Sherman v. OTA Franchise Corp. (In re Essential Fin. Educ., Inc.)

Decision Date03 May 2021
Docket NumberCase No. 18-33108,Adv. Pro. No. 20-3092
Citation629 B.R. 401
Parties IN RE: ESSENTIAL FINANCIAL EDUCATION, INC. Debtor. Daniel Sherman, Chapter 7 Trustee, Plaintiff, v. OTA Franchise Corporation, Defendant.
CourtU.S. Bankruptcy Court — Northern District of Texas

David Wilson Dodge, Matthew Edward Furse, Glast, Phillips & Murray, P.C., Dallas, TX, for Plaintiff.

Samuel Gary Brooks, Mark L. Eisenhut, Call & Jensen APC, Newport Beach, CA, Samuel Harris Johnson, Johnson Law, PLLC, Plano, TX, Robert M. Yaspan, Law Offices of Robert M. Yaspan, Woodland Hills, CA, for Defendant.

MEMORANDUM OPINION AND ORDER REGARDING CROSS-MOTIONS FOR SUMMARY JUDGMENT OF THE TRUSTEE AND OTA FRANCHISE CORPORATION

Michelle V. Larson, United States Bankruptcy Judge.

Before this Court are cross-motions for summary judgment: 1) the Motion for Partial Summary Judgment (the "Trustee Motion ") and Brief in Support (the "Trustee Brief "),1 filed by Daniel Sherman, the duly appointed Chapter 7 Trustee (the "Trustee ") for the bankruptcy estate of Essential Financial Education, Inc. (the "Debtor " or "Essential "); and 2) the Motion for Partial Summary Judgment (the "OTAF Motion ") and Brief in Support (the "OTAF Brief ")2 filed by OTA Franchise Corporation ("OTAF " or the "Defendant "). The Court will refer to the Trustee Motion, the Trustee Brief, the OTAF Motion, and the OTAF Brief collectively as the "Summary Judgment Motions ." In the Trustee Motion, the Trustee requests summary judgment on the first four causes of action contained in his Original Adversary Complaint to Avoid and Recover Transfers (the "Complaint ").3 Two of these counts deal with actual and constructive fraudulent transfers under § 548(a)(1) of the Bankruptcy Code,4 and the remaining causes of action are for actual and constructive fraudulent transfers brought pursuant to § 544(b) of the Bankruptcy Code and the Texas Uniform Fraudulent Transfer Act ("TUFTA "), which is codified in Chapter 24 of the Texas Business and Commerce Code. The Trustee also requests summary judgment on many of the affirmative defenses OTAF asserted in its Answer (the "Answer ").5 OTAF, in turn, requests summary judgment on the Trustee's TUFTA causes of action, and the Trustee's fifth cause of action for avoidance of preferential transfers, where the Trustee claims that certain transfers made to OTAF are avoidable preferences. For the reasons that follow, the Court will grant in part and deny in part the Trustee Motion and will deny the OTAF Motion.

I. Jurisdiction and Venue.

This Court has subject matter jurisdiction over this proceeding pursuant to 28 U.S.C. § 1334. This is a core proceeding under 28 U.S.C. § 157(b). The bankruptcy court has authority to adjudicate this matter pursuant to the United States District Court for the Northern District of Texas Miscellaneous Order No. 33. Both parties have consented to this Court hearing this matter and determining the issues on a final basis. The following shall constitute this Court's reasoning pursuant to Rule 56 of the Federal Rules of Civil Procedure, as made applicable in adversary proceedings pursuant to Rule 7056 of the Federal Rules of Bankruptcy Procedure.

II. Undisputed Facts6 and Procedural Posture.

OTAF is a Nevada corporation that licenses independent trading and financial education centers that utilize OTAF's proprietary systems to offer their clients "efficient and cost-effective trading education solutions."7 OTAF operates under a franchise model in which it licenses its intellectual property to various entities across the United States who operate "Online Trading Academy Centers" in exchange for royalties and other fees paid to OTAF.

In 2011, OTAF entered into a franchise agreement (the "2011 Agreement ") with Thomas Caufield ("Caufield "), under which OTAF granted Caufield a license to operate an Online Trading Academy Center in the Dallas area (the "Dallas Center ") in exchange for an initial franchise fee of approximately $1.3 million (the "Franchise Fee ").8 The 2011 Agreement provided that Caufield would also pay a royalty fee equal to the greater of $2 million or 10% of the gross revenues of the Dallas Center,9 as well as a bevy of other fees.10

Caufield raised the money to pay the Franchise Fee through a purported private placement offering by OTA Holdings, LLC, a Wisconsin limited liability company Caufield owned and operated.11 Through this private placement, Caufield raised between $600,000.00 and $750,000.00.12

By April of 2015, Caufield had fallen behind on approximately $200,000.00 in delinquent royalty fees due to OTAF under the 2011 Agreement.13 To remedy this situation, Caufield sought an additional investor in the Dallas Center. Caufield found such an investor in Michael Ludlow ("Ludlow "), with whom he formed Essential. Ludlow invested $600,000.00 in exchange for a 33% ownership interest in Essential. Thereafter, Essential, through Caufield and Ludlow, began negotiating with OTAF to transfer Caufield's franchise license to Essential. OTAF eventually agreed to grant Essential a franchise license in exchange for a payment of approximately $500,000.00.14 On October 20, 2015, Essential and OTAF executed a new franchise agreement (the "2015 Agreement ") under which Essential would run the Dallas Center.15

Pursuant to the 2015 Agreement, OTAF retained the right to (i) access and inspect Essential's premises, (ii) interview its personnel and customers, and (iii) access its financial data, including its bank information and Essential's QuickBooks accounting data.16 OTAF also retained the right to demand copies of tax returns.17 The 2015 Agreement also contained a section entitled "Grant of Security Interest," in which OTAF purported to take a security interest in "all proceeds of [Essential's] Online Trading Academy Center and in all of the assets, including equipment, furniture, fixtures, and signs used by, at or in connection with, your Online Trading Academy Center and its related business."18 OTAF did not file a UCC-1 financing statement related to this purported security agreement.19

Part of OTAF's business model included a mechanism for franchisees to contract with Universal Guardian Acceptance, LLC ("UGA ") to provide factoring services to support or provide cash flows to franchisees.20 UGA's factoring services involved purchasing student contracts from franchisees in exchange for the collection rights on those contracts.21 Essential entered into such a factoring agreement with UGA on November 4, 2015 (the "UGA Agreement ").22 Essential, pursuant to a similar mechanism, also entered into an agreement with Universal Account Servicing, LLC ("UAS "), UGA's affiliate, under which UAS provided collection services for student contracts Essential did not factor (the "UAS Agreement ").23

Only one year after entering into the 2015 Agreement, Essential found itself having financial difficulties when it began bouncing payments for payroll tax liabilities to the IRS.24 Furthermore, in February of 2016, Caufield began circulating a "Private Placement Memorandum" in which Tuition Funding Source, LLC ("TFS "), a separate legal entity that Caufield wholly owned and managed, purported to offer a series of promissory notes in the principal amount of $50,000 plus interest at an annualized rate of return of 17.9% with a repayment period of up to 15 months.25 Through this offering, TFS obtained funds from individuals, including several students of Essential (the "Student Lenders ").

Thereafter, in 2017, Caufield was served with a subpoena from the Securities and Exchange Commission (the "SEC Subpoena ") related to an investigation into his personal affairs, including his relationships with the Student Lenders.26 Caufield notified Gene Longobardi ("Longobardi "), OTAF's Chief Operating Officer, of the pending SEC investigation on November 24, 2017. Shortly thereafter, on December 4, 2017, OTAF delivered to Essential two letters, each with the subject line, "Notice of Defaults and Required Actions" (the "Incurable Breach Notice ," the "Past Due Notice ," and, collectively, the "Breach Notices ").27 In the Incurable Breach Notice, OTAF informed Essential that it had received the SEC subpoena and that Essential had committed several "incurable breaches" of the 2015 Agreement, including engaging in "misconduct that unfavorably affect[ed] OTAF's reputation" and committing "act[s] or omission[s] of fraud or misrepresentation."28 OTAF further provided in the Incurable Breach Notice that, "effective immediately":

1. Tom Caufield is no longer a person qualified to be the "General Manager" as defined in the [2015 Agreement]. Mike Ludlow and Sean Manning have both qualified to operate in the capacity as General Manager.
2. Tom Caufield must immediately take steps to transition out of all operations of the franchised business and by December 22 may not be involved in the operations of the [franchised] business in any capacity.
3. Tom Caufield may have access to records of the franchised business solely for the purposes of responding to the [SEC Subpoena].29

Finally, OTAF demanded that "all possible actions (including the payment of money) must be taken to put right any harms caused to any individuals who are customers of Online Trading Academy."30

In the Past Due Notice, OTAF notified Essential that it was delinquent $101,467.62, comprised of various invoices provided in an attached account statement.31 OTAF noted that failure to pay such amounts when due constituted a breach of the 2015 Agreement if the delinquency was not cured within 10 days from the date of the Past Due Notice.32 Finally, OTAF required Essential to provide a "current operating credit card" for future purchases from OTAF and "current banking information for ACH payments," each of which was required pursuant to the 2015 Agreement.33

The months following the Breach Notices saw the rapid devolution of Essential's financial existence. Nevertheless, Essential managed to wipe out the...

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