Cary Oil Co. v. Mg Refining & Marketing

• Decision Date: 22 October 2002
• Docket Number: 99 Civ. 1725(VM).
• Citation: 230 F.Supp.2d 439
• Parties: CARY OIL CO., INC., et al., Plaintiffs, v. MG REFINING & MARKETING, INC., et al., Defendants.
• Court: U.S. District Court — Southern District of New York

230 F.Supp.2d 439

CARY OIL CO., INC., et al., Plaintiffs, v. MG REFINING & MARKETING, INC., et al., Defendants.

99 Civ. 1725(VM).

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

October 22, 2002.

Order Denying Reconsideration October 31, 2002.

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Richard G. Tashjian, Tashjian & Padian, Jerome K. Walsh, Lane & Mittendorf L.L.P., New York City, for plaintiffs.

Robert B. Bernstein, Kaye, Scholer, Fierman, Hays & Handler, L.L.P., Jeffrey Barist, Milbank, Tweed, Hadley & McCloy L.L.P., New York City, for defendants.

DECISION AND ORDER

MARRERO, District Judge.

Before the Court is a Report and Recommendation (the "Report") issued by Magistrate Judge Douglas F. Eaton recommending that: (1) the Court grant a motion by defendants Metallgesellschaft Refining and Marketing, Inc. ("MGRM"), Metallgesellschaft Corporation ("MG Corp.") and Metallgesellschaft AG ("MGAG") (collectively the "Defendants") for summary judgment dismissing the complaint in regard to the claims by plaintiffs Dalton Petroleum, Inc. ("Dalton"), RK Distributing, Inc. ("RK Distributing"), Merritt Oil Company ("Merritt Oil"), and Higginson Oil Company ("Higginson Oil"); and (2) deny the motion for summary judgment by Defendants with respect to the other eleven plaintiffs in this action. For the reasons discussed below, the Court adopts the Report's recommendations. A copy of the Report is attached and incorporated to this Decision and Order.

I. FACTUAL BACKGROUND¹

Plaintiffs in this case (collectively "Plaintiffs") are fifteen corporations engaged in the business of marketing and/or distributing petroleum products in the United States. Defendants are in the business, among other things, of selling petroleum products. MGAG, a German corporation, is the sole shareholder of MG Corp., a Delaware corporation with offices in New York, which in turn is the sole shareholder of MGRM, a Delaware Corporation that is now defunct and formerly had offices in New York, Texas and Maryland.

In the early 1990s, MGRM sought to attract customers of its petroleum marketing business by offering "innovative risk management programs" that were not being offered by other energy marketers at the time. (MG Corp. Confidential Descriptive Memorandum, December 1993, attached as Ex. 1 to Plaintiffs' Opposition to Defendants' Motion for Summary Judgment, Dated Nov. 7, 2001 ("Pls.' Opp."), at 3). MGRM offered to help customers hedge the risks associated with volatile price fluctuations in global petroleum prices. Under certain conditions, MGRM offered customers "an option to unwind their hedges early to take advantage of favorable market movements." (Report by Siegfried Hodapp, President of MG Corp., dated March 2, 1992, attached as Ex. 5 to Pls.' Opp., at 2.) According to MGRM, this program was offered "not only [to] protect[] station owners against risk, but also to allow[] them to participate in upside profit potential." (Id. at 3.)

As a part of this risk management program, MGRM offered its customers three types of long-term petroleum supply contracts in the early 1990s. Each of the fifteen plaintiffs in this action entered into one or more of these contracts with MGRM. Under the first type of contract, termed a "guaranteed margin contract," MGRM supplied a customer with a specified amount of gasoline or diesel fuel with a variable price over a set time period. The other two types of contracts, termed a "ratable" and a "flexie" contract, were fixed-price supply contracts. The ratable contract provided for monthly delivery of a specified volume, apportioned "ratably" over the contract's five-year or ten-year term. The flexie differed from the ratable contract, in that, unlike the ratable's monthly delivery schedule, the flexie contracts allowed customers to schedule delivery flexibly within the contract term.

Both the ratable and the flexie contracts contained a cash "blow-out" option. If, during the contract term, the price of petroleum futures on the New York Mercantile Exchange ("NYMEX") rose higher than the fixed price in the contract, the customer could use this option to cash-out its obligation to take delivery of the petroleum it had contracted to purchase. If a customer chose to exercise this option under a flexie contract, MGRM was to provide it with a cash payment equal to the difference between the NYMEX price and the contract price, multiplied by the number of gallons to be cashed out.

As is readily apparent, the option clauses in the flexie contracts presupposed, not unreasonably, that MGRM would maintain long hedge positions—positions giving it the right to buy the product it was obliged to deliver to its customers at or near the prices at which it was obliged to sell—in order to avoid the risk of literally open-ended losses that otherwise could have been sustained by MGRM if market prices rose above the contract prices. Nevertheless, the flexie contracts did not expressly require MGRM to maintain such hedge positions.

Soon after these contracts went into effect, Defendants began to experience financial difficulty. In order to reduce its exposure under the flexie contracts and others, MGRM had hedged by purchasing oil futures contracts on the NYMEX and off-exchange derivatives. When oil prices dropped sharply in late 1993, MGRM faced huge margin calls and suffered other short-term losses, plunging the entire conglomerate into a severe liquidity crisis and pushing it to the brink of insolvency. At the last minute, MGAG's creditors stepped in and orchestrated a reorganization and bail out. This involved, among other things, financial and managerial restructuring, new lines of credit and liquidation of MGRM's hedge positions in derivatives traded on and off the exchange markets.

Although MGAG survived the crisis, the legal and regulatory fallout has been substantial. In addition to facing numerous law suits, MGRM became the target of a Commodity Futures Trading Commission ("CFTC" or the "Commission") inquiry. Prior to the institution of any enforcement action, MGRM submitted an offer of settlement that was accepted by the Commission and resulted in the issuance of a consent order. See MG Refining and Marketing, Inc., CFTC Docket No. 95-14, 1995 WL 447455, *2, *6 (July 27, 1995). The uncontested recitals that preceded the decretal portion of the order set forth the Commission's findings that the contracts here at issue were "illegal off-exchange futures contracts." The decretal portion of the order, to which MGRM explicitly agreed, provided in relevant part that MGRM would cease offering the contracts and promptly notify all purchasers of the contracts that the Commission had found the contracts to be "illegal and void." The order thus arguably relieved MGRM of its obligations under the contracts. And that is the heart of Plaintiffs' grievance. They contend that Defendants breached their duties to Plaintiffs by proposing and entering into a settlement with the CFTC for the express purpose of obtaining a statement that the contracts were void in order to avoid their contractual duties and eliminate their exposure to Plaintiffs.

In January and February of 1996, eight of the plaintiffs, including Dalton Petroleum, entered into general release agreements prepared by MGRM. (See Cancellation and Release Agreements ("Release Agreements"), attached as Ex. 25 to Defendants' Motion for Summary Judgment, dated October 1, 2001 ("Defs.' Mot.").) Dalton Petroleum's Release Agreement specifically released MGRM from its obligations under its ratable and flexie contracts with Dalton Petroleum. (Id.) In contrast, the Release Agreements signed by the other seven plaintiffs specifically released MGRM from its obligations under the ratable contracts, but the Release Agreements did not mention the flexie contracts. (Id.)

On reassignment of this case from Judge Lewis A. Kaplan, this Court referred it to Magistrate Judge Eaton for consideration of dispositive motions. Defendants filed a motion for summary judgment. On January 4, 2002, Magistrate Judge Eaton issued his Report. Defendants and Plaintiffs each submitted separate objections to the Report, as well as memoranda responding to each other's objections.

In addition, the International Swaps and Derivatives Association ("ISDA"), the Securities Industry Association ("SIA") and the Bond Market Association ("BMA") filed an amici curiae memorandum in support of Plaintiffs' Objections to the Magistrate Judge's Report. In an Order dated March 21, 2002, the Court indicated that it would consider the amici curiae memorandum on the limited issue of the legislative history and intent of the Commodity Futures Modernization Act of 2000 (the "CFMA"). Defendants filed a response to the amici curiae memorandum.

II. DISCUSSION

A. STANDARD OF REVIEW

The Federal Magistrate Act provides that a district judge may "designate a magistrate to conduct hearings, including evidentiary hearings" in order to "submit to a judge of the court proposed findings of fact and recommendations for the disposition" of a motion for summary judgment. 28 U.S.C. § 636(b)(1)(B) (2000). In reviewing the Report, this Court "may accept, reject, or modify, in whole or in part, the findings or recommendations made by the magistrate." 28 U.S.C. § 636(b)(1); see Fed.R.Civ.P. 72(b). Any party may object to the Magistrate Judge's findings and recommendations. See id. If an objection is timely filed, as is the case here, the Court is bound to make a "de novo determination of those portions of the report ... or recommendations to which objection is made." Id.; see also United States v. Male Juvenile, 121 F.3d 34, 38 (2d Cir.1997). Having conducted a careful de novo review of the Magistrate Judge's well-reasoned Report, and of the objections by Defendants and Plaintiffs, the Court adopts the recommendations of the Report.

B. THE ENFORCEABILITY OF THE FLEXIE CONTRACTS

The Commodity Exchange Act ("CEA"), 7 U.S.C. § 1 et seq.,...