United States District Court, N.D. Texas, Fort Worth Division
MEMORANDUM OPINION AND ORDER
O'CONNO UNITED STATES DISTRICT JUDGE.
the Court is Appellant Living Benefits Asset Management,
LLC's (“LBAM”) Brief (ECF No. 8), filed
September 2, 2017; Appellee Kestrel Aircraft Company,
Inc.'s (“Kestrel”) Brief (ECF No. 11), filed
October 2, 2017; and Appellant's Reply (ECF No. 12),
filed October 17, 2017. This action is before the Court on
appeal from of an order of the United States Bankruptcy Court
for the Northern District of Texas, Fort Worth Division.
After considering the motion, briefing, the record on appeal
and relevant law, the Court DENIES the
appeal and holds that the bankruptcy court's order should
be and is hereby AFFIRMED.
appeal is from the bankruptcy court's March 9, 2017 oral
ruling and March 23, 2017 final judgment order-incorporating
its prior findings in the oral ruling. The order held that,
while Kestrel breached its contract with LBAM, LBAM was not
entitled to recover on the contract because it failed to
register under the Investment Advisors Act of 1940
(“IAA”) and therefore the contract is voidable
under the IAA. This Court has jurisdiction pursuant to 28
U.S.C. § 158(a).
filing for bankruptcy, Appellant LBAM contracted with
Appellee Kestrel, to provide independent consulting services
in connection with Kestrel's attempt to raise $135
million in capital to pay for a prototype airplane, the terms
of which the parties detailed in an Engagement Letter, dated
August 29, 2013 (the “Engagement Letter”). Bankr.
R. 2255-77, ECF No. 6-8.Kestrel engaged LBAM for its knowledge
and expertise in developing a life settlement-driven
investment vehicle. The Engagement Letter required LBAM to
advise Kestrel on how life settlements could be structured as
collateral as part of Kestrel's attempt to raise the
capital to fund their venture. Bankr. R. 1085, 1552, 1560,
1565, ECF No. 6-3 In return, Kestrel agreed to pay LBAM a
flat fee of $950, 000.00 (the “flat fee”). Bankr.
R. 2258, ECF No. 6-8.
Engagement Letter required LBAM to advise Kestrel on how it
could invest in life settlements as a means of providing a
collateral hedge for investors. LBAM also modeled a
hypothetical portfolio of life settlements for Kestrel to
help Kestrel understand how life settlements worked-the costs
involved, when policies matured, and what kind of cash flow
life settlements provided. Bankr. R. 1043, 1098-99, ECF No.
6-3. Kestrel used the model at its investor presentations.
LBAM also prepared a Confidential Information Memorandum (the
“CIM”) that stated that acquiring settlements
would generate for Kestrel in excess of $85 million out of
$100 million of insurance during 10-year term of investment.
Bankr. R. 3076, ECF No. 6-12. Kestrel used this CIM at
potential investors meetings, usually with an LBAM employee
present to answer technical questions if necessary. The CIM
described the potential investment in Kestrel and how the
life settlement portfolio would act as part of the security
against the debt facility to be obtained in order to fund
Kestrel's plans. The life settlement portfolio would
provide principal protection to the investors; the CIM
predicted high figure returns over a 10-year period from
these portfolios. Barnkr. R. 3062, ECF No. 6-12.
Engagement Letter required Kestrel to purchase life
settlements from LBAM only, for two years after signing the
contract. Bankr. R. 2257, ECF No. 6-8. Under this
arrangement, the Engagement Letter contained a draft
Origination Agreement to use as a contract between the
parties in the event of future life settlement purchases.
Bankr. R. 1375, 1591 ECF No. 6-3. While the Origination
Agreement was not a contract, it was attached to the
Engagement Letter and mentioned within the contract. Bankr.
R. 2257, ECF No. 6-8. The Origination Agreement generally
provided that, upon request by Kestrel, LBAM would locate
entire life settlement policies, which met a set of criteria
established by Kestrel, for purchase by Kestrel. Id.
at 2263-65. The terms of the Origination Agreement also gave
Kestrel a substantial amount of managerial control over any
potential purchase of life settlements. Id. The
Origination Agreement also required LBAM to provide
additional services if Kestrel raised sufficient capital from
life settlement purchases. But as Kestrel did not raise the
capital, the Origination Agreement was never signed or used
by the parties.
November 16, 2015, LBAM filed a voluntary petition for
bankruptcy relief under chapter 11 of title 11 of the United
States Bankruptcy Code. On December 16, 2016, LBAM commenced
adversarial proceedings against Kestrel in the bankruptcy
court, arguing that LBAM had provided all the services
required by Kestrel according to the Engagement Letter, and
that Kestrel breached the Engagement Letter by only paying
LBAM a portion of the contractual flat fee. Bankr. R. 19, ECF
No. 6-1. Kestrel countered that the contract was covered
under the Investment Advisors Act of 1940, 15 U.S.C. §
80b-1 et seq. (the “IAA”), and that
because LBAM had not registered under the act, the contract
was voidable. The bankruptcy court conducted a trial from
January 30, 2017, to February 1, 2017. Bankr. R. 34, ECF No.
6-1. On March 9, 2017, the bankruptcy court entered an oral
ruling with findings of facts and conclusions of law.
Id. at 34. The bankruptcy court found that while
Kestrel breached the Engagement Letter, LBAM could not
recover because it failed to register under the IAA, making
the contract voidable. Id. at 1053.
bankruptcy court first addressed whether life settlements
were securities for the purposes of the IAA. Bankr. R. 1121,
ECF No. 6-3. It utilized the Supreme Court's test in
Securities & Exchange Commission v. W.J. Howey
Co., 328 U.S. 293 (1946) for defining securities under
the Securities Act of 1934, namely, that “an investment
contract is a security if the investor, one, expects
profits; two, from a common enterprise that; three,
depends solely on the efforts of others.” Bankr. R.
1121, ECF No. 6-3. It found that the first prong was
satisfied with no analysis. Id. (“We won't
dwell on the first prong. Clearly, Kestrel expected profits
from the life settlements.”). The bankruptcy court then
analyzed the third prong, whether profits are derived solely
from the efforts of others. Applying the rule in Long v.
Shultz Cattle Company, 881 F.2d 129 (5th Cir. 1989),
noting that “substantive economic realities must govern
over form, ” the bankruptcy court noted that the
critical inquiry is whether the efforts made by those other
than the investor are the undeniably significant
ones-“those essential managerial efforts which affect
the failure or success of the enterprise.” Bankr. R.
1122, ECF No. 6-3. The court found that the efforts of
Kestrel heavily depended on LBAM's expertise, and while
the duties imposed on Kestrel were significant the success of
the proposed investments in life settlements depended on
LBAM. Accordingly, the court found that the third prong of
Howey was satisfied. Id. at 1123.
bankruptcy court then considered the second prong, whether
there was a common enterprise. The bankruptcy court applied
the Fifth Circuit's broad vertical test in Long.
The Fifth Circuit requires an inquiry into whether the
fortuity of the investments is essentially dependent upon
promoter expertise. Long, 881 F.2d at 134. While
there must be interdependence between the investor and the
promoter-that interdependence may be shown by the
investor's reliance on the promoter's expertise,
regardless of whether the promoter receives only a flat fee
or a commission. Id. at 1124-25. The bankruptcy
court found that the second prong was satisfied. Id.
regarding the IAA, it found that the evidence established, at
the very least, LBAM was in the business of advising others,
including Kestrel, as to the advisability of investing in
life settlements. Id. “There's no way to
look at Defendant's Exhibit 1 and the Origination
Agreement and conclude that LBAM was not an investment
advisor as to life settlements within the meaning of 15
U.S.C. § 80b-2(a)(11).” Id. at 1126.
bankruptcy court finally addressed LBAM's motion to
exclude all parol evidence from the proceedings. It admitted
that it used parol evidence in reaching the above findings,
namely testimony and email communications leading up to and
after the execution of the contract. It found, however, that
consideration of parol evidence did not prejudice LBAM.
Id. at 1129.
March 23, 2017, the bankruptcy court entered final judgment,
and LBAM filed a motion for a new trial, or alternatively a
motion to alter the judgment, which the bankruptcy court
denied. Id. at 1801. LBAM now appeals the bankruptcy
court's final judgment. Id. at 1-3.