Geren v. Quantum Chemical Corp.

• Decision Date: 21 September 1993
• Docket Number: No. 92 Civ. 3911(PNL).,92 Civ. 3911(PNL).
• Parties: Preston M. GEREN, Jr., Individually, and for all owners of the subordinated debt securities of Quantum Chemical Corporation, similarly situated as of December 27, 1988, Plaintiff, v. QUANTUM CHEMICAL CORPORATION, John Hoyt Stookey, F.L. Brophy, William J. Armfield IV, John M. Belk, Frederick H. Bruenner, Alvin W. Bunis, Mildren Splewak Dresselhaus, S.C. Lea, Michael A. Nicolais, Peter C. Scotese, W. Bruce Thomas, Dillon, Read & Co., Inc., the First Boston Corporation, Dillon, Read Interfunding, Inc., the Travelers Insurance Company, First Boston Securities Corporation and Houlihan, Lokey, Howard & Zukin, Inc., Defendants.
• Court: U.S. District Court — Southern District of New York

832 F. Supp. 728

Preston M. GEREN, Jr., Individually, and for all owners of the subordinated debt securities of Quantum Chemical Corporation, similarly situated as of December 27, 1988, Plaintiff, v. QUANTUM CHEMICAL CORPORATION, John Hoyt Stookey, F.L. Brophy, William J. Armfield IV, John M. Belk, Frederick H. Bruenner, Alvin W. Bunis, Mildren Splewak Dresselhaus, S.C. Lea, Michael A. Nicolais, Peter C. Scotese, W.

Bruce Thomas, Dillon, Read & Co., Inc., the First Boston Corporation, Dillon, Read Interfunding, Inc., the Travelers Insurance Company, First Boston Securities Corporation and Houlihan, Lokey, Howard & Zukin, Inc., Defendants.

No. 92 Civ. 3911(PNL).

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

September 21, 1993.

Curtis V. Trinko, New York City (Dean Carlton, Gene I. Mesh, Michael Phebes, of counsel), for plaintiff and the Class.

Breed, Abbott & Morgan, New York City (Eric M. Nelson, William M. Sunkel, of counsel), for defendants Quantum Chemical Corp., John Hoyt Stookey, William J. Armfield IV, John M. Belk, Frederick H. Bruenner, Alvin W. Bunis, Mildred Splewak Dresselhaus, S.C. Lea, Peter C. Scotese, W. Bruce Thomas, and Houlihan, Lokey, Howard & Zukin, Inc.

Cravath, Swaine & Moore, New York City (Vicki Share Fleiss, Robert F. Mullen, Susan M. Creavin, Frances M. Lynch, of counsel), for defendants Dillon, Read & Co., Inc., The First Boston Corp., Dillon, Read Interfunding, Inc., The Travelers Ins. Co., and First Boston Securities Corp.

OPINION AND ORDER

LEVAL, District Judge.

This is an action brought by a holder of corporate bonds against the corporation, its officer, and various advisors and lenders to the corporation, seeking damages because a corporation's distribution to its common stockholders of a special dividend caused a decline in the market value of the bonds. Defendants move to dismiss the complaint.

Background

Plaintiff Preston M. Geren, Jr., the owner of $100,000 face amount of the 8.875% subordinated debt securities issued by defendant Quantum Chemical Corporation, sues individually and on behalf of all owners of a variety of subordinated debt securities of Quantum (the "Bonds"), similarly situated on December 27, 1988 (generally, the "Bondholders").¹ On that date, Quantum issued a statement reflecting its intention to pay a special dividend of $50 per share to its stockholders. This dividend was paid on January 10, 1989.

According to the complaint, Quantum incurred indebtedness of approximately $1.221 billion (including $80 million in various fees) to pay the special dividend.² Payment of the dividend allegedly caused the total shareholder's equity of Quantum to decrease from $748 million to negative $406 million. As a result, payment of the dividend caused the market value of the Bonds to decline by approximately 50%; the complaint states that the market value of Bonds with a face amount of $1.25 billion declined by $625 million.

Along with Quantum, a Virginia corporation with its principal place of business in New York, defendants include the directors of Quantum, the investment advisors who advised Quantum on the special dividend, the entities that originally funded the special dividend through a bridge loan, the entity that was to underwrite an offer of debt securities to finance the special dividend after the bridge loan, and a valuation consulting firm that assisted the investment advisors.

With one exception, noted below, each of the nine counts of the complaint seeks damages of $600 million, representing the decline in value of the Bonds caused by payment of the special dividend. The various defendants move to dismiss all counts of the complaint. Fed.R.Civ.P. 12(b)(6).

Discussion

On a motion to dismiss, the court must accept the factual allegations in the complaint as true, drawing all reasonable inferences in favor of the plaintiffs, in order to determine whether the complaint is legally sufficient on its face. Goldman v. Belden, 754 F.2d 1059, 1065-67 (2d Cir.1985); Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir.1989). The court "should not dismiss the complaint pursuant to Rule 12(b)(6) unless it appears `beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" Goldman v. Belden, 754 F.2d at 1065 (quoting Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 101-02, 2 L.Ed.2d 80 (1957)).

A. Counts I, V, and VII: Claim for Breach of Duty of Good Faith and Fair Dealing

Counts I, V, and VII all set out essentially the same cause of action. Count I, captioned "misappropriation of assets," alleges that Quantum and its directors owed to the bondholders a duty of good faith and fair dealing and that they violated this duty by diminishing and misappropriating the assets of Quantum by incurring substantial debt to fund the special dividend. Count V alleges that the bondholders had a contractual relationship with Quantum requiring the company to act with the utmost good faith and to engage in fair dealing and that defendants knowingly interfered with the bondholders contractual rights. Count VII again alleges that the director defendants breached their duty of good faith and fair dealing to the bondholders.

Each of these counts is based on a contractual duty of good faith and fair dealing running from the corporation to its bondholders: they allege that the actions of Quantum in incurring debt to pay the special dividend violated this contractual duty.

The relationship between Quantum and the Bondholders is governed by contract — the indenture for the Bonds. The indenture contains extensive provisions governing the rights of the parties and the obligations of the corporation. The principle promise by Quantum is

that it will duly and punctually pay or cause to be paid the principal of, premium, if any, and interest, if any, on the Debentures of such series at the place, at the respective times and in the manner provided in the Debentures in such series.

§ 5.01. To protect the Bondholders against future creditors acquiring prior claims against the assets of the corporation, the indenture also contains an agreement by Quantum not to incur certain secured indebtedness while any of the debentures remain outstanding. § 5.05. With the exception of this prohibition on secured indebtedness, the indenture places no restrictions on the amount or purpose of debt to be incurred by the corporation.

Plaintiff does not claim that defendants violated an explicit covenant in the indenture. The claim set out in Counts I, V, and VII is that defendants violated an implied covenant of good faith and fair dealing not to take an action such as the financing and payment of the special dividend that would reduce the market value of the debentures by diminishing the likelihood that all interest and principal payments would be met.

Every contract governed by New York law, including the indenture at issue here, contains an implied covenant of good faith and fair dealing. Hartford Fire Ins. Co. v. Federated Department Stores, Inc., 723 F.Supp. 976, 991 (S.D.N.Y.1989) (citing Rowe v. Great Atlantic & Pacific Tea Co., 46 N.Y.2d 62, 412 N.Y.S.2d 827, 830, 385 N.E.2d 566, 568-69 (1978)). Such an implied covenant, however, can only impose an obligation "consistent with other mutually agreed upon terms in the contract." Sabetay v. Sterling Drug, Inc., 69 N.Y.2d 329, 335, 514 N.Y.S.2d 209, 212, 506 N.E.2d 919, 922 (1987); accord Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F.Supp. 1504, 1517 (S.D.N.Y.1989). "The covenant is violated when a party to a contract acts in a manner that, although not expressly forbidden by any contractual provision, would deprive the other of the right to receive the benefits under their agreement." Don King Productions, Inc. v. Douglas, 742 F.Supp. 741, 767 (S.D.N.Y.1990) (citing cases); accord Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F.Supp. at 1517; Collard v. Incorporated Village of Flower Hill, 75 A.D.2d 631, 632, 427 N.Y.S.2d 301, 302 (2d Dept.1980), aff'd, 52 N.Y.2d 594, 439 N.Y.S.2d 326, 421 N.E.2d 818 (1981). Put another way, the implied covenant "ensures that parties to a contract perform the substantive bargained-for terms of their agreement." Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F.Supp. at 1517 (citation omitted).

For example, in Van Gemert v. Boeing Co., 520 F.2d 1373 (2d Cir.), cert. denied, 423 U.S. 947, 96 S.Ct. 364, 46 L.Ed.2d 282 (1975), holders of convertible debentures had an express contractual right to receive notice of the issuer's intent to redeem the debentures; this notice would allow them to determine whether they wanted to exercise the conversion privilege attached to their bonds. The indenture did not specifically provide for the form of this notice. The issuer gave notice through a press release that did not provide the information necessary for the bondholders to decide whether to exercise their conversion rights prior to redemption of the debentures. The Second Circuit relied on the implied covenant of good faith and fair dealing to construe the notice requirement as mandating the furnishing of sufficient information to permit bondholders to assess meaningfully their options. 520 F.2d at 1383-85. However, courts have declined to find that the implied covenant of good faith and fair dealing adds to the contract a substantive provision not included by the parties. See, e.g., Harris Trust and Savings Bank v. E-II Holdings, Inc., 926 F.2d 636, 643-44 (7th Cir.) (New York law), cert. denied, ___ U.S. ___, 112 S.Ct. 192, 116 L.Ed.2d 152 (1991); Metropolitan Life Insurance Co. v. RJR Nabisco, Inc., 716 F.Supp. 1504 (S.D.N.Y.1989); Hartford Fire Insurance Co. v. Federated Department Stores, Inc., 723 F.Supp. at 990-93.

In Metropolitan Life Insurance Co. v. RJR Nabisco, Inc., 716 F.Supp. 1504 (S.D.N.Y.1989), then District Judge Walker faced the almost identical legal issue to that presented here. In RJR Nabisco, the issuer engaged in a leveraged...