Case Law Update: Beware Representing the Company and the Equity in Insider Transactions

Case: Blast Fitness Group, LLC v. Gary W. Cruickshank, Chapter 7 Trustee of The Estate of Blast Fitness Group, LLC (In re Blast Fitness Group, LLC), no. 16-10236-MSH (Bankr. D. Mass.).

Opinion By: Judge Melvin S. Hoffman

January 8, 2019

Facts:

Chapter 7 Trustee brought forth an adversary proceeding seeking damages and injunctive relief against the law firm of Goodwin Proctor, a Goodwin partner, and a former Goodwin attorney (collectively the Goodwin Defendants), along with dozens of other defendants, for allegedly depriving Blast Fitness Group, LLC (BFG) of profit opportunities and diverting valuable assets which lead to BFG’s Chapter 7 filing.

Goodwin, on behalf of BFG and a BFG subsidiary, had drafted an asset purchase agreement to acquire three fitness clubs in 2012 (the Bally Transaction). In order to raise capital for this acquisition, members of BFG agreed to sell a preferred member interest to Dixon Limited Partnership, an affiliate of BFG’s controlling equity holder (Mr. Dixon). The member consent was drafted by the Goodwin Defendants and stated that a direct subsidiary of BFG would be acquiring the three fitness clubs. These member funds were used to subsidize the purchases and upon closing BFG had not received the clubs because they were sold to three LLC’s in which Mr. Dixon managed and effectively owned. Mr. Dixon then directed BFG to make above market rent payments to the LLC’s which managed the three fitness clubs.  In 2012, Mr. Dixon also transferred profitable BFG clubs for less than full consideration to Newfit, LLC, another LLC effectively owned by him.  Goodwin had drafted that asset transfer agreement. Mr. Dixon also transferred BFG received clubs from Lexfit, LLC (also owned by him) to Newfit. Goodwin drafted that agreement as well.

The Trustee’s causes of action against the Goodwin Defendants included legal malpractice, breach of professional fiduciary duty, breach of contract, violation of Mass. Gen. Laws ch. 93A, § § 2 and 11, and unjust enrichment in the form of attorneys’ fees paid to Goodwin. The Trustee also sought to recover attorneys; fees in the Newfit and Lexfit transactions as fraudulent transfers under MFTA § § 5 and 6 and Bankruptcy Code § 550. Goodwin filed motions to dismiss all counts and moved for partial summary judgment on the fraudulent transfer counts and unjust enrichment count with the Goodwin partner joining in on the motion for partial summary judgment. The former Goodwin partner sought dismissal of all counts against him.

Holding:

The Goodwin Defendants’ motions to dismiss relating to the 2012 Bally transaction were denied. The Court found unconvincing the Goodwin Defendants’ arguments that claims relating to this transaction were time-barred by the three year statute of limitations governing malpractice under M.G.L. ch. 260, § 4 because BFG should have realized they did not receive the fitness clubs upon closing, their payment of rent for these properties to Mr. Dixon’s LLC’s, and Mr. Dixon’s knowledge of this should be imputed to the other members. The Court agreed with the Trustee that the statute of limitations was tolled under M.G.L. ch. 260, § 12 which governs tolling when a defendant fraudulently conceals a cause of action from the plaintiff. The Court found that because a fiduciary relationship existed between the Goodwin Defendants and BFG, they had a duty to inform BFG members that they were paying for but not acquiring the fitness clubs. The Court also ruled that rental payments were irrelevant because members were not required to make inquiry into non-BFG entities and Mr. Dixon’s knowledge of the transfer should not be imputed to BGF members because under the adverse domination doctrine his knowledge of the transaction was not enough to prevent tolling.

The Court denied the Goodwin Defendants’ motions to dismiss the Trustee’s claims of malpractice, breach of fiduciary duty, violation of M.G.L. ch. 93A, and breach of contract relating to the Newfit and Lexfit transactions.  The Court found unconvincing Goodwin’s arguments that there was no breach of duty because there was no conflict of interest in simultaneously representing BFG and its controlling equity holder, Mr. Dixon, because it is not unlawful and is common for firms to represent an LLC and its controlling equity holder in transactions designed to favor that main equity holder. The Court ruled that the Trustee’s amended complaint states a claim upon which relief can be granted because a duty of undivided loyalty was owed to BFG and they were harmed through lost revenue and club sales to Newfit and Lexfit for less than market value.

The unjust enrichment claim against the former Goodwin partner was dismissed because the claim did not specify that he had received substantial payments from BFG to which he was entitled. The Court ruled that the motion for partial summary judgment on fraudulent transfers under MFTA §§ 5 and 6 and Bankruptcy Code § 550 in the form of attorneys’ fees paid to Goodwin and the partner was premature and denied without prejudice. Goodwin argued that BFG received sufficient value for the transfers in the form of legal services and that the second fee was not paid by BFG. The Court allowed the Trustee to seek additional discovery to determine whether the second payment was in fact from BFG and if sufficient value was given for the transfers.

Read The Full Case Here

Summary Prepared By:

Erica James

New Lawyers Section Liaison to Bankruptcy Law Section