In re Granite Partners, LP
| Decision Date | 14 May 1997 |
| Docket Number | 94 B 41684(SMB),and 94 B 41685(SMB).,Bankruptcy No. 94 B 41683(SMB) |
| Parties | In re GRANITE PARTNERS, L.P., Granite Corporation, and Quartz Hedge Fund, Debtors. |
| Court | United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York |
Willkie Farr & Gallagher, New York City (Benito Romano, John R. Oller, of counsel), for Chapter 11 Trustee.
Berlack, Israels & Liberman, L.L.P., New York City (Steven E. Greenbaum, Edward S. Weisfelner, of counsel), for Unofficial Investors' Committee.
Gold Bennett & Cera, L.L.P., San Francisco, CA (Solomon B. Cera, Susan D. Resley, of counsel), Bernstein Litowitz Berger & Grossmann, L.L.P., New York City (Jeffrey A. Klafter, Robert S. Gans, of counsel), for Primavera Familienstiftung and Hubert Looser.
Cleary Gottlieb Steen & Hamilton, New York City (Thomas J. Moloney, Mitchell A. Lowenthal, Robin A. Henry, Carmine D. Boccuzzi, Jr., of counsel), for Kidder Peabody & Co., Inc.
Morgan, Lewis & Bockius, L.L.P., New York City (Gary G. Staab, Catherine A. Ludden, Gerald M. Freedman, of counsel), for Donaldson, Lufkin & Jenrette Securities Corporation.
Section 510(b) of the Bankruptcy Code mandates subordination of damage claims "arising from the purchase or sale" of a security of the debtor.1 Many of the debtors' shareholders and limited partners filed damage claims in these cases charging a variety of wrongs covering an extended period of time. Some have alleged that the debtor's post investment fraud induced them to hold on to their interests rather than sell them. The issue that the Court must decide under section 510(b) is whether this post-investment fraud gives rise to the type of claim that must be subordinated. For the reasons stated below, the Court concludes that it does.
The background to these three cases is described in this Court's decision in Goldin v. Primavera Familienstiftung (In re Granite Partners, L.P.), 194 B.R. 318 (Bankr. S.D.N.Y.1996) ("Granite"), and District Judge Robert W. Sweet's opinions in Primavera Familienstiftung v. Askin, No. 95 Civ. 8905, 1996 WL 494904 (Aug. 30, 1996) ("Primavera"), and ABF Capital Management v. Askin Capital Management, L.P., 957 F.Supp. 1308 (1997) ("ABF Capital"). Briefly, the debtors invested in collateralized mortgage obligations created and sold, inter alia, by Kidder, Peabody & Co., Inc. ("Kidder"), Donaldson, Lufkin & Jenrette Securities Corp. ("DLJ") and Bear Stearns & Co., Incorporated ("Bear Stearns") (collectively, the "Brokers"). Approximately 130 entities purchased interests in the debtors, either as shareholders in Granite Corporation or Quartz Hedge Fund, or as limited partners in Granite Partners, L.P. The funds collapsed in late March and early April 1994, and the debtors filed their chapter 11 cases on April 7, 1994.
Seventy four investors filed proofs of claim (or interest) in these cases. The chapter 11 trustee, Harrison J. Goldin (the "Trustee"), objects to the claims, or alternatively, seeks to subordinate them under section 510(b), contending that they arise from the purchase or sale of a security in one or more of the debtors. Kidder and DLJ have joined in the latter request. The members of the unofficial investors committee ("UIC")2, Primavera Familienstiftung ("Primavera") and Hubert Looser oppose the Trustee's motion.3 The opponents acknowledge that any damage claims arising from a fraudulent inducement to invest in the debtors must be subordinated under section 510(b). They also contend, however, that they were duped into holding on to their investments as a result of the debtor's post-investment fraud. These fraudulent retention or maintenance claims, they argue, are independent torts, do not arise from the purchase or sale of the debtor's security, and hence, should share pari passu with the other, general unsecured claims.
Before answering the question, I must first consider who, among the many claimants, has asserted the type of post-investment fraud claim at issue. At the outset, and except for the UIC, Primavera and Looser, all of the other investors have either defaulted on the motion, or withdrawn their objections. Most of the claims assert fraud in some conclusory fashion. Some claimants filed only the official claim form; others annexed brief explanatory statements or documents, or both, but even these still allege fraud in the inducement.4 None purport to assert a fraudulent retention claim.
Primavera and the UIC have also filed district court complaints in which they allege wrongdoing by the debtors or the debtors' insiders. Assuming that the debtors are liable under the doctrine of respondeat superior for any fraud or other wrong committed by their insiders, I will consider these allegations as amplifying the proofs of claim filed by the plaintiffs in those cases.
In its third amended complaint, dated November 8, 1996 ("Third Am. Compl."), Primavera charges federal securities fraud and common law fraud against the Brokers and the debtors' insiders.5 Primavera did not name the debtors as parties because of the automatic stay, but the complaint includes a section devoted exclusively to their liability, and aptly titled, "Liability of the Granite Funds." The allegations in this section are limited to claims of fraudulent inducement. The section alleges misrepresentations in the "private placement memoranda and other marketing materials" relating to the debtors' investment strategy, (Third Am. Compl. ¶¶ 27-28), the use of sophisticated computer models, (id. at ¶ 29), and the leverage ratios and hedging strategy. (Id. at ¶ 30.) Primavera avers that it (and the members of the uncertified class it purports to represent) relied on these misrepresentations, (id. at ¶ 32), but does not say how. Nevertheless, the alleged misrepresentations relate to the marketing of the securities, and do not allege any post-investment fraud (other than the failure to perform in accordance with the pre-investment misrepresentations). Accordingly, the part of the complaint that Primavera expressly devoted to an exposition of the debtors' liability alleges only inducement claims.
Parsing the allegations asserted against the debtors' insiders leads to the same conclusion. In the first claim, based on section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act") and Rule 10b-5 promulgated thereunder,6 Primavera alleges that the defendants made misrepresentations "to induce the plaintiff and the members of the class to purchase securities issued by the Granite Funds." (Third Am. Compl. at ¶ 117.) Further, "had the plaintiff and the members of the class known of the material adverse information not disclosed by the defendants', or been aware of the truth, they would not have purchased the Granite Funds securities." (Id. at ¶ 121.) These are fraudulent inducement, and not fraudulent retention, claims. Similarly, in its third claim based on common law fraud, Primavera alleges that the debtors' insiders made material misrepresentations with the intent of inducing the plaintiffs and members of the class to purchase securities issued by the debtors. (Id. at ¶ 132) (emphasis added.) As is apparent from a cursory reading of the Primavera complaint, the allegations against the debtors and their insiders raise pure inducement claims, and hence, must be subordinated pursuant to 510(b).
This leaves the UIC, whose complaint in ABF Capital has already been the subject of a thorough decision by Judge Sweet. The complaint alleges, inter alia, that David Askin and Askin Capital Management, L.P. ("ACM"), two of the debtors' insiders,7 continually issued false statements between September 1991 and March 1994, and that the plaintiffs relied on these false statements in purchasing and retaining their interests. ABF Capital, 957 F.Supp. at 1315-16. In particular, ACM, aided and abetted by the Brokers, used artificially-inflated performance results in reports sent to the investors. Id. at 1316.
The Brokers moved to dismiss the UIC's aiding and abetting claim. In their motion, they sought to separate the fraudulent inducement and fraudulent maintenance claims, and argued that the latter were legally insufficient. Judge Sweet first broke the fraudulent maintenance claims down into two separate components: (1) ongoing misrepresentations of the debtors' performance and (2) concealment of the debtors' investment practices which prevented the plaintiffs from withdrawing their investments. Id. at 1328-29. He then assumed, without deciding, that the distinction between the inducement and maintenance claims was a valid one, id., and proceeded to evaluate the motion.
First, Judge Sweet ruled that the misrepresentations regarding the debtors' performance stated a fraudulent maintenance claim. The plaintiffs alleged that the debtors' insiders, aided and abetted by the brokers, passed inflated marks on to the plaintiffs, and in reliance upon the false statements regarding performance, the plaintiffs retained their interests in the debtors. Id. Second, the allegations of a continuing concealment of the inducing fraud also stated a fraudulent maintenance claim:
Moreover, the fraudulent maintenance claim is not predicated exclusively on the existence of post-investment statements, but on ACM\'s failure to disclose the falsity of the statements that initially induced the Plaintiffs\' investments. ACM, which had a direct relationship with the Plaintiffs, clearly has an affirmative duty to disclose such information, and its failure to do so constitutes a primary fraud upon which an aiding and abetting claim can be based. Thus the primary fraudulent maintenance claim is adequately pleaded.
Id. The question for this Court is whether 11 U.S.C. § 510(b) mandates the subordination of either...
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