The demise of McNally Smith: Bankruptcy hearing this week for failed St. Paul music college
ST. PAUL — Between March and November last year, the co-founders of McNally Smith College of Music loaned the school $1.33 million in a failed attempt to keep the St. Paul school in business.
That's according to filings in two bankruptcy cases — one for the school and another for Jack McNally personally.
The for-profit college's gross income, records show, fell from $10.6 million in 2016 to $9.6 million a year later amid declining enrollment and increases in tuition discounts.
McNally and co-founder Doug Smith sought to convert the school to nonprofit status but ran out of time and money.
Starting in November, records show, they stopped paying their employees and other bills.
Among the $11 million in bankruptcy claims against the school are $242,000 in unpaid federal and state payroll taxes, $198,000 in attorneys fees, $109,000 for utilities, $75,000 in rent for administrative offices and $54,000 to the Lowry Building for student housing.
Jack McNally reported the school also collected $564,000 from students in prepaid tuition for the spring 2018 semester that never took place.
McNally announced Dec. 14 that the school would close at the end of the fall semester, leaving students with limited transfer options because of the school's weak accreditation.
Smith went on to personally pay more than $8,000 to several administrators who helped wind down the school's operations and another $10,000 for the school's bankruptcy filing.
The school also incurred a $151,000 fine from the state Department of Labor for failing to turn over employee records in January.
McNally sold his Cass County home in March and moved to Arizona, joining his wife at a gated-community golf course home that they rent. After earning $120,000 last year, he now makes $12 an hour as a safari Jeep tour guide. Combined with Social Security checks, it's enough to break even on a monthly budget of $3,900.
"They'd been shoveling money in to keep the school going for quite some time. In Jack's case, it actually bankrupted him," said John Lamey, McNally's bankruptcy attorney.
Whether McNally Smith students, employees and customers get some of their money back may depend, in part, on a hearing Wednesday, April 25, in the school's bankruptcy case.
Exchange Street Partners LLC, an investment group led by Todd Geller of Minnetonka, bought the mortgage on the downtown school building from Bremer Bank in January, just before the bankruptcy case was filed.
Geller's group has asked a judge to declare the school "single asset real estate," using a provision in bankruptcy law meant for companies that exclusively manage leased property, such as apartment buildings and shopping malls.
If they prevail, the judge will lift an automatic stay related to the bankruptcy, enabling Geller to rush a foreclosure sale of the building.
Geller argues the school qualifies because its only income now comes from a $95,000 annual lease to the History Theatre, its longtime tenant.
Patti Sullivan, the court-appointed trustee for the estate, opposes the motion, citing the building's long history as a college.
Pat Hennessy, Sullivan's attorney, said it's often the case in a foreclosure sale that the lone bidder is the mortgage holder. If Exchange Street Partners is able to buy the building for no more than what they are owed — about $4.5 million — there will be nothing left from the sale to pay back other creditors.
"That's the worst-case scenario," Hennessy said.
If Geller's group gets the building in a foreclosure sale, the trustee still would have six months to find a different buyer and redeem from the foreclosure sale, Hennessy said. But that buyer could opt to buy straight from Exchange Street Partners instead, again leaving nothing for unsecured creditors.
Geller and his attorney did not return phone messages.
Sullivan has been looking for companies to lease or buy the building, and Hennessy said he's confident they'll find one who will pay more than the cost of the mortgage.
Meanwhile, Hennessy is negotiating with Geller's group for a guarantee that there will be something for unsecured creditors.
"I think it's likely we will reach an agreement," he said.
Claims total $11 million
The music school's assets appear to be worth substantially more than what Geller is owed but not enough to fully pay off creditors.
The school building was appraised at $10.16 million, records show. The college also owns recording equipment and other items worth an estimated $3.4 million.
Some of that property is missing, however. Records show valuable microphones and a Sheryl Crow-autographed guitar were stolen days after the school closed, and some employees never returned school-owned computers.
The only known secured creditors besides Exchange Street Partners are two small mechanic's liens and the U.S. Small Business Administration for a 2011 loan worth $432,000.
So any estate sale proceeds over about $5 million can be divided among employees, students and other unsecured creditors, once bills related to the bankruptcy court case are paid.
Claims against McNally Smith were due Thursday. The bankruptcy court received 230 claims totaling just over $11 million.
Those claims included the Exchange Street Partners mortgage and claims from the IRS, many former employees and students, and $683,000 from Doug Smith and his wife.
Jack McNally did not file a claim against the school. However, he listed himself as a creditor in his personal bankruptcy.
McNally's personal filing listed just under $400,000 in personal property assets and $3.28 million in liabilities. Nearly all of his liabilities are related to the music school, and there's considerable overlap with the business bankruptcy.
His lawyer, Lamey, said business-related debts are included in both filings in case McNally is sued personally by students or others.
Credit transfer problem
In the school bankruptcy case, the claimants include 10 students who allege that the school misled them about the school's accreditation and the transferability of their credits.
Two of those students sued the school in 2017, before it closed; the first to sue, Caroline Brady, has reached a confidential settlement, according to her claim.
David Such and his son Traverse, of Cascade, Wis., did not make a formal allegation of wrongdoing. But they say they too were misled by school officials, who falsely told them McNally Smith credits would transfer to schools like the University of Southern California.
Such filed a claim for $109,843 — the amount he and his late wife paid in cash for their son's tuition and related expenses over seven semesters in St. Paul. Traverse was 15 credits short of a bachelor's degree in guitar performance when the school closed.
"He went there to get a degree and we poured all that money into it and he has nothing to show for it," Such said in an interview. "That's extremely frustrating."
Traverse now is enrolled at the Los Angeles College of Music. Like McNally Smith, it's a for-profit school with national accreditation, but it accepted about two-thirds of his St. Paul credits.
This time, Such said, his son is getting assurances about credit transfer in writing.
"He's not taking anyone's word anymore," Such said. "We've been burned once and don't want to get burned again."