Arkansas Razorbacks Football Coach John L. Smith's $40 Million Mistake

by Mark Friedman  on Monday, Nov. 5, 2012 12:00 am  

LOUISVILLE, Ky. — In front of the cameras, John L. Smith was being feted as the new head football coach of the Arkansas Razorbacks. Behind the scenes, his financial world was collapsing.

A week after he was hired on April 23, a circuit judge in Jefferson County, Ky., hit the 63-year-old Smith with a judgment for $865,198 in favor of cardiologist Dr. John Rhodes III of Louisville, a former partner in developing upscale single-family homes in Kentucky.

The judgment was slightly more than the $850,000 contract Smith signed to be the head coach of the Razorbacks, who many picked to be in contention for the national championship.

The judgment was a huge blow to Smith. He claimed he hadn’t understood that signing loan documents as a member of several limited liability companies would leave him on the hook for millions of dollars. Smith said he thought he only would be responsible for a prorated share of the losses equal to his share of ownership in the LLCs.

He planned to use that defense in some of the other collection lawsuits that were pending against him in Kentucky. Those lawsuits sought nearly $8 million from Smith in connection with the loans the LLCs took out for real estate developments.

Smith also said in the court documents that he felt targeted by Rhodes because he was the only member of the LLC named as a defendant in the lawsuit. Rhodes in his court filings said he tried to collect the money from the other members.

Unfortunately, the loan documents contained the fateful phrase “joint and several,” meaning the lender could target any one of the partners who signed the promissory notes to collect all of the money. And the first judge to hear his explanation was not persuaded, setting Smith’s ignorance-of-the-law defense up for more failures.

“Smith was not duped into signing the Notes, but instead had sufficient time to read the agreements, ask questions and/or seek legal counsel regarding the documents’ terms,” Jefferson Circuit Judge Audra Eckerle concluded in Rhodes’ case against Smith. “That Smith believed his liability was pro rata is irrelevant to the fact that he freely signed documents that clearly and unequivocally provide for joint and several liability.”

Smith’s mistakes led him to seek Chapter 7 bankruptcy protection in September for $40.7 million in debt, most of which is tied to the real estate investments. His assets were listed at $1.3 million. But Smith might not be responsible for all the debt. He is disputing most of the claims and says the debts are tied to the other investors. And in one lawsuit, Smith has filed a counterclaim against the other members of his investment group.

His story serves as a cautionary tale for those involved in LLCs who sign loan documents without first understanding the terms.

If a member of an LLC signs a loan personally guaranteeing debt, he could be responsible for the entire amount, said Terry Franzen, an Atlanta attorney who handles consumer financial services issues.

“In today’s financial environment, it’s not that unusual for a lender to require the members of an LLC to personally guarantee a loan,” Franzen said.

Still, a LLC member could negotiate with the lender over how much exposure of a loan he is willing to have and place that in the loan documents, she said.

She said Smith’s lesson should be “know what you’re signing, and if you need to consult with counsel, do that before you sign it.”

Arkansas Business reviewed hundreds of pages of court documents filed in a half-dozen lawsuits in Jefferson Circuit Court in Kentucky. The documents still left unanswered questions surrounding the deals and the strained relationship between some of the partners. Smith declined to comment through Zack Higbee, University of Arkansas at Fayetteville director of football media relations.

Smith Comes to Louisville

After football coaching stints at the University of Idaho and Utah State, Smith signed a five-year contract to be the head coach of the University of Louisville in 1998. He would be paid $375,000 per year, the Washington Post reported.

In his five seasons at Louisville, Smith racked up a 41-21 record. His best season was in 2001, when he went 11-2 and won the Liberty Bowl.

It was while at Louisville that Smith most likely met real estate developer R. Stephen Canfield, according to a Kentucky real estate agent, who asked not to be named because of his relationship with Canfield.

Canfield was a well-known developer in Louisville and a U of L booster. In 1985, Canfield had started Canfield Development Co., which specializes in the development of upscale single-family homes and neighborhoods throughout the Louisville area, according to the company’s website.

“The homeowners will recognize the greatest rate of return on their investments in our neighborhoods and they will enjoy the greatest sense of community due to the attention we give to … site selection and location,” the website said.

“Louisville is a college sports town,” the real estate agent said. “And these college coaches tend to become local celebrities.”

Canfield declined to be interviewed. “I would love to tell the story, but I cannot,” he said. “None of these partners are going to talk to you. They can’t because of the lawsuits.”

Smith’s bankruptcy filing indicates that he first tiptoed into real estate development with Canfield in 2002 by becoming an investor in Terra Landis LLC.

Another investor in Terra Landis was John R. Mason, a senior vice president of Republic Bank & Trust Co. of Louisville. Mason and Smith were neighbors in the Louisville suburb of Prospect. Mason declined to comment.

Smith told The Associated Press in July that he started dabbling in real estate with one investment in one subdivision.

“It was a situation where we all made a little and said, ‘Well, that’s good. Let’s see if we can make a little more,’” Smith told the AP.

More Investments

Thanks to his 0.661 winning percentage at Louisville, Smith landed another head coaching job at Michigan State University in Lansing. After his first season in 2003, when he went 8-5, Smith started losing.

During the next three seasons, he compiled a 14-21 record, and Michigan State didn’t want him back for the 2007 season. ESPN.com reported that Smith’s contract, which had been paying $1.35 million a year, had been bought out for $1.5 million.

While Smith struggled on the football field, he increased his real estate investing. Smith didn’t create or get involved in any new companies in 2003 or 2004, but starting in 2005, he became involved in four separate LLCs as an investor with developer Canfield back in Kentucky.

Most of the LLCs had “Terra” in their names and were tied to Canfield’s real estate or land development projects.

The real estate market was hot during 2005. In 2004, 13,901 homes were sold in Jefferson County, Ky., according to Tre Pryor, a real estate agent and editor of the LouisvilleHomeBlog. The next year, sales jumped to 15,228 and stayed almost as hot in 2006, when 15,181 homes were sold.

As with the other projects, Canfield “managed the affairs of the LLCs, and the developments they owned, solely and exclusively,” Smith said in an Aug. 13, 2011, affidavit filed as part of the lawsuit involving Dr. John Rhodes.

To become a 10 percent owner of Terra Acquisitions II LLC, for example, Smith invested $1,000. He owned larger percentages in other entities.

According to the operating agreement of Terra Acquisitions, Smith would receive 10 percent of the profits of the LLC, and Smith said he thought that also meant that he would only be responsible for 10 percent of any losses.

He said he based that understanding on the wording in the operating agreement.

Other investors with Smith on several of the projects were Canfield; Rhodes; Smith’s neighbor, John Mason; Dr. Mushtaque Juneja, a Louisville anesthesiologist; and G.J. Hart of Louisville. Hart was the CEO of the Texas Roadhouse restaurant chain (which, despite its name, is based in Louisville) until August 2011, when he became CEO of the California Pizza Kitchen.

Smith would also rely on the LLC’s operating agreement when it said that “no Interest Holder shall have personal liability for the obligations for the Company.”

Smith told the AP in July that he thought real estate development was a safe investment.

“You may not make money, but you won’t lose money,” he said.

Warning Signs

After losing his job at Michigan State, Smith continued his real estate investments with Canfield. But home sales in Jefferson County started to show signs of trouble, dipping almost 3 percent in 2007 to 14,748.

That statistic didn’t seem to bother Canfield or his investors. They pushed forward with additional projects.

In May 2007, Canfield announced a new development called Shakes Run, a 250-acre development that would include 460 single-family home sites, a 6,400-SF clubhouse with indoor and outdoor pools and more than 70 acres of green space, according to an article in the Louisville Business Journal. Homes in the subdivision started at $350,000.

Canfield told the business journal that there was “tremendous interest” in the property and that all 50 lots in the first phase had been sold.

Smith was an investor in Shakes Run as well as Canfield’s Poplar Woods, a 93-lot development on 203 acres, which was also getting off the ground in 2007. The Louisville Business Journal article said home prices there would start at $760,000.

Canfield said the Poplar Woods land cost $5 million and developing it would take another $7 million. And still Canfield was hunting for more projects.

“I’m always looking for high-quality in good locations,” he told the business journal in 2007.

Great Recession

The next year, of course, the Great Recession reached full force. But that didn’t stop Canfield, who was pushing forward with plans to bring 450 home lots to the Louisville market.

In June 2008, he told the Louisville Business Journal that he decided to continue the projects because of the success of his other developments.

“I’ve got a lot to sell,” Canfield said. “But we’ve been really busy. … I’m cautiously optimistic.”

And he noted that there was interest in his developments.

“Good houses in good developments in good locations always sell,” Canfield said in the 2008 article. “The market is good — not great like 2005 — but it is good.”

But the housing market wasn’t good.

In 2008, home sales in Jefferson County plummeted 23 percent to 11,369. The financial strains of Canfield’s LLCs were beginning to show.

“Although the LLCs Operating Agreements make no ex-press mention of capital contributions beyond initial contributions, Canfield, as manager of the LLCs, made numerous and substantial capital calls upon the LLCs’ members in the past several years,” Smith said in his Aug. 13, 2011, affidavit.

Smith said he paid Canfield’s LLCs $15,000 in December 2008.

Dr. Juneja said in court filings that he contributed more than he should have to keep the LLCs going. He didn’t return a call seeking comment.

In 2009, the need for cash intensified for Canfield’s business entities. Various loans were going into default, according to court documents.

Meanwhile, after two years out of coaching, Smith was hired as outside linebackers coach and special teams coordinator at the University of Arkansas.

He was earning more than $200,000 in both 2009 and 2010, but his real estate investments were being sacked.

Through a self-named trust, Rhodes, a member of Terra Acquisitions LLC and Terra Acquisitions II LLC, loaned a total of $600,000 to the LLCs in two separate promissory notes in March and July 2009.

Rhodes probably infused the project with cash to keep the appearance that Canfield Developments wasn’t in financial trouble, said the real estate agent who asked not to be named.

“It behooves everyone to keep the product first class,” the agent said.

“It would be the kiss of death … if any developer of that kind declared bankruptcy.”

Rhodes, when reached at his mansion in Louisville, declined to comment. He said he has a lot to say about Smith, but his attorney told him not to comment.

In his affidavit, Smith re-called that in September 2009 “Rhodes approached the members of [the LLCs] and demanded that they needed to ‘take care of’ the loans that the Rhodes Trust allegedly made to” the LLCs, Smith said in his affidavit.

So Smith and the other members signed a document that refinanced and consolidated the loans on Sept. 1, 2009. After the loans were consolidated, Smith made two payments that totaled $70,000.

Smith said, “I believed that these amounts were being applied, in part, to pay the Rhodes Trust for my supposed personal liability upon the Note.”

But those payments weren’t being applied to the loans.

Rhodes didn’t say in his court filings where the money went — and it didn’t seem to matter. Judge Eckerle said in a ruling in February that Rhodes didn’t have to use Smith’s $70,000 to pay down the promissory notes.

Despite the $70,000 infusion, Smith said the LLCs continued to “have extreme economic difficulties.

Canfield continued to make numerous and substantial capital calls upon the LLCs’ members.”

In early 2010, Smith said he finally told Canfield and the other members of the LLC that he “was no longer able to make these substantial capital contributions.”

It is unclear if any of the other members were continuing to give money to the LLCs.

Rhodes, on May 4, 2010, filed the collection lawsuit only against Smith for the entire balance of the $624,000 September 2009 loan. By the time Eckerle issued her ruling in February of this year, four other lawsuits naming Smith as a defendant had been filed. Those lawsuits were seeking $7.7 million. A fifth lawsuit naming Smith was filed on Aug. 21.

Rhodes had a slam-dunk case against Smith because he had signed for the loan personally guaranteeing the entire amount. Eckerle ruled in Rhodes’ favor on a motion for a summary judgment, meaning he didn’t have to present the evidence at a trial.

Smith said in court filings that he felt that Rhodes was picking on him because Smith was the only person named in the lawsuit. The lawsuit was “in retaliation for Smith’s refusal to continue contributing to the LLCs,” his Kentucky attorney, Jonathan Goldberg, wrote.

Rhodes said in his court filings that he tried to collect from the other members of the LLCs, but he didn’t say why he singled out Smith for litigation. And, ultimately, it didn’t matter why.

“The joint and several liability language of the Note permits [Rhodes] to choose who to enforce the Note against without any preconditions,” Rhodes’ attorney D. Christopher Robin-son wrote in a court filing.

But their business associates were having their own financial problems. John Mason eventually filed for bankruptcy protection on the last day of 2011, listing $21.7 million in debts and $999,615 in assets. In October 2010, Canfield was sued for defaulting on the $400,000 balance of a $1.6 million loan that he took out in 2004. Two more suits filed this year allege that Canfield defaulted on loan balances of $870,000 and $188,000.

Judge Eckerle blasted Smith for not understanding the terms of the loan. “Smith is a sophisticated businessman capable of understanding terms and entering into legally binding contracts,” Eckerle wrote. “Having failed to either read or comprehend the significance of the joint and several liability provisions, he may not now assert that he was fraudulently induced to sign by Plaintiff’s actions.”

Away from the courthouse, Smith received some good fortune in 2012.

At the end of the Razorbacks 2011 season, Smith accepted a job as the head coach of his alma mater, Weber State in Utah, where he would make $130,000 annually according to the Salt Lake City Tribune.

As Smith was preparing for the 2012 season, Arkansas Razorbacks Head Coach Bobby Petrino was involved in an April 1 motorcycle accident with a woman on his football staff. After an investigation into the incident and the circumstances surrounding the woman’s hiring, Petrino was fired.

Smith agreed to abandon Weber State for a one-season contract as the Razorbacks’ head coach. Smith told the AP in July that he revealed his financial troubles to Arkansas Athletic Director Jeff Long before he was hired.

Smith told the AP that he wasn’t embarrassed about the financial mess he was in.

“It’s something that’s happened,” Smith told the AP. “I made some mistakes, and to be honest with you, I’m a football coach, not a businessman.”

 

 

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