In re Worldcom, Inc.

377 B.R. 77

In re WORLDCOM, INC., et al., Reorganized Debtors.

No. 02-13533 (AJG).

United States Bankruptcy Court, S.D. New York.

October 15, 2007.

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Weil, Gotshal & Manges LLP (Joseph Allerhand, Esq., Marcia L. Goldstein, Esq., Lori R. Fife, Esq., Alfredo R. Perez, Esq., Adam P. Strochack, Esq. Of Counsel), New York, NY, for Reorganized Debtors.

Hulett Harper Stewart LLP (Kirk B. Hulett, Esq., Jennifer A. Kagan, Esq., Randall, R. Sjoblom, Esq., Of Counsel), San Diego, CA, Law Offices of Andrew W. Hutton (Andrew W. Hutton, Esq., Of Counsel), San Diego, CA, Lowenstein Sandler P.C. (Michael S. Etkin, Esq., Of Counsel), Roseland, NJ, for Abbott Claimants.

OPINION GRANTING IN PART, DENYING IN PART, CLAIMANTS' MOTION FOR SUMMARY JUDGMENT; GRANTING IN PART, DENYING IN PART, DEBTOR'S MOTIONS FOR SUMMARY JUDGMENT

ARTHUR J. GONZALEZ, Bankruptcy Judge.

I. INTRODUCTION

On July 21, 2002, and continuing thereafter, WorldCom Inc. and certain of its subsidiaries (hereinafter "WorldCom" o "Reorganized Debtors") filed for bankruptcy under Chapter 11 of the Bankruptcy Code in the Southern District of New York. Roger B. Abbott ("Abbott") subsequent filed proof of claim number 17111 against WorldCom for $222 million, based on allegations contained in a California state action.¹ Other parties, who were shareholders of WorldxChange (together with Abbott, the "Claimants"), also filed proofs of claims against WorldCom based on the allegations in the California state action.² As summarized in a recent opinion from the Court,³ the allegations in the California state action concern a corporate transaction in which the Claimants agreed to merge a company they owned, WorldxChange, with World Access, Inc. ("WAXS"), a company partially owned by WorldCom. The Claimants contend that they entered the stock-for-stock transaction in part because of an alleged misrepresentation that WorldCom was obligated each month to purchase $25 million in services from WAXS via a Carrier Services Agreement (the "CSA").

Present before the Court are motions for summary judgment from both sides. The Claimants move for summary judgment with respect to their first cause of action for rescissory damages for violations of California Corporations Code section 25401, 25501, and 25504. Defendant WorldCom partially moves for summary judgment on statute of limitations grounds and for a determination of the date of sale. The specific issues the Court must decide are (1) did WorldCom make a misrepresentation that violated section 25401, (2) what was the date of sale of the stock-for-stock merger for purposes of calculating damages, (3) is the Claimants' claim barred by the applicable statute of limitations, (4) did the Claimants have knowledge of the facts they allege constitute fraud, which is an absolute defense to liability, (5) is WorldCom a "control person" of WAXS under California law, and (6) should the Court draw any adverse inference from certain non-parties' invocations of their Fifth Amendment rights not to testify.

II. STATEMENT OF FACTS

WAXS was a public company incorporated under Delaware law. (See Amended Complaint, ¶ 35; Debtor's Statement of Undisputed Facts in Support of Motion for Partial Summary Judgment as to the Date of Sale on Fifth Omnibus Objection to Proofs of Claims Pursuant to Local Rule 7056-1(A) ("Debtor's SOF as to Date of Sale"), ¶ 1). John D. Phillips ("Phillips") was, at relevant times, a director, Chairman, and Chief Executive Officer of WAXS. (Amended Complaint, ¶ 13.) WorldxChange ("WorldxChange") was a corporation organized under California law. (Debtor's SOF as to Date of Sale, ¶ 2.) Roger B. Abbott founded WorldxChange and was its largest shareholder. (Id.) Phillips has been a business colleague of Bernard Ebbers ("Ebbers") since at least 1993, when WorldCom acquired a company Phillips founded, Advanced Telecommunications Corp. (Ex. 57 to Kirk B. Hulett's Declaration in Support of Claimants' Motion for Summary Judgment on the First Cause of Action for State Securities Law Violations ("Hulett Decl.")) Ebbers was the Chief Executive Officer of WorldCom. (See Amended Complaint, ¶ 20.) W. Tod Chmar ("Chmar") was an Executive Vice President of WAXS. (Id., ¶ 18.) Scott Sullivan ("Sullivan") was Chief Executive Office of WorldCom. (Id., ¶ 22.)

In 1996, Cherry Communications owed WorldCom hundreds of millions of dollars for services WorldCom provided. (Ex. 38 to Hulett Decl.) In July 1997, WorldCom and Cherry Communications entered into a settlement agreement under which Cherry Communications executed promissory notes in WorldCom's favor and executed a pledge and security agreement giving WorldCom control of a majority (51%) of Cherry Communications' voting stock. (Id.) Phillips was appointed CEO of Cherry Communications and entered into a prepackaged bankruptcy, filed in the United States Bankruptcy Court for the Northern District of Illinois on October 24, 1997.⁴ (Id.) As the key component of Cherry Communications' reorganization plan, Cherry Communications agreed to merge with WAXS. (Exs. 2, 38 to Hulett Decl.) As part of this transaction, WorldCom agreed to extinguish the debt Cherry Communications owed in exchange for stock in WAXS. (Ex. 38 to Hulett Decl.)

On June 5, 1998, WorldCom and Cherry Communications entered into the CSA. (Ex. 8 to Declaration of Adam P. Strochak dated June 25, 2007 ("Strochak Decl.")) Under the CSA, WorldCom was obligated to purchase at least $300 million in annual services from WAXS, pre-payable at $25 million per month. (See Exs. 2, 13, 21, 38 to Hulett Decl.) The Bankruptcy Court approved the merger plan between Cherry Communications and WAXS in September 1998. (Exs. 2, 38 to Hulett Decl.) On December 14, 1998, the WAXS and Cherry Communications merger was finalized and WAXS succeeded to the rights and obligations of Cherry Communications under the CSA. (See Amended Compliant, ¶ 38.)

WAXS subsequently asserted in its public filings that WorldCom was obligated to purchase at least $25 million a month in services under the CSA, and that the CSA had a "rolling 12-month evergreen term," meaning it was only cancelable on a year's notice. (See Exs. 42, 46, 51, 52, and 106 to Hulett Decl.) The accounting firm of Ernst & Young referred to the CSA as a "take or pay" contract. (Ex. 5 to Hulett Decl.)

In April 1999, Abbott met with Phillips and Chmar and began negotiating a sale of WorldxChange to WAXS. (Ex. 110 to Hulett Decl.) At the time, WorldxChange owed millions of dollars to WorldCom. (Id.) The parties do not dispute that Phillips sent Abbott a copy of WAXS's CSA with WorldCom, which Abbott received on or around May 7, 1999. (Id.; see also Abbott Claimants' Statement of Disputed Material Facts In Response to Reorganized Debtor's Statement of Undisputed Material Facts In Support of Motion for Summary Judgment on Statute of Limitations Issue, ¶ 18.)

On February 11, 2000, WAXS and WorldxChange entered into an Agreement and Plan of Merger ("Merger Agreement"), pursuant to which each share of WorldxChange stock would be converted to .6583 shares of WAXS stock at the occurrence of the merger's closing. (See Agreement and Plan of Merger, § 1.7(c), Ex. 9 to Strochak Decl.) The Merger Agreement stated that it would become effective on the Closing Date (the "Effective Time") after the parties filed a Delaware Certificate of Merger and a California Agreement of Merger (the "Certificates") with the Delaware Secretary of State and with the California Secretary of State, respectively, or at such subsequent time that WorldxChange and WAXS agreed to and specified in the Certificates. (See Merger Agreement, § 1.3.) The Merger Agreement further stated that effects of the merger, such as the property rights of the parties becoming vested in the surviving corporation, would take place "[a]t or after the Effective Time." (Id. at § 1.4.)

WAXS's stock closed at $22.88 on February 11, 2000. WorldCom owned 10.65 percent of WAXS common stock in early 2000. (Ex. 109 to Supp. Decl. of Adam Strochak dated July 19, 2007 ("Supp. Strochak Decl.") (1999 10-K.))

On May 24, 2000, WAXS filed a registration statement with the Securities and Exchange Commission ("SEC") in connection with the Merger Agreement. (Ex. 63 to Strochak Decl.) The SEC approved the registration statement on November 14, 2000. (Ex. 17 to Strochak Decl.) The California Public Utilities Commission approved the WAXS — WorldxChange merger on October 19, 2000. (Ex. 16 to Strochak Decl.) A majority of WAXS's shareholders approved the merger on December 14, 2000. (Ex. 44 to Strochak Decl.) December 18, 2000 was the closing date of the merger. (Ex. 67 at Strochak Decl.) On that date, WAXS's stock closed at $2.72 per share. (Ex. 7 to Strochak Decl.)

WorldCom did not purchase at least $25 million a month in services under the CSA. For example, revenue from WorldCom in 1999 was only $267 million and totaled only $53 million for the first quarter of 2000. (Ex 7 to Hulett Decl.) For the second quarter of 2000, the revenue was $63 million. (Ex. 10 to Hulett Decl.) This figure dropped to $29 million for the third quarter of 2000. (Ex. 10 to Hulett Decl.) WorldCom, for disputed reasons, made "true up" payments that for some months or quarters made up the difference between the obligated monthly amount of $25 million and an amount based on actual usage, but in some periods did not. For example, WorldCom made a "true up" payment of $17.5 million for the first quarter of 2000, and $20 million in the third quarter of 2000. The parties dispute how the amounts of the payments were calculated. The Claimants allege that the "true-ups" were used to increase revenues and designed to allow WAXS to meet Wall Street's earnings estimates. The Debtor claims that the "true-ups" were negotiated between WAXS and WorldCom in good faith based on the amount of traffic WorldCom...