In re Southwest Supermarkets, LLC

• Decision Date: 26 May 2005
• Docket Number: Bankruptcy No. 2-01-14812-RJH.,Bankruptcy No. 2-01-14811-RJH.,Bankruptcy No. 2-01-14809-RJH.,Bankruptcy No. 2-01-14805-RJH.,Bankruptcy No. 2-01-14808-RJH.,Bankruptcy No. 2-01-14806-RJH.,Bankruptcy No. 2-01-14807-RJH.,Adversary No. 03-00945.,Bankruptcy No. 2-01-14810-RJH.
• Citation: 325 B.R. 417
• Parties: In re SOUTHWEST SUPERMARKETS, LLC, Debtor. Daniel P. Collins, Trustee for the Bankruptcy Estate of Southwest Supermarkets, L.L.C.; Southwest Holdings, L.L.C., Plaintiffs, v. Kohlberg and Company, et al., Defendants.
• Court: U.S. Bankruptcy Court — District of Arizona

325 B.R. 417

In re SOUTHWEST SUPERMARKETS, LLC, Debtor Daniel P. Collins, Trustee for the Bankruptcy Estate of Southwest Supermarkets, L.L.C.; Southwest Holdings, L.L.C., Plaintiffs, v. Kohlberg and Company, et al., Defendants.

Bankruptcy No. 2-01-14805-RJH.

Bankruptcy No. 2-01-14806-RJH.

Bankruptcy No. 2-01-14807-RJH.

Bankruptcy No. 2-01-14808-RJH.

Bankruptcy No. 2-01-14809-RJH.

Bankruptcy No. 2-01-14810-RJH.

Bankruptcy No. 2-01-14811-RJH.

Bankruptcy No. 2-01-14812-RJH.

Adversary No. 03-00945.

United States Bankruptcy Court, D. Arizona.

May 26, 2005.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Marty Harper, Gary D. Ansel, Kelly J. Flood, Andrew S. Jacob, Shughart, Thomson & Kilroy, P.C., Anthony R. Lucia, Curt W. Clausen, Lucia, Stark, Williamson, L.L.P., Phoenix, AZ, for Plaintiff Trustee.

Richard M. Lorenzen, Charles A. Blanchard, Perkins, Coie, Brown & Bain, P.A., Phoenix, AZ, Leslie G. Fagen, Robert N. Kravitz, Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York City, for Defendants Kohlberg and Company, et al.

Michael R. Scheurich, Robert A. Shull, Mariscal, Weeks, McIntyre & Friedlander, P.A., for Defendants Edmond Beaith, Harold Gaubert, Jr., Lora Gentles, Erich Sielaff, Louis Vannatta, Andrew M. Vigil and John Williams.

Ronald W. Myers, Phoenix, AZ, for Defendant Bruce Kromer.

Richard A. Segal, Gust Rosenfeld P.L.C., Phoenix, AZ, for defendant Pack.

Doug Tobler, Hammond & Tobler, P.C., Phoenix, AZ, for Defendant Michael S. Geele.

OPINION RE KOHLBERG'S MOTION TO DISMISS SECOND AMENDED COMPLAINT

RANDOLPH J. HAINES, Bankruptcy Judge.

Defendants' motion to dismiss argues that statutes of limitations bar the Trustee's claims for breaches of fiduciary duty and for avoidance of fraudulent transfers to themselves by the Debtor's managers. The Court concludes that the protections of statutes of limitations are not available to self-dealing fiduciaries. The Court also concludes that the discovery rule applicable to actual fraudulent transfers prevents the running of limitations against the hypothetical creditor of § 544(a)(2),¹ who is statutorily defined to lack knowledge of any wrongdoing. For these and other reasons, the motion to dismiss must be denied.

Background Facts

The Trustee's Second Amended Complaint (the "Complaint") portrays a milking² of the Debtor by its owners and managers from the time they took control of it until it filed bankruptcy. Because this is a motion to dismiss, these well-pleaded allegations of the Complaint must be treated as true.

On July 24, 1995, Kohlberg & Co. ("Kohlberg")³ purchased Southwest Supermarkets ("Southwest" or the "Debtor"), which became its wholly owned subsidiary. Southwest then owned and operated approximately 23 retail grocery stores in and around Phoenix and Tucson, Arizona, and El Paso Texas. The purchase price was approximately $21.5 million. The Complaint alleges that Southwest was insolvent at the time of its acquisition, and that its assets were used to finance approximately half of the purchase price, rendering it even more insolvent.

As part of the acquisition, Kohlberg and Southwest entered into a "fee agreement" where Southwest agreed to pay Kohlberg a $1 million fee for its efforts in arranging the acquisition. Southwest also agreed to pay Kohlberg a management fee each year of either $200,000 or five percent of earnings before interest, taxes, depreciation and amortization ("EBITDA"), whichever was greater, for Kohlberg's management services. Such fees were paid based on positive EBITDA even though massive debt service, which is disregarded in the calculation of EBITDA, caused Southwest to operate at a loss most years. As Southwest was expanded to include 42 stores, its debt was increased from $9.75 million to $45.7 million, and its annual interest expense increased from $0.6 million to $7.3 million. Yet while Southwest lost more than $20 million in 1997, Kohlberg was paid a management fee of $200,000 based on positive EBITDA, and a $450,000 management fee in 1998 when Southwest lost more than $3.6 million. And because Southwest had its own President and CEO, there is no indication that Kohlberg actually provided any services for these "management fees."

Shortly after the acquisition in 1995, Kohlberg hired Jim Pack to serve as CEO and President of Southwest. Pack purchased a 2% interest in Southwest for $200,000. When Pack resigned as CEO in May of 1997, Southwest purchased his 2% interest for $1.5 million and his vested options for $1.869 million. Also in 1997, Jerome Miller, another Southwest officer, was paid $800,000 by Southwest for his vested options.

Southwest apparently also agreed to cover certain of the Kohlberg Defendants' tax liabilities arising from their ownership of Southwest. In 1996 and 1997, Kohlberg estimated that distributions of $5,829,664 were necessary to pay the tax liabilities arising from Southwest's expected profits, and Southwest paid this amount to Kohlberg. The tax liabilities that actually accrued for those years turned out to be approximately half of the amount that had been disbursed to Kohlberg, but Southwest never requested a reimbursement of the overpayment of approximately $2.9 million, and none was ever made. An email from the Debtor's CEO to Kohlberg just one month prior to Southwest's bankruptcy states that "All is quiet (at least within my privy) regarding the $2.9 million Company receivable from Kohlberg."

Southwest filed this Chapter 11 case in November, 2001. While Southwest was still debtor in possession, this Court approved a global settlement agreement among the Debtors, the secured creditors and the Official Unsecured Creditors' Committee. That agreement assigned to the secured creditors all of the "Kohlberg claims" of the Debtor and Debtor in Possession, which included all of the claims now being asserted by the Trustee.⁴ Very shortly thereafter, the Court granted the Debtors' motion for appointment of a Chapter 11 Trustee, and Daniel Collins was subsequently appointed Trustee on May 30, 2002. On or about September, 2003, the secured creditors re-assigned to the Trustee all the claims that had been assigned to them under the global settlement agreement. That re-assignment provides that any proceeds generated from the litigation of the Kohlberg claims be distributed to creditors according to the Code's priority scheme.

The Trustee filed the complaint initiating this adversary proceeding on November 4, 2003, just prior to expiration of the Code's two-year statutes of limitations,⁵ and subsequently filed his First Amended Complaint. Kohlberg moved to dismiss it, largely on statutes of limitations grounds. The Court granted Kohlberg's motion with respect to many counts of the complaint, but granted the Trustee leave to amend to plead any reasons why the statutes of limitations should be tolled.⁶ The Trustee filed the Second Amended Complaint (the "Complaint"), and Kohlberg has again moved for its dismissal, again largely on grounds of statutes of limitations. After supplemental briefing at the request of the Court and oral argument, the Court took the motion under advisement.

Self Dealing Fiduciaries Toll Statutes of Limitations

The Second Amended Complaint asserts causes of action for both breach of fiduciary duty and actual fraudulent transfers on account of: (1) the $2.9 million tax overpayments in 1996; (2) the $2.3 million paid in May 1997 to buy out the interests of the Debtor's CEO James Pack; and (3) payment of $3.6 million from 1995 to 1999 as "acquisition fees" and "management fees." Kohlberg has moved to dismiss all of these counts on grounds of statute of limitations, and argues that no discovery rule should bar the running of the statute because the Debtor's secured creditors (who assigned these claims to the Trustee) had an opportunity to discover the Debtor's true financial condition.

The Trustee responds that statutes of limitations should be equitably tolled for actions alleging fraudulent self-dealing by a fiduciary. The Trustee's position is well founded and well taken. Particularly Delaware law has held for more than sixty years that equitable tolling is appropriate for actions alleging self-dealing by corporate fiduciaries that results in insolvency:

Sound public policy requires the acts of corporate officers and directors in dealing with the corporation to be viewed with a reasonable strictness.... [W]here they are required to answer for wrongful acts of commission by which they have enriched themselves to the injury of the corporation, a court of conscience will not regard such acts as mere torts, but was serious breaches of trust, and will point the moral and make clear the principle that corporate officers and directors, while not in strictness trustees, will, in such case, be treated as though they were in fact trustees of an express and subsisting trust, and without the protection of the statute of limitations, especially where insolvency of the corporation is the result of their wrongdoing.⁷

Subsequent cases made clear that although actual knowledge of the wrongdoing would render this tolling doctrine inapplicable,⁸ the doctrine is distinct from and does not require a showing of fraudulent concealment.⁹ This history and doctrine was recently explained and followed by the First Circuit¹⁰ and by an Oklahoma Bankruptcy Court, the latter of which concluded: "Thus, where a complaint satisfies the elements of a prima facia case for equitable tolling — i.e., it contains allegations of self dealing for profit by a fiduciary — it is ordinarily inappropriate to summarily dismiss a claim as untimely under an otherwise applicable statute of limitations pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure."¹¹

Here the Defendants unquestionably had such fiduciary duties, and the complaint unquestionably alleges their self dealing for profit. Kohlberg was being paid fees to provide management for the Debtor. Due to the allegation of...