QVT Fund LP v. Eurohypo Capital Funding LLC I, C.A. No. 5881-VCP

• Decision Date: 08 July 2011
• Docket Number: C.A. No. 5881-VCP
• Parties: QVT FUND LP and QUINTESSENCE FUND L.P., Plaintiffs, v. EUROHYPO CAPITAL FUNDING LLC I, EUROHYPO CAPITAL FUNDING LLC II, and EUROHYPO AG, Defendants.
• Court: Court of Chancery of Delaware

QVT FUND LP and QUINTESSENCE FUND L.P., Plaintiffs, v. EUROHYPO CAPITAL FUNDING LLC I EUROHYPO CAPITAL FUNDING LLC II and EUROHYPO AG, Defendants.

C.A. No. 5881-VCP

COURT OF CHANCERY OF THE STATE OF DELAWARE

Submitted: March 29, 2011

Decided: July 8, 2011

MEMORANDUM OPINION

Philip A. Rovner, Esq., Jonathan A. Choa, Esq., POTTER ANDERSON & CORROON LLP; Wilmington, Delaware; Daniel P. Cunningham, Esq., Robert Juman, Esq., Elizabeth M. Devaney, Esq., Ben Harrington, Esq., QUINN EMANUEL URQUHART & SULLIVAN LLP, New York, New York; Attorneys for Plaintiffs.

Thomas A. Beck, Esq., Brock E. Czeschin, Esq., Lisa M. Pietrzak, Esq., Robert L. Burns, Esq., RICHARDS LAYTON & FINGER, P.A., Wilmington, Delaware; Amanda J. Gallagher, Esq., Martin S. Bloor, Esq., Katherine Z. Machan, Esq., Patrick C. Ashby, Esq., LINKLATERS LLP, New York, New York; Attorneys for Defendants.

PARSONS, Vice Chancellor.

This action is before the Court on a motion to dismiss relating to the amended complaint of plaintiff investment funds seeking to compel payment on preferred securities they purchased through various affiliates of a German bank. The defendant bank had sought to raise capital in a manner that would allow it to boost its core capital solvency ratios without diluting common shareholders. To do so, the bank issued a tranche of trust preferred securities through a pair of Delaware limited liability companies and Delaware trusts. The holders of the trust preferred securities were entitled to dividend payments if the bank met certain profitability targets or made payments on other preferred securities.

The dispute between the parties involves whether a series of payments made in 2009 to third-party holders of certain participation certificates of the bank triggered an obligation to make payments on the trust preferred securities. The plaintiffs allege that the participation certificates qualify as preferred securities, which, as discussed below, is a predicate to their argument that they are owed dividends. They further contend that, as a result, even though dividends were paid to them earlier in 2009, the bank is required to pay them additional dividends because the payments made on the participation certificates were not made before or contemporaneously with the dividends they received earlier that same fiscal year. In opposition, the defendants deny that the participation certificates are preferred securities. Moreover, they argue that the plaintiffs received all payments they were entitled to because the only requirement of the relevant provision in the governing trust agreements is that the trust preferred securities be treated equally.The defendants contend that this provision is therefore inapplicable because the plaintiffs received the dividend they were entitled to in that same fiscal year.

The plaintiffs further allege that the defendants violated the Delaware implied covenant of good faith and fair dealing both by failing to make payments on their preferred securities, despite making similar payments in previous years, and by ceasing to be a profit-seeking entity as a result of the bank's entry into a domination agreement. The plaintiffs contend that under the operative governing documents, the defendants were required to protect the plaintiffs' interests. The defendants counter that they violated no duty because the operative documents did not require any such payment. Alternatively, they seek to dismiss or stay this action in favor of first-filed litigation in German courts, both because key witnesses are located in Germany and because the outcome is dependent on the resolution of key questions of German law.

I have carefully considered the parties' submissions and their various arguments. For the reasons stated in this Memorandum Opinion, I deny the defendants' motion to dismiss.

I. BACKGROUND

A. The Parties

Plaintiffs, QVT Fund LP and Quintessence Fund L.P. (collectively, "Plaintiffs"), are limited partnerships organized in the Cayman Islands. They purport to bring this action on behalf of two Delaware trusts, Eurohypo Capital Funding Trust I ("Trust I") and Eurohypo Capital Funding Trust II ("Trust II") (collectively, the "Delaware Trusts" or "Trusts").

Defendant Eurohypo AG ("Eurohypo" or the "Bank") is a German stock corporation that operates as an international bank. It is indirectly wholly owned by Commerzbank AG ("Commerzbank") through Commerzbank's subsidiary, Commerzbank Inlandsbanken Holding GmbH ("IBH"). Eurohypo organized two Delaware limited liability companies, Defendant Eurohypo Capital Funding LLC I ("LLC I") and Defendant Eurohypo Capital Funding LLC II ("LLC II") (collectively, the "Delaware LLCs") in order to raise capital. Collectively, the Bank and the LLCs are referred to as Defendants.

B. Facts

1. The relevant capital structure

Under the German Banking Act, banks are required to hold a minimum amount of capital known as Regulatory Banking Equity Capital.¹ While a variety of securities qualify as Regulatory Banking Equity Capital, all such securities must possess certain equity-like features. Debt instruments cannot be counted as Regulatory Banking Equity Capital.

Between 1998 and 2007, Eurohypo AG raised over €1 billion in Regulatory Banking Equity Capital by issuing securities to the investing public in Germany and the United States. Those securities included trust preferred securities that were issued by theDelaware Trusts (the "Trust Preferred Securities") and certain "Participation Certificates" or "Participation Rights" issued in Germany by the Bank.

Trust preferred securities are attractive for German banks because they qualify as Regulatory Banking Equity Capital, yet can be marketed effectively to international investors. Trust preferred securities are issued frequently by Delaware statutory trusts established for this purpose. Proceeds from the sale of these securities then are used to purchase subordinated debt from the sponsoring bank, with interest payments on the debt funding any preferred dividends on the trust preferred securities.

Here, the relevant capital structure relating to Plaintiffs' Trust Preferred Securities follows a similar model. Specifically, the Bank created the Delaware LLCs and exchanged subordinated notes for capital. The LLCs, in turn, created the Delaware Trusts. The LLCs also issued two classes of preferred securities. They issued Class A Preferred Securities, as well as common securities, to the Bank and Class B Preferred Securities to each of the two Delaware Trusts. Proceeds from the sale of the Class B Preferred Securities funded the capital the LLCs paid to the Bank in exchange for the subordinated notes. Finally, the Trusts issued the Trust Preferred Securities to United States investors and used the resulting proceeds to fund their purchase of the Class B Preferred Securities.

Both the Delaware Trusts and LLCs are governed by agreements (collectively, the "Agreements") that spell out the terms and conditions under which payments are to bemade on the relevant securities.² Each Agreement is governed by Delaware law pursuant to an express choice of law provision.³ A limited number of provisions in the Agreement, however, explicitly incorporate or reference German laws and regulations.⁴

In some situations under the Agreements, described in greater detail below, when the Bank makes coupon payments on the subordinated notes held by the LLCs, the LLCs make payments on the Class B Preferred Securities, which then permit the Trusts to make dividend payments to the holders of their Trust Preferred Securities. When the LLCs do not make payments to the Delaware Trusts on the Class B Preferred Securities, however, the coupon payments on the subordinated notes flow back to the Bank as owner of the Class A Preferred Securities. While the Bank is the controlling member of both LLCs, its ability to limit payments on the Class B Preferred Securities is restricted by contract. The LLC Agreements both state that "[i]t is the intention of the [LLCs] not to [make] capital payments on the Class A Preferred Securities."⁵ Moreover, the terms of the LLC Agreements obligate the LLCs to make payments on the Class B Preferred Securitieswhen certain requirements are met. For one, the LLCs must make annual payments on the Class B Preferred Securities if Eurohypo has sufficient Distributable Profits.

2. The pusher provisions

Importantly, the LLC Agreements contain "pusher provisions" that provide if the Bank makes any payment, redemption, or other distribution on any so-called "Parity" or "Junior" securities, the LLCs must make a corresponding payment on the Class B Preferred Securities held by the Trusts. In turn, the Trusts must make a corresponding payment to holders of the Trust Preferred Securities. The LLC Agreements define "Parity Securities," in pertinent part, as "each of the most senior ranking preference shares of the Bank, if any."⁶ "Junior Securities" are defined broadly to encompass "each class of preference shares of the Bank ranking junior to Parity Securities, if any, and any other instrument of the Bank ranking pari passu therewith or junior thereto [any class of preference shares]."⁷ Complicating matters in this dispute is the fact that the term "preference shares" as used in the definitions of both Parity and Junior Securities is not defined in the Agreements.

In relevant part, the first pusher provision relates to Junior Securities and states that:

[I]f the Bank or any of its subsidiaries declares or pays any dividend or makes any other payment or other distribution on its Junior Securities, the [LLCs] shall be deemed to havedeclared Capital Payments on the Class B Preferred Securities at the Stated Rate in full . . . for the Class B Payment Date falling on or after the date on which such dividend was declared or payment made if such Junior Securities pay dividends annually.⁸

Another almost identical provision relates to Parity Securities and provides that:

[I]f the

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