The opinion of the court was delivered by: Rakoff, District Judge:
Bayerische Landesbank, New York Branch et al. V. Aladdin Capital Management LLC
Before: LIVINGSTON and LOHIER, Circuit Judges, and RAKOFF, District Judge.*fn1
Appeal from Orders and Judgment of the United States District
Court for the Southern
District of New York granting the motion of Defendant-Appellee
Aladdin Capital Management
LLC ("Aladdin") to dismiss the Amended Complaint for failure to
state a claim.
Plaintiffs-Appellants Bayerische Landesbank, New York Branch, and
investors in a Collateralized Debt Obligation ("CDO") managed by
Aladdin, contend that
Aladdin breached its duty to the investors by managing the
investment portfolio in a grossly
1 negligent fashion, causing plaintiffs to lose their entire $60
million investment. Plaintiffs, who
2 were not parties to the contract naming Aladdin as the portfolio
manager and defining its duties,
3 contend that they were intended third-party beneficiaries of the
contract, or, in the alternative,
4 that Aladdin breached a duty in tort by managing the portfolio in a
reckless and grossly negligent
We hold that plaintiffs have plausibly alleged that the parties to the contract intended the 7 contract to benefit the investors in the CDO directly and create obligations running from Aladdin 8 to the investors. We further hold that plaintiffs have plausibly alleged that the relationship 9 between Aladdin and the plaintiffs was sufficiently close to create a duty in tort for Aladdin to 10 manage the investment on behalf of plaintiffs. Finally, we hold that plaintiffs have alleged 11 sufficient facts that plausibly suggest Aladdin acted with gross negligence in managing the 12 investment portfolio, ultimately leading to the failure of the investment vehicle and plaintiffs' 13 losses.
Accordingly, for the reasons stated below, the judgment of the district court is 15 REVERSED and the case is REMANDED to the district court for further proceedings 16 consistent with this Opinion.
In this case, we are called on to determine whether an investor in a special investment 26 vehicle -- a synthetic collateralized debt obligation ("CDO") that sold interests in a credit 27 default swap -- can bring an action against the manager of the investment portfolio for the loss 28 of its investment where the investor was not a party to the contract that defined the manager's 29 role and duties.
Plaintiffs-Appellants Bayerische Landesbank ("Bayerische") and Bayerische Landesbank 31 New York Branch filed this action against Defendant-Appellee Aladdin Capital Management 1 LLC ("Aladdin") for breach of contract and gross negligence based on Aladdin's alleged 2 disregard of its obligation to manage the portfolio in favor of the investors. Aladdin's 3 purportedly gross mis-management allegedly caused plaintiffs to lose their entire $60 million 4 investment in the CDO. On January 31, 2011, plaintiff Bayerische Landesbank, New York 5 Branch filed its original Complaint in the United States District Court for the Southern District 6 of New York seeking to recover damages for the loss of its investment, and later filed an 7 Amended Complaint joining its parent, Bayerische Landesbank, as co-plaintiff. Aladdin moved 8 to dismiss the Amended Complaint, and, by Order dated July 8, 2011, the district court granted 9 the motion. The district court held that, because of a provision of the contract limiting intended 10 third-party beneficiaries to those "specifically provided herein," plaintiffs could not bring a 11 third-party beneficiary breach of contract claim, and held also that plaintiffs could not "recast" 12 their failed contract claim in tort. For the reasons described below, however, we conclude that 13 plaintiffs have properly alleged both a breach of contract claim and a tort claim.
The pertinent allegations in plaintiffs' Amended Complaint, together with those 16 "documents . . . incorporated in it by reference" and "matters of which judicial notice may be 17 taken," Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002) (internal quotation 18 marks omitted), are as follows:
19 Plaintiff Bayerische Landesbank is a publically regulated bank incorporated in Germany 20 with its principal place of business in Munich, Germany. Co-plaintiff Bayerische Landesbank, 21 New York Branch is the New York branch of Bayerische Landesbank and is a federally 22 chartered bank licensed by the United States Office of the Comptroller of the Currency.
1 Defendant Aladdin is a Delaware limited liability company with its principal place of business in 2 Stamford, Connecticut. Aladdin is a registered investment adviser under the Investment 3 Advisers Act of 1940, and is a subsidiary of Aladdin Capital Holdings LLC ("ACH"), an 4 investment bank.
In December 2006, plaintiffs invested $60 million in a collateralized debt obligation 6 structured and marketed by defendant Aladdin and by non-parties Goldman Sachs & Co. and 7 Goldman Sachs International (collectively, "Goldman Sachs"). A CDO is a financial instrument 8 that sells interests (here in the form of "Notes") to investors and pays the investors based on the 9 performance of the underlying asset held by the CDO. The CDO at issue in this case, called the 10 Aladdin Synthetic CDO II ("Aladdin CDO") was a "synthetic" CDO, meaning that the asset it 11 held for its investors was not a traditional asset like a stock or bond, but was instead a derivative 12 instrument, i.e., an instrument whose value was determined in reference to still other assets. The 13 derivative instrument the Aladdin CDO held was a "credit default swap" entered into between 14 the Aladdin CDO and Goldman Sachs Capital Markets, L.P. ("GSCM") based on the debt of 15 approximately one hundred corporate entities and sovereign states that were referred to as the 16 "Reference Entities" and comprised the "Reference Portfolio."
A credit default swap ("CDS") is a financial derivative that allows counterparties to buy 18 and sell financial protection for the creditworthiness of specific corporations or sovereign 19 entities, here the Reference Entities. A counterparty taking the position that the Reference 20 Entities would not experience a "Credit Event" -- such as bankruptcy, default, restructuring, or 21 failure to pay a defined obligation -- is said to be the "protection seller," similar to an insurance 22 underwriter. A counterparty taking the position that the Reference Entities would experience a 1 Credit Event is the "protection buyer," similar to an individual purchasing insurance. A credit 2 default swap differs from traditional insurance in that the protection buyer need not actually own 3 the underlying asset or security in order to purchase protection on it. More to the point, the 4 protection seller is, in effect, taking a long position and betting that there will be no Credit 5 Event, while the protection buyer is taking a short position and betting that there will be a Credit 6 Event.
Here, Aladdin and Goldman Sachs created a shell entity, the "Issuer" of the Aladdin 8 CDO, to serve as the protection seller, while GSCM served as the protection buyer. Thus, 9 GSCM was to pay premiums to the Issuer in order to purchase protection against the occurrence 10 of a Credit Event. The Issuer was also authorized to establish a separate "short" Reference 11 Portfolio, which would reverse the counterparties' positions -- i.e. the Issuer would be the 12 protection buyer and GSCM would be the protection seller.
13 Since the Issuer was just a shell entity, Aladdin and Goldman Sachs, in order to fund the 14 CDO and have money available to pay GSCM in the event of a Credit Event, marketed interests 15 in the CDO to investors in the form of Notes. The Notes were formally issued by the Issuer, 16 Aladdin Synthetic CDO II SPC, and the Co-Issuer, Aladdin Synthetic CDO II (Delaware) LLC, 17 which are limited liability companies incorporated under the laws of the Cayman Islands and 18 Delaware, respectively. Aladdin, as "Portfolio Manager," used the money received from 19 investors who purchased the Notes to purchase interest-yielding securities that, together with the 20 payment of premiums by GSCM, were intended to pay quarterly interest payments to 21 Noteholders until the CDO matured in December 2013, when the principal would be returned to 22 the Noteholders. The principal that investors paid to purchase the Notes was available to cover 23 payments to GSCM as the protection buyer if there were a Credit Event.
The Issuer split the Notes into separate Series, each with different levels of risk and 2 return. Each Series of Notes had a specific level of risk, or "subordination," that protected each 3 Series of Notes against possible losses to the invested principal. For each Series issued, a 4 separate "Indenture" spelled out the relationship between the Noteholders of that Series and the 5 CDO. If a Reference Entity in the Reference Portfolio (i.e., the securities underlying the CDS) 6 suffered a Credit Event, GSCM would reduce the level of subordination for the affected Series 7 by a certain percentage amount, depending on the weight of the relevant Reference Entity in the 8 Reference Portfolio. The plaintiffs here purchased Notes in both Series B-1 and Series C-1. The 9 level of subordination for plaintiffs' Series B-1 Notes was 5.15% and the level of subordination 10 for the Series C-1 Notes was 4.65%.
11 The structure of the CDS entered into by the Issuer and GSCM allowed the Issuer to 12 change the composition of the overall Reference Portfolio by trading Reference Entities into or 13 out of the Reference Portfolio. This trading also affected the level of subordination. If the Issuer 14 replaced a low-risk Reference Entity (reflected by a smaller "spread" or insurance premium) 15 with a higher-risk Reference Entity (reflected by a larger spread), that would increase the level of 16 subordination for the Noteholders, and vice versa.
17 If the level of subordination for a Series went more than 1% below zero, the entire 18 amount invested by the Noteholders in that Series would go to GSCM, and the Notes would 19 become worthless and no longer deliver interest payments. Plaintiffs allege that the Series they 20 invested in could sustain Credit Events with respect to approximately ten or eleven Reference 21 Entities before their subordination levels fell to more than 1% below zero. Additionally, if 22 Aladdin purchased protection for Reference Entities through the short portfolio, the Noteholders' 23 subordination levels would be increased if those short Reference Entities experienced a Credit 24 Event. Thus, the financial interests of GSCM and the Noteholders were adverse.
Since the Issuer was just a shell entity, the Noteholders needed someone to manage the 2 Reference Portfolio, and, according to plaintiffs, protect the Noteholders by minimizing the 3 occurrence of losses and avoiding Credit Events. Here, Goldman Sachs and Aladdin structured 4 the CDO so that Aladdin would manage the CDO as an independent investment manager on 5 behalf of the Noteholders.
6 Plaintiffs allege that they purchased their Notes in the Aladdin CDO after Aladdin and 7 Goldman Sachs came to the offices of Bayerische's New York branch to present marketing 8 materials regarding the then-proposed Aladdin CDO and to solicit plaintiffs' investment. In the 9 marketing book defendant provided to plaintiffs, defendant Aladdin allegedly represented that its 10 interests were aligned with the Noteholders' interests and that it would manage the Reference 11 Portfolio in a conservative and defensive manner to avoid Credit Events and thus losses to 12 Noteholders. Aladdin's formal responsibilities, however, were spelled out in the Portfolio 13 Management Agreement ("PMA"), an agreement between Aladdin and the shell Issuer that was 14 not signed by the Noteholders. Plaintiffs purchased $60 million of the total $100 million worth 15 of Notes from Goldman Sachs, which underwrote the CDO (i.e., Goldman used its own money 16 to purchase the Notes from the Issuer before reselling those Notes to investors like plaintiffs).
Plaintiffs did not enter into any direct contract with Aladdin. Aladdin, as the Portfolio 18 Manager, selected the initial approximately one-hundred Reference Entities that comprised the 19 Reference Portfolio. Plaintiffs allege that, following the issuance of the Aladdin CDO on 20 December 19, 2006, Aladdin managed the portfolio in a grossly negligent fashion, culminating 21 in the Reference Entities sustaining 11 credit events just three years into the CDO's seven-year 22 term, thereby causing plaintiffs' Notes to default. As a result, plaintiffs lost their entire $60 1 million principal investment and any future interest from the remaining four years of the CDO 2 term. Plaintiffs allege that, had Aladdin simply left the initial Reference Portfolio in place, 3 plaintiffs would not have suffered any losses whatsoever.
4 On the basis of the foregoing allegations, the Amended Complaint asserts two claims: (1) 5 a claim in contract alleging that Aladdin breached its obligations under the PMA; and (2) a claim 6 in tort alleging that Aladdin's conduct was grossly negligent, resulting in harm to the 7 Noteholders. On May 23, 2011, Aladdin moved to dismiss the Amended Complaint for failure 8 to state a claim, pursuant to Federal Rule of Civil Procedure 12(b)(6). On July 8, 2011, the 9 district court held oral argument on defendant's motion to dismiss and dismissed the complaint 10 from the bench. The district court confirmed its ruling from the bench by Order dated July 8, 11 2011 and Judgment dated July 11, 2011. On July 15, 2011, plaintiffs moved for reconsideration 12 of the district court's ruling, which the district court denied by Order dated September 14, 2011. 13 Plaintiffs timely appealed the district court's Judgment and Orders.
Jurisdiction. At the outset, we have an independent obligation to determine whether 16 federal jurisdiction exists in this case. In the district court, the parties asserted that federal 17 jurisdiction over this action existed pursuant to 28 U.S.C. § 1332, which provides for diversity 18 jurisdiction for disputes between, inter alia, "citizens of a State and citizens or subjects of a 19 foreign state." Id. § 1332(a)(2). This form of diversity jurisdiction is often referred to as 20 "alienage" jurisdiction. See, e.g., JPMorgan Chase Bank v. Traffic Stream (BVI) Infrastructure 21 Ltd., 536 U.S. 88, 94-97 (2002) (describing history of alienage jurisdiction). Despite the parties' 22 agreement that such jurisdiction exists here, however, "we ...