As the subprime litigation wave evolved in late 2008, among the many cases arising were cases I described at the time as "new wave" subprime-related cases, where the target company’s financial problems were due not to the company’s own exposure to subprime-related assets, but rather due to the company’s exposure to other companies that suffered reverses because of the subprime meltdown.


One particular type of these new wave cases involved companies that were sued because of the target companies’ exposure to Lehman Brothers. In a May 17, 2010 order (here), Southern District of New York Judge John G. Koeltl ruled on the motion to dismiss in a case pending against JA Solar Holdings and certain of its directors and offices, in which it was alleged that the company had misrepresented its exposure to Lehman Brothers. In what is as far as I know the first ruling in one of the Lehman exposure cases, Judge Koetltl denied the defendants’ motion to dismiss.


As discussed at greater length here, JA Solar was sued in December 2008, after the company announced on November 12, 2008 that it was recording an impairment for the entire principal value of a Note the company had purchased from Lehman Treasury, a Netherlands-based affiliate of Lehman Brothers.


In July 2008, JA Solar completed a $400 million financing, following which it purchased a $100 million note from Lehman Treasury with an October 9, 2008 maturity date. The note was supposed to have 100% principal protection and was guaranteed by Lehman Brothers.


The plaintiffs alleged that the company made two sets of misrepresentations or omissions about the Note. First, in an August 12, 2008 press release and subsequent conference call, the company and its CFO mentioned that Lehman brothers was managing its cash but did not mention the purchase of the Note, or the nature of the company’s relationship to Lehman as a result of the company’s investment in the Note.


Second in a September 16, 2008 press release and conference call, on the day following the Lehman bankruptcy, the company disclosed the $100 million Note for the first time, but stressed that the Lehman unit that had issued the Note had not filed for bankruptcy and emphasized that the note was "principal protected." In the subsequent conference call, the company’s CFO stated that the company expected that at the end of the Note’s term "there will be principal and interest returned to us."


In the same call, but only in response to analysts’ questioning, the CFO acknowledged that the only recourse if the Lehman affiliate company does not repay the Note was a guarantee by Lehman, which was in bankruptcy.


On November 12, 2008, the company recorded a $100 million impairment charge for the value of the Note.


The defendants moved to dismiss the complaint, arguing that the company had no duty to disclose the Note in the August communications and that the total information in the September call adequately disclosed the information about the Note and the Lehman guarantee.


Judge Koeltl found that the plaintiffs had adequately alleged that in the August conference call the company’s CEO had made a misleading statement about Lehman’s role with the company. He found that the statements misrepresented "how JA Solar’s cash was invested and the truthful nature of JA’s Solar’s relationship with Lehman Brothers."


Judge Koeltl also found that the plaintiff had adequately alleged misrepresentations in connection with the September statements. Among other things, the company’s CEO had stressed that the Note has "100% principal protection" without stating that "any possible protection was provided solely by the bankrupt Lehman Brothers." Judge Koeltl added that "it is difficult to understand how JA Solar could have assured investors that the Note was fully protected when the only protection was provided by a company in bankruptcy."


Judge Koeltl rejected the defendants’ arguments that, in response to the analysts’ questions, the CFO had clarified the full effect of the Lehman Brothers bankruptcy. Judge Koeltl said that whether the statements effectively counterbalanced the prior statements is a factual question "that cannot be resolved in a motion to dismiss," adding that the plaintiffs "have pleaded sufficient facts at this stage to call in to question whether Mr. Lui’s statements cleansed the allegedly misleading statements. "


Finally Judge Koeltl found that the plaintiffs had adequately alleged scienter, finding that the plaintiffs had adequately alleged that the defendants knew in August that "JA Solar had not simply engaged Lehman Brothers to manage its cash, but rather than JA Solar had purchased the $100 million Note" which was guaranteed by Lehman from a Lehman affiliate. He also found the defendants knew "in spite of their statements in September 2008 that the Note had 100% principal protection and that they expected the principal and interest to be returned, that Lehman Brothers was the only guarantor of the Note and that Lehman Brothers was, in fact, in bankruptcy."


Judge Koeltl found that the defendants’ knowledge of these facts, in contradiction of their public statements, "satisfies the scienter requirement."


While a lot might be said about this decision, the overall impression is that Judge Koeltl was persuaded that the company had simply not been candid about its exposure to Lehman Brothers. Of course, it is hard now to recall how tumultuous and uncertain things were in the days in early fall 2008, but alleged facts create the impression that the company was straining to avoid disclosing how exposed it was to Lehman Brothers. Whether the defendants actually believed they would be able to redeem the Note at maturity, notwithstanding Lehman’s bankruptcy, is one issue that will have to be sorted out in this case as it goes forward.


I have in any event added the ruling in the JA Solar case to my running tally of subprime-related dismissal motions rulings, which can be accessed here.


Special thanks to a loyal reader for providing a copy of the JA Solar opinion.


Apologies: My apologies that this blog site was unavailable almost the entire day on May 17, 2010. Once again my hosting service, LexBlog, experienced server problems that managed to take the entire site offline for an extended period of time. I apologize to anyone inconvenienced by this hosting service failure.