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Brown Media Corp. v. K&L Gates, LLP

United States District Court, E.D. New York

February 28, 2018

K&L GATES, LLP and EDWARD M. FOX Defendants.

          Law Office of Daniel L. Abrams, PLLC Attorney for the Plaintiffs

          Silverman Acampora LLP Attorneys for the Defendants Anthony A. Acampora, Esq., Of Counsel



         On or about November 27, 2013, Brown Media Corporation (“Brown Media”) and Roy E. Brown (“Roy”) (together, the “Plaintiffs”) commenced this action against K&L Gates, LLP (“KLG”), Edward M. Fox (“Fox”, together with KLG the “Defendants”) as well as a recently dismissed individual defendant, Eric T. Moser.

         The claims in this action arise from a related bankruptcy proceeding. Therefore, the case was automatically referred to the United States Bankruptcy Court for the Eastern District of New York (the “Bankruptcy Court”).

         On December 1, 2014, the Defendants filed a motion, pursuant to 28 U.S.C. § 157(d); Federal Rule of Bankruptcy Procedure (“Fed. R. Bankr. P.”) 5011; and Local Bankruptcy Rule 5011-1, to withdraw the automatic reference and have the case proceed before this Court. On or about January 14, 2015, while that motion was pending, the Defendants filed a second motion, pursuant to Fed.R.Bankr.P. 7012 and Federal Rule of Civil Procedure (“Fed. R. Civ. P.” or “Rule”) 12(b)(6), to dismiss the complaint.

         On January 28, 2015, this Court withdrew the reference from the Bankruptcy Court.

         On November 21, 2015, the Court granted the Defendants' motion to dismiss the complaint pursuant to Rule 12(b)(6) on the grounds that res judicata bars the Plaintiffs' claims for breach of fiduciary duty, tortious interference and common law fraud (“2015 MTD Decision”).

         On April 14, 2017, the U.S. Court of Appeals for the Second Circuit vacated the Court's judgment issued pursuant to the 2015 MTD Decision, ruling “[b]ecause the plaintiffs' claims are not of the sort that should have been raised in the underlying bankruptcy proceedings nor do they implicate the validity of the asset sale confirmed in the bankruptcy proceedings, res judicata does not bar them.” Docket Entry (“DE”) 18 at 2.

         On February 8, 2018, Eric T. Moser was voluntarily dismissed from this case.

         Presently before the Court is the motion by the Defendants, pursuant to Rule 12(b)(6) to dismiss the Plaintiffs' entire complaint for failure to state a claim upon which relief can be granted. As stated above, the previous decision that dismissed the complaint was vacated and remanded by the Second Circuit for further proceedings consistent with its opinion. For the following reasons, the Defendants' motion to dismiss pursuant to Rule 12(b)(6) is granted in part and denied in part.

         I. BACKGROUND

         Unless otherwise noted, the following salient facts are drawn from the complaint and are construed in favor of the Plaintiffs.

         A. The Parties

         Brown Media is a Delaware Corporation, which was established in March 2010 for the express purpose of acquiring the assets of an entity known as Brown Publishing Company and its affiliated entities (collectively “Brown Publishing”).

         Roy is an individual residing in Cincinnati, Ohio. He presently owns the substantial majority of the stock of Brown Media, and is the former CEO, shareholder, and director of Brown Publishing. Roy is also a part of Brown Publishing's management group.

         The defendant, KLG, is an international law firm with approximately forty-five offices located throughout the United States and abroad. The individual defendant Fox and former defendant Moser are attorneys and former partners at KLG, both of whom currently reside in New York.

         B. Pre-Bankruptcy

         Brown Publishing was a closely-held corporation, which was controlled by Roy; his brother Clancy; his parents, Bud and Joyce; the company's former General Counsel, Joel Dempsey (“Dempsey”); and one Joel Ellingham (“Ellingham”) (collectively, the “Managers”). Brown Publishing was a family business, having been founded in 1920 by Roy's grandfather.

         At an unspecified time, Brown Publishing received financing from a company known as Windjammer Capital (“Windjammer”). In connection with their financing arrangement, Windjammer allegedly retained an equity option, so that, in the event the loan was not repaid, Windjammer could exercise its option and force the sale of Brown Publishing's assets to recoup its investment.

         For reasons not set forth in the complaint, it is alleged that in late 2008, although not yet in default, the Managers feared that Windjammer might soon exercise its option, which would result in their losing control of Brown Publishing. As a result, the Managers sought legal advice as to how best to maintain control of the enterprise.

         In this regard, on or about December 12, 2008, allegedly on behalf of himself and the other Managers, Dempsey contacted Fox and KLG. On that date, Dempsey allegedly supplied Fox and KLG with a document entitled the “Warrant Put Memo” (the “Memo”), which sets forth the issues about which the Managers required legal advice. It is unclear who prepared the Memo, but, as to its contents, the complaint alleges as follows:

The [ ] Memo ask[ed] KLG for advice related to, inter alia, the legal ramifications of a proposed transaction whereby the Managers create a new LLC and Managers Roy, Dempsey, and Ellingham acquire the assets of Brown Publishing through the new LLC. This proposed transaction was to take place outside of bankruptcy. Legal issues specifically identified in the [ ] Memo included what actions to take, if any, with regards [sic] to Windjammer Capital, possible successor liability related to the proposed transaction, what state would be an advantageous one for incorporation of the new LLC, the tax consequences to the Managers, shareholder disclosure requirements, if any, and other issues pertaining to Brown Publishing's lenders.

See Compl. ¶ 20.

         It is alleged that the Memo did not contemplate a bankruptcy. In fact, as noted above, Brown Publishing allegedly was not in default of any loans at this time and the Managers were specifically seeking advice about how to retain equity control through a non-bankruptcy transaction.

         Allegedly, in response to the Memo, KLG and the individual Defendants provided advice directly to Roy and Dempsey, and billed the Managers for the time spent providing these legal services. In particular, KLG allegedly advised the Managers on ways to reduce the possibility of so-called successor liability - i.e., the possibility that the new LLC would succeed to the debts and liabilities of Brown Publishing after acquiring its assets. In order to minimize this possibility, KLG allegedly advised Roy not to participate in any eventual transaction, and advised Dempsey to relinquish his shares in an entity known as Brown Media Holdings Company (“Media Holdings”), so that he could become the majority owner of the new LLC.

         By March 2009, Brown Publishing was in imminent danger of defaulting on its loan agreement with Windjammer. See Compl. ¶ 26. Accordingly, the Managers allegedly took a series of actions to protect Brown Publishing's interests.

         In or about March 2009, the Managers allegedly decided to enter into a non-bankruptcy transaction that was structured similarly to the one contemplated by the Defendants in the Memo. The complaint does not provide many supporting details concerning this transaction. From the complaint, the Court cannot determine the parties to the transaction or any of the relevant terms or conditions. However, it is alleged that, in proceeding with this transaction, the Managers followed advice provided by KLG, namely, Roy did not participate and Dempsey relinquished his shares in Media Holdings.

         At or about the same time, in March 2009, Windjammer allegedly commenced a lawsuit in Ohio, seeking to invalidate this transaction. Again, the complaint does not provide many supporting details, including the identities of the parties to that action. Nor does it specify whether the action was commenced in state or federal court; or what legal theory Windjammer asserted. Nevertheless, an unidentified Ohio court allegedly approved the transaction and authorized it to move forward.

         However, again for reasons not explained in the complaint, at some unspecified time, the Managers allegedly rescinded the March 2009 transaction and, on the advice of KLG, proceeded to bankruptcy.

         In this regard, it is alleged that when “[t]he March 2009 transaction did not solve the problems associated with Brown Publishing's debt, ” Dempsey contacted Fox in early May 2009 for advice. See Compl. ¶ 26. From May 2009 to June 2009, KLG allegedly advised the Managers that a sale of Brown Publishing's assets in bankruptcy was their best strategy in order to retain control of the company.

         Further, KLG apparently advised Roy and Dempsey, in their individual capacities, to attempt to purchase Brown Publishing's assets through a sale pursuant to Section 363 of the United States Bankruptcy Code, 11 U.S.C. § 363 (“§ 363”), which authorizes the bankruptcy court to conduct a sale of a bankruptcy debtor's assets outside of the ordinary course of business. The complaint alleges that KLG suggested that, if the Managers, acting through the new LLC, purchased Brown Publishing's assets in a sale pursuant to § 363, they “could eliminate successor liability and related tax concerns, and that Roy's family members could potentially join the purchase.” In June 2009, KLG allegedly notified Roy and Dempsey that the firm was interested in representing Brown Publishing in its bankruptcy proceeding. According to the complaint, KLG did not disclose any conflict of interest created by simultaneously (a) representing Brown Publishing in connection with its bankruptcy filing; and (b) advising the Managers in connection with their efforts to retain control of Brown Publishing and acquire its assets. In particular, KLG allegedly did not seek or obtain a waiver from the Managers. Nor did the firm seek consent to represent both the Managers and Brown Publishing.

         In July 2009, Brown Publishing allegedly retained KLG as counsel. After being so retained, KLG allegedly continued to advocate for a sale of Brown Publishing's assets to the Managers by way of a sale in bankruptcy pursuant to § 363, despite the Managers' expressed preference for an out-of-court restructuring. In this regard, KLG allegedly began preparing a strategy by which the Managers would maximize their odds of prevailing in a public auction for the company's assets. In particular, in August 2009, KLG and Dempsey began preparing a “stalking horse asset purchase agreement.” (the “APA”)

         Although not described in the complaint, the Court will take judicial notice of the basic concept of a stalking horse bid in bankruptcy. As one court has noted:

A stalking horse bidder in a bankruptcy proceeding makes an initial bid to purchase the assets of a debtor on the theory that the initial bidder's “initial research, due diligence, and subsequent bid may encourage later bidders.” In re 310 Associates, 346 F.3d 31, 34 (2d Cir. 2003). Stalking horse bidders often contract to receive a “break-up fee” compensating it for its bidding activities should a higher bid ultimately emerge and win an eventual asset auction. See In re Integrated Res., Inc., 147 B.R. 650, 659 (S.D.N.Y. 1992).

In re MSR Resort Golf Course LLC, 13-cv-2448, 2014 WL 67364, at *2 n.3 (S.D.N.Y. Jan. 7, 2014). As the Second Circuit has succinctly stated: “A ‘stalking horse' contract is a first, favorable bid strategically solicited by the bankrupt company to prevent low-ball offers.” In re WestPoint Stevens, Inc., 600 F.3d 231, 239 n.3 (2d Cir. 2010).

         In addition to preparing the APA, KLG also allegedly provided the managers with specific advice concerning, inter alia, how much to bid and how to frame their bid so as to maximize the chances that a bankruptcy court would approve an eventual sale. Further, KLG allegedly provided advice regarding the formation of Brown Media, the entity into which the purchased assets of Brown Publishing would be transferred, namely, the “stalking horse.” KLG also allegedly provided advice as to the benefits of filing the bankruptcy petition in New York.

         The complaint alleges that KLG was also active in seeking funding for the Managers' planned purchase of Brown Publishing's assets. In this regard, allegedly, “KLG provided advice to the Managers on the price they should offer, and revised documents drafted by the Managers and sent to potential capital [investors].” Compl. ¶ 35. In addition, Fox allegedly referred the Managers to a friend of his at W&L Ross, a company that acquires other distressed companies, and participated in a conference call with the Managers and individuals at Goldman Sachs.

         Allegedly, KLG provided advice to Roy and Dempsey regarding the Managers' efforts to convince Brown Publishing's lenders to finance the Managers' purchase. Among other things, KLG allegedly made extensive edits to a memo prepared by Roy on behalf of himself and the other Managers for this purpose.

         It is further alleged that the Managers eventually obtained a funding commitment from Guggenheim Partners (“Guggenheim”) to support their purchase offer. The complaint alleges that KLG worked directly with Guggenheim and the Managers to prepare the APA and encouraged Guggenheim to provide a debtor-in-possession loan to infuse capital into Brown Publishing during the Chapter 11 proceeding and preserve the value of its assets.

         However, shortly before Brown Publishing's bankruptcy filing, KLG allegedly urged the Managers, and Brown Media, to obtain separate counsel. In particular, Fox allegedly recommended that the Managers retain his friend and former partner, Richard Levy, Esq. The Managers agreed to retain Levy. However, by the time they did so, Brown Media had already been formed for the purpose of placing a stalking horse bid and ultimately acquiring Brown Publishing's assets; and substantive portions of the APA were already negotiated and in place. Around the same time, at KLG's suggestion, Brown Publishing hired Tom Carlson (“Carlson”) as an independent director with a mandate to manage the sales process.

         C. The Bankruptcy Filing

         On April 30, 2010, Brown Publishing filed for Chapter 11 bankruptcy in the Eastern District of New York. The complaint alleges that, “[a]s part of the filing, KLG sought to be and was eventually retained as [Brown Publishing's] Counsel.” Compl. ¶ 45. Apparently, KLG submitted a disclosure statement (the “Disclosure Statement”) in furtherance of the Bankruptcy Court's approval of its retention as counsel for Brown Publishing. Allegedly, this Disclosure Statement failed to disclose KLG's prior representation of the Managers. The complaint also alleges that the Disclosure Statement did not disclose “the extent of Defendants' relationships with all of the members of the Bank Group and many other major creditors.” Compl. ¶ 47. However, the complaint does not define the term “the Bank ...

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