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Xerion Partners I LLC v. Resurgence Asset Management

February 22, 2007

XERION PARTNERS I LLC, XERION PARTNERS II MASTER FUND LIMITED, COHANZICK CREDIT OPPORTUNITIES MASTER FUND LTD., DALTON DALTON INVESTMENTS, LLC, AND SOF INVESTMENTS, L.P., PLAINTIFFS
v.
RESURGENCE ASSET MANAGEMENT, LLC, JAY CAROTHERS, MARK SCOTT, COLEEN COLREAVY, ROBERT WEBBER, BYRON HANEY, AND DELOITTE & TOUCHE USA LLP, DEFENDANTS.
BAY HARBOUR MANAGEMENT LLC, PLAINTIFF
v.
JAY CAROTHERS, MARK SCOTT, COLEEN COLREAVY, ROBERT WEBBER, DELOITTE & TOUCHE USA LLP AND "JOHN DOE" "1"-"20," DEFENDANTS.



The opinion of the court was delivered by: Chin, D.J

OPINION

These related cases arise from a private placement of debt securities issued by furniture retailer Levitz Home Furnishings, Inc. ("LHFI") in November 2004. Plaintiffs Xerion Partners I LLC, Xerion Partners II Master Fund Limited, Cohanzick Credit Opportunities Master Fund Ltd., Dalton Investments, LLC, and SOF Investments, L.P. (collectively "Xerion") and plaintiff Bay Harbour Management LLC ("Bay Harbour") bring these related actions for securities fraud, common law fraud, and negligent misrepresentation against defendants Jay Carothers, Mark Scott, Coleen Colreavy, and Robert Webber, all current or former corporate employees of LHFI (the "Individual Defendants"), and Deloitte & Touche USA LLP ("Deloitte"), the accounting firm that audited LHFI's financial statements. Xerion also sues defendant Resurgence Asset Management, LLC, the majority shareholder of LHFI, and Byron Haney, a Managing Director of Resurgence and a director of LHFI (together "Resurgence").

The Individual Defendants, Deloitte, and Resurgence move to dismiss for failure to state a claim upon which relief may be granted pursuant to Federal Rule of Civil Procedure 12(b)(6) and for failure to comply with the pleading requirements of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act ("PSLRA"). For the reasons set forth below, the motions are granted.

BACKGROUND

A. The Facts

For purposes of these motions to dismiss, the facts as alleged in Xerion's amended complaint and Bay Harbour's second amended complaint are assumed to be true.

Bay Harbour and Xerion's allegations are essentially the same. Relevant differences are discussed below.

1. The Parties

Plaintiffs are sophisticated, accredited investors within the meaning of the Securities Act of 1933. (BHAC ¶ 38; XAC ¶ 47).*fn1

At the time the debt securities were placed, the Individual Defendants were employed by LHFI: Carothers was Chairman and Chief Executive Officer; Scott was Chief Operating Officer; Colreavy was Senior Vice President of Finance (she is now Chief Financial Officer); and Webber was General Counsel and Senior Vice President. (BHAC ¶¶ 15-18; XAC ¶¶ 14-17). Resurgence owned 84% of LHFI's common stock and 100% of three different series of LHFI preferred stock. (XAC ¶ 13). Haney was a director of LHFI and a managing director of Resurgence. (Id. ¶ 18). Deloitte was LHFI's accounting firm prior to and at the time of the placement of the debt securities. (Id. ¶ 19; BHAC ¶ 24).

2. The Offering

In November 2004, LHFI offered $130 million in debt securities (the "Offering") in the form of "high yield" or "junk" bonds, with interest rates of 12 and 15%, pursuant to an offering circular dated October 29, 2004 (the "Circular"). (LHFI Circular 8; BHAC ¶¶ 37-38; XAC ¶¶ 42-43). The Offering was not registered with the Securities Exchange Commission ("SEC") and was available for purchase only by accredited investors within the meaning of the 1933 Securities Act and relevant regulations. (LHFI Circular).

The Circular included LHFI's audited financial statements for the periods ending March 31, 2003 and 2004, and unaudited financial information for the period ending June 30, 2004. (LHFI Circular 13; BHAC ¶¶ 111-12; XAC ¶ 46). LHFI's financial information was certified by Deloitte as complying with the accounting principles generally accepted in the United States ("GAAP"). (LHFI Circular F-2; BHAC ¶ 113; XAC ¶ 48). The financials also included calculations of earnings before interest, taxes, depreciation, and amortization ("EBITDA"), and "pro formas" or future projections of EBITDA, measurements that do not comply with GAAP and are not accepted by the SEC. (LHFI Circular 13; see BHAC ¶¶ 63-64; XAC ¶ 48).

In connection with the Offering, LHFI conducted a "Road Show" for potential investors, attended by Carothers, Scott, and Colreavy. (BHAC ¶¶ 58, 60; XAC ¶ 75).

The following statements from the Circular are relevant here. LFHI's leasehold interests were represented as having a value of $73 million as of June 2004,*fn2 a representation that was repeated at the Road Show. (BHAC ¶¶ 82-83; XAC ¶¶ 50, 52).

Also, the Circular represented LHFI's goodwill as having a value of approximately $90 million as of June 2004. (BHAC ¶ 95; XAC

¶ 61). In the Circular and at the Road Show, LHFI and the Individual Defendants stated that LHFI had certain strengths, including, inter alia, strong and diversified vendor relationships and a highly experienced management team. (LHFI Circular 3; see BHAC ¶ 75; XAC ¶ 67). Also in the Circular and at the Road Show, LHFI stated that its EBITDA for the preceding twelve months was $32 million audited as of June 30, 2004, and $36 million unaudited as of September 30, 2004. (BHAC ¶ 60; XAC ¶ 76). Finally, the Circular reported that LHFI had a net loss of $11 million for the quarter ending June 30, 2004. (XAC ¶ 81; see BHAC tbl. 2).

Xerion purchased $29.4 million of the debt securities. (XAC ¶ 113). Bay Harbour purchased or holds the rights to $19 million. (BHAC ¶ 9).

3. Deloitte's Role

Deloitte served as LHFI's independent auditor and audited and issued reports on LHFI's financial statements prior to, at the time of, and in connection with the Offering. (BHAC ¶ 24; XAC ¶ 89).

In its report addressed to the LHFI board of directors attached to the Circular, Deloitte stated that it had conducted an audit of LHFI's financial information in accordance with generally accepted auditing standards of the United States ("GAAS"), and that, in Deloitte's reasonable opinion, the financial statements complied with GAAP and "presented fairly, in all material respects, the consolidated financial position of the Company at March 31, 2004 and 2003." (LHFI Circular F-1).

4. Events After the Offering

The sale of the debt securities closed on November 9, 2004. LHFI reported a net loss of $10 million for the second quarter ending August 31, 2004. (XAC ¶ 81; see BHAC tbl. 2). For the third quarter ending December 31, 2004, LHFI reported a net loss of $28 million. (XAC ¶ 81; see BHAC tbl. 2). On March 11, 2005, Carothers resigned as Chairman and CEO of LHFI. (XAC ¶ 73). Thereafter, LHFI announced a business strategy different from what had been outlined in the Circular and at the Road Show. (Id.).

In its year-end statement for March 31, 2005, LHFI reported an annual net loss of $212 million. (Id.). Also on March 31, 2005, LHFI reported the value of its leasehold interests as of that date as $48 million. (BHAC ¶ 84; XAC ¶ 55). Xerion subsequently learned that the $73 million figure cited in the Circular was calculated in 2001. (XAC ¶ 58). On the same day, LHFI reported that the stated value of its goodwill as of that date was zero. (Id. ¶ 62; BHAC ¶ 99).

In April 2005, plaintiffs were advised that LHFI was experiencing financial difficulties. (BHAC ¶ 157; XAC ¶ 115). The price of the debt securities purchased by the plaintiffs declined from a high of $104 per share on January 21, 2005, to a low of $52 on September 30, 2005. (XAC ¶ 120). On October 11, 2005, LHFI filed for Chapter 11 bankruptcy protection. (BHAC ¶ 159; XAC ¶ 121).

B. Plaintiff's Allegations

1. Individual Defendants and ...


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