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Barnard v. Verizon Communications

January 31, 2011

TALBOT BARNARD, ET AL., PLAINTIFFS,
v.
VERIZON COMMUNICATIONS, INC., ET AL., DEFENDANTS.



The opinion of the court was delivered by: Pratter, J.

MEMORANDUM

INTRODUCTION

This case arises out of the bankruptcy of Idearc, Inc. ("Idearc"), a former subsidiary of Defendant Verizon Communications ("Verizon"). The Plaintiffs are former equity investors in Idearc, which filed for Chapter 11 protection on March 31, 2009 in the United States Bankruptcy Court for the Northern District of Texas. Their interest in Idearc was extinguished on December 21, 2009, when the Bankruptcy Court confirmed a reorganization plan pursuant to which Idearc cancelled its existing common stock. The Plaintiffs are all members of an unofficial shareholder group that became known as the Spencer Ad Hoc Equity Committee, which participated in -- and vehemently objected to -- the terms of the Bankruptcy Court's reorganization plan.

Idearc became separated from Verizon through a "spin-off" transaction in 2006. The Spencer Committee alleges that Idearc's spin-off and its subsequent bankruptcy were elements of an "elaborate fraudulent scheme," orchestrated mostly by Verizon, which unlawfully and without compensation deprived the Committee members of their Idearc shares. The Committee further claims that a second Defendant, J.P. Morgan Chase Bank ("JPMC" or "the Bank"), participated in aspects of the alleged fraudulent scheme, particularly in its capacity as the administrative and collateral agent for certain Idearc creditors, to whom new stock in the company was issued after its bankruptcy. The reorganized Idearc now goes by the name of SuperMedia, Inc.

The Committee's Second Amended Complaint sets forth seven claims. Count I alleges that Verizon violated the Communications Act of 1934, as amended by the Telecommunications Act of 1996, 47 U.S.C. § 151 et seq. ("the Communications Act"); Counts II and III allege that both Verizon and JPMC violated Section 10(b) of the Securities Exchange Act ("the Exchange Act") of 1934 and Rule 10b-5 promulgated thereunder; Count IV alleges that both Verizon and JPMC committed common-law fraud; Count V alleges that JPMC committed conversion; Count VI alleges that both Verizon and JPMC violated the Committee members' constitutional rights, under the heading of a Bivens claim; and Count VII "reasserts" three of the Committee's first six claims under the heading of a "shareholder direct right of action." This Court has subject matter jurisdiction over these claims pursuant to 28 U.S.C. §§ 1331 and 1367.

Verizon and JPMC have each filed a Motion to Dismiss the Second Amended Complaint, which if granted would dispose of all of the Spencer Committee's claims. For the reasons that are set forth below, each of these two Motions will be granted in full, and Counts I through VII of the Complaint will be dismissed with prejudice.

FACTUAL AND PROCEDURAL BACKGROUND

For the purposes of these motions to dismiss, the facts alleged in the Second Amended Complaint are considered to be true. Conley v. Gibson, 355 U.S. 41, 45 (1957). On that basis, the facts are as follows.

A "spin-off" is a transaction through which a corporation can divorce itself from a subsidiary, creating a new and separate entity and ordinarily distributing complete ownership of that new entity to its own shareholders via a pro rata dividend. In late 2006, Verizon spun off its Yellow Pages publishing business, which became an independent company called Idearc.

In conjunction with this transaction, and before Idearc had become an independent company, two lender banks (J.P. Morgan Ventures and Bear Stearns & Co.), with JPMC acting as their agent, entered into an agreement pursuant to which they would trade approximately $7 billion in previously-held Verizon debt for commensurate Idearc debt. As a result, Idearc began its short life with substantial liabilities. Before its independence, Idearc also issued $2 billion in debt to Verizon itself, as partial consideration for the Yellow Pages operation and an exclusive publishing contract.*fn1 (Idearc also paid cash, and issued all of its own shares to Verizon, which duly distributed them to its own shareholders.) One immediate effect of the spin-off transaction was thus a notable reduction in Verizon's own indebtedness.

On March 31, 2009, less than three years after its spin-off, Idearc filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Northern District of Texas ("the Bankruptcy Court") (Case No. 09-31828). The Plaintiffs in this matter are 17 individuals and one non-profit entity who claim to have held, in aggregate, approximately 6 million shares in Idearc on the day of its Chapter 11 filing.*fn2 It is not known -- because it has not been pled in the Complaint -- when or how or at what price any of the various Plaintiffs' shares were acquired.

The triggering event for the instant lawsuit was the Bankruptcy Court's issuance, on December 21, 2009, of a Confirmation Order which confirmed a Plan of Reorganization for Idearc ("the Plan").*fn3 Under the Plan and Order, Idearc canceled all of its stock -- thus reducing the value of Plaintiffs' stake in Idearc to zero -- and issued new shares to its creditors. The Plan and Order created a Litigation Trust, which was assigned an exclusive right to pursue any claims that might lie against Verizon in connection with the spin-off and debt exchange. The Plaintiffs concede that the sole beneficiaries of the Trust are Idearc's bankruptcy estate and creditors.

As Idearc shareholders, the Plaintiffs were considered parties in interest in the Idearc bankruptcy proceeding, and they participated actively in that matter under the heading of the "Spencer Committee," named for two of its members.*fn4 The counsel for the Committee in the Idearc bankruptcy proceeding was Peter Talbot, who also represents its members in this matter. The Committee sought unsuccessfully to have Idearc's Chapter 11 petition dismissed, alleging, inter alia, that Idearc's bankruptcy was fraudulent, and that Idearc and Verizon had colluded to commit common-law and securities fraud.*fn5 After the Bankruptcy Court issued the Confirmation Order, the Committee filed notice of appeal. It also filed motions that would have rescinded the Confirmation Order and stayed its implementation. These were denied on March 5, 2010.

The Spencer Committee filed this lawsuit on March 25, 2010, and has amended its Complaint twice. Although the Second Amended Complaint suffers from stylistic defects that render many of its allegations puzzling, an essential theory of the case is discernable. According to the Committee, the Idearc spin-off was "a massive, Enron-style debt off-loading" transaction, designed by Verizon to clean up its balance sheet and divest itself of its Yellow Pages business without paying the taxes that would attend an ordinary sale. The Committee asserts that Verizon saddled Idearc with "unsustainable" debt, so that the company was "insolvent" at its genesis. As the agent for two of Verizon's lenders, JPMC facilitated the transfer of Verizon's obligations to Idearc. All of this was done in the expectation that Idearc would soon declare bankruptcy and be recapitalized, with new shares of Idearc stock issuing to its creditors, JPMC's clients.

Given the central role of the Bankruptcy Court in crafting and approving the Plan of Reorganization, the Committee necessarily attacks the integrity of the Idearc bankruptcy. The Second Amended Complaint implies that there is some legal or perhaps logical inconsistency in awarding Idearc's causes of action against Verizon to a Litigation Trust, but barring shareholders from bringing derivative claims on behalf of Idearc or asserting other claims (such as fraudulent conveyance) generally reserved for creditors. It also attacks the valuation that Idearc presented in submissions to the Bankruptcy Court, describing it as "facially preposterous" and "so irrational that expert testimony in support of it should not be allowed." The Complaint suggests that the Bankruptcy Court ought to have held a trial before canceling Idearc's common stock, during which the Committee could have challenged the 2006 Verizon-Idearc debt transaction.*fn6

Verizon and JPMC have each filed a Motion to Dismiss the Second Amended Complaint. Both of the Defendants argue that the Complaint's securities and common-law fraud claims do not satisfy the applicable pleading requirements; that a Bivens claim cannot lie against a private defendant; and that the Committee's "shareholder direct right of action" merely reiterates other claims. In addition, Verizon maintains that the Complaint fails to specify any basis on which it might be liable to Committee members under the Communications Act; and JPMC attests that the Committee's conversion claim is res judicata and at any rate deeply flawed.

On September 20, 2010, the Spencer Committee filed a Motion for Summary Judgment as to Counts II, III, IV and VII of the Second Amended Complaint. This Motion asserts that the central thesis of the Complaint -- viz., that Verizon's transfer of debt to Idearc was invalid -- has been "judicially admitted" by Idearc's litigation trustee in a separate lawsuit that the Litigation Trust has initiated against Verizon (U.S. Bank Nat'l Assoc., Litig. Trustee of the Idearc, Inc., et al. Litig. Trust v. Verizon Communications, et al., Case No. 10-01842 (N.D. Tex. 2010)). The Court has not ruled on the Committee's Motion for Summary Judgment, and will not need to in light of its disposition of the Defendants' Motions to Dismiss.*fn7

On January 10, 2011, the Court denied the Spencer Committee's request that this case be stayed pending the outcome of their appeal of the Bankruptcy Court's Confirmation Order to the Court of Appeals for the Fifth Circuit. The Court concluded that the Committee had not offered any "compelling" rationale for putting the matter in suspense, Stadler v. McCulloch, 882 F. Supp. 1524, 1527 (E.D.Pa. 1995), and observed, inter alia, that the success of the Committee's appeal of the Order will turn on legal questions that are largely distinct from those presented here.*fn8

LEGAL STANDARDS

A motion to dismiss pursuant to FED. R. CIV. P. 12(b)(6) tests the legal sufficiency of a complaint. Conley v. Gibson, 355 U.S. 41, 45-46 (1957). While Rule 8 of the Federal Rules of Civil Procedure requires only "a short and plain statement of the claim showing that the pleader is entitled to relief," FED. R. CIV. P. 8(a)(2), in order to "give the defendant fair notice of what the ... claim is and the grounds upon which it rests," Twombly, 127 S. Ct. at 1964-65 (2007) (quoting Conley, 355 U.S. at 47), the plaintiff must provide "more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Id. (citations omitted).

Specifically, "[f]actual allegations must be enough to raise a right to relief above the speculative level ... ." Id. at 1965 (citations omitted). To survive a motion to dismiss, a civil complaint must allege "factual content [that] allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Ashcroft v. ...


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