Bash v. Textron Fin. Corp.

• Citation: 524 B.R. 745
• Decision Date: 15 January 2015
• Docket Number: No. 5:12 CV 987.,5:12 CV 987.
• Parties: Brian A. BASH, Trustee, Plaintiff, v. TEXTRON FINANCIAL CORP., et al., Defendants.
• Court: U.S. District Court — Northern District of Ohio

524 B.R. 745

Brian A. BASH, Trustee, Plaintiff

v.TEXTRON FINANCIAL CORP., et al., Defendants.

No. 5:12 CV 987.

United States District Court, N.D. Ohio, Eastern Division.

Signed Jan. 15, 2015.

Kelly S. Burgan, Joseph M Esmont, Eric R. Goodman, Joseph F. Hutchinson, Jr., Thomas R. Lucchesi, Alexis C. Osburn, David F. Proano, Michael A. VanNiel, Daniel R. Warren, Baker & Hostetler–Cleveland, Cleveland, OH, for Plaintiff.

Memorandum of Opinion and Order

PATRICIA A. GAUGHAN, District Judge.

INTRODUCTION

This matter is before Court upon the Proposed Conclusions of Law Recommending that District Court Deny in Large Part or in their Entirety, the Cross–Motions for Summary Judgment of the Plaintiff Trustee and the Defendant Fortress Credit Corporation (“R & R”). (ECF 74, in Adversary Proceeding 12–5101).¹ This is an adversary proceeding stemming from the Fair Finance bankruptcy filing. For the reasons that follow, the R & R is ACCEPTED to the extent it recommends that the cross motions for summary judgment be denied. The Court did, however, address issues that were not addressed in the R & R, e.g., subsequent transferee liability, true sale, and the Ponzi scheme intent element of a fraudulent transfer claim. For the reasons set forth in the R & R and more fully below, the motions for summary judgment are DENIED.

FACTS

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 SPE”). Textron, Fortress, and the Trustee moved to withdraw the reference to bankruptcy court. The Court granted the motions. This Court previously granted Textron's motion to dismiss.

Many of the background facts of this case are undisputed.² The Court will provide an overview of the transaction in the facts section and then, as necessary, address specific facts in connection with specific arguments in the analysis section.

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”).

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. At the time of the buyout, Fair Finance had a strong balance sheet with assets exceeding liabilities by approximately $14 million. After the purchase, Tim Durham became the CEO of Fair Finance.

Shortly thereafter, Durham, Cochran, and related business entities “borrowed” money from Fair Finance and recorded the transactions as “related party loans.” Generally speaking, these loans were unsecured. In addition, advances on these loans continued after the maturity dates passed. Fair Finance accrued interest on the related party loans and included the unpaid accrued interest as net income. When borrowing limits were reached, the limits were increased and the maturity dates extended. Eventually, Fair Finance did not have sufficient cash to pay the interest and principal owed to V–Noteholders without issuing new V–Notes.

In February of 2008, Fortress made a $50 million secured revolving loan to Fair SPE. Fair SPE was set up for the purpose of closing the loan with Fortress. Fair SPE is a wholly owned subsidiary of Fair Finance. The transaction works as follows: Fair Finance “sold” certain Customer Accounts to Fair SPE. Fair SPE paid Fair Finance the fair market value of the receivables with money borrowed from Fortress. The cash flow Fair SPE received from consumer payments on the Customer Accounts was used to repay the Fortress loan. As part of the transactions, Fortress acquired a security interest in the Customer Accounts. According to the Trustee, the Customer Accounts that Fair Finance sold to Fair SPE were the only “real” assets Fair Finance owned.

Prior to closing the loan, Fortress engaged in due diligence. Fortress's primary focus centered on the consumer accounts as those assets secured the Fortress loan. Fortress focused on the potential risk that the receivables themselves were fraudulently created. Fortress points out that there is no dispute that the Fortress loan was in fact repaid from proceeds of the consumer loans.

Fortress also received financial statements from Fair Finance that disclosed the presence of the related party loans and that Fair Finance was increasing the issuance of V–Notes. Fortress does not dispute that it knew that the related party loan balances were increasing and accruing interest. Fortress also knew that while the financial statements prepared in 2003 and 2004 were audited, those prepared in 2005 and 2006 were “reviewed” and did not comply with FIN 46.³ In addition, Fair Finance changed accounting firms between 2004 and 2005. Fortress received a background report on Durham and Cochran. Notably, both individuals did not fully disclose all information requested from the investigator. For example, Cochran indicated that he had never been arrested, yet the report disclosed that he had been arrested for domestic violence. In addition, Durham did not disclose all of his real estate holdings. The report indicates that a number of media articles have appeared about Durham. In many of them, including one that issued shortly before the loan closing, Durham is described as a wealthy man living an extravagant lifestyle. He owned several expensive cars and yachts, as well as priceless artwork. He appears to have lived a life of debauchery, including hosting a “fantasy pajama and lingerie” party and posting photographs of the party on the internet. In addition, Durham donated considerable amounts of money to various politicians. In one article, the media accused Durham of engaging in insider trading. Durham disputed the accusation and threatened to sue the publisher.

After completing its due diligence, Fortress closed the loan with Fair SPE. Eventually, Fair Finance could not raise enough funds to pay the V-note holders and the fraud collapsed. A federal grand jury indicted Durham and Cochran and both are currently serving lengthy prison sentences.

Thereafter, Fair Finance was forced into involuntary bankruptcy. The Trustee was appointed as of February 24, 2010. Prior to the filing of this adversary proceeding, the Trustee recognized that Fair SPE was a subsidiary of Fair Finance and that the lockbox holding customer payments on the accounts receivable belonged to Fair SPE. Those proceeds were used to continue to pay off the Fortress line of credit even after the bankruptcy was filed. The Trustee and Fortress entered into a payoff agreement, pursuant to which the Fortress loan was to be paid in full. In exchange, Fortress agreed to relinquish its lien on the Fair SPE Customer Accounts. Thereafter, the Trustee informed the bankruptcy court that the Fortress loan was paid in full and moved the court to transfer title of the Customer Accounts to Fair Finance. The Trustee did not disclose his intent to file the current claims against Fortress.

This adversary proceeding followed. The Court previously dismissed defendant Textron and further dismissed certain claims filed against Fortress. The remaining claims are as follows:

• Count two is a claim for avoidance and recovery of actual fraudulent transfers under 11 U.S.C. §§ 548(a)(1)(A), 550(a) and 551 ;

• Count four asserts a claim 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 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 ;

• Count twenty is a claim for Equitable Subordination under 11 U.S.C. § 510(c) ; and

• Count twenty-one is a claim for the Disallowance of Claims Under 11 U.S.C. § 502(d).

The parties cross move for summary judgment and each opposes the other's motion. The bankruptcy judge recommends that the Court deny the parties' motions for summary judgment on counts two, four, five, six, seven, eight, eighteen, twenty, twenty-one, and all of Fortress's affirmative defenses with the exception of laches, waiver, and judicial estoppel. With regard to these three affirmative defenses, the bankruptcy court recommends granting summary judgment in favor of the Trustee. Both the Trustee and Fortress object to the R & R, and each filed responses the other's objections.

STANDARD OF REVIEW

Rule 56(a) of the Federal Rules of Civil Procedure, as amended on December 1, 2010, provides in relevant part that:

A party may move for

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