Eagle Creek Subdivision, LLC

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NORTH CAROLINA
IN RE:
EAGLE CREEK SUBDIVISION, LLC 	Case No. 08-04292-8-JRL
EAGLES TRACE, LLC 	Case No. 08-04293-8-JRL
AUMOND GLEN, LLC 	Case No. 08-04294-8-JRL
BACK CREEK FARMS SUBDIVISION, LLC 	Case No. 08-04295-8-JRL
SADDLEBROOK SUBDIVISION, LLC 	Case No. 08-04296-8-JRL
THE HEIGHTS SUBDIVISION, LLC 	Case No. 08-06502-8-JRL
KELSEY GLEN, LLC 	Case No. 08-06503-8-JRL
THE RAPIDS AT BELMEADE, LLC 	Case No. 08-06504-8-JRL
WATER MILL, LLC 	Case No. 08-06506-8-JRL
CHANDLER OAKS, LLC 	Case No. 08-06507-8-JRL
MYERS MILL, LLC 	Case No. 08-06508-8-JRL
RIVER CHASE SUBDIVISION, LLC 	Case No. 08-06509-8-JRL
THE VILLAGE AT WINDSOR CREEK, LLC 	Case No. 08-07020-8-JRL
LISMORE PARK, LLC 	Case No. 08-07026-8-JRL
OLD TOWNE, LLC 	Case No. 08-07170-8-JRL
Chapter 11
DEBTORS.
___________________________________________________________________________
ORDER
This case is before the court on the motion to substantively consolidate the debtors’ cases
filed by the committee of holders of junior deeds of trust and owners of tenancy-in-common
interests. On November 10, 2008, the court conducted a hearing on this matter in Raleigh, North
Carolina. This opinion provides the rationale for the oral ruling at the conclusion of the hearing
SO ORDERED.
SIGNED this 26 day of November, 2008.
________________________________________
J. Rich Leonard
United States Bankruptcy Judge
____________________________________________________________
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denying the motion.
BACKGROUND
The debtors are limited liability companies managed by Landcraft Management, Inc.
(“Landcraft”). The sole members of each debtor and the sole owners of Landcraft are J. Franklin
Martin, Scott A. Stover, and Matthew A. McDonald. 	In addition to the debtors, other limited
liability companies were formed by the same parties and are managed by Landcraft. Each of the
debtors was created for the purpose of acquiring undeveloped tracts of land located in North
Carolina or South Carolina, obtaining the necessary permits and approvals, developing the tracts as
residential subdivision projects, and selling the lots to various builders for their subsequent
construction and sale.
Landcraft follows a similar business plan for each subdivision project. Typically, Landcraft
begins each project by creating a limited liability company (“LLC”), arranging for an acquisition
and development loan with a bank, and contracting with one or more builders to purchase lots.
Pursuant to these contracts, each builder agrees to make a cash deposit and supply a letter of credit
to secure its agreement to purchase lots on a specific timetable. Based on this arrangement, the
banks receive a first mortgage on property to be developed, while the builders sometimes receive
a second mortgage securing their cash deposits. Subsequent to closing, Landcraft often solicits
investments from individuals to provide additional capital. These investors receive either junior
deeds of trust or undivided tenancy-in-common interests in the property being developed.
Landcraft has followed this business plan for approximately fifteen years. However, within
the recent past, certain projects have suffered economic losses, delays, and financing difficulties.
As a result, on June 27, 2008, Eagle Creek Subdivision, LLC, Eagles Trace, LLC, Back Creek Farms
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1Somewhat ironically, Eagle Creek is the only debtor with property in this district. The
other cases involve property throughout North and South Carolina, and were filed here as
affiliates of Eagle Creek.
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Subdivision, LLC, Aumond Glen, LLC, and Saddlebrook Subdivision, LLC filed petitions for
Chapter 11 relief. Subsequently, on September 22, 2008, The Heights Subdivision, LLC, Kelsey
Glen, LLC, The Rapids at Belmeade, LLC, Water Mill, LLC, Chandler Oaks, LLC, Myers Mill,
LLC, and River Chase Subdivision, LLC filed for relief under Chapter 11. Next, The Village at
Windsor Creek, LLC and Lismore Park, LLC filed for Chapter 11 relief on October 9, 2008. On
October 15, 2008, Old Towne, LLC also filed for Chapter 11 relief.
The court authorized the appointment of a committee to represent individual investors
holding certain junior deeds of trust and certain undivided tenancy-in-common interests in property
being developed by the debtors (the “Committee”). On October 21, 2008, the Committee filed a
motion to substantively consolidate the debtors’ cases. At hearing, the Committee requested that
its motion be amended to exclude Eagle Creek Subdivision, LLC from substantive consolidation.1
DISCUSSION
The Committee contends that the debtors’ cases should be substantively consolidated
because the debtors’ reorganization efforts are unlikely to succeed individually and will result in
excessive costs and little return for secured and unsecured creditors other than the banks holding
first priority liens. 	Moreover, the Committee asserts that Landcraft has treated the debtors as
affiliates, rather than as separate legal entities, to such an extent that the debtors have no separate
existence and are not adequately capitalized.
The court has authority to grant substantive consolidation of separate bankruptcy estates
pursuant to its general equitable powers under § 105 of the Bankruptcy Code. See Union Sav. Bank
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v. Augie/Restivo Baking Co., Ltd. (In re Augie/Restivo Baking Co.), 860 F.2d 515, 518 (2d Cir.
1988). In determining whether substantive consolidation is necessary, this court has applied a two-
factor test developed by the Second Circuit. See In re Convalescent Ctr. of Roanoke Rapids, Inc.,
Case No. 06-00310-8-RDD (Bankr. E.D.N.C. Aug. 7, 2006). Under this test, the court considers (i)
“whether creditors dealt with the entities as a single economic unit and did not rely on their separate
identity in extending credit, . . . or (ii) whether the affairs of the debtors are so entangled that
consolidation will benefit all creditors.” In re Convalescent Ctr. at 5 (citing In re Augie/Restivo
Baking Co., 860 F.2d 515, 518 (2d Cir. 1988)). Because it forces creditors of one debtor to assume
an equal priority position with creditors of less solvent debtors, substantive consolidation should be
used “sparingly.” In re Augie/Restivo Baking Co., 860 F.2d at 518 (citing Chem. Bank New York
Trust Co. v. Kheel, 369 F.2d 845, 847 (2d Cir. 1966)).
In support of substantive consolidation, a financial consultant hired by the Committee, James
Neil, testified before the court. The Committee hired Mr. Neil to analyze the financial records of
Landcraft and the five debtors who initially filed for bankruptcy protection. After conducting his
analysis, Mr. Neil produced detailed reports addressing each debtor’s bank account which
highlighted the dates and amounts of every transfer, disbursement and receipt of funds between 2005
and 2008. At hearing, Mr. Neil established that during this period of time, the debtors transferred
money to and from Landcraft on a regular basis. Additionally, Landcraft transferred money into
each debtor’s bank account to be used to pay contractors. Mr. Neil testified that it was exceedingly
difficult, if not impossible, to trace funds once they were transferred from individual debtors to
Landcraft’s sole bank account. 	Mr. Neil further established that individual investors typically
provided financing by writing checks which were made payable to a particular debtor. Each debtor
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then deposited its checks into its individual bank account. However, Mr. Neil’s analysis reflected
that many of these checks were subsequently transferred to other debtors for the purpose of funding
other subdivisions.
Also testifying at hearing was Scott Stover, President of Landcraft and member of each of
the debtors. 	Mr. Stover established that the primary source of funding for each project was an
acquisition and development loan from a bank. The purpose of each bank loan was to fund the
purchase of land and construction going forward. In addition, each LLC contracted with prospective
builders to purchase lots and provide cash deposits to be applied at closing. In addition to the banks’
first priority loans and builders’ cash deposits, Landcraft solicited financing from individual
investors who received secondary liens on a particular project. Mr. Stover also established that
principals of Landcraft sometimes contributed capital to the projects. Mr. Stover further established
at hearing that the frequent transfer of funds out of certain subdivision projects and into Landcraft
resulted in Landcraft owing approximately $15,142,986.38 to the debtors and their non-debtor
affiliates. Mr. Stover also admitted that Landcraft has no real estate or other assets from which it
can repay its indebtedness to each LLC.
In response to the motion to substantively consolidate, the debtors argue that a substantive
consolidation of their cases is neither appropriate nor feasible under the circumstances.
Furthermore, the debtors contend that the Committee cannot satisfy the two-factor test for
substantive consolidation applied by this court in In re Convalescent Center. First, the debtors argue
that their cases should remain separate because their respective banks, contractors, and unsecured
creditors dealt separately with each of the debtors. Secondly, the debtors assert that their affairs are
not entangled because each debtor uses a separate bank account, Employer ID Number, place of
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business and contractor.
Although the debtors believe their cases should remain separate, the debtors agree with the
Committee to the extent that the individual investors’ claims should be pooled and all administrative
claims should be consolidated. The debtors support a consolidation of the individual investors’
claims because these investments overlap among the various subdivisions. Additionally, the debtors
argue that administrative claims should be consolidated as most of the professionals employed by
the debtors are the same in each case.
Several of the banks holding first liens on the debtors’ real property also assert that the
Committee cannot satisfy the test for substantive consolidation. SunTrust Bank (“SunTrust”) is a
secured creditor of Aumond Glen, LLC and Saddlebrook Subdivision, LLC and argues that it
extended loans based on the circumstances of each debtor’s financial information, rather than the
financial status of the debtors as a whole. SunTrust also contends that substantive consolidation is
inappropriate because the creditors vary with respect to each project. Additionally, SunTrust argues
that the debtors held separate bank accounts and that it was Landcraft, and not the debtors, who
commingled funds. 	Like SunTrust, KeyBank contends that it relied on the separate corporate
existence of each borrower in making loans to Back Creek Farms Subdivision, LLC and River Chase
Subdivision, LLC. KeyBank also asserts that the facts do not support substantive consolidation
because the debtors do not share common creditors.
In addition, several of the secured creditors object to the Committee’s motion because their
rights would be prejudiced by a substantive consolidation. At hearing, First Tennessee Bank argued
that if it foreclosed on its rights in the Water Mill property and encountered a deficiency, its
recovery would be reduced significantly if spread out among the unsecured creditors of every debtor.
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Wachovia Bank, the holder of first liens on real property owned by The Rapids at Belmeade, LLC,
Chandler Oaks, LLC, and Myers Mill, LLC, agreed that a substantive consolidation would unfairly
place the rights of second deed holders ahead of a bank’s deficiency claim.
The Bankruptcy Administrator also objects to substantive consolidation. At hearing, the
Bankruptcy Administrator asserted that the Committee’s request to separate Eagle Creek
Subdivision, LLC from the other debtors was strong evidence that the debtors’ cases were not so
hopelessly entangled as to necessitate substantive consolidation.
Substantive consolidation is extraordinary relief that is not expressly authorized by the
Bankruptcy Code. Rather, such relief is authorized pursuant to the court’s general powers under §
105 but is reserved for the rare situation in which administration of a set of cases would unjustly
disturb the rigid corporate boundaries that separate them. See In re Fas Mart Convenience Stores,
Inc., 320 B.R. 587, 594 (Bankr. E.D. Va. 2004) (“[s]ubstantive consolidation should be used
sparingly to prevent injustice.”). 	This court has considered two critical factors in determining
whether the substantive consolidation of estates is appropriate. See In re Convalescent Ctr., Case
No. 06-00310-8-RDD (Bankr. E.D.N.C. Aug. 7, 2006). Accordingly, the Committee must establish
that (i) “creditors dealt with the entities as a single economic unit and did not rely on their separate
identity in extending credit,” or (ii) “the affairs of the debtors are so entangled that consolidation
will benefit all creditors.” In re Convalescent Ctr. at 5.
First, it is clear that creditors, save perhaps for the individual investors, dealt with the debtors
as single purpose entities in widely disparate areas of the southeast. Mr. Stover established that each
bank issued an acquisition and development loan to an LLC on an individual basis. Furthermore,
the record reflects that the banks did not cross-collateralize between projects. Similarly, builders
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contracted with the entities individually when entering into lot purchase agreements. These creditors
either did not know or did not care that the same business plan was being run in other places. Thus,
substantive consolidation is not appropriate under the first part of the test.
Second, the record is fairly accurate in establishing how funds were disbursed among the
debtors. At hearing, Mr. Neil provided a detailed report of the financial records of the five initial
debtors, including the source and distribution of every dollar that flowed through the debtors’ bank
accounts over a three-year period. Based on the record, the court sees no evidence of any money
inappropriately disappearing or otherwise being applied outside of Landcraft’s business model. In
fact, the record shows that the principals of the debtors poured personal funds into these projects in
an attempt to keep them afloat. Additionally, the Committee’s request to exclude one of the debtors
from substantive consolidation undermines its own assertion that the debtors’ assets are inseparable.
Whether the creditors of one debtor may ultimately have a claim against the assets of another debtor
because of the intermingling of funds is a difficult legal issue reserved for another day; nonetheless,
the financial records do not present the degree of hopeless entanglement on which to base
substantive consolidation.
Based on the foregoing, the court DENIES the Committee’s motion to substantively
consolidate the debtors’ cases. The court recognizes that there may be an equitable basis for the
investors to bring a consolidated claim that applies to each case in the same way. 	However,
responsibility falls on the Committee to assert such a claim. 	Furthermore, an administrative
consolidation would result in the impermissible redistribution of funds from solvent cases toward
the payment of administrative expenses in insolvent cases. The court is unwilling to authorize the
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consolidation of administrative claims without the express consent of the parties.
“END OF DOCUMENT”
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