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In re SRC Liquidation LLC

United States District Court, D. Delaware

November 16, 2017




         EiserAmper LLP ("Plaintiff), as trustee of the SRC Liquidating GUC Trust ("Trust") created in the Chapter 11 cases of The Standard Register Company and its affiliates ("Debtors"), appeals the Bankruptcy Court's dismissal of an adversary proceeding against Robert M. Ginnan, Joseph P. Morgan, Jr. ("Officer Defendants"), Roy W. Begley Jr., F. David Clarke, III, John Q. Sherman, II, Julie D. Klapstein, John J. Schiff, Jr., and R. Eric McCartney ("Director Defendants"), asserting causes of action including breach of fiduciary duty and avoidance of fraudulent transfers. The appeal is fully briefed. (See D.I. 15, 20, 36) For the reasons stated below, the Court will affirm the dismissal.

         I. BACKGROUND

          Facing economic difficulties, including a decline in the demand for traditional printing services and underfunded pension obligations, The Standard Register Company and its subsidiaries (the "Company") pursued restructuring and ultimately entered into a strategic combination transaction to acquire a competitor, WorkflowOne (the "Acquisition"). In connection with the Acquisition, Officer Defendants prepared financial projections regarding the combined companies to determine whether the Acquisition made sense. (A62 ¶ 18)[1] On July 31, 2013, the Company's board approved the Acquisition, along with transaction bonuses totaling $900, 000 for Morgan and $325, 000 for Ginnan.[2] (A69 ¶¶ 54, 55) Half of each bonus was contingent on the Company attaining "certain performance-related thresholds" in the "first quarter of 2014." (See SA48) Having met those thresholds, Officer Defendants later received the full amount of the bonuses. (See A69 ¶¶ 54-55) Ultimately, the synergies and growth that management had projected for the combined companies were not achieved. (See D.I. 20 at 15) The Company defaulted on its debt and, on March 15, 2015, filed for relief under Chapter 11 of the Bankruptcy Code. In May 2015, the Bankruptcy Court granted the creditors' committee standing to pursue causes of action on behalf of the estates. The creditors' committee filed a complaint focused on its secured lenders, including Silver Point Capital L.P. ("Silver Point") and, within weeks, reached a $5 million settlement with those parties. (B.D.I. 696) Following the settlement, Plaintiff amended the complaint (Adv. D.I. 6) ("Complaint") which now focuses on Defendants' decision to pursue the Acquisition as the alleged cause of the Company's eventual bankruptcy.

         The purported unreliability of the projections presented to the board in connection with the Acquisition is the basis of Plaintiff s breach of fiduciary duty claim. (See Al 54 (Plaintiff describing projections as "the linchpin" of its claims)) Count I of the Complaint alleges that Defendants breached their fiduciary duties under Ohio law[3] by approving the Acquisition without fully and adequately informing themselves, and by relying on unrealistic and overly optimistic projections which they knew or should have known the Company could not achieve following the Acquisition, and (ii) the Officer Defendants breached their fiduciary duty by knowingly preparing unreliable and unattainable financial projections. Count I further alleges that Defendants breached their duty of loyalty by approving the Acquisition to preserve their positions and their compensation.

         Count II of the Complaint seeks avoidance of the bonuses paid to the Officer Defendants as constructively fraudulent transfers pursuant to § 548(a)(1)(B) of the Bankruptcy Code. Count III seeks avoidance of the bonuses to the Officer Defendants as fraudulent transfers pursuant to § 544 of the Bankruptcy Code - which permits a bankruptcy trustee to bring a claim for fraudulent transfer under applicable state laws - and the Ohio Uniform Fraudulent Transfer Act, codified at Ohio Revised Code § 1336.01 et seq. Count IV seeks the disallowance of Defendants' claims against the estates in accordance with § 502(d) of the Bankruptcy Code.[4]

         Defendants moved to dismiss the Complaint. (Adv. D.I. 19) On February 8, 2016, the Bankruptcy Court conducted a hearing on the motion to dismiss and ruled from the bench, dismissing Count I with prejudice, and dismissing Counts II, III, and IV without prejudice. On February 19, 2016, the Bankruptcy Court entered an order dismissing the Complaint for the reasons stated at the hearing and granting Plaintiff leave to amend Counts II-IV within 30 days. (Adv. D.I. 53; A302-03) (the "Dismissal Order") Rather than amend, Plaintiff filed a notice of appeal on March 1, 2016. (D.I. 1) The Bankruptcy Court then issued a Supplemental Memorandum Order further discussing its dismissal of Count I with prejudice. (Adv. D.I. 61; A3 04-12) ("Memorandum Order") Addressing its dismissal of Count I with prejudice, the Bankruptcy Court determined that the Complaint failed to plausibly allege any facts - as opposed to general conclusions - demonstrating that the projections were in fact "unrealistic and overly optimistic" or that Defendants knew or should have known this at the time (see A3 07-08); failed to plausibly allege entrenchment or lack of disinterestedness to support the alleged breach of loyalty (see A309-11); and failed to plausibly allege facts demonstrating that any breach of fiduciary duty was the proximate cause of the bankruptcy and any resulting damages (see A311).


          Plaintiff raises several issues on appeal, but its main argument is that dismissal of any of the Counts was improper because the Bankruptcy Court failed to accept all factual allegations in the Complaint as true and failed to draw all reasonable inferences in favor of Plaintiff. (See D.I. 15 at 16-19) According to Plaintiff, the Bankruptcy Court also improperly subjected Plaintiff to a "heightened pleading standard" based on Plaintiffs access to discovery produced to the creditors' committee in the course of the Chapter 11 cases. (See Id. at 19-23)

         With respect to the breach of fiduciary duty claim, Plaintiff argues that the Bankruptcy Court erred in granting the motion to dismiss because the Complaint plead sufficient facts to overcome Ohio's business judgment rule. (See Id. at 27-32) According to Plaintiff, the Complaint plausibly alleges facts demonstrating that, in light of their knowledge of the ongoing declines in the print industry, Defendants breached their duty of care by preparing and accepting projections which they knew or should have known were unrealistic and unattainable. (See id.) Plaintiff further argues that the Complaint plausibly alleges facts demonstrating that Defendants were motivated to prepare unrealistic projections in order to retain their corporate control and equity interests, lacked disinterestedness in the Acquisition by virtue of the possible bonuses, and therefore breached their duty of loyalty. (See Id. at 37-41) With respect to causation, Plaintiff contends that the Complaint plausibly alleges facts from which the Bankruptcy Court could infer that Defendants' actions preparing and accepting unrealistic projections caused the Company to severely overpay for the Acquisition, burdened it with overwhelming secured debt and highly restrictive covenants it could not support, and was therefore the proximate cause of the bankruptcy and resulting damages. (See Id. at 41-45) Plaintiff further contends that dismissal of the fiduciary duty claim with prejudice was an abuse of discretion because the Bankruptcy Court did not explain its reasoning. (See Id. at 45-47)

         Regarding the fraudulent transfer claims, Plaintiff argues that the Complaint contained sufficient factual allegations to demonstrate that Debtors were insolvent or rendered insolvent at the time they paid the bonuses and that a strong stock price at the time of the Acquisition cannot rebut a claim of insolvency at the pleading stage. (See Id. at 49-53) Plaintiff further argues that the Complaint contained sufficient allegations to plausibly state that Debtors did not receive reasonably equivalent value for the transaction-related bonuses because "the board effectively destroyed the Debtors' prospect of remaining in business by overpaying for the Acquisition" and thus "[i]t would belie all common sense to find that the Debtors received reasonably equivalent value" for any bonuses paid in connection with the Acquisition. (See Id. at 54-58)


         Appeals from the Bankruptcy Court to this Court are governed by 28 U.S.C. § 158. Pursuant to § 158(a), district courts have mandatory jurisdiction to hear appeals "from final judgments, orders, and decrees" and discretionary jurisdiction over appeals "from other interlocutory orders and decrees." 28 U.S.C § 158(a)(1) and (3). In conducting its review of the issues on appeal, this Court reviews the Bankruptcy Court's findings of fact for clear error and exercises plenary review over questions of law. See Am. Flint Glass Workers Union v. Anchor Resolution Corp., 197 F.3d 76, 80 (3d Cir. 1999). Whether a party sufficiently states a claim is a question of law, over which this court exercises de novo review. See Mayer v. Belichick, 605 F.3d 223, 229 (3d Cir. 2010).

         Evaluating a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) requires the Court to accept as true all material allegations of the complaint. See Spruill v. Gillis, 'ill, F.3d 218, 223 (3d Cir. 2004). "The issue is not whether a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims." In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1420 (3d Cir. 1997) (internal quotation marks omitted). Thus, a court may grant a motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) "only if, accepting all well pleaded allegations in the complaint as true, and viewing them in the light most favorable to plaintiff, plaintiff is not entitled to relief." Id.

         However, to survive a motion to dismiss, Plaintiff must allege facts that "raise a right to relief above the speculative level." Bell Atl Corp. v. Twombly, 550 U.S. 544, 555 (2007). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). At bottom, "[t]he complaint must state enough facts to raise a reasonable expectation that discovery will reveal evidence of [each] necessary element" of Plaintiffs claim. Wilkerson v. New Media Tech. Charter Sch. Inc., 522 F.3d 315, 321 (3d Cir. 2008) (internal quotations omitted). The Court is not obligated to accept as true "bald assertions, " Morse v. Lower Merion Sch. Dist., 132 F.3d 902, 906 (3d Cir. 1997) (internal quotation marks omitted), "unsupported conclusions and unwarranted inferences, " Schuylkill Energy Res., Inc. v. Pennsylvania Power & Light Co., 113 F.3d 405, 417 (3d Cir. 1997), or allegations that are "self-evidently false, " Nami v. Fauver, 82 F.3d 63, 69 (3d Cir. 1996).

         This Court reviews the Bankruptcy Court's decision to dismiss Count I of the Complaint with prejudice - that is, without a further opportunity for amendment - for abuse of discretion. See Lorenz v. CSX Corp., 1 F.3d 1406, 1413 (3d Cir. 1993). An abuse of discretion exists if the Bankruptcy Court's ruling "rests upon a clearly erroneous finding of fact, an errant conclusion of law, or an improper application of law to fact." In re SGL Carbon Corp., 200 F.3d 154, 159 (3d Cir. 1999).


         A. Pleading Standard

          As an initial matter, Plaintiff argues that the Bankruptcy Court erred by improperly subjecting Plaintiff to a "heightened pleading standard" in light of discovery produced during the Chapter 11 cases. (See D.I. 15 at 19-23) In the motion to dismiss, Defendants asserted that the Complaint failed to identify any facts demonstrating a flaw in the projections, and that this failure was "telling" because the creditors' committee "had the benefit of thousands of pages in discovery when it drafted its Amended Complaint" (A107), including the projections (A105), minutes of the board meetings at which the projections were presented and discussed (id.), sworn declarations from Morgan and Ginnan (B.D.I. 586, 588) detailing how the projections were prepared and presented to the board (A 107), and certain advisory opinions obtained by the Company prior to the Acquisition (A107-08).[5] What consideration, if any, the Bankruptcy Court should give to Defendants' assertions, in light of the fact that Rule 9(b)'s standard is sometimes relaxed at the pleading stage for bankruptcy trustees, was discussed at the hearing on the motion to dismiss. (See A280 at 73:18-22) According to Plaintiff, the limited discovery received by the creditors' committee was focused primarily on relief sought by the Debtors in connection with post-petition financing and sale efforts and was reviewed in a compressed time frame. (D.I. 15 at 20) On appeal Plaintiff argues that "[t]he fact that pleading standards are typically relaxed for trustees who may not have access to evidence to support [their] claim at the pleading stage, does not imply that there ought to be a heightened pleading standard for trustees whose attorneys had some access." (Id. at 22-23) Defendants respond that the Bankruptcy Court correctly applied the Twombly-Iqbal standard in determining whether the Complaint contained sufficient factual allegations and did not apply a heightened standard. (D.I. 20 at 3-4)

         Rule 8(a) of the Federal Rules of Civil Procedure requires that a complaint contain "a short and plain statement of the claim showing that the pleader is entitled to relief." Fed.R.Civ.P. 8(a)(2). When a plaintiffs allegations involve claims of fraud, [6] the plaintiff must also meet the threshold pleading standard set forth in Federal Rule of Civil Procedure 9(b), which requires that "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." Fed.R.Civ.P. 9(b). Rule 9(b) is a heightened pleading standard intended "to protect a defendant from the burdens of discovery associated with a fraud claim." In re Liberty State Benefits of Delaware, 541 B.R. 219, 233 (Bankr. D. Del. 2015). Courts sometimes relax the heightened standard for bankruptcy trustees bringing fraud claims on behalf of a debtor and its creditors where the trustee has not been afforded any discovery prior to filing a complaint.[7]

         Defendants correctly explain that all claims - whether brought by a bankruptcy trustee or not - are subject, at a minimum, to the Twombly-Iqbal standard, and applying that standard to a bankruptcy trustee's claims does not impose a "heightened pleading standard." (D.I. 20 at 3-4) The Court finds no indication in the hearing transcript, Dismissal Order, or Memorandum Order that the Bankruptcy Court applied any heightened pleading standard in dismissing the Complaint. The record merely reflects that, based on Defendants' repeated statements that Plaintiff had the benefit of discovery, the Bankruptcy Court sought to clarify Defendants' position during oral argument as to whether some different pleading standard should apply:

Case [l]aw supports the proposition that there is a lower threshold for [a] Trustee to meet, recognizing that they don't necessarily have all the institutional knowledge.... I've wondered whether or not [Defendants are], sort of, imposing the flip side of that coin where you've got a Liquidating Trustee that is the successor, effectively, to a Committee that had all the benefits of Discovery Rule 2004 ....

(A214, 7:16-7:25) In seeking clarification from Defendants, the Bankruptcy Court inquired whether the analysis should be "pretty strict where we have players that have, frankly, all of the financial records of the company or had access to much more than [the court] would see in a Chapter 7 case." (See A257, 50) While Defendants agreed to the characterization of the argument (see A257, 50), and Plaintiff makes much of this exchange on appeal, the Court finds no indication that the Bankruptcy Court "appeared to erroneously accept Defendants' argument" that the Complaint was subject to a heightened pleading standard in light of the discovery that was provided, as Plaintiff has asserted on appeal (D.I. 15 at 19), or that the Bankruptcy Court applied any standard other than Twombly-Iqbal in determining that dismissal was appropriate. Rather, the transcript reflects the Bankruptcy Court's agreement that a bankruptcy trustee is generally afforded greater pleading liberality. (See A256-57, 49:23-50:1 ("It is a well settled proposition that a Bankruptcy Trustee, typically, receives more deference at the Rule 12 stage . . .")) The Court finds no merit in the argument that the Bankruptcy Court applied a heightened pleading standard.

         B. Breach of Fiduciary Duty (Count I)

         Directors of Ohio corporations owe the corporation a duty of care and a duty of loyalty, duties which are codified in the Ohio Revised Code. "[U]nder the duty of care, a director must perform his duties 'with the care that an ordinary prudent person in a like position would use under similar circumstances, '" while "under the duty of loyalty a 'director shall perform his duties as a director ... in good faith, in a manner he reasonably believes to be in [or not opposed to] the best interests of the corporation.'" Radol v. Thomas, 772 F.2d 244, 256 (6th Cir. 1985) (quoting Ohio Rev. Code § 1701.59(B)). Ohio's business judgment rule creates a presumption that fiduciaries have acted with care, in the best interests of the company, and in good faith. See Ohio Rev. Code § 1701.59(D)(1) ("A director shall not be found to have violated the director's duties . . . unless it is proved by clear and convincing evidence that the director has not acted in good faith, in a manner the director reasonably believes to be in or not opposed to the best interests of the corporation, or with the care that an ordinarily prudent person in a like position would use under similar circumstances ..."); Brosz v. Fishman, 99 F.Supp.3d 776, 785 (S.D. Ohio 2015) (noting presumption under Ohio law "that any action taken by a director on behalf of the corporation is taken in good faith and for the benefit of the corporation.").

         "The decisions of disinterested [fiduciaries] will not be disturbed if they can be attributed to any rational business purpose." Koos v. Cent. Ohio Cellular, 641 N.E.2d 265, 273 (Ohio Ct. App. 1994)). "Ohio courts adhere to the 'business judgment rule, ' and will not inquire into the wisdom of actions taken by the directors in the absence of fraud, bad faith or abuse of discretion." Id. at 272 (quoting Radol, 772 F.2d at 256). A plaintiff asserting liability for damages based on breach of fiduciary duty must show by clear and convincing evidence "that the director's action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to the corporation or undertaken with reckless disregard for the best interests of the corporation." Ohio Rev. Code § 1701.59(E).

         1. ...

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