Dorula v. Holmes (In re Starlight Grp., LLC)
| Decision Date | 12 June 2015 |
| Docket Number | Case No. 11–18241–RGM,Adv. No. 13–1060–RGM |
| Citation | 531 B.R. 611 |
| Parties | In re: Starlight Group, LLC, Debtor. W. Michael Dorula, et als., Plaintiffs, v. J. Gregory Holmes, Defendant. W. Michael Dorula, Objector, v. J. Gregory Holmes, Respondent. Robert A. Meletti and Julie E. Meletti, Objectors, v. J. Gregory Holmes, Respondent. |
| Court | U.S. Bankruptcy Court — Eastern District of Virginia |
Richard G. Hall, Annandale, VA, for Plaintiffs.
John T. Donelan, Law Office of John T. Donelan, Alexandria, VA, for Defendant.
The question presented in this case is the relative priority of various unsecured claims, in particular, whether the claims of creditors who loaned money to the debtor in reliance on security agreements that were ineffective to grant liens on real property have priority over the unsecured claims of a creditor who was not an owner of the debtor but who controlled the debtor and knew that the security agreements were ineffective to grant liens on the debtor's real property.1 The court concludes that the unsecured creditors' claims have priority over the claims of the creditor in control of the debtor by virtue of the unsecured creditors' equitable liens, or in the alternative, equitable subordination. The chapter 7 trustee is not a party to the litigation.
Starlight Group, LLC, the debtor, bought residential real estate at short sales and resold it from January 2009 until November 2011 when it filed bankruptcy.2 During this period, it bought 82 properties and had sold all but four when it filed bankruptcy. Its gross receipts for this period were more than $27.5 million. Statement of Financial Affairs, Question 1. This phase was the idea of J. Gregory Holmes, a top-selling real estate agent who prides himself on his expertise in pricing real estate. He observed that there were many properties in Northern Virginia that were “underwater,” that is, the debt secured by the property was greater than the value of the property; that some of the owners were unable to make the contractual mortgage payments; and, that mortgage lenders were willing to approve short sales—a sale where the lender accepted less than the amount owed to it—at prices less than the market value. He realized that if he purchased a distressed property at a short sale, he could make a quick profit by promptly reselling the property himself at its market value. 1 Tr. 47. These observations gave rise to Holmes' scheme which the parties called “the Holmes Model.” 5 Tr. 176. There were two key elements: The purchases were cash transactions and Holmes was the real estate agent for the purchase and the sale of the property.3
Holmes approached Spencer C. Brand, a trusted friend and mentor. He proposed that Brand—and at Brand's suggestion, Starlight, Brand's single-member limited liability company—purchase the distressed properties at the below-market price with money Starlight borrowed from private lenders to conduct its business and not for specific purchases. He would then quickly resell them for a profit and would split the profit, 90% to himself and 10% to Brand.
Starlight's first purchase was funded solely by Holmes who borrowed $110,000 on his life insurance policy and lent it to Starlight. 1 Tr. 47–48. After the first few transactions proved very successful, Holmes approached W. Michael Dorula and negotiated a loan from him to Starlight. 1 Tr. 68. Dorula became an intermediary for his friends who also lent money to Starlight. At Starlight's height, it had more than $2.3 million in outstanding loans to the Dorula lenders and $800,000 to Holmes.
Holmes' key accounting idea was that at the end of each transaction—the purchase and then the sale of the distressed property—the lenders' money would be restored to Starlight's bank account and the profits would be split. 1 Tr. 61–62. Between the real estate owned and the money in the bank, the lenders would be assured of repayment of their loans. 7 Tr. 22–23.
Homes testified that 1 Tr. 61. Starlight received the net proceeds from each sale and made disbursements—principally monthly interest payments to the lenders and the profits to Holmes and Brand as computed by Holmes. Brand acted on behalf of Starlight in this regard. In addition, once Holmes established the relationship with Dorula, Brand was responsible for lender relations and dealt directly with Dorula who acted on behalf of his friends. 6 Tr. 75; 1 Tr. 61.
The venture ended shortly after Brand admitted to Holmes that he had unsuccessfully invested idle funds in the stock market and had lost more than $400,000. 4 Tr. 92. Holmes later learned that Brand had been paying himself more than the profits Holmes had determined were due to him. This amount, charged to Brand as compensation on Starlight's books, amounted to several hundred thousand dollars. 3 Tr. 153–155.
When informed of the situation, Holmes and the Dorula lenders agreed to place the proceeds from the sales of the remaining properties owned by Starlight in escrow. 3 Tr. 52. The escrow agent was initially Northern Virginia Title & Escrow. Id.; 5 Tr. 236–239. Although the settlement company was owned by Scott Flanders, Don Olinger, a Dorula lender, was the individual who had authority to disburse money from it. The funds were moved to American Title & Escrow because of concern over the close relationship between Holmes and Flanders. 5 Tr. 59. Olinger distributed the money in the escrow account to the Dorula lenders, to the exclusion of Holmes. Holmes filed suit against Starlight to stop the distributions to the Dorula lenders and Starlight filed a chapter 7 petition. 3 Tr. 59.
There was extensive oral testimony and numerous exhibits at the seven-day trial of this matter. The transcript is 1,788 pages long.4 The principal witnesses were Holmes, Brand and Dorula. Holmes devised the Holmes Model, lent Starlight substantial amounts of money and was Starlight's real estate agent. He filed three proofs of claims totaling $1,019,860.09. He found almost all of the properties Starlight purchased and was the primary listing agent for their sale. He earned a real estate commission on each property Starlight purchased and another when it was sold. Brand was responsible for dealing with the lenders, keeping the books and making disbursements. He made no claims against Starlight and was granted a discharge in bankruptcy of his debts on April 30, 2012. Starlight's business was run ostensibly by Brand, but, in fact, by Holmes. Despite the fact that they started the venture as trusted friends, Holmes trenchantly blames Brand for Starlight's failure. Brand, in turn, blames Holmes, but acknowledges his errors and accepts responsibility for them and their contribution to Starlight's failure. Their testimony was not always consistent.
After having heard the testimony of Holmes, Brand and the other witnesses, examined the exhibits, and considered the access of both Holmes and Brand to information, their respective biases, their roles in the business venture, their stakes in the litigation and its outcome,5 and their demeanor, the court finds that neither Holmes nor Brand was wholly reliable and that their testimony should be considered with skepticism. Discrepancies were considered and reconciled when possible. Some testimony of each was disregarded because it lacked credibility. Overall, Brand was more credible than Holmes. The findings of fact are based on the entire record with Holmes and Brand being given credit when appropriate.
Dorula's credibility was also considered. He lent his money to Starlight and filed a proof of claim for $174,128. He was the liaison between Brand and the other lenders who were his friends. They collectively filed proofs of claims for $1,994,984. They were paid, generally, 14% per annum on their loans. Starlight paid Dorula, generally without the knowledge of his friends, an additional 5% override on their loans. 7 Tr. 204–205. The cost to Starlight was a total of 19% per annum.
Dorula was the spokesman for the lenders when Starlight collapsed and negotiated the establishment of the escrow account from which payments were made to Dorula and his friends within 90 days before Starlight filed bankruptcy. 5 Tr. 90–91. The chapter 7 trustee filed preference suits against Dorula and Robert Meletti, one of Dorula's friends and a fellow lender, and threatened preference suits against the rest. Docket Entry 88, ¶ 5–6. Prior to the trial in these matters, the Dorula lenders and the trustee reached a settlement. Id. It allowed the Dorula lenders to retain the money they were paid and established a basis for distributing the remaining funds the trustee recovered. Brooks, another creditor, objected to the proposed settlement because it could give the Dorula lenders a more favorable distribution than he would get, depending on the outcome of the objections to Holmes' and his claims. The proposed settlement was not prosecuted during the trial of these matters but has since been approved. In general, Dorula was a credible witness, but he—for himself and his friends—had a clear interest in recharacterizing or subordinating Holmes' claims. He is the primary moving party on the objections and is the complainant, together with his wife, in the adversary proceeding.
Holmes was licensed as a realtor in 1986. 1 Tr. 28. He testified that he was the third highest selling Century 21 agent in the country in 1999, 2000, and 2001. 1 Tr. 29. He met Brand about 1997, and they became close friends. Brand became his mentor and they spoke many times during the week.6 In 2004, Holmes decided, in addition to selling real estate, to start investing in real estate. Brand made the same decision, organized Starlight and invested through it.7 Both financed their...
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