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Ltd. v. Croscill Home LLC

United States District Court, D. Delaware

February 14, 2018

ZOHAR CDO 2003-1, LIMITED, ZOHAR II2005-1 LIMITED, and ZOHAR III, LIMITED, Plaintiffs,
v.
CROSCILL HOME LLC, f/k/a CROSCILL ACQUISITION, LLC, DENALI ACQUISITION LLC, DURA BUYER, LLC, GLOBAL AUTOMOTIVE SYSTEMS, LLC, GORHAM PAPER AND TISSUE, LLC, IMG HOLDINGS, INC., JEWEL OF JANE LLC, LVD ACQUISITION, LLC, d/b/a OASIS INTERNATIONAL, RM ACQUISITION, LLC, SNELLING HOLDINGS, LLC, STILA STYLES, LLC, and LYNN TILTON, Defendants.

          REPORT AND RECOMMENDATION

          SHERRY R. FALLON UNITED STATE DISTRICT JUDGE.

         I. INTRODUCTION

         Presently before the court in this declaratory judgment action concerning ownership and control over certain Delaware limited liability companies ("LLCs") and a Delaware corporation are the following motions: (1) plaintiffs Zohar CDO 2003-1, Ltd. ("Zohar I"), Zohar II2005-1, Ltd. ("Zohar II"), and Zohar III, Ltd.'s ("Zohar III") (collectively, the "Zohar Funds" or "Plaintiffs") motion to remand the case to the Delaware Court of Chancery; (2) defendants Croscill Home LLC, formally known as Croscill Acquisition, LLC ("Croscill"), Denali Acquisition LLC ("Denali"), Dura Buyer, LLC ("Dura Buyer"), Global Automotive Systems, LLC ("GAS"), Gorham Paper and Tissue, LLC ("Gorham"), Jewel of Jane LLC ("Jewel of Jane"), LVD Acquisition, LLC, doing business as Oasis International ("LVD/Oasis"), RM Acquisition, LLC ("RM"), Snelling Holdings, LLC ("Snelling Holdings"), Stila Styles, LLC ("Stila") (collectively, the "portfolio LLCs"), IMG Holdings, Inc. ("IMG"), and Lynn Tilton's ("Tilton") (collectively, "Defendants") motion to transfer venue or, in the alternative, to stay proceedings; and (3) Plaintiffs' motion for expedited proceedings. (D.I. 4; D.I. 7; D.I. 24)[1] For the following reasons, I recommend that the court grant Plaintiffs' motion to remand the case to the Delaware Court of Chancery, and award costs and attorney's fees incurred as a result of the-removal of the case. Therefore, I recommend that the court deny as moot Defendants' motion to transfer venue, and Plaintiffs' motion for expedited proceedings.

         II. BACKGROUND

         A. Parties

         The Zohar Funds are Cayman Island exempt companies. (D.I. 1-1 at 203, ¶ 10; 204, ¶¶ 11-12) Croscill, Denali, Dura Buyer, GAS, Gorham, Jewel of Jane, LVD/Oasis, RM, Snelling Holdings, and Stila are Delaware limited liability companies. (Id. at 205-208, ¶¶ 13-16, 19-23) IMG is a Delaware corporation. (Id. at 207, ¶ 18) Tilton is the principal of Patriarch Partners, LLC and its affiliates, is the sole manager of each of the portfolio LLCs, and is the sole director of IMG. (Id. at 208, ¶ 24) Zohar I is a member of the following portfolio LLCs: GAS, LVD/Oasis, RM, and Snelling Holdings. (Id. at 203, ¶ 10) Zohar I owns 16.9% of the outstanding common stock of IMG. (Id.) Zohar II is a member of the following portfolio LLCs: Dura Buyer, GAS, Jewel of Jane, LVD/Oasis, RM, and Snelling Holdings. (Id. at 204, ¶ 11) Zohar II also owns 68.2% of the outstanding common stock of IMG. (Id.) Zohar III is a member of the following portfolio LLCs: Croscill, Denali, Dura Buyer, GAS, Gorham, LVD/Oasis, RM, Snelling Holdings, and Stila. (Id. at ¶ 12) Zohar III owns 14.8% of the outstanding common stock of IMG. (Id.)

         The Zohar Funds are separate collateralized loan obligation ("CLO") investment vehicles created by Tilton that issued and sold notes, which entitled noteholders to interest payments over time and return of principal at the maturity date. The notes were sold to investors for cash and the proceeds were used to purchase a pool of assets to serve as collateral for the funds. (Id. at 208, ¶ 54) The Zohar Funds collectively raised over $2.5 billion from the sale of CLOs.[2] (Id.) Prior to March 2016, the Zohar Funds were managed by affiliates of Patriarch Partners, LLC ("Patriarch Managers"), an investment firm owned by Tilton.[3] (Id. at 209, ¶ 26) As collateral manager, the Patriarch Managers were tasked with managing the loans and other assets of the Zohar Funds. (Id. at ¶ 27) As with most secured transactions, the rights of the Zohar Funds' noteholders and the obligations of the Zohar Funds are set forth in indentures. (Id. at ¶ 27) The duties, responsibilities, and privileges of the collateral manager were set out in the Collateral Management Agreements ("CMAs") for each of the Zohar Funds. (Id.) In addition to selling notes to investors, the Zohar Funds issued preference shares, which are currently owned by an entity owned and controlled by Tilton.[4] (Id. at 214, ¶ 35)

         Much of the collateral acquired Toy the Zohar Funds consisted of loans extended to small-to mid-sized manufacturing companies, with the aim of rehabilitating their businesses and maximizing profits. (Id. at 216, ¶ 41) The Zohar Funds loaned money under various arrangements. Some involved standard repayment of principal and interest while others included equity investments in portfolio companies. This equity was acquired either in the same transaction in which the Zohar Funds extended loans or through subsequent transactions in which those loans were restructured. (Id.) This arrangement of obtaining equity in exchange for a loan was of paramount importance to the Zohar Funds because it offset losses arising from a defaulted loan and had a lucrative upside if a portfolio company turned profitable. The entire consideration for the acquisition of these loans came from funds in the Zohar Funds' accounts. (Id.) These equity positions were titled and beneficially owned in the Zohar Funds' names and, thus, constituted part of the collateral under the Zohar Funds' indentures that served as security for repayment of the noteholders. (Id.)

         In the case of the portfolio LLCs at issue in this action, the Zohar Funds extended one or more loans to each of the portfolio LLCs and simultaneously acquired equity interests. (Id. at ¶ 42) In each instance, that equity was in the form of membership interests titled in the name of the Zohar Funds pursuant to the governing LLC agreement for each portfolio LLC. (Id.) In the case of IMG, the Zohar Funds acquired common stock of IMG in a restructuring of loans extended to IMG and in a legal settlement with IMG's founders. (Id.)

         B. Facts

         1. Zohar Funds' Failure to Repay Noteholders and the Replacement of Collateral Manager

         The Zohar Funds performed poorly under the Patriarch Managers. (Id. at 217, ¶ 43) On November 20, 2015, Zohar I defaulted on its obligation to repay the noteholders. (Id.) On March 2, 2016, the Patriarch Managers resigned as collateral managers for the Zohar Funds, and Alvarez & Marsal Zohar Management ("AMZM"), a Delaware limited liability company, was appointed as collateral manager for each of the Zohar Funds. (Id. at ¶ 44) On January 2, 2017, Zohar II defaulted on its obligation to repay the noteholders, and MBIA Insurance Corporation ("MBIA") paid approximately $770 million in claims on the outstanding principal and interest due. (Id. at ¶ 45) It is alleged that Zohar III faces imminent default on its obligation to repay noteholders on April 15, 2019. (Id. at ¶ 46)

         When the Patriarch Managers resigned as the Zohar Funds' collateral managers, they were required by the CMAs to turn over collateral manager books and records to the Zohar Funds and AMZM. When the Patriarch Managers failed to do so, the Zohar Funds filed suit in Delaware Chancery Court on April 22, 2016 to enforce their contractual rights under the CMAs and against the Patriarch Managers. See Zohar CDO 2003-1, LLC v. Patriarch Partners, LLC, No. CV 12247-VCS, 2016 WL 6248461, at *6 (Del. Ch. Oct. 26, 2016), aff'd, 165 A.3d 288 (Del. 2017). After a two-day trial, Vice Chancellor Slights ruled in the Zohar Funds' favor and ordered Patriarch to turn over twelve categories of documents. Id. at **12-18. Enforcement of this judgment remains ongoing before Vice Chancellor Slights. (D.I. 33, Ex. A at 3)

         2. Zohar I Auction Case

         On September 12, 2016, Patriarch Partners XV, LLC and Octaluna LLC (together, "Auction Case Plaintiffs"), two of Tilton's affiliates, filed an action against U.S. Bank National Association ("U.S. Bank") and MBIA (together, the "Auction Case Defendants") in New York state court, seeking to enjoin the auction of certain assets which purportedly backed certain defaulted debt issued by Zohar I ("the Auction Case"). (D.I. 1, Ex. B) U.S. Bank was Zohar I's trustee, and MBIA was one of Zohar I's three creditors (the Auction Case Plaintiffs being the other two creditors). (Id. at ¶ 1) Moreover, as the holder of the senior outstanding notes, MBIA was deemed the "controlling party" under the relevant indenture, and, as such, had the power to direct U.S. Bank, as it did, to begin a sale process and administer the auction. (Id. at ¶ 4) The Auction Case Plaintiffs asserted in the Auction Case, inter alia, that the Auction Case Defendants improperly attempted to sell equity interests ultimately owned by Tilton, not the Zohar Funds. (Id. at ¶ 8; D.I. 1 at ¶ 2) For example, an August 26, 2016 "Notice of Public Sale and Invitation to Bid" issued by U.S. Bank listed collateral purportedly being sold through the Zohar I Auction, including 757 shares of common stock of Defendant IMG ("IMG auction shares"). (D.I. 1-1, Ex. C)

         On September 13, 2016, U.S. Bank removed the Auction Case to the District Court for the Southern District of New York ("SDNY") based on the Edge Act, 12 U.S.C. § 632, because it involved a party, U.S. Bank, "organized under the laws of the United States and ar[ose] out of 'international or foreign banking.'" (D.I. 1 at ¶ 3) While the Auction Case temporarily delayed the auction of Zohar I's assets, the SDNY court ultimately rejected the Auction Case Plaintiffs' attempt to enjoin the auction, and the assets were sold on December 21, 2016. (Id. at ¶ 7) MBIA purported to purchase the auction collateral, including the IMG auction shares, through a credit bid and, as such, MBIA now claims to own the equity interests in the auction collateral, including the IMG auction shares. (Id. at ¶ 7) On December 27, 2016, the Auction Case Plaintiffs sought leave to amend their complaint in the Auction Case, to add claims for money damages resulting from the completed auction and to add Tilton as a plaintiff. (D.I. 1, Ex. H) On December 30, 2016, the SDNY court denied leave to amend, noting that the Auction Case Plaintiffs' proposal "to now seek damages in addition to injunctive relief... would alter the entire case." (Id., Ex. I) On January 20, 2017, the SDNY court dismissed the Auction Case as "moot, " pursuant to Federal Rule of Civil Procedure 4l(a)(1)(A)(ii), in light of the completed auction. (Id., Ex. J)

         3. 2016 Chancery Case

         On November 29, 2016, Zohar II and Zohar III brought suit in Delaware Chancery Court against Tilton and three portfolio companies[5] under 8 Del. C. § 225[6] seeking an order confirming the Zohar Funds' election, by written consent, of new directors to replace Tilton and others from the boards of the three portfolio companies that they claimed to beneficially own. (D.I. 6, Ex. A) The Zohar Funds allege that this action was limited to three companies because "Tilton's continued noncompliance with the books and records case judgment impeded the Zohar Funds from ascertaining the ownership of other companies." (D.I. 5 at 7) On December 20, 2016, Tilton asserted counterclaims arguing that she owned not just the equity in the three companies at issue, but all other portfolio companies as well. (D.I. 33 at 9)

         The Chancery Court held a six day trial in the Spring of 2017. On November 30, 2017, the Chancery Court ruled against Tilton and found in favor of Zohar II and Zohar III on all counts of the complaint, determined the Zohar Funds to be the beneficial owners of the equity in the three portfolio companies, and dismissed Tilton's counterclaim seeking a declaratory judgment that the Zohar Funds' written consents were invalid. See Zohar II2005-1, Ltd. v. FSAR Holdings, Inc., 2017 WL 5956877 (Del. Ch. Ct. Nov. 30, 2017). Specifically, the court found that "[t]he transactional documents.. .clearly show that the Zohar Funds acquired the [p]ortfolio [c]ompanies' equity, " and "these agreements are unambiguous so extrinsic evidence is neither required nor admissible." Id. 2017 WL 5956877, at *33 n.316.

         On December 20, 2017, the Chancery Court granted Tilton's motion for a stay of the judgment pending an appeal to the Delaware Supreme Court. (D.I. 14, Ex. 5) Tilton's additional counterclaims are stayed pending outcome of appeal.[7] (D.I. 33, Ex. A at 9)

         4. RICO Case

         On January 16, 2017, the Zohar Funds filed an action against Patriarch Partners, LLC, Patriarch Partners VIII, LLC, Patriarch Partners XIV, LLC, Patriarch Partners XV, LLC, Octaluna LLC, Octaluna II LLC, Octaluna III LLC, Ark II CLO 2001-1, LLC, Ark Investment Partners II, L.P., and Tilton (collectively, the "RICO Defendants") in the Southern District of New York asserting, inter alia, violations of the federal Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. § 1961 et seq. ("RICO") and various state law torts (the "RICO Case"). (D.I. 1 at ¶ 10) Additionally, the Zohar Funds sought a declaration that certain LLC agreement amendments and irrevocable proxies executed by Tilton were invalid, and that the Zohar Funds, not Tilton, own certain equity interests. (Id.) The complaint lists the specific LLC agreement amendments and proxies that the Zohar Funds seek to have declared invalid, including those executed by the eleven portfolio LLCs in the action subjudice. (D.I. 9, Ex. 1 at ¶¶ 73-74, nn.9, 10)

         On March 6, 2017, the RICO Defendants filed a motion to dismiss the complaint pursuant to Federal Rules of Civil Procedure 12(b)(1) and 12(b)(6). Zohar CDO 2003-1, Ltd., et al. v. Patriarch Partners, LLC, et al., 17-cv-307-WHP (S.D.N.Y. Mar. 6, 2017), ECF No. 53. In the motion dismiss, Tilton argued that "there is no basis of federal jurisdiction" over the RICO Case, including its claims concerning beneficial ownership, "requiring dismissal of th[e] case in its entirety." Zohar CDO 2003-1, Ltd., et al. v. Patriarch Partners, LLC, et al., 17-cv-307-WHP (S.D.N.Y. Mar. 6, 2017), ECF No. 54 at 31.

         On November 27, 2017, while the motion to dismiss was still pending before the court, the RICO Defendants filed an answer, counterclaims, and third-party claims. (D.I. 1, Ex. L) The RICO Defendants' third-party claims include causes of action against various parties, including MBIA and U.S. Bank, [8] seeking, inter alia, the rescission of any purported transfer of the IMG auction shares through the Zohar I Auction, damages resulting from any improper and illegal purported transfer of equity, including the IMG auction shares, and a declaration that Tilton, not Zohar I or MBIA, is the ultimate beneficial owner of the portfolio company equity at issue, including the IMG auction shares. (Id.)

         On December 29, 2017, the SDNY court granted the RICO Defendants' motion to dismiss, and dismissed the Zohar Funds' RICO claims based on the Private Securities Litigation Reform Act of 1995, and declined supplemental jurisdiction over the remainder of the Zohar Funds' state law claims. (D.I. 18, Ex. B) As to the RICO Defendants' counterclaims and third-party claims, the court directed the parties to submit additional briefing by January 26, 2018, explaining why the court should retain jurisdiction over the third-party claims and why these claims qualify as an impleader action under Federal Rule of Civil Procedure 14. (Id. at 35-36)

         5. Tilton's State Court Actions

         On November 13, 2017, Tilton, Octaluna, LLC, Octaluna II, LLC, Patriarch Partners VIII, LLC, and Patriarch Partners XIV, LLC filed an action in the Superior Court of Arizona against Zohar I, Zohar II, and AMZM seeking a declaratory judgment that Tilton is the beneficial owner of the stock in MD Helicopters, Inc. (D.I. 33, Ex. A at 23) On November 22, 2017, Tilton and her affiliated entities filed a motion to expedite the declaratory relief proceeding, which remains pending with the state court. (Id.) The named defendants filed a motion to dismiss on January 12, 2018 for lack of personal jurisdiction and forum non conveniens, which remains pending with the court. (Id.)

         On November 13, 2017, Tilton, Octaluna III, LLC, and Patriarch Partners XV, LLC filed an action in California state court against Zohar III and AMZM seeking a declaratory judgment that Tilton is the beneficial owner of Stila. (Id. at 24) On January 12, 2018, Zohar III and AMZM filed a motion to dismiss for lack of personal jurisdiction and forum non conveniens, which remains pending with the court. (Id.) A hearing on the motion to dismiss, as well as Tilton's motion for trial preference, is scheduled for March 5, 2018. (Id.)

         On November 13, 2017, Tilton, Octaluna, LLC, Octaluna II, LLC, Patriarch Partners VIII, LLC, Patriarch Partners XIV, LLC, and Patriarch Partners XV, LLC filed an action in Michigan state court against the Zohar Funds and AMZM seeking a declaratory judgment that Tilton is the beneficial owner of Dura Buyer and GAS. (Id. at 25) Tilton filed a motion to expedite the declaratory relief proceeding on November 22, 2017. (Id.) A hearing on this motion was scheduled for February 2, 2018. (Id.) On January 12, 2018, the Zohar Funds ...


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