First Owners' Association of Forty Six Hundred Condominium, Inc. v. Gordon Properties, LLC et al
Filing
24
MEMORANDUM OPINION Signed by District Judge Leonie M. Brinkema on 9/5/12. (gwal, )
L
R\
SEP - 5 2012
IN THE UNITED STATES DISTRICT COURT FOR THE
EASTERN DISTRICT OF VIRGINIA
Alexandria
JLERK. U.S. DISTRICT COURT
Division
ALEXANDRIA. VIRGINIA
In
re:
GORDON PROPERTIES, LLC, and
CONDOMINIUM SERVICES, INC.,
Debtors
FIRST OWNERS ASSOCIATION OF
FORTY SIX HUNDRED CONDOMINIUM
INC. ,
l:12cv394
(LMB/TRJ)
Appellant,
v.
GORDON PROPERTIES, LLC,
CONDOMINIUM SERVICES,
and
Appellees.
MEMORANDUM OPINION
Before the Court is an appeal by First Owners' Association
of Forty Six Hundred Condominium, Inc. (the "Association" or
"appellant")1 of the bankruptcy court's denial of its motion for
substantive consolidation, in which the Association sought to
consolidate the Chapter 11 petitions of Condominium Services,
Inc. ("CSI") and its parent company, Gordon Properties, LLC
("Gordon Properties")(collectively, "appellees"). For the
reasons that follow, the decision of the bankruptcy court will
The Association is referred to as "FOA" in some documents.
be reversed and remanded for reconsideration in light of this
Memorandum Opinion.
I.
BACKGROUND
This case involves three entities that have spent
significant time and money litigating in numerous fora since at
least 2006. Their various claims have been heard by the Virginia
state courts, the bankruptcy court in this district, at least
one arbitrator, several district judges, and the Fourth Circuit.
All these disputes center on a property located at 4600 Duke
Street in Alexandria, Virginia, known as the Forty Six Hundred
Condominium (the "Condominium"), a high-rise building built in
1975 by Bryan Gordon. Containing over 400 units, the Condominium
consists of middle-to-low-income residential units as well as
approximately 40 commercial units. Appellant's Br. at 8. The
property also includes two street-level commercial "pad" sites,
one occupied by a gas station and the other by a restaurant.
Appellees' Br. at 1. The Association, a Virginia nonstock
corporation, is the unit owners' association under the Virginia
Condominium Act, Va. Code Ann. § 55-79.39, et seq. E.g., First
Owners' Ass'n of Forty Six Hundred Condo., Inc. v. Gordon
ProPs-' 41° B-R- 364, 366-67 (Bankr. E.D. Va. 2012); Condo.
Servs., Inc. v. First Owners' Ass'n of Forty Six Hundred Condo.,
Inc., 281 Va. 561, 566 (2011).
After Bryan Gordon completed construction of the
Condominium, he created appellee CSI, a Virginia corporation, to
manage the property. Bryan Gordon's unexpected death in 1978 led
to the placement of his assets, including approximately 40
Condominium units and ownership of CSI, into a trust for the
benefit of his four grandchildren: Bryan Sells, Brandy Sells,
Lindsay Wilson and Julia Langdon. In 2002, appellee Gordon
Properties was formed "to receive certain assets from the Bryan
Gordon, Jr. Trust." Appellant's Br. at 6. The four grandchildren
are the sole members of Gordon Properties. CSI has been a
wholly-owned subsidiary of Gordon Properties since that time but
was operated by a trustee until he was removed from his post in
2005 amid evidence of financial improprieties. Appellees' Br. at
2. Bryan Sells, the managing member of Gordon Properties, became
CEO of CSI after the trustee's removal. His cousin Lindsay
Wilson served as CSI's president from 2003 to 2010.2
In July 2006, the Association's board of directors notified
CSI that its management contract was terminated after 27 years
In addition to being the CEO of CSI and manager of Gordon
Properties, Bryan Sells is now also president of the
Association. See First Owners' Ass'n of Forty Six Hundred
Condo., Inc. v. Gordon Props., No. I:llcvl060, Dkt. No. 55 (E.D.
Va. filed Sept. 30, 2011) (Ellis, J.). This development is a
result of new members being seated on the Association's board of
directors pursuant to an order of the bankruptcy court. See Dkt.
No. 15. The new board has established a special litigation
committee in an attempt to reduce conflicts of interest.
of service. CSI refused to recognize this termination, and the
resulting dispute prompted multiple lawsuits between the parties
in state court, three of which are relevant to this appeal. The
first of the three relevant cases was filed by Gordon Properties
in 2006 in the Circuit Court for the city of Alexandria. In this
2006 case, Gordon Properties sued the Association, alleging that
the termination of CSI violated the Association's bylaws.
Appellant's Br. at 15. The court rejected Gordon Properties'
reading of the bylaws and granted summary judgment in favor of
the Association. Condo. Servs., Inc., 281 Va. at 580 n.3.3
Meanwhile, after the Association's board terminated CSI,
CSI continued collecting its management fees. To accomplish
this, Bryan Sells wrote to the Condominium unit owners and
instructed them to continue sending their payments to CSI while
his cousin Lindsay Wilson, then CSI's president, opened a new
bank account under the Association's name to receive those
3
Gordon Properties' counsel in that case failed to timely notice
an appeal, rendering the circuit court judgment the final
decision. See In re Gordon Props., No. 09-18086, Dkt. No. 379
(hereinafter, "Hearing Tr."), at 170:3-24 (Bankr. E.D. Va. filed
Oct. 2, 2009). The law firm that represented Gordon Properties
was presumably not paid following its failure to comply with the
limitations period because it is listed as a creditor in the
Gordon Properties' bankruptcy. Id^ It has not filed a proof of
claim.
R.
at 209.
payments. See, e.g., R. at 282-85.4 Lindsay Wilson was assisted
by CSI's accountant, who falsely represented that she was the
Association's secretary. See, e.g., id. at 284; see also
Appellant's Ex. 6 (email titled "new account for FOA" from CSI
accountant to Bryan Sells). From those payments it received, CSI
paid itself its management fees. In 2009, the Association sued
CSI for breach of contract and conversion. First Owners' Ass'n
of Forty Six Hundred Condo., Inc. v. Condo. Servs., Inc., No.
CL09-1018 (Va. Cir. Ct. filed 2009)(hereinafter "Case CL091018").
CSI raised an affirmative defense that the Association's
board lacked authority to terminate its management contract;
however, the state court struck that defense based on the
judgment in the 2006 case, and it granted summary judgment to
the Association on the conversion claim after all of the
evidence had been presented. Condo. Servs., Inc., 281 Va. at
571-74 (affirming circuit court's decision to strike and grant
summary judgment). The jury awarded the Association $70,667 for
breach of contract; $91,125 in compensatory damages plus
Citations to the record refer to the electronic page numbers of
the combined documents - specifically, the notice of appeal and
three related attachments - found at the first entry on the
docket sheet in this case. Citations to "Appellant's Ex." refer
to appellant's exhibit book [Dkt. No. 2], which was originally
produced for the August 22, 2011 evidentiary hearing before the
bankruptcy court.
$275,000 in punitive damages for the conversion; and $11,390 in
prejudgment interest. Id. at 580-81 (upholding judgment);
Appellant's Reply at 6. The judgment is the basis for the
Association's proof of claim against CSI in the bankruptcy
proceeding.
Around the same time that it terminated CSI as its property
manager in 2006, the Association determined that the commercial
pad site occupied by the restaurant and owned by Gordon
Properties had been under-assessed for several years, and it
proceeded to levy an increased assessment. In response, Gordon
Properties filed a multi-count lawsuit in 2008 challenging,
among other things, the Association's assessment of the site.
Gordon Props., LLC v. First Owners' Ass'n of Forty Six Hundred
Condo., Inc., No. CL08-1432 (Va. Cir. Ct. filed
2008)(hereinafter, "Case CL08-1432"). On January 15, 2009, the
Association counterclaimed for breach of contract and for an
accounting. R. at 136-42 (amended counterclaim).5 In addition to
seeking certain storage fees and assessments from Gordon
Properties, appellant alleged that Gordon Properties "owes the
Association $96,000 in assessments which it diverted to CSI and
The counterclaim was against Gordon Properties alone; CSI was
not a party to Case CL08-1432. Records from the relevant state
court proceedings show appellant to be correct that "there was
never a lawsuit involving both Gordon Properties and CSI."
Appellant's Reply at 2.
never paid the Association." Id. at 138 SISI 13-14. Neither party
ultimately prevailed on any issue: Gordon Properties' eight
claims were either stricken by the court or rejected by the
jury, the jury found for Gordon Properties on the Association's
counterclaim for breach of contract, and the court struck the
Association's request for an accounting. R. at 81-85 (Judge
Kemler's July 27, 2009 final order). The Association did not
appeal, and the Virginia Supreme Court did not accept Gordon
Properties' petition for appeal. Appellant's Br. at 18 n.8.
On October 2, 2009, Gordon Properties filed a petition for
bankruptcy under Chapter 11, listing four creditors. R. at 178.6
On January 29, 2010, the Association filed a proof of claim in
the amount of $315,673.36 for alleged under-assessments on
Gordon Properties' restaurant for the period from 2003 to 2008.7
"According to its schedules, even if all [four creditors']
claims are allowed, Gordon Properties has net equity of about
$9,600,000." R. at 180. CSI filed a bankruptcy petition under
Chapter 11 on January 26, 2011. It scheduled one creditor, the
Specifically, the Association and Burke & Herbert Bank and
Trust Co., which holds the deeds of trust on certain Condominium
units, were listed as secured creditors. See In re Gordon
Props., No. 09-18086, Dkt. No. 1, at 16, 19-20. Additionally,
two law firms were listed as unsecured creditors. Id.; see supra
n.3.
c—
On August 23, 2012, the bankruptcy court disallowed the claim.
In re Gordon Props., No. 09-18086, Dkt. No. 424.
Association, which filed a proof of claim in the amount of
$453,533.12, based on the judgment in Case CL09-1018 plus
interest. A proof of claim was also filed by the IRS for
$1,955.45. "According to [CSI's] schedules, if both claims are
allowed, it has a net deficit of about $426,000." Id.
On September 29, 2010, an order was entered granting
appellees' motion for joint administration of the two bankruptcy
estates and permitting Gordon Properties to continue making
capital contributions to CSI. Id. at 11. The two bankruptcies
were thereafter administratively consolidated. After the
Association filed a motion for substantive consolidation, the
bankruptcy court held a one-day evidentiary hearing and
subsequently denied the motion in a memorandum opinion issued on
February 8, 2012. Appellant timely noticed this appeal.8
II.
DISCUSSION
Substantive consolidation, having no express statutory
basis, is a construct of federal common law and emanates from
equity. In re Owens Corning, 419 F.3d 195, 205 (3d Cir. 2005);
Sav. Bank v. Augie/Restivo Baking Co. Ltd. (In re Auqie/Restivo
Baking Co.), 860 F.2d 515, 518 (2d Cir. 1988). "No court has
Since the filing of this appeal, Judge Ellis, in a separate
appeal by the Association from the bankruptcy court's order in
an adversary proceeding, has sua sponte ordered the Association
and Gordon Properties to brief the issue of whether Gordon
Properties filed its bankruptcy petition in bad faith. See First
Owners' Ass'n, No. I:llcvl060, Dkt. No. 54.
held that substantive consolidation is not authorized, though
there appears nearly unanimous consensus that it is a remedy to
be used sparingly." In re Owens Corning, 419 F.3d at 208-09
(citations, footnote, and internal quotation marks omitted). Its
"sole purpose ... is to ensure the equitable treatment of all
creditors." In re Augie/Restivo Baking Co., 860 F.2d at 518.
Substantive consolidation "treats separate legal entities
as if they were merged into a single survivor .... The result
is that claims of creditors against separate debtors morph to
claims against the consolidated survivor." In re Owens Corning,
419 F.3d at 205 (internal quotation marks omitted). In the
process, "liabilities of consolidated entities inter se are
extinguished by the consolidation." Drabkin v. Midland-Ross
CorP- (In re Auto-Train Corp.), 810 F.2d 270, 276 (D.C. Cir.
1987) .
Challenging the bankruptcy court's denial of its motion for
substantive consolidation, appellant argues that the bankruptcy
court's factual findings were clearly erroneous and that its
legal analysis improperly ignored Stone v. Eacho (In re Tip Top
Tailors, Inc.), 127 F.2d 284 (4th Cir. 1942), which appellant
contends requires courts in this district to apply the
equivalent of corporate veil-piercing analysis to motions for
substantive consolidation. Appellees respond that the bankruptcy
court applied the correct law in this case and that
consolidation is unwarranted under any test.
A. Standard of Review
Pursuant to 28 U.S.C. § 158(a), a district court has
jurisdiction to consider appeals from final judgments, orders,
and decrees of a bankruptcy court, including orders resolving
motions for substantive consolidation. In re Bonham, 229 F.3d
750, 761-62 (9th Cir. 2000)(holding that substantive
consolidation orders are final and appealable); see, e.g., In re
Owens Corning, 419 F.3d at 204 (holding that "[a]11 four [Third
Circuit] factors weigh heavily in favor of . . . jurisdiction to
consider the appeal" pursuant to 28 U.S.C. § 1291 "of an order
granting substantive consolidation"); In re Augie/Restivo Baking
Co./ 860 F.2d at 516-17 (proceeding to merits on substantive
consolidation order).
A district court sitting as an appellate court in a
bankruptcy proceeding reviews the lower court's conclusions of
law de novo. See In re Merry-Go-Round Enters., Inc., 400 F.3d
219, 224 (4th Cir. 2005) (citing Three Sisters Partners, L.L.C.
v. Harden (In re Shangra-La, Inc.), 167 F.3d 843, 847 (4th Cir.
1999)). Factual findings of the bankruptcy court are reviewed
for clear error. Id.; Fed. R. Bankr. P. 8013. Findings of fact
will be overturned as "clearly erroneous" if consideration "of
10
the entire record leaves [the reviewing court] with the definite
and firm conviction that a mistake has been committed." Harmon
v. Levin, 772 F.2d 1150 (4th Cir. 1985). "[D]ue regard shall be
given to the opportunity of the bankruptcy court to judge the
credibility of the witnesses." Fed. R. Bankr. P. 8013.
Finally, decisions committed to the discretion of the
bankruptcy court are reviewed for abuse of discretion. Robbins
v. Robbins (In re Robbins), 964 F.2d 342, 345 (4th Cir. 1992);
see In re Permian Producers Drilling, Inc., 263 B.R. 510,
517 (W.D. Tex. 2000)("Because it is an exercise of a bankruptcy
court's equitable power under section 105(a), an order for
substantive consolidation is reviewed for abuse of
discretion.")(citations omitted).
B. Standing
Appellees argue in passing that the Association, as a
creditor rather than the trustee or debtor-in-possession, lacks
standing to pursue a motion for consolidation based on a veil-
piercing theory. See Appellees' Br. at 13-14 (citing SteyrDaimler-Puch of Am. Corp. v. Pappas, 852 F.2d 132 (4th Cir.
1988)).9 Appellant responds that appellees are precluded from
challenging standing because they did not present the argument
to the bankruptcy court and are therefore raising it for the
Q
Gordon Properties has remained a debtor-in-possession in its
bankruptcy.
11
first time on appeal.
Appellant is incorrect as a matter of
law. Standing is an aspect of subject matter jurisdiction and
not subject to waiver. See FW/PBS, Inc. v. City of Dallas, 493
U.S.
215,
230-31 (1990).
Appellees' substantive argument is nevertheless
unpersuasive in light of numerous well-reasoned cases finding
that creditors have standing to pursue substantive
consolidation. See In re Lahijani, No. 02-01797, 2005 WL
4658490, at *4 n.41 (Bankr. CD. Cal. Oct. 3, 2005) (collecting
cases). Steyr, cited by appellees, is not to the contrary. The
court there held that an alter ego cause of action is the
property of the bankruptcy estate under 11 U.S.C. § 541(a), and
it was therefore held by the trustee. 852 F.2d at 135-36. Steyr
did not involve a motion for substantive consolidation under the
bankruptcy court's equitable powers, and nothing in its
reasoning compels the extension of its holding to such motions.
The Court will, therefore, consider this appeal on its merits.
C
The Association's Motion for Substantive Consolidation
The parties disagree about what law governs appellant's
motion and whether the bankruptcy court's factual findings were
clearly erroneous.
1-
The Bankruptcy Court's Legal Conclusions
The Association argues that the bankruptcy court ignored
12
the binding precedent in Stone. In that case, the Fourth Circuit
reversed the lower court's refusal to consolidate the bankruptcy
estates of a parent corporation with its subsidiary, finding
that substantive consolidation was appropriate given the
insolvency of the two corporations, the lack of adherence to
corporate forms such that the subsidiary had no separate
existence, and the likelihood that creditors transacting
business with the subsidiary believed they were dealing with the
parent corporation. Stone, 127 F.2d at 287-88, 290.10 These
circumstances justified allowing the creditors of both
corporations to share equally in the pooled assets of the two
corporations.
Id. at 288.
Although Stone did not set forth a specific test for
substantive consolidation, its general approach of focusing on
equity to creditors and refusing to "be blinded by corporate
forms," has been widely noted and followed. See, e.g., In re
Vecco Constr. Indus., Inc., 4 B.R. 407, 408-09 (Bankr. E.D. Va.
1980)(granting debtors' motion to substantively consolidate the
bankruptcies of a parent corporation and four wholly owned
10
The Court of Appeals decided Stone on the heels of Sampsell v
Imperial Paper & Color Corp., 313 U.S. 215 (1941), in which the
Supreme Court affirmed "an order consolidating the estates" in
bankruptcy on the grounds that "[m]ere legal paraphernalia will
not suffice to transform into a substantial adverse claimant a
corporation whose affairs are so closely assimilated to the
affairs of the dominant stockholder that in substance it is
little more than his corporate pocket." Id. at 218.
13
subsidiary corporations where accounts were largely intertwined,
the parent had assumed the assets and liabilities of the
subsidiaries, the corporations shared directors and office
space, and no creditor would be harmed by consolidation);11 see
also, e.g., In re Cyberco Holdings, Inc., 431 B.R. 404, 416
(Bankr. W.D. Mich. 2010)(observing that of the early
consolidation cases, Stone "is certainly the one most akin to a
modern court's notion of substantive consolidation").
The Fourth Circuit has not had occasion to revisit the
standard for deciding motions to consolidate, but since Stone,
two other circuits have developed specific tests governing such
motions. Explaining that substantive consolidation is a remedy
for which the "sole purpose . . . is to ensure the equitable
treatment of all creditors," the Second Circuit identified "two
ii
Although In re Vecco did not cite Stone, the consolidation
criteria it recognized are similar to the considerations set out
by the Fourth Circuit:
First, the degree of difficulty in segregating and
ascertaining individual assets and liability. Second,
the
presence
statements.
or
absence
Third,
of
consolidated
financial
the profitability of consolidation
at a single physical location. Fourth, the commingling
of assets and business functions. Fifth, the unity of
interests and ownership between the various corporate
entities.
Sixth,
corporate
guarantees
of
assets
the existence
without
on
loans.
formal
formalities.
4
B.R.
at
410.
14
of parent and inter
Seventh,
observance
the
of
transfer
corporate
critical factors" in assessing a motion for consolidation:
"(i) whether creditors dealt with the entities as a single
economic unit and did not rely on their separate identity in
extending credit; or (ii) whether the affairs of the debtors are
so entangled that consolidation will benefit all creditors." In
re Augie/Restivo Baking Co., 860 F.2d at 518 (emphasis added)
(internal quotation marks and citations omitted). Under the
burden-shifting test devised by the D.C. Circuit, a party
seeking consolidation "must show not only a substantial identity
between the entities to be consolidated, but also that
consolidation is necessary to avoid some harm or to realize some
benefit." In re Auto-Train Corp., 810 F.2d at 276. If the party
meets its initial burden but a creditor thereafter objects to
consolidation on the grounds that it would be prejudiced, "the
court may order consolidation only if it determines that the
demonstrated benefits of consolidation heavily outweigh the
harm." Id. (internal quotation marks omitted)(requiring courts
to "conduct a searching inquiry to ensure that consolidation
yields benefits offsetting the harm" inflicted).12
The Third, Sixth, and Ninth Circuits have adopted the
Augie/Restivo test, while the Eighth and Eleventh Circuits use
the Auto-Train test, or a variation on it. At least one Second
Circuit case cites to Auto-Train, without suggesting that
Augie/Restivo has been in any respect abrogated. See FDIC v.
Colonial Realty Co., 966 F.2d 57, 61 (2d Cir. 1992).
15
Without explaining why he chose not to follow Stone,
or
elaborating on why application of In re Augie/Restivo was
appropriate in this case, the bankruptcy judge concluded that
"the Augie/Restivo test is generally preferred over the Auto-
Train test." R. at 185. The bankruptcy court rejected the
Association's argument for consolidation as "favor[ing] factors
more appropriately considered in an action to pierce the
corporate veil rather than a motion for substantive
consolidation. The tests are different." Id.
at 18 6. He then
found no basis for consolidation under In re Augie/Restivo
because "CSI and Gordon Properties properly and clearly
maintained their separate identities," there were "no accounts
to unravel" post-petition, and "there is no evidence that any
creditor . . . was confused about the identity of the company
with which it was dealing. Id. at 185-86.
The bankruptcy court's opinion failed to fully evaluate
equitable considerations, despite Stone's clear teaching that it
is "well settled that courts will not be blinded by corporate
forms nor permit them to be used to defeat public convenience,
justify wrong or perpetrate fraud . . . ." 127 F.2d at 288.
Instead, courts "will look through the forms ... as justice
may require." Id. This focus on fairness also permeates the
decisions of courts after Stone. See, e.g., Eastgroup Props, v.
16
S. Motel Ass'n, Ltd., 935 F.2d 245, 249 (11th Cir. 1991)("[T]he
basic criterion by which to evaluate a proposed substantive
consolidation is whether the economic prejudice of continued
debtor separateness outweighs the economic prejudice of
consolidation.")(internal quotation marks and citation omitted);
In re Vecco, 4 B.R. at 409-10 (assessing motion based on rights
of the creditors and observing a "liberal trend in allowing
consolidation of proceedings" which "arises from . . . increased
judicial recognition of the widespread use of interrelated
corporate structures by subsidiary corporations operating under
a parent entity's corporate umbrella for tax and business
planning purposes")(citing Soviero v. Nat'l Bank of Long Island,
328 F.2d 446, 448 (2d Cir. 1964)).13 Appellees argue that Stone
"is of little to no consequence in determining the propriety of
the substantive consolidation remedy because the evolution of
Many courts that have applied the Augie/Restivo test have to
some degree recognized the Stone focus on equity, suggesting
that the two cases may not be inherently incompatible, as the
parties appear to believe. See, e.g., In re Owens Corning, 419
F.3d at 205 (finding that the reasons "for allowing substantive
consolidation as a possible remedy span the spectrum and often
overlap. For example, Stone and Soviero followed the well-trod
path of alter ego analysis in state ^pierce-the-corporate-veil'
cases."); cf. William H. Widen, Corporate Form and Substantive
Consolidation, 75 Geo. Wash. L. Rev. 237, 269 n.102, 272-73
(2007)(disagreeing with the analytical approach in In re Owens
Corning but acknowledging that "the economic efficiency
rationale and the veil piercing rationale for substantive
consolidation coexist" and that courts frequently combine the
elements).
17
the law on this question has passed it by." Appellees' Br. at
15. To the contrary, Stone is not only good law, and binding
precedent in this circuit, it fits comfortably within the
current
case law.
The Stone approach is particularly appropriate here.
Specifically, in both bankruptcies, the Association is the sole
active creditor, and not even appellees argue that any creditor
would be harmed by consolidation.14 Absent consolidation, the
Association, which has a valid state court judgment for
compensatory and punitive damages, will be unlikely to collect
because CSI lists no assets. Were its and Gordon Properties'
estates consolidated, the single combined estate would be
sufficient to pay the claims of all the creditors in both
bankruptcies. In fact, Gordon Properties would have $9 million
in scheduled assets left after the claims of the consolidated
creditors were paid. R. at 180.
14
In fact, appellant represented to the bankruptcy court that
one of Gordon Properties' law firm creditors joined the motion
for substantive consolidation. R. at 209 (footnote). The absence
of any harm to or objection by other creditors is significant
given that the reason courts grant substantive consolidation
"sparingly" is their fear of subordinating the rights of
creditors. See Colonial Realty Co., 966 F.2d at 61 ("[T]his
Court has insisted that substantive consolidation be invoked
'sparingly because of the possibility of unfair treatment of
creditors.'" (quoting Chem. Bank N.Y. Trust Co. v. Kneel, 369
F.2d 845, 847 (2d Cir. 1966))).
18
Equity also points toward consolidation because the same
individuals who controlled CSI when it was found liable for
conversion run Gordon Properties. In the letter that Bryan Sells
sent to Condominium unit owners, which launched the conversion
scheme, he identified himself as a representative of both
debtors. See Appellant's Ex. 5. The record created by the
bankruptcy court's August 22, 2011 evidentiary hearing clearly
established that Gordon Properties and CSI are controlled by the
same individuals and that over the last few years, Gordon
Properties has given CSI approximately $900,000, without an
established protocol or proper record-keeping, to cover CSI's
expenses, payroll, and litigation costs. See Hearing Tr. at
51:2-23 (Q:"On how many occasions [during the last five years
did Gordon Properties decline to provide funds requested by
CSI]?" A:"It doesn't happen very often. A handful."),15 58:18-24
(Bryan Sells testifying that he knows of no document setting
forth all the transfers from Gordon Properties to CSI), 64:15-20
(Bryan Sells recollecting that the amount of Gordon Properties'
Unless otherwise stated, quotes from the evidentiary hearing
are Bryan Sells' responses to questions from the attorney then
representing the Association.
19
"paid-in capital" to CSI exceeds $900,000).16
These payments to CSI began before it engaged in the
conversion17 and continued after Gordon Properties filed for
bankruptcy. See, e.g., id. at 57:2-24 (Q:"As you sit here today,
you can't remember why $77,000 was transferred from Gordon
Properties to CSI when Gordon Properties was already in
bankruptcy?" A:"That's correct.").18 During his testimony, Sells,
a Harvard-trained lawyer, was unable to say in which capacity he
was functioning - as Gordon Properties' managing member or as
CSI's CEO - when making these various financing decisions. See
According to appellant, Gordon Properties provided nearly
$400,000 to CSI between April 2008 and January 2011 for payroll,
operating expenses, and litigation costs, and $138,000 of that
money was paid between October 2009 and February 2010. Hearing
Tr.
at 24:19-25:8.
With respect to whether there is a nexus between the allegedly
improper control by Gordon Properties and CSI's conversion,
appellant argues that because CSI required Gordon Properties'
financial support before the conversion began, Gordon Properties
directly benefitted from the management fees CSI paid itself
because these fees lessened Gordon Properties' support
obligations.
18
The Court is not moved by appellees' argument that its years
of loans were eventually converted into capital contributions.
Although this restructuring was certainly not legally improper,
and there is no suggestion it was not fully compliant with
applicable regulation, a post hoc decision to re-categorize
these undocumented loans as capital contributions does not
resolve whether appellees observed corporate formalities when
the payments were made. Moreover, there is evidence in the
record that years of inadequate documentation by appellees was a
primary reason their accountant recommended converting the loans
into capital contribution. See Hearing Tr. at 129:22-130:130:9.
20
id. at 41:13-44:22 (Q:"When you're [deciding whether to approve
a CSI expense request] are you doing that in a dual role
as . . . CEO of CSI and . . . managing member ... at Gordon
Properties?" A:"I haven't really given that much thought. I
don't know."). The evidence presented to the bankruptcy court
clearly showed that "corporate formalities were not followed
with respect to the transfer of in excess of $900,000."
Appellant's Br. at 10 (internal quotation marks omitted).
Additionally, CSI uses office space owned by Gordon Properties
without a rental agreement.19 Hearing Tr. at 49:15-50:11. In
fact, no written agreements exist that define the business
relationship between appellees, despite CSI's management of all
Gordon Properties'
assets. Id.
Despite these facts favoring the Association's position,
the bankruptcy court found that the two entities' separate bank
accounts and separate tax returns undercut the Association's
Although it is the purview of the lower court to make
credibility findings, Bryan Sells' inconsistent testimony with
respect to whether CSI's management fee included rent to Gordon
Properties cannot be ignored. Compare Hearing Tr. at 45:25-46:11
("I don't believe [CSI] has paid anything more than a nominal
rent on occasion."), with id. at 140:18-22 (responding to his
own attorney's question asking whether the office space
"factor[s] in at all in determining what the amount of the
management fee is?" with "It's inclusive in the management fee.
Yes."). His assertion that the blatant discrepancies in his
answers are attributable to his never having been explicitly
asked whether rent was included in the management agreement is
unavailing.
Id. at 178:16-181:19.
21
motion for consolidation. R. at 181. It observed that the two
corporations are engaged in different businesses, that CSI at
one time managed other condominium associations, and that there
is no evidence that any creditor of the two entities was
confused about the identity of the corporation with which it was
dealing. Id. at 186. It also referenced testimony by Bryan Sells
that his hopes for CSI's post-litigation business prospects
justified Gordon Properties' investment in its subsidiary. All
the above-referenced facts are properly considered on remand in
an analysis of the equities pursuant to Stone.
2.
The Bankruptcy Court's Factual Findings
In addition to the bankruptcy court's failure to fully
consider the equities and other relevant facts in light of
Stone, it accorded significant weight to a factual finding that
is erroneous. Specifically, the bankruptcy judge incorrectly
believed that both appellees were at some point parties in the
same state court case and that the state court passed on whether
Gordon Properties should be liable for CSI's conduct:
"Ultimately, in a suit in which the condominium association
sought relief against both CSI and Gordon Properties, the state
court found in favor of the condominium association against CSI,
but against the condominium association and in favor of Gordon
22
Properties which was dismissed from the case." Id. at 181.20 This
misunderstanding of the state court record led the bankruptcy
judge to conclude that "[s]ubstantive consolidation would
provide the [Assocation] with a remedy it was denied in state
court." R. at 187. He characterized this statement, with which
his analysis both begins and ends, as "a final, relatively
unique consideration" and ultimately concluded that the
"elements supporting substantive consolidation are not
sufficiently present in this case." Id. at 182, 187.
A careful review of the state court proceedings reveals
that the bankruptcy judge's view of the record is mistaken. As
discussed in Section I, CSI and Gordon Properties were never
20
The memorandum opinion continued:
The [Association sued both CSI and Gordon Properties.
The court found in favor of Gordon Properties. The
efforts of the [A] ssociation to reach the assets of
Gordon Properties under state law were unsuccessful.
But that is exactly what it seeks to do here. In this
case,
it
would
be
inappropriate
to
allow
the
[A] ssociation to conduct an end run around the prior
adverse state court determination.
I^- at 187; see also Hearing Tr. at 147:7-148:2. This same
misunderstanding was reflected in the bankruptcy judge's
most recent opinion disallowing the Association's proof of
claim in Gordon Properties' bankruptcy: "One suit involved
a claim by the [A]ssociation against both CSI and [Gordon
Properties]. It was tried before a jury which found for the
[A]ssociation
against
CSI
but
not
against
[Gordon
Properties]." In re Gordon Props., No. 09-18086, Dkt. No.
423, slip op. at *9 (Bankr. E.D. Va. Aug. 23, 2012).
23
named together as parties in any of the state court lawsuits
relevant to this appeal. In Case CL08-1432, litigation in which
neither side was successful, Gordon Properties sued the
Association in connection with the Association's assessment of
Gordon Properties' restaurant site, and the Association
counterclaimed for breach of contract and an accounting. CSI was
not a party to this litigation.
In Case CL09-1018, the
Association sued CSI for breach of contract and conversion and
prevailed; Gordon Properties was not a party to this lawsuit.
Appellees do not acknowledge the bankruptcy court's factual
error or clarify the record. See Appellees' Br. at 5, 12-13.
Instead, arguing res judicata,21 they maintain that the amended
counterclaim and trial transcripts in Case CL08-1432 show that
"the issue of control of CSI by Gordon Properties was . . . the
precise issue on which the liability of Gordon Properties for
conversion by CSI of the $91,125 dollars in management fee was
pled and pursued in the 2008 State Court litigation." Appellees'
Br. at 16. This argument is flawed for several reasons.
First, the language of the Association's amended
counterclaim in Case CL08-1432 does not establish that an alter
ego claim or theory was pursued:
21
Appellees framed the question as one of collateral estoppel
before the bankruptcy court but argue on appeal that the
doctrine of res judicata applies. Compare Hearing Tr. at 8:2110:9, 15:11-23, with Appellees' Br. at 15-19.
24
Between August
of
2006
and
December
of
2007,
Gordon
[Properties] caused CSI to pay itself approximately
$96,000 in so called "management fees," although CSI
was no longer the management agent for the Association
and
provided
[Properties]
$96,000
in
no
services
owes
to
the
assessments
the
Association.
Association
which
it
Gordon
approximately
diverted
to
CSI
and
never paid to the Association.
R. at 135 3SI 13-14 (amended counterclaim) . CSI was not named as
a party to the suit, and the amended counterclaim, read as a
whole and read against the trial transcripts, does not establish
that veil-piercing was litigated in Case CL08-1432.
Appellees argue that the trial transcripts and the court's
answer to a question from the jury support their position that
Gordon Properties' control over CSI was at issue. Id. at 149-76.
First, as Gordon Properties acknowledges, its chosen defense to
the breach of contract counterclaim was that it had paid its
contractually required assessments to CSI and had therefore
satisfied its obligations to the Association. See R. at 171; see
also Appellant's Br. at 26 ("Gordon Properties argued that CSI
was an agent of [the Association] and that Gordon Properties had
fulfilled its obligations by paying CSI."); Hearing Tr. at
12:21-13:8; R. at 173 (state court closing argument in which the
Association theorized that Gordon Properties directed its
assessments to CSI, thereby breaching its contract with the
25
Association, to "prop up" CSI).22 That some details of the inter
relationship between appellees was elicited as a result of
Gordon Properties' defense simply does not establish that an
alter ego claim was actually litigated. Although it is
impossible to discern the precise basis on which the jury
rejected the Association's counterclaim from the record
generated below and the parties' filings, one simply cannot
surmise from appellees' presentation that substantive
consolidation would result in "a remedy the Association was
denied in state court." R. at 186.23
Bryan Sells was questioned about this defense during his
deposition testimony, which was played at trial:
Q: The first ground of defense states the counterclaim
is barred by the defense of payment. What is the . . .
factual basis for that defense?
A:
[W]hat it refers to is Gordon Properties did,
in
fact, pay its assessments in full. And they were
deposited into the [bank account created by CSI]. And,
of course, that account has also been turned over.
Q: But what was turned over didn't include monies that
went out to CSI .... The assessments that you claim
Gordon
Properties
paid
into
the
account
were
not
repaid to the association in full, were they?
A: I see that as a matter between [the Association]
and CSI.
Id.
What complicates the record is that appellees, without
explicitly admitting that CSI and Gordon Properties were never
parties to the same case, now argue that the Association should
have brought its veil-piercing claim in Case CL08-1432 pursuant
to Va. Sup. Ct. R. 1:6, which requires a litigant to raise all
claims arising from the "same conduct, transaction, or
26
Second, as both parties point out, during deliberations,
the jury asked the court whether Gordon Properties, a party to
the case, and CSI, a corporation discussed by the parties, were
separate legal entities. R. at 178. Without consulting the
parties on how the court should respond, the court instructed
the jury that CSI and Gordon Properties were separate legal
entities, which is a factually true statement. Id. at 177.
Although failing to consult the parties may have been improper,
the circuit court's decision to respond to the question does not
establish that an alter ego theory was actually litigated in the
case submitted to the jury for decision. See Appellees' Br. at
occurrence" in a single suit or face preclusion. See Appellees'
Br. at 15-19. In advancing this argument, appellees initially
represented that the amended counterclaim in Case CL08-1432 was
filed after the judgment awarding damages to the Association
against CSI for conversion was issued in Case CL09-1018;
however, the Association actually filed its amended counterclaim
11 months before it received the judgment against CSI.
(Appellees corrected their misstatement at oral argument.) The
Association argues that the chronology is significant because
without an underlying judgment against CSI for conversion, it
had no basis to seek a veil-piercing claim against Gordon
Properties in No. CL08-1432 and therefore preclusion does not
apply. See Appellant's Reply at 11-13. Although the Court does
not agree that Dana v. 313 Freemason, 266 Va. 491, 499 (2003),
stands for the proposition that a plaintiff cannot litigate a
substantive claim and an alter ego claim in the same case, as
appellant suggests, this dispute between the parties is not
dispositive. Contrary to appellees' claim before the bankruptcy
court, the Association did not pursue a veil piercing theory in
any state case, and even if it could have done so, appellees
cite no case law to support the proposition that res judicata
should therefore bar a motion for substantive consolidation in a
bankruptcy proceeding.
27
5.
Appellees have not shown that appellant is either precluded
or estopped from seeking consolidation.
III.
CONCLUSION
The bankruptcy court afforded heavy weight in its analysis
to the state court proceedings; however, its characterization of
those proceedings was clearly erroneous, which undermines the
validity of the court's conclusion. Moreover, the court failed
to address the applicability of Stone and weigh the equities.
Accordingly, the decision of the bankruptcy court will be
reversed and remanded. On remand, the bankruptcy court should
re-evaluate his conclusions in light of an accurate
understanding of the state court litigation; evaluate all the
facts in light of Stone, or clearly explain why that case does
not apply to the motion; and consider whether the equitable
treatment of all creditors is best served by consolidation.
An Order reversing the bankruptcy court's decision and
remanding it will be issued with this Memorandum Opinion.
Entered this §
day of September, 2012.
!§L
Alexandria, Virginia
Leonie M. Brinkema
United States District Judge
Appellees argue that because the Association did not object to
the trial court's ruling and "made no effort to challenge it on
appeal," it should now be collaterally estopped from taking a
position different from the trial court's. The trial court's ex
parte response to the question from the jurors does not
constitute the type of ruling that would collaterally estop the
Association from litigating the issue.
28
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