Derivative Standing to Pursue Recharacterization, Equitable Subordination, and Breach of Fiduciary Duty Claims on behalf of Debtors Optim Energy, LLC Denied by Bankruptcy Court

In re Optim Energy, LLC, No. 14-10262 (BLS), 2014 WL 1924908 (Bankr. D. Del. May 13, 2014)

On May 13, 2014, the Honorable Brendan L. Shannon issued an Opinion denying an unsecured creditor’s request for derivative standing to pursue claims on behalf of debtor Optim Energy, LLC (“Optim Energy”) and its affiliated debtors (collectively, the “Debtors”) for recharacterization, equitable subordination, and breach of fiduciary duties against direct and indirect non-debtor owners, ECJV Holdings, LLC (“ECJV”) and Cascade Investments, L.L.C. (“Cascade”).  Walnut Creek Mining Company (“Walnut Creek”), the Debtors’ largest non-insider general unsecured creditor, alleged that the insiders engaged in a scheme that transformed them from 100% equity holders to senior secured lenders holding claims in excess of $700 million secured by first priority liens on substantially all of the Debtors’ assets.  Despite Walnut Creek’s allegations of, inter alia, undercapitalization and inequitable conduct, the Court found the allegations insufficient to support colorable claims warranting derivative standing.

By way of background, in 2007, Cascade (through ECJV) and PNM Resources, Inc. (“PNMR”) formed Optim Energy as a Delaware limited liability company.  To support its funding needs, Optim Energy entered into an unsecured credit facility (the “Wells Fargo Credit Facility”) with Wells Fargo Bank (“Wells Fargo”).  Optim Energy’s obligations under the Wells Fargo Credit Facility were guaranteed jointly and severally by Cascade and ECJV, and the Debtors agreed to reimburse Cascade and ECJV for any payments made to Wells Fargo pursuant to the guarantees.  As a result of the reimbursement agreement, the Debtors were required to pay quarterly fees to Cascade, as collateral agent, and Cascade and ECJV took security interests in substantially all of the Debtors’ assets.  Wells Fargo, Cascade, and ECJV agreed that the guarantee claims of Cascade and ECJV would be subordinate to those of Wells Fargo under the facility.  In 2010, PNMR and ECJV made additional contributions, which were used to pay down the Wells Fargo Credit Facility.  In 2011, PNMR, Cascade, and ECJV restructured Optim Energy, which led to additional contributions by ECJV that were used to pay down the Wells Fargo Credit Facility further and to purchase PNMR’s interest in Optim Energy.

In 2013, the Debtors fell behind on payments to Cascade in the amount of $1.934 million.  The parties entered into a forbearance agreement that expired February 14, 2014.  On February 11, 2014, as the Debtors prepared to enter into bankruptcy, Cascade satisfied all of the Debtors’ outstanding obligations under the Wells Fargo Credit Facility.  This payment triggered the Debtors’ obligations to reimburse Cascade and ECJV, and Cascade and ECJV became the Debtors’ senior secured lenders with liens on substantially all of the Debtors’ assets.

The Court’s analysis began by easily dispensing with Walnut Creek’s claims grounded in breach of fiduciary duty.  Optim Energy’s members eliminated any fiduciary duties owed to Optim Energy, any member, or any other party in Optim Energy’s operating agreement, which is permitted under Delaware’s Limited Liability Company Act.  See 6. Del. Code § 18-1002(c).

With respect to the recharacterization claim, the Court did not find sufficient indicia to support that Cascade and ECJV intended their secured claims to be disguised as equity contributions — the  overarching inquiry to any recharacterization dispute.  See Cohen v. KB Mezzanine Fund II, LP (In re SubMicron Sys. Corp.), 432 F.3d 448, 455-56 (3d Cir. 2006).  The Court acknowledged the complicated nature of the analysis given the dual roles Cascade and ECJV maintained as equity holders and lenders, but held that the transactions between the parties demonstrated that they “were able to clearly identify and document debt versus equity arrangements.”  Importantly, the parties specifically documented that the Debtors’ reimbursement obligations were to constitute indebtedness and were “not . . . [to] be treated as an equity or capital contribution by [Cascade and ECJV].”  Likewise, the documents governing ECJV’s 2010 and 2011 capital contributions clearly stated that the parties intended the payments as equity.  Additionally, the Court found no support that Optim Energy was undercapitalized during the 2007 transactions given the existence of the Wells Fargo Credit Facility.  It highlighted that Optim Energy was not experiencing liquidity problems in 2007 and was able to satisfy its operating costs during the seven years prior to bankruptcy.   Finally, the Court found significant that (i) ECJV’s shares in Optim Energy remained equal with PNMR following the guarantee and reimbursement agreements, (ii) the 2007 grants of security to Cascade and ECJV by the guarantee and reimbursement agreements resulted from demands made by Wells Fargo, and (iii) the agreement to subordinate Cascade and ECJV’s secured obligations was limited to the claims of Wells Fargo and not an atypical financial arrangement.

The Court disposed of Walnut Creek’s final claim for equitable subordination because it was unable to allege any inequitable conduct, even under the more stringent standard for insiders.  Cascade and ECJV fulfilled their obligations under the guarantees, and the results thereof simply arose from the long-standing agreements between the parties.

Equally important as the legal principles it stands for, the Optim Energy Opinion shows the speed with which the Delaware Bankruptcy Court can hear, analyze, and adjudicate complex issues.  In less than one month’s time, the issues were fully briefed, argued, and ultimately decided by the Court.  The Opinion has been appealed, and while the issues quickly moved through the Bankruptcy Court, they are likely to grind to a halt in the Delaware District Court given its overwhelming docket.  Check back for further developments.