You Don’t Get 3 Strikes When Filing A Complaint

December 12, 2014Articles Law360

Reprinted with permission from Law360. (c) 2014 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.

In a 28-page opinion released Nov. 25, 2014, in the Tropicana Entertainment bankruptcy (Bank. D. Del. 08-10856), Judge Carey of the Delaware Bankruptcy Court provided an opinion regarding a defendant’s motion to dismiss an amended complaint. Judge Carey granted the majority of the motion to dismiss, denying a second request for leave to amend because “The Trustee has now had ample opportunity to present a properly pled complaint.” This ruling illustrates the importance of providing all the necessary details and required allegations in a complaint, particularly if the court has already provided you with one “do-over”.

Background

Pursuant to the confirmed plans in the Tropicana bankruptcy cases, Lightsway Litigation Services LLC was appointed as the trustee of a litigation trust tasked with pursuing claims against insiders of the debtors. On Feb. 17, 2010, the trustee filed a complaint against William J. Yung III, Wimar Tahoe Corporation, Columbia Sussex Corporation and others asserting claims for breach of fiduciary obligations, breach of contract, breach of the implied covenant of fair dealing, and equitable subordination. The defendants filed a motion to dismiss the complaint and, after a hearing, the court entered an order denying the motions to dismiss, but directing the trustee to file an amended complaint. On Feb. 9, 2011, the trustee filed the first amended complaint against Yung, Wimar and Columbia. Opinion at *3.

The defendants filed another motion to dismiss. After briefing and oral argument, the court entered the opinion and corresponding order granting the motion in part and denying it in part.

Judge Carey’s Opinion

While the amended complaint contains five claims, all of which are addressed in the motion to dismiss and the opinion, the only claim this article will discuss is the trustee’s amended claim that “[defendant] Yung breached fiduciary duties owed to the Debtors based upon his equity ownership and control of the management, operation, and finances of the Debtors.” Opinion at *17.

This section of the opinion spans pages 17-21, providing a detailed analysis of who is owed fiduciary duties, and when. When a company is healthy, all duties are owed to the equity holders; in this case the parent company. “When a corporation is solvent, those duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation.”[1] And when a company is insolvent, fiduciary duties are owed to the creditors as they are “the principal constituency injured by any fiduciary breaches that diminish the firm’s value.”[2] As stated by the court, “[t]he solvency or insolvency of the corporation determines which constituency has the right to pursue a derivative claim based on a breach of fiduciary obligation.” Opinion at *20.

Citing the Delaware Chancery Court’s Production Resources decision,[3] the opinion states that “To meet the burden of pleading insolvency, a plaintiff must plead facts showing that the debtor-corporation has either 1) a deficiency of assets below liabilities with no reasonable prospect that the business can be successfully continued in the fact thereof, or 2) an inability to meet maturing obligations as they fall due in the ordinary course of business.” Opinion at *20-21. In this case, the trustee failed to plead specific facts, alleging only that “[the defendant's] misconduct propelled the Debtors into insolvency, which ultimately led to the filing of the bankruptcy cases in the Spring of 2008.” Opinion at *20.

While there is no doubt that the debtors filed for bankruptcy, “[the complaint contains] no facts to provide a basis from which [the court] can infer whether any or all of the Debtors were insolvent or when insolvency occurred.” Opinion at *21. Although the defendants did not raise insolvency in their motion to dismiss the original complaint, this is a necessary fact for the plaintiffs to establish standing. As the Third Circuit has held, “[i]t is the plaintiffs’ burden, at the pleading stage, to establish standing.”[4] The plaintiff’s failure to plead sufficient facts to establish standing led to the court’s holding that “The Trustee has now had ample opportunity to present a properly pled complaint. The request for leave to again amend the complaint is denied.” Opinion at *21.

Lessons Learned

In this case, the failures of the trustee in crafting a complaint that satisfied the pleading standards of the Delaware bankruptcy court, even with two bites at the apple, led to the court’s dismissal of a cause of action that could have resulted in significant damage awards for the trustee. In the pleading stage of an action, not only must you plead each required element of a complaint, but you must also establish that you have standing to bring the complaint and that the court has jurisdiction to hear it. As shown in this case, the ability to amend a complaint pursuant to Federal Rule of Bankruptcy Procedure 7015 is not unconditional.

Pleading requirements are rather straightforward and can be easily overlooked. Yet, their importance cannot be overstated. Procedural victories can provide the same relief as victories after a hearing on the merits and can be significantly less expensive to obtain. While efforts to obtain a procedural victory may require extensive briefing and contain an element of uncertainty, if successful, they avoid the cost of discovery and a trial. Thus, it behooves litigants to carefully guard against making procedural mistakes and to ensure that pleadings are complete. This holds doubly true when filing an amended pleading.

Reprinted with permission from Law360. (c) 2014 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.