Bash v. Textron Fin. Corp.
| Decision Date | 09 November 2012 |
| Docket Number | No. 5:12 CV 987.,5:12 CV 987. |
| Citation | 483 B.R. 630 |
| Parties | Brian A. BASH, Trustee, Plaintiff, v. TEXTRON FINANCIAL CORP., et al., Defendants. |
| Court | U.S. District Court — Northern District of Ohio |
OPINION TEXT STARTS HERE
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.
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 millionand had $59 million in assets and $46 million in liabilities. Included in the assets were Customer Accounts totaling $54 million. The liabilities included $39 million in obligations on the V–Notes.
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.1 Neither DC Investments nor FHI had any significant assets, other than an interest in Fair Finance.
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:
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¦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 existing V–Notes, or used to fund operating losses. During this time period, Fair Finance never received any significant payment on the Insider Loans. Moreover, Durham caused Fair Finance to repeatedly modify the terms of the Insider Loans in default, rather than take any collective action. Durham believed that Fair Finance's auditors would determine that since an Insider Loan was not in default, the loan could be valued as an asset at face value.
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.
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...
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