Norddeutsche Landesbank Girozentrale, et al., Plaintiffs-Respondents-Appellants,
Lynn Tilton, et al., Defendants-Appellants-Respondents.
appeals from the order of the Supreme Court, New York County
(Eileen Bransten, J.), entered March 17, 2016, which granted
the part of defendants' motion seeking to dismiss the
negligent misrepresentation claim, and denied the part of the
motion seeking to dismiss the fraudulent misrepresentation
Gibson, Dunn & Crutcher LLP, New York (Caitlin J.
Halligan, Randy M. Mastro, Lawrence J. Zweifach and Mark A.
Kirsch of counsel), for appellants-respondents.
& Androphy, New York (Michael M. Fay, Jenny H. Kim and
Chris L. Sprengle of counsel), for respondents-appellants.
M. Mazzarelli, J.P. Richard T. Andrias David B. Saxe Paul G.
Feinman Judith J. Gische, JJ.
January 2005, plaintiffs purchased $75 million of notes
issued by the collateralized debt obligation (CDO) fund Zohar
II 2005-1, Limited (Zohar II). In April 2007, plaintiff
purchased $60 million of notes issued by CDO fund Zohar III,
Limited (Zohar III and, together with Zohar II, the Funds).
Pursuant to collateral management agreements with the Funds,
defendant Patriarch Partners, LLC (Patriarch LLC) was engaged
to select and manage the collateral to be held by the Funds.
Defendants Patriarch Partners XIV, LLC (Patriarch XIV) and
Patriarch Partners XV, LLC (Patriarch XV) are controlled by
Patriarch LLC and defendant Lynn Tilton, and are the
respective collateral managers of Zohar II and Zohar III.
Tilton is the principal and controlling member of the
Patriarch entities. At least as far as the indentures
governing the Funds represented them to be, the Funds were
ordinary CDOs, that is, they were supposed to hold debt
obligations. Further, the Funds were "blind, "
meaning that investors like plaintiffs did not know the
identities of the companies to whom the loans that made up
the Funds were made (the Portfolio Companies).
March, 2015, the Securities and Exchange Commission commenced
administrative and cease-and-desist proceedings against
defendants (as well as against one other Zohar fund not
involved in this litigation), alleging that Tilton and the
Patriarch entities defrauded the Funds and their investors
"by providing false and misleading information, and
engaging in a deceptive scheme, practice and course of
business, relating to the values they reported for these
funds' assets." The order commencing the proceeding
directed that cease-and-desist proceedings be commenced to
determine whether their allegations were true, and whether
remedial action was appropriate in the public interest.
to plaintiffs, the SEC proceeding alerted them to the need to
perform their own investigation into their investment in the
Funds. They claim that, upon the completion of that
investigation, they concluded that the Funds were not CDOs at
all. Rather, plaintiffs contend that, unbeknownst to them
because of deliberate concealment by defendants, the Funds
were de facto private equity funds. Plaintiffs claim to have
discovered that defendants used the proceeds from Fund
investors to obtain controlling positions in the Portfolio
Companies, which turned out to be distressed and already at
risk of failure. Further, they discovered that defendants
purposely siphoned off the value in the Portfolio Companies
to the point that they collapsed, including by taking
excessive management fees for themselves, causing significant
losses to plaintiffs and other investors. Less than two
months after the SEC commenced its proceeding, plaintiffs
commenced this action. Their complaint asserts two causes of
action, for fraudulent misrepresentation and for negligent
moved to dismiss the complaint pursuant to CPLR 3211(a)(5)
and (a)(7). They argued that the claims are barred under the
applicable six-year statute of limitations for fraud, because
plaintiffs filed their complaint 10 years after they made
their investments. They further argued that plaintiffs could
not avail themselves of the fraud discovery toll, contending
that they were on notice of their claims as early as 2009,
based on numerous disclosures made to them by defendants over
a lengthy period of time that should have alerted plaintiffs
that the Funds were not garden variety CDOs. These
disclosures included the indentures governing the issuance of
the Funds. Defendants pointed out that the Zohar II indenture
detailed CDOs to be acquired by Zohar II from another fund,
and that with respect to 23 out of the 27 borrowers listed
therein, the other fund "owns equity interests in each
such borrower, which equity interests... are also being
transferred to [Zohar II]."
also directed the court to certain marketing materials
released by them in February 2007 with respect to the Funds,
known as the "Patriarch Presentation." The
Patriarch Presentation disclosed that "[o]n January 13,
2005, Patriarch closed a $1.1 billion CDO, Zohar II, Limited,
in order to purchase companies and originate loan assets to
companies undergoing pervasive change." The Patriarch
Presentation further showed Zohar II's projected equity
interest in various Portfolio Companies. Zohar's
projected equity interest in several of the companies was
shown as 100%, and its interest in various other companies
was reflected as high as between 80% and about 96%. The
Patriarch Presentation also disclosed Zohar III's
projected equity interests in various entities of up to 40%.
Defendants assert that, in total, the Patriarch Presentation
disclosed that the Funds' combined equity interests
exceeded 50% for 23 Portfolio Companies, and amounted to a
100% interest in seven Portfolio Companies.
Patriarch Presentation further disclosed that the Funds'
investment strategies included "[p]urchasing power to
acquire companies by way of myriad sales processes including
direct negotiations and acquisitions, Section 363 sales (in
Bankruptcy) and Article 9 foreclosure sales (under the
Uniform Commercial Code) with the subsequent re-levering of
capital structures to meet such companies' and the Zohar
funds' debt-financing requirements." In addition, it
provided that "the Zohar asset yield is a product of a
high yield current coupon combined with added loan accretion,
preferred equity and common equity interests... the enhanced
quality of the assets reduces the default probability of the
portfolio and renders the added preferred loan and equity
returns, in most cases, highly collectable."
also relied on the transcript of a December 12, 2011 Zohar
III investor call, in which plaintiffs participated and in
which they declined an opportunity to ask questions. The
purpose of the call was for Tilton to discuss Zohar III's
performance with investors and to allow investors to ask
Tilton any questions. Tilton explained that
"[the Funds] were raised to buy the loans and the equity
of distressed companies. And when I say the equity, not buy
the equity, but we agreed to contribute the equity of the
companies that we purchased into these deals in whole or in
part. And most of the time when the equity was purchased, it
was purchased with my own money... these funds are completely
dependent upon the upside potential [i.e., growth] of these
companies, which is one of the reasons that we agreed to do
that, because we buy very distressed companies, either in
Article 9 foreclosure sales or through bankruptcy 363 sale or
through asset sales, and the theory is always taking that
long journey of rebuilding companies and creating values. And
so the feeling for us would be that if you were only putting
the loans and not the upside in, that, in my view, it would
be taking a lot of risk without sharing the reward. And so
these deals were always set up such that we would go out and
we would buy these companies, the loans would be made from
these funds, sometimes also with asset-based loans above them
or have been used to replace them, and then a percentage of
the equity would be contributed into these funds."
"it's really important to understand that this is
not like in any way typical CDOs, where you're owning
pieces of publically traded loans where you can exit at a
price. This is [illiquid][i.e., higher risk]. We need to
actually create value in the companies and then we need to
exit the value in the companies. That said, most CDOs also
don't hold the equity value of the companies you
don't see that anywhere."
arguing that plaintiffs had sufficient information to at
least begin an inquiry into the true nature of the CDOs well
before the commencement of the SEC proceeding, defendants
further relied on a publicly available SEC disclosure
released by them in February 2012. That disclosure revealed
that Patriarch Partners "primarily invests on behalf of
its CDO Clients in undervalued, distressed companies or
divisions and other assets thereof" and often
"seeks to make opportunistic investments on behalf of
its CDO Clients with the primary purpose of obtaining
influence over or control of financially troubled companies,
focusing on turning around' these Assets by restoring
their value." The filing contained the following several
disclosures about the Funds' equity positions in
Portfolio Companies, and the risks inherent therein. For
example, it stated that:
"affiliates of the Investment Advisor often may take an
equity position in these same companies. Despite being under
no legal obligation to do so, these affiliates often transfer
to CDO Clients the equity ownership of Assets in which the
CDO Clients invest, thereby increasing the potential for
returns on such Assets beyond the investments made by the CDO
Clients. No credit is given to this equity ownership by the
rating agencies and the value of this equity ownership is ...