Judge Hopkins
Chapter 11
MEMORANDUM OF DECISION ON ORDER GRANTING PARTIAL SUMMARY JUDGMENT
This is an action to avoid an alleged fraudulent transfer of $100,000 pursuant to 11 U.S.C. § 548(a)(1). Presently before the Court are cross-motions for summary judgment.
THE PARTIES
The Plaintiff, GLC Limited ("GLC"), is the chapter 11 debtor. GLC was a retail liquidation company. Its purported business was the sale and redistribution of wholesale consumer products. In retrospect, GLC argues that the business was nothing more than a Ponzi scheme.
Defendant Hunter Miller Family, L.L.C. ("the Miller Family LLC") advanced $250,000 to GLC. In return, GLC made two $50,000 payments to the Miller Family LLC within one year of the bankruptcy filing. GLC now seeks to recover these payments from the Miller Family LLC and Defendant Hunter Miller ("Miller") (collectively, "Defendants") as fraudulent transfers. Miller is the manager of the Miller Family LLC.
PROCEDURE
GLC moves for summary judgment under § 548(a)(1)(A)(actual fraud) and § 548(a)(1)(B)(constructive fraud). The Defendants move for summary judgment on the defense set forth in 11 U.S.C. § 548(c)(transfer received in good faith for value given).
SUMMARY JUDGMENT STANDARD
"The court shall grant summary judgment if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(a). The filing of cross-motions does not necessarily mean that summary judgment is warranted. Profit Pet v. Arthur Dogswell, LLC, 603 F.3d 308, 312 (6th Cir. 2010). "[C]ourts must evaluate each party's motion on its own merits, taking care to draw all reasonable inferences against the party whose motion is under consideration." Id.
HOLDING
GLC has sustained its burden of proof under § 548(a)(1)(A). However, the record supports conflicting inferences concerning the § 548(c) defense. Therefore, the action shall proceed to trial on the § 548(c) defense.
SECTION 548(A)(1)(A) STANDARD
Section 548(a)(1)(A) provides:
(a)(1) The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of
the petition, if the debtor voluntarily or involuntarily—
(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted[.]
To prevail under § 548(a)(1)(A), the movant must prove: (1) a transfer of an interest of the debtor in property; (2) which occurred within two years
prior to the bankruptcy filing; and (3) made with actual intent to hinder, defraud, or delay.
See In re Taubman, 160 B.R. 964, 983 (Bankr. S.D. Ohio 1993). The first and third elements are established, as a matter of law, if the debtor operated a Ponzi scheme.
See In re Canyon Systems Corp.,
343 B.R. 615, 635-37 (Bankr. S.D. Ohio 2006). The existence of a Ponzi scheme requires the following proof: (1) deposits were made by investors; (2) the debtor conducted little or no legitimate business operations as represented to investors; (3) the purported business operations of the debtor produced little or no profits or earnings; and (4) the source of payments to investors was from cash infused by new investors.
Id. at 630.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 extended the look-back period from one year to two years. In re Doctors Hospital of Hyde Park, Inc., 507 B.R. 558, 631 (Bankr. N.D. Ill. 2013).
FACTS
Gregory and Linda Crabtree were the sole shareholders of GLC. Following GLC's formation, the Crabtrees solicited others to invest in GLC. James Donnan ("Donnan") was one of the first investors in GLC. Donnan also agreed to solicit others to invest in GLC. Donnan received a 15%-20% commission on most investments he solicited.
Donnan solicited investments from approximately 100 individuals and entities. Donnan told Miller that GLC purchased discounted goods and resold them for a profit. From 2007 to 2010, GLC received investments totaling $81,916,000. During the same period, GLC purchased inventory totaling $11,793,000. GLC maintained warehouses in Huntington, West Virginia, Proctorville, Ohio, and Columbus, Ohio, as well as retail locations in several other cities and states.
See Deposition of Hunter Miller at 46. A similar representation is found in the Affidavit of James Burritt ("Burritt").
Investors were told that the money they were investing would be used to purchase inventory from highly recognized companies, such as Sears, Target, and Rite-Aid, which GLC would then sell in its retail stores or on eBay and generate significant returns for investors.
Affidavit of James Burritt at ¶ 14. The Defendants argue that Burritt's statement constitutes inadmissible hearsay concerning the representations that GLC, through Donnan, made to investors about its business operations. The Court agrees. However, Miller's deposition testimony of similar effect is not hearsay. See Fed. R. Evid. 801(d)(2).
Investors generally agreed to invest funds in GLC for a period of six to twelve months, at interest rates between 50% to 70% per annum. For most investors, the only documentation of the investment was a one-page sheet that identified the investor, the amount and duration of the investment, the rate of return, and a payment schedule. The document was no more than two or three sentences.
The facts set forth in this sentence are derived from paragraph 15 of the Affidavit of James Burritt. The Defendants argue that these statements are hearsay. The Court disagrees. This information appears to be based upon Burritt's personal observations as Chief Restructuring Officer of GLC and custodian of the company's records which memorializes the referenced investments.
As early investments came due GLC had to raise funds to repay those obligations and Donnan's commissions. Increasing amounts of new money was necessary to ensure that GLC would have sufficient funds to repay prior investment obligations. Eventually, GLC was unable to generate the needed funds and it defaulted on its obligations to current investors.
The Miller Family LLC transferred $250,000 to GLC on April 2, 2010. Several related documents were executed the day before. GLC executed a $250,000 promissory note ("Note") in favor of the Miller Family LLC. The Note required the payment of all principal and interest, at a rate of 6% per annum, in one payment on or before April 1, 2011. Donnan and Crabtree executed personal guaranty agreements in favor of the Miller Family LLC to secure the Note. Lastly, GLC and the Miller Family LLC entered into a profit sharing agreement ("Agreement"). The Agreement required GLC to pay the Miller Family LLC $200,000 per year "for as long as [the Miller Family LLC] maintains its investment in GLC." The payments were payable in quarterly installments of $50,000. The first year's payments were due on July 1, 2010, October 1, 2010, January 1, 2011, and April 1, 2011. The Agreement further provided: "In the event [the Miller Family LLC's] investment in GLC shall last longer than one year, the payments of $50,000 each shall continue to be paid on the first day of each quarter for as long as [the Miller Family LLC] maintains an investment in GLC." The Miller Family LLC did not pay GLC any money, beyond its $250,000 payment, in exchange for the Agreement.
On July 1, 2010, GLC transferred $50,000 to the Miller Family LLC. GLC transferred another $50,000 to the Miller Family LLC on October 1, 2010. By December of 2010, GLC began to default on its obligations and James Burritt ("Burritt") was appointed as Chief Restructuring Officer. On January 18, 2011, Donnan paid $175,000 to the Miller Family LLC in exchange for the Note, the Agreement, and the guaranty agreements.
GLC filed its bankruptcy petition on February 28, 2011. Upon closer review of GLC's records, Burritt discovered meager business operations and several abnormal characteristics in GLC's accounting records, including a lack of supporting documentation and significant adjustments without any stated reason. Much of GLC's records consisted of hand-written notes directing payments to certain investors without any explanation or support.
DID GLC OPERATE A PONZI SCHEME?
The record supports a finding that GLC operated a Ponzi scheme. First, investors deposited funds with GLC. Second, GLC conducted little of the business operations it represented to Miller. For example, Burritt's investigation led to the discovery of meager business operations and abnormal accounting practices. Moreover, less than 15% of investor funds were used to purchase inventory between 2007 and 2010. Third, GLC's operations produced little or no profits or earnings. Without increasing amounts of cash from new investors, GLC did not have the means to satisfy its obligations to earlier investors. Fourth, earlier investors were paid from funds deposited by later investors. See Canyon Systems, 343 B.R. at 630.
By affidavit, Burritt states that "GLC was engaged in a Ponzi scheme." See Affidavit of James Burritt at ¶ 18. The Court's finding of a Ponzi scheme is not based upon Burritt's characterization. It is based upon the undisputed facts in the record that support a finding of a Ponzi scheme.
Importantly, the Defendants did not offer any evidence or argument to support a reasonable inference that GLC did not operate a Ponzi scheme. The Defendants' sole opposition to the finding of a Ponzi scheme rests upon the Defendants' objections to the admissibility of portions of the Affidavit of James Burritt, discussed previously.
SECTION 548(A)(1)(A) ANALYSIS
The existence of a GLC Ponzi scheme satisfies the first and third elements under § 548(a)(1)(A), those elements being the transfer of an interest of the debtor, made with actual intent to hinder, defraud, or delay. Canyon Systems, 343 B.R. at 635-37. The record also supports the second element. GLC made the transfers on July 1, 2010, and October 1, 2010, within the two years preceding the GLC bankruptcy filing on February 28, 2011. Accordingly, GLC has sustained its burden of proof under § 548(a)(1)(A).
SECTION 548(C) DEFENSE
The Defendants assert a defense under § 548(c), which provides in relevant part:
[A] transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation.
To establish the defense, a defendant bears the burden of proving that the transfer was:
(1) received in good faith; and (2) for reasonably equivalent value.
Canyon Systems, 343 B.R. at 651. 1. Good Faith
a. Applicable Legal Standard
The Bankruptcy Code does not define the term "good faith." Instead, it is a fact-specific inquiry that is decided on a case-by-case basis. In re Lake States Commodities, Inc., 253 B.R. 866, 878 (Bankr. N.D. Ill. 2000). In the context of a Ponzi scheme, relevant factors include: (1) the defendant's experience as an investor; (2) whether the promised rates of return exceeded market rates; (3) whether the debtor provided implausible explanations how the debtor could pay the promised returns; and (4) any indication of the debtor's insolvency. Id.
b. Applicable Procedural Standard
The Defendants cite the record for various factors they believe to support a finding of good faith. Such a finding is inappropriate on summary judgment, however, if the record supports a reasonable inference of a lack of good faith. See Hunt v. Cromartie, 526 U.S. 541, 553 (1999)("Summary judgment in favor of the party with the burden of persuasion, however, is inappropriate when the evidence is susceptible of different interpretations or inferences by the trier of fact."); see also Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255 (1986)("The evidence of the non-movant is to be believed, and all justifiable inferences are to be drawn in his favor."). Therefore, the issue is whether the record supports a reasonable inference that the Defendants lacked the requisite good faith. The Court believes it does.
c. Additional Facts Related to Good Faith
The Miller Family LLC and Miller, who is an experienced investor, possess an ownership interest in a payday loan business called Wishbone LLC ("Wishbone"). Wishbone is funded, in part, by third-party loans from individuals. The loans have a typical duration of one to three years and pay interest between 12% to 15%. Wishbone provides ample financial information to the investors, such as financial statements and tax returns.
d. Good Faith Analysis
Miller is an experienced investor. Moreover, his payday loan business solicits loans from third-parties much like GLC did. Miller knew that Wishbone only paid 12% to 15% on these short-term loans. He also knew that Wishbone provided ample financial information to the investors. Therefore, it is not unreasonable to infer that Miller and the Miller Family LLC had reason to believe that GLC was an extraordinary investment.
The Agreement required GLC to pay the Miller Family LLC an indefinite return of 80%. Upon return of its principal, the Note entitled the Miller Family LLC to an additional 6%. Thus, if the Miller Family LLC opted for a return of its principal after one year, it stood to gain 86% on its investment. That is quite a difference from the 12% to 15% that Wishbone paid. This, combined with GLC's refusal to provide financials, supports a reasonable inference that the Miller Family LLC knew, or should have known, that GLC was an extraordinary deal.
It is not unreasonable to infer from these facts that the Miller Family LLC and Miller may have lacked the requisite good faith to sustain their burden of proof under § 548(c). 2. Reasonably Equivalent Value
Because the factual dispute surrounding good faith precludes summary judgment under § 548(c), it is unnecessary to address the issue of value. However, suffice it to say, the record also supports conflicting inferences with respect to value. In short, construing all inferences against the Defendants, it is not unreasonable to infer that GLC may have made the two $50,000 payments to the Miller Family LLC pursuant to the terms of the Agreement, for which the Miller Family LLC paid no consideration.
The term "value" in § 548(c) has the same fundamental meaning as the phrase "reasonably equivalent value" in § 548(a)(1)(B). Canyon Systems, 343 B.R. at 651. Therefore, for the same reason that the Defendants are not entitled to summary judgment under § 548(c) - i.e., conflicting inferences on the issue of "value" - GLC is likewise not entitled to summary judgment under § 548(a)(1)(B)(avoidance of a transfer for less than reasonably equivalent value). Although the Court's ruling on § 548(a)(1)(A) satisfies GLC's burden of proof, the Court will give GLC the opportunity at trial to prove its case under § 548(a)(1)(B) if it so chooses.
CONCLUSION
For the foregoing reasons, GLC is entitled to partial summary judgment to the extent that it has sustained its burden of proof under § 548(a)(1)(A). Conflicting inferences preclude summary judgment, for either side, on any other basis. An order to this effect will be entered separately.
The Court's order is not a final order determinative of all issues in this action. See H.D.V.-Greektown, LLC v. City of Detroit, 568 F.3d 609, 619 (6th Cir. 2009)(order granting partial summary judgment is not a final order). Consequently, there is no Constitutional impediment to the entry of the order under Stern v. Marshall, 131 S. Ct. 2594 (2011) and its progeny. See GLC Limited v. Rowsey (In re GLC Limited), Adv. No. 12-1051 (Bankr. S.D. Ohio Nov. 27, 2012). --------
This document has been electronically entered in the records of the United States Bankruptcy Court for the Southern District of Ohio.
IT IS SO ORDERED.
/s/ _________
Jeffery P. Hopkins
United States Bankruptcy Judge Dated: November 17, 2014 Copies to: Ryan S. Lett
RLett@fbtlaw.com James C. Frooman
jfrooman@fbtlaw.com Andrew M. Simon
andrew.simon@squiresanders.com
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