Day Care–Sam Furr, LLC v. Ross (In re Ross)

478 B.R. 715

In re Jeffrey C. ROSS, Sr., Debtor.Day Care–Sam Furr, LLC and Carol McKinnell, Plaintiffs,

v.Jeffrey C. Ross, Sr., Defendant.

Bankruptcy No. 11–30812.

Adversary No. 11–03147.

United States Bankruptcy Court,

W.D. North Carolina,

Charlotte Division.

Sept. 11, 2012.

Richard B. Fennell, James, McElroy & Diehl, PA, Charlotte, NC, for Plaintiffs.

Dennis M. O'Dea, SFS Law Group, Matthews, NC, for Defendant.

MEMORANDUM OF DECISION

J. CRAIG WHITLEY, Bankruptcy Judge.

In this action Plaintiffs Day Care–Sam Furr, LLC (“Day Care”) and Carol McKinnell (“McKinnell”) (collectively “Plaintiffs”) seek to establish a debt owed them by Defendant/Debtor Jeffrey C. Ross, Sr. (“Ross”) and further, to obtain a declaration that the obligation is non-dischargeable in bankruptcy under Section 523(a)(2) (false pretenses, false representations and fraud), Section 523(a)(4) (fiduciary defalcation/fraud) and Section 523(a)(6) (willful and malicious injury). A trial was held on June 4, 2012. John R. Buric and John R. Brickley represented the Plaintiffs; Dennis O'Dea appeared on behalf of Ross.

Held: As described herein, Ross used his personal relationship with McKinnell to induce her to fund Day Care in order that it could acquire and hold a property that he wished to ultimately purchase under a Section 1031 “like kind” exchange with another of his properties (Community House). Thereafter, he encouraged McKinnell to have Day Care obtain a line of credit on the representation that this lending facility would be used to improve Day Care's property. However, without McKinnell's knowledge or consent, Ross immediately drew down on Day Care's line of credit and used $220,000 of the proceeds to pay a personal debt. He successfully concealed his misuse of the loan proceeds from Plaintiffs for the ensuing two years.

Ross not only breached his agreements with McKinnell and/or Day Care, his misuse of the proceeds from the letter of credit conduct constitutes willful conversion and fraud under North Carolina law. Thus, Plaintiffs are entitled to recover their actual damages, punitive damages, costs, and interest from Ross. Further, these obligations are non-dischargeable in bankruptcy under Sections 523(a)(2), (a)(4) and (a)(6).

I. FACTUAL AND PROCEDURAL BACKGROUND

In early 2006, Ross was in negotiations to purchase a 19–acre tract of land located in Huntersville, NC (the “Sam Furr property”). Ross hoped to construct a “build to suit” day care facility on a portion of that property for lease to Nobel Learning Communities, Inc. (“Nobel”).¹ At the time, Ross owned another parcel of real property located on Community House Road, in Charlotte, NC (the “Community House property”). Originally, Ross tried to interest Nobel in the Community House property, but Nobel found the tract too small for its purposes. Ross then located the Sam Furr property for Nobel and put the Community House property up for sale.

By April 2006, Ross had a contract on the Community House property and had accepted a substantial good faith deposit from Parks Hunter (“Hunter”), the prospective purchaser. However, Hunter was not ready to close. This delay created problems for Ross who needed to purchase the Sam Furr property for his prospective deal with Nobel. Ross could not afford to buy the Sam Furr property until he sold the Community House property.

After a third party declined to lend Ross the money to acquire the Sam Furr property, he attempted to borrow the money from McKinnell, his long time girlfriend. If McKinnell would advance the $475,000 purchase price, upon completion of the day care project, Ross promised to return McKinnell's advance and pay her a fixed $125,000 return.

McKinnell was a divorced homemaker with teenage children. Her primary asset was her home, which she owned free and clear of liens. McKinnell was interested in Ross's proposal, thinking this would provide her a return on her equity and thereby afford her greater financial independence from her ex-husband. However, McKinnell had no experience in business, let alone real estate development. Thus, she was reluctant to incur debt on her home in order to loan Ross the Sam Furr property purchase money.

Hoping to persuade McKinnell, on or about April 13, 2006, Ross took her to meet with his attorney, Joseph Tissue (“Tissue”). Tissue had been working with Ross on both the Community House property and the Sam Furr property/Nobel deals. At that meeting, Ross and Tissue made a second proposal to McKinnell whereby the parties would employ a limited liability company to acquire and develop the Sam Furr property. As proposed, Ross would own 90% of the LLC and serve as its manager. McKinnell would own 10%, despite the fact that she would be contributing all of the capital by which the LLC would purchase the Sam Furr property. Ross once again proposed to pay McKinnell a flat $125,000 return for use of her money, with the further offer that the LLC would cover debt service on her home loan. Anticipating McKinnell's agreement, Tissue formed Day Care in April 2006.

However, obtaining McKinnell's agreement proved not to be so simple. In addition to her unfamiliarity with real estate development, McKinnell did not want to contribute capital to an LLC that she did not control—particularly since she was going to have to mortgage her house to obtain her investment money. She did not accede to Ross's second proposal.

Discussions between Ross and McKinnell concerning the day care development continued over the summer. Agreement was reached only when Ross offered to make McKinnell the sole member, manager and registered agent of Day Care in exchange for her capital contribution to the LLC and the remainder of their agreement. This satisfied McKinnell's control issue and she agreed to fund Community House and thereby the Sam Furr property purchase.

By this point, Ross and Tissue had added an additional wrinkle to the deal. They hoped to shield Ross's prospective gain on the Community House property sale from taxation through use of an IRC Section 1031 “like kind” exchange. Ross originally sought a loan from McKinnell so he, Ross, could buy the Sam Furr property. Now it was necessary that a third party acquire the tract and hold it until Ross could close the Community House property sale. Ross would then be in a position “swap” his Community House property proceeds for the Sam Furr property.² Because McKinnell owned Day Care, Tissue deemed it to be a suitable “accommodation party” for tax purposes. Having a LLC hold title to the Sam Furr property would shield McKinnell from personal liability for the LLC's debts.

The arrangement was implemented on August 30, 2006 at Tissue's office. Day Care's Articles were amended to make McKinnell its sole member. Tissue closed a home equity line for McKinnell, and she borrowed $575,000 against her home to fund her capital contribution to Day Care.

Ross and McKinnell then executed two agreements prepared by Tissue to memorialize their arrangement. First, the parties signed a Real Estate Acquisition and Qualified Exchange Accomodation (sic) Agreement (the “Accommodation Agreement”). The Accommodation Agreement provided that McKinnell ³ would purchase and hold the Sam Furr property until Ross sold the Community House property. At that time, Ross would purchase the Sam Furr property from McKinnell as a Section 1031 replacement property. Ross testified at his deposition that he intended to be bound by this document.

Second, Ross and Day Care (acting through McKinnell), executed a Project Management Agreement for Qualified Exchange Accomodation (sic) Arrangement (the “Management Agreement”). The Management Agreement governed the relationship between Ross and Day Care with respect to the Sam Furr property. It gave Ross certain rights, such as managing improvements to the property and hiring the professionals to do the work. Ross testified at his deposition that he understood the Managing Agreement, and intended to be bound by it.

The two Agreements were not specific as to the compensation and division of profits. Notably, the Management Agreement did not give Ross the right to any compensation for his efforts. Ross and McKinnell never discussed Day Care payingRoss for any work that he may perform on its behalf.

Further, and unlike Ross's prior offers to McKinnell to pay her a fixed $125,000 return for the use of her money, the Acquisition Agreement also did not provide McKinnell a profit when the Qualified Exchange was made. Rather, she would receive only the return of her investment, costs and interest paid to her lender. See Accommodation Agreement 2.3.1. However, if Ross failed to complete the swap within 180 days of the Sam Furr property purchase (not the swap property), Day Care (McKinnell) was entitled to retain the Sam Furr property and claim against Ross for any resulting loss.

Ross says there was a further, unwritten agreement that when the Sam Furr property was leased or sold, McKinnell was to be reimbursed her costs and receive a $125,000 profit. Anticipating that he and McKinnell would be married by this point, Ross says the profits over and beyond this amount were to be shared. McKinnell denies his assertion, and it appears this was an understanding in Ross's mind only and an amorphous one at that.⁴ The Project Management Agreement contains a merger clause (Par. 12) while the Acquisition Agreement specifically prohibits verbal, unsigned amendments. See Par. M. Ross says he realized at some point that the written documents did not include their (his) oral understanding about the division of profits, but he never asked Tissue to correct that oversight, if that is what it was. As such, the two written documents comprise the parties' entire agreement.

Under those written agreements, Ross stood to profit (vis-à-vis McKinnell), if he completed the swap. He would acquire the Sam Furr property by virtue of what is essentially an interest free loan from McKinnell. If...