In re Delta Financial Corp., Bankruptcy No. 07-11880 (CSS).
| Decision Date | 15 December 2008 |
| Docket Number | Adversary No. 08-50287 (CSS).,Bankruptcy No. 07-11880 (CSS).,Docket No. 34.,Docket No. 30.,Docket No. 41.,Docket No. 27.,Docket No. 24. |
| Citation | 398 B.R. 382 |
| Parties | In re DELTA FINANCIAL CORPORATION, et al., Debtors. Delta Financial Corporation, Plaintiff, v. Westchester Surplus Lines Insurance Company, United States Fire Insurance Company and Axis Specialty Insurance Company, Defendants. |
| Court | U.S. Bankruptcy Court — District of Delaware |
John E. James, Richard L. Horwitz, Gabriel R. MacConaill Potter, Anderson & Corroon, LLP, Wilmington, DE, Matthew L. Jacobs (Argued), Ronald R. Peterson (Argued), Megan A. Byrnes, Jenner & Block, LLP, Washington, D.C., for Delta Financial Corporation.
Carl N. Kunz, III, Thomas M. Horan, Douglas N. Candeub, Morris James LLP, Wilmington, DE, Joseph K. Powers (Argued) Edward J. Kirk, J. Gregory Lahr, Sedgwick, Detert, Moran & Arnold, LLP, New York, NY, for Westchester Surplus Lines Insurance Company.
Kevin F. Brady, Christina Thompson, Marc J. Phillips, Connolly Bove Lodge & Hutz, LLP, Wilmington, DE, for Axis Specialty Insurance Company/Unites States Fire Insurance Company.
Gary P. Seligman (Argued), Howard Anglin, Wiley Rein LLP, Washington, D.C., for Axis Specialty Insurance Company.
Joan M. Gilbride (Argued), Kaufman, Borgest & Ryan, LLP, Valhall, NY, for Unites States Fire Insurance Company.
This is an action for a declaratory judgment that the defendants are required to provide insurance coverage to the debtors and certain of the debtors' officers and directors for defense costs and indemnification in connection with a pending state court action.
Delta Financial Corporation, the lead Chapter 11 debtor in the underlying bankruptcy cases, and certain of its officers and directors were sued pre-petition in New York state court. The plaintiff in the state court action asserts a number of claims arising from a 2001 restructuring transaction. The plan involved a two-part transaction. First, the unsecured notes and senior secured notes were surrendered to Delta LLC, a newly created entity formed to facilitate the transaction. In exchange, the note holders received certain interests in Delta LLC and its newly formed management company. Second, in exchange for the surrender of the notes by Delta LLC to Delta Financial, Delta Financial transferred excess "cash flow certificates" that it valued at $153 million to Delta LLC. The parties intended for the value of the cash flow certificates contributed by Delta Financial to equal the outstanding balance of the notes surrendered by Delta LLC, i.e., approximately $153 million. The second restructuring transactions closed in 2001.
The state court action was commenced in 2003 against Delta Financial and certain of its officers and directors. The plaintiffs in that underlying action assert that, at the time of the closing of the second restructuring transactions, the cash flow certificates were not worth the value attributed to them by Delta Financial, i.e., $153 million, but, rather, they had a fair market value that was $110 million lower. Immediately after the commencement of the state court action, Delta Financial notified the insurers under its primary and two excess D & O policies of the litigation and made a demand for defenses costs and indemnification. The insurance policies contained a provision excluding claims for "Loss on account of any Claim made against any Insured: ... based upon, arising out of, or attributable to the actual ... payment by the Company of allegedly inadequate ... consideration in connection with the Company's purchase of securities issued by any company." Chiefly based upon this exclusion, the primary insurer denied coverage, arguing that the claims asserted in the state court action arose from Delta Financial issuing cash flow certificates worth less than $153 million in connection with Delta Financial's purchase of its own unsecured notes and senior secured notes.
In December 2007, Delta Financial and its affiliates filed Chapter 11. Shortly thereafter, Delta Financial commenced this adversary proceeding, seeking a declaration that the insurers are required to provide coverage for defense costs and indemnification in connection with the pending state court action. In addition, Delta Financial seeks compensatory and punitive damages related to the primary insurer's denial of coverage. The defendants have moved to dismiss the complaint. The primary argument asserted by the defendants is that coverage is unavailable because of the "inadequate consideration" exclusion under the policies.
Under the applicable law, the court must apply the "but for" test to determine whether the exclusion applies. In so doing the Court must determine the specific type of harm or damage plaintiffs in the state court action claim to have suffered; what specific "operative act" brought about the alleged harm based upon the alleged facts and without reference to plaintiffs' theories of liability; and whether the operative act is explicitly covered by the exclusion. If the operative act is explicitly covered by the exclusion then the clause will exclude any claims that only arise because of that act.
The operative act that brought about the alleged harm was the exchange of the notes worth $153 million for cash flow certificates worth $110 million less. All the claims asserted against the defendants in the state court action arose from the operative act of the exchange and are excluded from coverage. Thus, the insurers are not required to provide coverage for defense costs and indemnification in connection with the pending state court action.
As all of claims asserted by Delta Financial in this action are based upon the assumption that the exclusion is inapplicable, the Court will grant the motion to dismiss in its entirety.
The Court has jurisdiction over this adversary proceeding under 28 U.S.C. § 1334. Venue of this proceeding is proper in this district under 28 U.S.C. §§ 1408 and 1409. Whether this is a core proceeding under 28 U.S.C. § 157(b) is subject to a pending motion and is discussed below.1
In February, 2008, Delta Financial Corporation, a debtor in possession in the underlying Chapter 11 cases pending before the Court ("Delta Financial"), commenced this adversary proceeding by filing a Complaint against: (1) Westchester Surplus Lines Insurance Company ("Westchester"); (2) United States Fire Insurance Company ("U.S.Fire"); and (3) Axis Specialty Insurance Company ("Axis" and, collectively with Westchester and U.S. Fire, the "Insurers"). Delta Financial seeks declaratory relief and damages under a policy issued by Westchester (the "Policy") as well as two "follow-form" excess policies issued by U.S. Fire and Axis.2 More specifically, Delta Financial seeks a declaratory judgment that the Insurers are required to provide coverage for defense costs and indemnification in connection with a pending state court against Delta Financial and its officers and directors. That action is pending in the Supreme Court of the State of New York for Nassau County and is captioned Delta Funding Residual Exchange Co., LLL, et al. v. Delta Financial Corp., et al., Index No. 003084/2004 (the "Underlying Action"). In addition, Delta Financial seeks compensatory and punitive damages related to Westchester's denial of coverage under the Policy.
Westchester filed an answer and a demand for a jury trial. In addition, Westchester filed a motion for determination that this adversary proceeding is a non-core proceeding as well as a motion requesting the district court to withdraw the reference of this adversary proceeding.3 That same day, U.S. Fire and Axis each filed a motion to dismiss the Complaint under Fed.R.Bankr.P. 7012(b)(6). Subsequently, Westchester filed a motion for judgment on the pleadings under Fed. R.Bankr.P. 7012(c). This matter is now ripe for decision.
In August 2000, Delta Financial restructured its debt by offering holders of certain unsecured senior notes ("Senior Notes") the opportunity to exchange those notes for secured 9½ percent senior secured notes ("Senior Secured Notes") and warrants for Delta Financial common stock. The Senior Secured Notes were secured by excess cash flow certificates held by Delta Financial and its affiliates. Delta Financial was in the business of originating and creating securitizations of the home mortgages it originated. Interests in the securitized pools of mortgages were then sold to investors. The excess cash flow certificates entitled their holder to cash payments if the return on the securitized pools of mortgages exceeds the amount due to investors. Most holders of the Senior Notes accepted this offer.
Within a few weeks of closing the first restructuring, Delta Financial informed the holders of the Senior Secured Notes that it could not meet its obligations to them. Delta Financial stated that bankruptcy was likely because of: mortgage delinquencies; the high servicing costs of its mortgage portfolios; diminishing ability to make interest payments on the Senior Notes and Senior Secured Notes; and low corporate ratings by Moody's and Fitch. In an attempt to avert bankruptcy, Delta Financial proposed a second restructuring plan and advised the holders of the Senior Notes and Senior Secured Notes, which collectively held approximately $150 million in debt, that Delta Financial would file bankruptcy unless the note holders accepted the new plan.
The plan, which involved another exchange offer, is described in:(a) the Registration Statement (Form S-4), which was filed with the Securities and Exchange Commission on May 4, 2001, as amended (the "Registration Statement"); (b) the Preliminary Prospectus, dated May 3, 2001, as amended, and as defined in ...
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...unambiguously a "purchase" within the natural and ordinary meaning of the word. Cf. Delta Fin. Corp. v. Westchester Surplus Lines Ins. Co. (In re Delta Fin. Corp.), 398 B.R. 382, 402 (Bankr. D.Del.2008) (holding that an exchange of securities may constitute a "purchase" within the meaning o......
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...giving rise to liability, i.e., the (‘operative act’), is determinative, not the theories of liability alleged." In re Delta Fin. Corp. , 398 B.R. 382, 397 (Bankr. D. Del. 2008). Here, the operative act is the SBPG's termination of the IT Contract. All of the Plaintiffs' claims, no matter h......