Gibbons’ Representation of James R. Zazzali as DBSI Chapter 11 and Litigation Trustee Concludes After 11+ Years
The Business Advisor
On December 11, 2020, Delaware Bankruptcy Judge Christopher Sontchi approved the Final Report of the DBSI Estate Litigation Trust and on March 17, 2021, upon the Trustee’s certification of completion of all tasks necessary to wind down the Trust, the last two remaining DBSI chapter 11 cases were finally closed. This concludes the firm’s 11-plus-year fiduciary representation of our colleague, James R. Zazzali. Perhaps the most notable aspect of this representation involved the recovery of a $13.6 million judgment as an avoidable fraudulent transfer from the IRS. That litigation, as well as other highlights of this representation, are described below.
On August 31, 2009, James R. Zazzali, Of Counsel to Gibbons and former Chief Justice of the Supreme Court of New Jersey, was appointed the chapter 11 Trustee for DBSI Inc. and 51 affiliated chapter 11 debtors in jointly administered cases pending in the U.S. Bankruptcy Court for the District of Delaware. Zazzali retained Gibbons as his counsel in the chapter 11 case. Mr. Zazzali’s appointment was occasioned by the publication of the preliminary findings of a court-appointed examiner that the debtors and their non-debtor affiliates were generally run as a unified business by a control group of senior managers with conflicts of interest and hopelessly commingled funds despite contrary representations made to their investor creditors.
Representation of the chapter 11 Trustee involved, among other issues, the resolution of significant issues relating to corporate governance, substantive consolidation, fraudulent transfers, breaches of fiduciary duties and conflicts of interest, and numerous contested matters relating to the debtors’ multimillion-dollar real estate portfolio. Approximately 34,000 creditor claims were filed, which was then the largest number of claims in a single case ever handled by the debtors’ claims agent, and liabilities were estimated to be over $600 million.
After a significant period of due diligence and discussions between Gibbons, on behalf of the Trustee, and the Official Committee of Unsecured Creditors, the Trustee and the Committee filed a joint liquidation plan on August 17, 2010 that addressed the diverse creditor body and the extensive web of interrelated debtors and non-debtor affiliates, as well as maximized the value of the debtors’ assets for all parties in interest. The plan was successfully confirmed on October 26, 2010, at which time then-presiding Bankruptcy Judge Peter Walsh called the confirmed chapter 11 cases the second most complex group of business bankruptcy cases filed in his court. Among other things, the plan substantively consolidated the bankruptcy estates of 24 plan debtors and created two liquidation trusts and two litigation trusts. Gibbons was selected as counsel to the DBSI Liquidating Trust, which was created to hold the debtors’ technology and tenant-in-common related assets, and the DBSI Real Estate Liquidating Trust, created to hold the debtors’ multimillion-dollar real estate asset portfolio. The Liquidating Trusts were in effect for a period of seven years, during which the technology and real estate asset portfolios were liquidated for the benefit of an estimated $760 million in beneficiary claims. The Liquidating Trusts were terminated in September 2017.
Following confirmation of the plan on October 26, 2010, Gibbons also represented Mr. Zazzali as the Post-Confirmation Trustee of two DBSI litigation trusts, the DBSI Estate Litigation Trust, formed to hold estate causes of action, and the DBSI Private Actions Trust (PAT), to which individual claimants assigned their claims for prosecution by the Trustee. As counsel to Zazzali as DBSI Estate Litigation Trustee, Gibbons filed more than 850 avoidance actions in the U.S. Bankruptcy Court naming more than 1,350 defendants seeking to avoid and recover thousands of preferential and fraudulent transfers. All of these matters were settled, with the exception of one fraudulent transfer matter that was tried to a verdict in the U.S. Bankruptcy Court for the District of Idaho, where Gibbons successfully obtained a $2.9 million judgment against a seller of real estate. That judgment was affirmed on appeals to the U.S. District Court and the Ninth Circuit Court of Appeals and ultimately paid in full in summer 2020.
In addition, the complex litigation matters described below, involving insiders, taxing authorities, and broker-dealers, were filed on behalf of Mr. Zazzali1.
DBSI Insider and Taxing Authority Fraudulent Transfer Action: Gibbons commenced an adversary proceeding against various insiders of DBSI to avoid, set aside, and recover fraudulent transfers made to DBSI insiders as part of their massive scheme of corporate looting and financial fraud. The Trustee also asserted claims to avoid and recover fraudulent transfers made by DBSI to the IRS and various state taxing authorities to satisfy the personal tax obligations of the insiders. Gibbons successfully opposed motions to dismiss filed by the IRS and the state taxing authorities based on their sovereign immunity defenses. The U.S. District Court for the District of Idaho later granted the Trustee’s motion for summary judgment denying the IRS’ good faith and fair value defense and avoiding the transfers to the IRS in the amount of approximately $13.6 million. Specifically, the court found “that equity demands the Government not be permitted to keep this money.” The IRS appealed this adverse judgment to the Ninth Circuit Court of Appeals, which affirmed judgment in favor of the Trustee. Although there was an expressed intent by the IRS to file a petition for certiorari to the U.S. Supreme Court, shortly prior to an extended deadline to do so, the idea was abandoned, and the judgment was thereafter satisfied in full by the IRS.
The Trustee settled his claims in the adversary proceeding with all but one of the DBSI insider defendants, obtaining a default judgment in the amount of $18.6 million against DBSI’s former CEO, Douglas Swenson.
DBSI Insider Damages Action: The firm commenced an action in the U.S. District Court for the District of Delaware against the former DBSI insiders and others (the “Insider Damages Action”), which was later transferred to the District of Idaho. The Trustee alleged in the Insider Damages Action that these insiders violated federal RICO and securities laws in the course of an elaborate Ponzi-like scheme to defraud investors in the real estate interests and notes and bonds that DBSI marketed. The Insider Damages Action sought to recover some portion of the over $500 million lost by these investors. Motions to dismiss brought by the defendant insiders were largely denied. The Trustee filed a motion for partial summary judgment that resulted in the district judge entering final judgment against the remaining non-settling insiders in the amount of $196 million.
DBSI Broker Dealer Damage Action: Gibbons commenced four actions in the U.S. District Court for the District of Delaware on behalf of the DBSI PAT, later transferred to the District of Idaho, against numerous broker-dealers, corporate parents, control persons, and registered representatives who were involved in the marketing and sale of DBSI-created investment offerings. The claims asserted included violations of §10(b) and Rule 10(b)(5) of the Securities Exchange Act of 1934; violations of various state blue sky laws, §20(a) of the Securities Exchange Act of 1934; breach of contract; fraud; professional negligence; and breach of fiduciary duty.
The claims arose out of investments by members of the DBSI PAT who purchased or otherwise acquired securities in one or more DBSI-created investment offerings from one or more of the broker-dealer defendants in what turned out to be nothing more than a classic Ponzi scheme that collapsed in November 2008, when more than 150 DBSI related entities filed petitions for bankruptcy. Settlements in these actions yielded over $23 million.
DBSI Professional Malpractice Actions: Gibbons commenced multiple professional malpractice actions against DBSI’s prior counsel, accountants, and due diligence providers alleging professional negligence/malpractice; federal and state RICO claims; aiding and abetting breaches of fiduciary duty; aiding and abetting fraud; civil conspiracy; breach of contract; and recovery of fraudulent transfers and preferences. Each of those matters was hotly contested, but all settled at various stages of the litigation.
The Financial Restructuring & Creditors Rights team involved in this representation included Karen A. Giannelli, Mark B. Conlan, Natasha Songonuga, Dale E. Barney and Brett S. Theisen. Numerous members of the Firm’s Commercial & Criminal Litigation, Corporate, and Real Property Groups were also involved.
1 Although each of these matters was commenced in the District of Delaware, all were later transferred to the U.S. District Court for the District of Idaho because DBSI and its affiliated debtors had their principal places of business in Boise, Idaho.