Official Committee v. Coopers & Lybrand

• Decision Date: 20 February 2003
• Docket Number: Docket No. 01-9432.
• Citation: 322 F.3d 147
• Court: U.S. Court of Appeals — Second Circuit
• Parties: OFFICIAL COMMITTEE OF THE UNSECURED CREDITORS OF COLOR TILE, INC., as assignee of the claims of the Chapter 11 estates of Color Tile, Inc. and Color Tile Holdings, Inc. Plaintiff-Appellant, v. COOPERS & LYBRAND, LLP, Defendant-Appellee, Investcorp, S.A., ABF Acquisition Corp., Investcorp Bank, E.C., Investcorp Holdings Limited, Jon W. Hedley, Charles J. Philippin, E. Garrett Bewkes, III, Walter F. Loeb, Window Investments Limited, Shades International Limited, Shades Investments Limited, Blind Equity Limited, Blinds Holdings Limited, AIBC Investcorp Finance B.V., Investcorp Investment Holdings Limited, Acquisition Capital Limited, Corporate Capital Limited, Funding Capital Limited and Planning Capital Limited, Defendants, Investcorp International, Inc., CIP Limited, Corporate Equity Limited, Acquisition Equity Limited, Funding Equity Limited, Planning Equity Limited, Elias N. Hallack, Nemir A. Kirdar, Michael L. Merritt, Paul W. Soldatos, Defendants-Third-Party-Plaintiffs-Counter-Defendants, Eddie M. Lesok, Third-Party-Defendant-Counter-Claimant, N. Laurence Nagle, Third-Party-Defendant.

322 F.3d 147

OFFICIAL COMMITTEE OF THE UNSECURED CREDITORS OF COLOR TILE, INC., as assignee of the claims of the Chapter 11 estates of Color Tile, Inc. and Color Tile Holdings, Inc. Plaintiff-Appellant, v. COOPERS & LYBRAND, LLP, Defendant-Appellee, Investcorp, S.A., ABF Acquisition Corp., Investcorp Bank, E.C., Investcorp Holdings Limited, Jon W. Hedley, Charles J. Philippin, E. Garrett Bewkes, III, Walter F. Loeb, Window Investments Limited, Shades International Limited, Shades Investments Limited, Blind Equity Limited, Blinds Holdings Limited, AIBC Investcorp Finance B.V., Investcorp Investment Holdings Limited, Acquisition Capital Limited, Corporate Capital Limited, Funding Capital Limited and Planning Capital Limited, Defendants, Investcorp International, Inc., CIP Limited, Corporate Equity Limited, Acquisition Equity Limited, Funding Equity Limited, Planning Equity Limited, Elias N. Hallack, Nemir A. Kirdar, Michael L. Merritt, Paul W. Soldatos, Defendants-Third-Party-Plaintiffs-Counter-Defendants, Eddie M. Lesok, Third-Party-Defendant-Counter-Claimant,

N. Laurence Nagle, Third-Party-Defendant.

Docket No. 01-9432.

United States Court of Appeals, Second Circuit.

Argued: September 30, 2002.

Decided: February 20, 2003.

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Peter M. Fishbein, Kaye Scholer LLP, New York, NY (Jane W. Parver, Michael

A. Lynn, Efrem Schwalb, on the brief), for Plaintiff-Appellant.

William R. Maguire, Hughes Hubbard & Reed LLP, New York, NY (Vilia B. Hayes, on the brief), for Defendant-Appellee.

Before: MINER, SOTOMAYOR, and KATZMANN, Circuit Judges.

MINER, Circuit Judge.

The action giving rise to this appeal was commenced in the United States District Court for the Southern District of New York (Cedarbaum, J.) by plaintiff-appellant Official Committee of the Unsecured Creditors of Color Tile, Inc. ("Color Tile Committee"), as assignee of the bankruptcy estate of Color Tile, Inc., against defendant-appellee Coopers & Lybrand, LLP ("Coopers"), an accounting firm that provided auditing and consulting services for Color Tile and its controlling shareholders. The services were provided in connection with a merger and acquisition transaction (the "Transaction") and a public debt offering that was used to finance the Transaction. The gravamen of the claims asserted against Coopers is that it breached the fiduciary duties it owed to Color Tile, as well as the terms and conditions of its consulting agreement with Color Tile, by failing to disclose to Color Tile's Board of Directors all material information pertaining to the Transaction. Color Tile Committee alleges that the Transaction would not have taken place had these disclosures been made. The District Court dismissed the claims for breach of fiduciary duty and breach of contract set forth in the Second Amended Complaint upon a finding that, under Texas law, the complaint failed to state claims upon which relief could be granted because the facts pled therein demonstrated as a matter of law the affirmative defense of in pari delicto. The District Court subsequently denied a motion filed by Color Tile Committee to reconsider the dismissal of the Second Amended Complaint in light of the District Court's decision to grant partial summary judgment in favor of certain other defendants and for leave to file a Third Amended Complaint.

On appeal, Color Tile Committee principally argues that the District Court erred in dismissing its Second Amended Complaint on the pleadings because the defense of in pari delicto had not been established as a matter of law. For the reasons that follow, we affirm the judgment of the District Court, although we decline to embrace the entirety of the District Court's analysis of Texas law with respect to the in pari delicto defense.

BACKGROUND

The facts forming the basis for this litigation are set forth in two comprehensive published opinions written by the District Court, see Official Comm. of Unsecured Creditors of Color Tile, Inc. v. Investcorp S.A., 80 F.Supp.2d 129 (S.D.N.Y.1999) ("Color Tile I"); Official Comm. of Unsecured Creditors of Color Tile, Inc. v. Investcorp, S.A., 137 F.Supp.2d 502 (S.D.N.Y.2001) ("Color Tile II"), familiarity with which is assumed. We therefore summarize below only those facts and proceedings relevant to the present appeal.

I. Events Leading Up to the District Court Proceedings

Before it ceased operations, Color Tile was a Delaware corporation, headquartered in Fort Worth, Texas, that was a large specialty retailer of floor covering products. Since approximately 1989, Color Tile was a portfolio company of the "Investcorp Group," an affiliation of investment entities engaged in the business of acquiring control of companies by investing its own funds as well as the funds of its wealthy foreign investors. The Investcorp Group was a long-standing client of Coopers, which had performed the due diligence on Color Tile before Color Tile was acquired by the Investcorp Group and which had been retained as Color Tile's outside auditor after the Investcorp Group acquired Color Tile.

In 1993, the Investcorp Group attempted to make Color Tile a more attractive candidate for an initial public offering by arranging for Color Tile to acquire the assets of American Blind Factory ("ABF"), a privately-owned, family-run company headquartered in Michigan that sold blinds and wallpaper through direct response marketing and retail stores. Through a series of complicated M & A transactions, Color Tile (through a wholly-owned subsidiary) eventually acquired ABF's assets and certain of its liabilities in late 1993/early 1994. The total cost of the Transaction to Color Tile was approximately $104 million. To finance the Transaction, the Investcorp Group arranged for Color Tile to raise $200 million in a public high-interest bond offering. The proceeds from this offering were used to pay the purchase price and transaction costs of the Transaction and to retire certain preexisting Color Tile bank debt that its lenders required Color Tile to pay down before they would consent to the Transaction.¹

Coopers performed certain consulting services for Color Tile in connection with the Transaction and the high-interest bond offering, the most significant of which were reviewing ABF's financial condition, performing due diligence on ABF, and analyzing how Color Tile would financially perform after acquiring ABF's assets. Color Tile Committee alleges that, as a result of these activities, Coopers learned that the financial projections used by the Investcorp Group to substantiate the Transaction were unrealistic and that, because these financial projections bore no resemblance to the actual performance of the two companies, there was a significant risk that Color Tile would be unable to meet its financial obligations as they came due and to operate its business in a competitive fashion after the Transaction closed. (This alleged knowledge on the part of Coopers is referred to as the "Negative Conclusions" in the various complaints subsequently filed by Color Tile Committee.) Coopers allegedly failed to share these Negative Conclusions with the five-member Color Tile Board of Directors, three of whom were members of Color Tile's management ("Management Directors") and two of whom were affiliated with the Investcorp Group ("Investcorp Group Directors").

The Investcorp Group's optimistic financial projections about the Color Tile-ABF combined operations never came to pass, and Color Tile began to experience difficulties servicing its new debt. In or about December 1995, Color Tile defaulted on a $10.4 million interest payment due on its high-interest bonds, and the following month it filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code. In September of 1997, a global settlement was reached between Color Tile's bankruptcy estate and its various creditors, pursuant to which an assignment was made to Color Tile Committee² authorizing it to prosecute certain claims on behalf of the bankruptcy estate.

II. District Court Proceedings

In December 1997, Color Tile Committee filed a complaint in the District Court against various Investcorp Group affiliates ("Investcorp Group Defendants"), the Investcorp Group Directors, and Coopers. The complaint was amended once in March 1998 ("First Amended Complaint") and once again in August 1998 ("Second Amended Complaint") after the District Court had granted from the bench Coopers' motion to dismiss on the ground that, under New York law, the facts pled in the First Amended Complaint demonstrated as a matter of law the affirmative defense of in pari delicto.

Color Tile Committee alleged several causes of action against Coopers in its Second Amended Complaint, only two of which are relevant to this appeal. First, Color Tile Committee alleged that Coopers breached the fiduciary duties it owed to Color Tile by not informing Color Tile's Board of Directors of the Negative Conclusions, and in particular, that: (1) the Transaction "was being forced on Color Tile by the Investcorp Group for the interests of the Investcorp Group and was detrimental to the interests of Color Tile"; and (2) the Transaction "created a grave risk that Color Tile would be unable to meet its obligations as they became due and operate its business competitively." Color Tile Committee further alleged that Coopers' breach of its fiduciary duties to Color Tile "proximately caused damage to Color Tile," because "absent the breach, Color Tile would not have consummated the Transaction." In particular, Color Tile Committee alleged that, if Coopers had informed Color Tile's Board of Coopers' Negative Conclusions, the Management Directors would have informed the underwriter of the high-interest bond offering and the lenders whose consents were required to close the Transaction of the Negative Conclusions. Allegedly, those entities would not have permitted the...