Quadrant Structured Prods. Co. v. Vertin

• Decision Date: 20 June 2013
• 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, and EBF & ASSOCIATES, LP, Defendants.
• Court: Court of Chancery of Delaware

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, andEBF & ASSOCIATES, LP, Defendants.

C.A. No. 6990-VCL

COURT OF CHANCERY OF THE STATE OF DELAWARE

Date Submitted: March 22, 2013

Date Decided: June 20, 2013

REPORT PURSUANT TO

DELAWARE SUPREME COURT RULE 19(c)

Lisa A. Schmidt, Catherine G. Dearlove, Russell C. Silberglied, Cory D. Kandestin, Robert L. Burns, Susan M. Hannigan, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Harold S. Horwich, P. Sabin Willett, Samuel R. Rowley, BINGHAM McCUTCHEN 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, Nicholas F. Joseph, Sean P. Baldwin, 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.

Collins J. Seitz, Jr., Garrett B. Moritz, Eric D. Selden, SEITZ ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; Attorneys for Defendant EBF & Associates, LP.

LASTER, Vice Chancellor.

Plaintiff Quadrant Structured Products Company, Ltd. ("Quadrant") owns notes issued by defendant Athilon Capital Corp. ("Athilon"). Before filing this lawsuit, Quadrant did not comply with the no-action clauses in the indentures governing its notes. The defendants moved to dismiss on that basis, and Quadrant responded with arguments that this Court rejected in 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). At the time, Quadrant did not distinguish the language of the Athilon no-action clause from the clause at issue in Feldbaum and Lange. I granted the motion, observing that Feldbaum and Lange were "directly on point."

On appeal, Quadrant argued that the Athilon clause differs critically from the Feldbaum/Lange clause because the former refers only to claims under the indenture, but the latter referred to both the indenture and the notes. By order dated February 12, 2013, the Delaware Supreme Court directed me "to issue an opinion analyzing the significance (if any) under New York law of the differences between the no-action clauses."

For the reasons set forth herein, Quadrant has persuaded me that the language of the Athilon no-action clause distinguishes this case from Feldbaum and Lange. Had Quadrant previously made this argument, I would have relied on the no-action clause to dismiss only Counts VII-VIII and part of Count X, and then reached the defendants' other grounds for dismissing the remaining counts.

I. FACTUAL BACKGROUND

The facts are drawn from Quadrant's verified amended complaint (the "Complaint" or "CC") and the documents it incorporates by reference, including (i) an indenture dated as of December 21, 2004, between Athilon and Deutsche Bank Trust Company Americas, as Trustee, governing the Subordinated Deferrable Interest Notes, Series A and B, and (ii) an indenture dated as of July 26, 2005, between Athilon and The Bank of New York, as Trustee, governing the Senior Subordinated Deferrable Interest Notes, Series A, B, C and D. For present purposes, the indentures are substantively identical, so I refer to them singly as the "Indenture." Quotations are from the 2004 indenture.

A. Athilon's Corporate Structure And Business Model

Athilon is a Delaware corporation with its principal place of business in New York, New York. Athilon and its wholly owned subsidiary, Athilon Asset Acceptance Corp. (jointly, the "Companies"), were formed in 2004 to sell credit default swaps to financial institutions. Through its subsidiary, Athilon wrote credit default swaps covering senior tranches of collateralized debt obligations. At the parent level, Athilon guaranteed the swaps.

Athilon was financed originally with $100 million of equity capital. It raised another $600 million of debt capital, comprising $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 that will mature, depending upon the series, in 2035, 2045, or 2047. Interest payments on the Notes are deferrable for up tofive years at Athilon's option. All of the Notes rank in priority below Athilon's credit default swap obligations.

The Companies' organizational documents limit their permissible lines of business to selling credit default swaps and require compliance with strict operating guidelines. The Companies only can invest in high quality securities of short duration, and their portfolios must be sufficient at all times to cover any credit default swaps and the Notes. The guidelines mandate that if a "Suspension Event" occurs and remains uncured, then the Companies must enter "runoff" mode. When in that status, the Companies cannot write new business and must pay off existing credit default swaps as they mature.

B. The Business Model Fails.

Before the financial crisis of 2008, market participants discounted the risks faced by credit derivative product companies, enabling Athilon to underwrite over $50 billion in nominal credit default risk. Measured against its $700 million in committed capital, Athilon operated with a vertiginous leverage ratio of 71:1. 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. The rating agencies gave the Companies "AAA/Aaa" debt ratings and investment grade counterparty credit ratings.

In 2008, the Companies found themselves in distress, and they lost their AAA/Aaa ratings at the end of that year. By early 2009, the Companies had sustained several Suspension Events. In 2010, Athilon unwound two credit default swaps at a cost of $370million, more than three times its equity capital. By August, the Companies no longer held any investment grade debt or counterparty credit ratings. Under the operating guidelines, the Companies entered permanent runoff mode.

C. The EBF Takeover

With Athilon in distress, the trading prices of its debt securities fell precipitously. EBF & Associates, LP ("EBF") seized the opportunity to purchase a large position in the riskiest tranche of Notes (the "Junior Notes") at a significant discount. In August 2010, EBF acquired 100% of Athilon's equity. EBF installed the current board of directors, which the Complaint alleges is dominated and controlled by EBF. In May 2011, nine months after EBF took control, Quadrant acquired its position in the Notes.

Quadrant alleges that Athilon is insolvent. Excluding its outstanding credit default swaps, Athilon continues to carry $600 million of debt, but its assets allegedly have a fair market value of only $426 million. As of September 30, 2011, Athilon's shareholder's equity, measured according to GAAP, stood at negative $660 million. The Complaint alleges that Athilon has no prospect of returning to solvency because it can only sell credit default swaps, and the market for that business has collapsed.

Quadrant argues that under the 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 designees on the Athilon board, by contrast, are pursuing strategies designed to benefit EBF and its affiliates. They have caused Athilon to continue paying interest on the Junior Notes, notwithstanding the right to defer those payments and the fact that the Junior Notes would receive nothing in an orderlyliquidation. They also agreed to pay Athilon Structured Investment Advisors LLC ("ASIA"), an EBF affiliate, above-market service fees to manage Athilon's day-to-day operations. 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.

D. The Quadrant Complaint

In October 2011, Quadrant filed suit against Athilon, its officers and directors, EBF, and ASIA. As amended, the Complaint contained ten counts:

• Count I asserted a derivative claim on behalf of Athilon against the individual defendants for breaching their fiduciary duties by (i) continuing to pay interest on the Junior Notes; (ii) paying above-market service and license fees to EBF; (iii) departing from an appropriately conservative capital investment strategy; and (iv) causing Athilon to violate its organizational documents and operating guidelines.

• Count II asserted a derivative claim against EBF for aiding and abetting the breaches of fiduciary duty alleged in Count I.

• Count III sought a permanent injunction barring the individual defendants from causing Athilon to pay the interest and fees identified in Count I.

• Counts IV and V challenged the payment of interest and fees under the Delaware Fraudulent Transfer Act ("DFTA").

• Count VI sought a permanent injunction under the DFTA against the continuing payment of interest and fees.

• Count VII contended that by taking the actions detailed in Count I and elsewhere in the complaint, Athilon breached the implied covenant of good faith and fair dealing that inheres in the Indenture.

• Count VIII asserted that EBF had tortiously interfered with Athilon's obligations under the Indenture.

• Count IX asserted that Athilon paid

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