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In re ClassicStar Mare Lease Litigation

United States Court of Appeals, Sixth Circuit

July 18, 2013

In Re: ClassicStar Mare Lease Litigation
v.
ClassicStar Farms, Inc., GeoStar Corporation, Tony P. Ferguson, ClassicStar 2004, LLC, Thomas E. Robinson (12-5467); John W. Parrott (12-5475), Defendants-Appellants. West Hills Farms, LLC, Arbor Farms, LLC, Nelson Breeders, LLC, MacDonald Stables, LLC, Jaswinder Grover, Monica Grover, Plaintiffs-Appellees,

Argued: March 14, 2013

Appeal from the United States District Court for the Eastern District of Kentucky at Lexington. Nos. 5:06-cv-00243; 5:07-cv-00353—Joseph M. Hood, District Judge.

COUNSEL

ARGUED:

Kannon K. Shanmugam, WILLIAMS & CONNOLLY LLP, Washington, D.C., for Appellants.

Barry D. Hunter, FROST BROWN TODD, Lexington, Kentucky, for Appellees in 12-5467 and 12-5475.

ON BRIEF:

Kannon K. Shanmugam, WILLIAMS & CONNOLLY LLP, Washington, D.C., for Appellants.

Barry D. Hunter, FROST BROWN TODD, Lexington, Kentucky, for Appellees in 12-5467 and 12-5475.

Before: MERRITT, CLAY, and GRIFFIN, Circuit Judges.

OPINION

CLAY, Circuit Judge.

This case arises from the fraudulent operation of an investment vehicle called the Mare Lease Program. Plaintiffs, a group of investors, alleged that Defendants violated the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1962(c), by convincing them to invest in the Mare Lease Program and related entities in order to take advantage of various tax deductions. Little did Plaintiffs know that the assets which formed the basis of the touted tax deductions were dramatically undervalued and, in some cases, wholly fictitious. After extensive discovery, Plaintiffs moved for summary judgment on their RICO claim as well as parallel state-law fraud and breach of contract claims. The district court granted summary judgment to Plaintiffs on each claim and awarded damages of approximately $49.4 million and prejudgment interest in excess of $15.6 million. Because we agree that the record reflects no genuine dispute over any material facts, we AFFIRM the district court's grant of summary judgment.

BACKGROUND

A. The Mare Lease Program

In 1990, David Plummer created the Mare Lease Program to enable investors to participate in his horse-breeding business while taking advantage of the sizable tax benefits associated with raising horses. Plummer, who operated the Mare Lease Program through a company named New Classic Breeders, LLC, was a nationally recognized expert in horse-breeding and the tax consequences of related investments. Plummer encouraged investors to take advantage of a provision in the tax code which classified horse-breeding investments as farming expenses, entitling investors to a five-year net operating loss carryback period instead of the typical two years. See 26 U.S.C. § 172(b)(1)(G).

An investor in the Program would lease a breeding mare from New Classic Breeders for a single season; the mare would be paired with a suitable stallion, and the investor could keep any resulting foals, which could then be either kept or sold. Investors could deduct the amount of their initial investment—which, unsurprisingly, tended to be based on the amount they wished to deduct for the previous five years—and also realize the gain from owning a valuable Thoroughbred foal. Investors were encouraged to hold their foals for at least two years before selling them, qualifying the sale for the much lower long-term capital gains tax rate. See 26 U.S.C. § 1231(b)(3)(A).

Between 2001 and 2005, the Mare Lease Program generated more than $600 million in revenue. The Program was aggressively marketed to wealthy individuals, who were assured that it was a reliable way to generate tax deductions and convert ordinary income into long-term capital gains. Accordingly, the economic success of the Program hinged on the investors' eligibility to receive the advertised tax benefits. To reassure investors that the Program's tax advantages were legitimate, they were given tax advice by two law firms hired by Defendants: Handler, Thayer, and Duggan, LLC, and Hanna Strader P.C. These firms and an accounting firm purported to have vetted the Mare Lease Program, and they opined that the investments would be fully tax deductible as promised.

B. The Scheme

GeoStar Corporation is a privately held company specializing in oil and gas exploration. By around 2000, GeoStar and its publicly traded affiliate, Gastar Exploration, Ltd., had acquired a number of undeveloped oil and gas properties, and they were looking for ways to raise capital to exploit these properties. GeoStar executives were introduced to David Plummer and the Mare Lease Program around that time, and in 2001, GeoStar acquired New Classic Breeders through a holding company it created named ClassicStar Farms, Inc., and it renamed the business ClassicStar, LLC ("ClassicStar"). David Plummer served as the president of ClassicStar Farms, Inc. until 2003, when he became GeoStar's director of marketing. After David Plummer moved to GeoStar, his son Spencer Plummer became president of ClassicStar Farms. Together with GeoStar executives, including Defendants, they operated the Mare Lease Program.

In an effort to finance its undeveloped oil and gas properties, GeoStar encouraged Mare Lease Program investors to exchange their interests in the Program for interests in coalbed methane wells owned by GeoStar subsidiaries, as well as Gastar stock. GeoStar and ClassicStar told investors that they could take advantage of the five-year operating loss carryback period associated with their horse-breeding investments, and then quickly convert those investments into oil and gas interests that, unlike the foals, would not need to be held for two years before being sold. Investors were told that these transfers would be tax-free because they could deduct any gain from the conversion as intangible drilling costs associated with the development of the wells. See 26 U.S.C. § 263(c). In this way, GeoStar was able to channel investors' money through the Mare Lease Program into its oil and gas developments.

To further entice investors into the Mare Lease Program, ClassicStar arranged for a large part (usually half) of the initial investment to be financed through the National Equine Lending Company ("NELC"), which was represented to be "a national lender on approved credit." (R. 1701, Ex. 9, at 7.) Investors would deduct the entirety of their investment, including the loan, from their taxable income from the past five years.[1] Although it was consistently described as a third-party lender, NELC was in fact owned and operated by Gary Thomson, David Plummer's brother-in-law. Spencer Plummer told one of Plaintiffs' financial advisers that "we can control him [Thomson] and what he does, " (R. 1701, Ex. 7, at 8, ) but none of the investors was ever told that NELC had no funds of its own. ClassicStar provided all of NELC's funds and arranged sham three-way transactions in which funds were transferred from ClassicStar to NELC, loaned to an investor, and then paid back to ClassicStar as part of an investment in the Mare Lease Program. The purpose of these transactions was to make the Program attractive to investors by allowing them to drastically increase their investments and, by extension, their tax deductions.

GeoStar and ClassicStar's efforts in promoting the Mare Lease Program were successful, so successful in fact that investors purchased interests in many more mares than were actually owned by ClassicStar. Although investors were repeatedly told that they were leasing actual horses, ClassicStar never owned anywhere near the number of horses purportedly being leased. Between 2001 and 2004, ClassicStar owned between $10 million and $56 million worth of mares, but sold an average of $150 million worth of mare lease packages during each of those years. (R. 1701, Ex. 23.) By the end of 2004, the difference between the value of the mares owned by ClassicStar and the value of the mare leases sold to investors was approximately $270 million. (R. 1701, Ex. 5, at 195–97.) To disguise the shortfall, ClassicStar substituted less valuable quarter-horses for Thoroughbreds and, in many cases, simply did not identify the horses that investors believed they were leasing.

To conceal the shortfall of mares and funnel money into their oil and gas interests, GeoStar and ClassicStar encouraged investors to exchange their mare leases for interests in various oil and gas properties. However, by mid-2003, these interests were also oversold. The tax deductions for intangible drilling costs used to entice investors out of the Mare Lease Program, like the mare lease deductions themselves, were dubious because they were based on fictitious assets, work that was never performed, and costs that were never expended.

Faced with a severe shortfall of assets in both the Mare Lease Program and their oil and gas programs, and no longer wishing to offer investors Gastar stock in exchange for their (largely worthless) interests in these other programs, GeoStar and ClassicStar created First Equine Energy Partners, LLC ("FEEP"). FEEP purported to offer investors a vehicle to combine equine interests—those contributed to the program by the investors themselves—with oil and gas interests to be contributed by GeoStar and its subsidiaries. (R. 1701, Ex. 68.) However, FEEP was never properly funded by GeoStar, and it owned either few assets or none at all. As one of Plaintiffs' experts testified, "FEEP as realized by ClassicStar was merely another means to perpetuate the ruse that began with the Mare Lease Program in which ClassicStar failed to deliver mares to participants." (R. 1701, Ex. 9, at 65.)

As a result of the dramatic overselling of the Mare Lease Program, resulting in "investments" in horses that largely did not exist, coupled with the sham loans from NELC designed to artificially inflate the size of the investments and the illusory nature of FEEP, the IRS has since disallowed the investors' tax deductions.[2] Among the numerous problems with the Program was that investors had claimed deductions related to improperly inflated expenditures on assets that did not exist. The government also opened a criminal investigation into the scheme to facilitate fraudulent tax deductions. Because of their participation in the Mare Lease Program, David Plummer, Spencer Plummer, an accountant named Terry Green, and one of the Defendants in this case, John Parrott, each pleaded guilty to one count of conspiracy to defraud the United States.

C. The Defendants

GeoStar Corporation has its principal place of business in Mt. Pleasant, Michigan. Together, Thom Robinson, Tony Ferguson, and John Parrott own approximately 75% of GeoStar, as well as a controlling interest in Gastar, GeoStar's publicly traded affiliate. GeoStar acquired New Classic Breeders—later ClassicStar, LLC—through a holding company named ClassicStar Farms, Inc. ClassicStar and its employees thereafter acted as GeoStar's agents, with all fundamental financial and operational decisions made by GeoStar. Although Robinson and GeoStar had the final word on most financial matters, particularly with respect to the Mare Lease Program, ClassicStar managed its own employees. ClassicStar Farms, Inc. and ClassicStar 2004 had no operations or employees separate from ClassicStar, but each entered into contracts in its own name.

Thomas Robinson was President and CEO of GeoStar and served as a co-manager of ClassicStar. By all accounts he had the final word on all fundamental decisions regarding ClassicStar's operations and finances, including its management of the Mare Lease Program. Robinson orchestrated the original acquisition of New Classic Breeders from David Plummer, and he then hired Plummer first as president of ClassicStar Farms, Inc., and then as GeoStar's head of marketing. Robinson also served as President and CEO of First Source Wyoming, a GeoStar affiliate, and Gastar; in those roles he directed the acquisition and development of oil and gas properties around the world. Finally, Robinson helped create FEEP, helped draft its private placement memoranda, and sat on its advisory committee.

Tony Ferguson was a vice president of GeoStar and co-manager of ClassicStar. He also served as Vice President of Operations at First Source Wyoming, as an owner and Executive Vice President of Gastar, and as tax partner and president of the manager of FEEP. Ferguson was actively involved in the marketing and promotion of the Mare Lease Program and the conversion of those interests into oil and gas interests. All questions related to the tax implications of the conversions went to Ferguson. He provided cover stories to investors when they inquired as to why they were not being assigned specific horses, and he was aware that less valuable quarter-horses were being substituted—sometimes only on paper—for Thoroughbreds in investors' mare lease packages. At one point, David Plummer "lamented the fact that Tony [Ferguson] was taking his money for horses and using it for something else, using it for gas." (R. 1701, Ex. 19, at 24–25.)

John Parrott was a vice president of GeoStar and a vice president of ClassicStar. Parrott reviewed and approved the marketing materials used by ClassicStar to promote the Mare Lease Program, including the attorney opinion letters that purported to confirm the legitimacy of the advertised tax deductions. He also either drafted or revised the language of the mare lease contracts themselves. Together with Robinson, Parrott helped draft the FEEP private placement memoranda and sat on its advisory committee. When Parrott pleaded guilty to conspiracy to defraud the United States, he admitted the following facts:

As Vice President of GeoStar Corp. between approximately 2001 and 2009, I assisted in the preparation of documents and other activities designed, pursuant to conversations and agreements with others, to allow taxpayers to take deductions to which they were not entitled, relating to their investments in the ClassicStar Mare Lease Program and related endeavors.

(R. 1701, Ex. 8, at 46.)

D. The Plaintiffs

Plaintiffs collectively invested approximately $90 million in the Mare Lease Program in 2003 and 2004. Each of them received some sort of presentation from ClassicStar describing the nature of the Program, including its tax advantages, expected return on investment, and unique financing structure. Each signed a mare lease agreement, made the appointed payments together with a loan from NELC, and later received a schedule purporting to list the mares and breeding pairs that ClassicStar had assigned to them. Each received a tax opinion letter from one of the two law firms associated with ClassicStar and GeoStar; Arbor Farms, West Hills Farms, and Nelson Breeders received advice from Hanna Strader, and the Grovers and MacDonald Stables received advice from Handler Thayer.

MacDonald Stables exchanged its interests in the Mare Lease Program for shares of Gastar stock and interests in FEEP. The Grovers converted their mare leases into interests in FEEP and other GeoStar subsidiaries. The remaining Plaintiffs each invested considerable sums in the Mare Lease Program, primarily financed through short- and long-term loans from NELC. Although Plaintiffs received the value of some of the foals they were promised, the return never approached the amount of their investments because of the absence of a sufficient number of horses in the Program. After adding their out-of-pocket losses to the amount of the fraudulently obtained tax deductions that Plaintiffs must repay to the IRS, Plaintiffs' collective losses totaled $16, 468, 603.87. (R. 2267-1.)

On July 28, 2006, Plaintiffs filed a complaint in the United States District Court for the Eastern District of Kentucky, alleging twenty-eight counts against twenty-three defendants, including federal RICO claims, violations of federal and state securities laws, common-law fraud, breach of contract, negligent misrepresentation, unjust enrichment, theft, and civil conspiracy. (R. 769.) Dozens of similarly situated plaintiffs filed analogous actions against many of the same defendants in California, Florida, Pennsylvania, and Utah. Pursuant to 28 U.S.C. § 1407, the United States Judicial Panel on Multidistrict Litigation consolidated the cases before a single district court. Because Plaintiffs' case was filed earliest, it became the lead case in the newly consolidated litigation.

After years of contentious pretrial proceedings and discovery, Plaintiffs moved for summary judgment on their RICO, fraud, and breach of contract claims. In a comprehensive opinion, the district court granted summary judgment to Plaintiffs on each of the three claims. The court accepted Plaintiffs' damages calculation and determined that their out-of-pocket losses, or "their cash investment less any return, " amounted to $16, 468, 603.87. (R. 2314, at 95.) Because Plaintiffs were entitled to treble damages under RICO, see 18 U.S.C. ยง 1964(c), the district court multiplied these losses by three, to arrive at the figure of $49, 405, 811.61. The court concluded ...


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