Jp Morgan Chase Bank v. Winnick
| Decision Date | 23 June 2004 |
| Docket Number | No. 03 Civ. 8535(GEL).,03 Civ. 8535(GEL). |
| Citation | 350 F.Supp.2d 393 |
| Parties | JP MORGAN CHASE BANK, in its capacity as Administrative Agent under the Credit Agreement, Plaintiff, v. Gary WINNICK, Dan J. Cohrs, Lodwrick M. Cook, Hank Millner James C. Gorton, Joseph Clayton, Thomas J. Casey, S. Wallace Dawson Jr., Susan Dullabh, Thomas Robershaw, David A Walsh Joseph P. Perrone, Robin Wright, Patrick Joggerst, Brian Fitzpatrick, David Carrey, Jackie Armstrong, Mark Attanasio, David L. Lee, Geoffrey J.W. Kent, Eric Hippeau, Norman Brownstein, William E. Conway, Jr., Defendants. |
| Court | U.S. District Court — Southern District of New York |
Ralph C. Ferrara, Colby A. Smith, Jonathan E. Richman, Jeffrey S. Jacobson, Debevoise & Plimpton, New York, N.Y. for defendants.
Michael L. Hirshfeld, Andrew E. Tomback, Allan S. Brilliant, Millbank, Tweed, Hadley & McCloy, for plaintiff.
This action presents another strand in the web of litigation surrounding the alleged accounting fraud and eventual bankruptcy of the telecommunications company Global Crossing, Ltd. ("GC"). Plaintiff JP Morgan Chase Bank brings this action on behalf of a syndicate of commercial banks ("the Banks") against various officers, directors, and employees of GC in connection with a series of loans extended to GC between August 17, 2001, and September 28, 2001, pursuant to a credit agreement entered into in August 2000 (the "Credit Agreement"). The Banks claim that GC made intentional and negligent misrepresentations to the Banks regarding the company's compliance with certain financial covenants in the Credit Agreement in order to mislead the Banks into continuing to extend the company credit. Plaintiffs seek $1.7 billion in damages. Defendants now move for dismissal of, or in the alternative, for summary judgment against, the plaintiffs' claims. For the reasons set forth below, the motion to dismiss will be granted in part; as to the remaining claims, the motion for summary judgment will be denied.
The relevant facts, which are drawn from the complaint except where otherwise noted, are as follows. On August 10, 2000, the Banks entered into a Credit Agreement with GC to extend a total of $2.25 billion of credit to GC, $1.7 billion of which was in the form of a credit facility (or line of credit) (the "Credit Facility") and the remainder of which was in the form of a term loan. Under the terms of the Credit Agreement, the Banks agreed to extend credit to GC up to the $1.7 billion limit provided in the Credit Facility, provided a GC officer certified that the company was in compliance with the covenants and the other terms of the Credit Agreement at the time of each borrowing. Failure to comply with the covenants in the agreement would result in a default, terminating GC's line of credit and causing all of its debt under the Credit Agreement (including the term loan and any amount extended under the Credit Facility) to come immediately due. Under the agreement, each loan request was "deemed" a "representation and warranty" by GC that no "event of default" had occurred. (See Jacobson Decl. Ex. A, Credit Agreement § 4.02.) The Banks also secured the right under the Credit Agreement to inspect GC's books and records "upon reasonable prior notice ... and as often as reasonably requested." (Id. § 5.07.)
Whether or not the company was in compliance with its covenants was to be determined in part by calculating its "Total Leverage Ratio," or the ratio of its debt to a specific measure of its earnings styled as "four-quarter trailing consolidated earnings before interest, taxes, depreciation and amortization" ("Consolidated EBITDA"). GC was required to maintain a Total Leverage Ratio below 4.75 during the relevant time period, meaning that GC's debt could not exceed 4.75 times its Consolidated EBITDA. Consolidated EBITDA, as defined in the Credit Agreement, included regular recurring income booked under Generally Accepted Accounting Principles ("GAAP"), as well as "deferred revenue," which consisted of income received that could not, in accordance with GAAP, be booked in the current accounting period. The use of Consolidated EBITDA as a measure was significant in that a main source of GC's revenue was sales of "indefeasible rights of use" ("IRU"), the right to use capacity on its fiber-optic network for a specified time period. Under GAAP, revenue from IRU sales could not be booked up front, but rather, had to be amortized over the life of the IRU. By including deferred revenue in Consolidated EBITDA, the company was able to report revenue from the IRU sales up front, thus increasing its total reported income and decreasing its Total Leverage Ratio.
The complaint alleges that following a slowdown in the telecommunications industry in late 2000 due to a glut of capacity on the market, GC began engaging in "improper reciprocal trades of IRUs with other distressed participants in the industry." (Compl.¶ 14.) These reciprocal transactions, or "swaps" of capacity, would typically involve a sale of capacity to another telecom provider in exchange for that provider's agreement to purchase capacity from GC of an equivalent stated value; each company would then be able to book the revenue from the sale. In fact, the complaint alleges, these transactions were "of little to no value to [GC]," as the capacity purchased was unnecessary and the income created by the sales was artificial; they were entered solely in order to create the appearance of revenue, to inflate the Consolidated EBITDA, and thus to meet the company's debt covenants and the financial expectations of the securities markets.
Reporting revenue from the improper swaps up front and including it in its Consolidated EBITDA successfully deceived the Banks into believing that GC was financially solvent, when in fact it was on the brink of financial collapse. "The artificial revenue became a significant enough portion of [GC's] Consolidated EBITDA to make the Defendants' certifications false" beginning with financial statements submitted at the end of the fourth quarter of 2000 (Compl.¶ 15), and allowed the company to continue to draw on its Credit Facility until it had reached the $1.7 billion maximum under the agreement at the end of September 2001. On the basis of GC's inclusion of revenue from swaps in its 2000 annual report on Form 10-K and in its quarterly reports for the first three quarters of 2001, the Banks now bring claims against defendants for intentional and negligent misrepresentation, as well as related claims of conspiracy and aiding and abetting. Defendants move for dismissal of all claims for failure to allege any actionable misrepresentations, and in the alternative, for summary judgment on grounds that the plaintiffs could not reasonably have relied on the defendants' misrepresentations.
On a motion to dismiss pursuant to Fed.R.Civ.P. 12(b)(6), the Court must accept as true all well-pleaded factual allegations in the complaint and view them in the light most favorable to the plaintiff, drawing all reasonable inferences in its favor. Leeds v. Meltz, 85 F.3d 51, 53 (2d Cir.1996). The Court will not dismiss a complaint for failure to state a claim "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim that would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). Beyond the facts in the complaint, the Court may consider "any written instrument attached to it as an exhibit or any statements or documents incorporated in it by reference." Cortec Indus., Inc. v. Sum Holding, L.P., 949 F.2d 42, 47 (2d Cir.1991).
The defendants' principal argument on their motion to dismiss plaintiffs' claims, and their sole argument on plaintiffs' fraud claims in particular, is that the plaintiffs have failed to allege any actionable misrepresentation on the part of the defendants. In order to state a claim for fraud under New York law, the plaintiff must allege that the defendant made a "material misrepresentation or omission of fact." Schlaifer Nance & Co. v. Estate of Andy Warhol, 119 F.3d 91, 98 (2d Cir.1997).1 Defendants claim that their forms 10-Q for the first and second quarters of 2001, which were provided to the Banks at the time the loans were sought, specifically and truthfully disclosed the existence of reciprocal swap transactions. (See D. Br. 7-8; Jacobson Decl. Ex. MM at 11, 16; OO at 21.)2 This should have put the Banks on notice "of the very information they claim not to have had when they made the loans," and should have "superseded whatever was said or was not said about such transactions" in the 2000 10-K. (D.Br.8.)
The defendants' arguments on this front are unconvincing, because disclosure of these transactions did not put the plaintiffs on notice of the underlying fraud. Plaintiffs do not claim that the defendants failed to disclose the existence of reciprocal capacity trades; indeed, as plaintiffs concede, the existence of such transactions was known to the Banks when they entered into the Credit Agreement in August 2000. (P. Opp.5.) Nor do they claim that reciprocal transactions are intrinsically improper: the Banks do not contest that, as the defendants have argued, such arrangements could serve the legitimate business purpose of allowing telecommunications companies to avoid unnecessary capital construction costs by engaging in mutual trades of capacity. Rather, the gravamen of plaintiffs' claim is that beginning in the fourth quarter of 2000, GC's transactions had no purpose other than to create the appearance of revenue. As such, they had no legitimate business justification, and GC's reporting of the revenue derived from them was inherently false and misleading. It is therefore immaterial that defendants' first and second...
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