Opinion
Case No. 00 B 10099 (SMB), Adv. Proc. No. 00/2286A
January 2, 2001
Robert N.H. Christmas, Esq., NIXON PEABODY LLP, New York, New York, Attorneys for Plaintiff, TekInsight.Com, Inc.,
Bruce Frankel, Esq., Neil Siegel, Esq., of Counsel, ANGEL FRANKEL, P.C. New York, New York, Attorneys for Defendant Stylesite Marketing, Inc., Michael L. Molinaro, Esq., John W. Guarisco, Esq., of Counsel, NEAL, GERBER EISENBERG, Chicago, Illinois, Attorneys for Defendant First Source Financial LLP
MEMORANDUM DECISION AND ORDER DENYING MOTION FOR REARGUMENT
The plaintiff, TekInsight.Com, Inc. (the "plaintiff" or "Teklnsight"), seeks reargument of my earlier decision dismissing its complaint. See TekInsight.Com, Inc. v. Stylesite Mktg., Inc. (In re Stylesite Mktg., Inc.), 253 B.R., 503 (Bankr. S.D.N.Y. 2000). In brief, the plaintiff filed this adversary proceeding to impose a constructive trust on certain cash and TekInsight stock transferred to the defendant Stylesite Marketing, Inc. ("Stylesite") in exchange for Stylesite stock. The defendants moved jointly to dismiss the complaint for failure to state a claim under Fed.R.Civ.P. 12(b)(6), a motion I granted on three independent grounds. First, the Securities Purchase Agreement (the "Agreement") between the plaintiff and Stylesite barred the plaintiff's quasi-contractual remedy. Stylesite, 253 B.R. at 507-08. Second, the complaint failed to state a claim for the imposition of a constructive trust claim. Id. at 508-10. Third, § 510(b) of the Bankruptcy Code subordinated the plaintiff's underlying claim, and therefore, barred the constructive trust remedy. Id. at 510-12.
Stylesite subsequently pledged the TekInsight stock to the defendant First Source Financial LLP.
The plaintiff made a timely motion for reargument, challenging the Court's reliance on each of the three grounds. Initially, the plaintiff contends that the defendants conceded the sufficiency of the parts of the complaint I deemed insufficient. (Reply Memorandum of Law by TekInsight.Com in Further Support of Motion to Reargue and for Reconsideration, dated Dec. 19, 2000 ("Plaintiff's Reply Memo."), at 4; see Memorandum of Law by TekInsight.Com in Support of Motion to Reeargue and for Reconsideration, dated Nov. 27, 2000 ("Plaintiff's Reargument Memo."), at 3-4.) Next, the plaintiff argues that I ignored the language in the Agreement which, according to the plaintiff, permits the imposition of a constructive trust. (Id. at 4-5.) Lastly, TekInsight contends that I overlooked or failed to reconcile Second Circuit case law that "specifically addressed and resoundingly rejected" the principle that § 510(b) mandates the subordination of the constructive trust claim. (Id. at 2; accord id. at 6-7.)
For the reasons that follow, the reargument motion is denied.
DISCUSSION
A. Motion for Reargument
A party moving for reargument must demonstrate that the court overlooked controlling decisions or factual matters "that might materially have influenced its earlier decision." Anglo-American Ins. Group, P.L.C. v. Calfed, Inc., 940 F. Supp. 554, 557 (S.D.N.Y. 1996) (quoting Morser v. AT T Information Sys., 715 F. Supp. 516, 517 (S.D.N.Y. 1989)); accord Farkas v. Ellis, 783 F. Supp. 830, 832-33 (S.D.N.Y.), aff'd 979 F.2d 845 (2d Cir. 1992). The rule permitting reargument must be narrowly construed to avoid repetitive arguments on issues that the court has already fully considered. Farkas v. Ellis, 783 F. Supp. at 832. Further, the parties cannot advance new facts or arguments, and may not submit affidavits or new material. Pereira v. Aetna Cas. Sur. Co. (In re Payroll Express Corp.), 216 B.R., 713, 716 (S.D.N.Y. 1997).
Bankr.S.D.N.Y.R. 9023-1(a) governs a motion for reargument. It states:
A motion for reargument shall be served within 10 days after the entry of the Court's determination of the original motion and, unless the Court orders otherwise, shall be made returnable within the same amount of time as required for the original motion. The motion shall set forth concisely the matters or controlling decisions which counsel believes the Court has not considered. No oral argument shall be heard unless the Court grants the motion and specifically orders that the matter be reargued orally.
Rule 9023-1(a) is derived from Rule 6.3 of the local civil rules for the United States District Court for the Southern District of New York.
B. The Sufficiency of the Complaint
TekInsight contends, in the first instance, that I ignored the defendants' concession regarding the sufficiency of certain allegations. The defendants moved to dismiss under Fed.R.Civ.P. 12(b)(6) for failure to state a claim upon which relief can be granted. They pointed to two deficiencies: the Agreement barred the constructive trust remedy, and the plaintiff failed to plead a confidential or fiduciary relationship, one of the four elements of a constructive trust claim. (Memorandum of Law in Support of Joint Motion to Dismiss Complaint to Establish Constructive Trust, undated [ECF Doc. No. 3], at 7-8.) The motion did not discuss the allegations pertaining to the other three elements.
The four elements are (1) a confidential or fiduciary relationship, (2) a promise, (3) a transfer in reliance on the promise, and (4) unjust enrichment. Koreag Controle et Revision S.A. v. Refco F/X Assocs., Inc. (In re Koreag, Controle et Revision S.A.), 961 F.2d 341, 362 (2d Cir. 1992), cert denied 506 U.S. 865 (1992); Sharp v. Kosmalski, 351 N.E.2d 721, 723 (N.Y. 1976); Stylesite, 253 B.R. at 508.
The omission, however, does not imply a concession. The defense of legal insufficiency is not subject to waiver, and a defendant can make successive Rule 12(b)(6) motions. Vega v. State Univ. of New York Bd. of Tr., No. 97 Civ. 5767 (DLC), 2000 WL 381430, at *2 (S.D.N.Y. Apr. 13, 2000); Jones v. Clinton, 858 F. Supp. 902, 906 (E.D. Ark. 1994); Sharma v. Skaarup Ship Mgmt. Corp., 699 F. Supp. 440, 444 (S.D.N.Y. 1998), aff'd, 916 F.2d 820 (2d Cir. 1990), cert. denied, 499 U.S. 907 (1991). Thus, the defendants could make another Rule 12(b)(6) motion challenging the sufficiency of the remaining allegations.
A second motion would be a waste of time, and lead to the same result. In their response to the reargument motion, the defendants remarked on TekInsight's failure to identify a mistake in the analysis or conclusion granting the motion to dismiss; the plaintiff only argued that it had not been raised. (Joint Memorandum of Law in Opposition to Motion to Reargue and for Reconsideration, undated [ECF Doc. No. 13], at 6-7.) TekInsight replied that it had "clearly plead the elements required for the imposition of a constructive trust," and referred to the discussion in its memorandum opposing the motion to dismiss. (See Plaintiff's Reply Memo. 4 n. 5.) This is the same argument I considered and rejected once and now twice, and there is no purpose in doing it a third time.
This reference is curious since the plaintiff argues that the issue was not raised in connection with the dismissal motion.
Furthermore, TekInsight put its entire complaint in issue, even if the defendants didn't. TekInsight's opposition memorandum devoted more time to a discussion of the sufficiency of its complaint than it did to each of the other two issues it now raises as a basis for reargument. Point I of its opposition memorandum was entitled "TekInsight Has Pleaded All of the Required Elements for the Creation of a Constructive Trust." (Memorandum of Law by TekInsight.Com, Inc. in Opposition to Defendants' Motion to Dismiss, dated June 26, 2000 ("Plaintiff's Opposition Memo."), at 3.) Under this Point, the plaintiff recited the four elements of a constructive trust claim, (id. at 3-4), and parsed its own pleading to demonstrate its sufficiency under three of them. It identified the allegations supporting the express or implied promise made by Stylesite, (id. at 4), and the transfer underlying the claim. (Id.) The memorandum then went on to highlight Stylesite's inequitable conduct and unjust enrichment:
The plaintiff argued that the absence of a fiduciary relationship, the fourth element, did not preclude the imposition of a constructive trust. (Plaintiff's Opposition Memo. 5.)
With regard to the showing of unjust enrichment, Stylesite was unjustly enriched due to the transfer of funds and stock to it by TekInsight. This transfer occurred only due to TekInsight's reliance upon the representations made by Stylesite, representations that were not truthful, accurate or complete. Shortly after receiving the funds and stock, Stylesite transferred the TekInsight stock to First Source, who by and through Stylesite's actions was also unjustly enriched. [Complaint] at ¶ 25.
(Plaintiff's Opposition Memo. 4-5; accord id. at 7) ("both Defendants have been unjustly enriched . . . because Stylesite secured the transfer of stock and funds from TekInsight through gross misrepresentations).)
The determination of legal insufficiency stemmed from the rejection of the plaintiff's analysis. TekInsight based its claim of unjust enrichment on two facts: Stylesite lied, and as a result, it received TekInsight stock and cash in exchange for its own stock. The plaintiff referred to Stylesite's misrepresentations and its "trick and deceit," but upon closer scrutiny, I concluded that the complaint failed to state a claim for fraud. Stylesite, 253 B.R. at 509. This inadequacy was significant because the complaint did not spell out any other inequitable conduct needed to support the imposition of a constructive trust. Id. at 509.
The opinion acknowledged that although wrongful conduct is not always necessary to impose a constructive trust, the cases cited by TekInsight involved some type of wrongful or inequitable conduct missing from its complaint. Stylesite, 253 B.R. at 509-10.
In addition, Stylesite's receipt of the TekInsight stock, without more, did not establish unjust enrichment. Stylesite acquired the TekInsight stock and cash pursuant to a valid contractual transaction in which it parted with its own stock. The plaintiff never alleged that the value of the Stylesite stock it received was less than it had bargained for, and TekInsight never tendered the Stylesite stock back to Stylesite. Id. at 510.
In short, the defendants never conceded the issue I decided, the plaintiff raised and argued the issue I decided, and it has not indicated that I overlooked anything when the issue was decided.
C. The Language of the Agreement
In their earlier motion to dismiss the complaint, the defendants invoked the well-settled rule that a quasi-contractual claim such as unjust enrichment is barred if a written contract between the parties governs the subject matter of the dispute. The Agreement admittedly covers the exchange of TekInsight stock and cash for Stylesite stock, and TekInsight can maintain its claim to its legal, contractual remedies. It cannot, however, demand quasi-contractual relief. The plaintiff responded to the defendants' argument, inter alia, that it lacked an adequate remedy at law, and the Agreement preserved all remedies for breach or violation "available to it under provisions of this Agreement or otherwise, whether at law or in equity." Consequently, it could raise the constructive trust claim. (Plaintiff's Opposition Memo. 7.)
I implicitly rejected the plaintiff's position when I relied on the general rule, and dismissed the complaint. See Stylesite, 253 B.R. at 507-08. The plaintiff did not cite any authority to support the notion that the parties could contractually agree to a quasi-contractual remedy that the law generally forbade. Further, the quoted contract language merely preserved remedies otherwise available at law or equity, but did not create new remedies. The quasi-contractual remedy was unavailable to TekInsight, the Agreement didn't change that, and I now explicitly reject the argument I implicitly rejected the first time it was made.
D. The Section § 510(b) Claim
In the motion to dismiss, the defendants argued that § 510(b) of the Bankruptcy Code barred the constructive trust remedy. Surprisingly, the plaintiff never responded directly to this argument, nor did it mention § 510(b) in its opposition papers. It now argues that § 510(b) is immaterial, and that I overlooked two Second Circuit cases, Sanyo Elec., Inc. v. Howard's Appliance Corp. (In re Howard's Appliance Corp.), 874 F.2d 88, 93-94 (2d Cir. 1989), and In re Koreag, Controle et Revision S.A., 961 F.2d 341, in the earlier opinion. According to TekInsight, these cases "specifically addressed, and resoundingly rejected" the idea that § 510(b) restricted the right to a constructive trust sought by a defrauded shareholder.
TekInsight's belated argument is disingenuous at best. Neither of its cases dealt with § 510(b) or its effect on a constructive trust remedy. Rather, both recognized the general proposition that bankruptcy law will enforce a constructive trust to the same extent that applicable non-bankruptcy law does. While I have no quarrel with the general proposition, it does not follow, as TekInsight insists, that Congress cannot change the general rule in specific circumstances where principles of equity dictate.
In fact, the legislative history to § 510(b) demonstrates that Congress did intend to modify the general rule in the case of defrauded shareholders. The Securities Exchange Commission (the "SEC") resisted proposed § 510(b), advocating the restitutionary rights of rescinding shareholders over those of general creditors. The competing positions focused on the rationale for restitution:
Whether the rescinding security holder should be subordinated to, share pari passu with, or have priority over, unsecured creditors requires consideration of the elements of restitutionary relief. Generally, American law disfavors the general creditor whenever he competes with persons who have transferred property to a debtor in a voidable transaction.
H.R. Rep. 95-595, at 195 (1977) Citing the influential law review article authored by Professors John Slain and Homer Kripke, the House Committee on the Judiciary first identified the reason for the general rule: the premise that in extending credit, the unsecured creditor does not rely on the debtor's ownership of the property transferred by the rescinding transferor. Id. The Committee then observed that equity was different. In the case of stock, "the unsecured creditor does rely on an apparent cushion of equity securities in making the decision to extend credit." Id. Professors Slain and Kripke concluded that shareholders alone should bear the risk of illegality in the issuance of securities. Id.
See John J. Slain Homer Kripke, The Interface Between Securities Regulation and Bankruptcy — Allocating the Risk of Illegal Securities Issuance Between Securityholders and the Issuer's Creditors, 48 N.Y.U.L. Rev. 261 (1973).
The adoption of § 510(b) reflected the general acceptance of the Slain and Kripke position, and the rejection of the SEC's position. Id. at 196; see In re Flight Transp. Corp. Sec. Litig., 730 F.2d 1128, 1137 (8th Cir. 1984), cert. denied, 469 U.S. 1207 (1985) Moreover, the House Judiciary Committee's discussion explains why defrauded shareholder claims must be treated differently in bankruptcy. The law presumes that creditors do not extend credit based on the debtor's ostensible ownership of property transferred pursuant a voidable transaction. Accordingly, restoring the property to the transferor instead of using it to pay the general creditors is fair, and consistent with the creditors' expectations.
Where the creditor expressly relies on the debtor's apparent ownership, its claim will prime the defrauded parties' right to restitution. For example, a good faith purchaser of the property for value will cut off the rights of the beneficiary of a constructive trust. Ansellem v. HOZ West 56th Street Assocs., No. 86 Civ. 4451 (MGC), 1988 WL 142501, at *4 (S.D.N.Y. Dec. 30, 1988); RESTATEMENT OF RESTITUTION § 172 (1937); Simonds v. Simonds, 380 N.E.2d 189, 194 (N.Y. 1978).
Conversely, a creditor reviewing the debtor's balance sheet should assume, in light of the absolute priority rule, that he will receive payment before the shareholders do. Granting the defrauded shareholder rights equal to or greater than the general creditors is unfair and contravenes the expectations of the parties. TekInsight's reliance on general constructive trust law, and bankruptcy cases that do not implicate § 510(b), misses the very distinction that Congress made in § 510(b)
Finally, TekInsight's discussion of Second Circuit law ignores Jezarian v. Raichle (In re Stirling Homex Corp.), 579 F.2d 206 (2d Cir. 1978), cert. denied, 439 U.S. 1074 (1979), an important pre-Code case whose holding is codified in § 510(b). Stirling Homex concerned the status of claims asserted by defrauded investors in an insolvent entity. According to the Court of Appeals, the issue was "whether persons who were allegedly induced by fraud to purchase Homex stock should be allowed, in a reorganization proceeding, to assert claims in such a way as to achieve parity with ordinary unsecured tort and contract claimants." Id. at 211. Answering the question in the negative, the Court concluded that where the corporation is insolvent, the equities favor the general creditors over the shareholders. Id. at 213. Consequently, "[w]e will not allow stockholders whose claims are based solely on the alleged fraud that took place in the issuance of the stock to deplete further the already meager pool of assets presently available to the general creditors." Id.
Stirling Homex did not involve a constructive trust remedy, but its language and reasoning clearly signal how a defrauded stockholder's constructive trust claim should fare. The Second Circuit counseled that shareholders competing for the "meager poo1 of assets" may be tempted to assume the role of creditor, and "all attempts of that kind should be viewed with suspicion." Id. (quoting Newton Nat'l Bank v. Newbegin, 74 F. 135, 140 (8th Cir. 1896) (internal quotation marks omitted). Regardless of the remedy sought, the defrauded shareholder may not compete on an equal or superior footing with the general creditor. TekInsight's prayer for restitution rather than damages attempts to sidestep subordination, but does not change the equities which run in favor of the general creditors.
Whether TekInsight's § 510(b) argument is new, or simply a rehashing of one made implicitly in opposition to the original motion, it does not warrant reconsideration. For this reason and the others discussed above, the plaintiff's motion for reargument is denied in its entirety.
So ordered.