Securities & Exchange Commission v. Kaleta et al

Filing 156

MEMORANDUM AND ORDER. ORDERED that Investors Objections seeking priority security interests in the proceeds of the sale of the BR Houston radio station assets are DENIED.(Signed by Judge Nancy F. Atlas) Parties notified.(arrivera, )

UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF TEXAS
HOUSTON DIVISION

SECURITIES AND EXCHANGE
COMMISSION,
Plaintiff,

§
§
§
§
v.
§
§
ALBERT FASE KALETA and
§
KALETA CAPITAL MANAGEMENT, §
INC. et al.,
§
Defendants,
§
§
and
§
§
BUSINESSRADIO NETWORK, L.P. §
d/b/a BizRadio and DANIEL
§
FRISHBERG FINANCIAL SERVICES, §
INC., d/b/a DFFS CAPITAL
§
MANAGEMENT, INC.,
§
Relief Defendants. §

CIVIL ACTION NO. 4:09-3674

MEMORANDUM AND ORDER
Before the Court in this receivership proceeding are claims of individuals
(“Investors”) asserting security interests in the proceeds of the sale of certain radio
station assets held by a Court-appointed receiver, Thomas L. Taylor, III, Esq.
(“Receiver”) to South Texas Broadcasting, Inc. (“STB”). The Investors claim security
interests in the proceeds of the radio station assets through contractual and equitable

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1

subrogation to the secured status of two entities, Industrial Info Resources, Inc.
(“IIR”) and STB, which entities made secured loans with the radio station assets as
collateral.1

The Court conducted an evidentiary hearing on October 3, 2011

(“Hearing”) regarding the sale of the radio station assets. Prior to and after the
Hearing, the Investors filed Objections in Support of Investor Objections to Sale
(“Objections”) [Docs. ## 70, 71, 80, 82, 110, 111, 123, 132] and the Receiver filed

1

The Investors are Ronald and Lavonne Ellisor, Doug and Kay Shaffer, Richard
Kadlick, Steve Cook, Larry Mullins, TR Dunn Family Trust, Florence Reiley, Ed and
Helena Gray, Kevin Deering, Martin Grosbol, James and Patricia Stewart, Timothy
Koehl, Marcus Erickson, Robert Ficks, Kohur Subramanian, and John Willis, as
executor of the Estate of Geraldine J. Willis. See Investors’ “Senior Liens” Summary
(“Investors Summary”) [Doc. # 123-1], at 16.
Also listed is Investor Phillip Jones. He is not included in the Investors’ Post-Hearing
Brief, [Doc. # 132], at 1, but is listed on the Investors Summary, in which Investors’
counsel identified claims at issue for purposes of the Investors’ Objections here. See
Investors Summary [Doc. # 123-1], at 16. The Investors’ Post-Hearing Brief lists one
individual with the same last name, “Alisa K. Jones.” To the extent the latter
individual represents Phillip Jones or vice versa, the Court reaches their claims.
Tompkins, Inc. and Ronald Martens also are named on the Investors Summary.
However, that Summary does not indicate any funds transferred from Tompkins, Inc.
and Martens to IIR or STB, see id., and thus these Investors have failed to prove their
claims for reasons explained hereafter. The Court does not rule on these two claims.
Sailaja Uri Konduri, Diane and Paul Collings, Johnny and Betty Gauntt, Tony Huerta,
Jacob Tsabar, Kurt Everson, George and Marene Tompkins, Richard Burkhart, James
Maas, Bob and Kathy Horlander, Don Keil, Dr. Gerald Crouch, Paul and Simona
Williams, Carlos Barbieri, Ivan Curiel, Jack McElligot, Pamela McElligot, and
Raymond Warner are listed in the Investors’ Post-Hearing Brief but are not named on
the Investors Summary. The Court does not specifically rule on the claims of these
individuals, but the principles set forth in this Memorandum and Order govern these
investors to the extent applicable factually.

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responses [Docs. ## 81, 114, 121, 140]. Having considered the full record in this case,
the parties’ arguments, and governing legal authorities, the Court rejects the Investors’
claims.
I.

BACKGROUND
Defendants Albert Kaleta (“Kaleta”), Daniel Frishberg (“Frishberg”), and

Kaleta Capital Management (“KCM”) allegedly perpetrated several frauds related to
promissory-note securities. In one alleged scheme, Defendants solicited investors to
make loans to certain entities related to radio station KTEK 110 AM, operated by
Kaleta, Frishberg, and/or KCM. These entities include BusinessRadio Houston, LLC
(“BR Houston”), BusinessRadio Network L.P. (“BR Network”), BusinessRadio
Licensee, LLC (“BR Licensee”), and Biz Radio Network, LP (“Biz Radio”). The
Investors, on various dates from April 2008 through January 2009, made investments
through their agent, Wallace Bajjali Development Partners, LP (“WB Development
Partners”). Biz Radio is not registered as an entity in Texas or Delaware2 and there
is no evidence this entity has any legal existence.
On November 13, 2009, the Securities and Exchange Commission (“SEC”)
commenced this action against Kaleta, Frishberg, and KCM, alleging violations of the
anti-fraud provisions of the federal securities laws [Doc. # 1]. The Court subsequently

2

STB Exs. 21, 22.

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appointed Taylor as the Receiver for KCM [Doc. # 7] and Relief Defendants BR
Network, and Daniel Frishberg Financial Services, Inc. d/b/a DFFS Capital
Management, Inc. (“DFFS”) (collectively, the “Receivership”) [Doc. # 34]. The
Receivership’s assets included the radio station and related assets.
On March 7, 2011, the Receiver moved the Court for entry of orders approving
bidding and sale procedures and approving the sale of radio station assets free and
clear of all liens, claims, encumbrances, and other interests [Docs. ## 62, 65, 72, 119].
Investors filed, then subsequently amended and supplemented and, finally, withdrew,
various objections to the sale of the radio station assets to STB [Docs. ## 70, 71, 80,
82, 110, 111, 123, 132]. The issue of whether the Investors hold a perfected security
interest in the sale of the radio station assets remains hotly contested [See Docs. ##
132, 140].
The Investors argue that they hold senior perfected security interests in certain
BR Houston assets by virtue of contractual and equitable subrogation to the interests
of IIR and/or STB or its parent or affiliate, Salem Broadcasting.3 IIR held a senior
perfected interest in BR Houston by virtue of secured loans made by IIR to BR

3

The parties do not dispute that Salem Broadcasting is an affiliate of STB, but do not
explain the entities’ precise relationship. See Transcript [Doc. # 138], at 57. Under
the Subordination and Intercreditor Agreement among STB and WB Fund II, as agent
for IIR, STB is the “Subordinate Lender” and IIR is the “Senior Lender.” See
Investors Hearing Exhibit (“Investors Ex.”) 1, at 1.

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Houston through IIR’s Administrative Agent, Wallace Bajjali Investment Fund II,
L.P. (“WB Fund II”).4 The IIR loan helped to finance BR Houston’s purchase of
certain radio station assets from STB, and STB took a subordinated note from BR
Houston on those assets as partial payment.5 Under the IIR Subordination Agreement
among STB and WB Fund II, as agent for IIR, any subsequent lender that pays off
some or all of the “Subordinate Loan” (STB’s loan) or the “Initial Senior Loan” (IIR’s
loan) provides “Replacement Financing”; such a subsequent lender may become a
“Senior Lender” with higher priority than STB.6
The Receiver contends that the Objecting Investors are not contractually or
equitably subrogated to the interests of IIR or STB because (1) the Investors cannot
trace their funds to payments of either IIR or STB’s loan, or their funds were
commingled with tainted funds from Kaleta, Frishberg, and KCM; (2) equity disfavors
tracing their funds; (3) the Investors lack perfected interests in BR Houston assets; (4)
the Investors are not contractually subrogated to IIR or STB; and (5) the Investors are
not equitably subrogated to IIR or STB. The threshold issues under contractual or

4

WB Fund II is a distinct entity from WB Development Partners, the entity through
which the Investors invested in the nonexistent Biz Radio.

5

Receiver’s Pre-Hearing Brief [Doc. # 81], at 7-8; Investors Amended Pre-Hearing
Brief [Doc. # 111], at 8. In effect, BR Houston borrowed funds from IIR to purchase
radio station assets from STB.

6

See Investors Ex. 1, at 8, § 6.

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equitable subrogation theories are whether the Investors have established that their
funds paid the debts of BR Houston to IIR or STB and whether they hold duly
enforceable secured interests in the radio station assets. The Court also addresses
whether the Investors meet the other requirements of contractual and equitable
subrogation.
II.

DISCUSSION
Subrogation “is a substitution of one person in place of another with reference

to a lawful claim, demand or right, so that he who is substituted succeeds to the rights
of the other in relation to a debt or claim, and its rights, remedies, or securities.” 73
AM. JUR. 2D SUBROGATION § 1 (2d ed. 2011). Texas law provides for both contractual
and equitable subrogation, Frymire Eng’g Co. v. Jomar Int’l, Ltd., 259 S.W.3d 140,
142-46 (Tex. 2008); Fortis Benefits v. Cantu, 234 S.W.3d 642, 649-50 (Tex. 2007),
and requires that the party seeking subrogation establish that its funds paid off the debt
of another. See In re Hwang, 452. B.R. 187, 193 (N.D. Tex. 2011) (“burden of proof
is on the one claiming equitable subrogation”; party seeking subrogation did not “meet
its burden . . . because it did not establish that its predecessor . . . in fact paid off the
[debt]”); Chase Home Fin., L.L.C. v. Cal W. Reconveyance Corp. 309 S.W.3d 619,
633 (Tex.App.—Houston [14 Dist.] 2010) (evidence produced by party seeking
subrogation“conclusively proved that proceeds from [a subsequent note] were used

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6

to pay off [a prior note]”); Reliable Life Ins. Co. v. Brown & Root, Inc., 607 S.W.2d
621, 631 (Tex. Civ. App.—Waco 1980, reh’g denied) (proof from party seeking
subrogation was “far from conclusive” and not “competent” as to the amount of
party’s funds, if any, that were used to discharge the indebtedness); 73 AM. JUR. 2D
SUBROGATION § 84 (“The burden is generally on the party claiming subrogation to
show that he is entitled to it.”).
A.

Tracing Issues and Commingling of Funds

The Investors have identified twenty-three monetary transfers that they argue
create interests subrogated to IIR or STB’s secured claims against BR Houston.7 The

7

The Investors claim their funds were included in one or more of the following
payments:
Date of Payment & Payee

Amount of Payment

May 15, 2008 to STB

$200,000

July 3, 2008 to STB

$130,000

Jul. 8, 2008 to STB

$400,000

Jul. 8, 2008 to STB

$865,000

Jul. 16, 2008 to STB

$276,824

July 21, 2008 to IIR

$265,000

July 24, 2008 to IIR

$95,000

Aug. 1, 2008 to IIR

$136,231

Sept. 30, 2008 to IIR

$248,000

Sept. 30, 2008 to IIR

$472,947

Jan. 5, 2009 to IIR

$315,000

(continued...)
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Investors rely on records of Wallace Bajjali Fidelity Account Nos. 636-299103 (the
“11% Account”) and 636-299189 (the “12% Account”) to claim that they funded
transfers to IIR or STB.8 The Court’s close review of these and other documents,
however, reveals that the vast majority of the Investors cannot establish that their
personal funds were paid to IIR or STB, a threshold predicate for subrogation. In
summary, for some of the Investors, the balances for the WB Development Partners
accounts dipped to almost zero after the Investors’ payments and before the later
sizeable transfers to IIR or STB claimed by the Investors, made after others’ funds
replenished the accounts. The lowest intermediate balance rule thus defeats these
Investors’ claims. For many, there is no evidence that those Investors’ funds (as
opposed to others’ commingled funds) were used in the identified transfers. For yet
other Investors, their funds were commingled with substantial pre-existing balances
in the 11% and 12% Accounts or other large sums deposited on the day (if not the
same time) as the Investors and before remittances from the accounts to IIR or STB.
Lowest Intermediate Balance Rule.– Money is fungible. See Tex. Boll Weevil
Eradication Found., Inc. v. Lewellen, 952 S.W.2d 454, 461 (Tex. 1997). The lowest

7

(...continued)
Investors Summary [Doc. # 123-1], at 16.

8

See Investors Ex. 9.A-9.F [Doc. # 123].

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intermediate balance rule is often applied in trust cases where trust proceeds are
commingled with non-trust proceeds in a debtor’s account. See In re Al Copeland
Enter., 991 F.2d 233, 235 n.1 (5th Cir. 1993); Vaughn Motors, Inc. v. Weathers, No.
00-50358, 2001 WL 85918, at *2-*3 (5th Cir. Jan, 25, 2001) (unpublished) (citations
omitted) (applying the lowest intermediate balance rule to commingled funds).
According to the lowest intermediate balance rule, “if the balance of cash on hand on
any interim day was less than the amount of the trust fund claims, then the trust fund
claims are limited to that ‘lowest intermediate balance.’” In re Al Copeland Enter.,
991 F.2d at 235 n.1; accord U.S. v. McConnell, 258 B.R. 869, 875 (N.D. Tex. 2001)
(citations omitted). Investors Martin Grosboll, James Stewart, Geraldine Willis, and
Tim Koehl’s claims are defeated by this rule. These Investors claim their funds were
included in a September 30, 2008 transfer to IIR totaling $472,947. The balance in
the 12% Account in which these Investors’ funds were deposited dipped below $620
after the these Investors’ funds were received into that account and before the
September 30 transfer to IIR. The Court adopts the argument by the Receiver in his
post-hearing brief that these Investors cannot trace their transfers to payments to IIR
or STB.9

9

Receiver’s Post-Hearing Brief [Doc. # 140], at 10-11 n.3.

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Other Failures of Proof of Tracing of Payments to IIR or STB.– Other
Investors’ subrogation claims fail because they Investors have not demonstrated by a
preponderance of the evidence that their claimed contributions actually were paid into
the 11% and 12% Accounts or were used to make payments from those Accounts to
IIR or STB. First, it is noted that the Investors’ proof is materially incomplete or
inconsistent. A comparison of bank statements in evidence10 with summaries prepared
by David Wallace (“Wallace Summary”)11 and Investors’ counsel (“Investors
Summary”),12 loan documents with the Investors,13 and Wallace’s Hearing Testimony
(“Wallace Test.”)14 reveals that many of the Investors’ claims are not supported by the
dates and amounts of account deposits shown by the bank records to have been made
by those Investors.15 In addition, several Investors lack loan documents showing the
10

Investors Ex. 9.A-9.F.

11

Investors Ex. 9.G.

12

Investors Summary [Doc. # 123-1], at 16.

13

See, e.g., STB Exs. 47, 48, 74, and 75 [Doc. # 122].

14

Wallace Test. [Doc. # 138].

15

There are no bank statements, for example, to support contentions regarding Ellisor’s
$30,000 and $10,000 claims, T.R. Dunn Family Trust’s $20,000 claim,
Subramanian’s $313,032 claim, Jones’ $165,000 claim, Grosbol’s $14,000 and
$36,000 claims, and Erickson’s $148,000 claim. See Receiver’s Post-Hearing Brief
[Doc. # 140], at 11-14 nn. 5, 7 and exhibits cited therein. Although bank statements
show a payment by Erickson for $150,000 to the 11% Account on September 24,
2008, the amount and date of this payment does not match the Investors’ claim of a
(continued...)

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claimed amounts or loan dates.16 Moreover, a close review of the 11% and 12%
Accounts bank statements reveals that, significantly, at most relevant times the
accounts had substantial preexisting balances consisting of funds from other investors
or elsewhere and/or the Investors’ funds were deposited on the same day as and
commingled with other investors’ money.17 The Investors therefore have failed to

15

(...continued)
$148,000 loan on September 30, 2008. See Investors Summary [Doc. #123-1], at 16.
Similarly, although bank statements show a payment by Grosbol for $50,000 to the
12% Account on July 29, 2008, the amount and date of this payment does not match
the Investors’ claim that Grosbol made $36,000 and $14,000 loans on August 1, 2008
and August 11, 2008, respectively. See id.
Bank statements do not show that Gray’s $50,000 investment payment was made, as
Investors claim, to the 12% Account; rather, the bank records indicate funds were
deposited into the 11% Account. Further, there is no indication in the bank records
or the Wallace Summary that Mullins made a payment to IIR or STB on July 15,
2008. See Receiver’s Post-Hearing Brief [Doc. # 140], at 11-14 nn. 4, 7 and exhibits
cited therein.

16

There are no promissory notes or security agreements reflecting the claimed loan
amounts or dates of investments by Ellisor for a $30,000 payment, Jones for a
$165,000 payment, T.R. Dunn Family Trust for $20,000, Grosbol for $14,000 and
$36,000, or Erickson for $150,000 and $148,000. See Investors Summary [Doc.
#123-1], at 16. Although there is a 12% Note and Security Agreement with Investor
Grosbol for $50,000, see STB Ex. 76, Grosbol Promissory Note for $50,000 to 12%
Account; STB Ex. 77 Grosbol Junior Security Agreement for 12% Account, the
Investors do not claim that Grosbol made one single $50,000 loan; they claim that
Grosbol made two loans, for $14,000 and $36,000, each on separate dates. See
Investors Summary [Doc. #123-1], at 16.

17

This evidentiary deficiency defeats some or all of the claims of Grosbol, Schaffers,
Kadlick, Cook, the TR Dunn Family Trust, Reiley, Gray, Deering, Ellisor. See
Receiver’s Post-Hearing Brief [Doc. # 140], at 11-13 nn. 5, 7 and exhibits cited
therein.

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present persuasive evidence that any particular Investor’s funds were used as part of
any particular payment of the IIR or STB loans. Further, certain investors’ funds
appear to have been paid at least in part to BR Network18 or to “BizRadio,”19 neither
of which received the IIR or STB loans. Indeed Biz Radio is not a legally-registered
entity. Thus, the Court holds that each of the above-noted Investors’ claims of priority
based on payment of BR Houston’s notes due to IIR and STB are rejected.
Commingling with Tainted Funds.– The Investors’ contentions regarding
tracing also fail to some extent because a party seeking subrogation has the burden to
establish that the funds it used to pay off the debt of another were “untainted.” Cf.
United States v. McConnell, 258 B.R. 869, 874 (N.D. Tex. 2001); In re Hyang Ran
Hwang, 452. B.R. 187, 193 (N.D. Tex. 2011); 73 AM. JUR. 2D SUBROGATION § 84.
Due to the fungibility of money, any commingling generally is enough to warrant
treating all funds as commingled. United States v. Ward, 197 F.3d 1076, 1083 (11th
Cir. 1999) (citing United States v. Moore, 27 F.3d 979, 976-77 (4th Cir. 1994)) (“Once
proceeds become tainted, they cannot become untainted.”); U.S. v. Tencer, 107 F.3d

18

This is true of certain Ellisor payments.

19

This is true of certain payments by TR Dunn Family Trust, Koeh, and Erickson and
possibly others. For example, Erickson’s claim for a $148,000 loan to IIR on
September 30, 2008 conflicts with the Wallace Summary, which shows that this
amount was transferred as part of a $20,000 transfer to “BizRadio” on
October 7, 2008. See Investors Ex. 9G.

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1120, 1131 (5th Cir. 1997);20 SEC v. Byers, 637 F. Supp. 2d 166, 177 (S.D.N.Y.
2009);21 SEC v. Lauer, No. 03-80612-Civ, 2009 WL 812719, at *4-*5 (S.D. Fla.
Mar. 26, 2009). Transfers from a Ponzi scheme are presumptively tainted because a
Ponzi scheme is, as a matter of law, insolvent from inception. See Quilling v.
Schonsky, 247 F. App’x 583, 586, 2007 WL 2710703, at *2 (5th Cir. 2007)
(unpublished) (citations omitted) (applying the Texas Uniform Fraudulent Transfer
Act).22 David Wallace testified at the Hearing that periodic payments of principal and
20

In Tencer, the Fifth Circuit noted
several district courts have upheld the forfeiture of the entire balance
of accounts containing both tainted and untainted funds. There, courts
have concluded that the commingling of crime proceeds and “clean”
money makes money laundering less difficult and may even be
necessary to successful completion of the offense. Such untainted
funds have therefore been found to be “involved” for purposes of the
forfeiture statute.
107 F.3d at 1134 (citations omitted).

21

In Byers, a group of investors objected to a pro rata distribution plan claiming they
were the only investors entitled to a distribution from a specific account into which
they could trace their investments. Id. at 176. The court held that mere “coincidence
cannot be a basis to treat [certain] investors more favorably” than other similarly
situated investors. Id. Moreover, the court observed that only some evidence that
commingling occurred is sufficient to support a pro rata distribution of all assets, and
thereby rejected any priority claims. Id. at 179.

22

Investors cite United States v. Davis, 226 F.3d 346 (5th Cir. 2000); United States v.
McConnell, 258 B.R. 869 (N.D. Tex. 2001), aff’g in part, rev’g in part In re Flying
Boat, Inc., 245 B.R. 241 (N.D. Tex. 1999); United States v. Loe, 49 F. Supp. 514
(E.D. Tex. 1999), to argue that “cases in the Fifth Circuit approve tracing of funds in
commingled accounts or tainted accounts if tracing is possible without significant
(continued...)

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interest were made by BR Network to Wallace Bajjali in connection with Investors’
promissory notes from BR Network, which were put into the 11% and 12% Accounts
in which the Investors’ funds were held.23 BR Network’s account spreadsheet24 also
demonstrates that BR Network made at least one payment back to the 12% Account.25
Two Investors, Ficks and Erickson, may have made payments directly traceable
to loan repayments on September 24, 2008 and September 26, 2008 to IIR.26 The
Receiver contends that these payments were commingled with fraudulent proceeds
from Kaleta, Frishberg, and/or KCM and that the records of Network and other entities
are unreliable.

22

Without definitely resolving the Receiver’s contentions, these

(...continued)
burden on the Court.” Investors Post-Hearing Brief [Doc. # 132], at 12. In these
cases, unlike in the instant case, various transfers were supported by evidence. See
Davis, 226 F.3d at 357 (government proved that aggregate withdrawals from
commingled account exceeded the amount of clean funds available); McConnell, 258
B.R. at 876 (government met its burden of tracing); Loe, 49 F. Supp. at 523
(observing that the court could trace the clean funds based on evidence).
Accordingly, these cases do not apply here.

23

Wallace Test. [Doc. # 138], at 130-131.

24

Investors Ex. 11.

25

An entry for May 23, 2008 indicates “Repayment P&I on 12% Secured Note” for
$499,967. Investors Ex. 11. The earliest payment into the 12% Account is from
Gray, who, according to the bank statements, transferred $75,000 on July 22, 2008.
See Investors Ex. 9.B.

26

See Receiver’s Post-Hearing Brief [Doc. # 140], at 15 & n.8. The Wallace Summary
shows Erickson’s $148,000 payment as being attributable to BizRadio, not to IIR or
STB, see Investors Ex. 9.G, and is thus not traceable to the secured loans by the
Investors’ admission.

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investors’ claims fail for reasons set forth below.
Equity Does Not Support the Investors’ Position on Tracing.– Investors in a
Ponzi scheme generally occupy equivalent positions. See, e.g., U.S. v. Durham,
86 F.3d 70, 72-73 (5th Cir. 1999) (citing and upholding district court finding that all
“fraud victims were in equal positions and should be treated as such.”). Accordingly,
courts recognize that equity should not permit one group a preference over another and
that as a result, some investors will receive less than they would under a tracing
distribution. See id. In Durham, it was “uncontested by [the] court or [any] party that
all but $8,803.99 of the money in the [relevant] accounts could be traced to seven
claimants.” Durham, 86 F.3d at 72. Nevertheless, the district court declined to find
that the investors’ assets could be traced because the “ability to trace the seized funds
to [certain parties was] the result of the merely fortuitous fact that the defrauders
spen[t] the money of the other victims first.” Id. The Fifth Circuit affirmed,
emphasizing that a district court, “in exercising its discretionary authority in equity,
was not obliged to apply tracing” even where there was no dispute that tracing would
have been permissible. Id. at 72-73 (citations omitted); see also SEC v. Forex Asset
Mgmt., 242 F.3d 325, 331 (5th Cir. 2001) (emphasizing that a district court is vested
with broad discretionary powers to determine the most equitable remedy).27 In
27

In SEC v. PrivateFX Global One, Ltd., et al., 778 F. Supp. 2d 775, 783-84 (S.D. Tex.
(continued...)

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utilizing those broad equitable powers, district court courts often support the
implementation of pro rata distribution plans. See, e.g., Forex Asset Mgmt, 242 F.3d
at 330-32.
This Court adopts this reasoning.

A pro rata distribution plan is more

appropriate than tracing in this case. Kaleta and Frishberg solicited the Investors at bar
as well as many others.28 It is merely fortuitous that the Investors happened to invest
through WB Development Partners.29 In cases where investors are similarly situated,
equity favors treating them alike.

Moreover, most of the Investors failed to

demonstrate that their specific funds paid IIR or STB’s loans or that their funds were
in accounts untainted by fraudulently-obtained money. Accordingly, equity does not
support tracing the Investors’ funds.
The Court denies the Objections because the Investors cannot trace their funds
to payments of IIR or STB, some of the Investors’ funds were tainted with
27

(...continued)
2011), Judge Gray Miller also approved a pro rata plan of distribution over the
objection of a group of investors who could trace their funds directly to segregated
accounts and argued that they should be the sole recipients of any distribution from
those accounts. Id. at 778. Relying on Durham and Forex, Judge Miller rejected the
investors’ tracing arguments and approved the pro rata plan of distribution. Id. at
781-84. See also SEC v. Amerifirst Funding, Inc., No. 3:07-CV-1188-D, 2008 WL
919546, at *4 (N.D. Tex. Mar. 13, 2008).

28

Wallace Test. [Doc. # 138], at 105; Ellisor Hearing Test. (“Ellisor Test.”) [Doc. #
138], at 164.

29

See Wallace Test. [Doc. # 138], at 118.

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fraudulently-obtained monies, and equity disfavors benefitting certain defrauded
investors (the Investors) similarly situated to other defrauded investors.
B.

Contractual Subrogation

Even if the Investors were able to trace the expenditure of their funds in
repayments of the IIR or STB loans, and the Court were so inclined to exercise its
equitable discretion to permit tracing, these Investors would not prevail under their
contractual subrogation theory because they failed to comply with the “Replacement
Financing” requirements described in IIR’s original loan documents.30
The Texas Supreme Court has observed that contract-based subrogation rights
should be governed by the parties’ express agreement and not invalidated by equitable
considerations that might control in the absence of an agreement. Fortis Benefits v.
Cantu, 234 S.W.3d 642, 648-650 (Tex. 2007).31 The claim is created by an agreement
that grants the right to pursue reimbursement from a third party in exchange for

30

Although the Investors contend that they are subrogated to both IIR and STB’s
security interests in BR Houston’s assets, the Investors principally rely on the IIR loan
documents for their arguments. See Investors Pre-Hearing Brief [Doc. # 123-1], at
4. The Investors do not cite any STB loan documents besides the Subordination and
Intercreditor Agreement among IIR, WB Fund II, and STB, (“IIR Subordination
Agreement”), Investors Ex. 1, and as discussed infra note 42, the Court is
unpersuaded that the IIR Subordination Agreement is a basis for the Investors’
contractual subrogation claims.

31

Thus, “[w]here a valid contract prescribes particular remedies or imposes particular
obligations, equity generally must yield unless the contract violates positive law or
offends public policy.” Fortis, 234 S.W.3d at 648-49.

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payment of a loss. Mid-Continent Ins. Co. v. Liberty Mut. Ins. Co., 236 S.W.3d 765,
774 (Tex. 2007). In this case, there are no agreements between IIR and the Investors
stating that these Investors’ rights are subrogated to IIR’s. The Investors’ own loan
documents do not bind BR Houston because those loan documents are between the
Investors and Biz Radio, a non-existent entity distinct from BR Houston. Under a
contractual subrogation theory, therefore, the Investors must qualify as secured lenders
by meeting the requirements of IIR documents for Replacement Financing.
The Investors argue that they bargained for and received a first Priority Perfected
Security Interest as subsequent creditors, as Replacement Financing, as Senior Secured
Noteholders, or as “other senior lenders,” as defined in (1) IIR’s Senior Secured
Promissory Note from BR Houston (“IIR Initial Note”),32 (2) IIR’s Security Agreement
with BR Houston through its Administrative Agent WB Fund II (“IIR-BR Houston
Security Agreement”),33 (3) the UCC Financing Statement filed by WB Fund II as
Agent for IIR (“IIR UCC Filing”),34 or (4) IIR’s Subordination and Intercreditor
Agreement (“IIR Subordination Agreement”).35 These arguments fail as to the
32

Investors Ex. 6, at 2, ¶ 4.

33

Investors Ex. 2, at 1, 4.

34

Investors Ex. 4.

35

Investors Ex. 1, at 8. The Investors also claim that their priority security interests
were ratified by the Subordination Agreement among WB Development Partners, BR
(continued...)

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Investors except Erikson and Fisk because only these two Investors have made even
a colorable threshold showing that they can trace their funds to IIR. The Court
therefore turns to (1) whether these two Investors have proven entitlement to a
contractually subrogated priority security interest in BR Houston assets and (2)
whether those interests are perfected.
1.

Loan Documents

The IIR Initial Note and the IIR-BR Houston Security Agreement are
sophisticated commercial contracts that anticipate there might be “Replacement
Financing” for IIR’s loan and that those who provide Replacement Financing under the
requirements of the loan documents were to become “senior lenders.”

IIR’s

March 28, 2008 Initial Note for $4,000,000, for example, signed by BR Houston,
provides for the priority of interests on BR Houston “collateral”:
The principal amount, plus all interest accrued, shall be senior in right of
payment and security to the indebtedness owed by [BR Houston] to Seller [STB]
and shall be pari passu in right of payment and security to any other

35

(...continued)
Houston, BR Licensee, and BR Network (“Crider Agreement”). See Investors PreHearing Brief [Doc. # 123-1], at 8 (citing Investors Ex. 3, at 3, ¶ 10). The Crider
Agreement is not a viable source of rights for the Investors’ contractual subrogation
claims because this document is dated January 31, 2010, months after the Investors
made their loans. The Investors argue no basis for any retroactive effects of this
document, and it does not provide grounds for either contractual or equitable
subrogation.

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indebtedness of the Company for money borrowed that is Replacement
Financing.36
The March 28, 2008 Security Agreement between BR Houston and WB Fund II as
Administrative Agent for IIR similarly anticipates replacement financing by
subsequent “senior lenders,” by noting that BR Houston “intends from time to time to
borrow additional funds from other lenders to pay amounts owing under the IIR Note
. . . and amounts owing to South Texas Broadcasting, Inc.”:37
[BR Houston intends] to issue to such lenders (other than South Texas
Broadcasting, Inc.) additional senior secured promissory notes that are
secured by this Agreement on a pari passu basis with the IIR Note (such
promissory notes, together with the IIR note, are collectively referred to
herein as the “Senior Secured Notes” . . . ) and that are senior in right of
payment and priority to the subordinated secured promissory notes issued
by the Borrower to South Texas Broadcasting, Inc.38

36

Investors Ex. 6, at 2, ¶ 4. The Initial Note also anticipates that BR Houston could
obtain additional financing up to a maximum of $1,750,000 “plus any portion of this
Note that is paid with the proceeds of such Replacement Financing”:
The parties hereto acknowledge that [BR Houston] intends to obtain
additional financing secured by the Collateral and use the proceeds of
such financing to, among other things, satisfy [BR Houston’s]
obligations under the Initial Note and the promissory notes issued by
[BR Houston] to Seller [STB] (“the Replacement Financing,” which
term shall include any additional financing borrowed by the Company
to repay any such Replacement Financing).”
Id. Here, the Investors claim to have lent a total of $2,952,856 to IIR or STB, which
does not exceed the payment maximum. See Investors Summary [Doc. # 123-1], at
16.

37

Investors Ex. 2, at 2.

38

Id.

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For Replacement Financing lenders to become “senior lenders” with priority rights, the
IIR-BR Houston Security Agreement requires that BR Houston “take or cause to be
performed such acts and actions as shall be necessary or appropriate to assure that the
[security interest] upon the Collateral shall not become subordinate or junior to the
security interests, liens or claims of any other person or entity.”39
The Investors do not have a valid claim for contractual subrogation because their
loan documents do not meet the requirements in the IIR-BR Houston Security
Agreement. The Investors made either 11%40 or 12%41 loans to Biz Radio, not to BR

39

Investors Ex. 2, at 4, ¶ 5.

40

Investor Ficks has a 11% Promissory Note for $100,000 (“11% Note”), signed by
Kaleta as Biz Radio’s General Partner, and a “Security Agreement” for $100,000
(“11% Agreement”), signed by Biz Radio and WB Development Partners acting as
Ficks’ agent. See STB Ex. 44, Ficks Promissory Note for 11% Account; STB Ex. 45,
Ficks Promissory Note for 11% Account; STB Ex. 46, Ficks Security Agreement for
11% Account.

41

Investor Erickson’s 12% loan documents are not in the record, which further
undermines his claim. However, many of the Investors who invested in the 12%
Account do have loan documents in the record corresponding to their claims here.
Irrespective of the lack of documentation of Erickson’s “loans,” the Court reviewed
sample 12% loan documents, e.g., the 12% Promissory Note (“12% Note”) and
“Junior Security Agreement” (“12% Agreement”) between Biz Radio and the
Investors’ agent WB Development Partners for Investor Subramanian. See STB Ex.
26, Subramanian Promissory Note for 12% Account; STB Ex. 27, Subramanian
Junior Security Agreement for 12% Account.
As discussed supra note 26, the Court considers only Erickson’s claim for a $150,000
loan to IIR. Erickson’s claim for a $148,000 loan to IIR on September 30, 2008
conflicts with the Wallace Summary, which shows that this amount was transferred
(continued...)

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Houston.

The Investors’ Notes and Agreements accordingly do not meet the

requirements for “Senior Notes” or “Replacement Financing” set by the IIR-BR
Houston Security Agreement and related documents.42
The Investors also did not execute a “counterpart” to the IIR-BR Houston
Security Agreement. The IIR -BR Houston Security Agreement provided that each
payee named in a “Senior Secured Note will be permitted to execute a counterpart of
this Agreement concurrently with the Borrower’s delivery to such payee of its Senior
Secured Note and thereby become a Secured Party.”43 The IIR Agreement requires
execution of a security agreement in order for a subsequent lender to become a
“Secured Party.” There is no proof in the record that the Investors obtained BR
Houston’s agreement to grant new security interests because BR Houston did not sign

41

(...continued)
as part of an October 7, 2008 $20,000 transfer to “BizRadio,” not IIR.

42

The Investors also argue that a Subordination Agreement between IIR and STB
provides a basis for Investors’ contractual subrogation claims. See Investors Ex. 1.
The Court is unpersuaded. The Subordination Agreement establishes rights between
the signatories; it does not expressly establish rights for non-signatory BR Houston.
Moreover, section 21 of the Subordination Agreement provides that the agreement is
not intended to benefit others and requires that any modifications be made by an
agreement in writing. Investors Ex. 1, at 17. The Investors provide no evidence that
IIR and STB made any modifications in writing to benefit the Investors.

43

Investors Ex. 2, at 1 (emphasis added). A “Secured Party” means “the Initial Secured
Party for so long as any indebtedness remains unpaid under the IIR note,” “each other
payee named in any of the Senior Secured Notes,” and the Administrative Agent. See
id., at 1-2, ¶ 1.

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security agreements in favor of the Investors. Thus, the Investors did not become
“Secured Part[ies]” recognized under IIR’s loan documents.
In addition, the collateral described in IIR’s and Investors’ 11% and 12%
Agreements materially differ. The Investors’ 11% and 12% Agreements define
“Collateral” as the “Borrower’s [Biz Radio’s]” (i) “Equipment,” (ii) “Furniture and
Fixtures,” and (iii) all “Proceeds” therefrom.44

The IIR-BR Houston Security

Agreement and Note define “Collateral” as also containing categories of assets
different from those in the Investors’ collateral. The Investors’ collateral did not
include: (i) “Membership Interests,” (ii) “Accounts,” (iii) “Intangibles,” (iv)
“Contracts,” (v) “Leases,” and (vi)“Other Contracts.”45 These distinctions further
weigh against finding that the Investors’ funds were intended by BR Houston to be the
“Replacement Financing” contemplated in the IIR-BR Houston Security Agreement
and Note. Accordingly, the Investors’ loan documents do not grant those Investors
security interests in the BR Houston collateral pursuant to the IIR-BR Houston
Security Agreement.
2.

Investors’ Unperfected Interests

44

See Investors Ex. 2, at 2-3, ¶ 2.

45

Compare STB Ex. 46, Ficks Security Agreement for 11% Account and STB Ex. 27
Subramanian Junior Security Agreement for 12% Account, with Investors Ex. 2 IIRBR Houston Security Agreement, at 2-3, ¶ 2.

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For the Investors to establish senior interests in BR Houston assets, the Investors
would have had to hold “perfected interest[s]” under law. Section 9.502(a)(2) of the
Texas Business and Commerce Code (the Texas version of the Uniform Commercial
Code (“Texas U.C.C.”)) provides that a financing statement is effective only if it
“provides the name of the secured party or a representative.” IIR perfected its security
interests when WB Fund II, as IIR’s agent, filed a U.C.C. financing statement listing
WB Fund II as the “Administrative Agent for Industrial Info Resources, Inc., and other
senior lenders.”46 The Investors made their loans through WB Development Partners,
not WB Fund II. However, the Investors argue that WB Fund II is an agent of WB
Development Partners, and that the Investors thus can benefit as secured creditors
through WB Fund II. The Investors’ argument is unsupported by any evidence of an
agency relationship.47 Accordingly, the Investors’ argument that WB Fund II is their
“representative” and identified on IIR’s U.C.C. financing statement in accordance with
section 9.502(a)(2) is rejected.48

46

See Investors Ex. 4.

47

Counsel’s oral argument to this effect is insufficient.

48

It is noted there is no evidence Biz Radio (or any Business Radio entity) met the duty
under the Investors’ Security Agreements to perfect the Investors’ interests. See, e.g.,
STB Ex. 46 Ficks Security Agreement for 11% Account, at 3 ¶ 5; STB Ex. 27,
Subramanian Junior Security Agreement for 12% Account, at 3 ¶ 5.

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The Investors also rely on the reference generally to “other senior lenders” in
IIR’s UCC filing.49 This general term “other senior lenders” is insufficient to perfect
any interests the Investors may claim here. See Matter of E.A. Fretz Co., 565 F.2d 366
(5th Cir. 1978). A financing statement must give public notice of a possible security
interest and must identify the secured party sufficiently to enable a third party to
contact the secured for further information. In re Copper King Inn, Inc., 918 F.2d
1404, 1408 (9th Cir. 1990) (applying Montana law) (financing statement did not
perfect third creditor’s security interest where that creditor–one of the three secured
creditors–was omitted from the statement); In re Wilco Forest Machinery, Inc., 491
F.2d 1041, 1045 (5th Cir. 1974) (applying Alabama law) (financing statement provided
reasonable notice where it was signed by a corporation that had ceased its separate
corporate existence by merger, but was still in existence as a division in the newly
merged corporation, and where statement identified the correct address for the
division). In E.A. Fretz, the Fifth Circuit held that subsidiaries of Revlon, a secured
creditor, could not rely on a financing statement filed by their parent, even though the
express purpose of the underlying security agreement was to secure payment of all
debts owed to Revlon and “present and future divisions and affiliates of Revlon.” Id.
at 368-72. In Fretz, unlike the case at bar, Revlon’s UCC filing listed only that

49

See Investors Ex. 4.

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company as the secured party, and did not recite or refer to other affiliated entities
generally or by name. While IIR’s UCC filing referred generally to “other senior
lenders” in addition to IIR and WB Fund II as agent for IIR, the reference is far too
vague to provide notice to third parties of Investors’ putative interests. There is no
indication who “other senior lenders” might be. As the Fretz court explained:
We are unwilling to impose on any junior secured creditor, with knowledge or
without, the additional risk that, at a date subsequent to his perfection, any
affiliate of the senior creditor or any stranger to it unnamed as secured parties
in a security agreement or financing statement could be metamorphosed into
senior or secured parties by virtue of an assignment “or otherwise.” We also
decline to impose upon a junior secured creditor the burden of a frequent check
to determine whether any secured parties have secretly assigned their claims to
a senior secured party whose interest has been perfected.
Id. at 372. In the instant case, IIR’s UCC filing did not list the Investors by name or
through their agent WB Development Partners. The IIR UCC filing fails to give
adequate public notice of the Investors’ claims of security interests in BR Houston
assets. Accordingly, even if the Investors could show their funds paid the IIR loan, the
Investors do not hold perfected security interests in BR Houston’s assets under the
Texas U.C.C.
C.

Equitable Subrogation

Alternatively, the Investors argue that they are equitably subrogated to the
claims of IIR. Equitable subrogation applies “in every instance in which one person,
not acting voluntarily, has paid a debt for which another was primarily liable and
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which in equity should have been paid by the latter.” Frymire Eng’g Co. v. Jomar
Int’l, Ltd., 259 S.W.3d 140, 142 (Tex. 2008) (quoting Mid-Continent Ins. Co. v.
Liberty Mut. Ins. Co., 236 S.W.3d 765, 774 (Tex. 2007)). Because the Investors
cannot establish that they (1) involuntarily (2) paid a debt primarily owed by another
(3) in a situation that favors equitable relief, the Court denies their equitable
subrogation claim.
1.

Third-Party Debt

“A right to subrogation is often asserted by one who pays a debt owed by
another.” Frymire, 259 S.W.3d at 143 (citation omitted). In Frymire, the Texas
Supreme Court stated the first requirement for equitable subrogation is that one person
has paid a debt for which another was primarily liable. Id. In the instant case, it is
uncontested that BR Houston was primarily liable for a debt to IIR.50 However, as
discussed above, the vast majority of Investors cannot trace their funds to the
repayment of IIR (or STB) debt. Accordingly, these Investors have failed to show that
they in fact paid a debt owed to IIR. The only Investors who arguably have made a
sufficient tracing showing are Erikson51 and Ficks.
2.

Involuntary Payment

50

See Receiver’s Pre-Hearing Brief [Doc. # 81], at 9-10; Investors Amended PreHearing Brief [Doc. # 111], at 14.

51

The Court considers only Erickson’s claim for a $150,000 loan to IIR. See supra note
26.

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The Investors have not shown that their payments were involuntary. “A
payment is voluntary when the payor acts ‘without any assignment or agreement for
subrogation, without being under any legal obligation to make payment, and without
being compelled to do so for the preservation of any rights or property.’” Frymire,
259 S.W.3d at 145 (citing First Nat’l Bank of Kerrville v. O’Dell, 856 S.W.2d 410,
415 (Tex. 1993) (citations omitted)); Oury v. Saunders, 13 S.W. 1030, 1031 (Tex.
1890) (defining a voluntary payment as one made without “legal obligation”).52
In Frymire, a hotel owner hired Price Woods (a general contractor) to remodel
a hotel meeting room. 259 S.W.3d at 142. Price Woods subcontracted the air
conditioning work to Frymire (a subcontractor). Id. As part of its contract with Price
Woods, Frymire agreed (1) to pay for any damages caused to Price Woods or the hotel
owner as a result of Frymire’s performance of the work and (2) to obtain liability
insurance to cover this indemnity obligation. Id. In the course of working on a chilled

52

See also Ruharts v. First Gibraltar Bank, FSB, 896 F.2d 107, 115 (5th Cir. 1990)
(quoting Kone v. Harper, 297 S.W. 294, 297 (Tex. Civ. App.—Waco 1927)) (“One
who advances money to pay off an incumbrance on realty at the instance of either the
owner of the property or the holder of the incumbrance, either on the express
understanding or under circumstances from which an understanding will be implied,
that the advance made is to be secured by a first lien on the land, is not a mere
volunteer, and in the event the new security is for any reason not a first lien on the
property, the holder of such security, if not chargeable with culpable and inexcusable
neglect, will be subrogated to the rights of the prior incumbrancer under the security
held by him, unless the superior or equal equities of others would be prejudiced
thereby, and to this end equity will set aside a cancellation of such security and revive
the same for his benefit.”), aff’d sub nom. Ward-Harrison Co. v. Kone, 1 S.W.2d 857
(Tex. Comm’n App. 1928, judgm’t adopted).

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water line, Frymire installed an “Add-A-Valve” manufactured by Jomar. Id. The
water line later ruptured at the site of Jomar’s valve. Id. Although the rupture
apparently was caused by the faulty valve, the hotel owner sought indemnification
from Frymire pursuant to the terms of its contract. Frymire’s insurer paid the hotel.
Subsequently, Frymire, through its insurer, sued Jomar to recoup the indemnification
payment to the hotel, claiming damages from Jomar’s negligence, product liability,
and breach of warranty.
Frymire relied on the hotel’s rights and sued under a theory of equitable
subrogation. The central issue was whether Texas law permitted Frymire to “step into
the shoes of and pursue the claims” that the hotel had against Jomar. Id. The court
held that Frymire’s indemnification payment to the hotel was “involuntary”: Although
“Frymire’s decision to contract with Price Woods was voluntary, its duty to honor that
contract was not.” Id. at 146. Thus, “having acted to satisfy a legal obligation and to
protect its interests under the contract (and its reputation in the marketplace), Frymire
involuntarily extinguished a debt primarily owed by Jomar to the hotel owner.” Id.
The fact that Frymire’s obligation to pay the hotel arose from Frymire’s contract with
Price Woods (an innocent party) rather than Jomar (an alleged wrongdoer) was central
to the court’s holding. The court emphasized, “Frymire would lack standing to seek
equitable subrogation if Frymire had contracted with Jomar, rather than with Price
Woods, to pay the hotel’s damages caused by Jomar.” Id. In contrast to Frymire,
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there simply was no obligation on the Investors to pay IIR’s loan owed by BR
Houston. The Investors in this case did not contract with IIR, the innocent party in
the case. Rather, the Investors’ promissory notes and security agreements were with
Biz Radio, an alleged wrongdoer, and distinct from BR Houston, the debtor on IIR’s
loan. Accordingly, the Investors are not entitled to equitable subrogation to IIR’s
priority secured interest on assets of BR Houston.53
3.

Superiority of Equitable Interests

Under equitable subrogation, the equity of the party seeking subrogation must
be superior to that of other claimants, 50 AM. JUR. SUBROGATION §12 at 690-91. The
burden is on the party claiming equitable subrogation to establish his entitlement. In
re Hwang, 452. B.R. 187, 193 (N.D. Tex. 2011); Murray v. Cadle Co., 257 S.W.3d
291, 300 (Tex.App.—Dallas 2008) (citations omitted). The trial court has discretion
to balance the equities in view of the totality of the circumstances. Murray, 257
S.W.3d at 300 (citing Providence Inst. for Sav. v. Sims, 441 S.W.2d 516, 519-20 (Tex.
1969)). In conducting this balancing test, courts generally consider factors such as (1)
whether there was negligence on the part of the party claiming subrogation, (2)
whether that party had notice of other interests, and (3) whether the superior or equal
53

The Investors may claim their payments were involuntary because they intended to
pay money to Biz Radio, the entity on their Notes and Security Agreements, not BR
Houston. This argument is unavailing. Biz Radio did not owe IIR any debt and gave
no collateral as security to IIR. Thus, there is no basis for equitable subrogation on
this basis.

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equities of other interests will be prejudiced if equitable subrogation is allowed. Id.
at 299-300 (citations omitted). Here, all three factors weigh against the Investors.
The Investors did not know the nature of their investments and failed to
undertake due diligence.54 They have presented no proof they sought information
about the loans they were extending or the loan documents. The documents the
Investors signed did not identify BR Houston as the entity to which they allegedly
loaned the funds. Closer examination by the Investors or others for their benefit likely
would have brought to light many of the deficiencies now in issue. To the extent the
payments were intended to retire BR Houston’s debt to IIR or STB, the Investors also
failed to perfect their alleged security interests by filing any U.C.C. financing
statements, let alone financing statements properly identifying the Investors or an
agent for them. The Investors had constructive notice of other investors, including
STB’s perfected junior lien on the radio station. Further, granting the Investors a
priority interest would unfairly prejudice others who invest in or through KCM and
Wallace Bajjali or related entities. Equity does not support equitable subrogation in
favor of the Investors.

54

See Ellisor Test. [Doc. # 138], at 177-178.

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III.

CONCLUSION
Because all but two of the Investors have failed to trace their funds to

payments of BR Houston’s debts to IIR or STB, all have failed to show the equities
support tracing, all have failed establish various elements of a claim for contractual
subrogation, and all have failed to meet their burden on equitable subrogation, the
Investors’ Objections are rejected. Accordingly, it is hereby
ORDERED that Investors’ Objections seeking priority security interests in the
proceeds of the sale of the BR Houston radio station assets are DENIED.
SIGNED at Houston, Texas, this 2nd day of December, 2011.

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