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Jenny Smith v. Haynes & Haynes P.C.

Summarizing by Kathleen DiSanto

Life Partners Creditors' Trust, et al v. James Sun

Fifth Circuit generally holds that heightened pleading standards in Rule 9(b) do not apply to claims that don’t rely on fraudulent activity, even though the overall scheme may be fraudulent.

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Case Type:
Business
Case Status:
Affirmed in part and Reversed in part
Citation:
No. 17-11477 (5th Circuit, May 31,2019) Published
Tag(s):
Ruling:
AFFIRM the district court’s judgment of dismissal as to Counts 5, 8, 11, and 12. However, it REVERSED the dismissal of Counts 1–4, 6, 9, and 10 and REMAND
Procedural context:
On January 20, 2015, Life Partners Holdings filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code. The Chapter 11 trustee filed bankruptcy petitions on behalf of the LP subsidiaries, LPI and LPI Financial Services, on May 19, 2015. The Chapter 11 trustee then filed a series of adversary proceedings on behalf of the bankruptcy estates. One of the proceedings targeted Pardo and other LP Entities executives and insiders. The district court assigned to that case withdrew the bankruptcy reference and denied the defendants’ motions to dismiss, some of which raised arguments similar to those raised by the Licensees. The case proceeded to trial, where a civil jury found that Pardo was liable for fraud and that Pardo and other LP insiders were unjustly enriched. The district court’s final judgment awarded the LP Entities’ bankruptcy estates and the plaintiff- investors in the case more than $40 million in damages. The five related adversary proceedings before this panel target the LP Entities’ Licensees. The Chapter 11 trustee filed the original complaint in this adversary proceeding in October 2015. The Chapter 11 trustee amended the complaint twice before the bankruptcy judge abated all adversary proceedings pending confirmation of the Chapter 11 plan. The plan created Creditors’ Trust and assigned it two types of claims: (1) claims for liabilities owed to the LP Entities’ bankruptcy estates (Estate Claims), which the Chapter 11 trustee had previously asserted in the adversary proceedings; and (2)claims previously held by individual LP Entities investors (Investor Claims), which Creditors’ Trust asserted for the first time in the third amended complaint. After the Chapter 11 plan was confirmed, the bankruptcy judge lifted the abatement and proceeded to consider the adversary proceedings, including this one. Creditors’ Trust then filed its third amended complaint. The Third Amended Complaint is the one before the Court and states as follows: asserting the following claims: (A) Estate Claims • Count 1: Actual fraudulent transfer under Texas Business & Commerce Code § 24.005(a)(1) through 11 U.S.C. § 544 (against all Licensees listed on Exhibit 4 of the third amended complaint). Exhibit 4 lists “the annual total commissions received by the Defendant Licensees from 2008 through February[] 2015.” Thus, Creditors’ Trust claims that the commissions the Licensees received from the LP Entities are fraudulent transfers that can be avoided under the Bankruptcy Code. • Count 2: Constructive fraudulent transfer under Texas Business & Commerce Code § 24.005(a)(2) through 11 U.S.C. § 544 (against all Licensees listed on Exhibit 4). • Count 3: Actual fraudulent transfer under 11 U.S.C. § 548(a)(1)(A) (against “Certain Licensees” listed on Exhibit 4). • Count 4: Constructive fraudulent transfer under 11 U.S.C. § 548(a)(1)(B) (against “Certain Licensees” listed on Exhibit 4). • Count 5: Preferences under 11 U.S.C. § 547 (against “Certain Licensees” listed on Exhibit 4). Creditors’ Trust claims that the commissions received by “Certain Licensees” are also avoidable as preferential transfers under the Bankruptcy Code. • Count 6: Recovery of avoided transfers under 11 U.S.C. § 550 (against all Licensees). • Count 7: Breach of contract (against all Licensees). Creditors’ Trust later agreed to voluntarily abandon this claim, and it is not at issue on appeal. • Count 8: Equitable subordination of the Licensees’ claims against the LP Entities’ bankruptcy estates under 11 U.S.C. § 510(c) (against all Licensees). • Count 9: Disallowance of the Licensees’ claims against the LP Entities’ bankruptcy estates under 11 U.S.C. § 502(d) (against all Licensees). (B) Investor Claims • Count 10: Negligent misrepresentation (against “Certain Licensees,” with a reference to Exhibit 5 of the third amended complaint). Exhibit 5 is a “chart detailing the . . . relationship between Licensees and Investors with regard to sales to specific investors.” Creditors’ Trust’s negligent misrepresentation claims appear to be primarily based on the Licensees’ distribution of the LP Entities’ offering materials to investors. • Count 11: Breach of the Texas Securities Act (against “Certain Licensees,” with a reference to Exhibit 5). Creditors’ Trust claims that the fractional interests were “unregistered securities,” and “certain Licensees” were “unlicensed brokers engaged in the sale” of these securities. • Count 12: Breach of fiduciary duty (against “Certain Licensees,” with a reference to Exhibit 5). Creditors’ Trust claims that as 8 securities brokers, the Licensees owed the investors a fiduciary duty which they breached by making material misrepresentations. Many of the Licensees filed or amended previously filed motions to dismiss the third amended complaint. The district court withdrew the reference in the adversary proceeding and referred the motions to the bankruptcy judge. The bankruptcy judge held two hearings on the motions before filing his report and recommendation. The bankruptcy judge recommended dismissal of the fraudulent transfer claims, the preference claim, the negligent misrepresentation claim, and the breach of fiduciary duty claim. The judge further recommended that the Texas Securities Act claim be dismissed in part on limitations grounds, and that the equitable subordination and disallowance claims be dismissed in part as to Licensees who did not file claims in the LP Entities’ bankruptcy cases.5 As to each claim for which he recommended dismissal, the bankruptcy judge also recommended that Creditors’ Trust be granted leave to amend the third amended complaint. After reviewing the bankruptcy judge’s recommendations, the district court issued a memorandum opinion and order dismissing all of Creditors’ Trust’s claims against the Licensees with prejudice. In contrast to the bankruptcy judge’s recommendation, however, the district court declined to permit Creditors’ Trust to amend its complaint to correct the pleading defects. Creditors’ Trust also asserted a constructive trust claim in the third amended complaint. However, as Creditors’ Trust acknowledges, a constructive trust is “a practical mechanism to enforce the substantive Counts” in its complaint—a remedy rather than a substantive claim. Creditors’ Trust then filed a motion for reconsideration, urging the court to grant leave to amend the third amended complaint based on an “oral motion” Creditors’ Trust made before the bankruptcy judge. Creditors’ Trust attached a fourth amended complaint with significantly longer exhibits which it insisted addressed the pleading issues identified in the district court’s order. The district court denied the motion. Creditors’ Trust appeals three determinations by the district court: (1) its grant of the Licensees’ motions to dismiss; (2) its denial of leave to amend the third amended complaint; and (3) its denial of the motion for reconsideration.
Facts:
In 1991, Brian Pardo founded LPI for the purpose of selling “viaticals”— investments in life insurance policies that the insureds had sold to third parties.2 LPI’s parent company, Life Partners Holdings, and a related entity, LPI Financial Services, were also engaged in this business. The LP Entities used a multi-level marketing structure to promote their investment offerings to investors. First, the LP Entities contracted with “Master Licensees” to (1) refer potential investors to the LP Entities and (2) recruit additional licensees. The licensees recruited by Master Licensees—called “Referring Licensees”—would in turn enter into two contracts: one with the LP Entities to refer potential investors, and another with the Master Licensee to facilitate their sharing of the commissions received from the LP Entities’ sales. The LP Entities produced offering materials for both types of Licensees to distribute to potential investors. Through their Licensees, the LP Entities sold life insurance policies in shares referred to as “fractional interests.” Under their investment contracts with the LP Entities, the investors funded an escrow account with sufficient funds to keep the policies in effect during the life expectancies of the insureds as estimated by the LP Entities on their offering materials. If the insureds survived beyond the LP Entities’ estimate, the investors also agreed to contribute additional funds for premiums until the policies reached maturity. Initially, the LP Entities focused on policies in which the insureds had been diagnosed with AIDS because the disease shortened the insureds’ life expectancies in comparison to the actuarial life expectancies used by insurance companies. However, shortly after the LP Entities entered the viaticals market, medical advances significantly increased life expectancies for AIDS patients. As a result, by 2004, the LP Entities had pivoted their business model to focus on elderly insureds who were terminally ill—individuals whose life expectancies would presumably also be shorter than the actuarial estimates. The LP Entities hired Dr. Donald Cassidy to identify appropriate insureds and estimate their life expectancies. However, it soon became apparent that Dr. Cassidy did not have the ability to perform either task with any accuracy. Of the 302 policies that the LP Entities originated between 2004 and 2007, Dr. Cassidy predicted that 157 would mature by the end of 2007. Only seven matured during that time. Undeterred, the LP Entities continued to use the inaccurate life expectancies to set the purchase price of the fractional interests, which resulted in the LP Entities overcharging investors. In addition, the offering materials distributed by the Licensees continued to represent that the insureds had short life expectancies when their life expectancies were likely no shorter than the actuarial estimates. According to Creditors’ Trust, the LP Entities’ offering materials also contained numerous other misrepresentations regarding the life insurance industry and the LP Entities’ investment offerings. Most of these misrepresentations were related to Dr. Cassidy’s flawed life expectancy estimates, which the LP Entities used to support their claims that the fractional interests were sound investments with a “superior yield potential,” that the policies would mature relatively quickly, that the investments were low-risk even if the LP Entities’ life expectancy predictions were incorrect, that the LP Entities’ prices were appropriate, and that the LP Entities had a positive track record with past life insurance investments. These misrepresentations form the basis of several of Creditors’ Trust’s claims against the Licensees. Over a twelve-year period, the LP Entities raised more than $1.8 billion from the sale of more than 100,000 fractional interests to investors. Even when investors began expressing doubts because policy maturities were long overdue and media coverage suggested Dr. Cassidy’s predictions were inaccurate, Pardo and other LP Entities insiders continued to represent that Dr. Cassidy’s predictions were accurate and that the policies would mature imminently. The Licensees disseminated these representations to the investors. Throughout this time, the Licensees received commissions and fees under their contracts with the LP Entities. Between 2008 and 2015, these commissions and fees totaled more than $27.6 million. While investors knew that a portion of their investment funds would be used to pay fees, they were not given specifics as to how that money was distributed. On average, the Licensees received 12% of the money an investor provided in exchange for a fractional interest, which was well above the industry standard for a commission in a securities transaction. Due to the large commissions paid to the Licensees—as well as large distributions made to Pardo and other LP Entities executives—Creditors’ Trust alleges that the LP Entities were insolvent for much of their existence prior to filing for bankruptcy. Because the life settlements were bad investments, each new purchase of a fractional interest created a liability to the investor. And because the LP Entities were depleting all their resources on commissions and distributions, they did not have sufficient funds to cover those liabilities. Instead, the LP Entities—through the Licensees—continued to recruit new investors to keep the business funded. Eventually, however, the LP Entities no longer had enough capital to conduct their business operations or continue maintaining the policies that had not yet matured. As the fraudulent practices of the LP Entities came to light through media coverage, investors began to file class action lawsuits against the companies. In addition, the SEC began investigating the LP Entities. The SEC filed suit based on its findings, and the Western District of Texas found that Pardo had “knowingly—or at least recklessly—violated securities laws.”
Judge(s):
ELROD, HIGGINSON, and ENGELHARDT, Circuit Judges

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