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Image Masters, Inc., et al. v. Chase Home Finance

March 11, 2013

IMAGE MASTERS, INC., ET AL.
v.
CHASE HOME FINANCE, ET AL.



The opinion of the court was delivered by: Goldberg, J.

MEMORANDUM OPINION

This bankruptcy appeal stems from a $65 million Ponzi scheme perpetrated by Wesley Snyder through his then-existing company, Image Masters, Inc. ("Image Masters"). After the collapse of that scheme, Lynn E. Feldman, the Chapter 7 Trustee for the bankruptcy estates ofImage Masters and related entities (collectively, "Debtors"), commenced two adversary proceedings in the United States Bankruptcy Court seeking to avoid and recover nearly $26 millionin transfers made by the Debtors to numerous financial institutions.

Presently before the Court is the Trustee's appeal from the bankruptcy court's dismissal of the adversary complaints. For reasons set forth below, we will affirm the bankruptcy court's judgment in part, vacate in part and remand for further proceedings.

I. FACTUAL AND PROCEDURAL BACKGROUND

Image Masters and the other Debtors*fn1 were wholly owned, controlled and operated by Wesley Snyder ("Snyder"). From between 1988 and September 2007, Snyder orchestrated a Ponzi scheme through Image Masters, which defrauded more than 800 homeowners and investors.

Image Masters implemented its scheme through what has been referred to as a "Wrap-Around Equity Slide Down Discount Mortgage Program." Through this program, homeowners were induced to refinance their existing mortgages by entering into new conventional residential mortgages with various lenders. Snyder convinced the homeowners to use the conventional mortgages to "cash out" the equity in their homes in a first closing by borrowing more money from the lenders than they needed to pay off their existing mortgages. At a second, subsequent closing, Snyder then persuaded the homeowners to give Image Masters the excess funds from their conventional loan refinancings (what has been referred to as the "wrap amounts"), and to sign new notes and mortgages in favor of Image Masters. The Image Masters' mortgages were in the same amount as the refinanced conventional mortgages with the lenders, but at lower interest rates and, in some cases, for shorter terms than the conventional mortgages. (Id. at ¶¶ 7, 30-31, 33, Ex. A, at 3, 4.*fn2

Pursuant to the Image Masters' mortgages, Image Masters contractually assumed responsibility for paying the homeowners' monthly mortgage payments to the lenders. On a monthly basis, therefore, the homeowners paid Image Masters the monthly payments required under the Image Masters' mortgages, and in turn, Image Masters was obligated to pay the lenders the monthly payments owed by the homeowners under their conventional mortgages. Neither Snyder, Image Masters, nor any of the other Debtors had a direct relationship with any lenders obligating them to make mortgage payments. The various lenders were also not parties to any of the Image Masters' mortgages, notes or subrogation agreements. (Id. at ¶¶ 33-34, 37-38, Ex. A, at 4.)

To make the scheme appear plausible, Snyder informed the homeowners that the wrap amounts would either be: (1) used by Image Masters immediately to pay down the homeowners' conventional mortgages, or (2) invested by Image Masters, with the proceeds being used to pay the difference between what the homeowners paid Image Masters and what the homeowners were obligated to pay to the lenders on the conventional mortgages. No profits were actually earned on the wrap amounts, and Snyder did not use these funds to reduce the principal balances owed by the homeowners on the conventional mortgages. Instead, Snyder used, in part, the payments he received from new homeowners to keep pre-existing homeowners' conventional mortgages current. (Id. at ¶¶ 32, 35-36.)

Snyder also used money generated from investors in his "Wrap Around Participation Program" ("the mortgage participation investors") to meet some of Image Masters' obligations to the homeowners. Through this program, Snyder persuaded individuals to invest funds with Image Masters in return for a security interest in certain Image Masters' mortgages. In reality, however, these investors were never granted valid, perfected security interests in the Image Masters' mortgages and no such security interests were ever recorded. Rather, Snyder used the funds he received to perpetuate his Ponzi scheme. (Id. at ¶¶ 36, 49-51.)

Image Masters also prepared fraudulent accounting records to reflect the interest, principal and monthly payments due to the lenders under the conventional mortgages, and the interest, principal, monthly payments and prepayments that the homeowners believed had been applied to pay the conventional mortgages. Image Masters provided each homeowner with fabricated monthly statements that showed a reduction in his Image Masters' mortgage equal to the amount the homeowner gave to Image Masters at the second closing. The fabricated monthly statements also showed a credit for that month's mortgage payment to Image Masters plus any additional principal submitted to Image Masters by the homeowner. The homeowners never received statements from the lenders regarding their true conventional mortgage balances because Image Masters required each homeowner to sign a change of address form directing all correspondence related to the conventional mortgage be mailed directly to Image Masters. (Id. at ¶¶ 39-40, 42.)

Eventually, the Ponzi scheme collapsed when Image Masters was unable to generate income or receive new funds/investments sufficient to remain current on the homeowners' conventional mortgages with the lenders. (Id. at ¶¶ 5, 53.)

On November 9, 2007, the United States Attorney for the Middle District of Pennsylvania charged Snyder with mail fraud arising from his orchestration of this Ponzi scheme. The criminal information alleged that, of the $65.6 million received from the homeowners and investors, Snyder forwarded only $39.1 million to the lenders for payment of the conventional mortgages. Snyder pled guilty to these charges and, on July 2, 2008, was sentenced to 146 months imprisonment, and ordered to make restitution in the amount of $29,267,080. (Id. at ¶¶ 52, 54, 56-58.)

Prior to the criminal charges, on September 18, 2007, Image Masters and the other Debtors filed voluntary petitions for relief under Chapter 7 of the Bankruptcy Code. Lynn E. Feldman was appointed permanent Trustee of the Debtors' estates on November 27, 2007. (Chase Compl. ¶¶ 5-6.)

On March 16, 2009, the Trustee initiated an adversary proceeding against the following lenders: Chase Home Finance, Citimortgage, Inc., Countrywide Home Loans, Inc., Fifth Third Bank, GMAC Mortgage Corp.,*fn3 Provident Funding Associates, L.P., Saxon Mortgage, Inc., Sovereign Bancorp, Inc., Suntrust Bank, Wachovia Bank, N.A. and Wells Fargo Home Mortgage (the "Chase action"). In her complaint, the Trustee sought to avoid and recover nearly $24 million in alleged fraudulent transfers made by Image Masters to these lenders. Specifically, the Trustee alleged that such transfers were avoidable as constructively fraudulent transfers under the Bankruptcy Code, 11 U.S.C. §§ 544 & 548(a)(1)(B), and the Pennsylvania Uniform Fraudulent Transfer Act ("PUFTA"), 12 Pa. C.S. § 5104(a)(2), because, Image Masters did not receive reasonably equivalent value in exchange for the transfers. The Trustee alternatively claimed that the transfers were avoidable as "actually" fraudulent transfers under the Bankruptcy Code, 11 U.S.C. §§ 544 & 548(a)(1)(A), and PUFTA, 12 Pa. C.S. §§ 5104(a)(1) & 5105, in that they were made with actual intent to hinder, delay or defraud creditors of Image Masters. Finally, the Trustee asserted that the transfers that were made within ninety days before the bankruptcy filings were also avoidable as preferential transfers under the Bankruptcy Code, 11 U.S.C. § 547(b). (See id.)

The Chase lenders moved to dismiss the Trustee's complaint, contending that: (1) the constructive fraud claims (Counts I, II and IV) should be dismissed pursuant to FED. R. CIV. P. 12(b)(6) because theDebtors received reasonably equivalent value for each of the challenged transfers; (2) the actual fraud claims (Counts I and III) should be dismissed pursuant to:(i) FED. R. CIV. P. 12(b)(6) because the complaint demonstrated the existence of a good faith defense to actual fraud under 11 U.S.C. § 548(c), and (ii) FED. R. CIV. P. 9(b) for failure to plead the requisite fraudulent intent with sufficient particularity; and (3) the homeowners were necessary parties under FED. R. CIV. P. 19 such that failure to join them required dismissal of the complaint. (Chase Action, Dkt. No. 09-2092, Bankr. E.D. Pa., Doc. Nos. 25-42, 73.)

Following oral argument and supplemental briefing, the bankruptcy court granted the Chase lenders' motions by memorandum opinion and order dated December 17, 2009. The bankruptcy court also provided the Trustee with thirty days to amend her complaint in compliance with the court's memorandum opinion. The Trustee did not file an amended complaint, opting instead to appeal. On February 4, 2010, the bankruptcy court dismissed the action. (See id., Doc. Nos. 78-89, 93.)

While the motions to dismiss were still pending in the Chase action, the Trustee initiated a second adversary complaint on August 31, 2009 against the following defendants: ABN Amro Mortgage Group, Inc., First Horizon Home Loan Corp., Florida Capital Bank Mortgage, Loancity.com,*fn4 M&T Mortgage Corp., Morequity Inc., Nbank, Principal Residential Mortgage, Provident Savings Bank, National City Bank, Federal Home Loan Mortgage Corp., Federal National Mortgage Association, Wells Fargo Bank, Bank of New York and Park Granada, LLC (the "ABN action"). In her complaint, the Trustee sought to avoid and recover more than $25 million in alleged fraudulent and preferential transfers.*fn5 On February 2, 2010, the ABN lenders filed a joint motion to dismiss, arguing that the ABN complaint was nearly identical to the Chase complaint, and should thus be dismissed on the same grounds. On March 3, 2010, the bankruptcy court issued a consent order, granting the motion and dismissing the action. (See ABN Action, Dkt. No. 09-2143, Bankr. E.D. Pa., Doc. Nos. 1, 35, 39.)

The Trustee filed notices of appeal with this Court on December 24, 2009, February 9, 2010 and March 10, 2010. By Order dated April 14, 2010, we consolidated the two adversary proceedings for purposes of this appeal. (Trustee's Br. 6.)

On March 2, 2012, oral argument was held on the matter. A telephone conference was later held on December 21, 2012. On January 4, 2013, at the Court's request, the parties submitted additional letter briefs. The matter is now ripe for disposition.

II. THE BANKRUPTCY COURT'S OPINION

In granting the motions to dismiss, the bankruptcy court decided each contention raised in favor of the Chase and ABN lenders (hereinafter, "Lenders").

Regarding the Trustee's constructive fraud counts, the bankruptcy court found that the complaints*fn6 failed to plausibly state an essential element of the claim-that is, that the transfers lacked reasonably equivalent value. Specifically, the bankruptcy court concluded that the complaints, their exhibits, the exhibits attached to the motions to dismiss and the Trustee's concessions during oral argument established that Image Masters received a dollar-for-dollar reduction in liability to the homeowners under the Image Masters' mortgages. In reaching this conclusion, the bankruptcy court noted that the relevant documents evidenced that: (1) Image Masters had contractually agreed with the homeowners to pay the regular monthly amounts due on the conventional mortgages with the Lenders, and (2) each transfer to a Lender constituted "a disbursal to or for the benefit of the homeowner as the advance of the wrap amount, which Image Masters owed to the homeowner." In re Image Masters, Inc., 421 B.R. 164, 177-80 (Bankr. E.D. Pa. 2009).

With respect to the actual fraud counts, the bankruptcy court first concluded that a "good faith" defense was established on the face of the complaints. The court found that the complaints demonstrated that there was no relationship, contractual or otherwise, between Image Masters and any of the Lenders. Further, the bankruptcy court also rejected the Trustee's allegation that the Lenders should have known about the Ponzi scheme given that they received multiple payments from a single source, concluding that "the Trustee's allegations fail[ed] to state in any way that Defendants acted in anything other than [] good faith." Id. at 180-83.

The bankruptcy court also dismissed the actual fraud counts for failure to plead with particularity pursuant to Rule 9(b). Relying on several cases outside of this circuit, the court held that Rule 9(b) requires a plaintiff to plead "fraudulent intent with respect to each transfer sought to be avoided and [to] connect the allegations against the defendant to the debtor's scheme to defraud creditors."*fn7 Id. at 186. The bankruptcy court concluded that the Trustee did not satisfy this standard in that she failed to adequately allege any "badges of fraud" to demonstrate fraudulent intent, and neglected to plead a connection between the Lenders and the Ponzi scheme. It was noted that the Trustee did not allege that the Lenders were involved in, or aware of, the lending relationship between Image Masters and the homeowners; that the Lenders had a financial relationship with Snyder, Image Masters or some other Debtor; or that the Lenders acted in some fraudulent, unlawful or wrongful manner. Id. at 184-85.
Lastly, the bankruptcy court dismissed the complaints for failure to join the homeowners as necessary parties under Rule 19. The bankruptcy court first determined that the homeowners had a substantial interest in the subject matter of the bankruptcy proceedings, and that disposing of the proceedings absent joinder would impair or impede their ability to protect their interests. The bankruptcy court reasoned that, if the transfers were avoided, the Lenders "might very well assert claims against the homeowners for either or both (1) immediate payment (again) of the full amount of all avoided transfers or (2) declare defaults for non[] payment under the terms of the conventional loans." Id. at 189. The bankruptcy court also found that the homeowners were necessary parties because failure to join them could leave the Lenders subject to a substantial risk of incurring double or otherwise inconsistent, contradictory, and unwarranted obligations. The bankruptcy court concluded that, given the two pending class action suits filed by certain homeowners,*fn8 parallel proceedings would exist involving construction of the same loan contracts, and the Lenders "could be subject to potentially different, potentially duplicative, and potentially inconsistent interpretations and determinations regarding their rights and obligations." Id. at 189-90.

III. ISSUES RAISED ON APPEAL

The issues raised by the Trustee are as follows:

1. Whether the bankruptcy court erred in dismissing the claims for constructive fraudulent transfers on the grounds that Image Masters received reasonably equivalent value in exchange for the transfers made to the Lenders;

2. Whether the bankruptcy court erred in dismissing the claims for actual fraudulent transfers based on its conclusion that the complaints established the Lenders' affirmative defense of "good faith";

3. Whether the bankruptcy court erred in dismissing the claims for actual fraudulent transfers on the grounds that the Trustee failed to plead the ...


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