Accountants Stars of Show During Blockbuster SavaSeniorCare Trial
Jotham Sederstrom Oct. 9, 2012, 7 a.m.
Two top forensic accountants squared off in a Manhattan courtroom this summer, armed with scores of spreadsheets, loan documents and bank wire records, for a decisive battle in a legal war for control of about 170 nursing homes.
The trial in New York Supreme Court had its origins eight years ago, when real estate investor Ruby Schron teamed up with his lawyer, Leonard Grunstein, in a labyrinthine $1.3 billion leveraged buyout that created SavaSeniorCare. At issue for the two expert witnesses: the exact whereabouts of $100 million.
On Mr. Schron’s side was Harvey R. Kelly, whose 30-year career as an auditor and forensic accountant included investigations into the WorldCom and Health South scandals. Mr. Kelly is managing director and head of corporate investigations practice at AlixPartners, the firm that acted as claims agent and consultant to the trustee overseeing the liquidation of Bernard L. Madoff’s securities firm.
Providing expert testimony for Mr. Grunstein was David S. Williams, the chief executive officer of Deloitte Financial Advisory Services LLP. A veteran of the firm’s Forensic & Dispute Services unit, Mr. Williams has also been the national leader of the firm’s valuation services practice. Since 2004, he has been a member of the executive committee of Deloitte FAS and of the board of the parent company, Deloitte LLP. AlixPartners and Deloitte said the firms’ policies prevent the accountants from commenting.
The case, which hinged on how much money from a $100 million loan by Mr. Schron actually found its way to Mr. Grunstein and his companies, is representative of the assignments that have driven growth in forensic accounting practices as New York real estate values plunged and more owners went to court to protect their shrinking equity. The accountants in Schron v. Grunstein were more than $110 million apart in their estimates of how much money was lent.
“Whether a loan is funded is a typical issue” said Joseph Nelson, a partner at Berdon LLP, who estimated the New York-based firm’s forensic practice has been growing at a 100 percent annual clip for several years. The answer, he said, can determine whether money invested in a property was a capital contribution or a loan and thereby establish how much of an asset each investor owns. In the nursing home case, the accounting helped determine that Mr. Schron could acquire the company without any further investment by simply assuming the debt.
Mr. Schron, head of Cammeby’s International, is a significant—and notoriously secretive—player in the real estate market. According to published accounts, he owns and manages more than 25,000 residential units and 10 million square feet of commercial and industrial space, including a stake in the Woolworth Building. Prior to the nursing home deal, Mr. Grunstein had represented Mr. Schron in “dozens of matters” as his primary legal counsel, according to court testimony cited in Justice O. Peter Sherwood’s Sept. 6 decision.
In 2004, Mr. Grunstein and investment banker Murray Forman approached Mr. Schron with a proposal to buy Mariner Health Care Inc., a public company that operated more than 250 nursing homes and owned real estate associated with about 170 of them.
“Schron was interested in owning the real estate, not operating nursing homes,” the judge wrote. “Grunstein and Forman proposed a complex transaction employing a ‘PropCo/OpCo’ structure whereby Old Mariner’s real estate would be separated from the nursing home operations.”
A newly formed company, National Senior Care Inc., bought all of the shares of Old Mariner, then sold the real estate to one of Schron’s companies, SMV. That entity then leased the properties to another newly formed company, SavaSeniorCare, controlled by Mssrs. Grunstein and Forman. National Senior Care retained the operations of about 100 nursing homes located on properties that were leased from third parties.
While neither Mr. Grunstein nor Mr. Forman put any of his own money into the deal, Mr. Schron raised about $1.1 billion in financing, acquiring real estate valued at about $800 million. According to documents signed at closing, the financing included a $100 million loan to the owner of Sava that gave him an option to acquire the company, the judge wrote.
By 2010, the deal had soured. Mr. Schron sued Mssrs. Grunstein and Forman, saying they owed him more than $100 million under loan agreements and accusing them of “stealing for themselves tens of millions of dollars of value, properties and rights,” Bloomberg News reported.
When Mr. Schron sought to exercise his option, Mr. Grunstein claimed that the loan was never funded and that there was no indebtedness to be released and contributed toward a purchase of the company, the judge wrote. The rival accountants’ task was to sort out transactions among some 30 people and entities involved in the buyout, as well as the movement of money through an escrow account from entities on Mr. Schon’s side of the deal to Mr. Grunstein and his companies, to establish whether, and how much of, the money was lent.
After the court ruled in March that the option was enforceable, the 10-day, non-jury trial in August focused on the limited issue of the amount of indebtedness available to be paid at the closing toward the purchase price.
Mr. Williams testified that parties to complex transactions such as this typically prepare a “deal book” to document the agreement. In this case, no deal book was prepared, though schedules of sources and uses of the funds transferred at the closing were prepared by Marks, Paneth & Shron, an accounting firm engaged by the acquirers to ensure there was adequate funding to complete the deal. Much of Mr. Grunstein’s defense involved the alleged unreliability of the documents, the judge wrote.
Mr. Kelly said a promissory note signed by both sides at the time of closing—and amended and restated in 2006 when a second, $20 million loan was made—was the best evidence that the loan existed. And he said documents showed that the nursing home company had made use of the money, including making a $65 million loan to the “New Mariner” entity on the day of the transaction.
Aided by Mr. Kelly, the plaintiffs argued that “at least $118 million of excess Schron funds are shown on the sources and uses schedules” prepared by accountants in December 2004.
“When both counterparties sign and agree to something, that’s the best evidence from the accounting point of view,” Mr. Kelly testified. “We have a multitude of documents that support [that conclusion] throughout the years, all of which are consistent with the notion that there was a loan, and it had been funded.”
Documents included “audited financial statements of SavaSeniorCare that an outside independent audit firm rendered the opinion that [an entity controlled by Mr. Grunstein] had contributed $100 million,” he said. “So, you’ve got years’ worth of very consistent documents demonstrating that. I find that the most credible evidence.”
Mr. Williams said the promissory note called for a wire transfer that never took place .
“My expectation in looking at this that there it would be wire instructions and that those instructions would be followed,” he said. “The fact that they were not followed, in my opinion, was notable, but it does not signal where I stopped. I continued to look for it.”
Mr. Williams said his analysis showed that only about $8.3 million of the $100 million remained in the escrow account after paying for real estate and associated expenses and deducting $26.7 million in “over-funded” resources returned to Schron after the closing.
The judge rejected that argument as a “red herring,” saying “the dispute must be resolved on the basis of the 2006 Term Loan and the 2006 Note.” A bigger problem for the defendants, according to the judge, was the testimony of Mr. Grunstein and Mr. Forman themselves that Mr. Schron had said the loan wasn’t being funded.
“Apart from the fact that all of the documentary and non-party witness evidence contradict their testimony, their evasive answers and manner on the witness stand left the court with a firm belief that both gave testimony that was less than candid,” the judge wrote. He ordered the defendants to proceed with the transfer of control of the company “without further delay.”
Steven A. Engel, an attorney with Dechert LLP who represented Mr. Schron, said it would be an overstatement to say the accountants’ testimony was the sole determinant of the outcome. But given the judge’s doubts about defendants’ credibility, he said, “their whole case was based on the experts.” He credited Mr. Kelly for his “very cautious” approach, and said Dechert is moving forward with additional claims against Mr. Grunstein. Attorneys for Mr. Grunstein filed a notice of appeal.
Michael R. Hepworth, an attorney at PLA Piper LLP, which represented the defendants, didn’t respond to a request for comment.