Terrill Horton v. Walter O'Cheskey

Case: 12-11200 Document: 00512430988 Page: 1 Date Filed: 11/05/2013
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 12-11200
United States Court of Appeals
Fifth Circuit
FILED
November 5, 2013
In the Matter of: American Housing Foundation,
Lyle W. Cayce
Clerk
Debtor
Terrill J. Horton,
Appellant,
versus
Walter O’Cheskey, as Chapter 11 Trustee,
Appellee.
Appeal from the United States District Court
for the Northern District of Texas
USDC No. 2:12-CV-20
Before SMITH, PRADO, and ELROD, Circuit Judges.
PER CURIAM:*
Terrill Horton appeals a judgment of the district court affirming a judg-
* Pursuant to 5TH CIR. R. 47.5, the court has determined that this opinion should not
be published and is not precedent except under the limited circumstances set forth in 5TH
CIR. R. 47.5.4.
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ment of the bankruptcy court disallowing his claim for a $1.4 million loan guar-
anteed by the debtor, American Housing Foundation (“AHF”). Those courts
concluded that, because AHF was insolvent and did not receive reasonably
equivalent value for the guaranty, it could be set aside as a fraudulent convey-
ance under § 548(a)(1)(B) of the Bankruptcy Code. Horton also was not entitled
to the good-faith defense of § 548(c), and the bankruptcy court denied his fraud
and breach-of-fiduciary-duty claims against AHF.
Horton appeals on a number of grounds, all of which require this court
to believe his version of events. Finding no clear error in any of the factual
findings of the bankruptcy court, we affirm.
I.
The bankruptcy court determined after a bench trial that Horton had
entered into an arrangement with the debtor, AHF, and its president, Steve
Sterquell, for the sole purpose of creating an illegal tax shelter. Pursuant to
that arrangement, Horton gave a loan of about $1.4 million to a new entity,
White Chapel H.I. Ltd. (“White Chapel”), in which Horton would have a 99.99%
limited-partnership interest. For an initial capital contribution of $20, AHF
would have a 0.01% general partnership interest. Horton delivered the $1.4
million in a check directly to AHF as the general partner. Horton later signed
a non-recourse promissory note for an additional $15.7 million (but did not
actually deliver that money) to increase his stake in White Chapel to that
amount.
AHF guaranteed the $1.4M loan from Horton to White Chapel, and that
guaranty is the central dispute. The bankruptcy court found that, because
AHF was insolvent and the 0.01% interest in White Chapel was not reasonably
equivalent value for the guaranty, it was a fraudulent conveyance that could
be set aside.
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Moreover, Horton could not claim the good-faith exception to the fraud-
ulent-conveyance rule because the bankruptcy court determined that the
whole transaction was structured so that Horton could post $15 million in
losses and thereby claim $3 million in illegal tax benefit. Horton never
intended for the White Chapel transaction to produce any value; he merely
expected it to post losses that, as the 99.99% limited partner, he could claim as
deductions so he could receive the tax benefit as well as the return of his loan.
The bankruptcy court relied on an email from Sterquell to Horton explicitly
charting the expected loss on the investment and the corresponding tax benefit
that would result. Horton claimed never to have read the email, but the bank-
ruptcy court disbelieved that testimony.
II.
We review a district court’s affirmance of a bankruptcy court
decision by applying the same standard of review to the bank-
ruptcy court decision that the district court applied. We thus gen-
erally review factual findings for clear error and conclusions of law
de novo. A finding of fact is clearly erroneous only if on the entire
evidence, the court is left with the definite and firm conviction that
a mistake has been committed. We give deference to the bank-
ruptcy court’s determinations of witness credibility.
Liberty Mut. Ins. Co. v. Lamesa Nat’l Bank (In re Schooler), 725 F.3d 498, 503
(5th Cir. 2013) (internal quotes and citations omitted).
III.
Section 548(a)(1) of the Bankruptcy Code permits the bankruptcy court
to set aside as fraudulent certain conveyances made from, or obligated by, the
debtor within two years before the bankruptcy petition was filed. The bank-
ruptcy court found that Horton’s arrangement did not meet the actual-fraud
provision of § 548(a)(1)(A) because the trustee could not establish that the
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scheme was intended to defraud AHF’s other creditors. The court held, how-
ever, that the guaranty met the constructive-fraud requirements of
§ 548(a)(1)(B)(i) and (ii)(I) because AHF was insolvent at the time and did not
receive reasonably equivalent value for the guaranty.
Horton challenges only the finding regarding reasonably equivalent
value. The bankruptcy court had found no such value because AHF was only
a 0.01% general partner in White Chapel (the entity that received the loan)
and would share in the losses and profits to that extent (0.01%) only. Further,
Horton offered no other “evidence of value received by AHF in exchange for its
guaranty.” Horton argues without elaboration, on the other hand, that his loan
strengthened the corporate group, fulfilled AHF’s capitalization of another
company, and allowed AHF’s use of the funds (admittedly as the general part-
ner in White Chapel), which in turn reduced or eliminated claims against the
estate, preserved AHF’s worth, and delayed bankruptcy.
“A bankruptcy court’s finding of reasonably equivalent value,” however,
“is a factual determination subject to a ‘clearly erroneous’ standard of review.”
Stanley v. U.S. Bank Nat’l Ass’n (In re TransTexas Gas Corp.), 597 F.3d 298,
306 (5th Cir. 2010). “The question of reasonable equivalence is largely a ques-
tion of fact, as to which considerable latitude must be allowed to the trier of
the facts.” Id. (internal quotation marks omitted).
The bankruptcy court’s finding that there was no reasonably equivalent
value was not clearly erroneous. As the 0.01% partner, AHF would receive
only that proportion of any profit realized by use of the loan, which was payable
with interest within five months. Horton’s only responses are that the loan
later did shore up AHF’s capitalization, maintained its worth, and reduced
other claims against the estate. Even if that were true, the bankruptcy court
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determines reasonably equivalent value at the time of the exchange. 1 It was
not clearly erroneous to find, given that AHF had a 0.01% partnership interest
in White Chapel at the time of the exchange, that AHF did not receive reason-
ably equivalent value for its guaranty of a $1.4 million loan.
Horton argues that, even if the guaranty meets the requirements of
§ 548(a)(1)(B), he is entitled to the good-faith defense of § 548(c). That provi-
sion permits a claimant who provided value in good faith to retain an interest
in the voided obligation to the extent he gave value to the debtor. § 548(c).
Horton claims he gave $1.4 million in value to AHF. As already discussed, the
bankruptcy court’s finding that AHF did not receive any value in exchange for
its guaranty was not clearly erroneous.
Even if Horton did give some value to AHF for the guaranty—say, about
$140 given AHF’s 0.01% interest—the bankruptcy court also found that Hor-
tron did not enter the transaction in good faith. Courts review a determination
of good faith for clear factual error, Hannover, 310 F.3d at 800, and look to
whether the claimant was on notice of the debtor’s insolvency or the fraudulent
nature of the transaction:
The good faith test under Section 548(c) is generally presented
as a two-step inquiry. The first question typically posed is whether
the transferee had information that put it on inquiry notice that
the transferor was insolvent or that the transfer might be made
with a fraudulent purpose. While the cases frequently cite either
fraud or insolvency, these two elements are consistently identified
as the triggers for inquiry notice. The fraud or insolvency predi-
cate is set forth in countless cases . . . .
. . . The weight of the authority . . . indicates that a court
should focus on the circumstances specific to the transfer at
1 Jimmy Swaggart Ministries v. Hays (In re Hannover Corp.), 310 F.3d 796, 802 (5th
Cir. 2002) (“Thus, consistent with economic reality, this and other circuits unequivocally hold
that for purposes of § 548 the value of an investment, even a risky one, such as we have before
us now, is to be determined at the time of purchase.”).
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issue—that is, whether a transferee reasonably should have
known . . . of the fraudulent intent underlying the transfer.
Once a transferee has been put on inquiry notice of either the
transferor’s possible insolvency or of the possibly fraudulent pur-
pose of the transfer, the transferee must satisfy a “diligent inves-
tigation” requirement.
Christian Bros. High Sch. Endowment v. Bayou No Leverage Fund, LLC (In re
Bayou Grp., LLC), 439 B.R. 284, 310–12 (S.D.N.Y. 2010) (internal quotations
and citations omitted).
The bankruptcy court found that Horton was a “successful and shrewd
businessman” and that even if he were to be believed that he didn’t understand
the details of the deal, “he did understand and, in fact, he counted on both the
$3+ million tax refund and repayment of his loan to White Chapel.” Thus,
“[r]elative to the motives of legitimate creditors in the AHF Bankruptcy Case,
the Court [could not] conclude that Horton acted in good faith in connection
with the Horton Deal.” In other words, and as Horton recognizes, the bank-
ruptcy court’s judgment regarding good faith was based on its finding that the
arrangement was an illegal tax shelter. Thus the guaranty was fraudulently
given, and Horton had reason to know of the fraudulent intent.
Horton disputes the bankruptcy court’s finding that the arrangement
was an illegal tax shelter. He claims error on three grounds: first, that the
bankruptcy court improperly applied the “economic substance doctrine” to
characterize the deal as an abusive tax shelter; second, that the Trustee’s
expert’s testimony was not admissible; and third, that the bankruptcy court
did not have jurisdiction to determine that the deal was an illegal tax shelter. 2
2 Before addressing these arguments, we note that Horton admitted in the record that
the tax scheme was fraudulent and claimed that he was duped by Sterquell. Indeed, Horton’s
whole alternative argument based on fraud and breach of fiduciary duty is that the scheme
was fraudulent and he was defrauded. It is hard to square his admission that the scheme
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The bankruptcy court did not explicitly say it was applying the economic-
substance doctrine. It merely found that, based on the evidence discussed in
the facts, the sole purpose of the Horton Deal was to create an illegal tax shel-
ter. Horton contends that the bankruptcy court failed to apply the doctrine
correctly; he does not dispute that the doctrine can apply. He also does not
dispute that the doctrine has an objective component (whether the arrange-
ment has a reasonable prospect of realizing profit) as well as a subjective com-
ponent (whether the taxpayer concluded the transaction for a legitimate, non-
tax purpose). See Klamath Strategic Inv. Fund v. United States, 568 F.3d 537,
543–44 (5th Cir. 2009).
None of the errors that Horton asserts is based on a mistake of law. All
are based on his hoping that this court believes his version of events: that his
subjective motive was not solely for the purpose of claiming the tax deduction
and that the bankruptcy court ignored the potential for White Chapel and
Hurike (another entity involved) to make a profit. As discussed, however, there
was plenty of evidence that this transaction was fraudulent and that Horton
knew or should have known about it.
Horton’s only other issue on appeal is that the doctrine was applied to
the wrong transaction—to the White Chapel-Horton-AHF transaction rather
than to Hurike, which used AHF funds to invest in sham properties. This
argument defies common sense. The question is whether Horton himself, in
giving money to White Chapel with the expectation that it would post a loss
that he could claim on his tax return, was a sham transaction. Whether Hurike
was part of the arrangement further down the line that would ultimately help
realize the loss of profits, and whether Horton knew of Hurike’s role, do not
was fraudulent with his claim in the briefs that it was not an abusive tax shelter. In an
abundance of caution, we nevertheless address these arguments.
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change either component of the economic substance test. Horton still entered
into a transaction that he knew or should have known had no reasonable pros-
pect of making a profit, for the sole purpose of claiming some tax deductions.
The good-faith exception does not apply if Horton knew or should have
known of the fraudulent nature of the transaction. The bankruptcy court was
not wrong to apply the economic-substance doctrine to determine whether the
deal was a fraudulent enterprise. And surely the bankruptcy court did not
clearly err in finding that, given the evidence, Horton knew or should have
known it was a fraudulent tax scheme.
Horton claims that the bankruptcy court erred in admitting the testi-
mony of Stephen Coen, the trustee’s expert. Horton maintains that the testi-
mony was irrelevant and not based on any “explanation,” “factual or legal
basis,” or “methodology.” Without his testimony, the bankruptcy court’s opin-
ion is left “without evidentiary support.” We agree with the district court, how-
ever, that even if the testimony was wrongly included, the court relied on sev-
eral other pieces of evidence in coming to its conclusion.
Even so, the court did not abuse its discretion in admitting the testi-
mony. Coen had eighteen years of experience working as an attorney for the
IRS. He also explicitly worked on cases involving illegal tax shelters. He did
provide an “explanation” and a “factual basis” for his conclusions: He reviewed
all the documents and transactions involved in the Horton Deal. He concluded
that the deal was a fraudulent tax scheme and that Horton knew or should
have known about it. The bankruptcy court has wide latitude to admit such
expert testimony. 3
3 See EEOC v. Boh Bros. Constr. Co., No. 11-30770, 2013 U.S. App. LEXIS 19867, at
*33 (5th Cir. Sept. 27, 2013) (en banc) (“In rulings on the admissibility of expert opinion
evidence the trial court has broad discretion and its rulings must be sustained unless mani-
festly erroneous”) (quoting Wellogix, Inc. v. Accenture, L.L.P., 716 F.3d 867, 881 (5th Cir.
2013)).
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Horton claims, finally, that the bankruptcy court did not have jurisdic-
tion to consider the tax status of the arrangement under § 505 of the Bank-
ruptcy Code and the Declaratory Judgment Act (“DJA”). The Trustee agrees
that under § 505 of the Code, 4 the bankruptcy court may decide the tax liability
only of debtors and their estates but not of creditors and other non-debtors. 5
The Trustee also agrees that the DJA prohibits the federal court from “declar-
[ing] the rights and other legal relations of any interested party” with respect
to federal tax matters except pursuant to § 505. 6
The bankruptcy court’s judgment does not violate either § 505 or the DJA
because it does not determine Horton’s tax liability; it does not determine that
Horton owes the IRS any money. The bankruptcy court merely considered the
intended tax consequences of the transaction and whether it had a legitimate
business purpose as evidence of Horton’s lack of good faith. Indeed, Horton did
not claim a tax deduction, and if he did, he could still litigate the issue with
the IRS.
Horton asserts, without elaboration or supporting argumentation, that
the bankruptcy court’s determinations may nevertheless “involve complex
questions of collateral estoppel.” Horton cites no case, however, suggesting
4 “[A]fter determination by a court of a tax under this section, the governmental unit
charged with responsibility for collection of such tax may assess such tax against the estate,
the debtor, or a successor to the debtor, as the case may be, subject to any otherwise appli-
cable law.” 11 U.S.C. § 505(c).
5 See IRS v. Prescription Home Health Care, Inc. (In re Prescription Home Health Care,
Inc.), 316 F.3d 542, 548 (5th Cir. 2002) (“Sister circuits that have addressed directly whether
bankruptcy courts have jurisdiction over the tax liabilities of non-debtors have held they do
not.”).
6 “In a case of actual controversy within its jurisdiction, except with respect to . . . a
proceeding under section 505 or 1146 of title 11, . . . any court of the United States . . . may
declare the rights and other legal relations of any interested party seeking such declara-
tion . . . .” 28 U.S.C. § 2201.
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that a bankruptcy court’s determination of the likely tax status of a transaction
as part of a good-faith analysis might have any preclusive effect in future liti-
gation.
Indeed, were Horton to attempt to claim his deduction, issue preclusion
would not be a problem. If the IRS in that litigation tried to claim that the
issue was precluded, then Horton could argue that the bankruptcy court could
not have made a tax liability determination because it lacked the subject-mat-
ter jurisdiction to do so; and without subject-matter jurisdiction, issue preclu-
sion does not attach.
In other words, the bankruptcy court did not have jurisdiction to deter-
mine Horton’s tax liability, and should that liability be an issue in future liti-
gation, the bankruptcy court’s judgment would not collaterally estop future lit-
igation of that issue. The bankruptcy court did have jurisdiction, however, to
determine whether Horton had good faith; and to determine good faith, it had
jurisdiction to consider whether the transaction was likely fraudulent; and to
determine whether the transaction was likely fraudulent, it had jurisdiction to
determine that the arrangements had all the trappings of an abusive tax shel-
ter. These findings have no effect beyond the present litigation.
IV.
With respect to Horton’s fiduciary duty claim, the bankruptcy court
found that AHF owed a duty to White Chapel and not to Horton and that in
any event, the facts would not give rise to such a claim. Horton claims on
appeal that the bankruptcy court erred by finding that AHF owed no direct
fiduciary duty to Horton. Because this court can affirm on any grounds in the
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record, 7 we affirm on the ground that, even if a fiduciary duty were owed, it
was not violated because Horton knew or should have known that the whole
partnership was a fraudulent scheme.
For the same reasons that the bankruptcy court rejected the good-faith
defense under § 548(c), there is no breach of fiduciary duty. Because Horton
knew or should have known that Sterquell would use his loan funds as part of
a fraudulent scheme to post losses through White Chapel, the mere fact that
the scheme failed does not mean he can claim a breach of fiduciary duty against
AHF.
Horton maintains that Sterquell misused the funds by not investing in
the Hurike properties. But those properties were part of the fraud, and Horton
still expected the investment in these properties to create losses. It is no argu-
ment to say that Sterquell breached a fiduciary duty by not fulfilling his end
of a fraudulent bargain. The bankruptcy court’s factual finding that AHF did
not undertake acts amounting to a breach of a duty was not clearly erroneous.
Finally, with respect to the fraud claim, the bankruptcy court found that
the claim fails on the merits because Horton did not rely on representations
from AHF and Sterquell that they knew to be false and that they made intend-
ing to defraud him. 8 Horton did not dispute that finding on appeal. Still, he
7 Ad Hoc Group of Timber Noteholders v. Pac. Lumber Co. (In re Scotia Pac. Co., LLC),
508 F.3d 214, 218–19 (5th Cir. 2007) (“A bankruptcy court’s findings of fact are reviewed for
clear error and its conclusions of law de novo. This Court may affirm if there are any grounds
in the record to support the judgment, even if those grounds were not relied upon by the
courts below.” (internal citations and quotation marks omitted)).
8 Reliance on a representation is an element of fraud. See Daldav Assocs., L.P. v.
Lebor, 391 F. Supp. 2d 472, 475 (N.D. Tex. 2005) (“The elements for actionable fraud under
Texas law are: (1) a material representation was made; (2) it was false when made; (3) the
speaker knew it was false, or made it recklessly without knowledge of its truth and as a
positive assertion; (4) the speaker made it with the intent that it should be acted upon; and
(5) the party acted in reliance and suffered injury as a result.”).
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claimed in bankruptcy court that AHF fraudulently misrepresented its sol-
vency. The bankruptcy court determined, however, that Horton did not rely
on this representation at all.
In fact, Horton did not expect AHF to be solvent; he understood that the
whole arrangement was structured so that he could somehow post losses that
would run directly to him so he could claim a tax refund. Thus, he was not
fraudulently induced by promises of false profit or solvency because he
expected the enterprise to lose profit. A finding of “reasonable reliance” or
“reliance” is one of fact, 9 and the bankruptcy court did not clearly err by finding
that Horton did not rely on any representations.
The judgment of the district court, affirming the judgment of the bank-
ruptcy court, is AFFIRMED.
9 Cf. Coston v. Bank of Malvern (In re Coston), 991 F.2d 257, 260 (5th Cir. 1993).
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