(Re: D.I. 2721, 2397)

OPINION ON CONFIRMATION2

KEVIN J. CAREY, UNITED STATES BANKRUPTCY JUDGE.

Before the Court is the Debtors' Motion for Approval of Certain Compromises and Settlements, Partial Substantive Consolidation, and Related Relief with Respect to the Plan (D.I. 2721) (the "Motion"), and the Debtors' request for confirmation of the First Amended Joint Chapter 11 Plan of Liquidation of Woodbridge Group of Companies, LLC and Its Affiliated Debtors (D.I. 2397) (the "Plan"), The Debtors have resolved all objections to confirmation of the Plan, except for the Objection (D.I. 2767) (the "Objection") filed on behalf of Lise La Rochelle and others (the "Dissenting Creditors").3

A hearing was held on October 24, 2018, at which a joint record was made regarding the Motion and confirmation of the Plan. The following items in support of the Motion and Plan confirmation were admitted into the record:

Counsel for the Dissenting Creditor's cross-examined Mr. Sharp, Mr. Kapila and Ms. Young at the hearing. After argument, I took the matters under advisement. For the reasons set forth below, the Objection will be overruled, the Motion will be granted, and the Plan will be confirmed.

FACTUAL BACKGROUND

On December 4, 2017, a total of 279 Debtors commenced voluntary cases under chapter 11 of the Bankruptcy Code. Thereafter, on February 9, 2018, March 9, 2018, March 23, 2018 and March 27, 2018, additional affiliated Debtors (27 in total) commenced voluntary cases under chapter 11 of the Bankruptcy Code. The bankruptcy cases arise out of a massive, multi-year fraudulent scheme perpetrated by Robert Shapiro between (at least) 2012 and 2017.7 As part of this fraud, through the Woodbridge entities, Shapiro raised over one billion dollars from approximately 10,000 investors — as either Noteholder or Unitholders — and used approximately $368 million of new investor funds to pay existing investors — a typical characteristic of Ponzi schemes.8

After the bankruptcy cases were filed, the SEC filed a complaint in Florida federal court against Shapiro and his affiliates, including the Debtors, detailing much of the massive fraud perpetrated by Shapiro prepetition.9 The SEC asked the Florida court to appoint a receiver who would displace the Debtor's management.10

On December 14, 2017, an official committee of unsecured creditors (the "Unsecured Creditors' Committee") was appointed. On January 23, 2018, the Court approved a settlement among the Debtors, the SEC and the creditor constituencies providing for the formation of an official ad hoc noteholder group (the "Noteholder Committee"), and an official ad hoc unitholder group (the "Unitholder Committee"), as well as a replacement board (the "New Board") and management for the Debtors.

Immediately following the appointment of the New Board, the Debtors focused on bringing the chapter 11 cases to a rapid consensual resolution, so as to return as much money as possible, as promptly as possible, to creditors.11 In March 2018, Debtors' counsel hosted several all-day negotiating sessions attended by the parties and their professionals.12 On March 22, 2018, the Debtors, the Unsecured Creditors' Committee, the Noteholders Committee, and the Unitholders Committee signed a Summary Plan Term Sheet that memorialized an agreement in principle containing the fundamental terms of a chapter 11 plan.13 The parties continued to negotiate extensively the details of a plan, and on July 9, 2018, the Debtors filed the initial versions of the Plan and Disclosure Statement.

The Ponzi Scheme Summary

The Sharp and Kapila Declarations contain detailed findings based on their separate investigations and analyses of the Debtors' prepetition operations to support their conclusions that Shapiro conducted a significant Ponzi scheme through the Debtors.14

Under Shapiro's control and during the period from August 2012 through December 1, 2017, the prepetition Debtors raised more than $1.29 billion from over 10,000 unsuspecting investors nationwide by selling those investors two primary products: five-year Units and twelve-to eighteen-month Notes.15 The prepetition Debtors claimed the Notes would be repaid based on the purported revenues the Debtors would receive from issuing short-term loans to unrelated third-party property owners.16 In reality, there was no robust and safe cash flow stream from third-party borrowers, as a very small fraction of investor money flowed form the prepetition Fund Debtors to unrelated third parties.17 Rather, Shapiro created disguised affiliates (the PropCos and MezzCos, which are defined in the Motion) to which money was loaned.18 These "borrowers" did not even have bank accounts, and they had no ability to service the required interest payments on an ongoing basis.19 In addition, they had no ability to retire the debt when due, other than through the sale of real estate, which did not appear to be contemplated and was not effectuated.20 The annual cash flow from sales of real property was well below the amount of principal and interest paid by Shapiro to investors.21

The prepetition Debtors used funds received primarily from new investors to make payments of approximately $425 million of "interest" and "principal" to existing investors.22 Shapiro also used commingled investor money to pay approximately $80 million in commissions, primarily to sales agents who sold the fraudulent "investments" and used investor money to pay at least $30 million for the benefit of Shapiro and his wife, as well as their related entities (including, for example, purchasing luxury items, travel, wine and the like).23 While funds from the commingled account were used to purchase the Debtors' real properties, these purchases were directly contrary to material representations made to investors.24

Moreover, investments were solicited, and payments of "interest" were made to existing investors, without regard to whether such investors' investments realized value (or even existed).25 For example, on certain occasions, Shapiro issued Notes for properties that the Debtor never actually acquired, including properties at 778 Sarbonne Road in Los Angeles and 53 Huron Street in Brooklyn.26 And much like the famous play "The Producers," the Debtors purchased the "Owlwood Estate" (an iconic luxury residence in the Los Angeles, California area) in September 2016 for $90 million, but signed notes to the Fund Debtors for alleged borrowings in the aggregate amount of $112 million — well above the purchase price of the property.27

In late 2017, Shapiro's fraudulent scheme unraveled.28 As federal and state investigations intensified and unfavorable press reports began to emerge, the prepetition Debtors found it increasingly difficult to raise new capital from investors.29 When new investment dried up, the inability to make the required servicing payments on the Notes and the Units became inevitable; indeed, the prepetition Debtors were unable to make the December 2017 interest and principal payments due on the Notes, which quickly precipitated the filing of the initial Debtors' bankruptcy cases.30

Plan Summary

The Plan contemplates liquidating each of the Debtors. The Debtors' assets consist largely of approximately 189 real properties, cash and the "Liquidation Trust Actions."31 The Plan proposes to substantively consolidate (i) the Fund Debtors32 into Woodbridge Mortgage Investment Fund 1, LLC, and (ii) the Other Debtors into Woodbridge Group of Companies, LLC ("WGC").33

To liquidate and distribute the proceeds of the assets, the Plan provides for the creation of two entities: (i) a Wind-Down Entity, which will own many of the Debtors' assets (including the Debtors' real properties) and will sell those assets to generate cash, and (ii) a Liquidation Trust, which will own the Wind-Down Entity and receive cash generated by the Wind-Down Entity and will distribute that (and other) cash to creditors.34 The Unsecured Creditors' Committee, the Noteholders Committee and the Unitholders Committee unanimously selected Mr. Michael Goldberg (the SEC's designee to the Debtors' New Board) to serve as the proposed Liquidation Trustee.35 The Liquidating Trust Supervisory Board will consist of five members — three selected by the Unsecured Creditors' Committee, and one each selected by the Noteholder Committee and the Unitholder Committee.36

The Plan incorporates certain settlements, including resolution of disputes about whether the Units are claims against or equity in the Debtors (if the Units are equity they would not be entitled to payments), and whether the Notes are validly secured (either directly or indirectly) by the subject real properties.37 Rather than spend significant time and money litigating these complicated issues, the parties negotiated and settled upon allowance of claims for Unitholders at a 27.5% discount as compared to Noteholders' claims.38 Thus, the settlement is accomplished by affording Noteholders Class A Liquidation Trust Interests for 100% of the Net Note Claims, and affording Unitholders Class A Liquidation Trust Interests for only 72.5% of their Net Unit Claims.39 Unitholders also get Class B Liquidation Trust Interests for the other 27.5% of their Net Unit Claims, so that they may receive an additional payment if there is any money remaining after payment of all of the other creditor claims contemplated under the Plan.40

The Plan also incorporates a "netting" mechanism so that distributions of Liquidation Trust Interests will be made based on the Net Note Claim or Net Unit Claim. These net amounts are calculated based on the Outstanding Principal Amount of a Note Claim or a Unit Claim minus the aggregate amount of all Prepetition Distributions received by the claimholders.41 The Note and Unit claims are "netted" due to the conclusion that the Debtors operated as a Ponzi scheme, in which case the Prepetition Distributions to Noteholders or Unitholders could be avoided and recovered for the benefit of other investors under state and federal fraudulent transfer laws.42

The Plan's classification and treatment of claims and equity interests is as follows:43

CLASS     DESCRIPTION                      IMPAIRED/                       PROJECTED
                                           UNIMPAIRED                      RECOVERY

None      Administrative Claims            Unimpaired                      100%

None      Professional Fee Claims          Unimpaired                      100%

None      Priority Tax Claims              Unimpaired                      100%

None      DIP Lender Claims44               Unimpaired                      100%

Class 1   Other Secured Claims             Unimpaired                      100%

Class 2   Priority Claims                  Unimpaired                      100%

Class 3   Standard Note Claims             Impaired                        60%-70%

Class 4   General Unsecured Claims          Impaired                        60%-70%

Class 5   Unit Claims                       Impaired                        40%-50%

Class 6   Non-Debtor Loan Note Claims45     Impaired                        60%-70%

Class 7  Subordinated Claims               Impaired (deemed to reject)     0%

Class 8  Equity Interests                  Impaired (deemed to reject)     0%

Plan Voting

The Young Declarations showed that, overall, impaired creditors overwhelmingly accepted the Plan:46

            Dollar Amount        Number of Votes to     Dollar Amount        Number of
            Voted to Accept/     Accept/Percentage      Voted to Reject/     Voted to Reject/
            Percentage                                  Percentage           Percentage

Class 3     $642,287,310./      5,715/95.12%           $35,069,584/          293/4.88%
            94.82%                                     5.18%

Class 4     $6,906,309/         38/97.44%              $11,160/              1/2.56%
            99.84%                                     0.16%

Class 5     $194,474,404/       974/97.01%             $6,487,594/           30/2.99%
            96.77%                                     3.23%

Class 6     $428,000/           6/50%                  $377,000/             6/50%
            53.17%                                     46.83%

DISCUSSION

The Dissenting Creditors assert that they are secured creditors who invested money in various real properties owned by the Debtors and, in return, received a note and assignment of an interest in a mortgage that was secured by liens against the real properties. Therefore, they argue, they have the right to be repaid 100% of their claims from the proceeds of the sale of certain real property subject to those liens. Some of the Dissenting Creditors filed an adversary proceeding against the Debtors seeking declaratory judgment that they hold pre-petition, valid, perfected, first-priority liens against certain real property owned by the Debtors.47 The Debtors moved to dismiss the adversary complaint and, on October 5, 2018, I issued an Opinion and Order granting dismissal of the complaint.48 The Dissenting Creditors filed an appeal of the October 5, 2018 Opinion and Order, which is currently pending.49

In the objection to plan confirmation, the Dissenting Creditors argue that the Plan relies on the "core assumption" that the Debtors operated a massive Ponzi scheme, yet the Debtors have failed to provide any evidence of the Ponzi scheme. Without proving the Ponzi scheme, the Dissenting Creditors argue that the Plan settlements are not fair or reasonable, and the Plan's proposed substantive consolidation is improper under the Bankruptcy Code and Third Circuit law. For the reasons that follow, I conclude that these arguments have no merit.

The Debtors Presented Sufficient Evidence of the Ponzi Scheme.

The SEC defines a Ponzi scheme as follows:

Ponzi schemes typically share three common characteristics: (i) the business activity depends on outside investor money; (ii) the investor money is not used according to the stated purpose (some of the investor money is used to pay the returns promised to earlier investors); and (iii) the business enterprise lacks profits sufficient to provide the promised returns and, therefore, depends on an ever-increasing supply of investor money.51

The Debtors submitted the Declarations of Mr. Sharp and Mr. Kapila, which describe their separate investigations and analyses of the Debtors that support their conclusions that the Debtors were operated as a massive Ponzi scheme. Mr. Kapila was retained by the SEC to conduct a forensic accounting investigation of the Debtors.52 At the confirmation hearing, Mr. Kapila testified that he had extensive experience analyzing Ponzi schemes as a forensic accountant and as a bankruptcy trustee.53 His analysis of the Debtors' cash flows and transactions beginning in July 2012 showed that the Debtor entities "were not generating sufficient cash flows by way of working capital or income to be able to support the obligations they were incurring."54 In his Declaration, Mr. Kapila wrote:

Mr. Kapila concluded that "[t]he Woodbridge Entities did not generate sufficient cash flow from mortgage receivables, other real estate investments or any other source to fund the payments to investors. Clearly, even with the use of the cash balance carried over from [Woodbridge Structured Funding, LLC]'s activities the only other source of funds available to the Woodbridge Entities to make the $265 million of principal payments and $103 million in Returns to WMIF Investors were funds from later investors, a classic Ponzi scheme attribute."56 Further, Mr. Kapila determined that, despite maintaining separate bank accounts, the Woodbridge Entities transferred approximately $1.66 billion (exceeding 10,700 transactions) among the Woodbridge Entities, resulting in extensive commingling of investor funds.57

Mr. Sharp also testified at the confirmation hearing about his forensic investigation of the Debtors.58 His investigation was able to utilize the analysis that Mr. Kapila had done through September 2017 and, with greater access to the Debtors' books and records, complete the analysis through the rest of the prepetition period.59 Mr. Sharp also concluded that the Debtors' cash flows were insufficient to make the promised "interest" and "principal" payments to investors and, therefore, "the prepetition Debtors used funds received primarily from new investors to make payments to old investors."60 He testified that it was not possible to track an individual investor's contribution to a fund to any specific piece of real property because the Debtors commingled those contributions.61 Routinely, investor monies were placed into a Fund Debtor's bank account and comingled with other investor monies; then, monies from the Fund Debtor's accounts were transferred to the Woodbridge Group's accounts and commingled on that level; and, further, the monies would be transferred to attorney trust accounts, which would be sent to escrow to purchase various properties.62

Both Mr. Kapila and Mr. Sharp have the experience and expertise to support their analyses that are detailed in their Declarations. The Dissenting Creditors offered no contrary evidence of their own. Therefore, I accept the conclusions of Mr. Kapila and Mr. Sharp that the Debtors were operated as a Ponzi scheme.

The Plan Settlements are Reasonable.

The Dissenting Creditors object to the Plan settlement, including (i) the Plan's different treatment of the Unitholder Claims and Noteholder Claims, (ii) elimination of intercompany claims and liens; and (iii) the "netting" or fixing claim amounts by deducting the amount of any prepetition payments from the original principal amount of claim. In the Motion, the Debtors argue that:

The Motion — and the Disclosure Statement — provide a lengthy discussion of the nature of the claims and issues that are being compromised in the Plan.64 A brief description of those claims follows:

The Debtors argue that global compromises and settlements of these issues should be approved either independent of the Plan (through the Motion) or as part of the Plan.

"To minimize litigation and expedite the administration of a bankruptcy estate, `[c]ompromises are favored in bankruptcy.'"65 However, "the unique nature of the bankruptcy process means that judges must carefully examine settlements before approving them."66 "[T]he decision whether to approve a compromise under Rule 9019 is committed to the sound discretion of the Court, which must determine if the compromise is fair, reasonable, and in the interest of the estate."67 It is the "duty of a bankruptcy court to determine that a proposed compromise forming part of a reorganization plan is fair and equitable."68

A bankruptcy court may approve settlements under Bankruptcy Rule 901969 or as part of a debtor's plan.70 The standards for approving settlements under Rule 9019 or as part of a plan are the same.71 Bankruptcy courts should consider four factors when evaluating a proposed settlement:

In evaluating the probability of success in litigation, the court is not required "to decide the numerous questions of law and fact raised by [the objections], but rather to canvass the issues to see whether the settlement fall[s] below the lowest point in the range of reasonableness."73 Here, the Debtors note that the claims are highly-contested disputes between and among the different stakeholders. The description of the claims set forth in the Disclosure Statement shows that there are colorable claims on both sides of the issues. The settlements provide an arm's-length negotiated resolution of the complex, uncertain issues that strikes a fair balance between the potential range of litigated outcomes.

The Dissenting Creditors, however, focus in particular on the Plan's extinguishment of liens between the various Debtor entities. Relying on Matter of Gulfco Investment Corporation74 and Mansaray-Ruffin,75 the Dissenting Creditors argue that the Debtors are prohibited from extinguishing liens in a plan. Initially, I note that neither case involves the elimination of the debtor entities' intercompany liens through a global settlement in a plan. Mansaray-Ruffin involved a chapter 13 debtor who amended her plan and filed a claim on behalf of a mortgagee in an effort to invalidate the lien upon her property without filing an adversary proceeding. The Mansaray-Ruffin court held, in part, that the debtor could not disregard Bankruptcy Rule 7001(2) and include a provision in her chapter 13 plan that would run afoul of the Bankruptcy Rules.76 An adversary proceeding provides the creditor with "greater procedural protection" by requiring a complaint, a summons, an answer, and discovery, and generally only concludes after a trial or dispositive motion.77 The Mansaray-Ruffin court also noted that:

The elimination of the Debtors' disputed intercompany liens in this matter is taking place through a global settlement negotiated at arm's-length between and among the Debtors and various creditor constituencies. These facts are markedly different from the debtor's one-sided actions in Mansaray-Ruffin.

The Gulfco court held that a secured creditor's lien could not be eliminated through substantive consolidation.79 In Gulfco, the Chapter X trustee, with the support of the SEC, requested consolidation to preserve the value of two debtor companies for the benefit of creditors.80 The Court of Appeals for the Tenth Circuit wrote:

Unlike Gulfco, this case presents compelling circumstances — that is, fraud in the form of a massive Ponzi scheme — to allow the parties to enter into a settlement concerning the Debtors' disputed intercompany liens. The settlement is not merely an administrative convenience. There are complex multi-layered issues involving the intercompany liens that the parties have carefully and vigorously negotiated. Moreover, for reasons discussed infra, substantive consolidation of the Debtors is consistent with Third Circuit law. The Mansaray-Ruffin and Gulfco cases are distinguishable from the facts of this case. I conclude that those cases do not hinder the Debtors' probability of success on the merits. The comprehensive settlement of the issues, including the elimination of the intercompany liens, clearly falls within a range of reasonableness.

The likely difficulty of collection falls in favor of approval because the absence of a settlement would result in lengthy and expensive litigation on a variety of fronts that would eat up the successful litigants' ability to recover on their claims.

The third factor clearly supports approval of the global compromises and settlements in the Plan. The myriad of complex issues described in the Disclosure Statement could take years and millions of dollars to litigate to finality. Mr. Sharp described the multiple "all-day negotiating sessions" and "extensive debate and discussion" among the parties about those key legal issues that were necessary to reach resolution.82 Certain parties distributed detailed position papers on the issues in advance of the meetings.83 The Debtors aptly described the potential effect of the litigation in their Motion:

The Debtors argument is convincing. Here, the benefits of the plan settlement to the multitudinous investors heavily out-weighs the lengthy and costly litigation that lies in wait if the settlements are not approved.

The final element to consider — the paramount interest of creditors — easily falls in favor of approval of the settlement. The creditors voted overwhelmingly in favor of the Plan. The Debtors reported that 85% of the noteholders and unitholders participated in the voting.85 Mr. Sharp stated that the Plan is proposed with "the honest purpose of maximizing the ultimate recoveries for all of the Debtors' creditor constituencies and efficiently resolving the Debtors' Estates."86

Consideration of the Martin factors leaves no doubt that the global settlements included in the Plan, and as set forth in the Motion, fall well within any range of reasonableness. I conclude that the settlements are fair and in the best interests of the various creditor groups. The settlement will be approved.

The Plan's Proposed Substantive Consolidation of the Debtors is Appropriate and Permissible.

The Dissenting Creditors object to the substantive consolidation of Debtors in the Plan. The Court of Appeals for the Third Circuit described substantive consolidation in the 2005 Owens Corning opinion, as follows:

The Owens Corning court recognized that substantive consolidation could disadvantage some creditors, writing "[t]he bad news for certain creditors is that, instead of looking to assets of the [entity] with whom they dealt, they now must share those assets with all creditors of all consolidated entities, raising the specter for some of a significant distribution diminution."88 The Third Circuit said that courts should balance certain principles (not as a checklist) when deciding whether to order substantive consolidation:

Reviewing these policies led the Owens Corning court to hold that a party seeking substantive consolidation must prove that:

The Debtors argue that the facts of this case fall squarely within the second rationale for substantive consolidation (i.e., the hopeless commingling of assets and liabilities). As the Third Circuit explained in Owens Corning,

The Debtors have presented substantial evidence to demonstrate that Shapiro was running the Debtors as a Ponzi scheme. The Declarations of Messrs. Kapila and Sharp provide ample evidence that the Debtors' assets were hopelessly commingled, and their business affairs were entangled. I agree with the Debtors that the Debtors' assets and liabilities are so scrambled in this case that separating them would be prohibitive and would harm creditors. As Mr. Sharp testified:

The Dissenting Creditors, relying on the New Century case, point out that other courts have rejected substantive consolidation as part of a plan settlement.96 However, New Century did not involve a massive Ponzi scheme like the one run by Shapiro in this case. The facts and circumstances in this case comport with the principles discussed in Owens Corning: (i) this Ponzi scheme is the type of compelling circumstance that overcomes the general expectation of recognizing corporate separateness; (2) substantive consolidation addresses the harm caused by the Debtors to the creditors; (3) the Plan's substantive consolidation accomplishes more than "administrative convenience" because it results in equitable treatment of defrauded creditors; and (4) substantive consolidation is being used defensively to remedy the harm to creditors caused by the commingling of assets in the Ponzi scheme — and is not being used offensively to disadvantage a particular group of creditors.

A substantial majority of the creditors constituencies voted in favor of the Plan, which includes substantive consolidation. The record before me supports the conclusion that substantive consolidation in the Plan is appropriate under the principles and holding of Owens Corning.

The Plan Meets the Requirements of Bankruptcy Code § 1129(a) and 1129(b).

The Dissenting Creditors also argue that the Plan does not meet the confirmation requirements of Bankruptcy Code § 1129(a), specifically § 1129(a)(10), because there is no evidence that the Plan was accepted by impaired classes on a "per debtor" basis. In Tribune, I decided that "[i]n the absence of substantive consolidation, entity separateness is fundamental" and the requirement of § 1129(a)(10) must be satisfied by each debtor in a joint plan.97 This Plan provides for substantive consolidation; therefore, acceptance by one impaired class satisfied § 1129(a)(10).98 The Voting Tabulation showed that the Plan was accepted overwhelmingly by all but one of the impaired classes of creditors entitled to vote.99

The evidence submitted by the Debtors support the conclusion that the Plan meets all of the applicable requirements of Bankruptcy Code § 1129(a) and (b).100 The record clearly shows that the Debtors worked assiduously with all of the creditor constituencies in good faith and submitted this Plan as a result of those extensive arm's-length negotiations. Mr. Sharp's Declaration supports the liquidation analysis performed by DSI, which demonstrates that the recovery under the Plan on Claims is greater than that which creditors would receive in a chapter 7 case.101

CONCLUSION

For the reasons set forth above, I conclude that the Debtors have provided ample evidence that the Debtors were operated as part of a massive Ponzi scheme. The settlements in the Plan are reasonable and, to a large degree, the product of an exceptional effort by the respective professionals. Substantive consolidation is appropriate. The Debtors have met all of the applicable confirmation requirements of Bankruptcy Code § 1129. The Dissenting Creditors' Objection will be overruled. The Motion will be granted and the Plan will be confirmed. An appropriate Order follows.