LEONIE M. BRINKEMA, District Judge.
Before the Court is an appeal by First Owners' Association of Forty Six Hundred Condominium, Inc. (the "Association" or "appellant")
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
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.
In July 2006, the Association's board of directors notified CSI that its management contract was terminated after 27 years 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, 709 S.E.2d 163.
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 payments. See, e.g., R. at 282-85.
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, 709 S.E.2d 163 (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 $275,000 in punitive damages for the conversion; and $11,390 in prejudgment interest. Id. at 580-81, 709 S.E.2d 163 (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).
On October 2, 2009, Gordon Properties filed a petition for bankruptcy under Chapter 11, listing four creditors. R. at 178.
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.
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 Augie/Restivo Baking Co.), 860 F.2d 515, 518 (2d Cir.1988). "No court has 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, 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.
Pursuant to 28 U.S.C. § 158(a), a district court has jurisdiction to consider appeals from final judgments, orders, and
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 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).
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 Steyr-Daimler-Puch of Am. Corp. v. Pappas, 852 F.2d 132 (4th Cir.1988)).
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.C.D.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.
The parties disagree about what law governs appellant's motion and whether the bankruptcy court's factual findings were clearly erroneous.
The Association argues that the bankruptcy court ignored 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.
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 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);
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 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,
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 186. 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. 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)).
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.
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."),
These payments to CSI began before it engaged in the conversion
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 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.
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,
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 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,
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:
R. at 135 ¶¶ 13-14 (amended counterclaim). CSI was not named as a party to
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 Association, to "prop up" CSI).
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
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.
4 B.R. at 410.
Id. 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, 2012 WL 3644788 (Bankr.E.D.Va. Aug. 23, 2012).
Id.