Bend 1031 exchange ‘arguably’ a Ponzi, judge says

Bend 1031 exchange ‘arguably’ a Ponzi, judge says

By Andrew Moore
The Bulletin

May 07. 2009

A U.S. bankruptcy judge said Wednesday at a hearing in Portland that Summit 1031 Exchange, a Bend-based real estate services company, arguably ran a Ponzi scheme and that its business was a “house of cards” waiting to collapse.

Judge Randall Dunn made the remarks before approving a liquidation plan for Summit Accommodators Inc., which did business as Summit 1031 Exchange. The plan will attempt to return more than $40 million in asserted claims to the company’s roughly 120 unsecured creditors by, among other things, selling speculative real estate throughout the Western United States and Mexico that was purchased by the company’s shareholders or related third parties through as many as 91 separate legal entities.

Summit filed for Chapter 11 bankruptcy protection in December, stating on its Web site then that it had a “liquidity problem” and was short more than $14.2 million due its clients. A trustee appointed to the case and the creditors’ committee have since agreed to liquidate the company’s assets, according to filings in the case.

“(Summit) filed for bankruptcy because they were $14 million short, and they couldn’t bring it current, and were operating, arguably, a Ponzi scheme, that (Summit) had been engaged in for years, and it had run its scheme,” Dunn said in court Wednesday.

“They couldn’t stop up the hole anymore, much as they tried, so they had to file for bankruptcy because they had no alternative. The house of cards was collapsing.”

The liquidation plan allows the trustee to transfer assets, mainly 87 different properties identified so far, from the company and its related legal entities into a trust that will attempt to sell the properties in order to make distributions to the company’s creditors, who in addition to the $14 million are also seeking related damages, according to Jeanette Thomas, the attorney for the official committee of unsecured creditors.

Many of the creditors are individuals who hired the company to perform 1031 exchanges. A 1031 exchange allows property owners to defer tax on the capital gain from the sale of a business or investment property if they purchase a similar property with equal or greater value within 180 days. Such treatments are different from the $250,000 federal capital gains exemption for the sale of a primary residence.

A caveat of the transaction — named after Section 1031 of the U.S. tax code, which explains how such transactions are to be structured — is money from the sale of the property cannot be handled by the property owner and must be processed through a third party, which is known in the 1031 exchange industry as a qualified intermediary. Summit acted as a qualified intermediary.

Additionally, the qualified intermediary wires the client’s funds to the seller of the replacement property. In the interim, according to industry standards, the money is typically held in a bank account or some other investment that can be easily converted to cash in order to complete a client’s purchase.

There are no laws specifying where a 1031 exchange company can or cannot park its clients’ money. However, Summit, in its exchange contract, did specify it would place its clients’ money into deposit accounts at financial institutions, according to testimony heard Wednesday from Kevin Padrick, the Chapter 11 trustee appointed by the court to oversee Summit’s bankruptcy.

Padrick testified that Summit deposited the money but then transferred roughly 90 percent of it to Inland Capital Corp., a corporation owned by Summit’s four principal shareholders: Mark Neuman, Brian Stevens, Timothy Larkin and Lane Lyons.

“Inland was described by them as a conduit,” Padrick said on the stand Wednesday. “What they did was to take exchange funds from Summit and provide those to Inland, and Inland provided those funds to various entities or to (the four principal shareholders) directly as well as in a few cases to unrelated third parties.”

Padrick testified that, over time, tens of millions of dollars were transferred from Summit to Inland, often for purchase of speculative real estate or, in some cases, for personal reasons. Padrick said Neuman used money from Inland to renovate his home and provide a down payment for his daughter to purchase a home.

The money transferred out of Summit was replaced with money deposited by new exchange clients, Padrick said. He added that based on his examination of Summit’s accounting records, he believes the company first experienced a liquidity crisis in 1995 and then had another one in 1998.

A similar liquidity crisis precipitated the company’s bankruptcy filing in December, according to filings in the case.

Filings also state Summit is the subject of FBI and state investigations.

A local phone number listed for Neuman is no longer in service. Robert Vanden Bos, an attorney for Neuman, declined through a representative to comment on the Summit case.

How much creditors can expect to receive from Summit’s asset liquidation is dependent on a number of variables, but Judge Dunn remarked in court Wednesday that it would be a “phenomenal result” if creditors received 100 cents on the dollar.

Thomas, the attorney for the creditors, said to The Bulletin after the hearing that she’s unable to speculate how much the creditors might recoup. But she said the sale of Summit’s speculative properties isn’t likely to add up to much given the depressed real estate market.

“Lots of the property is underwater,” Thomas said, referring to property that is worth less than what it was purchased for. “The (trustee) will have to decide whether to carry it and at a cost of what. I think it’s very unlikely in the next two to five years that property prices are going to double.”

Andrew Moore can be reached at 541-617-7820 or at amoore@bendbulletin.com.