GAB ENTERPRISES, INC.
ROCKY GORGE DEVELOPMENT, LLC, et al.,
Graeff, Berger, Nazarian, JJ. [*]
"A bad beginning makes a bad ending, " and in this case, the parties' difficult relationship at the beginning of this development project presaged its eventual demise. In 2003, Rocky Gorge Homes, LLC ("Rocky Gorge") and GAB Enterprises, Inc. ("GAB") created RGHGAB at Frederick, LLC ("RGHGAB"), to buy, develop, and sell property in Frederick County. Like many others, this deal failed to predict the catastrophic collapse of the real estate market about five years later, which left RGHGAB holding a figurative bag that contained a nearly $9 million promissory note guaranteeing property worth less than $3 million. In an effort to salvage its interest, and after some back-and-forth with GAB, RGHGAB formed another corporation, Waverley View Investors, LLC ("Waverley"), to purchase the promissory note at a much-reduced price. But GAB says that it wished to acquire the property itself, and initiated involuntary bankruptcy proceedings against RGHGAB (the "Bankruptcy Proceeding") that sought to force Waverley out and obtain the note for its own. Those efforts did not succeed, but did generate a written opinion explaining the issues the Bankruptcy Court was and was not deciding in ruling against GAB.
GAB tried again in the Circuit Court for Frederick County in a nine-count complaint (the "Circuit Court Proceeding") alleging that the CEO of Rocky Gorge, Christopher Dorment, fraudulently formed Waverley to eradicate GAB's interest in RGHGAB. The circuit court granted Rocky Gorge's Motion to Dismiss and for Summary Judgment on the ground that the previous findings of the Bankruptcy Court barred GAB's claims under the doctrine of collateral estoppel. We disagree that the Bankruptcy Court decision resolved the claims Rocky Gorge brings in this case, so we reverse the dismissal, as well as the circuit court's decision to grant summary judgment on other contested counts, and remand for further proceedings.
We start with the Note that set the process in motion, then watch the parties' business relationship unravel as the property's value plummeted, then chronicle the two phases of litigation that bring everyone before us.
1. Purchase (RGHGAB) and Repurchase (Waverley) of the Note
Rocky Gorge, as an 80% member, and GAB, as a 20% member, formed RGHGAB as a Maryland limited liability company on November 10, 2003. The Chairman and CEO of Rocky Gorge at the time was (and by all indications still is) Christopher Dorment. His wife, Rosemary, plays a role later on, but was not a member of Rocky Gorge. GAB acted through its President, Gary Berman. RGHGAB was formed to purchase a promissory note on a loan secured by a 93-acre tract of land in Frederick (the "Property"), then foreclose. Under the RGHGAB Operating Agreement (the "Operating Agreement"), RGHGAB would develop the Property. The Operating Agreement tasked Rocky Gorge with obtaining financing and required all parties to "use good faith and best efforts in all dealings."
The parties secured the financing with a Promissory Note dated January 30, 2004 ("the Note"), made by Rocky Gorge and held by BB&T Bank ("BB&T"). The original principal amount of $2.75 million tracked the principal amount in an accompanying Indemnity Deed of Trust. A recital to the Note contained Mr. Dormant's personal guaranty of full repayment and GAB's guaranty of partial repayment in the event of a default. As time went by, the principal amount of the Note was amended, ballooning to nearly $9 million as of September 12, 2007, and the maturity date ultimately was extended to January 15, 2010. GAB claims that it continued to guarantee partial repayment of the Note only because of "Mr. Dorment's re-affirmation that he had, and would retain, sufficient assets to secure each modification of the Note."
In the meantime, the parties ran into trouble, not just because the property value fell as the amount due under the Note rose, but also because Mr. Dorment and Mr. Berman seem never to have agreed on the terms of the Operating Agreement. As early as 2005, GAB filed suit against Rocky Gorge, claiming that it violated the Operating Agreement by trying to sell some of the Property. The parties ultimately settled that dispute and executed a Second Amendment to the Operating Agreement, under which GAB obtained additional development rights. There was a second round of litigation in 2008 and 2009, after a dispute between the parties about a payment to RGHGAB on the Note from BB&T for nearly $150, 000. According to the Complaint in this case, Rocky Gorge ultimately was ordered by an arbitrator to repay the funds to BB&T, but never did so. It is not clear from the record what, if any, action GAB undertook in response.
By late 2009, the Property's value had dropped far below the increasing amount due under the Note. Although the record does not contain specific evidence of why no development occurred throughout this time (we surmise that the parties were occupied watching the Property decline in value and feared throwing good money after bad), RGHGAB found itself with no funds and a need for further financing. Mr. Berman declined to make further contributions, although he suggested turning to his father, Malcolm Berman, for funding. It seems, though, that whatever conditions the senior Mr. Berman wished to impose, Mr. Dorment found them unfavorable and pursued further funds on his own.
We will discuss below, and in detail, the findings of the United States Bankruptcy Court for the District of Maryland (the "Bankruptcy Court") in the litigation that underlay the Circuit Court's dismissal of this case. The Bankruptcy Court's eventual decision provides, however, a succinct narrative of the next phase of the parties' relationship:
[a]t all times [Mr.] Dorment advised [Mr.] Berman of the situation facing the venture. This was required in that Section 5.3 of the Operating Agreement required [Mr. Berman's] agreement to dissolve or terminate the venture, to do anything in contravention of the agreement, to do any act that would make it impossible to carry on the ordinary business of the venture, or to possess or assign rights in company property or assign rights in company property other than for a company purpose.
By a letter dated November 12, 2009, [Mr.] Dorment advised [Mr.] Berman of his intention to buy [the Note] at a discount and that he was seeking fresh equity capital and that this would require ceding of control of the project and dilution of their equity stakes. How he could cede control of the project without the consent of [Mr.] Berman is unclear.
On February 3, 2010, Mr. Dorment proposed to Mr. Berman that they form a new entity to take on the Note. Even the Bankruptcy Court, looking back, could not discern how Mr. Dorment intended to do this without Mr. Berman's consent, but Mr. Dorment apparently had "concluded that the only practical course of action would be for a new entity to buy [the Note], and 'if the Managing Member reaches that conclusion, the Managing Member would proceed ahead with the goal of protecting the interests of the Company even if the minority member objected.'"
At this point, BB&T had extended the Note's maturity date of January 15, 2010. But when Mr. Dorment sought to enter a forbearance agreement with BB&T on March 30, 2010, Mr. Berman-"true to his uncooperative nature, " as the Bankruptcy Court put it-"refused to sign the agreement." Mr. Dorment's continuing efforts to marshall support from Mr. Berman or his father were unavailing. Mr. Dorment then obtained a commitment from another bank that would let Waverley buy the note from BB&T. Under the new deal, Mr. and Mrs. Dorment would serve as personal guarantors, the obligation would be secured further by the Note, and Waverley would act as the purchaser. Rocky Gorge assigned the note purchase agreement to Waverley, completing the transaction (in which, by the way, Waverley agreed to release all prior guarantees, including GAB's) on September 17, 2010. Then, in October 2010, Waverley undertook to foreclose on the Property.
GAB resisted these efforts almost immediately. On October 28, 2010, it filed a Motion to Stay the Sale of Property and Dismiss Foreclosure Action in the Circuit Court for Frederick County (the "Motion to Stay"). Although we now know that the interests of the GAB and RGHGAB ended up adverse to one another, at the time GAB sought the stay derivatively on behalf of RGHGAB. The details don't matter here, but the short story is that after this Court denied RGHGAB's (i.e., GAB's) appeal of the Circuit Court's denial of the Motion to Stay, Waverley resumed its efforts to foreclose.
2. The Bankruptcy Proceeding
Undaunted, GAB looked to another forum, and filed a Petition for Involuntary Bankruptcy (Chapter 7) in the Bankruptcy Court on January 11, 2011. The Petition was unusual: GAB listed no other petitioning creditors in the Petition and characterized its own claim as a loan in the amount of nearly $440, 000. The filing brought the foreclosure proceeding to an abrupt halt because of the automatic stay that issued from the Bankruptcy Court, so Waverley sought relief from the stay on February 22, 2011, arguing (in the "Motion for Relief") that it should be permitted to foreclose on the Property as a secured creditor. GAB opposed the Motion for Relief, alleging that Mr. Dorment "secretly created Waverley for the purpose of improperly transferring [RGHGAB's] assets and other corporate opportunities to Waverley, and wiping out the interests in [RGHGAB's] property of not only GAB but also [of RGHGAB's] other creditors." As far as we can tell, the Motion for Relief was not addressed directly by the Bankruptcy Court.
Next, the Trustee in the Bankruptcy Proceeding filed a First Amended Complaint for Equitable Subordination and Equitable Disallowance on May 9, 2011 (the "Bankruptcy Complaint") against Rocky Gorge and Waverley. The Trustee asserted that Mr. Dorment, Rocky Gorge, and Waverley had "engaged in inequitable conduct" and improperly engaged in self-dealing that harmed RGHGAB and its creditors (including only GAB by name). The complaint sought equitable subordination of Rocky Gorge and Waverley's claims against RGHGAB and equitable disallowance of these claims.
The Bankruptcy Court held a trial that spanned three days in October and November 2011, and on April 24, 2012 issued a Memorandum of Decision (the "Memorandum") and entered Judgment for Waverley and Rocky Gorge dismissing the Bankruptcy Complaint. The Court found broadly that Mr. Dorment's decision to assign the Note to Waverley caused no harm to any of the creditors-GAB or any of the six creditors that lacked priority claims. It approached the question three different ways:
First, the Bankruptcy Court found at the outset "a total absence of harm by the actions complained of to the one creditor holding a secured claim [i.e., Waverley or the [remaining] holders of claims without priority." (Emphasis added.) A cause of action for equitable subordination in involuntary bankruptcy requires harm to creditors (citing In re: Kreisler, 546 F.3d 863, 866-67 (7th Cir. 2008)), and as the Bankruptcy Court saw it, "[t]his project was so far indebted to [Waverley] that there was no scenario under which the Trustee's constituent body, the holder of unsecured claims, could receive any distribution whatsoever." The Bankruptcy Court qualified its decision by pointing out that "Rocky Gorge might have a fiduciary relationship to GAB, but that is not what this adversary proceeding concerns."
Second, the court denied GAB's claim for equitable subordination. GAB had sought to subordinate Waverley's claim and transfer its lien to the Trustee; it also sought equitable subordination of Rocky Gorge's claim. Under 11 U.S.C.A. § 510 (2004), which codifies the doctrine, a court may "subordinate . . . all or part of an allowed claim to all or part of another allowed claim." Id. § 510(c)(1). But again, equitable subordination requires a showing of injury to other creditors, and, again, the Bankruptcy Court found that "no harm was caused to the creditor body by [Mr.] Dorment forming a group to acquire the Note in and of itself." (Emphasis added.) The court cautioned once more that "there could well be a cause of action in what is essentially this two-party dispute between [Mr.] Berman and [Mr.] Dorment operating through their legal entities. But resolution of the potential dispute is for another day in another jurisdiction." (Emphasis added.)
Third, the Trustee sought not just to subordinate, but also to disallow Waverley's and Rocky Gorge's claims, which as the Bankruptcy Court noted is available "'only 'in extreme instances-perhaps very rare-where it is necessary as a remedy.'" (quoting Adelphia Recovery Trust v. Bank of America, N.A., 390 B.R. 80, 99 (S.D.N.Y. 2008)). The Bankruptcy Court again found that there was "nothing in the nature of inequitable conduct or unfairness on [Mr.] Dorment's part. The creditors . . . were then at least $5 million under water and suffered no change in position as a result of the transfer of the Note to parties friendly to [Mr.] Dorment." The court further found "as a fact that the primary motivation of [Mr.] Dorment was to limit his liability on the guaranty and secondarily to protect the venture." Once again, the court was careful to point out that "[Mr.] Berman, as a partner-creditor, may have a claim against his co-venturer. However, the court finds nothing in the behavior of [Mr.] Dorment or his co-venturers in Waverley to mandate the awesome punishment of equitable disallowance being imposed on them."
GAB appealed the Bankruptcy Court's decision to the United States District Court for the District of Maryland, but dismissed the appeal pursuant to a ...