In re Federalpha Steel LLC

Decision Date31 May 2006
Docket NumberAdversary No. 05 A 978.,Bankruptcy No. 03 B 43059.
Citation341 B.R. 872
CourtU.S. Bankruptcy Court — Northern District of Illinois
PartiesIn re FEDERALPHA STEEL LLC, Debtor. Federalpha Steel LLC Creditors' Trust, Plaintiff, v. Federal Pipe & Steel Corporation; Russel Metals, Inc.; FA Steel Management, Inc.; Gilles Leroux; Sylvain Garneau; Wirth Limited; and Sunbelt Group, LLP, Defendants.

Frances Gecker, Micah Krohn, Frank/Gecker LLP, Chicago, IL, Attorneys for plaintiff Federalpha Steel LLC Creditors' Trust.

Shalom L. Kohn, James C. Blenko, David A. Hall, Sidley Austin LLP, Chicago, IL, Attorneys for defendants Federal Pipe & Steel Corporation; Russel Metals, Inc.; FA Steel Management, Inc.; Gilles Leroux; Sylvain Garneau; Wirth Limited; and Sunbelt Group, LLP.

MEMORANDUM OPINION

A. BENJAMIN GOLDGAR, Bankruptcy Judge.

In May 2002, Federal Pipe & Steel Corporation and Alpha Steel Corporation jointly formed Federalpha Steel LLC to run three steel service centers. Federalpha rapidly ran into financial trouble. In mid-2003, Russel Metals, Inc. acquired Federal Pipe's parent company. On reviewing Federal Pipe's financial condition, Russel Metals concluded that the liability posed by Federalpha was too great: Federal Pipe had to withdraw from Federalpha before Federalpha ended up in bankruptcy. On October 30, 2003, Federal Pipe did withdraw, securing a full release of any claims Federalpha had against Federal Pipe, its affiliates, officers, and employees. The next day, Federalpha sought relief under chapter 11 of the Bankruptcy Code.

A plan of reorganization proposed by Federalpha was confirmed on August 25, 2004. Under the plan, unsecured creditors received $900,000. They also received certain causes of action Federalpha had against Federal Pipe, Russel Metals, and other insiders of Federalpha. A trust agreement created the Federalpha Steel LLC Creditors' Trust, and another agreement formally assigned to the Trust the causes of action described in the plan. The plan provided that any recovery on the assigned causes of action would not belong to the estate but would be distributed on a pro rata basis to unsecured creditors.

In March 2005, the Trust brought a fifteen-count complaint against Federal Pipe, Russel Metals, two Russel Metals subsidiaries (Wirth Limited and Sunbelt Group, LLP), and two former managers of Federalpha who were also officers of Federal Pipe (Sylvain Garneau and Gilles Leroux). Counts I and II of the complaint seek to avoid the release Federalpha gave to Federal Pipe on the ground that it was a fraudulent transfer under sections 548(a)(1)(A) and (B) of the Code. Counts III through XII are state law claims against various defendants.1 Count XIII alleges that Russel Metals received from Federalpha preferential transfers voidable under section 547. Counts XIV and XV allege that Wirth and Sunbelt also received voidable preferential transfers from Federalpha.

Federal Pipe, Russel Metals, Leroux, and Garneau have now filed a series of motions seeking dismissal of all counts of the complaint or abstention on certain counts.2 Specifically, these defendants contend that the state law claims in Counts III through XII should be dismissed for lack of subject matter jurisdiction, and that if those counts are dismissed, the court should abstain from hearing Counts I and II. Alternatively, the moving defendants assert that Counts I through XII should be dismissed for failure to state a claim or plead fraud with particularity, and Russel Metals argues that Counts IX, X, and XIII should be dismissed for lack of personal jurisdiction.

For the reasons discussed below, the motion to dismiss Counts III through XII for lack of subject matter jurisdiction and for abstention on Counts I and II will be granted. The motion to dismiss Count XIII for lack of personal jurisdiction, however, will he denied.

1. Jurisdiction

The court has subject matter jurisdiction over Counts I, II, and XIII of the complaint pursuant to 28 U.S.C. § 1334(a) and the district court's Internal Operating Procedure 15(a). The claims in those counts constitute core proceedings. 28 U.S.C. §§ 157(b)(2)(A), (E), (F), (H). As for Counts III through XII, a court always has jurisdiction to determine its jurisdiction. Gladney v. Pendleton Corr. Facility, 302 F.3d 773, 775 (7th Cir. 2002).

2. Facts

The complaint (along with the attached exhibits) alleges the following facts, all of which are assumed to be true for the purpose of determining subject matter jurisdiction. See Transit Express, Inc. v. Ettinger, 246 F.3d 1018, 1023 (7th Cir. 2001).

Federalpha was a venture formed by two unprofitable steel operating companies, Federal Pipe and Alpha Steel. (Compl. at ¶ 2). Alpha Steel was a familyowned enterprise that operated a single steel service center in Hammond, Indiana. (Id. at ¶ 15). Federal Pipe, a whollyowned subsidiary of Leroux Steel (id. at ¶ 3), was much larger, operating a network of over fifty steel service centers in th, midwest and eastern United States (id. a 1112). Alpha Steel and Federal Pipe both lost money in 2001 and the first half of 2002. (Id. at ¶¶ 13-14, 17). Their combined losses in the first half of 2002 totaled more than $2 million. (Id. at ¶ 18).

In early or mid-2002, Alpha Steel and Federal Pipe decided to create Federalpha to own and operate three unprofitable steel service centers located in the Midwest: Alpha Steel's Hammond facility and Federal Pipe's facilities in Peotone, Illinois, and Plymouth, Michigan. (Id. at ¶ 19).

On May 6, 2002, Federalpha was duly formed as an Illinois limited liability company. (Id. at ¶ 20). On July 9, 2002, Federal Pipe and Alpha Steel executed an operating agreement for Federalpha. (Id. at ¶ 21). Federalpha was to be a "manager-managed" LLC. (Id. at ¶ 22; Ex. A at ¶ 5.1.1). FA Steel Management, Inc., a corporation wholly owned by Federalpha, was the designated manager. (Compl. at ¶ 23; Ex. A at ¶ 5.1.1). But although FA Steel was purportedly vested with management authority, Federalpha was actually run as a joint venture over which Federal Pipe actively exercised de facto authority. (Compl. at ¶ 23). Gilles Leroux, chairman, president, and CEO of Leroux Steel, and Sylvain Garneau, executive vice president of Federal Pipe, were Federal Pipe's two representatives on FA Steel's board of directors. (Id. at ¶¶ 5-6).

To operate, Federalpha needed funding, but it had no operating history of its own and consisted of three unprofitable steel centers. (Id. at ¶ 24). Because Federal Pipe had been active in the steel service center industry for more than fifty years, it shouldered the burden of obtaining bank and trade credit for Federalpha. (Id. at ¶¶ 25-26). Federal Pipe unconditionally guaranteed Federalpha's obligations to its lenders. (Id. at ¶ 27). Capitalizing on its own existing business relationships, Federal Pipe also represented to Federalpha's prospective trading partners that it stood behind Federalpha and that Federalpha was creditworthy. (Id. at ¶¶ 29-30). But for these representations and the need to maintain good relations with Federal Pipe, these trading partners would not have done business with Federalpha. (Id. at ¶¶ 31-32).

Despite Federal Pipe's representations, Federalpha in fact was not creditworthy. (Id. at ¶ 34). Federal Pipe and Alpha Steel never contributed enough capital to Federalpha to give it a reasonable chance of success. (Id. at ¶ 35). In addition, Federal Pipe and Alpha Steel assigned to Federalpha $20 million in liabilities and $0 in accounts receivable. (Id. at ¶¶ 36-37, 39). And when Federalpha violated the financial covenants with its lenders only four months after its formation, Federal Pipe failed to contribute the cash, property, and services Federalpha needed to survive, although the operating agreement required these contributions. (Id. at ¶¶ 43-45).

In early 2003, Russel Metals began taking steps to acquire Leroux Steel, Federal Pipe's parent company. (Id. at ¶¶ 47-48). Around the same time, Russel Metals reviewed Federal Pipe's operations and concluded that Federalpha was not profitable and was at risk of insolvency. (Id. at ¶ 49). At the direction of Russel Metals, Federal Pipe made a de facto withdrawal from Federalpha. (Id. at ¶¶ 50-52). Federal Pipe stopped participating in Federalpha's management and stopped honoring its duties and obligations under the operating agreement. (Id. at ¶ 50). Leroux and Garneau likewise ceased all efforts as directors of FA Steel to manage Federalpha. (Id. at ¶ 51).

In July 2003, Russel Metals completed its acquisition of Leroux Steel. (Id. at ¶ 53). The same month, executives of Russel Metals acknowledged internally that bankruptcy was a possibility for Federalpha. (Id. at ¶ 55). Russel Metals also concluded that Federal Pipe's obligations to Federalpha and its lenders represented a $5 million contingent liability. (Id. at ¶ 57). Russel Metals and Federal Pipe accordingly began devising a way for Federal Pipe to withdraw formally from Federalpha before Federalpha ended up in bankruptcy. (Id. at ¶ 58). In doing so, Russel Metals, Federal Pipe, Leroux, and Garneau sought to maximize the benefits to Russel Metals and Federal Pipe from the withdrawal regardless of the welfare of Federalpha, the interests of Federalpha's creditors, and the duties and obligations Federal Pipe owed to Federalpha under the operating agreement. (Id.).

On September 30, 2003, Federal Pipe, Alpha Steel, PHA Steel LLC (an Alpha Steel affiliate), and Federalpha entered into an agreement allowing Federal Pipe to withdraw as a member of Federalpha and releasing (among other things) all claims of Federalpha against Federal Pipe and its "affiliates, officers or employees." (Id. at ¶¶ 59-60). Under the agreement, Federal Pipe assumed certain liabilities of Federalpha and also funded a $1 million certificate of deposit to be pledged as collateral in...

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