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Adelphia Recovery Trust v. Bank of America

May 4, 2009

ADELPHIA RECOVERY TRUST, PLAINTIFF,
v.
BANK OF AMERICA, N.A., ET AL., DEFENDANTS.



MEMORANDUM AND ORDER

Table of Contents

1. Factual Background................................................. 6

A. The Adelphia Fraud............................................... 6

B. Overview of the Co-Borrowing Facilities.............. ............ 7

C. The UCA/HHC Co-Borrowing Facility............................... 10

i. The UCA/HHC Term Sheet Was Prepared by the Defendants......... 11

ii. The UCA/HHC Term Sheet Contained Omissions and Misstatements. 12

iii. The UCA/HHC Term Sheet Defects were known To the Defendants. 12

D. The CCH Co-Borrowing Facility................................... 13

i. The CCH Term Sheet Was Prepared by the Defendants............. 15

ii. The CCH Term Sheet Contained Omissions and Misstatements..... 15

iii. The CCH Term Sheet Defects were known to the Defendants..... 17

E. The Olympus Credit Facility..................................... 19

i. The Olympus Term Sheet Was Prepared by the Defendants......... 20

ii. The Olympus Term Sheet Contained Omissions and Misstatements. 21

iii. The Olympus Term Sheet Defects were known to the Defendants. 22

2. Procedural Background............................................. 23

A. Proceedings in the Bankruptcy Court............................. 24

B. Proceedings before this Court................................... 27

3. Standard of Review................................................ 30

A. Substantive Law is Pennsylvania State Law....................... 30

B. Procedural Law used is that of the Southern District of New York 30

C. Pleading Standard under Fed. R. Civ. P. 8(a).................... 31

D. Pleading Standard for Fraud under Fed. R. Civ. P. 9(b).......... 32

4. Discussion........................................................ 33

A. Claim 38 -- Aiding and Abetting Fraud against the Agent Banks and Their Affiliated Investment Banks is not Dismissed............. 33

i. Background of Claim 38........................................ 34

ii. Aiding and Abetting Fraud is a Valid Claim under Pennsylvania State Law .................................................... 35

iii. Aiding and Abetting Fraud is Plead with Particularity....... 44

iv. Group Pleading of the Agent Banks and Their Affiliated Investment Banks Is Permitted ................................ 52 ............................................................. 57

v. Co-Borrowing Term Sheets Do Not Contradict the Amended Complaint

B. Claim 37 -- Aiding and Abetting a Breach of Fiduciary Duty against the Agent Banks and Their Affiliated Investment Banks.......... 59

i. Background of Claim 37........................................ 60

ii. Aiding and Abetting a Breach of Fiduciary Duty is Pled with Enough Particularity ......................................... 63

iii. Pleadings Related To the Three Facilities................... 65

C. Claim 54 -- Fraudulent Concealment against the Investment Banks Is Dismissed...................................................... 66

i. Background of Claim 54........................................ 67

ii. Elements of Fraudulent Concealment........................... 68

iii. The Investment Banks Did Not Have an Affirmative Duty to Speak Based on a Fiduciary Duty or Unique Knowledge ................ 71

D. Claim 55 -- Fraud against the Agent Banks and their Affiliated Investment Banks Is Dismissed In Part.......................... 78

i. Background of Claim 55........................................ 80

ii. Elements of a Fraud Claim.................................... 80

iii. Claim 55 Sub-Claims which are not pled with the Necessary Particularity ................................................ 81

iv. The Following Sub-Claims Meet Pleading Requirements.......... 89

E. Claim 31 Avoidance and Recover of Intentionally Fraudulent Obligations and Transfers Under 11 U.S.C. §§ 548 and 550 against the Margin Lenders............................................. 99

............................................................ 101

i. Claim 31 Background........................................... 99

ii. SSB Moves For Dismissal of Claim 31 on the Basis it is Untimely

iii. Goldman Sachs Moves for Dismissal of Claim 31 on the Basis That It Had Not Been Plead With Particularity ............... 105

6. Order............................................................ 110

McKENNA, D.J.

This action arises from the bankruptcy of Adelphia Communications Corporation ("Adelphia") following the disclosure of $2.2 billion in liabilities that had not previously been reported on its balance sheet. The liabilities at Adelphia stemmed in part from Adelphia's participation in Co-Borrowing Loan Facilities ("Co-Borrowing Facilities"). Beginning in 1999 Adelphia participated in three such Co-Borrowing Facilities. The Rigas family which was the prior management of Adelphia*fn1 had Rigas family entities ("RFEs") enter into Co-Borrowing Facilities with public Adelphia subsidiaries. This arrangement allowed the RFEs controlled by the Rigas family to borrow billions of dollars guaranteed almost exclusively by Adelphia's assets. The Rigas family used the Co-Borrowing Facilities to draw down billions of dollars for their own purposes. Adelphia was left to pay the bill.

Adelphia's disclosure of billions of dollars in liabilities connected to the Co-Borrowing Facilities led to a precipitous chain of events concluding with Adelphia filing for bankruptcy. The Adelphia Recovery Trust ("ART") was formed to prosecute Adelphia's claims against numerous entities that allegedly assisted the Rigas family in perpetrating a massive financial fraud against Adelphia.*fn2

This order addresses ART's claims against 26 Banks and 22 affiliated Investment Banks. ART alleges these Banks and their affiliated Investment Banks helped to structure the Co-Borrowing Facilities which played a role in the collapse of Adelphia. This Court previously addressed some of Defendants' motions to dismiss ART's claims pursuant to Rule 12(b)(6). This order addresses the various Agent Banks and Investment Banks motions' to dismiss the October 31st 2007 Amended Complaint Claims 37, 38, 54 and 55 (collectively, the "Tort Claims"). In addition, this order addresses the motions for dismissal of Claim 31 against Salomon Smith Barney ("SSB") and Goldman Sachs ("GS").

This Court DENIES the various Defendants' motions for dismissal of Claims 31, 37 and 38. This Court GRANTS Defendants' motions for dismissal of Claim 54 against the Investment Bank Defendants. This Court GRANTS in part and DENIES in part Defendants' motions to dismiss Claim 55.

1. Factual Background

It is useful to summarize the factual history of the Rigas family fraud owing to the complexity of this case.

On a 12(b)(6) motion for dismissal a court will take factual allegations in the Amended Complaint as true. "For purposes of reviewing the dismissal of a complaint for failure to state a claim, we accept the complaint's factual allegations . . . as true." Roth v. Jennings, 489 F.3d 499, 501 (2d Cir. 2007); see also Leatherman v. Tarrant County Narcotics Intelligence & Coordination Unit, 507 U.S. 163, 164 (1993).

A. The Adelphia Fraud

Adelphia was a cable company founded in 1952 by John Rigas. By the late 1990's Adelphia had grown to be the sixth largest cable-television provider in the United States. However, beginning in the late 1990's the Rigas family needed access to billions of dollars of capital to acquire cable businesses, purchase stock to maintain their majority stockholder status at Adelphia, and finance an extravagant lifestyle. (Am. Cmpl. ¶ 807.) The Rigas family did not have enough personal capital or available credit to finance these expenditures. Lacking in capital or credit, the Rigas family turned to the balance sheet of Adelphia to finance their acquisitions, stock purchases, and lifestyle. The Rigas family caused Adelphia to enter into a series of financial transactions whereby RFEs could borrow hundreds of billions of dollars against the balance sheet of Adelphia under Co-Borrowing Facilities. The Rigas family was not entitled to use Adelphia as a source of credit or capital for their own ends because Adelphia was a public company. (Am. Cmpl. ¶¶ 802-04.) The Rigas family worked with the Agent Banks and their affiliated Investment Banks to create the Co-Borrowing Facilities. (Am. Cmpl. ¶¶ 825-30.)

B. Overview of the Co-Borrowing Facilities

Co-Borrowing Facilities allowed the Rigas family to gain access to the credit and capital of Adelphia. According to the Amended Complaint, the Co-Borrowing Facilities were structured primarily with this purpose in mind. All Co-Borrowing Facilities were set up so both Adelphia and the RFEs could borrow up to the entire amount of the Co-Borrowing Facility. (Am. Cmpl. ¶ 826.) The impact of this arrangement was that Adelphia was liable for the entire amount borrowed by the RFEs. Further, the Co-Borrowing Facilities were capitalized in a lopsided manner. Adelphia pledged significant assets to the Co-Borrowing Facilities, while the RFEs pledged a minute share of assets.*fn3 The Co-Borrowing Facilities were unprecedented. They pledged the credit and assets of a publicly-held company for the benefit of private enterprises owned by the public company's senior management.

To put each Co-Borrowing Facility into operation the Rigas family needed the approval of Adelphia's independent directors. To win the approval of the Adelphia independent directors, the Rigas family worked with the Agent Banks and their affiliated Investment Banks to prepare deceptive term sheets. (Am. Cmpl. ¶¶ 6, 10, 827.) At board meetings the Adelphia independent directors relied on these term sheets and misrepresentations made by the Rigas family to approve the Co-Borrowing Facilities. Yet the Adelphia independent directors did not know that the information supplied to Adelphia was misleading. (Am. Cmpl. ¶ 10.) The actual terms of the Co-Borrowing Facilities later memorialized in the credit agreements were materially different than the terms in the term sheets. (Am. Cmpl. ¶¶ 827, 879, 947.)

After the Co-Borrowing Facilities were approved, the RFE Co-Borrowers began to withdraw significant amounts of money from the facilities. According to the Amended Complaint, by the time the full amount of money borrowed was disclosed, the RFEs had withdrawn roughly 3.4 billion dollars. (Am. Cmpl. ¶ 11.) The money withdrawn from the Co-Borrowing Facilities was used to purchase Adelphia securities for Rigas family accounts, purchase cable companies controlled by the Rigas family, build a private golf course, and for numerous other personal purposes. (Am. Cmpl. ¶ 7.)

The Amended Complaint alleges three Co-Borrowing Facilities were used to perpetuate the Rigas family's fraud: the UCA/HHC Facility, the CCH Facility, and the Olympus Facility.*fn4 (Am. Cmpl. ¶ 825.) The extent to which the Co-Borrowing Facilities are described in the Amended Complaint is critical in determining the adequacy of the pleadings. The following focuses on the three Co-Borrowing Facilities whose creation the Plaintiffs allege was critical to the fraud.

C. The UCA/HHC Co-Borrowing Facility

The UCA/HHC Co-Borrowing Facility was approved at the April 22, 1999 board meeting by the Adelphia independent directors. (Am. Cmpl. ¶ 848.) Wachovia, BMO, and PNC Bank acted as Agent Banks (collectively, the "UCA/HHC Agent Banks").*fn5 The Investment Banks affiliated with these Agent Banks were Wachovia Securities, BMO ND, and PNC Capital Markets. (Am. Cmpl. ¶ 1037.) The UCA/HHC Agent Banks and their affiliated Investment Banks structured the facility and assisted in drafting documentation. (Am. Cmpl. ¶ 843.) At the board meeting the independent directors were presented with a summary term sheet which described the terms and conditions of the UCA/HHC Co-Borrowing Facility ("UCA/HHC Term Sheet"). (Am. Cmpl. ¶¶ 847, 861, 862, 864.) However, the credit agreement for the UCA/HHC Co-Borrowing Facility (which memorialized the actual terms of the facility) was finalized two weeks later on May 6, 1999 and was not shown to the independent directors at the time they approved the transaction. (Am. Cmpl. ¶ 842.) By the time of the petition date, 831 million dollars was outstanding under the UCA/HHC Facility. (Am. Cmpl. ¶ 877.)

ART argues the UCA/HHC Term Sheet was prepared by the UCA/HHC Agent Banks and their affiliated Investment Banks. The UCA/HHC Term Sheet contained omissions and misstatements which the UCA/HHC Agent Banks and their affiliated Investment Banks were aware of. This allegation forms the basis for the Plaintiffs' claims of aiding and abetting fraud, aiding and abetting a breach of fiduciary duty, fraudulent concealment, and fraud.

i. The UCA/HHC Term Sheet Was Prepared by the Defendants

In furtherance of the Rigas family fraud in early 1999, the Rigas family worked with UCA/HHC Agent Banks and their affiliated Investment Banks to prepare and approve a summary term sheet describing the terms and conditions of the UCA/HHC Co-Borrowing Facility. (Am. Cmpl. ¶¶ 847, 861, 862, 864.) On April 22, 1999, the UCA/HHC Term Sheet was presented by Timothy Rigas and James Brown at a meeting of the Adelphia board of directors. Present at this meeting were the Adelphia independent directors. (Am. Cmpl. ¶ 848.) Timothy Rigas and James Brown presented the UCA/HHC Term Sheet and made verbal misrepresentations about the UCA/HHC Facility based on the information set forth in the term sheet. (Am. Cmpl. ¶¶ 850-52.)

ii. The UCA/HHC Term Sheet Contained Omissions and Misstatements

The Amended Complaint alleges the UCA/HHC Term Sheet portrayed the Co-Borrowing Facility as being restrictive and significantly limiting of affiliate transactions. (Am. Cmpl. ¶ 860.) During the same period the UCA/HHC Term Sheet was being drafted the UCA/HHC Agent Banks and Investment Banks were aware that the Rigas family was planning to engage in conduct and affiliate transactions in violation of those restrictions. (Am. Cmpl. ¶ 861.)

Had the actual terms of the UCA/HHC Facility (which appeared in the credit agreement, not the UCA/HHC Term Sheet) been disclosed to the independent directors or had the intentions of the Rigas family (which were known by the Investment and Agent Banks) been disclosed, the UCA/HHC Facility would not have been approved. (Am. Cmpl. ¶¶ 860, 864, 866-68.)

iii. The UCA/HHC Term Sheet Defects were known To the Defendants

The Agent Banks and Investment Banks were made aware of the violative plans of the Rigas family on or about February 1999 "in a request for proposal that [the Rigas's] sent to the Agent Banks and to 25 to 30 other banks seeking participation in this facility". (Am. Cmpl. ¶ 862.) On February 23, 1999, Wachovia ("Lead Agent Bank") was informed via email by Adelphia's Director of Finance that the Rigas family intended to use the UCA/HHC Facility to borrow money for personal use. (Am. Cmpl. ¶ 863.) A similar email was sent on the same date to Bank of America. (Am. Cmpl. ¶ 863.) At no time prior to March 27, 2002 did Adelphia disclose the enormous "contingent liabilities it had amassed as a result of the RFE's draws from the UCA/HHC Co-Borrowing Facility." (Am. Cmpl. ¶ 875.)

D. The CCH Co-Borrowing Facility

The Rigas family went back to the trough less than a year after the UCA/HHC Facility was approved. "Once again, the Rigas family made use of Adelphia's access to bank debt and the public capital markets for their own benefit." (Am. Cmpl. ¶ 878.) The Rigas family worked with a set of Agent Banks and their affiliated Investment Banks to design another Co-Borrowing Facility, based on the UCA/HHC Facility blueprint. This facility was named the CCH Facility.

The CCH Co-Borrowing Facility was approved at the March 9, 2000 board meeting by the Adelphia independent directors. (Am. Cmpl. ¶ 879.) The CCH Facility was a Co-Borrowing Facility with the following banks acting as Agent Banks: BofA, Chase, CIBC, BAS, TDI, Barclays, BMO, Wachovia, Citibank, ABN AMRO, BNS, BONY, Credit Lyonnais, CSFB, DLJ, Fleet, Merrill Lynch, Mitsubishi Trust, Morgan Stanley, Rabobank, and SunTrust (collectively, the "CCH Agent Banks"). (Am. Cmpl. ¶ 881.) The Investment Banks affiliated with the CCH Agent Banks are identified in paragraph 1037 of the Amended Complaint (Am. Cmpl. ¶ 1037.)

At the Board Meeting, the independent directors were presented with a summary term sheet which described the terms and conditions of the CCH Co-Borrowing Facility ("CCH Term Sheet"). (Am. Cmpl. ¶ 903.) However, the credit agreement for the CCH Co-Borrowing Facility (which memorialized the actual terms of the facility) was prepared a month later on April 14, 2000 and was not shown the independent directors at the time they approved the transaction. (Am. Cmpl. ¶¶ 879, 886, 901.) By the petition date, the CCH Facility had approximately 2.5 billion dollars outstanding. (Am. Cmpl. ¶ 923.)

ART alleges the CCH Term Sheet was prepared by the CCH Agent Banks and their affiliated Investment Banks. The CCH Term Sheet contained omissions and misstatements which the CCH Agent Banks and their affiliated Investment Banks were aware of. This allegation forms the basis for ART's claims of aiding and abetting fraud, aiding and abetting breach of fiduciary duty, fraudulent concealment, and fraud.

i. The CCH Term Sheet Was Prepared by the Defendants

The CCH Agent Banks were deeply involved in drafting documents related to the CCH Facility. The CCH Agent Banks and Investment Banks conducted significant due diligence, prepared an offering memorandum with the assistance of Adelphia, and received compliance certificates from Adelphia. (Am. Cmpl. ¶ 882.) The CCH Agent Banks and their affiliated Investment Banks worked closely with the Rigas family to prepare a summary term sheet describing the terms of the CCH Co-Borrowing Facility. (Am. Cmpl. ¶ 885.)

ii. The CCH Term Sheet Contained Omissions and Misstatements

The Amended Complaint catalogs three areas of omissions and misstatements in the CCH Term Sheet. (Am. Cmpl. ¶¶ 891-97). First, provisions in the CCH Term Sheet implied affiliate transactions would be restricted. The CCH Term Sheet contains a clause prohibiting transactions not on the same terms as could be obtained in transactions with 3rd parties. (Am. Cmpl. ¶ 893.) The CCH Term Sheet contained a clause which led the independent directors to believe that the proceeds of the CCH Facility would be used in specific ways which would be to the benefit of Adelphia. (Am. Cmpl. ¶ 891.) The CCH Term Sheet represented the CCH Facility would contain a restrictive investments clause which would place substantial limits on affiliated transactions. (Am. Cmpl. ¶¶ 894, 895.)

Second, the CCH Term Sheet did not define whether the leverage ratio (the amount which each borrower could borrow in relation to assets) was calculated on a combined basis or individual basis. The failure to define the leverage ratio was a material omission. If the leverage ratio was defined as being individualized then each borrower was limited to only borrowing under the CCH Facility the amount of assets and collateral which that borrower pledged to the CCH Facility. (Am. Cmpl. ¶ 889.) If the leverage ratio was calculated on a combined basis then each borrower could borrow up to the total value of all assets pledged to the facility. In the Adelphia board meeting of March 9, 2000 the leverage ratio was described by Rigas and Brown as being individualized against each borrower. The CCH Term Sheet could be taken to support these oral contentions because the CCH Term Sheet was ambiguous and did not define the leverage ratio. Id. However, the final CCH Credit Agreement (which was finalized after the March 9, 2000 board meeting) explicitly stated that, "[l]everage ratio means, with respect to the Companies on a combined basis." (Am. Cmpl. ¶ 901.)

Third, the CCH Term Sheet did not disclose that each borrower would be permitted to draw down the entire amount available under the facility (without regard to the amount of capital they had pledged). This was a material omission. As an exemplar, Highland Prestige, an RFE and Co-Borrower in the facility, would be able to borrow up to the total amount of the CCH Facility even though it had pledged a relatively small amount of collateral. (Am. Cmpl. ¶¶ 902, 914.)

iii. The CCH Term Sheet Defects were known to the Defendants

The CCH Agents Banks and their affiliated Investment Banks knew or should have known that the statements in the CCH Term Sheet were false and/or misleading. First, the structure of the CCH Facility was so unprecedented that it should have raised red flags. According to the Amended Complaint the CCH Agent Banks were sophisticated parties who knew or should have known the CCH Term Sheet was misleading. (Am. Cmpl. ¶¶ 4, 826.) The CCH Agent Banks and their affiliated Investment Banks knew that despite the representations made to the independent directors, "the true terms and conditions of the CCH Co-Borrowing Facility provided no benefit to Adelphia and were not in Adelphia's interests." (Am. Cmpl. ¶ 917.)

Second, a Confidential Information Memorandum prepared in March 2000 indicates the CCH Agent Banks and their affiliated Investment Banks knew the CCH Term Sheet contained misstatements and omissions. The Confidential Information Memorandum was prepared by the CCH Agent Banks and affiliated Investment Banks and was sent to CCH Lenders. The Memorandum "made clear that the collateral put up by the ACC co-borrowers was significantly greater than the collateral put up by Highland Prestige." (Am. Cmpl. ¶ 905.) "This information was not stated in the CCH Term Sheet presented to the Independent Directors and was not disclosed to them at the March 9, 2000 Board of Directors Meeting." Id.

Third, the Agent Banks and Investment Banks knew in March 2000 that the collateral pledged by the RFEs was de minimis in comparison to the amount which would be withdrawn by the RFEs. (Am. Cmpl. ¶ 908, 1036.) The Investment Banks and Agent Banks knew the Rigas family "intended to engage in conduct and affiliate transactions that violated these restrictions." (Am. Cmpl. ¶ 908.)*fn6

E. The Olympus Credit Facility

Roughly a year after opening the CCH Credit Facility the Rigas family sought to raise additional funds. (Am. Cmpl. ¶ 924.) The Olympus Credit Facility was structured in much the same way as the CCH and UCA/HHC Facilities had been structured. (Am. Cmpl. ¶ 930.) The Olympus Credit Facility was a Co-Borrowing Facility with both RFEs and Adelphia contributing capital. (Am. Cmpl. ¶ 952.)

The Olympus Co-Borrowing Facility was approved at the August 7, 2001 board meeting by the Adelphia independent directors. (Am. Cmpl. ΒΆ 932.) The Olympus Facility was a Co-Borrowing Facility with the following banks acting as Agent Banks: BMO, Wachovia, BNS, Fleet, BONY, BofA, Bankers Trust Company, Citicorp, TDI, Chase, Deutsche Bank, CSFB, Credit Lyonnais, ...


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