In re Vartec Telecom, Inc.

• Decision Date: 16 December 2005
• Docket Number: Bankruptcy No. 04-81694-HDH-11.,Adversary No. 05-3514.
• Citation: 335 B.R. 631
• Parties: In re VARTEC TELECOM, INC., et al., Debtors. Official Committee of Unsecured Creditors of Vartec Telecom, Inc., Excel Communications Marketing, Inc., Excel Management Services, Inc., Excel Products, Inc., Excel Telecommunications, Inc., Excel Telecommunications of Virginia, Inc., Excel Teleservices, Inc., Excelcom, Inc., Telco Communications Group, Inc., Telco Network Services, Inc., Vartec Business Trust, Vartec Properties, Inc., Vartec Resources Services, Inc., Vartec Solutions, Inc., Vartec Telecom Holding Company, Vartec Telecom International Holding Company, Vartec Telecom of Virginia, Inc., Debtors, on Behalf of the Bankruptcy Estates of Said Debtors, Plaintiff, v. Rural Telephone Finance Cooperative, Defendant.
• Court: U.S. Bankruptcy Court — Northern District of Texas

335 B.R. 631

In re VARTEC TELECOM, INC., et al., Debtors.

Official Committee of Unsecured Creditors of Vartec Telecom, Inc., Excel Communications Marketing, Inc., Excel Management Services, Inc., Excel Products, Inc., Excel Telecommunications, Inc., Excel Telecommunications of Virginia, Inc., Excel Teleservices, Inc., Excelcom, Inc., Telco Communications Group, Inc., Telco Network Services, Inc., Vartec Business Trust, Vartec Properties, Inc., Vartec Resources Services, Inc., Vartec Solutions, Inc., Vartec Telecom Holding Company, Vartec Telecom International Holding Company, Vartec Telecom of Virginia, Inc., Debtors, on Behalf of the Bankruptcy Estates of Said Debtors, Plaintiff, v. Rural Telephone Finance Cooperative, Defendant.

Bankruptcy No. 04-81694-HDH-11.

Adversary No. 05-3514.

United States Bankruptcy Court, N.D. Texas, Dallas Division.

December 16, 2005.

COPYRIGHT MATERIAL OMITTED

J. Michael Sutherland, Stephen A. Goodwin, Peter Tierney, Carrington, Coleman Sloman & Blumenthal, LLP, Dallas, TX, for Plaintiff Official Committee of Unsecured Creditors of VarTec.

Toby L. Gerber, William R. Greendyke, John N. Schwartz, Fulbright & Jaworski, LLP, Dallas, TX, for Defendant Rural Telephone Finance Cooperative.

MEMORANDUM OPINION ON MOTION TO DISMISS COUNT TEN

HARLIN D. HALE, Bankruptcy Judge.

This opinion addresses the question as to whether "deepening insolvency" may be pled as a separate cause of action or whether it is treated only as a breach of a separate duty under state tort law or as a theory of damages. In the instant adversary proceeding, the Rural Telephone Finance Cooperative ("RTFC") has filed a Motion to Dismiss Count Ten of Complaint and Brief in Support ("Motion to Dismiss"). The Official Committee of Unsecured Creditors of VarTec Telecom, Inc., et al. (the "Committee") filed a response. Both the RTFC and the Committee presented argument at the hearing. After reviewing the pleadings and hearing the argument of counsel, the Court took the Motion to Dismiss under advisement for further consideration. After consideration, the Court finds that deepening insolvency would not be recognized as a tort under Texas law; and therefore, the Motion to Dismiss should be granted.

Causes of Action

The Original Complaint filed by the Committee asserts ten causes of action against the RTFC: (1) fraudulent transfers; (2) preferences; (3) avoidance of the RTFC's prepetition security interests; (4) avoidance of the RTFC's replacement liens and super priority protections; (5) disgorgement (6) disallowance of the claims of the RTFC; (7) equitable marshaling of assets; (8) equitable subordination of claims; (9) deepening insolvency; and (10) turnover.

The Instant Motion

In the Motion to Dismiss, the RTFC has asked that the Committee's ninth cause of action, entitled "Count Ten-Deepening Insolvency" in the Original Complaint be dismissed for failure to state a claim upon which relief may be granted, pursuant to Federal Rule of Civil Procedure 12(b)(6), as made applicable by Federal Rule of Bankruptcy Procedure 7012(b). For the purpose of this Motion to Dismiss, the Court will adopt the factual allegations in the Original Complaint as true and will draw all factual inferences in favor of the Committee's position and against the RTFC.

Jurisdiction

This memorandum opinion constitutes the Court's findings of fact and conclusions of law pursuant to Federal Rules of Bankruptcy Procedure 7052. The Court has jurisdiction pursuant to 28 U.S.C. §§ 1334 and 151, and the standing order of reference in this district. This proceeding is core, pursuant to 28 U.S.C. § 157(b)(2)(A), (B), (E), (F), (H), (K) & (O).

I. FACTS ALLEGED IN THE COMPLAINT¹

VarTec Telecom, Inc. ("VarTec"), along with its sixteen direct and indirect domestic subsidiaries, each of which is a debtor in this administratively consolidated proceeding, and its eighteen non-debtor direct and indirect foreign subsidiaries provided telecommunications services to North America and Europe.

VarTec was founded in 1989 and began its business by marketing a "10-10 dial-around" long distance service to small business and residential customers. VarTec then began to offer traditional local, long distance, and wireless telephone services as well as internet access.

In February 2000, VarTec and the RTFC executed loan agreements which provided for a $334 million term loan and a revolving line of credit of up to $200 million (the "Loan Agreements"). In connection with the Loan Agreements, on February 28, 2000, VarTec Telecom Holding Company ("VarTec Holding"), a wholly owned subsidiary of VarTec, executed a Pledge and Security Agreement to secure the obligations to the RTFC under the Loan Agreements by granting a security interest in stock in six of VarTec's subsidiaries.

In 2001, VarTec sought approval from the RTFC to acquire a number of companies commonly referred to as the Excel companies or Excelcom, Inc. ("Excel") which marketed its services through a multi-level marketing concept and offered services similar to those of VarTec. Excel had an international network of over 130,000 independent representatives who participated in the multi-level marketing scheme and received commissions and bonuses based on the usage of Excel products by customers they had recruited the success of the independent representatives efforts in their "downline." The RTFC approved the acquisition, which closed in April 2002, and VarTec Holding executed a Modification to Pledge and Security Agreement dated May 15, 2002, which added the stock, but not the assets, of Excel and several other subsidiaries of VarTec.

According to the Original Complaint, almost immediately after the acquisition of Excel, VarTec began to encounter financial difficulties which prompted the RTFC to question the financial viability of VarTec, and on September 25, 2002, a Second Modification to Pledge and Security Agreement was executed by VarTec Holding. In this agreement, the stock in VarTec Resource Services, Inc. was added to the security held by the RTFC.

On November 19, 2003, VarTec met with the RTFC to discuss its weakening financial condition, and revealed that as of September 2003, its projected earnings before interest, taxes, depreciation and amortization ("EBITDA") for 2003 was approximately $25 million, well below its earlier projected EBITDA of $180 million for 2003. At that same meeting, VarTec claimed that it had begun to address the significant issues causing its downturn in earnings and presented projections for an increased EBITDA in 2004 of approximately 20 percent over 2003 earnings.

The RTFC apparently did not have much faith in VarTec's projected improvement for 2004, and on November 30, 2003 downgraded VarTec's borrower risk rating from 4.4 to 7.0, a rating that represents a "problem credit" under the RTFC's guidelines that grades risk on a scale of 1.0 to 10.0, with a 10.0 rating considered uncollectible. The RTFC began negotiating an amendment to the Loan Agreements by trying to acquire additional collateral to secure VarTec's indebtedness. This effort culminated in the execution of a third amendment to the Loan Agreements. As a condition of the third amendment to the Loan Agreements, several of VarTec's subsidiaries executed unconditional joint and several guarantees to the RTFC guaranteeing the obligations of VarTec under the Loan Agreements, and VarTec Holding executed its own separate guarantee along the same lines. The guarantors included the Excel companies, whose assets accounted for approximately half of the value of the Debtor's receivables and property, plant and equipment. None of the guarantors had guaranteed the indebtedness to the RTFC under prior agreements.

To further enhance its security position, the RTFC also required that VarTec and certain subsidiary guarantors execute and obtain deposit account control agreements, and that other security, cash controls, and lien perfection arrangements be made in connection with the third amendment to the Loan Agreements to perfect security interests in deposit accounts and funds in which the RTFC did not previously have a perfected security interest.

VarTec's financial condition continued to deteriorate through the first half of 2004. Instead of achieving the optimistic revenue growth portrayed in its projections, VarTec's revenues actually declined rapidly. In May 2004, the RTFC downgraded VarTec's loans to an 8.0 rating, and the National Rural Utilities Cooperative Finance Corporation, RTFC's source of funds, established a loan loss reserve for VarTec of approximately $134 million and placed the loan on non-accrual by May 2004, recognizing that the Loan Agreements were undersecured.

In May 2004, VarTec and the RTFC discussed bankruptcy alternatives. In addition, they began working on yet another amendment to the Loan Agreements. RTFC representatives working with VarTec informed RTFC's board by July 1, 2004, of the high probability of VarTec's bankruptcy and indicated RTFC's intent to work with VarTec on planning for a bankruptcy filing by VarTec. At around the same time, both the RTFC and VarTec engaged bankruptcy counsel to assist in bankruptcy planning efforts.

Leading up to VarTec's bankruptcy filing on October 7, 2004, the RTFC arranged for VarTec to pay down the Loan Agreement by $90 million through a loan to Telephone Electronics Corporation, the proceeds of which were transferred to VarTec. Conditioned on the $90 million pay down of VarTec's indebtedness, the RTFC entered into a First Amended Restated Credit Agreement ("FARCA"), on October 7, 2004. Under the FARCA, the RTFC agreed to combine VarTec's term loan agreement and revolving line of credit agreement. Prior to this transaction, the RTFC's loans to VarTec were not secured by the assets or stock of Telephone Electronics Corporation.

In addition, to receiving the $90 million pay down on its loans within three weeks of bankruptcy, the Original Complaint...