Quadrant Structured Prods. Co. v. Vincent Vertin, Michael Sullivan, Patrick B. Gonzalez, Brandon Jundt, J. Eric Wagoner, Athilon Capital Corp.
| Decision Date | 20 October 2015 |
| Docket Number | C.A. No. 6990-VCL |
| Parties | QUADRANT STRUCTURED PRODUCTS COMPANY, LTD., Individually and Derivatively on behalf of Athilon Capital Corp., Plaintiff, v. VINCENT VERTIN, MICHAEL SULLIVAN, PATRICK B. GONZALEZ, BRANDON JUNDT, J. ERIC WAGONER, ATHILON CAPITAL CORP., ATHILON STRUCTURED INVESTMENT ADVISORS LLC, MERCED CAPITAL, L.P., MERCED PARTNERS LIMITED PARTNERSHIP, MERCED PARTNERS II, L.P., MERCED PARTNERS III, L.P., and HARRINGTON PARTNERS, L.P., Defendants. |
| Court | Court of Chancery of Delaware |
Catherine G. Dearlove, Russell C. Silberglied, Susan M. Hannigan, Matthew D. Perri, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Sabin Willett, Harold S. Horwich, Samuel R. Rowley, MORGAN, LEWIS & BOCKIUS LLP, Boston, Massachusetts; Attorneys for Plaintiff Quadrant Structured Products Company, Ltd.
Philip A. Rovner, Jonathan A. Choa, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Philippe Z. Selendy, David Elsberg, Sean P. Baldwin, Nicholas F. Joseph, Rollo C. Baker IV, QUINN EMANUEL URQUHART & SULLIVAN, LLP; New York, New York; Attorneys for Defendants Vincent Vertin, Michael Sullivan, Patrick B. Gonzalez, Brandon Jundt, J. Eric Wagoner, Athilon Capital Corp., and Athilon Structured Investment Advisors LLC.
Garrett B. Moritz, Eric D. Selden, ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; Philippe Z. Selendy, David Elsberg, Sean P. Baldwin, Nicholas F. Joseph, Rollo C. Baker IV, QUINN EMANUEL URQUHART & SULLIVAN, LLP; New York,New York; Attorneys for Defendants Merced Capital, L.P., Merced Partners Limited Partnership, Merced Partners II, L.P., Merced Partners III, L.P., and Harrington Partners, L.P.
LASTER, Vice Chancellor.
Defendant Athilon Capital Corporation ("Athilon" or the "Company") became insolvent under the balance sheet test during the financial crisis of 2008. The Company remained insolvent for some time. At least by summer 2014, however, Athilon had returned to solvency.
During the intervening period of insolvency, defendant Merced Capital, L.P. and its affiliates (together, "Merced") acquired 100% of Athilon's equity. Merced is an investment manager that sponsors private equity funds. Through four of its funds, Merced acquired all of Athilon's equity.1 Merced also purchased significant quantities of Athilon's publicly traded notes at deep discounts to their face value.
In a series of transactions that took place during 2011 and 2012, Athilon paid cash to purchase relatively illiquid securities from Merced. In January 2015, Athilon paid cash to purchase a sizeable block of notes from Merced. This post-trial decision addresses the challenges to those transactions.
The party challenging the transactions is plaintiff Quadrant Structured Products Company, Ltd. ("Quadrant"), an entity in the same business as Athilon. Like Merced, Quadrant purchased Athilon's publicly traded notes at deep discounts. Quadrant invested in the notes believing that Merced would dissolve Athilon and liquidate its assets. Although in liquidation Athilon's assets might not be sufficient to satisfy all of its creditors, it could pay off the senior notes in full and provide a meaningful recovery on the more junior notes. Creditors like Merced and Quadrant who had purchased the notes at discounted prices would reap healthy returns.
But Merced had other plans for Athilon. Merced recognized that under the terms of the indentures that governed Athilon's notes, Athilon was not obligated to dissolve and liquidate. Merced planned to continue operating Athilon, return the Company to solvency, and then generate returns for itself over time in its capacity as the holder of 100% of Athilon's equity. Generating returns for equity holders is the opposite of a fiduciary wrong; it is the purpose of a for-profit entity. See generally Leo E. Strine, Jr., The Dangers of Denial: The Need for a Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law, Wake Forest L. Rev. (forthcoming 2015).
Through this litigation, Quadrant sought initially to force Athilon to liquidate. Quadrant originally contended that Athilon only could engage in the defunct business of writing uncollateralized credit default swaps. Because that business was no longer viable, Quadrant contended that Athilon had to sit on its cash until its last swap rolled off, at which point the Company would be required to liquidate. After that claim was dismissed,Quadrant continued to press fraudulent transfer and breach of fiduciary duty claims challenging transactions between Athilon and Merced.2 During the litigation, Quadrant learned about Athilon's purchases of securities and notes from Merced. In April 2015, Quadrant filed a second amended and supplemental complaint (the "Supplemental Complaint") challenging those transactions.
Quadrant contended at trial that the repurchase of Merced's notes breached express covenants in the indenture governing the notes and also violated the implied covenant of good faith and fair dealing. Quadrant also contended that the repurchases of the notes constituted a fraudulent transfer. Relying on its status as a creditor of an insolvent company, Quadrant claimed derivatively that the repurchases of the notes and the securities constituted breaches of fiduciary duty by Merced and the individual defendants, who comprised Athilon's board of directors (the "Board").
This post-trial decision rejects Quadrant's claims.
A five-day trial took place on June 22-25 and 30, 2015. The parties submitted over 900 exhibits, called six fact witnesses and five expert witnesses, and lodged twenty-three depositions. The following facts were proven by a preponderance of the evidence.
Athilon was formed in 2004 by non-party Lightyear Capital LLC ("Lightyear"), a private equity firm. Athilon's executive team envisioned selling credit protection products in two markets: workers' compensation reinsurance and credit default swaps. The workers' compensation business never took off. The swap business did.
Through a wholly owned subsidiary, Athilon wrote uncollateralized credit default swaps on senior tranches of collateralized debt obligations. Athilon guaranteed the swaps that its subsidiary wrote. Athilon's original equity capital consisted of $100 million contributed by Lightyear. On the strength of its equity capital and business model, Athilon raised $600 million in long-term debt.
• In 2004, Athilon issued two series (A and B) of Subordinated Deferrable Interest Notes (the "Mezz Notes") in an aggregate principal amount of $150 million. The Mezz Notes will mature in 2045.
• In 2005, Athilon issued four series (A, B, C, and D) of Senior Subordinated Deferrable Interest Notes (the "Senior Notes") in an aggregate principal amount of $250 million. The Series A and B Senior Notes will mature in 2035 and the Series C and D Senior Notes will mature in 2045.
• In 2006, Athilon issued Junior Subordinated Deferrable Interest Notes (the "Junior Notes") in an aggregate principal amount of $50 million. They will mature in 2046.
• In 2007, Athilon issued a fifth series of Senior Notes (Series E) in an aggregate principal amount of $100 million, and a third series of Mezz Notes (Series C) with a face value of $50 million. They will mature in 2047.
In total, Athilon issued $350 million of Senior Notes, $200 million of Mezz Notes, and $50 million of Junior Notes (collectively, the "Notes"). All of the Notes were subordinate to Athilon's obligations on its swaps.
All of the Notes were issued pursuant to and are governed by indentures. The evidence at trial established that the indentures are borrower-friendly documents that contain relatively few covenants and other protective provisions. The pertinent indenture for the claims in this case is the one governing the Senior Notes (the "Senior Indenture").
The interest rates on the Senior Notes and the Mezz Notes were initially determined by auctions that occurred every twenty-eight days. The rates fluctuated slightly above LIBOR, much like commercial paper and other cash-like securities. In 2007, the auctions failed. Since then, the Senior Notes and the Mezz Notes have paid a contractually specified rate equal to one-month LIBOR plus 250 basis points (L+250). The Junior Notes initially paid interest at a fixed rate of 6.27% per annum. On November 15, 2013, the Junior Notes began paying three-month L+250. The evidence at trial established that these are low and borrower-friendly rates.
To write uncollateralized swaps, Athilon needed triple-A ratings from the two leading credit rating agencies, Moody's and Standard & Poor's ("S&P"). To obtain them, Athilon committed to conduct its business in accordance with operating guidelines approved by the agencies (the "Operating Guidelines"). Athilon's certificate of incorporation (the "Charter") mandated compliance with the Operating Guidelines.3
The Operating Guidelines restricted Athilon's business to guaranteeing swaps written by a triple-A rated subsidiary. The Operating Guidelines devoted eight pages to defining the criteria for and terms of the swaps that Athilon's subsidiary could write. See JX 13.0008-.0020. The Operating Guidelines also constrained the type of investments that Athilon could make. Generally they were limited to dollar-denominated investments of the highest credit quality, such as Treasury securities, money market funds, short-term repurchase agreements on Treasury securities, and short-term commercial paper. See JX 13.0038.
The Operating Guidelines defined a series of items as "Suspension Events," including if the counterparty credit ratings of Athilon or its subsidiary were downgraded below triple-A status. JX 13.0021-.0022. Once a Suspension Event occurred, then Athilon no longer could write new swaps until the Suspension Event was cured. If the Suspension Event persisted more...
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