UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF KENTUCKY
LEXINGTON DIVISION
IN RE:
RUSSELL CAVE COMPANY, INC.
DEBTOR CASE
NO. 99-50142
Chapter
11
THE OFFICIAL COMMITTEE OF
UNSECURED CREDITORS PLAINTIFF
VS. ADV.
NO. 01-5035
BMO NESBITT BURNS EQUITY
INVESTMENTS (U.S.), INC., et al. DEFENDANTS
MEMORANDUM OPINION
Defendants General Electric Capital Corporation (AGECC@) and GE
Capital Equity Capital Group, Inc. (together Athe GE defendants@) have moved to dismiss the plaintiff=s Amended Complaint to Equitably Subordinate Certain
Claims (Doc. #56) filed herein on May 11, 2001. The motion to dismiss and the plaintiff=s response were heard on August 17, 2001, and
submitted for decision. This court has
jurisdiction of this matter pursuant to 28 U.S.C. ' 1334(b); it is a core proceeding pursuant to 28
U.S.C. ' 157(b)(2)(O).
The plaintiff=s current amended
complaint was filed pursuant to the order of this court entered on April 20,
2001 (Doc. #52). It had originally
filed its Amended Complaint to Equitably Subordinate Certain Claims on March 2,
2001 (Doc. #7). The GE defendants filed
their motion to dismiss this amended complaint on March 12, 2001 (Doc.
#22). The court=s April 20, 2001
order dismissed Counts I and II; Counts III and IV sought equitable
subordination of claims arising from certain debentures and a subordinated
note. The order directed the plaintiff
to file an amended complaint Asetting forth with particularity the alleged inequitable conduct
of the GE Defendants and the original debenture holders, and the specific
injury resulting from such alleged inequitable conduct.@ After the filing of the current amended
complaint, the GE defendants renewed their motion to dismiss on June 26, 2001
(Doc. #61).
A motion to dismiss
made pursuant to F.R.Civ.P.
12(b)(6), made applicable in bankruptcy by F.R.Bankr.P.
7012(b), is for failure to state a claim upon which relief can be granted. As set out in Perniciaro v. Natale (In re
Natale), 136 B.R. 344, 348 (Bankr. E.D.N.Y. 1992), the court, in
determining such a motion
must presume that the factual allegations
of the complaint are true and all reasonable inferences are to be made in favor
of the nonmoving party. Jenkins v.
McKeithen, 395 U.S. 411, 421-22, 89 S.Ct. 1843, 1848-49, 23 L.Ed.2d 404
(1969). The purpose of a motion to
dismiss is to assess the legal sufficiency of a complaint, not to judge the
weight of evidence which might be offered in its support. Geisler v. Petrocelli, 616 F.2d 636,
639 (2nd Cir. 1980).
However, on a motion to dismiss, it is clear that the court does not
have to accept every allegation in the complaint as true in assessing its
sufficiency. 5A Charles A. Wright &
Arthur R. Miller, Federal Practice and Procedure '1357, at 311-18 (2d
ed. 1990). The allegations of a
complaint must be "well-pleaded" and thus the court need not accept
"sweeping and unwarranted averments of fact." Haynesworth v. Miller, 820 F.2d 1245,
1254 (D.C.Cir. 1987). Legal
conclusions, deductions or opinions couched as factual allegations in a
complaint are not given a presumption of truthfulness. 2A James Wm. Moore et al., Moore's
Federal Practice &12.07[2.-5], at
12-63 to 12-64 (2d ed. 1991). A
complaint is subject to dismissal if it fails to allege a required element
which is necessary to obtain relief sought.
Moore, supra, at 12-68; (cite omitted). A motion under Fed.R.Civ.P. 12(b)(6) should also be granted if a
bar to relief is apparent from the face of the complaint. Moore, supra, at 12-68 to 12-69.
The court's task under Rule 12(b)(6) is
then to determine the sufficiency, and not the merits, of the amended
complaint. See also Pereira v.
Binet, et al. (In re Harvard Knitwear, Inc.), 153 B.R. 617 (Bankr. E.D.N.Y.
1993), and Allard v. Weitzman (In re DeLorean Motor Co.), 991 F.2d 1236
(6th Cir. 1993).
The court=s power to
equitably subordinate creditors= claims is codified at 11 U.S.C. ' 510(c) which provides in
pertinent part:
Notwithstanding subsections (a) and (b) of
this section, ... , the court mayB
(1) 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 or all or part of an allowed interest to all or part of
another allowed interest[.]
The conditions that must be satisfied
before equitable subordination is applied have been organized as a three-part
test first articulated in Benjamin v. Diamond (In re Mobile Steel Co.), 563
F.2d 692, 700 (5th Cir. 1977):
(i) The claimant must have engaged in some
type of inequitable conduct. ... (ii) The misconduct must have resulted in
injury to the creditors of the bankrupt or conferred an unfair advantage on the
claimant. ... (iii) Equitable subordination of the claim must not be
inconsistent with the provisions of the Bankruptcy Act. (Citations omitted.)
This test has been recognized and adopted
by many courts, including the Sixth Circuit.
See First Nat=l Bank of Barnesville v. Rafoth (In re
Baker & Getty Fin. Servs., Inc.), 974 F.2d 712 (6th Cir. 1992).
The Sixth Circuit
has, however, gone on to Afurther develop@ the principles of
equitable subordination, and has held that a showing of creditor misconduct is
not necessary for the court to make a determination that a claim should be
equitably subordinated. United
States v. Noland (In re First Truck Lines, Inc.), 48 F.3d 210, 218 (6th
Cir. 1995), rev=d, United States v.
Noland,
517 U.S. 535, 541, 116 S.Ct. 1524, 1527 (1996). Since the Supreme Court=s reversal in First Truck did not
address the question of whether creditor misconduct is a necessary element of
equitable subordination, the Sixth Circuit=s pronouncement on the subject remains the
law in this circuit.
So-called Ano-fault@ subordination
looks to the Anature and origin@ of the claim. See SPC Plastics Corp. et al. v. Griffith
(In re Structurlite Plastics Corp.), 224 B.R. 27, 35 (B.A.P. 6th Cir.
1998). So far the only types of claims
that have been subordinated in the absence of creditor misconduct are tax
penalty and stock redemption claims. In
re First Truck Lines, Inc., 48 F.3d at 219; In re Structurlite Plastics
Corp., 224 B.R. at 36. Barring a
demonstration that the Anature and origin@ of the claim
justifies equitable subordination, however, it would appear that inequitable
conduct must be proven. In Official
Unsecured Creditors Comm. v. Ampco-Pittsburgh Corp. (In re Valley-Vulcan Mold
Co.), 237 B.R. 322, 334 (B.A.P. 6th Cir.
1999), the panel cited Structurlite and agreed with its holding
concerning Ano-fault@ equitable
subordination, but then went on to state:
In holding the Committee was not entitled
to equitable subordination, the bankruptcy court again noted the Committee=s failure to prove
any facts warranting the relief sought.
The court pointed out there was nothing in the evidence to support the
Committee=s allegation of
undercapitalization or asset-stripping and that the Committee had already
failed in its attempts to prove that any transfer at issue was fraudulent under
Ohio law.
.
. .
Accordingly, the bankruptcy court did not
abuse its discretion in denying the Committee=s request for equitable
subordination ... See, e.g., Paulman v. Gateway Venture Partners III, L.P.
(In re Filtercorp, Inc.), 163 F.3d 570, 583 (9th Cir. 1998)
(stating A>subordination
requires some showing of suspicious, inequitable conduct=@ even beyond
initial undercapitalization of an enterprise).
As concerns the
level of proof required to demonstrate that claims should be subordinated, the
dealings of fiduciaries with their corporations are subject to Arigorous scrutiny,@ and when
challenged by an objection with a substantial factual basis, the burden is on
them to prove the good faith and fairness of a transaction. In re Mobile Steel Co., 563 F.2d at
701. Creditors who are not insiders (and therefore not fiduciaries) are subject
to a higher standard. As stated by the
court in Carter-Waters Oklahoma, Inc. et al. v. Bank One Trust Co., N.A., et
al. (In re Eufaula Indus. Auth.), 266 B.R. 483, 489 (B.A.P. 10th Cir.
2001):
If the claimant is an insider or a
fiduciary, the party seeking equitable subordination need only show Aunfair@ conduct. Estes v. N & D Props., Inc. (In re N
& D Props., Inc.), 799 F.2d 726, 731 (11th Cir. 1986). However, where non-insider claims are
involved, the level of pleading and proof is significantly higher. Id. at 731-32. Although courts now agree that equitable subordination
can apply to a non-insider creditor, the circumstances are Afew and far
between.@ Kham & Nate=s Shoes No. 2, Inc.
v. First Bank, 908 F.2d 1351, 1356 (7th Cir. 1990); accord
Waslow v. MNC Commercial Corp. (In re M. Paolella & Sons, Inc.), 161
B.R. 107, 119 (E.D.Pa. 1993) (AEquitable subordination has seldom been invoked, much less
successfully so, in cases involving non-insiders and/or non-fiduciaries.@), aff=d, 37 F.3d 1487 (3d
Cir. 1994). Importantly, a non-insider
creditor Agenerally owes no
fiduciary or contractual duty to the other creditors of a debtor [and
therefore] must be found to have engaged in some specific conduct that gave
rise to a fiduciary, contractual, or other legally recognized duty to the other
creditors before its claim will be equitably subordinated.@ Andrew DeNatale
and Prudence B. Abram, The Doctrine of Equitable Subordination as Applied to
Nonmanagement Creditors, 40 Bus.Law. 417, 430 (1985) (footnote omitted).
The GE defendants contend that they are not
insiders, and therefore not fiduciaries, and that they are subject to this
higher level of proof. The plaintiff
responds that insider status cannot be resolved on a motion to dismiss.
As set out above,
the court=s task on a motion
to dismiss is to determine the sufficiency of the complaint, that it alleges
each required element to obtain the relief sought. For purposes of a complaint seeking equitable subordination, the
elements that must be alleged are inequitable conduct on the part of the
claimant, damage to the debtor=s creditors or an unfair advantage to the claimant, and
consistency with the provisions of the Bankruptcy Code.
The plaintiff
contends first of all that the amended complaint alleges specific facts
concerning the GE defendants= insider status.
Regarding the debentures, these include in Count I, & 80, the
acquisition of a controlling block of the debtor=s common stock by BMO Nesbitt Burns
Equity Partners, Inc. and Brand Equity Ventures I-A, L.P. (referred to
collectively in the amended complaint as Athe Investors@), the Investors= power to select
two members of the debtor=s board of
directors and to veto outside directors unacceptable to them, the active
participation of the Investors= personnel in board activities and strategic decisions of debtor=s management, the
Investors= preparation of
business plans and financial projections used by the debtor, and the Investors= direct
negotiations with Heller Financial, Inc. concerning modification of the terms
of the debtor=s $15 million
revolving credit facility with Heller. The Investors assigned their interests
in the debentures to the GE defendants in July 1999.
Inequitable conduct
on the part of the Investors is alleged in Count I at && 81-82. The plaintiff contends that the GE
defendants= transactions with
the debtor were purposely structured to give them and their assignors the
rewards of an equity investment in the debtor while forcing the other creditors
to subsidize the risk. In order to
pursue their equity return, the amended complaint alleges, the Investors
accelerated the debtor=s shift from a
traditional mail order business to retail stores, thereby increasing the debtor=s expenses and
debt. The amended complaint alleges
that the Investors kept the debtor in operation and incurring new debt long
after it made business sense to do so.
The amended complaint at Count I, & 83 further alleges that the Investors= inequitable
conduct resulted in injury to the debtor=s creditors by impairing the debtor=s ability to pay
its creditors, impairing the liquidation value of the debtor=s assets and
causing the debtor to incur additional debt after it was no longer reasonable
to do so. Finally, Count I alleges at & 84 that equitable
subordination of all claims arising from the Debentures is not inconsistent
with any provision of the Bankruptcy Code.
In Count II, in
regard to equitable subordination of the subordinated note, the plaintiff made
allegations of insider status for defendant GECC at & 87. The plaintiff alleged there that GECC, while
formally having only observer status, participated actively in the meetings and
decision-making of the debtor=s board of directors, and gave directions to and exercised veto
power over debtor=s management. The plaintiff further alleged that GECC
participated in the debtor=s negotiations with other financing entities, and took an active
role in formulating plans and projections for use by the debtor=s management.
Allegations of
inequitable conduct are found in && 88-89. These include GECC=s delaying agreement on a credit facility
to be extended to the debtor while its financial condition continued to
deteriorate so that the debtor was unable to obtain the credit facility;
abandoning its involvement in managing the debtor=s business and developing plans to
address its deteriorating financial condition; failure to exercise control over
the debtor to cause it to cease operations and cease incurring debt; and
keeping the debtor in operation and continuing to incur debt after it was no
longer reasonable to do so in an effort to enhance GECC=s equity interest
in the debtor.
Injury to the
debtor=s creditors is
alleged at & 89: impairment of the debtor=s ability to pay
its creditors, impairment of the liquidation value of the debtor=s assets, and the
debtor=s incurring
additional debt after it was no longer reasonable for the debtor to do so. Finally, Count II alleges at & 90 that equitable
subordination of any and all claims arising from the Subordinated Note is not
inconsistent with any provision of the Bankruptcy Code.
It appears to the
court that the plaintiff has amended its complaint with sufficient facts to
survive a Rule 12(b)(6) motion to dismiss.
The plaintiff has alleged facts to support its position that the GE
defendants and their assignors, the Investors, were insiders, and that it is
therefore unnecessary to demonstrate inequitable conduct on their part. Such allegations nothwithstanding, the
plaintiff has also alleged inequitable conduct as set out above. It has further alleged specific instances of
harm to the debtor=s other creditors,
or unfair advantage to the GE defendants and/or the Investors.
As stated in Bower
v. Federal Express Corp., 96 F.3d 200, 203 (6th Cir. 1996), AIn order for a
dismissal to be proper, it must appear beyond doubt that the plaintiff would
not be able to recover under any set of facts that could be presented
consistent with the allegations of the complaint.@
The court concludes that the plaintiff is not precluded from recovery
under some set of facts consistent with its allegations, and that the plaintiff=s motion to dismiss
for failure to state a claim should therefore be overruled. An order in conformity with this opinion
will be entered separately.
Dated:
By the Court -
Judge William S. Howard
Copies
to:
Raymond
J. Lembke, Esq.
Frank
T. Becker, Esq.