Walters v. Lynch (In re 3PL4PL, LLC)

619 B.R. 441

IN RE: 3PL4PL, LLC, Debtor.

Jared Walters, Chapter 7 Trustee of 3PL4PL, LLC, et al., Plaintiffs.

v.Kevin B. Lynch, et al., Defendants.

Case No. 14-22402 MER

Adversary No. 15-1120 MER

United States Bankruptcy Court, D. Colorado.

Signed June 22, 2020

James T. Markus, Steven R. Rider, Jennifer M. Salisbury, Markus Williams Young & Hunsicker LLC, Denver, CO, David Wadsworth, Wadsworth Garber Warner Conrardy, P.C., Littleton, CO, for Plaintiffs.

Lance Henry, Patrick D. Vellone, Matthew M. Wolf, Allen Vellone Wolf Helfrich & Factor P.C., Charles R. Scheurich, Onsager Fletcher Johnson LLC, Joseph J. Bronesky, Patrick L. Hughes, Eric E. Johnson, Denver, CO, for Defendants.

ORDER¹

Michael E. Romero, Chief Judge The tripartite relationship between debtors, their lawyers, and their secured creditors is rarely harmonious. Secured creditors are not particularly happy when their collateral becomes a debtor lawyer's war chest. And yet this three-headed Cerberus guards the gates of many commercial bankruptcies, often deciding whether the debtor will rest in Hades or Elysium. This case tests the limits of a debtor's power to fund their strategic litigation plan at the expense of secured creditors.

BACKGROUND

A. The Lenders and the Loans

3PL4PL, LLC ("3PL4PL ") was formed by its parent company, LogisticsFinance, LLC ("LogisticsFinance "), as a special purpose entity to conduct lending programs with other entities.² Between 2010 and 2012, BIA Investors, SFHT, LLC and SFCRT, LLC ("Lenders ") made loans ("Primary Loans ") to 3PL4PL, the proceeds of which were intended to be used by 3PL4PL to finance its financial services business. According to its business model, 3PL4PL would profit by re-lending the Lenders' capital on margin.³

Specifically, pursuant to the terms of the promissory notes and other loan documents between 3PL4PL and the Lenders (collectively, the "Loan Documents "), 3PL4PL was obligated to use the proceeds of the Primary Loans to lend money to third-party entities ("Borrowers ").⁴ In exchange, the Borrowers⁵ delivered promissory notes to 3PL4PL ("Third-Party Notes ").⁶ 3PL4PL established separate accounts at Union Bank for each of its Borrowers, into which the Third-Party Borrowers deposited payments due under the Third-Party Notes ("Loan Payments ").

Under the Loan Documents, 3PL4PL was obligated to use the operating income derived from the Loan Payments to pay the Loans from the Lenders before taking profits as net income. Accordingly, the Lenders took security interests in 3PL4PL's assets.⁷ The specific grant of 3PL4PL's security interest defines the Lenders' collateral as:

[A]ll of Borrower's right, title and interest in and to all cash and cash investments, investment property, goods, documents, inventory, equipment, general intangibles, accounts, chattel paper, instruments, contracts, contract rights, and all other tangible and intangible property of Borrower, whether now existing or hereafter coming into existence and all products and proceeds of the foregoing.⁸

3PL4PL's obligation to pay the Loans before distributing profits is further memorialized by its affirmative covenants in the Loan Documents. It would not:

[D]ispose, sell, lease or transfer any party of the Collateral, incur assume or suffer to exist any lien upon any of the Collateral or file or suffer to be on file or authorize to be filed, in any jurisdiction, any financing statement or like instrument with respect to all or any part of the Collateral, except Borrower may dispose, sell, lease or transfer the Collateral upon indefeasible repayment in full, in cash, of the Secured Obligations

[or]

until all Secured Obligations are indefeasibly repaid in full, in cash, pay any dividends or make any distributions or payment or redeem, retire or purchase any of its membership interests or other equity.⁹

To perfect its lien, BIA Investors, LLC filed its UCC-1 financing statement with the Colorado Secretary of State on June 18, 2014, containing the following collateral description:

All of Debtor's assets, goods, Accounts, Equipment, Inventory, contract rights or rights to payment of money, leases, license agreements, franchise agreements, General Intangibles, commercial tort claims, documents, instruments (including any promissory notes), chattel paper (whether tangible or electronic), cash, receivables, deposit accounts, fixtures, letters of credit rights (whether or not the letter of credit is evidenced by a writing), securities, and all other investment property, supporting obligations and financial assets, whether now owned or hereafter acquired, wherever located; and all Debtor's Books relating to the foregoing, and any and all claims, rights and interests in any of the above and all substitutions for, additions, attachments, accessories, accessions and improvements to and replacements, products, proceeds and insurance proceeds of any or all of the foregoing.¹⁰

The arrangement began going sideways in the fall of 2013, as 3PL4PL began making transfers to LogisticsFinance from the Borrowers' accounts at Union Bank.¹¹ Between October 28, 2013, and July 18, 2014, 3PL4PL made seventeen (17) transfers to LogisticsFinance and Kevin Lynch ("Lynch "), the president of LogisticsFinance, totaling $1,873,000 ("Transfers ").¹² The Amended Complaint alleges the Transfers were intended to and in fact enabled Lynch to misappropriate and convert the proceeds of the Third-Party Notes to his own use.¹³

B. Transfers to the Law Firm Defendants

Plaintiffs argue Sherman & Howard, LLC ("Sherman "), Haynes & Boone, LLP ("Haynes ") and Allen & Vellone, P.C. ("Allen ") (collectively, "Law Firm Defendants " or "Law Firms ") were all subsequent transferees of the Transfers, as fee payments in their role as counsel to Lynch, 3PL4PL and/or LogisticsFinance. At the heart of this case is the Law Firms' alleged connections to and facilitation of the Transfers through their attorney trust accounts.

1. Attorney Trust Accounts Generally

Naturally, the mechanics of the Law Firms' financial transactions with 3PL4PL and LogisticsFinance implicate the rules governing attorney trust accounting.¹⁴ Colorado Rule of Professional Conduct 1.15(A)(a) expressly provides lawyers must hold "property of clients or third persons that is in the lawyer's possession in connection with a representation separate from the lawyer's own property." In Colorado, this is often accomplished through the lawyer establishing a COLTAF account, which refers to a Colorado lawyer's client trust account maintained pursuant to Colorado's Interest on Lawyer Trust Accounts (IOLTA) program, administered by the Colorado Lawyer Trust Account Foundation ("COLTAF ").

2. Sherman & Howard

Lynch originally retained Sherman on or about November 11, 2013.¹⁵ By agreement dated February 17, 2014, Sherman expanded its representation to include 3PL4PL and LogisticsFinance.¹⁶ Sherman's retention agreement provides any funds advanced to the firm as a deposit would be held in Sherman's COLTAF account, unless otherwise directed by the client.¹⁷ Sherman's agreement further provides "[b]y making such a deposit, you agree that the firm has a possessory security interest in the advance deposit for services it has performed and will perform in the future."¹⁸ The agreement requests an advance deposit in the amount of $20,000.¹⁹

Between November 14, 2013, and July 11, 2014, LogisticsFinance tendered six such "advance deposits" to Sherman ranging from $20,000 to $50,000, for a grand total of $200,000, or 1000% of the $20,000 advance deposit originally contemplated.²⁰ Over the same time period, Sherman made seven transfers out of its COLTAF account for LogisticsFinance in the total amount of $20,063.50, in line with its initial $20,000 estimate.²¹ However, with LogisticFinance's additional transfers, as of July 11, 2014, or nine months into the representation, the positive balance held for LogisticsFinance in Sherman's COLTAF account was just shy of $180,000. Over the next six months from July 28, 2014 to January 21, 2015, Sherman made five more transfers out of its COLTAF account totaling $144,930.²² Sherman refunded the remaining balance of $35,000 back to LogisticsFinance through two transfers on December 9, 2014, and December 12, 2014.²³ Thus, the total of all advanced deposits to Sherman that were not returned to LogisticsFinance is $165,000.

The transfers out of LogisticsFinance's COLTAF account with Sherman, other than the transfers back to LogisticsFinance, are described in the documentary evidence only as "apply to balance."²⁴ Betty Martinez-Lane, Controller of Sherman, asserts all of these entries represent ordinary course payment of LogisticsFinance's incurred legal fees, which then became ordinary operating income for Sherman.²⁵ Plaintiffs dispute this assertion.

3. Haynes & Boone

Lynch originally retained Haynes on February 14, 2014.²⁶ The engagement agreement with Haynes provides for an initial $15,000 retainer, which Haynes agrees would be held in a client trust account absent contrary instruction.²⁷ The Haynes engagement agreement also provides it would "hold the retainer as security for your payment obligations to us[.]"²⁸

Between February 18, 2014, and July 8, 2014, LogisticsFinance made eleven transfers to Haynes ranging from $12,305 to $50,000.²⁹ The grand total of all transfers by LogisticsFinance into Haynes trust account during this five-month period equals $302,110.03.³⁰ Concomitantly, Haynes issued ten invoices to LogisticsFinance totaling $141,646.33.³¹ At the request of its client, Haynes made three transfers back to LogisticsFinance between August 29, 2014, and December 17, 2014, totaling $155,000.³² Haynes is still holding the balance of $5,738.98 in its trust account for LogisticsFinance.

Crystal J. White, controller of Haynes, asserts all the transfers from Haynes' trust account represent ordinary course payment of LogisticsFinance's incurred legal fees, which then became ordinary operating income for Haynes.³³ Trustee...