Should Dodd-Frank Be Applied Retroactively?

The SEC is seeking civil penalties from Rajat K. Gupta, a former director of Goldman Sachs for alleged insider trading. The SEC has not sued in federal court, but, rather has filed an administrative proceeding against Mr. Gupta as authorized by the new Dodd-Frank Act.

Rajat K. Gupta, a former director of Goldman Sachs, sued the SEC in the U.S. District Court for the Southern District Of New York, 11-CV-1900 on March 18, 2011, claiming that the administrative action by the SEC against him is unconstitutional because it seeks to retroactively apply provisions of Dodd-Frank § 929P, which amended § 8A of the Securities Act of 1933. In other words, Mr. Gupta is arguing that the alleged violations took place before Dodd-Frank was enacted so the SEC cannot use an administrative proceeding.

According Mr. Gupta's Complaint, there is no expression of Congressional Intent that civil penalties provision of Dodd-Frank can be applied retroactively. Section 4 of Dodd-Frank provides that “except as otherwise provided this Act shall take effect one day after the enactment of the Act.” Dodd-Frank became law on July 21, 2010. All of the conduct alleged occurred prior to that date. Without retroactive application of Dodd-Frank, the Commission could have sought civil penalties against Gupta in a Federal District Court.

The SEC alleged that Mr. Gupta engaged in a trading scheme by providing material non-public information that he obtained in the course of his duties as a member of the Board of Directors of The Goldman Sachs Group, Inc. and Procter & Gamble to Raj Rjaratnam, the manager of a hedge fund called Galleon Management, LP. Currently, Mr. Rjaratnam is on trial for criminal charges brought against him by the U.S. Attorney of the Southern District of New York.

Mr. Gupta claims that the actions brought against him should be determined by a jury. He points out that an appeal from an adverse administrative finding would first be to the Commission itself before any further judicial review. Mr. Gupta claims that he would be deprived of the application of the Federal Rules of Evidence which preclude unreliable evidence such as multiple layers of hearsay that Commission would seek to offer in an administrative proceeding. Also it would impede Mr. Gupta’s ability to seek indemnification for contribution thereby unfairly enhancing the magnitude of the amounts for which he would be exposed. These charges resulting from retroactive application of Dodd-Frank impose new legal consequences on Mr. Gupta even though arising from pre-Dodd-Frank conduct. Mr. Gupta points out that at least one Commissioner, Kathleen L. Casey, has publicly questioned the retroactive application of Dodd-Frank.

Mr. Gupta alleges that his attorney filed a 35-page response to a Wells Notice on Monday February 28, 2011. By that afternoon the staff received authorization to proceed against Mr. Gupta even though there is no record that the Commission met to consider the submission of the Wells response. Further, Mr. Gupta alleges that a copy of the submission was turned over by the Staff to the United States Attorney’s Office for use in the prosecution of Mr. Rajaratnam. Mr. Gupta seeks as a remedy (a) that Dodd-Frank provisions prospectively empowering the Commission to seek civil penalties against non-registered persons in administrative proceedings in lieu of a plenary action in Federal Court cannot be applied against him, and (b) the Commission is acting in bad faith and a discriminatory manner against him.

Mr. Gupta has raised significant legal issues which will apparently be decided in the very near future.

Edward X. Clinton, Sr.

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Matrixx Initiatives, Inc. et al v. Siracusano, et al, 09-1156

SUPREME COURT UNANIMOUSLY REJECTS NARROW INTERPRETATION OF §10B(5)

On March 22, 2011 the United States Supreme Court decided Matrixx Initiatives, Inc. et al v. Siracusano, et al, 09-1156, which reaffirmed its holding in Basic Inc. v. Levinson, 485 U.S. 224 (1988).

In Basic the defendant made misleading statements denying that it was engaged in merger negotiations when, in fact, it was conducting preliminary negotiations. Basic urged a bright-line rule that preliminary negotiations are material only when the parties to merger negotiations reach an agreement in principal. The Supreme Court in Basic rejected that bright-line rule. Accordingly, a claim was stated under Section 10b(5).

The Plaintiffs alleged in Matrixx that Matrixx and three executives failed to disclose a possible link between its leading product, Zicam, a cold medicine, and the loss of smell. Matrixx became aware of several complaints by users of Zicam but contended that the complaints were not statistically significant and accordingly that disclosure was not necessary. Matrixx also sought to defend its turf in other ways. It learned that a research doctor was going to deliver a lecture in which he would reference the fact that various complaints were made by other users of Zicam. Matrixx learned of the proposed presentation and informed the doctor that it did not have permission to use its name. The doctor proceeded with the presentation without mentioning Matrixx.

Plaintiffs complained that Matrixx violated Section 10b(5) by making untrue statements of fact and failing to disclose material facts necessary to make the statements not misleading in an effort to maintain artificially high prices for its leading product Zicam. The Supreme Court rejected that narrow approach and held that other facts could be considered, including other studies providing a link between Zicam and loss of smell.

The unanimous Supreme Court opinion written by Justice Sotomayor represents an affirmation and expansion of Basic. A very important case.

Edward X. Clinton, Sr.

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Contract Law - Repudiation

ARLINGTON LF LLC v. ARLINGTON HOSPITALITY INC., Court of Appeals, 7th Circuit 2011 - Google Scholar

This case holds that a finance company breached an agreement with a bankruptcy debtor when it refused to lend further funds to the debtor. The Seventh Circuit held that because the finance company repudiated the contract, it could not obtain any further relief under that contract.

Arlington Hospitality was the manager of the Ameriquest hotel chain. The Finance company agreed to lend Hospitality the sum of $11 million under a revolving line of credit.

The Bankruptcy court approved the term sheet and Hospitality drew 3.53 million on the credit line.

After the loan was made the finance company decided to terminate its relationship with Hospitality. It notified Hospitality that it would no longer advance any more funds to Hospitality. Slip Opinion at 7.

Several months later Hospitality repaid the $3.5 million loan, but did not pay the fees associated with the loan. The finance company sought an award of those fees from the Bankruptcy Court.

The Seventh Circuit held that when the finance company stated that it would not advance further funds under the "DIP loan" (debtor in possession loan) it "committed an anticipatory breach of the parties' lending agreement.

Under Illinois law, "when one party has committed a repudiation, the other party can treat the contract as ended." Slip Opinion at 15 (citing Timmerman v. Grain Exch. LLc, 915 N.E.2d 113, 124 (Ill. App. 2009); Truman L. Flatt & Sons, Co., Inc., v. Schumpf, 649 N.E.2d 990, 994 (Ill. App. 1995).

A party commits an anticipatory repudiation when it manifests a clear, unequivocal intent not to perform under the contract when performance is due. Id. citing In re Marriage of Olsen, 428 N.E.2d 684, 686 (Ill. 1988); Draper v. Frontier Ins., Co., 638 N.E.2d 1176, 1181 (Ill. App. 1994).

There was no retraction of the repudiation.

Thus, when it repudiated the contract, the Finance Company lost the right to any future performance by Hospitality.

Comment: this case is an excellent summary of the law of contract and repudiation.

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Contract Law - Seventh Circuit Upholds Verdict Based On Oral Contract

MMG FINANCIAL CORPORATION v. MIDWEST AMUSEMENTS PARK, LLC, Court of Appeals, 7th Circuit 2011 - Google Scholar

This case was decided by the Seventh Circuit on January 5, 2011.

The Plaintiff, MMG Financial, brought suit against Midwest Amusements Park, LLC on the ground that Midwest has failed to pay for 24 go-karts that Midwest financed. The go-karts were originally sold by another company, Team Hurricane, but they were financed by MMG Financial. Thus, this is a routine equipment financing transaction. What makes the case unusual is that the parties drafted, but did not sign, a comprehensive written agreement which laid out the terms of the deal.

The sales agreement identified Midwest as the purchaser of the go-karts; MMG Financial as the finance company and Team Hurricane as the dealer. The price was to be $89,502.12 and the balance was to be paid over 24 months at an interest rate of 24%.

Midwest (which did business under the name Gronvall) did not sign the agreement, but it took delivery of the go-karts.

Midwest never made any payments for the go-karts.

MMG filed suit and Midwest filed a counterclaim alleging that MMG had never paid the original vendor of the go-karts.

At trial Midwest disputed that there was a contract. It also argued that MMG breached the contract by failing to pay for the go-karts. The evidence of the breach was an email from a CRG (the manufacturer of the go karts) that MMG had failed to pay for the go-karts. The district court excluded the email on the ground that it was hearsay.

The district court granted summary judgment to MMG on Midwest's counterclaim because Midwest was unable to point to any admissible evidence that MMG had breached the financing agreement. As the Seventh Circuit noted, "the evidence Midwest offered to establish that MMG had failed to pay Cameron Motorsports for the go-karts is classic hearsay...the testimony of its own employees repeating what Cameron Motorsports had told them." The statements were offered "to prove the truth fo the matter asserted, namely that MMG had not paid Cameron Motorsports for the go-karts shipped to Midwest." Slip Opinion at 8. Thus, Midwest was unable to point to any evidence showing that MMG breached the contract.

Comment: the plaintiff was able to prove to the jury that the parties accepted the draft sales agreement, even though it was never signed. This demonstrates that, in a rare case, the failure to obtain the signature on an agreement can be overcome with testimony and proof.

Edward X. Clinton, Jr.

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First Bank v. UNIQUE MARBLE AND GRANITE CORPORATION, Ill: Appellate Court, 2nd Dist. 2010 - Google Scholar

First Bank v. UNIQUE MARBLE AND GRANITE CORPORATION, Ill: Appellate Court, 2nd Dist. 2010 - Google Scholar

This case is significant because it holds that an assignee for the benefit of creditors can recover fees even where another creditor has a valid security interest in all of the assets.

Unique Marble was a fabricator of marble and granite countertops. It fell upon hard times and, on November 18, 2008, it entered into an assignment for the benefit of creditors. James Gallo was the assignee and he took title to all of the assets of Unique Marble.

Three days later Gallo personally delivered a copy of the assignment to First Bank.

On December 23, 2008, First Bank obtained a judgment against Unique Marble in the amount of $451,568.08.

First Bank then brought collection proceedings against Unique Marble and its corporate officer.

On May 22, 2009, Gallo petitioned to intervene in the First Bank v. Unique Marble lawsuit. He sought $35,000 in fees and expenses.

First Bank argued that Gallo could not collect fees and expenses because of its prior security interest (which it had perfected on October 22, 2004).

The trial court granted First Bank summary judgment against Gallo. Gallo appealed and the Illinois Appellate Court for the Second District reversed.

The court reasoned that an assignment for the benefit of creditors is a "unique trust arrangement in which the assignee (or trustee) holds hte property for the benefit of a special group of beneficiaries, the creditors." Illinois Bell Telephone Co. v. Wolf Furniture House, Inc. 157 Ill. App. 3d 190, 194-95 (1987). The assignee owes a fiduciary duty to the creditors. Some debtors prefer to use an assignment for benefit of creditors (as opposed to bankruptcy) because the assignment process is much cheaper.

First Bank argued that it had priority over Gallo because First Bank had perfected its security interest before Gallo perfected his security interest.

The Court held that Gallo had a common law right to fees and expenses. As the Court noted "if assignees were required to forgo payment in favor of perfected security interests, no assignee would take on the risk of liquidating assets, and assignments for the benefit of creditors would cease to be available as an efficient method of maximizing the liquidation value of troubled companies."

Finally, the court held that Gallo could be compensated on the basis of quantum meruit principles. In so holding the Court ruled that Gallo had conferred a benefit on the Bank as well as all creditors.

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