Opinion
No. 02-3836 MMC (Consolidated Cases).
July 12, 2004
The above-titled consolidated proceeding consists of three matters: (1) Crown Paper Liquidating Trust v. PricewaterhouseCoopers, et al., C 02-3836 MMC ("the Liquidating Trust case"); (2) Fort James Corporation v. Crown Vantage, Inc., et al., C 02-3838 ("the Fort James case"), and (3) Crown Paper Co., et al., v. Fort James Corp., et al., C 02-3839 MMC ("the Crown Vantage case").
By order filed September 25, 2003, the Court granted in part and denied in part nine motions to dismiss filed by defendants in the Liquidating Trust case and the motion to dismiss filed by defendants in the Crown Vantage case. In its order, the Court dismissed (1) all claims in the First Amended Complaint in the Liquidating Trust case ("the PWC FAC"), as well as 10 of the 13 counts in the First Amended Complaint in the Crown Vantage case ("the FJ FAC"), "to the extent the claims are based on conduct occurring while JRC [James River Corporation] was Crown's sole shareholder," (see Order Granting in Part and Denying in Part Defs. Mots. to Dismiss, Deferring Ruling on Certain Issues, filed September 25, 2003, ("Order of September 25, 2003") at 27:9-11, 27:16-17); (2) dismissed 18 of the 86 counts in the PWC FAC and 1 of the 13 counts in the FJ FAC without leave to amend, (see id. at 27:13, 27:18-19); (3) dismissed 2 of the 86 counts in the PWC FAC and 1 of the 13 counts in the FJ FAC with leave to amend, (see id. at 27:12, 27:20); and (4) deferred ruling on portions of three of the motions to dismiss the PWC FAC, specifically, the portions addressing claims based on "conduct occurring after JRC was no longer Crown's sole shareholder," until such time as other defendants had the opportunity to file motions to dismiss to address claims based on "conduct occurring after JRC was no longer Crown's sole shareholder," (see id. at 27:24-28:7).
Plaintiffs refer to Crown Vantage, Inc. ("Crown Vantage") and Crown Paper Company ("Crown Paper") "interchangeably" and "collectively" as "Crown," except where necessary to differentiate between the two entities. (See FJ FAC ¶ 4; PWC FAC ¶ 21.) For the purposes of this order, the Court will refer to plaintiffs as "Crown," except where necessary to differentiate between them.
Now before the Court is the motion of defendants Fort James Corporation, Fort James Operating Company, Fort James Fiber Company, and Fort James International Holdings, Ltd. (collectively, "Fort James") to dismiss, pursuant to Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure, the FJ FAC. Also before the Court are five motions to dismiss, pursuant to Rules 12(b)(6) and 9(b), the PWC FAC, filed, respectively, by the following defendants: (1) McGuireWoods LLP, as successor to McGuire Woods Battle Boothe, LLP ("McGuire Woods"); (2) Merrill Lynch Co., Merrill Lynch Pierce Fenner Smith, (collectively, "Merrill Lynch") and Salomon Brothers ("Salomon"); (3) Houlihan Lokey Howard Zukin ("Houlihan Lokey"); (4) Ernest Leopold ("Leopold"), William Daniel ("Daniel"), Joseph T. Piemont ("Piemont"), and E. Lee Showalter ("Showalter"); and (5) Clifford Cutchins ("Cutchins"), Stephen Hare ("Hare"), and Robert C. Williams ("Williams"). Each of the above-referenced motions addresses Crown's claims based on conduct occurring after JRC was no longer Crown's sole shareholder. Additionally, before the Court are the deferred portions of three motions to dismiss, filed, respectively, by (1) PricewaterhouseCoopers LLP, f/k/a Coopers Lybrand ("PWC"); (2) Ernst Young LLP ("E Y"); and (3) Credit Suisse First Boston Corporation, as successor to Donaldson, Lufkin Jenrette ("DLJ"), i.e., the portions addressing claims based on conduct after JRC was no longer Crown's sole shareholder.
Having considered the papers filed in support and in opposition to the motions, the Court deems the matters appropriate for decision thereon, VACATES the hearing scheduled for July 13, 2004, and rules as follows.
FACTUAL BACKGROUND
Crown's claims arise out of a series of transactions, which Crown refers to as the "Spin," and from the aftermath of those transactions. In the pleadings, Crown defines the "Spin" as "a scheme by Fort James to unload vastly over-valued but under-performing assets onto Crown, and to cause Crown to borrow well over half a billion dollars, all of which monies were then taken by Fort James, while Crown remained obligated to pay on the loans." (See FJ FAC ¶ 627; see also PWC FAC ¶¶ 12-17.)
At a hearing conducted on August 15, 2003, Crown expanded on its definition of the Spin by explaining that, in its view, the Spin consisted of four transactions, occurring when: (1) JRC transferred assets and liabilities to Crown Paper, in exchange for Crown Paper stock; (2) Crown Paper borrowed money from third parties; (3) JRC obtained from Crown Vantage pay-in-kind notes; and (4) Crown transferred cash to JRC.
The following facts, taken from the FJ FAC and from the PWC FAC, are assumed true solely for the purposes of the motions to dismiss:
The Court, in setting forth the background facts, has focused on the allegations concerning behavior occurring after JRC was no longer Crown's sole shareholder. The Court's order of September 25, 2003 contains a more detailed description of the alleged conduct occurring during the period in which JRC was Crown's sole shareholder.
Prior to the transactions comprising the Spin, JRC, defendant Fort James' predecessor, was Crown's sole shareholder. (FJ FAC ¶¶ 249-50, 260(a); PWC FAC ¶¶ 254-55, 265(a).) After the transactions comprising the Spin, JRC distributed "all of the outstanding shares of Crown Vantage to the JRC shareholders," which was the first time there existed a "public market" for Crown stock. (FJ FAC ¶¶ 257, 260(o); PWC FAC ¶ 262, 265(o).) After the stock distribution, JRC continued to "exercise adverse dominion and control" over the Crown directors, and the "vestiges of JRC's control of Crown continued through and up to the time Crown filed for bankruptcy." (FJ FAC ¶¶ 346, 389; PWC FAC ¶¶ 351, 394.) JRC, assisted by the other defendants, "continued to misrepresent and/or conceal Crown's true financial condition . . . long after Crown became insolvent." (FJ FAC ¶ 389; PWC FAC ¶ 394.) The "concealment of Crown's true financial condition artificially prolonged the life of Crown while giving the illusion . . . that Crown's business was prosperous when, in fact, it was not." (FJ FAC ¶ 393; PWC FAC ¶ 398.)
More specifically, Crown Vantage was a "publicly traded holding company owning 100% of Crown Paper's outstanding stock," (PWC ¶ 3), and JRC was the "sole shareholder" of Crown Vantage, (FJ FAC ¶¶ 260(a), 630; PWC FAC ¶ 265(a)).
Defendant McGuire Woods, a law firm who represented Crown, concealed from Crown after the Spin "all documents and information related to the Spin." (FJ FAC ¶ 350; PWC FAC ¶ 355.) Defendants Merrill Lynch and Houlihan Lokey, after the transfers, provided "false and misleading opinions" that the Spin had been "fair and equitable and not a fraudulent transfer." (FJ FAC ¶ 351; PWC FAC ¶ 356.) Defendant PWC prepared and disseminated "false and misleading financial statements" to assist JRC in "the perpetuation of the illusion of growth and prosperity and artificially prolonging Crown's life." (FJ FAC ¶ 489; PWC FAC ¶ 494.) Defendant Salomon, who "conducted due diligence regarding Crown's post-Spin operations," did not advise Crown of "the true nature of the assets." (FJ FAC ¶¶ 357-58; PWC FAC ¶¶ 362-63.) DLJ, defendant Credit Suisse First Boston Corporation's predecessor, who was Crown's financial advisor beginning in 1997, did not advise Crown of the true value of its assets and should have advised Crown to file for bankruptcy, rather than to continue as a "going concern." (FJ FAC ¶¶ 360, 379-80; PWC FAC ¶¶ 365, 384-85.)
Defendant E Y, an accounting firm that began performing services for Crown after the Spin, prepared audits for Crown that falsely represented Crown's financial position. (FJ FAC ¶¶ 20, 538; PWC FAC ¶¶ 23, 543.) In particular, E Y "intended to hide the fact" that other defendants had "failed to properly write-down" the value of certain assets. (FJ FAC ¶ 608; PWC FAC ¶ 612.) Defendant Showalter, a Crown director, worked with E Y to approve each of E Y's audits of Crown so as "to conceal Crown's deepening insolvency, to hide the over-valuing of the transferred assets and to conceal his wrongdoing and that of [the other] Defendants." (FJ FAC ¶¶ 30, 436; PWC FAC ¶¶ 33, 441.) Defendants Daniel and Piemont, both of whom were Crown directors, had "conflicts of interest at the time of the Spin" and failed thereafter to take any steps to "remedy the Spin." (FJ FAC ¶¶ 442-43; PWC FAC ¶ 447-48.) Defendant Leopold, a Crown director, defendant Williams, JRC's President and CEO, and defendants Cutchins and Hare, both JRC Senior Officers, all "were aware of Crown's insolvency, under capitalization, its inability to pay debts as they matured and the fraudulent nature of the transfers," but failed to disclose such information to Crown after the Spin. (FJ FAC ¶¶ 341-43; PWC FAC ¶¶ 346-48.)
On March 18, 1998, JRC and Crown entered into an Option and Settlement Agreement, under which Crown's obligations to JRC were modified and Crown released any "potential claims arising out of the Spin" that Crown had against JRC and certain "generically described parties." (FJ FAC ¶¶ 323-24, 333; PWC FAC ¶¶ 328-29, 338.) "Crown received nothing in return for the release of claims." (FJ FAC ¶ 335; PWC FAC ¶ 340.)
Showalter, in his capacity as a Crown director but acting in the best interest of JRC, voted to approve the Option and Settlement Agreement. (FJ FAC ¶ 438; PWC FAC ¶ 443.) Piemont and Daniel voted to approve the Option and Settlement Agreement even though it provided no benefit to Crown. (FJ FAC ¶ 443; PWC FAC ¶ 448.) Leopold signed the Option and Settlement Agreement on behalf of Crown, thereby "potentially absolv[ing] JRC of any liability for certain prior wrongful acts done to Crown," even though Leopold had, four months earlier, stated to JRC that one of the Spin transactions had been "a one-sided deal, drafted only in favor of JRC." (FJ FAC ¶¶ 431-32; PWC FAC ¶¶ 436-37.) E Y, knowing there was "no economic justification" for the Option and Settlement Agreement, "failed to identify, record, or disclose that the Agreement was absent arms length fairness or proper consideration." (FJ FAC ¶¶ 517-18; PWC FAC ¶¶ 522-23.) DLJ advised Crown to enter into the Option and Settlement Agreement in order to "protect" JRC and other defendants from liability as a result of the Spin. (FJ FAC ¶¶ 386-87; PWC FAC ¶¶ 391-92.)
On March 15, 2000, Crown, having "become insolvent by well in excess of $1 Billion," filed for bankruptcy protection. (FJ FAC ¶ 13.)
LEGAL STANDARD
A motion to dismiss under Rule 12(b)(6) cannot be granted unless "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." See Conley v. Gibson, 355 U.S. 41, 45-46 (1957). Dismissal can be based on the lack of a cognizable legal theory or the absence of sufficient facts alleged under a cognizable legal theory. See Balistreri v. Pacifica Police Dep't, 901 F.2d 696, 699 (9th Cir. 1990). In analyzing a motion to dismiss, the court must accept as true all material allegations in the complaint and construe them in the light most favorable to the nonmoving party, see NL Industries, Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir. 1986), and may take judicial notice of matters of public record, see Lee v. City of Los Angeles, 250 F.3d 668, 688-89 (9th Cir. 2001).
DISCUSSION
Defendants argue that the remaining claims in the FACs should be dismissed on numerous grounds. The primary issue is whether Crown has stated any viable claims against defendants based on conduct occurring on or after August 25, 1995. Other than the claims brought on behalf of creditors, all of plaintiffs' remaining claims arise from plaintiffs' allegations that defendants, acting on their own, as members of a conspiracy, and/or as aiders and abetters of other defendants, (1) engaged in various acts in an effort to prevent Crown from learning the truth about the fraudulent "Spin" transactions and/or otherwise caused Crown's deepening insolvency, and (2) caused Crown, in 1998, to enter into the Option and Settlement Agreement that itself constituted a fraudulent transaction.
The only other issues pertain to plaintiffs' two counts filed in the Crown Vantage case and brought on behalf of creditors.
In its prior order, the Court noted that although the FACs do not state the date on which JRC ceased being Crown's sole shareholder, a judicially-noticeable document indicated Crown stock began trading on NASDAQ as of August 28, 1995. (See Order of September 25, 2003 at 6:26-28.) Crown now requests, and no defendant has opposed, the Court take judicial notice of an SEC filing indicating JRC distributed "all of the common stock of [Crown]" to third parties on August 25, 1995. (See Loeb Decl. Ex. 8.) It would thus appear that JRC ceased being Crown's sole shareholder on August 25, 1995, (see id.), and the new shareholders were able to publicly trade the shares as of August 28, 1995.
The FACs unambiguously allege that the fraudulent conveyances comprising the Spin occurred while Fort James was the sole shareholder of Crown. (See FJ FAC ¶¶ 257, 260(o); PWC FAC ¶ 262, 265(o).) Plaintiffs now assert that, after having conducted further investigation, they discovered one of the Spin transactions, a transfer of approximately $484,900,000 from Crown to Fort James, occurred on August 28, 1995, i.e., after Fort James was no longer Crown's sole shareholder. Because this assertion is not included in the FACs and, indeed, is at odds with the allegations in the FACs, the Court will consider plaintiffs' arguments with respect to the $484,900,000 transfer only in determining whether leave to amend is proper.
A. Effect of Imputation
In its prior order, the Court found that plaintiffs' claims brought on behalf of Crown are barred by the doctrine of in pari delicto, to the extent the claims are based on conduct occurring while JRC was Crown's sole shareholder. Under the doctrine of in pari delicto, the acts of a corporation's agents taken at the behest of the corporation's sole shareholder are imputed to the corporation, even if the acts could be considered adverse to the corporation. "In explaining the basis for this result, the Second Circuit has stated: `This rule imputes the agent's knowledge to the principal notwithstanding the agent's self-dealing because the party that should have been informed was the agent itself albeit in its capacity as principal. Where, as here, a sole shareholder is alleged to have stripped the corporation of assets, the adverse interest exception to the presumption of knowledge cannot apply.'" (See Order of September 25, 2003 at 15:12-17 (quoting Mediators, Inc. v. Manney (In re Mediators), 105 F.3d 822, 827 (2nd Cir. 1997).) In the instant case, as a result of the doctrine of in pari delicto, Crown is deemed to have known the details of the Spin transactions, for example, that it received from JRC "heavily depreciated, overvalued and in some cases environmentally contaminated assets" and "enormous liabilities" that left Crown "fatally wounded." (See FJ FAC ¶ 13).
Defendants argue that the knowledge imputed to Crown while it was owned by JRC remains within the knowledge of Crown after JRC distributed its shares to third parties. As a consequence, defendants argue, plaintiffs' post-Spin claims fail because the success of such claims depends upon Crown lacking knowledge of the details of the Spin transactions. (See Defs.' Joint Memo. in Support of Mots. to Dismiss Post-Spin Claims at 11:4-12:13.) For example, defendants argue, plaintiffs cannot establish that Crown justifiably relied on post-Spin "false" statements or was injured by omissions concerning the value of assets transferred to Crown during the Spin transactions because Crown, as a consequence of its imputed knowledge, knew the truth about the assets transferred to it during the Spin transactions.
See, e.g., PWC FAC ¶¶ 362, 362 (alleging Salomon, in 1996, conducted "due diligence regarding Crown's post-Spin operations" and did not inform Crown of the "true nature of the assets which had been spun or of JRC's motivations in divesting the assets for cash").
Plaintiffs, in opposition, do not argue that any post-Spin claims would be valid if the knowledge imputed to Crown while wholly owned by JRC remains imputed to Crown after JRC distributed Crown shares to third parties. Rather, plaintiffs argue that the knowledge imputed to Crown while JRC was Crown's sole shareholder does not continue to be imputed to Crown after JRC was no longer Crown's sole shareholder.
Because a corporation can only act through individuals, "[a] corporation's `knowledge' can only be that of those individuals whose personal knowledge may be legally imputed to it." See J.W. Woolard Mechanical Plumbing, Inc. v. Jones Development Corp., 367 S.E.2d 501 (Va. 1988). The knowledge of a corporation's sole shareholder is legally imputed to the corporation. See National Carloading Corp. v. Astro Van Lines, Inc., 593 F.2d 559, 562 (4th Cir. 1979) (applying Virginia law; holding where individual who was sole shareholder of two corporations caused one corporation to transfer its only valuable asset to the other corporation, corporations "had notice of this state of facts").
The Court, in its previous order, found Virginia law governs plaintiffs' claims against Fort James, PWC, McGuire Woods, Merrill Lynch, Salomon, DLJ, Leopold, Cutchins, Hare, Williams, Daniel, Piemont, Showalter, and, with the possible exception of one claim governed by New York law, Houlihan Lokey. (See Order of September 25, 2003 at 13:3-13, 20:18-21:7.) The Court further found New York law governs the contract-based claims against DLJ, (see id. at 22:10-11), and that California law governs the contract-based claims against E Y, (see id. at 13:14-16), but did not reach the issue of whether non-contract based claims against DLJ and E Y are governed by Virginia law, as plaintiffs appeared to contend at the hearing conducted September 25, 2003. Thus, all remaining claims are governed by Virginia, New York, or California law. No party has argued that the Court's resolution of the issues now before it would vary dependent on which state's law is applied.
As noted, the parties disagree as to whether a corporation's knowledge remains imputed to the corporation after the corporation is purchased by new owners who are unaware of the imputed information. Where courts have considered this question, they have found that a corporation retains its imputed knowledge even after a change in ownership. As stated in one such opinion, in which the court applied the law of New Jersey and relied on the common law of both New Jersey and New York, "[t]he process of acquisition simply does not sanitize the acquired corporation, notwithstanding the fact that it has gained new owners and fresh management." See Fireman's Fund Ins. Cos. v. Meenan Oil Co., 755 F. Supp. 547, 553 (E.D.N.Y. 1991) (holding corporation's claim against insurance policy barred under exclusion for "expected" damage, where corporation's prior owners knew corporation's underground oil facility was leaking; holding corporation deemed to have such knowledge even after corporation purchased by new owners; stating corporation's knowledge not "erased" after purchase by new owners). Similarly, in Alice Roofing Sheet Metal Works, Inc., 775 S.W.2d 869 (Tex.App. 1989), the court, applying Texas common law, held that "later-acquired knowledge by new and subsequent corporate shareholders and officers does not constitute new knowledge to the corporate entity." See id. at 870 (holding where new owners of corporation discovered former sole shareholder used corporate funds for personal use, corporation's suit against former sole shareholder barred under statute of limitations because corporation deemed to have knowledge of sole shareholder's acts when they occurred); see also 3 Fletcher Cyc. Corp. § 801 (1999) ("The rule is that a corporation, being once charged with notice of the character of a transaction, continues to be affected by such notice whatever changes may occur in the personnel of its working force.").
The Fifth Circuit, in discussing Alice Roofing, has acknowledged the holding therein as reflecting a "general rule of imputation." See Federal Deposit Ins. Corp. v. Shrader York, 991 F.2d 216, 222 (5th Cir. 1993).
Plaintiffs, in support of their argument that the above principles are inapplicable to the instant action, argue at length that defendants' post-Spin knowledge and actions cannot be imputed to Crown under the doctrine of in pari delicto or otherwise. According to plaintiffs, "After [JRC] ceased being Crown's sole shareholder, Crown became legally incapable of actively participating in its own wrongdoing (through agency principles)[;] [t]he `sole actor' exception disappeared, and Crown's allegations of adverse interest prevent imputation after that time." (See Pls.' Consolidated Response in Opp. to Defs.' Mots. to Dismiss at 2:18-22.) Plaintiffs also contend that the Court decided this issue adverse to defendants when the Court, in a section of its prior order titled "Application of In Pari Delicto Defense," stated, "In light of Crown's allegations that JRC was not Crown's sole shareholder after the completion of the transactions that comprised the Spin, however, and the allegations that the independent board members could have taken steps to remedy the alleged wrongdoing by defendants, defendants are not entitled to dismissal of Crown's claims to the extent the claims are based on conduct occurring after JRC was no longer Crown's sole shareholder." (See Order of September 25, 2003 at 18:6-11.) These arguments, however, misconstrue the issue now being raised by defendants. Defendants do not contend that any of defendants' post-Spin knowledge or conduct is properly imputed to Crown; rather, defendants argue that Crown's knowledge concerning the details of the Spin transactions, imputed to Crown while Crown's agents were acting at the behest of Crown's sole shareholder, remains imputed to Crown after the Spin transactions.
Plaintiffs also assert that courts have "refus[ed] to impute knowledge to an innocent successor corporation." (See Pls.' Consolidated Response in Opp. to Defs.' Mots. to Dismiss at 10:25-26.) The cases plaintiffs cite for this proposition, however, hold that the conduct of the corporation's agent at issue therein was not properly imputed to the corporation at any time. See Ash v. Georgia-Pacific Corp., 957 F.2d 432, 436 (7th Cir. 1992) (holding knowledge of plaintiff's chief operating officer not imputed to plaintiff where chief operating officer acted "adversely to his employer"); In re Cendant Corp. Sec. Litig., 139 F. Supp.2d 585, 597-98 (D.N.J. 2001) (holding actions of plaintiff's agents not properly imputed to plaintiff where agents' actions were "against the best interests of the company"); Battenfeld of America Holding Co. v. Baird, Kurtz Dobson, 60 F. Supp.2d 1189, 1194, 1217 (D. Kan. 1999) (holding fraudulent actions taken by plaintiff corporation's chief financial officer not imputed to plaintiff because conduct was "adverse to the interest" of plaintiff at time conduct occurred). None of the cases on which plaintiffs rely involves the situation where a sole shareholder directed the agents of a corporation it wholly owned to participate in a fraud. In any event, the cited cases do not consider the relevant issue of whether knowledge, once properly imputed to a corporation, disappears after the corporation is purchased by "innocent" parties; thus, they are inapposite.
In short, plaintiffs cite no authority for the proposition that a corporation, after its ownership is transferred to new parties, is no longer bound by knowledge it acquired before the transfer. Although no party has offered any Virginia law directly bearing on this issue, the Court finds no basis on which to conclude the highest court of Virginia, as well as the highest courts of the states of California and New York, would hold that a corporation's imputed knowledge is erased when the corporation is sold to new owners who, in their individual capacities, lack such knowledge. Consequently, defendants are entitled to dismissal of plaintiffs' remaining claims, to the extent such claims are dependent on a showing that defendants failed to disclose certain facts, where knowledge of such facts was earlier imputed to Crown during the time JRC was Crown's sole shareholder.
To the extent the Supreme Court of Virginia has ruled on a related issue, such ruling appears consistent with the Court's decision herein. In particular, the Supreme Court of Virginia, applying the "general rule, that a party who consents to and participates in an immoral or illegal act cannot recover damages from other participants for the consequence of that act," has held that an executor of the estate is barred from recovery if the decedent would have been barred. See Miller v. Bennett, 56 S.E.2d 217, 218, 221 (1949). In other words, under Virginia law, a decedent's conduct is imputed to the executor, even though the executor had no involvement in or knowledge of the illegal activity.
As noted, defendants assert that all remaining claims brought on behalf of Crown are based on Crown's lack of knowledge of the true nature of the Spin transactions, and plaintiffs, in their opposition, have not taken issue with this assertion. Consequently, the remaining claims, with the exception of the two counts brought on behalf of creditors in the Crown Vantage case, are subject to dismissal.
The Court next turns to the question of whether plaintiffs should be afforded an opportunity to amend. Plaintiffs, in an appendix attached to their opposition, have submitted a proffer setting forth additional details concerning defendants' conduct after the Spin transactions. For example, plaintiffs state they are prepared to allege that JRC, Williams, and Hare, when writing a letter to PWC in September 1995, falsely stated that "Crown's pre-Spin financial statements were correct," (see Appendix A to Pls.' Consolidated Response in Opp. to Defs.' Mots. to Dismiss Post-Spin Claims ¶ 6), that PWC "sought to hide the fraudulent nature of the Spin" when it prepared a memorandum for Crown in October 1995, (see id. ¶ 9), that McGuire Woods, during the period of 1996 through 1999, provided "audit response letters" to Crown in which McGuire Woods "failed to disclose . . . that Crown had been the victim of fraud in the Spin transactions," (see id. ¶ 19), and that Leopold, when drafting a letter on August 25, 1995, had an "appropriate opportunity" to "disclose the truth about what he knew about the [Spin] transactions," but instead he "said nothing," (see id. ¶ 23). Leave to amend to allege such additional facts, as well as similar assertions set forth by plaintiffs in their proffer, would be futile because the success of such claims is dependent on Crown being ignorant of the "truth" of the Spin transactions. As discussed above, the knowledge imputed to Crown while JRC was its sole shareholder remains imputed to Crown in the post-Spin period. Accordingly, leave to amend to allege the information set forth in plaintiffs' proffer will be denied.
Additionally, as noted, see, supra, n. 7, plaintiffs now assert, in contradiction to the allegations in the FAC, that one of the cash transfers from Crown to JRC comprising the Spin occurred shortly after JRC transferred its Crown shares to third parties. Specifically, plaintiffs now assert Crown transferred the funds at issue into an escrow account while JRC was Crown's sole shareholder, the actual transfer from the escrow agent to JRC occurring shortly after JRC transferred its Crown shares to third parties. Assuming, arguendo, the relevant date is the date JRC took possession of the funds from the escrow officer, Crown, before that date, knew such transaction was, as Crown has alleged, "fraudulent," (see FJ FAC ¶ 13; PWC FAC ¶¶ 16-17), because, according to Crown, such transaction was undertaken by Crown's agents, and others, at the behest of Crown's sole shareholder.
Finally, the Court notes that in its previous order, the Court dismissed three of plaintiffs' claims, specifically, claims for negligent misrepresentation against, respectively, Fort James, Merrill Lynch, and Salomon, with leave to amend in order to afford plaintiffs the opportunity to clarify that such claims are based on a theory of constructive fraud and to the extent such claims are based on conduct occurring after JRC was no longer Crown's sole shareholder. (See Order of September 25, 2003 at 21:19-22:1.) In light of the above discussion, however, leave to amend for such purpose would be futile, and, consequently, that part of the Court's prior order is hereby VACATED.
Accordingly, plaintiffs' remaining claims, with the exception of the two counts brought on behalf of creditors in the Crown Vantage case, will be dismissed without leave to amend. As discussed, amendment would be futile in that, as a matter of law, the knowledge imputed to Crown while Crown was wholly owned by JRC remained imputed to Crown although JRC no longer was the sole shareholder.
In light of this finding, the Court does not address defendants' additional arguments pertaining to the remaining claims brought on behalf of Crown.
B. Fraudulent Conveyance Claims
The remaining claims in these consolidated proceedings are Counts 1 and 2 of the Crown Vantage case, both of which are fraudulent conveyance claims brought pursuant to 11 U.S.C. § 544(b) against Fort James and on behalf of creditors. In Count 1, plaintiffs seek to set aside the Spin transactions and, in Count 2, plaintiffs seek to set aside the 1998 Option and Settlement Agreement.
"[T]he trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor." 11 U.S.C. § 544(b). "Applicable law" within the meaning of § 544(b) includes state law. See Wyle v. C.H. Rider Family (In re United Energy Corp.), 944 F.2d 589, 593 (9th Cir. 1991). The parties submit, and the Court agrees, that Virginia law governs Counts 1 and 2. Under Virginia law, a transfer "given with intent to delay, hinder or defraud creditors, purchasers or other persons of or from what they are or may be lawfully entitled to shall, as to such creditors, purchasers or other persons, their representatives or assigns, be void," see Va. Code Ann. § 55-80, and a transfer "which is not upon consideration deemed valuable in law . . . by a transferor who is thereby rendered insolvent, shall be void as to creditors whose debts shall have been contracted at the time it was made. . . .," see Va. Code Ann. § 55-81.
Fort James argues that the two fraudulent conveyance claims are subject to dismissal.
1. Identification of Creditors
Fort James argues that plaintiffs fail to state a claim for fraudulent conveyance because plaintiffs cannot establish there are any creditors whose claims against Crown existed at the time of the conveyances plaintiffs now seek to set aside.
"Federal courts applying fraudulent transfer law at the pleading stage generally require that the complaint allege the existence of an actual creditor holding an allowable unsecured claim who could avoid a transfer under applicable state law in the absence of a bankruptcy proceeding." Neilson v. Union Bank of California, N.A., 290 F. Supp.2d 1101, 1146 (C.D. Cal. 2003) (citing cases). "Courts are divided, however, as to whether a complaint must specifically allege the identity of the creditor to state a claim under § 544(b)." Id. at 1147 (citing conflicting holdings in district court cases).
Assuming, arguendo, a plaintiff should be required to specifically allege the identify of a creditor whose claim existed at the time of the alleged fraudulent conveyance, here, plaintiffs have specifically alleged, in Count 1, the identity of creditors whose claims existed at the time of the Spin transactions, (see FJ FAC ¶ 720), and, in Count 2, the identity of creditors whose claims existed at the time Crown entered into the Option and Settlement Agreement, (see FJ FAC ¶ 745 (incorporating by reference ¶ 720)). Fort James, however, asserts that the allegations supporting Count 1 are "at war with the facts." (See Fort James' Mot. To Dismiss at 24:21-22.) Requesting that the Court take judicial notice of the claims filed in the bankruptcy court by the identified creditors, (see Coyne Decl. Ex. 4-12), Fort James argues that each identified creditor alleges a claim that arose on a date after August 1995. Consequently, Fort James contends, because no creditor has a claim against Crown that existed on August 25, 1995, the date plaintiffs assert the Spin transactions were complete, (see FJ FAC ¶¶ 248-254), the claims of the identified creditors do not support Count 1.
With respect to Count 2, Fort James argues that plaintiffs have not identified any creditors. This is incorrect, as plaintiffs have pointed out by referring Fort James to ¶ 745 of the FJ FAC.
Plaintiffs do not oppose the Court taking judicial notice of the claims filed by the creditors. Plaintiffs, however, argue that Fort James' interpretation of the claims is not supported by a review thereof. The Court agrees. For example, the Tennessee Department of Revenue, in a box on the claim form in which it was asked to identify the "date debt was incurred," wrote "06/95-03/00," (see Coyne Decl. Ex. 10 at 254), which is sufficient to allege that, in the creditor's view, some amount of the debt Crown owes to the creditor was incurred on or before August 25, 1995. As another example, the Environmental Protection Agency alleges that its claim against Crown is based in part on Crown's "manufactur[ing] manganese during the calendar years 1995 and 1996," (see Coyne Decl. Ex. 4 at 177); there is no language in the claim from which the Court could, in the context of a motion to dismiss, definitively conclude any such claim arose after August 25, 1995. Similarly, the claims submitted, respectively, by American Express Financial Corporation and Alliance Capital Management, L.P., indicate that each of those two creditors seeks to recover on a debt incurred in "August 1995," (see Coyne Decl. Exs. 11, 12); neither claim includes language indicating that such claim was incurred after August 25, 1995.
Accordingly, as the Court cannot conclude from the judicially-noticeable documents that plaintiffs are unable to establish the existence of creditors whose claims against Crown had accrued as of the time of the conveyances plaintiffs seek to set aside, Fort James is not entitled to dismissal of Counts 1 and 2 on this ground.
2. Settlement Agreement and Release
Fort James, relying on plaintiffs' allegation that Crown entered into the Option and Settlement Agreement with JRC, argues that the agreement should be interpreted as releasing JRC from the claims alleged in Counts 1 and 2. Assuming, arguendo, the agreement is enforceable, Fort James points to no language in the agreement that could be construed as releasing JRC from any claims held by creditors. Moreover, Fort James fails to explain how the creditors, who were not parties to the Option and Settlement Agreement, could be bound by the agreement.
Accordingly, Fort James is not entitled to dismissal of Counts 1 and 2 based on the Option and Settlement Agreement between Crown and JRC.
3. Consideration Deemed Valuable in Law
Fort James argues plaintiffs cannot establish that Crown, when it transferred assets to JRC, failed to receive "consideration deemed valuable in law." See Va. Code Ann. § 55-81. In making this argument, Fort James seeks, in effect, a ruling limiting Counts 1 and 2 to claims that the conveyances were "given with intent to delay, hinder or defraud creditors," as is required under § 55-80.
Under § 55-81, "a transfer undertaken by an insolvent debtor, or by a debtor who is thereby rendered insolvent, without return to him of valuable consideration is de jure fraudulent as against any existing creditor without any need to prove intent to defraud." See Balzer Associates, Inc. v. Lakes on 360, Inc., 463 S.E.2d 453, 455 (Va. 1995) (emphasis in original). "A valuable consideration is said to be a benefit to the party promising, or to a third person at his request, or an inconvenience, loss, or injury, or the risk of it, to the party promised." White v. Alleghany Mountain Corp., 159 Va. 394, 401-02 (Va. 1932) (internal quotation and citations omitted).
a. Count 1
In Count 1, plaintiffs seek to set aside the conveyances Crown made to JRC that occurred during the Spin, which, accordingly to the FAC, were transfers of monies totaling $551,200,000. (See FJ FAC ¶ 651(f).)
Fort James argues that plaintiffs have alleged JRC transferred assets such as papers mills to Crown in exchange for the transfers of monies, and, consequently, that plaintiffs have alleged there was valuable consideration to support the conveyances. As plaintiffs point out, however, they have actually alleged that the transfers of monies from Crown to JRC constituted a return of capital, and not an exchange of monies for assets. Specifically, plaintiffs allege that Crown transferred the sum of $551,200,000 to JRC "without consideration," and that the transfers constituted a "return of the capital investment of JRC." (See FJ FAC ¶¶ 252, 256.) Additionally, plaintiffs allege that JRC transferred the paper mills and other assets to Crown in exchange for 100% of Crown's common stock, (see FJ FAC ¶¶ 250, 651(c)), and that JRC reported to the Internal Revenue Service that such transaction "was not a `sale' of assets to Crown," (see FJ FAC ¶ 256).
In its reply in support of its motion to dismiss, Fort James, relying on a California Court of Appeal opinion applying California law, argues that a return of capital constitutes valuable consideration if the transfer benefits the transferor corporation. See Annod Corp. v. Hamilton Samuels, 100 Cal.App.4th 1286 (2002). Assuming, arguendo, Fort James' interpretation of Annod Corp. is correct and that the highest court of Virginia would adopt the reasoning stated therein, here, plaintiffs' FAC cannot be reasonably interpreted as alleging Crown's transfer of $551,200,000 to JRC benefitted Crown. Rather, the FAC expressly alleges to the contrary by stating that Crown, after transferring the $551,200,000 to JRC, was "unable to pay debts as they came due and [was] without sufficient liquidity, capital, and assets to operate profitably as a going concern." (See FJ FAC ¶ 260(1).)
Fort James also argues that the Court should reject plaintiffs' characterization of the Spin transactions and instead find that JRC transferred assets in return for the $551,200,000. This argument, made in the context of a motion to dismiss, is premature.
Consequently, the Court cannot find, from the face of the complaint, that Crown's transfer of $551,200,000 to JRC was for consideration deemed valuable in law. Accordingly, Fort James is not entitled to dismissal of Count 1 based on a failure to allege the subject conveyances were not upon consideration deemed valuable in law.
b. Count 2
In Count 2, plaintiffs seek to set aside the conveyance Crown made to JRC under the Option and Settlement Agreement, specifically the release granted by Crown to JRC thereunder.
Fort James, requesting the Court take judicial notice of the Option and Settlement Agreement, argues the face of the agreement establishes that in return for the release by Crown, JRC gave Crown consideration deemed valuable in law. Specifically, Fort James notes that under the Option and Settlement Agreement, JRC agreed to release Crown from some of Crown's obligations to JRC arising under agreements made during the Spin, such as Crown's obligation to make certain payments to JRC under the terms of "PIK Notes." Plaintiffs, in opposition, argue that under Virginia law the forgiveness of an obligation owed under a fraudulently obtained agreement does not constitute consideration deemed valuable in law.
Plaintiffs do not oppose the Court's taking judicial notice of the Option and Settlement Agreement and, indeed, rely on statements in the Option and Settlement Ageement in support of other arguments. (See, e.g., Pls.' Mem. in Opp. to Separate Mot. of Def. Fort James to Dismiss FAC at 12-13.)
This is a reference to "Pay-in-Kind Notes" that Crown alleges JRC "forced" Crown to issue during the Spin. (See FJ FAC ¶ 252.)
The Supreme Court of Virginia has stated that "the forbearance to prosecute an invalid, worthless or unfounded claim is not a consideration recognized by the law as valuable." See Pierce v. Plogger, 286 S.E.2d 207, 210 (Va. 1982) (quoting Hooff v. Paine, 2 S.E.2d 313, 314 (1939) (alteration in original). Examples of forbearance of "clearly unenforceable" claims, and hence not consideration deemed valuable in law, include "a promise to forbear from claims under an illegal contract, . . . or one which is without consideration, or which is barred by the statute of limitations, or of the discontinuance of a vexatious lawsuit brought to harass. . . ." See Hooff, 2 S.E.2d at 314-15 (holding plaintiff's promise not to file mechanic's lien, where plaintiff had no right to file mechanic's lien, not valid consideration). In short, under Virginia law, "consideration fails if it be shown that the claim is wholly and certainly unsustainable at law or in equity." See id. at 315.
Here, plaintiffs allege that the Spin transactions, which include the agreements under which Crown became obligated to JRC and which are the focus of the Option and Settlement Agreement, constituted fraudulent conveyances. Although the Court, in its prior order, found that Crown itself was barred from recovering damages from Fort James based on conduct occurring while JRC was Crown's sole shareholder, the Court did not hold that plaintiffs had failed to allege that the conveyances were fraudulent as to third parties. In that plaintiffs' FAC alleges that the Spin agreements lacked valuable consideration, plaintiffs have sufficiently pleaded that any claim for breach of such agreements would be "wholly and certainly unsustainable at law or in equity."
Consequently, the Court cannot find, from the face of the complaint and judicially-noticeable documents, that JRC's promise to release Crown from certain of its obligations owed as a result of agreements entered into during the Spin constituted consideration deemed valuable in law. Accordingly, Fort James is not entitled to dismissal of Count 2 based on a failure to allege the release conveyed by Crown was not upon consideration deemed valuable in law.
4. Intentional Fraud
Fort James argues that Count 2, as a pleading matter, does not allege a claim of fraudulent conveyance on a theory of intentional fraud because plaintiffs do not allege the Option and Settlement Agreement was made with "intent to delay, hinder, or defraud creditors." See Va. Code Ann. § 55-80. Although plaintiffs argue that the subject complaint contains such an allegation, plaintiffs, in support of that argument, point to an allegation specific to the Spin transactions only. (See FJ FAC ¶¶ 254, 258.) Plaintiffs, however, state in their opposition that "[a]ctual misrepresentations were made to Crown creditors to accomplish the [r]elease." (See Pls.' Mem. in Opp. To Separate Mot. of Def. Fort James to Dismiss FAC at 17:3-5.) There being no reason to conclude that any such allegations, if made in the complaint, would be futile, the Court will afford plaintiffs the opportunity to amend Count 2 to clarify such count is based in part on a theory that the parties entered into the Option and Settlement Agreement with the intent to delay, hinder or defraud creditors.
CONCLUSION
For the reasons discussed above,
1. Defendants' motions to dismiss the First Amended Complaint in the Liquidating Trust case, Crown Paper Liquidating Trust v. PricewaterhouseCoopers, et al., C 02-3836 MMC, are hereby GRANTED, and the First Amended Complaint in that action is hereby DISMISSED without leave to amend.
2. Fort James' motion to dismiss the First Amended Complaint in the Crown Vantage case, Crown Paper Co., et al., v. Fort James Corp., et al., C 02-3839 MMC, is hereby GRANTED in part and DENIED in part, as follows:
a. Count 2 is dismissed, with leave to amend, to the extent it is based on a theory of intentional fraud.
b. Counts 3 through 12 are dismissed without leave to amend.
c. In all other respects, the motion is denied.
d. Plaintiffs may file a Second Amended Complaint, no later than August 6, 2004, to cure the deficiency in Count 2 as set forth above.
This order closes Docket Numbers 88, 91, 93, 208, 210, 211, 213, 216, 226, and 278.
In light of the Court's issuance of the instant order, plaintiffs' motion to strike DLJ's proposed order is DENIED as moot.