In re Greater Southeast Community Hosp. Corp.

• Decision Date: 31 October 2005
• Docket Number: Adversary No. 04-10459.,Bankruptcy No. 02-02250.
• Citation: 333 B.R. 506
• Parties: In re GREATER SOUTHEAST COMMUNITY HOSPITAL CORP., I, et al., Debtors. Sam J. Alberts, Trustee for the DCHC Liquidating Trust, Plaintiff, v. Paul Tuft, et al., Defendants.
• Court: United States Bankruptcy Courts – District of Columbia Circuit

333 B.R. 506

In re GREATER SOUTHEAST COMMUNITY HOSPITAL CORP., I, et al., Debtors Sam J. Alberts, Trustee for the DCHC Liquidating Trust, Plaintiff, v. Paul Tuft, et al., Defendants.

Bankruptcy No. 02-02250. Adversary No. 04-10459.

United States Bankruptcy Court, District of Columbia.

October 31, 2005.

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Ted A. Berkowitz, Farrell Fritz, PC, Uniondale, NY, Joseph R. Damato, Seyfarth Shaw, David Fisher, Assistant Attorney General, Peter D. Isakoff, Cleveland Lawrence, III, Weil, Gotshal & Manges LLP, Holly E. Loiseau, Jeffrey W. Kilduff, O'Melveny & Myers LLP, Washington, DC, Deryck A. Palmer, New York, NY, Christopher R. Mirick, Andrew M. Troop, Weil, Gotshal & Manges LLP, Boston, MA, for Debtors.

OPINION REGARDING DFENDANTS' MOTIONS TO DISMISS

S. MARTIN TEEL, JR., Bankruptcy Judge.

This Opinion resolves a series of motions filed by various defendants ¹ in this adversary proceeding initiated by Sam J. Alberts as Trustee of the DCHC Liquidating Trust (the "Trust") established by the plan (the "Plan") confirmed under chapter 11 of the Bankruptcy Code, 11 U.S.C. ? 101 et seq., in the jointly administered cases of Doctors Community Healthcare Corporation ("DCHC") and its subsidiary and affiliated debtor corporations (collectively the "Debtors").² The Trust alleges that DCHC's former directors and officers (the "D & 0 Defendants"), with assistance from two law firms (collectively the "Law Firm Defendants"), Epstein Becker & Green P.C. ("Epstein Becker") and Kutak Rock LLP ("Kutak Rock"), negligently and in some instances intentionally drove the Debtors further into debt in furtherance of a Ponzi scheme perpetrated by the Debtors' primary if not sole lender, National Century Financial Enterprises ("NCFE"), and its subsidiary and affiliated lenders (collectively the "NCFE Entities"). It seeks recovery not only for assets actually drained out of the Debtors' estates prior to their bankruptcy filings, but also for the debt accumulated by the Debtors in the years leading up to DCHC's bankruptcy filing?€”an amount totaling $242 million.

To that end, the Trust has filed a twenty-one count Complaint against the Defendants alleging breach of fiduciary duty (Counts I-V)³ and corporate waste (Counts V-IX) with respect to the D & 0 Defendants; aiding and abetting fiduciary duty (Count XIII) and malpractice (Count XIV) with respect to the Law Firm Defendants; and "deepening insolvency" (Counts X-XI) with respect to all of the Defendants. It also claims (presumably in the alternative) that the Law Firm Defendants "aided and abetted deepening insolvency" (Count XI), and seeks the recovery of fraudulent conveyances from the Law Firm Defendants pursuant to 11 U.S.C. ?? 544, 548, and 550 and Arizona Rev. St. ? 44-1004 and 44-1005 (Counts XVI-XXI). Finally, the Trust claims that it may recover damages for Counts I-XIV in the alternative as a "hypothetical judgment creditor" under the "strong-arm" provision of 11 U.S.C. ? 544(a) (Count XV).

I

The Debtors filed petitions under chapter 11 of the Bankruptcy Code on November 20, 2002. After protracted proceedings lasting almost 18 months, the Debtors achieved confirmation of the Plan on April 5, 2004, and their operations were taken over by entities known as the "Reorganized Debtors." Section 6.6 of the Plan provides for the creation of the Trust, which is charged with liquidating certain assets of the Debtors and distributing the proceeds to certain classes of creditors (including certain unsecured creditors).⁴ Among the assets transferred to the Trust were any claims that the Debtors could have raised before, on, or after the petition date with respect to third parties, (see Plan ?? 1.50, 1.53, 6.6(c)), as well as any claims against the former directors and officers of the Debtors arising out of their management and governance of the Debtors in an amount not exceeding $10 million. (See Plan ?? 1.50,1.103,12.1).

The Plan also provides for the creation of a "Liquidating Trust Reserve" in the amount of $1 million to be used toward the prosecution of unliquidated claims transferred to the Trust. (Plan ? 1.51). The Plan further provides that the Debtors' chapter 11 cases will remain open until the Trust resolves all claims in its possession, (Plan ? 6.7), and that this court retains jurisdiction over any adversary proceeding initiated by the Trust. (Plan Art. XI(b)).

Pursuant to its mandate under the Plan, the Trust initiated the instant adversary proceeding on November 19, 2004. (D.E. No. 1). Presumably in response to motions to dismiss filed by Epstein Becker and Kutak Rock,⁵ the Trust filed an amended complaint on April 15, 2005 (D.E. No. 45) (the "Complaint"). The Complaint alleges that DCHC purchased a number of subsidiary hospitals (including the other Debtors) from 1992 through 1999, and that DCHC obtained financing from NCFE or one of the NCFE Entities to either purchase each hospital or fund its accounts receivables. (Compl.?? 5-6). The funding obtained from NCFE and the NCFE Entities was not procured in the best interests of the Debtors, but rather was obtained at NCFE's direction in furtherance of a Ponzi scheme directed by NCFE. (Compl. ?? 115-125).

According to the Complaint, the NCFE Entities loaned far more money to the Debtors than the Debtors could reasonably repay. (Compl.??61, 65, 78-79, 96, 110). Instead, successive NCFE Entities would "pay off the debt of a particular Debtor and assume a new lender-borrower relationship with that Debtor. (Compl.?? 46-48, 58-65, 67, 76-79, 89-90). The Complaint alleges that this strategy decreased the value of the Debtors' assets from December 31, 1999, to December 31, 2002, from a net deficit of $205 million to a net deficit of $460 million. (Compl.?? 119-122). The Debtors' deepening insolvency was a direct result of the D & O Defendants' abdication of their duties in favor of NCFE as well as the wasteful practices of the Debtors. (Compl.?? 123-125, 148-172). The Complaint further alleges that the Law Firm Defendants helped cause the Debtors' deepening insolvency by failing to warn the Debtors of the consequences of their funding arrangements with the NCFE Entities and by issuing opinion letters and sponsoring testimony that allowed the NCFE Entities to overfund the Debtors. (Compl.?? 126-147).

Kutak Rock, Epstein Becker, the D & O Defendants, and former DCHC directors Rebecca Parrett and George Krauss have all filed separate motions to dismiss the Trust's Complaint.⁶ Although certain issues and arguments overlap in their motions, each movant (with the possible exception of George Krauss)⁷ raises at least one unique argument. Consequently, the court is left with a morass of arguments to sift through in deciding whether the Trust's suit should proceed to discovery.

II

Defendants move to dismiss the Complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure as incorporated by Federal Bankruptcy Rule 7012. The rule permits dismissal of a complaint due to "failure to state a claim upon which relief can be granted." FED. R. CIV. P. 12(b)(6). "A Rule 12(b)(6) motion is intended to test the legal sufficiency of the complaint." Kingman Park Civic Ass'n v. Williams, 348 F.3d 1033, 1040 (D.C.Cir. 2003). To survive such a motion, "a complaint need only set forth `a short and plain statement of the claim,' FED. R. Crv. P. 8(a)(2), giving the defendant fair notice of the claim and the grounds upon which it rests." Id. at 1040. "However, the court need not accept inferences drawn by plaintiffs if such inferences are unsupported by the facts set out in the complaint. Nor must the court accept legal conclusions cast in the form of factual allegations." Kowal v. MCI Communications Corp., 16 F.3d 1271, 1276 (D.C.Cir.1994).

In addition to making numerous arguments regarding the sufficiency of the Trust's pleading, the Defendants also assert a variety of affirmative defenses as grounds for dismissal under Rule 12(b)(6). Although not resolved ordinarily on a motion to dismiss, such defenses "may be raised by pre-answer motion under Rule 12(b) when the facts that give rise to the defense are clear from the face of the complaint." Smith-Haynie v. District of Columbia, 155 F.3d 575, 578 (D.C.Cir. 1998).

The arguments raised by the various defendants fall into four basic categories: (1) arguments regarding the sufficiency of the Trust's claims against all of the Defendants; (2) arguments regarding the sufficiency of claims raised by the Trust against the D & 0 Defendants; (3) arguments regarding the sufficiency of claims raised by the Trust against the Law Firm Defendants; and (4) arguments relating to affirmative defenses asserted by all of the parties. The court considers each of these categories in turn.

A. Claims Against All Defendants

1. "Deepening Insolvency" claims

Counts X-XII of the Complaint plunge this court into the on-going debate over the existence and nature of the socalled "deepening insolvency" cause of action. Briefly stated, the theory "refers to the `fraudulent prolongation of a corporation's life beyond insolvency,' resulting in damage to the corporation caused by the increased debt." Kittay v. Atlantic Bank of New York (In re Global Serv. Group, LLC), 316 B.R. 451, 456 (Bankr.S.D.N.Y. 2004) (quoting Schacht v. Brown, 711 F.2d 1343, 1350 (7th Cir.1983)). Originally a theory of damages, see id. at 456-57, the concept has taken on a life of its own, with several courts treating it as an independent cause of action. See, e.g., Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 349-52 (3d Cir.2001) ("LaffeHy "); Official Comm. of Unsecured Creditors v. Credit Suisse First Boston (In re Exide Technologies, Inc.), 299 B.R. 732, 750-52 (Bankr.D.Del.2003). Under either permutation, the sine qua non of the concept is that ...