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UNITED STATES DISTRICT COURTSOUTHERN DISTRICT OF TEXAS

HOUSTON DIVISION

12261 FONDREN, LLC, individually § and derivatively on behalf of §Riverbank Realty, LP, §

Plaintiff, §§

vs. §§

RIVERBANK REALTY GP, LLC, §ALLEN GROSS, and § CIVIL ACTION NO. 4:09-cv-04074GFI MANAGEMENT SERVICES, INC., §

Defendants §§

- and - §§

RIVERBANK REALTY, LP, §Nominal Defendant §

MEMORANDUM OF LAW IN SUPPORT OF DEFENDANTS’ PARTIAL MOTION TO DISMISS

Case 4:09-cv-04074 Document 11 Filed in TXSD on 02/26/10 of 28

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TABLE OF CONTENTS

Page

I. SUMMARY OF THE ARGUMENT..........................................................................................1

II. FACTUAL AND PROCEDURAL BACKGROUND ..............................................................1

A. The History of the Property and the Loan ...............................................................1

B. The Proceedings Initiated by Plaintiff .....................................................................4

III. ISSUES AND LEGAL STANDARD ......................................................................................5

IV. ARGUMENT AND AUTHORITIES ......................................................................................7

A. Delaware Law Applies to the Breach of Fiduciary Duty Claims ............................7

B. Plaintiff Has Failed to State a Claim for Which Relief Can Be Granted ................8

C. Plaintiff’s Breach of Duty of Care Claim Must Be Dismissed..............................12

D. Plaintiff’s Breach of Duty of Loyalty Claims Must Be Dismissed .......................15

E. Plaintiff Has Failed to State a Claim for Aiding and Abetting and Conspiracy....18

F. Plaintiff Has Failed to State a Claim for Alter-Ego...............................................19

V. CONCLUSION .......................................................................................................................21


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TABLE OF AUTHORITIES

Page

Federal Court CasesAlberto v. Diversified Group, Inc.,

55 F.3d 201 (5th Cir. 1995) .......................................................................................................19American Fuel Corp. v. Utah Energy Development Co.,

122 F.3d 130 (2d Cir. 1997) ......................................................................................................19Ashcroft v. Iqbal,

129 S. Ct. 1937 (2009) ............................................................................................................5, 6Bell Atl. Corp. v. Twombly,

550 U.S. 544 (2007) ....................................................................................................................5Chambers v. Time Warner, Inc.,

282 F.3d 147 (2d Cir. 2002) ........................................................................................................7C-T of Virginia, Inc. v. Barrett,

124 B.R. 689 (W.D. Va. 1990), aff'd, 958 F.2d 606 (4th Cir. 1992)...........................................8In Re Currency Conversion Fee Antitrust Litigation,

265 F. Supp. 2d 385 (S.D.N.Y. 2003) .......................................................................................20In re Marvel Entertainment Group, Inc.,

273 B.R. 58 (D. Del. 2002)........................................................................................................15In re Newbridge Networks Sec. Litig.,

926 F. Supp. 1163 (D.D.C. 1996)................................................................................................6Klaxon Co. v. Stentor Elec. Mfg. Co.,

313 U.S. 487, 61 S. Ct. 1020, 85 L. Ed. 1477 (1941) .................................................................7Kowal v. MCI Commc’ns Corp.,

305 U.S. App. D.C. 60, 65-66, 16 F.3d 1271, 1276-77 (1994) ...................................................6Labajo v. Best Buy Stores, L.P.,

478 F. Supp. 2d 523 (S.D.N.Y. 2007) .........................................................................................7LaSalle Nat'l Bank v. Perelman,

141 F. Supp. 2d 451 (D. Del. 2001) ............................................................................................8Powers v. British Vita, PLC,

969 F. Supp 4 (S.D.N.Y. 1997) ...................................................................................................8Sysco Food Service of Metro New York, LLC v. Jekyll & Hyde, Inc.,

2009 WL 4042758 (S.D.N.Y. Nov. 17, 2009) ..........................................................................20Tellabs, Inc. v. Makor Issues & Rights, Ltd.,

551 U.S. 308 (2007) ....................................................................................................................6Torch Liquidating Trust v. Stockstill,

561 F.3d 377 (5th Cir. 2009) ...............................................................................................10, 14Yamaha Motor Corp., U.S.A. v. United States,

779 F. Supp. 610 (D.D.C. 1991)..................................................................................................6

State Court CasesAllied Capital Corp. v. GC-Sun Holdings, L.P.,

910 A.2d 1020 (Del. Ch. 2006) .................................................................................................18Aronson v. Lewis,

473 A.2d 802 (Del. 1984)..........................................................................................................15


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BelCom Inc. v. Robb,1998 WL 229527 (Del. Ch. 1998).............................................................................................16

Brehm v. Eisner,746 A.2d 244 (Del. 2000)..........................................................................................................12

Data Mgmt. Internationale, Inc. v. Saraga,2007 WL 2142848, at *3 (Del. Super. Ct. July 25, 2007).........................................................14

Geyer v. Ingersoll Publications Co.,621 A.2d 784 (Del. Ch. 1992) .....................................................................................................8

Gilbert v. El Paso Co.,490 A.2d 1050 (Del. Ch. 1984), aff'd, 575 A.2d 1131 (Del. 1990)...........................................18

Globis Partners, L.P. v. Plumtree Software, Inc.,2007 WL 4292024, at *15 (Del. Ch. Nov. 30, 2007) ................................................................18

Gotham Partners, L.P. v. Hallwood Realty Partners, L.P.,2000 WL 1476663 (Del. Ch. Sept. 27, 2000)..............................................................................8

Guth v. Loft, Inc.,5 A.2d 503 (Del. 1939)..............................................................................................................16

In re American Intern. Group, Inc.,965 A.2d 763 (Del. Ch. 2009) ...................................................................................................18

In re J.P. Stevens & Co. S'holders Litig.,542 A.2d 770 (Del. Ch. 1988) ...................................................................................................15

In re Walt Disney Co. Derivative Litig.,907 A.2d 693 (Del. Ch. 2005), aff'd, 906 A.2d 27 (Del. 2006).................................................12

Ivanhoe Partners v. Newmont Mining Corp.,535 A.2d 1334 (Del. 1987)........................................................................................................16

Katz v. Oak Indus., Inc.,508 A.2d 873 (Del. Ch. 1986) .....................................................................................................8

Kuroda v. SPJS Holdings, L.L.C.,971 A.2d 872 (Del. Ch. 2009) ...................................................................................................14

Malpiede v. Townson,780 A.2d 1075 (Del. 2001)........................................................................................................19

Morris v. New York State Dep't of Taxation & Fin.,623 N.E.2d 1157 (N.Y. 1993) ...................................................................................................19

North American Catholic Educational Programming Foundation, Inc. v. Gheewalla,930 A.2d 92 (Del. 2007)........................................................................................................9, 13

Orman v. Cullman,794 A.2d 5 (Del. Ch. 2002) .........................................................................................................8

Production Resources Group, L.L.C. v. NCT Group, Inc.,863 A.2d 772 (Del. Ch. 2004) ...............................................................................................8, 14

Schoon v. Smith,953 A.2d 196, 206 (Del. 2008)....................................................................................................8

Sinclair Oil Corp. v. Levien,280 A.2d 717 (Del. 1971)..........................................................................................................15

Smith v. Van Gorkom,488 A.2d 858 (Del. 1985)......................................................................................................8, 15

Solash v. Telex Corp.,1988 WL 3587 (Del. Ch. Jan. 19, 1988) ...................................................................................15


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Solomon v. Pathe Communications Corp.,1995 WL 250374 (Del. Ch. April 21 1995) ..............................................................................17

Steinman v. Levine,2002 WL 31761252 (Del. Ch. Nov. 27, 2002) ..........................................................................16

Trenwick America Litigation Trust v. Ernst & Young, L.L.P.,906 A.2d 168 (Del. Ch. 2006), aff'd mem., 931 A.2d 438 (Del. 2007) .....................................18

Weinberger v. UOP, Inc.,457 A.2d 701 (Del. 1983)..........................................................................................................16

StatutesTEX. BUS. CORP. ACT ANN. art. 8.02 (West 2009) ..........................................................................7TEX. BUS. ORGS. CODE ANN. § 1.104..............................................................................................7TEX. REV. LIMITED PARTNERSHIP ACT. art. 6132a–1 § 9.01(a) (Tex. Rev. Civ. Stat. Ann. (Vernon

Supp. 2009)..................................................................................................................................7


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Riverbank Realty GP, LLC (“Borrower GP”), Allen Gross (“Gross”), and GFI

Management Services, Inc. (“GFI Management”) (collectively, the “Defendants”) submit this

Memorandum of Law in Support of Defendants Partial Motion to Dismiss and respectfully state

as follows:

I. SUMMARY OF THE ARGUMENT

1. This case is, fundamentally, a contract case. It involves an alleged breach of a

non-recourse guaranty agreement with very limited carve-outs and should be nothing more.

Yet, faced with a potential deficiency and limited rights against Mr. Gross as guarantor, 12261

Fondren, LLC (“Plaintiff”) has tried to turn this case into something much more complicated.

The reason is obvious: the limited guaranty from Mr. Gross provides for a minor recovery, if

anything. Not to be deterred by the agreement between the parties, Plaintiff has tried to construct

a Complaint, in which a simple breach of contract case has been distorted into a derivative

breach of fiduciary duty claim with trumped up claims for alter-ego, aiding and abetting, and

conspiracy tossed in for good measure.

2. As set forth in this Memorandum, Plaintiff’s claims cannot withstand legal

scrutiny. Accordingly, Plaintiff’s claims for breach of fiduciary duty, alter-ego, aiding and

abetting, and conspiracy should be dismissed.

II. FACTUAL AND PROCEDURAL BACKGROUND

A. The History of the Property and the Loan

3. The Riverbank Apartments are a Class C apartment complex located at 12261

Fondren Road in Houston, Texas (the “Property”). The Property is approximately 30 years old

and comprised of 320 residential apartments. The Property was acquired by Riverbank Realty,


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L.P. in 2002 and has been managed by GFI Management since that time.1 Despite the fact that

the tenant profile for this Property (especially post-Hurricane Katrina) is one of high turnover

with a high rate of delinquent rental payments, the occupancy rate at the Property remained

above 80% until the unfortunate events of 2008, as further described below.

4. On or about March 7, 2006, Riverbank Realty, L.P. (the “Borrower”) executed

that certain Promissory Note (the “Note”), as maker, payable to the order of CIBC Inc., as payee,

in the original principal amount of $8,600,000.00. See Exhibit 1 to Plaintiff’s Original

Complaint. This was a refinance of an existing loan on the Property. The Note was secured by

the Deed of Trust, Assignment of Leases and Rents and Security Agreement (the “Deed of

Trust”) executed on or about March 7, 2006. See Exhibits 2 and 3 to Plaintiff’s Original

Complaint.

5. On or about March 7, 2006, Allen Gross executed the Indemnity and Guaranty

Agreement (the “Guaranty”) in connection with the Note and Deed of Trust. See Exhibit 4 to

Plaintiff’s Original Complaint. The Guaranty was non-recourse, with exception of certain

contractual carve-outs that were defined in the Guaranty. Id. Specifically, the Guaranty did not

guaranty any portion of principal or interest under the Note. Id.

6. On or about September 15, 2006, the Note, Deed of Trust, and Guaranty were

assigned to the J.P. Morgan Chase Commercial Mortgage Securities Trust 2006-CIBC16 (the

“Trust”). See Exhibit 5 to Plaintiff’s Original Complaint. 2 Wells Fargo Bank, N.A. is the trustee

1 GFI Management manages approximately 9,600 apartment units in the Houston area and 20,000 units in the United States.

2 However, the Allonge that allegedly transferred the Note to the Trust, attached as Exhibit 5 to the Complaint, is not dated.


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for the Trust and Midland Loan Services, Inc. (“Midland”) is the special servicer for the Trust.3

As the servicer, Midland is the party that determines whether the loan should be refinanced,

worked out, or sent to foreclosure. Upon information and belief, Midland is the party that is

directing this litigation.

7. Until 2008, the Property was owned and managed without incident. However, the

events of 2008 had a devastating impact. First, the effects of the financial and economic collapse

were felt by the tenant base at the Property. Many of the tenants were hourly wage earners who

lost their jobs as a result of the economic crisis. These tenants were forced to vacate the Property

or became delinquent on their rental payments. Second, Hurricane Ike made landfall in the

Houston area on September 13, 2008 and caused significant damage to the Property.

8. While the Property was covered under GFI Management’s master liability policy,

the insurance claim process has been slow with minimal recovery. To make matters worse, the

primary carrier under the insurance policy is AIG, which found itself in the middle of a

government bailout and a host of other problems at the end of 2008 and 2009. In total, the

Property has received less than $30,000 in insurance proceeds from the damages caused by

Hurricane Ike, all of which has been applied to the costs of maintaining, repairing, and restoring

the Property, thereby protecting Plaintiff’s collateral. Yet, with no contractual obligation to do

so, GFI Management and other affiliated entities loaned almost $475,000 of their own funds to

the Property for rehabilitation and repairs for the damages caused by Hurricane Ike inuring to the

benefit of the Property and the Plaintiff.

9. At the end of 2008, it became increasingly clear that the Property was in distress

and the loan needed to be restructured and representatives of the Borrower and GFI immediately

3 The Trust is a Real Estate Mortgage Investment Conduit (“REMIC”), which is afforded certain tax advantages under the Internal Revenue Code (the “Tax Code”) and to maintain those advantages it must comply with the restrictions prescribed by the Tax Code.


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reached out to the Trust and Midland. Despite significant effort by the Borrower and its

representatives to refinance the Note or implement a strategy that would allow for additional

capital to be invested in the Property, the negotiations, if they can be called that, with Midland

were unsuccessful. Ultimately, Midland refused to sit down and talk with the Borrower or its

representatives about the problems facing the Property or to visit the Property with the Borrower

despite repeated requests to do so.

B. The Proceedings Initiated by Plaintiff

10. Unexpectedly, Midland threatened the appointment of a receiver through an

emergency, ex parte proceeding. Ultimately, on May 29, 2009, Wells Fargo, on behalf of the

Trust, filed its Original Petition and Application for Appointment of Receiver and Temporary

Restraining Order in the 234th Judicial District Court of Harris County, Texas.

11. In the continued effort of cooperation, the Borrower consented to the appointment

of a receiver and on July 10, 2009, the Court entered an Agreed Order Granting Plaintiff’s

Application for Appointment of a Receiver. At the time the receiver was appointed and took

possession, occupancy at the Property was approximately 82%.

12. On or about November 19, 2009, the Note, Deed of Trust, and Guaranty were

assigned by the Trust to the Plaintiff.

13. Refusing to negotiate a much needed restructuring of the loan, Plaintiff moved

forward with the foreclosure. On December 1, 2009, the Property was sold at a nonjudicial

foreclosure sale for $3,970,000.00.

14. Despite Defendants’ efforts to work with Midland at every turn and suggesting

multiple alternatives and solutions to resolve the disputes between the parties, Midland continued

to put its head in the sand and force the parties down the litigation path. In this case, Plaintiff or


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Midland is seeking alleged deficiency damages that are approximately 80% of the face amount

of the Note, even though the Trust received principal and interest payments for over 2 years and

took title to the Property by virtue of their credit bid at the foreclosure.

15. Knowing that the Guaranty does not cover its vastly overstated deficiency

damages, Plaintiff has asserted claims for breach of fiduciary duty, aiding and abetting breach of

fiduciary duty, conspiracy, and alter-ego in the hope that it can recover damages well beyond

what is contemplated by the express contract between the parties or what is permitted to be

recovered under applicable law. There is no legal basis for these claims, and as set forth more

fully below, they must be dismissed.

III. ISSUES AND LEGAL STANDARD

16. This Motion asks the Court to determine whether the Plaintiff has sufficiently

pled its claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty,

conspiracy, and alter-ego. As set forth below, the claims of breach of fiduciary duty, aiding and

abetting, and conspiracy are governed by Delaware law and the claim for alter-ego is governed

by New York law. However, the standard of review for each claim is consistent.

17. To survive a motion to dismiss under Rule 12(b)(6), a complaint must “contain

sufficient factual matter . . . to ‘state a claim to relief that is plausible on its face.’” Ashcroft v.

Iqbal, 129 S. Ct. 1937, 1949 (2009) (citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570

(2007)). To satisfy this threshold, a plaintiff must “plead[] factual content that allows the court

to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id.

This “requires more than labels and conclusions, and a formulaic recitation of the elements of a

cause of action . . . . Factual allegations must be enough to raise a right to relief above the

speculative level.” Twombly, at 555 (citations omitted).


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18. To implement the standards set forth in Twombly and Iqbal, a court confronted

with a motion to dismiss should adhere to a “two-pronged approach.” Iqbal, 129 S. Ct. at 1950.

First, “a court . . . can . . . begin by identifying pleadings that, because they are no more than

conclusions, are not entitled to the assumption of truth. While legal conclusions can provide the

framework of a complaint, they must be supported by factual allegations.” Id. Second, “[w]hen

there are well-pleaded factual allegations, a court should assume their veracity and then

determine whether they plausibly give rise to an entitlement to relief.” Id. This is a “context-

specific task that requires the reviewing court to draw on its judicial experience and common

sense.” Id. The complaint must be dismissed if the factual allegations “do not permit the court

to infer more than the mere possibility of misconduct.” Id.

19. While a court considering a motion to dismiss should construe the complaint

liberally, it is not “required to draw argumentative inferences in favor of the plaintiffs.” Yamaha

Motor Corp., U.S.A. v. United States, 779 F. Supp. 610, 611 (D.D.C. 1991). Nor must a court

accept unsupportable or absurd inferences asserted in the complaint, or legal conclusions cast as

factual allegations. See Kowal v. MCI Commc’ns Corp., 305 U.S. App. D.C. 60, 65-66, 16 F.3d

1271, 1276-77 (1994); In re Newbridge Networks Sec. Litig., 926 F. Supp. 1163, 1168 (D.D.C.

1996) (“[T]he court need not accept inferences drawn by plaintiffs if such inferences are

unsupported by the facts set out in the complaint.”).

20. In considering a motion to dismiss, the Court should “consider the complaint in its

entirety, as well as other sources courts ordinarily examine when ruling on Rule 12(b)(6)

motions to dismiss, in particular, documents incorporated into the complaint by reference, and

matters of which a court may take judicial notice.” Tellabs, Inc. v. Makor Issues & Rights, Ltd.,

551 U.S. 308, 322 (2007). “Even where a document is not incorporated by reference, the court


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may nevertheless consider it where the complaint relies heavily upon its terms and effect, which

renders the document integral to the complaint.” Chambers v. Time Warner, Inc., 282 F.3d 147,

153 (2d Cir. 2002) (internal quotation marks omitted). Moreover, “[w]here a plaintiff’s

conclusory allegations are clearly contradicted by documentary evidence incorporated into the

pleadings by reference, . . . the court is not required to accept them.” Labajo v. Best Buy Stores,

L.P., 478 F. Supp. 2d 523, 528 (S.D.N.Y. 2007).

IV. ARGUMENT AND AUTHORITIES

A. Delaware Law Applies to the Breach of Fiduciary Duty and Related Claims

21. In a diversity action, a federal court must apply the choice of law rules of the state

in which the complaint was filed. See Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 496,

61 S. Ct. 1020, 85 L. Ed. 1477 (1941). With respect to breach of fiduciary duty and related

claims, Texas statutes that codify the “internal affairs doctrine” specifically control the choice of

law issue. See Tex. Bus. Corp. Act Ann. art. 8.02 (Vernon Supp. 2009) (stating that “internal

affairs of a foreign corporation, … shall be governed solely by the laws of its jurisdiction of

incorporation”); Tex. Rev. Limited Partnership Act. art. 6132a–1 § 9.01(a) (Tex. Rev. Civ. Stat.

Ann. (Vernon Supp. 2009)) (stating that the “laws of the state under which a foreign limited

partnership is formed govern its organization and internal affairs and liability of its partners”);

Tex. Bus. Orgs. Code Ann. § 1.104 (stating that “the jurisdiction that governs an entity as

determined under Sections 1.101-1.103 applies to the liability of an owner, a member, …).

22. Here, Riverbank Realty, L.P. and Riverbank Realty GP, LLC are both Delaware

entities. See Plaintiff’s Original Complaint at ¶ 6. Accordingly, Delaware law applies to the

breach of fiduciary duty claims, aiding and abetting, and conspiracy claims.


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B. Plaintiff Has Failed to State a Claim for Which Relief Can Be Granted

23. Generally speaking, directors of a corporation owe a fiduciary duty only to the

corporation and its shareholders.4 Geyer v. Ingersoll Publications Co., 621 A.2d 784, 787 (Del.

Ch. 1992); LaSalle Nat’l Bank v. Perelman, 141 F. Supp. 2d 451 (D. Del. 2001). Although

directors’ fiduciary duties are not construed to the same heightened level of trustees, directors

owe the corporation and its shareholders certain fiduciary duties. Smith v. Van Gorkom, 488

A.2d 858 (Del. 1985). These fiduciary duties include the duty of care and the duty of loyalty.

Schoon v. Smith, 953 A.2d 196, 206 (Del. 2008). The duty of good faith is a subset of the duty

of loyalty. Orman v. Cullman, 794 A.2d 5, 14 n.3 (Del. Ch. 2002). The duty of care requires

directors to act on an informed basis, while the duty of loyalty derives from the prohibition

against self-dealing inherent in the fiduciary relationship. Schoon, 953 A.2d at 206.

24. In Delaware, as in most jurisdictions, the relationship between a corporation and

its creditors is contractual in nature, and the terms of the contracts govern the relationships. Katz

v. Oak Indus., Inc., 508 A.2d 873, 879 (Del. Ch. 1986). The law assumes that creditors can

adequately protect their interests “through contractual agreements … and other sources of

creditor rights.” Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 790

(Del. Ch. 2004). Debtholders and other creditors, therefore, may only rely on the protections

provided in their debt instruments. Powers v. British Vita, PLC, 969 F. Supp 4 (S.D.N.Y. 1997);

C-T of Virginia, Inc. v. Barrett, 124 B.R. 689, 692-93 (W.D. Va. 1990), aff’d 958 F.2d 606 (4th

Cir. 1992) (holding that directors owed no fiduciary duties to creditors in connection with

leveraged buyout since once directors “determined that the best way to serve shareholder

4 In the limited partnership context, courts have held “[a]bsent a contrary provision in the partnership agreement, the general partner of a Delaware limited partnership owes the traditional fiduciary duties of loyalty and care to the Partnership and its partners.” Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 2000 WL 1476663, at *10 (Del. Ch. Sept. 27, 2000).


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interests was to place the firm on the market, ... the directors’ duties were limited ... to [gaining]

the highest price for its shareholders. [This] duty cannot extend to the interests of current or

future unsecured creditors of the company.”).

25. Nevertheless, there has been much legal wrangling over the issue of whether the

fiduciary obligations of corporate directors or general partners extend to creditors as a company

enters the zone of insolvency or becomes insolvent. With respect to Delaware law, that debate

ended with the Delaware Supreme Court’s decision in North American Catholic Educational

Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007). In Gheewalla, the court

held that a corporate director has no fiduciary duty to the corporation’s creditors, regardless of

the corporation’s financial condition. 930 A.2d at 103. While the court left open the opportunity

for creditors to bring derivative actions on behalf of an insolvent corporate entity, there were no

new fiduciary obligations created. Id. at 101-02. (emphasis added). Specifically, the Gheewalla

court noted:

Recognizing that directors of an insolvent corporation owe direct fiduciary duties to creditors, would create uncertainty for directors who have a fiduciary duty to exercise their business judgment in the best interest of the insolvent corporation. To recognize a new right for creditors to bring direct fiduciary claims against those directors would create a conflict between those directors’ duty to maximize the value of the insolvent corporation for the benefit of all those having an interest in it, and the newly recognized direct fiduciary duty to individual creditors. Directors of insolvent corporations must retain the freedom to engage in vigorous, good faith negotiations with individual creditors for the benefit of the corporation. Accordingly, we hold that individual creditors of an insolvent corporation have no right to assert direct claims for breach of fiduciary duty against corporate directors.

Gheewalla, 930 A.2d at 103 (footnote omitted) (emphasis in original).

26. Undoubtedly aware of its inability to assert direct causes of action, Plaintiff has

attempted to cast its claims as derivative in nature, but when examined, it becomes apparent that


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Plaintiff has not alleged breaches of fiduciary duties against the corporate entity. Instead,

Plaintiff has crafted a complaint alleging direct causes of action against the Defendants and tried

to hide those direct claims with a “derivative” band-aid.

27. The Fifth Circuit recently affirmed dismissal of a similar complaint filed by a

group of creditors asserting breaches of fiduciary duty allegedly on behalf of the corporation.

Torch Liquidating Trust v. Stockstill, 561 F.3d 377 (5th Cir. 2009). In Torch, the plaintiff was a

liquidating trustee representing the interests of all unsecured creditors. All of Torch’s claims for

breach of fiduciary duty against the former directors were contributed or assigned to a liquidating

trust as part of Torch’s plan of reorganization in its bankruptcy case. The original complaint was

drafted before the Gheewalla decision and it originally asserted direct causes of action against

the Torch directors. After Gheewalla, the plaintiff amended the complaint and “replaced nearly

all of its prior references to ‘creditors’ with new references to ‘creditors and shareholders’ and

sought damages on behalf of creditors and shareholders.” Id. at 382. After the amended

complaint was filed, the district court dismissed the action noting that plaintiff lacked standing to

assert claims on behalf of creditors and that the directors were protected by the business

judgment rule. Id. at 383-84.

28. The Fifth Circuit affirmed the district court’s dismissal, but on different grounds,

holding that the plaintiff failed to state a claim on which relief could be granted. Id. at 389. The

court noted that the complaint failed to allege any “actual, quantifiable damages suffered by

Torch.” Id. at 390. The Fifth Circuit specifically noted that the plaintiff sought damages

incurred by the creditors and shareholders, not damages suffered by the corporation.

29. In its Complaint, Plaintiff has alleged breach of contract, breaches of fiduciary

duties, aiding and abetting breach of fiduciary duty, conspiracy and alter-ego. The defendants


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named in each of those claims (except for breach of contract) and the allegations to support those

claims are set forth in the chart below:

Claim Party Allegations in ComplaintBreach of Duty of Care • Riverbank Realty GP, LLC

• Allen Gross• Allowing the Property to waste

following Hurricane Ike. Complaint at ¶ 63

• Failing to cause Borrower to pay to Noteholder all rents and revenues from the Property. Id.

• Failing to cause Borrower to remit insurance proceeds from the Claim to Noteholder. Id.

• Failing to cause Borrower to otherwise comply with the terms of the Loan Documents. Id.

Breach of Duty of Loyalty • Riverbank Realty GP, LLC• Allen Gross

• Payments were made to pay management fees to GFI Management and not Plaintiff. Complaint at ¶ 67

• Payments were made to the Defendants’ lawyers and not Plaintiff. Complaint at ¶ 68

Aiding and Abetting Breach of Fiduciary Duty

• GFI Management • GFI Management accepted payments for management fees and knew rents and revenues were not being paid to Plaintiff. Complaint at ¶ 73-74.

Conspiracy • Riverbank Realty GP, LLC• Allen Gross• GFI Management

• Defendants acted intentionally to use assets of the Borrower to enrich themselves at the expense of Plaintiff. Complaint at ¶ 76.

Alter-Ego • Allen Gross• GFI Management

• Allen Gross is the CEO, Chairman, CFO, President and Director of GFI Management. Complaint at ¶ 49.

• Allen Gross governs every aspect of GFI Management. Complaint at ¶ 58.

• On information and belief, Allen Gross has complete and


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exclusive control of GFI Management. Complaint at ¶ 59

30. Defendants will address Plaintiff’s causes of actions and allegations in turn.

C. Plaintiff’s Breach of Duty of Care Claim Must Be Dismissed

31. The duty of care requires that directors use the amount of care that ordinarily

careful and prudent men would use in similar circumstances. In re Walt Disney Co. Derivative

Litig., 907 A.2d 693, 749 (Del. Ch. 2005), aff’d, 906 A.2d 27 (Del. 2006). Directors must inform

themselves of material information that is reasonably available. Importantly, Delaware courts

have held that the concept of “substantive due care” is “foreign” to Delaware courts because of

the business judgment rule. Brehm v. Eisner, 746 A.2d 244, 264 (Del. 2000). “Courts do not

measure, weigh or quantify directors’ judgments. . . Due care in the decisionmaking context is

process due care only.” Id. (emphasis in original).

32. Plaintiff has alleged two primary types of breach of the duty of care. One relates

to the alleged decision not to comply with the loan documents, and the other relates to an

allegation that the value of the Property was not maintained after Hurricane Ike. No matter how

the claims are cast or described, they do not satisfy the pleading requirements under Rule 12.

33. With respect to Plaintiff’s allegation that the Borrower failed to comply with the

loan documents, Plaintiff does not allege that the process by which the decisions were made by

the Defendants was improper. Instead, Plaintiff attempts to have this Court do exactly what the

Delaware Supreme Court refused to do in Brehm, which is to make after-the-fact judgments

about whether the Defendants’ decisions were right or wrong. Without any allegation that the

process by which the Defendants made their decisions, the breach of fiduciary duty of care

claims cannot survive.


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34. Moreover, a closer look at the breach of fiduciary duty of care claim shows that

Plaintiff is complaining about alleged actions by the Defendants that harmed the Plaintiff, not the

Borrower. The Gheewalla court held that such claims were not actionable. Gheewalla, 930

A.2d at 103. In the Complaint, Plaintiff repeatedly refers to actions directed at the Plaintiff to

support its breach of duty of care claims.

• Defendants failed to cause Borrower to pay to Plaintiff all rents and revenues from the Property;

• Defendants failed to cause Borrower to remit insurance proceeds from the Claim to Plaintiff; and

• Defendants failed to cause Borrower to otherwise comply with the terms of the Loan Documents with Plaintiff.

Complaint at ¶¶ 63 and 64.

35. While blatantly alleging that Borrower failed to make payments to Plaintiff, the

Complaint attempts to cure the plaintiff’s problem in Torch by alleging that the Borrower

suffered harm in the amount of $6,900,000.00. Yet, Plaintiff’s own Complaint contradicts this

allegation. In at least 5 different places, the Complaint alleges that damages of $6,900,000.00

were suffered. In three of those places, it is the Plaintiff that was allegedly harmed, but in the

other two, it was the Borrower.

• Paragraph 17 – Accordingly, after applying all credits and offsets (including yield maintenance), a deficiency of over $6,900,000.00 remains on the Note and continues to accrue interest at the default rate, plus costs and expenses.

• Paragraph 54 – Noteholder has suffered damages as a result of Allen Gross’s breaches of the Guaranty in an amount in excess of $6,900,000.00.

• Paragraph 64 – As a result, Borrower suffered damages in an amount in excess of $6,900,000.00.

• Paragraph 69 – Borrower GP’s and Allen Gross’s conduct proximately caused damages to Borrower in an amount in excess of $6,900,000.00.

• Paragraph 77 – The actions of Borrower GP, Allen Gross, and GFI Management have


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caused injury to Plaintiff in an amount in excess of $6,900,000.00.

36. Ultimately, this Complaint suffers from many of the same deficiencies as the

complaint in Torch. The Fifth Circuit was abundantly clear that the damage from a derivative

breach of fiduciary duty claim must be to the corporate entity, not to the creditors. The damages

allegedly incurred by the Plaintiff (or Noteholder) cannot be simply imputed to the Borrower and

reclassified as the Borrower’s damages. In Torch, the plaintiff alleged that the creditors and

shareholders suffered damages of not less than $35,800,000, but the Court refused to consider

these damages that Torch suffered. Torch, 561 F.3d at 390. Likewise, the Court should refuse to

consider the damages of the Plaintiff as the damages of Borrower.

37. With respect to the allegation that the Property was not maintained after

Hurricane Ike, this claim is covered by the Guaranty. Plaintiff has asserted a claim for breach of

the Guaranty which has a carve-out for alleged waste of the Property. See Complaint at ¶ 53(e).

When a plaintiff’s claim arises solely from a breach of contract, the plaintiff “generally must sue

in contract, and not in tort.” Kuroda v. SPJS Holdings, L.L.C., 971 A.2d 872, 889 (Del. Ch.

2009) (quoting Data Mgmt. Internationale, Inc. v. Saraga, 2007 WL 2142848, at *3 (Del. Super.

Ct. July 25, 2007) (“In preventing gratuitous ‘bootstrapping’ of contract claims into tort claims,

courts recognize that a breach of contract will not generally constitute a tort.”) “Thus, in order to

assert a tort claim along with a contract claim, the plaintiff must generally allege that the

defendant violated an independent legal duty, apart from the duty imposed by contract.” Id. See

generally Production Resources, 863 A.2d at 801 n.88 (Del. Ch. 2004) (stating that certain

contract claims had been improperly pled as breach of fiduciary claims).

38. Further, the Plaintiff has failed to plead sufficient facts in support of its waste

claim to overcome the presumption of the business judgment rule: “that in making a business

decision the directors of a corporation acted on an informed basis, in good faith and in honest


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belief that the action taken was in the best interest of the company.” Van Gorkom, 488 A.2d at

872 (quoting Aronson v. Lewis, 473 A.2d 802, 812 (Del. 1984)).

39. Under the business judgment rule, directors’ decisions will not be disturbed if

they can be attributed to any rational purpose and a court will not substitute its own notions of

what is or is not sound business judgment. In re Marvel Entertainment Group, Inc., 273 B.R. 58,

78 (D. Del. 2002) (citing Sinclair Oil Corp. v. Levien, 280 A.2d 717, 719-20 (Del. 1971)).

Because businessmen and women are correctly perceived as possessing skills, information and judgment not possessed by reviewing courts and because there is great social utility in encouraging the allocation of assets and the evaluation and assumption of economic risk by those with such skill and information, courts have long been reluctant to second-guess such decisions when they appear to have been made in good faith.

In re J.P. Stevens & Co. S’holders Litig., 542 A.2d 770, 780 (Del. Ch. 1988) (quoting Solash v. Telex Corp., 1988 WL 3587 (Del. Ch. Jan. 19, 1988)).

40. Plaintiff has not alleged facts sufficient to overcome the business judgment of the

Defendants. Plaintiff has not alleged facts that would indicate that Defendants failed to act in a

commercially reasonable manner. Plaintiff acknowledges the damage to the Property was

caused by Hurricane Ike, not the action of the Defendants. Plaintiff has not made any allegation

that the Property was inadequately maintained prior to Hurricane Ike (indeed, Plaintiff never

asserted any defaults under the loan prior to Hurricane Ike), nor has Plaintiff alleged that

Defendants inappropriately used the insurance funds. The Court must presume that the

Defendants were acting in good faith to maintain the Property.

41. For these reasons, Plaintiff’s breach of duty of care claim should be dismissed.

D. Plaintiff’s Breach of Duty of Loyalty Claims Must Be Dismissed

42. The duty of loyalty requires directors to take affirmative action to protect the

corporation and refrain from conduct that would injure the corporation. Guth v. Loft, Inc., 5


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A.2d 503, 510 (Del. 1939). Generally, “directors must eschew any conflict between duty and

self-interest.” Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334, 1345 (Del. 1987)

(citing Guth, 5 A.2d at 510; Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del. 1983)). “A

director must [ ] exercise good faith in advancing the corporation’s interests.” BelCom Inc. v.

Robb, 1998 WL 229527 at *3 (Del. Ch. 1998), aff’d mem., 725 A.2d 443 (Del. 1999).

43. However, payment of a legal obligation, even to an insider or self-interested

director, without more, is not a breach of the duty of loyalty. Steinman v. Levine, 2002 WL

31761252 at *12 (Del. Ch. Nov. 27, 2002), aff’d mem., 822 A.2d 397 (Del. 2003). In Steinman,

the plaintiff sued the corporate directors and other defendants alleging that the corporation

should not have made a principal payment pursuant to a loan agreement, even though the

payment was legally owed, because the noteholder was a related entity to certain members of the

board of directors. Id. Specifically, the plaintiff alleged that the payment was a “breach of the

duty of loyalty because it was a ‘self-dealing’ transaction ‘approved by the Defendant

Directors.’” Id. The court wholly rejected plaintiff’s claim, granted the defendants’ motion to

dismiss for failure to state a claim, and stated:

[Plaintiff’s] duty of loyalty claim must fail because Chorus was merely paying money legally owed to ING and Fund I. [Plaintiff] does not claim that the $4,500,000 paid was not actually owed to Fund I and ING. He makes no claim for waste. He does not even claim that the repayment of the loan was not entirely fair. Rather, [Plaintiff] claims that paying money legally owed was detrimental to stockholders because it transferred capital from Chorus to ING and Fund I. Anytime a corporation pays a legal obligation, however, it may be argued that it decreases the value of stockholders’ equity. Without more, there cannot be a cause of action for such a payment.

Id. (footnotes omitted).

44. Similarly, in Solomon v. Pathe Communications Corp., the Delaware Chancery

Court granted the defendants’ motion to dismiss for failure to state a claim for breach of duty of


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loyalty. 1995 WL 250374 (Del. Ch. April 21, 1995), aff’d, 672 A.2d 35 (Del. 1996). In

Solomon, a group of shareholders sued the corporate directors and Credit Lyonnais Bank for

entering into a transaction in which the directors agreed not to take any action and allow Credit

Lyonnais Bank to foreclose on the assets of the corporation. Id. at *4. In granting the motion to

dismiss, the court accepted, as true, the plaintiff’s allegation that the directors were not

disinterested and that they were appointed by and accountable to Credit Lyonnais Bank. Id. at

*5. The court held that “[e]ven in a self-interested transaction in order to state a claim a

shareholder must allege some facts that tend to show that the transaction was not fair.” Id. The

court concluded that the Plaintiff did nothing more than allege that the “transaction was a self-

dealing one and, in conclusionary fashion, that it was ill-informed, coercive, grossly unfair, etc.”

and that this was insufficient to state a claim. Id. at *6.

45. Here, Plaintiff’s claim for breach of duty of loyalty reveals nothing more than

complaints about failure to pay funds allegedly owed to the Plaintiff. The essence of Plaintiff’s

claim for breach of duty of loyalty is that Borrower paid funds to GFI, the company that manages

its Borrower’s assets, and to Borrower’s attorneys. GFI Management was approved by the

lender in connection with the closing of the loan and Plaintiff took no action to remove GFI

Management at anytime prior to the appointment of the receiver. GFI Management is a

sophisticated management company with deep experience and extensive market knowledge in

the Houston market.

46. Regardless of GFI Management’s experience and knowledge of the market, there

are no allegations that these payments were not fair or that the Borrower was not contractually

obligated to make the payments, nor are there any allegations that Plaintiff took any steps under

the loan documents to stop such payments. In fact, the only evidence in the Complaint is to the


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contrary. See Complaint at ¶¶ 32, 67, 69, and 73 (stating that the payments to GFI were for

“management fees”). Plaintiff’s Complaint fails to state a claim for breach of fiduciary duty of

loyalty.

E. Plaintiff Has Failed to State a Claim for Aiding and Abetting and Conspiracy

47. “Under Delaware law, a valid claim for aiding and abetting a breach of fiduciary

duty requires: (1) the existence of a fiduciary relationship; (2) the fiduciary breached its duty;

(3) a defendant, who is not a fiduciary, knowingly participated in a breach; and (4) damages to

the plaintiff resulted from the concerted action of the fiduciary and the nonfiduciary.” In re

American Intern. Group, Inc., 965 A.2d 763, 831 (Del. Ch. 2009) (quoting Globis Partners, L.P.

v. Plumtree Software, Inc., 2007 WL 4292024, at *15 (Del. Ch. Nov. 30, 2007). See also Allied

Capital Corp. v. GC-Sun Holdings, L.P., 910 A.2d 1020, 1038 (Del. Ch. 2006) (noting that

aiding and abetting claims are essentially civil conspiracy claims brought in the context of

matters relating to the internal affairs of corporations).

48. Similarly, a claim for civil conspiracy regarding breach of fiduciary duty requires

that three elements be alleged and ultimately established: (1) the existence of a fiduciary

relationship, (2) a breach of the fiduciary’s duty, and (3) a knowing participation in that breach

by the defendants who are not fiduciaries. Gilbert v. El Paso Co., 490 A.2d 1050, 1057 (Del.

Ch. 1984), aff’d, 575 A.2d 1131 (Del. 1990).

49. As set forth above, there is no viable claim for breach of fiduciary duty in the

Complaint. Without an underlying claim for breach of fiduciary duty, there can be no claim for

aiding and abetting breach of fiduciary duty or conspiracy. See Trenwick America Litigation

Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 218 (Del. Ch. 2006), aff’d mem., 931 A.2d 438

(Del. 2007) (dismissing both aiding and abetting and conspiracy claims when underlying breach


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of fiduciary duty claim was dismissed) (citing Malpiede v. Townson, 780 A.2d 1075, 1096-97

(Del. 2001) (explaining the existence of a viable underlying claim for breach of fiduciary duty is

a necessary element of an aiding and abetting claim)).

50. Accordingly, the aiding and abetting and conspiracy claims should be dismissed.

F. Plaintiff Has Failed to State a Claim for Alter-Ego

51. Though not stated as a separate cause of action, Plaintiff has pled an alter-ego

claim against Mr. Gross and GFI Management and alleged that they are the alter-ego of each

other. See Complaint at ¶¶ 49, 55, and 59. As admitted in the Complaint, Mr. Gross is a resident

of the State of New York, GFI Management is incorporated in New York, and its headquarters

are located in New York. Consequently, the Court must apply New York law when analyzing

the alter-ego claim. Alberto v. Diversified Group, Inc., 55 F.3d 201, 203-04 (5th Cir. 1995)

(applying Texas choice of law rules and holding that the state of incorporation determined the

applicable state law for an alter-ego claim).

52. Under New York law, the party seeking to pierce the corporate veil must make a

two-part showing: (i) that the owner exercised complete domination over the corporation with

respect to the transaction at issue; and (ii) that such domination was used to commit a fraud or

wrong that injured the party seeking to pierce the veil. American Fuel Corp. v. Utah Energy

Development Co., 122 F.3d 130, 134 (2d Cir. 1997) (citing Morris v. New York State Dep't of

Taxation & Fin., 623 N.E.2d 1157, 1160-61 (N.Y. 1993)). “While complete domination of the

corporation is the key to piercing the corporate veil, ... such domination, standing alone, is not

enough; some showing of a wrongful or unjust act toward [the party seeking piercing] is

required.” Id. (quoting Morris, 623 N.E.2d at 1161).

53. To support its claim for alter-ego in the Complaint, Plaintiff has made only three


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allegations:

• Allen Gross is the CEO, Chairman, CFO, President and Secretary of GFI Management. Complaint at ¶ 49.

• Allen Gross governs every aspect of GFI Management. Complaint at ¶ 58.

• On information and belief, Allen Gross has complete and exclusive control of GFI Management. Complaint at ¶ 59.

54. There are no non-conclusory allegations, much less evidence, of dominion or

control of GFI Management by Mr. Gross. Moreover, the allegations included in the Complaint

are false. Mr. Gross is the Chairman and President of GFI Management, but he is not the CEO,

CFO, or Secretary. The fact that a website states that Mr. Gross “governs every aspect (sic) of

his Manhattan-based firm” is not sufficient to satisfy the pleading requirements for an alter-ego

claim.5 Even if the Plaintiff’s claims were true, they are not enough to state a claim for alter-ego.

55. “[P]urely conclusory allegations cannot suffice to state a claim based on veil-

piercing or alter-ego liability, even under the liberal notice pleading standard.” In Re Currency

Conversion Fee Antitrust Litigation, 265 F. Supp. 2d 385, 426 (S.D.N.Y. 2003). Vague

allegations that lack any substance will not be considered sufficient for pleading alter-ego under

New York Law. See Sysco Food Service of Metro New York, LLC v. Jekyll & Hyde, Inc., 2009

WL 4042758 (S.D.N.Y. Nov. 17, 2009); In re Currency, 265 F. Supp. 2d at 426 (stating “[t]he

unadorned invocation of dominion and control is simply not enough”).

56. Accordingly, the alter-ego claims should be stricken from the Complaint.

5 Plaintiff’s misstatements are littered throughout their alter-ego allegations. First, the website that Plaintiff is allegedly quoting from in paragraph 58 of the Complaint is a website for GFI Capital Resources, Inc., not GFI Management. Second, the quote from the website is that Mr. Gross “governs every facet of his Manhattan-based firm,” not every “aspect”. Again, the “Manhattan-based firm” refers to GFI Capital Resources, Inc., not GFI Management as insinuated in the Complaint. In addition, the very next executive listed on the GFI Capital Resources, Inc. website is Frederick K. Mehlman and the first sentence of Mr. Mehlman’s biography states that he “is Chief Executive Officer of GFI Management Services.” Attached as Exhibit A are two (2) screen shots from the website of GFI Capital Resources Group, Inc. supporting these statements.


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V. CONCLUSION

57. The Plaintiff’s claims for breach of fiduciary duty, aiding and abetting breach of

fiduciary duty, conspiracy and alter-ego should be dismissed. The Plaintiff has improperly

asserted direct causes of action against the Defendants under the veil of a derivative claim on

behalf of the Borrower. The claims are exposed by a review of the Plaintiff’s allegations of

alleged harm and damages suffered by the Plaintiff, not the Borrower. Moreover, Plaintiff has

failed to plead facts to overcome the business judgment rule and to satisfy the pleading

requirements for self-interested transactions. Without the underlying claim for breach of

fiduciary duty, the claims for aiding and abetting and conspiracy cannot survive. Finally, the

Plaintiff’s conclusory allegations cannot support a claim for alter-ego.

Defendants, Riverbank Realty GP, LLC, Allen Gross, and GFI Management Services,

Inc., request that the Court enter an order (i) dismissing Plaintiff’s claims for breach of fiduciary

duty, alter-ego, aiding and abetting breach of fiduciary duty, and conspiracy, (ii) dismissing GFI

Management Services, Inc. from the Complaint, and (iii) granting any other relief, both equitable

and legal, to which they may be justly entitled.

Dated: February 26, 2010.


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Respectfully submitted,

/s/ Daniel K. HedgesDaniel K. HedgesState Bar No. 09369500Jim D. AycockState Bar No. 24034309Thomas A. WoolleyState Bar No. 24042193PORTER & HEDGES, LLP1000 Main Street, 36th FloorHouston, Texas 77002Phone: (713) 226-6000Facsimile: (713) 228-1331e-mail: [email protected]

COUNSEL FOR DEFENDANTS


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CERTIFICATE OF SERVICE

This is to certify that a true and correct copy of the foregoing document was served on

the following counsel of record on February 26, 2010 via certified mail and ECF:

Darryl Wade AndersonFulbright & Jaworski, LLPFulbright Tower1301 McKinney, Suite 5100Houston, TX 77010-3095(713) 651-5151 – Phone(713) 651-5246 - Fax

/s/ Daniel K. HedgesDaniel K. Hedges


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