was not identified, but Defendant Mr. Freeh assumed either New York or Ohio law could apply. The Court will conduct a choice-of-law analysis to determine which state's law governs the state constructive fraudulent transfer claim based on factors such as the parties' domicile, residence, incorporation, business location, and places of injury and conduct.
Ohio is the Debtor’s place of incorporation, while New York serves as its principal place of business. The alleged injury, linked to constructive fraudulent transfers, likely occurred in either Ohio or New York, as compensation decisions were made at the Debtor's corporate headquarters in New York. Jurisdiction with the most significant contacts is thus likely to be either state. Under Ohio law, a transfer can be deemed a constructive fraudulent conveyance if the debtor received no reasonably equivalent value and either engaged in a transaction with insufficient remaining assets or intended to incur debts beyond its ability to pay (Ohio Uniform Fraudulent Transfer Act, § 1336.04). Similarly, New York law requires that a constructive fraudulent transfer lacks fair consideration and may leave the debtor insolvent or with unreasonably small capital (New York Debtor, Creditor Law, § 273-75). The Amended Complaint does not provide sufficient facts to support claims that the Debtor failed to receive reasonably equivalent value or fair consideration for bonuses and compensation, leading to the dismissal of the Committee’s section 544 claim.
Regarding preferences, the Amended Complaint alleges that within two years prior to the Petition Date, Defendants received significant transfers, including salaries and bonuses. The Committee seeks to avoid these transfers under section 547 of the Bankruptcy Code, which allows avoidance of transfers of the debtor’s property interest if five conditions are met, subject to defenses. Specifically, these conditions require that the transfer was made to a creditor for an antecedent debt while the debtor was insolvent, within specified timeframes, and enabled the creditor to receive more than they would in a Chapter 7 case (11 U.S.C. § 547(b)). For the pleading to be sufficient, the Amended Complaint must provide adequate facts for each element of section 547(b) to inform Defendants of the preference claims against them.
The Amended Complaint's preference claims against Mr. Freeh are deemed insufficient due to a lack of specific factual details, such as the date, amount, or type of transfer, rendering it impossible to identify any avoidable transfer. The Court finds the pleadings fail to meet the standards set forth in Twombly and Federal Rule of Civil Procedure 8, leading to the conclusion that these claims cannot survive Mr. Freeh’s motion to dismiss. While one transfer to Dr. Blomen is identified by amount and type, the Complaint lacks sufficient facts regarding any other transfers, particularly failing to specify if any were made for identifiable antecedent debts or within the relevant time frame before the Petition Date. Similar deficiencies are noted in the claims against Dr. Blomen and Blomenco B.V.
Regarding the deepening insolvency claim, the Amended Complaint alleges that the Defendants delayed the Debtor’s insolvency petition, leading to further obligations that the Debtor could not meet, resulting in asset dissipation and increased insolvency. The creditors reportedly suffered losses as a result. The applicable law for this claim is disputed among the parties, with references to Ohio, New York, and Pennsylvania law, necessitating a choice-of-law analysis due to significant differences in the laws of these jurisdictions. The Court will analyze which jurisdiction has the greatest interest in applying its law, considering the significant contacts and the purpose of the relevant laws. Deepening insolvency is classified as a tort when recognized, according to various case precedents.
In cases involving torts that breach laws regulating conduct, the jurisdiction where the tort occurred typically has the greatest interest, and its law will generally apply. This principle applies to the alleged tort of deepening insolvency, suggesting that New York law governs since the actions in question likely took place at the Debtor's principal place of business in New York. However, New York does not recognize deepening insolvency as an independent cause of action; it is viewed instead as a theory of damages arising from a breach of a separate duty or tort. A plaintiff must prove that the defendants' actions, which allegedly prolonged the corporation's life and increased its debts, also constituted a separate actionable claim. Given that all independently recognized claims by the Committee have been dismissed, there is no viable basis for the deepening insolvency claim to stand. Therefore, the claim is dismissed against the defendants. Additionally, the Amended Complaint alleges breaches of unspecified employment-related agreements, but lacks identification of these agreements, rendering it impossible to ascertain any provisions that could support the claim.
To adequately allege an agreement, a plaintiff must specify the contract provisions relevant to the claim. The Committee's breach-of-contract claim does not meet the standards set by Federal Rule of Civil Procedure 8(a)(2), failing to provide the Defendants with fair notice of the claim and its grounds. Consequently, the Court grants the motion to dismiss regarding the breach-of-contract claim, echoing precedents where claims were dismissed for lack of specificity in naming the contract and its terms.
In the context of unjust enrichment, the Amended Complaint asserts that the Defendants received property interests from excessive bonuses and compensation without providing equivalent value to the Debtor, resulting in unjust enrichment. The Committee seeks recovery based on these allegations.
A choice-of-law analysis is needed due to disagreement on applicable law for the unjust enrichment claim. Under New York's principles, an interest analysis applies, necessitating the law of the jurisdiction where the actions occurred. Since the compensation decisions likely occurred in New York, New York law governs the claim.
For a valid unjust enrichment claim under New York law, three elements must be established: (1) the defendant was enriched, (2) at the plaintiff's expense, and (3) equity and good conscience oppose allowing the defendant to retain the benefits. While the Amended Complaint claims the Defendants were enriched through bonuses at the Debtor's expense, it fails to adequately detail how equity and good conscience would prevent the Defendants from keeping those bonuses. The allegations are deemed too general and lack the necessary factual specificity to support the claim.
Allegations that Defendants caused the Debtor's insolvency and worsened its financial situation by granting themselves bonuses lack the necessary specificity regarding causation, resulting in an inadequate pleading of the third element for unjust enrichment claims. This deficiency, along with the dismissal of a deepening insolvency claim, leads to the conclusion that the unjust enrichment claim cannot withstand motions to dismiss. The court references previous cases highlighting that general assertions of unjust benefits are insufficient for establishing a cause of action.
The Amended Complaint additionally claims Defendants engaged in "inequitable, unconscionable, and unfair conduct," harming the Debtor and its creditors while granting Defendants an unfair advantage. The Committee seeks equitable subordination of Defendants' claims under section 510 of the Bankruptcy Code, which allows a court to subordinate claims based on the claimant's conduct. For equitable subordination to be granted, a three-part test must be met: 1) evidence of inequitable conduct by the defendant, 2) proof that this misconduct harmed creditors or unfairly advantaged the defendant, and 3) assurance that the remedy aligns with bankruptcy law. The third prong of this test is considered less significant under the current Bankruptcy Code, which explicitly provides for equitable subordination, contrasting with earlier statutes.
The excerpt addresses the application of the Mobile Steel test in assessing whether a complaint can survive a motion to dismiss in bankruptcy proceedings. Specifically:
1. **Mobile Steel Test**: The third prong is deemed likely moot, meaning that if a complaint meets the first two prongs, it can withstand dismissal.
2. **First Prong Requirements**: To satisfy the first prong, the Amended Complaint must clearly outline inequitable conduct by the Defendants that, while potentially lawful, contradicts equity and good conscience. This includes conduct such as fraud, breach of fiduciary duty, and unjust enrichment.
3. **Paradigms of Inequitable Conduct**: Historically, inequitable conduct is identified within three paradigms: (i) fraud, illegality, or breach of duty; (ii) undercapitalization; and (iii) using the debtor as an instrumentality for another's benefit.
4. **Insider Scrutiny**: The standard for identifying inequitable conduct is more rigorous for insiders of the debtor than for ordinary creditors. Insiders can be found to engage in inequitable acts based on unfair conduct or breach of duty.
5. **Dismissal of Claims**: The Committee's claims against the Defendants for breach of fiduciary duty and unjust enrichment were previously dismissed for lack of sufficient allegations, meaning these cannot serve as grounds for asserting inequitable conduct.
6. **Lack of Allegations**: The Amended Complaint fails to allege relevant conduct under the first and third paradigms. Consequently, the heightened scrutiny for insiders does not apply, as there are insufficient allegations to support claims of inequitable conduct.
7. **Remaining Basis for Claims**: The only remaining potential basis for inequitable conduct relates to allegations of undercapitalization, which are touched upon in the Amended Complaint.
The analysis concludes that without valid claims under the first two paradigms, the Committee's allegations hinge solely on undercapitalization.
Under-capitalization alone does not suffice to allege inequitable conduct without adequate pleadings related to other types of conduct as outlined in the first and third paradigms. The Seventh Circuit's ruling in *In the Matter of Lifschultz Fast Freight* establishes that under-capitalization does not justify equitable subordination of an insider's claim under section 510(c) of the Bankruptcy Code. An adequate claim for equitable subordination must include well-pleaded allegations of suspicious and inequitable conduct beyond mere under-capitalization, as reiterated in related case law. Due to the insufficient pleadings regarding inequitable conduct, the Court finds that the first prong of the Mobile Steel test has not been met, and thus, there is no need to analyze the second prong regarding creditor injury or unfair advantage. Consequently, the equitable subordination claim against Defendants Dr. Blomen and Blomenco B.V. is dismissed.
Additionally, the Committee seeks to disallow all claims of Defendants under section 502(d) of the Bankruptcy Code, arguing that the Defendants have not returned property recoverable under sections 544, 547, 548, and 550. Section 502(d) mandates disallowance of claims from entities that have received voidable transfers until such transfers are returned. However, since the Committee did not state any avoidance claims under the relevant sections, the issue of unrecovered voidable transfers is irrelevant. Therefore, there is no basis for disallowing the Defendants' claims, and their motion to dismiss these objections is granted. The Court notes the potential for amendments under Federal Rule of Civil Procedure 15(a)(2).
Following an initial amendment to a complaint, courts generally grant further amendments at their discretion unless it is deemed futile. The case law, including Acito v. IMCERA Group, Inc., highlights futility as a key exception. The Committee is allowed to replead all dismissed claims except for the deepening insolvency claim, which is denied leave to amend due to its legal unrecognition in New York. Consequently, both motions to dismiss by Dr. Blomen and Blomenco B.V. and Mr. Freeh are granted in full, while the Committee has sixty days to replead the remaining claims. The Committee's Amended Complaint largely consists of stylistic and grammatical updates without new factual enhancements. The remaining Defendants did not seek to dismiss the Amended Complaint but filed answers instead. Additionally, Dr. Blomen received a bonus payment of $168,452.92 in February 2008, while John Freeh was not listed as a recipient. Several other Defendants are noted as recipients of various payments from the Debtor. Ohio Rev. Code § 1701.59 outlines a director's duty to act in good faith and in the best interests of the corporation, which Dr. Blomen referenced in his motion, stating he served as CEO until November 2007 and subsequently as a director of the Parent.
Dr. Blomen contends that he does not owe any fiduciary duty to the Debtor regarding alleged breaches occurring after his resignation as CEO on December 31, 2007. He argues that these factual assertions are inappropriate for resolution at the Rule 12(b)(6) motion stage. However, the breach-of-fiduciary-duty claim against him is being dismissed for other reasons. The Amended Complaint alleges that Defendants also breached fiduciary duties to the Debtor's creditors, but Ohio case law presents conflicting views on whether directors and officers owe fiduciary duties to creditors in cases of insolvency. Some rulings suggest that such duties exist, while others assert they do not, depending on interpretations of Ohio Rev. Code 1701.59. The Court does not need to determine if a fiduciary duty to creditors is recognized under current law, as the Committee's claim suffers from pleading deficiencies. Additionally, while the Amended Complaint lacks certain allegations, the Court can take judicial notice of the Debtor’s principal business location and assets from the Petition. The Amended Complaint has also failed to specify any transfers made to Mr. Freeh, which is discussed further in relation to preference claims.
The pleading deficiencies present independent grounds for dismissing the constructive fraudulent transfer claims against Mr. Freeh, as the pleadings fail to meet the minimum requirements of Federal Rule of Civil Procedure 8(a) necessary to provide fair notice of the claims. The motion from Dr. Blomen and Blomenco B.V. argues that the Committee lacks standing to bring the section 544 claim due to the absence of a specific triggering creditor capable of avoiding the transfer under state law; however, relevant case law, specifically Musicland Holding Corp. v. Best Buy Co., suggests that identifying an actual creditor is not a necessary requirement for standing in the Southern District of New York.
The geographic diversity of the Defendants' residences, spanning several states, does not significantly affect the legal analysis, as creditors are also widely distributed. While Schedule 3(c) of the Statement of Financial Affairs lists transfers made to Mr. Freeh in the year preceding the Petition Date, it lacks sufficient detail to pinpoint the specific transfers relevant to the preference claims.
The concept of deepening insolvency appears to be a viable cause of action in Pennsylvania, based on the Third Circuit's perspective that the Pennsylvania Supreme Court would recognize it as a cognizable injury. However, both Ohio and New York courts do not recognize deepening insolvency as an independent cause of action. Dr. Blomen and Blomenco B.V. reference In re Magnesium Corp. to argue for the application of Ohio law, yet in the cited case, deepening insolvency was not explicitly pled. The Complaint's construction does not support deepening insolvency as a component of any traditional tort claims.
Deepening insolvency claims are governed by Delaware law, applying to allegations of fiduciary duty violations by the debtors' officers and directors. However, Delaware law does not recognize deepening insolvency as a separate cause of action. A breach of fiduciary duty claim would be governed by the internal affairs doctrine of the debtors' state of incorporation. Even under Ohio law, deepening insolvency lacks recognition as an independent cause of action, as noted by contrasting judicial opinions across jurisdictions. Some courts treat it as an independent cause of action, while others view it merely as a theory of damages or reject its validity entirely, often regarding it as redundant to existing claims such as breach of fiduciary duty and fraud.
The legal representatives for the parties involved have differing views on the applicable law, with the Committee reserving the right to argue for the application of another state's law later in the proceedings. A creditor, John Freeh, holds a significant unsecured claim against the debtors, while Dr. Blomen and Blomenco B.V. are not listed as creditors. Under Section 101(31)(B) of the Bankruptcy Code, both Dr. Blomen and Mr. Freeh are classified as insiders due to their positions as directors or officers of the debtor. Amendments to complaints are permitted under Federal Rule of Civil Procedure 15(a)(1), and the Committee has already exercised this right.
