130 F.3d 657 (5th Cir. 1997), 96-21001, Askanase v. Fatjo

Docket Nº:96-21001.
Citation:130 F.3d 657
Party Name:David ASKANASE, Trustee; Fitness Corporation of America, Plaintiffs-Appellants, v. Tom J. FATJO, et al., Defendants, Tom J. Fatjo, Jr.; C.A.J.A. Enterprises, Inc.; Bayou Park Club Partnership, A Texas General Partnership; Criterion Research, Inc.; Elstead Investment Co., A Texas General Partnership; Ron Hemelgarn; Air 500 Ltd.; Beechmont Partnershi
Case Date:December 23, 1997
Court:United States Courts of Appeals, Court of Appeals for the Fifth Circuit

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130 F.3d 657 (5th Cir. 1997)

David ASKANASE, Trustee; Fitness Corporation of America,



Tom J. FATJO, et al., Defendants,

Tom J. Fatjo, Jr.; C.A.J.A. Enterprises, Inc.; Bayou Park

Club Partnership, A Texas General Partnership; Criterion

Research, Inc.; Elstead Investment Co., A Texas General

Partnership; Ron Hemelgarn; Air 500 Ltd.; Beechmont

Partnership; Coordinated Spa Services, Inc.; Deluxe Office

Products; Fitness Research International; Great Lakes

Leasing Agency; H & C International; Hemelgarn Racing,

Inc.; Management Computer; Newtowne Enterprises, Inc.;

Quad Cities Ltd.; Spa One Advertising; Spa Computer; Spa

Janatorial; Spa Lady, Inc.; Spa Printing; Twenty-First

Century; WHM Enterprises; Watson Melby Hemelgarn

Partnership; Westchester Spa Partnership; Ernst & Young,

formerly known as Ernst & Whinney; Housprops, Inc., A Texas

Corporation; Houstonian Holdings Partnership, A Texas

Partnership; Peter M. Jackson; Ahmed Mannai; Fitness

Investment N V, A Netherlands Antilles Corporation; Fitness

Investment (Texas), Inc., A Texas Corporation; Houstonian

Estates Investment Co. N V, A Netherlands Antilles

Corporation; Mannai Investment Company, Inc., C, A Delaware

Corporation; Xantor, Inc., A Panamanian Corporation;

Parkgate Associated Ltd.; Parkgate, Inc., A Corporation;

Roger A. Ramsey; John Snideman, doing business as Financial

Services Corporation; John Snideman, doing business as

Management Accounting, Inc.; Gerald M. H. Stein; Joseph J.

Zilber; JZL Ltd., A Nevada Corporation; ZL Company, Inc.,

A Delaware Corporation; Zilber, Inc.; Zilber Ltd., A

Nevada Corporation; Financial Services Corporation;

Management Accounting, Inc.; Hfund, Inc.; Corporate

Communications Center, Defendants-Appellees.

In the Matter of: LIVINGWELL, INC., Debtor.

David ASKANASE, Trustee, Appellant,


Tom J. FATJO, Jr., Appellee.

In the Matter of: LIVINGWELL (NORTH), INC.; LivingWell

(Midwest), Inc., Debtors.

David ASKANASE, Appellant,


M W B LEASING, INC., Appellee.

In the Matter of: LIVINGWELL (MIDWEST), INC.; LivingWell,

Inc., Debtors.

David J. ASKANASE, Appellant,


TOWNE REALTY, INC.; Joseph J. Zilber, Appellees.

In the Matter of: LIVINGWELL, INC., Debtor.

David J. ASKANASE, Appellant,


ZILBER LTD.; Joseph J. Zilber, Appellees.

No. 96-21001.

United States Court of Appeals, Fifth Circuit

December 23, 1997

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Rhett G. Campbell, Kenneth M. Morris, John S. Brannon, David Allen Furlow, Morris & Campbell, Houston, TX, Andrew L. Jefferson, Jr., Houston, TX, for Plaintiffs-Appellants.

Robert L. Ketchand, Houston, TX, John V. Singleton, Jr., Houston, TX, for Fatjo and Parkgate, Inc.

Leonard Harvey Simon, Todd Jeffrey Zucker, Bouar, Simon & Miller, Houston, TX, for Bayou Park Club Partnership, Elstead Investment Co., Housprops, Inc., Houstonian Holdings Partnership, Jackson, Mannai, Fitness Investment N V, Houstonian Estates Investment, Mannai Investment Co.,

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Inc., Xantor, Inc., Parkgate Associated, Ltd. and Hfund, Inc.

John Wesley Wauson, Wauson & Associates, Houston, TX, for Hemelgarn, Beechmont Partnership, Coordinated Spa Services, Inc., Great Lakes Leasing Agency, H & C International, Hemelgarn Racing, Inc., Newtowne Enterprises, Inc., Quad Cities, Ltd., Twenty-First Century, Snideman and Management Accounting, Inc.

James Andrew Heaton, Ernst & Young, Washington, DC, Melanie A. Gray, Gregory Scott Coleman and Mark Steven Elias, Weil, Gotshal & Manges, Houston, TX, Ralph I. Miller, Weil, Gotshal & Manges, Dallas, TX, for Ernst & Young.

Ronald J. Restrepo, Houston, TX, for Ramsey.

Albert Scott Solochek, Milwaukee, WI, for Stein, Zilber, JZL, Ltd., ZL Co., Inc., Zilber, Inc. and Zilber, Ltd.

Appeal from the United States District Court for the Southern District of Texas.

Before GARWOOD, DUHE and DeMOSS, Circuit Judges.

DUHE, Circuit Judge:

Appellant, the Bankruptcy Trustee of LivingWell, Inc. and related companies, appeals from a take nothing judgment in favor of the Defendants, Ernst & Young, LivingWell's auditors, and Tom Fatjo et al., who are either former directors, officers, or shareholders of LivingWell, Inc. or separate businesses owned by these officers, directors, or shareholders. The fifteen issues asserted on appeal basically involve five claims. First, the Trustee argues that he may recover money LivingWell paid its subsidiaries, officers and directors, and their related businesses. He does so under the trust fund doctrine, which prohibits an insolvent corporation from paying money or distributing assets to its directors in preference to creditors. Second, the Trustee sues the directors alleging misconduct and breach of the duty of loyalty and care and their fiduciary duty. Third, the Trustee claims that the directors fraudulently caused LivingWell to transfer money and assets to themselves and unlawfully redeemed LivingWell stock. Fourth, the Trustee sues the majority shareholder, Ahmed Mannai, for damages on the basis that Mannai controlled the board of directors through his two agents and is therefore responsible as a director. Last, the Trustee sues Ernst & Young, who audited LivingWell, for breach of contract, negligence, gross negligence, fraud, and fraud based conspiracy. We affirm.


In October of 1983, three Texas limited partnerships, the Houstonian Properties, Ltd. ("HPLtd"), the Houstonian Estates, Ltd.,("HELtd") and LivingWell, Ltd., and one Texas general partnership, Houstonian General Partnership ("HGP") combined to form the Houstonian, Inc., a Texas Corporation. The Houstonian's major assets were: the Houstonian Properties Hotel, Conference Center, and Club, the Manor and Ambassador Houses, twenty-nine condominium units in the Houstonian Estates Condominiums, a 4.8 acre parcel of land adjacent to the Club and Condominium, the Houstonian Preventive Medicine Center and its exclusive rights to market, develop, and sell the LivingWell Programs and related operating assets. In exchange for these assets HPLtd received Houstonian Inc. common stock; HGP received common stock which it distributed to HELtd; LivingWell received common stock. In 1985, the Houstonian was merged into LivingWell. 1

In 1984, LivingWell purchased 82 fitness clubs in the southeastern United States for over $10 million cash, shares of its common stock, and an agreement that, if, over the next five years, the clubs achieved certain earnings goals, then the sellers would receive additional consideration up to $10 million (50% in cash and 50% in value of common stock). Ron Hemelgarn, one of the principal shareholders of the seller, became a LivingWell director.

In March of 1985, LivingWell acquired over 200 fitness facilities nationwide for $15.5

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million cash, 1,774,750 shares of LivingWell common stock and 68,572 shares of LivingWell's Series C Convertible Preferred Stock. As an additional part of the transaction, LivingWell could issue up to 750,000 shares of common stock over the next five years if one of the acquired groups reached specified earnings levels.

On March 29, 1985, Zibler, Ltd., purchased 50,000 shares of LivingWell's Series D Convertible Preferred Stock for $5 million. Zibler, Ltd., loaned an additional $10 million to LivingWell and Zibler had the option to acquire warrants to purchase 3,233,790 shares of common stock at prices of $4 to $8 per share.

  1. Source of Capital

    In September of 1985, LivingWell sold $16.1 million of 12% convertible, subordinated debentures. Net proceeds were used to pay existing debt and increase capital. Through 1985 and into 1986, LivingWell successfully converted preferred stock into common stock thereby raising additional funds in the public markets. In May 1986, LivingWell sold $52 million of subordinated debentures and warrants. Of the nearly $51 million in net proceeds, $40.15 million was used to retire outstanding debts.

  2. Relevant Transactions

    1. PAC

    In June 1986, LivingWell and certain of its individual shareholders created a separate financing company, Paramount Acceptance Corporation ("PAC"), a Delaware corporation, to collect LivingWell's receivables. PAC had its own officers and directors. Prior to PAC's creation, LivingWell collected its receivables (club and membership fees and dues) through its regional subsidiaries (LW North, LW South, and LW Midwest).

    2. Sale of Clubs

    During 1986, LivingWell sold 41 clubs to Powercise, Inc., a corporation formed by some LivingWell employees. Shortly thereafter, T.H.E. Fitness Centers, Inc., an outside group, acquired other of LivingWell's small clubs. As part of the deal, T.H.E. received rights to the Powercise technology owned by LivingWell and LivingWell received equivalent stock in T.H.E.

    3. Hfund Transaction

    When the Houstonian Hotel and Conference Center experienced financial difficulty that threatened foreclosure, a new entity, called Hfund, Inc., was created. LivingWell exchanged its interest in the Houstonian fitness operations for preferred stock in the newly formed Hfund, Inc., a Delaware corporation. Pursuant to the exchange, additional cash was made available to the mortgage holder thereby avoiding foreclosure.

    4. Bankruptcy Filing

    When the prospect of bankruptcy became apparent LivingWell attempted to restructure its organization. LivingWell continued its operations and in 1988 generated $136 million in revenues. From 1988 through most of 1989, LivingWell attempted to restructure...

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