Reynolds v. Behrman Brothers Management Corporation

Background

Thomas E. Reynolds, the Chapter 7 trustee of Atherotech Holdings, Inc. and Atherotech, Inc., sued Behrman Brothers Management Corporation (BBMC), the companies’ former financial advisor, for breach of a Financial Advisor Agreement. The agreement was governed by New York law. It covered advisory services involving growth, operations, business partnerships, budgets, capital structure, debt and equity levels, financing, and cash management.

The agreement also contained an exculpation clause, meaning a provision limiting liability. It stated that BBMC could not be liable to Holdings for conduct related to its retention or performance of services unless a final, non-appealable judgment found that BBMC engaged in willful misconduct or gross negligence. The agreement also stated that BBMC reserved the right not to provide services at any time.

The trustee alleged three forms of breach: BBMC advised Atherotech to pursue growth dependent on process and handling fees paid to physician customers; BBMC arranged a June 2013 dividend recapitalization that allegedly maximized payments to BBMC-affiliated shareholders while leaving Atherotech with excessive debt; and BBMC failed to develop a contingency plan after Atherotech stopped paying the fees in July 2014. The Debtors filed Chapter 7 bankruptcy petitions in March 2016.

Motion to dismiss and contract interpretation

BBMC moved to dismiss the amended complaint under Rule 12(b)(6), which tests whether a complaint states a legally sufficient claim. The court considered whether the complaint plausibly alleged a contract, the trustee’s performance, BBMC’s failure to perform, and damages.

The court held that Section 13’s liability limitation unambiguously applied to direct contract claims between Holdings and BBMC, not only to indemnification claims. Therefore, to state a contract claim, the trustee had to allege that BBMC’s services failed to meet the agreement’s standards and that the conduct constituted willful misconduct or gross negligence.

The court rejected BBMC’s argument that the agreement guaranteed no particular advice or result. Although BBMC had discretion concerning the time and effort devoted to its services and could decline to provide services, the advice it did provide still had to comply with the agreement’s terms.

Dividend-recapitalization theory

The court found that the complaint plausibly alleged that BBMC breached Section 1(a)(ii)(B), which allowed BBMC to advise on the “appropriate levels of debt and equity.” The court concluded that “appropriate” could plausibly mean a debt level that should not foreseeably lead to insolvency. The complaint alleged that BBMC advised Atherotech to assume debt that BBMC knew would likely cause insolvency while seeking the largest possible dividend for BBMC-affiliated shareholders.

The court also found that the complaint adequately alleged willful misconduct or gross negligence. It alleged that BBMC knew Atherotech’s business model depended heavily on the fees, knew of the Department of Justice investigation and the company’s potential exposure, failed to disclose that information when obtaining a solvency opinion, and focused on benefits to Fund IV partners while disregarding Atherotech’s interests.

The court nevertheless held that damages were not adequately pleaded. The trustee sought lost profits, avoidable liabilities, and recovery of the management fee. The court found that lost profits and similar losses were consequential damages and that the complaint did not allege that BBMC assumed responsibility for those losses when the agreement was made. The complaint also did not adequately plead recovery of the management fee as either benefit-of-the-bargain damages or rescissory damages, which are damages serving as the financial equivalent of canceling a contract.

The court allowed the trustee to seek leave to replead damages on the dividend-recapitalization theory. The trustee was directed to submit a letter and proposed Second Amended Complaint within the time specified by the court, and to explain why amendment would be sufficient and not futile. The opinion did not grant leave to amend automatically.

The court rejected BBMC’s statute-of-limitations argument at this stage. The parties agreed that the claim had to accrue on or after June 21, 2013, and the dividend recapitalization closed on June 28, 2013. Because the complaint did not establish untimeliness on its face, the court declined to dismiss the dividend-recapitalization theory on that ground.

Other theories and disposition

The court dismissed the growth-strategy theory because the complaint did not adequately allege willful misconduct or gross negligence. Atherotech had already resumed paying the fees before BBMC became its advisor, the relevant government fraud alert came later, and the complaint alleged that paying such fees was an industry practice before the alert.

The court dismissed the contingency-plan theory because it was not tied to a specific contractual obligation. The agreement described services BBMC might provide but did not require BBMC to provide any particular service, and it expressly reserved BBMC’s right not to provide services.

Judge Lorna G. Schofield concluded that BBMC’s motion was granted. The trustee may seek leave to replead only to the limited extent described in the opinion, concerning damages for the dividend-recapitalization theory. The Clerk of Court was directed to close Docket No. 24.