The opinion of the court was delivered by: PIERRE N. LEVAL
PIERRE N. LEVAL, U.S.D.J.
This an action brought by a holder of corporate bonds against the corporation, its officer, and various advisors and lenders to the corporation, seeking damages because a corporation's distribution to its common stockholders of a special dividend caused a decline in the market value of the bonds. Defendants move to dismiss the complaint.
Plaintiff Preston M. Geren, Jr., the owner of $ 100,000 face amount of the 8.875% subordinated debt securities issued by defendant Quantum Chemical Corporation, sues individually and on behalf of all owners of a variety of subordinated debt securities of Quantum (the "Bonds"), similarly situated on December 27, 1988 (generally, the "Bondholders").
On that date, Quantum issued a statement reflecting its intention to pay a special dividend of $ 50 per share to its stockholders. This dividend was paid on January 10, 1989.
According to the complaint, Quantum incurred indebtedness of approximately $ 1.221 billion (including $ 80 million in various fees) to pay the special dividend.
Payment of the dividend allegedly caused the total shareholder's equity of Quantum to decrease from $ 748 million to negative $ 406 million. As a result, payment of the dividend caused the market value of the Bonds to decline by approximately 50%; the complaint states that the market value of Bonds with a face amount of $ 1.25 billion declined by $ 625 million.
With one exception, noted below, each of the nine counts of the complaint seeks damages of $ 600 million, representing the decline in value of the Bonds caused by payment of the special dividend. The various defendants move to dismiss all counts of the complaint. Fed. R. Civ. P. 12(b)(6).
On a motion to dismiss, the court must accept the factual allegations in the complaint as true, drawing all reasonable inferences in favor of the plaintiffs, in order to determine whether the complaint is legally sufficient on its face. Goldman v. Belden, 754 F.2d 1059, 1065-67 (2d Cir. 1985); Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989). The court "should not dismiss the complaint pursuant to Rule 12(b)(6) unless it appears 'beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" Goldman v. Belden, 754 F.2d at 1065 (quoting Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1957)).
A. Counts I, V, and VII: Claim for Breach of Duty of Good Faith and Fair Dealing
Counts I, V, and VII all set out essentially the same cause of action. Count I, captioned "misappropriation of assets," alleges that Quantum and its directors owed to the bondholders a duty of good faith and fair dealing and that they violated this duty by diminishing and misappropriating the assets of Quantum by incurring substantial debt to fund the special dividend. Count V alleges that the bondholders had a contractual relationship with Quantum requiring the company to act with the utmost good faith and to engage in fair dealing and that defendants knowingly interfered with the bondholders contractual rights. Count VII again alleges that the director defendants breached their duty of good faith and fair dealing to the bondholders.
Each of these counts is based on a contractual duty of good faith and fair dealing running from the corporation to its bondholders: they allege that the actions of Quantum in incurring debt to pay the special dividend violated this contractual duty.
The relationship between Quantum and the Bondholders is governed by contract -- the indenture for the Bonds. The indenture contains extensive provisions governing the rights of the parties and the obligations of the corporation. The principle promise by Quantum is
that it will duly and punctually pay or cause to be paid the principal of, premium, if any, and interest, if any, on the Debentures of such series at the place, at the respective times and in the manner provided in the Debentures in such series.
§ 5.01. To protect the Bondholders against future creditors acquiring prior claims against the assets of the corporation, the indenture also contains an agreement by Quantum not to incur certain secured indebtedness while any of the debentures remain outstanding. § 5.05. With the exception of this prohibition on secured indebtedness, the indenture places no restrictions on the amount or purpose of debt to be incurred by the corporation.
Plaintiff does not claim that defendants violated an explicit covenant in the indenture. The claim set out in Counts I, V, and VII is that defendants violated an implied covenant of good faith and fair dealing not to take an action such as the financing and payment of the special dividend that would reduce the market value of the debentures by diminishing the likelihood that all interest and principal payments would be met.
Every contract governed by New York law, including the indenture at issue here, contains an implied covenant of good faith and fair dealing. Hartford Fire Ins. Co. v. Federated Department Stores, Inc., 723 F. Supp. 976, 991 (S.D.N.Y. 1989) (citing Rowe v. Great Atlantic & Pacific Tea Co., 46 N.Y.2d 62, 412 N.Y.S.2d 827, 830, 385 N.E.2d 566 (1978)). Such an implied covenant, however, can only impose an obligation "consistent with other mutually agreed upon terms in the contract." Sabetay v. Sterling Drug, Inc., 69 N.Y.2d 329, 335, 514 N.Y.S.2d 209, 212, 506 N.E.2d 919 (1987); accord Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F. Supp. 1504, 1517 (S.D.N.Y. 1989). "The covenant is violated when a party to a contract acts in a manner that, although not expressly forbidden by any contractual provision, would deprive the other of the right to receive the benefits under their agreement." Don King Productions, Inc. v. Douglas, 742 F. Supp. 741, 767 (S.D.N.Y. 1990) (citing cases); accord Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F. Supp. at 1517; Collard v. Incorporated Village of Flower Hill, 75 A.D.2d 631, 632, 427 N.Y.S.2d 301, 302 (2d Dept. 1980), aff'd, 52 N.Y.2d 594, 439 N.Y.S.2d 326, 421 N.E.2d 818 (1981). Put another way, the implied covenant "ensures that parties to a contract perform the substantive bargained-for terms of their agreement." Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F. Supp. at 1517 (citation omitted).
For example, in Van Gemert v. Boeing Co., 520 F.2d 1373 (2d Cir.), cert. denied, 423 U.S. 947, 46 L. Ed. 2d 282, 96 S. Ct. 364 (1975), holders of convertible debentures had an express contractual right to receive notice of the issuer's intent to redeem the debentures; this notice would allow them to determine whether they wanted to exercise the conversion privilege attached to their bonds. The indenture did not specifically provide for the form of this notice. The issuer gave notice through a press release that did not provide the information necessary for the bondholders to decide whether to exercise their conversion rights prior to redemption of the debentures. The Second Circuit relied on the implied covenant of good faith and fair dealing to construe the notice requirement as mandating the furnishing of sufficient information to permit bondholders to assess meaningfully their options. 520 F.2d at 1383-85. However, courts have declined to find that the implied covenant of good faith and fair dealing adds to the contract a substantive provision not included by the parties. See, e.g., Harris Trust and Savings Bank v. E-II Holdings, Inc., 926 F.2d 636, 643-44 (7th Cir.) (New York law), cert. denied, 116 L. Ed. 2d 152, 112 S. Ct. 192 (1991); Metropolitan Life Insurance Co. v. RJR Nabisco, Inc., 716 F. Supp. 1504 (S.D.N.Y. 1989); Hartford Fire Insurance Co. v. Federated Department Stores, Inc., 723 F. Supp. at 990-93.
In Metropolitan Life Insurance Co. v. RJR Nabisco, Inc., 716 F. Supp. 1504 (S.D.N.Y. 1989), then District Judge Walker faced the almost identical legal issue to that presented here. In RJR Nabisco, the issuer engaged in a leveraged buy-out, in which a group of investors "buy the company under financial arrangements that include little equity and significant new debt. . . . [A] portion of this debt is generally secured by the company's assets." Id., 716 F. Supp. at 1505 n.1. As a result of RJR Nabisco's assumption of billions of dollars of new debt, the value of bonds previously issued by the company declined significantly. Two institutional bondholders brought suit, claiming that RJR Nabisco's incurrence of debt violated an implied covenant of good faith and fair dealing. Judge Walker rejected this claim, reasoning that the indentures at issue gave the bondholders only the explicit right to receive periodic interest payments and the repayment of principal. Judge Walker explained that,
There being no express covenant between the parties that would restrict the incurrence of new debt, and no perceived direction to that end from covenants that are express, this Court will not imply a covenant to prevent the recent LBO and thereby create an indenture term that . . . was not bargained for here and was not even within the mutual contemplation of the parties. . . . These plaintiffs do not invoke an implied covenant of good faith to protect a legitimate, mutually contemplated ...