How Much Will LandAmerica’s 1031 Customers Recover?

The saga keeps getting worse for 450 former LandAmerica customers who last fall tried to complete a simple real estate deal and now can’t get funds they thought would be safely held for a few months by the formerly Innsbrook-based Fortune 1,000 company. With every passing month, legal expenses are gobbling up millions of a […]

May 17, 2009; 4:27 PM • by Aaron Kremer

The saga keeps getting worse for 450 former LandAmerica customers who last fall tried to complete a simple real estate deal and now can’t get funds they thought would be safely held for a few months by the formerly Innsbrook-based Fortune 1,000 company.

With every passing month, legal expenses are gobbling up millions of a possible final settlement figure. Of course, the settlement could be greater if various lawsuits against a bank and former executives prove fruitful.

The exchangers, who placed money with LandAmerica’s1031 division to avoid paying a tax penalty on the purchase of a new property, are trying to recover $420 million plus possible damages.

But in a ruling that surprised many local attorneys, U.S. Bankruptcy Court Judge Kevin R. Huennekens ruled last week that the funds customers parked with the exchange were property of the bankruptcy estate and need not be returned ASAP.

“People thought they were getting into a paper-shuffling transaction, filling out some paperwork and deferring for a tax benefit,” said Ronald Page, an attorney with Cantor Arkema who represented one of the 1031 exchangers. His firm represents 49 other exchangers. “Instead they were putting at hazard in some cases millions.”

Local lawyers who are following the case unanimously say they have no idea how much the exchangers might eventually recover, but it will likely be months and maybe years until they see their money.

In his ruling, Huennekens said LandAmerica’s 1031 contracts were clearly written to state that the 1031 exchange offered neither escrow nor trust accounts. He also said that treating the exchangers as unsecured creditors would be the cheapest and fastest way of getting them any money back.

“The bankruptcy process is designed to address and resolve this very kind of collective action problem. … This can be best accomplished through the plan confirmation process,” he wrote in his opinion. “While it may not be the perfect remedy, it does offer the most inexpensive and expeditious method for distributing these funds on a ratable basis to those who deserve to receive them.”

And even if he had not ruled that the 450 customers of LandAmerica’s 1031 Exchange business are creditors that must get in line for the bankrupt company’s assets, it would have been hard for them to get their funds.

That’s because LandAmerica’s 1031 Exchange division poured money in formerly obscure kind of investment called an auction-rate security, which is now very difficult to value. It’s those investments, which are bundles of student loans, that have caused so much trouble. Auctions for the bundles of securities ground to a halt early last year. Now nobody seems to know what they are worth, even though the underlying student loans continue to pay interest. The company hired by LandAmerica to value the securities did not return a call seeking explanation. r

At the end of February, LandAmerica’s Exchange company had $141.3 million in its bank account, according to the balance sheet submitted to the court. That does not include the $290 million in auction-rate securities. [That figure dates to February 2008. Richmond BizSense was unable to determine the dollar figure if liquidated today or whether any of those securities had been sold.]

Now that they have been ruled unsecured creditors, exchangers will battle with other creditors, including the LandAmerica parent company, which wants back $65 million that it lent its subsidiary when the auction rate securities went sour.

The exchange customers range from individuals who lost $50,000 to businesses doing million-dollar transactions.

“I was under the impression that this money would be safer than putting it in a personal bank account that was insured by the FDIC. … In other words, I though there was zero risk here,” Eric Gordon said in a deposition. Gordon sold a property in Christiansburg and parked the funds with LES until he was to close on another property. He is represented by Cantor Arkema.

Lawyers Fees Adding Up

And the pot of money is dwindling as lawyers’ fees gobble up millions. A quick overview of charges so far (and please note, there is no insinuation that any of the rates are unreasonable or unwarranted):

•    Law firm Bingham McCutchen has billed $1.8 million for work Dec. 3 through Feb. 28, including meals at $35 a person. The hourly rate is about $600 an hour, which blends fees of attorneys and paralegals. One lawyer, Neil W. Townsend, charges $880 an hour. Lawyer Anthony Carbone charges $945 an hour. The itemized bill included a $600 dinner downtown on Cary Street in December for seven people.

•    The law firm Willkie Farr & Gallagher billed $1.4 million for December, about $1 million for January and $1 million for February. One lawyer, Marc Abrams, charges $994 an hour. A legal assistant bills $235 an hour.

•    McGuire Woods, which is representing both LFG and LES, billed $2.8 million for Nov. 26 through Feb. 28.

The ruling might also hammer the nation’s 1031 businesses, because customers can also set up accounts at banks rather than use intermediaries like LandAmerica did. Consumers can look at the ruling and determine it’s not worth the risk.

“Everyone in the industry assumed that based on the documents, the money was held in escrow,” said Richard Chess, a partner in American Realty Capital Markets who has sold exchange accounts for many years. “The judge has turned the whole 1031 business on its ear.”

Chess said he would guess that 1031 customers might get back 10 or 20 cents on the dollar, if they’re lucky.

Who knew What When?

In January, we asked, “Was LandAmerica’s 1031 exchange a Ponzi scheme?”

That has not been answered, at least according to interviews with lawyers familiar with the case. Some former executives have been deposed, but it’s not clear if any of them knew that they were going to declare bankruptcy and still allowed new clients to park funds in the 1031 Exchange, knowing full well they would not get their money back. Lawsuits have also named executives, which could lead to upward of $75 million in awards by triggering officer and director insurance.

It’s also not yet clear who authorized the purchase of auction-rate securities.

May 17, 2009 4:27 PM 0