In re Marketxt Holding Corp.

• Decision Date: 10 January 2006
• Docket Number: Bankruptcy No. 04-12078 (ALG).,Adversary No. 05-01268 (ALG).
• Citation: 336 B.R. 39
• Parties: In re: MARKETXT HOLDINGS CORP., Debtor. Alan Nisselson, as Chapter 11 Trustee of MarketXT Holdings Corp., and the Official Committee of Unsecured Creditors, Plaintiffs, v. Empyrean Investment Fund, L.P., Empyrean General Partner, LLC, Ash Master Fund, II, LLC, Ash Master Fund II, L.P., Ash Fund LP f/k/a Empyrean Fund, LP, Ash Fund II LP, Ash Capital, LLC f/k/a, Ash Capital Management, Ash General Partner, LLC, Ash Offshore Fund, Ltd., Ash General Partner Offshore, Ltd., Rauf Ashraf, and John Does 1 through 10, Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

336 B.R. 39

In re: MARKETXT HOLDINGS CORP., Debtor.

Alan Nisselson, as Chapter 11 Trustee of MarketXT Holdings Corp., and the Official Committee of Unsecured Creditors, Plaintiffs, v. Empyrean Investment Fund, L.P., Empyrean General Partner, LLC, Ash Master Fund, II, LLC, Ash Master Fund II, L.P., Ash Fund LP f/k/a Empyrean Fund, LP, Ash Fund II LP, Ash Capital, LLC f/k/a, Ash Capital Management, Ash General Partner, LLC, Ash Offshore Fund, Ltd., Ash General Partner Offshore, Ltd., Rauf Ashraf, and John Does 1 through 10, Defendants.

Bankruptcy No. 04-12078 (ALG).

Adversary No. 05-01268 (ALG).

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

January 10, 2006.

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Brauner, Baron, Rosenzweig & Klein, LLP by Howard L. Simon, New York, NY, for Alan Nisselson, Chapter 11 Trustee, Plaintiff.

Kaye Scholer LLP by Lester M. Kirshenbaum, Margarita Y. Ginzburg, Dina Rovner, New York, NY, for the Official Committee of Unsecured Creditors, Plaintiff.

J.L. Saffer, P.C. by Jennifer L. Saffer, New York, NY, for Defendants.

MEMORANDUM OF OPINION

ALLAN L. GROPPER, Bankruptcy Judge.

The Court has consolidated for decision three motions by the Chapter 11 Trustee (the "Trustee") of MarketXT Holdings, Inc. (the "Debtor") and its Official Creditors Committee (the "Creditors Committee"), and one motion by the Defendants in the above — captioned adversary proceeding. The Trustee's first motion seeks to hold Rauf Ashraf ("Ashraf"), the principal of Empyrean Investment Fund, LP ("EIF"), in contempt of an order of this Court and to enforce the Defendants' agreement to hold certain funds in escrow.¹ The Trustee's second motion seeks to consolidate the preliminary hearing on Plaintiffs' motion for a preliminary injunction with the final hearing with respect to (i) all of the Trustee's claims against Defendants EIF and Empyrean General Partner, LLC ("EGP"), and (ii) the Trustee's equitable claims against the remaining Defendants, while severing any remaining claims for a separate trial should such a trial prove necessary. The Trustee's third motion, pursuant to Fed. R. Civ. P. 21 made applicable through Rule 7021 of the Bankruptcy Rules, seeks to amend the complaint in this adversary proceeding to add as defendants Ash Market Neutral Fund, Ltd. ("AMNF"), Ash Fund, LP, formerly known as Empyrean Investment Fund, LP ("AF"), and Empyrean Fund, LP ("EFLP").

The Defendants' motion, pursuant to Fed. R. Civ. P. 60(b) and 65(b), made applicable through Bankruptcy Rules 9024 and 7060, seeks to clarify or modify a prior order of the Court and (i) allow Ashraf "to actively manage" the funds held in escrow and (ii) permit the Defendants to pay reasonable professional fees and expenses in connection with the litigation as well as the contractual management fees that have accrued since the commencement of this litigation.

The facts found hereafter were adduced in part over 12 days of hearings in connection with the Trustee's motion for a preliminary injunction. Since the Defendants have not completed their case on the motion for a preliminary injunction, they were given a full opportunity to introduce all the evidence they deemed relevant to the contempt motion, as well as other motions that are decided hereby. The findings and conclusions made hereafter will apply only to the instant motions, as to which the record is complete. Based on that record, the Court makes the following findings of fact and conclusions of law.

Background

The Debtor is a corporation, once known as Tradescape Corp. and later T Corp., owned and operated by Omar Amanat ("Amanat") and members of his family. The Debtor developed and at one time apparently had great success with an electronic system for trading securities. On June 3, 2002, it entered into a transaction with E * Trade Financial Corp. ("E * Trade"), pursuant to which it sold its wholly-owned subsidiary, Momentum Securities, LLC ("Momentum"), to E * Trade for 11,750,000 shares of E * Trade stock (originally calculated to have a market value of $100 million) and a potential additional $180 million in E * Trade stock if Momentum thereafter achieved certain defined annual revenue thresholds (the "Earn Out"). Of the 11,750,000 shares of E * Trade stock received, the Debtor placed approximately 2.4 million shares in escrow for possible claims against Momentum. The remaining 9,400,000 shares (the "Non-Escrow E * Trade Stock") were subject to contractual and securities law restrictions limiting the Debtor's ability to dispose of the stock without registration and/or without E * Trade's consent and cooperation. As a practical matter, this made it difficult if not impossible for the Debtor to liquidate the shares at a time when it was under increasing pressure from its creditors to raise cash (and when it appears that the market price of E * Trade shares was falling).

The record shows that the Debtor made numerous efforts to liquidate the Non-Escrow E * Trade Stock.² Eventually, the Debtor negotiated a transaction with affiliates of Bank of America (collectively, "B of A") with respect to a disposition of the stock. It was in connection with this transaction that Amanat enlisted the aid of Ashraf, who was just embarking on his own as a founder and prospective manager of a group of hedge funds in Boston.³ As the deal was structured, EIF would act as a middleman between the Debtor and B of A, for at least part of the transaction, advancing to the Debtor the proceeds to be obtained from B of A, obtaining a pledge of the stock in return, and placing the stock with B of A for sale or other disposition.

At a critical stage of the transaction, on March 28, 2003, a telephone call took place between representatives of E * Trade, the Debtor and Ashraf regarding the transaction. E * Trade appears to have disparaged Amanat in this conversation, after which Amanat and Ashraf apparently agreed to raise the interest rate payable on the loan from EIF to the Debtor from 8% with a one-year term to 19% with a four-year term and a 19% prepayment penalty. The parties hotly contest whether Ashraf was acting at arms length. The Defendants claim that Ashraf and Amanat had a business relationship as independent parties, and that the more onerous terms of the transaction reflected Ashraf's understanding of the risks as a consequence of the phone call on March 28, 2003. The Trustee has adduced evidence that Amanat was separately e-mailing Ashraf during the phone call, giving him advice on how to deal with the E*Trade principals. (Tr. Hr'g on July 15, 2005 at 106-07.) Earlier that day, the Trustee asserts that Amanat had given Ashraf the advice, "you have to start sounding panicky" when speaking to E*Trade's representatives. (Tr. Hr'g on July 15, 2005 at 129-30 and E-mail dated March 28, 2003, Pls. Ex. 173.)

The following were the material elements of the transactions among the Debtor, EIF and B of A:

1. On March 28, 2003, the Debtor pledged to EIF the 9,400,000 shares of Non-Escrow E * Trade Stock (the "Pledge Agreement"). In return, EIF agreed to advance to the Debtor up to $17,200,000 (50% of the then market value of the pledged shares) payable only from the proceeds of the sale or other disposition of the stock itself.⁴ The note evidencing the EIF advances (the "Note") bore interest at the non-default rate of 19% per annum and had a four-year term, with a prepayment penalty equal to 19% over the life of the loan if the Debtor paid down any of the advances prior to maturity. The Trustee alleges that in practical terms, by virtue of the prepayment penalty, EIF became entitled to nearly 100% of the face amount of the proceeds of the stock. (Pls. Compl. at 8.)

2. On or about April 9, 2003, EIF and B of A consummated a "STARS" Variable Share Prepaid Forward Contract, in which EIF transferred 6,746,168 of the shares of the stock to B of A for $27,435,933.30 (the so-called "STARS transaction"). B of A undertook to liquidate the shares, retaining for itself the benefit of any appreciation in the value of the shares. As agreed, the proceeds of this transaction were distributed as follows: EIF paid $12,000,000 to Softbank Finance Corporation and one of its affiliates (collectively, "Softbank"), major creditors of the Debtor, and about $658,000 to other creditors. EIF kept the balance, transferring it into accounts held by the Defendants and/or other Ashraf-controlled entities.⁵

3. About a month later, in early May 2003, the Debtor and B of A entered into a second transaction pursuant to which the Debtor sold the remaining 2,400,000 shares of the Non-Escrow E * Trade Stock directly to B of A for $14,600,000 (the so-called "Collar transaction").⁶ Unlike the STARS transaction, EIF was not a party, but it received most of the consideration. From the more than $14,000,000 in proceeds, the Debtor received an amount slightly in excess of $200,000 to pay its expenses, B of A received approximately $400,000, and EIF received the balance, apparently as a "prepayment" of its advances to the Debtor pursuant to the Note. In all, EIF has contended that this "prepayment" plus the Debtor's repayment of $1,700,000 on June 16, 2003 gave rise to a "prepayment penalty" in excess of $10 million under the Note.

The Complaint in this adversary proceeding alleges that the net effect of the foregoing and certain related transactions was as follows: The Debtor originally possessed Non-Escrow E * Trade Stock with a current market value of $40 million and a liability to Softbank under the Softbank Settlement. Afterwards, the Debtor held no Non-Escrow E * Trade Stock. Its obligation to Softbank was reduced by $12 million, but it had a new obligation to EIF of approximately $15 million bearing a higher interest rate than the Softbank debt. EIF, on the other hand, while advancing no money of its own in any of the transactions, now had approximately $30 million in cash,...