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Hangley Aronchick Segal & Pudlin

The Far Reaches of In Pari Delicto in the Lernout Case
The insolvency proceedings of Lernout & Hauspie, a European monolith that built itself into an international leader in the health care speech and language applications market, generated significant ripples here in the United States, as most recently evidenced in last week’s decision from the 1st U.S. Circuit Court of Appeals in Nisselson v. Lernout.

In 2000, Lernout & Hauspie (L&H) aggressively sought out an entry into the American markets. To that end, it approached Dictaphone, an established corporation that had established itself as a force in the industry. L&H wooed Dictaphone by lauding its financial stability and presented Dictaphone with a rosy view of the long-term and profitable synergies that could be achieved by a combination of their two companies.

Dictaphone conducted extensive due diligence. Throughout the due diligence period, L&H’s executives, investment bankers, attorneys and auditors spoke to L&H’s financial prowess. Ultimately, Dictaphone agreed to a merger in which L&H acquired all of Dictaphone’s stock in exchange for L&H stock, valued at almost $1 billion. As part of the merger, L&H set up a Delaware subsidiary corporation (Dark Acquisition Corp.) and transferred all of Dictaphone’s stock into the subsidiary, which was quickly renamed Dictaphone (New Dictaphone).

Under the terms of the merger agreement, New Dictaphone inherited all of Dictaphone’s assets and assumed all of its liabilities. This was all done in accordance with Delaware law. L&H’s chief executive officer, in connection with the merger, doubled as New Dictaphone’s chief executive and only officer; he also signed the merger agreement on Dark’s behalf. The old Dictaphone ceased to exist.

Shortly after the consummation of the merger, the truth about L&H came out — its revenues were not as stated and, in fact, the $70 million net profit it had recorded for the years 1998 through mid-2000 was in fact a net loss of about the same amount. The share price of L&H plummeted and both L&H and New Dictaphone filed for Chapter 11 relief.

New Dictaphone was able ultimately to confirm a plan of reorganization. As part of the Plan, New Dictaphone transferred any claims it might have arising out of the merger to a litigation trust. The trust’s trustee brought suit in federal district court against myriad L&H officers, directors, lawyers, auditors and investment bankers, seeking damages to recover for the “loss or diminution of [old Dictaphone’s] value as a going concern.”

The trustee alleged that over a four year period, the officers, directors, attorneys, auditors and investment bankers of L&H had engaged in a “fraudulent scheme designed to inflate the value of L&H’s stock,” and when the truth came out, rendering the L&H shares given to old Dictaphone worthless, the result was that the consideration given by L&H to old Dictaphone was non-existent. The trustee sued under a variety of federal and state grounded theories including federal securities fraud, common law fraud, unfair trade practices, negligent misrepresentation and conspiracy.

Several of the defendants moved to dismiss the trustee’s complaint. Their primary arguments were that first, the trustee lacked standing, and second, the claims were barred by the in pari delicto doctrine. The district court dismissed the trustee’s case on both grounds, and the trustee appealed.

The 1st Circuit spoke to three distinct issues. The first was whether or not the district court could even consider a motion to dismiss under Fed.R.Civ. P. 12(b)(6) when so many of the allegations of the complaint contained allegations of fact. This argument the circuit court dismissed summarily: “While most Rule 12(b)(6) motions are premised on a plaintiff’s putative failure to state an actionable claim, such a motion may sometimes be premised in the inevitable success of an affirmative defense.”

Dismissing a case under Rule 12(b)(6) based on an affirmative defense requires that the facts establishing the defense are definitively ascertainable from the complaint and other allowable sources of information, and those facts suffice to establish the affirmative defense with certitude. It was in this context, the circuit court stated, that it would view the defendants’ motions to dismiss.

The second issue was whether the trustee had standing to sue. The district court had viewed both the in pari delicto doctrine and the absence of a cognizable injury as issues involving standing, but the circuit court disagreed. In pari delicto, stated the court, does not implicate a plaintiff’s standing but rather constitutes an affirmative defense. However, the court ultimately chose not to deal with the “cognizable injury” issue.

While this issue is often considered first, it is addressed first because the issue often calls into question a federal court’s Article III power to hear a case. Here, at least for purposes of their motions to dismiss, defendants decided to not contest the trustee’s assertion that the conduct attributed to them resulted in an injury that could result in redress. Instead, they argued that even if Article III standing existed, the claims asserted belong exclusively to the old Dictaphone shareholders and thus, prudential standing, rather than Article III standing, was implicated. This type of standing, unlike Article III standing, does not require resolution as an initial matter.

Having so stated, the court elected to not grapple with what it concluded to be an “often elusive distinction between direct and derivative claims”, a distinction with it characterized as “tenebrous.” And because the court believed that it had a clear basis for ruling on the appeal without delving into the issue of standing, it chose to “bypass these uncharted waters” in what it believed were the unique facts presented here, namely, a stock-for-stock merger.

The third issue, and the crux of the court’s opinion, dealt with the in pari delicto affirmative defense. The court began its analysis by recognizing that the doctrine is grounded on two premises — one is that “courts should not lend their good offices to mediating disputes between wrongdoers,” and the second is that “denying judicial relief to an admitted wrongdoer is an effective means of deterring illegality.”

Over time, stated the court, courts have expanded the doctrine’s sweep. Early expansions went so far as to dismissing suits whenever a plaintiff played any role, no matter how modest, in harm-producing activity. As it has evolved, though, the doctrine has evolved into a two-pronged test, covering situations in which a plaintiff bears “at least substantially equal responsibility” for the wrong, and preclusion of the suit would “not interfere with purposes of underlying law or otherwise contravene public policy.”

Here, since the trustee did not request that the district court differentiate between the application of the doctrine as it applies to state law, the court adopted one test, that set forth above.

Using the two-pronged test, the court first addressed the trustee’s argument that the innocent party here is old Dictaphone; after all, it bore no responsibility for the fraud, and certainly bore less responsibility that any of the defendants. The circuit court rejected this argument. Even assuming that old Dictaphone would be a proper party to sue, the trustee overlooked the fact that old Dictaphone ceased to exist by virtue of the merger and any rights the trustee had to make the claims asserted “passes directly through New Dictaphone.”

This chain means that the trustee was not acting in place of and through old Dictaphone, but in place of and through New Dictaphone. The question thus presented was whether New Dictaphone could have asserted these claims pre-bankruptcy in the face of the in pari delicto doctrine, since if New Dictaphone lost those claims pre-petition, the filing of a bankruptcy cannot revive them.

Having concluded that the doctrine must be utilized looking at the trustee as the successor to New Dictaphone, the court concluded that the first “prong” of the doctrine would bar the trustee’s suit. Using state law, the court stated that while generally a parent and subsidiary are separate entities, courts may disregard that separation to defeat fraud practiced by those controlling the subsidiary.

The court concluded that this was a case where application of this exception was appropriate, since both L&H and New Dictaphone were controlled by the same core group — indeed, Dark was, even according to the trustee, created by L&H for the express purpose of furthering the fraud. This conduct, stated the court, must be imputed to New Dictaphone.

The trustee advanced a number of arguments in an attempt to alter the conclusion. First, he argued that the directors of old Dictaphone became directors of New Dictaphone, suggesting that this militated against a finding of control. The court was not swayed; it stated that the it is the unlawful activity at the time the activity occurs that is the focus of the inquiry, and at the time of the activity, L&H was in total control of Dark. Other arguments, including the adverse interest exception to the in pari delicto doctrine, were similarly unavailing — in fact, New Dictaphone actually benefited by the alleged fraud, netting it almost $1 billion (the assumed value of old Dictaphone).

After reviewing the first prong, the court turned to the second prong of the doctrine, namely, the public policy considerations. The trustee argued that use of the doctrine to prevent a recovery for a wrong would frustrate public policy.

In response, the court noted the following: one, the trustee is not bringing suit on behalf of an innocent target, but rather, on behalf of a complicit party; second, to allow the suit would in effect allow New Dictaphone, a perpetrator, to reap the rewards of its actions and then collect again from the defrauders but not for the benefit of those defrauded; and third, that the trustee’s assertion that the recovery would go to those who were the innocent victims was not necessarily correct.

The final argument raised by the trustee was one with seeming appeal. He argued that unless the dismissal were reversed, the innocents — creditors of old Dictaphone — would have no opportunity for redress, as they may not be in privity with the alleged wrongdoers (the lawyers, auditors, investment bankers, officers and directors of L&H).

The court responded by stating the even if the trustee’s premise were true, its holding did not “break any new ground,” and that the potential for default in this case “is something about which creditors had notice — something that should have been priced into their decisions to extend credit. Equity does not require courts to provide a belt when creditors had fair warning that they ought to have purchased suspenders.”

The result is not one most would expect. But then again, the transaction underlying the court’s opinion is not present in the typical case of this type. One thing is certain. The doctrine of in pari delicto is not only alive and well, but can drive some pretty interesting results in certain circumstances.

11-17-2006

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Gunster, Yoakley & Stewart, P.A.

FIRST EVENT FROM ORBIS USA RAISES MONEY FOR KIDS@HOME
Orbis USA, the newly created organization dedicated to bringing together professionals and promoting the South Florida business community, held its Thanksgiving fundraiser at Tarpon Bend on November 9th to benefit Kids@Home. The event raised more than $500 for the organization, which was matched dollar for dollar by Joel Altman, president of the Altman Companies netting the group $1000.

In addition, more than 500 cans, boxes and containers of non-perishable food items were donated.

(l-r) Michael Schimmel and David Scileppi
“It was a wonderful event, bringing together more than 70 professionals who raised money for a great organization and also had a terrific time,” said David Scileppi, an attorney with Gunster Yoakley and co-founder of Orbis.

“We are very gratified by the turn-out and the positive feedback,” added Michael Schimmel, Orbis’s other co-founder, also with Gunster Yoakley. “The group ranged from real estate professionals to educators to human resource specialists and all were looking forward to our next event.”

Kids@Home, a Boca Raton-based non-profit organization providing a comprehensive array of independent living and self-sufficiency care for teenagers who at 18-years-old are aging out of foster care. The goal is to ensure the safety, permanency and well being of teens as they transition from foster care by providing coordination and linkages to housing, education, employment, and caring adults.

11-17-2006

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Gunster, Yoakley & Stewart, P.A.

GUNSTER YOAKLEY MAKES DONATION TO LOCAL UNITED WAY TO HELP FEED THE HUNGRY
To help make this year’s holiday season a little brighter for deserving families in Palm Beach County, the law firm of Gunster, Yoakley & Stewart has made a donation to the Town of Palm Beach United Way that will be used to help feed the hungry throughout the community.

“Gunster is extremely proud to partner with the United Way to provide this much-needed assistance during the holiday season,” said Nicole Atkinson, attorney at Gunster Yoakley and a member of the allocations committee for the Town of Palm Beach United Way. “We are wholly committed to being active members of the community, helping however we can to improve the lives of those around us.”

The Town of Palm Beach United Way is a local, volunteer-driven organization that currently supports 109 vital health and human service programs at 46 local non-profit agencies, and has been aiding in the community for 62 years. Through partnerships, long-term planning and wise investment of donor contributions, the United Way works to create lasting positive changes in Palm Beach County. More than 50 volunteers carefully review agency requests for funding, paying special attention to agency management, program delivery and outcomes, as well as accountability to ensure that donations are really making a difference.

“The life-saving work of the United Way would not be possible without the financial support of local individuals and companies, like Gunster Yoakley,” said Peter Elwell, chairman of the Business and Professional Campaign Committee of the Town of Palm Beach United Way. “We thank the firm for their generous donation and support.

11-17-2006

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Foley Hoag LLP

Foley Hoag Congratulates Mascoma Corporation on Series B Funding
Foley Hoag LLP recently served as legal counsel to Mascoma Corporation in its second round of venture financing. Mascoma, a biomass-to-ethanol company is headquartered in Cambridge, Massachusetts with research and development operations in Hanover, New Hampshire. Mascoma is leading development of unique biotechnology and partnering in deployment of cellulosic production into the ethanol market.

Foley Hoag provides comprehensive legal services to clients throughout the United States and around the world. We serve a wide range of industries including biopharma, energy and utilities, financial services, manufacturing, and technology. With 250 lawyers located in Boston and Washington, D.C. we provide creative solutions and results-oriented advice in the areas of bankruptcy, restructuring and workouts; corporate finance, mergers and acquisitions, and IPOs; labor and employment; litigation; environmental issues and land use; government strategies; intellectual property; tax, trusts and estates; and white collar and business crimes. As a member of Lex Mundi, the global network of independent law firms, we ensure that our clients have access to high-quality legal advice regardless of how far their businesses take them.

11-17-2006

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Choate Hall & Stewart LLP

Choate Co-Sponsors Seminar "EuroStrategies for US Companies: Perspectives on International Technology and Corporate Finance
Choate was proud to co-sponsor "EuroStrategies for US Companies: Perspectives on International Technology and Corporate Finance". This event took place on Nov. 17, 2006, from 7:30am - 11:00am at the MIT Faculty Club.

Europe is home to a substantial number of leading universities and state-of-the-art research facilities as well as promising technologies that might—with the right financing strategy or partner--be commercialized. New Englandboasts a significant number of well established technology-focused venture capitalists and strategic investors. The challenges lies in bringing together technology and investment in both Europe and New England to create emerging enterprises with a foothold in both regions. This forum focused on the substantial opportunities and unique challengesin this effort. Directors and executive officers of private, venture-backed, and public companies with an interest in international corporate finance were encouraged to attend.

11-17-2006

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Brown, Raysman, Millstein, Felder & Steiner, L.L.P.

City of Los Angeles Ordered to Pay Thelen Reid $1.2 Million in Attorneys' Fees
In a first-of-its-kind ruling, a judge in Los Angeles has ordered the City to pay $1.2 million in attorneys' fees after a jury in June rejected claims by the City that a subcontractor had submitted false claims in connection with its work on the Hyperion Waste Water Treatment Plant near LAX.

At a Nov.13 hearing, the court found the City’s false claims case against Chicago Bridge & Iron Company N.V. (CBI) to be clearly frivolous, and ordered the City of Los Angeles to pay CBI’s attorneys' fees. CBI was represented by a Thelen Reid & Priest LLP trial team led by Los Angeles-based partner Timothy Pierce and associate Kaveh Badiei.

“To the best of our knowledge, this is the first time a contractor has recovered its attorneys' fees after defeating a public agency’s charge under the False Claims Act,” Pierce said. “We are hopeful that the result in this case will cause public agencies in California to think twice before automatically asserting a counterclaim for violation of the False Claims Act against contractors seeking to be compensated on public works construction projects.”

CBI was the major subcontractor on a project to upgrade the Hyperion Plant. CBI completed its work in 1997, but has never been paid the remaining $2.2 million it was owed. Although there were no issues with CBI’s work, CBI’s payment claim became entangled in a dispute between the City and the general contractor that went to litigation in 1999. In June, a unanimous jury awarded CBI the full unpaid contract balance and, based on findings by the jury, the court subsequently found the City liable to the contractors for over $18 million of penalties under the California Prompt Payment Statute.

Having successfully defended against the City’s counterclaim, CBI sought recovery of its attorneys' fees under the False Claims Act, which allows a successful defendant to recover its fees if it can demonstrate that the agency’s claims were clearly frivolous.

11-17-2006

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Simpson, Thacher & Bartlett, LLP

Firm Represents China Life Insurance Company in Citigroup-Led Consortium to Acquire Guangdong Development Bank Co., Ltd. for $3.1 Billion
Simpson Thacher recently represented China Life Insurance Company Limited ("China Life"), China's largest life insurer, in its participation in an investor consortium led by Citigroup Inc. to acquire 85.59% of Guangdong Development Bank Co., Ltd. ("GDB"), headquartered in Guangzhou, Guangdong Province, for a total consideration of RMB 24.27 billion (equivalent to US$3.1 billion). China Life will acquire 20% of GBD for RMB 5.67 billion (equivalent to US$720 million), and will be one of three 20.00% shareholders of GDB (including Citigroup). This transaction was noteworthy in a number of respects. It is the largest acquisition to date of a majority stake in a Chinese financial institution. It is also one of the largest takeover battles in China to date as the Citigroup-led consortium competed for over 18 months with two other consortia, including a consortium led by France's Societe Generale.

11-17-2006

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