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Grede v. Bank of New York

June 12, 2009

FREDERICK J. GREDE, NOT INDIVIDUALLY BUT AS LIQUIDATION TRUSTEE OF THE SENTINEL LIQUIDATION TRUST, PLAINTIFF,
v.
THE BANK OF NEW YORK AND THE BANK OF NEW YORK MELLON CORP., DEFENDANTS.



The opinion of the court was delivered by: James B. Zagel United States District Judge

Judge James B. Zagel

MEMORANDUM OPINION AND ORDER

I. BACKGROUND

On March 3, 2008, Plaintiff Liquidation Trustee filed a complaint against Defendant Bank alleging several counts: (1) avoidance and recovery of fraudulent transfers pursuant to §§ 548(a)(1)(A) and 550(a) of the Bankruptcy Code; (2) avoidance and recovery of fraudulent transfers pursuant to 740 ILCS 160/5(a)(1) and 160/8(a), and §§ 544(b)(1) and 550(a) of the Bankruptcy Code; (3) avoidance and recovery of preferential transfers pursuant to §§ 547(b) and 550(a) of the Bankruptcy Code; (4) equitable subordination of claims and transfer of subordinated lien pursuant to § 510(c) of the Bankruptcy Code; (5) disallowance of proof of claim; (6) equitable disallowance of proof of claim; (7) action to determine validity and extent of lien and for turnover of property under 11 U.S.C. §§ 542 and 506; and (8) aiding and abetting/knowing participation in breach of fiduciary duty by Sentinel insiders.

On May 2, 2008, Defendants filed a motion to dismiss Plaintiff's complaint, pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6). The motion was granted as to Counts V-VII, and denied as to the remaining counts. In my opinion memorandum, I invited Plaintiff to amend Count VIII, which was inadequately pled. On March 19, 2009, Plaintiff amended Count VIII of his complaint, and included Counts V-VII in the amended complaint. Because the Trustee's inclusion of these counts is not a request that I revisit my prior rulings, but rather an attempt at preserving its right to appeal my ruling on those counts, I need not address Counts V-VII here. My discussion will be limited to Count VIII. Because the facts relevant to Count VIII are summarized in my previous opinion, Grede v. Bank of New York, No. 08 C 2582, 2009 WL 188460 (N.D. Ill. 2009), they will not be recounted here.

II. STANDARD OF REVIEW

A Rule 12(b)(6) motion tests the sufficiency of a complaint, not the merits of a case. Autry v. Northwest Premium Servs., Inc., 144 F.3d 1037, 1039 (7th Cir.1998). I must accept all well-pleaded factual allegations in the complaint as true, drawing all reasonable inferences from those facts in Plaintiff's favor. Cleveland v. Rotman, 297 F.3d 569, 571 (7th Cir.2002). "While a complaint attacked by a Rule 12(b)(6) motion to dismiss does not need detailed factual allegations, a plaintiff's obligation to provide the grounds of his entitlement to relief requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007) (citations and quotations omitted). Plaintiff's factual allegations must be sufficient "to raise a right to relief above the speculative level." Id. To survive, a complaint must contain enough facts, when, accepted as true, "state a claim to relief that is plausible on its face." Id. at 570.

III. DISCUSSION

In Count VIII of his complaint, Plaintiff alleges that Defendant Bank of New York ("BONY") colluded with Sentinel insiders Philip Bloom, Eric Bloom and Charles Mosley, aiding and abetting their breaches of fiduciary duty to Sentinel. The Blooms and Mosley, Plaintiff claims, commingled customer securities and funds with Sentinel's own house account, commingled securities and funds of certain segregated accounts with those of other segregated accounts, improperly pledged customer assets to secure a loan from BONY, maintained customer funds and securities in accounts not registered to Sentinel as agent or trustee, and transferred and pledged segregated securities to collateralize BONY loans. Plaintiff maintains that as a result of BONY's knowing participation in these breaches of fiduciary duty by Sentinel insiders, Sentinel has been damaged.

In response, BONY has sought the shield offered under New York law, which gives the claim for defrauding a corporation with the cooperation of management to the creditors of the corporation, not to the guilty corporation itself, in this case, Sentinel and its trustee. Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 120 (2d Cir. 1991). "The rationale underlying the Wagoner rule derives from the fundamental principle of agency that the misconduct of managers within the scope of their employment will normally be imputed to the corporation." In re CBI Holding Co., Inc., 529 F.3d 432, 448 (2d Cir. 2008) (citation omitted). However, "management misconduct will not be imputed to the corporation if the officer acted entirely in his own interests and adversely to the interests of the corporation." Id. (citation omitted). This is known as the adverse interest exception. In order for it to apply, "the guilty manager must have totally abandoned his corporation's interests[.]" Id. (citation omitted).

The adverse interest exception is itself subject to another exception known as the "sole actor" rule. The Mediators, Inc. v. Manney (In re Mediators, Inc.), 105 F.3d 822, 827 (2d Cir. 1997). Where "principal and agent are one and the same," the agent's knowledge is imputed to the principal regardless of whether the agent has abandoned the corporation's interest. Id.

Where only some of a corporation's owners were involved in a fraud in their role as managers, courts consider whether those insiders who were innocent and unaware of the misconduct had sufficient authority to stop the fraud. When the innocent insiders lack authority to stop the fraud, the "sole actor" exception to the "adverse interest" exception applies, and imputation is thus proper, because all relevant shareholders and decisionmakers were involved in the fraud. However, when the innocent insiders possessed authority to stop the fraud, the "sole actor rule" does not apply, because the culpable agents who had totally abandoned the interests of the principal, and were thus acting outside of the scope of their agency, were not identical to the principal.

In re CBI Holding Co., Inc.,311 B.R. 350, 373 (S.D.N.Y. 2004), aff'd in part, rev'd on other grounds by In re CBI Holding Co., Inc., 529 F.3d 432. Therefore, Sentinel's trustee cannot sue BONY if some corporate purpose was served by the breach of duty, and all the persons with authority to prevent the breach participated in it. Conversely, if no corporate purpose was served by the breach, and there were innocent insiders who had sufficient authority to stop the fraud, the Trustee has standing to make its claim on behalf of Sentinel.

In my previous ruling, I rejected Defendants' assertion that Plaintiff failed to adequately plead BONY's knowing and substantial assistance to the insiders. Grede v. Bank of New York, 2009 WL 188460, at *9. The deficiency of the initial pleading of Count VIII was rooted instead in Plaintiff's failure to adequately allege the existence of innocent Sentinel insiders with authority to stop the ...


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