Judge rejects trustee’s argument in FRM case

The bankruptcy trustee for Financial Resources Mortgages Inc. will have to go after dozens of Ponzi scheme victims one by one if it wants to collect assets and interest that it claims belongs to the bankrupt estate, a federal judge ruled last week.U.S. Bankruptcy Judge J. Michael Deasy rejected the trustee’s motion for a default judgment against those who have not contested the complaint filed against some 500 lenders 17 months ago. Instead, Deasy ruled that the omnibus complaint was outdated and not specific enough, and ordered the trustee to break it up.FRM, along with loan servicing agent CL&M, shut its doors in November 2009, leaving numerous investors – who thought they were making hard-money loans for specific construction projects – empty-handed. The Meredith companies’ presidents — Scott Farah and Donald Dodge – are in federal prison, after pleading guilty to the biggest Ponzi scheme in the state’s history.But the fate of the victims of that scheme is still up in the air, particularly the fate of those victims with mortgages filed in their name or the name of a trust.Trustee Steven Notinger maintained that since all the funds were commingled, all the victims should be treated equally, and that the estate has the right to go after property, even when it is mortgaged in a specific lender’s name, as well as the interest FRM had previously paid that lender.However, a number of the victims have argued that CL&M (where most of the money was stored) acted as no more than a conduit, that the property and interest belong to them, not to the estate.In a key test case — Notinger v. Migliaccio — Judge Deasy ruled in July that individual mortgages were, in fact, valid, but that some money could belong to the estate, if it was commingled and fraudulently transferred.But the question remains: What exactly constitutes commingling of funds? In a filing last week, Migliaccio’s attorney, Bertrand Zalinsky, argued that only the lender’s money was commingled in two servicing accounts, and those accounts were segregated from the operating account. That kind of commingling is permitted, Zalinsky said, since lawyers do it with their clients funds held in escrow all the time. Thus, he argued, the funds were held in trust, and never really became FRM or CL&M’s, and the estate had no claim on them.”That’s wrong factually and legally,” said Jim Donchess, Notinger’s law partner. “It’s a circular argument, that some people should be able to keep everything, while other people [those that did not have filed mortgages] should lose everything.””Everything” in this case doesn’t amount to that much compared to the $150 million in claims that have been submitted. Thus far, the trustee has roughly collected about $4 million, but it only has $2.4 million after expenses, Donchess said. Those expenses include some $300,000 to lenders in various settlements, he said.Whatever is decided in the Migliaccio test case, the overall case became more difficult to resolve when Deasy rejected Notinger’s motion to set an Oct. 14 deadline for all those who have not settled to answer the trustee’s suit or face a default judgment.Notinger answered that the statue of limitations will run out in a few months, and that delay would cost the estate money. One of those victims – represented by attorney Joe Foster — objected, arguing that the 62-page complaint did not specify how much each was expected to pay.”The defendants here are victims; they are not perpetrators,” Foster argued. “The trustee should not be permitted to force the defendants to incur the costs of fashioning answers or dismissal motions. Instead, it should be forced to bring proper complaints.”On Sept. 12, Deasy agreed, calling one large complaint an “inappropriate vehicle” for litigation, “neither practical, nor efficient,” and gave the trustee until Nov. 15 to file cases against “individual defendants, or against groups of defendants who share common ownership”Donchess said he expected the trustee would file “dozens” of such cases, but he could not give an exact number. Nor could he say how many of the 500 defendants have settled and how many still remain outstanding. However, he did say that the ruling was not a setback, and that the cost of separate litigation would not be substantially more than including it in one case. — BOB SANDERS/NEW HAMPSHIRE BUSINESS REVIEW