Brian Bash v. Textron Financial Corporation

RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit I.O.P. 32.1(b)
File Name: 16a0205p.06
UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
_________________
In re: FAIR FINANCE COMPANY, ┐
Debtor. │
│
__________________________________________ │
BRIAN A. BASH, Chapter 7 Trustee, │
No. 15-3854
Plaintiff-Appellant, │>
│
v. │
│
│
TEXTRON FINANCIAL CORPORATION, │
Defendant-Appellee. │
┘
Appeal from the United States District Court
for the Northern District of Ohio at Akron.
No. 5:12-cv-00987—Patricia A. Gaughan, District Judge.
Argued: April 22, 2016
Decided and Filed: August 23, 2016
Before: MOORE, GIBBONS, and DAVIS,* Circuit Judges.
_________________
COUNSEL
ARGUED: Daniel R. Warren, BAKER & HOSTETLER LLP, Cleveland, Ohio, for Appellant.
Mitchell A. Karlan, GIBSON, DUNN & CRUTCHER LLP, New York, New York, for Appellee.
ON BRIEF: Daniel R. Warren, Thomas D. Warren, Joseph F. Hutchinson, Jr., David F. Proaño,
BAKER & HOSTETLER LLP, Cleveland, Ohio, for Appellant. Mitchell A. Karlan, GIBSON,
DUNN & CRUTCHER LLP, New York, New York, James P. Schuck, Kenneth C. Johnson,
Quintin F. Lindsmith, BRICKER & ECKLER LLP, Columbus, Ohio, for Appellee.
*
The Honorable Andre M. Davis, Senior Circuit Judge for the United States Court of Appeals for the
Fourth Circuit, sitting by designation.
1
No. 15-3854 Bash v. Textron Financial Corp. Page 2
_________________
OPINION
_________________
ANDRE M. DAVIS, Senior Circuit Judge. In this appeal from the dismissal of an
adversary proceeding in bankruptcy, we are obliged to explore some uncharted territory of Ohio
substantive and procedural jurisprudence.
For more than six decades, members of the Fair family operated Fair Finance Company
(the “Debtor”) as a profitable and respected financial services company in Northeast Ohio. In
2002, Tim Durham and James Cochran purchased the Debtor in a leveraged buyout and
transformed the Debtor’s factoring operation into a front for a Ponzi scheme, the proceeds of
which went largely to fund Durham’s and Cochran’s extravagant lifestyles and various
struggling business ventures. In 2009, the Ponzi scheme collapsed when Durham, Cochran, and
Rick Snow, the Debtor’s Chief Financial Officer, were indicted for wire fraud, securities fraud,
and conspiracy. The Debtor entered involuntary bankruptcy and Brian Bash, as Chapter 7
Trustee (the “Trustee”), brought a number of adversary proceedings to recover on behalf of the
Debtor’s estate and, by extension, the Ponzi scheme’s unwitting investors. In the adversary
proceeding at issue in this appeal, the Trustee brought numerous claims against Appellee Textron
Financial Corporation (“Textron”), whose alleged assistance in the concealment and perpetuation
of the Ponzi scheme lies at the root of all the claims asserted. The district court granted
Textron’s Rule 12(b)(6) motion to dismiss for failure to state a claim, and the Trustee timely
appealed the dismissal as to all but one of his claims.
As we explain within, we hold that, because the Trustee has set forth sufficient factual
allegations to demonstrate the existence of an ambiguity in a 2004 financing and funding
contract between the Debtor and Textron, we REVERSE the dismissal of the Trustee’s actual
fraudulent transfer claim. We further hold that the Trustee was not required to plead facts in
anticipation of Textron’s potential in pari delicto affirmative defense to survive a motion to
dismiss; accordingly, we REVERSE the dismissal of the Trustee’s civil conspiracy claim.
Finally, in light of the reinstatement of the Trustee’s actual fraudulent transfer and civil
conspiracy claims, we also REVERSE the dismissal of the Trustee’s equitable subordination
No. 15-3854 Bash v. Textron Financial Corp. Page 3
and disallowance claims. We AFFIRM, however, the dismissal of the Trustee’s constructive
fraudulent transfer claim as time barred.
I.
A.1
In 1934, Arthur Ray Fair founded the Debtor to finance the automobile sales of a family-
owned car dealership. B.C. R. 8 (First Am. Compl. at 26:152).2 Over the next six decades,
members of the Fair family expanded the Debtor into a successful factoring company,
purchasing accounts receivable at discounted rates and handling the billing and collection of
client-owned customer accounts for a fee. Id. at 26:151–54. To support its purchase of accounts
receivable, the Debtor sold investment certificates, or so-called V-Notes, to unsophisticated
investors throughout Northeast Ohio. Id. at 26:155–58. The V-Notes routinely provided for six-
month maturities and paid interest at a rate one-half of one percent higher than the rate payable
on bank certificates of deposit. Id. at 26:158–27:160. The Debtor issued the V-Notes through
private placements after filing offering circulars with the Ohio Division of Securities. Id. at
27:161. As of 2001, the Debtor held title to approximately $54 million in accounts receivable,
1
We draw our factual recitations from the Trustee’s amended complaint and documents—attached as
exhibits to the parties’ briefing on Textron’s motion to dismiss—referenced and quoted therein. “[A]s a general
rule, matters outside the pleadings may not be considered in ruling on a 12(b)(6) motion to dismiss unless the
motion is converted to one for summary judgment under Fed. R. Civ. P. 56.” Jackson v. City of Columbus, 194 F.3d
737, 745 (6th Cir. 1999) (quoting Weiner v. Klais & Co., 108 F.3d 86, 88 (6th Cir. 1997)), abrogated on other
grounds by Swierkiewicz v. Sorema N.A., 534 U.S. 506 (2002). However, “when a document is referred to in the
pleadings and is integral to the claims, it may be considered without converting a motion to dismiss into one for
summary judgment.” Commercial Money Ctr., Inc. v. Ill. Union Ins. Co., 508 F.3d 327, 335–36 (6th Cir. 2007).
Because the attached documents were incorporated by reference and quoted extensively, they are central to the
Trustee’s claims. Moreover, neither party contests the appropriateness of their consideration on review of Textron’s
motion to dismiss.
2
For purposes of this opinion, documents filed in the United States Bankruptcy Court for the Northern
District of Ohio prior to the motion to withdraw the adversary proceeding’s reference to the bankruptcy court are
cited using a “B.C.” designation for “bankruptcy court.” The adversary proceeding’s bankruptcy court docket is
captioned Bash v. Textron Financial Corporation, et al., No. 12-05101-aih. Documents filed in the United States
District Court for the Northern District of Ohio following the withdrawal of the adversary proceeding from the
bankruptcy court are cited using a “D.C.” designation for “district court.” The adversary proceeding’s district court
docket is captioned Bash v. Textron Financial Corporation, et al., No. 12-cv-00987-PAG. Only documents filed
within the district court will have a Page ID. Finally, documents filed in the United States Bankruptcy Court for the
Northern District of Ohio in the Debtor’s principal bankruptcy case are cited using a “B.P.” designation for
“bankruptcy petition.” The Debtor’s principal bankruptcy docket is captioned In re Fair Finance Company, No. 10-
50494.
No. 15-3854 Bash v. Textron Financial Corp. Page 4
owed $39 million in V-Notes, had never missed a V-Note payment (interest or otherwise), and
had most recently operated at a $3 million profit. Id. at 27:165–28:166.
In January 2002, Donald Fair sold the Debtor to Fair Holdings, Inc. (“FHI”) in a
leveraged buyout. Id. at 5:24. Durham and Cochran, two Indiana businessmen, founded FHI to
serve as a holding company for the Debtor. Id. at 5:25, 6:32–33. They also formed a secondary
holding company, DC Investments, LLC (“DCI”), which existed exclusively to own FHI. Id. at
28:171–72. Durham and Cochran were DCI’s sole members. Id. at 28:170.
To purchase and operate the Debtor, FHI entered into a Loan and Security Agreement
(“2002 L&SA”) with Textron and United Bank (“United”) on January 7, 2002.3 D.C. R. 20
(Mot. to Dismiss First Am. Compl. (“Mot. to Dismiss”) Ex. A) (Page ID #874–915). Under the
terms of the 2002 L&SA, Textron and United agreed to make a $22 million revolving line of
credit4 available to FHI and the Debtor. Id. at 3–4 (Page ID #876–77). In exchange for
extending the line of credit, Textron and United were entitled to interest and fees on amounts
borrowed, with all such payments to be made through a lockbox arrangement. Under the
arrangement, payments made on Debtor-owned accounts receivable would be made directly into
a lockbox account and a designated lockbox agent would transfer appropriate funds to Textron
and United as necessary. Id. at 4–5 (Page ID #877–78). To secure the loan, FHI pledged all of
its present and future assets, i.e., its non-diluted interest in the Debtor. Id. at 6–8 (Page ID #879–
81).5 Of particular relevance to the present action, the 2002 L&SA included the following
provision regarding the scope of the security interest created thereunder:
(c) It is Borrower’s express intention that this Agreement and the continuing
security interest granted hereby, in addition to covering all present obligations of
Borrower to Lenders and their respective Affiliates pursuant to the Obligations,
shall extend to all future obligations of Borrower to Lenders intended as
replacements or substitutions for said Obligations, whether or not such
3
Immediately following the consummation of the leveraged buyout, the parties amended the 2002 L&SA to
add the Debtor as a Borrower. D.C. R. 20 (Mot. to Dismiss First Am. Compl. (“Mot. to Dismiss”) Ex. B) (Page ID
#916–918)
4
The 2002 L&SA provided that Textron and United’s pro rata share of the line of credit would be
$12 million and $10 million, respectively. D.C. R. 20 (Mot. to Dismiss Ex. A, at 3–4) (Page ID #876–77).
5
To facilitate the leveraged buyout, FHI also issued a $4.1 million seller’s note to Donald Fair secured by a
second priority lien in FHI’s assets. B.C. R. 8 (First Am. Compl. at 29:181–82).
No. 15-3854 Bash v. Textron Financial Corp. Page 5
Obligations are reduced or entirely extinguished and thereafter increased or
reincurred.
Id. at 7 (Page ID #880). As discussed in this opinion, the continued efficacy of the security
interest created by the 2002 L&SA is at the heart of the Trustee’s fraudulent transfer claims.
The 2002 L&SA also provided that FHI and the Debtor would furnish Textron and
United with (1) monthly certified financial statements, (2) yearly audited financial statements,
(3) yearly financial statements and tax returns for the loan’s guarantors (Durham and Cochran),
and (4) any other relevant materials. Id. at 14–15 (Page ID #887–88). In addition, Textron and
United enjoyed the right to audit FHI and the Debtor up to four times per year. Id. at 16 (Page
ID #889). To perfect the security interest established under the 2002 L&SA, Textron and United
filed a UCC Financing Statement with the Ohio Secretary of State on January 8, 2002. D.C. R.
20 (Mot. to Dismiss Ex. C) (Page ID #919–21).
After settlement of the leveraged buyout, Durham became the Debtor’s CEO and
immediately began a campaign of selling additional V-Notes with substantially longer maturities
and elevated interest rates. B.C. R. 8 (First Am. Compl. at 6:36–7:37). Durham then directed a
significant portion of the new V-Note capital into a series of “insider loans” for his personal
benefit, the benefit of other failing companies that he and Cochran owned or controlled, and the
benefit of the officers and directors of those failing companies. Id. at 7:37–38. Generally, the
insider loans followed a common path: Durham would cause the Debtor to lend money to FHI
(the Debtor’s parent), and FHI would then lend a corresponding amount directly to an insider or
to DCI (FHI’s parent), which would then lend the money to an insider. Id. at 7:39.
By the end of 2002, the Debtor had made more than $30 million in insider loans. Id. at
7:40. By the end of 2006, that number had grown to approximately $137 million, and by
September 2009, the Debtor had made more than $228 million in insider loans. Id. at 7:40–8:41.
While the insider loans were delineated as performing assets in the Debtor’s offering circulars,
id. at 36:235–37:236, the loans were made on commercially unreasonable terms, “permitt[ing]
financially distressed [i]nsiders to defer all payments for years at a time, to ‘secure’ the loans
with inadequate collateral, without perfecting liens, and allow[ing] borrowers to exceed their
credit limits without review,” id. at 34:217–18. Moreover, when an insider loan approached
No. 15-3854 Bash v. Textron Financial Corp. Page 6
default, Durham would cause the Debtor to modify the loan and prevent the Debtor from
enforcing its rights and/or collecting amounts due. Id. at 34:218–35:226. Unsurprisingly, at no
point did the Debtor receive any significant payments on any of the insider loans, id. at 9:46, and
as of the filing of the Debtor’s bankruptcy petition, the outstanding balance on the insider loans
totaled approximately $233 million, id. at 37:237.
During Durham and Cochran’s ownership and control of the Debtor, the company did
maintain its factoring operations. Id. at 8:44. However, because the Debtor’s accounts
receivable assets remained fairly steady, the company’s factoring operation alone could not
support its ever increasing issuance of V-Notes and insider loans. Id. at 8:44–9:48.
Accordingly, by December 2003, the Debtor was operating as “a classic Ponzi scheme,”
constantly requiring the issuance of new V-Notes to pay off existing V-Notes as they matured
and to make the requisite monthly interest payments to all V-Note holders. Id. at 9:47–48.
Importantly, the offering circulars issued by the Debtor to effectuate the sale of new V-Notes
concealed the Debtor’s insolvency, “failed to fully and fairly disclose that the Debtor would use
the proceeds of [the] V-Notes to make [i]nsider [l]oans,” and “grossly overvalued” the insider
loans that were made. Id. at 36:233–35. The outstanding balance to V-Note holders totaled
approximately $208 million as of the filing of the Debtor’s bankruptcy petition. Id. at 37:238.
Textron’s March 29, 2002 audit of the Debtor and FHI, as well as subsequent internal
communications, reveal that Textron knew, as early as spring 2002, that Durham had been
causing the Debtor to make insider loans and that the Debtor had dramatically increased its V-
Note placements. D.C. R. 66 (Order Redacting Decl. of Michael VanNiel in Connection with
Trustee’s Br. in Opp’n to Mots. of Textron Financial Corp. & Fortress Credit Corp. to Dismiss
First Am. Compl. (“Redacted VanNiel Decl.”) Exs. 1–2) (Page ID #3523–28). Further,
Textron’s August 2002 audit evidences the company’s early concern regarding the Debtor and
FHI’s troubling business practices. D.C. R. 66 (Redacted VanNiel Decl. Ex. 4, at 3–4) (Page ID
#3531–34). The official who reviewed the audit noted that the Debtor’s “[t]otal assets grew
primarily due to an $11.8 [million] investment in other current receivables,” representing
advances made to FHI, and that “[t]he cash was raised for the advances by issuing V-6
certificates.” Id. at 3 (Page ID #3533). The official further noted that FHI had provided a series
No. 15-3854 Bash v. Textron Financial Corp. Page 7
of “loans to several affiliated entities” and included a recommendation that Textron examine the
“financial health” of the insider loans going forward. Id. at 4 (Page ID #3534).
In a March 2003 internal Textron memorandum, a Textron official discussed the Debtor
and FHI’s financial positions in-depth and, when evaluating the Debtor’s 2002 internal balance
sheet, explained that the company had made a variety of loans to “companies substantially
owned by Tim Durham and Jim Cochran” and had listed the loans as assets. D.C. R. 20 (Mot. to
Dismiss Ex. F, at 7–8) (Page ID #956–57). The Textron official explained that the loans were
entirely funded through the increasing issuance of V-Notes and that, should additional liquidity
be needed in response to a rise in V-Note redemptions, Textron would expect the Debtor to
liquidate its insider loans. Id. Despite the acknowledged risks associated with the Debtor’s
practice of issuing insider loans, the Textron official noted his belief that Textron’s exposure was
limited as a result of covenants contained in the 2002 L&SA, specifically the subordination of
the V-Notes to Textron and United’s security interest and the Debtor’s ability to limit V-Note
payments “in any calendar month to 10% of any calendar month’s net cash.” Id. at 3 (Page ID
#952). Ultimately, the official expressed his belief that the overall relationship would continue
to be a profitable one for Textron. Id. at 9 (Page ID #958).
As months passed, however, Durham’s operation of the Debtor continued to be a point of
concern for Textron. In an August 2003 letter to Durham, Textron’s Senior Vice President of
Portfolio Management, Ralph Infante, explained that FHI and the Debtor were in default under
the 2002 L&SA and that Textron would require updated financials, access to the companies’
certified public accountant, and access to the companies’ legal counsel to address Textron’s
questions and concerns regarding the Debtor’s V-Note program. D.C. R. 20 (Mot. to Dismiss
Ex. G) (Page ID #959–60). Under the terms of the 2002 L&SA, the Debtor and FHI had been
required to provide Textron with their 2002 audited financial statements by April 30, 2003. D.C.
R. 20 (Mot. to Dismiss Ex. A, at 14–15) (Page ID #887–88). Yet, as of August 2003, Textron
had only received a draft report of the companies’ 2002 financials. D.C. R. 20 (Mot. to Dismiss
Ex. G) (Page ID #959–60). Moreover, the draft audit it did receive showed a host of
irregularities, including (1) the existence of “related party” transactions, a portion of which were
nonperforming; (2) limited or non-existent security interests in the “related party” transactions;
No. 15-3854 Bash v. Textron Financial Corp. Page 8
and (3) line items that resulted in an overstating of each company’s net worth. D.C. R. 20 (Mot.
to Dismiss Ex. H, at 7–8) (Page ID #967–68).
As the 2002 L&SA’s January 6, 2004 maturity date approached, the parties began
discussing whether a renewed agreement would be possible. D.C. R. 20 (Mot. to Dismiss Exs.
H–I) (Page ID #961–70). On November 13, 2003, Textron’s Infante sent an email to Durham
and Cochran to communicate the results of a credit committee meeting during which Infante
pitched replacing the line of credit established under the 2002 L&SA with a new commitment
funded solely by Textron. D.C. R. 20 (Mot. to Dismiss Ex. I) (Page ID #970). Infante explained
that, while the credit committee had yet to make a final determination, the Debtor and FHI’s
frequent insider loans and decision to use the Debtor’s V-Note program “as a piggy bank to
finance” the insider loans was a serious point of concern. Id. Infante also noted that the credit
committee members believed that it was “wrong” for the V-Note capital to be used for anything
but “the growth and profitability of [the Debtor]” and that, “[i]n today’s world of Sarbanes-
Oxley, predatory lending and recent court rulings,” the credit committee members were
concerned that their knowledge of where the V-Note proceeds were going “could come back to
haunt” them. Id.
Ultimately, however, after (1) reviewing the Debtor’s V-Note circulars and determining
that they complied with Ohio placement requirements, (2) receiving accountant assurances that
the affiliated entities benefited by the insider loans had sufficient assets to secure the debts,
(3) receiving Durham and Cochran’s promise to have insiders pay down a portion of the loans,
and (4) introducing a covenant that limited the creation of future insider loans, Textron felt
comfortable maintaining its relationship with the Debtor and FHI. D.C. R. 66 (Redacted
VanNiel Decl. Ex. 9) (Page ID #3561–64). United found no comfort in these considerations,
however, and, as early as July 16, 2003, had written Textron and urged it to either buy out
United’s interest under the 2002 L&SA or exercise its rights under the 2002 L&SA by declaring
the Debtor and FHI in default and accelerating the entire amount due under the promissory note.
D.C. R. 66 (Redacted VanNiel Decl. Ex 6) (Page ID #3548). Textron chose the former option
and worked with the Debtor and FHI to establish the terms under which Textron would move
No. 15-3854 Bash v. Textron Financial Corp. Page 9
forward without United, its “uncooperative” partner. D.C. R. 20 (Mot. to Dismiss Ex. H) (Page
ID #962–69); D.C. R. 66 (Redacted VanNiel Decl. Ex. 9) (Page ID #3561–64).
On January 6, 2004, the Debtor and FHI entered into a First Amended and Restated Loan
and Security Agreement (“2004 ARL&SA”). D.C. R. 66 (Redacted VanNiel Decl. Ex. 10) (Page
ID #3565–625). The 2004 ARL&SA’s opening recitals explained that (1) pursuant to the 2002
L&SA, Textron and United had “committed to make loans to [the Debtor and FHI] in an
aggregate amount not to exceed $22,000,000” and that the Debtor and FHI “granted a security
interest to [Textron and United] in substantially all [their] business assets”; (2) under the 2002
L&SA, the Debtor and FHI delivered to Textron “promissory notes, security agreements,
mortgage deeds, guaranties and other loan documents” that, together with the 2002 L&SA,
constituted the “Original Loan Documents”; (3) the Debtor, FHI, and Textron “desire[d] to
amend and restate the Original Agreement in order to reduce the amount of the aggregate loans
to $17,500,000 and to modify certain of the terms and conditions of the lending”;6 and
(4) “[c]ontemporaneously with the execution of this Agreement,” Textron agreed to purchase
and United agreed to sell “and release all of its interest in the Original Loan Documents.” Id. at
1 (Page ID #3565). As was the case with the 2002 L&SA, the 2004 ARL&SA incorporated a
“Grant of Security Interest” provision, under which the Debtor and FHI “assign[ed] [Textron] a
continuing security interest and lien upon” the Debtor and FHI’s assets and provided that:
(c) It is Borrowers’ express intention that this Agreement and the continuing
security interest granted hereby, in addition to covering all present obligations of
Borrowers to Lender and its Affiliates pursuant to the Obligations, shall extend to
all future obligations of the Borrowers to Lender intended as replacements or
substitutions for the Obligations, whether or not the Obligations are reduced or
entirely extinguished and thereafter increased and reincurred.
Id. at 7–8 (Page ID #3571–72).
The 2004 ARL&SA differed from the 2002 L&SA in several respects. The 2004
ARL&SA provided for a new interest rate, a new fee schedule, and new events of default. Id. at
5, 17–18 (Page ID #3569, 3581–82). New covenants were added, one of which required the
6
An internal Textron memorandum specifically explained that the Debtor would be able to operate under a
decreased credit facility “due to [the Debtor’s] ongoing access to the unsecured subordinate debt market in the form
of the V6 certificate.” D.C. R. 66 (Redacted VanNiel Decl. Ex. 7) (Page ID #3550).
No. 15-3854 Bash v. Textron Financial Corp. Page 10
Debtor and FHI to “reduce the total amount of related-party indebtedness . . . in accordance
with” an attached payment schedule, while another required the Debtor and FHI to refrain from
“mak[ing] any loan or advances to any Affiliate, Dealer or any other Person.” Id. at 11–14 (Page
ID #3575–78). Several new conditions precedent were added, the most relevant of which
required the Debtor and FHI to deliver to Textron 50% of the amount due to United under the
Original Loan Documents or otherwise required to release United as well as “all accrued interest,
fees, expenses, and other charges owing” under the Original Loan Documents. Id. at 14–15
(Page ID #3578–79). Additionally, because the Debtor and FHI’s legal counsel had expressed
concerns as to whether the insider loans were adequately disclosed in the V-Note offering
circulars, the 2004 ARL&SA confirmed the parties’ decision to amend the offering circulars but
to postpone the release of the updated offering circulars to avoid sending “an unsettling message
to the market.” Id. at Schedule 25(p) (Page ID #3624); D.C. R. 66 (Redacted VanNiel Decl. Ex.
19) (Page ID #3813–14). One of the 2004 ARL&SA’s final provisions provided that it was
“intended by the Borrowers and Lender to be the final, complete, and exclusive expression of
the agreement between them” and that the “Agreement supersedes all prior oral or written
agreements related to the subject matter hereof.” D.C. R. 66 (Redacted VanNiel Decl. Ex. 10, at
23) (Page ID #3587).
In addition to executing the 2004 ARL&SA, the parties executed a new promissory note
in the amount of $17,500,000. D.C. R. 66 (Redacted VanNiel Decl. Ex. 15) (Page ID #3733–
35). The January 6, 2004 promissory note provided as follows: “This Promissory Note and the
advances contemplated hereunder are made pursuant to the terms and provisions of that certain
First Amended and Restated Loan and Security Agreement . . . .” Id. Additionally, “[f]or the
purpose of inducing [Textron] to lend money or extend credit to [the Debtor and FHI] by a
revolving loan . . . in the Maximum Loan Amount of $17,500,000,” both Durham and Cochran
executed new continuing unlimited personal guarantees. D.C. R. 66 (Redacted VanNiel Decl.
Ex. 16) (Page ID #3736–51). Textron did not file a UCC financing statement upon the execution
of the 2004 ARL&SA. On July 31, 2006, Textron did, however, file a UCC financing statement
amendment, purporting to evidence the continuation of the security interest established on
January 8, 2002, pursuant to the 2002 L&SA. D.C. R. 20 (Mot. to Dismiss Ex. D) (Page ID
#922).
No. 15-3854 Bash v. Textron Financial Corp. Page 11
Despite the assurances of Durham and Cochran and the new covenants created in the
2004 ARL&SA, a series of internal Textron modification requests evidence the lender’s
knowledge and growing discontent concerning Durham and Cochran’s commitment to
continuing their fraudulent scheme. D.C. R. 66 (Redacted VanNiel Decl. Ex. 12) (Page ID
#3628–96). For example, a February 10, 2005 modification request indicates that the Debtor and
FHI continued to miss deadlines for providing Textron with audited financials. Id. (Page ID
#3629–30). As it turned out, the delay stemmed from the Debtor and FHI’s termination of their
accounting firm in response to the firm’s determination that it could not issue the Debtor an
unqualified audit opinion due to its many concerns regarding the Debtor’s insider loans and
solvency.7 B.C. R. 8 (First Am. Compl. at 68:415–71:426). And while the Debtor and FHI’s
new accounting firm issued an unqualified consolidated audit opinion for 2003 and 2004, the
new firm later determined that the accounting analysis employed in the opinion was flawed, and
it instructed Durham not to use the opinion in future offering circulars, an instruction Durham
did not follow. Id. at 72:430–75:446.
When the new accounting firm conducted a new audit that employed the appropriate FIN
468 analysis, the audit showed that the Debtor and FHI had overvalued the insider loans since
2002 and that the combined entities were insolvent by more than $21 million. D.C. R. 66
(Redacted VanNiel Decl. Ex. 12) (Page ID #3666–68). After the firm provided the Debtor and
FHI with its preliminary reports in the spring of 2006, the Debtor and FHI terminated the second
accounting firm to avoid the release of an adverse audit opinion. B.C. R. 8 (First Am. Compl. at
75:446–48, 78:460–79:470); D.C. R. 66 (Redacted VanNiel Decl. Ex. 24) (Page ID #3882–96).
The Debtor and FHI then chose to release financial statements that were reviewed by a third
accounting firm and certified by Durham, as opposed to releasing audited financial statements.
Id.
7
The Debtor and FHI did not tell Textron that they had terminated their accounting firm but instead
explained that the firm resigned to avoid a conflict of interest. D.C. R. 20 (Mot. to Dismiss Ex. M) (Page ID #986).
8
FIN 46 is an anti-fraud interpretation developed by the Financial Accounting Standards Board that calls
for a consolidated analysis of related entities to avoid inaccurate financial pictures. D.C. R. 20 (Mot. to Dismiss Ex.
O) (Page ID #1006).
No. 15-3854 Bash v. Textron Financial Corp. Page 12
Textron continued to work with the Debtor and FHI through these issues, waiving various
covenant violations and extending the loan on multiple occasions through the execution of ten
distinct amendments to the 2004 ARL&SA. D.C. R. 66 (Redacted VanNiel Decl. Ex. 17) (Page
ID #3752–3808). In exchange for the waivers and extensions, Textron received consideration in
the form of significant non-refundable fees and assurances that Durham and Cochran were
working to find an alternative lender that could refinance the loan and repay Textron in full. Id.;
B.C. R. 8 (First Am. Compl. at 80:475–77). For example, upon the execution of the first waiver
and amendment, Textron received a wavier fee of $30,000, D.C. R. 66 (Redacted VanNiel Decl.
Ex. 12) (Page ID #3752–57), two $43,750 accommodation fees in exchange for the third and
fourth amendments, id. (Page ID #3763–71), and a graduated series of fees totaling $135,000 in
exchange for the execution of the seventh amendment to the 2004 ARL&SA, id. (Page ID
#3783–88).
On July 20, 2007, the Debtor and FHI finally secured alternative funding in the form of a
$23 million asset sale transaction, and Textron received a total payment of $16,999,927.09,
representing all the money owed under the 2004 ARL&SA. B.C. R. 8 (First Am. Compl. at
82:493); D.C. R. 66 (Redacted VanNiel Decl. Ex. 18) (Page ID #3809–12). In turn, Textron
agreed to release all liens securing the loan documents. D.C. R. 66 (Redacted VanNiel Decl. Ex.
18) (Page ID #3809–12). The Trustee alleges, and Textron does not dispute that, from the
execution of the 2004 ARL&SA to Textron’s payoff, the Debtor and FHI made more than $300
million in payments to Textron. Appellant’s Opening Br. 14.
Approximately two years after Textron’s relationship with the Debtor and FHI ended, the
FBI raided the Debtor’s headquarters, seizing its documents and computers. B.C. R. 8 (First
Am. Compl. at 19:111). On March 15, 2011, Durham, Cochran, and the Debtor’s Chief
Financial Officer, Rick Snow, were indicted for wire fraud, securities fraud, and conspiracy. Id.
at 20:113. All three were convicted of various counts alleged in the indictment, and each is now
serving a federal prison sentence. United States v. Durham, 766 F.3d 672 (7th Cir. 2014)
(affirming Cochran’s twenty-five-year prison sentence and Snow’s ten-year prison sentence);
United States v. Durham, 630 F. App’x 634 (7th Cir. 2016) (unpublished) (affirming Durham’s
resentencing to a term of fifty years’ imprisonment).
No. 15-3854 Bash v. Textron Financial Corp. Page 13
B.
After the FBI raided the Debtor’s headquarters and the Ponzi scheme collapsed, certain
V-Note holders filed a petition for involuntary bankruptcy against the Debtor. B.P. R. 1
(Involuntary Bankr. Pet. (Chapter 7)). Following his appointment, the Trustee filed a number of
adversary proceedings in the Bankruptcy Court for the Northern District of Ohio, including the
present action against Textron, Fortress Credit Corporation, and Fair Facility I, LLC. B.C. R. 1
(Compl.); B.C. R. 8 (First Am. Compl.). As to Textron, the only relevant defendant on appeal,
the Trustee brought aiding and abetting claims, a conspiracy claim, claims to avoid and recover
actual and constructive fraudulent transfers under 11 U.S.C. § 544(a) and (b)(1), O.R.C.
§ 1336.04(A)(1) and (A)(2), O.R.C. § 1336.05(A), O.R.C. § 2307.61, 11 U.S.C. § 550(a), and 11
U.S.C. § 551, and equitable subordination and disallowance claims. B.C. R. 8 (First Am. Compl.
at 112–16, 124–26, 128, 130, 132, 135–37).
In March 2012, both Textron and the Trustee moved to have the adversary proceeding’s
reference to the bankruptcy court withdrawn pursuant to 28 U.S.C. § 157(d) so that the case
could proceed in the United States District Court for the Northern District of Ohio. D.C. R. 1
(Def.’s Mot. to Withdraw Reference to the U.S. Bankr. Ct. for the Northern Dist. of Ohio) (Page
ID #1–23); D.C. R. 2 (Trustee’s Mot. for Entry of Order Withdrawing Reference of Adv.
Proceedings) (Page ID #137–56). The district court granted the motions on April 20, 2012. D.C.
R. 19 (Order Apr. 19, 2012) (Page ID #824). That same day, Textron moved in the district court
to dismiss the Trustee’s claims for lack of standing, failure to state a claim, and failure to timely
file the claims within the applicable statutes of limitations. D.C. R. 20 (Mot. to Dismiss) (Page
ID #825–1025). The district court referred the adversary proceeding to the bankruptcy court for
pretrial supervision and the filing of a report and recommendation on all dispositive motions.
D.C. R. 29 (Order Apr. 30, 2012) (Page ID #1605).
On July 31, 2012, the bankruptcy court issued a report and recommendation addressing
Textron’s motion to dismiss. D.C. R. 60 (R.&R. to Deny Def.’s Mot. to Dismiss) (Page ID
#3458–65). The bankruptcy court recommended denying Textron’s motion to dismiss in full,
concluding that the Trustee had sufficiently pled each claim and that resolution of the claims on a
motion to dismiss was inappropriate as Textron’s arguments in favor of dismissal required the
No. 15-3854 Bash v. Textron Financial Corp. Page 14
resolution of factual disputes. Id. at 3–8 (Page ID #3459–65). Textron objected to the report and
recommendation, D.C. R. 75 (Obj. of Def. to R.&R. on Mot. to Dismiss Am. Compl.) (Page ID
#5412–50), and on November 9, 2012, the district court rejected the report and recommendation
and granted Textron’s motion to dismiss, D.C. R. 122 (Mem. Op. & Order Nov. 9, 2012) (Page
ID #7210–58).
As to the Trustee’s fraudulent transfer claims, the district court concluded as a matter of
law that the 2004 ARL&SA was not a novation of the 2002 L&SA and, as a result, the security
interest conveyed pursuant to the 2002 L&SA continued in full force. Id. at 24–28 (Page ID
#7233–37). Further, because Textron had maintained a valid security interest in the Debtor’s
assets since 2002, neither the 2004 ARL&SA nor the payments made thereunder could qualify as
“transfers” for purposes of a fraudulent transfer claim. Id. The district court also determined
that any post-execution bad faith on the part of Textron did not render the 2002 security interest
invalid for purposes of the Trustee’s fraudulent transfer claims. Id.
Next, the district court addressed the Trustee’s aiding and abetting claim and determined
that dismissal was appropriate in light of a recent decision by the Ohio Supreme Court, in which
the court explained that Ohio does not recognize a cause of action for tortious acts undertaken.
Id. at 28–29 (Page ID #7237–38). Turning to the Trustee’s civil conspiracy claim, the district
court concluded that the allegations of the amended complaint established that the in pari delicto
bar to tort recovery was applicable. Id. at 30–35 (Page ID #7239–44). Specifically, the district
court explained that Durham and Cochran so dominated the Debtor that their conduct would be
imputed to the Debtor and that, even if the Ohio Supreme Court would recognize an innocent
insider exception to foreclose such imputation in certain circumstances, the Trustee had failed to
allege the existence of any innocent insider. Id. After imputing Durham and Cochran’s
wrongful conduct to the Debtor, the district court found that the Debtor was, at a minimum, as
culpable as Textron in perpetuating the Ponzi scheme, and it dismissed the Trustee’s civil
conspiracy claim under the in pari delicto affirmative defense. Id. Lastly, the district court
concluded that the Trustee’s equitable subordination and disallowance claims should also be
dismissed. Id. at 35–36 (Page ID #7244–45). The bankruptcy court had recommended denying
the dismissal of those claims because Textron had not yet filed a proof of claim in the Debtor’s
No. 15-3854 Bash v. Textron Financial Corp. Page 15
bankruptcy proceeding. Id. Although Textron did not object to that recommendation, the district
court sua sponte dismissed those claims because it had already dismissed the Trustee’s
underlying substantive claims. Id.
The November 9, 2012 memorandum opinion and order dismissing the Trustee’s claims
against Textron was merged into the district court’s July 24, 2015 final judgment, and, on August
3, 2015, the Trustee filed a timely notice of appeal. D.C. R. 261 (Not. of Appeal) (Page ID
#57085–87).
II.
The Trustee argues that the district court improperly dismissed his fraudulent transfer,
civil conspiracy, and equitable subordination and disallowance claims. We examine each claim
in turn and review de novo whether the district court properly granted Textron’s motion to
dismiss. Mertik v. Blalock, 983 F.2d 1353, 1356 (6th Cir. 1993). “A claim survives such a
motion if its ‘[f]actual allegations [are] enough to raise a right to relief above the speculative
level on the assumption that all of the complaint’s allegations are true.’” Jones v. City of
Cincinnati, 521 F.3d 555, 559 (6th Cir. 2008) (alteration in original) (quoting Bell Atl. Corp. v.
Twombly, 550 U.S. 544, 555 (2007)).
A.
1.
We turn first to the Trustee’s fraudulent transfer claims. The Trustee asserts that,
pursuant to the Ohio Uniform Fraudulent Transfer Act (“UFTA”), Ohio Rev. Code § 1336.01 et
seq.,9 the Debtor can avoid the obligations incurred and payments made under the 2004
ARL&SA because the security interest conveyed by the Debtor to secure the 2004 ARL&SA and
all the payments made in accordance with the Debtor’s obligations under that agreement qualify
as either actual or constructive fraudulent transfers. Because, as discussed below, the Trustee’s
constructive fraudulent transfer claim is barred by the applicable statute of limitations, we limit
our discussion here to the Trustee’s actual fraudulent transfer claim.
9
The Trustee brings the fraudulent transfer claims under 11 U.S.C. § 544, which permits a bankruptcy
trustee to seek avoidance of fraudulent transfers under applicable state laws.
No. 15-3854 Bash v. Textron Financial Corp. Page 16
Section 1336.04(A)(1) of the Ohio UFTA provides that “[a] transfer made or an
obligation incurred by a debtor is fraudulent” and avoidable as to a creditor, “if the debtor made
the transfer or incurred the obligation . . . [w]ith [the] actual intent to hinder, delay, or defraud
any creditor of the debtor.” The Ohio UFTA broadly defines “transfer” as “every direct or
indirect, absolute or conditional, and voluntary or involuntary method of disposing of or parting
with an asset or an interest in an asset, and includes payment of money, release, lease, and
creation of a lien or other encumbrance.” § 1336.01(L). And it defines “lien” to include “a
security interest created by agreement.” § 1336.01(H). Importantly, however, the Ohio UFTA
explicitly carves out all “[p]roperty to the extent it is encumbered by a valid lien” from the
statute’s definition of a transferable asset. § 1336.01(B)(1).10 When read in concert, these
provisions provide that, to state a claim for relief under the Ohio UFTA, the Trustee must allege
facts plausibly suggesting that the 2004 ARL&SA, including its conveyance of a security interest
in all of the Debtor’s property, and the payments made pursuant to the 2004 ARL&SA,
constitute transfers under the Ohio UFTA. That is, he must show that the assets or interests in
assets conveyed by the Debtor pursuant to the 2004 ARL&SA were not already encumbered by a
valid lien.
The district court dismissed the Trustee’s actual fraudulent transfer claim, concluding that
the Trustee had failed to make such a showing. Specifically, the district court determined that,
because the 2004 ARL&SA was merely a refinancing of the 2002 L&SA, the security interest
established pursuant to the 2002 L&SA remained in full force and encumbered any assets or
interests in assets conveyed with regard to the 2004 ARL&SA. Bash v. Textron Fin. Corp.,
483 B.R. 630, 646 (N.D. Ohio 2012). The district court thus concluded that the Trustee had
failed to allege the existence of an avoidable transfer for purposes of the Ohio UFTA. Id.
On appeal, the Trustee argues that three independent grounds exist for nullifying or
invalidating the lien, or security interest, established under the 2002 L&SA, thereby rendering
the 2004 ARL&SA, including its grant of a security interest, and the payments made thereunder
10
Property encumbered by a valid lien does not constitute a transferable asset because, from the time a
valid lien is perfected, the property is no longer considered part of the debtor’s estate. Comer v. Calim, 716 N.E.2d
245, 249 (Ohio Ct. App. 1998).
No. 15-3854 Bash v. Textron Financial Corp. Page 17
avoidable transfers.11 First, the Trustee contends that the 2004 ARL&SA was a novation of the
2002 L&SA and that, when the 2002 L&SA was extinguished, so too was the security interest
granted thereunder. Next, the Trustee argues that, if this Court turns first to the contractual
obligations incurred pursuant to the 2004 ARL&SA and finds them avoidable as incurred for the
purpose of defrauding the Debtor’s creditors, then the 2002 lien securing those contractual
obligations becomes a legal nullity. Finally, the Trustee asserts that this Court may use its
equitable powers to subordinate the 2002 security interest in light of Textron’s post-perfection
bad faith and that such subordination would effectively render Textron’s lien invalid for
purposes of the Ohio UFTA.
Because we conclude that the Trustee has demonstrated that the district court erred in
determining as a matter of law that the parties did not intend the 2004 ARL&SA as a novation of
the 2002 L&SA, we reverse the judgment of the district court on the Trustee’s first theory and
remand for further proceedings without examining the merits of the Trustee’s other two
arguments. We note, however, that our silence as to the two alternative theories for invalidating
the 2002 security interest should in no way be taken as a comment in favor of or against the
viability of such arguments going forward; specifically, our vacatur of the judgment means that
the district court may, in its discretion and in light of this opinion, revisit those issues upon
remand.
2.
The Trustee argues that, under Ohio law, the 2004 ARL&SA constituted a novation of
the 2002 L&SA. Thus, the Trustee contends that, upon execution of the 2004 ARL&SA, the
2002 L&SA along with its underlying security interest was extinguished. As a result, the Trustee
asserts that the Debtor’s assets were not encumbered by a preexisting valid lien and that he may
therefore seek avoidance of the 2004 ARL&SA, including the security interest granted
thereunder, and all payments made pursuant to that obligation as fraudulent transfers. The
11
At no point does the Trustee assert that the 2002 L&SA, its grant of a security interest, or any of the
payments made to Textron pursuant to the 2002 L&SA constitute avoidable transfers under the Ohio UFTA, likely
recognizing that Textron seemingly acted in good faith when it initially entered into business with Durham and
Cochran—an affirmative defense allowing a recipient of a fraudulent transfer to nonetheless avoid liability. See
Ohio Rev. Code §1336.08(A) (“A transfer or obligation is not fraudulent . . . against a person who took in good faith
and for a reasonably equivalent value . . . .”).
No. 15-3854 Bash v. Textron Financial Corp. Page 18
district court disagreed with the Trustee’s argument and, instead, determined that the
2004 ARL&SA constituted a mere refinancing of the 2002 L&SA that did not impact the
ongoing validity of the 2002 security interest. At the motion to dismiss stage and on the record
before us, however, we must agree with the Trustee that the allegations are sufficient to state a
claim and that genuine factual disputes surround the issue of the effect of the 2004 ARL&SA on
the continuing validity of the security interest conveyed under the 2002 L&SA.
“A contract of novation is created where a previous valid obligation is extinguished by a
new valid contract, accomplished by substitution of parties or of the undertaking, with the
consent of all the parties, and based on valid consideration.” McGlothin v. Huffman, 640 N.E.2d
598, 601 (Ohio Ct. App. 1994). The Ohio Court of Appeals has explained that “[i]ntent,
knowledge and consent are the essential elements in determining whether a purported novation
has been accepted.” Nat’l City Bank v. Reat Corp., 580 N.E.2d 1147, 1149 (Ohio Ct. App. 1989)
(alteration in original) (quoting Bolling v. Clevepak Corp., 484 N.E.2d 1367, 1379 (Ohio Ct.
App. 1984)). “A party’s knowledge of and consent to the terms of a novation need not be
express, but may be implied from circumstances or conduct.” Id. “[T]he evidence of such
knowledge and consent,” however, “must be clear and definite, since a novation is never
presumed.” Bolling, 484 N.E.2d at 1379. These basic principles have routinely been applied in
cases involving contracts delineating financial rights and obligations. See, e.g., Noland v.
Wilmington Sav. Bank (In re D & K Aviation, Inc.), 349 B.R. 169, 175–77 (Bankr. S.D. Ohio
2006) (noting that, where a new note has been executed between existing parties, Ohio law
provides for a presumption in favor of finding a new loan transaction to be “a renewal of the
original debt that retains the same security” as opposed to a novation; a party may overcome this
presumption by demonstrating that the parties intended for the “new loan transaction [to]
discharge[] [the] prior debt and its corresponding security”); Holland v. Assocs. Fin. (In re
Holland), 16 B.R. 83, 87 (Bnkr. N.D. Ohio 1981) (“It is well settled in Ohio that renewals of
notes, or changes in the form of the evidence of a precedent debt, do not create a new debt, or
operate as a discharge or satisfaction of the old debt, unless it is expressly agreed between the
parties.”).
No. 15-3854 Bash v. Textron Financial Corp. Page 19
Here, the district court concluded as a matter of law that the parties clearly intended the
2004 ARL&SA to be a mere refinancing of the 2002 L&SA and not a novation. In so
concluding, the district court emphasized that (1) the 2004 ARL&SA provided for a security
interest in the same collateral that was encumbered under the 2002 L&SA; (2) the
2004 ARL&SA actually reduced the aggregate line of credit available to the Debtor; (3) the
language of the 2002 L&SA12 provided for Textron’s security interest to extend to cover “future
obligations of Borrower to Lenders intended as replacements or substitutions for said
Obligations, whether or not such Obligations are reduced or entirely extinguished and thereafter
increased”; and (4) one of the 2004 ARL&SA’s recitals set forth the parties’ “desire to amend
and restate the Original Agreement.” Bash, 483 B.R. at 647–48. These facts, to varying degrees,
do support the district court’s conclusion that the parties did not clearly intend the
2004 ARL&SA to be a novation of the 2002 L&SA. Importantly, however, there remains
extensive evidence that went unexamined by the district court, evidence that supports the
Trustee’s contention that the parties clearly and overwhelmingly manifested their intent for the
2004 ARL&SA to constitute a novation of the 2002 L&SA, making it inappropriate to determine
the parties’ intent at the motion to dismiss stage. See Crane Hollow, Inc. v. Marathon Ashland
Pipe Line, LLC, 740 N.E.2d 328, 340 (Ohio Ct. App. 2000) (noting that, “if [a] contract is
ambiguous, ascertaining the parties’ intent constitutes a question of fact”).
Turning first to the text of the 2004 ARL&SA, several provisions evidence the parties’
intent for the 2004 ARL&SA to wholly replace and extinguish the 2002 L&SA as the operative
agreement between the parties. For example, Paragraph 39 expressly sets forth the parties’
desire to have the 2004 ARL&SA “supersede[] any and all prior oral or written agreements
relating to the subject matter thereof.” D.C. R. 66 (Redacted VanNiel Decl. Ex. 10, at 23) (Page
ID #3587). In the same vein, Paragraph 35 explains that the 2004 ARL&SA “constitutes the
entire agreement of Borrowers and Lender relative to the subject matter hereof.” Id. at 21 (Page
ID #3585). Further, in Paragraph 11, the Debtor and FHI agreed to “grant, pledge, convey and
12
The Trustee contends that the district court inappropriately relied on evidence outside the 2004 ARL&SA
when examining the parties’ intent. Graham v. Drydock Coal Co., 667 N.E.2d 949, 952 (Ohio 1996) (“The intent of
the parties is presumed to reside in the language they chose to use in their agreement.”). Because the 2004
ARL&SA is ambiguous as to the parties’ intent, however, an exploration of relevant extrinsic evidence is permitted.
Shifrin v. Forest City Enters. Inc., 597 N.E.2d 499, 501 (Ohio 1992).
No. 15-3854 Bash v. Textron Financial Corp. Page 20
assign” a new security interest in and lien upon their property to Textron “to secure the prompt
and full payment and complete performance of all obligations of Borrowers to Lender under [the
2004 ARL&SA].” Id. at 6–8 (Page ID #3570–72). Lastly, in the conclusion to the
2004 ARL&SA’s recitals, the parties explicitly confirmed that the 2004 ARL&SA was the
product of “valuable consideration, the receipt and sufficiency of which are hereby
acknowledged.” Id. at 1 (Page ID #3565). Read together, these provisions support a finding that
the parties demonstrated their intent to “extinguish[] their obligations under the prior agreement”
and be bound anew under the terms of the 2004 ARL&SA. See 216 Jamaica Ave., LLC v. S & R
Playhouse Realty Co., 540 F.3d 433, 439 (6th Cir. 2008) (applying Ohio law).
We find additional evidence of the parties’ intent to have the 2004 ARL&SA operate as a
novation of the 2002 L&SA in the circumstances surrounding the execution of the 2004
ARL&SA. First, the parties entered into the 2004 ARL&SA on the date the 2002 L&SA
matured. Second, the parties replaced the 2002 promissory note and personal guarantees with a
new promissory note and new personal guarantees. Third, the 2004 ARL&SA imposed
significant new terms on both parties, including (1) new interest rate and fee terms; (2) an
increased financial commitment on the part of Textron; (3) a requirement that the Debtor and
FHI deliver to Textron 50% of the amount required to obtain United’s release from the 2002
L&SA as well as “all accrued interest, fees, expenses and other charges owing by Borrowers
under the Original Agreement”; and (4) the removal of United as a lender. D.C. R. 66 (Redacted
VanNiel Decl. Ex. 10, at 14–15) (Page ID #3578–79). It is true that any one of these facts, in
isolation, might fail to constitute a clear manifestation of the parties’ intent to have the
2004 ARL&SA serve as a novation of the 2002 L&SA. However, when examined together, in
conjunction with the relevant provisions of the 2004 ARL&SA, and in the light most favorable to
the Trustee as the nonmoving party, these facts demonstrate, at the very least, the existence of an
ambiguity as to whether the parties clearly intended the 2004 ARL&SA to extinguish the
2002 L&SA. Potti v. Duramed Pharm, Inc., 938 F.2d 641, 647 (6th Cir. 1991) (explaining that,
“[u]nder Ohio law, [while] interpretation of written contract terms is a matter of law for initial
determination by the court,” “when the relevant contract language is ambiguous . . . the job of
interpretation is turned over to the fact finder”). To be sure, the ambiguity in this case is not so
much over the discrete meaning of a contract term or the elements of a bargained-for
No. 15-3854 Bash v. Textron Financial Corp. Page 21
performance. Rather, it derives from the unique role an ostensible novation plays in setting the
framework for performance. Under the circumstances here, a “new agreement” does not
necessarily require the creation of a new security interest, but neither does a “new agreement”
foreclose a finding of an intent on the part of the contracting parties that prior dealings have
come to an end and that a new lien be created.
In that light, it bears mention that the principal, if not singular, case that the district court
relied upon, Official Committee of Unsecured Creditors of Tousa, Inc. v. Citicorp North
America, Inc. (In re TOUSA, Inc.), No. 09-60589, 2011 WL 1627129 (S.D. Fla. Mar. 4, 2011), is
distinguishable from the case here. In In re TOUSA, Inc., the district court concluded that the
execution of a Second Amended and Restated Revolving Credit Agreement did not constitute a
new obligation for the purposes of a fraudulent conveyance claim because a preexisting security
agreement remained in effect. Id. at *7–8. In determining that the initial security agreement still
bound the plaintiff, the district court relied heavily on the Second Amended and Restated
Revolving Credit Agreement’s explicit statement that “it was the ‘intent of the parties . . . that the
security interests and [l]iens granted in the [c]ollateral under and pursuant to the [o]riginal
[s]ecurity [a]greement shall continue in full force and effect.’” Id. at *1, *7 (alterations in
original). No such language exists in the 2004 ARL&SA at issue in this case and that renders
decision of the issue as a matter of law especially challenging. We think that challenge cannot
be met here.
Accordingly, because the Trustee has established the existence of an ambiguity as to
whether the parties clearly intended the 2004 ARL&SA to extinguish the 2002 L&SA and the
security interest it created, we conclude that the district court erred when it determined as a
matter of law that the 2004 ARL&SA was not a novation of the 2002 L&SA and that the security
interest created pursuant to the 2002 L&SA remained in full force. The Trustee sufficiently
showed, for purposes of withstanding Textron’s motion to dismiss, that the Debtor’s assets were
no longer encumbered by a preexisting valid lien when the parties executed the 2004 ARL&SA
and the Debtor granted Textron a new security interest in its assets.
Moreover, we hold that the Trustee has sufficiently stated a plausible claim for relief
under the Ohio UFTA. The Trustee pled facts that, taken as true, demonstrate that the 2004
No. 15-3854 Bash v. Textron Financial Corp. Page 22
ARL&SA, the security interest the Debtor granted pursuant to the 2004 ARL&SA, and all
payments made by the Debtor in accordance with its obligations under the 2004 ARL&SA
amount to fraudulent transfers under the Ohio UFTA because each transaction was undertaken in
an effort to perpetuate a Ponzi scheme that inevitably collapsed and left hundreds of
unsophisticated Ohio investors holding the bag. See, e.g., Rieser v. Hayslip (In re Canyon Sys.
Corp.), 343 B.R. 615, 636–37 (Bankr. S.D. Ohio 2006) (compiling cases in which transfers made
in the course of a Ponzi scheme were determined to have been made with the actual intent to
hinder, delay, or defraud creditors as a matter of law).13
3.
As an alternative basis for affirming the dismissal of the fraudulent transfer claims,
Textron argues that the claims are barred by the applicable statutes of limitations. For purposes
of an actual fraudulent transfer claim, the Ohio UFTA provides that:
[a] claim for relief with respect to a transfer or an obligation that is fraudulent
. . . is extinguished unless [the] action is brought . . . within four years after the
transfer was made or the obligation was incurred or, if later, within one year after
the transfer or obligation was or reasonably could have been discovered by the
claimant.
Ohio Rev. Code § 1336.09(A). In the case of a constructive fraudulent transfer claim, the Ohio
UFTA provides that the claim must be brought “within four years after the transfer was made or
the obligation was incurred.” § 1336.09(B).
Here, the Trustee is seeking to avoid the obligations incurred under the 2004 ARL&SA
and all transfers of assets made in connection with the 2004 ARL&SA, including the grant of the
2004 security interest. The parties executed the 2004 ARL&SA on January 6, 2004; the
Debtor’s bankruptcy petition was not filed until February 8, 2010. Accordingly, because the
Trustee brought the constructive fraudulent transfer claim well outside the applicable four-year
13
And while Textron argues that the novation analysis is ultimately irrelevant because the 2004 ARL&SA
was the subject of its own valid lien, Textron cannot use the creation of a lien that the Trustee has plausibly alleged
is itself avoidable as a fraudulent transfer as a shield from application of the Ohio UFTA. Cf. § 1336.01(L) (broadly
defining “transfer” as “every direct or indirect, absolute or conditional, and voluntary or involuntary method of
disposing of or parting with an asset or an interest in an asset, . . . includ[ing] payment of money, release, lease, and
creation of a lien or other encumbrance” (emphasis added)).
No. 15-3854 Bash v. Textron Financial Corp. Page 23
statute of limitations, we agree with Textron and conclude that the Trustee’s constructive
fraudulent transfer claim is time barred. As for the Trustee’s actual fraudulent transfer claim, the
parties agree that it must fall within the ambit of the latter portion of § 1336.09(A), the
provision’s discovery rule, in order to be timely. The parties disagree, however, as to whether,
for purposes of § 1336.09(A), discovery occurs when the transfer is discoverable or when the
transfer’s fraudulent nature is discoverable.
When resolving an issue of state law, “we look to the final decisions of that state’s
highest court, and if there is no decision directly on point, then we must make an Erie guess to
determine how that court, if presented with the issue, would resolve it.” Conlin v. Mortg. Elec.
Registration Sys., Inc., 714 F.3d 355, 358–59 (6th Cir. 2013). “Intermediate state appellate
courts’ decisions are also viewed as persuasive unless it is shown that the state’s highest court
would decide the issue differently.” Savedoff v. Access Grp., Inc., 524 F.3d 754, 762 (6th Cir.
2008). In this instance, neither the Ohio Supreme Court nor Ohio’s Court of Appeals has
directly addressed the issue before us. Accordingly, we must “consider all relevant data,
including jurisprudence from other jurisdictions,” Combs v. Int’l Ins. Co., 354 F.3d 568, 577 (6th
Cir. 2004) (internal citations and quotation marks omitted), and we must “make [the] best
prediction, even in the absence of direct state court precedent, of what the [Ohio] Supreme Court
would do if it were confronted with this question,” Managed Health Care Assocs., Inc. v.
Kethan, 209 F.3d 923, 927 (6th Cir. 2000) (first alteration in original) (quoting Welsh v. United
States, 844 F.2d 1239, 1245 (6th Cir. 1988)).
The only cases to have directly addressed the issue of accrual of a claim under the
discovery rule of § 1336.09(A) of the Ohio UFTA have arisen in the federal district courts sitting
in Ohio, and those decisions, in addition to reaching varied conclusions, offer little in the way of
guidance. See Bradley v. Miller, 96 F. Supp. 3d 753 (S.D. Ohio 2015); Fitness Quest Inc. v.
Monti, No. 5:06CV2691, 2012 WL 3587491 (N.D. Ohio Aug. 20, 2012); Treinish v. Spitaleri (In
re Spitaleri), No. 05-94988, 2006 WL 4458357 (Bankr. N.D. Ohio May 9, 2006). For example,
in 2006, the Bankruptcy Court for the Northern District of Ohio concluded that the Ohio UFTA
did not provide a savings clause, as was the case with Ohio’s repealed fraudulent conveyance
statute, but instead provided a “constructive discovery” clause that hinged on discovery of the
No. 15-3854 Bash v. Textron Financial Corp. Page 24
transfer and not on discovery of the fraud. In re Spitaleri, 2006 WL 4458357, at *2. In making
this distinction, however, the court did not cite any Ohio cases that had previously required a
plaintiff to demonstrate that she discovered the existence of the transfer within one year of filing
her complaint, as opposed to requiring that she establish when she discovered the transfer’s
fraudulent nature. Id.
While a district court in another case relied on In re Spitaleri to conclude that “the statute
of limitations on Ohio fraudulent transfer claims begins to run on the date that a creditor could
have discovered the transfer, and not when the alleged fraud was discovered,” the court sought to
bolster this holding by citing two unpublished opinions of the Ohio Court of Appeals. Fitness
Quest, Inc., 2012 WL 3587491, at *5 (citing Davis v. McDowell, No. H-06-001, 2006 WL
2242875 (Ohio Ct. App. June 30, 2006); Cunningham v. Cunningham, No. 01CA007938, 2002
WL 1263964 (Ohio Ct. App. May 29, 2002)). Those state court decisions, however, prove fairly
unsupportive upon close inspection. In each instance, the state court employed a limited
constructive discovery analysis, at no point directly considering whether discovery of a transfer
without knowledge of its fraudulent nature would be sufficient, presumably because, in each
case, it appears that the creditor actually became aware of the transfer and the transfer’s
fraudulent nature simultaneously. Davis, 2006 WL 2242875, at *1 (discovering that appellant
transferred home months after claimant obtained a state court judgment against appellant);
Cunningham, 2002 WL 1263964, at *2 (discovering, during the course of divorce proceedings,
that appellant “gifted” home to his brother the same day appellant filed for divorce).
More recently, a district court for the Southern District of Ohio charted a contrary course
altogether. See Bradley, 96 F. Supp. 3d at 770. The court in Bradley relied on Ohio’s general
discovery-rule principles to conclude that the Ohio UFTA’s discovery rule would only begin to
run once the plaintiff had “knowledge of such facts as would lead a fair and prudent man, using
ordinary care and thoughtfulness, to make further inquiry.” Id. (quoting Hambleton v. R. G.
Barry Corp., 465 N.E.2d 1298, 1300–01 (Ohio 1984)). Accordingly, because the plaintiff
“‘possessed knowledge sufficient to lead a reasonably prudent person to make inquiry and had
such inquiry been made with reasonable care and diligence, it would have led to the discovery of
No. 15-3854 Bash v. Textron Financial Corp. Page 25
the alleged’ fraudulent transfer,” the district court dismissed the plaintiff’s fraudulent transfer
claim as time barred. Id. (quoting Hambleton, 465 N.E.2d at 1301).
Ultimately, while direct guidance is limited or altogether absent, in light of Ohio’s
broader statute of limitations and discovery rule case law, jurisprudence from other courts, and
the purpose of the Ohio UFTA, we hold that, if the Ohio Supreme Court were presented with this
issue, it would conclude that the discovery rule starts to run, and a claim accrues, for purposes of
§ 1336.09(A) when the plaintiff reasonably could have discovered the transfer’s fraudulent
nature.
Ohio courts have yet to specifically offer direction as to the proper trigger for the Ohio
UFTA’s discovery rule. They have, however, routinely applied the discovery rule in response to
statutory provisions and common law principles of equity to toll applicable statutes of limitations
until an injured party “discovers or, in the exercise of reasonable care, should have discovered”
her injury. Invr’s REIT One v. Jacobs, 546 N.E.2d 206, 209–11 (Ohio 1989) (concluding that
the discovery rule provided for under Ohio Rev. Code § 2305.09(D) resulted in the tolling of the
statute of limitations in fraud, conversion, and breach of trust cases until the plaintiff discovered
or reasonably could have discovered the injury that forms the basis of her suit); see Zimmie v.
Calfee, Halter & Griswold, 538 N.E.2d 398, 401 (Ohio 1989) (explaining that, under the
discovery rule, a cause of action accrues and the statute of limitations begins to run on a legal
malpractice claim “when there is a cognizable event whereby the client discovers or should have
discovered that his injury was related to his attorney’s act or non-act and the client is put on
notice of a need to pursue his possible remedies against the attorney”); O’Stricker v. Jim Walter
Corp., 447 N.E.2d 727, 730–31 (Ohio 1983) (determining that, even before the Ohio legislature
amended Ohio Rev. Code § 2305.10 to expressly provide for a discovery rule for asbestos-
related exposure claims, equitable principles required a tolling of the statute of limitations until
the plaintiff “discovered his cancer and the causal relationship to asbestos exposure”).
Throughout each application of the discovery rule, the crux of the inquiry was not at what
point in time the defendant engaged in the allegedly wrongful conduct but at what point in time
the plaintiff possessed or should have possessed, upon the exercise of reasonable diligence,
“actual knowledge not just that [she] has been injured but also that the injury was caused by the
No. 15-3854 Bash v. Textron Financial Corp. Page 26
conduct of the defendant.” Flagstar Bank, F.S.B. v. Airline Union’s Mortg. Co., 947 N.E.2d
672, 676 (Ohio 2011). Were we to adopt the interpretation offered by Textron in this case, that
the Ohio UFTA’s discovery rule begins to run when a plaintiff discovers, or upon the exercise of
reasonable diligence, could have discovered the mere existence of the transfer, we would be
adopting an application of the discovery rule that is in tension with Ohio’s broader statute of
limitations and discovery rule jurisprudence—jurisprudence that the Commissioners were aware
of when adopting the UFTA. See SASCO 1997 NI, LLC v. Zudkewich, 767 A.2d 469, 475 (N.J.
2001) (explaining that the National Conference of Commissioners on Uniform State Laws,
which approved the UFTA in 1984, “drafted the tolling provision [of the UFTA] to mirror the
common-law discovery rule which, they noted, was generally applicable to fraud actions” (citing
National Conference of Commissioners on Uniform State Laws, Proceedings in Committee of
the Whole on the Uniform Fraudulent Transfer Act 117 (July 29, 1984))). Rather, Ohio
precedent weighs in favor of our conclusion that § 1336.09(A)’s one-year discovery period
begins to run when a plaintiff discovers or, upon the exercise of reasonable diligence, could have
discovered the transfer and its fraudulent nature. This is because, absent requiring the actual or
constructive discovery of a transfer’s fraudulent nature, application of the discovery rule would
continue to “lead to the unconscionable result that the injured party’s right to recovery c[ould] be
barred by the statute of limitations before he is even aware of its existence.” O’Stricker,
447 N.E.2d at 730 (internal citation and quotation marks omitted).
In addition to aligning with Ohio’s broader statute of limitations and discovery rule
jurisprudence, reading § 1336.09(A)’s one-year discovery period as beginning to run when the
plaintiff discovers or, upon the exercise of reasonable diligence, could have discovered the
transfer’s fraudulent nature is supported by the decisions of other state courts to have addressed
this aspect of their states’ UFTA. While not every jurisdiction to have taken up the discovery
rule has so concluded, see Nat’l Auto Serv. Ctrs., Inc. v. F/R 550, LLC, No. 2D14-3632, 2016
WL 1238265, at *5 (Fla. Dist. Ct. App. Mar. 30, 2016) (determining that the plain language of
§ 726.110(1) of Florida’s UFTA mandates that the one-year discovery period begins to run
“from the date the transfer was discovered or could reasonably have been discovered”), we find
persuasive the numerous state court decisions that have concluded that a coherent reading of the
UFTA’s full statute of limitations provision, the overall purpose of the UFTA, and general
No. 15-3854 Bash v. Textron Financial Corp. Page 27
discovery rule principles support a determination that discovery for purposes of a fraudulent
transfer claim requires both knowledge of the transfer and knowledge of the transfer’s fraudulent
nature. See, e.g., Schmidt v. HSC, Inc., 319 P.3d 416, 426 (Haw. 2014) (en banc) (explaining
that, because “[t]he term ‘transfer’ in HRS § 651C-9(1) clearly refers to the ‘fraudulent transfer’
identified in the preceding” portion of the statute of limitations provision and because “the
obvious purpose of the UFTA is to prevent fraud and to provide a remedy to those who are
victims of fraudulent transfers,” the discovery rule allowed a plaintiff “to file an action within
one year of the discovery of the ‘fraudulent nature’ of a transfer”); Workforce Sols. v. Urban
Servs. of Am., Inc., 977 N.E.2d 267, 278–79 (Ill. App. Ct. 2012) (relying on general Illinois
discovery rule principles to conclude that the discovery rule of Illinois’s UFTA “postpon[es] the
start of the limitations period until the injured party knows or should know it has been injured
and knows or should know that the injury was wrongly caused”); Freitag v. McGhie, 947 P.2d
1186, 1189 (Wash. 1997) (en banc) (concluding that “[c]ommon sense and the statutory purpose
of the UFTA necessitate a finding that the statute begins to run with the discovery of the
fraudulent nature of the conveyance”); see also Duran v. Henderson, 71 S.W.3d 833, 839 (Tex.
Ct. App. 2002) (noting that, under the UFTA’s discovery rule, a cause of action accrues when the
claimant discovers the fraud or would have discovered the fraud upon the exercise of reasonable
diligence); Moore v. Browning, 50 P.3d 852, 859 (Ariz. Ct. App. 2002) (same).
Finally, we note that, in deeming discovery to occur at the point when a transfer’s
fraudulent nature is discovered or reasonably could be discovered, we are mindful of the broader
purpose of the Ohio UFTA. The Ohio UFTA’s overall purpose is to discourage fraud and
provide aggrieved creditors with a means to recover assets wrongfully placed beyond their reach.
Accordingly, to require a claimant to bring suit within one year of discovering a transfer, without
having discovered facts that would put the claimant on notice as to the transfer’s fraudulent
nature, would be to interpret § 1336.09(A) in a manner that is directly at odds with the animating
purpose of the UFTA. Because, “[i]f the statute were to begin to run when the transfer was
made, without regard as to whether the claimant discovered or could have discovered the
fraudulent nature of the transfer, those successful at concealing a fraudulent transfer would be
rewarded” and those injured would have their claims lapse before even becoming aware of the
damage, as pointedly illustrated by the facts in this case. Freitag, 947 P.2d at 1190.
No. 15-3854 Bash v. Textron Financial Corp. Page 28
In sum, mindful of Ohio’s broader statute of limitations and discovery rule jurisprudence,
the interpretations of the discovery rule in other jurisdictions, and the overall purpose of the Ohio
UFTA, we conclude that the Ohio Supreme Court, if faced with this issue, would determine that
§ 1336.09(A)’s discovery rule begins to run at the point when a plaintiff discovers or, in the
exercise of reasonable care, could have discovered the transfer and its fraudulent nature.
Applying that rule here, the execution of the 2004 ARL&SA was first reasonably discoverable as
of August 2004, when the Debtor’s offering circulars filed with the Ohio Division of Securities
made note of the $17,500,000 line of credit created under the 2004 ARL&SA. However, the
second amended complaint contains extensive factual allegations to support the Trustee’s
contention that the injured investors did not and could not have reasonably discovered the
fraudulent nature of the 2004 ARL&SA and the lien created thereunder until November 24,
2009, when the FBI raided the Debtor’s offices and Durham and Cochran’s operation of the
Debtor as a Ponzi scheme was revealed—a date delayed by Durham and Cochran’s purposefully
inadequate disclosures and improper accounting practices, both of which were undertaken with
Textron’s acquiescence. Accordingly, because the Debtor’s investors filed the Chapter 7
bankruptcy petition against the Debtor on February 8, 2010, we conclude that the Trustee’s
actual fraudulent transfer claim was timely under § 1336.09(A)’s discovery rule.
B.
Having determined that the Trustee’s actual fraudulent transfer claim survives Textron’s
motion to dismiss, we next address the Trustee’s civil conspiracy claim. Textron argues that
three independent grounds exist for affirming the district court’s dismissal of the Trustee’s civil
conspiracy claim: lack of standing, the affirmative defense of in pari delicto, and limitations.
We address (and reject) each argument in turn.
1.
“As a creature of statute, the trustee in bankruptcy has only those powers conferred upon
him by the Bankruptcy [Code].” Stevenson v. J.C. Bradford & Co. (In re Cannon), 277 F.3d
838, 853 (6th Cir. 2002) (alteration in original) (quoting Cissell v. Am. Home Assurance Co.,
521 F.2d 790, 792 (6th Cir. 1975)). Pursuant to 11 U.S.C. § 541(a)(1), a “trustee stands in the
No. 15-3854 Bash v. Textron Financial Corp. Page 29
shoes of the debtor and has standing to bring any action that the bankrupt could have brought had
he not filed a petition for bankruptcy.” In re Cannon, 277 F.3d 853. Conversely, “[i]f a cause of
action belongs solely to the estate’s creditors, . . . then the trustee has no standing to pursue the
claim.” Id. Whether a cause of action belongs to the debtor estate or to its creditors is a question
of state law. Id.
Textron urges this Court to adopt the Second Circuit’s reasoning in Shearson Lehman
Hutton, Inc. v. Wagoner, 944 F.2d 114, 120 (2d Cir. 1991), which concluded that, “when a
bankrupt corporation has joined with a third party in defrauding its creditors, the trustee cannot
recover against the third party for the damage to the creditors.” Id. at 118. The court elaborated
however, that whether a trustee has standing to recover for “damage to the corporation, apart
from that done to the third-party creditor noteholders” was a separate question. Id. at 118–19.
To answer the latter question, the Second Circuit considered whether the corporation had
possessed, before it entered bankruptcy, any claims under which the third party “could have been
held liable” and ultimately concluded that, because the corporation’s sole stockholder and
decision maker participated in the fraud alongside the third party, any damage endured fell
exclusively on the creditors, not the corporation. Id. at 119.
As other circuits have recognized, the Second Circuit’s decision in Wagoner appears to
conflate the affirmative in pari delicto defense14 with the issue of standing. See, e.g., Moratzka
v. Morris (In re Senior Cottages of Am., LLC), 482 F.3d 997, 1003 (8th Cir. 2007) (collecting
cases in which “other circuits have declined to conflate the constitutional standing doctrine with
the in pari delicto defense”); Official Comm. of Unsecured Creditors of PSA, Inc. v. Edwards,
437 F.3d 1145, 1149–50 (11th Cir. 2006) (explaining that, while a debtor’s wrongdoing was
material to the ultimate success of a trustee’s claim against an alleged accomplice in the debtor’s
Ponzi scheme, the debtor’s wrongdoing did not bear on the trustee’s standing “because ‘[a]n
analysis of standing does not include an analysis of equitable defenses, such as in pari delicto’”
(alteration in original) (quoting Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co.,
14
The in pari delicto defense stems from “the equitable principle that ‘[n]o Court will lend its aid to a man
who founds his cause of action upon an immoral or illegal act.’” Terlecky v. Hurd (In re Dublin Sec., Inc.), 133 F.3d
377, 380 (6th Cir. 1997) (alteration in original) (quoting Jones v. Hyatt Legal Servs. (In re Dow), 132 B.R. 853, 860
(Bankr. S.D. Ohio 1991)). The defense and its application to the Trustee’s civil conspiracy claim will be analyzed in
depth in the following section.
No. 15-3854 Bash v. Textron Financial Corp. Page 30
267 F.3d 340, 346 (3d Cir. 2001))); R.F. Lafferty, 267 F.3d at 346 (“In general, [s]tanding
consists of both a case and controversy requirement stemming from Article III, Section 2 of the
Constitution, and a subconstitutional prudential element. An analysis of standing does not
include an analysis of equitable defenses, such as in pari delicto.” (alteration in original)
(internal citations and quotation marks omitted)). We think the reasoning of these cases is
sound, and we therefore decline to inject an equitable defense into Article III of the
Constitution’s “case or controversy” requirement. Rather, our task here is to determine whether
(1) the plaintiff has alleged that the debtor “suffered some actual or threatened injury due” to the
alleged illegal conduct of the defendant; (2) the injury is “fairly traceable to the challenged
action”; and (3) there is a “substantial likelihood that the relief requested will redress or prevent
[the plaintiff]’s injury.” In re Cannon, 277 F.3d at 852 (alteration in original) (quoting Grendell
v. Ohio Sup. Ct., 252 F.3d 828, 832 (6th Cir. 2001)).
The Trustee’s amended complaint explicitly alleges an injury to the Debtor. Specifically,
the Trustee asserts that Textron, in exchange for hundreds of thousands of dollars in interest and
fees, not only turned a blind eye to Durham and Cochran’s fraudulent behavior, but actually
assisted the two Indiana businessmen in looting the Debtor and transforming its once profitable
factoring operation into a front for a Ponzi scheme. Accordingly, because the relief requested
would redress the Debtor’s alleged injury and because the alleged injury is separate from any
injury suffered by the Debtor’s investors, we conclude that the Trustee has standing to pursue the
civil conspiracy claim.
2.
While in pari delicto principles do not deprive the Trustee of standing to bring a civil
conspiracy claim against Textron, the affirmative defense is by no means immaterial at this
juncture. As Textron asserted and the district court concluded, the Trustee’s civil conspiracy
claim is likely barred by the common law in pari delicto defense, which “derives from the Latin,
in pari delicto potior est conditio defendentis,” meaning “[i]n a case of equal or mutual fault . . .
the position of the [defending] party . . . is the better one.” Bateman Eichler, Hill Richards, Inc.
v. Berner, 472 U.S. 299, 306 (1985) (alterations in original) (quoting Black’s Law Dictionary
711 (5th ed. 1979)). This equitable defense is used to bar a plaintiff’s recovery when the
No. 15-3854 Bash v. Textron Financial Corp. Page 31
plaintiff “bears at least substantially equal responsibility for the underlying illegality” upon
which the claim is based, Pinter v. Dahl, 486 U.S. 622, 635–36 (1988), in light of “the policy
that ‘no Court will lend its aid to a man who founds his cause of action upon an immoral or
illegal act,’” Downie-Gombach v. Laurie, 41 N.E.3d 858, 865 (Ohio Ct. App. 2015) (quoting In
re Dow, 132 B.R. 853, 860 (Bankr. S.D. Ohio 1991)). The in pari delicto defense has repeatedly
been used to bar the actions of “bankruptcy trustee[s] against third parties who participated in or
facilitated wrongful conduct of the debtor[s].” Mosier v. Callister, Nebeker & McCullough,
546 F.3d 1271, 1276 (10th Cir. 2008) (collecting cases).
Here, the Trustee acknowledges of course that he stands in the shoes of the Debtor and
that the in pari delicto defense may be raised against a bankruptcy trustee to the same extent it
could have been raised against a debtor prior to the filing of bankruptcy. Appellant’s Opening
Br. 42. The Trustee, however, argues that the district court’s dismissal of his civil conspiracy
claim pursuant to the in pari delicto defense was inappropriate because Durham and Cochran’s
fraudulent conduct should not have been imputed to the Debtor. Id. at 43.
A principal is generally charged with the knowledge of and conduct undertaken by its
agent operating within the scope of his employment. First Nat’l Bank of New Bremen v. Burns,
103 N.E. 93, 94 (Ohio 1913). Such knowledge and conduct, however, will not be imputed to a
principal if its agent “is engaged in committing an independent fraudulent act on his own
account, and the facts to be imputed relate to this fraudulent act.” Am. Export & Inland Coal
Corp. v. Matthew Addy Co., 147 N.E. 89, 92 (Ohio 1925); Restatement (Third) of Agency § 5.04
(2006) (“[N]otice of a fact that an agent knows or has reason to know is not imputed to the
principal if the agent acts adversely to the principal in a transaction or matter, intending to act
solely for the agent’s own purposes or those of another person.”). This principle is known as the
adverse interest exception. First Nat’l Bank of New Bremen, 103 N.E. at 94.
The adverse interest exception is not absolute, however. Pursuant to the sole actor
doctrine, if the agents responsible for the adverse conduct are the officers or directors of the
principal and those officers or directors “so dominated and controlled the [principal] that the
[principal] had no separate mind, will, or existence of its own,” then the officers and directors are
No. 15-3854 Bash v. Textron Financial Corp. Page 32
deemed the “alter egos” of the principal and “any malfeasance on their parts is directly
attributable to the [principal].” In re Dublin Sec., 133 F.3d at 380.
In determining that Durham and Cochran so dominated the Debtor as to trigger the sole
actor doctrine, the district court emphasized that, in the amended complaint, the Trustee alleged
that Durham and Cochran immediately began operating the Debtor as a fraudulent scheme and
controlled all aspects of the Debtor’s operations. Bash, 483 B.R. at 651–52. On appeal, the
Trustee does not take issue with the district court’s conclusion that Durham and Cochran
dominated the Debtor. Appellant’s Opening Br. 43. Rather, the Trustee reiterates that, “even if
the ‘sole actor’ doctrine might otherwise apply here, it is subject to the ‘innocent insider’
exception, which exists if the company had at least one innocent decision-maker who could have
stopped the wrongdoing if he or she had known of it.” Id.
“The innocent insider exception is a corollary to the sole actor rule. . . . The touchstone
of the innocent insider exception is control. If an innocent person inside the corporation had the
power to stop the fraud, the agent and the company are not mere alter egos, so the sole actor rule
cannot apply.” Unencumbered Assets, Tr. v. Great Am. Ins. Co., 817 F. Supp. 2d 1014, 1036
(S.D. Ohio 2011) (quoting McHale v. Citibank, N.A. (In re 1031 Tax Grp., LLC), 420 B.R. 178,
202 (Bankr. S.D.N.Y. 2009)); see Gold v. Deloitte & Touche LLP (In re NM Holdings Co.),
411 B.R. 542, 549 (E.D. Mich. 2009) (explaining that “the presence of innocent decision makers
is an indication that the sole actor rule should not apply because the wrongdoer was not really a
sole actor”); Cohen v. Morgan Schiff & Co. (In re Friedman’s Inc.), 394 B.R. 623, 632–34 (S.D.
Ga. 2008) (emphasizing “that the sole actor rule does not apply if innocent decision-makers
could have stopped the fraudulent activity”); Midwest Mem’l Grp. LLC v. Citigroup Global
Mkts. Inc., No. 322338, 2015 WL 5519398, at *11 (Mich. Ct. App. Sept. 17, 2015) (unpublished)
(“For the existence of an innocent decision-maker to preclude application of the sole actor rule,
there must exist[] at least one innocent decision maker who, if he had been alerted to the fraud,
could have stopped it.” (alteration in original) (internal citation and quotation marks omitted));
Glenbrook Capital Ltd. P’ship v. Dodds (In re Amerco Derivative Litig.), 252 P.3d 681, 696
(Nev. 2011) (concluding that the presence of innocent insiders is relevant in assessing whether a
sole actor exists sufficient to overcome the adverse interest exception); O’Halloran v.
No. 15-3854 Bash v. Textron Financial Corp. Page 33
PricewaterhouseCoopers LLP, 969 So. 2d 1039, 1045 (Fla. Dist. Ct. App. 2007) (noting that “the
presence of any innocent decision-maker in the management of a corporation can provide the
basis for invoking the adverse interest exception, preventing the imputation of wrongdoing and
defeating the use of the in pari delicto defense against the corporation”).
In ruling on the motion to dismiss, the district court correctly noted that no Ohio court
has adopted or otherwise directly addressed whether the existence of an innocent decision maker
or insider would preclude the application of the sole actor doctrine. Bash, 483 B.R. at 652.
However, the district court went on to conclude that, regardless of whether Ohio would embrace
an innocent insider exception to the sole actor doctrine, “the [amended] complaint is completely
devoid of any allegations regarding innocent insiders or any control they may have exerted over
the [D]ebtor.” Id. Thus, the district court concluded that the innocent insider exception was
inapplicable, the adverse interest exception to imputation was negated by the sole actor doctrine,
and, upon imputing Durham and Cochran’s wrongful conduct to the Debtor, the Trustee’s civil
conspiracy claim was barred by the in pari delicto defense.
In reaching these conclusions, however, the district court failed to give heed to a basic
principle of federal civil procedure: a plaintiff is not required to plead facts necessary to defeat
an affirmative defense. See Frank v. Dana Corp., 646 F.3d 954, 963 (6th Cir. 2011) (concluding
that, because good faith was an affirmative defense to a claim under § 20(a) of the Securities and
Exchange Act of 1934, the district court erred in requiring the plaintiff to plead that the
defendants did not act in good faith). As the Supreme Court has explained,
A complaint is subject to dismissal for failure to state a claim if the allegations,
taken as true, show the plaintiff is not entitled to relief. If the allegations, for
example, show that relief is barred by the applicable statute of limitations, the
complaint is subject to dismissal for failure to state a claim; that does not make
the statute of limitations any less an affirmative defense. Whether a particular
ground for opposing a claim may be the basis for dismissal for failure to state a
claim depends on whether the allegations in the complaint suffice to establish that
ground, not on the nature of the ground in the abstract.
Jones v. Bock, 549 U.S. 199, 215–16 (2007) (holding “that failure to exhaust is an affirmative
defense under the PLRA, and that inmates are not required to specially plead or demonstrate
exhaustion in their complaints”). Accordingly, we conclude that the district court erred when it
No. 15-3854 Bash v. Textron Financial Corp. Page 34
dismissed the Trustee’s civil conspiracy claim based in part on its determination that the Trustee
had failed to plead facts demonstrating the existence of an innocent insider, which the district
court assumed, for purposes of its decision, would potentially defeat Textron’s affirmative in
pari delicto defense.
Although the district court expressed no opinion as to whether the Ohio Supreme Court
would adopt the innocent insider exception to the sole actor doctrine, this litigation’s prolonged
procedural history necessitates that we venture an “Erie guess” in the name of judicial efficiency,
and we conclude that the Ohio Supreme Court would adopt the innocent insider exception to the
sole actor doctrine. Ohio has long followed the sole actor doctrine. See First Nat’l Bank of New
Bremen, 103 N.E. at 96. Although no Ohio court appears to have decided whether to apply the
innocent insider exception to that doctrine, see Unencumbered Assets, Tr., 817 F. Supp. 2d at
1036, the innocent insider exception is a corollary that flows ineluctably from the agency
principles that underlie the sole actor doctrine.
The United States District Court for the Southern District of New York has described
why this is the case. The adverse interest exception to the in pari delicto doctrine applies “the
fiction of imputation” by asking “whether the knowledge of the agent that is to be imputed to the
principal was gained within, or outside of, the scope of agency.” In re CHI Holding Co.,
311 B.R. 350, 373 (S.D.N.Y. 2004), aff’d in part and rev’d in part, 529 F.3d 432 (2d Cir. 2008).
“Even when an agent is defrauding his principal, unless the agent has totally abandoned the
interests of the principal and is acting entirely in his own, or another person’s, interest, that agent
is acting within the scope of his agency.” Id. The sole actor doctrine is based on the recognition
that, when a particular agent or set of agents “are one and the same” as the principal, “it would
be nonsensical to refrain from imputing the agent’s acts of fraud to the corporation, despite the
agent’s total abandonment of the corporation’s interests, because the agent is identical to the
corporation.” Id. (internal quotation marks omitted). But, “when the innocent insiders possessed
authority to stop the fraud, the ‘sole actor rule’ does not apply, because the culpable agents who
had totally abandoned the interests of the principal, and were thus acting outside the scope of
their agency, were not identical to the principal.” Id. In other words, a set of agents cannot be
said to be the sole actor who is one and the same as the principal when others exist within the
No. 15-3854 Bash v. Textron Financial Corp. Page 35
principal who had sufficient authority to stop the fraud had they known of it. Accordingly, we
hold that the Ohio Supreme Court, if given the chance, would apply the innocent insider
exception to the sole actor doctrine.
3.
Finally, we turn to Textron’s contention that the Trustee’s civil conspiracy claim is time
barred. Under Ohio law, “the applicable statute of limitations for filing a civil conspiracy
[claim] is the relevant limitations statute for the underlying cause of action.” Davis v. Clark Cty.
Bd. of Comm’rs, 994 N.E.2d 905, 909 (Ohio Ct. App. 2013). Here, the Trustee alleges that
Textron conspired with Durham to defraud the Debtor. Accordingly, for the claim to be timely,
it must have been filed within four years of the date that the Debtor first discovered or should
have discovered the fraud. Inv’rs REIT One, 546 N.E.2d at 209–10. Recognizing that Durham
and Cochran perpetrated the fraud in the Debtor’s name, the Trustee does not assert that the
Debtor was unaware of the fraud. Appellant’s Reply Br. 29. Rather, the Trustee argues that the
doctrine of “adverse domination” applies to equitably toll the four-year statute of limitations
because the directors and officers are unlikely to initiate actions or investigations into fraudulent
conduct when such actions or investigations would reveal their own wrongdoing. Id.
The Ohio Supreme Court has yet to expressly address the adverse domination doctrine in
any context, and in December 2015, the court declined to answer a certified question from this
court as to whether Ohio would “apply the doctrine of adverse domination to toll the statute of
limitations provided by Ohio Rev. Code § 2305.09 for a claim of breach of fiduciary duty
brought against a director or officer of an Ohio corporation.” Antioch Co. Litig. Tr. v. Morgan,
633 F. App’x 296, 302 (6th Cir. 2015); Antioch Co. Litig. Tr. v. Morgan, 45 N.E.3d 242 (Ohio
2016). As a result, on March 24, 2016, the Sixth Circuit ventured in a nonprecedential decision
an “Erie guess” as to whether the Ohio Supreme Court would adopt the adverse domination
doctrine to toll or extend the statute of limitations for a breach of fiduciary duty claim and
answered the question in the negative. Antioch Co. Litig. Tr. v. Morgan, -- F. App’x --, No. 14-
3790, 2016 WL 1161233, at *1–3 (6th Cir. Mar. 24, 2016) (unpublished). In so doing, the Court
emphasized two points. First, the Court noted that “[t]he Ohio Court of Appeals has twice
rejected adverse domination as generally lacking support in Ohio’s statutes and judicial
No. 15-3854 Bash v. Textron Financial Corp. Page 36
decisions.”15 Id. at *2. Next, the Court underscored that “other courts considering the question
of adverse domination have focused on whether state law would apply a discovery rule to the
relevant claim for purposes of the statute of limitations” and explained that, because Ohio’s
legislature only provided a limited discovery rule for those § 2305.09 actions grounded in fraud
and conversion, “the Ohio Supreme Court has declined to expand application of the discovery
rule” to other torts arising under § 2305.09, including claims for breach of fiduciary duty. Id. at
*3.
Antioch Co. Litigation Trust is an unpublished decision lacking precedential authority.
Mfrs.’ Indus. Relations Ass’n v. E. Akron Casting Co., 58 F.3d 204, 208 (6th Cir. 1995); United
States v. Williams, 15 F.3d 1356, 1363 n.6 (6th Cir. 1994). So while we find benefit in
thoughtfully considering the Court’s analysis, we are not bound by the decision. We do note,
however, that while we conclude that the Ohio Supreme Court, if presented with this issue,
would apply the doctrine of adverse domination to toll the statute of limitations provided by
Ohio Rev. Code § 2305.09 for a claim of fraud, our decision is in line with the thrust of this
Court’s analysis in Antioch Co. Litigation Trust.
As the Court in Antioch Co. Litigation Trust explained, when considering whether state
law would embrace the adverse domination doctrine to toll or extend a cause of action’s statute
of limitations, other courts “have focused on whether state law would apply a discovery rule to
the relevant claim for purposes of the statute of limitations.” Id. at *2. Courts routinely look to a
state’s application of the discovery rule when considering the doctrine of adverse domination
because “adverse domination shares the same theoretical underpinnings as the discovery rule.”
Id. at *2 (quoting Wilson v. Paine, 288 S.W.3d 284, 287 (Ky. 2009)). The discovery rule
operates in many jurisdictions to toll the statute of limitations for certain tort claims until the
plaintiff discovers or, upon the exercise of reasonable diligence, could discover that she has been
injured by the wrongful conduct of another. See, e.g., Alexander v. Sanford, 325 P.3d 341, 353–
54 (Wash. Ct. App. 2014); Wilson, 288 S.W.3d at 286–87; Resolution Tr. Corp. v. Grant, 901
15
As noted by the dissent in Antioch Co. Litigation Trust, however, these two opinions, written sixty years
apart, come from one of Ohio’s twelve intermediate appellate courts and provide little in the way of analysis or
precedential support. Id. at *5 (Moore, J., dissenting). Moreover, neither case addressed the application of the
adverse domination doctrine to claims of fraud. Accordingly, they are of limited value in assessing the issue before
us.
No. 15-3854 Bash v. Textron Financial Corp. Page 37
P.2d 807, 813–14 (Ok. 1995); Clark v. Milam, 452 S.E.2d 714, 718 (W.Va. 1994). And most
courts have “uniformly embraced adverse domination” as a natural extension of a state’s
discovery rule, Wilson, 288 S.W.3d at 288, tolling a cause of action’s statute of limitations
because, when controlled by culpable directors, a corporate plaintiff will be unable to
“independently acquire the knowledge and resources necessary to bring suit,” id. at 288 (quoting
Hecht v. Resolution Trust Corp., 635 A.2d 394, 504 (Md. 1994)). See Alexander, 325 P.3d at
354; FDIC v. Smith, 980 P.2d 141, 145–46 (Or. 1999); Grant, 901 P.2d at 813–14; Clark, 452
S.E.2d at 718.
Here, the Ohio legislature has expressly set forth a limited discovery rule for purposes of
§ 2305.09, providing that, if an action under § 2305.09 “is for trespassing under ground or injury
to mines, or for the wrongful taking of personal property, the causes thereof shall not accrue until
the wrongdoer is discovered; nor, if it is for fraud, until the fraud is discovered.” § 2305.09. In
light of this mandate, the Ohio Supreme Court has explained that, in fraud cases, “the date of
discovery [will] toll the running of the governing statute of limitations until the plaintiff
discovers or, in the exercise of reasonable care, should have discovered the complained-of
injury.” Inv’rs REIT One, 546 N.E.2d at 210. Accordingly, because the Ohio legislature
expressly provided for a discovery rule in actions sounding in fraud and because the adverse
domination doctrine is “merely a corollary of . . . [the] discovery rule,” Wilson, 288 S.W.3d at
288, giving credence to the basic principle that knowledge of a cause of action is meaningless
unless it is coupled with an ability to act, we conclude that the Ohio Supreme Court, if presented
with this issue, would apply the doctrine of adverse domination to toll the statute of limitations
provided by Ohio Rev. Code § 2305.09 for a claim of fraud.
Thus, because the four-year statute of limitations was tolled pursuant to the adverse
domination doctrine until the FBI raided the Debtor and the Debtor, for the first time, possessed
knowledge of Durham, Cochran, and Textron’s alleged wrongdoing and the ability to act on that
knowledge, we conclude that the Trustee’s civil conspiracy claim is timely.
No. 15-3854 Bash v. Textron Financial Corp. Page 38
C.
A brief word is in order as to the district court’s dismissal of the Trustee’s equitable
subordination and disallowance claims. The district court exclusively rested its sua sponte
dismissal of the Trustee’s equitable subordination and disallowance claims on its dismissal of the
Trustee’s underlying substantive claims. Accordingly, because we reverse the district court in
part and remand for further proceedings on the Trustee’s actual fraudulent transfer and civil
conspiracy claims, we also reverse the district court’s dismissal of the Trustee’s equitable
subordination and disallowance claims.
III.
For the reasons set forth above, we REVERSE the district court’s dismissal of the
Trustee’s actual fraudulent transfer, civil conspiracy, and equitable subordination and
disallowance claims, and we AFFIRM the district court’s dismissal of the Trustee’s constructive
fraudulent transfer claim.