BASH v. TEXTRON FINANCIAL CORP.No. 5:12 CV 987.
483 B.R. 630 (2012)
Brian A. BASH, Trustee, Plaintiff,
TEXTRON FINANCIAL CORP., et al., Defendants.
TEXTRON FINANCIAL CORP., et al., Defendants.
United States District Court, N.D. Ohio, Eastern Division.
November 9, 2012.
Alexis C. Osburn, David F. Proano, Joseph M. Esmont, Joseph F. Hutchinson, Jr., Kelly S. Burgan, Michael A. Vanniel, Thomas R. Lucchesi, Baker & Hostetler, Cleveland, OH, for Plaintiff.
Brian M. Lutz, Lee G. Dunst, Mitchell A. Karlan, Janet M. Weiss, Nancy E. Hart, Gibson, Dunn & Crutcher, Benjamin R. Nagin, John G. Hutchinson, John J. Kuster, Lee S. Attanasio, Sidley Austin, New York, NY, James P. Schuck, Kenneth C. Johnson, Laura M. Zaremski, Quintin F. Lindsmith, Bricker & Eckler, Columbus, OH, Daniel A. Demarco, Deborah A. Coleman, Hahn, Loeser & Parks, Cleveland, OH, for Defendants.
Memorandum of Opinion and Order
PATRICIA A. GAUGHAN, District Judge.
This matter is before the Court upon the Report and Recommendation of Bankruptcy Judge Marilyn Shea-Stonum Recommending that the Court Deny Textron's Motion to Dismiss (Doc. 60). Also before the Court is the Report and Recommendation of Bankruptcy Judge Marilyn Shea-Stonum Recommending that the Court Deny Fortress' Motion to Dismiss (Doc. 61). Defendants filed objections to the respective Report and Recommendations ("R & R"). This is an adversary proceeding stemming from the Fair Finance bankruptcy filing. For the reasons that follow, the R & R addressing Textron's motion is REJECTED. Textron is DISMISSED. The R & R addressing Fortress's motion is ACCEPTED in PART and REJECTED in PART. The state law claims filed against Fortress are DISMISSED and the Trustee may not recover treble damages under O.R.C. § 2307.61. All other claims remain pending against Fortress.
Plaintiff, Brian A. Bash, is the Chapter 7 Trustee appointed for Fair Finance Company ("Fair Finance" or "Debtor"). Fair Finance filed a Chapter 7 petition in bankruptcy court. The Trustee filed various adversary proceedings, including the instant case filed against defendants, Textron Financial Corporation ("Textron"), Fortress Credit Corporation ("Fortress"), and Fair Facility, LLC ("Fair Finance SPE"). Textron, Fortress, and the Trustee moved to withdraw the reference to this Court. The Court granted the motions and re-referred this matter to the bankruptcy court for all pretrial purposes. Textron and Fortress moved to dismiss the First Amended Complaint. The Trustee opposed the motions and the Bankruptcy Court Judge recommends that the Court deny the motions.
For purposes of ruling on the objections to the R & Rs, the facts in the complaint are presumed true.
Fair Finance was a family run business for over six decades. Fair Finance's business included the purchase of accounts receivable ("Customer Accounts") from other merchants. In order to finance the purchase of some of these Customer Accounts, Fair Finance issued V-Notes to investors. V-Notes required interest payments and typically had maturity dates of between 6 and 24 months. Fair Finance sold the V-Notes through private placements that were effected by offering circulars filed with the Ohio Division of Securities ("ODS"), although the ODS neither approved or disapproved the V-Notes as "investments." Prior to 2002, Fair Finance made a profit of more than $3 million
In 2002, Fair Holdings, Inc. ("FHI") purchased Fair Finance through a leveraged buyout. FHI was owned by DC investments, LLC, which in turn was owned by Tim Durham and James Cochran. After the purchase, Tim Durham became the CEO of Fair Finance. In order to finance the purchase, FHI drew down approximately $16 million on a $22 million line of credit from Textron and United Bank. Textron's obligation under the line of credit was $12 million and United Bank's obligation was $10 million. The remaining funds were available to FHI as a line of credit. Under the terms of the loan, receipts collected from the Customer Accounts owned by Fair Finance were deposited into a "lockbox" bank account in Fair Finance's name. It appears that all payments made to Textron on the loan to FHI were paid out of funds contained in the lockbox account held by Fair Finance. The loan was guaranteed by Durham and Cochran and the assets of FHI were put up as collateral. In addition, Fair Finance granted Textron a security interest in its assets.
Immediately after the buyout, Fair Finance sold additional V-Notes through private placements. These V-Notes had substantially longer maturities and substantially higher interest rates. By selling these V-Notes, Fair Finance's debt to V-Noteholders increased. The monies received from V-Noteholders were used to make "loans" to Durham and other entities he owned or controlled ("Insider Loans"). The Insider Loans were structured such that Fair Finance loaned money to FHI, which in turn would lend money directly to an "insider," i.e., Durham himself, or another entity he owned or controlled. Sometimes FHI loaned money to DC Investments, which in turn loaned the funds to the insider. The Insider Loans were used to fund other failing companies, including Obsidian, and to pay for Durham's extravagant lifestyle. Many of these companies were financially insolvent. As the balance of the Insider Loans increased, the debt owed on the V-Notes also increased. The balances are as follows:
Year Insider Loan Balance V-Note Balance 2002 $30 million $66.5 million 2003 not clear from complaint $82.2 million 2004 $82 million $111.8 million 2005 $106 million $136.5 million 2006 $137 million $160.9 million 2007 $167 million $182.7 million 2008 not clear from complaint $192.4 million September of 2009 $228 million $208.8 million
From 2002 through 2009, virtually all of the money obtained through the private placements of V-Notes was loaned to insiders, used to pay interest expenses on
Within several months of the buyout, Fair Finance became grossly undercapitalized and incapable of paying its debts in the ordinary course of business. By no later than December of 2003, Fair Finance was operated as a classic Ponzi scheme. Fair Finance could not pay the V-Notes as they matured without relying on new borrowed money from other individuals through additional private placements. The private placement offerings failed to inform investors that funds loaned to Fair Finance through a V-Note would in turn become the subject of an Insider Loan or would be used to pay interest and principal on outstanding V-Notes.
By 2003, Fair Finance's auditors were concerned that the Insider Loans were not made on commercially reasonable terms and were functionally distributions to Durham and other insiders. In June of 2005, Durham fired the auditors.
The Obsidian Loan
From 2001 through 2006, Obsidian was a public company. Durham was the founder and CEO of the company. FHI used Fair Finance's money to issue an unsecured line of credit to Obsidian ("Obsidian Loan"). Despite mounting losses, the line of credit was increased to $8 million by April of 2003. No interest or principal payments were required for a three-year period. In Obsidian's public filings, Obsidian revealed that it owed FHI $4.8 million and had converted approximately $900,000 worth of debt owed to FHI into preferred stock in Obsidian. Public filings revealed that Obsidian's auditors questioned whether the entity was a going concern.
In 2003, Textron prepared an internal memorandum regarding Obsidian. The document was circulated to Textron's credit committee and contained a summary of Obsidian's balance sheet for 2001 and 2002. The financial statements showed that Obisidan was insolvent, losing money, had negative cash flow and negative net income as of October of 2002. The memorandum further provided that Obsidian was engaging in "aggressive" restructuring and that its "liquidity remains strained and several subsidiary credit facilities ... contain covenant defaults." An Insider Loan was arranged by Durham and FHI "in response to" these problems.
In February of 2004, the Obsidian line of credit was amended to extend the maturity date by two years and increase the maximum balance from $8 million to $12 million.
Both FHI and DC Investments made commercially unreasonable loans to subsidiaries of Obsidian or purchased defaulted loans of these entities. In connection with these transactions, FHI and DC Investments used funds "borrowed" from Fair Finance. The underlying debt obligations were often extended and breached covenants were waived.
Textron received interim financial statements from Fair Finance and conducted regular audits. Textron discovered the Insider Loans in 2002. As early as March of 2002, Textron's auditors told Durham that his inability to obtain appropriate agreements which would serve to protect Textron's priority was "well beyond" what Textron ordinarily tolerated.
In August of 2003, Textron learned from its accounting consultants that the Insider Loan balance had increased to approximately $43 million by July of 2003. Thereafter, Textron demanded that Fair Finance grant it open access to its auditors. By no later than December of 2003, Textron received information on the performance of the Insider Loans, which indicated that the insiders were generally insolvent and the loans had irregular payment histories, were in default, or had terms providing that no payments were due for many years. Textron had access to Durham's financial statements, which showed that Durham used the proceeds of the V-Notes to purchase luxury items.
In addition, Textron started reviewing the offering circulars by no later than November of 2003. Textron demanded that Durham produce a legal opinion stating that the offering circular adequately disclosed the Insider Loan to FHI. In approximately December of 2003, Durham provided Textron with a legal opinion in which the law firm declined to opine that the offering circular adequately disclosed the Insider Loans.
Textron's President of Portfolio Management sent Durham an email in November of 2003 expressing concern that Durham's use of proceeds from V-Notes "as a piggy bank" to "fund losses of [Durham's] affiliates" was "wrong." In the same email, Textron noted that the credit committee was concerned that "in today's world of Sarbanes-Oxley, predatory lending and recent court rulings (Lehman Brothers) ... the issue of us knowing that the [V-Note] proceeds are going else where [sic] could come back to haunt us. The [Credit Committee] is currently litigating a suit that we have been dragged into as a result of the same."
Textron continued to engage in extensive diligence on Fair Finance, including researching the conditions that Fair Finance had to meet in order to offer V-Notes, auditing Fair Finance on a quarterly basis, reviewing monthly financial reports, and actively inquiring into Fair Finance's financial condition. An internal audit report relating to Fair Finance observed that just after the buyout in 2002, the V-Note debt increased and that certain "other receivables ... do not appear to be related to [Fair Finance's] core business and as such should be monitored by FCS's Portfolio Manager as they might impair [Fair Finance's] liquidity." Shortly thereafter, Textron learned that Fair Finance's financial statements showed a $1.4MM line item for "coach lease advances." Textron knew that Durham owned a motorcoach company and an internal Textron email questioned whether Durham was advancing funds to the motorcoach company. Textron also questioned whether the loan agreement prohibited this type of activity.
Under the terms of the original loan, Fair Finance was obligated to provide Textron with 2002 audited financial statements
The audit report revealed that Durham and Cochran assumed a $4.1 million note payable to the individual who sold Fair Finance to FHI. By assuming the liability, it appeared that FHI received a capital infusion. Durham, however, was already obligated on the note. Although the audit revealed that the entities had equity of approximately $5 million, proper treatment of the note and other payments revealed that the entities were insolvent even before considering that the Insider Loans would not likely be repaid.
An internal Textron monthly portfolio review determined that Fair Finance's net worth was negative by more than $7 million as of November 30, 2003.
The Textron/United bank loan matured in 2004. At that point, United Bank was concerned about Fair Finance's failure to provide timely audit opinions. According to an internal Textron memorandum, Textron wanted to remove United Bank as an "unsupportive/disruptive participant." Textron allowed Fair Finance to refinance its loan. After the refinance, United Bank was removed as a lender and Textron agreed to lend up to $17.5 million.
Under the terms of the refinanced loan, Textron, FHI, and Fair Finance entered into a First Amended and Restated Loan and Security Agreement ("Refinance"). Textron allowed Fair Finance to draw on its line of credit.
As part of the Refinance, Durham promised to reduce the balance of the Insider Loans by May of 2004. This did not occur. In addition, pursuant to the terms of the Refinance, Durham was to amend Fair Finance's then-current offering circular to increase the disclosures about the Insider Loans. In order to reduce investor "alarm," Textron and Durham jointly decided to postpone the additional disclosures until such time as the disclosures would be less likely to generate the attention of investors. An internal Textron memorandum explained:
Textron and its counsel specifically tracked the amount of V-Notes that were sold before Durham expanded the disclosures of the Insider Loans in 2004.
Under the terms of the Refinance, the year 2003 audit was due on April 30, 2004. Textron ultimately agreed to extend the deadline to April 30, 2005. On April 28, 2005, Rick Snow, Fair Finance's Chief Financial Officer, informed Textron that BGBC resigned as auditors, purportedly because it accepted work on behalf of Obsidian and, therefore, BGBC wanted to avoid any "conflicts." Textron responded that it was "very disturbing" that the auditors resigned. In fact, however, BGBC did not resign, but was terminated by Snow. Durham hired Somerset CPAs to act as new auditors. Somerset also acted as the auditor for Obsidian. On June 10, 2005, BGBC wrote Textron a letter explaining that it had been informed that Durham retained new auditors. The letter did not indicate that BGBC had voluntarily resigned or had any conflicts of interest.
In a letter from BGBC to Durham and Cochran, BGBC noted that:
In September of 2005, Somerset (the new auditors), issued an unqualified consolidated audit opinion for the years 2003 and 2004. Audits consolidating multiple years are extremely unusual. Somerset issued an unqualified opinion because it incorrectly determined that if an Insider Loan was not in default under its contractual terms, the loan should be treated as performing. In or around April of 2006, Somerset discovered its error and determined that under correct accounting analysis 90% of the Insider Loan balance was at least partially impaired. Therefore, Somerset determined that the entities lost approximately $20 million in 2005 because of the Insider Loans.
In addition, Somerset determined that Fair Finance was subject to a "FIN 46," which is an anti-fraud rule developed by the Financial Accounting Standards Board to address issues related to "off balance sheet" related parties. Somerset also determined that Durham and Snow had overvalued the Insider Loans to inflate Fair Finance's financial picture since 2002. In May of 2006, Snow delivered to Textron a preliminary FIN 46 analysis for 2005. The analysis showed that the combined entities were insolvent by more than $21 million. On July 18, 2006, Somerset instructed Durham not to provide the previously issued 2004 audit opinion to V-Noteholders or regulators because the audit opinion was "no longer appropriate." Notwithstanding Somerset's request, an offering circular for a significant V-Note issuance was sent to noteholders with the 2004 audit opinion attached.
Textron knew by June 1, 2006, that Durham was planning on terminating Somerset to avoid receiving an adverse audit opinion. As a result, Textron and Durham planned to issue financial statements certified only by Durham. On August 15, 2006, Somerset was fired before it issued its adverse opinion. In other words, two sets of auditors were terminated within a span of approximately one year.
Textron made a significant profit from its relationship with the Durham entities. As Textron noted several times, "despite the manner in which Durham and Cochran have run Fair [Finance], this is a very profitable relationship for [Textron]." Between January of 2002 and July of 2007, Textron collected approximately $10 million in interest and fees even though the line of credit was usually only $17.5 million.
The memorandum further notes that FHI finances various activities of other Durham businesses "through the up streaming of cash from Fair Finance."
Around the same time, Fair Finance's management asked Textron to waive certain covenant defaults relating to the Refinance. In response, Textron noted that it was "uncomfortable with several issues," including the increase in Insider Loans and the substantial delay in the production of financial statements. The email went on to state:
Textron further observed that a "significant portion of the Insider Loans require no cash payment of accrued interest of principal until maturity." Durham responded that the reason so many Insider Loans had no payments due until maturity was to "minimize non-performance issues" relating to the loans.
In March of 2005, Textron indicated that it would not renew its loan when it matured in 2006. The specific reasons provided for its decision included delays in issuing audited financial statements and the use of V-Note proceeds to finance the Insider Loans. Nonetheless, Textron agreed to a three-month extension of the Textron Loan in exchange for a $43,000 fee. Several additional short-term extensions were granted in exchange for extension fees. A June 1, 2006 Textron Credit Modification Request ("Modification Request") sent to Textron's Credit Committee, revealed that Durham and Textron were planning a "go forward" strategy that would allow Fair Finance to "perpetuate the V-Note program." The Modification Request further explained that "the most straight forward solution" to registering the V-Notes with the ODS was not likely to succeed because the "legacy of the related entities poor operating results could undermine Fair's ability to continue the V-Note program." The Modification
In 2006, Durham sent the ODS financial statements that were certified by himself, instead of audited financial statements. In the statements, Durham indicated that the financial statements "may or may not" comply with FIN-46. Durham certified that the statements might not comply with FIN-46 because of the "cost of compliance," and because he believed that FIN-46 would confuse noteholders. The financial statements did not disclose the following:
In 2006 and 2007, Durham began looking for a new lender to replace the Textron loan. Durham engaged The Riderwood Group, LLC ("Riderwood") to assist him in this regard. Durham represented to Riderwood that the Insider Loans were valid assets. Riderwood determined that Durham's representations were false, but Riderwood continued to assist Durham in locating a lender. Although approached by Riderwood, defendant Fortress declined to make a loan to Fair Finance.
In early 2007, Fair Finance and FCS Advisors, Inc. d/b/a Brevet Capital Partners ("Brevet") entered into a letter of intent. Brevet would agree to lend money to Fair Finance only if restrictions were placed on the making of Insider Loans and the financial statements were reviewed by a national accounting firm. The letter of intent also contained an exclusivity clause preventing Fair Finance from discussing the refinancing of the Textron loan with other potential lenders. Almost immediately thereafter, Fair Finance, under Durham's direction, began discussing its refinancing options with Summit Consumer Receivables Fund, LLC and certain of its affiliates ("Summit"). Summit agreed to purchase Fair Finance's customer accounts receivable without any restriction on how the funds could be used. In exchange, Fair Finance received sufficient funds to pay off the Textron Loan. On approximately July 20, 2007, Summit and Fair Finance agreed to the foregoing transaction.
Defendant Fortress provided approximately $16 million to Summit to finance the acquisition of Fair Finance's customer accounts. Fortress is the finance arm of a highly sophisticated publicly-held hedge fund with over $43 billion under its direct management. Fortress conducted due diligence and had access to Fair Finance's financial records. As of the date the loan closed, Fair Finance owed approximately $167 million to V-Noteholders.
Shortly thereafter, Durham re-commenced discussions with Fortress about borrowing an additional $50 million. From October of 2007 through early February of 2008, Fortress conducted due diligence regarding the potential $50 million loan. This due diligence was separate from the due diligence conducted with respect to the initial Summit loan. The due diligence included a review of the 2003 and 2004
Fortress also possessed the 2005 and 2006 financial reviews prepared by an accounting firm employed by Fair Finance. Those reviews showed that Fair Finance had accrued more interest on the loan to FHI than its profits. Thus, Fair Finance could not repay the interest on the V-Notes without borrowing additional funds. In addition, the maximum line of credit provided by Fair Finance to FHI had been exceeded by nearly $42 million. In order to bring its line of credit down below the maximum, the loan balance was reduced by $58 million, but Fair Finance acquired $61 million in other Insider Loans. In other words, FHI "sold" Insider Loans to Fair Finance in order to reduce its direct debt. These financial statements showed that Fair Finance did not comply with FIN-46.
In addition, Fortress conducted numerous interviews with Fair Finance's management. In November of 2007, Fortress requested audit opinions from Fair Finance for 2005 and 2006. No such documents existed and, instead, Fair Finance provided financial statements subject only to an accounting "review." Fortress was provided documents showing that by December of 2007, the Insider Loans totaled more than $124 million. In addition, financial information to which Fortress had access showed that the increase in the outstanding V-Notes closely approximated the increase in the Insider Loans. At this time, the value of the Insider Loans had little realizable value and, as such, if properly valued, Fair Finance was insolvent.
In February of 2008, the Fortress Loan closed. As of this date, Fair Finance owed approximately $185 million to the V-Noteholders. To facilitate the transaction, Fortress entered into a revolving loan facility with Fair Finance through a "special purpose entity," i.e., Fair Finance SPE. Fortress required Fair Finance to create this special purpose entity. Fair Finance SPE and Fair Finance were controlled by, among others, Durham and Cochran. The loan documents from Fortress imposed numerous obligations directly on Fair Finance, and Fair Finance itself was listed as a "guarantor" under the loan agreement. In addition, Fair Finance was required to (and, in fact, did) enter into an agreement dictating the sale and transfer of the Customer Accounts from Fair Finance to Fair Finance SPE.
The revolving loan facility created a line of credit that Fair Finance could draw on from time to time. The amount of available credit depended upon the amount and quality of the Customer Accounts, which were the only asset owned by Fair Finance that had any substantial value. The loan was structured such that the over the life of the loan, Fair Finance purportedly "sold" the Customer Accounts to Fair Finance SPE, which Fair Finance SPE paid
The amount of fees and interest paid by Fair Finance to Fortress from February 2008 through November of 2009 totaled approximately $4 million.
On March 15, 2011, Durham, Cochran, and Snow were indicted by a federal grand jury, charging each of them with conspiracy, wire fraud, and securities fraud in connection with their operation of Fair Finance as a Ponzi scheme. The jury returned guilty verdicts on some of the counts as to each defendant. That case is still pending in that defendants have not yet been sentenced.
Shortly after the criminal case began, the Trustee filed this adversary proceeding containing twenty-one claims for relief. Count one asserts a claim for avoidance and recovery of actual fraudulent transfers against Textron under 11 U.S.C. § 544(a) and (b)(1), O.R.C. § 1336.04(A)(1), O.R.C. § 2307.61, 11 U.S.C. § 550(a), and 11 U.S.C. § 551. Count two is a claim for avoidance and recovery of actual fraudulent transfers against Fortress and Fair Finance SPE under 11 U.S.C. §§ 548(a)(1)(A), 550(a) and 551. Count three is a claim for avoidance and recovery of constructive fraudulent transfers against Textron under 11 U.S.C. § 544(a) and (b)(1), O.R.C. § 1336.04(A)(2), 11 U.S.C. § 550(a), and 11 U.S.C. § 551. Count four asserts a claim against Fortress and Fair Finance SPE for avoidance and recovery of actual fraudulent transfers under 11 U.S.C. § 544(a) and (b)(1), O.R.C. § 1336.04(A)(1), O.R.C. § 2307.61, and 11 U.S.C. §§ 550(a) and 551. Count five is a claim for avoidance and recovery of constructive fraudulent transfers against Fortress and Fair Finance SPE brought under 11 U.S.C. § 548(a)(1) (B), 11 U.S.C. § 550(a), and 11 U.S.C. § 551. Count six is a claim against Fortress and Fair Finance for the Avoidance and Recovery of Constructive Fraudulent Transfers asserted under 11 U.S.C. § 544(a) and (b)(1), O.R.C. § 1336.04(A)(2), 11 U.S.C. § 550(a), and 11 U.S.C. § 551. Count seven is a claim against Fortress and Fair Finance SPE for the Avoidance and Recovery of Constructive Fraudulent Transfers brought under 11 U.S.C. § 544(a) and (b)(1), O.R.C. § 1336.05(A), 11 U.S.C. § 550(a), and 11 U.S.C. § 551. Count eight is a claim for Avoidance and Recovery of Post-Petition Transfers against Fortress under 11 U.S.C. §§ 549, 550(a), and 551. Count nine is a claim for the Avoidance and Recovery of Constructive Fraudulent Transfers against Textron under 11 U.S.C. §§ 544(a) and (b)(1), 550(a), and 551, and O.R.C. § 1336.05(A). Counts ten and eleven assert claims for "aiding and abetting" against Textron and Fortress, respectively. Counts twelve and thirteen are claims for aiding and abetting breach of fiduciary duty against Textron and Fortress, respectively. Counts fourteen and fifteen are claims for aiding and abetting theft, against Textron and Fortress, respectively. Counts sixteen and seventeen assert claims for conspiracy against Textron and Fortress, respectively. Count eighteen is a claim asserted against Fortress for the Avoidance and Recovery of Preferential Transfers asserted under 11 U.S.C. §§ 547, 550, and 551. Counts nineteen and twenty are claims for Equitable
Defendants Textron and Fortress separately moved to dismiss the complaint and the Bankruptcy Judge recommends that the Court deny the motions. Both parties filed objections and the Trustee filed a response. Defendants filed replies thereto.
STANDARD OF REVIEW
1. Objections to the R & R
Federal Rule of Civil Procedure 72, which governs the matter herein inasmuch as timely objections have been made to the Report and Recommendation, provides in part:
As stated in the Advisory Committee Notes, "The term `de novo' signifies the magistrate's findings are not protected by the clearly erroneous doctrine, but does not indicate that a second evidentiary hearing is required." citing United States v. Raddatz,
2. Standard for dismissal
When considering a motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure, the allegations of the complaint must be taken as true and construed liberally in favor of the plaintiff. Lawrence v. Chancery Court of Tenn.,
In addition, a claimant must provide "enough facts to state a claim to relief that is plausible on its face." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 569,
Id. at 1949 (citations and quotations omitted). See also, Hensley Mfg. v. ProPride, Inc.,
1. Fraudulent transfer claims (counts one, three, and nine)
According to Textron, the Bankruptcy Judge erred in concluding that factual issues preclude dismissal of the fraudulent transfer claims. According to Textron, the Trustee's fraudulent transfer claims must be dismissed because the loan repayments were not "transfers" as a matter of law. Textron claims that repayments made pursuant to a valid perfected security interest are not "transfers" under Ohio law. Textron claims that it perfected a lien in the Customer Accounts by filing a UCC-1 Financing Statement on January 8, 2002. According to Textron, the Refinance expressly provided that the security interest in the Customer Accounts would remain. As such, Textron was not required to "re-perfect" the lien. Because a valid lien existed, the fraudulent transfer claims fail because the repayments were not "transfers."
In response, the Trustee argues that Textron did not have a valid lien within the meaning of the Ohio Revised Code. According to the Trustee, the Refinance constituted a "novation." The Trustee argues that he is only seeking to avoid obligations incurred under the Refinance. It appears that the Trustee is claiming that the Refinance is not secured by the UCC-1 Financing Statement. Thus, there is no valid security interest. Further, the Trustee argues that Textron acted in bad faith to perpetrate a fraud. As such, any "lien" is not valid under Ohio law. In other words, transfers made pursuant to a perfected security interest may be considered "transfers" for fraudulent transfer purposes if circumstances exist such that a Court would reorder the priorities even in the face of a perfected lien.
Upon review, the Court finds that Trustee fails to state fraudulent transfer claims against Textron in counts one, three, and nine.
As an initial matter, the Court finds that, for purposes of this case, the Refinance does not ultimately give rise to a transfer because the Refinance does not amount to a novation as a matter of law. Here, it is undisputed that FHI provided a security interest in the Customer Accounts in 2002 in order to secure a loan of $22 million. It is further undisputed that Textron perfected the security interest by a filing UCC-1 Financing Statement in 2002. Thereafter, during the Refinance, the parties "amended" and "restated" the terms of the lending relationship, including reducing the total amount of credit available to Fair Finance under the parties' lending relationship to $17.5 million.
In re TOUSA, Inc., 2011 WL 1627129, at *3-4.
The district court affirmed the bankruptcy judge. Specifically, the court found that although the language in the amended loan agreements indicated that they were "restating" the prior agreements, other language indicated that the parties kept all rights and obligations arising under the prior agreements. Id. at *7. Moreover, the amended line of credit actually decreased the credit limit available, indicating that the "new obligations" are merely the "previous" obligations, albeit on different terms. Id. The court further indicated that because the lender had already perfected a security interest in the very same collateral, no "transfer" of property occurred by the granting of liens under the amended loan documents. Id. See also, In re Holland,
The Court finds In re TOUSA, Inc. analogous to the instant case. Like In re TOUSA, Inc., the refinance of the Textron Loan involved an existing line of credit and a security interest taken at the outset of the lender/borrower relationship. In addition, the amount of credit available to Fair Finance after the refinance was reduced from the amount available under the terms
The Trustee argues that a novation occurred, which wholly extinguished all prior obligations under the original note and created an entirely new obligation. Thus, the granting of a security interest in the Customer Accounts under the amended loan documents constituted a "transfer." None of the cases relied on by the Trustee involved the refinancing of a line of credit where the overall credit available decreased. For the reasons set forth above, the Court disagrees with the Trustee's argument and relies instead on the reasoning in In re TOUSA, Inc. Moreover, the express language in the contract indicates that the parties intended to "amend and restate" the original loan security agreement.
Absent a "transfer" occurring, the Trustee's claim fails because repayments by Fair Finance were made pursuant to a valid perfected security interest. See, Melamed v. Lake Cnty. Nat'l Bank,
The Trustee argues that there is a question of fact as to whether the perfected security interest constitutes a "valid" lien. According to the Trustee, there is no valid underlying obligation. The Bankruptcy Judge concluded that factual issues as to whether the lien is valid precluded dismissal. This Court disagrees. As set forth above, the Court concludes that the security interest was perfected as of the date of the original loan and that the modification did not constitute a "transfer." As such, the relevant inquiry is whether the initial security interest granted in 2002 pursuant to the original loan is an invalid lien. Simply stated, the Complaint is entirely devoid of any facts or allegations supporting such a determination. Moreover, to the extent that the Trustee is arguing that Textron's "lack of good faith" renders the 2002 security interest "invalid," the Court rejects the argument. While the Trustee may be correct that the Court could subordinate claims in a preference action, this Court rejects the Trustee's suggestion that the bad faith of a
Accordingly, the Court REJECTS the R & R and finds that Textron is entitled to dismissal of counts one, three, and nine because no "transfer" occurred. Having so concluded, the Court need not reach Textron's alternative arguments, i.e., the security agreements and subsequent repayments were made in exchange for reasonably equivalent value, the Trustee failed to adequately allege Textron's intent to "hinder, delay, or defraud any creditor of the debtor," and the statute of limitations bars the claims.
2. "Aiding and abetting" claims (counts 10, 12, and 14)
In these counts, the Trustee purports to assert claims for "aiding and abetting," "aiding and abetting breach of fiduciary duty," and "aiding and abetting theft." The Bankruptcy Judge relied on the Sixth Circuit's decision in Aetna Cas. & Sur. Co. v. Leahey Constr. Co., Inc.,
Textron objects to this conclusion on the grounds that the Ohio Supreme Court very recently ruled that Ohio does not recognize such claims. It appears that the Trustee now argues that the Ohio Supreme Court's ruling was limited to the facts of the case before it.
Upon review, the Court finds that the objection to the R & R is well-taken. In DeVries Dairy, L.L.C. v. White Eagle Coop. Assn., Inc.,
Although the Trustee argues that the Ohio Supreme Court did not completely foreclose the possibility that Ohio would recognize a claim under different facts, the dissent belies the Trustee's argument. The dissent in DeVries, expressly noted, "The district court is not asking us whether the facts of this case are sufficient to establish liability. It is asking us whether, if the facts are sufficient, a defendant can be held liable for tortious acts in concert." Thus, the dissent acknowledges that the majority concluded that no such cause of action exists regardless of the facts presented. Accordingly, the Court finds that, based on DeVries, the Trustee fails to
3. Conspiracy (count 16)
a. In pari delicto
Textron argues that the in pari delicto doctrine bars the tort claims, including the conspiracy claim. The Trustee disagrees.
"In pari delicto" means "in equal fault." Pinter v. Dahl,
In Terlecky v. Hurd (In re Dublin Securities),
Citing Terlecky, the Bankruptcy Judge concluded that the in pari delicto doctrine is available only if Textron is able to demonstrate that it is less culpable than the debtor. The Bankruptcy Judge went on to conclude that "clearly, a determination of culpability is a factual dispute, which requires reviewing facts and weighing evidence." As such, the Bankruptcy Judge recommends denying Textron's motion to dismiss.
Textron objects to this conclusion. According to Textron, the Bankruptcy Judge applied the wrong standard. Under the in pari delicto doctrine, Textron need only establish that the debtor is at least "equally" responsible. It need not show that the debtor is more responsible for the wrongdoing. Moreover, Textron points out that Terlecky itself upheld the district court's dismissal of certain state law tort claims on the grounds of in pari delicto. According to Textron, the complaint here, like the complaint in Terlecky, establishes the doctrine of in pari delicto on its face. Therefore, there are no factual issues to resolve and dismissal is appropriate under Sixth Circuit law.
Upon review, the Court agrees with Textron. With respect to the first element of the defense, Textron need only show that the debtor is at least as culpable as Textron. Textron need not establish that it is less culpable. Moreover, depending on the allegations in the complaint, dismissal may be entirely appropriate at the pleading stage. Terlecky,
The Court now turns to whether the allegations in the complaint establish the in pari delicto doctrine. Textron argues that the complaint establishes that the debtor was an active and essential participant in the alleged wrongdoing. The complaint expressly refers to the debtor as a "classic ponzi scheme" and further alleges that the officers maintained total control over the debtor. In response, the Trustee argues that in pari delicto involves a "factual determination" and that two exceptions
The Court must first determine whether the wrongdoing of Durham and Cochran can be imputed to the debtor for purposes of determining whether in pari delicto applies to bar the Trustee's claim. Under traditional agency principles, a principal is liable for the acts of its agents, provided the acts are taken within the scope of the agent's employment. An exception exists, however, "if the agent acted adversely to the principal and entirely for his own, or another's purposes." In re Nat'l Cen. Fin. Enterprises, Inc.,
Similarly, the "sole actor doctrine," applies to limit the "adverse interest" exception. Under the "`sole actor doctrine,' if the wrongdoer who acted adversely to the principal's interests `dominated and controlled' the principal such that the principal `had no separate mind, will, or existence of its own' then the wrongful conduct is directly attributed to the principal." In re Nat'l Cen. Fin. Enterprises, Inc.,
Here, assuming arguendo that the acts taken by Durham and Cochran are subject to the "adverse interest" exception, the Court finds that their actions can nonetheless be imputed to the debtor under the "sole actor" doctrine such that the "adverse interest" exception does not apply. The complaint contains overwhelming allegations regarding Durham's control over the debtor. For example, the Trustee alleges that Durham purchased the debtor and "almost immediately commenced operating the debtor as a massive fraudulent scheme...." (Am. Compl. ¶ 2). In fact, the Trustee acknowledges that the "complaint avers that Durham controlled all aspects of the Debtor's operations...." (Doc. 36 at p. 97). Moreover, the complaint
The Trustee argues that the "innocent insider" exception negates the application of the "sole actor" rule. This Court disagrees. As an initial matter, Textron argues that no Ohio court has ever recognized the "innocent insider" exception and the Trustee fails to point to any case suggesting that Ohio would adopt it. See e.g., The Unencumbered Assets, Trust v. Great American Ins.,
Having concluded that the actions of Durham and Cochran can be imputed to the debtor, the Court further finds that the debtor is at least "equally" as culpable as Textron as a matter of law. The complaint is replete with allegations of the massive fraud engaged in by Durham and Cochran and, as set forth infra, these individuals were indicted and convicted for their roles in the fraud. In fact, it does not even appear that the Trustee is claiming that the debtor is not equally as culpable. Rather, the Trustee's arguments rest on whether the actions of Durham and Cochran can be imputed to the debtor. Having answered that question in the affirmative, the Court finds that the in pari delicto doctrine applies because the debtor is at least "equally" responsible for the harm.
For these reasons, the Court grants Textron's request to dismiss the conspiracy claim on the grounds of in pari delicto.
Having concluded that the in pari delicto doctrine bars the conspiracy claim, the
4. Equitable subordination and disallowance of claims (counts 19 and 21)
Textron does not object to the Bankruptcy Judge's conclusion that the claims are not subject to dismissal on the grounds that Textron has yet to file a proof of claim. However, having disposed of the substantive claims against Textron, any consideration of judicial economy is no longer relevant. Accordingly, the Court sua sponte dismisses these claims. In so doing, the Court need not address Textron's argument regarding damages in that no claims remain pending.
1. The avoidance claims (counts two, four, five, six, seven, and eight)
Fortress argues that the Bankruptcy Judge erred in concluding that factual issues preclude dismissal of the avoidance claims. Fortress's arguments will be addressed in turn.
a. "Transfer of an interest of the debtor"
Fortress argues that the avoidance claims must be dismissed because the Complaint fails to allege that Fortress received "a transfer of an interest of the debtor in property" as required by statute. According to Fortress, it never received a transfer from Fair Finance. Rather, any monies it received came directly and solely from Fair Finance SPE, a separate corporate entity.
To address this argument, an understanding of the nature of the transaction is required. It appears that the transaction between Fair Finance, Fair Finance SPE, and Fortress was designed to work as follows:
The Trustee claims that these "transactions" were in reality a mechanism designed to allow Fortress to provide a line of credit to Fair Finance and use the Customer Accounts as security for the loan. In other words, Fair Finance SPE's "purchase" of the Customer Accounts was simply a way to funnel money through a different corporate entity, thus allowing Fortress to avoid the effects of a bankruptcy filing by Fair Finance. Thus, the funds paid by Fair Finance SPE in repayment of the loan were, in reality, transfers made by Fair Finance to Fortress.
The parties make a myriad of arguments regarding disregarding the corporate form and recharacterizing or collapsing the transactions such that any funds transferred by Fair Finance SPE to Fortress are actually funds transferred directly by Fair Finance to Fortress.
Upon review, the Court finds that dismissal is not warranted because the Trustee adequately alleges that the corporate form of Fair Finance SPE should be disregarded.
In re Fisher, 296 Fed.Appx. 494, 506 (6th Cir. Oct. 10, 2008).
Here, the Trustee alleges that Fair Finance SPE had no employees of its own. (Am. Compl. ¶ 605). Further, the complaint avers that Fair Finance SPE "used the same address, telephone number, facsimile number, and email notice as the debtor." Id. In addition, it "had no bank accounts it controlled, filed no tax returns ... and was completely incapable of servicing the Customer Accounts it `purchased.'" Id. Rather, all of these actions were taken by Fair Finance. (Id. at ¶¶ 607-08). Moreover, the Complaint alleges that the debtor received the loan funds directly from Fortress and that the debtor cleared with Fortress which accounts the debtor should purchase from the market and transfer to Fair Finance SPE. (Id. at ¶ 609). Further, Fair Finance was entitled to withdraw funds out of the lockbox accounts as a "servicer." (Id. At 616(d)). Loan funds borrowed from Fortress were "directly routed to a Debtor-owned account for use by Durham in furtherance of the Ponzi scheme." (Id. at 607.) In addition, the Trustee expressly alleges that Durham and Cochran, who owned and controlled Fair Finance, also owned and controlled Fair Finance SPE. (Id. at 602). The Court finds that these allegations sufficiently allege that Fair Finance SPE had no separate mind, will, or existence of its own, which is sufficient to support an alter ego finding.
Moreover, it can fairly be inferred that Fair Finance set up Fair Finance SPE to further its fraudulent scheme and that Fair Finance SPE acted as "a mere facade" for the operation of Fair Finance. Loan funds borrowed from Fortress were "directly routed to a Debtor-owned account for use by Durham in furtherance of the Ponzi scheme." (Id. at 607.) Fair Finance created Fair Finance SPE only after Fortress declined to consider making the debtor a direct loan. (Id. at 482). Moreover, Fair Finance SPE was controlled by Durham and Cochran, who in turn have been convicted of a massive fraudulent scheme.
Contrary to Fortress's argument, the Court finds that these allegations, especially in light of the overall fraudulent scheme, are sufficient to state avoidance claims because the transfers made by Fair Finance SPE could arguably be attributable to Fair Finance.
Fortress repeatedly refers the Court to the loan and sale documents, arguing that they conclusively establish the "separateness" of Fair Finance and Fair Finance SPE. This Court disagrees. To hold that
The Court finds that dismissal of these claims is also not warranted because the Complaint contains allegations that Fair Finance itself directly transferred funds to Fortress. See, e.g., Am. Compl. ¶ 108 ("From February 2008 to September 2011, the Debtor paid Fortress a total of $72 million on the line of credit under the Fortress Loan."); Am. Compl. ¶ 109 ("... all payments made by the Debtor to Fortress on the Fortress line of credit ... were not made by the debtor in good faith...."); Am. Compl. ¶ 644 ("Over the life of the Fortress Loan, and in addition to the liens and security interests granted to Fortress ..., the Debtor made no less than approximately $72 million of transfers to Fortress...."). Fortress argues that these are "general" allegations and that the Trustee himself conceded that all payments made to Fortress were made by Fair Finance SPE. According to Fortress, the loan documents provide that payments are to be made by Fair Finance SPE and the Trustee does not allege a breach of those documents. The Court rejects both arguments. As an initial matter, the Court does not find a "concession" on the part of the Trustee that the parties followed the loan documents. To the contrary, the Trustee argues that to accept Fortress's arguments, the Court must assume that the parties followed the documents. This "assumption" would be a fact that the Court cannot consider at this stage. The Court agrees with the Trustee and declines to presume that the parties at all times complied with the documents. Moreover, the Court finds that the Trustee need not expressly allege a breach of the loan and sale documents in order to allege that the debtor made payments to Fortress. Rather, the allegations speak for themselves. Here, the Trustee alleges that the debtor itself made payments to Fortress. An allegation of breach is simply not required.
Having concluded that the complaint fairly alleges a basis on which to conclude that Fair Finance SPE is the alter ego of Fair Finance, the Court need not reach whether the transaction should be "recharacterized" or "collapsed" or whether Fortress can be liable as a "subsequent transferee."
b. Actual intent to hinder, delay, or defraud
Fortress argues that counts two and four fail for the additional reason that the Trustee does not sufficiently allege that the debtor made the transfer with the "actual intent to hinder, delay, or defraud" its creditors. According to Fortress, the "Ponzi scheme presumption" does not apply. In addition, Fortress argues that the Trustee's request to collapse the Fortress loan transaction into the Ponzi scheme must fail. Fortress claims that in order to collapse the transactions, the Trustee must allege that Fortress had "specific knowledge" of the "scheme used to pay off a Ponzi scheme investor." Because no such allegations appear in the complaint, the intentional fraudulent transfer claims should be dismissed.
Upon review, the Court finds that dismissal is not warranted because at this point, the Court cannot say that the Ponzi scheme presumption does not apply based on the allegations in the complaint.
"Actual fraudulent conveyance claims ... turn on the intent of the debtor in making the transfer; the state of mind of the transferee is irrelevant.
While this rule in universally applied to transfers made by a Ponzi-scheme debtor to its investors, "some courts have held that, even with the presumption available, the plaintiff must still show that the transfer at issue was made `in furtherance of' the Ponzi scheme itself." Zazzali v. 1031 Exchange Group, LLC (In re DBSI, Inc.),
Upon review, the Court finds that the Trustee adequately pleads entitlement to the "Ponzi scheme presumption," such that the element of "actual intent to hinder, delay, or defraud" is satisfied at the
Based on these allegations, the Court finds that the complaint sufficiently alleges that Fair Finance's transfers to Fortress were at a minimum "related" to the Ponzi scheme.
Fortress further argues that the Trustee fails to allege diminution of the debtor's estate. Fortress refers the Court to the arguments and analyses it presented to the Bankruptcy Court. The Trustee responds in kind.
For these reasons, the Court finds that the intentional fraudulent transfer claims cannot be dismissed.
2. Constructive fraudulent transfer and preference claims (counts five, six, seven, and 18)
Fortress argues that "because the Trustee is unable to state a claim for actual fraudulent transfer, his constructive fraudulent transfer claims and his preference claim also fail." This Court, however, concluded that the Trustee stated claims for actual fraudulent transfer. As such, Fortress's argument is rejected.
3. Post-petition transfers (count seven)
Fortress argues that the Trustee cannot recover post-petition transfers because his own delay in attempting to recharacterize the post-petition payments precludes him from obtaining recovery now. According to Fortress, for nearly two years, the Trustee allowed Fortress to receive more than $15 million in transfers on the loan. Fortress claims that its affirmative defense of laches precludes the claim as a matter of law. Fortress objects to the Bankruptcy Judge's conclusion that "a determination of whether the doctrine of laches applies would require a factual analysis." (R & R at p. 5). In response, the Trustee argues that some courts have held that equitable defenses, such as laches, should never be applied in an action to recover postpetition transfers. Regardless, the Trustee claims that Fortress bears the burden of establishing that the
Upon review, the Court finds that the R & R correctly determined that factual issues preclude application of the affirmative defense of laches to the post-petition claim at this time. Even assuming arguendo that the complaint establishes that the Trustee unreasonably delayed in asserting the claim, the Court agrees with the Trustee that the complaint does not establish that Fortress suffered prejudice as a result or is asserting the defense with "clean hands." Accordingly, dismissal is not appropriate.
4. Equitable subordination and disallowance (Counts 20 and 21)
Fortress argues in a footnote only that the equitable subordination and disallowance claims should be dismissed as premature. Although the Trustee does not respond to this argument, the Court finds that because substantive claims remain pending against Fortress, judicial efficiency is best served by allowing these claims to proceed at this time.
5. State law claims (counts 11, 13, 15, and 17)
Fortress makes the same arguments that Textron made in connection with the state law claims, including that the Ohio Supreme Court does not recognize claims for aiding and abetting and that the in pari delicto doctrine bars the tort claims. The Trustee's responses mirror those made in response to Textron's arguments. For the same reasons set forth above, the Court finds that the in pari delicto doctrine bars the tort claims. The aiding and abetting claims fail for the additional reason that those claims are not recognized under Ohio law.
Fortress argues that the Trustee's claim for treble damages under O.R.C. § 2307.61 fails because there are no allegations that Fortress either "willfully damaged" Fair Finance's property or committed a "theft offense" as required by the statute. Fortress objects to the R & R on the grounds that it failed to address the statute and, instead, concluded that damages calculations are "not appropriate for a motion to dismiss." According to Fortress, the statute is not applicable to the facts alleged in the complaint and, as such, treble damages are unavailable as a matter of law. In response, the Trustee argues that Ohio law allows a party to recover treble damages against a party that commits a "theft offense," or for any "attempt, conspiracy, or complicity in committing" a theft offense. According to the Trustee, actual fraudulent conveyances are theft offenses for purposes of the statute.
Upon review, the Court finds that the Trustee does not sufficiently alleged entitlement to treble damages under O.R.C. § 2307.61. As an initial matter, the Court agrees with Fortress that the R & R incorrectly determined that this issue involves the "calculation of damages." Rather, the Court finds that, assuming the allegations in the complaint are true, the Trustee fails to allege entitlement to treble damages under O.R.C. § 2307.61. As Fortress points out, the complaint expressly seeks treble damages pursuant to this statute. The Trustee did not assert entitlement to common-law punitive damages or treble damages under any other theory or recovery. O.R.C. § 2307.61 provides as follows:
Thus, on its face this statutory damages provision applies to actions brought pursuant to O.R.C. § 2307.60(A). That section provides a cause of action for "anyone injured in person or property by a criminal act...." Therefore, in order to recover treble damages under O.R.C. § 2307.61, a plaintiff must allege that the defendant committed a criminal act of damage to property or theft. Red Ferris Chevrolet, Inc. v. Aylsworth, 2008 WL 4377549 (Ohio.Ct.App. Sept. 29, 2008). Here, however, reading the complaint in the light most favorable to the Trustee, the complaint does not allege that Fortress committed a criminal act. Nor does the Trustee cite a case in which a court has applied O.R.C. § 2307.61 to a fraudulent conveyance claim in a bankruptcy proceeding. Accordingly, plaintiff is not entitled to treble damages under O.R.C. § 2307.61 as a matter of law and Fortress's objection to the R & R is well-taken.
For the foregoing reasons, the R & R related to Textron's Motion to Dismiss is REJECTED. For the reasons stated herein, Textron's motion to dismiss is GRANTED and Textron is DISMISSED from this lawsuit. The R & R related to Fortress's Motion to Dismiss is ACCEPTED in PART and REJECTED in PART. The R & R is REJECTED to the extent it recommends denying Fortress's Motion to Dismiss as it relates to counts eleven, thirteen, fifteen, and seventeen. Those claims are DISMISSED. In addition, the Court finds that the Trustee has not properly alleged entitlement to treble damages under O.R.C. § 2307.61. The Court ACCEPTS the conclusions reached in the R & R, but for the reasons stated herein, with regard to the avoidance claims (counts two, four, five, six, seven, and eight), the preference claims (count 18), and the claims for equitable subordination (count 20) and disallowance of claims (count 21). Accordingly, these claims remain pending against defendant Fortress.
IT IS SO ORDERED.
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