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Derivative Standing Denied to Bring Claims for Recharacterization, Equitable Subordination and Breach of Fiduciary Duties

By Charlene D. Davis

On May 13, 2014, Judge Brendan Shannon of the United States Bankruptcy Court in Delaware entered an order and issued a decision denying a motion for derivative standing to pursue claims in In re: Optim Energy, LLC (Case No. 1410262 (BLS) against pre and post-petition lenders, who were also equity holders, for recharacterization, equitable subordination and breach of fiduciary duties. The Court found that the movant, Walnut Creek Mining Company (“Walnut Creek”), had failed to state colorable claims in the proposed complaint against the lenders/equity holders Cascade Investments, LLC (“Cascade”) and ECJV Holdings, LLC (“ECJV”). Colorable claims is one of three circumstances that the Third Circuit has held that a party seeking derivative standing must demonstrate. See Official Committee of unsecured creditors of Cybergenices Corp. ex rel. Cybergenics Corp. v. Chinery 330 F.3d 548 (3d Cir. 2003).

The Debtors own and operate three power plants in Texas. Each of the debtors is wholly owned indirectly by Cascade through its wholly owned subsidiary ECJV. ECJV owns one of the debtors, Optim Energy, LLC (“Optim Energy”) directly and the other two debtors indirectly through its own wholly owned subsidiary. In turn, Cascade is owned by PNM Resources, Inc. (“PNMR”), an energy holding company.

In early 2007, PNMR and Cascade (through ECJV) formed Optim Energy. Optim Energy was initially capitalized with $10.00 by each of ECJV and PNMR and $2.5 million from each for operating expenses.

Within 5 months, in May of 2007, Optim Energy sought to acquire the Altura Cogen Plant but needed to finalize a deal with Wells Fargo Bank National Association (“Wells Fargo”) for financial support for the bid. In the interim, according to board minutes, Optim Energy’s President advised that PNMR agreed (i) to provide a guaranty (contingent on a back-up guaranty for half of the obligation from Cascade) and (ii) to treat any payments on the guarantees as capital contributions. Subsequently, on June 1, 2007, a series of transactions occurred.

  • PNMR contributed its ownership of Altura Power L.P. (“Twin Oaks”) and its Twin Oaks plant to Optim Energy for an agreed fair market value of $553.8 million.
  • ECJV made a cash contribution to Optim Energy of $276.9 million and Optim Energy distributed the cash to PNMR, making PNMR and ECJV each 50% owners.
  • Optim Energy entered into a five year unsecured credit facility with Wells Fargo with initial availability of $1 billion (the “WF Credit Facility”).
  • Cascade and ECJV jointly and severally guaranteed the WF Credit Facility (the “WF Guarantees”).
  • Optim Energy entered into an agreement to reimburse Cascade and ECJV for any payments made on the WF Guarantees which payments were explicitly described as indebtedness not capital contributions (the “Guaranty Reimbursement Agreement”).
  • Optim Energy gave Cascade and ECJV a security interest in substantially of the Debtors assets to secure obligations under the WF Guarantee (the “Security Agreement”).

Later in June 2007, Optim Energy distributed $87.5 million to each of ECJV and PNMR from the WF Credit Facility and in August 2007, it acquired the Altura Cogen plant for $477.9 million, funded by cash contributions of $42.5 million from each of PNMR and ECJV and borrowings under the WF Credit Facility. Altura Cogen LLC pledged its real property including the Altura Cogen Plant to Cascade and ECJV. In August 2007, Optim Energy began a project with NRG Energy, Inc. to develop the Cedar Bayou Plant and EnergyCo Cedar Bayou 4, LLC pledged all of its real property including the Cedar Bayou Plant to Cascade and ECJV.

In 2008, the WF Credit Facility was increased to $1.12 billion and ECJV, PNMR and Optim Energy entered into a Contribution Agreement pursuant to which ECJV and PNMR each made a $15 million capital contribution and agreed to four additional quarterly capital contributions. The proceeds of the 2008 capital contributions were to be used, in part, to pay down the WF Credit Facility.

In 2011, the WF Credit Agreement was amended to remove Optim Energy’s representation of solvency. In September of 2011, Optim Energy was restructured to reduce PNMR’s ownership to 1% and increase ECJV’s ownership to 99% and ECJV made a capital contribution of $5 million to pay down loans on the WF Credit Facility. The documentation expressly described the funds as a capital contribution.

In January 2012, ECJV exercised an option to purchase PNMR’s 1% interest in Optim. The interest was valued at $0. At the end of the following year, 2113, the Debtors failed to pay a guarantee fee due Cascade under the Guaranty Reimbursement Agreement; entering into a forbearance agreement with Cascade and ECJV instead.

On February 11, 2014, Cascade wired funds equal to the amount outstanding under the WF Credit Facility to a new account at Wells Fargo. The following day, February 12, 2014, the Debtors filed bankruptcy and Wells Fargo set-off the funds in Cascade’s new account against the amount due under the WF Credit Facility, triggering the Debtors’ obligations under the Guaranty Reimbursement Agreement and Security Agreement. Following the filing, the Bankruptcy Court approved debtor-in-possession financing from Cascade and ECJV in an order that set deadlines for any committee and for parties other than a committee to challenge the pre-petition indebtedness claimed by Cascade and ECJV. No committee was appointed, but Walnut Creek, the largest unsecured creditor, filed a motion asking the Court to grant it standing to challenge the pre-petition obligations on the basis of recharacterization, equitable subordination and breaches of fiduciary duties.

Despite the seemingly complex structure of the Debtors’ financial arrangements with Cascade and ECJV, the Court had little difficulty denying the motion because Walnut Creek failed to plead colorable claims in its proposed complaint. First, the Court found that the claims of breach of fiduciary duty were not sustainable, since Delaware limited liability companies may eliminate the fiduciary duties of directors or members by provisions in operating agreements and Optim Energy had done just that in 2011. Second, the Court found that ‘the many transactions and financial arrangements that give rise to Cascade and ECJV’s secured claims were structured and intended as debt obligations that are not susceptible to recharacterization as equity contributions”. Third, the Court found that, even using the rigorous scrutiny standard applicable to the conduct of insiders, there were no allegations of inequitable conduct on the proposed complaint. As a consequence, Walnut Creek was denied derivative standing to pursue these challenges.

A copy of the opinion can be found here.

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