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ROSELINK INVESTORS, L.L.C. v. SHENKMAN

April 12, 2004.

ROSELINK INVESTORS, L.L.C., a New Jersey Limited Liability Company, ZIGMUNT WILF, BNE ASSOCIATES, a New Jersey partnership, DAVID HALPERN, DAVANNE REALTY CO., INC., a corporation, and ANDREW ABRAMSON, Plaintiffs
v.
MARK R. SHENKMAN and CHARLES R. CUMELLO, Defendants



The opinion of the court was delivered by: MICHAEL MUKASEY, Chief Judge, District

OPINION AND ORDER

Plaintiffs Roselink Investors, L.L.C., Zigmunt Wilf, BNE Associates, David Halpern, Davanne Realty Co., Inc., and Andrew Abramson (collectively "Creditors") purchased Units offered in a private offering by Crown Books Corp. ("Crown Books") and Crownbooks.com ("CB.com"), a wholly-owned subsidiary of Crown Books responsible for Crown Books' Internet sales. Creditors purchased the Units in exchange for (i) a promissory note in a principal value equal to the purchase price of each Unit, and (ii) a warrant to purchase common stock in Crown Books at a fixed exercise price. Defendants Mark Shenkman and Charles Cumello were directors of CB.com. Creditors have sued defendants for breaches of fiduciary duties, fraudulent transfer, and tortious interference with contractual relations. Both parties have moved for summary judgment. For the reasons stated below, defendants' motion is granted.

  I.

  Plaintiff Roselink Investors, LLC is a New Jersey limited liability company with its principal place of business in New Jersey. (Compl. ¶ 4) Roselink's members reside in New Jersey or Pennsylviania. (Id.) Plaintiff Zigmunt Wilf resides in New Jersey. (Id. at ¶ 5) Plaintiff BNE Associates is a New Jersey partnership, and all its partners are residents of New Jersey. (Id. at ¶ 6) Plaintiff David Halpern resides in New Jersey. (Id. at ¶ 7) Plaintiff Davanne Realty Co. is a New Jersey corporation with its principal place of business in New Jersey. (Id. at. ¶ 8) Plaintiff Andrew Abramson resides in New Jersey. (Id. at ¶ 9) Defendant Mark Shenkman resides in Connecticut. (Id. at ¶ 10) Defendant Charles Cumello resides in Maryland. (Id. at ¶ 11) Therefore, subject matter jurisdiction arises under 28 U.S.C. § 1332(a)(1). Venue is proper in this district pursuant to 28 U.S.C. § 1391(a)(2) because a substantial part of the events giving rise to this action occurred within this district.

  II.

  The following facts are either undisputed or are presented in the light most favorable to plaintiffs. See Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587-88 (1986)

  Crown Books is a Delaware corporation based in Maryland. (Id. at ¶ 12) After becoming one of the country's top discount retailers of books and book-related products, Crown Books filed a voluntary petition for bankruptcy relief under Chapter 11 of the Bankruptcy Code, 11 U.S.C. § 101 (2000), in July 1998. (Id. at ¶ 12-13) Crown Books emerged from bankruptcy with two working capital loans provided by Paragon Capital LLC ("Paragon") and Foothill Capital Corporation ("Foothill"). (Id. at ¶ 14) Substantially all of Crown Books' assets were pledged to Creditors. (Id.)

  In December 1999, Crown Books formed CB.com, also a Delaware corporation, a wholly-owned subsidiary that was to pursue an Internet retail sales strategy. (Id. at ¶ 16) Crown Books estimated that its total costs to implement this Internet strategy would range from $3 million to $7 million, excluding marketing expenses. (Id. at ¶ 17) To raise the necessary funds, Crown Books and CB.com extended a private offering to accredited investors on December 14, 1999. (Id. at ¶ 18) The private offering was for a minimum of ten and a maximum of 20 Units, each of which consisted of a three-year 6% subordinated promissory note to CB.com in the principal amount of $500,000, and a three-year warrant to purchase 183, 824 shares of common stock of Crown Books at $2.72 per share. (Defendants' Statement Pursuant to Local Civil Rule 56.1 ("Deft. Stmt."), Ex. A at i)

  About February 23, 2000, Creditors entered into subscription agreements with Crown Books and CB.com. (Compl. ¶ 19) Creditors purchased Units with an aggregate principal amount of more than $1 million. (Id. at ¶ 20) The private offering closed in March 2000 after raising approximately $4 million, $1 million of which was transferred immediately to Crown Books from CB.com. (Id. at ¶ 25) By January 2001, the functionality of CB.com's website was about 80% complete. (Id. at ¶ 26)

  In the latter part of 2000, Crown Books found itself with accelerated holiday inventory receipts, unplanned trade payments for these receipts, and sales trends that were lower than reflected in its business plan. (Id. at ¶ 27) On December 8, 2000, Crown Books entered into an agreement with Paragon and Foothill to seek capital to lower its debt. (Id. at ¶ 28) The agreement obligated Crown Books to pay $1.5 million on or before December 12, 2000, at least $2 million on or before January 10, 2001, and at least $1.5 million on or before February 15, 2001. (Deft. Stmt., Ex. G at 2) About December 11, 2000, Shenkman and Cumello authorized a loan of $1.5 million from CB.com to Crown Books ("the Loan"). (Compl. ¶ 30) Two months later, Crown Books filed another voluntary petition for relief under Chapter 11 of the Bankruptcy Code. (Id. at ¶ 36)

  Plaintiffs have brought seven claims for relief against Creditors. Claim One is for breach of fiduciary duty. Claim Two is for breach of the duty of loyalty. Claim Three is for breach of the duty of good faith. Claim Four is for common law wrongful transfer of funds. Claim Five is for violation of § 1304(a)(2) of the Delaware Uniform Fraudulent Transfer Act. Claim Six is for violation of § 1305(a) of the Delaware Uniform Fraudulent Transfer Act. Claim Seven is for tortious interference with contractual relations.

  III.

 A. Breach of Fiduciary Duty Claims

  Creditors allege that defendants, as directors of CB.com, owed them fiduciary duties of due care, loyalty and good faith. (Compl. ¶¶ 38, 45, 52) According to Creditors, defendants owed them fiduciary duties because CB.com was insolvent "when the Loan was made or was rendered insolvent by the Loan." (Id. at ¶ 38) Creditors claim that by making the Loan defendants breached their fiduciary duties. (Id. at ¶¶ 39-42, 46-49, 53-56) The threshold question is whether defendants owed Creditors any fiduciary duties. If so, the next question is whether defendants breached these duties. Delaware law, upon which the parties have relied, controls. See Texaco A/S (Denmark) v. Commercial Ins. Co. of Newark, NJ, 160 F.3d 124, 128 (2d Cir. 1998) (parties' consent to application of forum law completes choice of law inquiry); American Fuel Corp. v. Utah Energy Development Co., 122 F.3d 130, 134 (2d Cir. 1997) (same).

  1. Did defendants owe plaintiffs any fiduciary duties?

  Under Delaware law, when one company wholly owns another, the directors of the parent and the subsidiary are obligated to manage the affairs of the subsidiary in the best interests only of the parent and its shareholders. See Anadarko Petroleum Corp. v. Panhandle Eastern Corp., 545 A.2d 1171, 1174 (Del. 1988) (dismissing subsidiary's claim against parent corporation and three former directors of the subsidiary for breach of fiduciary duty by modifying contracts between subsidiary and parent); Dennis J. Block, Nancy E. Barton & Stephen A. Radin, THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF CORPORATE DIRECTORS 376 (5th ed. 2002). However, "where a corporation is operating in the vicinity of insolvency, a board of directors is not merely the agent of the residue risk bearers, but owes its duty to the corporate enterprise." Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., Civ. A. No. 12150, 1991 WL 277613, at *34 (Del. Ch. Dec. 30, 1991). Delaware law requires that directors

 
recognize that in managing the business affairs of a solvent corporation in the vicinity of insolvency, circumstances may arise when the right (both the efficient and the fair) course to follow for the corporation may diverge from the choice that the stockholders (or the creditors, or the employees, or any single group interested in the corporation) would make if given the opportunity to act.
Id. at n.55. Once a corporation enters "the zone of insolvency," the directors owe fiduciary duties not only to the corporation's shareholders but to its creditors as well. See Geyer v. Ingersoll Publications Co., 621 A.2d 784, 791 (Del. Ch. 1992). This means that directors of a wholly-owned subsidiary, who otherwise would owe fiduciary duties only to the parent, also owe fiduciary duties to creditors of the subsidiary when the subsidiary enters "the zone of insolvency."

  There is no dispute here that CB.com was at least within "the zone of insolvency" when defendants made the Loan. Indeed, the facts show that CB.com was insolvent from the moment it was formed. All of its $4 million of capital was acquired through the private offering, in which promissory notes were issued in exchange for Units. (Plaintiffs' Counterstatement of Undisputed Facts ("Pl. Cstmt.") ¶¶ 18-23) Because Crown Books decided to raise the capital through loans rather than a stock offering, CB.com's liabilities exceeded its assets when the Units were issued, which rendered CB.com insolvent from inception. "[A]n entity is insolvent when it has liabilities in excess of a reasonable market value of assets held." Geyer, 621 A.2d at 789; see also BLACK'S LAW DICTIONARY 799 (7th ed. 1999) (defining "insolvent" as ...


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