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In re Starlight Group, LLC

United States District Court, E.D. Virginia, Alexandria Division

September 6, 2016

Starlight Group, LLC, Debtor,
William Brooks and Charles M. Floury, Appellees. Michael Dorula, Robert Meletti, and Julie Meletti, Appellants,

         Appeal from United States Bankruptcy Court, Eastern District of Virginia Case No.11-18241



         This matter comes before the Court on Appellants Michael Dorula, Robert Meletti, and Julie Meletti's appeal from the Bankruptcy Court's Memorandum Opinion dated May 20, 2016. Dkt. No 1, Exh. 2. The appeal has been fully briefed by the parties. Dkt. Nos. 10, 12, 13. This Court has jurisdiction over the appeal pursuant to 28 U.S.C. 158(a)(1). For the reasons discussed herein, this Court AFFIRMS the decision of the Bankruptcy Court.

         I. Background

         A. Factual Background

         This case arises out of the Chapter 7 bankruptcy of Starlight Group, LLC, a real estate investment entity formed by Spencer Brand in 2004. Brand formed Starlight in order to solicit investments to purchase residential real estate in Northern Virginia and resell it for a profit. The venture had some early success, which led a number of investors to make loans to Starlight. Those investors included Appellees William Brooks and Charles Flory, who made loans to Starlight in May 2005. The arrangement with Brooks and Flory provided that they could get their original investment back, plus ten percent interest, after three years. However, the loans were not secured by any of Starlight's properties or assets. By 2007, the market had changed and Starlight had accumulated a large amount of debt owed to investors and mortgage companies. It also had on hand a number of properties that it was unable to sell for a profit. Brooks and Flory became aware at that time that the investments were losing money, but did not take action to withdraw their funds.

         When the three years were up in 2008, Brooks and Flory asked Brand to return their original investment. Their attorney, Ronald L. Eakin, wrote a demand letter to Starlight on April 28, 2008. Brand informed them that he did not have the money to repay their loans and explained that he was losing money and that the Starlight business was "bleak." Over the next two years, Brooks and Flory claim to have repeatedly inquired about the state of Starlight, and Brand acknowledged one social encounter in January 2009, but Brooks and Flory took no further steps to recoup their money.

         In early 2009, Brand began working with Greg Holmes, a realtor, to create a new and hopefully profitable business model. The new model revolved around short-sales of homes; Brand offered to use Starlight (what he described to Holmes as his "defunct" LLC) as the buyer, and in return Starlight would receive somewhere between ten and fifty percent of any profit from the sales-the precise amount of which was disputed by Brand and Holmes. The enterprise was essentially run by Holmes, with Brand appearing at closings and as necessary to facilitate the purchase of the properties. Soon, Holmes recognized the need for more capital and he contacted Dorula, an accountant, who helped him line up investors (which included the Melettis). Brand pitched Dorula on the success of the Starlight project to encourage further investment.

         The Holmes/Starlight enterprise Dated: a number of new investors; the investors received interest at a rate of 15% monthly, and their loans were secured by a lien on all of Starlight's assets, including its properties. Although the loans were secured (as opposed to Brooks and Flory's unsecured loans), they were never perfected. Within the first two years of this arrangement, Starlight incurred over $2 million in debt. Starlight ended up recording a small profit in 2008, and, after accounting for consultancy fees paid to Holmes and Brand, losses in 2009 and 2010. By 2011 it owed its investors $3.4 million. Starlight's financial issues were compounded by Brand's misuse of the funds. Brand used the secured creditors' funds for personal expenses and also used them to day-trade on the stock market.

         In 2010, Brand approached Brooks and Flory about resolving their claims (which totaled just over $1 million combined). By this point, all of the other "first wave" investors had given up on recouping their money. He offered them $200, 000, paid in $833.33 monthly installments, secured by a Starlight property and guaranteed by Brand personally. Brooks testified that Brand told him that they would never get anything if they didn't take this agreement, and Brooks stated that he figured "something is better than nothing." After some negotiations (during which Brooks and Flory were represented by counsel), Brooks and Flory entered into a Settlement Agreement with Brand and Starlight on June 25, 2010. The brief agreement and states that "whereas Starlight and Northstar have been unable to meet their monthly and final payment obligations, and will be unable to do so in the future." At the time Brooks and Flory signed the agreement, Starlight showed a negative balance on its general ledger. At that time Starlight's bank account contained $652, 291.60. Brand honored the Settlement Agreement, and never missed a monthly payment.

         In November 2011, Starlight, LLC filed for Chapter 7 bankruptcy. Brand's personal bankruptcy followed in January 2012. Brooks and Flory filed Proof of Claims (POCs) in the Starlight bankruptcy for the original, full value of their investment in Starlight. They argued that they were induced to enter the settlement agreement by Brand's fraudulent representation that Starlight was "unable to meet [its] monthly and final payment obligations, and will be unable to do so in the future." They argue that Starlight was actually a thriving business that could have paid their claims, and that Brand lied to them by implying that Starlight was shutting down operations in spring 2010 during the settlement negotiations. Appellants are secured creditors of Starlight from the "second wave" of the business, and they objected to Brooks and Flory's POCs, requesting that they be limited to the amount of the Settlement Agreement they signed with Starlight in 2010.

         B. Procedural Background

         On February 25, 2013, the Appellants filed objections to the POCs of the Appellees in the Chapter 7 Bankruptcy Case of Starlight Group, LLC. The bankruptcy court held two days of evidentiary hearings on the Brooks and Flory POCs, and overruled the Appellants' objections finding that Brand had obtained a novation of Brooks and Flory's claims by constructive fraud. The Appellants appealed the Bankruptcy Court's ruling and this Court remanded to the Bankruptcy Court on January 31, 2014 for further findings of fact related to the constructive fraud ruling.

         On October 21, 2014, the Bankruptcy Court issued an opinion in favor of Appellees on the basis of additional arguments in May of that year. The Bankruptcy Court held that Brand had obtained the novation by constructive and actual fraud. Again, Appellants appealed this finding and on February 20, 2015, the Court again remanded the case to the Bankruptcy court for further findings on ...

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