Banking & Finance  March 31, 2006

Deep in debt: A Bear of a bankruptcy

A Windsor-based finance company has filed for Chapter 11 bankruptcy protection, while hundreds of local investors – a list that ranges from well-known business people and retired teachers to a church and family trusts – pursue $39 million in claims against it.

The filing by Blue Bear Funding LLC identifies almost 500 claims, from as little as $50 to as much as $3.5 million. Claimants include Fort Collins car dealer Mike Dellenbach, former Colorado Cattleman’s Association president Donald LeFever, and the Christ Center Community Church in  Fort Collins.

Gary Harsin fits the demographic of many of Blue Bear’s investors – more than 60 years old, a retired teacher, church-going. He heard of the investment through several friends from his church, and he invested in Blue Bear through an independent factoring company run by a personal friend.

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Harsin said he was told that he could get a return of up to 12 percent, although he assumed that the return would actually be less. He said he was also aware of the risks involved.

“I don’t have any complaints about them misrepresenting any of that,” he said. “When they explained factoring work, it sounded like a good investment.”

Factoring is the business of purchasing accounts receivable from cash-strapped companies. The factoring companies generally purchase the accounts for around 80 percent to 90 percent of total value.

Harsin said he was not, however, aware of non-factoring investments Blue Bear would be making, such as real estate loans and an investment in a startup company. He said he probably would not have participated if he knew that.

Harsin and his wife, Jeanne, have a claim against Blue Bear worth more than $73,000, according to the bankruptcy filing.

“It hasn’t had any tremendous impact on our lifestyle,” Harsin said of the bankruptcy. “We didn’t invest money that we needed to live on.”

Not all of the investors were as lucky as Harsin. Many of them invested a large portion of their savings. Some of them invested their IRAs, or funds in the names of their children.

$39 million question

So how does a company lose tens of millions in investments in just two years? That’s the $39 million question. And it’s one that the involved parties can’t answer – either for lack of knowledge or because the bankruptcy is still in court and such answers are still being worked out.

Blue Bear started business in late 2003 as 1st American Factoring LLC. According to contracts dated 2004, Blue Bear – then 1st American – was run by David Karst, managing partner, with assistance from local consultant Russell Disberger.

Blue Bear’s current chief operating officer, John Davis, said there were a number of issues that contributed to the company’s downfall.

One contributor was that Blue Bear was using an accrual method of accounting, which measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur. Davis said accrual works well, but not for startup companies involved in the financial arena.

“We were accruing income as if the portfolio was performing when in fact large pieces of the portfolio were not performing,” Davis said.

“Bottom line on the whole thing … no one was paying attention,” he said.

What no one noticed was that, according to public records, Blue Bear was not only investing money as a factoring company, but also investing in real estate and startup companies.

“Blue Bear was involved with loans and the factoring of accounts receivable,” Davis said. “If you talk to the investors of Blue Bear, that’s not the way it was represented to them. They almost universally tell me they were told that Blue Bear was only going to be in the factoring business.”

Investing with friends

Individual investors said they were not aware that Blue Bear was making loans outside the factoring business. Because of the way the company was set up, many investors had little or no direct contact with Blue Bear management.

Most of the investors gave their money to independent factoring companies, or IFCs, run by people outside of the Blue Bear organization.

“The idea was (for Blue Bear) to be a third-party factoring company,´ said Disberger, who has written a regularly featured column on business management for the Northern Colorado Business Report in the past.

The IFC structure also explains how so many different investors came to be tied to Blue Bear.

According to federal securities regulations, a single IFC can have up to 35 non-accredited investors. Consequently, each IFC – there were nine in all that provided money to Blue Bear – translated to more potential sources of capital.

Davis explained that the IFCs were formed for the purpose of using Blue Bear as a factoring service. Blue Bear’s contracts with the IFCs stated that Blue Bear would perform almost all duties, including completing the paperwork required to form the IFCs, while the directors of the IFCs were responsible for attracting investors.

In all, nine IFCs, all based in Fort Collins or Windsor, were formed:

n Empire Factoring LLC, formed by Reed Gilmore on Oct. 23, 2003.

n IHS Factoring LLC, formed by Philip Wilgers on Oct. 23, 2003.

n Midwest Factoring LLC, formed by Jeremy Smith on April 13, 2004.

n Provision Factoring LLC, formed by Tad Borrett on Oct. 23, 2003.

n Return on Investment Capital LLC, formed by Vicky Dix on Oct. 23, 2003.

n Sage Factoring LLC, formed by James Nutt on Feb. 12, 2004.

n Sierra Factoring LLC, formed by Virginia Brinkman on Dec. 21, 2004.

n Sunflower Factoring LLC, formed by Jodi Dreiling on May 18, 2004.

n Willow Factoring LLC, formed by James Noonan on Oct. 23, 2003.

In many cases, investors in the IFC were acquaintances, business associates, friends or family of the people who set up the IFC. Attempts by the Business Report to contact the directors were not successful. Several declined to comment on the ongoing bankruptcy case for confidentiality reasons; others did not return calls.

Fort Collins lawyer Mark Korb invested with Jim Nutt’s Sage Factoring. As a lawyer, Korb pores over contracts for a living. He said that what he invested in and what he got were not one and the same.

“I was participating as an investor in an entity which would obtain a secured position in factoring accounts receivable received through Mr. Karst’s company,” he said. “Sage was supposed to be getting a secured position in an asset when it put the investors’ money at risk. It doesn’t appear that that occurred.”

There are two instances on record that show Blue Bear’s non-factoring related loans (see related story on page 29A). But Davis, Blue Bear’s COO, said there were others.

“That’s where the problem started, no question about it,” he said about the loans. “They were purported to be secured, but upon further review and investigation it turns out they weren’t secured or weren’t completely secured.”

The loan activity was not apparent to the investors who spoke with the Business Report.

One woman, who asked not to be named, said she and her husband invested their retirement funds. The bankruptcy filing put her claim at almost $200,000.

“It has caused me to look for a job,” she said. Her husband, who retired from the agricultural industry, is already working again.

Red flags

The same unnamed investor said she’s behind Davis and the five-year plan to come out of bankruptcy submitted to the U.S. Bankruptcy Court in Denver March 17 “100 percent.” Not all of the investors are as optimistic.

“I doubt we’ll ever get penny one back,´ said William Gillespie, 80, who invested $5,000 in Wilgers’ IHS Factoring in January 2005. Like many other investors, he heard of the high-return investment through a friend.

“There’s probably a greed element in this because they were offering 12 percent,” he said. “I kind of took it at its face value.”

Gillespie said he didn’t feel misled about the possible risks of the factoring business.

As far as Gillespie is concerned, the business is too far under to recover its losses.

“I think they should have declared Chapter 7,” he said.

In Chapter 7, a company completely halts operation and a trustee is appointed by the court to liquidate any remaining assets to pay off claimants. Blue Bear filed Chapter 11, which provides a company protection from creditors while it continues operations and reorganizes its assets per a court-approved plan.

One investor, a retired man in his 70s who wanted to remain anonymous, said that he would prefer to claim his losses under Chapter 7 rather than wait for the company to reorganize. The investor said he would rather take the loss on his investment and recover a portion of his money.

Davis said the company will go into Chapter 7 bankruptcy if at any time the creditors, as a group, wish to do so.

Davis, who joined Blue Bear in October 2004 as a salesman of factoring services, became COO of the company in January 2005. During the same time, Blue Bear’s CFO Frank Clark resigned.

Davis said the red flags were waiving within a few months.

“By the middle of March, we knew we had a major problem,” he said.

David Karst resigned from Blue Bear on Aug. 22, the same date of the bankruptcy filing. Still, Karst continues to own 45 percent of the business through KFG LLC. He also continues to work on factoring through his company National Cash Flow Specialists, which was founded in 2001 in Fort Collins.

Karst declined to comment on the Blue Bear bankruptcy. In an e-mail response to Business Report inquiries, Karst indicated that he intends to make a statement once certain issues involving the bankruptcy are resolved.

Five-year plan

Davis said the thrust of Blue Bear’s reorganization plan, put together by the company, its lawyers, a group formed by the creditors and their lawyers, is to attempt to recover as much of the investors’ money as possible during the next five years.

The anonymous investor in his 70s said he was made aware of the risks when he invested in Blue Bear through a friend, but that there were some warning signs. He asked to review a balance and investment summary, which he was promised but he never received.

About a month before the bankruptcy, he received word that there might be some concerns collecting payment on some of the investments. At that time, he wanted to take out all of his money, but took out only half. The bankruptcy filing lists his claim as more than $53,000.

“I made a bad mistake,” he said. “I guess you never get too old to make a mistake. It makes me real scared about what to do with my money – how to invest it.”

Additionally, he feels that there is little chance of recovering any of what is lost.

“I think they’ll spend as much as they’ll make back,” he said.

Davis wouldn’t comment on how much it is costing Blue Bear to continue operations. Aside from the expense of its lawyers and accountant, the company still employs five full-time workers.

According to Blue Bear lawyer Alice White, when the company filed for bankruptcy in August, it listed $14.1 million in assets. In October, the company wrote down $11.2 million of its accounts receivable, basically as bad debt. In November, it wrote down an additional $193,000. In total, the company now has around $2.6 million in assets – much of which is in accounts receivable.

“When you’re 75 years old, you don’t know if you’ll be around for five years,” one investor noted, referring to the recovery plan proposed by Blue Bear.

A Windsor-based finance company has filed for Chapter 11 bankruptcy protection, while hundreds of local investors – a list that ranges from well-known business people and retired teachers to a church and family trusts – pursue $39 million in claims against it.

The filing by Blue Bear Funding LLC identifies almost 500 claims, from as little as $50 to as much as $3.5 million. Claimants include Fort Collins car dealer Mike Dellenbach, former Colorado Cattleman’s Association president Donald LeFever, and the Christ Center Community Church in  Fort Collins.

Gary Harsin fits the demographic of many of Blue Bear’s investors – more than…

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