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CARY OIL CO., INC. v. MG REFINING & MARKETING

October 23, 2002

CARY OIL CO., INC., ET AL., PLAINTIFFS,
V.
MG REFINING & MARKETING, INC., ET AL., DEFENDANTS.



The opinion of the court was delivered by: VICTOR Marrero, United States District Judge.

    DECISION AND ORDER

Before the Court is a Report and Recommendation (the "Report") issued by Magistrate Judge Douglas F. Eaton recommending that: (1) the Court grant a motion by defendants Metallgesellschaft Refining and Marketing, Inc. ("MGRM"), Metallgesellschaft Corporation ("MG Corp.") and Metallgesellschaft AG ("MGAG") (collectively the "Defendants") for summary judgment dismissing the complaint in regard to the claims by plaintiffs Dalton Petroleum, Inc. ("Dalton"), RK Distributing, Inc. ("RK Distributing"), Merritt Oil Company ("Merritt Oil"), and Higginson Oil Company ("Higginson Oil"); and (2) deny the motion for summary judgment by Defendants with respect to the other eleven plaintiffs in this action. For the reasons discussed below, the Court adopts the Report's recommendations. A copy of the Report is attached and incorporated to this Decision and Order.

I. FACTUAL BACKGROUND*fn1

Plaintiffs in this case (collectively "Plaintiffs") are fifteen corporations engaged in the business of marketing and/or distributing petroleum products in the United States. Defendants are in the business, among other things, of selling petroleum products. MGAG, a German corporation, is the sole shareholder of MG Corp., a Delaware corporation with offices in New York, which in turn is the sole shareholder of MGRM, a Delaware Corporation that is now defunct and formerly had offices in New York, Texas and Maryland.

In the early 1990s, MGRM sought to attract customers of its petroleum marketing business by offering "innovative risk management programs" that were not being offered by other energy marketers at the time. (MG Corp. Confidential Descriptive Memorandum, December 1993, attached as Ex. 1 to Plaintiffs' Opposition to Defendants' Motion for Summary Judgment, Dated Nov. 7, 2001 ("Pls.' Opp."), at 3). MGRM offered to help customers hedge the risks associated with volatile price fluctuations in global petroleum prices. Under certain conditions, MGRM offered customers "an option to unwind their hedges early to take advantage of favorable market movements." (Report by Siegfried Hodapp, President of MG Corp., dated March 2, 1992, attached as Ex. 5 to Pls.' Opp., at 2.) According to MGRM, this program was offered "not only [to] protect[] station owners against risk, but also to allow[] them to participate in upside profit potential." (Id. at 3.)

As a part of this risk management program, MGRM offered its customers three types of long-term petroleum supply contracts in the early 1990s. Each of the fifteen plaintiffs in this action entered into one or more of these contracts with MGRM. Under the first type of contract, termed a "guaranteed margin contract," MGRM supplied a customer with a specified amount of gasoline or diesel fuel with a variable price over a set time period. The other two types of contracts, termed a "ratable" and a "flexie" contract, were fixed-price supply contracts. The ratable contract provided for monthly delivery of a specified volume, apportioned "ratably" over the contract's five-year or ten-year term. The flexie differed from the ratable contract, in that, unlike the ratable's monthly delivery schedule, the flexie contracts allowed customers to schedule delivery flexibly within the contract term.

Both the ratable and the flexie contracts contained a cash "blow-out" option. If, during the contract term, the price of petroleum futures on the New York Mercantile Exchange ("NYMEX") rose higher than the fixed price in the contract, the customer could use this option to cash-out its obligation to take delivery of the petroleum it had contracted to purchase. If a customer chose to exercise this option under a flexie contract, MGRM was to provide it with a cash payment equal to the difference between the NYMEX price and the contract price, multiplied by the number of gallons to be cashed out.

As is readily apparent, the option clauses in the flexie contracts presupposed, not unreasonably, that MGRM would maintain long hedge positions — positions giving it the right to buy the product it was obliged to deliver to its customers at or near the prices at which it was obliged to sell — in order to avoid the risk of literally open-ended losses that otherwise could have been sustained by MGRM if market prices rose above the contract prices. Nevertheless, the flexie contracts did not expressly require MGRM to maintain such hedge positions.

Soon after these contracts went into effect, Defendants began to experience financial difficulty. In order to reduce its exposure under the flexie contracts and others, MGRM had hedged by purchasing oil futures contracts on the NYNEX and off-exchange derivatives. When oil prices dropped sharply in late 1993, MGRM faced huge margin calls and suffered other short-term losses, plunging the entire conglomerate into a severe liquidity crisis and pushing it to the brink of insolvency. At the last minute, MGAG's creditors stepped in and orchestrated a reorganization and bail out. This involved, among other things, financial and managerial restructuring, new lines of credit and liquidation of MGRM's hedge positions in derivatives traded on and off the exchange markets.

Although MGAG survived the crisis, the legal and regulatory fallout has been substantial. In addition to facing numerous law suits, MGRM became the target of a Commodity Futures Trading Commission ("CFTC" or the "Commission") inquiry. Prior to the institution of any enforcement action, MGRM submitted an offer of settlement that was accepted by the Commission and resulted in the issuance of a consent order. See MG Refining and Marketing, Inc., CFTC Docket No. 95-14, 1995 WL 447455, *2, *6 (July 27, 1995). The uncontested recitals that preceded the decretal portion of the order set forth the Commission's findings that the contracts here at issue were "illegal off-exchange futures contracts." The decretal portion of the order, to which MGRM explicitly agreed, provided in relevant part that MGRM would cease offering the contracts and promptly notify all purchasers of the contracts that the Commission had found the contracts to be "illegal and void." The order thus arguably relieved MGRM of its obligations under the contracts. And that is the heart of Plaintiffs' grievance. They contend that Defendants breached their duties to Plaintiffs by proposing and entering into a settlement with the CFTC for the express purpose of obtaining a statement that the contracts were void in order to avoid their contractual duties and eliminate their exposure to Plaintiffs.

In January and February of 1996, eight of the plaintiffs, including Dalton Petroleum, entered into general release agreements prepared by MGRM. (See Cancellation and Release Agreements ("Release Agreements"), attached as Ex. 25 to Defendants' Motion for Summary Judgment, dated October 1, 2001 ("Defs.' Mot.").) Dalton Petroleum's Release Agreement specifically released MGRM from its obligations under its ratable and flexie contracts with Dalton Petroleum. (Id.) In contrast, the Release Agreements signed by the other seven plaintiffs specifically released MGRM from its obligations under the ratable contracts, but the Release Agreements did not mention the flexie contracts. (Id.)

In addition, the International Swaps and Derivatives Association ("ISDA"), the Securities Industry Association ("SIA") and the Bond Market Association ("BMA") filed an amici curiae memorandum in support of Plaintiffs' Objections to the Magistrate Judge's Report. In an Order dated March 21, 2002, the Court indicated that it would consider the amici curiae memorandum on the limited issue of the legislative history and intent of the Commodity Futures Modernization Act of 2000 (the "CFMA"). Defendants filed a response to the amici curiae memorandum.

II. DISCUSSION

A. STANDARD OF REVIEW

The Federal Magistrate Act provides that a district judge may "designate a magistrate to conduct hearings, including evidentiary hearings" in order to "submit to a judge of the court proposed findings of fact and recommendations for the disposition" of a motion for summary judgment. 28 U.S.C. § 636 (b)(1)(B) (2000). In reviewing the Report, this Court "may accept, reject, or modify, in whole or in part, the findings or recommendations made by the magistrate." 28 U.S.C. § 636 (b)(1); see Fed.R.Civ.P. 72(b). Any party may object to the Magistrate Judge's findings and recommendations. See id. If an objection is timely filed, as is the case here, the Court is bound to make a "de novo determination of those portions of the report . . . or recommendations to which objection is made." Id.; see also United States v. Male Juvenile, 121 F.3d 34, 38 (2d Cir. 1997). Having conducted a careful de novo review of the Magistrate Judge's well-reasoned Report, and of the objections by Defendants and Plaintiffs, the Court adopts the recommendations of the Report.

B. THE ENFORCEABILITY OF THE FLEXIE CONTRACTS

The Commodity Exchange Act ("CEA"), 7 U.S.C. § 1 et seq., requires that futures contracts be marketed and entered into only through certain designated "contract markets," which meet very specific CEA requirements. The issue of enforceability arises in this case because section four ("§ 4") of the CEA makes it unlawful for any person

to offer to enter into, to enter into, to execute, [or] to confirm the execution of . . . a contract for the purchase or sale of a commodity for future delivery unless . . . such transaction is conducted on or subject to the rules of a board of trade which has been designated by the Commodity Futures Trading Commission as a `contract market' for such commodity . . .

7 U.S.C. § 6 (a)-(a)(1). One of the Defendants' principal arguments for summary judgment is that the flexie contracts, which appear to be "contracts for the purchase or sale of a commodity for future delivery," were never entered into in accordance with the rules that this section specifies. Absent some exception to § 4, the flexie contracts would therefore qualify as unlawful off-exchange futures contracts.

Plaintiffs assert that the Magistrate Judge's recommended ruling: (1) incorrectly concludes that the flexie contracts entered into by RK Distributing, Merritt Oil and Higginson Oil were unlawful, off-exchange futures contracts; (2) is inconsistent with Judge Kaplan's decision in Commodity Futures Trading Comm'n v. Hanover Trading Corp., 34 F. Supp.2d 203, 206 (S.D.N.Y. 1999) and common law permitting the enforceability of unlawful contracts; and (3) incorrectly found that the contract enforcement provision of the CFMA is not applicable to the flexie contracts in this case. (See Plaintiffs' Limited Objections to Magistrate Judge Eaton's January 4, 2002 Report and Recommendation to Judge Marrero Regarding Defendants' Motion for Summary Judgement, dated February 8, 2002 ("Pls.' Obj."), at 1-2.)

1. Were Certain Flexie Contracts Unlawful Off-exchange Contracts?

To reach his conclusion that the flexie contracts entered into by RK Distributing, Merritt Oil and Higginson Oil were unlawful off-exchange futures contracts and unenforceable as a matter of law, the Magistrate Judge relied on the thorough analysis set out in MG Refining & Marketing, Inc., v. Knight Enterprises, Inc. et al., 25 F. Supp.2d 175, 180-88 (1998) ("Knight II"). Although that case is unrelated to the instant case, the underlying facts were similar.

In Knight II, eighteen of MGRM's petroleum customers had entered into flexie contracts that were almost identical to the flexie contracts in the instant case. Considering MGRM's motion for summary judgment, the Court quickly rejected plaintiffs' assertion that the flexie contracts could qualify under the "trade option," or the "swaps" exception*fn3 to the CEA. See Knight II, 25 F. Supp.2d at 181. Instead, it focused on whether the flexie contracts at issue qualified for the "forward contract" exception*fn4 to the CEA. Reviewing caselaw and administrative opinions issued by the CFTC, the Court concluded that the question of whether a transaction qualified for the forward contract exception depended on the underlying purpose of the transaction. See id. at 184 ("The underlying purpose of a transaction is . . . the touchstone of the forward contract analysis."). According to this analysis, transactions that have been entered into for purely speculative purposes do not qualify for the forward contract exception. Although there is no "definitive list" of elements for determining this purpose, "[s]uch an assessment entail[s] . . . a review of the `overall effect' of the transaction as well as a determination of "what the parties intended." Id. at 183 (quoting 1990 Statutory Interpretation Concerning Forward Transactions (the "1990 CFTC Statutory Interpretation"), 55 Fed. Reg. 39188, 39191).

The plaintiffs in that case argued that the CFTC 1990 Statutory Interpretation "radically revised" the underlying purpose test and replaced it with a more "objective" one, under which contracts "should be considered legal forward contracts whenever they are entered into between commercial parties in connection with their businesses, and when the contracts set forth specific delivery obligations imposing on the parties substantial risks of an economic nature." Id. at 182. The Court rejected this argument, stating:

Although the Customers are correct to note that the 1990 Statutory Interpretation clarified that routine physical delivery under a contract is not an absolute precondition for application of the forward contract exception, the Customers overstate the CFTC's holding when they contend that this opinion marks an abandonment of the underlying purpose test altogether. . . . In fact, far from undermining the traditional forward contract analysis, the CFTC explicitly reiterated the proposition that to identify a forward contract, the "transaction[s] must be viewed as a whole, with a critical eye towards [their] underlying purpose."

Id. at 183 (quoting CFTC 1990 Statutory Interpretation, at 39190). The Knight II court found that if it were to consider the flexie contracts in isolation, it "might be inclined to grant MG's motion against most of the Customers in [the] case." Id. at 185. However, because "the record contain[ed] evidence that the flexies may have been negotiated as part of larger transactions, which included the sale not only of flexies but of certain ratable contracts," the court concluded that the underlying purpose of the flexie contracts presented a genuine issue of material fact to be resolved at trial. Id. at 187-88. In reaching its conclusion, the court noted that MGRM's former president admitted that he implemented a strategy to offer customers a "risk management situation in which [MGRM] tried to fix [the customers'] price at a level that [MGRM] thought would be attractive when the market was in the lower third of what [MGRM] perceived to be its normal pattern." Id. at 187. Relying on this description of MGRM's strategy, the court stated:

When viewed as part of these larger, ongoing transactions, some of the descriptions of the transactions between MG and the Customers might thus be read to suggest that the flexies were viewed by both as instruments for insuring against certain price fluctuations that might arise as petroleum was delivered under the terms of the ratable or other contracts.

Id. at 187-88.

Applying the analysis in Knight II to the instant case, the Magistrate Judge found that the record clearly indicated that RK Distributing, Merritt Oil and Higginson Oil had all entered into their respective flexie contracts for purely speculative purposes. (Report at 23.) In their objections, Plaintiffs contend that the Magistrate Judge incorrectly applied the legal standard for the forward contract exception set out in Knight II.*fn5 More specifically, Plaintiffs assert that "Judge Eaton recommends a rule whereby a contract qualifies as a forward contract only if, at the time of contracting, the parties planned to take physical delivery under the terms of the specific contracts in dispute." (Pls.' Obj. at 15.) Plaintiffs are incorrect.

The Report clearly concluded that the "underlying motivation" of RK Distributing, Merritt Oil and Higginson Oil for entering into these transactions was to engage in speculation. The Report noted: "[Plaintiffs] intended to `blow out' these contracts by obtaining one or more cash payments during times when the price of gasoline and diesel fuel spiked, and it was highly likely that these prices would spike during the next five to ten years." (Report at 23.) The record fully supports the Magistrate Judge's conclusion.

a. RK Distributing

In a declaration dated August 2, 1995, RK Distributing's President, Thomas Cowden, stated, "I saw the [flexie] contract not as an avenue to take delivery of gasoline, but as a speculative investment or gamble that the market price of gasoline would rise above 62 cents. . . . I had no intention of taking delivery of 42,000,000 gallons [the amount covered by the flexie contract] and, in fact, did not have the capacity to take delivery of this much gasoline." (Report at 24 (quoting Declaration of Thomas Cowden, dated August 2, 1995, attached as Ex. 3 to Defs.' Mot. at 2) (emphasis added).) Although Cowden later tried to retract this statement in a subsequent declaration, the Court fully agrees with the Magistrate Judge's conclusion that any reasonable jury would find that RK Distributing entered into its flexie contract for purely speculative purposes. Furthermore, as the Report notes, RK Distributing "never had a ratable contract with MGRM, and never took delivery of any product from MGRM." (Report at 23.) Accordingly, there were no other contracts with MGRM that the flexie contract could possibly have hedged.

b. Merritt Oil

After the close of discovery, Merritt submitted a declaration describing hypothetical situations in which he would have wanted to take delivery of petroleum under the flexie contract. (See Declaration of Richard Merritt, dated October 31, 2001, included in Declarations in Support of Plaintiffs' Opposition to Defendants' Motion for Summary Judgement, dated November 7, 2001.) According to Merritt's declaration, if the market price ever exceeded the price in the flexie contract, "it would have been easy for me to sell the entire contract volume." (Report at 31.) However, as the Report notes, the flexie contracts required that a customer notify MGRM forty-five days before it wanted physical delivery. In this situation, Merritt Oil could not have "easily" re-sold the petroleum obtained from the flexie contract unless the market price stayed above the contract price at the end of forty-five days.

Such an eventuality was unpredictable at best, and if the market price of petroleum fell significantly below the price in the flexie contracts, Merritt Oil would have faced an enormous loss. Merritt Oil has presented no evidence that it, or any other petroleum customer, ever bought and re-sold large amounts of petroleum with this amount of risk involved. Merritt's written statement that "[w]e don't ever pull any product" confirms that he did not enter into the flexie contract with an intent to possibly commit to take delivery of large amounts of petroleum at a fixed price and attempt to resell it on the market forty-five days later. (See Report at 31.)

Although Plaintiffs are correct to note that the question of a party's intent for entering into a contract is typically a jury question (See Pls.' Obj. at 15), "ultimate or conclusory facts and conclusions of law . . . cannot be utilized on a summary judgment motion." BellSouth Telecommunications, Inc. v. W.R. Grace & Co., 77 F.3d 603, 615 (2d Cir. 1996) (quoting 10A Charles Alan Wright, Arthur R. Miller & Mary Kay Kane, Federal Practice and Procedure § 2738, at 486 and 489 (1983) and Fed.R.Civ.P. 56(e)). Merritt's self-serving statements that he would have wanted to take delivery of petroleum in some circumstances were made after the close of discovery in this case and clearly contradict his sworn statements from 1995. Merritt's later statements "are insufficient to raise a triable issue of material fact, and hence were properly disregarded" by the Magistrate Judge. Id. Accordingly, the Court agrees with Magistrate Judge's conclusion that "no reasonable jury could find that Merritt's purpose was to take delivery of these huge volumes of product, which vastly exceeded his 1993 . . . sales volume." (Report at 31.)

c. Higginson Oil

Like Cowden and Merritt, Kim Wayne Higginson, the former Vice President and current President of Higginson Oil, gave a sworn declaration indicating that he never intended to take delivery of physical product under the flexie contract:

Mr. Gelvin [MGRM's salesperson] presented the [flexie] contract to me as one under which it was not likely that I would ever have to take delivery of gasoline. His emphasis and primary selling point was the likelihood that the market price of gasoline would rise above 62 cents, and therefore there would be no obligation to take any delivery under the contract. . . . Based on Mr. Gelvin's representations . . ., and my own experience in the business, I felt certain that the market price of gasoline would rise above 62 cents sometime during the term of the [flexie] contract.

(Report at 32 (emphasis added).) Six years later, Higginson sought to modify part of this statement, indicating that his use of the word "certain" was too strong. (Report at 33.) Like Merritt, Higginson also presented a hypothetical situation in which he contends he would have taken delivery of the petroleum under the flexie contract and re-sold it for a profit. As with Merritt, the submission of this hypothetical presents speculative and conclusory assertions of fact which the Court may disregard on a motion for summary judgment. See BellSouth Telecommunications, 77 F.3d at 615.

Plaintiffs also assert that the Magistrate Judge incorrectly concluded that no reasonable jury would find that the flexie contracts entered into by Higginson Oil, RK Distributing and Merritt Oil were "negotiated as part of larger transactions." (Pls.' Obj. at 18.) They contend that the Magistrate Judge "reduces this discussion to the trivial question of whether a customer's flexie matches the customer's ratable contracts, gallon-for-gallon and product-for-product." (Id.) The Plaintiffs are incorrect. As discussed above, the Magistrate Judge considered a number of sworn statements made by officers of RK Distributing, Merritt Oil and Higginson Oil, as well as the relative quantities of petroleum covered by the ratable and flexie contracts. These statements, combined with the fact that there was little or no match between the volumes of petroleum covered by the ratable and the flexie contracts, amply support the Magistrate Judge's conclusion that there is no genuine issue of material fact as to the underlying purpose of the flexie contracts with respect to these three plaintiffs.*fn7

d. Satterfield Oil Co.

However, it is not entirely clear that Satterfield Oil entered into the flexie contract for purely speculative purposes. Unlike the officers of RK Distributing, Merritt Oil and Higginson Oil, the President of Satterfield Oil, M. M. Satterfield, Jr., did not give a declaration indicating that he viewed the flexie contracts as a way to speculate on the petroleum markets. Although he stated that he entered into the flexie contract because he wanted to get involved in futures trading, he also stated that he entered MGRM's "program" to help manage his inventory costs. (See Deposition of M. M. Satterfield, dated August 16, 2000, attached as Ex. E to MG Defendants' Memorandum of Law in Support of Their Objections to Magistrate Judge Eaton's Report and Recommendation, dated February 8, 2002 ("Def's. Obj."), at 87-88.) It is unclear from the record what MGRM's "program" was and whether it was somehow linked to legitimate hedging or managing inventory costs. Although this seems unlikely in light of the quantities of petroleum involved, it is not sufficiently clear to support granting summary judgment with respect to Satterfield Oil.

2. Are the Flexie Contracts Enforceable?

Plaintiffs assert that even if the Court finds that the if Flexie contracts entered into by RK Distributing, Merritt Oil and Higginson Oil violate the CEA, such a finding would only render the contracts voidable under the Restatement (Second) of Contracts (the "Restatement") and Judge Kaplan's decision in Commodity Futures Trading Comm'n v. Hanover Trading Corp., 34 F. Supp.2d 203, 206 (S.D.N.Y. 1999). (See Pls.' Obj. at 11.) In his Report, the Magistrate Judge fully considered and rejected the same argument. On this issue, the Magistrate Judge noted that the Restatement prescribes that a contract is unenforceable if its enforcement "is clearly outweighed in the circumstances by a public policy. . . ." (Report at 36-37 (quoting Restatement (Second) of Contracts § 178 (1981)).) Reviewing the CEA and the record in the instant case, the Magistrate Judge concluded that: (1) the CEA expressed a strong public policy that trading parties covered by the Act comply with its terms; (2) the parties' "justified expectations" did not call for keeping the flexie contracts in force for ten years; and (3) if enforcement is denied, it would not result in any forfeiture by RK Distributing, Merritt Oil or Higginson Oil. (Report at 36-39 (quoting Restatement § 178).) The Court fully agrees with the Magistrate Judge's conclusion.

As discussed above, § 4 of the CEA clearly states that it is unlawful for any person to enter into "a contract for the purchase or sale of a commodity for future delivery" unless such transaction is conducted on a commodities exchange approved by the CFTC. 7 U.S.C. § 6 (a). This provision is central to the Act's primary purpose of preventing fraud and protecting investors. See Ricci v. Chicago Mercantile Exchange, 409 U.S. 289, 303 (1973) ("[T]he express will of Congress is that to deal in commodity futures one must either be, or deal through, a member of a board of trade having specified qualifications and carrying official designation as a contract market."); see also Commodity Futures Trading Com'n v. British American Commodity Options Corp., 788 F.2d 92, 94 (2d Cir. 1986). Furthermore, as the Magistrate Judge noted, at the time Plaintiffs entered into the flexie contracts in this case, the CEA provided that entering into an off-exchange futures contract was a felony punishable by a fine of up to $1,000,000 and imprisonment for up to five years. (Report at 37 (citing 7 U.S.C. § 13 (a)(5).) Considering the CEA's central purpose of protecting investors by requiring that unexempted commodities transactions be executed on a designated board of trade, this Court fully agrees with the Magistrate Judge that unlawful off-exchange contracts are unenforceable.

Contrary to Plaintiffs' assertions, this conclusion is not inconsistent with Judge Kaplan's decision in Hanover Trading, 34 F. Supp. at 206. The facts of Hanover Trading were very different from the instant case. In that case, the CFTC sued Hanover Trading Corporation ("Hanover") and a number of so-called "relief defendants" — those who are not charged with wrongdoing — asserting that Hanover misappropriated customer funds and made fraudulent solicitations to investors to enter into unlawful off-exchange commodities contracts. Hanover Trading, 34 F. Supp. at 204. The CFTC settled the case with respect to all defendants except one relief defendant named Aronowitz. Id. Aronowitz, who worked for Hanover, helped solicit customers to enter into the transactions, but there was no evidence that he knew of the fraudulent nature of his employer's conduct. Id. at 205. The CFTC sought to have Aronowitz disgorge the commissions that he had earned from Hanover, based on the theory that since the contracts he had sold were unlawful and unenforceable, he had not acquired legal and equitable title to the funds. Id. In turn, this theory was based on the assumption that Hanover never held a legitimate interest in the funds because the contracts it had sold violated the CEA and were void as a matter of law. Id. at 206. Rejecting this argument, the court stated:

[T]he Commission's argument here flies in the face of a plethora of authority holding that even contracts made in violation of the securities laws, and thus subject to Section 29(b) of the Securities Exchange Act of 1934, which states that such contracts are `void,' are merely voidable at the option of the innocent party.

Id. (citing Mills v. Electric Auto-Lite Co., 396 U.S. 375, 387 (1970). Although this analogy was perhaps useful in Hanover Trading, it has no application to the instant case. As the Magistrate noted in his Report:

Most violations of the 1934 Act consist of fraudulent representations The Commodity Exchange Act is different from the 1934 Act in many ways, but some of its violations also consist of fraudulent sales practices. In such cases, it makes sense to analogize to Section 29(b) of the 1934 Act.

(Report at 40 (emphasis added).) Plaintiffs in this case are not in the same position as the relief defendant in Hanover Trading because they have not established that Defendants engaged in any fraudulent conduct. (Id.)*fn8 Furthermore, it is not plausible that RK Distributing, Merritt Oil or Higginson Oil had any "justified expectations" in being able to enforce the flexie contracts. In Hanover Trading, the CFTC sought to "seize funds paid as compensation for services actually performed for [Hanover] [a]nd the fact that [the relief defendant] performed services for Hanover for which he presumably was entitled to be paid — is significant." Hanover Trading, 34 F. Supp.2d at 207. In contrast, there is no evidence in the instant case that RK Distributing, Merritt Oil or Higginson Oil gave money or "acted to their detriment in reliance on the flexies." (Report at 39.)

2. The CFMA's Contract Enforcement Provision

Plaintiffs and amici both assert that the Magistrate Judge's Report erred in its failure to apply the CFMA to the transactions at issue in this case. More specifically, they contend that the CFMA's contract enforcement provision, codified at 7 U.S.C. § 25 (a)(4) (Supp. 2001), renders the flexie contracts at issue in this case enforceable, regardless of any violation of the CEA. In his Report, the Magistrate Judge applied the standard set forth in Landgraf v. USI Film Products, 511 U.S. 244 (1994) and concluded that the CFMA does not apply retroactively to the flexie contracts at issue. (Report at 42.) The Court agrees.

As the Supreme Court noted in Landgraf, "the presumption against retroactive legislation is deeply rooted in our jurisprudence, and embodies a legal doctrine centuries older than the Republic." 511 U.S. at 265. Absent a constitutional violation, however, a Court is bound to apply civil legislation retroactively if that is what Congress clearly intended. Id. at 267-68. The requirement that Congress "first make its intention clear helps ensure that Congress itself has determined that the benefits of retroactivity outweigh the potential for disruption or unfairness." Id. at 268.

On December 21, 2000, Congress amended the Commodities Exchange Act through the enactment of the CFMA. See Commodities Futures Modernization Act, Pub. L. No. 106-554, 114 Stat. 2763 (2000).*fn9 The CEMA inserted a new sub-section into 7 U.S.C. § 25 entitled "Contract enforcement between eligible counterparties":

No agreement, contract, or transaction between eligible contract participants*fn10 or persons reasonably believed to
be eligible contract participants, and no hybrid instrument sold to any investor, shall be void, voidable, or unenforceable, and no such party shall be entitled to rescind, or recover any payment made with respect to, such an agreement, contract, transaction, or instrument under this section or any other provision of Federal or State law, based solely on the failure of the agreement, contract, transaction, or instrument to comply with the terms or conditions of an exemption or exclusion from any provision of this chapter or regulations of the Commission.

7 U.S.C. § 25 (a)(4). As the Report notes, Plaintiffs argue that this new sub-section applies to the 1993 flexie contracts because 7 U.S.C. § 25 (d), which was added in 1983, states:

The provisions of this section shall become effective with respect to causes of action accruing on or after the date of enactment of the Futures Trading Act of 1982 [January 11, 1983]: Provided, That the enactment of the Futures Trading Act of 1982 shall not affect any right of any parties which may exist with respect to causes of action accruing prior to such date.

The Magistrate Judge found that sub-section (d) only applies to private rights of action created by section 25, and not to breach of contract actions based on state law, such as those asserted in the instant case. (Report at 43.) The Magistrate Judge also found that, under the standard set out in Landgraf, the CFMA's insertion of the new contract enforcement provision did not evince a "clear congressional intent" to retroactively make unlawful off-exchange contracts enforceable. (Id.)

Plaintiffs contend that: (1) the time limitations in subsection (d) unambiguously apply to all provisions of section 25, including the contract enforcement provision, which Congress inserted into the code seventeen years after subsection (d) was created, and (2) applying the contract enforcement provision to the flexie contracts in the instant case does not raise retroactivity concerns because the provision would not take away any vested rights or disrupt any justified expectations held by the parties. The Court disagrees.

As the Report notes, Landgraf clearly sets out the standard that the Court must apply to determine whether the CFMA covers the contracts at issue in this case:

When a case implicates a federal statute enacted after the events in suit, the court's first task is to determine whether Congress has expressly prescribed the statute's proper reach. If Congress has done so, of course, there is no need to resort to judicial default rules. When, however, the statute contains no such express command, the court must determine whether the new statute would have retroactive effect, i.e., whether it would impair rights a party possessed when he acted, increase a party's liability for past conduct, or impose new duties with respect to transactions already completed. If the statute would operate retroactively, our traditional presumption teaches that it does not govern absent clear congressional intent favoring such a result.

511 U.S. at 280.

In the instant case, the Court agrees with the Magistrate Judge that Congress has not "expressly prescribed" the CFMA's temporal reach. On January 11, 1983, a new "section 22" was inserted into the CEA when the Futures Trading Act of 1982 came into force. See Futures Trading Act of 1982 (the "FTA"), Pub. L. No. 97-444 § 235, 96 Stat. 2294, 2322-24 (1983) (codified at 7 U.S.C. § 25). Section 22(a)(1) of the CEA now provides that any person who violates the Act "shall be liable for actual damages" resulting from the violation. FTA § 235, 96 Stat. at 2322. Section 22(a)(2) provides that the causes of action authorized by this new section, with some minor exceptions, "shall be the exclusive remedies under [the CEA] available to any person who sustains loss as a result of any alleged violation of this Act." Id. at 2323. Finally, section 22(d) provides that "[t]he provisions of this section shall become effective with respect to causes of action accruing on or after the date of enactment of the Futures Trading Act of 1982 . . . ." Id. at 2324. It is clear from the text of the FTA that the time limitations set out in section 22(d) apply to the statutory causes of action created by section 22.

When Congress enacted the CFMA in December 2000, it modified parts of section 22(a)(1) and (2) and added a new "section 22(a)(4)," the contract enforcement provision which is quoted above. Section 22(a)(4) provides that no contract between "eligible contract participants" shall be "void, voidable or unenforceable" due to the contract's failure to comply with an exemption or exclusion under the CEA. CFMA § 120, 114 Stat. at 2763A-404 (codified at 7 U.S.C. § 25 (a)(4)). Although the wording of the section's text indicates that it eliminates certain defenses to breach of contract actions, there is nothing to suggest that it creates a new statutory cause of action. Thus, the time limitations of section 22(d), which apply to causes of action arising under section 22, do not seem to apply to this new sub-section. At the very least, Congress did not "expressly prescribe" such a result. See Landgraf, 511 U.S. at 280.*fn11

Having concluded that Congress did not "expressly prescribe" the CFMA's temporal reach, the next question under Landgraf is whether the application of section 22(a)(4) to the flexie contracts at issue in this case "would have retroactive effect." Id. This question presents a more difficult issue. Although statutory retroactivity is generally disfavored, "deciding when a statute operates retroactively is not always a simple or mechanical task." Id. at 268. As the Supreme Court noted in Landgraf, Justice Story has provided influential guidance on this topic: "[E]very statute, which takes away or impairs vested rights acquired under existing laws, or creates a new obligation, imposes a new duty, or attaches a new disability, in respect to transactions or considerations already past, must be deemed retrospective . . . ." Id. at 269 (quoting Society for the Propagation of Gospel v. Wheeler, 22 F. Cas. 756 (C.C.N.H. 1814) (No. 13, 156)).

Seeking to rely on Justice Story's opinion, Plaintiffs assert that the contract enforcement provision of the CFMA does not raise retroactivity concerns because MGRM had no "vested right" to get out of its contracts by invoking an illegality defense. (See Pls.' Obj. at 7-8.) However, Justice Story's opinion "merely described" that the impairment of a vested right "constituted a sufficient, rather than a necessary, condition for invoking the presumption against retroactivity." Hughes Aircraft Co. v. United States, 520 U.S. 939, 947 (1997) (emphasis in original). Instead, the Supreme Court has used "various formulations to describe the `functional conception[n] of legislative retroactivity,' and made no suggestion that Justice Story's formulation was the exclusive definition of presumptively impermissible retroactive legislation." Id. (quoting Landgraf, 511 U.S. at 269).

Hughes Aircraft is instructive on this point. In that case, a former employee of a government subcontractor brought a qui tam action under the False Claims Act (the "FCA") against his former employer, alleging that it had knowingly mischarged the government some time before 1986. Id. at 942. Prior to the enactment of an amendment to the ECA in 1986, such suits were barred if the information on which they were based was already in the government's possession. Id. Acknowledging that the government had knowledge of the alleged mischarging, the employee asserted that the 1986 amendment to the ECA applied retroactively, thus permitting his case to proceed. The Supreme Court disagreed, stating: "Given the absence of a clear statutory expression of congressional intent to apply the 1986 amendment to conduct completed before its enactment, we apply our presumption against retroactivity and hold that, under the relevant 1982 version of the FCA, the District Court was obliged to dismiss this action Id. at 952.

Like Plaintiffs in the instant case, the employee in Hughes Aircraft asserted that the 1986 amendment did not have a retroactive effect because it did not impose new duties with respect to transactions already completed. In response, the Court stated:

Id. at 947-48 (quoting Landgraf, 511 U.S. at 281-282) . The employee in Hughes also maintained that the 1986 amendment had no retroactive effect because it did not "change the substance of the extant cause of action, or alter a defendant's exposure for a false claim and thus [did] not "increase a party's liability for past conduct.'" Hughes Aircraft, 520 U.S. at 948 (quoting Landgraf, 511 U.S. at 280). The Court rejected this argument as well:

While we acknowledge that the monetary liability faced by an FCA defendant is the same whether the action is brought by the Government or by a qui tam relator, the 1986 amendment eliminates a defense to a qui tam suit — prior disclosure to the Government — and therefore changes the substance of the existing cause of action for qui tam defendants by "attach[ing] a new disability, in respect to transactions or considerations already past."

Id. (quoting Landgraf, 511 U.S. at 269) (emphasis added).

In the instant case, unlawful off-exchange contracts were clearly unenforceable before the enactment of the CFMA.*fn12 To the extent that the CFMA now renders certain off-exchange contracts enforceable, the statute "eliminates a defense" to a breach of contract action and "therefore changes the substance of the existing cause of action for defendants by "attach[ing] a new disability, in respect to transactions or considerations already past.'" Id.*fn13 Accordingly, the Court concludes that the "presumption against retroactivity" applies to the contract enforcement provision of the CFMA and that the flexie contracts in the instant case are unenforceable. Id. at 952.

C. PIERCING THE CORPORATE VEIL OF MGAG AND MG CORP.

In his Report, the Magistrate Judge recommends that the Court rule that MG Corp. and MGAG, the parents of MGRM, are not entitled to summary judgment as to any of the plaintiffs except Dalton Petroleum, RK Distributing, Merritt Oil and Higginson Oil. (Report at 48.) Defendants object to this recommendation, asserting that MGAG and MG Corp. are entitled to complete summary judgment with respect to all plaintiffs because they have not presented sufficient evidence to "pierce the corporate veil" and hold MGAG and MG Corp. liable for the conduct of their subsidiary, MGRM. More specifically, Defendants assert that: (1) the Magistrate Judge's recommended holding that "a breach of contract, without more, is sufficient to satisfy the `fraud or wrong' prong of New York's veil-piercing standard is wrong as a matter of law;" and (2) "in concluding that there was sufficient evidence of MG Corp. and MGAG's `domination and control' of MGRM" with respect to the alleged breach of contract, the Magistrate Judge `rewrote plaintiffs' complaint with respect to the alleged breach at issue." (Defs' Obj. at 1-2.) The Court disagrees with the first assertion. Although the Court agrees, in part, with the second assertion, the Court nevertheless concludes that the record supports the Magistrate Judge's ultimate recommendation.

Defendants' first argument is based on an assumption that the Magistrate Judge erroneously relied on Carte Blanche (Singapore) Pte., Ltd. v. Diners Club Int'l, Inc., 2 F.3d 24 (2d Cir. 1993), which Defendants allege has been effectively overruled by subsequent caselaw. (Def's. Obj. at 3-5.) In Carte Blanche, plaintiff Carte Blanche (Singapore) ("CBS") had obtained an arbitration award from Carte Blanche International ("CET"), based on CBI's breach of a franchise agreement between CBS and CBI. Unable to collect on its award, CBS brought an action against Diners Club International, the corporate parent of CBI. In its decision, the Circuit Court initially set out its understanding of relevant New York law: "While `New York is reluctant to pierce corporate veils,' exceptions are made in two broad situations: to prevent fraud or other wrong, or where a parent dominates and controls a subsidiary." Carte Blanche, 2 F.3d at 25. The court further elaborated that determining whether a parent corporation's control and domination requires a court to disregard the corporate form calls for an examination of a number of factors.*fn14 Considering a number of these factors, the court held that "the breach of the franchise agreement that caused CBS to suffer the damages found by the arbitrators was the result of domination and control of CBI by its parent, Diners Club." Id. at 26-27.

Although the Second Circuit has not explicitly overruled Carte Blanche, it has acknowledged that the veil piercing standard under New York law has shifted:

In Carte Blanche, we held that New York law permits plaintiffs to pierce the corporate veil either "to prevent fraud or other wrong, or where a parent dominates and controls a subsidiary." Since the district court's decision, we have interpreted Carte Blanche to require, in order to pierce the corporate veil, 11(j) that the owner exercised complete domination over the corporation with respect to the transaction at issue; and (ii) that such domination was used to commit a fraud or wrong that injured the party seeking to pierce the veil."

Thrift Drug, Inc. v. Universal Prescription Adm'rs, 131 F.3d 95, 96 (2d Cir. 1997) (quoting American Fuel Corp. v. Utah Energy Dev. Co., 122 F.3d 130, 134 (2d Cir. 1997)) (emphasis in original); see also Matter of Morris v. New York State Dep't of Taxation & Finance, 623 N.E.2d 1157, 1160-61 (N.Y. 1993).

Defendants in the instant case assert that the Magistrate Judge failed to realize that Carte Blanche misstates the law on New York's veil piercing standard and that, as a result, he erroneously rejected their argument that a subsidiary's breach of contract, without more, is legally insufficient to satisfy the "fraud or wrong" prong of New York's veil-piercing standard. (Report at 44.) Although Defendants are correct that the two prongs of the veil piercing standard under New York law are conjunctive rather than disjunctive, the Court nevertheless concludes that the Magistrate Judge's ultimate recommendation to deny summary judgement is fully supported by the record.

In his Report, the Magistrate Judge found that a reasonable jury could conclude that:

In December 1993, MGAG planned to get rid of the flexie contracts, because "those contracts definitely are not good for us." MGAG directed the firing of the officers of MGRM, who believed that the flexies were lawful and appropriate. MGAG directed MG Corp. to hire Nancy Kropp Galdy, who promptly unwound all of MGRM's hedges securing the flexie contracts.

(Report at 46 (quoting Metallgesellschaft Corp., et al. v. W. Arthur Benson, et al., American Arbitration Association Case No. 1311637194 (1995), Arbitration Transcript ("Arb. Tr."), attached to Pls.' Opp., at 1372-73 (testimony of Hans Nolting)).) The Magistrate Judge later summarized his findings:

I find that, as to each plaintiff, the transaction at issue was the dishonoring of a ten-year contract. The plaintiffs allege that there was a long campaign to get rid of the flexie contracts, including the December 1993 unwinding of the hedges, the January 1994 cancellation letter, the July 1995 Consent Order, and the refusal to make the `blow out' payments demanded by plaintiffs

(Report at 47.)

Having conducted an independent review of the record, the Court agrees with these factual findings. The record presents a genuine issue of material fact as to whether MGAG or MG Corp. completely dominated MGRM and through such domination sought, in bad-faith, to evade the company's obligations under the flexie contracts. If a jury were to make such findings, it would support piercing the corporate veil to hold either one or both companies liable.

The cases that Defendants cite are inapposite. In TNS Holdings, Inc. v. MKI Securities Corp., 703 N.E.2d 749 (N.Y. 1998), for example, the facts were significantly different from the instant case. In that case, plaintiffs sought to enforce an arbitration clause against defendant Batchnotice, her sister corporation, MKI, and her parent corporation, MAI. Id. at 750. Defendants MKI and MAI moved to stay the arbitration proceedings against them on the grounds that they were not parties to the arbitration agreement. Id. The Court, applying the New York veil piercing standard, held that "plaintiffs have failed to show that, even if MKI dominated Batchnotice, that control resulted in some fraud or wrong mandating disregard of the corporate form in this case." Id. at 751. Explaining its reasoning, the court stated: "There is no showing that through its domination, MKI misused the corporate form for its personal ends so as to commit a fraud or wrongdoing or avoid any of its obligations." Id. (citing Morris, 623 N.E.2d at 1160 (emphasis added).

In contrast, the record in the instant case presents a genuine issue of material fact as to whether MGAG or MG. Corp. (1) completely dominated business decisions being made at MGRM; and (2) used such domination to cause MGRM to attempt to avoid its obligations under the flexie contracts. Defendants' assertion that a breach of contract, without more, is insufficient to satisfy the `fraud or wrong' prong of New York's veil-piercing standard mistakenly presupposes that the record could only support a finding of a simple breach of contract. However, based on the current record in this case, a reasonable jury could conclude that MGAG and MG Corp. conceived of and directed a plan to nullify MGRM's obligation to perform under the flexie contracts. Such a conclusion would easily satisfy the second prong of New York's veil piercing test. See Thrift Drug, 131 F.3d at 96.

Defendants' second argument is that the Magistrate Judge's Report improperly "rewrote" Plaintiffs' complaint "to charge MGRM with earlier contract breaches, including in particular the removal of hedges in late 1993 and the sending of cancellation letters in early 1994 — and then concluded there was sufficient evidence of domination and control with respect to those breaches." (Def's. Obj. at 10 (citing Report at 46-47.) Although portions of Defendants' argument have some merit, the Court concludes that neither MGAG nor MG Corp are entitled to summary judgment on this basis.

The Court does not agree with the Report's conclusion that "[i]f the jury finds that MGAG and MG Corp. dominated the acts in December 1993 and January 1994, but not the later acts, it may still find that those two corporations are liable for causing damage to any plaintiff whose flexie was lawful." (Report at 47.) This conclusion is inconsistent with the allegations contained in Plaintiffs' amended complaint. Count One of the amended complaint charges that:

On or about July 27, 1995, MGRM breached the flexie contracts by agreeing to the CFTC Consent Order. By entering into that Consent Order precluding its own performance, MGRM breached its continuing obligation to maintain readiness both to deliver product and to pay the Customers for exercise of their option throughout the term of the flexie contracts.
For their participation in and domination and control over the foregoing, MGAG and MG Corp. are also liable to Plaintiffs under respondeat superior, piercing the corporate veil and alter ego doctrines.

(Plaintiffs' First Amended Complaint, dated May 25, 1999 ("Am. Compl."), ¶¶ 111 and 112, attached as Ex. B to Defs.' Obj.) It is clear from the text of the amended complaint that Plaintiffs' breach of contract action is limited to MGRM's agreement to enter into the Consent Order with the CFTC in July 1995. As discussed above, to prove that MGAG and/or MG Corp. are liable for the contract breaches that allegedly resulted from this agreement, Plaintiffs will have to show that: (1) MGAG or MG Corp. completely dominated MGRM; and (2) such domination caused MGRM to enter into the Consent Order. If a jury were to find that MGAG and/or MG Corp. were responsible f or MGRM's acts in December 1993 and January 1994, but not for MGRM's agreement to the July 1995 Consent Order with the CFTC, Plaintiffs would be unable to pierce the corporate veil and hold that particular defendant liable for MGRM's conduct. Although the 1993 and 1994 acts may be relevant to issues such as MGRM's motivation for entering into the Consent Order and MGAG and MG Corp.'s role in such a decision, these acts were not pled as independent breaches of the flexie contracts and cannot provide the basis for piercing the corporate veil alone.*fn15

In their objections, Defendants presume that the Magistrate Judge would have granted their motion for summary judgment on piercing the corporate veil had he only considered MGRM's decision to enter into the July 1995 Consent Order. (See Defs.' Obj. at 9-10.) According to Defendants' reasoning, this explains why the Magistrate Judge "rewrote" Plaintiffs' complaint to charge MGRM with earlier contract breaches in 1993 and 1994. (See id. at 10.) The Court disagrees.

Defendants contend that one particular sentence in the Report supports this argument. The Report states that "there is very little evidence that [MGAG or MG. Corp.] `procured' the CFTC Consent Order, or that MG Corp. and MGAG dominated MGRM's negotiations with the CFTC investigators." (Report at 45.) Reviewing the record, the Court does not fully agree with this finding. Several pieces of evidence create a genuine issue of material fact as to whether MGAG controlled the negotiations with the CFTC. For example, in an internal letter dated January 9, 1996, the Chairman of MGAG's board, Dr. Neukirchen, informed other board members of the following:

It is obvious that for the new MGRM management these [flexie] contracts were unattractive. [The] CFTC's decision made it possible to terminate these contract conditions with immediate effect. The conclusion of the settlement with [the] CFTC was imperative for the MG Group. Under these circumstances the [Board] decided to empower MG Corp. to reach this settlement. We still believe that this was the right decision.

(Letter of Dr. Neukirchen, dated January 9, 1996, attached as Ex. 10 to Pls.' Opp., at 2. (emphasis added).) Plaintiffs allege that MGAG fired certain members of MGRM and replaced them with "new management" to facilitate the execution of their plan to eliminate the flexie contracts. There is some evidence in the record that could support this allegation.

For example, some time in 1993, the President of MGRM, Arthur Benson, was demoted and Nancy Kropp and Michael Hutchinson took over the "day-to-day decision making" at MGRM. (Arb. Tr. at 9694 (testimony of Arthur Benson); Arb. Tr. at 1369 (testimony of Hans Nolting).) Hutchinson, in turn, reported to Hans Nolting, who was a Frankfurt based director of MG Corp. (Deposition of William G. Romanello, dated January 25, 2001, at 149, 164.) In December 1993, Kropp oversaw the elimination of the MGRM's hedge positions for the flexie contracts. Benson testified that the following month, she called him and said that "she wanted me to come up to New York immediately to talk about a meeting to see if we could now get rid of those 45-day flexie contracts." (Arb. Tr. at 9696 (testimony of Arthur Benson).)

Soon thereafter, there was a meeting attended by a number of people, including Benson, Kropp and Hutchinson. At that meeting, Hutchinson and others gave Benson advice on how to persuade MGRM's customers to get out of the flexie contracts. (Id. at 9697.) Hutchinson suggested that Benson tell the customers that "if the price ran up, that MG wouldn't be around and they wouldn't be able to cover the contracts." (Id. at 9698.) Benson became upset because he had already assured MGRM's customers that MGRM was not going to go bankrupt and would honor the flexie and ratable contracts. (Id. at 9699-9700.) Ultimately, Benson was fired by the President of MG Corp.

Considering such testimony, the January 9, 1996 letter by Neukirchen, and other pieces of evidence in the record,*fn16 a jury could reasonable conclude that: (1) a plan to eliminate the flexie contracts was conceived and approved of by officers of MG Corp. and MGAG; and (2) such a plan was executed by installing new management at MGRM and using this new management to eliminate the flexie contracts by voluntarily entering into the CFTC Order. If the jury reaches such conclusions after finding MGRM liable for breaching the flexie contracts, Plaintiffs will be able to pierce the corporate veil and hold MGAG and MG Corp. liable as well.*fn17

Finally, the Court notes that Defendants request the Court to defer its ruling on their motion to strike opinions offered by Plaintiffs' experts and allow them to re-institute the motion at a later date if summary judgment is denied in whole or in part. In his Report, the Magistrate Judge found that such a request is appropriate. (See Report at 48.) The Court agrees with the Magistrate Judge and adopts his recommendation.

III. CONCLUSION AND ORDER

For the reasons set forth above, it is hereby

ORDERED that Defendants' motion for summary judgement is GRANTED with respect to plaintiffs Dalton Petroleum, Inc., RK Distributing, Inc., Merritt Oil Company, and Higginson Oil Company, and is DENIED ...


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