(1) GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO MODIFY
PRELIMINARY INJUNCTION ORDER; (2) DECLINING TO APPROVE RECEIVER'S REPORT AND
RECOMMENDATIONS REGARDING VALUATION OF REAL ESTATE ASSETS OF RECEIVERSHIP
ENTITIES; (3) GRANTING RECEIVER'S MOTION FOR AUTHORITY TO PURSUE CLAIMS AGAINST LINMAR BORROWERS
GONZALO P. CURIEL, District Judge.
This is a civil enforcement action initiated by the Securities and Exchange Commission ("SEC"), in which the SEC alleges defendants Louis V. Schooler ("Schooler") and First Financial Planning Corporation d/b/a Western Financial Planning Corporation ("Western") defrauded investors through the sale of unregistered securities tied to interests in real property.
More specifically, the SEC alleges that, since 2007, Defendants have defrauded thousands of investors by offering and selling approximately $50 million worth of general partnership units ("GP units")-i.e., interests in general partnerships organized by Defendants-without disclosing material facts regarding the true value of the underlying land, the mortgages encumbering the properties, and when ownership of the underlying land was actually transferred from Defendants to the general partnerships ("GPs").
The Court has entered a preliminary injunction and appointed Thomas C. Hebrank ("Receiver") as permanent receiver to operate and manage the affairs of Western, its subsidiaries, and the several general partnerships that Western formed in connection with the sale of the aforementioned interests in real property.
Before the Court is Defendants' Motion for Modification of the [March 13, 2013] Preliminary Injunction Order to Remove the Real Estate General Partnerships from the Receivership ("Motion to Modify"). (ECF No. 195.) Both the Receiver and the SEC have filed responses in opposition to the Motion to Modify. (ECF Nos. 206, 207.) Defendants have filed a reply in support of their Motion to Modify. (ECF No. 407.) The Receiver has filed a sur-reply in opposition to the Motion to Modify. (ECF No. 455.) In addition, the Court has received more than 220 letters from investors in support of Defendants' Motion to Modify and approximately five letters expressing dissatisfaction with Defendants.
Also before the Court is the Receiver's Report and Recommendations Regarding Valuation of Real Estate Assets of Receivership Entities ("Valuation Report"). (ECF No. 203.) Defendants have filed a response to the Valuation Report. (ECF No. 210.) The Receiver has filed a reply in support of the Valuation Report. (ECF No. 457.)
Lastly before the Court is the Receiver's Motion for Authority to Pursue Claims Against LinMar Borrowers ("Motion for Authority"). (ECF No. 192.) The LinMar Borrowers are entities controlled by Schooler that owe money to Western. Defendants have filed an opposition to the Receiver's Motion for Authority, (ECF No. 205), and the Receiver has filed a reply in support thereof, (ECF No. 359).
On July 26, 2013, the Court held a hearing on the above matters, at which counsel for Defendants, the Receiver, and the SEC appeared. Having considered the parties' submissions, the Receiver's submissions, the letters from investors, and the applicable law, and for the reasons that follow, the Court will GRANT IN PART and DENY IN PART Defendants' Motion to Modify, DECLINE TO APPROVE the Valuation Report, and GRANT the Receiver's Motion for Authority.
I. Legal Standards
A. Supervisory Power
"The Power of a district court to impose a receivership or grant other forms of ancillary relief... derives from the inherent power of a court of equity to fashion effective relief." SEC v. Wencke, 622 F.2d 1363, 1369 (9th Cir. 1980). The "primary purpose of equity receiverships is to promote orderly and efficient administration of the estate by the district court of the benefit of creditors." SEC v. Hardy, 803. F.2d 1034, 1038 (9th Cir. 1986). The court may therefore employ "reasonable procedures" to serve this purpose. Id.
"A district court's power to supervise an equity receivership and to determine the appropriate action to be taken in the administration of the receivership is extremely broad." SEC v. Capital Consultants, LLC, 397 F.3d 733, 738 (9th Cir. 2005). A district court's supervisory decisions are reviewed for an abuse of discretion. Id.
B. Notice to Non-parties
"It is well settled that property cannot be subjected to a court's judgment unless reasonable and appropriate efforts have been made to give the property owners actual notice of the action." In re San Vincente Med. Partners Ltd., 962 F.2d 1402, 1407 (9th Cir. 1992) (internal quotation omitted). "The Constitution requires that property owners receive procedural due process in the form of notice and opportunity for a hearing." Id. "Whether the opportunity for a hearing must be afforded before any preliminary deprivation of property interest depends on a balancing of interests." Id. A court need not "dwell on the timing of the hearing" where there is an opportunity for a hearing before any material deprivation of a property interest occurs. Id.
Further, where a general partner represents and receives notice for a limited partner, the entire enterprise is deemed to have received notice of a proceeding. Id. Indeed, where a limited partner receives notice at all stages of the receivership proceedings and has every opportunity to participate in the proceedings (by, for example, submitting objections and appearing at a hearing), the fact that the limited partner is not a named part in the proceedings does not violate due process. Id. at 1408.
In short, "a district court has the power to include the property of a non-party limited partnership in an SEC receivership order as long as the party meets the minimum contacts standard set out in International Shoe and receives actual notice and an opportunity for a hearing." Id. Due process is satisfied where a non-party is "sufficiently involved in the receivership action." Id.
II. Motion to Modify
A. Defendants' Arguments
Defendants argue the GPs "have been wrongfully pulled into the receivership imposed on Western." Defendants assert the GPs should be immediately removed from the receivership for thirteen reasons: (1) the GPs are wholly independent, free-standing, third-party entities; (2) to the extent Western owns any units in the GPs, those units are non-voting units; (3) the GPs have never been provided with the due process requirements of notice and an opportunity to be heard; (4) the receivership has taken away control and imposed unnecessary costs on investors; (5) there is no threat, danger, or risk to the GPs or to the GPs' land investments for which a receiver is necessary to protect the GPs; (6) neither the SEC nor the Receiver have identified any evidence of misappropriation of funds, commingling, or other financial mismanagement; (7) any speculative concern regarding potential mismanagement of the GPs relied on by the SEC in its TRO application has now been demonstrated to not exist; (8) the GPs merely hold raw land, and their operational needs are minimal; (9) the GPs have, through "partnership administrators, " successfully carried out their operational needs at the nominal cost of $100 to $400 per month, compared to the Receiver's fees of $250 per hour; (10) the Receiver has implicitly endorsed the ability of Western personnel to handle the GPs' operational affairs, as the Receiver has kept such personnel in place; (11) the Court's original goal of "locking down" all bank accounts and taking inventory of Western's financial affairs has been accomplished; (12) the Receiver has gone far beyond the Court's stated purpose for the receivership, which was to "clarify Western's financial affairs"; and (13) removal of the GPs from the receivership will not hinder or prejudice the SEC's ability to litigate its pending claims against Defendants.
Defendants argue any risk of foreclosure or other creditor actions against the GPs could be staved off because Western would still be able to make mortgage payments on behalf of the GPs by setting up an "automatic payment plan" whereby the GPs could repay money to Western that GPs borrowed from Western to finance the GPs' original purchase of property from Western.
B. Receiver's Response
In response, the Receiver first asserts that Defendants' Motion to Modify is based on several factual misstatements and provides no basis to modify the Preliminary Injunction Order. The Receiver asserts that, "[d]ue to Western's inability to make payments on loans secured by GP properties, the receivership and accompanying litigation injunction provide much needed protection to the GPs." The Receiver further notes that, because the GPs are under the sole management and control of the GPs, Defendants' basis for seeking relief on behalf of the GPs is unclear.
Regarding the factual misstatements, the Receiver first asserts that, contrary to Defendants' assertions, the Receiver has never suggested that the GPs be dissolved. Rather, as stated in the Valuation Report, the Receiver suggests that investors vote on selling or retaining properties. The Receiver further corrects Defendants' assertion that the Receiver unilaterally ordered appraisals of the GP properties, noting this Court approved such a course of action in approving the Receiver's Second Report. The Receiver further corrects Defendants' assertion that Western's financial health has no impact on the GPs, noting that Western is the borrower on loans secured by GP properties and that a failure by Western to make payments on these loans could result in foreclosure of GP properties.
Regarding the protection the receivership provides to the GPs, the Receiver asserts Western has run out of cash and is thus no longer able to keep all loans secured by GP properties current. The Receiver thus asserts that, "[w]ithout the protection of the receivership, these mortgage defaults would expose GPs to the risk of losing properties via foreclosure and other adverse actions by creditors."
The Receiver asserts that Western has historically played a significant role in the operation and financing of the GPs. Western has (1) financed investor purchases of ownership units and collected note payments on behalf of the GPs, (2) made payments on loans secured by GP properties, (3) made loans to the GPs to cover shortfalls when bills were sent to investors to cover GP operating expenses, and (4) repurchased ownership units from investors who demanded a return of their capital.
The Receiver asserts that, as set forth in the Valuation Report, investors should remain in the receivership while they are permitted to vote on (1) staying in the receivership, selling their property interests, and retaining any right to recover from the receivership estate or (2) separating from the receivership estate, relinquishing their claims against the receivership estate, and taking sole responsibility for all mortgages and expenses associated with retaining their property interests. The Receiver notes that, while the litigation injunction contained in the Preliminary Injunction Order currently protects the GPs from actions by creditors, decisions should be made as soon as possible to preserve whatever equity exists in the properties for the benefit of investors.
Regarding Defendants' argument that an automatic payment plan could be set up to ensure Western has enough capital to pay mortgages on GP properties, the Receiver asserts such a thing would not be possible. The Receiver asserts that, prior to his appointment, Western was actively collecting loan payments from investors and was still unable to make mortgage payments and pay its operating expenses without constant cash infusions from Schooler. The Receiver further notes that some investors now refuse to repay amounts they borrowed from Western to purchase GP units, given the SEC's pending fraud allegations. The Receiver further notes that some of the GP accounts already had a zero balance at the time he was appointed. The Receiver thus asserts that, if remaining balances in other GP accounts are used to make loan payments to Western, investors will be directly harmed because no funds would remain to pay taxes, insurance, and other GP expenses.
The Receiver asserts Western's cash shortage is a direct result of Schooler draining Western's cash reserves prior to the receivership, refusing to put cash back into Western, and failing to repay loans Western made to entities he controls (namely, the LinMar Borrowers). As an example, the Receiver notes that Western raised approximately $80 million from investors in the forty-six GPs that purchased interests in Western's final thirteen land transactions, but that Western had virtually no cash when the Receiver was appointed. Of that $80 million, the Receiver asserts large sums were paid to Schooler and more than $1.26 million was loaned to the LinMar Borrowers. The Receiver thus asserts that, contrary to Defendants' assertions that the receivership has depleted Western's cash, it was Schooler who starved Western of cash thereby necessitating a reduction of Western's equity interests in the GPs. The Receiver asserts he has paid for receivership fees by reducing Western's equity interests (dollar for dollar) in various GPs in the total amount of $51, 001.
C. SEC's Response
The SEC also responds to Defendants' Motion to Modify. The SEC argues "the receivership remains necessary because the GPs have depended on, and continue to depend on, Western to manage the GPs, including the payment of mortgages and property taxes." The SEC asserts Western, under the control of Schooler, effectively functioned as the GPs' manager while the GPs were little more than limited partners. The SEC asserts that Schooler ensured Western paid the mortgages on the GP properties each month, that Schooler's employees conducted administrative tasks and acted as contact points for investors seeking information regarding their particular GPs, and that Schooler was expected to ultimately find purchasers for the GP properties and to negotiate any terms of sale.
The SEC asserts that, in addition to managing the GPs, Western used investor funds to pay its own expenses for months, and sometimes years, prior to deeding any land to the GPs. The SEC further asserts that, contrary to Defendants' claims that the GPs are not defendants' alter egos, that "[t]here is no allegation that corporate forms have been disregarded, " and that "there is no overlap in management or control between Western and the GPs, " the SEC did in fact allege that corporate forms were disregarded. The SEC asserts the Receiver's Initial and Second Reports have proven the SEC's allegations as correct. As an example, the SEC specifically notes that the investors in F-86 Partners (the GP offering ongoing at the time the SEC filed its Complaint), have been left with next to nothing in their GP account and have never been deeded the interest in land that Western promised them. The SEC argues that, "[d]espite defendants' desperate attempts to paint the GPs as wholly ...