In re Troll Communications, LLC

• Decision Date: 02 April 2008
• Docket Number: Bankruptcy No. 03-11508 (KJC).,Adversary No. 05-51605 (KJC).
• Citation: 385 B.R. 110
• Parties: In re TROLL COMMUNICATIONS, LLC, et al., Debtors. Michael B. Joseph, as Chapter 7 Trustee for Troll Communications, LLC, et al., Plaintiff v. Lincoln E. Frank, Andrew E. Kaplan, Peter E. Bergen, Daniel Neuwirth, Curtis Thompson, Jeffrey Lucking, Terry Tuttle, Seth J. Lehr, Scott Perricelli, Quad Venture Partners SBIC, LP, Quad Venture Partners, LP, Quad Ventures, LLC, Defendants.
• Court: U.S. Bankruptcy Court — District of Delaware

385 B.R. 110

In re TROLL COMMUNICATIONS, LLC, et al., Debtors Michael B. Joseph, as Chapter 7 Trustee for Troll Communications, LLC, et al., Plaintiff v. Lincoln E. Frank, Andrew E. Kaplan, Peter E. Bergen, Daniel Neuwirth, Curtis Thompson, Jeffrey Lucking, Terry Tuttle, Seth J. Lehr, Scott Perricelli, Quad Venture Partners SBIC, LP, Quad Venture Partners, LP, Quad Ventures, LLC, Defendants.

Bankruptcy No. 03-11508 (KJC).

Adversary No. 05-51605 (KJC).

United States Bankruptcy Court, D. Delaware.

April 2, 2008.

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Jason Custer Powell, Rick S. Miller, Ferry, Joseph & Pearce, P.A., Wilmington, DE, for Plaintiff.

Christopher Martin Winter, Michael R. Lastowski, Richard W. Riley, Duane Morris LLP, William H. Schorling, Buchanan Ingersoll & Rooney PC, James E. O'Neill, Pachulski Stang Ziehl & Jones LLP, Wilmington, DE, Blake T. Hannafan, Michael T. Hannafan, Hannafan & Hannafan, Ltd., Nicholas A. Pavich, Michael T Hannafan & Associates, Ltd., Chicago, IL, for Defendants.

MEMORANDUM¹

KEVIN J. CAREY, Bankruptcy Judge.

BACKGROUND

On May 16, 2003, Troll Communications, LLC and its affiliates filed voluntary petitions for relief under chapter 11 of the United States Bankruptcy Code.² The Debtors' cases were converted to cases under chapter 7 of the United States Bankruptcy Code on July 23, 2003 (main case docket no. 207). On July 27, 2003, Michael B. Josephs (the "Trustee") was appointed as the chapter 7 Trustee of the Debtors' estates (main case docket no. 210).

The Trustee commenced this adversary proceeding on May 13, 2005. On October 7, 2005, the Trustee filed the First Amended Complaint (the "Amended Complaint")(docket no. 47). The Amended Complaint asserts four counts against the defendants.³ Count One alleges claims for breach of fiduciary duty against the individual defendants. Count Two seeks avoidance and recovery of fraudulent transfers under 6 Del. C. § 1305(b) and 11 U.S.C. §§ 544, 550 and 551 against Quad Ventures Partners, LP. Count Three seeks avoidance and recovery of certain allegedly preferential transfers under 11 U.S.C. §§ 547, 550, and 551 against Quad Venture Partners, LP.

Before the Court are three motions to dismiss the Amended Complaint filed by the following groups of defendants: (1) Peter Bergen, Jeffrey Lucking and Curtis Thompson (docket no. 49)(the "Bergen Motion to Dismiss"), (2) Lincoln E. Frank, Andrew E. Kaplan, Daniel Neuwirth, Seth J. Lehr, Scott Perricelli, Quad Ventures Partners SBIC, LP, Quad Venture Partners, LP, and Quad Ventures LLC (docket no. 53)(the "Frank Motion to Dismiss"), and (3) Terry Tuttle (docket no. 56)(the "Tuttle Motion to Dismiss")(collectively the "Motions to Dismiss").⁴ For the reasons set forth below, the Frank Motion to Dismiss will be granted, in part, and denied, in part, with respect to Count One and will be denied with respect to Counts Two and Three. The Bergen Motion to Dismiss and Tuttle Motion to Dismiss will be granted, but the Trustee will be granted leave to amend the Amended Complaint to set forth more specific allegations relating to a breach of fiduciary duties arising from payments made to Quad.

FACTUAL ALLEGATIONS⁵

Troll was a publisher and direct marketer of books and educational products for use by pupils in grades Pre-K through 9. Troll distributed its products through multiple channels, including school book clubs, home continuity programs, a school library catalog, and retailers.

The June 30, 2001 financial statements.

As of June 30, 2001, according to the consolidated financial statement prepared on a "going concern basis" by Ernst & Young for Troll, Troll had a working capital deficit of approximately $16 million and a members' deficiency of approximately $55 million.⁶ In addition, Troll's existing revolver credit agreement with Fleet Capital Corporation ("Fleet") was to expire on March 31, 2002. Under this agreement, Fleet provided Troll with a revolving credit line of up to $19,500,000 through October 31, 2001, and $14,500,000 thereafter through maturity. Troll was advised that it would be unable to pay all existing obligations if it did not obtain alternative sources of capital. As Ernst & Young noted in its report of independent auditors, "with these uncertainties, there is `substantial doubt' about the Company's ability to continue as a going concern."

The April 2002 Agreement and Merger.

On April 17, 2002, QV, through its subsidiary QV SBIC, acquired a 90% interest in Troll. This acquisition was made through a merger and plan agreement dated March 22, 2002. Through this agreement, the owners of 100% of the membership interests in Troll Communications, LLC ("Communications") sold their membership interests to Troll Holdings, Inc. ("Holdings"); thus, the shareholders of Holdings acquired 100% of Communications' membership interests.

Holdings formed Troll NewCo, LLC ("NewCo"), a Delaware limited liability company, for the purpose of holding Communications' equity, which in turn held the equity in the Troll Subsidiaries.⁷ NewCo merged with and into Communications, such that all existing membership interests in Communications were canceled, leaving NewCo and Holdings as the 100% surviving members of Communications. As part of this transaction, Holdings issued stock to QVP SBIC and to the former owners of Communications, Willis Stein & Partners II, L.P. and Willis Stein & Partners, Dutch, L.P. (collectively, "Willis Stein"). Consequently, QVP SBIC then owned approximately 90% of Holdings' issued and outstanding shares, and Willis Stein then owned the remaining 10% of Holdings' issued and outstanding shares.⁸

In exchange for the 90% interest in Troll, QVP SBIC paid approximately $4.4 million, including transaction costs and the consideration paid to Willis Stein. The Trustee estimates that, even adjusting for the cancellation of debt⁹ by the previous owners, Communications' net asset value was negative $12.7 million when it was purchased by Holdings.

As part of the April 2002 transaction, QV entered into a management consulting agreement with Holdings to pay QV for prior consulting work in connection with Quad's acquisition of Troll and to provide consulting and other advice to Troll on an ongoing basis.

Moreover, on April 17, 2002, Communications and PNC Bank, N.A., ("PNC") entered into a revolving credit and security facility, secured by Troll's inventory and accounts receivable, whereby PNC made available a $15 million line of credit to Communications, which was to expire on April 17, 2005.

The June 30, 2002 financial statements.

According to Troll's internal financial statements dated June 30, 2002, Communications' accounts payable and other liabilities were $13.8 million. The tangible net worth of Communications was valued at negative $13.1 million. In the notes included in the consolidated financial statements dated June 30, 2002, prepared by PricewaterhouseCoopers ("PwC"), PwC indicated that Troll was in default on its credit facility with PNC because Troll violated the tangible net worth covenant in the credit agreement. In the same consolidated financial statements, PwC determined that there was "substantial doubt about Troll's ability to continue as a going concern."

Accordingly, the Trustee alleges that as of June 30, 2002, Troll was insolvent and remained insolvent through the time it filed its bankruptcy petition.

Additional loans and contributions to equity by Quad and LLR.

In the period between June 30, 2002, and August 20, 2002, Quad loaned approximately $5.4 million to Troll, evidenced by seven subordinated notes, convertible at the option of Quad, to fund Troll's operations. On August 20, 2002, approximately $1.5 million of Quad's debt was converted into equity in exchange for 27,000 Class A common stock in Holdings.

On September 9, 2002, pursuant to a note and warrant purchase agreement between Troll and Quad, Troll issued a new subordinated note of $4 million and stock warrants valued at $10,000 to Quad. In exchange, Quad canceled the outstanding subordinated notes of $3.9 million.

On September 23, 2002, pursuant to a securities purchase agreement, Troll issued equity (141,151 shares of Class D common stock in Holdings) to LLR Partners ("LLR") in exchange for payment (equity financing) of $7.5 million. This gave LLR a minority ownership position in Troll. Defendants, and Lehr and Perricelli were added to Holdings' board of directors as a result of this transaction.¹⁰

Also on September 23, 2002, Troll entered into an amended and restated management consulting agreement with Quad, and a separate management consulting agreement with LLR. The Trustee alleges that the cash proceeds from the equity transaction with LLR were used to pay QVP for the following (I) the $4 million subordinated note, plus interest in the amount of $22,591.27, and (ii) management consulting fees in the amount of $154,662. On February 26, 2003, Troll transferred another $134,694.04 to QVP for reimbursement of expenses.

As of September 30, 2002, Troll's EBIDA (i.e., earnings before interest, taxes, depreciation and amortization) was a negative $2.6 million. As of December 31, 2002, Troll's EBITDA was a negative $4.4 million.

On January 23, 2003, LLR and Quad entered into a mezzanine credit agreement to provide Troll with $4 million of additional capital. Quad provided half of the initial $2 million advance to Troll. However, on January 31, 2003, Troll's reported losses for the month were $1.5 million on sales of $3.7 million. Also, another $1.5 million in negative EBITDA was generated.

On February 12, 2003, Troll and Scholastic, Inc. entered into a sales contract for the purchase of substantially all of Troll's assets.

In March of 2003, Troll retained Phoenix Management Services ("Phoenix") to review its operations and advise on the overall financial condition of Troll. On April 3, 2003, Phoenix delivered a cash forecast report indicating that (a) a dramatic...