Campo v. Sears Holdings Corp.

• Decision Date: 21 July 2009
• Docket Number: No. 06 Civ. 4053 (LAK).,06 Civ. 4053 (LAK).
• Citation: 635 F.Supp.2d 323
• Parties: Fred P. CAMPO, et al., Plaintiffs, v. SEARS HOLDINGS CORPORATION, et al., Defendants.
• Court: U.S. District Court — Southern District of New York

635 F.Supp.2d 323

Fred P. CAMPO, et al., Plaintiffs, v. SEARS HOLDINGS CORPORATION, et al., Defendants.

No. 06 Civ. 4053 (LAK).

United States District Court, S.D. New York.

July 21, 2009.

Jay W. Eisenhofer, Esq., Geoffrey C. Jarvis, Esq., Grant & Eisenhofer P.A., Samuel H. Rudman, Esq., David A. Rosenfeld, Esq., Coughlin Stoia Geller Rudman & Robbins LLP, Mark C. Gardy, Esq., James S. Notis, Esq., Gardy & Notis, LLP, for Plaintiffs.

Paul Vizcarrondo, Jr., Esq., David B. Anders, Esq., Emil A. Kleinhaus, Esq., Jonathan E. Goldin, Esq., Wachtell, Lipton, Rosen & Katz, for Defendants.

MEMORANDUM OPINION

LEWIS A. KAPLAN, District Judge.

Lead plaintiffs, former shareholders of Kmart Holding Corporation ("Kmart"), bring this purported class action against Sears Holdings Corporation ("Sears"), Edward S. Lampert, and Julian Day. They claim that defendants knowingly made statements that substantially undervalued Kmart's real estate assets during and in the immediate wake of its reorganization in order artificially to suppress the price of the company's stock. The matter is before the Court on defendants' motion to dismiss the Consolidated Class Action Complaint (the "Complaint") on the ground that it fails to state a legally sufficient claim. For the reasons set forth below, the motion is granted.

Facts

The Parties

Kmart, the well known "big box" retailer, filed for Chapter 11 protection on January 22, 2002,¹ and emerged on May 6, 2003.² Under the plan of reorganization (the "Plan"), all of the outstanding shares of its common stock were cancelled, and new shares in the reorganized company were issued to various creditors of the bankrupt estate.³

Plaintiffs claim to represent a class of persons who sold Kmart shares in the period May 6, 2003, through September 29, 2004 (the "Class Period"). All class members therefore necessarily came to own their Kmart shares either through its distribution to them as creditors of the bankrupt estate pursuant to the Plan or by some post-reorganization transaction.

The defendants in this case are (1) Sears, which in 2005 allegedly succeeded to Kmart's liabilities in consequence of a transaction in which Kmart acquired Sears, Roebuck & Co. ("Sears, Roebuck"), (2) Mr. Lampert, who served as chairman of the board of Kmart from the date of its emergence from Chapter 11 on May 6, 2003, until March 2005,⁴ and (3) Mr. Day, who was Kmart's president and chief operating officer from March 2002 until January 2003 when he became its chief executive officer, serving in that capacity until October 2004.⁵

Factual Allegations

Before turning to the allegedly false and misleading statements, it is useful to outline plaintiffs' claim. The following factual allegations, which are assumed true for the purpose of this motion, are drawn from the Complaint and other documents properly before the Court on the motion.⁶

Kmart's Leases

By the 1980s, it became increasingly attractive to many commercial entities to rent rather than buy real estate.⁷ Kmart in particular began selling and then leasing back its property, structuring the lease terms to its own advantage.⁸ In many instances, its leases established very low, fixed rents for terms that often exceeded seventy-five years.⁹ By 2002, these leased store locations were "extraordinarily valuable."¹⁰ While the lease terms generally were not publicly available, they were accessible to senior management and members of Kmart's board through reports generated by Kmart's real estate market strategy ("REMS") department.¹¹

The Bankruptcy

As noted, Kmart and thirty-seven of its United States subsidiaries filed for Chapter 11 bankruptcy protection in early 2002.¹² While in bankruptcy, Kmart retained Rockwood Gemini Advisors ("RGA") to assist the company in analyzing and evaluating its real estate properties and Abacus Advisory & Consulting Corp., LLC ("Abacus") to assist with the liquidation of the inventory at a number of its stores.¹³ With the assistance of its real estate advisors, Kmart sought to auction approximately six hundred leases, of which it succeeded in selling sixty-seven outright and "designation rights" to fifty-six others for up to $138 million.¹⁴

Investments of Messrs. Lampert and Day

Shortly after Kmart filed for bankruptcy, Mr. Lampert, a former chairman of Kmart who no longer was affiliated with the company at the time, and the hedge fund that he managed, ESL Investments, LLC ("ESL"), began acquiring Kmart debt at distressed prices, ultimately buying about $1.8 billion in unsecured claims for an undisclosed amount.¹⁵ By August 2002, ESL had acquired sufficient debt to seek a place on one or more of the committees involved with Kmart's bankruptcy proceeding. In September 2002, ESL was appointed to the Financial Institutions Committee ("FIC"), which acted in the bankruptcy proceeding on behalf of institutions with holdings in Kmart at that time.¹⁶

On January 24, 2003, Kmart filed the Plan, the disclosure statement for which contained a liquidation analysis that reported that RGA estimated that Kmart's leases could be sold for $293.2 to $461.5 million.¹⁷ The disclosure statement further indicated that, upon Kmart's emergence from bankruptcy, its financial statements would employ fresh start accounting.¹⁸ Under this method, it explained, the company's "assets and liabilities [would] be stated at their reorganization value, which approximates fair value at the date of emergence from Chapter 11," and that the value of its non-current assets would be reduced on its balance sheet to account for "negative goodwill," or the difference between the fair market value of Kmart's net assets and the value ascribed to the reorganized company.¹⁹

At the same time, Kmart entered into a so-called investment agreement pursuant to which it (a) undertook, upon approval of the Plan and the company's emergence from Chapter 11, to issue 14 million new shares of common stock to affiliates of ESL and Third Avenue Partners ("TAP") at $10 per share,²⁰ and (b) granted ESL a two-year option to purchase 6.6 million new shares of common stock at $13 per share.²¹

The bankruptcy court confirmed the Plan on April 23, 2003.²² Kmart emerged from bankruptcy days later, and Mr. Lampert became its chairman.²³ Upon the closing of the investment agreement transactions, Mr. Lampert, through ESL, owned approximately 51.4 percent of Kmart's stock.²⁴

On September 10, 2003, Mr. Day acquired options to purchase approximately 1.5 million new Kmart common shares at $10 to $20 per share.²⁵ In 2005, he exercised options to purchase approximately 980,000 shares after Kmart's merger with Sears²⁶ and then sold those shares for $145 million, or at approximately $147 per share.²⁷

The Complaint alleges that defendants undervalued Kmart's real estate assets after Kmart emerged from bankruptcy in order to conceal the fact that Mr. Lampert had obtained control of the company at a price far below fair market value and to allow Messrs. Lampert and Day to acquire additional shares of Kmart at bargain prices.²⁸

The Allegedly False and Misleading Statements

Plaintiffs allege that defendants made false and misleading statements during the Class Period in a number of documents filed with the Securities and Exchange Commission ("SEC") in an effort to conceal the true value of Kmart's real estate portfolio.²⁹ For example, in its June 16, 2003 Form 10-Q and subsequent filings, Kmart stated that its plant, property, and equipment ("PPE") was worth $4.623 billion and that it had reduced that value by $4.613 billion "to adjust assets and liabilities to fair market value (`FMV'), and reflect the write-off of Predecessor Company's equity and the application of negative goodwill to long-lived assets."³⁰ Thus, Kmart's balance sheet carried its adjusted net PPE at $10 million.³¹ Plaintiffs argue this and like statements misrepresented the true value of Kmart's real estate assets, which, plaintiffs allege, actually was $9 to $18 billion.³² They contend that this understatement resulted in the prices at which plaintiffs sold shares being lower than they would have been had the true value of Kmart's real estate assets been disclosed.³³

The 2004 Store Sales

On June 4, 2004, Kmart announced that it would sell up to twenty-four of its stores to The Home Depot, Inc. ("Home Depot") for up to $365 million. Several weeks later, it announced the sale of up to fifty-four additional stores to Sears, Roebuck for up to $621 million.³⁴ Ultimately, Kmart sold eighteen stores to Home Depot for $271 million and fifty stores to Sears, Roebuck for $575.9 million.³⁵ Plaintiffs allege that, as a result of these announcements, the price of Kmart common stock rose from its closing price of $54.86 per share on June 3, 2004, the day before the Home Depot announcement, to $88.06 per share on September 29, 2004, the day that Kmart announced that it had finalized the Sears, Roebuck sale.³⁶

This Action

Almost two years later, plaintiffs commenced this action, alleging that defendants violated Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"),³⁷ and SEC Rule 10b-5 thereunder³⁸ on the theory outlined above. They allege also that Messrs. Lampert and Day were "controlling persons" within the meaning of Section 20(a) of the Exchange Act³⁹ and therefore are vicariously liable for the company's allegedly fraudulent acts.

Discussion

I. Standard Governing Motions to Dismiss

In deciding a motion to dismiss, a court ordinarily accepts as true all well-pleaded factual allegations and draws all reasonable inferences in the plaintiff's favor.⁴⁰ In order to survive such a motion, however, "the plaintiff must provide the grounds upon which his claim rests through factual allegations sufficient `to raise a right to relief above the speculative level.'"⁴¹ Although such motions are addressed to the face of the pleadings, the court may consider also (1) documents attached to or incorporated by reference in the complaint,...