One William St. Capital Mgmt., LP. v. Educ. Loan Trust IV

• Decision Date: 14 August 2013
• Docket Number: Index No. 652274/2012,Motion Seq. No. 001, 002, 003, 004
• Citation: 2013 NY Slip Op 31977
• Parties: ONE WILLIAM STREET CAPITAL MANAGEMENT, LP., Petitioner, v. EDUCATION LOAN TRUST IV, et al, Respondents.
• Court: New York Supreme Court

2013 NY Slip Op 31977

ONE WILLIAM STREET CAPITAL MANAGEMENT, LP., Petitioner, v. EDUCATION LOAN TRUST IV, et al, Respondents.

Index No. 652274/2012

Motion Seq. No. 001, 002, 003, 004

SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK: IAS PART 3

Motion Date: December 11, 2012

Dated: August 14, 2013

Eileen Bransten, J.:

Motion sequence numbers 001, 002,003 and 004 are consolidated for disposition.

This is an action/special proceeding by plaintiff/petitioner One William Street Capital Management L.P. ("OWS") seeking: (a) the payment of overdue principal and interest on $10 million of notes issued by respondent U.S. Education Loan Trust IV, LLC ("ELT") pursuant to an indenture; (b) an accounting; (c) a determination of OWS's rights under a trust; and, alternatively, (d) damages.

In motion sequence 001, OWS seeks judgment on the first cause of action in the petition, for payment of overdue principal and interest. The remaining motions are motions to dismiss brought by various respondents. In motion sequence 002, ELT moves, pursuant to CPLR 3211(a)(1), (3) and (7), for an order dismissing the petition. OWS cross-moves for leave to amend the petition.

Respondents Kildare Capital, Inc. ("Kildare") (motion sequence 003), as well as The Bank of New York ("BONY") and Education Loan Trust IV (the "Trust") (motion sequence 004), likewise seek dismissal of the petition pursuant to CPLR 3211(a)(7).

I. Background

Petitioner alleges that it is the owner of $10 million worth of Series 2007-1B-1 Notes (Notes), which are backed by government-guaranteed student loans. The Notes were originally issued on October 19, 2007 by ELT, as Issuer, pursuant to an indenture and a supplemental indenture (together, "Indenture"). The Notes were part of a total of $30 million worth of Notes issued by ELT. OWS purchased its Notes in January of 2011. The remaining notes are owned by non-party Merrill, Lynch, Pierce, Fenner & Smith ("Merrill").

At the time of issue, the Notes were "Reset Rate Notes," which, under the Indenture, means their interest rate reset quarterly during a "Floating Rate Term," which ended on November 30, 2008. As Reset Rate Notes, the Notes paid interest of three-month LIBOR plus 1.50%. LIBOR is a published reference indicating the average interest rate that certain leading banks in London charge when lending to other banks.

Petitioner alleges that, on December 1, 2008, the Notes automatically converted to "Auction Rate Notes." This meant that, starting on that date, ELT, as the issuer, andBONY, as the auction agent, were required to hold auctions every 28 days, to set the interest rate for the Notes.

The auction procedure required the auction agent to compare the bids of buyers, who specified the price they would pay for the Notes, and sellers, who specified the price at which they would sell. The result would be either a successful auction, an "all-hold" auction, or a failed auction. An all-hold auction was one in which there were no sellers and the Notes would bear a rate equal to 90% of one-month LIBOR. (Petition ¶ 70.)

Petitioner states that no such auctions were held in the first two auction periods, or, in fact, for over two years thereafter. It alleges that the auctions were not held because "the credit markets had seized up." (Petition ¶ 2.)

According to the petition, once the first two auction periods passed without an auction, the Notes had to be redeemed as soon as the Trust had funds available and, in the interim, had to bear interest at a rate of one-month LIBOR plus 2.50% until redeemed or until a successful auction at which there were sufficient closing bids.

Petitioner states that, contrary to the terms of the Indenture, ELT and BONY failed to provide timely notice of the conversion to Auction Rate Notes, failed to redeem the Notes after the first two missed auctions, failed to pay interest at the rate of one-month LIBOR plus 2.50%, and failed to provide notice to the noteholders of these any other defaults. (Petition ¶ 3.)

OWS states that it purchased its Notes in January 2011 because it had examined a prospectus and other information and concluded that the Indenture required a payment at the rate of one-month LIBOR plus 2.50%, despite the fact that the Notes appeared to be paying at LIBOR plus 1.50%. It further states that it contacted ELT, which allegedly stated that the Notes were supposed to pay one-month LIBOR plus 2.50% and that the discrepancy was being corrected. OWS alleges that it was not informed that the Notes should have been redeemed years earlier, or that ELT was in default on the timely payment of principal and/or interest under the Indenture.

OWS states that, in April, 2011, BONY recomputed the interest at one-month LIBOR plus 2.50%, but took no action to redeem the Notes. Thereafter, in June, BONY began conducting auctions. However, OWS asserts that ELT, BONY and Kildare, who was the broker-dealer hired by BONY to generate interest in auctions of the Notes, all failed to notify OWS or Merrill about the auctions. As such, because OWS and Merrill were the only owners of the Notes, there were no sellers.

The petition alleges that the result was an "all hold" auction, which lowered the interest rate from one-month LIBOR plus 2.50% to 90% of LIBOR, equivalent to less than 0.20%. Thereafter, ELT allegedly asserted that the Notes were "capped" at the net loan rate, set forth in the Indenture, which is computed by subtracting certain administrative fees from the Trust's interest income and dividing the net amount by thetotal value of the Trust's assets. OWS states that ELT has taken the position that the net loan rate is zero, meaning that administrative fees are so high that they exceed the revenues the Trust receives from the underlying government-guaranteed student loans.

In June 2012, petitioner commenced this hybrid special proceeding/action, pursuant to article 77 of the CPLR. The petition sets forth causes of action for: 1) payment of principal and interest; 2) an accounting; 3) a declaratory judgment; 4) equitable estoppel; 5) breach of the covenant of good faith and fair dealing; 6) breach of fiduciary duty; 7) aiding and abetting breach of fiduciary duty; and 8) negligent misrepresentation.

First, OWS seeks to require ELT and BONY to redeem the Notes at par and to pay interest at the rate of one-month LIBOR plus 2.50%. Alternatively, it argues that ELT should be equitably estopped from denying that it owes interest at the rate of one-month LIBOR plus 2.50% or it should pay damages for breach of the covenant of good faith and fair dealing. In the third alternative, it argues that it is entitled to tort damages for BONY's breaches of its fiduciary duty, ELT's and Kildare's aiding and abetting of that breach, and for ELT's negligent misrepresentations.

II. Leave to Amend

In motion sequence 002, petitioner moves for leave to amend the petition. Petitioner seeks to add two new petitioners, The Depository Trust Company ("DTC") and Cede & Co. ("Cede"). According to the proposed amended petition, DTC is a is a securities depository and clearing agency, registered with the Securities and Exchange Commission, for the settlement of trades in corporate and municipal securities on behalf of the financial institutions that constitute its Participants. Cede is DTC's nominee and is the record owner of the Notes beneficially owned by OWS.

The proposed amended petition also seeks to add two respondents, U.S. Education Servicing LLC ("Servicing") and Dr. Henry Howard. Servicing is the master servicer for the loans issued by the Trust and the administrator for the Trust and the Issuer. Dr. Howard is the Chairman, President and Chief Executive Officer of ELT, and the principal of Servicing.

The proposed amended petition asserts three new causes of action: 1) fraud against ELT, Dr. Howard and Servicing; 2) fraudulent conveyance against ELT; and (3) surcharge against BONY. It additionally asserts a claim for punitive damages. In addition, the proposed amended petition adds numerous pages of additional facts in support of both the new causes of action and the causes of action in the original petition. It also deletes many factual allegations set forth in the original petition.

It is well-established that leave to amend pleadings under CPLR 3025(b) should be freely given, absent prejudice or surprise resulting directly from the delay. See McGhee v. Odell, 96 A.D.3d 449, 450 (1st Dep't 2012). "On a motion for leave to amend a pleading, movant need not establish the merit of the proposed new allegations, but must 'simply show that the proffered amendment is not palpably insufficient or clearly devoid of merit.'" Miller v. Cohen, 93 A.D.3d 424, 425 (1st Dep't 2012) (quoting MBIA Ins. Corp. v. Greystone & Co., Inc., 74 A.D.3d 499, 500 (1st Dep't 2010)).

"A determination whether to grant such leave is within the Supreme Court's broad discretion, and the exercise of that discretion will not be lightly disturbed." Aurora Loan Serv., LLC v. Dimura, 104 A.D.3d 796, 796-797 (2d Dep't 2013) (internal citation and quotation marks omitted). "A party opposing leave to amend 'must overcome a heavy presumption of validity in favor of [permitting amendment].'" McGhee v. Odell, 96 A.D.3d at 450 (quoting Otis El Co. v. 1166 Ave. of Am. Condo., 166 A.D.2d 307, 307 (1st Dep't 1990).

Here, none of the respondents argues that any prejudice would arise from an amendment to the petition. Therefore, the motion to amend is granted, except as to certain causes of action, set forth below, which are without merit.

A. Payment of Principal and Interest

The first cause of action seeks payment of principal and interest on the Notes under the terms of the Indenture. As described above, OWS alleges that it is entitled to such payments given the failure to hold auctions as required under the terms of the Indenture. Based on such allegations, OWS has demonstrated that the proposed first cause of action is not palpably insufficient or devoid of...