(D.C. Civil No. 95-cv-01872) (D.C. Civil No. 95-cv-01886) (D.C. Civil No. 95-cv-01872) (D.C. Civil No. 95-cv-01886) On Appeal From the United States District Court For the Western District of Pennsylvania (D.C. Civil Action Nos. 95-cv-01872 and 95-cv-01886)
Before: Stapleton and Rosenn, Circuit Judges, and Restani,* Judge
The opinion of the court was delivered by: Stapleton, Circuit Judge
Opinion Filed November 24, 1998
*Hon. Jane A. Restani, Judge of the United States Court of International Trade, sitting by designation.
This appeal is from a decision in an adversary proceeding brought by plaintiff-appellant/cross-appellee Committee of Creditors Holding Unsecured Claims (the "Committee") against defendant-appellee/cross-appellant Citicorp Venture Capital, Ltd. ("CVC"). The action arises out of the chapter 11 reorganization of Papercraft Corporationfiled in the Western District of Pennsylvania. The Committee claims that CVC, while a fiduciary of Papercraft, secretly purchased millions of dollars of claims against Papercraft at a discount, seeking to control Papercraft's assets and make a profit at the expense of Papercraft's other creditors. CVC contends that the claims were properly purchased and that it acted in the best interests of both the company and its creditors. After a trial, the bankruptcy court entered a judgment against CVC, allowing CVC's purchased claims only to the extent of the discounted amount CVC paid for them and limiting its recovery to the percentage distribution provided in the plan multiplied by that discounted amount. On appeal, the district court agreed with the bankruptcy court's finding that CVC had breached its fiduciary duties, acted inequitably, and caused injury to Papercraft and its creditors. It disagreed, however, with the bankruptcy court's chosen remedy and remanded for a redetermination regarding the appropriate remedial action. This appeal followed.
I. THE FACTS FOUND BY THE BANKRUPTCY COURT*
In 1985, Papercraft completed a leveraged buyout in which CVC invested $5.8 million. As a result of this transaction, CVC was given a 28% equity interest in Papercraft's direct parent, Amalgamated Investment Corp., and the right to seat one representative on the boards of directors of Amalgamated, Papercraft, and Papercraft's wholly-owned operating subsidiaries, Barth & Dreyfuss of California and Knomark, Inc. CVC's vice president, M. Saleem Muqaddam, became CVC's representative on these
boards of directors, and he remained such during the time period relevant to this appeal.
Papercraft ran into financial difficulties a few years after the transaction, which forced a restructuring of the leveraged buyout ("LBO") debt. As part of the restructuring, Papercraft exchanged about 98% of its indebtedness for new First Priority Notes and Second Priority Notes. However, beginning in 1990, Papercraft was unable to meet the terms of the notes and sought to negotiate a second restructuring of its unsecured debt. An informal committee of major Papercraft creditors was formed and, after several months of negotiations, an agreement was reached on a restructuring plan. The plan, known as the "BDK plan," called for a merger of Papercraft's operating subsidiaries (Barth & Dreyfuss and Knomark) into a single entity, BDK Holdings, Inc., as part of a voluntary chapter 11 petition to be filed by Papercraft. The creditors' claims against Papercraft would then be converted into "BDK Units" consisting of stock and bonds issued by the new venture. The BDK plan was approved unanimously by Papercraft's directors, including CVC's Muqaddam, in March 1991.
Papercraft filed its voluntary petition under chapter 11 on March 22, 1991. As of the filing date, Papercraft had outstanding $90.7 million in First Priority Notes and $56.3 million in Second Priority Notes, none of which were held by CVC. Pursuant to the agreement among the creditors, Papercraft filed the BDK plan with the chapter 11 petition and an official Committee was formed to represent the interests of unsecured creditors.
Though the chapter 11 petition and BDK plan werefiled in March 1991, the required Papercraft disclosure statement, a prerequisite to confirmation of the plan, was not filed until October 1991. During this delay, CVC managed to purchase over 40% of the outstanding notes, at a significant discount. CVC, despite its earlier support of the BDK plan, then objected to the confirmation of that plan and offered its own competing plan, which called for a CVC purchase of Papercraft's assets. An account of the specific circumstances under which CVC took these actions follows.
In March 1991, Muqaddam, in a memorandum to CVC's Investment Committee, sought authorization to spend up to $10 million purchasing Papercraft notes. CVC officials granted the request in April 1991. Muqaddam, acting for CVC, then began making anonymous purchases of notes through various brokers. Between April and August 1991, CVC purchased $60,849,575.72 face value of the Papercraft notes for $10,553,541.88. These purchases represented a significant proportion of the outstanding Papercraft debt: CVC managed to acquire 38.3% of Papercraft's outstanding First Priority Notes and 46.4% of outstanding Second Priority Notes. In all, CVC's purchases amounted to 40.8% of Papercraft's total unsecured claims. It thus achieved a "blocking" position in the proposed reorganization. Although Muqaddam was a member of Papercraft's board, and therefore a fiduciary to the company and its creditors, neither he nor anyone else from CVC requested or obtained the approval of the board, the Committee, or the court before purchasing the notes. Nor did CVC disclose to any of the selling creditors its identity as buyer or itsfiduciary status.
At the same time CVC was surreptitiously purchasing claims, it also requested or otherwise obtained confidential information about Papercraft's financial stability and assets, including information that was not shared with Papercraft's other creditors. In early 1991, at Muqaddam's direction, two CVC employees visited the headquarters of Papercraft's Barth & Dreyfuss subsidiary to obtain information. During that visit, CVC copied financial statements, looked at the company's product lines, held meetings with management, and toured the facilities. A written report was subsequently completed by CVC, drafts of which were shared with Papercraft personnel. Indeed, Frank Kane, Papercraft's Chief Financial Officer, reviewed the report and gave comments directly to Muqaddam. None of this information was shared with the Committee. Papercraft personnel also forwarded a number offinancial analyses and other documents directly to CVC, including a tax analysis that had been completed by a consultingfirm at Muqaddam's request. In addition, a valuation of Papercraft assets and a distressed sale analysis completed
by Chanin and Company, the Committee's own financial advisor, was given to CVC by Papercraft personnel.
As CVC accumulated Papercraft debt and information between April and August 1991, it also formulated a reorganization plan designed to compete with the previously filed BDK plan. Muqaddam and his staff prepared a series of reports evaluating the possibility of a CVC asset purchase offer. These reports were based, in large part, on the information about Papercraft that had been forwarded to CVC by Kane. In the course of preparing an asset purchase offer, Muqaddam held a meeting with Kane and the Bank of New York Credit Corporation ("BNYCC") to discuss financing for a CVC asset purchase offer. Muqaddam then prepared a memorandum to CVC's Investment Committee requesting authorization to purchase Papercraft's assets. This authority was granted to Muqaddam in August 1991.
In early September 1991, CVC formalized an asset purchase offer by sending a letter to Papercraft detailing the plan and announcing a financing arrangement with BNYCC. Shortly before this announcement, Muqaddam informed the Committee, for the first time, that CVC had been purchasing claims. Soon after the asset purchase offer was announced, it was filed as a plan of reorganization by Papercraft. Papercraft also filed disclosure statements for both the BDK plan and the CVC plan in October 1991.
The BDK plan disclosure statement was approved by the bankruptcy court at a hearing in December 1991. Shortly thereafter, CVC withdrew its plan of reorganization, but then filed objections to confirmation of the BDK plan. The bankruptcy court ...