UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF KENTUCKY

LEXINGTON DIVISION

IN RE:

WALLACE G. WILKINSON CASE NO. 01-50281

Chapter 11

DEBTOR

MEMORANDUM OPINION

This matter is before the court to resolve the question of whether the claim of creditor Finis.com, formerly eCampus.com, Inc., should be allowed and if so, in what amount. The Chapter 7 trustee for Finis.com, J. James Rogan ("Rogan"), was appointed on December 12, 2001. Finis.com's predecessor, eCampus.com, Inc. had been in a Chapter 11 case that was filed on June 8, 2001. The trustee herein, Charles J. Lisle ("Lisle"), filed an omnibus objection to certain claims on April 18, 2003. Among the claims objected to were those characterized as "no liability," and "unliquidated." The claim of eCampus.com was included in both these characterizations. Rogan responded to the omnibus objection on May 19, 2003, and again on June 19, 2003. Lisle and Rogan filed memoranda in support of their respective positions on July 21 and July 29, 2003. The matter was heard on August 14, 2003, and submitted for decision on August 18, 2003.

Pertinent facts, including those provided by the parties in their joint stipulations, are as follows:

Lisle was appointed pursuant to the Findings of Fact, Conclusions of Law and Order Confirming Liquidating Plan of Reorganization Proposed by the Official Committee of Unsecured Creditors (the "Confirmation Order") entered in this case on December 14, 2001 (Jt. Stip. #2). By virtue of the Confirmation Order all assets of the debtor's estate have been vested in the trustee (Jt. Stip. #3). Under the terms of the Confirmation Order this court fixed November 13, 2001 as the bar date for filing proofs of claim (Jt. Stip. #4).

No debt to eCampus.com appeared on any schedules filed by the debtor. Finis.com filed Claim No. 86 in the amount of $87,562,604.54 on October 4, 2001. The claim was broken down into various parts: $47,076,999.30 for an "undocumented" capital contribution for the original subscription of May 1, 1999 for 4,409.836 shares of eCampus.com stock ⁽¹⁾; $20,000,000 on a May 18, 1999 note by Wallace's Bookstores, Inc. ("WBI"); $12,542,857 for advances by eCampus.com to WBI as of December 8, 1999; $163,577.53 for invoices due eCampus.com by WBI; and $7,779,170.71 for damages to eCampus.com (Jt. Stip. #5). The records of eCampus.com, Inc., now Finis.com, show the amount due it from WBI on the $20,000,000 note to be $11,794,815.72 (Jt. Stip. #31). No guaranty agreement signed by the debtor was attached to Claim No. 86, and the debt set out there was never personally guaranteed by the debtor. Rogan agrees that the debtor did not sign any documents to obligate himself personally on the various elements of the claim (Jt. Stip. #7).

Finis.com filed a substantially identical proof of claim (Claim No. 2975) in the Wallace's Bookstores, Inc. bankruptcy, Case No. 01-50545, on July 9, 2001 ("the WBI claim") (Jt. Stip. #6). On March 18, 2002, WBI filed its Debtors' Omnibus Objection No. 2 to certain claims ("the WBI objection"). The WBI objection objected to eCampus.com's claim on the basis that WBI's "review of the Reduce Unsecured Claims indicates that the amounts actually owed to the Reduce Unsecured Claims claimants is less than that claimed." On July 1, 2002, the court entered an order reducing Finis.com's claim to $7,667,144 (Jt. Stip. #19).

Lisle presented the affidavit of Jane Ciancanelli of J. Alix & Associates, forensic accountants hired by the Unsecured Creditors Committee, in support of his objection to the claim of Pearson Education, Inc. and in support of his objection to the discharge of the debtor. Her affidavit asserts that the debtor was operating a Ponzi scheme for several years prior to the filing of his bankruptcy petition. The affidavit further asserts that neither the debtor's businesses nor his individual assets could produce the income necessary to pay the interest due on loans he received, so that he was insolvent at all times during the operation of the Ponzi scheme (Jt. Stip. #22).

The Amended Liquidating Plan of Reorganization ("the Plan") dated September 27, 2001 defines an unliquidated claim as any claim subject to dispute or otherwise contested as to liability or amount. Plan Article I, §1.1.78. The treatment of unliquidated claims is provided for at Article VII, §7.6:

Any Creditor holding a Claim that has not been liquidated and allowed prior to the Confirmation Date shall have one hundred eighty (180) days following the Confirmation Order to file an adversary proceeding in the Court for liquidation or allowance of its Claim, or, on the 181st day after the Confirmation Date, its claim shall stand Disallowed, shall not be paid under the Plan and shall be discharged upon the completion of the Term.

Finis.com did not file an adversary proceeding to liquidate its claim prior to 180 days following the Confirmation Order (Jt. Stip. #12). Article VII, §7.7 of the Plan provides that prepetition claims may not be amended after confirmation to increase the amount thereof, and further provides that "any amendment increasing the amount of a Claim filed after Confirmation Date shall be deemed Disallowed in full and expunged without any action by the Trustee ..." Finis.com has not filed a motion to amend its claim (Jt. Stip. #13).

Article V, §5.5 of the Plan provides for subordination of claims pursuant to 11 U.S.C. § 510(b):

5.5 Class 5 - Subordinated Claims. Pursuant to Section 510(b) of the Bankruptcy Code, all Claims arising from recision of a purchase or from a sale of a security of an affiliate of the Debtor, as defined in Section 101(2) of the Bankruptcy Code, for damages arising from the purchase or sale of such security, or for reimbursement or contribution allowed under Section 502 of the Bankruptcy Code on account of such claim.

5.5.1 No distributions will be made with respect to any Subordinated Claims until all Allowed Claims that are senior to the Subordinated Claims are fully satisfied. Class 5 Claims are impaired by the Plan.

Rogan has stated that the $47,076,999.30 claim amount attributable to the original subscription for eCampus.com stock in May 1999 should be allowed as a subordinated claim against the estate (Jt. Stip. #15).

The debtor was one of the organizers of eCampus.com and was chairman of its board of directors until early 2001 (Jt. Stip. #27). He owned 3% of its stock; WBI owned 43.7% of its stock (Jt. Stips. #24 and 25). The debtor also owned 78% of the stock of WBI, and exercised sole control over it and its operations (Jt. Stips. #23 and 26).

Lisle has asserted that the objection to the subject claim has three bases: first, that there was no liability on the debtor's books and records for the claim, and the claim was an obligation of an affiliate of the debtor for which he had no responsibility; second, the claim was an unliquidated claim which Finis.com failed to liquidate in compliance with Article VII, § 7.6 of the Plan; and third, that even if the claim was not otherwise barred, it had been subordinated to payment of general unsecured claims under Article V, § 5.5 of the Plan. As set out above, Rogan has already agreed that this is the case for part of the claim.

Lisle asserts in regard to his "no liability" argument that the claim against the debtor is actually a claim for director liability which is now time-barred since the Plan prohibits amendments to prepetition claims. He points out that Rogan admits that the debtor did not personally obligate himself for the debts of WBI listed in Claim No. 86. He goes on to contend that since Finis.com never filed a proof of claim for damages resulting from director liability, he is not required to rebut the proof of claim as it stands. As stated in In re Allegheny Intern., Inc., 954 F.2d 167 (3rd Cir. 1992),

The burden of proof for claims brought in the bankruptcy court under 11 U.S.C.A. §502(a) rests on different parties at different times. Initially, the claimant must allege facts sufficient to support the claim. If the averments in his filed claim meet this standard of sufficiency, it is 'prima facie' valid. .... In other words, a claim that alleges facts sufficient to support a legal liability to the claimant satisfies the claimant's initial obligation to go forward. .... The burden of persuasion is always on the claimant. (Cites omitted.)

Allegheny Intern., Inc. at 173-174. See also In re Fullmer, 962 F.2d 1463 (10th Cir. 1992). The court's first task then is to determine whether the facts alleged by the claimant are sufficient to support the claim and a finding of prima facie validity.

As set out above, the claim is not supported by any proof that implicates the debtor personally. In fact the proof of claim is invalid on its face as it does not assert a claim or claims against the debtor, but only against WBI. The proof of claim does not even assert that the debtor is responsible for the alleged debts of WBI to eCampus.com. Lisle is therefore correct in his contention that there is nothing for him to rebut, and Rogan must go forward and prove Finis.com's claim by a preponderance of the evidence. In re Broadband Wireless Intern. Corp., 295 B.R. 140, 145 (B.A.P. 10th Cir. 2003); In re Chain, 255 B.R. 278, 281 (Bankr. D. Conn. 2000).

Rogan contends that the sums he seeks are for damages eCampus.com incurred as a result of breaches of fiduciary duty or possible fraud on the part of the debtor. In support of this contention, he makes reference to the affidavit of Jane Ciancanelli, referred to above. In the report attached to her affidavit, Ms. Ciancanelli came to the conclusion that the debtor had operated a Ponzi scheme for several years. She defines a Ponzi scheme as including an enterprise which makes payments to investors from the proceeds of a later investment rather than from the profits of an underlying business venture, giving investors the false impression that a legitimate profit-making business opportunity exists.

Ms. Ciancanelli's review of records and deposition testimony revealed that the debtor would routinely deposit the proceeds of a promissory note with an individual investor into his personal bank account. He would then transfer that money into a bank account in the name of WBI. These funds were separately tracked and could not be used without his specific approval. When he needed funds he caused WBI to transfer the necessary funds into his personal bank account. Between February 5, 2000, and February 5, 2001 he caused WBI to transfer $405 million into his personal bank account. Ms. Ciancanelli concluded that there was no explanation, other than the operation of a Ponzi scheme, for the magnitude, timing and volume of transfers between the debtor and WBI.

Ms. Ciancanelli also reviewed transactions whereby the debtor made transfers to related parties in the one year period prior to his bankruptcy filing without adequate consideration at a time when he was insolvent. These transfers included the retirement of a $15 million note receivable from Black Gold Holdings II, LLP ("Black Gold"), an entity related to L.D. Gorman, without adequate consideration. The debtor and Gorman, who had known each other for twenty years, were the two largest shareholders in WBI between July 26, 1996 and December 2000, accounting for 83% of the outstanding shares. Gorman was involved with the debtor in other business ventures as well. Between 1992 and 2001, Gorman loaned the debtor $481 million and was repaid $488 million, including interest. In December 2000 the debtor canceled Black Gold's note in exchange for WBI shares that had been pledged as collateral. At most the debtor was to have received 16,550 shares valued at no more than $3.6 million. Ms. Ciancanelli therefore concludes that the debtor did not receive adequate consideration for the retirement of the $15 million note receivable in December 2000.

Lisle does not controvert these statements, but the question remains whether they are sufficient to establish legal liability to the claimant, Finis.com, on its claim against the debtor. The court concludes without further analysis that they do not support a finding of breach of fiduciary duty. This court has previously held in Peoples Bank & Trust Co. v. Penick (In re Penick), Adv. No. 95-7065 (Bankr. E.D. Ky. July 31, 1996), quoting from In re Johnson, 691 F.2d 249 (6th Cir. 1982), that "[t]he term 'fiduciary' applies only to express or technical trusts and does not extend to implied trusts, which are imposed on transactions by operation of law as a matter of equity." Id., at 252. There has been no proof presented that the debtor was a fiduciary, and Finis.com's claim therefore cannot be based on breach of fiduciary duty.

Rogan's contention that the debtor committed fraud in regard to eCampus.com is based on Jane Ciancanelli's conclusion that the debtor was engaged in a Ponzi scheme for a number of years. He contends that a demonstration that the debtor carried on such a scheme is sufficient to prove fraud. He cites in support of this contention In re Taubman, 160 B.R. 964 (Bankr. S.D. Ohio 1993). There the Chapter 7 trustee brought an action to avoid transfers to individual investors by the debtor as part of a long-standing Ponzi scheme she operated. In analyzing these transfers, the court concluded that it was "appropriate to find actual intent [to commit fraud] from the Debtor's active participation in a ponzi (sic) scheme." Id. at 983. The transfers were determined to be fraudulent, and the trustee was successful in avoiding them.

The question here is whether Rogan has established that the debtor is personally liable for losses suffered by eCampus.com as a result of dealings between it and WBI. This court does not believe that he has. While the court agrees that evidence that the debtor engaged in a Ponzi scheme is compelling, Rogan does not make a direct connection between that activity and any personal liability of the debtor for debts owed to eCampus.com by WBI. Most of Rogan's arguments are based on the assumption that the debtor breached some fiduciary duty to eCampus.com. by, for instance, "arranging" the $20,000,000 loan to WBI. Aside from the fact that the debtor does not meet the definition of a fiduciary, Rogan does not present any proof to support his allegation that the debtor personally arranged for that loan.

Rogan makes reference to an affidavit of the debtor in which he purportedly stated that he exercised sole control of WBI. Rogan does not attach a copy of this affidavit, nor does he identify in what connection it was submitted. The debtor's control of WBI is not the issue, however, but rather what control, if any, he exercised over eCampus.com. The court is asked to assume that the debtor fraudulently induced eCampus.com to incur debt that he knew would not be repaid because there is evidence that he engaged in a Ponzi scheme. Without evidence of the debtor's personal responsibility for and involvement in the various losses suffered by eCampus.com, this is too great a leap to make. The court does not believe that Rogan provided evidence sufficient to support a claim that the debtor is liable for these losses, and his claim must be disallowed.

The net result of disallowance of this claim would appear to have no effect as to recovery by the claimant since the claim, if allowed, would be subordinated pursuant to the terms of the plan, and a full recovery by the unsecured creditors and other classes having a higher priority would be required before any recovery would be had by the claimant. The prospect that all higher classes of claims will be paid in full does not appear good at this time. An order in conformity with this opinion will be entered separately.

Copies to:

Ann E. Samani, Esq.

Elizabeth Lee Thompson, Esq.

1. Rogan explains this part of the claim as representing WBI's purchase of eCampus.com stock at $0.01 per share when subsequent purchasers paid $1.06 and $3.90 per share, the benefit being WBI's purchase of stock for $44,098.36 which others would have had to purchase for at least $47,076,999.30.