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Strong v. Cochran

United States District Court, D. Utah, Central Division

October 13, 2017

D. RAY STRONG, as Liquidating Trustee of the Consolidated Legacy Debtors Liquidating Trust, the Castle Arch Opportunity Partners I, LLC Liquidating Trust and the Castle Arch Opportunity Partners II, LLC Liquidating Trust, Plaintiff,
KIRBY D. COCHRAN, et al., Defendants.


          TENA CAMPBELL U.S. District Court Judge.

         This case arises out of the operation and bankruptcy of Castle Arch Real Estate Investment Company, LLC (CAREIC). Plaintiff D. Ray Strong (Trustee), in his role as liquidating trustee, is pursuing the Defendants to recover money for the Liquidating Trusts and Debtors. According to the Trustee, the individual Defendants, who participated in the management of CAREIC, fraudulently raised $73 million from real-estate investors, squandered the company assets, and used the money to compensate themselves at investors' expense. He asserts claims for breach of fiduciary duty, violation of state securities laws and RICO statutes, and unjust enrichment.

         Three sets of Defendants have filed motions to dismiss under Federal Rule of Civil Procedure 12(b)(6).[1] They collectively assert that the Trustee's complaint fails to state a claim for which relief may be granted because, among other reasons, the claims are time-barred, the fraud-based claims do not satisfy the Rule 9(b) pleading standard, certain claim elements (such as a fiduciary duty) are not sufficiently pleaded under Rule 8, and the equitable relief claims are barred because the Trustee has an adequate remedy at law.

         For the reasons set forth below, the court DENIES the motions to dismiss.


         In April 2004, Defendants Robert Geringer and Jeff Austin formed CAREIC as a California limited liability company in the business of real estate investment. CAREIC was “purportedly governed by an Amended Operating Agreement dated February 16, 2007. But in fact, in their operation and management of CAREIC, Management generally disregarded the Operating Agreement and applicable state law, ” and did not follow the typical management procedure for LLCs. (Am. Compl. ¶ 32, ECF No. 150.)

         CAREIC formed single-purpose or project-specific entities that were apparently designed to develop specific real estate projects or to take advantage of particular investment opportunities. For example, Castle Arch Smyrna, LLC (CAS), was formed to develop real property in Smyrna, Tennessee. Castle Arch Kingman, LLC (CAK), was formed in connection with the purchase and proposed development of land in Kingman, Arizona. CAREIC and its Pursuant to Fed.R.Civ.P. 12(b)(6), ECF No. 115; Mot. of Def. William H. Davidson to Compel Arbitration Pursuant to 9 U.S.C. § 4 & Utah Code § 78B-11-108; Stay the Case Pursuant to 9 U.S.C. § 3 & Utah Code § 78B-11-108; and to Dismiss Claims Pursuant to Fed.R.Civ.P. 12(b)(6), ECF No. 111. special purpose entities are, collectively, the Debtors.

         CAREIC, through the individual Defendants, raised over $73 million from investors. According to the Trustee, they raised that money by fraudulently telling investors that the money “would be used prudently to acquire, entitle, and develop real estate.” (Id. ¶ 2.) Rather than acting prudently, the Defendants “recklessly invested in raw land” and “pursued projects long after they knew, or should have known, these projects were either completely infeasible or so high risk that a prudent real estate developer would never have pursued them.” (Id. ¶¶ 3, 6.) The Trustee further alleges that the Defendants “brought no value to the Debtors' investors, and that the entire CAREIC operation was merely a scheme to generate personal salaries and other compensation for [the Defendants], at investors' expense.” (Id. ¶ 6.) The Defendants' Roles at CAREIC In the Amended Complaint, the Trustee categorizes three of the individual Defendants-Robert Geringer (who has not filed a motion to dismiss), Jeff Austin, and Robert Clawson-as CAREIC's “Officers.” (Id. ¶ 28.) Those Officers, along with Defendant William Davidson, are referred to in the complaint as the “Board, ” the “Directors, ” or “Management.” (Id.) The Amended Complaint also outlines the individual Defendants' personal involvement in CAREIC.

         For instance, Mr. Austin was CAREIC's Senior Vice President of Business Development and a member of the Board of Directors.

As Senior Vice President of Business Development, Austin was the person principally responsible for the Debtors' capital-raising activities, comprised of selling securities to the public through unlicensed broker-dealers by means of material misstatements and omissions. Austin had authority over the Debtors' sales materials (including the PPMs [private placement memoranda]) and its sales force.

(Id. ¶ 22.) Beginning in November 2010, Mr. Austin served as CAREIC's CEO. “As CEO, Austin had general charge of the business, affairs, and property of the Debtors and general supervision over its officers, employees, and agents.” (Id.) But “Austin was not registered with the Securities & Exchange Commission (‘SEC') or any relevant state authority as a broker-dealer or as being associated with a broker-dealer firm that was registered with the SEC.” (Id.)

         Mr. Davidson became a member of CAREIC's Board of Directors in January 2006 and served as Chairman of the Board from May 2007 to November 2010. “He acted as Chair at CAREIC's Board meetings, developed and set the agendas for meetings of the Board, and was charged with ultimate oversight of management.” (Id. ¶ 24.) He was also a member of CAREIC's Audit, Compensation, and Governance & Compliance Committees.

         Mr. Clawson was CAREIC's Managing Director of Business Development and a de factor officer and member of CAREIC's Board from 2004 to 2011. According to the Amended Complaint, Clawson was denied a formal title and his participation in the Company (at Board meetings and in drafting and structuring PPMs and other sales materials) was not disclosed in CAREIC's PPMs or its public filings because

Clawson has been, since at least 2003, barred by the SEC from functioning as a promoter, finder, consultant, agent, or other person who engages in activities with a broker, dealer, or issuer for purposes of the issuance or trading in any penny stock, or inducing or attempting to induce the purchase or sale of any penny stock.

(Id. ¶ 25.)

         The Private Placement Memoranda

         The Defendants raised money through the sale of securities offered in Private Placement Memoranda (PPMs). The Trustee, in his securities fraud claims, focuses on three PPMs-one for CAREIC securities, and two for securities of CAREIC's special purpose entities-each of which, he alleges, contained material misrepresentations and omissions.

         First, Management offered and sold investors approximately $38.4 million in CAREIC securities (Series A, B, C, D, and E). Of those five offerings, the complaint focuses on the PPM related to CAREIC's $7.1 million Series E offering (CAREIC Series E PPM).

         In the second set of offerings, Management sold securities of the single-purpose or project-specific entities. The PPMs at issue in this category are (1) the June 25, 2007 CAS PPM, through which Management raised $4.1 million, and (2) the February 1, 2008 CASDF PPM, through which Management raised $8.4 million.

         For each of the three, the Trustee enumerates the Management Defendants' personal involvement in the offerings, including drafting, revising, and approving the PPMs. (See, e.g., id. ¶¶ 198-207.) He lays out their use of the securities offerings, through the PPMs, as well:

The Management Defendants authorized the Debtors to use the Relevant PPMs to solicit investment from the investors who invested in CAREIC, CAS, and CASDF. The Management Defendants, or other sales representatives of Debtors, provided each investor with the PPM for the security invested in. The Debtors required investors in the Relevant Securities Offerings to attest that the offer to sell they had received was made through the Relevant PPMs. All of the investors who assigned their claims to the Trustee received a copy of the Relevant PPM in connection with the offer and sale of securities they purchased.

(Id. ¶ 208.) Lastly, the Trustee lists a multitude of material omissions in each of the relevant PPMs. (See id. ¶¶ 209-47.)

         Through those PPMs, the Defendants raised a significant amount of money for CAREIC and its special purpose entities (i.e., the Debtors). But because of the Defendants' purported self-dealing and reckless management, the Debtors ultimately suffered significant losses.


         In October 2011, a state-appointed receiver filed Chapter 11 bankruptcy petitions for CAREIC and its related entities in the District of Utah. In May 2012, the bankruptcy court appointed Mr. Strong as the Chapter 11 Trustee for CAREIC. After the bankruptcy court issued its 2013 Confirmation Order and confirmed the Trustee's Plan of Liquidation, the Trustee pursued this litigation in his capacity as the post-confirmation estate representative and liquidating trustee of trusts formed during the bankruptcy proceedings. In that capacity, he entered into a series of tolling agreements with the Defendants. Then, on October 30, 2014, he filed a complaint asserting claims against the former managers and board members, as well as entities associated with those individuals. According to the Trustee, this case was brought “to recover the tens of millions of dollars that investors and creditors have lost because of the Defendants' unlawful and fraudulent conduct and operation of the Debtors.” (Am. Compl. ¶ 1.)

         The Trustee originally asserted nineteen claims against the Defendants: a claim for breach of a fiduciary duty, seven fraud-based claims based on state and federal law (including securities laws, civil conspiracy, and a state RICO claim), eight claims seeking avoidance of fraudulent transfers, one claim for disallowance of bankruptcy claims, and two claims in equity (constructive trust and unjust enrichment). In 2015, the case was referred to arbitration, which ultimately failed for procedural reasons. (See May 9, 2017 Order & Mem. Decision at 1-3, ECF No. 151.)

         After the case returned to this court, some of the Defendants filed the motions now before the court. Those Defendants are the “Austin Defendants” (Jeff Austin and Austin Capital Solutions[3]), the “Clawson Defendants” (Robert Clawson and Hybrid Adviser Group[4]), and William H. Davidson. On the heels of those motions, the Trustee filed a motion to amend his complaint (see ECF No. 118), which the court granted while the parties were in the process of briefing the motions to dismiss. (See May 4, 2017 Order & Mem. Decision, ECF No. 147.)

         In the Amended Complaint, the Trustee dropped some claims and reduced his complaint to the following nine claims: breach of fiduciary duty, violation of state securities laws, violation of state RICO laws, civil conspiracy, disallowance of claims and subordination under bankruptcy law, unjust enrichment, constructive trust, and a new claim against Jeff Austin based on his alleged sale of securities without a license.[5] By doing so, the Trustee essentially voluntarily dismissed his claims for federal securities fraud, federal control person liability, ...

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