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Khan v. Douglas Machine & Tool Co.

September 29, 2009

SUBHAN KHAN, PLAINTIFF,
v.
DOUGLAS MACHINE & TOOL COMPANY, INC. AND TURBOCOMBUSTOR TECHNOLOGY, INC. DEFENDANTS.



MEMORANDUM OPINION AND ORDER

In this diversity action, plaintiff, Subhan Khan ("Khan"), sues defendants Douglas Machine & Tool Company, Inc., a Delaware corporation ("Douglas-Del") and TurboCombustor Technology, Inc. ("TCT") for failure to pay certain sums due to plaintiff under a debenture. Defendants move for summary judgment pursuant to Rule 56 of the Federal Rules of Civil Procedure ("Rule 56") dismissing plaintiff's action.*fn1

Defendants argue that Khan is inappropriately attempting to collect on the debenture in direct violation of his contractual obligations under a Subordination Agreement (the "Subordination Agreement"), in which Khan agreed that his debenture was junior to debt held by National City Bank ("NCB") and agreed not to take any action to enforce the debenture without first obtaining NCB's written consent. Plaintiff cross-moves for summary judgment, or in the alternative, to strike the affirmative defenses asserted in defendants' answer pursuant to Rules 8(c) and 12(f) of the Federal Rules of Civil Procedure on the ground that such defenses are insufficient as a matter of law and/or do not constitute valid defenses to this action. For the reasons that follow, defendants' motion is GRANTED, and plaintiff's cross-motion is DENIED.

BACKGROUND

The following facts are derived from the pleadings, affidavits, declarations, and attachments submitted in connection with the motions. The facts are undisputed except where indicated.

1. The 2005 Transaction

In 2005, Douglas-Del purchased two companies: Douglas Machine & Tool Company, Inc., an Ohio corporation ("Douglas-Ohio") and Douglas Machine & Manufacturing Limited Liability Company ("Douglas-KFT") (the "2005 Transaction"). (Surette Decl. ¶4-5) In the 2005 transaction, Douglas-Del bought the stock of Douglas-Ohio and the quotas of Douglas-KFT. (Id.) At the time of the 2005 transaction, Khan was the president of Douglas-Ohio, a company owned by Khan's brother, his wife, and two other shareholders; Khan was also one of four owners of Douglas KFT. (See id. ¶¶4-6; Khan Aff. ¶¶2, 4; Foster Aff. Ex. 1 ¶¶ 12-13). After the transaction, Khan remained president of Douglas-Ohio and became a shareholder of Douglas-Del. (Surette Decl. ¶6)

To help finance the 2005 Transaction, Khan loaned $833,333 to Douglas-Del pursuant to the terms of a 61/2 % Senior Convertible Debenture, which was executed on January 1, 2006 (the "Debenture"). (Khan. Aff. ¶4) The Debenture provided that it was to be governed by New York law. (Surette Decl. Ex. 1 §9(d)) Similar debentures were entered into between Douglas-Del and other Douglas-Del shareholders. (Khan Aff. ¶4; Surette Decl ¶6, Ex. 1 §2) Under the terms of the Debenture, Douglas-Del is obligated to pay interest upon the outstanding principal at the rate of 6.5% in semi-annual installments until December 31, 2011, at which time the entire principal and all theretofore accrued and unpaid interest becomes payable. (Surette Decl. Ex. 1 §1; Pl. Statement of Undisputed Facts ¶3)

NCB, a bank in Dayton, Ohio, provided additional financing for the 2005 Transaction. (Surette Decl. ¶8) In connection with NCB's provision of this financing, Khan executed the Subordination Agreement under which he agreed that his debt was junior to NCB's debt. (Surette Decl. ¶8, Ex. 2) The Subordination Agreement, apparently drafted by NCB's counsel (Khan Aff. ¶12), was executed by Khan and Douglas-Del and delivered to NCB on January 1, 2006. (Surette Decl. ¶8, Ex. 2.) Other debenture holders executed similar subordination agreements. (Surette Decl. ¶8) The Subordination Agreement provided that it was to be governed by Ohio law, and that until the senior debt had been paid in full, holders of junior debt would not "take any action of any kind to assert, collect or enforce any Junior Debt . . . without in each case first obtaining [NCB's] written consent." (Surette Decl. Ex. 2 at §§11, 4(c)).

2. The Events of 2007

On or about June 7, 2007, NCB advised Douglas-Del by written notice that Douglas-Del was in default on its loan to NCB, and that pursuant to the terms of the various subordination agreements, no further payments were permitted to any junior creditors. (Defs. Statement of Undisputed Material Facts ¶8; Surette Decl. Ex. 3) In this notice, NCB demanded payment in full not later than June 30, 2007 on its loans to Douglas-Del, as well as on six open leases to Douglas-Del. (Surette Decl. Ex. 3) Khan received a copy of this notice. (Defs. Statement of Undisputed Material Facts ¶8) That same day, NCB sent Khan a separate notice advising him that Douglas-Del was in default on its loans from NCB and that pursuant to the terms of the Subordination Agreement, Khan, as junior creditor, could not accept any further accrued interest payments from Douglas-Del. (Defs. Statement of Undisputed Material Facts ¶9; Surette Decl. Ex. 4)

After receiving the notice of default from NCB, Khan sent his own notice of default to Douglas-Del. (Defs. Statements of Undisputed Material Facts ¶10; Surette Decl. Ex. 5) In this notice, dated June 18, 2007, Khan stated he was "notifying [Douglas-Del] that it is in default [for failure to pay interest that was due on July 1, 2006 and December 31, 2006] and that [he was], under paragraph 6(a) of the Debenture, accelerating payment and declaring the entire principal and all accrued and unpaid interest immediately due and payable." (Surette Decl. Ex. 5) Khan has not been paid any sums on his Debenture since then-in fact, he has never been paid any sums on his Debenture. (See Pl. Statement of Undisputed Material Facts ¶4; Defs. Local Rule 56.1 Counterstatement ¶4)

On July 11, 2007, stockholders of Douglas-Del held an emergency meeting to discuss the current status of NCB's demand for payment, the possibility of new financing from LaSalle Business Credit, LLC ("LaSalle") or other alternative sources, a possible merger of Douglas-Del into TCT,*fn2 conversion of the 61/2 % convertible notes, and subordination to LaSalle or other financing sources. (See Khan Aff. Ex. F) During the meeting, the chair "indicated that Lasalle as a condition to making the loan and paying off NCB would require all stockholders to subordinate all payments from [Douglas-Del] to them," and that Khan "indicated that he was unwilling to do so." (Lauer Aff. Ex.)

The plaintiff and the defendants' accounts diverge with respect to the events that unfolded after Khan indicated at the July 2007 stockholders' meeting that he was unwilling to subordinate his Debenture to LaSalle. Defendants contend that because Khan refused to provide a new subordination agreement to LaSalle, the transaction was restructured. (See Defs. Reply Brief in Support of Motion for Summary Judgment and in Opposition to Pl. Cross-Motion (hereinafter "Defs. Reply") at 6) Instead of Douglas-Del repaying NCB, NCB sold for value and assigned its interest in the loan to TurboCombustor Techonology Holdings, Inc. ("TCT Holdings") on August 15, 2007, as part of a larger transaction by which TCT Holdings purchased commercial paper and capital assets involving Douglas-Del. (See Defs. Statement of Undisputed Material Facts ¶11; Defs. Counterstatement to Pl. Statement of Undisputed Material Facts ¶17; Surette Decl. Ex. 6) Thereafter, on August 29, 2007, TCT Holdings and LaSalle executed an Assignment Without Recourse, pursuant to which TCT Holdings sold for value and assigned its interest in the loan to LaSalle. (Defs. Statement of Undisputed Material Facts ¶13) Thus, defendants contend that as of August 29, 2007, NCB's interest in the loan from Douglas-Del was held by LaSalle.*fn3 Also, on August 29, 2007, Douglas-Del and Douglas-Ohio were merged into TCT. (Id. ¶12) Pursuant to the merger, TCT succeeded to all of the assets and obligations of Douglas-Del, including the obligations of Douglas-Del pursuant to the Debenture. (Surette Decl. ¶14) The Debenture was not assigned to TCT, assignment being prohibited without Kahn's consent, but passed to TCT by operation of law. (See Surette Decl. ¶14, Ex. 1 §9)

Khan does not appear to contest that the foregoing restructuring took place and was documented as defendants claim. However, Khan alleges that defendants engineered the aforementioned assignments in August 2007 as part of a "scheme" that was designed to give off the appearance that Douglas-Del's debt to NCB had not been paid and had been validly assigned to LaSalle via TCT Holdings, thereby preserving the continued effectiveness of the Subordination Agreement, when in fact, the debt was fully paid in August 2007, effectively terminating the restrictions on junior debt contained therein. (See Pl. Brief at 11-12; Khan Aff. ΒΆΒΆ8, 15-16, 19-21) The Court is unable from plaintiff's submissions to discern precisely how this alleged "scheme" is claimed to have operated as a factual matter. The best that can be said of Kahn's affidavit-and this tracks the arguments made in his counsel's memorandum of law-is that TCT Holdings was the alter ego of TCT, such that when TCT Holdings purchased the Douglas-Del loan, which became TCT's obligation as a result of the TCT-Douglas-Del merger, the debt was ...


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