United States District Court, S.D. New York
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
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.
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
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
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
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)
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
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 "having
liabilities that exceed the value of assets"). Therefore, CB.com owed
Creditors fiduciary duties from the moment Creditors purchased the
units.*fn1 2. Did defendants breach their fiduciary duties to creditors?
The fiduciary duties of directors of a corporation are twofold,
"`generally characterized as the duty of care and the duty of loyalty."
Norlin Corp. v. Rooney, Pace Inc., 744 F.2d 255, 264
(2d Cir. 1984). "The duty of care refers to the responsibility of a
corporate fiduciary to exercise, in the performance of his tasks, the
care that a reasonably prudent person in a similar position would use
under similar circumstances." Id. "The second restriction
traditionally imposed, the duty of loyalty, derives from the prohibition
against self-dealing that inheres in the fiduciary relationship."
Under Delaware law, to establish a breach of fiduciary duty, a
plaintiff first must prove facts sufficient to overcome the presumption
inherent in the business judgment rule. See Cinerama, Inc. v.
Technicolor, Inc., 663 A.2d 1156, 1162-64 (Del. 1995);
Cede & Co. v. Technicolor, Inc., 634 A.2d 345,
360-61 (Del. 1993); Spiegel v. Buntrock,
571 A.2d 767, 774 (Del. 1990); Citron v. Fairchild Camera &
Instrument Corp., 569 A.2d 53, 64 (Del. 1989); Smith v. Van Gorkam, 488 A.2d 858,
872 (Del. 1985). The business judgment rule "is a presumption that in
making a business decision the directors of a corporation acted on an
informed basis, in good faith and in honest belief that the action taken
was in the best interests of the company." Orman, 794 A.2d at
19-20 (quoting Aronson v. Lewis, 473 A.2d 805, 811
(Del. 1984)) (internal quotation marks omitted). Four elements define the
business judgment rule presumption: (1) a business decision; (2)
disinterestedness and independence; (3) due care; and (4) good faith.
See Cinerama, 663 A.2d at 1162-64; Cede, 634 A.2d at 360-61;
Spiegel, 571 A.2d at 774; Citron, 569 A.2d at 64;
Van Gorkam, 488 A.2d at 872; Aronson, 473 A.2d at
811-816; see also Dennis J. Block, Nancy E. Barton &
Stephen A. Radin, THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF
CORPORATE DIRECTORS 39, 85-88 (5th ed. 2002). The presumption of the
business judgment rule is rebutted in those rare cases where a plaintiff
establishes facts to show that any of the four elements was not present.
See Parnes v. Bally Entertainment Corp.,
722 A.2d 1243, 1246 (Del. 1999). "While the Delaware cases use a variety of
terms to describe the applicable standard of care, our analysis satisfies us
that under the business judgment rule director liability is predicated
upon concepts of gross negligence." Aronson, 473 A.2d at 812.
Under Delaware law, a court should "reach conclusions as to the
sufficiency of allegations regarding interest and independence only after considering all the facts
alleged on a case-by-case basis." Orman, 794 A.2d at 23.
Creditors claim that defendants owed them fiduciary duties "not to
divert, dissipate or unduly risk assets of Crownbooks.com that would be
necessary to satisfy Crownbooks.com's repayment obligation with respect
to the monies due on Plaintiffs' Notes." (Compl. ¶¶ 38, 45, 52)
Creditors argue that defendants breached their fiduciary duties "by
making the Loan without first ensuring that Crownbooks.com had retained
sufficient assets to pay its debts as they became due," "by failing to
obtain adequate security for the Loan as well as other protections for
Crownbooks.com as a lender and for Plaintiffs as creditors," and "by
causing Crownbooks.com to make the Loan without first obtaining any
assurance that Crown Books Corp. could obtain the other cash infusions
required under its agreement with Paragon and Foothills." (Id.
at ¶¶ 40-42, 47-49, 54-56) However, Creditors have failed to establish
sufficient facts to rebut the presumption of the business judgment rule.
a. Business Decision
It is not disputed that the Loan was the product of a business decision
on the part of defendants. Cumello stated in a letter dated December 22,
2000 quoted by Creditors in the Complaint that the Loan
was made in answer to the problem Crown Books was having with raising
cash needed to remain "in satisfactory standing with Paragon." (Compl. ¶ 29) Cumello
further explained in a letter to Creditors dated January 2, 2001
also quoted by Creditors in the Complaint that the Loan was made
"for the working capital needs of the parent." (Id. at ¶
31) Therefore, defendants' decision to make the Loan constitutes a
"business decision" for the purposes of the business judgment rule.
b. Disinterestedness and Independence
The Delaware Supreme Court has defined "interest" under a business
judgment rule analysis as meaning "that directors can neither appear on
both sides of a transaction nor expect to derive any personal financial
benefit from it in the sense of self-dealing, as opposed to a benefit
which devolves upon the corporation or all stockholders generally."
Aronson, 473 A.2d at 812. Further, the benefit to a director
must be material, Cede, 634 A.2d at 363, which means that it
must be "significant enough, in the context of the director's
economic circumstances, as to have made it improbable that the
director could perform her fiduciary duties to the shareholders without
being influenced by her overriding personal interest." Orman,
794 A.2d at 23 (internal quotation marks and ellipsis omitted) (emphasis
The Delaware Supreme Court has defined "independent" under a business
judgment rule analysis as meaning "that a director's decision is based on the corporate merits of the subject
before the board rather than extraneous considerations or influences."
Aronson, 473 A.2d at 816. "In assessing director independence,
Delaware courts apply a subjective `actual person' standard to determine
whether a `given' director was likely to be affected in the same or
similar circumstances." McMullin v. Beran,
765 A.2d 910, 923 (Del. 2000). "There must be coupled with the allegations of
control such facts as would demonstrate that through personal or other
relationships the directors are beholden to the controlling person."
Aronson, 473 A.2d at 815. "To be disqualifying, the nature of
the director interest must be substantial" and not merely "incidental."
Cinerama, 663 A.2d at 1169. If a plaintiff successfully
demonstrates facts sufficient to rebut the business judgment rule
presumption, then the burden of proof shifts to the defendant directors
to establish the "entire fairness" of the challenged transaction.
Kahn v. Lynch Communications Sys., Inc.,
638 A.2d 1110, 1115 (Del. 1994).
Creditors argue here that both Cumello and Shenkman were personally
interested in the Loan because "both Cumello and Shenkman had personal
interests that were placed at grave risk by the prospect of a Crown
Books' bankruptcy," and the Loan "enabled Crown Books to live for another
day, and in turn, advanced their respective interests for their own
personal benefit." (Pl. Mem. 53) Creditors allege that defendants served
as directors of both Crown Books and CB.com. (Compl. ¶¶ 10-11) Creditors also note
that Shenkman held ownership interests in two companies that together
owned 35% of the common stock of Crown Books, and that Cumello received a
salary as President and Chief Executive Officer of Crown Books. (Pl. Mem.
at 53-54) In short, Creditors argue that defendants were not
disinterested because they each had personal interests in Crown Books,
thereby placing them on both sides of the transaction. However, presence
on both sides of the transaction does not automatically rebut the
business judgment rule presumption. Cullman, 794 A.2d at 20
n.36. The interests attributed to defendants by Creditors do not deprive
defendants of the protection of the business judgment rule because of one
essential fact overlooked by Creditors: Crown Books was the sole
shareholder of CB.com.
As already discussed, defendants, as directors of CB.com, owed
fiduciary duties to CB.com's shareholders. CB.com's only shareholder,
however, was Crown Books, as CB.com was a wholly-owned subsidiary.
Therefore, defendants owed fiduciary duties to Crown Books as the only
shareholder. Under Delaware law, "in a parent and wholly-owned subsidiary
context, the directors of the subsidiary are obligated only to manage the
affairs of the subsidiary in the best interests of the parent and its
shareholders." Anadarko Petroleum Corp. v. Panhandle
Eastern Corp., 545 A.2d 1171, 1174 (Del. 1988).*fn2 This means
that defendants were obligated to consider the interests of Crown Books
in any business decision they made, such as the decision to make the
Loan. As a result, the personal interests attributed to defendants by
Creditors did not extend beyond those that defendants were already
obliged to consider because defendants had a fiduciary duty to consider
the interests of Crown Books as the sole shareholder of CB.com. Indeed,
given that Delaware law required defendants, as directors of a
wholly-owned subsidiary, to consider the interests of the parent company,
defendants would have been in breach of their fiduciary duties had they
not considered the best interests of Crown Books in deciding
whether to make the Loan.*fn3 Further, Creditors have not asserted any personal interests on the part of defendants relating specifically
to the Loan. In fact, it is undisputed that the money CB.com loaned to
Crown Books was transferred to Paragon, such that defendants did not
receive any of the transferred funds nor any benefit from the funds other
than some indirect, attenuated benefit from keeping Crown Books alive a
bit longer, which they were legally obliged to try to do anyway.
Even assuming arguendo that the interests attributed to
defendants by Creditors were additional interests beyond those defendants
were obligated to consider, Creditors must also establish that these
particular interests were material. Cede, 634 A.2d at 363. As
explained below, Creditors have failed to do so.
First, Shenkman's purported ownership interest in Crown Books is far
too attenuated to constitute a material interest sufficient to rebut the
business judgment rule presumption. Shenkman is the founder, President,
Chief Investment Officer and managing member of Shenkman Capital
Management, Inc. ("Shenkman Capital"). (Plaintiffs' Statement of
Undisputed Material Facts ("Pl. Stmt.") ¶ 8) Shenkman Capital is the
managing member and 1% owner of Royalty Books Associates ("Royalty").
(Id. at ¶ 9) Royalty owned approximately 35% of Crown
Books' stock. (Id.) Therefore, Shenkman's ownership interest in Crown Books is
comprised of his unspecified ownership interest in Shenkman Capital,
Shenkman Capital's 1% ownership interest in Royalty, and Royalty's 35%
ownership interest in Crown Books which makes Shenkman's
ownership interest in Crown Books some percentage of 1% of 35%. Even
assuming Shenkman owns 100% of Shenkman Capital, this would make his
interest in Royalty only 0.35%. This is far too little to render Shenkman
interested in the Loan or controlled by Crown Books under a business
judgment rule analysis. "[S]tock ownership alone, at least when it
amounts to less than a majority, is not sufficient proof of dominion or
control." Aronson, 473 A.2d at 815 (holding that 47% stock
ownership was not sufficient to rebut independence) (internal quotation
Cumello's employment as an officer of Crown Books also does not
constitute a material interest under the particular circumstances here.
Creditors argue that Cumello's employment with Crown Books gives him a
personal interest in keeping Crown Books out of bankruptcy for as long as
possible in order to protect his job. However, as already discussed
above, regardless of his position as an officer of Crown Books, Cumello
had a duty to Crown Books to manage CB.com in the best interests of Crown
Books, and certainly the best interests of Crown Books would include an
interest in keeping Crown Books out of bankruptcy for as long as possible. As a result, any personal interest Cumello had
in keeping Crown Books out of bankruptcy was consistent with the best
interests of Crown Books, and thus any indirect benefit to Cumello from
the Loan was immaterial. Therefore, Creditors have failed to establish
that defendants were personally interested in or dependent on the
business decision to make the Loan.
c. Due Care
"The duty of the directors of a company to act on an informed basis
forms the duty of care element of the business judgment rule."
Cinerama, 663 A.2d at 1164 n.13 (internal quotation marks and
ellipsis omitted). " [T]o invoke the rule's protection directors have a
duty to inform themselves, prior to making a business decision, of all
material information reasonably available to them." Aronson,
473 A.2d at 812. "[T]he standard for judging the informational component
of the directors `decisionmaking does not mean that the Board must be
informed of every fact. The Board is responsible for
considering only material facts that are reasonably
available, not those that are immaterial or out of the Board's
reasonable reach." Brehm v. Eisner, 746 A.2d 244, 259
(Del. 2000) (emphasis in original) "[T]he concept of gross negligence is
 the proper standard for determining whether a business judgment
reached by a board of directors was an informed one." Van
Gorkam, 488 A.2d at 873. Creditors have failed to present any facts sufficient to overcome the
business judgment rule presumption of due care. According to defendants,
they consulted counsel for CB.com and Crown Books before making the Loan
to discuss both legal and strategic concerns. (Cumello Dec. ¶¶ 22-26)
Additionally, Cumello reports that as President and Chief Executive
Officer of Crown Books, he "regularly received and reviewed financial
reports and updates regarding Crown Books' finances," "reviewed Crown
Books' monthly financial packages," and "had almost daily discussions
with Crown Books CFO regarding Crown Books' credit facilities with
Paragon and Ingram." (Id. at ¶ 41) It is unreasonable to
conclude that as directors of Crown Books and as an officer of Crown
Books, defendants would be uninformed about the financial condition of
the company. Indeed, Creditors have posited conflicting arguments for
this very reason. First, claiming that defendants were uninformed,
It is undisputed that defendants did not engage in
any credit risk assessment to determine whether
Crownbooks.com should have lent its cash assets to
Crown Books and, in particular, Shenkman did not
consider Crown Books' financial capacity to repay
the Loan. No independent financial consultants or
advisors were retained by defendants for the
purpose of evaluating Crown Books'
creditworthiness and capacity for loan repayment.
(Pl. Mem. 41) In short, Creditors argue that defendants were not
adequately informed about the financial condition of Crown Books, the recipient of the Loan. However, in the very next paragraph
Creditors take a wholly contradictory position, arguing: "It is also
undisputed that defendants already knew, through their dual
directorial status, that Crown Books did not possess the
financial wherewithal to repay, secure or otherwise guaranty
repayment of Crownbooks.com's funds." (Id.) (emphasis added)
Creditors then outline in detail the facts surrounding Crown Books'
demise in late 2000 as defendants struggled to meet Paragon's demands.
(Id. at 41-42) It is beyond any reasonable dispute that
defendants were well aware of Crown Books' financial condition when the
Loan was made, and thus were adequately informed in reaching the business
judgment to make the Loan.
Creditors' allegations boil down to a single contention: defendants
made a poor decision. Creditors argue that defendants should have ensured
that CB.com "retained sufficient assets to pay its debts as they became
due," obtained "adequate security for the Loan," and sought "assurance
that Crown Books Corp. could obtain the other cash infusions required
under its agreement with Paragon and Foothills." (Compl. ¶¶ 40-42)
However, all of these arguments are factual claims directed at the wisdom
of defendants' decision rather than at the level of information
underlying the decision. Under the business judgment rule, courts do not
"examine the wisdom of the decision itself." Brazen v.
Bell Atlantic Corp., 695 A.2d 43, 49 (Del. 1997). "[T]he Court gives great deference to the substance of the
directors' decision and will not invalidate the decision, will not
examine its reasonableness, and will not substitute [its] views for those
of the board if the latter's decision can be attributed to any rational
business purpose." Paramount Communications, Inc. v. QVC
Network Inc., 637 A.2d 34, 45 (Del. 1994); see also Sinclair
Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971) ("A
court under such circumstances will not: substitute its own notions of
what is or is not sound business judgment."); In re Caremark
International Inc. Derivative Litigation, 683 A.2d 1049, 1052 (Del. Ch.
1996) ("[T]o allege that a corporation has suffered a loss as a result of a
lawful transaction, within the corporation's powers, authorized by a
corporate fiduciary acting in a good faith pursuit of corporate purposes,
does not state a claim for relief against that fiduciary no matter how
foolish the investment may appear in retrospect."). Therefore, Creditors
have not demonstrated that defendants failed to exercise due care.
d. Good Faith
Delaware law does not recognize an independent duty of good faith.
Under Delaware law,
[a]lthough corporate directors are unquestionably
obligated to act in good faith, doctrinally that
obligation does not exist separate and apart from
the fiduciary duty of loyalty. Rather, it is a
subset or `subsidiary requirement' that is
subsumed within the duty of loyalty, as
distinguished from being a compartmentally distinct
fiduciary duty of equal dignity with the two
bedrock fiduciary duties of loyalty and due care.
Orman v. Cullman, 794 A.2d 5, 14 (Del. Ch.
2002) (quoting Emerald Partners v. Berlin, No. Civ.A.
9700, 2001 WL 115340, at *64 n.63 (Del. Ch. Feb. 7, 2001) (internal
quotation marks omitted). Good faith is also subsumed within the duty of
due care. Id. at 19-20. Accordingly, summary judgment is
granted for defendants dismissing Claim Three for breach of the duty of
Creditors have failed to present any facts demonstrating that
defendants acted in bad faith so as to establish a basis for their claims
for breach of the fiduciary duties of due care and loyalty. The Delaware
Supreme Court has defined "bad faith" as "not simply bad judgement or
negligence, but rather it implies the conscious doing of a wrong because
of dishonest purpose or moral obliquity; it is different from the
negative idea of negligence in that it contemplates a state of mind
affirmatively operating with furtive design or ill will." Desert
Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II,
L.P., 624 A.2d 1199, 1208 n.16 (Del. 1993). "[T]he absence of
significant financial adverse interest creates a presumption of good
faith, although the good faith requirement further demands an ad
hoc determination of the board's motives in making the business
decision." See Estate of Detwiler v. Offenbecher,
728 F. Supp. 103, 150 (S.D.N.Y. 1989) (citing Delaware law). Bad faith may be found where a business decision "is so far beyond the
bounds of reasonable judgment that it seems essentially inexplicable on
any ground other than bad faith." In re J.P. Stevens & Co., Inc.
Shareholders Litigation, 542 A.2d 770, 780-81 (Del.Ch. 1988). As
already discussed, Creditors have not established any significant
financial adverse interest on the part of defendants, so the only
question is whether the decision to make the Loan is so far beyond the
bounds of reasonable judgment that it must have been motivated by bad
According to Cumello, he "believed that if CB.com did not make the
Loan, CB.com's assets would be consolidated into the assets of Crown
Books, and the Unit Holders would lose their entire investment." (Cumello
Dec. ¶ 42) Cumello further believed that structuring the transfer "as
a loan, instead of a dividend, [would] balance the interests of CB.com
and Crown Books [because]. . . the loan would entitle CB.com to
repayments when it needed funds to pursue its development program
further." (Id. at ¶ 43) Cumello also "believed CB.com would
have recourse in bankruptcy" if Crown Books went bankrupt after the Loan.
(Id.) Shenkman shared Cumello's beliefs, approving the Loan
because he believed that "it was in the best interest of all the parties
involved, including the Unit Holders, CB.com and Crown Books." (Shenkman
Dec. ¶ 9) Defendants' expressed motivations for the Loan demonstrate
that there was no bad faith towards Creditors or CB.com in favor of Crown Books, and that defendants had a good
faith belief that the Loan would not harm Creditors or CB.com and could
benefit them in the long run.
Further, it is undisputed that CB.com could not survive without Crown
Books. According to Cumello,
without Crown Books, CB.com would: 1) be unable to
gain access to clients; 2) be unable to develop an
effective product which displayed current and
relevant books, periodicals and other products;
and 3) not have the back office infrastructure to
operate as an independent entity. As a result,
CB.com had no hope for success without Crown
(Cumello Dec. ¶ 13) Shenkman also believed that "[i]t was
essential to CB.com's survival that Crown Books also continue in
business." (Shenkman Dec. ¶ 9) Defendants' beliefs about the
dependence of CB.com on Crown Books are bolstered by the Offering
Memorandum governing Creditors' investment. The Offering Memorandum
states that CB.com intended "to attract significant online traffic and
business" through Crown Books' "established name, reputation and value
proposition." (Def. Strut., Ex. A at 4) The Offering Memorandum further
states that the purpose of CB.com is to "permit Crown Books
customers to shop online at Crown Books both from home and
in the stores, and  help to facilitate an online/offline community
for Crown Books." (Id.) (emphasis added) The Offering
Memorandum informed Creditors when they purchased the Units that CB.com,
as a wholly-owned subsidiary, existed for the benefit of Crown Books and would be
entirely dependent on Crown Books for its customer base and its
operations. In fact, the Offering Memorandum refers to the "Company"
almost exclusively whenever discussing the new venture for which the
Units were being offered, and the Offering Memorandum defines "Company"
as both CB.com and Crown Books, leaving little doubt about the
intimate, dependent relationship between these two entities.
(Id. at Ex. A) Indeed, the Offering Memorandum effectively
presents CB.com and Crown Books as one entity namely, the
"Company." (Id.) Therefore, defendants' business judgment that
the Loan would help save Crown Books and that preserving Crown Books
would help save CB.com was not "so far beyond the bounds of reasonable
judgment that it must have been motivated by bad faith." See In re
J.P. Stevens, 542 A.2d at 780-81. Indeed, all evidence is to the
contrary namely, that defendants acted in good faith to preserve
both Crown Books and CB.com.
Creditors argue also that defendants lacked discretion to use the
proceeds from the Unit sales for the Loan, but this argument is belied by
indisputable facts. The Offering Memorandum includes a provision entitled
"Broad Discretion in Use of Proceeds," which reads:
Although the Company has generally provided for
the intended use of the net proceeds from the
Offering as of the date of this Term Sheet, the
Company cannot specify with certainty the amount
of the net proceeds of the Offering that will be allocated for each
purpose. In addition, the Company reserves the
right to reallocate the use of net proceeds it
receives from the Offering in any manner it
deems advisable. Accordingly, the Company's
management will have broad discretion in
the application of the net proceeds. See `Use of
(Def. Stmt., Ex. A, ii) (emphasis added) This language leaves no
doubt about the "broad discretion" of defendants in their use of the
proceeds generated by Creditors' purchase of the Units. Moreover,
defendants' broad discretion over the use of the proceeds was further
articulated in the Supplement to the Offering Memorandum, which states:
"The Company reserves the right to reallocate the use of the net proceeds
received in the Offering in any manner it deems advisable."
(Id. at Ex. B, at 1) (emphasis added) Creditors argue that
"broad discretion" is not the same as "unabridged, unbridled and
unchecked discretion," and that defendants would need "sole" or
"absolute" discretion to permit the Loan. (Pl. Mem. 30) However, this is
not a case where directors transferred company funds into their personal
bank accounts; rather, defendants transferred funds to the parent
corporation with the purpose of assisting the parent, which was entirely
in keeping with their fiduciary duty to consider the best interests of
Crown Books. See Anadarko, 545 A.2d at 1174. Defendants did not
need absolute discretion to authorize the Loan, only broad discretion
over the use of the proceeds, which they had under the express terms of
the Offering Memorandum. Further, the "Broad Discretion" provision of the Offering Memorandum
refers to the "Use of Proceeds" provision, which states, in relevant
part, for the third time: "The Company reserves the right to reallocate
the use of the net proceeds it receives from the Offering in any
manner which it deems advisable." (Deft. Stmt., Ex. A at ii)
(emphasis added) This provision also expressly informed Creditors that
among the purposes for which the proceeds could be used was "for working
capital and general corporate purposes of Crown Books." (Id.)
Certainly, paying a debt owed by Crown Books in an attempt to avoid
bankruptcy qualifies as "general corporate purposes." Therefore,
defendants used the proceeds of the Unit sales for purposes expressly
permitted under the terms of the Offering Memorandum. Indeed, it is
entirely unclear for what purposes Creditors believe the proceeds could
have been used. They challenge the purposes for which defendants used a
portion of the proceeds namely, the Loan and yet offer no
purpose for which they believe these proceeds should have been used.
Creditors argue that at the time of the Loan CB.com "was already dead."
(Reply Memorandum of Law in Further Support of Plaintiffs' Motion for
Summary Judgment ("Pl. Reply") 38) So Creditors' argument essentially
boils down to the contention that defendants should have locked away
CB.com's funds and thrown away the key funds for which CB.com had
absolutely no use as a "dead" entity and which could be reallocated for any purposes under
the express terms of the Offering Memorandum and simply watched
idly as Crown Books went under. However, this again ignores the fact that
Crown Books was CB.com's parent company, and thus defendants owed Crown
Books a fiduciary duty to manage CB.com in the best interests of Crown
Books. Anadarko, 545 A.2d at 1174. In fact, doing as Creditors
demand may have constituted a breach of the fiduciary duties defendants
owed Crown Books. of course, defendants also had a fiduciary duty to
consider Creditors' interests as well, but defendants believed
rightly or wrongly that Creditors would lose the funds in
bankruptcy anyway, in which case the Loan put Creditors in no worse
position while possibly preserving Crown Books, and CB.com with it.
(Cumello Dec. ¶ 42) In sum, Creditors have not demonstrated that
defendants acted in bad faith.
As already discussed, Creditors' claims are essentially an attack on
the wisdom of defendants' decision. But the business judgment rule is
intended to protect directors against just such attacks because their
decisions are not to be second-guessed by courts with the benefit of
hindsight. Creditors made high-risk loans for a high-risk venture by a
high-risk company, and they lost the gamble. They were informed of all
the risks associated with CB.com and Crown Books when they purchased the
Units, and they were even afforded an opportunity to withdraw from their agreements with CB.com when CB.com failed to raise the
desired funds in the time expected yet Creditors chose not to
walk away. (Def. Stmt., Ex. B) Defendants cannot be held liable for a
business decision made in good faith with due care and without any
controlling influences or personal interests, and such is the case here.
Creditors have failed "to make a showing sufficient to establish the
existence of an element essential to [their] case,. and on which [they]
will bear the burden of proof at trial." See Celotex v.
Catrett, 477 U.S. 317, 322 (1986). They have failed to
establish facts necessary to negate any element of the business judgment
rule, and thus defendants are "entitled to judgment as a matter of law."
See Fed.R.Civ.P. 56. Accordingly, summary judgment is granted
for defendants dismissing Claim One for breach of fiduciary duty and
Claim Two for breach of the duty of loyalty.
B. Fraudulent Conveyance Claims
Creditors have brought claims against defendants for common law
wrongful transfer and statutory fraudulent transfer. Creditors argue that
defendants owed them "a duty not to wrongfully transfer or otherwise
divert assets from Crownbooks.com for other purposes." (Compl. ¶ 59)
Creditors further argue that defendants had a statutory duty "not to
cause Crownbooks.com, in its capacity as a debtor, to make any transfer or incur any obligation without receiving a reasonably equivalent
value in exchange therefore, at a time when Crownbooks.com was insolvent
or became insolvent as a result of said transfer" or "under circumstances
whereby the remaining assets of Crownbooks.com would be unreasonably
small in relation to the business or transaction." (Id. at
¶¶ 64, 68) According to Creditors, defendants breached their common
law and statutory duties by causing Crownbooks.com "to transfer $1.5
million to Crown Books Corp. by way of an unsecured loan." (Id.
at ¶¶ 60, 65, 69)
1. Choice of Law
Creditors argue that Delaware law should apply to these claims;
defendants argue that New York law should apply. "A federal court,
sitting in diversity, must look to the choice-of-law rules of the state
in which it sits here New York to resolve the
conflict-of-law questions." Arochem International, Inc. v.
Buirkle, 968 F.2d 266, 269-70 (2d Cir. 1992) (citing
Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487,
496 (1941)). The parties not only dispute which state's substantive law
should apply, but also which test under New York law should be applied to
resolve the choice-of-law question. According to Creditors, the Loan
involved the internal affairs of CB.com, and therefore the "internal
affairs doctrine" should apply. According to defendants, however,
Creditors' claims do not fall within the "internal affairs doctrine," and therefore an "interest
analysis" should apply.
"The internal affairs doctrine is a conflict of laws principle which
recognizes that only one State should have the authority to regulate a
corporation's internal affairs matters peculiar to the
relationships among or between the corporation and its current officers,
directors, and shareholders because otherwise a corporation could
be faced with conflicting demands." Edgar v. MITE
Corp., 457 U.S. 624, 645 (1982). Under the internal affairs
doctrine, "the law of the state of incorporation normally determines
issues relating to the internal affairs of a corporation."
First National City Bank v. Banco para el Comercio
Exterior de Cuba, 462 U.S. 611, 621 (1983) (emphasis in original).
"Different conflicts principles apply, however, where the rights of third
parties external to the corporation are at issue."
Id. at 621 (emphasis in original). Creditors' claims at issue
here are tort claims regarding the rights of "third parties
external to the corporation" as they are not brought by
shareholders, officers or directors, nor are they brought derivatively on
behalf of the corporation. Therefore, the "internal affairs doctrine" is
New York law employs an "interest analysis" in tort actions that
applies the law of the jurisdiction with the greatest interest in the
litigation. See Arochem, 968 F.2d at 270. Under this analysis, the court should focus almost exclusively
on the parties' domiciles and the locus of the tort. Id. "As
part of the interest analysis, the New York Court of Appeals has
distinguished between rules regulating conduct and rules governing loss
allocation. Generally, when the laws in conflict are conduct regulating,
the law of the locus jurisdiction applies." Id. "A fraudulent
conveyance statute is conduct regulating rather than loss allocating."
See GFL Advantage Fund, Ltd v. Colkitt, No. 03 Civ.
1256, 2003 WL 21459716, at *3 (S.D.N.Y. June 24, 2003).
The only two states at issue here are New York and Delaware. None of
the parties are domiciled in Delaware or New York, and the locus of the
alleged tort is New York. In order to lay venue in the Southern District
of New York, plaintiffs have alleged that "a substantial part of the
events and actions of Defendants giving rise to the claims asserted [by
plaintiffs] occurred within" New York. (Compl. ¶ 3) Additionally, the
private placement under which Creditors purchased the Units giving rise
to this litigation was supervised by a law firm located in New York.
(Def. Stmt., Ex. B) Creditors have not alleged any facts showing any
actions related to this litigation that occurred in Delaware.
Further, New York recognizes the right of contracting parties to agree
to the choice of law. See Turtur v. Rothschild Registry International, Inc., 26 F.3d 304, 310 (2d Cir.
1994). The Subordinated Note issued to Creditors here contains a
provision entitled "Governing Law," which states: "This Note shall be
governed by and construed in accordance with the laws of the State of New
York." (Def. Stmt., Ex. D, ¶ 7(B)) Further, the Subscription
Agreements entered into by the parties include a forum selection clause
Notwithstanding the place where this Subscription
Agreement may be executed by any of the parties
hereto, the parties expressly agree that all the
terms and provisions hereof shall be construed in
accordance with and governed by the laws of the
State of New York. The parties hereby agree that
any dispute which may arise between them
arising out of or in connection with this
Subscription Agreement shall be adjudicated
before a court located in New York City and
they hereby submit to the exclusive
jurisdiction of the courts of the State of New
York located in New York, New York and of the
federal courts in the Southern District of New
York with respect to any action or legal
proceeding commenced by any party. . . .
(Id. at Ex. C, ¶ 4.4) (emphasis added) In
Turtur, the Court of Appeals affirmed summary judgment against
securities brokers who brought an action for common law fraud after
purchasing units in a limited partnership. 26 F.3d at 305. The
subscription note by which the plaintiffs purchased the units contained a
forum selection clause nearly identical to the clause here. Id.
at 309. The Court held that the plaintiffs' fraud claim clearly arose out
of or was related to their investment, which was governed by the subscription note containing the forum selection
clause, and thus the forum selection clause applied to their fraud claim.
Id. at 310. The Court concluded that under the forum selection
clause New York law applied. Id. Likewise, under the forum
selection clause in Creditors' Subscription Agreements, New York law is
the applicable law here. (Def. Stmt., Ex. C, ¶ 4.4)
Creditors, in keeping with their argument that Delaware law applies,
have brought their fraud claims under Delaware law. (Compl. ¶¶ 64, 68;
Plaintiffs' Memorandum of Law in Opposition to Defendants' Motion for
Summary Judgment ("Pl. Mem.") 46-47) Defendants have moved for summary
judgment on the ground, among others, that Creditors have invoked the
wrong law, given that New York law actually applies. (Def. Mem. 28)
However, "the failure in a complaint to cite a statute, or to cite the
correct one, in no way affects the merits of a claim. Factual allegations
alone are what matters." Northrop v. Hoffman of Simsbury,
Inc., 134 F.3d 41, 45-46 (2d Cir. 1997) (internal quotation marks
omitted); see also Brandon v. Holt, 469 U.S. 464,
471 (1985) (holding that a court should decide the legal issues without
requiring a formal amendment of the complaint where the allegations
plainly identify a claim); Fed.R.Civ.P. 8 ("All pleadings shall be so
construed as to do substantial justice."). Further, both parties have
argued the merits of Creditors' fraud claims arguendo under New
York law. Therefore, these claims will be considered under New York law.
2. Applying New York Law
New York law does not recognize "a creditor's remedy for money damages
against parties who, like defendants here, were neither transferees of
the assets nor beneficiaries of the conveyance." F.D.I.C. v.
Porco, 75 N.Y.2d 840, 842, 552 N.Y.S.2d 910, 910 (1990);
see also Gallant v. Kanterman, 198 A.D.2d 76, 80,
603 N.Y.S.2d 315, 318 (1st Dep't 1993) (affirming dismissal of action for
fraudulent conveyance where defendants were neither transferees or
beneficiaries). This is because "[t]he creditor's remedy in a fraudulent
conveyance action is limited to reaching the property which would have
been available to satisfy the judgment had there been no
conveyance. . . ." Geren v. Quantum Chemical Corp.,
832 F. Supp. 728, 736 (S.D.N.Y. 1993), aff'd., 99 F.3d 401 (2d
Cir. 1995). Therefore, there can be no action for damages against a party
who did not receive any of the property sought by the creditors.
Creditors argue here that both Cumello and Shenkman benefited from the
Loan, as already discussed, because "both Cumello and Shenkman had
personal interests that were placed at grave risk by the prospect of a
Crown Books' bankruptcy," and the Loan "enabled Crown Books to live for
another day, and in turn, advanced their respective interests for their
own personal benefit." (Pl. Mem. 53) Creditors note that Shenkman held ownership
interests in two companies that together owned 35% of the common stock of
Crown Books, and that Cumello received a salary as President and Chief
Executive Officer of Crown Books. (Id. at 53-54) However,
receipt of a salary from the transferee corporation as an officer of the
corporation is not sufficient to render the officer a transferee or
beneficiary of the transfer. See T.L.C. Merchant Bankers, Inc.
v. Brauser, No. 01 Civ. 3044, 2003 WL 1090280, at *7 (S.D.N.Y.
March 11, 2003) (holding that payment of a salary to an officer of a
corporation receiving a transfer of assets did not render the officer a
transferee or beneficiary of the transfer). Crown Books was entitled to
pay Cumello a salary, and there is no evidence that his salary was in any
way derived from the transferred property. Indeed, the undisputed
evidence is that the property transferred in the Loan, namely $1.5
million, was transferred to Paragon. Further, Shenkman's ownership in two
companies holding stock in Crown Books is too attenuated a relationship
to render Shenkman a transferee or beneficiary of the Loan. In
Brenner v. Philips, Appel & Walden, Inc., No. 93
Civ. 7838, 1997 WL 33471053 (S.D.N.Y. July 22, 1997), the Court found no
evidence that defendants benefited from a transfer of $500,000 to a
company in which one of the defendants owned 35% of the shares.
Id. at *1, *5. There, the defendant had direct ownership of
more than one-third of the transferee corporation's stock, and the Court
nevertheless found no benefit to the defendant from the transfer.
Id. Here, Shenkman has some unspecified ownership interest in
two companies that together own 35% of the Crown Books' common stock,
leaving Shenkman with no direct ownership interest in Crown Books and
even further removed from the transfer property than the defendant was in
Brenner. Therefore, Creditors have failed to present any
evidence demonstrating a benefit to defendants from the Loan, "an element
essential to [their] case, and on which [they] will bear the burden of
proof at trial." See Celotex, 477 U.S. at 322. Accordingly,
summary judgment is granted for defendants dismissing Claim Four for
common law wrongful transfer of funds, Claim Five for violation of §
1304(a)(2) of the Delaware Uniform Fraudulent Transfer Act, and Claim Six
for violation of § 1305(a) of the Delaware Uniform Fraudulent
C. Tortious Interference Claim
Creditors allege that they and CB.com "were parties to Subordinated
Notes, which were binding and enforceable contracts at law." (Compl.
¶ 72) According to Creditors, defendants caused CB.com to breach
these contracts by rendering CB.com insolvent after transferring "all or
substantially all of its assets to another entity." (Id. at 74)
Creditors have brought this claim mistakenly under Delaware law, just as
they did their fraudulent conveyance claims. For the same reasons discussed above,
New York law controls this claim.
"Under New York law, the elements of a tortious interference claim are:
(a) that a valid contract exists; (b) that a `third party' had knowledge
of the contract; (c) that the third party intentionally and improperly
procured the breach of the contract; and (d) that the breach resulted in
damage to the plaintiff." Albert v. Loksen,
239 F.3d 256, 274 (2d Cir. 2001). A "third party" for the purposes of a
tortious interference claim is someone who is not a party to the contract at
issue. Finley v. Giacobbe, 79 F.3d 1285, 1295 (2d
Cir. 1996). For an agent of a party to the contract to qualify as a
"third party," the plaintiff must demonstrate that the agent acted
outside the scope of his authority, id., or "committed an
independent tortious act against the plaintiff." Albert, 239
F.3d at 275. "A corporate officer or director generally cannot be liable
for tortiously interfering with a contract between the corporation and a
third party." See Chardin v. Turkie, No. 97 CIV 4643,
1998 WL 886986, at *1 (S.D.N.Y. Dec. 18, 1998) (citing Murtha
v. Yonkers Child Care Assn., 45 N.Y.2d 913, 915, 411 N.Y.S.2d 219,
220 (1978)). "Where the corporate officer/director is acting within
the scope of his or her authority, the officer/director is not a third
party vis-a-vis the corporation and as such cannot interfere with its own
contract." Id. The parties do not dispute that a valid contract exists between
Creditors and CB.com. However, defendants do dispute the allegation that
they are "third parties" given their positions as directors of CB.com and
CB.com's status as a party to the contract with Creditors. Creditors
argue, on the other hand, that defendants are "third parties" because
they acted outside the scope of their authority when they made the Loan,
"promoting their own self-interests adversely to the interests of
Crownbooks.com." (Pl. Memo. 58) Citing the same personal interests
underlying their other claims namely, Shenkman's attenuated
ownership interest in Crown Books and Cumello's salaried position as an
officer of Crown Books Creditors once again argue that defendants
sought "to keep Crown Books alive" for their own personal gain.
(Id. at 59) But just as these interests were insufficient to
support their other claims, so are they insufficient to support this
claim. As already discussed, these interests were consistent with the
best interests of Crown Books, which defendants had a fiduciary duty to
consider as directors of CB.com, a subsidiary wholly owned by Crown
Books. See Anadarko, 545 A.2d at 1174. Therefore, defendants
acted well within the scope of their authority by trying "to keep Crown
Books alive." Moreover, Creditors have not alleged any independent torts
committed by defendants toward Creditors, and thus defendants cannot be deemed "third parties" for the purposes
of Creditors' tortious interference claim.
Creditors have failed to present any evidence establishing "an element
essential to [their] case, and on which [they] will bear the burden of
proof at trial." See Celotex, 477 U.S. at 322. Accordingly,
summary judgment is granted for defendants on Claim Seven for tortious
interference with contractual relations.
Summary judgment is appropriate when the "pleadings, depositions,
answers to interrogatories, and admissions on file, together with the
affidavits, if any, show that there is no genuine issue as to any
material fact and the moving party is entitled to judgment as a matter of
law." Fed.R.Civ.P. 56. Therefore, for the reasons stated above, summary
judgment is granted for defendants, and the complaint is dismissed.