Quadrant Structured Prods. Co. v. Vertin
| Decision Date | 07 November 2013 |
| Docket Number | No. 338, 2012.,338, 2012. |
| Citation | 106 A.3d 992 |
| Parties | QUADRANT STRUCTURED PRODUCTS CO., LTD., Individually and Derivatively on behalf of Athilon Capital Corp., Plaintiff Below, Appellant, v. Vincent VERTIN, Michael Sullivan, Patrick B. Gonzalez, Brandon Jundt, J. Eric Wagoner, Athilon Capital Corp., Athilon Structured Investment Advisors LLC, EBF & Associates, LP, Defendants Below, Appellees. |
| Court | United States State Supreme Court of Delaware |
Lisa A. Schmidt, Catherine G. Dearlove, and Russell C. Silberglied, Esquires, Richards, Layton & Finger, P.A., Wilmington, Delaware; Of Counsel: Harold S. Horwich, Sabin Willett (argued), and Samuel R. Rowley, Esquires, Bingham McCutchen LLP, Boston, Massachusetts, for Appellants.
Collins J. Seitz, Jr., Garrett B. Moritz, and Eric D. Selden, Esquires, Seitz Ross
Aronstam & Moritz LLP, Wilmington, Delaware; for Appellees EBF & Associates, LP.
Philip A. Rovner, Esquire, Potter Anderson & Corroon LLP, Wilmington, Delaware; Of Counsel: Philippe Z. Selendy, Nicholas F. Joseph (argued), and Sean P. Baldwin, Esquires, Quinn Emanuel Urquhart & Sullivan, LLP, New York, New York, for Appellees Athilon Capital Corp., Athilon Structured Investment Advisors LLC, Vincent Vertin, Michael Sullivan, Patrick B. Gonzalez, Brandon Jundt and J. Eric Wagoner.
Before HOLLAND, BERGER, JACOBS and RIDGELY, Justices, and SCOTT, Judge* constituting the Court en Banc.
Pending before this Court is an appeal from an order of the Delaware Court of Chancery dismissing a complaint. The plaintiff below, appellant, Quadrant Structured Products Company, Inc. (“Quadrant”), holds certain Notes issued by Athilon Capital Corp. (“Athilon”), an allegedly insolvent Delaware corporation. The Notes are long term obligations covered by two separate trust indentures that are governed by New York law. The defendants-below are EBF & Associates, LP (“EBF”), which indirectly owns 100% of Athilon's equity;1 Athilon Structured Investment Advisors (“ASIA”), an affiliated EBF entity, Athilon's board of directors, and (as a nominal defendant) Athilon.
In a two paragraph order issued on June 5, 2012, the Court of Chancery granted the defendants' motion to dismiss Quadrant's complaint, on the ground that all claims alleged therein were barred for failure to comply with the “no-action” clauses in the Athilon trust indentures. The dismissal order, a copy of which is attached to this Certificate as Exhibit A, cited two Court of Chancery decisions that the court found “directly on point”: Feldbaum v. McCrory Corp., 1992 WL 119095 (Del.Ch. June 1, 1992) and Lange v. Citibank, N.A., 2002 WL 2005728 (Del.Ch. Aug. 13, 2002). In both cited cases the Court of Chancery, applying New York law, held that those bondholder actions were barred by the no-action clauses of the respective trust indentures that governed the bonds at issue.
The plaintiff, Quadrant, appealed to this Court. By order dated February 12, 2013, this Court remanded the case to the Court of Chancery with directions to analyze the significance under New York law (if any) of the differences between the wording of the no-action clauses at issue in the two cited cases and in this Athilon case. A copy of this Court's remand order is attached to this Certificate as Exhibit B.
On June 20, 2013, the Court of Chancery, in a detailed and highly textured analysis of relevant New York case law, issued a Report on Remand, a copy of which is attached to this Certificate as Exhibit C. In its Report, the Court of Chancery held that: (i) “the language of the Athilon no-action clause distinguishes this case from Feldbaum and Lange, ” and (ii) the motion to dismiss should be denied except as to two (and part of a third) of the ten Counts of the Quadrant complaint. The matter was then returned to this Court, and was re-argued before us on October 23, 2013.
Section 500.27(a) of the Court of Appeals Rules of Practice authorizes certification of cases to the New York Court of Appeals “[w]henever it appears to ... a court of last resort of any other state that determinative questions of New York law are involved in a case pending before that court for which no controlling precedent of the Court of Appeals exists....”2 We have concluded that a resolution of the appeal before us depends on dispositive and unsettled questions of New York law that, in our view, are properly answered in the first instance by the New York Court of Appeals. Our reasons for so concluding are set forth below.
Athilon, a Delaware corporation, was formed in 2004 and (through a subsidiary) sold credit derivative products—in the form of “credit default swaps”4 covering senior tranches of collateralized debt obligations to large financial institutions. To finance those activities, Athilon raised (in addition to its initial equity capital) $600 million of debt capital consisting of $350 million in senior subordinated notes, $200 million in subordinated notes, and $50 million in junior notes (collectively, the “Notes”). The Notes are long term obligations covered by two separate indentures; one created in 2004 between Athilon and Deutsche Bank Trust Company Americas as Indenture Trustee; and the other, created in 2005 between Athilon and The Bank of New York, as Indenture Trustee. Because for present purposes the indentures are substantively identical, they are referred to singly as “the Indenture.”
Athilon's organizational documents limit its permissible lines of business to selling credit default swaps, and require compliance with strict operating guidelines. Those guidelines mandate that if a “Suspension Event”5 occurs and remains uncured, then Athilon must enter into “runoff” mode, meaning that Athilon cannot write new business and must pay off existing credit default swaps as they mature.
Before the financial crisis of 2008, Athilon underwrote over $50 billion in nominal credit default risk, but on a highly leveraged basis. Measured against Athilon's equity, Athilon's leverage ratio was a stratospheric 506:1. At that level, a 0.2% loss on the collateralized debt obligations covered by Athilon's credit default swaps would wipe out its equity cushion and render Athilon insolvent, at least on paper. Even so, the rating agencies gave Athilon “AAA/Aaa” counterparty credit ratings and investment grade debt credit ratings.
In 2008, Athilon found itself in distress and by the end of that year had lost its AAA/Aaa ratings. By 2010, Athilon had unwound two credit default swaps at a cost of approximately $370 million—more than three times Athilon's equity capital. By August 2010, Athilon no longer held any investment grade debt or counterparty credit ratings. Under its operating guidelines, Athilon entered permanent “runoff” mode.
With Athilon in distress, the trading prices of its debt securities fell precipitately. That enabled EBF to acquire a large position in the junior notes at a significant discount. In August 2010, EBF acquired control of 100% of Athilon's equity, and installed Athilon's current board of directors. Those directors, the complaint alleges, are dominated and controlled by EBF. Quadrant acquired its position in the Notes in May 2011, nine months after EBF took control.
In its complaint Quadrant alleges that as of September 30, 2011, Athilon's shareholders' equity, measured according to GAAP, stood at a negative $660 million. Quadrant alleges that Athilon is insolvent and has no prospect of returning to solvency, because it can only sell credit default swaps and because the market for that business has collapsed for enterprises, like Athilon, that hold no collateral.
At the heart of Quadrant's lawsuit is its claim that in these circumstances, a properly motivated board of directors would preserve Athilon's value for orderly liquidation in 2014, when the last credit default swap expires. The EBF board designees, however, are (according to Quadrant) pursuing strategies designed to benefit EBF and its affiliates at the expense of the remaining classes of Note holders. Specifically, the directors have caused Athilon to continue paying interest on the junior notes (which EBF holds), even though Athilon had a contractual right to defer those interest payments and those notes would receive nothing in an orderly liquidation. Athilon's directors also allegedly agreed to pay ASIA above-market fees to manage Athilon's day-to-day operations. The Court of Chancery characterized Quadrant's claim thusly:
Together, the EBF designees and ASIA have embarked on a high-risk investment strategy, contrary to the terms of Athilon's governing documents, that amounts to a “heads EBF wins, tails everyone else loses” bet. If the high-risk investments succeed, then the underwater Junior Notes and equity will benefit. If the investments fail, then the more senior tranches of Notes will bear the loss.”6
In October 2011, Quadrant filed this Court of Chancery action against EBF and its affiliates and against Athilon and its officers and directors. As amended, the complaint contained ten Counts. For present purposes, the relevant fact is that only two of those Counts—Counts VII and VIII—and part of a third, Count X, seek to enforce rights under the Indenture.7 The balance of Quadrant's claims for relief are based on either Delaware fiduciary or statutory law.
The circumstances out of which the questions of New York law arise are as follows: The basis of the defendant's motion to dismiss the complaint was (and is) that all of the claims asserted in Quadrant's complaint are barred by the no-action clause of the Indenture, which is governed by New York law. The no-action clause pertinently provides that:
No holder of any Security shall have any right by virtue or by availing of any provision of this Indenture to institute any action or proceeding at law or in equity or in bankruptcy or otherwise upon or under or with respect to this Indenture,...
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