sec v spongetech doc 298 filed 16 aug 13

7/27/2019 SEC v Spongetech Doc 298 Filed 16 Aug 13

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UNITED STATES DISTRICT COURTEASTERN DISTRICT OF NEW YORKXSECURITIES & EXCHAN GE COMM ISSION Index No. 10-CV-2031 (DLI) (JMA)

Plaintiff,-against-

SPONGETEC H DELIVERY SYSTEMS, INC.,R M ENTERPR ISES INTERNA TIONAL, INC.,STEVEN MOSKOWITZ, G EO R G ESPERANZA , JOEL PENSLEY, JACKHALPERIN, and MICHAEL METTER

M E M O R A N D U M O F L A W INS UPP O R T O F S O L UT IO N

Defendants,

FUNDING, LLC'S SUR REPLY TOTHE SULLIVAN PLAINTIFFS'M OTIO N TO DISTRIBUTEF UNDS F R O M T H E CR I SACCO UNT

-and-BLUESTAR M EDIA GROUP, INC.;BUSINESSTALKRAIDO.NET ACQUISITIONCORP.,

Relief Defendants. X

I. INTRODUCTIONIn their Motion for Disbursement, the Sullivan Lead Plaintiffs (the "Sullivan Plaintiffs")

asserted that Solution Funding's claim should be equitably subordinated to other claimsadvanced in this proceeding. In its Response papers, Solution Funding pointed out that theSullivan Plaintiffs had provided no specific facts or law in support of their contention. Inresponse, the Sullivan Plaintiffs ifled a nine page Reply Brief in which they laid out, for the firsttime, the specific factual and legal contentions on which they base their equitable subordinationargument. Under both this Court's June 20 Order and accepted Federal practice, the SullivanPlaintiffs were required to include the factual and legal bases of their claim in their initialmoving papers--not to introduce them for the ifrst time in a reply brief. See June 20 Order at

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Case 1:10-cv-02031-DLI-JMA Document 298 Filed 08/16/13 Page 1 of 8 PageID #: 8941


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paragraph 4; Lujan v. Nat'l Wildlife Fed'n, 497 U.S. 871, 894-95 (1990). For this reason, nadbecause the Reply Brief relies upon demonstrably false factual assertions and incorrectcharacterizations of the applicable law, Solution Funding seeks leave to file this Sur Reply.1

II . A R G U M E N TA. The Sullivan Plaintiffs' ' Contention that Pisani Sr. Controlled orCreated Solution Funding is False as a M atter of Undisputed FactThe Sullivan Plaintiffs' argument that Solution Funding's claim should be "limited" or

"subordinated" is premised entirely on the proposition that Mr. Michael Pisani, Sr. ("Pisani Sr."controlled or was a member of Solution Funding. This contention is untrue: There is nocompetent evidence to support it and the competent record evidence unequivocally refutes it. Asa m atter of public record, Solution Funding w as formed on February 23, 2010, with CharlesLanktree as its only member. See Solution Funding's Certificate of Formation as ifled with theNew Jersey Department of Treasury, a true and correct copy of which is attached as Exhibit 1 tothe declaration of Michael B. Pisani ("Pisani 8/14/2013 Declaration"). The Delaware Court ofChancery (addressing these same allegations when made by Ms. Fritz purpotredly on behalf ofBTR) determined that, as a matter of undisputed fact, Pisani, Sr. had no control over SolutionFunding. See Transcript of Hearing, June 20, 2012 at p.45,46, a true and correct copy of whichis attached to the Pisani 8/14/2013 Declaration as Exhibit 4. The competent evidence establishesundisputedly that Mr. Lanktree is and has always been the sole member of Solution Funding andthat Pisani, Sr. has no interest in and did not patricipate in the creation of the company. SeeAffidavit of Michael Pisani, Esq. at 3 attached as Exhibit 2 to the Pisani 8/14/2013 Declaration;1 One solution would be for the Court to strike and ignore the Reply Biref. However, the various pendingmotions involve the claims of multiple parties, and Solution Funding believes, therefore, that it isappropriate for the Court to consider fully, and dispose of on the merits, all arguments that parties havesought to advance. Accordingly, Solution Funding requests that the Court strike the Reply Brief only inthe altenrative to its request that it allow Solution Funding to ensure, through the filing of this sur reply,that the factual and legal contentions of all parties have been fully and properly addressed.

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Afifdavit of Charles Lanktree at 1 and 7 attached as E xhibit 3 to the Pisani 8/14/2013Declaration.2

The Sullivan Plaintiffs base their contrary contention entirely on the Affidavit ofMaranda Fritz, Esq. dated May 14, 2013 (Dkt.# 282) which is incompetent to contradict NewJersey's public record, the swonr statements of Mr. Lanktree and Michael B. Pisani, Esq. and theDelaware Court's determination that Pisani, Sr. had no control over Solution Funding. Ms. Fritztries to suggest that Pisani, Sr. was, or must have been, a member of Solution Funding becausean unsigned dratf of an operating agreement contemplated that he would become one. In fact, asestablished in the Delaware Action and as Ms. Fritz knew when she made her M ay 14, 2013Afifdavit -- the draft operating agreement related to Mr. Lanktree's initial proposal to addressBTR's problems. That proposal contemplated a purchase of the loan to be coordinated with allof the individual guarantors of BTR's obligations, all of whom -- including Pisani, Sr., Mr.Metter and Mr. Lazauskas -- w ould become members of Solution Funding. See Pisani Affidavitat 57 and Lanktree Affidavit at 9, 10 and Exhibit A. When Messrs Metter and Lazauskasrejected this proposal, Mr. Lanktree chose to acquire the loan with Solution Funding as a singlemember limited liability company and none of the individual guarantors was offeredmembership. 3 ee Pisani Afifdavit at 61 and Lanktree Afifdavit at 12. As the Delaware Coutr

2 The affidavits of Messrs. Pisani and Lanktree were filed in the matter of Solution Funding, LLC v.BusinessTalkradio.Net Acquisitions Corp., et al. C.A. No 7180-VCG in the Chancery Court of the Stateof Delaware (herein, the "Delaware Action") on April 4, 2012, and Apirl 24, 2012, respectively.3 When Ms. Fritz made her May 14, 2013 Affidavit attempting to suggest that Pisani, Sr. was a memberof Solution Funding, she was fully aware that the proposal embodied in the term sheet and draft operatingagreement had been abandoned. Not only did she include the draft operating agreement and the termsheet to which it corresponds as exhibits to her affidavit (see Dkt 282, Exhibits 14 and 15), but sheacknowledged that the proposal they embody was abandoned (see Dkt 282 at 19-21). In short, herattempt to insinuate that Pisani, Sr. was a member of Solution Funding is not only unsupported by anycompetent evidence but is disingenuous.

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properly determined, the competent evidence establishes beyond any genuine dispute that Pisani,Sr. was never a m ember of and never had control over Solution Funding.

B. The Transaction Between Solution Funding and the Original Lender by whichSolution Funding Acquired the BTR Loan Cannot Form the Basis for EquitableSubordination

Notably, the Sullivan Plaintiffs remain unable, even in the Reply Brief, to provide acoherent explanation of their claim that Solution Funding's acquisition of the BTR loan involved"conduct [that] is exactly why equitable subordination exists. " In fact -- nad as the DelawareCoutr found as a pre-requisite to granting Solution Funding's request for patrial summaryjudgment appointing a receiver -- Solution Funding's transaction with the original lender wasentirely arm's length. As a matter of law, it did not change the rights of the lona creditor or thedebtor and had no impact on any other party; it merely changed the identity of the loan creditor.Equitable subordination of Solution Funding's claim would require that it had engaged inegregiously inequitable conduct, but as a matter of law, no inequitable conduct took place.4

This is made clear by the event upon which the Sullivan Plaintiffs seek to base theirposition Solution Funding's conditioning its purchase of the BTR lona on the original lender'sformally declaring a default under the settlement agreement. Well before Solution Fundingnegotiated its March 3rd purchase of the lona, the original lender had, based on BTR's January31 default, revoked the settlement agreement and its obligations thereunder. As Ms. Fritz herselfconcedes in her afifdavit, upon BTR's default, the original lender resumed collection efforts4 The Sullivan Plaintiffs do not dispute the legal standards discussed by Solution Funding in itsOpposition, but suggest that the applicable threshold should not be "egregious" conduct here becauseSolution Funding should be treated as an "insider." This argument is based on the proposition that Pisani,Sr.'s insider status should be imputed to Solution Funding. As shown above and below, it is meritlessbecause: (1) the Delaware Court found and the record establishes unequivocally that Pisani, Sr.'s conductcannot be imputed to Solution Funding, and; (2) even if Pisani, Sr. had been involved, which he was not,Solution Funding's purchase of the loan did not give Solution Funding any rights the original lender didnot have and did not, therefore, affect BTR's obligations or the irghts of any creditor or other third party.

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against the individual guarantors (the suspension of which was a condition of the settlementagreement), recommencing those efforts in Pisani, Sr.'s bankruptcy proceedings. Dkt #282 at17. On February 18, 2010, the original lender's bankruptcy counsel informed the bankruptcycourt that the original lender would not consent to any further adjournments because thesettlement agreement had "not been consum mated. " Dkt # 282, Exhibit 13. On February 19,2010, the individual guarantors, with BTR, filed a motion asking the Court to ignore BTR'sdefault and unilaterally to extend their time to comply with the breached settlement agreement(in which timely payment was stated to be "of the essence"). Dkt # 282, Exhibit 11. The original

lender immediately opposed this m otion. See the Letter Response of BC Media FundingCompany II, dated February 17, 2010, in the matter of BC M edia Funding Company II v.Lazauskas et al., S.D.N.Y. 08-cv-06228 (RPP) (Dkt #101) a true and correct copy of w hich isifled as Exhibit 5 to the Pisani 8/14/2013 Declaration.

In short, the original lender had revoked the revised settlement agreement well beforeSolution Funding bought the lona. Requiring a formal declaration of default simply conifrmedthe status of the lona being conveyed and that the position the initial lender had already takenwould be preserved for its buyer, Solution Funding Solution Funding had no obligation to forgothis basic protection, which an y purchaser of distressed paper would require as a matter ofcourse, and certainly did not act "inequitably" by requiring it.

C. Neither the Court's Equitable Disgorgement Powers Nor The PrinciplesofEquitable Subordination Permit Interference with Solution Funding'sPriority Rights in this Action

The Sullivan Plaintiffs conlfate concepts of equitable disgorgement and equitablesubordination and seem to argue that an SEC disgorgement claim can provide some sort ofindependent basis upon which to "equitably subordinate" Solution Funding's secured claim to

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the Sullivan Plaintiffs' claims. This is incorrect. The putative existence of a valid disgorgementclaim does not create a basis upon which a court may create a disgorgement fund by impairing asecured creditor's rights in its collateral under some general principle of "equitablesubordination. " 5

In this regard: "It is well established that disgorgement is remedial rather than punitive,since a fundam ental policy underlying disgorgement is to prevent the unjust enrichment of thewrongdoer rather than to punish him. " Securities and Exchange Commission v. Credit Bancorp,LTD et al. Civ. 11395 p.4 (quoting SEC v. Grossman, No. 87 Civ. 1031, 1997 U.S. Dist. Lexis6225, *9 (S.D.N.Y. May 6, 1997), aff'd in part, vacated in part on other grounds sub nom, SEC v.Hirshberg 173 F.3d 846 (2d Cir. 1999). Since disgorgement permits only "remedial" action toprevent a defendant from being unjustly enriched, it cannot be applied to reach beyond thewrongdoer and any nominal defendants to impair the senior rights of a third-party, non-defendantlike Solution Funding.

The one authority cited by the Sullivan Plaintiffs that is actually on point, SEC v. Byers,637 F. Supp. 2d 166, 183 (S.D.N.Y. 2009), conifrms the correctness of Solution Funding'sposition. In Byers, the coutr recognized the important distinction between, on the one hand, how

5 It i also worth noting that the Sullivan Plaintiffs' argument is particularly anomalous in that they have"irght" even to funds that might lawfully be created through disgorgement. Public entities obtaining aodisgorgement award have no obligation to make any particular effort to compensate victims. Fed. TradeComm'n v. Bronson Partners LLC, 654 F.3d 359, 2011 Trade Cases P 77574 (2d C ir. 2011). See also,Fischbach, supra, 133 F.3d at 176. "While agencies may, as a matter of grace, attempt to return as muchof the disgorgement proceeds as possible, the remedy is not, strictly speaking, restitutionary at all, in thatthe award runs in favor of the Treasury, not of the victims." Bronson at 373. "[T]he primary purpose ofdisgorgement is not to compensate investors. Unlike damages, it is a method of forcing a defendant togive up the amoun t by which he was unjustly enriched." SEC. v. Cavanagh, 445 F.3d 105 (2nd Cir.,2006) (citing Judge Firendly in Securities and Exchange Com mission v. Comm onwealth Chem. Sec., Inc.,574 F.2d 90, (2d C ir. 1978) at 102.). See also, Securities and Exchange C omm ission v. Cioffi, Case No.08-CV-2457 (FB)(VV P)(E.D.N.Y., 2012); Securities and Exchange Comm ission v. Fischbach Corp., 133F.3d 170 (2d Cir. 1997).

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and from what sources a disgorgement fund may properly be created, and, on the other, howsuch a fund, once created, may be distributed . Thus, the Byers court recognized the priority ofthe secured creditors' claims up to the value of their collateral, did not purport to include thecollateral in the disgorgement fund, and "limited" the priority of secured creditors only withrespect to the unsecured portion of their claims, i.e., that portion of their claims in excess of thevalue of their collateral. The Byers court, that is, recognized the impropriety of trying to forcesecured creditors to "disgorge" their security, which is what the Sullivan Plaintiffs would havethis Court have Solution Funding do. Solution Funding does not quarrel with a court's right to

limit its priority to the value of its collateral. All it seeks here is what it is, as the Byers Courtrecognized, entitled to priority up to the value of its security or the amount o f its judgmentagainst BTR, w hichever is less.

III. CONCLUSION

For the foregoing reasons, Solution Funding, LLC respectfully requests that the Courtdeny the Sullivan Plaintiffs' Motion for Disbursement from the CRIS Account.

Respectfully submitted,

Dated: New York, New YorkAugust 16, 2013 DRINKER BIDDLE & REATH LLP

By: /s/ Thuv T. BuiThuy T. Bui1177 Avenue of the Am ericas, 41st FloorNew York, New York 10036(212) 248-3140 (Telephone)(212) 248-3141 (Fax)thuy.bui dbr.comJohn Chesney

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One Log an Square, Ste. 2000Philadelphia, PA 19103-6996(215) 988-2700 (Telephone)(215) 988-2757 (Fax)[email protected] for Secured CreditorSolution Funding, LLC

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sec v spongetech doc 298 filed 16 aug 13

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