In re Vaughan Co.

543 B.R. 325

In re: The Vaughan Company, Realtors, Debtor.

11–10–10759 JA

United States Bankruptcy Court, D. New Mexico.

Signed December 21, 2015

The Vaughan Company, Realtors, pro se.

AMENDED¹ MEMORANDUM OPINION REGARDING CONFIRMATION OF THE SECOND AMENDED PLAN

ROBERT H. JACOBVITZ, United States Bankruptcy Judge

Judith Wagner, Chapter 11 Trustee ("Trustee") of the estate of The Vaughan Company, Realtors ("Debtor" or "VCR") seeks confirmation of a Chapter 11 plan. The Court held a final confirmation hearing on November 20, 2015 and took the matter under advisement. VCR defrauded hundreds of innocent investors through its promissory note program which paid earlier investors with funds contributed by later investors. Through her plan, the Trustee seeks to effectuate a "rising tide" distribution method because she believes that type of distribution method is the most equitable way to distribute limited funds among investors defrauded by the scheme. The Unsecured Creditors' Committee objected to confirmation, asserting that the "rising tide" distribution method fails to comply with the confirmation requirements under the Bankruptcy Code. After carefully reviewing the applicable Bankruptcy Code sections in light of the relevant case law and the parties' arguments, the Court concludes that the plan is not confirmable.

BACKGROUND AND PROCEDURAL HISTORY

The Debtor commenced this voluntary Chapter 11 case on February 22, 2010. See Voluntary Petition (Docket No. 1). On the same date VCR's principal shareholder and president, Douglas F. Vaughan, commenced a personal Chapter 11 case (Case No. 10–10763). On March 23, 2010, the Securities and Exchange Commission ("SEC") filed a civil complaint against Mr. Vaughn and VCR in the United States District Court for the District of New Mexico alleging violations of federal securities laws (See D.N.M., Case No. 1:10–cv–00263–MV–WPL). The SEC alleged in its complaint that Mr. Vaughan perpetrated a fraudulent scheme by causing VCR to offer investors promissory notes bearing high, fixed rates of interest (the "Note Program"), which Mr. Vaughn falsely represented would be paid with profits generated by VCR.

In light of the SEC's civil suit against Mr. Vaughan and VCR, the United States Trustee ("UST") moved the Court for the appointment of a Chapter 11 Trustee or, alternatively, for the case to be converted to a case under Chapter 7 of the Bankruptcy Code (Docket No. 163). On April 26, 2010, the Court entered a stipulated order directing the UST to immediately appoint a Chapter 11 Trustee (Docket No. 185). Three days later, on April 29, 2010, the Court approved the UST's application to appoint Judith A. Wagner as Chapter 11 Trustee (Docket No. 195).

FINDINGS OF FACT

The Court makes the following findings of fact:

1. The Ponzi Scheme

VCR operated a legitimate real estate development and real estate brokerage business. VCR initiated its Note Program in or around 1993. Mr. Vaughan induced persons to invest in the Note Program by offering high rates of interest, claiming their investments would be used for legitimate business activities, and misrepresenting the safety of the Note Program. VCR operated its Note Program as a Ponzi scheme since at least 2005 but probably from a much earlier date. While operating the Note Program as a Ponzi scheme, VCR made payments to investors under the Note Program with funds it received from new Note Program investors. By 2009, VCR owed almost $75 million to investors under the Note Program. Because of the fungible nature of money and the vast commingling of VCR's funds, it was not possible to trace an investor's funds after VCR deposited the funds in its bank account.

2. Fraudulent and Preferential Transfer Actions and Estate Assets

The Trustee aggressively asserted preferential and fraudulent transfer actions. She filed 167 adversary proceedings. In the large majority of those adversary proceedings, the Trustee asserted fraudulent transfer claims against investors in the Note Program. The Trustee negotiated court approved settlements or obtained judgments in almost all of the adversary proceedings. Most of the funds in the estate available for distribution to creditors are attributable to recoveries in those adversary proceedings. The Trustee collected many of the judgments and settlements she obtained on the estate's behalf, and is in the process of determining collectability of the few that remain.

The estate has estimated cash on hand, as of November 19, 2015, of $3,742,894.15. The estate is likely to receive an additional $400,000.00 by the end of 2015 from a settlement of the estate's claims against U.S. Title Insurance. Upon receipt of these additional funds, the estate's estimated cash on hand will increase to $4,142,894.15 less any further amounts expended prior to receipt of the funds. In addition to its cash on hand, the estate currently holds title to approximately 84 acres of land received in a settlement of a fraudulent transfer action brought by the Trustee. This land is currently listed by the estate's realtor for $420,000.00.

3. Equity Holders.

On the petition date, VCR had two shareholders, Jim Salazar and Mr. Vaughan. Mr. Salazar held a 15% interest and Mr. Vaughan held an 85% interest. Mr. Vaughn forfeited all his shareholder interest in VCR in a plea agreement he made with the United States Attorney. See United States v. Vaughan, D.N.M., Case No. 11–cr–404–BB, Docket No. 125, p. 7, ¶ 14. Mr. Salazar assigned his shareholder interest to the VCR bankruptcy estate pursuant to a settlement agreement of the estate's claims against him. Accordingly, the only remaining shareholder interest in VCR is property of the bankruptcy estate.

4. The Plan

On March 11, 2015, the Trustee filed her Plan of Liquidation Dated March 11, 2015 (Docket No. 2053). The Trustee filed two amendments to the plan, one on April 30, 2015 (Docket No. 2174) and the other on July 21, 2015 (Docket No. 2469). The Chapter 11 Trustee's Second Amended Plan of Liquidation Dated July 21, 2015 (Docket No. 2469) (the "Plan") is the plan presently before the Court for confirmation. The Court entered an order approving the Disclosure Statement for the Plan (Docket No. 2470) on July 24, 2015 (Docket No. 2473). No other parties have filed a plan.

Classes

The Plan divides claims against the estate and interests into five separate classes: secured claims; priority unsecured claims; general unsecured claims/trade vendors; restitution claims; and shareholder interests. Class 1 consists of all secured claims, and Class 2 consists of all claims entitled to priority under 11 U.S.C. § 507(a) (excluding administrative expense and priority tax claims). While the Plan proposes to pay all Class 1 and Class 2 claims in full, there are currently no allowed Class 1 claims, and all allowed Class 2 claims have been paid in full. Class 3 consists of all allowed unsecured claims that are neither entitled to priority under 11 U.S.C. § 507(a) nor "Restitution Claims," as defined in the Plan. The total amount of allowed Class 3 claims is $300,615.12. The Plan proposes to pay thirty-five percent (35%) of each allowed Class 3 claim, or $105,215.29 total.

Class 4 Restitution Claims

Class 4 consists of all "Restitution Claims," which are defined in the Plan as (a) unsecured, non-priority claims filed in the case by persons who invested in the Note Program, limited to the amount of the restitution claimant's principal investment less any funds paid pre-petition by VCR to or for the benefit of the restitution claimant, except claims that have been fixed by settlement agreement or court order; and (b) Informal Restitution Claims. An Informal Restitution Claim is an investor claim proof of which was timely filed in Mr. Vaughn's Chapter 11 case but not in the VCR case, and which would have been a valid allowable claim against VCR's bankruptcy estate if timely filed in the VCR case.

Holders of Restitution Claims ("Restitution Claimants") in Class 4 consist only of those investors who, as of the petition date, received less from VCR than the principal amount they invested under the Note Program VCR operated as a Ponzi scheme. Investors who received all or more than the amount of their principal investment do not have allowed claims under the Plan.² Unless a claim has been fixed by settlement agreement or court order, the Plan calculates and fixes the claim amount for each Restitution Claimant based on the claimant's net pre-petition recovery—the allowed claim is the gross amount the investor contributed to VCR under the Note Program less the total amount VCR distributed to the investor on account of his or her investment as of the petition date, regardless of how that payment had been applied.³ Under this method of calculating the amount of an allowed Restitution Claim, all pre-petition payments VCR made to an investor as part of the illicit Note Program are considered a return of principal.

The amounts of the Restitution Claims vary in differing degrees from the amounts reflected in the proofs of claim filed in the VCR case and in Mr. Vaughan's Chapter 11 case. The amount of the Restitution Claims total $17,687,336.65, consisting of $16,072,440.33 in claims timely proof of which was filed in the VCR case and $1,614,896.32 in Informal Restitution Claims.

Additionally, the Plan combines certain Restitution Claims for purposes of determining the claimant's Principal Return Percentage, which is the percentage return on the total principal amount of the investment pre-petition, assuming all payments are applied to principal. For example, all or part of some Restitution Claims arises from the claimant's use of funds from their individual retirement account as their principal investment in the Note Program (an "IRA Claim"). To the extent an individual holds an IRA Claim and a Restitution Claim that is not an IRA Claim, those claims are combined under the Plan for purposes of determining the claimant's Principal Return Percentage. Likewise,...