Effect of SLUSA Delaware law. Furthermore, the Third Circuit found - - PDF document

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44CanalCenterPlaza,Suite400Alexandria,VA22314(703)739-0800Fax(703)739-1060www.abiworld.org RichardCorbiisanassociateinthe

SLIDE 1 44฀Canal฀Center฀Plaza,฀Suite฀400฀฀•฀฀Alexandria,฀VA฀22314฀฀•฀฀(703)฀739-0800฀฀•฀฀Fax฀(703)฀739-1060฀฀•฀฀www.abiworld.org

JOURNAL

A M E R I C A N B A N K R U P T C Y I N S T I T U T E

The Essential Resource for Today’s Busy Insolvency Professional

Written by: Richard฀J.฀Corbi Proskauer฀Rose฀LLP;฀New฀York rcorbi@proskauer.com

ecently the Third Circuit Court

f Appeals held in LaSala v.

Bordier et Cie that the Securities Uniform Standards Act (SLUSA) does not prevent a liquidating trust in bankruptcy from bringing Delaware state law and Swiss law claims against Swiss banks that allegedly assisted the debtor’s

fficers and directors in a “pump and

dump” scheme. In a typical “pump and dump,” company insiders artificially inflate the company’s stock price and then dump their overpriced stock on the

pen market for sale to unsuspecting

investors.1 There were two issues before the Third Circuit: (1) Whether state law aiding and abetting breach-of-fiduciary- duty claims—which have passed from a corporation to its bankruptcy estate to a trust—may be brought to federal court by the trustees of the trust notwithstand- ing the SLUSA, and (2) whether under the SLUSA, the trustees, as assignees

f individual investors in the debtor,

may assert in federal court claims char- acterized as arising under foreign law for aiding and abetting money laundering against foreign entities.2 The Third Circuit held that the SLUSA is no bar- rier on federal adjudication of state or foreign law claims,3 because such claims are direct corporate claims assigned to a trust from the estate did not intend to preempt direct corporate claims. Further, the Third Circuit held that the SLUSA

nly preempts claims based on the laws
f a state or territory of the United States,

thus not preventing foreign law claims against entities for violating foreign law.4

Factual Background

Between 1998 and 2001, the officers and directors engaged in a “pump-and- dump” scheme in which they artificially inflated AremisSoft’s stock price by representing that its financial position was stronger than it really was.5 After “pumping” the stock price, the directors “dumped” AremisSoft’s stock to unsus- pecting investors.6 The directors pur- portedly ran these insider-trading deals through sham entities and bank accounts with the assistance of defendants Bordier et Cie and Dominick Co., which orga- nized under the laws of Switzerland.7 The situation continued to worsen, and in March 2002 AremisSoft filed for Chapter 11 bankruptcy protection.8 At the time of the bankruptcy filing, a federal class action securities lawsuit, in which a group of purchasers of the debt-

r’s stock (purchasers) requested rescis-

sion of the stock-purchase contracts, was pending against the debtor.9 In order to settle the purchasers’ lawsuit, the parties to the bankruptcy proceedings agreed that the plan of reorganization would give to the purchasers all the causes of action owned by the debtor.10 The plan of reorganization included the creation of a state-law trust to take title to and prosecute the assigned claims for the purchasers’ benefit.11 The purchasers also assigned to the trust causes

f action that they owned individually

for actions related to the purchase of the debtor’s securities.12 The trustees asserted four causes of action against two Swiss Banks, Bordier et Cie and Dominick Co.: Two counts of aiding and abetting a breach of fiduciary duty and two counts of violating Swiss money-laundering laws.13 The district court dismissed the lawsuit by ruling that all four causes of action were preempted by SLUSA.14 The district court determined that all counts involved allegations of misrepresentations in connection with securities trades and that the lawsuit

perated like a class action in that the

trust was asserting claims for the benefit

f 6,000 shareholders of the debtor.15

Third Circuit Analysis: Aiding and Abetting Breaches

f Fiduciary Duty

The Third Circuit then examined the claims that were asserted by the trust and how it became the owner of the

claims. The Third Circuit explained that

two types of claims were assigned to the trust: (1) securities claims owned by the purchasers, and (2) fiduciary-duty claims

wned by the corporation (the debtor).16

The first two counts of the complaint

The Powers of a Liquidating Trustee Trump Federal Securities Laws in the Third Circuit

About the Author

Richard฀Corbi฀is฀an฀associate฀in฀the฀ Bankruptcy฀and฀Restructuring฀Group฀in฀ the฀New฀York฀City฀offjce฀of฀Proskauer฀ Rose฀LLP.

Code to Code

1 LaSala v. Bordeir et Cie, 519 F.3d 121 (3d Cir. 2008). 2 Id. at 126. 3 Id. 4 Id. at 143. 5 Id. at 126. 6 Id. 7 Id. 8 Id. 9 Id. 10 Id. 11 Id. at 127. 12 Id. 13 Id. 14 Id. at 129. 15 Id. 16 Id. at 130.

SLIDE 2 44฀Canal฀Center฀Plaza,฀Suite฀400฀฀•฀฀Alexandria,฀VA฀22314฀฀•฀฀(703)฀739-0800฀฀•฀฀Fax฀(703)฀739-1060฀฀•฀฀www.abiworld.org plead Delaware law claims against the Swiss banks for aiding and abetting the directors’ breaches of fiduciary duty to the debtor and the shareholders.17 Under Delaware law, aiding and abetting a breach of fiduciary duty has three elements: (1) a breach of a fiduciary duty, (2) knowing participation in that breach by the defendant and (3) damages.18 The alleged breach was the pump-and-dump scheme, by which the directors allegedly (1) inflated the debtor’s stock price by misrepresenting the company’s finances and then (2) unloaded the overpriced shares to the public.19 The Third Circuit explained that this scheme was disloyal so far as the directors allegedly used their positions of trust to pursue per- sonal gain at the expense of AremisSoft by inflating the debtor’s stock price and unloading the overpriced shares on to the public investors.20 Next, the Third Circuit addressed the question of who were the injured par-

ties. The trustees were claiming dam-

ages in their capacity as assignees of the true injured party that is AremisSoft— because AremisSoft’s stock price was falsely inflated, the company was even- tually forced into a liquidating bankruptcy.21 The Third Circuit examined Delaware law to determine the injured

parties. The Third Circuit explained

that “individual shareholders do not have standing to assert directly state law claims alleging harm to a corporation. Instead, those claims must be asserted by the corporation itself or through shareholder derivative litigation.”22 Determining whether the trust complained of harm to the debtor or the individual purchasers was not straightfor- ward because a pump-and-dump scheme could have two separate but overlapping causes of action treated differently under Delaware law. On the one hand, the purchasers allegedly overpaid for the stock, and were thus harmed to the extent of the value discrepancy between what they paid and what they received. Delaware law recognizes this as a direct harm, though the question may be somewhat academic, as the law seems to provide that the harm is irremediable (in defer- ence to the remedies provided by the federal securities laws).23 On the other hand, because of the pump-and-dump scheme, the debtor lost its economic viability, as reflected in its declining stock price and

bankruptcy. This is, under Delaware law,

a purely derivative harm, and one that is remediable if caused by a breach of fiduciary duty.24 Because such individual purchaser claims are not cognizable under Delaware law, the purchasers could not bring the claims on behalf of themselves.25 Even though the debtor no longer existed, the claims were not converted into individual purchaser claims.26 Rather, the claims passed to the debtor’s successor, the trust.27 The Third Circuit explained that both harms appeared on the face of the complaint, but that only the harm to the debtor was relevant to a claim for aiding and abetting a breach of fiduciary duty because the individual purchaser harms are not cognizable under Delaware law.28 It found that because the complaint alleged harm to the corporation and focused on the fact that the scheme pushed AremisSoft into a liquidating bankruptcy, the purchasers were harmed.29 In addition, by pleading the derivative harm to the purchasers, the Third Circuit found that the trust necessar- ily pled the initial harm to the corporation.30 The Third Circuit explained that just because the company no longer existed, the aiding-and-abetting breaches-of-fiduciary-duty claims were not converted into direct shareholder claims; rather, the corporate nature of the claims endured and ownership of the claims passed to the debtor’s succes- sors.31 The Third Circuit concluded that the aiding-and-abetting claims belonged to the debtor’s successor, i.e., the trust, and not the purchasers.32

Effect of SLUSA

The Third Circuit then examined whether SLUSA had an effect in the liti-

gation. SLUSA prevents plaintiffs from

bringing claims in the form of a “covered class action,” which is “any single lawsuit in which damages are sought on behalf of more than 50 persons or prospective class members, and questions of law or fact common to those persons or members of the prospective class, with-

ut reference to issues of individualized

reliance on an alleged misstatement or

mission, predominate over any ques-

tions affecting only individual persons

r members.”33 The SLUSA further pro-

vides that a “corporation, investment company, pension plan, partnership or

ther entity, shall be treated as one per-

son or prospective class member, but

nly if the entity is not established for the

purpose of participating in the action.”34 This means that a court is not to “look through” the entity to its constituents unless the entity was established for the purpose of bringing the action (circum- venting the SLUSA).35 This does not prevent harmed shareholders from bringing a securities action as an individual. Rather, the statute was created to prevent a group of plaintiffs from forming an entity solely for the purpose of bringing the securities claims in order to satisfy the statute, not to prevent a single bankruptcy estate from assigning its claims to an entity acting to protect the interests of a common class of plaintiffs.36 The trust can only bring those claims as assignee of the bankruptcy estate. Essentially, according to the Third Circuit, the covered class action defini- tion is comprised of two prongs.37 First, to be a covered class action, the claim must be brought “on behalf of 50 or more persons,” and second, questions of law

r fact common to “those persons” must

predominate.38 “Persons” or members of the prospective class refer to the original

wners of the claims

–those injured by the complained-of conduct.39 The phrase refers to the assignors of the claim, which means that the trust is not bringing the claims on behalf of the purchasers as the SLUSA uses the term because the purchasers are not the injured parties; rather, the trust is bringing the claims on behalf of the debtor.40 Furthermore, the Third Circuit found that the relevant issues were whether: (1) the directors were fiduciaries of the debtor; (2) the directors made misrepresentations on insider information in violation of their fiduciary duties; (3) the banks provided assistance to the directors that would warrant a finding of their being liable for aiding and abetting; and (4) the debtor was damaged by the concerted actions of the directors and banks.41 Neither these elements nor facts 17 Id. 18 Id. 19 Id. at 131-132. 20 Id. 21 Id. 22 Id. at 131. 23 Id. 24 Id. 25 Id. at 131-132. 26 Id. at 132. 27 Id. at 131 (citation omitted). 28 Id. at 132. 29 Id. 30 Id. at 132 (citation omitted). 31 Id. at 132. 32 Id. at 128. 33 Id. at 132 (citing 15 U.S.C. §78bb(f)(5)(D)). 34 Id. at 132-133. 35 Id. at 133-134. 36 Id. at 133. 37 Id. at 133. 38 Id. at 134. 39 Id. at 134. 40 Id. at 133-134. 41 Id. at 134.

SLIDE 3 had anything to do with the purchasers.42 The Third Circuit explained that the purchasers did not need to prove anything regarding themselves in order to succeed because they are proceeding as persons to whom the beneficial ownership of the claims was assigned by the true injured party, the debtor.43 The second prong, namely, “members” or “prospective class,” the Third Circuit explained, refers to the claim’s

riginal owners.44 The phrase “on behalf
f 50 or more persons” referred to some-
ne bringing a claim on behalf of 50 or

more injured persons.45 In other words, the foregoing phrase referred to the assignors of a claim, not to the assignee which in this case is the trust on behalf of the beneficial owners of the claims. Here, the trust is in the place of the debtor. Under this reading by the Third Circuit, the trust was not bringing the claims “on behalf of” the individual purchasers, as the term is used in the SLUSA, but rather, the trust brought the claims on the debtor’s behalf.46 The Third Circuit continued to rely

n SLUSA §78bb(f)(5)(C) and (D)

to support its reading of the SLUSA. Section 78bb(f)(5)(D) provided that corporations are not to be counted as more than one person unless the corporation was established for the purpose of the securities litigation.47 Section 78bb(f) (5) (C) provided “that exclusively derivative [shareholder] actions are not covered class actions for SLUSA purposes.”48 The Third Circuit explained, “when a corporation decides to bring a state law claim–even one alleging misrepresentations in connection with securities trades–SLUSA does not instruct the court to look through the corporation to its shareholders to determine the number of ‘persons’; instead, the corporation, in keeping with well- entrenched common-law principles, is counted as the one judicial person that it is.”49 No one argued or attempted to argue, the Third Circuit observed, that the debtor was set up for the spe- cific purpose of the litigation before the court.50 Section 78bb(f) (5) (C) adds support for the court’s holding because it operates to preserve causes of action that belong to corporations, even if 50

r more shareholders bring the claims

derivatively, based on the corporate fiduciaries’ breaches of duty.51 The Third Circuit explained: “We take from reading §78bb(f)(5)(C) and (D) together is that Congress did not intend SLUSA to reach any corporate-originat- ed claims, whether asserted by the corporation (or its assignee), as is addressed in §78bb(f)(5)(D), or asserted derivatively by shareholders, as is addressed in §78bb(f)(5)(C).”52 The Third Circuit pro- ceeded to examine the legislative history and case law, which explained that when a trustee brings a claim belonging to the bankruptcy estate, the claim is not a covered class action for SLUSA purposes.53 The Third Circuit emphasized the importance of the priority scheme set up by Congress. The court stated: “Giving effect to Congress’s desire not to preempt claims that pass from a debtor corporation to its bankruptcy estate is important because to do otherwise would work a significant change in the bankruptcy sys- tem that Congress created and...intended to leave undisturbed.”54 In differentiating between the Congressional intent of the Bankruptcy Code and the SLUSA, the Third Circuit explained: “Congress’s goal was to prevent a class of securities plaintiffs from running their claims through a single entity, not to prevent a single bankruptcy estate from assigning its claims to an entity capable of acting to protect the common interest of a class

f people.”55 The Third Circuit continued

that the fact that all the damages would go to the purchasers was irrelevant because the purchasers would recover in their capacity as beneficial owners of the claims assigned to the trust by the debt-

r’s estate.56 The Third Circuit conclud-

ed that the corporation’s claims did not take the form of a “covered class action,” irrespective of whether the claims are asserted by the corporation directly, its shareholders derivatively, its bankruptcy estate, its bankruptcy estate’s assignee or its successor.57

Conclusion

The Third Circuit Court of Appeals has illustrated that the Bankruptcy Code and the enforcement of the bankruptcy priority scheme are not trumped by federal securities laws. n Reprinted฀with฀permission฀from฀the฀ABI฀ Journal,฀Vol.฀XXVIII,฀No.฀1,฀February฀2009. The฀ American฀ Bankruptcy฀ Institute฀ is฀ a฀ multi-disciplinary,฀nonpartisan฀organization฀ devoted฀ to฀ bankruptcy฀ issues.฀ ABI฀ has฀ more฀than฀13,000฀members,฀representing฀ all฀facets฀of฀the฀insolvency฀fjeld.฀For฀more฀ information,฀ visit฀ ABI฀ World฀ at฀ www. abiworld.org. 44฀Canal฀Center฀Plaza,฀Suite฀400฀฀•฀฀Alexandria,฀VA฀22314฀฀•฀฀(703)฀739-0800฀฀•฀฀Fax฀(703)฀739-1060฀฀•฀฀www.abiworld.org 42 Id. at 134 (italics in original) (citation omitted). 43 Id. 44 Id. 45 Id. 46 Id. 47 Id. at 135. 48 Id. at 134. 49 Id. at 134-135. 50 Id. at 135. 51 Id. 52 Id. at 136 (citations omitted). 53 Id. at 136. 54 Id. 55 Id. at 137. 56 Id. 57 Id.