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Quadrant Structured Products Co., Ltd v. Vertin

Court of Chancery of Delaware

October 28, 2014

QUADRANT STRUCTURED PRODUCTS COMPANY, LTD, Individually and Derivatively on behalf of Athilon Capital Corp, Plaintiffs,
v.
VINCENT VERTIN, MICHAEL SULLIVAN, PATRICK B. GONZALEZ, BRANDON JUNDT, J. ERIC WAGONER, ATHILON CAPITAL CORP, ATHILON STRUCTURED INVESTMENT ADVISORS LLC, and EBF & ASSOCIATES, LP, Defendants.

Submitted: October 15, 2014

LISA A. SCHMIDT, CATHERINE G. DEARLOVE, RUSSELL C. SILBERGLIED, SUSAN M. HANNIGAN, RICHARDS, LAYTON & FINGER, P.A., WILMINGTON, DELAWARE; HAROLD S. HORWICH, SABIN WILLETT, SAMUEL R. ROWLEY, BINGHAM MCCUTCHEN LLP, BOSTON, MASSACHUSETTS; ATTORNEYS FOR PLAINTIFF QUADRANT STRUCTURED PRODUCTS COMPANY, LTD.

PHILIP A. ROVNER, JONATHAN A. CHOA, POTTER ANDERSON & CORROON LLP, WILMINGTON, DELAWARE; PHILIPPE Z. SELENDY, NICHOLAS F. JOSEPH, SEAN P. BALDWIN, QUINN EMANUEL URQUHART & SULLIVAN, LLP; NEW YORK, NEW YORK; ATTORNEYS FOR DEFENDANTS VINCENT VERTIN, MICHAEL SULLIVAN, PATRICK B. GONZALEZ, BRANDON JUNDT, J. ERIC WAGONER, ATHILON CAPITAL CORP., AND ATHILON STRUCTURED INVESTMENT ADVISORS LLC.

COLLINS J. SEITZ, JR., GARRETT B. MORITZ, ERIC D. SELDEN, SEITZ ROSS ARONSTAM & MORITZ LLP, WILMINGTON, DELAWARE; ATTORNEYS FOR DEFENDANT MERCED CAPITAL, L.P., FORMERLY KNOWN AS EBF & ASSOCIATES, LP.

MEMORANDUM OPINION

LASTER, VICE CHANCELLOR

Plaintiff Quadrant Structured Products Company, Ltd. ("Quadrant") owns debt securities issued by defendant Athilon Capital Corp. ("Athilon"). Quadrant alleges that Athilon is insolvent, which gives Quadrant standing to sue derivatively. Quadrant contends that the individual defendants, who are members of Athilon's board of directors (the "Board"), have breached their fiduciary duties by seeking in various ways to benefit Athilon's controller, defendant EBF & Associates ("EBF").

Importantly for present purposes, Quadrant contends that the Board has sought to benefit EBF by investing Athilon's assets in riskier securities. EBF owns all of Athilon's equity and junior notes, which Quadrant alleges are currently underwater and would not receive anything in an orderly liquidation. If the risk-on strategy succeeds, the securities that EBF owns will become valuable. If the strategy fails, more senior creditors like Quadrant will suffer the loss. Quadrant contends that because two of the members of the Board are agents of EBF and a third is not independent of EBF, a majority of the five member Board was interested in the decision to favor EBF such that the defendants must prove that the change in investment strategy was entirely fair. This argument presents a case-specific version of the general theory that a director who holds a material amount of common stock, or who wears two hats as a fiduciary for the corporation and for a large common stockholder, faces a conflict of interest when the corporation becomes insolvent. The conflict arises because the class of residual risk bearers expands to include creditors, and the directors must decide between two groups—creditors and stockholders—whose inherently different risk preferences give them inherently different interests, at a time when both groups can claim legitimately to be the proper subject of the director's decisional ministrations.

In an opinion dated October 1, 2014, this court dismissed the challenge to the Board's risk-on business strategy. Quadrant Structured Prods Co. v. Vertin, 2014 WL 5099428 (Del. Ch. Oct. 1, 2104) (the "Rule 12(b)(6) Opinion"). The Rule 12(b)(6) Opinion analyzed Quadrant's argument and reviewed pertinent case law, including Shandler v. DLJ Merchant Banking, Inc., 2010 WL 2929654 (Del. Ch. July 26, 2010) (Strine, V.C.); Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168 (Del. Ch. 2006) (Strine, V.C.), affdsub nom. Trenwick Am. Litig. Trust v. Billett, 931 A.2d 438 (Del. 2007) (TABLE), and Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772 (Del. Ch. 2004) (Strine, V.C.). These decisions recognized the conflict on which Quadrant grounds its argument. For example, in Production Resources, Chief Justice Strine, then a Vice Chancellor, noted that

[b]ecause creditors have no interest beyond the debts owed to them, they have no incentive (and much to risk) by encouraging business strategies that would risk the payment of the bulk of their claims but provide some hope that the firm's value will increase to the level at which there could be a return for the equity.

863 A.2d at 790 n.57; see Credit Lyonnais Bank Nederland, N.V. v. Pathe Commc'ns Corp., 1991 WL 277613, at *34 n.55 (Del. Ch. Dec. 30, 1991) (describing divergence of interests). Opinions such as Shandler, Trenwick, and Production Resources nevertheless spoke of the business judgment rule as providing the operative standard of review for decisions made by the board of an insolvent corporation that would help or hurt the firm as a whole. Rule 12(b)(6) Op., 2014 WL 5099428, at *20-25. From these cases, the Rule 12(b)(6) Opinion derived the principle that "when directors make decisions that appear rationally designed to increase the value of the firm as a whole, Delaware courts do not I speculate about whether those decisions might benefit some residual claimants more than others." Id. at*21.

Based on this principle, the Rule 12(b)(6) Opinion held that an allegedly risky shift is not sufficient to elevate the standard of review from the business judgment rule to entire fairness when a plaintiff challenges a business decision that will increase or decrease the value of the entity as a whole, as opposed a decision that transfers value to a particular person or class of security holders. Other than the potentially favorable implications of the risk-on strategy for the junior tranches of the capital stack owned by EBF, Quadrant's complaint did not identify a basis for rebutting the presumptions of the business judgment rule. When evaluated under the business judgment rule, the allegations of the complaint did not raise a reasonably conceivable inference that the Board's decision to take on additional risk was so extreme as to be irrational and suggestive of bad faith. Consequently, the Rule 12(b)(6) Opinion dismissed the risk-on claim.

Quadrant has moved for reconsideration of the dismissal. Rule 59(e) provides that "[a] motion for reargument setting forth briefly and distinctively the grounds therefor may be served and filed within 5 days after the filing of the Court's opinion or the receipt of the Court's decision." Ch. Ct. R. 59(f). The moving party bears the burden of demonstrating that the court "overlooked a decision or principle of law that would have controlling effect" or "misapprehended the law or the facts so that the outcome of the decision would be affected." Miles, Inc. v. Cookson Am., Inc., 677 A.2d 505, 506 (Del. Ch. 1995) (quoting Stein v. Orloff, 1985 WL 21136, at *2 (Del. Ch. 1985)). A Rule 59(f) motion is "not a mechanism for litigants to relitigate claims already considered by the court." Fisk Ventures, LLC v. Segal, 2008 WL 2721743, at *1 (Del. Ch. July 3, 2008), aff'd, 984 A.2d 124 (Del. 2009) (TABLE) (quoting Am. Legacy Found, v. Lorillard Tobacco Co., 895 A.2d 874, 877 (Del. Ch. 2005)).

In its motion for reconsideration, Quadrant argues that the Rule 12(b)(6) Opinion overlooked or misapprehended the implications of restrictions on Athilon's business imposed by Athilon's certificate of incorporation (the "Athilon Charter"). Under the Athilon Charter, Athilon only can engage in the limited business of guaranteeing credit default swaps written by its wholly owned subsidiary, Athilon Asset Acceptance Corp. ("Asset Acceptance"). Since the financial crisis of 2008, that business has no longer been viable. Asset Acceptance has not written any new swaps, and Athilon has not written any new guarantees. At present, Athilon's business consists of two legacy portfolios. On the i liability side, Athilon has a portfolio of guarantees for swaps that will continue to earn premiums until the last contracts expire in 2014 or shortly thereafter. On the asset side, Athilon has a portfolio of investments in securities intended to provide funds to pay off any guarantees that come due.

The Athilon Charter requires that Athilon conduct its business in compliance with certain operating guidelines approved by the credit rating agencies (the "Operating Guidelines"). The Operating Guidelines historically restricted Athilon to investing in short-term, low-risk securities, such as U.S. government and agency securities, certain Euro-dollar deposits, bankers' acceptances, commercial paper, repurchase transactions, money market funds, and money market notes with high short-term ratings. In May 2011, as part of implementing its risk-on strategy, the Board sought permission from the rating agencies to amend the Operating Guidelines to loosen the investment restrictions and expand its permitted investments. The rating agencies signed off, recognizing that the amendments would not cause a downgrade in ...


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