In re State Street Associates, L.P., Bankruptcy No. 04-63673.

• Decision Date: 23 March 2005
• Docket Number: Bankruptcy No. 04-63673.,Bankruptcy No. 04-63672.,Bankruptcy No. 04-80217.
• Citation: 323 B.R. 544
• Parties: In re STATE STREET ASSOCIATES, L.P., Debtor. In re State Street Houses, Inc., Debtor. State Street Associates, L.P. and State Street Houses, Inc., Plaintiffs, v. New York State Urban Development Corporation, Defendant.
• Court: U.S. Bankruptcy Court — Northern District of New York

323 B.R. 544

In re STATE STREET ASSOCIATES, L.P., Debtor In re State Street Houses, Inc., Debtor State Street Associates, L.P. and State Street Houses, Inc., Plaintiffs, v. New York State Urban Development Corporation, Defendant.

Bankruptcy No. 04-63673.

Bankruptcy No. 04-63672.

Bankruptcy No. 04-80217.

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

March 23, 2005.

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Hancock & Estabrook, LLP, Daniel Berman, of counsel, Syracuse, NY, for Debtors/Plaintiffs.

Nixon Peabody LLP, Robert N.H. Christmas, of counsel, New York City, Nixon Peabody LLP, William S. Thomas, Jr., of counsel, Rochester, NY, for defendant.

MEMORANDUM-DECISION, FINDINGS OF FACT, CONCLUSIONS OF LAW AND ORDER

STEPHEN D. GERLING, Chief Judge.

Before this Court is a Motion to Dismiss, pursuant to Federal Rule of Bankruptcy Procedure 7012 ("Fed.R.Bankr P.") incorporating Federal Rule of Civil Procedure 12(b)(6) ("Fed.R.Civ.P."), filed by New York State Urban Development Corporation ("Defendant" or "UDC") on September 13, 2004, in connection with a complaint filed against UDC on August 6, 2004, by State Street Associates, L.P. ("SSA") and State Street Houses, Inc. ("SSH"), collectively known as the "Debtors." The Debtors commenced this Adversary Proceeding against UDC, pursuant to §§ 541 and 542 of the U.S. Bankruptcy Code (11 U.S.C. §§ 101-1330) ("Code"), seeking the turnover of a certain portion of settlement proceeds (the "Settlement Proceeds") currently held by UDC, and for an accounting from UDC with respect to the Settlement Proceeds. This Adversary Proceeding arises in two voluntary cases filed pursuant to Chapter 11 of the Code by the Debtors on May 21, 2004. The cases have been jointly administered virtue of an Order signed on May 25, 2004. On November 18, 2004, the Debtors filed a response in opposition to UDC's Motion to Dismiss ("Dismissal Motion"). UDC then filed a reply on November 22, 2004, in further support of its Dismissal Motion. The Court heard oral argument on the Dismissal Motion on November 29, 2004 in Utica, New York. At the conclusion of the oral argument, the Court afforded the parties an opportunity to submit memoranda of law by December 13, 2004.

JURISDICTIONAL STATEMENT

The Court has core jurisdiction over the parties and subject matter of this Adversary Proceeding pursuant to 28 U.S.C. §§ 1334(b), 157(a), 157(b)(1), and 157(b)(2)(A), (E), and (O).

FINDINGS OF FACT

The complaint alleges the following facts, which for the purpose of ruling on UDC's Fed.R.Civ.P. 12(b)(6) motion, are taken as true. Bernheim v. Litt, 79 F.3d 318, 321 (2d Cir.1996). SSH is a New York corporation and legal title owner of the Kennedy Plaza Apartments ("Kennedy Plaza"), a subsidized residential apartment complex in Utica, New York. SSA is a New York limited partnership and is SSH's affiliate. SSA is the operator of Kennedy Plaza. UDC is a New York public benefit corporation.

On July 21, 1971, SSH borrowed $8,105,000 from UDC to construct and operate Kennedy Plaza. Since that date, UDC has loaned the Debtors additional money, and the parties have modified and consolidated their loan agreements several times. UDC secured its loans with a first mortgage lien containing an assignment-of-rents clause on the Kennedy Plaza property.

In the construction of Kennedy Plaza, a mortar additive manufactured by Dow Chemical ("Dow"), known commercially as "Sarabond," was utilized. The mortar subsequently failed, causing structural damage to the apartment complex.

In 1983, UDC and SSA, along with two other similarly damaged UDC financed parties, filed a civil action against Dow for the Sarabond failure in the United States District Court for the Southern District of New York (the "Dow Litigation"). See Loan Restructuring Agreement § 5.01 (Exhibit B attached to UDC Motion to Dismiss). They sought compensatory and punitive damages from Dow.

On July 31, 1985, the Debtors (along with the other plaintiffs in the Dow Litigation) executed Powers of Attorney ("POAs") authorizing UDC to direct and manage the Dow Litigation on their behalf and to take "any and all acts necessary and appropriate with respect to any settlement of the litigation."¹

On August 5, 1985, SSA borrowed $2,173,809 from the United States Department of Housing and Urban Development ("HUD"), under its Flexible Subsidy Loan Program. In return, SSA gave HUD a promissory note (the "HUD Note"), which accumulates interest at an annual, non-compounded rate of 1%. SSA could repay the loan from its accumulated profits or from its general funds. The Note matures in July 2025. SSA used the loan proceeds to finance repairs on Kennedy Plaza resulting from the Sarabond damage. UDC also loaned SSH additional money in exchange for a Building Loan Note in the principal amount of $2,100,000.² SSH also used the loan proceeds to repair Kennedy Plaza's masonry.

The Debtors also entered into a "Loan Restructuring Agreement" (the "LRA") dated July 31, 1985,³ in consideration of UDC granting the Debtors a ten year forbearance period from the closing date of the financing. See LRA § 2.01 (Exhibit B attached to UDC Motion to Dismiss). In the LRA, the Debtors assigned to UDC any settlement or award they might receive from the Dow Litigation; UDC would then use the assigned funds to pay off certain debts owed by the Debtors. See id. at § 5.02. The LRA prioritized the payments. See id. The first priority was the payment of the litigation expenses UDC incurred as the SSA's attorney in the Dow Litigation.⁴ See id. The second priority under the LRA's payment allocation plan was the HUD Note, along with the Note's accrued interest. See id. Payment of UDC's Building Loan Note was the third priority. See id. If any funds remained after a total of eight prioritized payments, the allocation plan would distribute 60% of the funds to UDC and 40% to SSA's Managing General Partner. Id.

On October 7, 1988, SSA purportedly revoked for cause the POA given to UDC to prosecute the Dow Litigation. See Exhibit B attached to UDC Reply in Further Support of Motion to Dismiss Complaint. However, on April 9, 1991, UDC and SSA agreed, in writing, to reinstate the POA and to make several modifications to the LRA. See Appendix 1 attached to Debtors' Supplemental Memorandum of Law in Opposition to UDC's Motion to Dismiss. They agreed to make the LRA modifications effective on August 1, 1991.⁵ See id.

Acting under the POAs, UDC, over the Debtors' objections, finalized a settlement with Dow in April of 1991.⁶ Dow paid UDC $20,000,000 for general damages (the "Sarabond Settlement"), and UDC released all of the Debtors' substantial punitive damage claims. UDC received the Sarabond Settlement that same month and held the funds for the benefit of all of the plaintiffs in the Dow Litigation as Attorney-in-Fact, Trustee, and Escrow Agent. There was a dispute among all the plaintiffs in the Dow Litigation over the distribution of the proceeds, and it was not until July 1992, that the Debtors and UDC entered into a settlement agreement (the "Settlement Agreement"). This Settlement Agreement provided that the Debtors would receive $7,056,000 as their share of the Sarabond Settlement. It also included an Amendment to the LRA (the "Amended LRA"), backdated so that it was also purported to be effective on July 31, 1991. UDC provided an additional five year forbearance period in the Amended LRA. See Amended LRA § 6 (Exhibit D attached to UDC Motion to Dismiss). The Amended LRA also revised the Sarabond Settlement priorities, making the amount payable to HUD the first, rather than second, priority:

Any award ... as a result of the [Dow] Litigation, or any portion of a settlement, or any portion of a settlement of the [Dow] Litigation ... shall be assigned to UDC and allocated and distributed ... in the following order of priority:

(a) To accrued interest on the HUD Flexile Subsidy Loan, then to the payment of the Two Million, One Hundred Seventy-three Thousand, Eight Hundred Nine ($2,173,809) Dollars principal thereof;...

Amended LRA § 10 (Exhibit D attached to UDC Motion to Dismiss).

At the time of the Settlement Agreement, UDC orally advised the Debtors that the Debtors must pay UDC $2,173,809 from the Debtors' Sarabond Settlement share, which UDC in turn would use to pay the HUD Note immediately as the first priority distribution under the Amended LRA. Thereafter, the Debtors believed that UDC had distributed the Settlement Proceeds in accordance with the Amended LRA, which included repaying the $2,173,809, plus accrued interest due under the HUD Note, as a first priority.

In December of 1998, six years after the Settlement Agreement, the Debtors inquired of UDC as to the distribution of the Settlement Proceeds. UDC responded that it had paid the designated portion of the Settlement Proceeds to HUD in satisfaction of the HUD Note. UDC then subsequently reversed its position and admitted that it had not yet paid HUD.⁷ UDC claimed that it did not have any obligation to pay over the Settlement Proceeds to HUD in satisfaction of the principal or interest due under the HUD Note until the year 2025, when the HUD Note matures. The Debtors allege that UDC has since admitted in open court that it made a "business judgment" decision not to repay the HUD Note and decided to "invest" the Settlement Proceeds for its own account, thereby benefitting from the low 1% non-compounded interest rate due on the HUD Note.

The Debtors filed the instant Adversary Complaint seeking: (1) turnover of the Settlement Proceeds, plus accrued interest earned on the proceeds since 1991; and (2) an accounting from UDC of the Debtors' $7,056,000.00 Sarabond Settlement share.

ARGUMENTS

The Debtors' argument in support of their turnover claim asserts that neither the POAs' terms nor the LRA nor the Amended LRA allowed UDC to retain or use the Settlement Proceeds for its own benefit. The POAs...