Zohar CDO 2003-1, Ltd. v. Patriarch Partners, LLC

Background

The Zohar Funds were collateralized loan obligations created through entities associated with Lynn Tilton and Patriarch Partners. The Patriarch Parties alleged that MBIA, AMZM, U.S. Bank, and the Zohar III Controlling Class misrepresented their treatment of Tilton’s and Patriarch’s ownership and control of portfolio companies, improperly caused the Patriarch Parties to resign as collateral managers, mishandled a Zohar I collateral auction, withheld information and fees, and breached contractual and fiduciary duties.

The third-party defendants moved to dismiss the third-party complaint under Rule 12(b)(6), which tests whether the pleaded facts state a legally sufficient claim. The court considered documents incorporated into the complaint, including proposals, term sheets, and the relevant indentures and collateral-management agreements.

Fraud, Misrepresentation, and Promissory Estoppel

Counts 1 through 3 alleged common-law fraud, negligent misrepresentation, and promissory estoppel against MBIA. The court dismissed these claims. It concluded that the October 2015 proposal did not say that the Patriarch Parties would retain ownership rights after resigning as collateral manager. The February 2016 bankruptcy-court statements described a tentative understanding, and the later MBIA proposal was conditional and was never finalized. The court also found that general allegations about other assurances did not satisfy the heightened requirement for pleading fraud with particularity.

Fiduciary-Duty Claims

Counts 4 and 5 alleged that AMZM, MBIA, and the Zohar III Controlling Class breached fiduciary duties. The court treated the claims as derivative claims—claims belonging to the Zohar Funds rather than claims for a separate injury to the Patriarch Parties—because the alleged harm was suffered directly by the Funds and would reach the Patriarch Parties only indirectly. Applying Cayman Islands law as described in the opinion, the court concluded that the Patriarch Parties could not pursue those derivative claims in this action. The claims were dismissed.

Auction, Contract, and Uniform Commercial Code Claims

Counts 6 through 9 and Count 19 challenged the method, timing, and terms of the Zohar I auction and alleged contract and New York Uniform Commercial Code violations. The court dismissed the auction-related claims because Judge Rakoff had approved the auction with modifications in an earlier judicial proceeding and because the Patriarch Parties did not allege concrete facts showing that potential bidders were prevented from participating or were confused by the notice process. The court also noted that Octaluna had a contractual “last look” right to submit a higher bid but did not exercise it.

Count 19 also alleged that U.S. Bank refused access to the Zohar Funds’ books and records. Unlike the auction-related allegations, this claim was adequately pleaded because the Patriarch Parties alleged a contractual right to inspect the records, made a demand, and alleged that U.S. Bank refused it. The court therefore allowed the books-and-records-related portion of Count 19 to proceed.

Conversion, AMZM Contract Claims, and Related Claims

Counts 10 through 12 alleged conversion, trespass to chattels, and aiding and abetting conversion based on the auction. The court dismissed them because the auction was not plausibly alleged to be commercially unreasonable, and because conversion could not be based merely on an alleged contract breach.

Count 14 alleged that AMZM breached the indentures and collateral-management agreements by failing to issue financial reports and by participating in other alleged misconduct. The court dismissed the claim because the cited agreements assigned reporting duties to the Zohar Funds and U.S. Bank, not AMZM, and because the other allegations were speculative or conclusory. Count 16, alleging breach of the implied covenant of good faith and fair dealing, was dismissed as duplicative of Count 14 and because that covenant could not create a new affirmative reporting duty. Count 17, alleging tortious interference, was dismissed because the Patriarch Parties had not adequately pleaded an underlying breach by AMZM.

Count 15 sought an equitable accounting. The court dismissed the claim against U.S. Bank as duplicative of the contract claim concerning records and information. The claim against AMZM was moot, and the claim against the Zohar Funds was stayed by the bankruptcy-related automatic stay.

U.S. Bank Fiduciary-Duty Claim

Count 18 alleged that U.S. Bank breached fiduciary duties concerning the auction and access to books and records. The auction-related allegations failed for the same reasons as the contract claims. But the court allowed the books-and-records-related claim to proceed because the indenture allegedly imposed both a contractual obligation and an independent fiduciary duty on U.S. Bank to make the records available to noteholders.

Aiding and Abetting

Count 20 alleged that MBIA, AMZM, U.S. Bank, and the Zohar III Controlling Class aided and abetted fiduciary-duty breaches. The court dismissed the claim because the Patriarch Parties had not adequately pleaded the underlying fiduciary breaches and had not alleged that the defendants knowingly participated in or induced U.S. Bank’s refusal to provide records.

Declaratory and Unjust-Enrichment Claims

Counts 21 and 22 sought declarations concerning the validity of irrevocable proxies and LLC-agreement amendments and the beneficial ownership and control of portfolio-company equity. The court stayed those claims because the ownership and control issues were being litigated in the Delaware Bankruptcy Court. Count 13, which alleged unjust enrichment against MBIA and depended on the ownership and control issues, was also stayed. The court noted that any claim concerning Zohar II or Zohar III assets was not ripe because MBIA was not alleged to have acquired those assets.

Disposition

The court dismissed all claims against MBIA Inc. It held that the third-party defendants’ motions were granted in part and denied in part; Counts 1 through 12 were dismissed; Count 13 was stayed; Counts 14 through 17 were dismissed; Counts 18 and 19 were dismissed except for the books-and-records-related claims; Count 20 was dismissed; and Counts 21 and 22 were stayed pending relevant determinations by the Delaware Bankruptcy Court. Judge P. Kevin Castel directed the Clerk to administratively terminate the motions, subject to reinstatement as to Counts 13, 21, and 22 after the Delaware Bankruptcy Court addressed the underlying issues.