Official Comm. Unsecured Creditors v. Investcorp

• Decision Date: 18 November 1999
• Docket Number: No. 97 CIV. 9261(MGC).,97 CIV. 9261(MGC).
• Citation: 80 F.Supp.2d 129
• Parties: OFFICIAL COMMITTEE OF the UNSECURED CREDITORS OF COLOR TILE, INC., Plaintiff, v. INVESTCORP S.A., Investcorp International Inc., CIP Limited, Corporate Equity Limited, Acquisition Equity Limited, Funding Equity Limited, Planning Equity Limited, Elias N. Hallack, Nemir A. Kirdar, Michael L. Merritt, Paul W. Soldatos, Jon P. Hedley, Charles J. Philippin, E. Garrett Bewkes, III, Walter F. Loeb, Coopers & Lybrand, L.L.P., Investcorp Bank, E.C., ABF Acquisition Corp., Investcorp Holdings Limited, Window Investments Limited, Shades International Limited, Shades Investments Limited, Blinds Equity Limited, Blinds Holdings Limited, AIBC Investcorp Finance B.V., Investcorp Investment Holdings Limited, Acquisition Capital Limited, Corporate Capital Limited, Funding Capital Limited, and Planning Capital Limited, Defendants.
• Court: U.S. District Court — Southern District of New York

80 F.Supp.2d 129

OFFICIAL COMMITTEE OF the UNSECURED CREDITORS OF COLOR TILE, INC., Plaintiff, v. INVESTCORP S.A., Investcorp International Inc., CIP Limited, Corporate Equity Limited, Acquisition Equity Limited, Funding Equity Limited, Planning Equity Limited, Elias N. Hallack, Nemir A. Kirdar, Michael L. Merritt, Paul W. Soldatos, Jon P. Hedley, Charles J. Philippin, E. Garrett Bewkes, III, Walter F. Loeb, Coopers & Lybrand, L.L.P., Investcorp Bank, E.C., ABF Acquisition Corp., Investcorp Holdings Limited, Window Investments Limited, Shades International Limited, Shades Investments Limited, Blinds Equity Limited, Blinds Holdings Limited, AIBC Investcorp Finance B.V., Investcorp Investment Holdings Limited, Acquisition Capital Limited, Corporate Capital Limited, Funding Capital Limited, and Planning Capital Limited, Defendants.

No. 97 CIV. 9261(MGC).

United States District Court, S.D. New York.

November 18, 1999.

COPYRIGHT MATERIAL OMITTED

Kaye, Scholer, Fierman, Hays & Handler, LLP, New York City by Peter M. Fishbein, Juan C. Ordonez, Michael A. Lynn, Jane W. Parver, for Plaintiff.

Hughes Hubbard & Reed LLP, New York City by William R. Maguire, Robert J. Sisk, Claudia G. McMullin, for Defendant Coopers & Lybrand L.L.P.

OPINION

CEDARBAUM, District Judge.

The plaintiff is the Official Committee of Unsecured Creditors of Color Tile, Inc. (the "Committee") which was appointed in the 1996 bankruptcies of Color Tile, Inc. ("Color Tile") and Color Tile Holdings, Inc. ("CT Holdings"). The Committee is empowered to prosecute certain claims, including the claims in this action, on behalf of the estates of Color Tile and CT Holdings, the Unsecured Creditors' Trust, and the Consumer Deposit Trust pursuant to an Order of the United States Bankruptcy Court for the District of Delaware approving the Global Settlement Agreement dated September 17, 1997 (the "Settlement").

The Committee, standing in the shoes of Color Tile, sues Coopers & Lybrand ("Coopers") for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and breach of contract in connection with a transaction that Color Tile completed in 1993 (the "1993 Transaction"). In addition, the Committee sues Coopers for negligence after the 1993 Transaction in performing the 1994 and 1995 annual audits of Color Tile's financial statements.¹

On July 31, 1998, I granted Coopers' motion to dismiss the Amended and Consolidated Complaint against it on grounds that it alleged that all the decision-makers for Color Tile were involved in the alleged malfeasance surrounding the 1993 Transaction, and that, under New York law, their knowledge of the negative financial aspects of the 1993 Transaction was imputed to Color Tile, stripping Color Tile (and the Committee on behalf of the Color Tile estate) of standing to sue Coopers for not informing Color Tile that the 1993 Transaction would probably have negative financial results.

In an effort to keep Coopers in the case, the Committee has filed the Second Amended and Consolidated Complaint (the "Complaint") which adds new allegations in paragraphs 76 through 82 that Color Tile's three management directors, who sat on Color Tile's board of directors in 1993, were ignorant of Coopers' negative conclusions about the 1993 Transaction, and that, had Coopers made full disclosure to them, the 1993 Transaction would not have been carried out. The Committee argues that the new allegations about the management directors are sufficient to prevent the imputation of the guilty knowledge of Color Tile's board of directors and controlling shareholder group from being imputed to Color Tile itself.

The Complaint is unchanged with respect to the allegations that Coopers performed the 1994 and 1995 audits negligently.

Coopers, reciting the same arguments that it made in support of its prior motion, moves to dismiss the Complaint pursuant to Fed.R.Civ.P. 12(b)(1) and 12(b)(6) for lack of standing and failure to state a claim for which relief may be granted. On June 30, 1999, the parties were directed to supplement the motion papers with briefs on the issue of which state's law New York courts would choose to apply to the Committee's claims against Coopers. For the reasons that follow, Coopers' motion to dismiss is granted.

BACKGROUND

The Complaint alleges the following facts.

Until it ceased doing business, Color Tile, a Delaware corporation headquartered in Fort Worth, Texas, was the largest specialty retailer of floor covering products in North America. In 1989, Investcorp S.A. and affiliated entities and individuals referred to in the Complaint as the "Investcorp Group" acquired Color Tile. The Investcorp Group formed a holding company, CT Holdings, to hold all the common stock of Color Tile. Through CT Holdings, the Investcorp Group exercised control over the management and operations of Color Tile and had the power to vote all of the common stock of Color Tile and to elect all of the directors of Color Tile. The management of Color Tile owned nonvoting stock in CT Holdings. Entities not affiliated with the Investcorp Group owned two classes of preferred stock in Color Tile.

At least as early as 1992, the Investcorp Group began preparing for a future public equity offering for the purpose of cashing out its interest in Color Tile. In 1993, the Investcorp Group determined that in order to effectuate a satisfactory public offering, Color Tile had to increase the multiple of its earnings by acquiring a high growth company. The Investcorp Group decided that Color Tile would acquire the assets (the "ABF Assets") of American Blind Factory, Inc., a Michigan-based business that sold blinds and wallpaper. The Investcorp Group dictated the price that Color Tile paid ABF Acquisition for the ABF Assets. This purchase price was more than twice the fair value of the ABF Assets. To undertake the purchase, Color Tile was forced by the Investcorp Group to issue $200 million of Senior Notes, the proceeds of which were used to pay for the ABF Assets and to replace lower interest bank debt. "The Investcorp Group forced Color Tile to acquire the ABF Assets at a grossly inflated price and to issue $200 million of expensive junk bond debt in order to further its own objective of cashing out its investment in Color Tile despite the fact that the [1993] Transaction was detrimental to Color Tile." (Compl. ¶ 50.) "To justify the purchase of the ABF Assets and the financing, the Investcorp Group used highly unrealistic projections of Color Tile's and ABF's sales and EBITDA growth." (Id.)

The 1993 Transaction was one in which the Investcorp Group was "interested," since an Investcorp affiliate, ABF Acquisition, sold the assets to Color Tile, the Investcorp Group received over $4 million in fees for arranging the 1993 Transaction, and the Investcorp Group used the 1993 Transaction to further its own exit strategy at the risk of the company's very viability and to the detriment of Color Tile's preferred stockholders.

At the time of the 1993 Transaction in December 1993, Color Tile had a five member board. Two of its directors, Paul W. Soldatos and Walter F. Loeb, were "Investcorp affiliated," because they worked for the Investcorp Group in capacities other than as Color Tile directors. The remaining three directors, however, had no interest in the Investcorp Group other than through their work as directors and managers of Color Tile (the "Management Directors"). They were the CEO, CFO, and President of Color Tile.

Beginning in 1990, Coopers served as Color Tile's financial advisor, consultant, due diligence advisor, accountant and auditor. It served in these capacities over a period of more than six years. In the course of the relationship, Coopers became intimately familiar with Color Tile's finances and financial condition, including its budgeting process and the reliability of its projections.

Coopers performed several accounting functions in connection with the 1993 Transaction. It reviewed Color Tile's operations for the nine months ended October 3, 1993, reaffirmed its audit results for Color Tile, and participated in the drafting of the prospectus and registration statement for the $200 million Senior Notes Offering. In addition, Coopers reviewed, analyzed and reported on the financial position of the target, ABF. Coopers performed the vast majority of Color Tile's due diligence of ABF; this due diligence gave Coopers knowledge about ABF and its future prospects which was superior to that of Color Tile's management. Coopers was also retained to review and report on the future performance projections of ABF, Color Tile, and the combined Color Tile-ABF entity. Because of its substantial knowledge of the operating and financial condition of both Color Tile and ABF, Coopers was in a superior position to understand and evaluate whether the projected operating results for the companies, on which the success of the 1993 Transaction relied, were reasonable and attainable.

Through its due diligence and financial accounting work, Coopers learned that the projections used to substantiate the 1993 Transaction were unrealistic and based on unreasonable assumptions. Coopers knew that, because the financial projections bore no resemblance to the actual performance of the two companies, there was a grave risk that Color Tile would be unable to meet its obligations as they became due and to operate the business in a competitive fashion after the 1993 Transaction. The Complaint refers to this knowledge as Coopers' "Negative Conclusions."

Further, Coopers "came to realize and know that the 1993 Transaction was being forced on Color Tile by the Investcorp Group for the interests of the Investcorp Group and was detrimental to the interests of Color Tile." (Id. ¶ 160.) Coopers knew that Color Tile's controlling shareholder group and Soldatos and Loeb "were breaching their fiduciary duties in forcing the 1993 Transaction upon Color Tile, which [Coopers]...