Eden Rock Fin. Fund, L.P. v Gerova Fin. Group Ltd.
Annotate this CaseDecided on December 21, 2011
Supreme Court, New York County
Eden Rock Finance Fund, L.P., EDEN ROCK FINANCE MASTER LIMITED, and EDEN ROCK UNLEVERAGED FINANCÉ MASTER LIMITED, Individually and Derivatively on Behalf of GEROVA FINANCIAL GROUP LTD., Plaintiffs,
against
Gerova Financial Group Ltd., STILLWATER ASSET BACKED OFFSHORE FUND, LTD., STILLWATER ASSET BACKED FUND II LP, STILLWATER CAPITAL PARTNERS, LLC, STILLWATER CAPITAL PARTNERS, INC., GARY T. HIRST, JOSEPH J. BIANCO, and JACK DOUECK, Defendants.
650613/2011
APPEARANCES:
For Plaintiff:
Sidley Austin, LLP
One South Dearborn
Chicago, Illinois 60603
(Thomas K. Cauley, Jr.)
For Defendants:
Spillane Weingarten LLP
1880 Century Park East
Suite 1004
Los Angeles, CA 90067
(Alex M. Weingarten)
DLA Piper
1251 Avenue of the Americas
New York, NY 10020-1104
(Joshua S. Sohn)
Herrick Feinstein, LLP 2 Park Avenue
New York, NY 10016
(Christopher P. Greeley)
Joseph J. Bianco, Pro Se
291 Seventh Avenue
New York, NY 10001
Bernard J. Fried, J.
These two motions by different defendants seek to dismiss the complaint on the same two grounds, both for failure to state a cause of action (CPLR 3211 [a] [7]), and based upon a defense founded on documentary evidence (CPLR 3211 [a] [1]).
Motion sequence 006 is made by defendants Gerova Financial Group Ltd. (Gerova), and defendant Gerova Asset Backed Holdings, L.P. (the onshore fund), both of which are allegedly incorporated under the laws of Bermuda. Gerova states that the latter is erroneously sued as Stillwater Asset Backed Fund II LP.
Motion sequence 009 is made by defendants Stillwater Asset Backed Offshore Fund Ltd. (the offshore fund), Stillwater Capital Partners LLC, Stillwater Capital Partners, Inc. (together, Stillwell Partners), and Jack Doueck (Doueck). Doueck is allegedly a managing principal of Stillwater Partners, Inc., a Delaware corporation that is the investment manager for the offshore and onshore funds, and is a board member of Gerova. The offshore fund and the onshore fund are referred to as the Stillwater funds, unless the context requires otherwise due to the Gerova transaction. All defendants also move for a stay (CPLR 2201), pending determination of an allegedly related class action pending in federal court.
Defendants' motions are granted to the extent of dismissing the fifth cause of action, pursuant to New York General Business Law § 349, dismissing the third cause of action as against the onshore fund, and are otherwise denied.
The three plaintiff entities operate a business, each using the name "Eden Rock" (collectively, Eden Rock), that invests in hedge funds. Plaintiffs assert claims for more than $30 million in redemptions, approximately $26 million from the offshore fund, and $4 million from the onshore fund. The assets that comprise the holdings of the Stillwater funds primarily include participation interests in portfolios of loans, including mezzanine loans, premium financing, and real estate investments (the Stillwater assets).
The following facts alleged in the complaint are deemed true for the purpose of the motion to dismiss for failure to state a cause of action (see CPLR 3211 [a] [7]).
Between April 2005 and March 2009, plaintiffs made a series of investments of over $29 million in the two funds. Plaintiff Eden Rock Finance Fund LP invested in the onshore fund, and plaintiffs Eden Rock Finance Master Limited, and Eden Rock Unleveraged Finance Master Limited invested in the offshore fund. In August 2008, plaintiffs began redeeming their shares in both funds. At the time of their last redemption on August 31, 2009, plaintiffs were owed more than $30 million.
After the offshore fund failed to pay plaintiffs in cash for their redemptions from the offshore fund, the offshore investors instituted a statutory demand in the Cayman Islands where the offshore [*2]fund was organized. A statutory demand is the first step toward an involuntary liquidation.
The plaintiff offshore investors withdrew the statutory demand in reliance on the offshore fund's representation that it would settle their claims by providing them with a payment-in-kind participation (the PIK), representing a proportionate interest in the assets of the two funds, which would return 10% of the outstanding principal each quarter.
Section 46 of the articles of association of the offshore fund provides, as pertinent: [a]ccounts payable to a Redeeming Shareholder in connection with the redemption of Shares shall be paid in cash (unless the Directors determine to pay the
redemption Price (or any part thereof) by way ofdelivery ofassets in specie ...
(ex. B to Complaint).
By Assignment and Participation Certificate (the offshore PIK), dated December 18, 2009 (Ex. C to Complaint), the offshore fund assigned to Eden Rock's custodial service a 1.32% ownership interest in a schedule of loan participation notes with a valuation of $3,422,923.
The complaint states that "[o]nce the PIK was implemented, the Offshore Fund's creditors were to hold a direct, contractual interest in payments made on certain assets ..." (Complaint, ¶61). Plaintiffs allege that they have received no payments from any of the loan participations comprising their 1.32% direct ownership interest in the offshore fund's assets, and have not received promised documentation of the PIK.
The offshore PIK certificate states that the value of the assets distributed was determined in a report by an independent valuation report prepared by Houlihan Smith & Co. (Houlihan), which, along with other documentation, would be furnished to Eden Rock upon request.
The complaint states that Stillwater did not release any audit report for the 2009 financials until more than one year after the offshore PIK, and that the report showed that the auditors would not issue an opinion of the value of the Stillwater assets, and that Stillwater had not followed generally accepted accounting principles (Complaint, ¶ 14). The complaint alleges that both funds would be insolvent if generally accepted accounting standards had been applied.
On May 29, 2008, Eden Rock Finance Fund, L.P. (Eden Finance) redeemed its holdings in the onshore fund, effective August 31, 2008. The complaint states that the onshore fund has failed to pay it any funds for its redemption, despite repeated demands and unfulfilled promises, and that Eden Finance remains a creditor of the onshore fund.
The following month, Stillwater entered into a transaction with Gerova (the Gerova transaction), whereby Gerova acquired all the assets of the Stillwater funds in exchange for its stock, which had little or no value. Plaintiffs never received any documentation that Gerova has assumed the liabilities of the onshore and offshore funds to plaintiffs, as had been promised at the time of the Gerova transaction.
Plaintiffs allege that the sole purpose of the Gerova transaction was to enrich Stillwater insiders with enhanced fees, with the result that the Stillwater assets are being depleted.
Plaintiffs allege that they have not been paid any money either as creditors or as shareholders prior to their redemptions, that they have not been provided with documentation to which they are entitled, and that they have been repeatedly promised documentation and payments that they have never received.
The complaint contains six causes of action. In support of the complaint, plaintiffs submit [*3]the affidavit of David Higgins (Higgins), a senior analyst at Eden Rock Capital Management, L.P. The first cause of action, stated against Gerova only,
alleges that plaintiffs are creditors of the funds and that the Gerova transaction is a fraudulent conveyance based upon actual fraud, under New York Debtor and Creditor Law § 276. It alleges that Gerova paid an inadequate consideration for the Stillwater funds' assets either at a time when the Stillwater funds were either insolvent or rendered insolvent thereby, that it was made with actual intent to hinder, delay or defraud plaintiffs as creditors of the Stillwater funds, that it left the funds with an unreasonably small capital, and occurred at a time when the funds knew or believed that they would incur debts beyond their ability to pay.The first cause of action sufficiently states a cause of action for fraudulent conveyance because it contains factual allegations to support each element of a cause of action based on Debtor and Creditor Law § 276 in sufficient detail (see Marine Midland Bank v Zurich Ins. Co., 263 AD2d 382, 383 [1st Dept 1999]).
The second cause of action, also against Gerova only, is based on constructive fraud under Debtor and Creditor Law §§ 272 through 275. Even though not all of the statutory provisions cited apply, the second cause of action also alleges sufficient facts to state a cause of action for constructive fraud. It alleges that plaintiffs are creditors of the Stillwater funds, which received an inadequate consideration in the form of Gerova stock for their assets at a time when the Stillwater funds were already insolvent or were rendered insolvent thereby, that Gerova left the funds with an unreasonably small capital, and the transaction occurred at a time when the funds knew or believed that they would incur debts beyond their ability to pay.
The elements of constructive fraud and actual fraud are identical, except that actual fraud requires an intentional deception, while constructive fraud generally requires "a confidential fiduciary relationship between the parties, or one having superior knowledge over the other" (see 60A NY Jur 2d, Fraud and Deceit § 2), and in constructive fraud it is not necessary to demonstrate knowledge of the falsity of a representation (see M & T Bank Corp. v Gemstone CDO VII, Ltd., 23 Misc 3d 1105[A], 2009 NY Slip Op 50590[U]. *8 [Sup Ct, Erie County], affd as mod 68 AD3d 1747 [4th Dept 2009]).
The third cause of action alleges common-law fraud against the Stillwater defendants and Doueck. It also sufficiently states a cause of action. Plaintiffs have sufficiently pleaded all the elements of common-law fraud, which are:
a representation of a material fact, the falsity of that representation, knowledge by the party who made the representation that it was false when made, justifiable reliance by plaintiff and resulting injury
(Monaco v New York Univ. Med. Ctr., 213 AD2d 167, 169 [1st Dept 1995]).
The third cause of action alleges that the Stillwater defendants and Doueck knowingly misrepresented that plaintiffs would be paid their redemption proceeds, that the PIK would make substantial quarterly payments, and that the Stillwater Funds were solvent, with the intention that plaintiffs would rely upon these misrepresentations, and that plaintiffs did so rely, and were damaged by foregoing their right to move to unwind the offshore fund prior to the Gerova transaction. The third cause of action has no applicability to the onshore fund, which is now defendant Gerova Asset Backed Holdings, L.P.
The moving defendants argue that plaintiffs have not sufficiently pleaded, and cannot plead, [*4]fraud because any damages flowing from forbearance from pursuing liquidation of the offshore fund in the Cayman Islands are too speculative to satisfy the "out-of-pocket rule" under New York law (see Rather v CBS Corp., 68 AD3d 49, 58 [1st Dept 2009]), that plaintiffs made no actionable misrepresentations, and that the fraud claim is duplicative of the contract claim.
The alleged promise that the PIKs would pay 10% quarterly qualifies as a representation of fact for pleading purposes because the complaint sufficiently alleges facts to support a finding that defendants "fraudulently and positively as with personal knowledge stated that something was to be done when he knew all the time it was not to be done ... . Such statements and representations when false are actionable [internal quotation marks and citation omitted]" (Channel Master Corp. v Aluminum Ltd. Sales, Inc., 4 NY2d 403, 408 [1958]).
Certainly,
a fraud claim can only be maintained alongside a claim for breach of contract if the fraudulent promise was "collateral or extraneous" to the alleged agreement. In other words, the defendant must have fraudulently induced the plaintiff to enter into the agreement, and that inducement must be a promise other than merely pledging to perform the terms of the contract
(GBJ Corp. v Eastern Ohio Paving Co., 139 F3d 1080, 1088 [6th Cir 1998]).
The fraud claim is not duplicative of the contract claim (see WIT Holding Corp. v Klein, 282 AD2d 527, 528 [2d Dept 2001]), because it includes an alleged misrepresentation that plaintiffs would be repaid with quarterly principal payments of 10% as consideration for withdrawing the statutory notice. This 10% alleged promise is not an obligation contained in any of the written contracts, and thus is sufficient for pleading purposes in the face of defendants' affirmative defense of the statute of frauds (NY General Obligations Law § 5-701), because an issue is presented whether the alleged oral agreement to pay 10% quarterly is unequivocally referable to Eden Rock's withdrawal of its statutory demand that had been filed in the Cayman Islands (see Benn v Benn, 82 AD3d 548, 549 [1st Dept 2011]).
There is no merit to defendants' contentions that the fraud cause of action violates New York's "out-of-pocket" rule. The "out-of-pocket" rule is not an obstacle to a creditor's claim that it was fraudulently induced to forbear from taking steps to collect a debt [citation omitted]" (Starr Foundation v American Intl. Group, Inc., 76 AD3d 25, 33 n 5 [1st Dept 2010]).
For pleading purposes, the third cause of action sufficiently pleads damages resulting from its forbearance in forcing the liquidation of the offshore fund, including the non-payment of the alleged 10% return of capital, and the costs associated with the Gerova transaction. The inquiry on a CPLR 3211 (a) (7) motion is limited to whether a plaintiff has a cause of action, not whether he has stated one (see Rovello v Orofino Realty Co., Inc., 40 NY2d 633 [1976]).
The fourth cause of action alleges breach of contract against the Stillwater defendants and Gerova. It states that it is pled in the alternative to the fraudulent transfer claim. It alleges that Gerova has failed to pay the redemptions in cash or to make any payments from either the onshore or offshore funds, and has failed to provide the documentation that defendants promised would be available upon request. Stillwater argues that there is no privity of contract between any Eden Rock entity and any Stillwater entity because all purchases were made through an intermediary, Fortis [*5]Prime Fund Solutions Custodial Services (Ire) Ltd. (Fortis). Higgins states in his affidavit that all purchases made by Fortis were on behalf of Eden Rock entities, that Eden Rock is the beneficial owner of such interests, and that Stillwater acknowledged Eden Rock in its correspondence as the beneficial owner, including listing Eden Rock Finance on its tax form 10-K. Thus, the fourth cause of action is sufficiently stated.
The fifth cause of action, which alleges violation of New York General Business Law § 349, is dismissed for failure to state a cause of action, because plaintiffs "failed to allege in the complaint the type of conduct that would have a broad impact on consumers at large [citation omitted]" (Golub v Tanenbaum-Harber Co., Inc., 88 AD3d 622 [1st Dept 2011]). Investments in hedge funds are not the type of transactions that the statute is intended to cover.
The sixth cause of action, which had pleaded a derivative claim of breach of fiduciary duty against the individual defendants on behalf of Gerova, is withdrawn, by plaintiffs, without prejudice.
Defendants seek dismissal of the complaint on the basis of documentary evidence (CPLR 3211 [a] [1]), specifically, the offshore PIK certificate, and a January 7, 2010 Participation Agreement (Ex. 2 to Rosenfield aff. in further support) for the onshore fund, which creates a special purpose vehicle for payment-in-kind (the SPV) for the onshore fund claimants, as well as the e-mail correspondence annexed to the Rosenfeld affidavit. The motion is denied because the documentary evidence does not conclusively demonstrate defendants' entitlement to judgment as a matter of law (see Leon v Martinez, 84 NY2d 83, 88 [1994]).
The documentary evidence annexed to the Higgins affidavit includes an undated e-mail from Mike Stavely (Stavely) of Eden Rock (ex. 3 to Higgins aff.), responding to a December 31, 2010 e-mail from Doueck. Stavely states that Eden Rock does not accept either the PIK or the SPV as satisfaction of the amounts owed to Eden Rock, because the Houlihan audit offered no opinion as to the valuation of the assets, on the ground that Stillwater did not follow generally accepted accounting standards, as required by the offering memorandum. Stavely also refers to uncertainty surrounding an $85 million potential tax liability, and other liabilities. The offshore PIK certificate states "[t]he net asset value of the Fund assets subject to the Distribution-in-kind was determined pursuant to an independent valuation report prepared by Houlihan Smith & Company which will be furnished to you upon request" (ex. B to Complaint). Thus, the PIK is insufficient to demonstrate defendants' entitlement to judgment as a matter of law, because it does not demonstrate conclusively that plaintiffs have been paid for their interests in the onshore and offshore funds in accordance with the terms of the operative documents, particularly paragraph 46 of the articles of association of the offshore fund, which permits delivery in specie, in lieu of cash.
Defendants have not submitted a copy of the Houlihan report, on which the valuation of the PIK and SPV is purportedly based. Defendants thus have not demonstrated that the valuations on which the SPV and PIK were allegedly calculated were made in accordance with the terms of the operative documents. In light of plaintiffs' rejection of the SPV and the PIK by Spivey, as noted above, the documentary evidence does not conclusively demonstrate delivery of the in species payment, which would have ended Eden Rock's status as a creditor.
The numerous factual assertions made by counsel for Gerova in its memoranda of law, upon which its arguments are based, would lack any evidentiary value even on a summary judgment motion, and have no bearing on these motions addressed to the sufficiency of the complaint (see Brown v Smith, 85 AD3d 1648, 1649 [4th Dept 2011]). [*6]
Defendants have not demonstrated a sufficient basis for the grant of a stay (CPLR 2201) pending resolution of class action litigation. No copy of the complaint in that action has been submitted.
Accordingly, it is
ORDERED that the motion of defendants Gerova Financial Group Ltd., and Gerova Asset Backed Holdings L.P. to dismiss the complaint, or alternatively to stay this action, is granted to the extent of dismissing the third cause of action against Gerova Asset Backed Holdings, L.P., and is otherwise denied; and it is further
ORDERED that the motion of defendants Stillwater Asset Backed Offshore Fund Ltd., Stillwater Capital Partners, LLC, Stillwater Capital Partners, Inc., and Jack Doueck to dismiss the complaint, or alternatively to stay this action, is denied.
DATED: ____________
E N T E R:
_______________________
J. S. C.
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