Tillman Enters. v. Horlbeck (In re Horlbeck)

• Docket Number: 18-cv-06650
• Decision Date: 25 August 2023
• Parties: IN RE TODD S. HORLBECK, Debtor. v. TODD S. HORLBECK, Appellant-Cross-Appellee. TILLMAN ENTERPRISES, LLC, Appellee-Cross-Appellant,
• Court: U.S. District Court — Northern District of Illinois

1

IN RE TODD S. HORLBECK, Debtor.

TILLMAN ENTERPRISES, LLC, Appellee-Cross-Appellant, v. TODD S. HORLBECK, Appellant-Cross-Appellee.

No. 18-cv-06650

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

August 25, 2023

On appeal from the U.S. Bankruptcy Court for the Northern District of Illinois, Eastern Division, Bankr. Case No. 15 B 28696, Judge Janet S. Baer

MEMORANDUM OPINON AND ORDER

Martha M. Pacold, Judge

The Bankruptcy Code generally gives a debtor a “fresh start” by permitting him to discharge his debts through bankruptcy proceedings. Bartenwerfer v. Buckley, 143 S.Ct. 665, 670 (2023). This policy inures to the benefit of the “honest but unfortunate debtor,” not one who obtained credit through dishonest means. Jendusa-Niclai v. Larsen, 677 F.3d 320, 324 (7th Cir. 2012) (quoting Marrama v. Citizens Bank of Mass., 549 U.S. 365, 367 (2007) (emphasis omitted)). The dishonest borrower must pay his debts even if he has filed for bankruptcy.

This appeal requires deciding whether a reasonable factfinder could conclude that Todd Horlbeck falls on the “honest” side of this divide.

I

A

Debtor defendant, appellant, and cross-appellee Todd Horlbeck ran a hedge fund called HCM L.P. that closed during the financial crisis of the late aughts. In the face of nosediving asset prices, Horlbeck intentionally inflated the net asset value of investors' shares in the fund's quarterly statements from Q4 2007 through Q4 2008. App. 241 ¶¶ 15-16.^[1] It turned out that Horlbeck had been misstating the value of HCM for at least the first three quarters of 2007 as well, though the parties dispute whether these 2007 misstatements were intentional, reckless, or neither. App 862. During 2007 and 2008, Horlbeck and other limited partners took distributions from HCM to which they were entitled, but those distributions were pegged to the inflated value of the fund that Horlbeck reported, not the actual value of the securities the fund held. App. 864. When HCM closed in April 2009, Horlbeck returned only a fraction of the investors' money. See App. 826 ¶¶ 31-32.

One group of investors in HCM was the Tillman family. Warner Tillman (“Warner”), the family representative in its dealings with Horlbeck, had a financial relationship with Horlbeck that lasted from 1992 until HCM's liquidation in 2009. See App. 334. When Horlbeck opened HCM in 2002, Tillman family members and entities started to invest as limited partners at Warner's direction. App. 480-81 ¶¶ 6-7. All told, the Tillmans invested $3,120,000 in HCM between December 2002 and January 2008. App. 480-81 ¶ 7.

In April 2009, Horlbeck notified the limited partners of HCM that he was liquidating the fund. Horlbeck returned $554,162.42 to Warner and the Warner Tillman Trust. App. 61 ¶ 32. This was over $1.1 million less than the $1.7 million they invested. Id. The record does not indicate how much, if anything, other members of the Tillman family lost, nor is there evidence as to losses by any other Tillman entities.

Horlbeck wrote a letter to Warner in May 2009, informing him that there had been “performance and reporting inaccuracies” in the quarterly statements, but that the inaccuracies had not affected the amount of Warner's final distribution.^[2]Months later, in August 2009, Horlbeck informed some limited partners that he had “discovered” errors with the net asset values reported in HCM's quarterly statements and that partners who had taken distributions had been “inadvertently” overpaid nearly $500,000 total. App. 306. Horlbeck told Warner that HCM owed the family entity additional money, but to receive it, family members would need to sign releases of claims against him, and the family would only receive a promissory note in exchange. Id.

At that point, the Tillmans retained an attorney to negotiate a settlement with Horlbeck and to investigate him. In November 2009, Horlbeck reached out to his investors again, telling them that he had received most of the settlements and releases back, attaching photocopies of checks that would be sent once holdouts executed their releases. App. 307. These checks were not for the full amounts owed, and Horlbeck again offered to sign promissory notes for the remainders. Id. Later in November, Horlbeck pressed Warner to settle and release his claims. App. 308. Horlbeck threatened to file for bankruptcy in the alternative. Id.

Horlbeck and the Tillmans eventually settled after a 14-month negotiation. In exchange for a release of all claims arising out of the family's investments in the hedge fund and Horlbeck's management of the fund, Horlbeck paid the Tillmans $22,500 and signed a promissory note for $1,242,500 to be paid over 20 years to Tillman Enterprises, LLC (“Tillman”) as the representative of the family. App. 312 ¶ 3a.-b. The settlement required Horlbeck to provide a financial affidavit disclosing his assets and liabilities. App. 314 ¶ 8f.

The Tillmans signed the agreement on September 27, 2010, though their attorney held it pending Horlbeck's provision of several items, including the financial affidavit. App 317-19; Tillman App. 584-85. The Tillmans' attorney sent Horlbeck's attorney a copy of the agreement on October 14, 2010, and instructed Horlbeck's attorney to hold the agreement in escrow “subject to our receipt and approval of the documents from [Horlbeck].” Tillman App. 586. Horlbeck signed the financial affidavit that day disclosing his and his wife's assets and liabilities. However, the financial affidavit omitted approximately $1.3 million in contingent liabilities in the form of promissory notes that Horlbeck had used to settle claims with other investors. Compare Tillman App. 605 (all boxes for contingent liabilities checked “no” on Horlbeck financial affidavit), with App. 68 ¶ 73 (answer admitting that Schedule F of Horlbeck's bankruptcy petition includes promissory note debts to other creditors for around $1.3 million incurred prior to the execution of the financial affidavit).

B

Horlbeck's management of HCM drew the attention of the fund's limited partners like the Tillmans, but it also raised eyebrows at FINRA, a Delaware corporation that Congress and the SEC have authorized to police the broker-dealer industry as a self-regulatory organization. See 15 U.S.C. § 78o-3; Fiero v. Fin. Indus. Regul. Auth., Inc., 660 F.3d 569, 571 & n.1 (2d Cir. 2011). Beginning in June 2009, and throughout the subsequent two years, Horlbeck and his broker-dealer, Cantella, answered questions from FINRA about HCM through counsel. App. 84956, 861-64, 883-97, 907-10. Critically for this case, Horlbeck admitted in his first set of responses to FINRA's questions that

in an effort to make the fund's performance appear better than it was, [he] reported a valuation to the partners that was not accurate. Thereafter, for each quarter in 2008, [he] reported to partners a valuation that was better than the actual valuation because the vast majority of partners were locked into the fund and could not take any withdrawals or liquidate their positions during the calendar year.

App. 863.

Horlbeck referred to FINRA in at least three communications with Warner Tillman during 2010. In a February email, Horlbeck told Warner that FINRA would likely call about their email communications, but Horlbeck encouraged Warner not to say much, stating, “discussing less, or nothing, rather might be the safest course of action.” App. 440. A March email informed Warner that Horlbeck had engaged an attorney for his “dealings” with FINRA. App. 441. And a July email told Warner that he should only go to FINRA as a “last resort” and that if Warner contacted FINRA, it would end Horlbeck's career. App. 901-02. None of these emails disclosed the extent or nature of the FINRA investigation, or that Horlbeck had admitted to FINRA that he intentionally understated losses on HCM's quarterly statements to avoid investor panic and that he and other limited partners had taken distributions pegged to the inflated net asset value of the fund.

FINRA's investigation of Horlbeck lasted over two years, culminating in an on-the-record interview and eventually, a letter of acceptance, waiver, and consent that FINRA accepted in December 2011. In that letter, Horlbeck admitted that he had violated FINRA's rules by understating losses on account statements he sent to investors, and as a result, he agreed to an indefinite bar on association with any FINRA member. Tillman App. 608-12. This effectively ended Horlbeck's career in the securities investment industry.

C

Returning to procedural developments in this case: Horlbeck failed to make payments under the promissory note, so Tillman sued Horlbeck for breach of contract in state court in October 2013. App. 68 ¶ 70. Horlbeck filed a chapter 7 bankruptcy petition, the matter at issue here, in August 2015. In re Todd S Horlbeck, No. 15-28696 (Bankr N.D.Ill. Aug. 21, 2015), ECF No. 1. The state court dismissed the breach-of-contract case without prejudice due to Horlbeck's bankruptcy petition. App. 68 ¶ 71.

Schedule F to the bankruptcy petition lists, among other debts, nearly $1.3 million owed to several creditors incurred in 2008 and 2009. Id. ¶ 73. It also lists Tillman Enterprises as a creditor for a promissory note in the amount of $1.1 million. Id. ¶ 72.

Tillman Enterprises brought a three-count adversary complaint in Horlbeck's Chapter 7 bankruptcy proceedings asserting that a debt he owed to it was not dischargeable because Horlbeck incurred the debt via fraud. App. 13-20 ¶¶ 71-122. Count I of the adversary complaint states that the debt is not dischargeable under 11 U.S.C. § 523(a)(19) (securities law violations). Count II states that it is not dischargeable under § 523(a)(2)(A) (fraudulent representation or omission)...