Opinion
Bankruptcy Case No. 98-30858-HCA-11, Adversary No. 00-3083, Civil Action No. 3:01-CV-2524-M
August 2, 2002
MEMORANDUM ORDER AND OPINION
Appellants, William H. Randall ("Randall") and Theodore A. Toro ("Toro"), Defendants below (collectively called "Defendants" or "Appellants"), seek reversal of the Bankruptcy Court's Final Judgment awarding damages in the amount of $1,945,494.83 to Appellee Erstmark Capital Corporation ("Erstmark"), entered by U.S. Bankruptcy Judge Harold C. Abramson on October 9, 2001 in Bankruptcy Case No. 3:98-30858-HCA-11. The Bankruptcy Court based its Judgment on its Amended Findings of Fact and Conclusions of Law, entered on September 18, 2001, in which the Court found that Appellants fraudulently transferred sums from Erstmark to themselves; that, in the alternative, those transfers constituted preferential transfers; and that Appellants breached their fiduciary duties to Erstmark's creditors by making the transfers. Appellants allege that the Bankruptcy Court erred in finding them liable for fraudulent transfers because the evidence did not demonstrate (a) that Defendants had the actual intent to hinder, delay, or defraud creditors, (b) that Defendants failed to provide to Erstmark reasonably equivalent value in exchange for the transfers, (c) that Defendants concealed the transfers, and (d) that Erstmark was insolvent at the time of the transfers. Additionally, Appellants contest that the law regarding preferential transfers supports the Bankruptcy Court's damages award, and deny that they breached fiduciary duties to Erstmark.
Because the Court finds that the Bankruptcy Court rested its damages award on its findings that Appellants fraudulently transferred certain sums from Erstmark to themselves and that Appellants breached their fiduciary duties to Erstmark, and this Court finds no error in the Bankruptcy Court's determination as to either finding, the Court AFFIRMS the Bankruptcy Court's Judgment.
Because the Bankruptcy Court's damages award rested on its determination that Appellants fraudulently transferred funds from Erstmark to themselves and that Appellants breached their fiduciary duties, the Court need not reach the issue of whether the transfers were preferential, as the Bankruptcy Court finding that the transfers were preferential was an alternative basis for the damages award.
I. Background
On January 30, 1998, Erstmark was the subject of an Involuntary Petition under Chapter 7 of the Bankruptcy Code. On February 27, 1998, the bankruptcy was converted to a Chapter 11 case. On July 2, 1998, Robert Yaquinto was appointed as Chapter 11 trustee for the Debtor. On April 28, 1999, the Bankruptcy Court entered its Order approving a Plan of Reorganization under Chapter 11, and on May 1, 1999, the Plan became effective, and all property of the Debtor, including the right to bring the claims asserted in the Adversary Proceeding, vested in the Debtor.
Randall and Toro founded Erstmark. They, together with their family members, were shareholders in the company. Randall was previously the President, Chief Executive Officer, and a Director of Erstmark, and Toro was Chairman of the Board, Secretary, and Treasurer. Erstmark had two affiliates, Erstmark Merchant Bankers and Erstmark Mortgage Corporation, both owned by Randall and Toro.
In its Findings and Conclusions, the Bankruptcy Court determined that, during the four years prior to Erstmark's bankruptcy, Randall made withdrawals from the Debtor's bank accounts, in the form of checks made payable to "cash" for approximately $126,321.97, and by counter withdrawals from Erstmark's accounts for approximately $650,273.32. Furthermore, the Court determined that Randall applied an additional $622,899.54 of Debtor's funds to pay various personal obligations and to purchase personal items. These personal obligations included $41,290 in payments to St. Mark's School, a $4,800 payment to Greene's Gold and Diamonds, monthly mortgage payments for Randall's home, and hundreds of thousands of dollars in personal credit card payments. The Court concluded that Erstmark's records revealed no business purpose for the transfers and did not show that Erstmark had received any consideration for the transfers.
In regard to Toro, the Bankruptcy Court determined that, during the four years immediately preceding the Petition date, Erstmark paid approximately $192,000.00 to Real Estate Analysts, a trade name for Toro. As with the Randall transfers, the Court found that Erstmark's records did not reveal any business purpose for those transfers, and did not indicate that Erstmark received consideration for the transfers. Although some of the checks from Erstmark to Real Estate Analysts stated that the payments were in repayment of a loan, the Bankruptcy Court concluded that the Debtor's tax returns and corporate records during the relevant time period did not identify any loans from shareholders to the Debtor in an amount sufficient to account for the transfers. The Court found that during the time of the Toro and Randall transfers, Erstmark was insolvent.
Based on these factual findings, the Bankruptcy Court held as a matter of law that Randall and Toro had fraudulently transferred the funds from Erstmark to themselves, or, alternatively, that the transfers from Erstmark to Randall and Toro constituted preferential transfers. Finally, the Court concluded that Appellants breached their fiduciary duties to Erstmark "by directing fraudulent and otherwise improper payments to themselves and entities under their control."
On October 9, 2001, the Bankruptcy Court entered its Final Judgment, in which it ordered Randall to pay damages in the amount of $1,449,494.83, and Toro to pay damages in the amount of $242,000. The Bankruptcy Court based its award against Randall on the $776,595.29 Randall withdrew from Erstmark's accounts, the additional $622,899.54 Randall applied toward his personal use, and $50,000 as exemplary damages for breach of his fiduciary duties. The Bankruptcy Court's award against Toro was based on the $192,000 Erstmark transferred to Real Estate Analysts and exemplary damages of $50,000.
II. Analysis
On appeal, the District Court reviews the Bankruptcy Court's factual findings for clear error, and decides issues of law de novo. Findings of fact are reversed as clearly erroneous only if the court is left "with the definite and firm conviction that a mistake has been made."
In re First City Bancorporation Inc., 282 F.3d 864, 867 (5th Cir. 2002); FED. R. BANKR. P. 8013.
In re Allison, 960 F.2d 481, 482 (5th Cir. 1992); see also Reich v. Lancaster, 55 F.3d 1034, 1045 (5th Cir. 1995).
A. Fraudulent transfer
Although the Bankruptcy Court also found the transfers fraudulent under 11 U.S.C. § 548 and Texas Business and Commerce Code § 24.006(b), the primary statutory sections upon which the Court relied were Texas Business and Commerce Code § 24.005(a)(1) and (b) and Texas Business and Commerce Code § 24.006(a). Section 24.005(a)(1) and (b) provide:
This section provides, in pertinent part:
(a)(1) The trustee may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within one year 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; or
(B)(i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
(ii)(I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation;
(II) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital; or
(III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor's ability to pay as such debts matured.
This statute provides:
(b) A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.
The reason for the Bankruptcy Court's reliance upon Texas Business and Commerce Code §§ 24.005 and 24.006(a) is that a four-year statute of limitations applies to actions for fraudulent transfers brought under these sections. TEX. BUS. COMM. CODE ANN. § 24.010(1), (2). In contrast, actions brought under Texas Business and Commerce Code § 24.006(b) and 11 U.S.C. § 548(a)(1) are subject to a one-year statute of limitations. Id. § 24.010(3); 11 U.S.C. § 548(a)(1).
(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or within a reasonable time after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation:
(1) with actual intent to hinder, delay, or defraud any creditor. . . .
(b) In determining actual intent under Subsection (a)(1) of this section, consideration may be given, among other factors, to whether:
(1) the transfer or obligation was to an insider;
(2) the debtor retained possession or control of the property transferred after the transfer;
(3) the transfer or obligation was concealed;
(4) before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;
(5) the transfer was of substantially all the debtor's assets;
(6) the debtor absconded;
(7) the debtor removed or concealed assets;
(8) the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;
(9) the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;
(10) the transfer occurred shortly before or shortly after a substantial debt was incurred; and
(11) the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.
TEX. BUS. COMM. CODE ANN. § 24.005(a)(1), (b) (Vernon 2002).
Section 24.006(a) states:
(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation.
Id. § 24.006(a).
The Bankruptcy Court first found that, under § 24.005(a)(1), the transfers "were made with actual intent to hinder, delay, or defraud present and future creditors of the Debtor." In making this determination, the Court placed special relevance on its findings that (a) Appellants were insiders, (b) Appellants "tried to conceal the [t]ransfers as `loans' or `loan payments,'" (c) Appellants "never gave reasonably equivalent value to the Debtor for the [t]ransfers," (d) the transfers "had no legitimate business purpose," and (e) Erstmark "was insolvent when the [t]ransfers were made." The Bankruptcy Court also determined that under § 24.006(a), the transfers were fraudulent as "[t]he Debtor did not receive reasonably equivalent value in exchange for the [t]ransfers, and the Debtor was insolvent when the [t]ransfers were made."
Amended Findings of Fact and Conclusions of Law ("Findings and Conclusions") at 6.
Appellants urge that the Bankruptcy Court erroneously determined that they were liable under § 24.005(a) because the Court erroneously applied three of the four factors it used in determining Appellants' actual intent. Appellants urge that, contrary to the Bankruptcy Court's determination, they provided reasonably equivalent value to Erstmark for the transfers, they did not conceal the transfers, and Erstmark was solvent at the time of the transfers. Appellants likewise contend that the Bankruptcy Court should not have found them liable under § 24.006(a) because they provided reasonably equivalent value and Debtor was not insolvent.
1. Did Appellants Provide Reasonably Equivalent Value and Attempt to Conceal the Transfers?
Appellants contend that they provided reasonably equivalent value to Erstmark in exchange for the transfers because they had loaned Erstmark approximately $3.3 million over the course of Erstmark's operation, and the transfers were merely repayments of their loans. Thus, Appellants also urge that they did not conceal the transfers by categorizing them as loan repayments, because the transfers were actually repayments for loans.
Appellants' Brief at 16.
Appellants, however, point to Erstmark's tax returns, which reveal few loans from the shareholders to the company, but show a high amount of loans made from Erstmark to the shareholders. Additionally, Steven Gummer, who acted as CFO of Erstmark from 1991 to early 1998, testified that, at the time Gummer was terminated from Erstmark, both Toro and Randall owed Erstmark money — not the other way around. Furthermore, as the Bankruptcy Court found, Appellants have presented no promissory notes or other documentation of the loans to support Appellants' arguments. Furthermore, Appellants proffer "no minutes of directors' meetings that would have approved the `loans' back and forth."
Plaintiff's Exh. 16-18 and Defendants' Exh. 35.
Record at 466.
Findings and Conclusions at 4.
Appellants' argument as to the proper characterization of the transfers rests in large part upon the testimony of Tom Blake, the accountant hired by Erstmark after the bankruptcy filing to calculate the amounts that were transferred between Appellants and Debtor. Blake testified at trial that Erstmark actually owes Appellants money. However, in its Findings of Fact, the Bankruptcy Court found that "Randall and Toro's position and the position of Mr. Blake, CPA, are untenable." A principal basis for Blake's finding that Erstmark was indebted to Appellants at the time of the transfers was Blake's reclassification of a transfer from Erstmark Mortgage Corporation ("Mortgage") to Debtor as a loan from Randall and Toro to the Debtor. Blake explained that he reclassified this transfer from Mortgage as a loan from Appellants because he determined that the loan consisted of Appellants' personal funds. However, Blake did not point to documentation clearly showing that the funds loaned by Mortgage to Debtor actually consisted of Appellants' personal funds. Additionally, at the time of Mortgage's "loan" to Erstmark, Mortgage actually owed Erstmark money. Thus, it is questionable whether Blake could credibly characterize the funds transferred from Mortgage to Erstmark as a loan, rather than a repayment of the outstanding loan. The Bankruptcy Court, in its determination of Blake's credibility, obviously did not accept his conclusions in regard to the Mortgage loan, and the Court does not find the Bankruptcy Court's factual determination as to this issue clearly erroneous.
Id.
After reviewing the record and the evidence, the Court concludes that it should not reverse the Bankruptcy Court's factual determination that the transfers from Erstmark to Randall and Toro were not loan repayments. Although the Court concedes that the financial relationship between Appellants and Erstmark is murky, the evidence supports the Bankruptcy Court's conclusion that the transfers to Appellants were not in repayment of loans made by them to Debtor. Thus, the Bankruptcy Court also did not clearly err in finding that Appellants attempted to conceal the transfers by deeming them "loan repayments," as the evidence supports the Bankruptcy Court's findings that the transfers were not such repayments.
2. Was Erstmark Insolvent at the Time of the Transfers?
Finally, Appellants contend that Erstmark was not insolvent at the time of the transfers. For purposes of determining insolvency under Texas Business and Commerce Code §§ 24.005 and 24.006, "[a] debtor is insolvent if the sum of the debtor's debts is greater than all of the debtor's assets at a fair valuation." Although Appellants point to Randall's testimony that Erstmark was not insolvent based on a fair valuation of its debts versus its assets, the Debtor's tax returns, along with the testimony of Mr. Gummer, show that Erstmark was insolvent from mid-1993 until its bankruptcy. Gummer also testified that he had repeatedly informed Appellants of the company's insolvency from mid-1993 on. Based on this evidence, the Court concludes that the Bankruptcy Court did not clearly err in determining that Erstmark was insolvent under Texas Business and Commerce Code §§ 24.005 and 24.006 during the relevant period.
Record at 441-54.
Id. at 455.
In sum, the Court finds that Appellants' objections to the Bankruptcy Court's findings on §§ 24.005 and 24.006 should be overruled. The evidence supports the Bankruptcy Court's conclusions as to the concealment of the transfers, Appellants' exchange of reasonably equivalent value for the transfers, and Debtor's insolvency.
B. Breach of Fiduciary Duty
The Bankruptcy Court also found that Appellants owed a fiduciary duty to Erstmark and its creditors, and that they breached that duty by transferring the funds from Erstmark to themselves. Appellants urge that they did not breach their fiduciary duties to Erstmark because the transfers they received were simply loan repayments. However, the Bankruptcy Court found that the transfers were not loan repayments, but were instead fraudulent transfers, and this Court has already concluded that the Bankruptcy Court's determination as to that issue should be affirmed. The evidence clearly supports the Bankruptcy Court's conclusions as to Appellants' breach of fiduciary duty. Steven Gummer testified that Randall and Toro had not acted in the creditors' best interest even after they knew the company was insolvent. While Erstmark was losing money, "they were taking money out." Additionally, Gummer testified that Appellants ordered him not to talk to any investors: "If any investor asked me any question about anything, I had to immediately turn them over to" Randall and Toro. Additionally, Gummer explained that "[t]hey asked me to not issue any financial statements or even put together any financial statements until they told me because they . . . wanted to be able to tell people that they weren't available." Certainly such constitutes evidence of breach of fiduciary duty; thus, the Court overrules Appellants' point of error on this issue.
Record at 473.
Id.
Id.
Appellants also object that the Bankruptcy Court incorrectly calculated the amount to be awarded Appellee as damages for breach of fiduciary duty, because breach of fiduciary duty claims arguably had a two-year limitations period at the time of the filing of this adversary proceeding. Appellants, therefore, assert that the Bankruptcy Court erred in concluding that Appellants should pay as damages to Erstmark the value of the transfers Randall and Toro received for the preceding four years. The Court finds this argument meritless, however, as a review of the Court's Findings of Fact and Conclusions of Law shows that the Bankruptcy Court based its compensatory damages award (equal to the value of the transfers) on its determination that the transfers should be avoided because they were fraudulent. The Bankruptcy Court did not base its compensatory damages award on its breach of fiduciary duty findings.
Prior to 1999, the year in which the Texas Legislature enacted Texas Civil Practice and Remedies Code § 16.004, which specifies that breach of fiduciary duty actions have a four-year limitations period, there was a split among the Texas courts of appeals as to whether the statute of limitations for breach of fiduciary duty claims was two or four years. Millan v. Dean Witter Reynolds, Inc., No. 04-00-00608-CV, 2002 WL 1559632 (Tex.App.-San Antonio Feb. 7, 2002, no pet.) ("In 1999, the Legislature specified a four-year limitations period for breach of fiduciary duty, largely because of the split among the courts of appeal in determining whether limitations was two or four years.").
The Bankruptcy Court explained, "[t]he [t]ransfers are . . . avoidable and recoverable from Randall [and] Toro . . . pursuant to 11 U.S.C. § 544, 548, and 550 and Texas Business and Commerce Code §§ 24.005(a), 24.006(a) [and] (b)[,] and 24.008." Findings and Conclusions at 6.
Although the Bankruptcy Court did base its exemplary award of $50,000 per Appellant on Randall and Toro's breach of fiduciary duty, Appellant does not take issue with this award.
III. Conclusion
In conclusion, the Court overrules Appellants' points of error in regard to the fraudulent transfer and breach of fiduciary duty issues, and therefore AFFIRMS the Bankruptcy Court's Final Judgment.
Although Appellants requested oral argument be allowed in this case, the Court denies such request, as it concludes that oral argument is unnecessary.
SO ORDERED.