Bash v. Textron Fin. Corp. (In re Fair Fin. Co.)

• Decision Date: 23 August 2016
• Docket Number: No. 15-3854,15-3854
• Citation: 834 F.3d 651
• Parties: In re: Fair Finance Company, Debtor. Brian A. Bash, Chapter 7 Trustee, Plaintiff-Appellant, v. Textron Financial Corporation, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

834 F.3d 651

In re: Fair Finance Company, Debtor.Brian A. Bash, Chapter 7 Trustee, Plaintiff-Appellant,

v.Textron Financial Corporation, Defendant-Appellee.

No. 15-3854

United States Court of Appeals, Sixth Circuit.

Argued: April 22, 2016

Decided and Filed: August 23, 2016

Rehearing Denied September 23, 2016

ARGUED: Daniel R. Warren, Baker & Hostetler LLP, Cleveland, Ohio, for Appellant. Mitchell A. Karlan, Gibson, Dunn & Crutcher LLP, New York, New York, for

Appellee. ON BRIEF: Daniel R. Warren, Thomas D. Warren, Joseph F. Hutchinson, Jr., Michael A. VanNiel, David F. Proaño, Baker & Hostetler LLP, Cleveland, Ohio, for Appellant. Mitchell A. Karlan, Gibson, Dunn & Crutcher LLP, New York, New York, James P. Schuck, Kenneth C. Johnson, Quintin F. Lindsmith, Bricker & Eckler LLP, Columbus, Ohio, for Appellee.

Before: MOORE, GIBBONS, and DAVIS,^* Circuit Judges.

OPINION

ANDRE M. DAVIS

, Senior Circuit Judge.

In this appeal from the dismissal of an adversary proceeding in bankruptcy, we are obliged to explore some uncharted territory of Ohio substantive and procedural jurisprudence.

For more than six decades, members of the Fair family operated Fair Finance Company (the “Debtor”) as a profitable and respected financial services company in Northeast Ohio. In 2002, Tim Durham and James Cochran purchased the Debtor in a leveraged buyout and transformed the Debtor's factoring operation into a front for a Ponzi scheme, the proceeds of which went largely to fund Durham's and Cochran's extravagant lifestyles and various struggling business ventures. In 2009, the Ponzi scheme collapsed when Durham, Cochran, and Rick Snow, the Debtor's Chief Financial Officer, were indicted for wire fraud, securities fraud, and conspiracy. The Debtor entered involuntary bankruptcy and Brian Bash, as Chapter 7 Trustee (the “Trustee”), brought a number of adversary proceedings to recover on behalf of the Debtor's estate and, by extension, the Ponzi scheme's unwitting investors. In the adversary proceeding at issue in this appeal, the Trustee brought numerous claims against Appellee Textron Financial Corporation (“Textron”), whose alleged assistance in the concealment and perpetuation of the Ponzi scheme lies at the root of all the claims asserted. The district court granted Textron's Rule 12(b)(6) motion to dismiss for failure to state a claim, and the Trustee timely appealed the dismissal as to all but one of his claims.

As we explain within, we hold that, because the Trustee has set forth sufficient factual allegations to demonstrate the existence of an ambiguity in a 2004 financing and funding contract between the Debtor and Textron, we REVERSE the dismissal of the Trustee's actual fraudulent transfer claim. We further hold that the Trustee was not required to plead facts in anticipation of Textron's potential in pari delicto affirmative defense to survive a motion to dismiss; accordingly, we REVERSE the dismissal of the Trustee's civil conspiracy claim. Finally, in light of the reinstatement of the Trustee's actual fraudulent transfer and civil conspiracy claims, we also REVERSE the dismissal of the Trustee's equitable subordination and disallowance claims. We AFFIRM , however, the dismissal of the Trustee's constructive fraudulent transfer claim as time barred.

I.

A.¹

In 1934, Arthur Ray Fair founded the Debtor to finance the automobile sales of a family-owned car dealership.

B.C. R. 8 (First Am. Compl. at 26:152).² Over the next six decades, members of the Fair family expanded the Debtor into a successful factoring company, purchasing accounts receivable at discounted rates and handling the billing and collection of client-owned customer accounts for a fee. Id. at 26:151–54. To support its purchase of accounts receivable, the Debtor sold investment certificates, or so-called V-Notes, to unsophisticated investors throughout Northeast Ohio. Id. at 26:155–58. The V-Notes routinely provided for six-month maturities and paid interest at a rate one-half of one percent higher than the rate payable on bank certificates of deposit. Id. at 26:158–27:160. The Debtor issued the V-Notes through private placements after filing offering circulars with the Ohio Division of Securities. Id. at 27:161. As of 2001, the Debtor held title to approximately $54 million in accounts receivable, owed $39 million in V-Notes, had never missed a V-Note payment (interest or otherwise), and had most recently operated at a $3 million profit. Id. at 27:165–28:166.

In January 2002, Donald Fair sold the Debtor to Fair Holdings, Inc. (“FHI”) in a leveraged buyout. Id. at 5:24. Durham and Cochran, two Indiana businessmen, founded FHI to serve as a holding company for the Debtor. Id. at 5:25, 6:32–33. They also formed a secondary holding company, DC Investments, LLC (“DCI”), which existed exclusively to own FHI. Id. at 28:171–72. Durham and Cochran were DCI's sole members. Id. at 28:170.

To purchase and operate the Debtor, FHI entered into a Loan and Security Agreement (“2002 L&SA”) with Textron and United Bank (“United”) on January 7, 2002.³ D.C. R. 20 (Mot. to Dismiss First Am. Compl. (“Mot. to Dismiss”) Ex. A) (Page ID #874–915). Under the terms of the 2002 L&SA, Textron and United agreed to make a $22 million revolving line of credit⁴ available to FHI and the Debtor.

Id. at 3–4 (Page ID #876–77). In exchange for extending the line of credit, Textron and United were entitled to interest and fees on amounts borrowed, with all such payments to be made through a lockbox arrangement. Under the arrangement, payments made on Debtor-owned accounts receivable would be made directly into a lockbox account and a designated lockbox agent would transfer appropriate funds to Textron and United as necessary. Id. at 4–5 (Page ID #877–78). To secure the loan, FHI pledged all of its present and future assets, i.e., its non-diluted interest in the Debtor. Id. at 6–8 (Page ID #879–81).⁵ Of particular relevance to the present action, the 2002 L&SA included the following provision regarding the scope of the security interest created thereunder:

(c) It is Borrower's express intention that this Agreement and the continuing security interest granted hereby, in addition to covering all present obligations of Borrower to Lenders and their respective Affiliates pursuant to the Obligations, shall extend to all future obligations of Borrower to Lenders intended as replacements or substitutions for said Obligations, whether or not such Obligations are reduced or entirely extinguished and thereafter increased or reincurred.

Id. at 7 (Page ID #880). As discussed in this opinion, the continued efficacy of the security interest created by the 2002 L&SA is at the heart of the Trustee's fraudulent transfer claims.

The 2002 L&SA also provided that FHI and the Debtor would furnish Textron and United with (1) monthly certified financial statements, (2) yearly audited financial statements, (3) yearly financial statements and tax returns for the loan's guarantors (Durham and Cochran), and (4) any other relevant materials. Id. at 14–15 (Page ID #887–88). In addition, Textron and United enjoyed the right to audit FHI and the Debtor up to four times per year. Id. at 16 (Page ID #889). To perfect the security interest established under the 2002 L&SA, Textron and United filed a UCC Financing Statement with the Ohio Secretary of State on January 8, 2002. D.C. R. 20 (Mot. to Dismiss Ex. C) (Page ID #919–21).

After settlement of the leveraged buyout, Durham became the Debtor's CEO and immediately began a campaign of selling additional V-Notes with substantially longer maturities and elevated interest rates. B.C. R. 8 (First Am. Compl. at 6:36–7:37). Durham then directed a significant portion of the new V-Note capital into a series of “insider loans” for his personal benefit, the benefit of other failing companies that he and Cochran owned or controlled, and the benefit of the officers and directors of those failing companies. Id. at 7:37–38. Generally, the insider loans followed a common path: Durham would cause the Debtor to lend money to FHI (the Debtor's parent), and FHI would then lend a corresponding amount directly to an insider or to DCI (FHI's parent), which would then lend the money to an insider. Id. at 7:39.

By the end of 2002, the Debtor had made more than $30 million in insider loans. Id. at 7:40. By the end of 2006, that number had grown to approximately $137 million, and by September 2009, the Debtor had made more than $228 million in insider loans. Id. at 7:40–8:41. While the insider loans were delineated as performing assets in the Debtor's offering circulars, id. at 36:235–37:236, the loans were made on commercially unreasonable terms, “permitt[ing] financially distressed [i]nsiders to defer all payments for years at a time, to ‘secure’ the loans with inadequate collateral, without perfecting liens, and allow[ing] borrowers to exceed their credit limits without review,” id. at 34:217–18. Moreover, when an insider loan approached default, Durham would cause the Debtor to modify the loan and prevent the Debtor from enforcing its rights and/or collecting amounts due. Id. at 34:218–35:226. Unsurprisingly, at no point did the Debtor receive any significant payments on any of the insider loans, id. at 9:46, and as of the filing of the Debtor's bankruptcy petition, the outstanding balance on the insider loans totaled approximately $233 million, id. at 37:237.

During Durham and Cochran's ownership and control of the Debtor, the company did maintain its factoring operations. Id. at 8:44. However, because the Debtor's accounts receivable assets remained fairly steady, the company's factoring operation alone could not support its ever increasing issuance of V-Notes and insider loans. Id. at 8:44–9:48. Accordingly, by December 2003, the Debtor was operating as “a classic Ponzi scheme,” constantly requiring the issuance of new V-Notes to pay off existing V-Notes as they matured and to make the requisite monthly interest...