Sedgwick Fundingco, LLC v. NewDelman (In re Grail Semiconductor, a Cal. Corp.)
| Decision Date | 20 January 2022 |
| Docket Number | 15-29890-A-7,FSL-7,Adv. 18-2180-A HSL-2 |
| Parties | In re: GRAIL SEMICONDUCTOR, A CALIFORNIA CORPORATION, Debtor. v. MITCHELL NEWDELMAN et al., Defendants. SEDGWICK FUNDINGCO, LLC, Plaintiff, |
| Court | U.S. Bankruptcy Court — Eastern District of California |
NOT FOR PUBLICATION
Argued and submitted on January 19, 2022 at Sacramento, California
Norman Neville Reid, Erik J. Ives, Ryan Schultz, Fox Swibel Levin & Carroll LLP and Jeffrey I. Golden, Beth E. Gaschen Weiland Golden Goodrich LLP for Sedgwick FundingCo, LLC;
Ivan K. Mathew, Ivan K. Mathew P.C. for Mitchell NewDelman, Frank Holze, and Willis Higgins
Honorable Fredrick E. Clement, Bankruptcy Judge Presiding These are cross-motions for summary judgment. Each party is a creditor of debtor Grail Semiconductor: (1) plaintiff/counter-defendant Sedgwick FundingCo, LLC ("Sedgwick"), an affiliate of Gerchen Keller Capital, LLC ("GKC"); and (2) defendants/counter-claimants Willis "Woody" Higgins, Mitchell NewDelman, and Frank Holze (collectively the "NewDelman Group"). At stake is $2.1 million on deposit with the Clerk of the Court, which are remnant funds from a now completed Chapter 7 bankruptcy by Grail Semiconductor. Insofar as Sedgwick is concerned, also at stake is potential additional liability to the NewDelman Group of upwards of $2.85 million for breach of contract and/or common law torts.
The source of the controversy is an intercreditor agreement between the parties. Intercreditor agreements are contracts between creditors of a common debtor that re-order or, in some cases, confirm each creditor's rights vis-à-vis other creditors. Sedgwick contends it holds a superior right to the disputed funds by virtue of the intercreditor agreement. In contrast, the NewDelman Group contends that Sedgwick owes it money for breach of the intercreditor agreement and/or for common law torts (including conspiracy to commit fraud by concealment) arising out of that agreement.
The disputed funds are the proceeds of prepetition state court litigation by the debtor. The Chapter 7 debtor, Grail Semiconductor, sued a competitor, Mitsubishi Electric & Electronics USA Inc. ("Mitsubishi Electric"), for breach of a non-disclosure agreement; that litigation consumed it for eight years. Grail Semiconductor was represented by the law firm of Niro, Haller and Niro ("the Niro firm"). After seven years of litigation, Grail Semiconductor needed additional funds to continue the fight; so, it took a secured loan from GKC and/or Sedgwick using future proceeds of the Mitsubishi Electric action as collateral. As a part of GKC's agreement to fund that loan, it demanded that existing secured creditors subordinate their rights to payment from litigation proceeds. GKC and the NewDelman Group attempted to enter into a pre-settlement intercreditor agreement, known as the "Priority Agreement," for the division of the Mitsubishi Electric litigation proceeds.
The court uses the word "attempted" purposefully because GKC, who last signed the agreement, added "Sedgwick FundingCo, LLC" as a party to, or third party beneficiary of, the agreement after all other parties had signed it. The record does not indicate that the NewDelman Group ever accepted the changed terms of the agreement.
The Priority Agreement designated the Niro firm to receive litigation proceeds into its client trust account and instructed that firm to pay those monies out to Sedgwick and to the NewDelman Group. And the Niro firm agreed to do so.
Indeed, the Mitsubishi Electric litigation did settle. But the amount of the settlement was not sufficient to pay all signatories to the Priority Agreement the amounts due them. And, unfortunately, the Priority Agreement was facially ambiguous as to how the Niro firm should distribute proceeds in the event of insufficiency. By describing Sedgwick as a "Second Priority" creditor and the NewDelman Group as a "Third Priority" creditor the agreement could reasonably be construed to require payment in full to Sedgwick before making any payment to the NewDelman Group. But the agreement also required the Niro firm to pay Sedgwick and the NewDelman Group "concomitantly" (at the same time) and in "pari passu" (at an equal rate) suggesting simultaneous, pro-rata payment of all parties from available funds.
Aware that the settlement would not pay the Niro firm's fees and all signatories of the intercreditor agreement the full amounts due them, Grail Semiconductor, Sedgwick, the Niro firm, and their principals cut a side deal for immediate and full payment of Sedgwick. The side agreement was reduced to writing, known as a "Letter of Intent." The Letter of Intent, and the Niro firm's actions to implement it, satisfy all elements of a civil conspiracy for which Sedgwick is liable. The Niro firm's actions to carry out the Letter of Intent satisfy most of the elements of fraud by concealment. Having already agreed in the Priority Agreement to receive and disburse litigation proceeds to the signatories to the agreement, the Niro firm acted as the signatories' (including the NewDelman Group) agent with respect to those proceeds and owed them fiduciary duties, including the duty of full disclosure. Notwithstanding that obligation, the Niro firm did not inform the NewDelman Group of the terms of the Letter of Intent or of the Niro firm's intention to pay Sedgwick, while paying NewDelman nothing. Instead, the Niro firm paid Sedgwick. By doing so, the Niro firm concealed a material fact from one of its principals, i.e., the NewDelman Group, causing injury; the only elements of fraud by concealment not resolved by this motion are: (1) the NewDelman Group's inability to discover the concealed fact by reasonable inquiry; and (2) reliance resulting in damages.
The bottom line is this. A genuine dispute of material facts exists as to: (1) whether the NewDelman Group accepted the Priority Agreement, as revised to add "Sedgwick FundingCo, LLC"; and (2) if so, that agreement's meaning. Not in dispute are the facts showing: (1) the Niro firm acted as an agent for both GKC/Sedgwick and the NewDelman Group in the receipt and disbursement of Mitsubishi Electric litigation proceeds and, therefore, owed each creditor fiduciary duties (including a duty of full disclosure); (2) Grail Semiconductor, GKC/Sedgwick, and the Niro firm entered into a civil conspiracy to defraud the NewDelman Group; (3) the Niro firm's disbursement of funds to Sedgwick, without payment to the NewDelman Group or notice, satisfies all the elements of fraud by concealment (except for the NewDelman Group's inability to discover the truth with reasonable inquiry and the existence, as well as amount, of damages); (4) the Niro firm's actions in disbursing funds were within the scope of the conspiracy with Grail Semiconductor and GKC/Sedgwick; and (5) Sedgwick is liable for the Niro's firm's fraud, if any.
In 2000, cousins Robert Stern and Donald Stern formed Grail Semiconductor as a California corporation;[1] its raison d'etre was to "hold and exploit" a "nonvolatile semiconductor memory device" developed by Donald Stern. Stipulation of Agreed Facts and Authenticity of Documents 6:7-16, ECF No. 240;[2] Compl. 3:14-16, ECF No. 1. Nonvolatile memory devices retain data even after the power to that device is shut off. Donald Stern and Robert Stern are, and were, Grail Semiconductor's only shareholders. As pertinent here, its Board of Directors was comprised of Donald Stern, Robert Stern and Richard L. Gilbert. Agreed Facts 6:13-7:14, ECF No. 240. At all pertinent times, Ronald Hofer ("Hofer") was Grail Semiconductor's Chief Executive Officer and Brad Woods ("Woods") was its Chief Financial Officer. Agreed Facts 7:15-18, ECF No. 240.
In 2001, Grail Semiconductor explored a joint venture with Mitsubishi Electric to capitalize on the nonvolatile semiconductor memory technology. As a part of those discussions Grail Semiconductor demanded, and Mitsubishi Electric signed, a non-disclosure agreement. Compl. 3:17-22, ECF No. 1. Mitsubishi Electric violated the agreement and "improperly used [Grail Semiconductor's] trade secrets" to develop its own memory chips. Compl. 3:20-22, ECF No. 1.
In 2011, Grail Semiconductor ceased business operations and, thereafter, devoted itself to litigation against Mitsubishi Electric for breach of the non-disclosure agreement and, later, against Renesas Electronics America, Inc. ("Renesas") for patent infringement. Agreed Facts 7:19-21, ECF No. 240. After 2011, Grail Semiconductor's primary source of monies was litigation funding loans. Agreed Facts 7:22-8:4, ECF No. 240.
In 2007, Grail Semiconductor brought a state court action against Mitsubishi Electric for breach of the non-disclosure agreement. Agreed Facts 8:6-11, ECF No. 240. At the outset, Grail Semiconductor was represented by the law firm of Schwartz, Rimberg & Morris LLP ("Schwartz firm") on an hourly basis. Agreed Facts 8:11-12, ECF No. 240.
In July 2011, Grail Semiconductor decided a multifaceted strategy change to the Mitsubishi Electric litigation was required. So, it replaced the Schwartz firm with the Chicago law firm of Niro, Haller & Niro Ltd. Agreed Facts 8:13-15, ECF No. 240. The Niro Firm's lead counsel in the case was Raymond P. Niro, Sr., the firm's founder and managing shareholder. Grail Semiconductor and the Niro firm signed a contingent fee agreement. Common Set of Ex. for Purposes of Cross-Motions Summary Judgment, Ashley Keller Aff. 1806:3-6, ECF No. 252. The fee agreement provided that the Niro firm would be compensated for its representation by receipt of a percentage of any recovery, but the agreement contained a "pay as you...
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