Stanziale ex rel. Evergreen Energy, Inc. v. Khan (In re Evergreen Energy, Inc.)

Citations: 546 B.R. 549; 2016 Bankr. LEXIS 497Docket: Case No. 12-10289 (KJC) (Jointly Administered); Adversary No. 12-50740 (KJC)

Court: United States Bankruptcy Court, D. Delaware; February 11, 2016; Us Bankruptcy; United States Bankruptcy Court

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On January 23, 2012, Evergreen Energy, Inc. and related entities initiated chapter 7 bankruptcy proceedings. The chapter 7 trustee, Charles A. Stanziale, Jr., subsequently filed a 15-count adversary complaint against former director Ilyas Tariq Khan and his controlled entities, alleging fraud, negligent misrepresentation, breach of fiduciary duty, tortious interference, avoidance of fraudulent and preferential transfers, and violations of 15 U.S.C. § 78o(a)(1). The claims stem from an unconsummated sale of Evergreen's subsidiaries and payments made under professional service agreements.

Evergreen, a Delaware corporation based in Denver, focused on developing K-Fuel, a patented coal performance enhancement process, amid competition from White Energy Company, Ltd. Financial difficulties were evident, with a 2010 balance sheet showing assets of approximately $29.56 million against liabilities of about $43.05 million, alongside concerns about its viability as a going concern. In December 2010, Evergreen's board invited Khan to join as Executive Chairman, despite his prior role with competitor White Energy, where he retained share interests. The board also approved a Professional Services Agreement with Crosby Special Situations Fund, later known as Stanhill Special Situations Fund, where Khan was a principal. The PSA initially compensated SSSF $250,000 annually and included additional expenses and warrants, which was later amended to increase compensation to $300,000 annually. The Defendants' motion to dismiss the First Amended Adversary Complaint is partially granted and partially denied.

Evergreen entered into a Professional Services Agreement (PSA2) with Crosby (Hong Kong) Ltd., where compensation was set at $663,750 and 238,654 three-year warrants. In January 2011, Khan described Evergreen's financial state as "perilous." By February 1, 2011, Evergreen raised $15.99 million through private placement of shares and warrants, despite Khan's resistance to a larger offering, which some management members believed was necessary. Evergreen paid Lazard Capital Markets $650,000 for placement services, while Crosby (Hong Kong) Ltd. received over $731,000 but sold less than half the securities and lacked the placement services that Lazard provided. The March 31, 2011, 10-Q filing revealed Evergreen's liabilities exceeded assets, raising doubts about its ability to continue as a going concern and the need for additional capital for the K-Fuel process. In spring 2011, Khan suggested to management that if the share price did not reach $5.00, the company should consider going private, and he expressed intent to purchase Evergreen. By September 26, 2011, Khan indicated he was forming a group to acquire Evergreen's K-Fuel business. The Evergreen board established a Special Committee to negotiate and explore alternatives. On September 28, 2011, Stanhill Capital Partners, Ltd., where Khan is a principal, submitted a $30 million offer to purchase shares of certain Evergreen subsidiaries holding K-Fuel rights, contingent on due diligence and other approvals. The offer specified that it was a formal proposal and that due diligence would be confirmatory and completed within 10 days. A condition of the offer was that no shares or options in the Sale Companies would be granted to third parties. Prior to this, in August 2011, Evergreen initiated an At the Market (ATM) stock sale program intended to generate capital, though the Stanhill Offer negatively impacted trading and the ATM's potential.

Khan was aware that the Stanhill Offer would limit Evergreen's opportunities for alternative financing and capital raising through ATM. He communicated to Evergreen and its Special Committee that Stanhill had secured financing for the offer. Evergreen filed an 8-K with the SEC on October 4, 2011, detailing the Stanhill Offer and Khan’s role. The Special Committee engaged Cooley, LLP as counsel on October 12, 2011, and retained Dahlman Rose & Co. as their lead financial advisor on October 19, 2011, to assess both the Stanhill Offer and possible alternatives. On November 1, 2011, the Special Committee informed the Evergreen board that their Financial Advisor would conduct a market test of K-Fuel to evaluate the Stanhill Offer's fairness, rather than to develop alternatives. This market test was delayed due to Khan's refusal to include a "Fiduciary Out" clause, hindering Evergreen's ability to explore other transactions. Khan also informed the board that Stanhill would take on the Bechtel Agreement and the Koppelman litigation, the latter involving a lawsuit from the Koppelman Trust against Evergreen regarding a royalty agreement. On November 3, 2011, the Financial Advisor allowed Stanhill’s representatives access to Evergreen's corporate and technical records. During a November 4, 2011 meeting, the board discussed potential delisting from the NYSE and Khan's plans to communicate with the NYSE about the Stanhill Offer, as well as seek financing from WPG Resources. Evergreen made one or more counterproposals to Stanhill during this evaluation period, including an early November 2011 proposal to purchase all of Evergreen’s shares.

On November 12, 2011, a report indicated that White Energy faced significant challenges with a $100 million facility in Indonesia due to a coal supplier's decision to charge the full export price, jeopardizing the project and negatively impacting White Energy's share price. Following this, on November 13, 2011, Khan resigned from the Evergreen board, prompting further complications. On November 14, Khan demanded the termination of an agreement with Bechtel, leading Evergreen’s board to view the Stanhill Offer as uncertain. By November 19, the Committee's Financial Advisor informed the board that negotiations with Stanhill hindered Evergreen's ability to market its K-Fuel business, with 59 out of 60 potential acquirers either unresponsive or unwilling to engage due to Stanhill's knowledge of Evergreen's technology. On November 22, Stanhill withdrew its acquisition offer, and Evergreen's board acknowledged that this situation impeded financing opportunities, forcing the company to seek alternative transactions and drastically cut costs. Ultimately, by January 17, 2012, Evergreen’s board decided to file chapter 7 petitions. 

In terms of legal standards, a motion to dismiss under Fed. R. Civ. P. 12(b)(6) tests the complaint's sufficiency without resolving disputes of fact. The complaint must present enough factual content to state a plausible claim for relief. The court employs a three-step analysis to assess sufficiency: identifying required elements of the claim, distinguishing between factual allegations and mere conclusions, and determining if well-pleaded factual allegations plausibly suggest entitlement to relief. The burden of proof for dismissal lies with the movant, and the assessment includes the complaint and any relevant documents.

The Trustee has filed claims of fraud and negligent misrepresentation against Khan, Stanhill, and SSSF, alleging they knowingly made false statements to Evergreen to encourage it to accept the Stanhill Offer instead of exploring other sale options or financing sources. The misrepresentations include claims that Stanhill would take on certain liabilities, provide interim financing during the sale process, and had secured financing for the closing. The Defendants argue that the allegations contradict the claims and fail to establish the necessary elements for fraud and negligent misrepresentation under Colorado law.

To prove fraud, a plaintiff must demonstrate that the defendant made a false representation of a material fact, knew it was false, that the plaintiff did not know of its falsity, intended for it to be acted upon, and that it resulted in damages. A fraud claim can also stem from a promise about a future act made with no intention of fulfillment, where the plaintiff changed their position based on reliance on the false statement. For negligent misrepresentation, the plaintiff must show that a party in a professional context made a careless misrepresentation of a material fact, knowing it would be relied upon, and that the injured party justifiably relied on it to their detriment.

The Defendants argue that the requirement of justifiable reliance on the alleged misrepresentations is unmet, citing that the Stanhill offer was conditional, Evergreen formed a Special Committee and sought alternative transactions, and made counteroffers to Stanhill. The Trustee contends that whether Evergreen justifiably relied on the misrepresentations is a factual issue inappropriate for resolution at the motion to dismiss stage. The court will disregard conclusory allegations that do not logically follow from the facts presented. The Stanhill Offer was conditional, described as a "formal proposal" that required a finalized sales agreement, indicating that reliance on such an offer is generally unreasonable. Nevertheless, the Trustee asserts that the claims are based on damages from reliance on the false offer, arguing that the conditional nature of the offer does not undermine the claims, as the Defendants portrayed the conditions as mere formalities.

The Trustee contends that courts have recognized justifiable reliance even when a writing disclaims such reliance. However, the Defendants argue that Evergreen's actions, as described in the Complaint, contradict any claim of reliance on the Stanhill Offer, citing that Evergreen proposed counteroffers and was actively negotiating, indicating it did not consider the Stanhill Offer binding. Additionally, Evergreen established a Special Committee to consider the Stanhill Offer and solicit alternatives, and its financial advisor conducted a market test involving outreach to 60 potential acquirers, with minimal responses. These points lead to the conclusion that the allegations do not support the assertion of justifiable reliance, resulting in the dismissal of the first and second counts.

Regarding the breach of fiduciary duty claim against Khan, the Trustee alleges conflicting interests due to Khan's roles and affiliations. The Defendants counter that Khan was not acting as a fiduciary in the Stanhill Offer process since he recused himself and is protected by an exculpation clause in Evergreen's Certificate of Incorporation, which limits liability for directors under Delaware law. Delaware principles stipulate that directors owe fiduciary duties of care and loyalty to the corporation and its shareholders, with the duty of care requiring informed decision-making and the duty of loyalty prioritizing shareholders' interests. To establish a breach of loyalty, one must demonstrate a self-interested, unfair transaction. Khan maintains he was not involved in the Special Committee evaluating the Stanhill Offer, citing Delaware law that exonerates directors who do not participate in decision-making from liability for board decisions.

The Complaint does not assert wrongful transaction approval but claims that Khan had divided loyalties while facilitating a bad faith offer that harmed Evergreen. Directors must exhibit utmost good faith and fairness in transactions where they have personal interests. The exculpation clause in Evergreen's Certificate of Incorporation does not permit dismissal of the fiduciary duty claim, as it shields directors from liability for breaches of the duty of care, but not for bad faith or loyalty breaches. The Trustee presents sufficient factual allegations to support claims for breaches of both fiduciary duties, preventing dismissal.

Regarding tortious interference with prospective business relations, the Trustee claims the Stanhill Offer disrupted Evergreen's financing opportunities. Defendants argue for dismissal due to insufficient allegations of reasonable likelihood for prospective transactions. Under Colorado law, a plaintiff must show intentional interference preventing contract formation, which does not require an existing contract but does require a reasonable likelihood of one. The Trustee mentions two financing prospects but fails to provide specific investors or detailed relationships, rendering the allegations vague and insufficient. Unlike the cited case Tara Woods, L.P. v. Fannie Mae, where a claim was supported by actual purchase offers, here, the Trustee's claims do not demonstrate any actionable economic relationships hindered by the Stanhill Offer. Consequently, the fourth claim for tortious interference will be dismissed.

Claims five through twelve of the Complaint assert that transfers to SSSF and Crosby (Hong Kong) constitute constructive fraudulent transfers due to Evergreen not receiving reasonably equivalent value. The Defendants argue for dismissal, asserting that the transfers were made to satisfy debts incurred through arms-length negotiations under the PSA and PSA2, thus implying reasonable value was received. The Trustee counters that the payments exceeded the agreed terms and market rates for investment banking services and that SSSF and Crosby (Hong Kong) failed to provide the agreed services. The Third Circuit's analysis of reasonably equivalent value is fact-driven, considering the totality of circumstances, good faith, and market value. The Complaint adequately states claims for fraudulent transfers, leading to the denial of the Motion to Dismiss for claims five through twelve.

Claims thirteen and fourteen seek to avoid payments to SSSF and Crosby (Hong Kong) under Bankruptcy Code § 547(b) and § 550, requiring that the creditor be an insider at the time of transfer. While SSSF and Crosby (Hong Kong) do not fit the statutory definition of "insider," the Trustee claims they are non-statutory insiders due to their close relationship with Evergreen. The Defendants argue that these entities were engaged in arms-length transactions negotiated before Khan joined Evergreen's board. Courts recognize that "insiders" may extend beyond the statutory definition, focusing on the closeness of the relationship and the nature of the transactions. The Complaint alleges that Khan owned or controlled SSSF and Crosby (Hong Kong), and that transactions occurred during his tenure as a director, with payments exceeding contractual terms and market rates. These allegations justify closer scrutiny, resulting in the denial of the Motion to Dismiss for claims thirteen and fourteen.

Crosby (Hong Kong) is accused by the Trustee of violating 15 U.S.C. § 78o(a)(1) by receiving fees for brokerage services, leading to the assertion that any payments made under PSA2 should be refunded. The Defendants contend this claim should be dismissed as Crosby (Hong Kong) was affiliated with Lazard Capital Markets, LLC, the SEC-registered agent responsible for compliance. The Trustee counters that Crosby (Hong Kong) must demonstrate its claimed exemption, but the allegations against it lack specificity regarding transactions or fees, resulting in the dismissal of this claim.

The Trustee requested leave to amend the Complaint if any claims were dismissed, citing Rule 15 of the Federal Rules of Civil Procedure, which encourages courts to permit amendments barring undue delays, bad faith, or futility. The Court determined that the proposed amendments would not add sufficient factual support to the first and second claims (fraud and negligent misrepresentation) concerning the Stanhill Offer, leading to the denial of the request to amend these claims.

However, the Trustee seeks to amend the fifteenth claim by adding details about Crosby (Hong Kong) filing a Form W-8ECI, which could substantiate the violation claim. The Court grants the Trustee the opportunity to amend this claim.

In conclusion, the Court partially grants and partially denies the Defendants' Motion to Dismiss: it grants dismissal of the fraud and negligent misrepresentation claims, tortious interference claims, and the violation of 15 U.S.C. § 78o(a)(1), while denying dismissal of the breach of fiduciary duty and fraudulent transfer claims, as well as the preference claims. An order will follow to reflect these decisions.

Jurisdiction for this case is established under 28 U.S.C. §§ 157 and 1334, with core proceedings defined in § 157(b)(2)(F, H, O). The parties have consented to a final order on all claims. NYSE Area, Inc. operates as an electronic stock market facilitating trade in equity securities and options, accounting for approximately 10% of NYSE-listed and 20% of Nasdaq-listed securities traded as of 2009. Colorado law governs the claims of negligent misrepresentation and fraud. To prove fraud, the plaintiff must show: (i) a fraudulent misrepresentation of a material fact by the defendant, (ii) reliance on that misrepresentation by the plaintiff, (iii) justification for that reliance, and (iv) resulting damages. The reasonableness of reliance on alleged misrepresentations is fact-specific and typically unsuitable for resolution at the motion to dismiss stage. Courts are not obligated to accept allegations that contradict judicially noticed facts or attached exhibits.

In Laks v. Coast Fed. Sav. Loan Ass’n, the court affirmed the dismissal of a promissory estoppel claim, emphasizing that experienced businessmen should understand the conditional nature of offers and could not have reasonably relied on them. The Trustee referenced Aceves v. U.S. Bank, where the court distinguished Laks, noting that the borrower claimed promissory estoppel and fraud due to reasonable reliance on a bank's negotiation offer. Various cases highlighted include Denver Health's negligent misrepresentation claim despite conflicting written policies, and the impact of a bank's comfort letter on similar claims. The internal affairs doctrine was cited to assert that Delaware law governs breach of fiduciary duty claims. Additionally, several cases were noted regarding the inadequacy of vague assertions about preventing business relationships without identifying specific entities, alongside allegations involving artificial value manipulation of a shopping center.

The court ruled that the plaintiff's assertion of the defendants' interference with the market was inadequate to establish a claim for intentional interference with prospective economic advantage. The plaintiff's Fraudulent Transfer Claims are grounded in the Bankruptcy Code, specifically under sections 548(a)(1)(B), 544, and Colorado statutes 38-8-105(b)(I) and (II) and 38-8-106(1). In analyzing "reasonably equivalent value" under the Colorado Uniform Fraudulent Transfer Act, the court stated that this determination requires a comprehensive review of the transaction's circumstances and operates under a standard of reasonableness. Prior rulings indicated that merely paying an antecedent debt does not automatically demonstrate reasonably equivalent value; rather, material factual issues may exist regarding the value received in exchange for services. The document also discusses the oversight of insider transactions, emphasizing that an LLC controlled entirely by an insider is considered an insider for scrutiny purposes. The excerpt references various legal precedents and statutes, including the necessity for brokers or dealers to register under 15 U.S.C.A. 78o(a)(1) to engage in securities transactions. Lastly, it notes that the letter brief did not seek to amend the claim for tortious interference with prospective business relations, leading to the conclusion that such an amendment would be futile based on the facts presented in the complaint.