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Cobalt Multifamily Investors I, LLC, et al v. Mark A. Shapiro

March 7, 2012

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

In August 2006, the court-appointed receiver (the "Receiver") for Plaintiffs Cobalt Multifamily Investors I, LLC, and its related entities (collectively, "Cobalt"), filed suit against three sets of attorneys and their law firms who provided professional services to Cobalt before it collapsed. These 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 Chapman and his firm Lum Danzis Drasco & Positan LLC (collectively, the "Lum Defendants"). The Receiver also filed claims in this action against Cobalt's principals, Mark A. Shapiro ("Shapiro"), Irving J. Stitsky ("Stitsky"), and William B. Foster ("Foster") (collectively, the "Cobalt Principals"). After the Cobalt Principals were convicted of securities fraud relating to their management of the Cobalt entities, the claims against them were voluntarily dismissed by the Receiver. (Dkt. No. 63.)

On March 28, 2008, the Court granted the Law Firm Defendants' motions to dismiss the Receiver's Complaint on the ground that the Receiver lacked standing to bring the claims.

Cobalt v. Multifamily Investors I, LLC v. Shapiro, No. 06-cv-6468, 2008 WL 833237 (S.D.N.Y. Mar. 28, 2008) (hereinafter "the 2008 Dismissal Order"). (Dkt. No. 58.) In light of the Second Circuit's partial reversal of Ernst & Young v. Bankr. Servs. (In re CBI Holding Co.), 318 B.R. 761 (S.D.N.Y. 2004), rev'd in part, 529 F.3d 432 (2d Cir. 2008), upon which this Court had based its decision, the Receiver moved for reconsideration of the Law Firm Defendants' motions to dismiss. (Dkt. No. 75.) The Court granted the motion for reconsideration on the ground that failure to do so would result in clear error. (Dkt. No. 85.)

On July 15, 2009, upon reconsideration, the Court granted in part and dismissed in part the motions to dismiss, concluding that the Receiver had standing to bring only: (1) legal malpractice claims against the Law Firm Defendants; (2) aiding and abetting conversion, breach of contract, and breach of fiduciary duties claims against the Cohen Defendants; and (3) a conversion and unjust enrichment claim against only Cohen. Cobalt v. Multifamily Investors I, LLC v. Shapiro, No. 06-cv-6468, 2009 WL 2058530 (S.D.N.Y. July 15, 2009) (hereinafter "the 2009 Partial Dismissal Order"). (Dkt No. 85.)

On December 23, 2009, in an unrelated case, the Second Circuit certified to the New York Court of Appeals a series of questions relating to the application of the "adverse interest" exception to the Wagoner rule and the related "sole actor" exception. Kirschner v. Grant Thornton LLP, 2009 WL 1286326 (S.D.N.Y. Apr. 14, 2009) (Kirschner I), questions certified sub nom. Kirschner v. KPMG LLP, 590 F.3d 186 (2d Cir. 2009) (Kirschner II), answering certified questions, 15 N.Y.3d 446 (2010) (Kirschner III), aff'd, 626 F.3d 673 (2d Cir. 2010) (Kirschner IV). Upon the application of the Certilman Defendants, the Court granted a stay of discovery pending the New York Court of Appeals' decision on the ground that the decision would impact adjudication of the claims pending in this litigation. (Dkt. No. 116.)

After the New York Court of Appeals issued its decision in Kirschner III, the Law Firm Defendants moved for reconsideration of this Court's 2009 Partial Dismissal Order. (Dkt. Nos. 126, 128, 130.) By report and recommendation, dated September 9, 2011 (the "Report"), familiarity with which is assumed, Magistrate Judge Michael H. Dolinger recommended that the motions be denied. Specifically, the Report concluded that: (1) Kirschner III did not constitute an intervening change in controlling law, and (2) the Court's 2009 Partial Dismissal Order did not constitute clear error. (Report 25.) The Law Firm Defendants each filed timely written objections to portions of the Report.

The Court has carefully reviewed the Report's thorough analysis and the parties' corresponding objections. For the reasons set forth below, the Court GRANTS the Law Firm Defendants' motions to reconsider on the ground that failure to do so would result in clear error. Upon reconsideration, the Court GRANTS IN PART and DENIES IN PART the Law Firm Defendants' motions to dismiss and DENIES the Receiver's request for leave to replead. The Court DENIES the Lum Defendants' motion to dismiss for failure to timely file an affidavit of merit pursuant to N.J. Stat. Ann. § 2A:53A-27, (Dkt. No. 134), and GRANTS the Receiver's cross-motion for an extension of time to file the required affidavit nunc pro tunc. (Dkt. No. 141.)

I. BACKGROUND*fn1

A. Facts

The Complaint alleges that the Cobalt Principals engaged in a massive fraud by using Cobalt to perpetrate a Ponzi scheme, which included their making egregious misrepresentations in order to persuade members of the public to invest millions of dollars in the enterprise. In the written materials disseminated to potential and actual investors, the Cobalt Principals allegedly misrepresented: (1) their personal and professional backgrounds, including their past criminal histories; (2) Stitsky's and Foster's involvement in Cobalt; (3) their plans for the investors' funds; and (4) the nature and scope of Cobalt's property holdings. The Cobalt Principals are alleged to have appropriated the majority of the funds invested in Cobalt for their own personal use.

The Complaint alleges that each of the Law Firm Defendants, as counsel for the Cobalt entities in varying capacities, assisted the Cobalt Principals in committing investor fraud. The Cohen Defendants are alleged to have, inter alia, aided in the creation of Vail Mountain Trust ("Vail"), an entity created by Shapiro in order to conceal his misappropriation of investor funds. (Compl. ¶¶ 94-95.) The Complaint alleges that the Cohen Defendants facilitated the transfer of over $9 million in investor funds from Cobalt to Vail, and from Vail to the Cobalt Principals for their personal expenses. (Compl. ¶¶ 97-103.)

The Complaint alleges that the Certilman Defendants, inter alia: (1) approved several private placement memoranda ("PPMs") issued to investors, which they knew contained material misrepresentations; (2) failed to perform due diligence that would have revealed that Cobalt was being operated as a Ponzi scheme with no positive cash flow; and (3) despite knowing that Shapiro was misusing investor funds for personal use, failed to apprise Cobalt of that fact or suggest that it be disclosed to investors. (Compl. ¶¶ 108-21.)

The Complaint alleges that the Lum Defendants, inter alia: (1) prepared and approved PPMs that they knew contained material misrepresentations; and (2) failed to perform due diligence that would have revealed that Cobalt was being operated as a Ponzi scheme with no positive cash flow. (Compl. ¶¶122-33.)

B. Procedural History

1.The 2008 Dismissal Order

In October 2006, the Law Firm Defendants filed motions to dismiss, arguing, inter alia, that the Receiver lacked standing to file suit, pursuant to the rule of standing articulated in Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 117 (2d Cir. 1991). (Dkt. Nos. 21, 23, 26.) The so-called Wagoner rule stands for the well-settled 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. Wagoner, 944 F.2d at 120; In re Bennett Funding Grp., Inc., 336 F.3d 94, 99-100 (2d Cir. 2003).*fn2

The Receiver argued that the Court should apply the "adverse interest" exception to the Wagoner rule, which states that where an individual corporate principal has "totally abandoned [the corporation's] interests and [is] acting entirely for his own or another's purposes," Kirschner III, 15 N.Y.3d at 466 (quoting Center v. Hampton Affiliates, Inc., 66 N.Y.2d 782, 784-85 (1985)) (emphasis in original), Wagoner does not apply, and the corporation has standing to assert claims against a third party that assisted the corporate agent in defrauding the corporation.

The Court rejected the Receiver's argument, finding that the Cobalt Principals had not totally abandoned the interests of the corporation because the Complaint alleged that they had provided at least some financial benefit to the Cobalt entities, such as: (1) using corporate funds accumulated by the fraud to pay promised returns to some investors; and (2) misappropriating most, but not all, of the funds raised from investors. 2008 Dismissal Order, 2008 WL 833237 at *4. Accordingly, the Court held that the Receiver lacked standing pursuant to the Wagoner rule and granted the Law Firm Defendants' motions to dismiss in their entireties in March 2008.

2. Motion for Reconsideration of the 2008 Dismissal Order; the 2009 Partial

Dismissal Order

In June 2008, the Receiver moved for reconsideration of the 2008 Dismissal Order based on the Second Circuit's opinion in Bankr. Servs., Inc. v. Ernst & Young (In re CBI Holding Co.), 529 F.3d 432 (2d Cir. 2008), which reversed a decision upon which this Court had relied.*fn3

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 439-40. During that period, CBI's accounting firm stated that the company's consolidated financial statements accurately reflected its financial position. Id. at 440. The bankruptcy court held that plaintiff BSI, the successor to CBI under its bankruptcy plan, had standing under the adverse interest exception to pursue fraud-based claims against the accounting firm because CBI's management had totally abandoned the corporation's interests. The district court reversed the bankruptcy court's decision, finding that the total abandonment standard had not been met because there was some evidence that various corporate purposes were served by the managers' fraud. The Second Circuit reversed the district court, holding that the bankruptcy court's determination did not constitute clear error.

In so doing, the Second Circuit stated that the total abandonment inquiry "looks principally to the intent of the managers engaged in misconduct," and that "[e]vidence that CBI actually benefitted from CBI's management's fraud does not make the bankruptcy court's finding that CBI's management did not intend to benefit the company clearly erroneous." Id. at 451 (emphasis in original). Based on that language, this Court interpreted the Second Circuit to have "concluded that a court can find that a corporation's manager 'totally abandoned' a corporation's interests even if the manager's actions also benefitted the corporation, because the relevant inquiry is whether the manager intended to benefit the corporation." 2009 Partial Dismissal Order, 2009 WL 2058530 at *6 (emphasis in original).

In 2008, this Court dismissed the Receiver's claims, holding that the total abandonment standard had not been met because the Complaint pled "at least some financial benefit to the Cobalt entities" as a result of the corporate managers' misconduct. 2008 Dismissal Order, 2008 WL 833237 at *4. The Court did not consider whether, notwithstanding any financial benefit that had accrued to Cobalt, the adverse interest exception might still apply as long as the Cobalt Principals had intended to totally abandon Cobalt's interests, as In re CBI Holding Co. indicated it might. The Court therefore granted the Receiver's motion for reconsideration. 2009 Partial Dismissal Order, 2009 WL 2058530 at *5-6.

Upon reconsideration, the Court held that, accepting as true all of the facts alleged in the Complaint, the Receiver had sufficiently stated a claim that the Cobalt Principals intended to totally abandon Cobalt's interests. Id. at *8. The Court therefore held that the adverse interest exception did apply, and concluded that the Receiver had standing to bring the following claims:

(1) legal malpractice claims against the Law Firm Defendants; (2) aiding and abetting conversion, breach of contract, and breach of fiduciary duties claims against the Cohen Defendants; and (3) a conversion and unjust enrichment claim against only Cohen.*fn4 Id. at *12.

3. Motion for Reconsideration of the 2009 Partial Dismissal Order

In January 2010, the Court ordered a stay of this case following the Second Circuit's certification to the New York Court of Appeals a series of questions relating to the application of the "adverse interest" exception to the Wagoner rule. Kirschner v. Grant Thornton LLP, 2009 WL 1286326 (S.D.N.Y. Apr. 14, 2009) (Kirschner I), questions certified sub nom. Kirschner v. KPMG LLP, 590 F.3d 186 (2d Cir. 2009) (Kirschner II), answering certified questions, 15 N.Y.3d 446 (2010) (Kirschner III), aff'd, 626 F.3d 673 (2d Cir. 2010) (Kirschner IV). The Kirschner case was brought by Marc Kirschner, the litigation trustee of Refco, a brokerage corporation forced to declare bankruptcy after it "disclosed that its president and chief executive officer had orchestrated a succession of loans . . . which hid hundreds of millions of dollars of the company's uncollectible debt from the public and regulators" in order to present to investors a falsely positive picture of Refco's finances. Kirschner III, 15 N.Y.3d at 457.

The Second Circuit asked, in relevant part: (1) "whether the adverse interest exception is satisfied by showing that the insiders intended to benefit themselves by their misconduct;" and (2) whether the exception is available only where the insiders' misconduct has harmed the corporation." Kirschner II, 590 F.3d at 194-95. The Court of Appeals answered the first question "no" and the second question "yes." Kirschner III, 15 N.Y.3d at 477. It held that intent alone did not result in application of the exception. Rather, the exception applies only where the corporation did not benefit at all from the fraud. Id. at 467. The Kirschner III Court further stated that the exception would not apply even if the corporation received short term benefits as a result of the fraud but suffered long term harm because of it. Id. at 468-69.

After the Court of Appeals issued its decision, the Law Firm Defendants moved for reconsideration of the 2009 Partial Dismissal Order denying in part their motions to dismiss, on the ground that Kirschner III constituted an ...


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