In re Stylesite Marketing, Inc.
| Decision Date | 10 October 2000 |
| Docket Number | Adversary No. 00/2286A.,Bankruptcy No. 00 B 10099(SMB) |
| Citation | 253 BR 503 |
| Parties | In re STYLESITE MARKETING, INC. f/k/a Diplomat Direct Marketing Corporation, Debtor. Tekinsight.Com, Inc. f/k/a Tadeo Holdings, Inc., Plaintiff, v. Stylesite Marketing, Inc. f/k/a Diplomat Direct Marketing Corporation and First Source Financial LLP, Defendants. |
| Court | U.S. Bankruptcy Court — Southern District of New York |
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Nixon Peabody LLP, for Plaintiff TekInsight.Com, New York City, Robert N.H. Christmas, of Counsel.
Angel & Frankel, P.C., for Defendant Stylesite Marketing, Inc., New York City, Neil Siegel, of Counsel.
Neal, Gerber & Eisenberg, for Defendant First Source Financial LLP, Chicago, Illinois, Michael L. Molinaro, John W. Guarisco, of Counsel.
Section 510(b) of the Bankruptcy Code subordinates claims arising from the purchase or sale of a security of the debtor.1 The principal question of bankruptcy law raised in this adversary proceeding is whether the plaintiff, a purchaser of the debtor-defendant's stock, can bypass this restriction by suing to impose a constructive trust on the consideration paid for the securities. Answering the question in the negative, and for the additional reasons discussed below, I grant the defendants' motion to dismiss the plaintiff's complaint.
Stylesite Marketing, Inc., f/k/a Diplomat Direct Marketing, Inc. (the "debtor" or "Stylesite") was primarily engaged in the business of directly marketing women's fashions and other soft good products through the internet, mail and other means. (See Complaint ¶ 5.) In or about May 1999, Stylesite and TekInsight.com., Inc. f/k/a Tadeo Holdings, Inc. ("TekInsight") began to discuss an infusion of capital into Stylesite. These discussions culminated in a Securities Purchase Agreement, dated as of June 30, 1999 (the "Agreement").3 Pursuant to the Agreement, TekInsight agreed to (1) purchase $1,000,000.00 of Stylesite's preferred stock (the "Stylesite Preferred") for cash, and (2) exchange its publicly traded common stock (the "TekInsight Common") valued at $1,000,000.00 for Stylesite's publicly traded common stock (the "Stylesite Common") of like value.4 (Id. ¶¶ 6-9, 17.)
Prior to the transaction, TekInsight conducted due diligence. Stylesite provided it with financial information, including its Annual Report (Form 10-KSB) for the fiscal year ended September 30, 1998, its subsequent SEC filings up to June 1, 1999, a March 1999 "Business Overview and Strategy" and various other financial and business information. (Complaint ¶¶ 11-14.) TekInsight also interviewed Stylesite officers, directors and employees. (Id. ¶ 15.) As a result of its due diligence, TekInsight concluded that Stylesite was a well-established sales and marketing business with a large customer base and satisfactory customer relations.
The terms of the Agreement did not suggest otherwise. Stylesite represented and warranted that (1) the financial statements were true and complete and fairly represented Stylesite's existing financial condition; (2) there had been no material adverse alteration in Stylesite's financial condition, operations or business subsequent to the issuance of the financial statements; (3) Stylesite was not aware of any facts that had not been disclosed to TekInsight in writing that it reasonably expected could have a material adverse impact on the transaction or Stylesite's ability to perform its obligations under the Purchase Agreement; (4) to the best of Stylesite's knowledge, there was no pending or threatened action, proceeding or investigation which could have a material adverse impact on the transaction; and (5) none of the representations or warranties made by Stylesite was untrue or misleading. (Id. ¶ 18.) Based on its due diligence, and in reliance on the truth and accuracy of the financial and business disclosures, TekInsight entered into the Agreement. (Id. ¶¶ 16, 19.)
All was not as it seemed, however, as Stylesite's disclosures were both inaccurate and incomplete. Stylesite faced substantial problems with its customers concerning merchandise returns. Specifically, and "upon information and belief, . . . Stylesite was unable or unwilling to perform promises and warranties made to hundreds, if not thousands, of its customers that it would accept merchandise returns, refund the purchase price and provide merchandise credits to customers for returned goods. . . ." (Id. ¶ 20).5 Stylesite did not disclose the magnitude and consequences of the merchandise credit and return problems to TekInsight prior to execution of the Agreement, (id. ¶ 21), and affirmatively implied their non-existence in the Agreement. (Id. ¶ 23.) Had TekInsight known of the merchandise credit and return problems, it would not have entered into the Agreement. (Id. ¶ 22.)
As a consequence, Stylesite obtained the TekInsight Common and the monies paid for the Stylesite Preferred by "trick and deceit." (Id. ¶ 24.) Further, Stylesite pledged the TekInsight Common to First Source Financial LLP ("First Source" and together with Stylesite, the "defendants") as additional collateral for existing indebtedness without TekInsight's knowledge or permission, and First Source has refused to return the stock to TekInsight. (Id. ¶¶ 25-26.)
The Complaint contains two claims for relief. Count One seeks to impose a constructive trust on the TekInsight Common and a direction compelling First Source to deliver the stock to TekInsight free and clear of all claims, liens and encumbrances. (Id. ¶ 27-28.) Count Two seeks to impose a constructive trust on the funds used to purchase the Stylesite Preferred. (Id. ¶¶ 29-30.)
The defendants contend, in the first instance, that the Agreement bars the imposition of a constructive trust. Specifically, quasi-contractual claims such as unjust enrichment are not permitted if a written contract between the parties governs the subject matter of their dispute. Briggs v. Goodyear Tire & Rubber Co., 79 F.Supp.2d 228 (W.D.N.Y.1999); Gidatex S.r.L. v. Campaniello Imports, Ltd., 49 F.Supp.2d 298, 301 n. 4 (S.D.N.Y.1999); Nelson v. Stanley Blacker, Inc., 713 F.Supp. 107, 111 (S.D.N.Y.1989); Clark-Fitzpatrick, Inc. v. Long Island R.R. Co., 70 N.Y.2d 382, 521 N.Y.S.2d 653, 516 N.E.2d 190, 193 (1987). The prohibition assumes the existence of a valid contract, and hence, does not apply if the contract is invalid. Thus, if the plaintiff invalidates the contract, he may then recover in quasi-contract based on unjust enrichment. Bazzano v. L'Oreal, S.A., No. 93 Civ. 7121, 1996 WL 254873, at *3 ; Chrysler Capital Corp. v. Century Power Corp., 778 F.Supp. 1260, 1272 (S.D.N.Y.1991); Clark-Fitzpatrick, Inc. v. Long Island R.R. Co., 521 N.Y.S.2d 653, 516 N.E.2d at 193; see JOHN D. CALAMARI & JOSEPH M. PERILLO, LAW OF CONTRACTS § 1-12, at 20 (3rd ed.1987).
Here, TekInsight is not seeking to avoid or disaffirm the Agreement, but rather, to ignore it. As discussed in the next section, TekInsight flirts with the argument that it was fraudulently induced to sign the Agreement, a ground for disaffirmance. Yet for tactical reasons, it never quite makes it. But if the contract is valid, TekInsight's remedies are limited by the aforementioned rule, and it cannot recover in quasi-contract. See Chrysler Capital Corp. v. Century Power Corp., 778 F.Supp. at 1272. Since TekInsight cannot eat its cake and have it too, the refusal to disaffirm the Agreement leaves a valid contract that bars the imposition of a constructive trust.
Even if the quasi-contractual remedy were not barred, the Complaint still fails to allege the right to a constructive trust. A constructive trust is an equitable remedy designed to prevent unjust enrichment, and restore legal title to one who, in equity, owns the res. Counihan v. Allstate Ins. Co., 194 F.3d 357, 360 (2d Cir.1999); Simonds v. Simonds, 45 N.Y.2d 233, 408 N.Y.S.2d 359, 380 N.E.2d 189, 193 (1978); Sharp v. Kosmalski, 40 N.Y.2d 119, 386 N.Y.S.2d 72, 351 N.E.2d 721, 723 (1976); Beatty v. Guggenheim Exploration Co., 225 N.Y. 380, 122 N.E. 378, 380 (1919)(Cardozo, J.). The right to impose a constructive trust is determined by state law. Sanyo Elec., Inc. v. Howard's Appliance Corp. (In re Howard's Appliance Corp.), 874 F.2d 88, 93-94 (2d Cir.1989). New York law6 generally requires proof of (1) a confidential or fiduciary relationship, (2) a promise, (3) a transfer in reliance on the promise, and (4) unjust enrichment. Koreag Controle et Revision, S.A. v. Refco F/X Assocs., Inc. (In re Koreag, Controle et Revision S.A.), 961 F.2d 341, 342 (2d Cir.1992), cert. denied, 506 U.S. 865, 113 S.Ct. 188, 121 L.Ed.2d 132 (1992); Sharp v. Kosmalski, 386 N.Y.S.2d 72, 351 N.E.2d at 723.
Notwithstanding the stated requirements, the remedy is a flexible one, and the facts need not satisfy every element in all cases. Counihan v. Allstate Ins. Co., 194 F.3d at 362; Palazzo v. Palazzo, 121 A.D.2d 261, 503 N.Y.S.2d 381, 383-84 (N.Y.App.Div.1986); see In re Koreag, Controle et Revision S.A., 961 F.2d at 352 (). For example, a court may impose a constructive trust in the absence of a fiduciary relationship, In re Koreag, Controle et Revision S.A., 961 F.2d at 354; RESTATEMENT OF RESTITUTION § 160 cmt. a (1937), or wrongful conduct by the defendant. Simonds v. Simonds, 408 N.Y.S.2d 359, 380 N.E.2d at 194; accord In re Koreag, Controle et Revision S.A., 961 F.2d at 354. Even innocent parties may be unjustly enriched, and what is required is that the defendant hold property "under such circumstances that in equity and good conscience he ought not to retain it." Miller v. Schloss, 218 N.Y. 400, 113...
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