Southmark Corp. v. Cagan

• Decision Date: 19 August 1993
• Docket Number: No. 92-2542,92-2542
• Citation: 999 F.2d 216
• Parties: SOUTHMARK CORPORATION, Plaintiff-Appellee, v. Jeffrey CAGAN and Cagan Realty, Inc., as Court-Appointed Receiver for Equity Builders Incorporated and Riviera Utilities of Arkansas, Inc., Defendants-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 216

999 F.2d 216

SOUTHMARK CORPORATION, Plaintiff-Appellee, v. Jeffrey CAGAN and Cagan Realty, Inc., as Court-Appointed

Receiver for Equity Builders Incorporated and

Riviera Utilities of Arkansas, Inc.,

Defendants-Appellants.

No. 92-2542.

United States Court of Appeals, Seventh Circuit.

Argued Jan. 25, 1993.

Decided July 8, 1993.

Rehearing and Suggestion for Rehearing In Banc Denied Aug. 19, 1993.

Arthur L. Klein, Hal R. Morris (argued), Michael R. Turoff, Carol L. McHugh, Arnstein & Lehr, Chicago, IL, for plaintiff-appellee.

Lawrence W. Schad, James Shedden, Beeler, Schad & Diamond, David A. Genelly (argued), Kenneth F. Berg, Fishman & Merrick, Chicago, IL, for defendants-appellants.

Before CUMMINGS and EASTERBROOK, Circuit Judges, and FAIRCHILD, Senior Circuit Judge.

CUMMINGS, Circuit Judge.

Little more than a year ago, we "strongly suggest[ed]" that this case, then before us on appeal from the denial of a motion to intervene, should be consolidated with two related cases in the district court. Southmark Corp. v. Cagan, 950 F.2d 416, 419 (7th Cir.1991). Our less than mandatory language failed to invoke the result we intended, however, and Southmark has come back to haunt us, once again in a form that does not resolve the merits of the underlying dispute.

On the surface, the structure of the present action is simple. Southmark sold a property known as Diamondhead to Equity Builders, Inc. When Equity's officers were sued in a related case, Jeffrey Cagan and Cagan Realty, Inc. (collectively "Cagan") were appointed as a receiver to represent Equity and Diamondhead's interests. In the present case, Southmark is suing Cagan and Equity to foreclose on the mortgage Southmark held to secure the Diamondhead sale. ¹ In defense, Cagan asserts that this mortgage was part of a criminal pyramiding or "Ponzi" scheme. He argues that Arkansas' fraudulent conveyance statute prevents Southmark from taking possession of Diamondhead because Southmark conspired to misappropriate money that belonged to Equity and partners who invested in Diamondhead. The district court granted summary judgment in favor of Southmark, finding that Equity was not injured by Southmark and that Cagan lacked standing to assert fraud claims against Southmark on behalf of the Diamondhead partnerships.

We reverse because significant factual issues bar Southmark from winning foreclosure of Diamondhead on summary judgment. The record does not disclose the mechanics of how the partnerships funded Equity's interest in Diamondhead, nor does it refute Cagan's charge that Southmark conspired with Equity's officers to divert Equity's income to Southmark. Until these issues are resolved, Southmark's foreclosure may not proceed. We order this case to be consolidated before Judge Grady with Cagan v. Southmark Corp., No. 91 C 3720 (N.D.Ill.), where Cagan and the Diamondhead investors are suing Southmark for the same conduct they allege as affirmative defenses to foreclosure in today's case.

The facts underlying these conclusions are considerably more complicated than the simple foreclosure described above suggests. ² In 1976, Kenneth Boula and Earl Dean Gordon formed an enterprise they dubbed "Financial Concepts." Billing themselves as investment advisors, Gordon and Boula solicited investors whom they organized into various limited partnerships. These limited partners then financed real estate purchases, and entities controlled by Gordon and Boula--corporate shells, it appears from our limited record--were general partners in each acquisition. In fact if not in form, Financial Concepts and Gordon and Boula controlled a web of real estate investments financed by disparate limited partnerships.

Gordon and Boula assured their "clients" that the real estate projects, which often required management and development, would produce steady income. Whether by criminal malice or poor business acumen, however, properties Gordon and Boula relied on to solicit investors did not yield the promised returns, and the two began to pay earlier partnerships with money garnered from more recent ones. Gordon and Boula would attract investors by promising to develop a particular property, but instead of developing the property they would use the newly acquired money to finance other partnerships whose properties had not produced the required cash. It was a classic Ponzi scheme. ³

In 1984, Gordon and Boula began to do business with Southmark, a Georgia corporation headquartered in Dallas that financed real estate developments by forming partnerships to supply the capital. Gordon arranged for Financial Concepts to become a licensed seller of Southmark partnerships, and in spring of 1985, the two companies signed a broker-dealer agreement. Over the next year, Financial Concepts sold $2.1 million of partnership interests for Southmark, a volume that earned Gordon and Boula bonuses and the designation "top producers." ⁴ Even as they earned kudos and cash on Southmark deals, however, Gordon and Boula knew that Financial Concepts needed much more income of its own to sate its partners' demands.

As Gordon tells the story, he and Boula thought Southmark's good graces could help extricate Financial Concepts from its cash-flow crisis. Gordon hoped Southmark might take over some or all of Financial Concepts' properties, and he met with a Southmark vice president in late 1985 to discuss his business problems. The vice president inspected Financial Concepts' books, and Gordon and Boula told him that they were financing older partnerships by soliciting new partners and telling the old partners that their real estate projects had generated the income. The Southmark vice president advised Gordon to consolidate his partnerships and deal with them through separate corporations, but had little else to offer. After this visit Gordon and Boula practiced business as usual until mid-1986, when the Illinois Attorney General barred Financial Concepts from selling real estate partnerships in Illinois--a setback Gordon claims to have communicated to Southmark. Gordon's affidavit suggests that Southmark knew early on exactly how Gordon and Boula did business, but looked the other way so that it could profit at the expense of investors in Financial Concepts.

Meanwhile, Southmark had bought Diamondhead, the property at issue in the present foreclosure action, for $1.7 million in 1984. Located in Hot Spring and Garland Counties, Arkansas, Diamondhead consisted of 1,000 lots, some undeveloped land, a small shopping building, a gas station and a water utility. In early 1987, the president of a Southmark division asked Gordon whether Financial Concepts would be interested in selling Diamondhead lots, and that spring Southmark told Gordon and Boula it was interested in selling Diamondhead outright. After negotiations, Gordon and Boula agreed to buy Diamondhead for $3.5 million on June 15, 1987. They set up a corporate shell called "Equity Builders, Inc." as their vehicle; Equity gave Southmark a note for the purchase price and Southmark took a mortgage on Diamondhead to secure the sale. ⁵

Viewing the facts in a light most favorable to Cagan, it appears that neither side undertook even rudimentary due diligence. Gordon and Boula, for example, took Southmark's word that Diamondhead was worth more than $3.5 million, when appraisals later revealed it was worth far less. Southmark represented that it had paid over $4 million for Diamondhead, when in fact it had paid $1.7 million. Gordon claims he thought he was getting a good deal on Diamondhead, but his own words provide an illuminating and alarming description of the sale's mechanics:

I really did not totally care what price we paid for the property * * * because I figured Boula and I could, at least for the short term, finance the price by borrowing money from our private syndications as we had done in the past. It was my hope however in the long run, that I could sell lots in Diamondhead at a profit, and use the proceeds to get my partner and myself * * * out of the cash flow problems we [were] then awash in.

D.App. at 127. Southmark, for its part, did not investigate Gordon and Boula's financing, nor did it investigate the assets of Equity, the corporate shell that purchased Diamondhead. Gordon's affidavit suggests that Southmark knew he and Boula would raise the money to pay Southmark by soliciting partners to develop Diamondhead. Who was duping whom in this no-questions-asked deal? As receiver for Equity and Diamondhead, Cagan argues that Southmark and Gordon and Boula conspired to meet mutual short-term cash needs by defrauding Equity and the Diamondhead investors.

Equity paid $350,000 down for Diamondhead, which Gordon and Boula borrowed from banks. Between June of 1987 and March of 1988, Gordon and Boula formed nine partnerships and promised to use the participating partners' investments to develop lots at Diamondhead. These partnerships had names like "Diversified Income Associates" or "Diversified Shared Equity Income Associates" or "Diversified Growth Partners." D.App. at 65. They were not diversified, of course, and as it turned out they did not involve income or growth either. Gordon and Boula solicited $1.1 million from these Diamondhead partnerships; of this, $900,000 went "directly or indirectly" into Southmark's pockets, while Gordon and Boula kept the balance--a point on which the parties agree. D.App. at 66; P.Br. at 2. The record does not permit us to track the $900,000 with any precision. Gordon stated that he "took the money raised for [Diamondhead] partnerships and used it to repay the initial down payment * * * and the first installment payment of around $500,000 to Southmark." D.App. at 129. The record does not state whether any partnership funds passed through Equity en route to Southmark.

The bubble finally burst in 1988, when investors in Financial Concepts filed a securities fraud class action against Gordon and Boula....