Holtschlag v. Colony Am. Fin. Lender (In re Mack Indus.)

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IN RE MACK INDUSTRIES LTD., et al., Debtors.

ARIANE HOLTSCHLAG, as Chapter 7 Trustee for Mack Industries II LLC, et al., Plaintiff-Appellants, v. COLONY AMERICAN FINANCE LENDER LLC, CAF REO-1 LLC, and Mack LOC I LLC, Defendant-Appellees.

No. 22 C 606

Bankruptcy No. 17-09308

United States District Court, N.D. Illinois, Eastern Division

March 7, 2024

CAROL A. DOYLE, JUDGE

MEMORANDUM OPINION AND ORDER

REBECCA R. PALLMEYER, UNITED STATES DISTRICT JUDGE

Ariane Holtschlag^[1] is the Chapter 7 Trustee for three debtors: Mack Industries II LLC (“Mack II”), Mack Industries V LLC (“Mack V”), and Mack Industries VI LLC (“Mack VI”) (collectively “Transferring Debtors”). All three of these entities are subsidiaries of Mack Industries, Ltd. (“Mack”), which is also in bankruptcy. The Trustee brought this action against a corporate lender Colony American Finance Lender LLC n/k/a CoreVest American Finance Lender (“Colony”), and two of Colony's subsidiaries-CAF REO-1 LLC (“CAF”) and Mack LOC I LLC (“LOC I”)-challenging certain transfers of real property from the Transferring Debtors to LOC I as fraudulent. The Trustee seeks to recover from Colony the value of the purported fraudulent transfers under Section 550(a) of the Bankruptcy Code or, in the alternative, under a veil-piercing theory that LOC I (and its intermediate parent CAF) are alter-egos of Colony. The bankruptcy court dismissed Holtschlag's complaint against Colony and CAF and entered a final and appealable judgment in these Defendants' favor. For the reasons explained here, the bankruptcy court's ruling is affirmed.

BACKGROUND

I. Factual Background

The following alleged facts are drawn from the Trustee's second amended complaint. (Trustee's Second Am. Compl. (“SAC”), Bankruptcy Record [9-2] (“Bankr. R.”) at 258-306.) Mack Industries was founded in 1998 and owned by James K. McClelland. (Id. ¶¶ 6-7.) One of Mack's lines of business was to acquire distressed real estate, rehab it, and then sell or rent it to generate income. (Id. ¶ 8.)

In connection with this business, Mack obtained loans from FirstMerit Bank N.A. (“FirstMerit”), secured by mortgages on real property. (Id. ¶ 25.) By 2012, Mack was in default on these loans; Mack had failed to pay real-estate taxes on the properties, as required by the loan terms, and did not cure the default after being notified. (Id. ¶ 26.) On August 23, 2012, FirstMerit filed a 130-count lawsuit against Mack and James McClelland seeking more than $7.2 million on 65 promissory notes and associated guarantees. (Id. ¶ 24.)

In December 2012, while the FirstMerit litigation was ongoing, Mack entered a Master Lease Agreement with American Residential Leasing Company LLC (“AR”). (Id. ¶ 14.) Under this agreement, Mack leased several hundred residential properties from AR that were then subleased to residential tenants. (Id. ¶¶ 15, 17.) Mack was obligated to maintain the leased properties, pay AR rental fees, and pay all property taxes for the leased properties. (Id. ¶ 17.) Between December 2012 and January 2014, Mack and AR amended this agreement twenty times, adding additional properties to the portfolio. (Id. ¶ 16.)

On January 17, 2013, FirstMerit filed an amended complaint against Mack adding foreclosure counts on the properties that secured the FirstMerit loan. (Id. ¶ 27.) Mack was able to avoid foreclosure, however, by selling the collateral and other properties owned by McClelland-affiliated business entities to AR in March 2013. (Id. ¶ 28.) After the sale, these properties were added to the Master Lease Agreement between AR and Mack, and Mack managed the properties under the Agreement. (Id. ¶ 29.) In light of Mack's loss of ownership over these properties, and its past inability to pay the real estate taxes on the properties, it was clear that the McClellands would face difficulty performing on the American Residential agreement. (Id. ¶¶ 30-31.)

Indeed, by the summer of 2014, Mack informed AR that it was incapable of meeting its obligations under the Master Lease Agreement and asked AR to renegotiate the Agreement's terms. (Id. ¶¶ 34-35.) During the ensuing negotiations, the Trustee alleges, representatives of Mack made statements revealing an intent to engage in fraudulent conduct if AR did not agree to Mack's proposed renegotiation terms.^[2](Id. ¶ 37.) Mack and AR were unable to agree on a modification to the Master Lease Agreement. (Id. ¶ 40.) By September 2014, Mack had stopped making its monthly rental payments to AR and stopped paying property taxes on AR's property as required under the Master Lease Agreement. (Id. ¶¶ 42, 43.) AR estimates that Mack owes more than $4.7 million in unpaid rent and $6.5 million in property taxes. (Id.) After June 2014, Mack also stopped providing AR with quarterly income statements-another violation of the Master Lease Agreement. (Id. ¶ 64.) On December 2, 2014, AR sent Mack a notice of default. (Id. ¶ 44.) On March 21, 2016, AR filed a complaint against Mack in Illinois state court for injunctive relief against Mack's conduct, damages for breach of the Master Lease Agreement, and entry of an order of prejudgment attachment to prevent Mack from further dissipating its assets. (Id. ¶ 72; see Compl. for Inj. and Other Relief [1], Am. Residential Leasing Co., LLC v. Mack Indus., Ltd., No. 2016-CH-03970 (Ill. Cir. Ct. Mar. 21, 2016).)

The Trustee alleges that between 2013 and 2017, the McClelland family made good on their threat by engaging in a systematic scheme to shield Mack's assets from AR and other creditors. This scheme included drawing down Mack's assets to pay the McClelland family's personal expenses and obligations, as well as funneling Mack's business and assets into a number of newly created business entities-some owned by Mack itself, and others by the family directly. (Id. ¶¶ 54-62, 76-83.) Through these actions, the McClellands were able to extract at least $10.7 million from Mack and its related companies, even as they claimed Mack could not satisfy its obligations to AR. (Id. ¶ 61.) Of particular importance here, the Trustee claims that the McClellands caused Mack to transfer real estate to these other affiliated entities-including the Transferring Debtors at issue in this case-during this period. (Id. ¶ 76(h).)

Throughout 2013 and into 2014, the McClelland family formed nineteen new business entities, including the three Transferring Debtors Mack II (created on February 28, 2013), Mack V (created on November 21, 2013), and Mack VI (created April 30, 2014). (Id. ¶¶ 50-51.) Mack was the sole owner of these entities. (Id. ¶ 51.) The Trustee alleges that Mack caused the Transferring Debtors to acquire hundreds of properties to renovate and resell. (Id. ¶ 56.) It is unclear as to when, with what funds, and from whom, these acquisitions took place. Although Mack itself owned some real estate after 2013, the Trustee alleges that most of the real estate acquired in and after 2013 was acquired by the Transferring Debtors and not by Mack. (Id. ¶ 55.) The Trustee alleges that the McClellands acquired real estate in the name of the new business entities and transferred real estate owned by Mack to these new entities, including the Transferring Debtors, thereby reducing the assets that could be collected by AR and Mack's other creditors. (Id. ¶ 57.)

On November 24, 2015, almost a year after AR sent Mack a notice of default under the Master Lease Agreement, the McClellands organized Mack LOC I LLC (“LOC I”). (Id. ¶ 97.)

Unlike the Transferring Debtors, LOC I was owned by James McClelland individually (not by Mack) through an intermediate entity, Mack LOC III LLC (“LOC III”)-presumably organized at some point after LOC I, though the complaint does not make this clear. (Id. ¶ 99.) LOC I, like the other McClelland-affiliated entities, was engaged in real-estate transactions. On or around December 29, 2015, LOC I entered into a revolving loan agreement with yet another lender, Colony American Finance, in which Colony provided funds for LOC I to acquire and renovate real estate, in an amount up to $15 million (later increased to $30 million). (Id. ¶¶ 103-04.) This loan was secured by a lien on LOC III's ownership interest in LOC I and by real estate acquired by LOC I. (Id. ¶¶ 105-06.)

In eight transactions between April and October 2016, the three Transferring Debtors transferred a total of 169 properties to LOC I: 152 properties from Mack II, 14 from Mack V, and three from Mack VI. (Id. ¶¶ 108, 115.) The Transferring Debtors held an average of 30% equity in the transferred properties that were encumbered by preexisting mortgages, while others had no prior valid mortgages and had their entire value transferred to LOC I. (Id. ¶¶ 111-12.) For each of these eight transactions, Colony (a) advanced a portion of the revolving $30 million loan, (b) agreed that prior mortgages on the properties would be paid and released (presumably by LOC I using the advanced funds, though the complaint does not make this clear), and (c) took back mortgages on the properties transferred to LOC I by the Transferring Debtors as security for the loans. (Id. ¶ 115.)

In her complaint, the Trustee alleges that Colony purposefully structured these transactions to prevent anyone else including Mack's and the Transferring Debtors' creditors, from seizing the assets at issue. (Id. ¶ 101.) The transactions would not have occurred, she claims, if Colony had not advanced a portion of the loan amount, helped pay off the mortgages, and taken on new ones. (Id. ¶ 116.) She contends, further, that the Transferring Debtors did not receive any value in exchange for transferring the property to LOC I and were insolvent when they made the transfers. (Id. ¶¶ 161-62.) According to the complaint, Colony “received far more than it...