# Balasiano v. Borell

> United States Bankruptcy Court, D. Delaware · August 31, 2023

URL: https://www.frixlaw.com/law-library/cases/10456252

## Case

- **Court:** United States Bankruptcy Court, D. Delaware
- **Decided:** August 31, 2023
- **Opinion:** 100trialcourt
- **Cited by:** 0 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/10456252

## How later opinions describe it (automated extraction)

- holding that “while undercapitalization may indicate inequitable conduct, undercapitalization is not in itself inequitable conduct.”

## Opinion text

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE

In re:
Chapter 11
FURNITURE FACTORY ULTIMATE
HOLDING, L.P.,! Case No. 20-12816 (TKS)
Debtor.

STEVEN BALASIANO, NOT
INDIVIDUALLY BUT SOLELY IN HIS
CAPACITY AS TRUSTEE OF THE
LIQUIDATION TRUST OF FURNITURE
FACTORY ULTIMATE HOLDING, L.P.,
et al., Adv. Pro. No. 22-50390 (JKS)
Plaintiff,
Related Adv. D.L 27, 29, 30, 31, 32, 33, 34, 35, and
vy. 36
JONATHAN H. BORELL, et al.,
Defendants.

OPINION
Before the Court are two motions seeking dismissal of the amended complaint (the
“Complaint”) filed by Steven Balasiano (the “Trustee”), solely in his capacity as Trustee of the
Liquidation Trust of Furniture Factory Ultimate Holding, L.P., et al. The first motion, brought
by the Defendant directors and officers (collectively, the “D&Os”), seeks to dismiss claims of
breach of fiduciary duties, fraudulent transfers, and breach of the applicable Limited Liability

' The Debtor’s service address in the chapter 11 case is FFO Liquidation Trust, c/o Province, LLC, 11111 Santa
Monica Blvd., Suite 525, Los Angeles, California 90025.
Ady. D.1. 27. The amended Complaint added allegations, counts, and removed two defendants. Compare Adv.
DA, 1 and Ady. DI. 27.

Company agreements (the “I)&Os Motion to Dismiss”).’ The second motion, brought by
Defendants Sun Capital Partners, Inc. (“Sun Capital Partners”), Sun Capital Management VI,
LLC (“Sun Management”), and Furniture Factory Note Holding LLC (“Note Holding” and
together with Sun Capital Partners, Sun Management and any other of its affiliates, “Sun
Capital”),’ seeks to dismiss claims of aiding and abetting breach of fiduciary duties,
recharacterization of debt, equitable subordination, and wrongful distribution (the “Sun Capital
Motion to Dismiss”, and together with the D&Os Motion to Dismiss, the “Motions to
Dismiss”).> Having considered the parties’ submissions, and for the reasons discussed below,
the Motions to Dismiss are granted, in part, and denied, in part.
PROCEDURAL BACKGROUND®
On November 5, 2020 (the “Petition Date”), Furniture Factory Ultimate Holdings, L.P.
and its debtor affiliates and subsidiaries (collectively, “FFO”) filed voluntary petitions for relief
under chapter 11 of the Bankruptcy Code,
On September 21, 2021, the Court confirmed the Plan,’ which became effective on
November 3, 2021 (the “Effective Date”). The Plan provided for the establishment of the

> Adv. DL 31.
4 The D&Qs (Borell, Crosby, Feinberg, Klafter, McConvery, Mullany, Rogalski, and Zigerelli), together with Sun
Capital, are the “Defendants.”
5 Ady. DL. 29,
6 references the docket in the main case, in re Furniture Factory Ultimate Holding, L.P., Case No, 20-12816.
Ady. DL. references the docket in this adversary proceeding, Balasiano, et al. y. Borell, et al., Adv. Pro. No. 22-
50390.
7 Findings of Fact, Conclusions of Law, and Order Confirming (D.I. 507) the First Amended Joint Plan of
Liquidation of Furniture Factory Ultimate Holding, L.P. and its Debtor Affiliates Pursuant to Chapter 11 of the
Bankruptcy Code (the “Plan’”) (D.I. 430).

Liquidation Trust (the “Trust”) on the Effective Date, and the Trustee was approved as the

trustee of the Trust.®
The Trustee commenced this adversary proceeding on July 12, 2022.7
On October 20, 2022, Defendants filed the Motions to Dismiss.'° On November 3, 2022,
the Trustee filed oppositions to the Motions to Dismiss.'! On November 10, 2022, the
Defendants submitted replies in support of their Motions to Dismiss,!2 On November 22, 2022, a

Notice of Completion of Briefing was filed. Oral argument was requested, but the Court
determined that argument was unnecessary to rule on the Motions to Dismiss.

§ Pursuant to the Liquidation Trust Agreement and Declaration of Trust, the Trustee has the authority to commence
all proceedings and take all actions that could have been taken by any member, officer, director, or shareholder of
FFO. D.1. 481, Ex. A.
° The Trustee filed a Complaint (Adv. D.L. 1) on July 12, 2022, and an Amended Complaint (Ady, D.L 27) on
October 6, 2022.
10 Defendants Sun Capital Partners, Inc., Sun Capital Partners Management VI, LLC, and Furniture Factory Note
Hoiding, LLC’s Motion to Dismiss Counts 4, 5, 6, 7, 8, and 10 of the Amended Complaint (Adv. D.I. 29); Former
Directors and Officers’ Motion to Dismiss Counts 1, 2,3, and 11 of Plaintiff's Amended Complaint (Adv. D.L 31).
The Trustee refers to the Counts by Arabic numerals and the Defendants refer to the Counts by Roman numerals.
For simplicity, the Court refers to the Counts by Arabic numerais. ,
1 ‘The Trustee’s Opposition to Sun Capital Partners, Inc.’s, Sun Capital Partners Management VI, LLC’s, and
Furniture Factory Note Holding, LLC’s Motion to Dismiss Counts 4, 5, 6,7, 8, and 10 of Plaintiff's Amended
Complaint (Adv. D.L 33); The Trustee’s Opposition to the Former Directors’ and Officers’ Motion to Dismiss
Counts 1, 2, 3, and 11 of Plaintifi’s Amended Complaint (Adv. D.I. 34).
2 Defendants Sun Capital Partners, Inc., Sun Capital Partners Management VI, LLC, and Furniture Factory Note
Holding, LLC’s Reply Brief in Support of its Motion to Dismiss Counts 4, 5, 6, 7, 8, and 10 of the Amended
Complaint (Adv. D.1. 35); Former Directors and Officers Reply Brief in Support of Their Motion to Dismiss Counts
1, 2,3, and 11 of Plaintiff's Amended Complaint (Adv. DI. 36).
B Adv. DLL 39,

FACTUAL BACKGROUND"
I. FFO’s Background and Business
FEO operated furniture factory outlet stores primarily in the South Central and Midwest
United States and carried prominent home furniture brands, including Serta, Jackson Catnapper
and United/Lane, as well as a range of products under its Natural elements brand.'° FFO
provided quality furniture at highly competitive prices with the “everyday low price” guarantee
(as opposed to a “high/low” pricing model that encouraged customers to negotiate down from an
item’s sticker price).!°
At its peak, FFO had annual revenues of approximately $143 million, operated 68
locations, and employed approximately 675 employees. As of the Petition Date, FFO operated
31 retail locations, a bedding manufacturing facility, and a distribution facility, and employed
approximately 270 employees.'”
As of the Petition Date, FFO had funded-debt obligations in the aggregate principal
amount of approximately $49.4 million, comprised of (i) $22 million outstanding under the

4 The Court adopts the facts from the Complaint, accepting all of the Complaint’s well-pleaded facts as true and
disregarding any legal conclusions. Fowler v. UPMC Shadyside, 578 F.3d 203, 210-11 Gd Cr. 2009),
Amend. Compl. J 29.
6 Amend. Comp. 928. See also Amend. Compl. | 11, The companies making up the FFO enterprise (the “FFO
Entities”) are organized as limited partnerships or member-managed limited liability companies under Delaware
law. As of the Petition Date, FFO’s corporate structure was as follows: Holding LP owns 100% of the interests in
Furniture Factory Holding, LLC (“FFH”), which itself owns 100% of the interests in Furniture Factory Intermediate
Holding, LLC (“FFIH”), which itself owns 100% of the interests in Furniture Factory Outlet, LLC (“Outlet”), which
itself owns 100% of the interests in Furniture Factory Outlet Transportation, Inc. Holding LP also owns 100% of the
interests in Bedding Holding, LLC, which itself owns 100% of the interests in Bedding Intermediate Holding, LLC,
which itself owns 100% of the interests in Bedding, LLC (“Bedding”).
Amend. Compl. { 30.

Stellus Credit Agreement (defined below), (ii) $12.7 million outstanding under the Sun Credit
Agreement (defined below) and (iii) $14.7 million outstanding under certain unsecured Grid
Notes (defined below); and trade debt of approximately $14.9 million, excluding lease
termination and rejection claims.'®
On December 17, 2020, the Bankruptcy Court approved the sale of substantially all of
FFO’s assets to American Freight FFO, LLC for approximately $14 million, plus the assumption
of certain liabilities. The sale closed on December 27, 2020.”°
Il. Sun Capital’s Acquisition of FFO
The FFO Entities were portfolio companies of Sun Capital. Sun Capital acquired FFO on
February 3, 2016, at an enterprise valuation of $34 million (the “Sun Acquisition”).

. Sun Capital acquired all the outstanding equity of FFO and FFO paid for a portion of its

own acquisition. First, FFO repurchased all of its outstanding limited liability company interests
for approximately $32 million. Thereafter, Sun Furniture Factory, LP, purchased an aggregate of

one million newly issued common units from FFO fora purchase price of $7.033 per common
unit, or $7,033,826.7!
To finance the acquisition, Sun Capital (through its affiliate Note Holdings) made an
additional capital investment into FFO in the form of unsecured grid notes, pursuant to a note

18 Amend, Compl. 7 31.
18 Order (A) Approving Asset Purchase Agreement; (B) Authorizing Sale of the Purchased Assets I'ree and Clear of
All Liens, Claims, Encumbrances, and Interests; (C) Authorizing the Assumption and Assignment of Certain
Executory Contracts and Leases in Connection Therewith; and (D) Granting Related Relief (D.I. 191).
20 Amend, Compl. 32.
21 Amend. Compl. □ 34. ;

purchase agreement, dated February 3, 2016, (the “Grid Notes”) in the initial amount of
$9,135,306.
On June 10, 2016, FFO entered into a Credit Agreement (the “Stellus Credit Agreement”)
by and among (a) FFO, as borrower, (b) FFH and certain subsidiaries of F¥O from time-to-time

party thereto, as guarantors, (c) Stellus Capital Investment Corporation (“Stellus”), and (d) each
of the Lenders (as defined therein) party thereto, in the original principal amount of up to $23
million.
At this time, Sun Capital transferred approximately 3.09% of its ownership interest in

FFH to Stellus and certain of Stellus’ affiliates pursuant to that certain Securities Purchase
Agreement, by and among Sun Furniture Factory, LP, FFH, and the purchasers thereto (the
“Stellus Securities Purchase Agreement”). In connection with the Stellus Securities Purchase
Agreement, Stellus also took a participation interest in the Grid Notes, pursuant to that certain
Participation Agreement, by and among Note Holdings and each of the participants thereto (the
“Stellus Participation Agreement”). As a result of the Stellus Participation Agreement, each of
Sun Capital’s and Stellus’ respective interests in the Grid Notes were correlated to its equity
interests in FFO.”

22 Amend. Compl. J 35. ‘The Grid Notes are unsecured, accrue interest in kind, and can be prepaid prior to maturity
without penalty. Amend. Compl. 35.
3 Amend, Compl. 37.

Following the Sun Acquisition, FFO’s new debt amounted to $32,135,306 — the amount
under the Grid Notes and Stellus Credit Agreement. By comparison, as of the date of the
acquisition, FFO’s funded debt obligations had been just over $2.5 million.”4
The Consulting Agreement
On February 3, 2016, FFO and Sun Capital entered into a consulting agreement (the
“Consulting Agreement”) whereby Sun Capital provided business consulting services to FFO in
exchange for an aggregate annual fee, paid in quarterly installments, and success fees upon the
consummation of certain transactions. While FFO’s management was responsible for day-to-day
business operations, the Trustee alleges that Sun Capital closely supervised and regularly
directed FFO’s management and operations, including through monthly financial reviews
attended by the management team and Sun Capital.”
After Sun Capital’s acquisition of FFO, Sun Capital replaced FFO’s respective Boards,
each of which were comprised of two Sun Capital appointees on a three-member board, with the
third member being Defendant Lawrence Zigerelli, FFO’s CEO.”®
In 2017, the members of each of the Boards consisted of Sun Capital appointees non-
defendant Roach and Defendants Borell and Zigerelli””’ The Trustee asserts that Sun Capital

4 Amend, Compl. { 38.
Amend. Compl. § 39. Certain types of transactions required Sun Capital’s explicit approval. Amend. Compl.
39.
26 Amend. Compl. J 40.
27 Amend. Compl. { 41. As of April 2018, Feinberg replaced Borell as a Sun Capital representative on the Boards,
and in or around November 2019, non-party Neuman replaced non-party Roach as Sun Capital representative on the
Boards, Amend. Compl. { 41.

exercised majority control of the Boards, influenced FFO’s management, and controlled FFO’s
finances to run FFO’s business operations and major company transactions.?8
IV. The Kentucky Acquisition
In September 2017, Sun Capital began to consider FFO’s acquisition of two Kentucky-
based retailers, Mattress & More and Furniture Liquidators (the “Kentucky Acquisition”) as part
of what was labeled a “Home Add-On Opportunity.””?
At the time of the Kentucky Acquisition, the Board members of each of the FFO Entities
consisted of Roach and Defendants Borell and Zigerelli, and the officers of the FFO Entities
consisted of Defendants Zigerelli, Klafter, McConvery, and Rogalski (collectively, the
“Kentucky Acquisition D&Os”).*° The Trustee alleges that these individuals were responsible
for, and involved in, considering and conducting due diligence on and approving the Kentucky
Acquisition.?! In addition to serving on the Boards, at this time, Borell also served on Sun’s
“Deal Team” that spearheaded the Kentucky Acquisition and presented it to FFO, and non-party
Roach served on Sun’s “Ops Team” that provided operational support, guidance, and counsel to
FFO’s management in connection with the Kentucky Acquisition.*

78 Amend. Compl. J 41.
2? Amend. Compl. { 42. Mattress & More was a retail mattress chain operating primarily in the Louisville
metropolitan area, and Furniture Liquidators was, like FFO, a value-oriented home furnishing chain, operating in
Kentucky and Indiana. Amend, Compl. 43.
The “Kentucky Acquisition D&Os” definition does not include Feinberg. Amend. Compl. 41.
31 Amend. Compl. q 44.
Amend, Compl. 45.

The Trustee alleges that there were cultural and operational differences between FFO and
the targeted businesses which were not explored during the due diligence process for tbe
Kentucky Acquisition.
The Complaint alleges Sun Capital — through FFO Board members Borell and Roach, as

well as non-defendant Feigenbaum, a senior associate at Sun Capital — pushed the Kentucky
Acquisition on FFO, urging the acquisition would “accelerate FFO store growth and market
expansion” and that the “improved ‘financiability’ [sic]” of the combined business should
enhance equity returns. Sun Capital also represented to FFO’s management, including
Defendants Zigerelli, Klafter, McConvery, and Rogalski, that the Kentucky Acquisition would
be a “strong fit with FFO in contiguous market,” allowing FFO to expand their store base into
surrounding states.**
In November 2017, approximately two months after it identified the Kentucky
Acquisition as a possible target, Sun Capital (through Feigenbaum and FFO Board members
Borell and Roach) recommended FIO offer $6.75 million to purchase Mattress & More and
Furniture Liquidators.”
The Complaint alleges the only diligence Sun Capital appeared to conduct in connection
with the Kentucky Acquisition was limited and based on flawed assumptions. For example, Sun
Capital focused only on historical data related to Mattress & More and Furniture Liquidators and

3 Amend. Compl. 147.
34 Amend. Compl. 147. The Trustee alleges that representations that were accepted at face value and not
challenged by the then-management team. Amend. Compl. § 47.
33 Amend, Compi. § 48.

assumed that past revenue and EBITDA would be indicative of future performance. Further, Sun
Capital failed to consider market trends, such as decreased in-store traffic and migration to e-

commerce, or the economic realities of the industry. The Trustee also argues that Sun Capital
ignored that the mattress industry was “softening” at the time of the transaction, leading to

ageressive price cuts and several notable bankruptcies by large mattress firms, which flooded the
market with inexpensive competing products. The Trustee continues that Sun Capital failed to
appreciate or consider the significant cultural differences between FFO and the Kentucky
Acquisition target companies that would cause significant, and insurmountable, problems when

FFO attempted to integrate the new businesses.*°
The Trustee alleges that the Boards (of which two of the three members involved in the

Kentucky Acquisition, Roach, and Feinberg, were also Sun Capital employees) and management
team (comprised of Defendants Zigerelli, Klafter, MeConvery, and Rogalski) failed to conduct

their own appropriate due diligence with respect to the proposed Kentucky Acquisition and
failed to appropriately assess the benefit of the transactions to FFO. The Complaint alleges that

neither the Boards, nor management team, sought any advice from third-party advisors or any
formal opinions regarding the proposed Kentucky Acquisition.*’
On or about February 6, 2018, the Boards (comprised of Roach and Defendants Borell

and Zigerelli) and the management team (comprised of Defendants Zigerelli, Klafter,
McConvery, and Rogalski), at the direction of Sun Capital, approved FFO’s purchase of Mattress

36 Amend. Compl. 49.
37 Amend. Compl, 50.
10

& More and Furniture Liquidators for a base purchase price of approximately $7,250,000.°8 At
this time, FFO’s total enterprise value was approximately $60 million.*?
VY. FFO’s Onboarding of the Kentucky Acquisition
The Complaint also alleges problems associated with the Kentucky Acquisition. First,
Mattress & More stores underperformed expectations under FFO’s stewardship, and sales

revenues declined, Operational reviews presented by Sun Capital to FFO in mid-2018, several
months after the Kentucky Acquisition closed, revealed this was due to “softness” in the mattress
industry. Mattress & More struggled to compete in the marketplace.*”
In addition, Sun Capital and the Kentucky Acquisition D&Qs initially planned to
liquidate certain of Furniture Liquidators’ inventory through a “retirement sale,” modify
inventory investments, and then rebrand the Furniture Liquidators’ stores under the FFO
banner.*! FFO sold Furniture Liquidators inventory as a “retirement sale,” while purchasing
significant inventory to replenish stores post-conversion. The Complaint alleges the retirement
sale saturated the market and significantly reduced demand for newly acquired full-priced
products after the stores reopened, and, as a result, FFO was saddled with excess inventory it was
unable to sell.“”

3% Amend. Compl. Jf 51-52.
# Amend. Compl. 53.
40 Amend. Compl. 4 55,
4! Amend. Compl. { 56.
4 Amend. Compl. 7 57.

Defendants Borell, Zigerelli, Klafter, McConvery, and Rogalski also oversaw FFO’s

attempt to convert and integrate the acquired Mattress & More and Furniture Liquidators stores.

Costs associated with these efforts exceeded initial projections by millions of dollars.
Further, FFO’s management team spent considerable time integrating the new businesses
acquired in the Kentucky Acquisition and away from FFO’s legacy business.“* The Complaint
asserts that the singular focus of Defendants Zigerelli, Klafter, McConvery, and Ro galski on the

newly acquired stores meant that critical, existing issues with FFO’s core business, such as the
need to expand FFO’s digital marketing to respond to consumers’ migration to online shopping,

were largely ignored.
The Trustee maintains that FFO management issues were exacerbated by a leadership
void at the top. Defendant Zigerelli, FFO’s then-CEO and President, historically had significant
latitude and freedom in running FFO. During the conversion and integration of the Kentucky
Acquisition, however, Zigerelli was “checked out,” “erratic” and “unsystematic,” which led to

strained relationships among the management team and created confusion around FFO’s going-
forward strategy.”
By early 2019, FFO was unable to pay its vendors."”

8 Amend, Compl. 4 58.
44 Amend. Compl. 459. In mid-to-late 2018, FFO’s management team that led the integration effort consisted of
Defendants Zigerelli, Klafter, McConvery, and Rogaiski. Amend. Compl. { 59.
4 Amend. Compl. ¥ 60.
46 Amend. Compl. 61.
Amend, Compl. § 62.
12

The Complaint alleges internal Sun Capital presentations throughout 2019 indicated that
pre-acquisition diligence was “inadequate” and that Sun Capital habitually “ignored” warming
signs with FFO’s business.** For example, the Complaint states:
e FFO and the acquired Kentucky businesses were “too different to combine
operationally” and there was a “marked difference in the two models and
inadequate consideration given to that.”
e Sun Capital “underestimated the complexity of the add-on, as well as the
ability to manage and integrate it.”
e Going forward, Sun Capital would need to improve its diligence, including by
“set[ting] the facts on shifts in the industry .. . and the health of the core
business,” “spend[ing] more time upfront to understand the local model and
market,” and conducting “continuous” consumer research.
e “Warning signals of declining core business were ignored,” Sun Capital
“missed that the customer was increasingly influenced by .. . digital
marketing, and visiting fewer stores before purchase.”
e = Zigerelli “was not programmatic and didn’t really want help,” and “the more
complex the issues and unsuccessful he was at resolving them, the more
erratic and unsystematic he and the rest of the team became.”
¢ Major key performance indicators “didn’t receive adequate attention from
[Sun Capital]” and were “habitually dismissed by the CEO”?
The Complaint also alleges because FFO failed to conduct its own independent diligence apart
from the deficient Sun Capital diligence, the above failures by Sun Capital equally apply to
FFO’s D&Os.
In addition, the Complaint states that, in a quarterly business review between Sun Capital
and FFO, it was admitted that:
e They “did not do a good job” with the Kentucky Acquisition.*”

4 Amend. Compl. { 62.
49 Amend. Compl. { 62.
30 Amend, Compl. 64.
13

e They had “lost [their] way,” “lost [their] brand identity,” “lost [their] core
customer with higher price points,” and “are confused.”*!
e Zigerelli had been “checked out” and FFO was “[v]oid of leadership.”
Moreover, the “[s]enior team [did] not work well together,” and
“(rJelationships are strained. Not communicate with each other. Not sure who
is responsible for what.”*
e FFO had “no strategy — no vision.”
By late 2019, FFO’s total enterprise value declined by 83% (from approximately $60.2
million to approximately $10.3 million)—a loss in value of almost $50 million over the course of
approximately 22 months.
Following this, FFO overhauled the management team, and effectively terminated
Zigerelli (vis-d-vis a “voluntary departure”) from the Boards and management. FFO’s new

management team, consisting of, at various times, Defendants Rogalski, Crosby, Klafter, and
Mullany, attempted to implement various operational changes to the acquired businesses.
VI. FFO’s Decline into Bankruptcy
Over the course of 2018 and 2019, FFO approved payment to Sun Capital of millions of
dollars in consulting fees, expense reimbursements, and distributions. FFO, strapped for cash,
borrowed additional money from Sun Capital to stay afloat, causing it to incur additional secured
debt.*°

31 Amend, Compl. ¥ 64.
Amend. Compl. 61.
3 Amend. Compl. {f 64, 65. The “senior team” included Borell, Zigerelli, Klafter, McConvery, and Rogalski,
Amend. Compl. { 66.
Amend. Compl. 66.
33 Amend. Compl, 68.
14

Immediately following the close of the Kentucky Acquisition, FFO paid at least $72,500
in management fees to Sun Capital.°®
Between April 5, 2018, and January 4, 2019, FFO paid Sun Capital more than $665,000
in consulting fees and reimbursement of expenses under the oversight of Defendants Feinberg,
Zigerelli, Klafter, McConvery, and Rogalski.>’
At an August 17, 2018, omnibus special meeting of the Boards, the Boards approved a
payoff of the Grid Notes and paid $1,488,781.43 to Sun Capital. Defendants Feinberg, Zigerelli,
and non-party Roach were all members of the Boards at this time. Defendants Borel! and
Rogalski also attended the meeting, with Rogalski presenting to the Board the proposed
distribution. Pursuant to a resolution of the Boards, Defendants Zigerelli, Rogalski, and Klafter

were authorized to take all actions necessary to implement the payoff of the Grid Notes.
By early 2019, FFO owed at least $4.7 million in outstanding vendor payments. Between

January and March 2019, FFO was undercapitalized and borrowed an additional $4 million from

Sun Capital under the Grid Notes.°°
Despite this borrowing, FFO needed additional liquidity—based in part on sales being
down 30%, not “being good in city markets,” and stretching vendors. On May 1, 2019, Sun
Capital provided FFO with $1.2 million, and on May 15, 2019, Sun Capital provided FFO with

Amend. Compl. 4 69. This was intended to be a “success fee” for completion of the acquisition. Amend. Compl.
Amend Compl. | 70.
58 Amend. Compl. § 71.
°° Amend. Compl. $72.
15

another $2.5 million (collectively, the “May 2019 Fundings”). At the time of the funding, the

May 2019 Fundings were not documented. Subsequently, on June 28, 2019, Outlet and Bedding,

as borrowers, Holding LP, and certain of its subsidiaries, as guarantors (collectively with Outlet
and Bedding, the “Sun Credit Agreement Loan Parties”) and Sun Capital, through Note
Holdings, entered into a Second Lien Credit Agreement (the “Sun Credit Agreement” and
together with all other loan documents related thereto, the “Sun Loan Documents”), for a $6
milion loan purportedly secured by a second lien on all of FFO’s assets, consisting of the May
2019 Fundings of $3.7 million, as well as $2.3 million in additional funding. Unlike prior
secured debt, the Sun Credit Agreement accrued interest in-kind and could be repaid without any
prepayment premiums or penalties. Rogalski signed the Sun Credit Agreement on behalf of each
of the FFO Entities, as borrowers and guarantors, and on behalf of Note Holdings, as lender,®°
Neither the Boards, nor anyone un-affiliated with Sun Capital, approved or gave any formal
consideration to either the May 2019 Fundings or entry into the Sun Credit Agreement.
On September 13, 2019, Sun Capital funded an additional $1 million to FFO without any
documentation (the “September 2019 Funding”). On September 18, 2019, the parties amended
the Sun Credit Agreement to provide for an additional $3 million loan to FFO, of which $1
million was previously funded (the “Sun Credit Agreement First Amendment”),

6 Amend. Compl. 73.
Amend. Compl. J 73.
® Amend. Compl. 74.
16

On November 27, 2019, the parties again amended the Sun Credit Agreement for an
additional $2 million in funding to FFO (the “Sun Credit Agreement Second Amendment,” and
together with the Sun Credit Agreement First Amendment, the “Sun Credit Agreement
Amendments”). The Trustee alleges that neither the Boards, nor any third party, approved or

gave any formal consideration to the Sun Credit Agreement Amendments. Mullany signed the
Sun Credit Agreement Amendments on behalf of each of the FFO Entities, as borrowers and

guarantors, and on behalf of Note Holdings, as lender. During this time FFO did not seek
funding from any source other than Sun Capital. Sun Capital did not record any UCC financing
statements on account of the Sun Credit Agreement until October 23, 2020, shortly before FFO
filed for bankruptcy.“
By November 2020, FFO owed approximately $14.9 million in outstanding vendor

paytnents and trade debt, as well as approximately $27.4 million in outstanding funded-debt
obligations to Sun Capital (excluding over $1 million in “consulting fees” owed to Sun
Capital).
On November 5, 2020, FFO filed for bankruptcy.

& Amend. Compl. 74.
*+ Amend, Compl. { 74.
65 Amend. Compl. { 75.
17

JURISDICTION
The Court has subject matter jurisdiction over this adversary proceeding under 28 U.S.C.
§ 1334(b). This matter presents both “core and “non-core” proceedings under 28 U.S.C.
§ 157(b)(2). Venue is proper in this district pursuant to 28 U.S.C. § 1409(a).
LEGAL STANDARD
A motion to dismiss under Rule 12(b)(6) challenges the sufficiency of the factual
allegations in the complaint.®* Rule 12(b)(6) is related to Rule 8(a)(2), which requires that a
pleading contain “a short and plain statement of the claim showing that the pleader is entitled to
relief”*? When a complaint is challenged by a motion to dismiss under Rule 12(b)(6), the
complaint “does not need detailed factual allegations, [but] a plaintiffs obligation to provide the
grounds of his entitle[ment] to relief requires more than labels and conclusions, and a formulaic
recitation of the clements of a cause of action will not do.”°® Two “working principles” underly
this pleading standard:
First, the tenet that a court must accept a complaint’s allegations as
true is inapplicable to threadbare recitals of a cause of action’s
elements, supported by mere conclusory statements. Second,
determining whether a complaint states a plausible claim is context
specific, requiring the reviewing court to draw on its experience
and common sense.®?

66 Kost v. Kozakiewicz, 1 F.3d 176, 183 (3d Cir. 1993).
S? Fed. R. Civ. P. 8(a)(2) and 12(b)(6), Fed. R. Bankr. P. 7008 and 7012.
68 Bell Atl. Corp. v. Fwombly, 550 U.S. 544, 555 (2007) (cleaned up).
6 Ashcroft v. Igbal, 556 U.S. 662, 663-64 (2009) (citation omitted).
18

Under this pleading standard, a complaint must nudge claims “across the line from
conceivable to plausible.”’”” The movant carries the burden of showing that dismissal is
appropriate. ”!
Tn analyzing a motion to dismiss, the Third Circuit instructs courts to follow a three-part
analysis. “First, the court must ‘tak[e] note of the elements a plaintiff must plead to state a
claim.’”’? Second, the court must separate the factual and legal elements of the claim, accepting
all of the complaint’s well-pleaded facts as true and disregarding any legal conclusions.” Third,
the Court must determine whether the facts alleged in the complaint are sufficient to show that
the plaintiff has a plausible claim for relief.“ After conducting this analysis, the court may
conclude that a claim has facial plausibility when the pleaded factual content allows the court to
draw the reasonable inference that the defendant is liable for the alleged misconduct.”
A heightened pleading standard is applicable to allegations of fraudulent transfer.”° Rule
9(b), made applicable by Bankruptcy Rule 7009, supplies this heightened standard:
In alleging fraud or mistake, a party must state with particularity □
the circumstances constituting fraud or mistake. Malice, intent,
knowledge, and other conditions of a person’s mind may be
alleged generally.””

” Twombly, 550 U.S, at 547.
Paul v. Intel Corp. (In re Intel Corp. Microprocessor Antitrust Litig.}, 496 P. Supp. 2d 404, 408 (D. Del. 2007).
2 Santiago v. Warminster Twp., 629 F.3d 121, 130 Gd Cir. 2010) (quoting igbal, 556 U.S. at 675).
B Id See also Fowler, 578 F.3d at 210-11 (citing Iqbal, 556 U.S. at 679).
Santiago, 629 F.3d at 130.
Igbal, 556 US, at 678 (citing Twombly, 530 U.S, at 356),
Pa, Emp. Benefit Tr. Fund v, Zeneca, Inc., 710 F. Supp. 2d 458, 478 (D, Del. 2010).
77 Fed, R. Civ. P. 9(b); Fed. R. Bankr. P. 7009,
19

Rule 9(b) requires plaintiffs to plead the “who, what, where, when, how, and why” ofa
fraudulent transfer claim.” The purpose of Rule 9(b)’s requirement that plaintiffs plead ihe
“circumstances” of the alleged fraud with particularity is to “place the defendants on notice of
the precise misconduct with which they are charged, and to safeguard defendants against
spurious charges of immoral and fraudulent behavior.” However, Rule 9’s “requirements .. .

are relaxed in the bankruptcy context, particularly in cases .. . in which a trustee has been
appointed,”®?
THE COMPLAINT
The Complaint asserts eleven counts: (1) D&Os’ breaches of their fiduciary duties to FFO
(counts 1-3); Gi) Sun Capital’s aiding and abetting of those breaches of fiduciary duties (counts
4-6); (iii) recharacterization of the purported debt owed by FFO to Sun Capital to equity (count
7); (iv) equitable subordination of Sun Capital’s claims to those of general unsecured creditors
(count 8); (v) avoidance and recovery of constructive fraudulent transfers made to Sun Capital
(count 9);*! (vi) wrongful distributions paid to Sun Capital (count 10); and (vii) D&Os’ breach of
Limited Liability Company agreements (count 11).

® See Gerbitz v. ING Bank, 967 F. Supp. 2d 1072, 1078 (D. Del. 2013). But see Seville Indus. Mach. Corp ¥.
Southmost Mach. Corp., 742 F.2d 786, 791 (3d Cir. 1984) (“Plaintiffs are free to use alternative means of injecting
precision and some measure of substantiation into their allegations of fraud”).
® Seville Indus. Mach. Corp., 742 F.2d at 791.
8 Zazzali vy. Mott (In re DBSI, Inc.), 445 BR. 344, 347-348 (Bankr, D. Del. 2011) (citation omitted).
8! No party moved to dismiss count 9.
20

D&Os MOTION TO DISMISS
The D&Os seek to dismiss Counts 1, 2, and 3 of the Complaint for alleged breach of
fiduciary duties (the “Fiduciary Duty Counts”) and Count 11 of the Complaint for breach of the
Limited Liability Company Agreements® (the “LLC Agreements Count”). Before addressing
these counts, the Court considers two global, threshold arguments made by the D&Os in support
of dismissal of the counts against them.
I. Counts 1, 2,3 and 11: Group Pleading
The D&Os seek to dismiss the Fiduciary Duty Counts on the basis that the Trustee
employs “group pleading” and “improperly groups all of the individual defendants into lists and
advances a theory of ‘collective responsibility.’*? The D&Os claim that the Complaint groups
all eight individual defendants together in each allegation, “even though not all eight defendants
served on the board of FFO at the same time.’** The D&Os maintain that the purported group
pleading or “collective responsibility” pleading in the Complaint does not satisfy the
requirements of Twombly and Iqbal because it does not provide any individual defendant the
information needed to properly respond to the allegations.®

8 See Amend. Compl., Exs. E (Furniture Factory Outlet, LLC, Amended and Restated Limited Liability Company
Agreement), F (Bedding, LLC Limited Liability Company Agreement), G (Furniture Factory Holding, LLC,
Limited Liability Company Agreement), and H (Furniture Factory Holding, LLC, Amended and Restated Limited
Liability Company Agreement) (collectively, the “LLC Agreements”).
8 Adv. DL 32 at 2, 14-19. Pertaining to Counts 1, 2,3, and 11.
4 Adv. 32 at 14-15,
8 Ady, DL 32 at 16-17.
2]

The Trustee denies improper “group pleading” and argues that he has “pleaded extensive
details known to it today (and without the benefit of full discovery) concerning the acts and

omissions that comprise the breach of fiduciary duty and breach of contract claims and .. .,
identified the responsible individuals.”** The Trustee maintains that “a pleading that ‘groups’
together particular directors and officers who collectively had responsibility for certain

transactions or actions is not per se improper. Rather, under /gbal and Twombly, the relevant
analysis is whether a particular defendant is given adequate notice of the allegations against
them.”87 The Trustee contends “the Amended Complaint provides more than adequate notice

under Fed. R. Civ. P. 8 to the [D&Os] of the claims asserted against them,88
Under Delaware law, a claim for breach of fiduciary duties may be dismissed where the

complaint (1) “lumps all of the individual Defendants together as ‘Officers and Directors’ . . .

without supplying specific facts as to each defendant’s wrongdoing;” (2) “has not provided any

specific facts as to which transactions a particular defendant authorized;” and (3) does not

“allege what authority any particular defendant had to approve such transactions.”®?
Courts in this district have dismissed claims for breach of fiduciary duties against certain

individual defendants who allegedly “were involved with” or “participated in [a] certain

86 Adv. DI. 34 at 8-9.
87 Adv, 34 at 9,
8 Ady. DI. 34 at 9.
8 Stanziale v. Heico Holdings, Inc. (In re Conex Holdings, LLC), 514 B.R. 405, 414 (Bankr. D. Del. 2014)
(applying Texas law) (cleaned up).
22

transaction,” and conclusory allegations were not enough to survive a motion to dismiss.” The

Delaware District Court has also dismissed claims for breach of fiduciary duty where a plaintiff
lumped all the individual defendants together, did not supply specific facts as to each defendant’s

wrongdoing, did not provide specific facts as to which transactions a particular defendant
authorized, and did not allege what authority any particular defendant had to approve such
transaction.”!
The Delaware Courts, however, have rejected defendants’ “group” pleading contention
when the complaint identifies the “dates, partics, and actions or inactions” of the defendants
which were “sufficient to put them on notice of the specific conduct that gives rise to the breach

of fiduciary claims asserted against them.”
Here, the Complaint identifies the dates, parties, and actions or inaction of each of the

D&Os. For each of the Fiduciary Duty Counts, the Trustee identifies a separate set of specific
directors and officers involved in the particular Count. Each Count is tied to a subset of the total

D&Os and coupled with a particular set of facts. More specifically, in Count 1 the Trustee
alleges that five of the eight D&Os (the Kentucky Acquisitions D&Os) were responsible for

% Kaye vy. Lone Star Fund V (U.S.), L.P., 453 B.R. 645, 682 (N.D. Tex. 2011) (applying Delaware law) (“The
Amended Complaint alleges that both ‘were involved with’ or ‘participated in’ certain transactions. As the Court has
already explained, such conclusory allegations are insufficient to withstand a motion to dismiss.”).
Tn re Conex Holdings, LLC, 514 BR. at 414.
® Buchwald Cap. Advisors LLC v. Schoen (In re OPP Liquidating Co., Inc.), Adv. Pro, No. 21-50431 (MF W), 2022
WL 774063, at *8 (Bankr. D. Del. Mar. 14, 2022) (footnote omitted); UD Dissolution Liquidating Trust v. Sphere
3D Corp. (nre UD Dissolution Corp.), 629 B.R. 11, 36-37 (D. Del. 2021) (rejecting “group pleading” argument
and finding Amended Complaint contained sufficient detail of actions taken by the Defendants, collectively and
individually, in furtherance of the alleged breaches of fiduciary duty); Hawk Mt. LLC v. Mirra, Civ. No. 13-2083,
2016 WL 4541032, at *2 (D. Del. Aug. 31, 2016) (permitting group pleading where defendants were alleged to have
acted together to facilitate a general scheme).
23

overseeing and approving the Kentucky Acquisition.” In similar fashion, Count 2 names the

Transfer D&Os and Count 3 names the Insider Loan D&Os and each count is accompanied by a

different set of facts and alleged wrongdoings. The Complaint contains sufficient dates, details,
and actions or inactions by the D&Os, collectively and individually, and is therefore sufficient to

put the D&Os on notice of the “specific conduct that gives rise to the breach of fiduciary claims
asserted against them.”°* Based on the allegations of the Complaint, the Court finds that the

Trustee has pleaded sufficient facts to overcome the group pleading argument.

% Amend. Compl. 9 44, 51, 56-60, More specifically, the Complaint sets forth the following related to each of the
Defendant D&Os:

“Defendant Involvement | Member of | Acquisition |. D&Os” | Loan”. | raph
“Defendant | vith □□ | Sun | D&Os” | Counts2'| D&Os” | etorentes
oe eee Capital} (Count) fand 1) | (Count) foe
Feb 2016 - Jun 2006 - qq 44-45, 47-48, 51,
2019 Jun 2008 - 67
jcvmny [77 nee ff
Apr2018- | Apr 2018 - {4 50, 70-71
Feinberg | Nov 2019 Nov 2019 P| x x
2016 - 2019 2006 - 91 39, 44, 47, 50-51,
2016-2019 | N/A qq 39, 44, 47, 50-51,
Jun 2019 - Sept 2019 - F139, 67, 74
Mullany | Dec 2020 __| Dec 2020 | *
. Dec 2016 - Apr 2019 - □□□ | x | qq 39, 44, 47, 50-51,
Rogalski | aug2019 | Aug 2019 x x * 58-60, 64-67, 70-71
. 2012-2019 | Feb 2016- pox {9 39, 44, 47, 50-51,
Zigerellt 20122019 Mar 2019 * 58-62, 64-67, 70-71

4 Inve OPP Liguidating Co., Inc., Adv. Pro. No. 21-50431 (MFW), 2022 WL 774063 at *8.
24

TE Counts 1, 2,3, and 11: Exculpation □

The D&Qs also argue that the Fiduciary Duty Counts and the LLC Agreements Count
should be dismissed because the LLC Agreements (as defined below) eliminate fiduciary duties
and exculpate the D&Os from liability for breach of any duties, including breach of contract,?°
The Trustee argues that “affirmative defenses, such as exculpation, may not be
considered at the motion to dismiss stage”® and, even if the Court considered the exculpation
clauses, they apply only to “Specified Officers,” “Specified Persons,” and “current or former
Managers.”””
The Court agrees that it need not address the D&Os’ arguments concerning the
exculpation clause because affirmative defenses, such as exculpation, may not be considered at

the motion to dismiss stage.”
IH. Counts 1, 2, and 3: Failure to State a Claim
The D&Os seek to dismiss each of the three Fiduciary Duty Counts for failure to state a

claim.

Ady, DL 32 at 21-22.
% Ady. 34 at 23.
Ady, DL 34 at 26-27.
% Giuliano v. Schnabel (In re DSI Renal Holdings, LLC), 574 B.R. 446, 471 (Bankr. D. Del. 2017) (citing Miller v.
McCown De Leeuw & Co., Inc. (In re The Brown Sch.), 368 B.R. 394, 401 (Bankr. D, Del. 2007)). See also
Deckard v. Gen, Motors Corp., 307 F.3d 556, 560 (7th Cir, 2002) (citations omitted) (“A motion to dismiss was
improper since release is an affirmative defense, Fed.R.Civ.P. 8(c), and the existence of a defense does not undercut
the adequacy of the claim.”).
25

A. The Fiduciary Duties of Care and Loyalty
Under Delaware law, corporate officers and directors owe the corporations they serve

duties of care and loyalty to “strive in good faith and on an informed basis to maximize the value

of the corporation for the benefit of its residual claimants, the ultimate beneficiaries of the firm’s
value.”®? When alleging breach of fiduciary duties, “to survive a motion to dismiss under Rule

12(b)(6), the Trustee must ‘plead around the business judgment rule.””!°? When assessing claims

for breach of fiduciary duties, the Court bears in mind that a director does not become “a

guarantor of success” by choosing to continue a firm’s operations when it may be insolvent.'®!
i. The Duty of Care
The duty of care “requires that directors of a Delaware corporation both: (1) ‘use that

amount of cate which ordinarily careful and prudent men would use in similar circumstances’;
and (2) ‘consider all material information reasonably available.’”' “The duty of care has been
described as the duty to act on an informed basis.”* “[D]uty of care violations are actionable
only if the directors acted with gross negligence,” which is “rarely found.”'"' Gross negligence

Quadrant Structured Prods. Co., v. Vertin, 102 A.3d 155, 172 (Del. Ch. 2014).
100 Joseph v. Frank (In Re Troll Comme'ns, LLC), 385 B.R. 110, 118 (Bankr. D, Del. 2008) (quoting Stanziale v.
Nachtomi (In Re Tower Air, Inc.), 416 F.3d 229, 238 (3d Cir. 2005)). Furthermore, “{ujnder Delaware law, the
business judgment rule presumes that in making a business decision the directors of a corporation acted on an
informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company.”
Liquidation Trust of Solutions Liquidation LLC y., Stienes (In re Solutions Liquidation LLC), 608 B.R, 384, 402
(Bankr. D, Del. 2019) (quoting Brehm y. Eisner (In re Walt Disney Co. Derivative Litig. }, 906 A.2d 27, 52 (Del.
2006)) (cleaned up).
101 Trenwick Am. Litig. Trust v. Ernst & Young, L-LP., 906 A.2d 168, 174 (Del. Ch, 2006), aff'd, 931 A.2d 438
(Del. 2007).
102 Bridgeport Holdings Inc. Liquidating Trust v. Bayer (In re Bridgeport Holdings, Inc.), 388 B.R. 548, 568
(Bankr. D. Del. 2008) (quoting fre Walt Disney Co. Deriv. Litig., 907 A.2d 693, 749 (Dei. Ch. 2005)).
103 Burtch v. Huston (in re USDigital, Inc.), 443 B.R. 22, 41 (Bankr. D. Del. 2011) (citation and footnote omitted).
104 fn re Walt Disney, 907 A.2d at 750 (citations and footnotes omitted).
26

is “conduct that constitutes reckless indifference or actions that are without the bounds of
reason.”
i. The Duty of Loyalty
“The duty of loyalty mandates that the best interest of the corporation and its
shareholders takes precedence over any interest possessed by a director, officer or controlling
shareholders and not shared by the stockholders generally.”!°° “A director is interested in a
transaction if ‘he or she will receive a personal financial benefit from a transaction that is not
equally shared by the stockholders’ or if ‘a corporate decision will have a material detrimental
impact on a director, but not on the corporation and the stockholders.’”!°? The private benefit to

the director must be “of a sufficiently material importance, in the context of the director’s
economic circumstances, as to have made it improbable that the director could perform her
fiduciary duties .. . without being influenced by her overriding personal interest.”1°
Additionally, “[a]cts taken in bad faith breach the duty of loyalty.”!
To state a bad-faith claim, a plaintiff must show either an extreme
set of facts to establish that disinterested directors were
intentionally disregarding their duties, or that the decision under
attack is so far beyond the bounds of reasonable judgment that it

105 AcPadden v. Sidhu, 964 A.2d 1262, 1274 (Del. Ch. 2008).
06 Cede & Co. Technicalor, Inc., 634 A.2d 345, 361 (Del. 1993) (cleaned up).
107 In re Trados Inc, S’holder Litig., C.A. 1512-CC, 2009 WL 2225958, at *6 (Del. Ch. July 24, 2009) (quoting
Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993).
108 Jy ye Gen. Motors Class H S’holders Litig., 134 A.2d 611, 617 (Del. Ch. 1999) (citations omitted).
109 Ryan v. Gifford, 918 A.2d 341, 357 (Del. Ch. 2007) (citation and footnote omitted).
27

seems essentially inexplicable on any ground other than bad
faith, |!
A complaint for breach of duty of loyalty may be dismissed where it “is devoid entirely
of factual support to establish that the transaction was self-interested,”!!!
B. Count 1: Kentucky Acquisition D&Os’ Breach of Fiduciary Duties’?
Count | alleges that the Kentucky Acquisition D&Os (comprised of Defendants Borell,
Zigerelli, Klafter, McConvery, and Rogalski) “breached their fiduciary duties to FFO by failing
to inform themselves fully and in a deliberate manner of material and reasonably available
information, including failing to conduct sufficient industry, market, and financial due diligence,

or retaining appropriate and experienced advisors.”!!? Count 1 further alleges that the Kentucky
Acquisition D&Os were grossly negligent (i) in pursuing the acquisition without first informing
themselves, and (ii) following the acquisition, with respect to integration and conversion of the

stores acquired, as well as substantial neglect of FFO’s core business.’
The D&Os seek to dismiss Count 1 arguing the alleged “poor decision-making” is
protected by the business judgment rule, which should be considered at the motion to dismiss

110 In re Chelsea Therapeutics Int’l Ltd. S’holders Litig., No. 9640-VCG, 2016 WL 3044721, at *7 (Del, Ch. May
20, 2016) (cleaned up and citation omitted),
In re Solutions Liquidation LLC, 608 B.R. at 402,
112 The Complaint lists Fienberg in the heading for Count | against the Kentucky Acquisition D&Os. However,
Feinberg is not included in the definition of the Kentucky Acquisition D&Os, nor is he specifically named in the
Complaint {ff 78-83. Additionally, his Board service (April 2018 through November 2019) began after the
Kentucky Acquisition (February 2018). Compare Amend. Compl. ff 14 (listing dates of Feinberg’s Board service),
44 (definition of Kentucky Acquisition D&Os), and 51 (closing of the Kentucky Acquisition). As a result, the Court
will dismiss Count 1 against Feinberg.
Amend. Compl. { 79.
14 Amend, Compl. [ 79-85.
28

stage.!'5 The D&Os contend that the wrongdoing allegations are “vague” and are the types of

claims the business judgment rule protects.!'© Additionally, the D&Os argue that the Trustee’s
hindsight or backwards-looking evaluation of the transactions do not meet the plaintiff's burden

of surmounting the business judgment rule.!!”? They maintain that Delaware law does not

“impose retroactive fiduciary obligations simply because [the fiduciary’s] chosen business

strategy did not pan out.”""
In response, the Trustee argues the Kentucky Acquisition D&Os exceeded more than

“poor decision making” because they acted on an uninformed basis and breached their duty of

care. The Complaint alleges that the Kentucky Acquisition D&Os:
e Never “sought any advice from third-party advisors or any formal opinions
regarding the proposed Kentucky Acquisition.”! 19
e “{I}ignored the stark cultural and deep operational differences, and market
trends, between FFO and the targeted businesses.”!”°

NS Ady, D,L. 32 at 20.
"6 Ady. DI. 36 at 1,
MW? Ady. DI. 32 at 17,
U8 Ady. D.I. 32 at 21 (citing Trenwick Am. Litig. Tr., 906 A.2d at 173).
Amend, Compl. 950.
0 Amend. Compl. #4 46, 50. More specifically, the Complaint alleges the following cultural and operational
differences between FFO and the targeted businesses.
First, Mattress & More operated standalone mattress stores, whereas FFO sold a
variety of furniture and accessories under one roof. Thus, FFO would be
acquiring an entirely new category of retail stores dedicated to bedding and
related accessories. Second, both Mattress & More and Furniture Liquidators
utilized a “high/low” pricing strategy which encouraged in-store negotiations
over the sticker price, and was fundamentally different than the everyday low
price strategy utilized by FFO, where the prices were fixed and non-negotiable.
Third, Mattress & More and Furniture Liquidators’ customers skewed more
middle-income, whereas FFO catered to a lower-to-middle income customer
base. Fourth, and relatedly, there was an inventory mismatch among the
businesses—specifically, the goods sold by Mattress & More and Furniture
Liquidators were not suited to FFO’s existing customer base. Finally, the
29

¢ “{I]gnored that the mattress industry was ‘softening’ at the time of the
transaction, leading to aggressive price cuts and several notable bankruptcies
by large mattress firms, which flooded the market with inexpensive competing
products.”!#!
e “(Failed to appreciate or consider the significant cultural differences between
FFO and the target companies of the Kentucky Acquisition ... that would
cause ... problems when FFO attempted to integrate the new businesses into
FFO.” 122
The Complaint further alleges that following the Kentucky Acquisition:
e Mattress & More stores underperformed expectations under FFO’s
stewardship and sales revenues declined.'”
e Furniture Liquidators change from a “high/low (‘haggling’) pricing model to
FFO’s everyday low price strategy” led to decreased sales and revenue; and
the “retirement sale” saturated the market, reducing demand, and, as a result,
“FEO was saddled with excess inventory it was unable to sell.”!™
° The Kentucky Acquisition D&Os “oversaw FFO’s waste of significant time
and resources attempting to convert and integrate” the two businesses,'”°
e “(T]he costs associated with these efforts exceeded initial projections by
millions of dollars” and the synergies between the business never
materialized.”!°
e The Kentucky Acquisition D&Os’ errors surrounding the Kentucky
Acquisition were acknowledged in a series of internal FFO/Sun Capital
presentations, which demonstrate, the complete failure of the diligence
process and the viability of the Trustce’s claims.

original and acquired businesses utilized different methods of distribution, with
Mattress & More and Furniture Liquidators shipping from outside warehouses,
and FFO maintaining its inventory solely in stores. In sum, Mattress & More
and Furniture Liquidators were fundamentaily different in significant, and
ultimately incompatible, ways with FFO’s existing business.
Amend. Compl ¥ 46.
Amend. Compl. { 49.
Amend, Compl. | 49.
23 Amend. Compl. ff] 55-56.
124 Amend. Compl. [ff 56-57.
25 Amend. Compl. [qf 58-59.
6 Amend. Compl. If 60-61.
7 Ady, D.I. 34 at 15.
30

The Court concludes, based on these allegations, the Complaint states a plausible claim
for breach of the duty of care. The facts, when viewed in the light most favorable to the Trustee,
give rise to the reasonable inference that the Kentucky Acquisition D&Os failed to use the

amount of care ordinarily careful and prudent men would use in similar circumstances and failed

to inform themselves when undertaking the Kentucky Acquisition.
Additionally, the Court rejects the D&Os’ argument regarding retroactive fiduciary
obligations. The Complaint alleges the lack of action or inaction by the Kentucky Acquisition
D&Os in conducting due diligence in relation to the acquisitions. Although the Trustee asserts
wrongdoing against the Kentucky Acquisition D&Os after the fact, the allegations are still within
the confines of a duty of care claim.
Finally, the D&Os’ argument that the claims against them are protected by the business
judgment rule fails. In Tower Air, Inc.,'”* the Third Circuit held that although the business
judgment rule is a “presumption that directors act in good faith, on an informed basis, honestly
believing that their action is in the best interest of the company,” it is an affirmative defense that
should not be considered at the motion to dismiss stage unless the plaintiff raises the business
judgment rule on the face of the complaint, Here, the Trustee did not raise the business
judgment rule on the face of the Complaint, and the D&Os acknowledge in their reply brief that

“the Complaint does not explicitly reference the business judgment rule.””? Consequently, the

Court will not consider the business judgment rule at the motion to dismiss stage.

28 Im re Tower Air, Inc., 416 F.3d at 238 (citations omitted).
29 Ady. D.L 36 at 5.
31

Therefore, viewed in the light most favorable to the Trustee, the facts give rise to the
reasonable inference that the D&Os have breached their duty of care. The Dé&Os Motion to
Dismiss Count 1 will be denied.
C. Count 2: Transfer D&Os’ Breach of Fiduciary Duties
Count 2 of the Complaint alleges that the Transfer D&Os (Defendants Borell, Klafter,
McConvery, Roglaski, Zigerelli, and Feinberg) breached their fiduciary duties by failing to act m
good faith and intentionally and knowingly permitted, and in certain instances, gave approval
for, FFO to make certain transfers to Sun Capital, which amounted to unlawful fraudulent
transfers, improper transfers, and/or a breach of the LLC Agreements.'?? The Complaint alleges
these transactions were for the sole benefit of Sun Capital when FFO was insolvent or in the

zone of insolvency.!?!
The four alleged fraudulent transfers from FFO to Sun Capital include: (i) from January
2017 through January 2018, at least $750,934 on account of management fees and
reimbursement expenses; (ii) on February 6, 2018, a $72,500 management fee in connection with
the Kentucky Acquisition; (iii) from April 2018 through January 2019, at least $665,347 on

account of management fees and reimbursement expenses; and (iv) on August 17, 2018,
$1,488,781 as repayment for the Grid Notes (collectively, the “Transfers”).'*?

0 Amend, Compl. { 86.
Amend, Compl. 786.
132 Amend. Compl. § 122.
32

The D&Os argue that Count 2 should be dismissed for failure to state a claim because the

Count fails to “allege specific conduct by each individual officer or director in authorizing the

challenged transaction.’”!? The D&Os contend that “the well-pled facts that a Trustee must set

forth to show that Defendants caused Fraudulent Transfers include (1) the specific facts as to

which transactions a particular defendant authorized [and] (2) what authority a particular
defendant had to approve such transactions.”'*4 The D&Os argue the Complaint fails as to all

four Transfers.
The Trustee claims that following the Kentucky Acquisition, “Sun Capital continued to

profit while burdening FFO with additional financial obligations.”°° The Complaint alleges that

the D&Os approved the Transfers, each of which constituted a separate breach of the duty of

loyalty by the Transfer D&Os, and that the Transfers were approved due to the “oversight of

interested Boards and management teams that lacked independence.”!*°
In support of the Trustee’s argument, the Complaint alleges a lack of disinterestedness on

part of the Transfer D&Os at the time the Transfers were made because at all relevant times “Sun

Capital dominated FFO’s respective Boards, each of which were comprised by two Sun Capital
appointees on a three-member board.”!?7

133 Ady. D.L. 32 at 22 (quoting Miller v. ANConnect LLC (in re Our Alechemy, LLC), No. 16-11596 (KG), 2019 WL
4447535, at *6 (Bankr. D, Del. Sept. 16, 2019)}.
4 Ady, D.I. 32 at 22 (cleaned up).
5 Ady. 34 at 5-6.
36 Amend. Compl. 84-87, see also D.I. 34 at 18.
37 Amend. Compl. § 40. At the time, the Board consisted of Roach, Borell, and Zigerelli, Roach and Boreli were
Sun Capital appointees. Amend. Compl. q 41.
33

In order to assert a breach of the duty of loyalty claim, a plaintiff need only prove that the

defendant was on both sides of the transaction.'°? “When directors of a Delaware corporation are

on both sides of a transaction, they are required to demonstrate their utmost good faith and the

most scrupulous inherent fairness of the bargain.”'°? Public policy demands of a corporate
officer or director to “protect the interests of the corporation committed to his charge” and

“sefrain from doing anything that would work injury to the corporation.”'4° “The rule that

requires an undivided and unselfish loyalty to the corporation demands that there shall be no

conflict between duty and self-interest.”"4!
Viewing the facts alleged in the Complaint in the light most favorable to the Trustee, Sun

Capital controlled the FFO Board, making it plausible that the D&Os were on both sides of the

transaction and benefitted at the expense of FFO. Therefore, there is a reasonable inference that

the Transfer D&Os breached their duty of loyalty in approving the Transfers. The D&Os Motion

to Dismiss Count 2 will be denied.
D. Count 3: Insider Loan D&Os’ Breach of Fiduciary Duties
Count 3 alleges that the Insider Loan D&Os (Defendants Borell, Crosby, Klafter,
McConvery, Rogalski, Mullany, Zigerelli, and Feinberg) breached their fiduciary duty by failing
to “act in good faith and intentionally and knowingly permitted FFO to incur significant insider

138 Miller vy. McCown De Leeuw & Co. (Inre Brown Sch.), 386 B.R. 37, 47 (Bankr. D, Del, 2008).
139 Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del. 1983) (citation omitted); In re The Brown Sch,, 386 B.R. at
47 (“The burden then shifts to the defendant to prove that the transaction was entirely fair.”).
40 Weinberger, 457 A.2d at 710 (internal quotations marks omitted, quoting Guth v. Lof, Inc., 5 A.2d 503, 510
(Del. Supr. 1939).
7@ (internal quotations marks omitted; quoting Guth, os at 519).

debt to Sun Capital in the form of the Grid Notes and the Sun Credit Agreement, which were in

reality equity contributions, for the sole benefit of Sun Capital at the expenses of the estates at a

time when FFO was undercapitalized, and was insolvent or in the zone of insolvency.”!?
The D&Os argue that Count 3 should be dismissed for failure to state a claim because it

proceeds on a theory of “deepening insolvency” which is not recognized under Delaware law.'?

They contend that the Trustee attempts to convert a “simple business failure into a breach of

fiduciary duty through a non-existent theory of ‘deepening insolvency.’”!*
In response, the Trustee acknowledges that a plaintiff may not plead an independent

cause of action for deepening insolvency, but argues, based on Jn re Brown Schools, that “the

invalidity of that cause of action ‘does not absolve directors of insolvent corporations of
responsibility. Rather, it remits plaintiffs to the contents of their traditional toolkit, which
contains ... causes of action for breach of fiduciary duty.’”!“? The Trustee argues that the Insider

Loan D&Os knowingly oversaw FFO’s acceptance of insider funding structured as “loans” or

“notes” in circumstances where Sun Capital was the only party to benefit from structuring
disguised as equity infusions. Further, the Trustee contends that “relevant documents were

executed by Insider Loan D&Os standing on both sides of the transaction, despite failing to seek

funding from any third-party sources or approval from independent manager or officers, and

2 Amend. Compl. Jf 89-90.
Adv, DL 32 at 25.
M4 Ady, DiI. 32 at 26.
45 Ady. D.I. 34 at 20 (citing In re Brown Schools, 386 B.R. at 46).
35

without any financial or legal consideration.”!"° The Trustee maintains that these facts articulate
self-interested and grossly negligent decision-making by the Insider Loan D&Os in violation of

the fiduciary duties of care and loyalty.
The parties are correct that Delaware law does not recognize the theory of “deepening
insolvency.”!“” “Even when a firm is insolvent, its directors may, in the appropriate exercise of

their business judgment, take action that might, if it does not pan out, result in the firm being
painted in a deeper hue of red.”!"*
The Trustee argues that Count 3 is not premised on the theory of deepening insolvency or

that the Insider Loan D&Os “should have filed for bankruptcy rather than enter into challenging
transactions.”"“? The Trustee claims that the Insider Loan D&Os violate the duty of care and

loyalty by the following:
¢ “Despite sales being down 30%, on May 1, 2019, Sun Capital provided FFO
with $1.2 million, and on May 15, 2019, Sun Capital provided FFO with
another $2.5 million... At this time, the May 2019 Fundings were not
documented.”!°°
* “[O]n June 28, 2019, Outlet and Bedding, as borrowers, Holding LP and
certain of its subsidiaries, as guarantors and Sun Capital, through Note
Holdings, entered into a Second Lien Credit Agreement, for a $6 million loan
purportedly secured by a second lien on all of FFO’s assets, consisting of the

M6 Adv, D.L 34 at 21.
47 Tremwick Am. Litig. Trust, 906 A.2d at 174 (“Refusal to embrace deepening insolvency as a cause of action is
required by settled principles of Delaware law.”).
148 Td.
149 T),1, 34 at 20 (citing Official Comm. Of Unsecured Creditors of Midway Games Inc. v. Nat'l Amusements Ine, (In
re Midway Games Inc.)}, 428 B.R. 303, 315 (Bankr. D. Del. 2010)).
50 Amend, Compl. 4 73.
36

May 2019 Fundings of $3.7 million, as well as $2.3 million in additional
funding.”
e “Unlike prior secured debt, the Sun Credit Agreement accrued interest in kind
and could be repaid without any prepayment premiums or penalties.”!*
e “[Nleither the Boards, nor anyone un-affiliated with Sun Capital, approved or
gave any formal consideration to either the May 2019 Fundings or entry into
the Sun Credit Agreement. Rogalski signed the Sun Credit Agreement on
behalf of each of the FFO Entities, as borrowers and guarantors, and on behalf
of Note Holdings, as lender.”!?
e “On September 13, 2019, Sun Capital funded an additional $1 million to FFO
without any documentation.”!**
e “It was not until September 18, 2019, the parties amended the Sun Credit
Agreement to provide for an additional $3 million loan to FFO, of which $1
million was previously funded.”!°°
“On November 27, 2019, the parties again amended the Sun Credit
Agreement for an additional $2 million in funding to FFO.”!*°
e “{N]either the Boards, nor anyone un-affiliated with Sun Capital, approved or
gave any formal consideration to the Sun Credit Agreement Amendments.
Mullany signed the Sun Credit Agreement Amendments on behalf of each of
the FFO Entities, as borrowers and guarantors, and on behalf of Note
Holdings, as lender.”!°7
¢ “During this time FFO did not seek funding from any additional sources other
than Sun Capital.”!°
At bottom, the Complaint alleges the Insider Loan D&Os knowingly oversaw FFO’s acceptance
of insider funding structured as “loans” or “notes” in circumstances where Sun Capital was the

Amend. Compl. § 73.
2 Amend. Compl. 73.
13 Amend. Compl. { 73.
54 Amend, Compl. q 74.
55 Amend. Compl. { 74.
66 Amend. Compl. 74.
57 Amend. Compl. ¥ 74.
538 Amend. Compl, ¥ 74.
37

only party to benefit from structuring the transactions in this manner.'” These allegations go to

the Board’s decision-making process, the relationship with Sun Capital, and violations of the

duties of care and loyalty, and are not a disguised deepening insolvency claim.
Viewing the facts in the light most favorable to the Trustee, the Complaint gives rise to

the reasonable inference that the Insider Loan D&Os did not exercise the duties of care and
loyalty in entering the transactions with Sun Capital which resulted in the alleged harm to FFO.

Therefore, the D&Os Motion to Dismiss Count 3 will be denied.
E. Count 11: LLC Agreements Count
Count 11 alleges that the Transfer D&Os breached Section 9 of the LLC Agreements by
causing wrongful distributions to Sun Capital.!® Count 11 alleges, in the alternative, that if Sun

Capital is not a member of the LLCs, then the Transfer D&Os breached Section 9 by causing
unlawful distributions to a non-member.!*!
i, Sun Capital is not a member under the LLC Agreements
Section 9 of the LLC Agreements, entitled “Distributions,” provides:
Distributions shall be made to the Members in accordance with
their Percentage Interests at the times and in the aggregate amounts
determined by the Board, Notwithstanding any provision to the
contrary contained in this Agreement, the Company shall not be
required to make a distribution to the Members on. account of their
interest in the Company if such distribution would violate Section

69 Amend. Compl. 490. See also Amend. Compl. { 69.
160 Amend. Compl. J] 142-149.
161 Amend. Compl. □ 148.
38

18-607 of the Act [Delaware Limited Liability Company] (the
“DLLC”) or any other applicable law.”!©
Section 18-607(b) of the DLLC Act “provides that if an LLC member receives a
distribution that results in the LLC becoming insolvent, and knew at that time that the LLC
would become insolvent as a result of the distribution, the LLC member is liable to the LLC for

the amount of the distribution.”!* The DLLC Act affords parties with broad discretion in
drafting LLC agreements and ensures that such agreements will be honored and given maximum
effect by a reviewing court.’
The D&Os seek to dismiss Count 11 for failure to plead adequately any underlying
breach because the Transfers did not constitute “wrongful distributions” under 6 Del. C, § 18-

607, and even if they did, Section 9 of the LLC Agreements does not affirmatively bar
distributions that could potentially violate section 18-607. The D&Os further argue that the
Complaint fails to identify any relevant contractual obligation that would give rise to a claim
against any of the D&Os.'©
The Trustee argues that to adequately plead a cause of action under the LLC Agreements
(and Section 18-607), the Trustee need only plead that the relevant Boards determined to make a
distribution to a member which resulted in in the LLC becoming insolvent, and that the member

16 See Amend, Compl. § 143; Bedding LLC Agreement, § 9; Outlet LLC Agreement, § 9; FFH LLC Agreement,
§9.
apersi-Cola Bottling Co. of Salisbury, Md. v. Handy, C.A. 1973-S, 2000 WL 364199, *3 (Del. Ch. Mar. 15,
000).
na Capital, inc. v. Law Office of Krug, C.A. No. 2018-0240-JRS, 2018 WL 3471562, at *5 (Del. Ch. July 18,
165 Because it has been determined that the Trustee did not utilize group pleading, the Court will only address the
D&Os remaining arguments. 30

had knowledge that the transfer would render the LLC insolvent. ‘The Trustee also disputes the

D&Os interpretation of Section 9 of the LLC Agreements, maintaining that the language that

FFO “not be required” to engage in conduct that is otherwise a violation of the law can
reasonably be interpreted as prohibiting that conduct.’
Section 9 of the LLC Agreements addresses distributions to members of the LLC.

Section 18-607(b) of the DLLC Act addresses an LLC member's receipt of a distribution and a
member’s liability to the LLC for wrongful distributions. As discussed below with respect to the

Sun Capital Motion to Dismiss Count 10, Sun Capital was not a member of Bedding, Outlet, or

FFH, the LLC’s that issued the Transfers.!®? Consequently, because Sun Capital was not a
member under the LLC Agreements and Section 9 only relates to members, the Trustee does not
plead a plausible claim for breach of Section 9 of the LLC Agreements with regard to a
distribution to “member” Sun Capital.
ii, Breach of Contract for Distribution to Non-Member Sun Capital
The Trustee alleges, in the alternative, that “to the extent Sun Capital is deemed to not be

a member of Bedding, Outlet or FFH, then the Transfer D&Os breached Section 9 by causing
unlawful distributions to a non-member.”!®* As mentioned above, Section 9 states:

16 Ady, DI. 34 at 23,
167 In re Hosp. Acquisition LLC, 625 B.R. 835, 841 (Bankr. D. Del. 2020) (footnote and citation omitted) (“When
interpreting a contract under Delaware law, the contract is construed using the objective theory of contracts. This
means that the terms of the contract should be given the meaning which would be understood by an objective,
reasonable third-party, and that the terms of a clear and unambiguous contract will be interpreted according to their
ordinary meaning.”).
168 Amend. Compl. § 148.
40

“Distributions shall be made to the Members... .”!6 Here, the Transfer D&Os are bound by the

plain meaning of the LLC Agreements.'7° For that reason, it is plausible that the Transfers

non-member Sun Capital is a violation of Section 9 of the LLC Agreement.
iii, Conclusion as to Count Lf
The D&Os Motion to Dismiss Count 11 will be granted, in part, and denied, in part.
CONCLUSION REGARDING THE D&Os MOTION TO DISMISS
As discussed above, the Complaint pleads plausible claims for breach of fiduciary duty as

to Counts 1 (except as to Feinberg), 2 and 3. As to Count 11, the Complaint does not state a
plausible claim for breach of the LLC Agreements as to a member but does state a plausible
claim for breach of the LLC Agreements as to a distribution to a non-member, As a result, the

D&Os Motion to Dismiss will be granted in part, and denied, in part, as to Counts 1 and 11; and

denied as to Counts 2 and 3.
SUN CAPITAL MOTION TO DISMISS
Sun Capital requests the Court dismiss Counts 4, 5, and 6 of the Complaint for aiding and

abetting breach of fiduciary duty (the “Aiding & Abetting Counts”); Count 7 of the Complaint
for recharacterization of various “notes” that Sun Capital made to FFO (the “Recharacterization
Count”); Count 8 of the Complaint for equitable subordination of Sun Capital’s claims (the
“Equitable Subordination Count”); and Count 10 of the Complaint for wrong distribution of

169 1 LC Agreements, § 9.
170 ty re Sols. Liquidation LLC, 608 B.R. at 406 (holding that “the Parties are bound by {the LLC Agreement] plain
meaning”).
A]

various transfers made by FFO to Sun Capital (the “Wrongful Distribution Count”). The

allegations stem from Sun Capital’s acquisition of FFO in 2016 and the events that followed,
including Sun Capital’s purported substantial control over FFO’s businesses, the Kentucky
Acquisition, and the alleged strain that was put on FFO’s liquidity — including various “loans”
made from Sun Capital to FFO and fees paid from FFO to Sun Capital. As set forth in detail
below, the Complaint alleges plausible claims for aiding and abetting breach of fiduciary duty,
-recharacterization, and equitable subordination, but not a plausible claim for wrong distribution.

I. Counts 4, 5, 6: Aiding & Abetting Counts .
To state a claim for aiding and abetting a breach of fiduciary duty, the plaintiff must
allege: “(1)} the existence of a fiduciary relationship, (2) a breach of the fiduciary’s duty,
(3) knowing participation in that breach by the defendants, and (4) damages proximately caused

by the breach.”!”
Sun Capital argues that the Trustee did not adequately plead that the D&Os breached any
fiduciary duty, thereby failing to establish that Sun Capital aided and abetted such breach. Sun

Capital further asserts that the Trustee failed to plead specific facts that any particular Sun
Capital entity knowingly participated in the D&Os’ alleged breach of their fiduciary duties. Sun
Capital maintains that the Trustee must demonstrate that the aider and abettor had actual or

11 NHB Assignments LLC v. Gen, Alt, LLC (In re PMTS Liquidating Corp.), 526 B.R. 536, 546 (D. Del. 2014)
(cleaned up) (quoting Shamrock Holdings v. Arenson, 456 F.Supp.2d 599, 610 (D. Del. 2006) (further citation
omitted).
42

constructive knowledge that their conduct was legally improper and that the Trustee’s conclusory
statements fail to adequately plead scienter or improper motive.
In response, the Trustee alleges that Sun Capital held a sufficiently high position, and
participated in the Boards’ decisions, so that the Boards’ knowledge could be imputed to Sun
Capital. The Trustee continues that Sun Capital directed the Boards’ breach of fiduciary duty
both through its representatives on FFO’s Boards and management teams, and as FFO’s
consultant. More specifically, the Trustee claims that (i) Sun Capital and FFO Board member
Borell served on Sun Capital’s “Deal Team” that led the Kentucky Acquisition and presented the
transaction to FFO; (ii) non-party Board member Roach served on Sun Capital’s “Ops Team”
which provided operational support, guidance, and counsel to FFO’s management in connection
with the transaction; and (iii) two of Sun Capital’s representatives, Defendants Klafter and
McConvery, were involved in conducting “flawed” diligence on, and ultimately approving, the
transaction.'”? In addition, the Trustee alleges Sun Capital exercised significant control over
through its consulting arrangement, whereby Sun Capital closely supervised and regularly
directed FFO’s managements and operations. In sum, the Trustee alleges that Sun Capital was
effectively the Board, controlled management, and had complete control over FFO’s direction
and strategy.
Sun Capital replies that the alleged conduct must purposely induce a breach of the
Board’s duty of care and that the Trustee did not allege such conduct in the Complaint. It argues

Adv, DI. 33 at 10-11,
43

the Trustee must allege something more than Sun Capital simply “dominated” or “ran” FFO
through its D&Os.
Sun Capital challenges two of the four elements of the claim for aiding and abetting a

breach of fiduciary duty. The Court first considers whether the Trustee’s claims for breach of

fiduciary duty by the D&Os meet the pleading standard to survive a motion to dismiss.‘ As
discussed above, the Court finds that the Trustee has met his pleading burden as to Counts 1

(except as to Feinberg), 2, and 3. Because the Court finds that these counts for breach of the

fiduciary duty of care and loyalty are plausible, the Trustee can maintain claims against Sun

Capital for aiding and abetting such breaches.
Next, the Court addresses Sun Capital’s argument that the Trustee has not alleged that

Sun Capital “knowingly participated” in the D&Os’ alleged breach of their fiduciary duties. “To

establish scienter, the plaintiff must demonstrate that the aider and abettor had ‘actual or
constructive knowledge that their conduct was legally improper.’ Accordingly, the question of
whether a defendant acted with scienter is a factual determination.”'™ At this stage of the

litigation, it is enough for the Trustee to plead that Sun Capital had material information that it
purposely failed to disclose,’”

173 Syn Capital has not raised whether a fiduciary relationship existed or whether the Trustee sufficiently pleaded
that damages were proximately caused by the (alleged) breach. Thus, the Court will not address these two factors in
the Counts for aiding and abetting breach of fiduciary duty.
4 RBC Cap. Markets, LLC v. Jervis, 129 A.3d 816, 862 (Del. 2015) (citations and footnotes omitted), Neurvana
LLC y. Balt USA, LLC, No. CV 2019-0034-KSJM, 2020 WL 949917, at *14 (Del. Ch. Feb. 27, 2020)
(citations and footnote omitted) (Well-pleaded facts must allege that the “aider and abettor acted with ‘scienter,” or
‘knowingly, intentionally or with reckless indifference.’”).
13 In re Tribune Co. Fraudulent Conv. Litig., No. 11MD2296 (DLC), 2019 WL 294807, at *27 (S.D.N.Y. Jan. 23,
2019), aff'd in part, vacated in part, remanded, 10 F.Ath 147 (2d Cir. 2021); Almond, ‘for Almond Fam, 200] Tr. □□
44

The Trustee alleges that Sun Capital’s own employees comprised over half of the

individual board members who allegedly breached fiduciary duties.'’ Sun Capital held two

seats on each of FFO’s three-member Boards.!”” The Trustee alleges that, through its
representatives on the FFO Boards and management teams, as well as its role as “consultant,”
Sun Capital directed the breaches of fiduciary duty. In other words, the Trustee claims that the

members of the Boards were the primary wrongdoers, and their knowledge was imputed to Sun

Capital.
The Delaware Court of Chancery has held:
When the fiduciary and primary wrongdoer is also a representative
of the secondary actor who either controls the actor or who
occupies a sufficiently high position that his knowledge is imputed
to the secondary actor, then the test is easier to satisfy. For
example, this court has recognized that the acquisition vehicles that
a controlling stockholder uses to effectuate an unfair freeze-out
merger are liable as aiders and abettors to the same degree as the
controller, because the controller’s knowledge is imputed to those
entities. This court also has employed the same reasoning to
recognize that an investment fund can be liable for aiding and
abetting when “the same individuals who have made the Fund’s
investment decisions” are also the fiduciaries who engaged in
misconduct.!”8
Here, the Trustee argues that Sun Capital wielded substantial control over the FFO

operations and was not merely involved in the (alleged) breaches of fiduciary duties but directed

Glenhill Advisors LLC, C.A. No. CV 10477-CB, 2018 WL 3954733, at *32 (Del. Ch, Aug. 17, 2018), aff'd sub nom.
Almond as Tr. for Almond Fan. 2001 Tr. v. Glenhill Advisors, LLC, 224 A.3d 200 (Del. 2019) (citations, footnotes,
and quotation marks omitted) (“Knowing participation in a board’s fiduciary breach requires that the third party act
with the knowledge that the conduct advocated or assisted constitutes such a breach.”).
176 See Amend, Compl. Y{f 12-15, 41, 50.
17 See Amend. Compl. ff 40-41.
178 In ye PLX Tech. Inc. S’holders Litig., No. CV 9880-VCL, 2018 WL 5018535, at *49 (Del. Ch. Oct. 16, 2018),
afP'd, 211 A.3d 137 (Del. 2019) (citations and footnotes omitted).
45

them. For example, the Trustee alleges Sun Capital pitched the Kentucky Acquisition to FFO □□□

the first instance and provided the “due diligence.”'”? The Trustee contends that Sun Capital
worked through the FFO Boards and management team to steer the integration and conversion
efforts of the Kentucky Acquisition.'®°
Both parties rely on Morrison y, Berry in support of their position. In that case, the

plaintiff alleged breach of fiduciary duty and aiding and abetting breach of fiduciary duty against
the company’s financial advisor, counsel, and the acquiror.'*! The plaintiff alleged that the law
firm aided and abetted the board’s breach of fiduciary duty by causing the board to carelessly
draft and release a schedule with material omissions.'®’ The Chancery Court held that the
allegations fell well-short of well-pled allegations of scienter.’*
The Trustee alleges the current facts are distinguishable because in Morrison the law firm

did not hold board or management positions. Sun Capital argues the holding in Morrison did not

revolve around the law firm’s position but the allegations of “intentionally and knowingly”
causing the Morrison board to be careless in their drafting.
The Court finds the Morrison Court’s analysis regarding the financial advisor’s role more

analogous to the allegations pleaded here. In Morrison, the advisor was alleged to use

1 See Amend. Compl $9 42, 45, 46-49, 51.
180 See Amend, Compl. □□ 39, 54-62.
181 Morrison v. Berry, C.A. No. 12808-VCG, 2020 WL 2843514, at *1-2 (Del. Ch. June 1, 2020),
82d FLL,
183 Ie.
46

backchannel conversations with the acquiror to gain insight and favorable treatment for the

acquiror. 84

Similarly, here, Sun Capital is alleged to have:
e Used its own Board members and exercised majority control over the FFO
Boards to make the Kentucky Acquisition.'*°
e Used its consulting agreement with FFO to not only exercise significant
control over FFO’s operations but also collect a management fee.'®
© Pushed through the Kentucky Acquisition without proper due diligence for its
own gain. !8”
e Created an information vacuum by not performing due diligence with regard
to the Kentucky Acquisition.'**
e Failed to consider the differing business models between FFO and the
Kentucky Acquisition companies.'*?
e Closely supervised and regularly directed FFO’s management and operations,
including through monthly financial reviews attended by the management
team and Sun Capital.!”°
* Put significant debt on FFO through the Grid Notes and Sun Credit
Agreement.!7!
Between making up a majority of each FO Board, being involved in the day-to-day FFO

business, serving as lender on the Grid Notes and the Sun Credit Agreement, as well as
orchestrating and consulting on the Kentucky Acquisition, it is reasonable to infer that Sun
Capital knew the FFO Boards were breaching their fiduciary duties and committing these acts

Td at *10,
185 Amend. Compl. □□□ 39-40, 42-53.
186 Amend. Compl. {ff 42-53.
87 Amend, Compl. {J 47-49.
188 Amend. Compl. 1 95.
189 Amend. Compl. ff 42-53.
99 Amend. Compl. J 39.
191 Amend. Compl, Jf 54-67.
47

intentionally and knowingly. As such, the Sun Capital Motion to Dismiss Counts 4, 5, and 6 will
be denied.
ll. Count 7: Recharacterization Count
In Count 7 of the Complaint, the Trustee seeks to recharacterize the Grid Notes and the

Sun Credit Agreement (amounting to approximately $28 million in outstanding principal and

interest) as equity.
“The Third Circuit has held that the overarching inquiry with respect to recharacterizing
debt as equity is whether the parties to the transaction in question intended the loan to be a

disguised equity contribution.”! While “[n]o mechanistic scorecard suffices,” the parties’
intent “may be inferred from what the parties say in their contracts, from what they do through
theit actions, and from the economic reality of the surrounding circumstance.”'” “No one factor

is dispositive of either the intent of the parties or whether a loan should be recharacterized as

equity. And a court can find recharacterization to be appropriate even if less than all of the

factors weigh in favor of a capital contribution.”!* Furthermore “in characterizing an instrument

as debt or equity, a court must focus its inquiry to a point at the very beginning of the parties’
relationship.” !”°

2 Official Comm, of Unsecured Creditors of Fedders N. Am., Inc. v. Goldman Sachs Credit Partners L.P. (in re
Fedders N. Am., Inc.), 405 B.R. 527, 554 (Bankr, D. Del. 2009) (citing Cohen vy. KB Mezzanine Fund If, LP (in re
SubMicron Sys. Corp.), 432 ¥.3d 448, 455-56 (Gd Cir. 2006).
193 SubMicron, 432 F.3d at 456; In re Optim Energy, LLC, No. 14-10262 (BLS), 2014 WL 1924908 at *7 (Bankr.
D. Del. 2014).
1 Weisfelner v. Blavatnik (In re Lyondell Chem, Co.), 544 BR. 75, 94 (Bankr. 8.D.N.Y. 2016) (footnotes and
citations omitted).
95 TJnited States v. State St. Bank & Tr. Co., 520 BR. 29, 74 (Banke. D. Del, 2014) (citations omitted),
48

Courts have considered the following factors in considering recharacterization,
commonly referred to as the Aufostyle test: (a) names given to the instruments, if any, evidencing
the indebtedness; (b) presence or absence of a fixed maturity date and a schedule of payments;
(c) no fixed rate of interest and interest payments; (d) whether repayment depended on success of

the business; (e) inadequacy of capitalization; (f) identity of interests between creditor and
stockholder; (g) security, if any, for the advances; (h) ability to obtain financing from outside
lending institutions; (i) extent to which the advances were subordinated to the claim of outside

creditors; (j) the extent to which the advances were used to acquire capital assets; (k) presence or

absence of a sinking fund; (1) presence or absence of voting rights; and (m) other
considerations.'”°
As instructed by the Third Circuit, the Court will look at the totality of the facts in
evaluating the Grid Notes and Sun Credit Agreement'*”
A. Names Given to Instruments, if any, Evidencing the Indebtedness
“The absence of notes or other instruments of indebtedness is a strong indication that the

advances were capital contributions and not loans.”'8

1% Jy re Our Alchemy, LLC, No. 16-11596 (KG), 2019 WL 4447535 at *6 (quoting Lipscomb v. Clairvest Equity
Partners Ltd. P’ship (In re LMI Legacy Holdings, Inc.), No. 13-12098 (CSS), 2017 WL 1508606, at *14 (Bankr. D.
Del. Apr. 27, 2017), aff'd, 625 B.R. 268 (D. Del, 2020) (further citation omitted); see also Youngman v. Yucaipa
Am. Alliance Fund I, L.P. (nre Ashine Corp.), 629 B.R, 154, 225 (Bankr. D, Del. 2021), order adopted in part,
rejected in part sub nom. In re ASHINC Corp., No. 1211564, 2022 WL 2666888 (D. Del. July 11, 2022)
(considering seven factors “(1) the name given to the instrument; (2) the intent of the parties; (3) the presence or
absence of a fixed maturity date; (4) the right to enforce payment of principal and interest; (5) the presence or
absence of voting rights; (6) the status of the contribution in relation to regular corporate contributors; and
(7) certainty of payment in the event of the corporation’s insolvency or liquidation.”).
197 In re Our Alchemy, LLC, No. 16-11596 (KG), 2019 WL 4447535 at *6 (citations omitted).
8 Bayer Corp. v. MascoTech, Ine. (In re AuioStyle Plastics, Inc.), 269 F.3d 726, 750 (6th Cir, 2001) (citing Roth
Steel Tube Co. v. Comm’r, 800 F.2d 625, 631 (6th Cir. 1986) (further citation omitted)).
49

i —- Grid Notes .
Sun Capital claims that the Grid Notes include principal amounts, interest rates, payment
terms, events of default, and remedies. The Trustee responds that this factor should not be given
much weight due to Sun Capital’s sophisticated nature and knowledge of recharacterization.

This factor weighs against recharacterization of the Grid Notes.
ii, Sun Credit Agreement
Sun Capital claims that the Sun Credit Agreement contains an interest rate, borrowing
conditions, and is referred to as a loan. The Trustee alleges that because Sun Capital dominated

the FFO Boards, the Sun Credit Agreement and advances thereunder were all executed by the

same FFO individuals on behalf of the “lender” and “borrower.”!°? Moreover, the Trustee

alleges that the May 2019 Fundings and the September 2019 Fundings were made initially
without documentation.2” Although the Trustee adequately pleads timing and execution issues,
the name of the instrument, Sun Credit Agreement, indicates a loan.’””' This factor weighs
against recharacterization of the Sun Credit Agreement.
B. Presence or Absence of a Fixed Maturity Date and a Schedule of Payments
“The lack of a fixed maturity date or a fixed obligation to repay suggests the advances

were not loans but equity contributions.”

199 Amend. Compl. 9] 40, 73-74.
208 Amend. Compl. {ff 73-74.
201 See Official Committee of Unsecured Creditors v. Comvest Group Holdings, LLC (in re HH Liquidation, LLC),
590 BR, 211, 292 (Bankr. D, Del. 2018) (“The instrument’s name clearly evidences a secured loan.”).
202 fy xe Our Alchemy, LLC, No. 16-11596 (KG), 2019 WL 4447535 at *7 (citations omitted).
50

i. Grid Notes
Sun Capital acknowledges that the Grid Notes do not contain an interim, periodic
payment schedule.2% The Grid Notes do contain a maturity date, allowance for prepayment —

however, such prepayment is “without premium or penalty." In In re Friedman's Inc., the

note was payable over four years after entry into the notes with no interim payment of
principal.“ Although there was a fixed maturity date, the company was not required to make

any principal payments over the four-year life of the notes, thus, the Hriedman’s Inc. court found

that this factor was neutral.?°° Here, although there is a fixed maturity date, FFO was not

required to make any principal payments for over four years. Therefore, this factor is neutral.

iit Sun Credit Agreement
The Sun Credit Agreement specifies a “Term Loan Maturity Date” and contemplates a

schedule of “pre-payments” under particular circumstances.” Like the Grid Notes, although
there is a maturity date, the [borrowers] Debtors were not required to make any principal
payments.2°8 Therefore, this factor is neutral.?”

203 See Adv. DL. 30, Ex. B, § 2, at A00S-006,
204 See Adv, D.L 30, Ex, B § 2(b), at A005.
205 Friedman’s Liquidating Tr. v. Goldman Sachs Credit Pariners, L.P. (In re Friedman’s Inc.}, 452. B.R. 512, 520
(Bankr. D. Del. 2011).
206 In re Friedman's Inc., 452 B.R. at 520.
207 See Adv. DJ. 30, Ex. C, § 1.01, A044 and § 2.03(b), A048-A049.
208 See Adv. 30, Ex. C, § 2.03(a), A048.
29 See In re Friedman's Inc., 452 B.R. at 520.
5]

C. No Fixed Rate of Interest and Interest Payments
The absence of a fixed rate of interest and interest payment “is a strong indication the

investment was a capital contribution, rather than a loan.”?!°
i. Grid Notes
The Grid Notes bore interest and such interest was payable-in-kind and was deferred until

the “schedule payment” date.2!' So although there was an interest rate, the interest accrued and

was added to the principal amount of the Grid Note.” “[D]eferral of interest payments does not

by itself mean that the parties converted a debt transaction to equity since the defendants still

expected to be repaid.”*!? Therefore, this factor is neutral.
ii, Sun Credit Agreement
The Sun Credit Agreement bore interest and such interest was payable-in-kind (not in

cash) and was deferred until the payment date.”!* So although there was an interest rate, the

interest accrued and was added to the principal amount of the Sun Credit Agreement.’
Therefore, this factor is neutral.

210 Td at 521.
21 Ady, DL. 30, Ex. B, § 1, A005.
212 Ady. D.1. 30, Ex. B, § 1, A005 (“Interest shall accrue on a daily basis at the rate of eleven percent (11%) per
annum, compounded annually, on the unpaid principal amount of this note then outstanding.”).
213 AyoStyle, 269 F.3d at 751; Off Unsecured Creditors Comm. of Broadstripe, LLC v. Highland Cap. Mgmt, £.P.
(In re Broadstripe, LLC), 444 B.R. 51, 96 (Bankr. D. Del. 2010) (“presence of PL interest is not decisive” of the
recharacterization analysis “especially in a distressed investment context.”). See also State Street Bank, 520 B.R. at
79 (“The Junior PIK Notes reflect all indicia of indebtedness, including the issuance of notes with payment at a
fixed interest rate (although payment of interest was deferred). . . .”).
214 See Adv, D.I. 30, Ex. C, § 2.05, A049-AQ50,
218 Ady. DI. 30, Ex. C, § 2.06(c), A050 (“Interest on each term Loan shall be due and payable in kind (and not in
cash) in arrears on each Interest Payment Date applicable thereto and at such other times as may be specified
herein.”); § 1.01, A035 (“Interest Payment Date’ means the last day of each calendar quarter, beginning with the
calendar quarter ending on September 30, 2019, and the Term Loan Maturity Date.”).
52

D. Whether Repayment Depended on Success of the Business
“If the expectation of repayment depends solely on the success of the borrower’s

business, the transaction has the appearance of a capital contribution? However, courts look

to the “underlying economic reality and the general tie between the loan’s repayment and the

success of the business;” such that a second source of repayment (security interest) would

mitigate against finding that the repayment depended on the success of the business.?!7
i. Grid Notes
Sun Capital argues that the Grid Notes do not limit repayment to FFO’s future profits.
The Trustee responds that the Grid Notes were unsecured. In In re Autobacs Strauss, Inc., the

lender conceded that the loans were unsecured and did not suggest an alternative source of

repayment existed, and as a result, the bankruptcy court found that the fourth factor weighed in

favor of recharacterization2!® Similarly, here, the Grid Notes were unsecured, and Sun Capital
offered no alternative source of repayment other than the success of FFO. Thus, this factor

weighs in favor of recharacterization of the Grid Notes.
ii, Sun Credit Agreement
Sun Capital also argues that the Sun Credit Agreement did not limit repayment to FFO’s

future profits, thus the repayment of the Sun Credit Agreement was not “solely dependent” on

FEO’s success. The Trustee responds that the Sun Credit Agreement was supported by a

26 In re Friedman’s Inc., 452 B.R. at 521 (citations and footnote omitted).
217 Autobacs Strauss, Ine. v. Autobacs Seven Co., Ltd. (In re Autobaes Strauss, Inc.), 473 B.R. 525, 575 (Bankr. D.
Del, 2012).
U8 Fed at 576.
53

subordinated security agreement and, at the time the agreement was entered into, FFO did not

have sufficient assets to repay the Sun Credit Agreement?!” Furthermore, Sun Capital did not

file UCC statements for the Sun Credit Agreement for over a year after the Sun Credit

Agreement was made.’ As pleaded, at the time the Sun Credit Agreement was entered into

and, as amended, funded with additional draws, there was no alternative to payment besides the

success of FFO’s business. Consequently, this factor weighs in favor of recharacterization of the

Sun Credit Agreement.
E. Inadequacy of Capitalization
“Thin or inadequate capitalization is strong evidence that the advances are capital
contributions rather than loans. Undercapitalization is particularly relevant when a corporation is

started by the shareholders with a minimal amount of capital who then make a Jarge loan of

money to the newly formed corporation. Capitalization is assessed both at the times of initial

capitalization and subsequent transactions.”””! In the context of a pre-existing lender (Sun
Capital) to a distressed company (FFO), “it is legitimate for the lender to take actions to protect
existing loans, including extending additional credit. Under similar circumstances, courts have

219 Amend, Compl. § 74 (“FFO would subsequently lean on this loan [Sun Credit Agreement] to try to dig out of the
hole created by the Kentucky Acquisition, periodically incurring more debt with FFO could not afford to repay.”).
20 Amend. Compl. {| 73-74. The Sun Credit Agreement, as amended, was entered into on June 28, 2019. Amend.
Compl. § 73. “Sun Capital did not record any UCC financing statement on account of the Sun Credit Agreement
until October 23, 2020, shortly before FFO filed for bankruptcy.” Amend. Compl. 74.
223 In re Autobacs Strauss, Inc., 473 B.R. at 576 (citations, footnotes and internal quotations marks omitted).
54

found that existing lenders are often the only source of funding when a debtor faces distress and

that the inability to obtain alternative financing is insufficient to support recharacterization.””””
i. Grid Notes

_ The Trustee alleges that the Grid Notes were made at a time that FFO was
undercapitalized, and no other creditor was willing to extend credit to FFO.””? Sun Capital
claims that these allegations are conclusory and should weigh in favor of dismissal. The

Complaint alleges that Sun Capital required FFO to pay for a substantial portion of its own
acquisition whereby it repurchased $32 million in equity interests, and then sold all of its

outstanding equity to Sun Capital for approximately $7 million." The Trustee claims it is

simple math to establish undercapitalization, given that Sun Capital financed the acquisition with
the Grid Notes to “make up the financing gap” and “further finance[d] the Sun Acquisition” with

the Stellus Credit Agreement.””°
The allegations in the Complaint are sufficiently plausible to find that FFO was
undercapitalized at the time of the Grid Notes issuance. As a result, this factor weighs in favor

of recharacterization of the Grid Notes.

222 Burtch vy. Salem Investment Partners, Uf, LP (In re Parker Sch, Uniforms, LLC), No, 18-10085 (CSS), 2021 WL
4553016, at *12 (Bankr. D, Del. Oct. 5, 2021) (citations, footnotes, quotation marks, and modifications omitted).
23 Amend. Compl. { 112. See also Amend. Compl. {72 (“By early 2019, FFO owed at least $4.7 million in
outstanding vendor payments. Between January and March 2019, FFO was clearly undercapitalized and had no
choice but to borrow an additional $4 million from Sun Capital under the Grid Notes.”).
224 Amend. Compl. § 34.
25 Amend. Compl. {4 35-36; Adv. D.I. 33 at 19.
55

Additionally, here, as alleged in the Complaint, Sun Capital was not a third-party lender

with an unchallenged existing loan. Sun Capital was the controlling shareholder of FFO and its

only purported “debt” is subject to recharacterization in the Complaint.”° This is not the

situation in which a pre-existing lender is trying to protect its interest; rather, all of Sun Capital’s
investments are challenged in the Complaint, so the “existing lender” becoming a “rescue

lender” argument does not have weight under the circumstances.
ii. Sun Credit Agreement
The same is true for the Sun Credit Agreement, but by the time Sun Capital was making
advances under the Sun Credit Agreement, FFO’s financial distress and undercapitalization had
worsened.2*” Thus, based on the factual assertions, this factor weighs in favor of

recharacterization of the Sun Credit Agreement.
F. Identity of Interests Between Creditor and Stockholder
“Another factor in the AutoStyle test is the identity of interest between the creditor and

the stockholder, If stockholders make advances in proportion to their respective stock

ownership, an equity contribution is indicated. On the other hand, a sharply disproportionate
ratio between a stockholder’s percentage interest in stock and debt is indicative of bona fide debt.

Where there is an exact correlation between the ownership interests of the equity holders and

26 Amend. Compl. fq 109-14.
227 Amend. Compl. □□□ 71-75. ‘

their proportionate share of the alleged loan this evidence standing alone is almost
overwhelming.”?8
i. Grid Notes
The Trustee asserts that “all advances made under the Grid Note[s] were in proportion to

Sun Capital’s equity interest in FFO” as a result of the Stellus Participation Agreement which

accorded Stellus certain participant interests in the original (2016) Grid Note”? Sun Capital
asserts that this allegation ignores the party who made the Grid Note loans — Note Holdings —

who held no equity in FFO at, or after, the initial Grid Note issuance. The Trustee responds that

Note Holding is wholly owned by Sun Furniture Factory, LP, FFO’s majority equity owner, and,

at the time the advances under the 2016 Grid Notes were issued, Sun Capital owned 100% equity
interests in FFO and 100% of the loans under the Grid Notes (through its 100% ownership
interest in Note Holdings).7° The Trustee argues that as a result of the Stellus Participation
Agreement, each of Sun Capital’s and Stellus’ respective interests in the Grid Notes were
cotrelated to its equity interests in FFO.”*!
The Court finds that the Trustee has pleaded sufficient facts, taken as true, to show

identity of interests between FFO and Sun Capital for purposes of recharacterization. ‘Thus, this

factor weighs in favor of recharacterization of the Grid Notes.

228 In re Autobacs Strauss, Inc., 473 B.R. at 577-78 (internal quotation marks omitted; quoting to In re AutoStyle
Plastics, Inc., 269 F.3d at 751 (citations, footnote, and quotation marks omitted).
229 Amend. Compl. Jf 35, 37, #11.
230 Amend. Compl. Jf 34-35.
Amend, Compl. { 37.
57

ii Sun Credit Agreement
Sun Capital asserts that neither the Complaint nor the Sun Credit Agreement indicate that

the term loan advances were proportionate to Note Holding’s stock ownership in FFO, The

Trustee did not respond nor does the Complaint make such an allegation. Thus, this factor

weighs against recharacterization of the Sun Capital Agreement.
G. Security, If Any, for the Advances
“If an advance is made on an unsecured basis, it is likely a capital contribution as
opposed to a loan,”
i. Grid Notes
The parties agree that the Grid Notes were unsecured, As aresult, this factor weighs in

favor of recharacterization of the Grid Notes.
iit Sun Credit Agreement
The Trustee alleges that, while on its face the Sun Credit Agreement was “secured,” the

agreement was actually either unsecured or unperfected.”*? In support, the Trustee argues the
following facts: (i) the May 2019 Fundings were not documented until June 28, 2019;? Gi) Sun

Capital made an additional loan on September 13, 2019 that was not documented until

September 18, 2019;7% and (iii) “Sun Capital did not record any UCC financing statements on

232 In re Our Alchemy, LLC, No. 16-11596 (KG), 2019 WL 4447535 at *8 (citing In re AutoStyle Plastics, 269 F.3d
at 752 (further citations omitted).
233, Amend. Compl. { 111; Adv. D.L 33 at 21.
234 Amend. Compl. { 73.
235 Amend, Compl. 74.
58

account of the Sun Credit Agreement until October 23, 2020.” Sun Capital responds that the

Sun Security Agreement specified how the terms of Sun Capital’s security interest was to be
perfected.??’
As alleged, Sun Capital did not file UCC statements for 16 months following the funding

to FFO (two weeks prior to the Petition Date). In other words, Sun Capital did not take any

measures to secure its claims vis-a-vis third parties. As a result, this factor weighs in favor of

recharacterization of the Sun Credit Agreement.
H. Ability to Obtain Financing from Outside Lending Institutions
“Yet another factor in the AufoStyle test is the debtor’s ability to obtain outside financing.
When there is no evidence of other outside financing, the fact that no reasonable creditor would

have acted in the same manner is strong evidence that the advances were capital contributions

rather than loans.”23* ‘The question in evaluating this factor is “whether a reasonable outside

creditor would have made a loan to the debtor on similar terms.”*??
i, Grid Notes
With respect the to 2016 Grid Notes, within months of entry into the 2016 Grid Notes,
Stellus and FFO entered the Stellus Credit Agreement (which included a participation interest in

236 Amend. Compl. J 74.
237 Ady, D.1. 30, Ex. D (Second Lien Security and Pledge Agreement), §3(b), A150-151.
238 J re Autobacs Strauss, Inc., 473 B.R. at 579 (citations and quotations marks omitted).
239 Fd. (citations and quotation marks omitted).
59

the 2016 Grid Notes).° As such, FFO was able to obtain outside financing. This factor weighs
against recharacterization of the 2016 Grid Notes.
With respect to the 2019 Grid Notes, Sun Capital argues that as an existing lender it was

issuing the loan to FFO at a time of financial distress to protect existing loans. In Jn re Parker

School Uniforms, LLC, the court held:
[I]n the context of pre-existing lenders lending to a distressed
company, it is legitimate for the lender to take actions to protect
existing loans, including extending additional credit. Under
similar circumstances, courts have found that existing lenders are
often the only source of funding when a debtor faces distress, and
that the inability to obtain alternative financing is insufficient to
support □□□□□□□□□□□□□□□□□□□□□□
Again, the question is “whether a reasonable outside creditor would have made a loan to

the debtor on similar terms.”
The Trustee alleges that by early 2019, FFO owed at least $4.7 million in outstanding
vendor payments, which necessitated the 2019 Grid Notes.“ The Trustee further alleges that

FFO was undercapitalized during early 2019.""* Taking these allegations as true, it is plausible
that no reasonable outside creditor would have made the loan on similar terms. As a result, this

factor weighs in favor of recharacterization of the 2019 Grid Notes.

2 Amend. Compl. Jf 36-37.
241 In re Parker Sch. Uniforms, LLC, No. 18-10085 (CSS), 2021 WL 4553016 at *12 (citations, footnotes, quotation
marks, and modifications omitted).
242 In re Autobacs Strauss, Inc., 473 B.R. at 579 (citations and quotation marks omitted).
43 Amend. Compl. { 72.
244 Amend. Compl. 72.
60

ii. Sun Credit Agreement
With regard to the Sun Credit Agreement, FFO needed additional liquidity because sales

were down 30% and vendors were being “stretched.”**? Sun Capital provided FFO financing
without documentation on May 1, May 15, and September 13, 2019. The Trustee alleges that

“during this time FFO did not seek funding from any additional sources other than Sun
Capital.”*47 Additionally, the Trustee asserts that “no other creditor was willing to extend
credit.”7"8
Sun Capital argues that, as existing lender, they continued to make advances to protect
their existing loans and “traditional factors that lenders consider (such as capitalization,
solvency, collateral, ability to pay cash interest and debt capacity rations) do not apply when

lending to a financially healthy company.”””? For the purposes of this motion, the Court

disagrees. At the time of the Sun Credit Agreement, there were allegations that FFO did not

solicit other lenders, nor did they even document the loan before advancing cash. The Sun
Credit Agreement was not advanced on the basis that a “typical” lender would make advances.

As a result, this factor weighs in favor of recharacterization of the Sun Credit Agreement.

45 Amend. Compl. § 73.
246 Amend. Compl. J 73.
“7 Amend. Compl. {fj 73-74.
248 Amend. Compl. § 112.
249 In ve Parker Sch. Uniforms, LLC, No. 18-10085 ce 2021 WL 4553016 at *12 (footnote omitted).

I. Extent to Which Advances were Subordinated to Claims of Outside
Creditors
Another factor “is the extent to which the payments to be made are subordinated to the

claims of outside creditors. Subordination of advances to claims of all other creditors indicates

that the advances were capital contributions, not loans.”?°°
Here, there are no allegations that either the Grid Notes or the Sun Credit Agreement

were subordinated to all other creditors. This factor weighs against recharacterization of the

Grid Notes and the Sun Credit Agreement.
J. The Extent to Which the Advances were Used to Acquire Capital Assets
The next factor “is whether the advances were used to acquire capital assets. Use of

advances to meet the daily operating needs of the corporation, rather than to purchase capital
assets, is indicative of bona fide indebtedness.”?>!
i. —- Grid Notes
The Complaint alleges that the 2016 Grid Notes were advanced by Sun Capital in
connection with its buy-out of existing equity.2* Thus, this factor weighs in favor of
recharacterization of the 2016 Grid Notes.
The Complaint alleges that the 2019 Grid Notes were used for FFO’s working capital
(and not capital assets).?? This factor weighs against recharacterization of the 2019 Grid Notes.

250 re Friedman’s Inc., 452 B.R. at 523 (quotation marks omitted, quoting In re AutoStyle Plastics, Inc., 269 F.3d
at 752).
fd (quotation marks omitted; In re AutoStyle Plastics, Inc,, 269 F.3d at 752).
232 Amend. Compl. fj 33-35.
233 Amend. Compl. { 72.
62

ii, Sun Credit Agreement
Similarly, the Trustee alleges the Sun Credit Agreement term loans were used to pay
down debts to its vendors.?°4 This factor weighs against recharacterization of the Sun Credit

Agreement.
K. Presence or Absence of a Sinking Fund
“The failure to establish a sinking fund for repayment is evidence that the advances were

capital contributions[.]’° The Complaint does not allege the presence of a sinking fund for the
Grid Notes or the Sun Credit Agreement. As a result, this factor weighs against
recharacterization of the Grid Notes and the Sun Credit Agreement.
L. Presence or Absence of Voting Rights
The Third Circuit identified the presence or absence of voting rights as a factor in
reconsidering the recharacterization of a claim.**° “Where the Complaint does not allege nor do

the primary notes grant any voting rights, the advance is likely a loan.”*°? The Trustee does not

allege that the Grid Notes or the Sun Credit Agreement granted any voting rights. As a result,
this factor weighs against recharacterization of the Grid Notes and the Sun Credit Agreement.

254 Amend. Compl. {{] 72-74.
255 In re Our Alchemy, LLC, No. 16-11596 (KG), 2019 WL 4447535 at *9 (citing In re AutoStyle Plastics, Inc., 269
F.3d at 753 (“The bankruptcy court noted the absence of a sinking fund and concluded that this factor weighed
toward equity.”) (further citations omitted)).
236 In re SubMicron Sys, Corp., 432 F.3d at 456 n. 8 (citations omitted).
57 Tn ve Our Alchemy, LLC, No. 16-11596 (KG), 2019 WL 4447535 at *9 (citations omitted).
63

M. Other Considerations
i, Acceleration Provision
In SubMicron, the Third Circuit identified the certainty of payment in the event of the
corporation’s insolvency or liquidation as a relevant factor for recharacterization claims.”* “The

‘certainty of payment’ factor cuts straight to what a lender cares about when making a loan,
especially in a distressed situation.”?”
For example, in Jn re Our Alchemy, LLC, the short-term maturity of the loan (75 days)
weighed in favor of treating the loan as debt, rather than equity.7°° In contrast, here, the Grid

Notes had a 2-5-year maturity and the Sun Credit Agreement had a 25-31-month maturity. Both

the Grid Notes and the Sun Credit Agreement were unsecured or unperfected and, as alleged,
during a time when FFO was undercapitalized, Additionally, as alleged, Sun Capital never

sought to accelerate and has asserted claims for $14.89 million on account of the Grid Notes and
$12.8 million on account of the Sun Credit Agreement.”*! The lack of acceleration provisions
and the lengthy terms of each of the loans favors recharacterization at this stage of the

proceeding.

258 re SubMicron Sys. Corp., 432 F.3d at 456 n. 8 (citations omitted).
259 In re HH Liquidation, LLC, 590 B.R, at 296.
260 In re Our Alchemy, LLC, No. 16-11596 (KG), 2019 WL 4447535 at *9.
Amend, Compl. { 76.
64

ii, Insider Status
The Trustee alleges that Sun Capital was an insider at all relevant times during the

issuance of the Grid Notes and the Sun Credit Agreement.”© “[A] claimant’s insider status and a

debtor’s undercapitalization alone wil! normally be insufficient to support the recharacterization

of a claim.”2 “For struggling businesses, an insider is often the only party willing to lend and

so recharacterization should not be used to discourage good-faith loans.”?
Sun Capital asserts that its insider status is insufficient to support recharacterization. The

Trustee responds that Sun Capital’s insider status is not the only factor; it is one of many factors

that favors recharacterization at this point in the proceedings. The Court will consider Sun
Capital’s insider status, at this stage of the proceedings. Thus, this factor weighs in favor of
recharacterization of the Grid Notes and the Sun Credit Agreement.
iii, Lack of Formatities
Another factor considered by courts is whether the loan was made with a “troubling lack

of formalities.”
Sun Capital minimizes this factor, arguing that in Aufobacs Strauss the court was

concerned that the board had violated the company’s bylaws and accounting rules in approving

262 Amend. Compl. 9 33-74.
263 In re Our Alchemy, LLC, No. 16-11596 (KG), 2019 WL 4447535 at *10 (citing Fairchild Dornier GMBH v. □□□□
Comm. of Unsecured Creditors (In re Dornier Aviation (N. Am.), Inc.), 453 F.3d 225, 234 (4th Cir. 2006)).
264 Im re Our Alchemy, LLC, No. 16-11596 (KG), 2019 WL 4447535 at *10 (citations and quotation marks omitted).
265 Tn re Autobacs Strauss, Inc., 473 B.R. at 581 (footnote and citation omitted); In re Cold Harbor Assocs., L.P.,
204 BR. 904, 916 (Bankr, E.D. Va. 1997).
65

certain agreements.26° The Autobacs Strauss court’s analysis, however, related to a breach of the

allegation of duty of care. With regard to recharacterization, the Autobacs Strauss court stated:
ABST alleges that the loan agreements were never approved or
discussed in any meetings by ABST’s board of directors, and that
no minutes exist regarding any such meeting. ABST alleges that
two of the directors of ABST, the two that were not AB7-telated,
were purposefully excluded from finance discussions, including
those related to the loans. Finally, ABST alleges that these actions
violated ABST by-laws and Accounting Rules. Thus, the
additional factor of a lack of formalities favors ABST and weigh in
favor of recharacterization,?™
Here, the Trustee alleges that at the time Sun Capital started making advances in May
2019, the fundings “were not documented” and “neither the Boards, nor anyone un-affiliated
with Sun Capital, approved or gave any formal consideration to either the May 2019 Fundings or

entry into the Sun Credit Agreement. Rogalski signed the Sun Credit Agreement on behalf of

each of the FFO Entities, as borrowers and guarantors, and on behalf of Note Holdings, as
lender. The allegation in Autobacs Strauss and here are similar. As a result, this factor

weighs in favor of recharacterization of the Grid Notes and the Sun Credit Agreement.
N. Conclusion
As mentioned above, “[n]o one factor is dispositive of either the intent of the parties or

whether a loan should be recharacterized as equity. And a court can find recharacterization to be
appropriate even if less than all of the factors weigh in favor of a capital contribution.”?°

In re Autobaes Strauss, Inc., 473 BR. at 560.
267 Fd at 581.
268 Amend. Compl. { 73.
269 In re Lyondell Chem. Co., 544 B.R. at 94 (footnotes and citations omitted).
66

Having evaluated the foregoing factors to determine whether the Trustee has alleged enough
facts, taken as true, to establish a plausible claim for recharacterization, the Court finds that the

following weigh in favor of recharacterization: repayment; inadequacy of capitalization; identity

between the creditor and stockholders (Grid Notes); security interest; ability to obtain outside
financing (2019 Grid Notes and Sun Credit Agreement); advances used to acquire capital assets

(2016 Grid Notes); and acceleration of the loan, insider transaction; and lack of formalities. The

Court will deny the Sun Capital Motion to Dismiss as to Count 7 of the Complaint because the

Trustee has pleaded a plausible claim for recharacterization of both the Grid Notes and the Sun
Credit Agreement.
Wii. Count 8: Equitable Subordination Count
The Bankruptcy Code provides that a court may, under principles of equitable
subordination, subordinate for the purposes of distribution all or part of an allowed claim to all or

part of another allowed claim.” Under the Mobile Steel framework,’”' equitable subordination
requires proof of three elements: “(i) the defendant engaged in some type of inequitable conduct;

270 Section 510(c) of the Bankruptcy Code states, in pertinent part:
(c) Notwithstanding subsections (a) and (b) of this section, after notice and a
hearing, the court may—
(1) under principles of equitable subordination, subordinate
for purposes of distribution all or part of an allowed claim to
all or part of another allowed claim or ali or part of an allowed
interest to all or part of another allowed interest.
11 U.S.C. § 510(c). See also The Bank of New York v. Epie Resorts-Pal Springs Marquis Villas, LLC (In re Epic
Cap. Corp.}, 290 B.R. 514, 523 (Bankr. D. Del. 2003), aff'd, 307 B.R. 767 (D. Del. 2004).
271 Benjamin v. Diamond (In the Matter of Mobile Steel Ca), 563 F.2d 692, 700 (Sth Cir. 1977).
67

(ii) the misconduct caused injury to the creditors or conferred an unfair advantage on the

defendant; and (iii) equitable subordination of the claim is consistent with bankruptcy law.”””*

“The [Plaintiffs] burden depends on whether the [lender], whose claim might be

subordinated, is an insider or non-insider. The burden of proof is less demanding when the

respondent is an insider.””” “Insiders, those in a position of influence over the Debtor, are held

to a higher standard than non-insider claimants, that is to say, their claims may be subordinated

more easily than those of parties who dealt with the Debtor at arm’s length.” ?”

For the putposes of a claim for equitable subordination, a party is an insider if it

“(i) meets the statutory definition of insider, or (ii) is in a close relationship with the debtor to

such an extent as to suggest transactions were not conducted at arms length.”’’° The statutory
definition of an insider under the Bankruptcy Code includes an “affiliate, or insider of an affiliate

22. In re Autobacs Strauss, Inc., 473 B.R. at 582 (footnotes and further citation omitted).
273 Inve Epie Cap. Corp., 290 B.R. at 524, In re HH Liquidation, LLC, 590 B.R. at 298 (citations, quotation marks,
and modifications omitted) (holding that “it is axiomatic that insider status alone is insufficient to warrant
subordination”).
24 Salkin vy, Chira (In re Chira), 353 B.R. 693, 723-24 (Bankr. 8.D. Fla, 2006), aff'd, 378 B.R, 698 (S.D. Fla,
2007), aff'd, 567 F.3d 1307 (11th Cir. 2009) (citing Matter of Mobile Steel Co., 563 F.2d at 701 (further citation
omitted)). As described in fn re Winstar Communications, Ine.:
When the creditor is an insider, the proof is not demanding. In such cases, a
bankruptcy trustee need only show “saterial evidence” of unfair conduct. For
non-insider claimants, egregious conduct must be established to justify equitable
subordination. The degree of non-insider misconduct has been variously
described as very substantial” misconduct involving “moral turpitude or some
breach of duty or some misrepresentation whereby other creditors were deceived
to their damage” or as gross misconduct amounting to fraud, overreaching or
spoliation. Nevertheless the test is the same; only the standard of proof required
differs.
Shubert v. Lucent Technologies Inc. (In re Winstar Comme’ns, Inc.), 348 B.R. 234, 284 (Bankr. D. Del. 2005), aff'd,
No, 01 01063 KIC, 2007 WL 1232185 (D. Del. Apr. 26, 2007), aff'd in part, modified in part, 554 F.3d 382 Gd Cir.
2009) (citations, modifications, and quotation marks omitted).
275 fn re Autobacs Strauss, Inc., 473 B.R. at 582-83,
68

as if such affiliate were the debtor.”?”° An affiliate includes a “corporation 20 percent or more of

whose outstanding voting securities are directly or indirectly owned, controlled, or held with

power to vote, by the debtor.”?”” Because Sun Capital owned more than 20% of FFO’s shares,
Sun Capital is a statutory insider of FFO.” Furthermore, the Complaint alleges a sufficiently
“close relationship” with Sun Capital to suggest that the transactions were not conducted at arms’
length”? Asa result, and for the purposes of the Sun Capital Motion to Dismiss, the Court will

rigorously scrutinize Sun Capital’s conduct (within the confines of the motion to dismiss
standard) and the Plaintiff “need not plead inequitable condu

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/10456252. Public record. Not legal advice.