United States District Court, D. Nevada
IN RE R & S ST. ROSE LENDERS, LLC Debtor.
R & S ST. ROSE LENDERS, LLC, et al., Appellants. BRANCH BANKING AND TRUST, Appellant,
OPINION AFFIRMING THE BANKRUPTCY COURT'S ORDER
DENYING SUBSTANTIVE CONSOLIDATION
P. GORDON UNITED STATES DISTRICT JUDGE.
Branch Banking and Trust (BB&T) and Commonwealth Land
Title Insurance Company (Commonwealth) appeal the bankruptcy
court's order denying their request to substantively
consolidate the bankruptcy estates of debtors R & S St.
Rose Lenders, LLC (Lenders) and R & S St. Rose, LLC (St.
Rose). Substantive consolidation is an equitable tool that
allows a bankruptcy court to combine the assets and
liabilities of separate but related legal entities into a
single pool from which all claims against the consolidated
debtors are satisfied and inter company claims are
extinguished. The upshot in this case is that if Lenders'
and St. Rose's estates are substantively consolidated, an
inter-company secured debt of $12 million would be
extinguished, putting BB&T in first priority position to
recover the proceeds from a sale of property in St.
Rose's estate. If substantive consolidation is denied,
Lenders' estate, against which BB&T has no claim,
would receive the sale proceeds.
Ninth Circuit adopted a two-factor test in In re
Bonham to guide the determination of whether substantive
consolidation is appropriate. Under the Bonham
factors, the bankruptcy court considers: “(1) whether
creditors dealt with the entities as a single economic unit
and did not rely on their separate identity in extending
credit; or (2) whether the affairs of the debtor are so
entangled that consolidation will benefit all
creditors.” 229 F.3d 750, 766 (9th Cir. 2000). The
bankruptcy court previously denied substantive consolidation
under both factors. On a prior appeal, the district court
affirmed denial of consolidation under the second factor but
remanded for reconsideration under the first factor. After
holding an evidentiary hearing, the bankruptcy court again
denied substantive consolidation. BB&T and Commonwealth
appeal that second denial. I affirm the bankruptcy
court's order denying substantive consolidation.
facts are largely undisputed. Debtors Lenders and St. Rose
are owned and operated (through intermediary companies) by
Saiid Forouzan Rad and R. Phillip Nourafchan. Rad and
Nourafchan formed St. Rose for the sole purpose of acquiring
a piece of property in Henderson, Nevada, which they planned
to sell within a year to Centex Homes. They formed Lenders
for the sole purpose of creating an entity through which
private individuals could loan money to St. Rose to help
purchase the property.
2005, St. Rose purchased the property through a $29 million
loan from Colonial Bank, N.A. (the “Acquisition
Loan”). This loan was secured by a first deed of trust
encumbering the property. Rad and Nourafchan personally
guaranteed the Acquisition Loan.
complete the purchase, St. Rose also received a $12 million
loan, purportedly from Lenders. This loan was evidenced by a
promissory note and secured by a second position deed of
trust on the property (the “Lenders DOT”).
Although the loan nominally was from Lenders, at that time
Lenders had no assets, no separate books and records, and no
bank account. Instead, Rad and Nourafchan obtained the funds
through loans from their friends and family. The individual
lenders' checks to fund the $12 million loan were not
made out to Lenders. Instead, the checks were made out to St.
Rose or another entity of Rad and Nourafchan's, R & S
Investment Group, LLC. St. Rose deposited the funds into its
bank accounts or directly into escrow. Lenders issued
promissory notes to the individual lenders. Despite
Lenders' obligation to pay interest under the promissory
notes, from 2005 to 2008 St. Rose made the interest payments
to the individual lenders. St. Rose (and not Lenders) also
issued tax forms to the individual lenders showing the
interest payments. The promissory note between Lenders and
required St. Rose to make annual interest payments to
Lenders, but St. Rose never made those payments. The Lenders
DOT secured the $12 million promissory note, but the
individual lenders actually advanced over $19 million to St.
chose not to buy the property. St. Rose and Colonial Bank
executed a modification of the Acquisition Loan to extend the
maturity date. As a condition of that modification, Colonial
Bank required Lenders to subordinate the Lenders DOT. Lenders
did so, and both the modification and the subordination
agreements were recorded.
Rose and Colonial Bank subsequently took a second loan from
Colonial Bank for approximately $43 million (the
“Construction Loan”). This loan was intended to
pay off the Acquisition Loan and to construct improvements on
the property. The loan was secured by a deed of trust on the
property and by Rad and Nourafchan's personal guarantees.
Colonial Bank expected that it would obtain a first position
deed of trust on the property to secure repayment of the
Construction Loan. Colonial Bank's escrow instructions to
Nevada Title Company required a first position deed of trust
and conditioned disbursements under the loan on Colonial Bank
having a first position deed of trust. To obtain that first
position, Lenders would have had to agree to subordinate the
Lenders DOT to the Construction Loan deed of trust.
Commonwealth issued title insurance to Colonial Bank for the
2008, the project was failing and Colonial Bank commenced
foreclosure on the property under the Construction Loan deed
of trust. During this process, it was discovered that the
Lenders DOT was in first priority position because it had
never been subordinated or reconveyed even though that was a
requirement of the Construction Loan's escrow and
funding. On July 9, 2008, Nevada Title sent an email to Rad
requesting reconveyance of the Lenders DOT. Rad did not
execute the subordination agreement and instead asked Nevada
Title what position the Lenders DOT was on the property.
Nevada Title responded on September 5, 2008, informing Rad
that the Lenders DOT was in priority position over the
next business day, Lenders created a separate balance sheet
and shortly thereafter obtained a bank account for the first
time. Additionally, St. Rose and Lenders' financial
records were updated to reclassify the debt owed to the
individual lenders that previously was booked to St. Rose to
instead be reported as Lenders' obligation. Tax
liabilities also were shifted from St. Rose to Lenders.
2009, Colonial Bank went into receivership and BB&T
became its successor in interest. In 2011, Lenders and St.
Rose filed separate petitions for bankruptcy. BB&T and
Commonwealth moved for substantive consolidation of the two
debtors' cases. The bankruptcy court denied the motion.
As to the first Bonham factor, the bankruptcy court
found that the debtors “are clearly related entities,
and as they acknowledge, it is apparent that they were sloppy
with certain corporate formalities during the period in which
the underlying business transactions transpired.” ECF
No. 34 at 86. The bankruptcy court nevertheless concluded
that Colonial Bank did not treat the debtors as a single
economic unit when it entered into the Construction Loan. In
reaching that conclusion, the bankruptcy court adopted
findings made by a Nevada state court in separate litigation.
Id. at 86-87. The bankruptcy court also found that
BB&T did not meet its burden of showing that the
individual lenders dealt with St. Rose and Lenders as a
single economic unit. According to the bankruptcy court,
BB&T's evidence was based on assumptions about what
the individual lenders thought when they sent their payments
to St. Rose instead of to Lenders and when they accepted the
interest payments from St. Rose instead of from Lenders.
Id. at 87. The court therefore held BB&T had not
shown Colonial Bank or the individual lenders treated the
debtors as a single economic unit. Id.
the second Bonham factor, the bankruptcy court held
that BB&T had not shown that the two debtors' affairs
were so entangled that consolidation would benefit the
creditors because the entities divided their assets in 2008,
and thus separation of the two entities' assets had
already occurred. Id. at 88. Finally, the bankruptcy
court concluded that substantive consolidation would not be
in the best interest of all creditors, as BB&T was
attempting to use it as a means to undermine the state
court's factual finding that the Lenders DOT was in a
priority position over the Construction Loan deed of trust.
Id. at 89. The bankruptcy court therefore denied
substantive consolidation. Id.
and Commonwealth appealed that denial. In the meantime, the
bankruptcy court approved the sale of the property for
approximately $13 million. St. Rose's bankruptcy plan,
which the bankruptcy court had confirmed, provided for
payment of the sale proceeds to Lenders as the first priority
position on the property.
District Judge Lloyd George remanded the bankruptcy
court's order denying substantive consolidation with
instructions to decide whether consolidation was warranted
under the first Bonham factor. Judge George affirmed
the bankruptcy court's ruling that the second
Bonham factor did not support substantive
consolidation. However, Judge George found the bankruptcy
court made two errors related to the first Bonham
factor. First, he concluded the bankruptcy court erred by
relying on a finding of fact by the state court; he remanded
for reconsideration of the first Bonham factor
“without reliance on or reference to the state court
order.” ECF No. 34 at 137-38. Second, Judge George
found the bankruptcy court erred by discounting
BB&T's evidence about how the individual lenders
treated the debtors. He took issue with the bankruptcy
deeming BB&T's arguments merely “assumptions .
. . based on conjecture, ” rather than reasonable
inferences from the evidence. Id. 138-39. Judge
George thus remanded for the bankruptcy court to resolve
whether BB&T and Commonwealth “met their burden
under the first Bonham factor as it concerns all
creditors, not merely Colonial Bank.” Id. at
Judge George addressed the purpose substantive consolidation
would serve. Id. He stated that “the sole aim
of substantive consolidation is fairness to all creditors;
the equitable treatment of all creditors.” Id.
That does not mean the “best interest of all of the
creditors, but an equitable treatment of and fairness to all
creditors.” Id. He noted that the best
interest of some creditors may be to receive treatment that
is unfair to other creditors, but substantive consolidation
is concerned with the equitable treatment of all creditors.
“Such inequitable treatment can arise through the
continued recognition of a claim created between entities
when both entities ...