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Living Benefits Asset Management, LLC v. Kestrel Aircraft Co., Inc.

United States District Court, N.D. Texas, Fort Worth Division

March 26, 2018




         Before 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.


         This 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).


         Before 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.[1]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.

         The 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.

         The 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.

         On 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.

         The 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;[2] 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.

         The 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.

         Then, 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.

         The 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.

         On 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.

         III. ...

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