Opinion
Case No. 17-31030 Adv. No. 19-3046 Adv. No. 19-3047
04-23-2020
In re: GYPC, INC., Debtor GYPC, INC., Plaintiff v. CHRISTOPHER F. CUMMINGS, Defendant GYPC, INC., Plaintiff v. ERIC WEBB, Defendant
Copies to: Patricia J. Friesinger Zachary B. White Daniel J. Gentry (Counsel for the Plaintiffs, electronically served) Casey M. Cantrell Swartz Michael L. Meyer W. Timothy Miller (Counsel for the Defendants, electronically served) Alfred J. Weisbrod, 111 W. First Street, Dayton, Ohio 45402 (Counsel for the Defendants)
Chapter 7
Decision (1) Denying Motions of Defendants Christopher Cummings and Eric Webb to Dismiss; (2) Denying Motions of Defendants to Disqualify Special Counsel; (3) Vacating Order Treating the Statute of Limitation Argument in Defendants' Motions to Dismiss as Motions for Summary Judgment; and (4) Granting Motions of the Chapter 7 Trustee to Amend the Complaints
I. Background
When GYPC, Inc. ("GYPC") was a debtor-in-possession in Chapter 11, and the statute of limitations for filing avoidance actions was fast approaching, it moved to retain special counsel, the court approved the retention, and GYPC subsequently filed a series of avoidance actions. see estate docs. 152-154 & 162. Two of those avoidance actions were against Christopher Cummings and Eric Webb (collectively, the "Defendants"), the only shareholders and directors of GYPC. In turn, the Defendants moved to dismiss these adversary proceedings, arguing that special counsel did not obtain the authority from the Defendants to sue the Defendants and the statute of limitation to file an authorized action has now passed. doc. 3 (19-3046); doc. 4 (19-3047). In addition, the Defendants allege that the complaints' causes of action are insufficiently plead. These dismissal motions included affidavits of each of the Defendants. The court, recognizing this unaddressed conflict of interest, scheduled a status conference and that conference ultimately led to a motion by the United States Trustee to convert the estate case to Chapter 7. estate doc. 210. The court granted that motion to convert by an agreed order. estate docs. 219. The Chapter 7 Trustee, Donald F. Harker, III (the "Trustee"), who was substituted as the proper party plaintiff in these adversary proceedings, responded to the motions to dismiss and included an affidavit of the Trustee and of special counsel, Patricia J. Friesinger ("Friesinger"). doc. 11 (19-3046) and doc. 12 (19-3047). The Trustee's responses also included a series of emails related to the pre-filing investigation of the avoidance actions against the Defendants.
Cummings, the CEO of GYPC, holds 91.94% of the equity shares of GYPC and Webb, GYPC's President, holds the remaining 8.06%. estate doc. 19 at 42. It is not in dispute that GYPC is a Delaware corporation. estate doc. 2 (Exhibit A).
The obvious conflict problems in the GYPC estate case made it inevitable that GYPC could not continue as a Chapter 11 debtor-in-possession. No creditors' committee was appointed that could have pursued this litigation. The corporation's representatives did not attempt to appoint any independent director to address these issues. The debtor-in-possession did not seek to retain conflict counsel to determine these issues independent of the wishes of the Defendants. The United States Trustee, as least as the record shows, was not consulted about a viable path forward. The Defendants, acting as fiduciaries of GYPC during this time period, suggest that they, in their respective individual capacities, should benefit from the failure of the estate to remedy this conflict between the Defendants as individuals, and the Defendants as directors. But the reality is special counsel reviewed this litigation as counsel for the debtor-in-possession, as authorized by an approved application to employ, and as noted in this decision, it does not appear that the Defendants did anything about this problem prior to the filing of the litigation.
The Trustee has also moved to amend the complaints to the extent the court finds the complaints insufficiently plead.
The court determined at that time, out of concern that the filings included documents beyond what may be considered on a dismissal motion, that the authority to sue issue should be treated as a motion for summary judgment. The court entered an order treating this issue upon summary judgment and provided a limited opportunity for discovery. doc. 16 (19-3046) & doc. 17 (19-3047). Subsequently, the Defendants filed a motion, asserting that Friesinger and her law firm Coolidge Wall, Co. L.P.A. ("Coolidge Wall" and, collectively with Friesinger, "Special Counsel") should be disqualified because Friesinger cannot be both a witness and an advocate, and further, this disqualification should be imputed to Coolidge Wall. doc. 29 (19-3047) & doc. 28 (19-3046).
Specifically, the Defendants attached to their motions to dismiss their respective affidavits that were substantively identical. doc. 3 (19-3046) and doc. 4 (19-3047) (Exhibit A). The affidavits indicate that the Defendants were aware from counsel to the debtor-in-possession that GYPC needed to pursue preference recoveries for those entities that received payments within 90 days of the petition date and the need to hire Coolidge Wall to pursue this litigation. That litigation was authorized according to the Defendants. But the Defendants further state that they were not aware of the need to file actions, and did not authorize, the pursuit of recoveries outside this 90-day window against insiders. The Defendants indicate that they were not aware of any potential litigation based on a preference or fraudulent transfer theory against them. Further, the Defendants assert, based on their understanding, they would not have approved such litigation. The Trustee attached the following documents to his response: 1) an affidavit of Friesinger; 2) a limited waiver of the work-product privilege and the attorney-client privilege by the Trustee; 3) a March 12, 2019 email from Friesinger to Ira Thomsen and Denis Blasius, counsel for GYPC; 4) a May 5, 2017 email sent by Cynthia Keller of Mindstream concerning each Defendant's 2016 W2 and a March 10, 2017 email from Webb to Cynthia Keller; 5) a March 21, 2019 email sent by Friesinger to Walter Reynolds, copied to Dennis Blasius, about transactions involving Cummings and March 26, 2019 emails about pre-petition transactions involving Webb; and 6) an email exchange between Reynolds and Friesinger on March 26-27, 2019 about the payments to the Defendants.
Walter Reynolds is a partner at Porter, Wright, Morris and Arthur ("Porter Wright"). Porter Wright filed the estate case and moved to be appointed as counsel to the debtor-in-possession, but based upon an objection filed by the United States Trustee, the motion was not approved by the court. See estate docs. 25 & 53.
GYPC's Statement of Financial Affairs disclose that pre-petition transfers were made to Cummings in the amount of $438,033.70 and to Webb in the amount of $498,167.54 during 2016 and 2017. estate doc. 19 at 43. Those transfers are the subject of these avoidable transfer proceedings.
The court is taking judicial notice of the filing of various documents from the estate case and the adversary proceedings pursuant to Federal Rule of Evidence 201. See New England Health Care Emps. Pension Fund v. Ernst & Young, LLP, 336 F.3d 495, 501 (6th Cir. 2003) (the court may consider public records or document otherwise appropriate for judicial notice on a motion to dismiss).
II. Jurisdiction
This court has jurisdiction pursuant to 28 U.S.C. § 1334(b) and this is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(F) & (H).
III. Motion to Dismiss Standard
A motion to dismiss an adversary proceeding for "failure to state a claim upon which relief can be granted" is governed by Federal Rule of Civil Procedure 12(b)(6) (applicable by Federal Rule of Bankruptcy Procedure 7012(b)). The factual allegations must put the defendant on notice as to the claims being alleged and provide a sufficient factual predicate to make the allegations plausible, and not merely possible. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). Federal courts are not obligated to accept as true legal conclusions couched as factual allegations. Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007). While detailed factual allegations are not necessary, the allegations must be sufficiently detailed to create more than speculation of a cause of action. Id. A claim is plausible if the factual allegations are sufficient to allow "the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." HDC, LLC v. Ann Arbor, 675 F.3d 608, 611 (6th Cir. 2012) (citations and internal quotation marks omitted). See Fed. R. Civ. P. 8(a)(2) (applicable by Fed. R. Bankr. P. 7008, which requires "a short and plain statement of the claim showing that the pleader is entitled to relief[.]").
IV. Analysis
A. Authority of Special Counsel
In its procedural order converting the corporate authority issue to summary judgment, the court wanted to ensure any relevant evidence was considered on this important question. However, upon a closer inspection of all the pending motions, the court has determined that, without regard to any of the extrinsic evidence the parties have attached to their filings, Special Counsel's authority to file the litigation against the Defendants was established through the approved application to employ Special Counsel for the debtor-in-possession ("Application to Employ"), the approved retention of the debtor-in-possession counsel, and the Statement of Financial Affairs.
See Application to Employ Patricia J. Friesinger And Coolidge Wall Co., L.P.A. As Special Counsel for Debtor-In-Possession, GYPC, Inc. Nunc Pro Tunc To the Date of The Filing of This Application, estate doc. 152; Statement of Financial Affairs, 30.1 and 30.2, estate doc. 19 at 43; and the Application to Employ Ira H. Thomsen as Case Attorney and the Law Offices of Ira H. Thomsen as Counsel for Debtor in Possession, estate doc. 69.
The Defendants argue that Special Counsel did not have actual authority to file the avoidance litigation. This argument appears to suggest that Special Counsel lacked "express authority" to file the litigation. The Restatement (Third) of Agency defines express authority as "actual authority that a principal has stated in very specific or detailed language." Restatement (Third) of Agency, § 2.01, comment b. But authority to act need not be granted by the principal in express language. See In re Palmdale Hills Prop., LLC, 457 B.R. 29, 47 (B.A.P. 9th Cir. 2011) (Authority granted to agent to file a proof of claim need not be express authority but may be actual authority based upon the agent's reasonable understanding that the agent was to act on the principal's behalf.). "Actual authority" is defined not based upon the view of the principal, but rather the view of the agent and whether the agent "reasonably believes, in accordance with the principal's manifestations to the agent, that the principal wishes the agent so to act." Restatement (Third) of Agency, § 2.01. See also State Farm Mut. Auto Ins. Co. v. Johnson, 396 P.3d 651, 656 (Colo. 2017) ("express authority" is contrasted with "implied authority" -- "authority to perform acts that are incidental to, or are necessary, usual, and proper to accomplish or perform, the main authority expressly delegated to the agent.") (internal citations and quotation marks omitted).
The Restatement (Third) of Agency elaborates on these principles:
As commonly used, the term "express authority" often means actual authority that a principal has stated in very specific or detailed language.Restatement (Third) of Agency, § 2.01, comment b (emphasis added). Further,
The term "Implied authority" is often used to mean actual authority either (1) to do what is necessary, usual, and proper to accomplish or perform an agent's express responsibilities or (2) to act in a manner in which an agent believes the principal wishes the agent to act based on the agent's reasonable interpretation of the principal's manifestation in light of the principal's objectives and other facts known to the agent. These meanings are not mutually exclusive. Both fall within the definition of actual authority. Section 2.02, which delineates the scope of actual authority, subsumes the practical consequences of implied authority.
Actual authority is a consequence of a principal's expressive conduct toward an agent, through which the principal manifests assent to be affected by the agent's action, and the agent's reasonable understanding of the principal's manifestation. An agent's actions establish the agent's consent to act on the principal's behalf, as does any separate manifestation of assent by the agent. When an agent acts with actual authority, the agent's power to affect the principal's legal relations with third parties is coextensive with the agent's right to do so, which actual authority creates . . . .
The focal point for determining whether an agent acted with actual authority is the agent's reasonable understanding at the time the agent takes action . . . . A principal's manifestations may reach the agent directly or indirectly . . . .
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The presence of actual authority requires that an agent's belief be reasonable at the time the agent acts. It is also necessary that the agent in fact believes that the principal desires the action taken by the agent.
* * *Restatement (Third) of Agency, § 2.01, comment c (emphasis added). See Dweck v. Nasser, 959 A.2d 29, 39-40 n. 60 (Del. Ch. 2008) (applying § 2.01 of the Restatement (Third) of Agency on actual authority). The Second Circuit, on similar agency principles, found counsel was authorized to file a UCC financing termination statement:
A principal's manifestation to an agent often consists of an intentional act. However, a principal may also convey actual authority to an agent through unintended conduct that the agent reasonably believes to constitute an expression of the principal's intentions.
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A principal's manifestation to an agent may be expressed in a form that is observable by third parties. Such an expression provides guidance to the agent and creates a record of the content of the principal's manifestation to the agent. The principal's expression also constitutes a basis for apparent authority when third parties observe it. Indeed, a primary function of stating an agent's authority in a formal written instrument such as a power of attorney is to enable the agent to display the instrument to third parties to demonstrate the agent's authority . . . .
* * *
Most conferrals of authority combine two elements. The first, always present, is a manifestation, however general or specific, by a principal as to the acts or types of acts the principal wishes to be done. The second, less invariably present, consists of instructions or directives that specify how or within what constraints acts are to be done. A principal's communications to an agent begin with an initial expression granting authority, followed in many instances by instructions or directions that clarify matters, prescribe in more specific terms what the principal wishes the agent to do, or reduce or enlarge the scope of the agent's authority.
JPMorgan and Simpson Thatcher's repeated manifestations to Mayer Brown show that JPMorgan and its counsel knew that, upon the closing of the Synthetic Lease transaction, Mayer Brown was going to file the termination statement that identified the Main Term Loan UCC-1 for termination and that JPMorgan reviewed and assented to the filing of that statement. Nothing more is needed.Official Comm. Of Unsecured Creditors of Motors Liquidation Co. v. JP Morgan Chase Bank, N.A. (In re Motors Liquidation Co.), 777 F.3d 100, 105 (2d Cir. 2015) (applying Delaware law). See also Palmdale Hills, 457 B.R. at 47. (applying the Restatement (Third) of Agency).
As to the scope of an agent's authority, the Restatement (Third) of Agency provides:
(1) An agent has actual authority to take action designated or implied in the principal's manifestations to the agent and acts necessary or incidental to achieving the principal's objectives, as the agent reasonably understands the principal's manifestations and objectives when the agent determines how to act.Restatement of Agency, § 2.02. Comment d to this section provides that:
(2) An agent's interpretation of the principal's manifestations is reasonable if it reflects any meaning known by the agent to be ascribed by the principal and, in the absence of any meaning known to the agent, as a reasonable person in the agent's position would interpret the manifestations in light of the context, including circumstances of which the agent has notice and the agent's fiduciary duty to the principal.
(3) An agent's understanding of the principal's objectives is reasonable if it accords with the principal's manifestations and the inferences that a reasonable person in the agent's position would draw from the circumstances creating the agency.
Acts necessary or incidental to achieving principal's objectives. If a principal's manifestation to an agent expresses the principal's wish that something be done, it is natural to assume that the principal wishes, as an incidental matter, that the agent take the steps necessary and that the agent proceed in the usual and ordinary way, if such has been established, unless the principal directs otherwise. The underlying assumptions are that the principal does not wish to authorize what cannot be achieved if necessary steps are not taken by the agent, and that the principal's manifestation often will not specify all steps necessary to translate it into action.Id. at comment d. Comment e provides, in part:
e. Agent's reasonable understanding of principal's manifestation. An agent does not have actual authority to do an act if the agent does not reasonably believe that the principal has consented to its commission. Whether an agent's belief is reasonable is determined from the viewpoint of a reasonable person in the
agent's situation under all of the circumstances of which the agent has notice . . . .Id. at comment e (emphasis added).
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Factors relevant to the reasonableness of an agent's understanding of the principal's manifestation include the fiduciary character of the agent's relationship with the principal and the agent's inability to react to the principal's unexpressed interests or wishes. An agent's fiduciary position obliges the agent to act loyally to serve the principal's interests and objectives that the agent knows or should know. See § 8.01.
In applying these agency principles, we begin with the fact that the principal in this case is the bankruptcy estate of GYPC - not the Defendants. GYPC, as the debtor-in-possession, had "all the rights . . . and powers, and [was to] perform all the functions and duties . . . of a trustee serving in a case under [Chapter 11]." 11 U.S.C. § 1107. As part of these duties and responsibilities, GYPC had the ability to pursue causes of action on behalf of the bankruptcy estate, including avoidance proceedings. In re iPCS, Inc., 297 B.R. 283, 287 (Bankr. N.D. Ga. 2003); See also 11 U.S.C. § 323(b) ("The trustee . . . has capacity to sue and be sued.").
The Defendants argue that, as directors of GYPC, only they could convey authority to file litigation. Directors do initiate and control litigation for the corporation. Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 101 (1991); Heine v. Streamline Foods, Inc., 805 F. Supp. 2d 383, 393-94 (N.D. Ohio 2011) (both applying Delaware law). However, the Thomsen law firm, as counsel to GYPC, were agents of the debtor-in-possession. See Burtch v. Ganz (In re Mushroom Transp. Co.), 282 B.R. 805, 818 (E.D. Pa. 2002) ("The agent has the duty of loyalty to act only for the principal's benefit."). Principles of agency apply to Chapter 11 cases and debtors in possession:
Ordinary principles of agency apply to the relationship between an officer or employee and a corporation operating under chapter 11 unless, in the appropriate case, the rules of agency are superceded or modified by the Bankruptcy Code or an order of the Bankruptcy Court. See, e.g., Strang v. Bradner, 114 U.S. 555, 560, 29 L. Ed. 248, 5 S. Ct. 1038 (1885) (applying agency principles to determine that misconduct of a third party could be imputed to a debtor). Central to these notions is the concept that the acts or inaction of an employee or officer acting within the scope of his employment can be imputed to the corporation. See Valles v. Albert Einstein Med. Ctr., 805 A.2d 1232, 2002 Pa.
LEXIS 1783, at *13 (Pa. 2002) (a master may be held liable for the acts of the servant when those acts are committed during the course of his employment and within the scope of his authority).Id. at 821-22. Further, officers and directors of a Chapter 11 debtor in possession may delegate duties to professionals. Id. at 825. ("While the debtor in possession may assign to others specific duties, it may not surrender the helm and let the debtor ship sail under someone else's captaincy."). Of course, one such professional is debtor in possession counsel. See 11 U.S.C. § 327(a) (". . . the trustee, with the court's approval, may employ one or more attorneys . . . ."); In re Count Liberty, LLC, 370 B.R. 259, 281 (Bankr. C.D. Cal. 2007) ("Counsel is charged with the duty to advise the debtor in possession of its responsibilities under the Code, and to assist the debtor in possession, and its principals, in discharging those responsibilities.").
A debtor in possession's management often delegates to counsel for the debtor in possession the filing and management of litigation. In ruling on professional fee applications, a bankruptcy court stated:
Nevertheless, given the central importance of the automatic stay for the benefit of the estates, the Court's jurisdiction and good order, as discussed above, it is easy to conclude that CWT [Cadwalader, Wickersham & Taft PLC] did have an independent obligation to start the Stay Litigation, whether based on a fiduciary duty that it had to Cenargo's estates and creditors in general or, alternatively, because by failing to have done so CWT would have breached the requirement under section 327(a) of the Bankruptcy Code that it be "disinterested." . . . Said differently, had CWT not acted in response to Lombard's stay violation, in deference to its new "clients" - the JPLs - CWT would have had its fees reduced under section 328(c) of the Bankruptcy Code ("the court may deny allowance of compensation for services and reimbursement of expenses of a professional person . . . if . . . such professional person is not a disinterested person, or represents or holds an interest adverse to the interest of the estate . . . .").In In re Cenargo Int'l, PLC, 294 BR. 571, 599-600 (Bankr. S.D.N.Y. 2003). An attorney may be an agent for the principal in filing litigation. In general, the law of agency applies to the attorney-client relationship. Pope v. Rice, 2005 U.S. Dist. LEXIS 4011, at*26-27 (S.D.N.Y. March 14, 2005); Lydon v. Eagle Food Ctrs., Inc., 696 N.E.2d 1211, 1214 (Ill. App. Ct. 1998). See also Rwanda v. Rwanda Working Group, 227 F. Supp. 2d 45, 63 (D.D.C. 2002). A principal may either provide express or implied authority to file an action. Lydon, 696 N.E.2d at 1214; NNN Siena Office Park I 2, LLC v. Wachovia Bank N.A., Case No. 2:12-cv-01524-MMD-PAL, 2014 U.S. Dist. LEXIS 126077, at *17 (D. Nev. Sept. 8, 2014) (Law firm had implied authority to represent party when agent of the party had implied authority to manage litigation for the party and hired the law firm to represent the party in the litigation.). As explained by the Court of Chancery of Delaware:
[I]n litigation, attorneys regularly "act[] as an arm of the corporation vis-a-vis the outside world." Stated slightly differently, as [the principal's] outside counsel, [the law firm] was given "the power to act on behalf of [the principal] with respect to third parties," litigated "at the behest of [the principal] and for his benefit," and remained subject to [the principal's] control.Jackson Walker L.L.P. v. Spira Footwear, Inc., Civil Action No. 3150-VCP, 2008 Del. Ch. LEXIS 82, at *26 (Del. Ch. June 23, 2008) (internal citations omitted).
Applying these principles, the application to employ debtor-in-possession counsel delegated the filing and management of litigation to the Thomsen firm and provided in pertinent part that:
The professional services that Counsel are to render include, but are not limited to, the following:
4.1 To give Debtor legal advice with respect to its powers and duties as Debtor-in-Possession in the continued operation of its businesses and management of its properties;
4.2 To represent Debtor, as Debtor-in-Possession, in connection with any adversary proceedings which are instituted within this case;
4.3 To prepare on behalf of Debtor, as Debtor-in-Possession, necessary amendments or additions to schedules, Petition, applications, motions, answers, orders, reports, objections, disclosure statement and plan of reorganization and other legal documentation in connection with this case;
* * *
4.6 Advise the Debtor regarding its ability to initiate actions to collect and recover property for the benefit of its estate;
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4.10 Assist the Debtor in reviewing, estimating and resolving claims asserted by or against the Debtor's estate;estate doc. 69 at 4-5 (emphasis added). This application was signed by Christopher Cummings as "Chief Executive Officer" and approved by the court (est. doc. 71).
4.11 Commence and conduct any and all litigation necessary and appropriate to assert rights held by the Debtor, protect assets of the Debtor's estate, or otherwise further the goal of completing the successful reorganization of the Debtor;
4.12 Provide general corporate, litigation and other legal services for the Debtor as requested by the Debtor; and
4.13 Perform all other necessary and appropriate legal services in connection with this Chapter 11 case for and on behalf of the Debtor.
Paragraph 2 of the Application to Employ the Special Counsel states: "The professional legal services Special Counsel is to render shall include but is not necessarily limited to, the following: (a) managing a large number of anticipated avoidance action adversary proceedings, including making settlement demands and filing separate adversary proceedings against targets of avoidance actions as identified in the Applicant's filed Statement of Financial Affairs . . . ." estate doc. 152 at 1-2 (emphasis added). The Statement of Financial Affairs (¶ 30.1 and 30.2) described the following amounts received in the one-year period preceding the filing of the Chapter 11 petition: Christopher Cummings $438,033.70 and Eric Webb $498,167.54. estate doc. 19 at 43. The Application to Employ further expressly excepted out actions against professionals but did not except out actions against insiders. estate doc. 152 at 4. Further, paragraph 3 of the Application to Employ states:
The statute of limitations for filing of avoidance action adversary proceedings is March 30, 2019 and the Applicant's Statement of Financial Affairs indicates approximately 400 separate targets of potential avoidance actions. As such, Special Counsel will need to commence representation as soon as practicable to be able to reduce the number of adversary proceedings (if possible) through review of transactions and discussion with counsel for such potential targets. Contemporaneously herewith, the Applicant is filing a motion to shorten the notice period for responses to this Application and will serve to all
creditors and parties in interest this Application along with a notice as to the deadline for responses hereto as soon as such deadline is determined.Id. at 2. The Application to Employ the Special Counsel was served upon the Defendants.
In sum, the employment of the Thomsen law firm as counsel to GYPC, the delegation of litigation responsibility to them, the terms of the Application relating to Special Counsel's employment to file the avoidable transfer claims as described by the Statement of Financial Affairs and which excepted out actions against professionals but not against insiders, a reasonable person in Friesinger's shoes only could believe that she had the authority to file the litigation against the Defendants. Given this actual authority, express authority from the mouths of the Defendants was not necessary. See Palmdale Hills, 457 B.R. at 50 (Express authority is not necessary for an agent to file a proof of claim for the agent's principal.).
Neither of the Defendants objected to Special Counsel's retention for the express purpose of filing avoidable transfer litigation against the targets identified in the Statement of Financial Affairs, including themselves. The Defendants knew, as disclosed in the Application to Employ, that the statute of limitations was about to expire. estate doc. 152 at 2. See 11 U.S.C. § 546(a)(1)(A) (providing two years from the order of relief to file an avoidance action). The objection period was the time to raise the issue, not after the statute of limitations had run. See Together Dev. Corp. v. Pappas (In re Together Dev. Corp.), 262 B.R. 586, 592 (Bankr. D. Mass. 2001) (finding appropriate the debtor's delegation of authority to the unsecured creditors committee to file a fraudulent transfer action against insiders over the objection of the insiders, particularly in light of the fact that the statute of limitation was about to expire). See also Palmdale Hills, 457 B.R. at 47 (Authority granted to agent to file a proof of claim need not be express authority but may be actual authority based upon the agent's reasonable understanding that the agent was to act on the principal's behalf.); Restatement (Third) of Agency § 1.03 comment e ("As between the agent and the principal, an unexplained failure to object may also in appropriate circumstances constitute a manifestation of assent or intention.") (emphasis added) See also Solomon v. Johansson, D.C. Civil No. 1987/249, 1989 U.S. Dist. LEXIS 18260, at *14-15 (D.V.I. Jan. 31, 1989) (quoting § 19(1) of the Restatement (Second) of Contracts) ("The manifestation of [the principal's] assent may be made wholly or partly by written or spoken words or by other acts or by failure to act.") (emphasis added).
B. Special Counsel Are Not Disqualified
The Defendants argue that Special Counsel must be disqualified because Friesinger is a necessary witness about whether the adversary proceedings were authorized by GYPC. Ohio Rule of Professional Conduct 3.7 provides that "[a] lawyer shall not act as an advocate at a trial in which the lawyer is likely to be a necessary witness," unless one of three exceptions apply:
1. The testimony relates to an uncontested issue;Federal courts have the inherent authority to disqualify counsel when appropriate. Mitchell v. Columbus Urban League, Case Nos. 2:18-cv-747, 2:18-cv-748, 2019 WL 4727378, at *1 (S.D. Ohio Sept. 27, 2019). Federal courts in Ohio are guided by the Ohio Rules of Professional Conduct. Miller v. Food Concepts Int'l LP, 2015 WL 6082602, at *7 (S.D. Ohio Oct. 16, 2015).
2. The testimony relates to the nature and value of legal services rendered in the case; or
3. The disqualification of the lawyer would work substantial hardship on the client.
For the reasons previously stated, the court finds no need for Friesinger to testify about the authority issue, or any other aspect of this litigation. The Friesinger affidavit was filed to address the authority issues only and the Trustee did not waive the attorney-client privilege for any other purpose. See Trustee affidavit, doc. 36 (paragraph 2) (19-3046) & doc. 37 (19-3047). As explained, the disclosure in filed documents in the estate case, particularly the unopposed Application to Employ, and the employment application of the debtor-in-possession, and the disclosures in the Statement of Financial Affairs are dispositive. Therefore, the court sees no need to address this issue any further with testimony or further evidence.
C. The Trustee May Amend the Complaint to Cure Pleading Deficiencies
The Defendants also argue that the complaints are insufficiently plead. Pleadings must contain "a short and plain statement of the claim showing that pleader is entitled to relief[.]" Fed. R. Civ. P. 8(a)(2) (applicable by Fed. R. Bankr. P. 7008). A complaint may not just list the elements of a cause of action but must contain sufficient factual allegations to state a plausible claim. Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 556 (2007). When pleading fraudulent or preferential transfers, the complaint should identify the transfers to be avoided, including the transferor, transferee, and the dates of the transfers. State Bank & Trust Co. v. Spaeth (In re Motorwerks, Inc.), 371 B.R. 281, 292-93 (Bankr. S.D. Ohio 2007). The complaint must contain sufficient information in order to allow a defendant to respond with appropriate affirmative defenses. Id. In addition, actual fraud claims must be plead with particularity pursuant to Federal Rule of Civil Procedure 9(b). In re Licking River Mining, LLC, 565 B.R. 794, 809 (Bankr. E.D. Ky. 2017). See also Harker v. I.R.S., Case No. 16-32161, Adv. No. 18-3008, doc. 32 at 12 n. 11 (Bankr. S.D. Ohio Aug. 30, 2018) (noting that a number of court decisions have concluded that Rule 9(b) does not apply to constructive fraud claims).
Rule 9(b) requires that "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person's mind may be alleged generally." Fed. R. Civ. P. 9(b).
As to the preference cause of action, as it is against insiders, the look-back period is not 90 days, but instead one year. 11 U.S.C. § 547(b)(4)(B). For claims outside the 90-day window, there is no presumption of insolvency. 11 U.S.C. § 547(f) (presumption of insolvency for preferential transfers during the 90-days prior to the filing of the petition). Insolvency is a required element of any preference claim and is defined by the Bankruptcy Code. 11 U.S.C. § 101(32). The complaint alleges that GYPC was insolvent at the time of the transfers as a conclusory statement but provides no background facts in support of that allegation. In addition, the description of the alleged transfers does not include the date of the transfers.
In regard to the fraudulent transfer counts, which raise both actual and constructive fraudulent transfers, the Defendants note that the complaints do not allege any facts in support of these allegations. Degirolamo v. McIntosh Oil Co. (In re Laurel Valley Oil Co.), Bankr. No. 05-64330, Adv. No. 12-6014, 2012 WL 2603429, at *3 (Bankr. N.D. Ohio July 5, 2012) (the complaint should provide specific facts, or indicia of fraud and cannot rely on bare bones pleading of elements of § 548).
In response, the Trustee asserts the complaints are sufficiently plead. The Trustee notes that the Defendants, as the only directors and shareholders of GYPC, provided the limited financial disclosure upon which the complaints are based. The Trustee requests that the motion be denied, or alternatively, moves for leave to amend the complaints.
In their reply, the Defendants assert that the Trustee had ample time to amend the complaint and should not be allowed to amend with leave of court. See Fed. R. Civ. P. 15(a)(2) (applicable by Fed. R. Bankr. P. 7015) (allowing amendment of pleadings by consent of the opposing party, or by leave of court, which should be "freely give[n] when justice so requires"). Further, the Defendants argue that the Trustee does not explain how the facts will be sufficiently plead in any amendment.
In reviewing the complaints, the court agrees with the Defendants that the avoidance causes of action are pled with a lack of specificity. However, until discovery commences, the Trustee can only amend the pleadings on the basis of the company's books and records and perhaps other limited information. In addition, the delay in this case is, in part, due to the unusual circumstances of the conversion of this case and the need for the Trustee to review the pending litigation filed during the Chapter 11. The dismissal of the complaints would be a draconian remedy that unfairly prejudices the estate's creditors. Therefore, the court, in its discretion, declines to take that step. See Hageman v. Signal L. P. Gas Inc., 486 F.2d 479, 484 (6th Cir. 1973) (court may determine a motion to amend not just upon delay, but lack of notice and substantial prejudice to the opposing party). Instead, the court grants the Trustee leave to amend the complaints and notes further amendments may be needed as discovery warrants. See Gowan v. Patriot Group, LLC (In re Dreier LLP), 452 B.R. 391, 408 (Bankr. S.D.N.Y. 2011) (courts take a more liberal view of actual fraud allegations when a trustee pleads a fraudulent conveyance cause of action).
V. Conclusion
For all these reasons, the Defendants' Motions to Disqualify Special Counsel are denied, the Defendants' Motions to Dismiss are denied, and the Trustee's Motions to Amend the Complaints are granted. The court will enter separate orders in the respective adversary proceedings. The Trustee shall amend his complaints within 28 days of the entry of the order granting the Motions to Amend.
This document has been electronically entered in the records of the United States Bankruptcy Court for the Southern District of Ohio.
IT IS SO ORDERED.
/s/ _________
Guy R. Humphrey
United States Bankruptcy Judge
Dated: April 23, 2020
Copies to: Patricia J. Friesinger
Zachary B. White
Daniel J. Gentry
(Counsel for the Plaintiffs, electronically served) Casey M. Cantrell Swartz
Michael L. Meyer
W. Timothy Miller
(Counsel for the Defendants, electronically served) Alfred J. Weisbrod, 111 W. First Street, Dayton, Ohio 45402 (Counsel for the Defendants)