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Cobalt Multifamily Investors I, LLC v. Shapiro

July 15, 2009

COBALT MULTIFAMILY INVESTORS I, LLC, ET AL., PLAINTIFFS,
v.
MARK A. SHAPIRO, ET AL., DEFENDANTS.



The opinion of the court was delivered by: Kimba M. Wood, U.S.D.J.

OPINION AND ORDER

The court-appointed receiver (the "Receiver") for Plaintiffs Cobalt Multifamily Investors I, LLC, and its related, defunct entities (collectively, "Cobalt"), filed suit against three sets of attorneys and their law firms who provided professional services to Plaintiffs before they became defunct. These three sets of attorneys and their law firms (collectively, the "Law Firm Defendants") are: (1) Robert F. Cohen, and his firm Cohen & Werz, LLC (collectively, the "Cohen Defendants"); (2) Martin P. Unger, and his firm Certilman Balin Adler & Hyman, LLC (collectively, the "Certilman Defendants"); and (3) Philip Champan, and his firm Lum Danzis Drasco & Positan (collectively, the "Lum Defendants").

On March 28, 2008, the Court granted Law Firm Defendants' motion to dismiss the Receiver's complaint ("Dismissal Order"), relying in part on the Court's decision in Ernst & Young v. Bankruptcy Services (In re CBI Holding Co.), 318 B.R. 761 (S.D.N.Y. 2004).*fn1 Subsequently, the Second Circuit Court of Appeals (the "Second Circuit") in Bankruptcy Services, Inc. v. Ernst & Young (In re CBI Holding Co.), 529 F.3d 432 (2d Cir. 2008), affirmed in part and reversed in part the Court's decision in In re CBI Holding Co.

In light of the Second Circuit's partial reversal in In re CBI Holding Co., the Receiver moves for reconsideration of the motion to dismiss in this case ("Motion for Reconsideration"). The Court GRANTS the Motion for Reconsideration on the ground that failure to do so would result in clear error.

Accordingly, the Court proceeds to reconsider its prior order dismissing the Receiver's claims for lack of standing. The Court in reconsidering the motion, reviews the Report and Recommendation issued by Magistrate Judge Michael H. Dolinger on November 27, 2007. The Report concluded that the Receiver has standing to bring malpractice and looting claims against the Law Firm Defendants. The Court adopts most of the Report's recommendations, and, thus, GRANTS in part and DENIES in part the Defendants' motion to dismiss.

I. Background

A. Facts

The Complaint alleges that Mark A. Shapiro, Irving J. Stitsky, and William B. Foster (collectively, "Individual Defendants" or "managers") engaged in a massive fraud on the investing public by founding the Cobalt entities and making egregious misrepresentations in order to persuade members of the public to invest millions of dollars in Cobalt.*fn2 In the written materials disseminated to potential and actual investors, Individual Defendants allegedly misrepresented: (1) their personal and professional backgrounds, such as failing to disclose their past criminal histories; (2) Stitsky and Foster's involvement in Cobalt; (3) their plans for the investors' funds; and (4) the nature and scope of Cobalt's property holdings. Individual Defendants allegedly appropriated the majority of the funds invested in Cobalt for their own personal use.

The Complaint alleges that all of Law Firm Defendants assisted the Individual Defendants in committing investor fraud, and in subsequently looting the Cobalt entities of corporate assets. Law Firm Defendants allegedly: (1) approved documents that they should have known contained material misrepresentations; (2) assisted the Individual Defendants in siphoning corporate funds into the Individual Defendants' bank accounts; and (3) helped conceal the Individual Defendants' criminal activities from both investors and law enforcement.

In addition, Defendant Cohen, as counsel of and trustee to Vail Mountain Trust ("Vail"), allegedly: (1) helped create Vail; (2) transferred $9 million from Cobalt to Vail; (3) and permitted the Vail funds to be used by the Individual Defendants for their personal expenses.

The Receiver also alleges that there were over 300 shareholders in Cobalt, who were unaware of the managers' fraud. Pursuant to their shareholders agreement, the shareholders had the authority to remove managers for fraudulent conduct.*fn3

In 2005, the Federal Bureau of Investigation raided Cobalt's offices as part of its criminal investigation of Cobalt and its managers. Soon thereafter, Cobalt became a defunct corporation. On July 20, 2006, the Court appointed the Receiver to marshal Cobalt's assets.

B. Procedural History

1. Complaint and Motion to Dismiss

On August 25, 2006, the Receiver filed suit against all the Law Firm Defendants on the grounds that Law Firm Defendants assisted Defendants in committing investor fraud, and then in looting Cobalt of its corporate assets. The Receiver also brought several claims against Cohen and Cohen & Werz, including claims for aiding and abetting conversion, aiding and abetting fraud, and breach of fiduciary duties.*fn4 Against Cohen alone, the Receiver brought claims of conversion and unjust enrichment.

In October 2006, the Law Firm Defendants filed a motion to dismiss all the claims in the Complaint. The Court referred the motion to dismiss to Magistrate Judge Michael H. Dolinger for a Report and Recommendation.

2. Report and Recommendation

On November 27, 2007, Magistrate Judge Dolinger issued a Report and Recommendation ("the Report"), familiarity with which is assumed. The Report recommended that the Court grant in part and deny in part the motion. Specifically, the Report concluded, in relevant part, that the Receiver has standing to assert his legal malpractice claim and corporate looting claim against all the Law Firms Defendants. The Report also concluded that the Receiver has standing to bring an aiding and abetting conversion claim against both Cohen and Cohen & Werz, and a conversion and unjust enrichment claim against Cohen.

3. Objections to the Report

The parties' principal objections to the Report address whether the Receiver has standing to assert his legal malpractice and looting claims against the Law Firm Defendants.*fn5 Law Firm Defendants argue that Receiver does not have standing to pursue any fraud-based claims against the Defendants. The Receiver counters that it is not bringing fraud-based claims and that, even if it were bringing fraud claims, it has standing to bring these claims against the Law Firm Defendants.

4. Dismissal Order

On March 28, 2008, the Court granted Law Firm Defendants' motion to dismiss in its entirety. In so doing, the Court deviated from the Report's recommendations.*fn6 In the Dismissal Order, the Court found that "[b]ecause all of the Receiver's claims against the Law Firm Defendants are based on allegations they assisted the Individual Defendants in committing fraud, the Receiver lacks standing to assert any of those claims." (emphasis added).

In reaching this conclusion, the Court relied upon a line of cases beginning with Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114 (2d Cir. 1991). The Second Circuit in Wagoner articulated the now well-settled principle that a bankruptcy trustee has standing to assert only those claims that the bankrupt corporation itself could have brought. Id. at 118. The Court, in granting the Law Firm Defendants' Motion to dismiss, relied upon Wagoner and its progeny, for the proposition that a bankrupt corporation, and by extension, an entity that stands in the corporation's shoes, lacks standing to assert claims against third parties for defrauding the corporation where the third parties assisted corporate managers in committing the alleged fraud.*fn7 See In re Bennett Funding Group, Inc., 336 F.3d 94, 99-100 (2d Cir. 2003).

The Court, in deciding that the Receiver lacked standing under the Wagoner rule, rejected the Receiver's argument that the "adverse interest exception" to the Wagoner rule was applicable. The Court wrote that the adverse interest exception states that if an individual corporate principal has "totally abandoned [the corporation's] interests and [is] acting entirely for his own or another's purpose," the Wagoner rule does not apply. (emphasis added). "In those circumstances[,] . . . the corporation has standing to assert claims against the third party that assisted the corporate agent in defrauding the corporation."

The Court found that the adverse interest exception was inapplicable in this case because the Individual Defendants had not totally abandoned the interests of the corporation. The Court stated:

As pleaded in the Complaint, the Individual Defendants' misconduct provided at least some financial benefit to the Cobalt entities . . . . Therefore, the Complaint alleges that the Individual Defendants did not totally abandon [] the interest of the corporation, and were not acting entirely for their own or another's purposes.

Accordingly, the Court concluded that the adverse interest exception did not apply, and that Law Firm Defendants' motion to dismiss should be granted.

4. In re CBI Holding Co. Decision

On June 16, 2008, less than three months after the Court issued the Dismissal Order, the Second Circuit issued Bankruptcy Services, Inc. v. Ernst & Young (In re CBI Holding Co.), 529 F.3d 432 (2d Cir. 2008). In In re CBI Holding Co., the Second Circuit considered the question at issue in the Dismissal Order -- whether the corporation's managers can be deemed to have totally abandoned the interest of the corporation, and, thus whether the adverse interest exception to the Wagoner rule applies.

In In re CBI Holding Co., the principal managers for CBI Holding Companies, Inc. and its subsidiaries (collectively, "CBI") engaged in inventory fraud during fiscal years 1992 and 1993 as part of a scheme to deceive the company's lenders. Id. at 439-440. During that period, Ernst & Young ("E&Y"), the accountants for CBI, stated that CBI's ...


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