As discussed in our update in Winter 2017, in early September 2017, a trial team consisting of Dale E. Barney, Mark B. Conlan, and Brett S. Theisen successfully tried to conclusion the valuation phase of the fraudulent transfer lawsuit of Zazzali v. Goldsmith in the U.S. Bankruptcy Court for the District of Idaho in Boise. In this case, we represent the plaintiff, James R. Zazzali, who is the Trustee of the DBSI Estate Litigation Trust. In late February and early March 2018, the same team tried the liability phase of this last of the DBSI avoidance actions. On October 17, the court issued a 69-page Memorandum of Decision awarding the Trustee a judgment against the defendant in the amount of $2.9 million. The court entered a final judgment in that amount on November 20. The court’s decision held that the Trustee proved the Ponzi scheme and resulting fraud, in the only lawsuit (out of more than 850 fraudulent transfer and other lawsuits filed in this case) that was tried to conclusion.
This last of the DBSI fraudulent transfer actions commenced by the firm on behalf of the Trustee involves a 177-acre parcel of development land located in Meridian, ID known as Tanana Valley. The DBSI group of companies was controlled by majority owner Douglas Swenson (“Swenson”), who, along with two of his sons and DBSI’s general counsel, were convicted in the U.S. District Court for the District of Idaho in 2014 on multiple counts of securities fraud and related charges. The convictions were affirmed by the Ninth Circuit Court of Appeals.
DBSI’s principal business between 2003 and 2008, when approximately 170 of the DBSI entities filed bankruptcy in the U.S. Bankruptcy Court for the District of Delaware, was the syndication and sale of tenant in common (TIC) real estate products. TIC interests are fractional shares in investment real estate, such as office, retail, and multifamily residential properties. Investors purchased interests in DBSI-sponsored TIC entities, and a DBSI “Masterlessee” leased those properties back and paid guaranteed “TIC rent” to the investors. TIC products were popular with passive real estate investors because they qualified as Internal Revenue Code Sec. 1031 “like-kind” exchanges that permitted investors to defer capital gains. DBSI sold TICs through both broker dealers and real estate brokers, known as the “securities channel” and the “real estate channel.” DBSI also raised investor money through the sale of various debt securities that were issued by “note and fund” subsidiaries.
Boise-area real estate developer Marty Goldsmith purchased the Tanana Valley property in October 2005 from a family trust for $19.2 million. In April 2006, Goldsmith contracted to sell the property to a Swenson-controlled company called Kastera LLC for an initial contract price of $35.8 million. At the time, Tanana Valley was raw land with a 13,000 square foot luxury home located on approximately five acres. After obtaining certain development entitlements from the City of Meridian, Goldsmith sold the property to a DBSI subsidiary known as DBSI Tanana Valley LLC. That entity took an assignment of Kastera’s contract and purchased the property for $28.8 million in a transaction that closed in February 2007. That transaction was funded with $28.4 million raised from investors by two note and fund entities, DBSI 2006 Land Opportunity Fund and DBSI 2006 Secured Notes Corp. Kastera paid the $400,000 balance of the purchase price out of its operating cash. Shortly after the closing, Swenson caused the property to be used in a series of TIC syndications, thereby furthering the fraud on investors. Gibbons instituted suit in October 2010 on behalf of the Trustee to recover the debtors’ transfers of the purchase price on various actual and constructive fraud theories arising out of the DBSI Ponzi scheme.
At the liability phase, the Gibbons team utilized Ponzi expert Gil Miller of Rocky Mountain Advisors, who, after a thorough analysis, opined that the DBSI companies operated with the characteristics of a Ponzi scheme. The court placed significant weight on Miller’s opinion. Based on that testimony and other proofs, the court determined that the Trustee was entitled to the benefit of the “Ponzi presumption” in support of a finding that the transfers to Goldsmith were made by DBSI with actual intent to defraud creditors and in furtherance of the Ponzi scheme. The court found the fact that Tanana Valley was TIC’d out shortly after the closing to be significant in its determination that the transfers were in furtherance of the Ponzi scheme.
Former DBSI accounting manager Matthew McKinley testified regarding the business records and operations of the DBSI group, as well as the securities and real estate channels. He verified that Swenson controlled ultimate decisions within the companies and described DBSI, Inc. as the “mothership” to which all of the other companies in the group reported. McKinley also described DBSI’s note and bond business that was used to raise funds to buy real estate, including the Tanana Valley property. The court characterized McKinley’s testimony as demonstrating “significant and detailed knowledge” of DBSI’s records and business.
The court was likewise persuaded by the testimony of former DBSI executive Gary Bringhurst. Bringhurst testified that DBSI was dominated by Swenson, and that no substantive financial decisions were made at DBSI without Swenson’s approval and direction. He also testified at length regarding DBSI’s weekly “cash meetings,” which were held starting in 2005, where sources and uses of cash were discussed. Swenson made all ultimate decisions regarding the purchase of TIC properties and other investments, including DBSI’s extensive – and ultimately insolvent – technology company portfolio. Bringhurst likewise testified about monthly “asset management meetings” during which it was apparent that the TIC portfolio was hemorrhaging cash and Swenson’s refusal to provide that information to investors. Finally, Bringhurst testified that, in 2007, the SEC issued a notice that TIC investments could be sold only by licensed broker dealers, which resulted in the cessation of sales through the real estate channel and the elimination of more than 50 percent of DBSI’s TIC cash flow.
The court’s findings ultimately led it to conclude that Goldsmith, as the recipient of DBSI’s fraudulent transfers in furtherance of its Ponzi scheme, was liable to the Trustee for the difference between the amount he received and the fair market value of the Tanana Valley property (as determined by the court in Phase I of the trial, held in September 2017).
The team has been ably assisted by local counsel Keely Duke and Kevin Griffiths of Duke Scanlan & Hall, PLLC.