Ubs Sec. Llc v. Highland Capital Mgmt.

• Decision Date: 21 July 2011
• Citation: 86 A.D.3d 469,2011 N.Y. Slip Op. 05979,927 N.Y.S.2d 59
• Parties: UBS SECURITIES LLC, et al., Plaintiffs–Respondents–Appellants,v.HIGHLAND CAPITAL MANAGEMENT, L.P., Defendant–Appellant–Respondent,Highland CDO Opportunity Master Fund, L.P., et al., Defendants,UBS Securities LLC, et al., Plaintiffs–Respondents–Appellants,v.Highland Capital Management, L.P., Defendant–Appellant–Respondent.
• Court: New York Supreme Court — Appellate Division

86 A.D.3d 469

927 N.Y.S.2d 59

2011 N.Y. Slip Op. 05979

UBS SECURITIES LLC, et al., Plaintiffs–Respondents–Appellants,

v.HIGHLAND CAPITAL MANAGEMENT, L.P., Defendant–Appellant–Respondent,Highland CDO Opportunity Master Fund, L.P., et al., Defendants,UBS Securities LLC, et al., Plaintiffs–Respondents–Appellants,

v.Highland Capital Management, L.P., Defendant–Appellant–Respondent.

Supreme Court, Appellate Division, First Department, New York.

July 21, 2011.

Lackey Hershman, LLP, New York (Paul B. Lackey of counsel), for appellant-respondent.Cadwalader, Wickersham & Taft LLP, New York (Gregory A. Markel of counsel), for respondents-appellants.MAZZARELLI, J.P., SWEENY, RENWICK, RICHTER, MANZANET–DANIELS, JJ.

Order, Supreme Court, New York County (Bernard J. Fried, J.), entered August 9, 2010, which, insofar as appealed from, in this consolidated action arising out of investment losses incurred by plaintiffs, denied defendant Highland Capital Management, L.P.'s motion to dismiss the complaint in the second action as to the first, third and fourth causes of action for fraudulent inducement, breach of the covenant of good faith and fair dealing and fraudulent conveyance, respectively, and granted the motion as to the fifth cause of action for tortious interference with contractual relations, unanimously modified, on the law, to grant the motion as to the first cause of action and as to those portions of the third and fourth causes of action that rely on conduct pre-dating the commencement of the prior action, and otherwise affirmed, without costs. Appeal from order, same court and Justice, entered June 21, 2010, which granted in part and denied in part plaintiffs' motion for leave to file an amended complaint, unanimously dismissed, without costs, as moot.

In April 2007, plaintiff UBS ¹ agreed to finance and act as placement agent in connection with the issuance of certain collateral debt obligations by defendant Highland Capital Management, L.P. (Highland). Highland, a Texas-based hedge fund, did not complete the issuance, and the agreement expired. At that point Highland owed UBS as much as $86 million under the arrangement, based on the depreciation of assets that UBS had been required to hold, or “warehouse.” However, because Highland still desired to issue the collateral debt obligations with UBS's assistance, UBS agreed to restructure the transaction. The new arrangement, formed in March 2008, consisted of two agreements between UBS, on the one hand, and Highland, and certain funds affiliated with Highland, on the other. A third agreement, referred to by the parties as an engagement letter, was entered into by UBS and Highland. The engagement letter provided, inter alia, that UBS would bear no risk in connection with losses in the securities to be held by UBS. It further provided that Highland would hold UBS harmless from any claims against UBS arising out of the breach of the agreements by Highland or its affiliated funds.

The agreements gave UBS the right to make margin calls on the Highland affiliated funds if the market value of the securities it was holding on behalf of those funds declined. During the fall of 2008, UBS made three such margin calls. The affiliated funds provided additional collateral in response to the first two margin calls, but not in response to the third call, made in November 2008. In December 2008, UBS terminated the restructured transaction before Highland could issue the collateral debt obligations, and demanded payment for almost $700 million in losses claimed as a result of the depreciation of the assets it was holding. Highland refused to pay.

In early 2009, UBS commenced an action against Highland and the affiliated funds asserting three causes of action. The first two causes of action alleged breach of contract against the affiliated funds only. The third claim was asserted against Highland, and was based on the indemnification language contained in the engagement letter. Highland asserted counterclaims for breach of contract and unjust enrichment against UBS arising out of the restructured transaction.

Highland moved to dismiss the complaint as against it, on the basis that the indemnification provision did not apply to the particular losses claimed by UBS. The court denied the motion, finding that UBS's interpretation of the clause was not unreasonable, and that there was at least a question of fact whether it applied. However, on February 18, 2010, this Court unanimously reversed, holding that

“[d]ismissal of plaintiffs' indemnification claim against Highland is warranted, since the agreements between the parties contain no promise on the part of Highland to undertake liability with respect to the investment losses suffered by plaintiffs, or to ensure or guarantee the performance of defendant off-shore funds' obligations to bear the risk of investment losses. Absent facts alleging that Highland otherwise breached the engagement letter, the indemnification provision contained in said letter was not triggered” (70 A.D.3d 526, 893 N.Y.S.2d 869).

The Clerk was directed to enter judgment against Highland dismissing the complaint.

Only two days before this Court issued its ruling, UBS had written a letter to the motion court, as required by the rules of the Commercial Part. It sought permission to move to amend its complaint to assert against Highland, and others, “a variety of new allegations that further support the indemnification and breach of contract claims that UBS already has alleged in the original Complaint.” UBS also stated in the letter that “the new causes of action arise out of the same or related circumstances and events as UBS's pending claims.”

Knowing that this Court had dismissed the complaint against Highland, the court granted the request, and UBS made its motion.

In support of the motion, UBS submitted an attorney's affirmation that summarized documents produced by Highland the month before. UBS claimed that the documents, primarily minutes of meetings of Highland's board of directors, formed the basis of the proposed new claims. Those documents, it was explained, revealed that Highland disregarded corporate formalities vis-a-vis the affiliated funds, that it knew that its methodology for pricing the assets held by UBS was unreasonable and inaccurate, and that it caused improper asset transfers and payments to the affiliated funds' creditors in the fall of 2008 and in 2009, when those funds were insolvent or nearly insolvent.

UBS also submitted the affidavit of Timothy Leroux, a former employee who was involved in the Highland transaction. According to Leroux, in November 2008, after UBS made the third margin call and Highland's affiliated funds were unable to immediately comply, Highland permitted UBS representatives to make several due diligence trips to its offices to evaluate the affiliated funds' finances, assets and business practices. Leroux attested:

“Among other things, the information that Highland Capital provided to UBS in November 2008 revealed the following:

(a) The Fund Counterparties[ ] did not satisfy their Initial Restructuring Collateral obligation by the Agreements using their own assets;

(b) CDO Fund had pledged and encumbered a substantial portion of its assets prior to entering the Agreements, and additional assets immediately thereafter;

(c) While Highland Capital was negotiating the Restructured Transaction, it did not tell UBS that it was planning to encumber more of the Fund Counterparties' assets, including immediately after March 14, 2008; (d) Highland Capital assigned unreasonable valuations to the Fund Counterparties' assets;

(e) Highland Capital was willing to ignore corporate formalities and commingle assets between and among various entities related to Highland Capital and the Fund Counterparties to satisfy debts and liquidity needs; and

(f) Highland Capital was willing to manage the Fund Counterparties without regard for the corporate form to achieve its goals” (emphasis added).

The proposed amended complaint included the following claims against Highland: (1) fraudulent inducement arising out of, inter alia, the misrepresentation of information and omissions to UBS concerning defendants' financial ability and commingling of assets; (2) breach of the covenant of good faith and fair dealing implied in the agreements underlying the restructured transaction; (3) fraudulent conveyance arising out of the transfer of cash and assets from the affiliated funds, impairing the funds' ability to satisfy their obligations to UBS, including transfers of assets made in March 2009 (after commencement of the original action); and (4) tortious interference with contract based on the allegation that Highland caused the affiliated funds to breach the agreements by fraudulently transferring assets and money.

In opposition, Highland asserted that UBS's complaint against it had been dismissed and could not be amended. Highland further argued that res judicata barred the proposed claims because they arose out of the same transaction or series of transactions as the original action. Highland maintained that the preclusive effect of this Court's decision dismissing the original action as against Highland was not diminished by the fact that UBS' claims against the affiliated funds and Highland's counterclaims were still pending. Highland also challenged the sufficiency of the claims and asserted that it could not have tortiously interfered with a contract to which it was a party.

The motion court denied that portion of UBS's motion that sought leave to add new claims against Highland, agreeing with Highland's position that a party cannot amend a pleading that has already been dismissed. However, the court expressly rejected Highland's res judicata argument, stating that “the evidence that UBS needs to prove the new claims is entirely different from the evidence that it needed to prove the contract claim that was...