Opinion
Case No. 17-31030 Adv. No. 19-3032
02-10-2020
In re: GYPC, INC., Debtor GYPC, INC., Plaintiff v. MINDSTREAM MEDIA, LLC, Defendant / Third-Party Plaintiff v. CHRISTOPHER CUMMINGS ERIC WEBB, Third-Party Defendants
Copies to: Patricia J. Friesinger (Counsel for the Plaintiff) Zachary B. White (Counsel for the Plaintiff) Matthew T. Schaeffer (Counsel for the Defendant and Third-Party Plaintiff) Casey M. Cantrell Swartz (Counsel for Third-Party Defendants) W. Timothy Miller (Counsel for Third-Party Defendants)
Chapter 7 Decision Denying Motion of Third-Party Defendants, Christopher Cummings and Eric Webb, to Dismiss the Third-Party Complaint of Mindstream Media, LLC (Doc. 18)
This decision addresses whether, in a preference action, a third-party complaint for indemnification should be dismissed for failure to state a claim. This court has jurisdiction pursuant to 28 U.S.C. § 1334(b) and the Standing Order of Reference, Amended General Order No. 05-02 (S.D. Ohio Sept. 16, 2016).
I. Factual and Procedural Background
GYPC, Inc., a Chapter 11 debtor, filed a complaint against Mindstream Media, LLC ("Mindstream") for the avoidance and recovery of certain preferential transfers. Following the conversion of the estate case from Chapter 11 to Chapter 7, Donald F. Harker, III was appointed as the Chapter 7 Trustee, and substituted as the proper party plaintiff in this adversary proceeding. Mindstream filed an answer and a third-party complaint (the "Third Party Complaint") against Christopher Cummings and Eric Webb (collectively, the "Third-Party Defendants"). The Third-Party Complaint alleges that the Third-Party Defendants are required, jointly and severally, to indemnify Mindstream for any preferential transfers it may be required to return to the bankruptcy estate. The Third-Party Defendants have moved to dismiss the Third-Party Complaint as failing to state a claim for which relief can be granted.
The genesis for the Third-Party Complaint and the Defendants' motion to dismiss is a July 12, 2016 Asset Purchase and Sale Agreement (the "Agreement"). The parties to the Agreement were General Yellow Pages Consultants, Inc. ("GYPC"), as seller; the Third-Party Defendants, as principals; Mindstream, as the buyer; and Eastport Holdings, LLC ("Eastport") as the parent company of Mindstream. Through the Agreement, GYPC sold substantially all of its assets to Mindstream.
The Agreement provided, in section 6.1(c), that the Third-Party Defendants are required to indemnify Mindstream from, among other things, any Excluded Liabilities. The transfers, made in January and February 2007 in the total amount of $53,153.60, were reimbursements for Excluded Liabilities which GYPC apparently made to Mindstream pursuant to § 10.1 of the Agreement.
However, in seeking dismissal of the third-party complaint, the Third-Party Defendants argue that before pursuing indemnification under section 6.1, Mindstream, through its parent Eastport, is required to offset any such damages or liability against GYPC's Preferred Membership Interest in Eastport, which GYPC acquired through the Agreement. See Section 6.6 of the Agreement. In addition, the Third-Party Defendants assert that under ¶ 10.1 of the Agreement, GYPC, and not the Third-Party Defendants, are responsible for any Excluded Liabilities.
II. Standard of Review
A motion to dismiss an adversary proceeding for "failure to state a claim upon which relief can be granted" is governed by Federal Rule of Civil Procedure 12(b)(6) (applicable by Federal Rule of Bankruptcy Procedure 7012(b)). The factual allegations must put the defendant on notice as to the claims being alleged and provide a sufficient factual predicate to make the allegations plausible, and not merely possible. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). Federal courts are not obligated to accept as true legal conclusions couched as factual allegations. Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007). While detailed factual allegations are not necessary, the allegations must be sufficiently detailed to create more than speculation of a cause of action. Id. A claim is plausible if the factual allegations are sufficient to allow "the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." HDC, LLC v. Ann Arbor, 675 F.3d 608, 611 (6th Cir. 2012) (citations and internal quotation marks omitted). See Fed. R. Civ. P. 8(a)(2) (applicable by Fed. R. Bankr. P. 7008, which requires "a short and plain statement of the claim showing that the pleader is entitled to relief[.]").
III. Analysis
The legal issue before the court is a narrow one. The Agreement addresses all the key terms between the parties and no party has requested that the court consider extrinsic evidence in making its determination. See Individual Healthcare Specialists, Inc. v. BlueCross Blue Shield of Tenn., Inc., 566 S.W.3d 671, 695 (Tenn. 2019) (noting Tennessee law has a "strong strain" of textualism "to keep the written words as the loadstar of contract interpretation."). First, ¶ 6.1 of the Agreement provides that GYPC, as seller, and the Third-Party Defendants, as the principals, shall indemnify Mindstream for any Excluded Liability. Second, Paragraph 10.1 states that if Mindstream pays any Excluded Liability, it should be reimbursed by GYPC. Finally, ¶ 6.6 of the Agreement requires that Eastport must first offset any damages it is entitled to against GYPC's Preferred Membership Interest.
Paragraph 6.1 of the Agreement states:
Indemnification by the Seller and Principals. Subject to the terms of conditions of this ARTICLE VI, from and after the Closing, the Seller and the Principals, jointly and severally, shall indemnify the Parent, the Buyer, and their Affiliates, successors, assigns, stockholders, partners, members, managers, agents, representatives, officers, directors or employees (each, a "Buyer Party") and save and hold each Buyer Party harmless against, Damages incurred or suffered by such Buyer Party resulting from or constituting:
(a) any breach of a representation or warranty of the Seller contained in this Agreement or the Seller Certificate;
(b) any failure by the Seller or any of the Principals to perform any covenant or agreement contained in this Agreement;
(c) any Excluded Liabilities, Excluded Assets, and any liabilities arising under any Employee Benefit Plans;
(d) any liabilities and obligations arising or accruing from the operation of the Business or the Acquired Assets prior to the Closing Date, except for the Assumed Liabilities, and with respect to any of the Business Employees with respect to their employment prior to the Closing Date or any termination of the Business Employees by the Seller;
(e) any Environmental Matter that existed or arose prior to the Closing Date with respect to the Business or any of the Acquired Assets;
(f) any liabilities and obligations resulting from or arising out of any bulk sales Law, bulk transfer Law, or any other similar Laws with respect to the transactions contemplated by this Agreement; and
(g) (i) any and all Taxes due with respect to the Business accruing prior to the Closing, including without limitation (i) any and all amounts which may be required to be paid to obtain all Tax Clearance Certificates and (ii) any claims or other liabilities arising out of the Seller's failure to obtain all such Tax Clearance Certificates.
Paragraph 6.6 of the Agreement states:
Offset.
(a) Except as otherwise provided for in Section 1.3(b) and Section 6.6(c), in pursuing the collection of any Damages to which a Buyer Party may be entitled under Section 6.1, other than based on fraud or willful misconduct, the Parent shall first offset such Damages against the Preferred Membership Interest issued to the Seller by a reduction and cancellation of Preferred Membership Interest (together with the elimination of any corresponding Preferred Return accrued, but unpaid on the reduced amount of Preferred Capital Contribution), in the aggregate (but excluding any eliminated accrued Preferred Return) equal to any amount of such Damages. In pursuing the collection of any Damages to which a Buyer Party may be entitled to under Section 6.1 based on fraud or willful misconduct, the Parent shall have a right of offset, in its sole discretion, of such Damages against the Preferred Membership Interest issued to the Seller in the manner described in the preceding sentence. In the event of any offset against the Preferred Membership Interest under this Section, the portion of the Preferred Capital Contribution attributable to the Seller as a Preferred Member shall be automatically reduced by an amount equal to any such Damages subject to such offset (as if the same had never been conveyed to the Seller under this Agreement, without any requirement for payment therefor) and the Seller shall pay promptly to the Parent the amount of any Preferred Return actually paid to the Seller thereon since the Closing Date.
(b) In the event of any offset, the Seller shall surrender any and all certificates representing the Preferred Membership Interest, to the extent offset against, and the Parent shall reissue, if applicable, new certificates representing any remaining Preferred Membership Interest to which the Seller may be entitled and/or otherwise amend the Operating Agreement.
(c) Upon final determination of any Damages due and owing by the Seller pursuant to this ARTICLE VI, in lieu of any offset provided for in Section 6.6(a) Seller and/or the Principals may elect to remit payment in immediately available funds to the Buyer Party in the full amount equal to such Damages, provided that such payment is made within ten (10) days following the determination of such Damages. In the event the Seller or any of the Principals fail to remit such payment within such ten (10) days, the Buyer shall have the right to offset otherwise provided for in Section 6.6(a).
The payments to Mindstream appear to have been based on post-closing adjustments required by ¶ 10.1 of the agreement. Since those funds are alleged to be preference payments, GYPC seeks the return of those pre-petition payments. If those payments were returned to the bankruptcy estate, there is no question that under ¶ 6.1 the Third-Party Defendants must indemnify Mindstream. It is also beyond debate that such indemnification has a condition precedent. Mindstream (and its parent Eastport) must first offset any claim it has against the Third-Party Defendants against GYPC's Preferred Membership Interest under the indemnification provisions in Section 6.6 of the Agreement, since those provisions create primary liability as to the Preferred Membership Interest and secondary liability against the Third-Party Defendants. The Third-Party Defendants argue that ¶ 10.1 absolves them from liability for these damages, but that section just provides that if either the buyer or seller parties receive any funds post-closing belonging to the other, they have an obligation to remit those funds to the counter-party within 30 days. Paragraph 10.1 does not release The Third-Party Defendants from their indemnification obligations under ¶ 6.1.
Paragraph 10.1 of the Agreement states:
Payment of Certain Monies. In the event that the Seller (or an affiliate thereof) pays or discharges, after the Closing, any Assumed Liabilities, the Buyer shall reimburse the Seller for the amount so paid or discharged within 30 days of being presented with written evidence of such payment or discharge. In the event that the Buyer (or an Affiliate thereof) pays or discharges, after the Closing, any Excluded Liabilities, the Seller shall reimburse the Buyer for the amount so paid or discharged within 30 days of being presented with written evidence of such payment or discharge. The Buyer shall promptly forward to the Seller all monies received by the Buyer or its Affiliates following the Closing with respect to any Excluded Asset, and the Seller shall promptly forward to the Buyer all monies received by the Seller or its Affiliates following the Closing with respect to any Acquired Asset.
The Preferred Membership Interest is defined in ¶ 1.5(b)(iv)(A) of the Agreement.
The Third-Party Defendants' other argument is that the claim is contingent and must be dismissed, but this argument conflates the establishment of damages and the remedies available to collect those damages. If the GYPC bankruptcy estate is able to prevail against Mindstream and recover on its preference claims, under the indemnification provisions of the Agreement, Mindstream's damages against The Third-Party Defendants will have been established. If Eastport and Mindstream are then successful in establishing a setoff against GYPC's Preferred Membership Interest in Eastport, the Third-Party Defendants' liability to Mindstream will be eliminated. GYPC and The Third-Party Defendants are all jointly and severally liable for damages caused by Eastport's or Mindstream's payment of Excluded Liabilities. Mindstream appropriately has brought the Third-Party Defendants into the adversary proceeding under Federal Rule of Civil Procedure 14 so that all rights between the parties with respect to the establishment of the damages can be litigated in one proceeding with all affected parties. See also § 6.6(c) of the Agreement ("Upon final determination of any Damages due and owing by the Seller pursuant to ARTICLE VI, in lieu of any offset provided for in Section 6.6(a) Seller and/or the Principals may elect to remit payment in immediately available funds to the Buyer Party in the full amount equal to such Damages[.]").
Specifically, Rule 14 allows Mindstream to join the Third-Party Defendants into the preference action because the Third-Party Defendants may be liable to Mindstream if the plaintiff prevails. Under Rule 14, a third-party defendant's liability to a third-party plaintiff on the original plaintiff's claims does not have to be definite, but only possible. Otherwise, Rule 14 would provide that joinder through a third-party complaint only can occur if a third-party defendant is liable to a third-party plaintiff. But the purpose of Rule 14 is to allow all parties with an interest in the litigation to be joined in one action and avoid piecemeal litigation. Specifically, Rule 14(a)(2) has the salutary function of allowing the Third-Party Defendants to assert any defenses which Mindstream has against GYPC, such as the setoff affirmative defense. See Kansas Pub. Emps. Retirement Sys. v. Reimer & Koger Assocs., Inc., 4 F.3d 614, 619-20 (8th Cir. 1993) ("Because a third-party defendant cannot relitigate the question of a third- party plaintiff's liability to the original plaintiff, this provision protects the third-party defendant against any prejudice that might result from the third-party plaintiff's failure to assert a particular defense against the original plaintiff.").
Mindstream need not exhaust the setoff remedy prior to suing the Third-Party Defendants. The Third-Party Complaint seeking indemnification is an appropriate contingent third-party claim for indemnification under Federal Rule of Civil Procedure 14. Rule 14(a)(1) provides, in pertinent part:
A defending party may, as third-party plaintiff, serve a summons and complaint on a nonparty who is or may be liable to it for all or part of the claim against it.Fed. R. Civ. P. 14(a)(1). Further, Rule 14(a)(2) provides, in pertinent part (emphasis added):
The person served with the summons and third-party complaint—the "third-party defendant":Fed. R. Civ. P. 14(a)(2) (emphasis added).
(A) must assert any defense against the third-party plaintiff's claim under Rule 12;
(B) must assert any counterclaim against the third-party plaintiff under Rule 13(a), and may assert any counterclaim against the third-party plaintiff under Rule 13(b) or any crossclaim against another third-party defendant under Rule 13(g);
(C) may assert against the plaintiff any defense that the third-party plaintiff has to the plaintiff's claim; and
(D) may also assert against the plaintiff any claim arising out of the transaction or occurrence that is the subject matter of the plaintiff's claim against the third-party plaintiff.
The contingent indemnification claim based upon the bankruptcy estate's initial claims against Mindstream is the precise type of claim envisioned by Rule 14(a). Rule 14(a) allows "additional parties whose rights may be affected by the decision in the original action to be joined so as to expedite the final determination of the rights and liabilities of all the interested parties in one suit." American Zurich Ins. Co. v. Cooper Tire & Rubber Co., 512 F.3d 800, 805 (6th Cir. 2008). As the Sixth Circuit explained:
Underlying Rule 14 is a desire "to promote economy by avoiding the situation where a defendant has been adjudicated liable and then must bring a totally new action against a third party who may be liable to him for all or part of the original plaintiff's claim against him." 6 Wright, Miller, Kane, Fed. Prac. & Proc.: Civ.2d § 1441 at 289-90 (2d ed.1990)). The third-party complaint is in the nature of an indemnity or contribution claim.Id. CSX Transp., Inc. v. Columbus Downtown Dev. Corp. elaborated on the purpose of Rule 14:
"A defendant may implead a party, even though a cause of action has not yet accrued, provided the claim is contingent upon the success of plaintiff's claim, and will accrue when defendant is found liable in the main action." New Mkt., 154 F.Supp.2d at 1228 n.13 (citing Community Fed. Sav. & Loan Ass'n v. Transamerica Ins. Co., 559 F. Supp. 536, 537 (E.D. Mo. 1983) ("The fact that defendant is not yet 'out of pocket' is not fatal to his third-party complaint.")).307 F.Supp.3d 719, 735 (S.D. Ohio 2018). See also Starnes Family Office, LLC v. McCullar, 765 F. Supp. 2d 1036, 1058 (W.D. Tenn. 2011) ("A claim for indemnification is proper under Rule 14(a)."); Wells Fargo Bank v. Gilleland, 621 F. Supp. 2d 545, 547 (N.D. Ohio 2009) ("By its own language, Rule 14 requires an indemnity claim in order to bring in a third-party defendant whereby the defendant is attempting to transfer liability from himself to a third-party defendant in the event he is found to liable to the plaintiff."); Trane U.S. Inc. v. Meehan, 250 F.R.D. 319, 321-22 (N.D. Ohio 2008) (internal quotation marks and citation omitted) ("A third-party claim is viable only when the third party's liability is in some way dependent on the outcome of the main claim or when the third party is secondarily liable to defendant."); Aviva Life Insurance Co. v. Burton (In re Burton), No. 08-50104, 2009 Bankr. LEXIS 630, at *18-19 (Bankr. E.D. Tenn. Feb. 20, 2009) (denying a Rule 12(c) motion on a contingent right of subrogation or indemnification relating to a nondischargeability proceeding against the debtor). If Mindstream is liable to GYPC, its claim is that it is entitled to be indemnified under the Agreement by the Third-Party Defendants.
The Third-Party Defendants may assert any affirmative defense they have against the plaintiff or the third-party plaintiff, such as the failure to satisfy the condition precedent of the setoff of the Preferred Membership Interest. See Fed. R. Civ. P. 14(a)(2)(A) & (C) (allowing the third-party defendant to assert Rule 12 defenses to a third-party complaint, or any defense the third-party plaintiff has against the plaintiff's claim). See Laethem Equip. Co. v. Deere & Co., 485 Fed. Appx. 39, 51 (6th Cir. 2012) (citing First Nat'l Bank of Louisville v. Hurricane Elkhorn Coal Corp. II, 763 F.2d 188, 190 (6th Cir. 1985)) ("Entitlement to a setoff is an affirmative defense which must be pled and proven by the party asserting it."). See also Doug Smith, Inc. v. Freedom Elec. Contractors, Inc., 133 B.R. 617, 620 n.2 (Bankr. S.D. Ohio 1991) ("Typically, a setoff occurs when a creditor: i) decides to exercise the right to setoff, ii) takes some action to accomplish the setoff, and iii) prepares some record, usually in the creditor's financial books, which evidences the setoff."). These are the precise type of claims envisioned by Rule 14.
But see ITS Fin., LLC v. Advent Fin. Servs., LLC, 823 F. Supp. 2d 758, 771 (S.D. Ohio 2011) (holding that setoff can only be based upon a liquidated debt and that an unliquidated claim must be pursued through affirmative claim, such as a counterclaim rather than via setoff.).
In summary, the offset is a condition precedent to the collection of any damages, but it is not a condition precedent to the establishment of the Third-Party Defendants' underlying liability for those damages, which can be accomplished through this adversary proceeding and the Third-Party Complaint.
IV. Conclusion
The motion to dismiss the Third-Party Complaint is denied. The Third-Party Defendants shall file an answer pursuant to Federal Rule of Bankruptcy Procedure 7012(a). A separate order will be entered consistent with this decision.
This document has been electronically entered in the records of the United States Bankruptcy Court for the Southern District of Ohio.
IT IS SO ORDERED.
/s/ _________
Guy R. Humphrey
United States Bankruptcy Judge
Dated: February 10, 2020
Copies to: Patricia J. Friesinger (Counsel for the Plaintiff) Zachary B. White (Counsel for the Plaintiff) Matthew T. Schaeffer (Counsel for the Defendant and Third-Party Plaintiff) Casey M. Cantrell Swartz (Counsel for Third-Party Defendants) W. Timothy Miller (Counsel for Third-Party Defendants)