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February 2014: Victory for Paulson & Co.

February 2014

On October 1, 2013, Quinn Emanuel obtained for its clients—senior executives of Paulson & Co. Inc.—a complete and decisive dismissal of a civil complaint brought by Five Mile Capital SPE B LLC (“Five Mile”) which sought more than $158 million in damages. The executives were directors of a portfolio entity, MSR Hotels & Resorts, Inc. (the “REIT”), also a defendant in the action. The total victory exonerated the executives and cleared the way for the REIT to successfully emerge from bankruptcy in 2013.

Before Five Mile commenced its action, certain of the REIT’s subsidiaries owned five iconic, luxury resorts across the United States. In 2011, those entities (the “Affiliated Debtors”) filed for bankruptcy relief in the United States Bankruptcy Court for the Southern District of New York. During those cases, the Affiliated Debtors and Five Mile entered into a stipulation consenting to a senior lender “credit bidding” its loans in exchange for the resorts in the absence of any higher and better offers. The resorts were sold to the lender under the Affiliated Debtors’ court-approved plan of reorganization. Five Mile, as the most junior lender to the Affiliated Debtors, was left with no recovery on account of its $50 million loan. Five Mile vociferously objected to the consummation of the sale, but its objections were found to be without merit and they were ultimately overruled.

The REIT had issued a “bad boy” guarantee on account of Five Mile’s loan—triggered if the borrower committed certain bad acts. The REIT also owned some of the trademarks used at the resorts. In an attempt to recover some value on account of its lost investment, Five Mile sued both the REIT and the directors, asserting direct and derivative claims on account of the defendants’ alleged actions and omissions in connection with the Affiliated Debtors’ sale of the resorts and administration of the trademarks. Five Mile specifically alleged that (i) the guarantee was an unconditional guarantee, (ii) the resorts were sold without its consent in violation of the loan agreement, (iii) there were “bad boy” acts on the basis of intentional misrepresentation, and (iv) the directors breached their fiduciary duties.

Quinn Emanuel filed a motion to dismiss the litigation in its entirety and on the merits. After two-and-a-half days of oral argument presented in late July 2013, the Bankruptcy Court issued a bench ruling on October 1, 2013 (reported at 2013 WL 5716897), granting the defendants’ motion and adopting Quinn Emanuel’s legal arguments. The Bankruptcy Court agreed that the plain language of the guarantee established that it was a limited, “bad boy” guarantee. Further, it held that there were no “bad boy” acts that could have triggered the limited guarantee. The Bankruptcy Court specifically determined that Five Mile’s consent to credit bidding by the lender during the course of the Affiliated Debtors’ bankruptcy cases was deemed consent under New York law to the sale of the resorts to that purchaser, even though every ancillary detail of the eventual transaction could not be foreseen at the time the consent was given. The Bankruptcy Court further observed that because the sale of the resorts was for reasonable value, i.e., the highest possible value that could be obtained in the marketplace, Five Mile failed to allege how it had suffered damages that the guarantee required in order to trigger liability. The Bankruptcy Court further rejected the claims that the borrower had made any misrepresentation or otherwise committed a “bad boy” act and found “exceedingly convincing” the arguments that the directors served their fiduciary duties appropriately and in complete good faith.