Opinion
Case No. 01-12264-SSM, Adversary Proceeding No. 02-8068.
August 14, 2002
Dennis Auerbach, Esquire, Covington Burling Washington, DC, Counsel for the plaintiff.
Alexander M. Laughlin, Esquire, Wiley Rein Fielding LLP, McLean, VA, Local counsel for the plaintiff.
John J. McJunkin, Esquire, Piper, Marbury Rudnick, L.L.P., Washington, DC, Counsel for defendant Nortel Networks, Inc.
Cecily Dumas, Esquire, Murphy, Sheneman, Julian Rogers, San Francsico, CA, Counsel for defendant Cisco Systems Capital Corporation.
K. Stewart Evans, Jr., Esquire, Pepper Hamilton, LLP, McLean, VA, Local counsel for defendant Cisco Systems Capital Corporation.
Malcolm Mitchell, Esquire, Vorys, Sater, Seymour Pease, L.L.P., Alexandria, VA, Local counsel for the Official Committee of Unsecured Creditors.
MEMORANDUM OPINION AND ORDER
A hearing was held in open court on July 16, 2002, on the motion filed by the defendants, Nortel Networks, Inc. ("Nortel") and Cisco Systems Capital Corporation ("Cisco"), to dismiss the complaint for failure to state a claim for relief. The plaintiff and the defendants were present by counsel, as was the Official Committee of Unsecured Creditors in the plaintiff's chapter 11 case. The court heard the arguments of the parties and took the matter under advisement. For the reasons stated, the motion will be denied.
The court previously announced its ruling from the bench and briefly stated the reasons. The purpose of this memorandum opinion and order is to effectuate the bench ruling and to assist the parties by providing a more detailed statement of the reasons.
Background
The plaintiff, Pathnet, Inc. ("PNI") filed a voluntary petition for reorganization under chapter 11 of the Bankruptcy Code on April 2, 2001. Five related companies, among them Pathnet Telecommunications, Inc. ("PTI") and Pathnet Operating, Inc. ("POI") filed chapter 11 petitions at the same time. PTI was the parent holding company, while PNI and POI were both operating subsidiaries. POI and three of its subsidiaries had their cases converted to chapter 7; however, PTI and PNI remained in chapter 11 and obtained confirmation of a joint plan of liquidation on March 12, 2002,
The present action was commenced by PNI on April 24, 2002, against Nortel and Cisco to recover approximately $9.3 million which PNI allegedly expended for their benefit without receiving anything of value in return. Prior to the filing of an answer, PNI filed an amended complaint on May 6, 2002. It is this complaint to which the present motion is directed.
The complaint asserts that PNI was a party to an Intercompany Services Agreement with POI dated August 9, 2000. The complaint further alleges that POI was specifically created at the behest of Nortel and Cisco as a condition to their making certain loans, and that under the agreement PNI was required to provide POI with a broad range of ongoing "essential services," all of which were necessary to POI's ability to operate since POI had no employees of its own. In exchange, POI was required to pay PNI an "Intercompany Services Fee," invoiced on a quarterly basis. PNI claims that during the prepetition period, it was underpaid a total of $4.8 million by POI for services performed under the agreement. In addition, PNI alleges that it paid approximately $4.2 million to creditors of POI, and posted approximately $300,000 in letters of credit on POI's behalf during this period, on terms outside of the agreement and on account of which it also received no consideration.
The complaint alleges that Nortel and Cisco were the intended beneficiaries of the uncompensated services, and that they did in fact benefit from these services because (a) the services preserved and protected POI's assets in which Nortel and Cisco have a security interest, and (b) underpaying for the services performed by PNI under the agreement gave POI $4.8 million in additional cash, which became cash collateral subject to Nortel's and Cisco's liens. PNI additionally alleges that Nortel and Cisco benefitted from the $4.5 million in creditor payments not encompassed by the agreement for the same reason (i.e., that the unpaid money became cash collateral subject to their liens). Finally, PNI alleges that at the time these transfers were made, PNI was either insolvent or became insolvent as a result of them.
Discussion I.
Under Rule 12(b)(6), Federal Rules of Civil Procedure, as incorporated by Rule 7012, Federal Rules of Bankruptcy Procedure, a complaint may be dismissed if it fails to state a claim for relief. In considering a Rule 12(b)(6) motion to dismiss, "a court must accept the factual allegations of the complaint as true, and must view the complaint in the light most favorable to the plaintiff." GE Inv. Private Placement Partners II v. Parker, 247 F.3d 543, 548 (4th Cir. 2001). A motion to dismiss for failure to state a claim should only be granted "where it is clear and apparent to the court that the plaintiff would not be entitled to relief under any state of facts which could be proved in support of a specific claim." Tahir Erk v. Glenn L. Martin Co., 116 F.2d 865, 870 (4th Cir. 1941) (emphasis added). As the Supreme Court has explained,
When a federal court reviews the sufficiency of a complaint, before the reception of any evidence either by affidavit or admissions, its task is necessarily a limited one. The issue is not whether a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims. Indeed it may appear on the face of the pleadings that a recovery is very remote and unlikely but that is not the test. . . .
Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974).
Here, the defendants advance two principal grounds for dismissal of the complaint.
The first is that the plaintiffs are judicially estopped from attacking payments which they have previously represented to this court were made in the ordinary course of business. The second is that, as a matter of law, the defendants do not occupy a position would allow them to be treated as parties for whose benefit the payments were made. Each of these arguments will be discussed in turn.
A.
The judicial estoppel argument relies on pleadings filed by PNI in related litigation before this court in which PNI affirmatively alleged that the intercompany services agreement provided for "fair and reasonable arm's length compensation" and that POI's obligations to PNI under the agreement "were incurred in the ordinary course of business or financial affairs" of the two companies and "according to ordinary business terms."
Motion of the Debtors for Order Under 11 U.S.C. § 105 and 365 Authorizing the Debtors to Reject the Intercompany Services Agreement ~ 15, In re Pathnet Telecommunications, Inc., et al., No. 01-12264-SSM (filed August 1, 2001).
Answer and Counterclaim at 11-12, Peyton v. Pathnet, Inc. (In re Pathnet Operating, Inc.), Case No. 01-12266-SSM, Adv. No. 02-8044 (filed April 11, 2002).
As an initial matter, the court notes that if "matters outside the pleading are presented to and not excluded by the court, the [Rule12(b)(6)] motion shall be treated as one for summary judgment and disposed of under Rule 56." Fed.R.Civ.P. 12(b)(6). However, a court is permitted to consider matters on the public record in connection with a motion to dismiss without converting the motion to one for summary judgment, and the court is also entitled to take judicial notice of pleadings filed among its own records. See Papasan v. Allain, 478 U.S. 265, 268, 106 S.Ct. 2932, 92 L.Ed.2d 209, n. 1 (1986) (stating that the Court was not precluded, in considering a motion to dismiss, from taking notice of items on the public record); see also Fletcher v. United States, 174 F.2d 373, 376 (4th Cir. 1949) ( "Certainly a judge may take cognizance of the records of his own court."), cert. denied 338 U.S. 851, 70 S.Ct. 82, 94 L.Ed. 521 (1948). Thus, the prior pleadings filed by the plaintiff may properly be considered in determining whether PNI is judicially estopped from claiming that payments it made under the agreement or on POI's behalf are avoidable as constructively fraudulent transfers.
In this regard, three elements must be satisfied before a court may apply judicial estoppel to foreclose the assertion of a claim or cause of action. First, the party sought to be estopped must seek to adopt a position inconsistent with that taken in prior litigation. Second, the position taken in the prior litigation must have been accepted by the court. And third, the party must have intentionally misled the court in order to obtain an unfair advantage. Lowery v. Stovall, 92 F.3d 219, 224 (4th Cir. 1996), cert. denied, 519 U.S. 1113, 117 S.Ct. 954, 136 L.Ed.2d 841 (1997); See also U.S. v. Simmons, 247 F.3d 118, 124 (4th Cir. 2001).
B.
PNI's claims in this action are grounded on § 548, Bankruptcy Code, and on the analagous Virginia statute, Va. Code Ann. § 55-81. The former allows a trustee (or debtor in possession) to avoid any transfer made by a debtor within one year of the filing of the bankruptcy if the debtor "received less than reasonably equivalent value in exchange for such transfer" and was insolvent when the transfer was made or became insolvent because of it. The Virginia statute declares void (as to existing creditors only) any transfer "which is not upon consideration deemed valuable in law" by an insolvent transferor. The plaintiff's theory as set forth in the complaint is not grounded on the payments having been made outside the ordinary course of business or on commercially unreasonable terms. Rather the plaintiff's theory is that PNI's failure to actually receive the payment that was contractually or otherwise due from POI effectively caused PNI to receive "less than reasonably equivalent value" or "consideration . . . valuable in law." Thus, while PNI may possibly be precluded in this action from asserting that the payments it made on POI's behalf were commercially unreasonable, its avoidance claim does not rest on a premise of commercial unreasonableness, nor is commercial reasonableness necessarily a defense to the avoidance action.
Since PNI has not pleaded in its complaint that the payments it made on POI's behalf were commercially unreasonable or were outside the ordinary course of business, and since at this point its theory of recovery is not dependent upon such a finding, the court need not make a final ruling as to whether all the requirements for invoking judicial estoppel are present. The court does note, however, that the allegation in the motion to reject the intercompany services agreement that the agreement provided for "fair and reasonable arm's length compensation" to PNI was surplusage, since the right of a trustee or debtor in possession to reject an executory contract is not dependent upon the contract being unfair or unreasonable. Rather, it is sufficient that the burden of performing the contract outweighs the benefits that would be received. The motion to reject alleged that rejection was appropriate, not because the contract was unfair when it was made, but rather because POI was no longer in a position to perform its end of the bargain by paying for the services PNI provided. Since there was no need for the court to make a finding that the contract terms, as such, were either reasonable or unreasonable, any position taken by PNI on that issue in moving to reject the agreement cannot be said to have been "accepted by the court" when it ruled in PNI's favor.
With respect to the answer and counterclaim filed in the avoidance action brought by POI's trustee, PNI's position that the financial transactions between PNI and POI were commercially reasonable and took place in the ordinary course of business is not peripheral to the litigation and does indeed go to the heart of PNI's defense. However, at this point there has been no trial and thus no judgment. Accordingly, the court can hardly be said to have "accepted" — at least at this point — the position set forth by PNI in its pleadings.
Of course, as the theory of the plaintiff's case is further fleshed out during discovery, and particularly if the court makes rulings in the action brought by POI's trustee adopting PNI's position concerning the reasonableness of the financial transactions between the two companies, judicial estoppel might well come into play. At the present time, however, the court is unable to conclude that judicial estoppel would operate as a bar to the causes of action pleaded in the complaint.
II.
Even absent judicial estoppel, the defendants assert that the transaction described in the complaint simply does not constitute an avoidable transfer for which the defendants can be held liable. Their argument is two-fold: first, that PNI simply has a straightforward claim against POI for breach of contract or for quantum meruit recovery, not a fraudulent transfer claim; and second, that the defendants, who were not the recipients of the transfer, are too remotely situated vis-a-vis the actual transferees to be liable on the theory that they were parties "for whose benefit such transfer was made."
A. Fraudulent Transfer under Section 548
A trustee or debtor in possession may avoid as a fraudulent transfer not only transfers made with actual intent to hinder, delay, or defraud creditors, but also
any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within one year before the date of the filing of the petition, if the debtor voluntarily or involuntarily —
* * *
(B)(i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
(ii) (I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation[.]
§ 548(a)(1), Bankruptcy Code. Here, PNI asserts that it was underpaid in the amount of $4.8 million for services rendered to POI in accordance with the agreement. The complaint also alleges that an additional $4.5 million was paid to numerous creditors of POI, presumably on terms not governed by the agreement, and for which PNI has received no value in return. The defendants assert that, given the existence of the intercompany services agreement, PNI's payments to various third parties on POI's behalf simply cannot be characterized as a voluntary conveyance because PNI had a contractual duty to make the payments. That PNI was not paid by POI as required by the agreement does not, the defendants argue, elevate a simple contract claim to a fraudulent conveyance.
The argument has some force. It certainly seems doubtful that Congress intended to allow mere commercial contract claims to form the basis for fraudulent transfer relief simply because the other party to the contract did not pay. At the same time, the court cannot say there is no set of facts which might be proved to support such a claim. This is particularly true since the complaint alleges that some $4.5 million in payments to POI's creditors were not made under the agreement. If A and B are sister corporations, the use of A's funds to pay B's creditors is a classic example of an avoidable transfer, even though such payment also gives rise to a claim for reimbursement. Although the court is somewhat skeptical that the $4.8 million in payments that are alleged to have been made under the agreement would similarly constitute an avoidable transfer, such a determination is more properly made after the factual record is fully developed, either on a properly-supported motion for summary judgment, or at trial.
B. Entity for Whose Benefit Transfers Were Made under Section 550
The next issue is whether, even assuming that the payments are voidable, PNI has pleaded a proper basis for recovering the amount of those payments from Nortel and Cisco, neither of whom was a recipient of the payments. If a transfer is avoided, the Bankruptcy Code permits a trustee or debtor in possession to recover the property, or the value of the property, not only from the transferee, but also from "the entity for whose benefit such transfer was made." § 550(a), Bankruptcy Code. Here, PNI does not assert that Cisco and Nortel are initial or subsequent transferees; rather, it asserts that the they are the entities for whose benefit the transfers were made.
In this regard, the Bankruptcy Code does not define "entity for whose benefit such transfer was made," nor is there any legislative history surrounding this phrase. See Bonded Fin. Serv., Inc. v. European Am. Bank, 838 F.2d 890, 896 (7th Cir. 1988). There is, however, a fair amount of case law, particularly in the Fourth Circuit, addressing this issue; unfortunately, none of the cases cited by either PNI or the defendants are closely analogous to the case at hand.
As a general matter, an "entity for whose benefit such transfer was made" is someone, other than an initial or subsequent transferee, who receives the benefit of the transfer from the debtor, but does not receive the actual money. See Lowry v. Security Pacific Business Credit, Inc. (In re Columbia Data Products, Inc.), 892 F.2d 26, 29 (4th Cir. 1989), citing Bonded Finance 838 F.2d. at 895. The paradigm example of this relationship is described as "when a debtor pays a creditor to satisfy a debt guaranteed by a third party." Id. In this situation, "the creditor is the initial transferee, and the guarantor, who is no longer liable for the debt, is the entity for whose benefit the transfer is made." Id. PNI claims that the secured creditors were beneficiaries within the meaning of the statute because (1) the intercompany services agreement specifically names Nortel, and by implication Cisco, as third-party beneficiaries; (2) POI was set up as a separate corporation at the insistence of Nortel and Cisco; and (3) any improvement in POI's cash position directly benefits Nortel and Cisco by virtue of their liens against POI's assets.
In this connection, the status of Cisco and Nortel as third-party beneficiaries of the intercompany services agreement is obviously entitled to some weight but is probably not conclusive on the question of whether they were the intended beneficiaries within the meaning of Section 550(a). Rather, PNI must prove that Cisco and Nortel actually received a benefit from the transfer. See In re Bullion Reserve of North America, 922 F.2d 544, 548-49 (9th Cir. 1991). However, that benefit need not be direct. For example, the Seventh Circuit held in In re Prescott, 805 F.2d 719 (7th Cir. 1986), that the debtor in possession could recover from a second lienholder which had its lien position enhanced as a result of a preferential setoff by the bank which held a first lien against the same collateral. Nevertheless, although any number of parties might realize some indirect benefit from an avoidable transfer, there obviously comes a point where the relationship of the targeted party is simply too remote to allow recovery. In Columbia Data, for example, the Fourth Circuit held that the debtor could not recover the value of a fraudulent transfer from a third party because the alleged "entity for whose benefit the transfer was made" had no business relationship with the transferor. Columbia Data, 892 F.2d. at 28. In this case, however, the complaint sufficiently alleges the existence of a business relationship, albeit indirect, between PNI and the defendants. Whether Nortel and Cisco are, as alleged, the entities for whose benefit the transfers were made is ultimately a question of fact (or, at least, a mixed question of fact and law). While it may be possible to resolve that issue on summary judgment, it is not an issue that can be resolved on a Rule 12(b)(6) motion to dismiss.
ORDER
For the foregoing reasons, it is
ORDERED:
1. The motion to dismiss for failure to state a claim for relief is denied.
2. The clerk will mail a copy of this memorandum opinion and order, or electronically transmit notice of its entry, to counsel for the parties, counsel for the Official Committee of Unsecured Creditors, and to the United States Trustee.