An Eckert Seamans associate prepared this overview.
In the case styled Sehoy Energy LP v. Haven Real Estate Grp., C.A. No. 12387-VCG (Del. Ch. Apr. 17, 2017), the Court of Chancery determined that an automatic stay of claims against a bankrupt entity did not apply to direct, non-derivative claims against the debtor’s co-defendants.
Background: This action involved plaintiffs who invested into a partnership (the nominal defendant), Haven Real Estate Focus Fund (the “Partnership”). The plaintiffs brought fiduciary, breach of contract, and fraud claims against the Partnership’s general partner, Haven Real Estate Group (“Haven”), controller, Albert Adriani (“Adriani”), and affiliate, Haven Chicago. After the investors brought suit, Haven Chicago filed for bankruptcy. The plaintiffs filed a motion to determine the impact of the bankruptcy proceedings on the instant action.
Plaintiffs’ Claims: The plaintiffs asserted three breach of contract claims against Haven and Adriani related to: (1) loaning unsecured money in violation of the Limited Partnership Agreement; (2) refusing to produce audited financial statements or allow inspection of books and records; and (3) making improper, unsecured loans without obtaining priority positions.
Plaintiffs also brought three fiduciary claims against Haven and Adriani for: (1) making illegal loans; (2) making false and misleading statements about the Partnership’s position and exposure to unsecured, junior loans so as to avoid the plaintiffs’ exercise of their right to withdraw; and (3) unfairly allocating sale proceeds from sale of collateral.
Plaintiffs’ fraud claims were based on alleged fraudulent inducement to get the plaintiffs to invest in the Partnership.
Parties Contentions: Plaintiffs asserted that the majority of their claims were direct claims, and therefore, they were not subject to the automatic stay entered in connection with Haven Chicago’s bankruptcy proceedings. Haven and Adriani opposed the plaintiffs’ motion, alleging that all claims against them were derivative, and therefore, they must be stayed because the cause of action was an asset of the bankrupt entity, Haven Chicago.
Court’s Analysis: The Court was faced with three issues: (1) whether it had jurisdiction to determine the scope of the automatic stay; (2) which claims were derivative and therefore must be stayed; and (3) whether the action should be stayed regardless of the aforementioned questions in the interest of judicial economy.
The Court explained that the law is clear that “a non-bankruptcy court has the right to consider whether the automatic stay order applies to matters before it.” Because it was unlikely that the bankruptcy court would ever face the question of whether the stay extended to Haven and Adriani, and because the analysis turned on a question of Delaware law regarding derivative and direct claims, the Court determined that it was in the best position and had inherent authority to determine that it had jurisdiction over the matter.
Nature of the Claims
Derivative claims for injury to the debtor from wrongs committed by the debtor’s officers become the property of the estate under 11 U.S.C. § 541 (Delaware law recognizes derivative claims as an asset of the company). The right to bring such claims vests exclusively with the trustee. Under § 362(a)(3) of the Bankruptcy Act, a plaintiff who asserts such derivative claims would be exercising control over property of the estate in violation of an automatic stay. Therefore, the stay analysis turned on whether the plaintiffs’ claims were derivative. The Court applied the Tooley test, which usually applies to corporations, to determine whether plaintiffs’ claims against the Partnership were derivative in nature.
Contract Claims: The breach of contract claims related to the making of unsecured loans appeared derivative because resulting harm would cause financial loss to the Partnership. However, the Court noted that the fundamental pass-through nature of the entity, whereby new investors who had not been harmed would share in the recovery, might allow for a contrary finding. The Court was not able to rule on these claims without a more developed record. On the other hand, failure to produce audited financials was affirmatively deemed a direct claim because inspection rights run directly to limited partners themselves, not to the Partnership.
Fiduciary Claim: The fiduciary claim at issue in the motion based on false and misleading disclosures was found to be direct because it affected the plaintiffs’ individual rights to withdraw their investments in the Partnership. The pre-Tooley precedent set forth in Manzo v. Rite Aid Corporation did not preclude this finding.
Fraud Claims: The fraud claims were common-law tort claims that were “quintessential examples of personal claims,” not subject to the Tooley test (although the Court would reach the same result under Tooley). Both claims directly affected the plaintiffs’ decisions to invest, or withdraw their investments, from the Partnership. Therefore, these claims were not derivative.
Based in part on the fact that the bankruptcy court would not rule inconsistently, as the current issues would not be presented to that court, the Court found that judicial economy was an unpersuasive reason to depart from the normal rule that a bankruptcy proceeding does not apply to claims against non-bankrupt co-defendants of a debtor.
Conclusion: In sum, the Court determined that the plaintiffs’ claims were largely direct in nature, and therefore, litigation of those claims would not be affected by the automatic stay entered in accordance with the pending bankruptcy proceedings.