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Grede v. Bank of New York Mellon

July 28, 2009


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



Plaintiff, Liquidation Trustee as Assignee of certain creditor claims, brings this action against Defendants alleging that they aided and abetted debtor investment manager's breach of fiduciary duty to its customers, aided and abetted debtor's fraud, and acted negligently toward debtor's customers. Defendants now move to dismiss the complaint for lack of standing, pursuant to Federal Rule of Civil Procedure 12(b)(1), and for failure to state a claim under Rule 12(b)(6). For the following reasons, Defendants' motion is granted.


Plaintiff in this case is the Liquidation Trustee of the Sentinel Liquidation Trust. Sentinel was an investment manager for sophisticated clients, including commodity brokers, hedge and pension funds, and financial institutions. Sentinel was a Bank of New York ("BNY") customer, initially as a client of its custodial services group and then as a client of its clearing services division. Trustee alleges that Sentinel insiders engaged in a fraudulent scheme to leverage customer assets, putting the company and the customers at risk if the market were to decline. This is exactly what happened, and in August 2007, Sentinel collapsed and filed for bankruptcy. Trustee alleges that Defendants knew of and participated in this scheme by establishing an account structure that facilitated the commingling of assets that should have been segregated and the misuse of customer funds. In early 2008, Trustee filed an adversary action against Defendants on the basis of their alleged misconduct, seeking to recover for the Liquidation Trust the value of the customer assets that he alleges were improperly desegrated and used as leverage. See Grede v. Bank of New York, No. 08 C 2582, 2009 WL 188460 (N.D. Ill. 2009). In 2009, Trustee filed another action against Defendants, this time as assignee of certain of Sentinel's customers' claims, seeking to recover the millions lost by these customers. Because Plaintiff's allegations in this case (the "customer action") are substantially similar to those asserted in the initial action against Defendants (the "Trustee action"), I see no need to restate them in great detail and refer the reader to the Trustee action for a more comprehensive factual background with regard to debtor Sentinel's business and the alleged misconduct by Defendants. Id. I will, however, address a few facts relevant to this case specifically.

On December 15, 2008, the bankruptcy court entered an order confirming the Fourth Amended Chapter 11 Plan of Liquidation for Sentinel (the "Plan"). Trustee, formerly the Chapter 11 trustee for Sentinel, became the Liquidation Trustee for the Sentinel Liquidation Trust (the "Trust"), which represents Sentinel's estate. As part of the Plan, claims held by Sentinel's customers who accepted the Plan were transferred to the Liquidation Trust, and the Trust became the assignee of the claims. The Plan established a distinct tranche of the Trust to hold the non-estate customer claims assigned to the Trust. Claims held in this tranche do not become property of the estate, and non-assignors of claims are entitled to no distributions from this special tranche. It is the assigned customer claims that Trustee now asserts against Defendants.*fn1 Defendants move to dismiss Trustee's complaint for lack of standing, pursuant to Federal Rule of Civil Procedure 12(b)(1), and for failure to state a claim under Rule 12(b)(6). Because Trustee does not have standing to bring the assigned claims, I need not reach the issue of the sufficiency of the complaint.


A. Whether Defendants' Standing Challenge is Barred by Res Judicata

The first issue I must address is Trustee's contention that res judicata bars BNY's standing challenge. Because the assignments at issue were made pursuant to Sentinel's chapter 11 liquidation plan -- a plan approved by the bankruptcy court -- Trustee maintains that Defendants are now launching "a collateral attack on the power of the Bankruptcy Court to effect an assignment of the claims by approving the Plan." Semi-Tech Litig., LLC v. Bankers Trust Co., 272 F. Supp. 2d 319, 324 (S.D.N.Y. 2003). I am not persuaded by this argument and find that res judicata does not bar BNY's standing challenge.

"To apply res judicata, three essential elements must exist: (1) a final judgment on the merits in an earlier action; (2) an identity of the cause of action in both the earlier and later suit; and (3) an identity of parties or privies in the two suits." Wade v. Hopper 993 F.2d 1246, 1252 (7th Cir. 1993). "The doctrine of res judicata bars suit on matters which were raised or could have been raised in previous litigation between the parties." Matter of Vitreous Steel Products Co., 911 F.2d 1223, 1234 (7th Cir. 1990). According to Trustee, Defendants have litigated their objections to the confirmation of the Plan. Although they did not challenge Trustee's standing to bring the assigned claims, they did challenge the assignments on other grounds. It was during that proceeding, Trustee argues, that the standing challenge should have been made.

This argument is problematic for two reasons. First, it appears that Defendants' objections to the plan were never ruled on, since the parties settled their dispute with regard to the Plan. Next, Trustee's contention that Defendants essentially waived their standing objection is unavailing. Standing, a jurisdictional question, cannot be waived. Wiggins v. Martin, 150 F.3d 671, 673 (7th Cir. 1998). While "[i]t is a well-established principle of bankruptcy law that a party with adequate notice of a bankruptcy proceeding cannot ordinarily attack a confirmed plan," In re Harvey, 213 F.3d 318, 321 (7th Cir. 2000) (citing 11 U.S.C. § 1327(a)), confirmation of a bankruptcy plan "is res judicata only as to issues that can be raised in the less formal procedure for contested matters[.]" Strong v. IRS (In re Strong), 203 B.R. 105, 114 (Bankr. N.D. Ill. 1996) (holding that "confirmation generally cannot have preclusive effect as to the validity of a lien, which must be resolved in an adversary proceeding as mandated by Fed.R.Bankr.P. 7001(2)."). "[A] confirmed plan acts more or less like a court-approved contract or consent decree that binds both the debtor and all the creditors." In re Harvey, 213 F.3d 318, 321 (7th Cir. 2000). But proceedings to recover money are adversarial under the Federal Rule of Bankruptcy Procedure 7001(1) and are more formal than contested matters. In re Matter of Beard, 112 B.R. 951, 955 (Bankr. N.D. Ind. 1990). Adversarial matters are initiated by a summons and complaint, to which defendants are expected to respond. Id. Contested matters are typically dealt with by motion and a response is generally not necessary. Id. "If an adversary proceeding is required to resolve the disputed rights of third parties, the potential defendant has the right to expect that the proper procedures will be followed." Id. It is difficult to see how the issue of standing in this adversarial action could have been litigated as part of the less-formal confirmation process before the adversarial action itself was even filed.

In support of his argument, Trustee relies on Semi-Tech, where the plaintiff, an entity created by a liquidation plan, brought claims assigned by debtor's creditors against a third-party defendant.*fn2 The defendant challenged the plaintiff's standing generally to assert such claims and also challenged the validity of the Bankruptcy Court's assignment of the claims. The court found that the attack on the validity of the assignments was a collateral one on the power of the bankruptcy court, barred by res judicata, but addressed the general standing challenge on the merits. In this case, Defendants are not claiming that assignments pursuant to the liquidation plan are invalid, only that Trustee has no standing to bring the assigned claims. Similar to Semi-Tech, the standing issue before me must be addressed on the merits.

B. Standing

Defendants argue that the Trustee lacks standing to bring this suit because the individual claims at issue here belong to third-party creditors and are non-estate claims. Federal bankruptcy law "places a trustee in the shoes of the bankrupt corporation and affords the trustee standing to assert any claims that the corporation could have instituted prior to filing its petition for bankruptcy." In re CBI Holding Co., Inc., 529 F.3d 432, 454 (2d Cir. 2008). The claims presented here are, according to the Amended Complaint, "the direct claims of certain of Sentinel's customers." In other words, Sentinel's customers are seeking recovery for harms BNY allegedly caused them, not Sentinel itself. Defendants maintain ...

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