Slip Copy
Slip Copy, 2011 WL 3896199 (Bankr.D.Ariz.)
(Cite as: 2011 WL 3896199 (Bankr.D.Ariz.))
Only the Westlaw citation is currently available.
United States Bankruptcy Court,
D. Arizona.
In re RADICAL BUNNY, LLC, Debtor.
RB Liquidation, Plaintiff,
v.
Quarles & Brady, LLP et al, Defendants.
Bankruptcy No. 08-13884.
Adversary No. 10-2104.
Aug. 24, 2011.
Bruce R. Heurlin, Heurlin Sherlock Panahi, John Barrett, Mark D. Lammers, Nancy J.
March, Deconcini McDonald Yetwin & Lacy PC, Tucson, AZ, Francis J. Burke, Jr.,
Steptoe & Johnson LLP, Phoenix, AZ, for Plaintiff.
Robert Moya, Sara Dreier-Moya, Robert Bornhoft, Brandie Bornhoft, Christian
Hoffmann, Sally Roof, Gary Shullaw, Mary Shullaw, Scott B. Garner, Morgan, Lewis &
Bockius, LLP, Irvine, CA, for Defendants.
ORDER DENYING MOTION TO DISMISS
CHARLES G. CASE II, United States Bankruptcy Judge.
I. Introduction
*1 On April 28, 2010, the Arizona Corporation Commission entered a cease and desist
order against Radical Bunny requiring payment of $189,800,867 plus interest in
restitution. In this lawsuit, RB Liquidation, LLC, Radical Bunny's successor in interest,
seeks the same amount from its former lawyer, Quarles and Brady ("Quarles"), because
of its alleged malpractice. Quarles moves to dismiss the complaint under Fed. R.B. Proc.
7012(b)(6) for failure to state a claim upon which relief may be granted. The motion is
denied.
II. Facts as Pled in the Complaint [FN1]
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FN1. All facts presented in this section are taken from the Complaint and are treated as
true only for the purposes of analyzing the motion to dismiss.
"To avoid dismissal under Rule 12(b)(6), a plaintiff must aver in his complaint 'sufficient
factual matter, accepted as true, to 'state a claim to relief that is plausible on its face." "
Al-Kidd v. Ashcroft, 580 F.3d 949, 956 (9th Cir.2009) (quoting Ashcroft v. Iqbal, 550
U.S. 544, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009) and Bell Atl. Corp. v.
Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)). "The Plaintiff is
given the benefit of the doubt in reviewing such motions, and all allegations of material
facts are taken as true and construed in the light most favorable to the nonmoving party."
In re Zavala, 444 B.R. 181,185 (Bankr.E.D.Cal. February 7, 2011) (citing Iqbal ).
In summary, the complaint alleges the following facts.
Radical Bunny obtained money from investors and in turn provided those funds to
Mortgages, Ltd. to fund loans on real estate projects. Non-Quarles attorneys advised
Radical Bunny that it may have securities laws issues in late 2006.
Based on this advice, Radical Bunny retained Quarles [FN2] in January 2006 to address
these legal issues. Radical Bunny advised Quarles of the potential legal problems when it
retained Quarles. According to the retention agreement prepared by
Quarles, [FN3] Radical Bunny retained Quarles to "represent the Company in connection
with its general corporate, securities and mortgage origination/lending law matters."
Upon retention, Quarles reviewed Radical Bunny's business documents, business
operations, and public documents and met with members of Radical Bunny. This
included a review of how Radical Bunny's investors did business with Radical Bunny and
how Radical Bunny did business with Mortgages Ltd.
FN2. The Complaint also names Quarles' current and former attorneys-Robert Bornhoft,
Christian Hoffman, P. Robert Moya, and S. Gary Shullaw--as defendants. For ease of
reference, actions allegedly taken by Quarles and its attorneys are referred to simply as
Quarles.
FN3. Exhibit 1 to the Complaint.
In late Spring and Summer 2007, Quarles sent Radical Bunny several legal documents
which Radical Bunny used to conduct business with existing and new investors. At that
point in time, Quarles knew or should have known that Radical Bunny was violating
Arizona and/or federal securities law based on its claimed legal research. Despite this
knowledge, Quarles never advised Radical Bunny of the violations in writing and did not
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terminate the attorney-client relationship. Further, Quarles never advised Radical Bunny
to stop doing business with Mortgages Ltd. and investors. And, even though it
communicated concerns regarding whether Radical Bunny's loans to Mortgage's Ltd.
were perfected, Quarles never instructed Radical Bunny to disclose these concerns to
investors or to stop selling to new or existing investors. Moreover, Quarles did not advise
Radical Bunny that it needed a Private Offering Memorandum, a document that Quarles
never prepared, until May 2008. Instead, Quarles continued to assist Radical Bunny in its
business dealings with Mortgages Ltd. and investors.
*2 Quarles fired Radical Bunny on June 10, 2008. [FN4] Though it listed several reasons
for the firing, the termination letter did not advise Radical Bunny to stop violating
Arizona and/or federal laws.
FN4. See Exhibit 4 to the Complaint.
Based on these allegations, RB Liquidators claims that Quarles was negligent in
representing Radical Bunny and seeks $189,800,867 in damages plus disgorgement of
feeds paid to Quarles.
III. Analysis
The Securities and Exchange Commission ("SEC") brought a civil suit against Radical
Bunny and its principals in United States District Court. Judge Bolton granted summary
judgment ("MSJ Order") in favor of the SEC and against Tom Hirsch, Berta "Bunny"
Walder, Howard Walder, and Harish Shah ("Principals") on April 12, 2011. In the MSJ
Order, Judge Bolton held that the Principals committed "egregious, continuous, knowing,
and substantial federal securities laws violations."
After issuance of the MSJ Order, Quarles filed this motion to dismiss in which it asks the
Court to dismiss the Complaint on two bases: 1) The MSJ Order precludes re-litigation of
whether Radical Bunny committed SEC violations; and 2) RB Liquidation's claims are
time barred under A.R.S. § 12-1542. Within Quarles' first theory are three subsidiary
issues: a) in pari delicto; b) issue preclusion; and 3) proximate causation. Within Quarles'
second theory is the subsidiary issue of whether the statute of limitations was extended
under 11 U.S.C. § 108.
The Court denies the Motion on all grounds.
A. In Pari Delicto
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In pari delicto is a "principle is founded upon the equitable doctrine of he who comes
into court must come with clean hands." Brand v. Elledge, 360 P.2d 213, 204
(Ariz.1961). This defense is inherently factual and, as candidly admitted by counsel at
argument, is rarely presented in the context of a motion to dismiss. Quarles' in pari
delicto defense is premised on the theory that "the principals--who are members of RB
Liquidation and stand to gain significantly from any recovery by RB Liquidation in this
lawsuit--simply do not have any equitable right to such recovery." However, under RB
Liquidation's operating agreement and the confirmed plan of reorganization the amount
of recovery for the Principals likely will be no more 1.5% of any damage award. By
granting the motion to dismiss, the Court would deny any potential recovery for the noninsider investors in Radical Bunny--the other 98.5%--without any factual record other
than the discussion in Judge Bolton's order. This result would turn the issue of "inequity"
on its head.
Further, under Arizona law, the Court must consider to what extent each party is at fault.
A court of law will not lend its aid to either of the parties to an illegal or fraudulent
transaction. However, it is true that where the parties are not equal in guilt (in pari
delicto ) but where one of them, although participating in the wrong, is less guilty than
the other, the party more at fault cannot employ the doctrine of pari delicto to shield his
deliberate invasion of the rights of the former.
*3 Id. at 205. The language in the MSJ Order does not consider to what degree, if any,
Quarles is at fault for the securities violation. Moreover, assignment of relative blame is a
mixed question of fact and law. As acknowledged by Quarles in its reply, in pari
delicto "is decided more often on summary judgment than on a motion to dismiss." That
is the situation here. For these reasons, he Court will not dismiss on in pari
delicto grounds.
B. Issue Preclusion
Quarles argues further that RB Liquidation should be bound by Judge Bolton's order,
even though directed only at the Principals, on the basis of issue preclusion and privity.
This argument also fails at this stage of the proceedings.
The parties agree on the standard to apply when determining issue preclusion:
(1) the issue at stake must be identical to the one alleged in the prior litigation;
(2) the issue must have been actually litigated [by the party against whom preclusion is
asserted] in the prior litigation; and
(3) the determination of the issue in the prior litigation must have been a critical and
necessary part of the judgment in the earlier action.
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McQuillion v. Schwarzenegger, 369 F.3d 1091, 1096 (9th Cir.2004) (quotation omitted).
To succeed in the Motion, Quarles must show privity between the Principals and RB
Liquidation. Generally, a nonparty to a lawsuit is not bound to the judgment. Taylor v.
Sturgell, 553 U.S. 880, 893 (2008). However, in Taylor the Supreme Court identified six
exceptions to this general rule:
1) The nonparty agrees to be bound;
2) if there is a " 'substantive legal relationship[s]' between the person to be bound and a
party to the judgment";
3) the nonparty was adequately represented by someone with the same interests;
4) the nonparty assumes control over the litigation;
5) a nonparty cannot relitigate through a proxy; and
6) a statutory scheme forecloses successive litigation.
Id. at 893-896. Exceptions one and four through six clearly have not been asserted.
Exceptions two and three are undercut by the fact that, although three out of the four
Principals are RB Liquidation's members, the members have no managerial control over
the LLC. Further, Radical Bunny, through the Chapter 11 Trustee, consented to the entry
of a judgment of a permanent injunction in the District Court case. At this juncture, it is
unclear whether a substantive legal relationship exists or whether RB Liquidation and the
Principals had the same interests. Dismissal, at this juncture and on this basis, is clearly
premature.
C. Causation
According to Quarles, the MSJ Order conclusively proves that Radical Bunny caused its
own injuries. In Quarles' view, RB Liquidation cannot argue that Radical Bunny did not
know that it was committing securities fraud because the MSJ Order found that the
Principals knew that they were doing precisely that.
Quarles application of the MSJ Order to the Complaint misses the mark. The essence of
the Complaint is that Quarles knew of Radical Bunny's wrongdoing, yet never took any
steps to stop Radical Bunny from continuing the wrongdoing. This lack of action is,
according to the Complaint, what proximately caused the injury. Nothing in the MSJ
Order precludes this contention.
D. Statute of Limitations
*4 Quarles claims that Radical Bunny knew or should have known of its claims as soon
as Quarles sent the termination letter and, in any event, once it was placed into
involuntary bankruptcy. Therefore, argues Quarles, as of June 10, 2008, but no later than
October 8, 2008, Radical Bunny knew of these claims. Yet, the Complaint was not filed
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until October 19, 2010 which is, according to Quarles, well past the two years statute of
limitations in A.R.S. § 12-1542. Additionally, Quarles argues, RB Liquidators is not
entitled to an extension under 11 U.S.C. § 108 because it only applies to a trustee in
bankruptcy.
For purposes of the Motion, the Court rejects this argument. The Complaint clearly states
that Radical Bunny did not know of the harm until it received the ACC Order on April
28, 2010. Using this as the base date, RB Liquidators filed the Complaint well within the
statute of limitations. Having found that the Complaint falls within the Arizona statute of
limitation for purposes of the Motion, there is no need to consider whether an extension
under Section 108 is necessary.
IV. Conclusion
Quarles has failed to show that it is entitled to dismissal under Rule 12(b)(6). The Court's
conclusions herein do not preclude a party from arguing the same position at a later stage
in the proceedings.
So ordered.
Slip Copy, 2011 WL 3896199 (Bankr.D.Ariz.)
END OF DOCUMENT
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