Landesbank v. Aladdin Capital Mgmt. LLC

• Citation: 692 F.3d 42
• Decision Date: 06 August 2012
• Docket Number: Docket No. 11–4306–cv.
• Parties: BAYERISCHE LANDESBANK, NEW YORK BRANCH and Bayerische Landesbank, Plaintiffs–Appellants, v. ALADDIN CAPITAL MANAGEMENT LLC, Defendant–Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

692 F.3d 42

BAYERISCHE LANDESBANK, NEW YORK BRANCH and Bayerische Landesbank, Plaintiffs–Appellants,

v.ALADDIN CAPITAL MANAGEMENT LLC, Defendant–Appellee.

Docket No. 11–4306–cv.

United States Court of Appeals,Second Circuit.

Argued: March 12, 2012.

Decided: Aug. 6, 2012.

David Spears (Jason Mogel, Laurie Faxon Richardson, on the brief), Spears & Imes LLP, New York, N.Y., for Plaintiffs–Appellants.

Jason M. Halper (Lambrina Mathews, on the brief), Cadwalader, Wickersham & Taft LLP, New York, N.Y., for Defendant–Appellee.

Before: LIVINGSTON and LOHIER, Circuit Judges, and RAKOFF, District Judge.^*

RAKOFF, District Judge.

In this case, we are called on to determine whether an investor in a special investment vehicle—a synthetic collateralized debt obligation (“CDO”) that sold interests in a credit default swap—can bring an action against the manager of the investment portfolio for the loss of its investment where the investor was not a party to the contract that defined the manager's role and duties.

Plaintiffs–Appellants Bayerische Landesbank (“Bayerische”) and Bayerische Landesbank New York Branch filed this action against Defendant–Appellee Aladdin Capital Management LLC (“Aladdin”) for breach of contract and gross negligence based on Aladdin's alleged disregard of its obligation to manage the portfolio in favor of the investors. Aladdin's purportedly gross mis-management allegedly caused plaintiffs to lose their entire $60 million investment in the CDO. On January 31, 2011, plaintiff Bayerische Landesbank, New York Branch filed its original Complaint in the United States District Court for the Southern District of New York seeking to recover damages for the loss of its investment, and later filed an Amended Complaint joining its parent, Bayerische Landesbank, as co-plaintiff. Aladdin moved to dismiss the Amended Complaint, and, by Order dated July 8, 2011, the district court granted the motion. The district court held that, because of a provision of the contract limiting intended third-party beneficiaries to those “specifically provided herein,” plaintiffs could not bring a third-party beneficiary breach of contract claim, and held also that plaintiffs could not “recast” their failed contract claim in tort. For the reasons described below, however, we conclude that plaintiffs have properly alleged both a breach of contract claim and a tort claim.

FACTUAL ALLEGATIONS

The pertinent allegations in plaintiffs' Amended Complaint, together with those “documents ... incorporated in it by reference” and “matters of which judicial notice may be taken,” Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir.2002) (internal quotation marks omitted), are as follows:

Plaintiff Bayerische Landesbank is a publically regulated bank incorporated in Germany with its principal place of business in Munich, Germany. Co-plaintiff Bayerische Landesbank, New York Branch is the New York branch of Bayerische Landesbank and is a federally chartered bank licensed by the United States Office of the Comptroller of the Currency. Defendant Aladdin is a Delaware limited liability company with its principal place of business in Stamford, Connecticut. Aladdin is a registered investment adviser under the Investment Advisers Act of 1940, and is a subsidiary of Aladdin Capital Holdings LLC (“ACH”), an investment bank.

In December 2006, plaintiffs invested $60 million in a collateralized debt obligation structured and marketed by defendant Aladdin and by non-parties Goldman Sachs & Co. and Goldman Sachs International (collectively, “Goldman Sachs”). A CDO is a financial instrument that sells interests (here in the form of “Notes”) to investors and pays the investors based on the performance of the underlying asset held by the CDO. The CDO at issue in this case, called the Aladdin Synthetic CDO II (“Aladdin CDO”) was a “synthetic” CDO, meaning that the asset it held for its investors was not a traditional asset like a stock or bond, but was instead a derivative instrument, i.e., an instrument whose value was determined in reference to still other assets. The derivative instrument the Aladdin CDO held was a “credit default swap” entered into between the Aladdin CDO and Goldman Sachs Capital Markets, L.P. (“GSCM”) based on the debt of approximately one hundred corporate entities and sovereign states that were referred to as the “Reference Entities” and comprised the “Reference Portfolio.”

A credit default swap (“CDS”) is a financial derivative that allows counterparties to buy and sell financial protection for the creditworthiness of specific corporations or sovereign entities, here the Reference Entities. A counterparty taking the position that the Reference Entities would not experience a “Credit Event”—such as bankruptcy, default, restructuring, or failure to pay a defined obligation—is said to be the “protection seller,” similar to an insurance underwriter. A counterparty taking the position that the Reference Entities would experience a Credit Event is the “protection buyer,” similar to an individual purchasing insurance. A credit default swap differs from traditional insurance in that the protection buyer need not actually own the underlying asset or security in order to purchase protection on it. More to the point, the protection seller is, in effect, taking a long position and betting that there will be no Credit Event, while the protection buyer is taking a short position and betting that there will be a Credit Event.

Here, Aladdin and Goldman Sachs created a shell entity, the “Issuer” of the Aladdin CDO, to serve as the protection seller, while GSCM served as the protection buyer. Thus, GSCM was to pay premiums to the Issuer in order to purchase protection against the occurrence of a Credit Event. The Issuer was also authorized to establish a separate “short” Reference Portfolio, which would reverse the counterparties' positions— i.e. the Issuer would be the protection buyer and GSCM would be the protection seller.

Since the Issuer was just a shell entity, Aladdin and Goldman Sachs, in order to fund the CDO and have money available to pay GSCM in the event of a Credit Event, marketed interests in the CDO to investors in the form of Notes. The Notes were formally issued by the Issuer, Aladdin Synthetic CDO II SPC, and the Co–Issuer, Aladdin Synthetic CDO II (Delaware) LLC, which are limited liability companies incorporated under the laws of the Cayman Islands and Delaware, respectively. Aladdin, as “Portfolio Manager,” used the money received from investors who purchased the Notes to purchase interest-yielding securities that, together with the payment of premiums by GSCM, were intended to pay quarterly interest payments to Noteholders until the CDO matured in December 2013, when the principal would be returned to the Noteholders. The principal that investors paid to purchase the Notes was available to cover payments to GSCM as the protection buyer if there were a Credit Event.

The Issuer split the Notes into separate Series, each with different levels of risk and return. Each Series of Notes had a specific level of risk, or “subordination,” that protected each Series of Notes against possible losses to the invested principal. For each Series issued, a separate “Indenture” spelled out the relationship between the Noteholders of that Series and the CDO. If a Reference Entity in the Reference Portfolio ( i.e., the securities underlying the CDS) suffered a Credit Event, GSCM would reduce the level of subordination for the affected Series by a certain percentage amount, depending on the weight of the relevant Reference Entity in the Reference Portfolio. The plaintiffs here purchased Notes in both Series B–1 and Series C–1. The level of subordination for plaintiffs' Series B–1 Notes was 5.15% and the level of subordination for the Series C–1 Notes was 4.65%.

The structure of the CDS entered into by the Issuer and GSCM allowed the Issuer to change the composition of the overall Reference Portfolio by trading Reference Entities into or out of the Reference Portfolio. This trading also affected the level of subordination. If the Issuer replaced a low-risk Reference Entity (reflected by a smaller “spread” or insurance premium) with a higher-risk Reference Entity (reflected by a larger spread), that would increase the level of subordination for the Noteholders, and vice versa.

If the level of subordination for a Series went more than 1% below zero, the entire amount invested by the Noteholders in that Series would go to GSCM, and the Notes would become worthless and no longer deliver interest payments. Plaintiffs allege that the Series they invested in could sustain Credit Events with respect to approximately ten or eleven Reference Entities before their subordination levels fell to more than 1% below zero. Additionally, if Aladdin purchased protection for Reference Entities through the short portfolio, the Noteholders' subordination levels would be increased if those short Reference Entities experienced a Credit Event. Thus, the financial interests of GSCM and the Noteholders were adverse.

Since the Issuer was just a shell entity, the Noteholders needed someone to manage the Reference Portfolio, and, according to plaintiffs, protect the Noteholders by minimizing the occurrence of losses and avoiding Credit Events. Here, Goldman Sachs and Aladdin structured the CDO so that Aladdin would manage the CDO as an independent investment manager on behalf of the Noteholders.

Plaintiffs allege that they purchased their Notes in the Aladdin CDO after Aladdin and Goldman Sachs came to the offices of Bayerische's New York branch to present marketing materials regarding the then-proposed Aladdin CDO and to solicit plaintiffs' investment. In the marketing book defendant provided to plaintiffs, defendant Aladdin allegedly represented that its interests were aligned with the Noteholders' interests and that it would manage the Reference Portfolio...