In re Repository Technologies, Inc.

• Decision Date: 13 February 2007
• Docket Number: Bankruptcy No. 06 B 04582.,Adversary No. 06 A 01247.
• Citation: 363 B.R. 868
• Parties: In the Matter of REPOSITORY TECHNOLOGIES, INC., Debtor. Repository Technologies, Inc., Plaintiff, v. William C. Nelson, IV, Defendant.
• Court: U.S. Bankruptcy Court — Northern District of Illinois

363 B.R. 868

In the Matter of REPOSITORY TECHNOLOGIES, INC., Debtor Repository Technologies, Inc., Plaintiff, v. William C. Nelson, IV, Defendant.

Bankruptcy No. 06 B 04582.

Adversary No. 06 A 01247.

United States Bankruptcy Court, N.D. Illinois, Eastern Division.

February 13, 2007.

COPYRIGHT MATERIAL OMITTED

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Steven J. Christenholz, DLA Piper U.S. LLP, Chicago, IL, Ann E. Pille, DLA Piper U.S. LLP, Chicago, IL, for William G. Nelson, IV, Defendant.

Jeffrey C. Dan, Crane, Heyman, Simon, Welch & Clar, Chicago, IL, Arthur G. Simon, Crane, Heyman, Simon, Welch & Clar, Chicago, IL, David K. Welch, Crane, Heyman, Simon, Welch & Clar, Chicago, IL, for Repository Technologies Inc., Plaintiff.

FINDINGS OF FACT AND CONCLUSIONS OF LAW FOLLOWING TRIAL

JACK B. SCHMETTERER, Bankruptcy Judge.

The Debtor filed a four count Adversary Complaint against William G. Nelson IV ("Nelson") asserting causes of action by Repository Technologies, Inc. ("RTI" or "Plaintiff'): (1) for recharacterization of Nelson's loans to equity; (2) equitable subordination of Nelson's loan claims against the Debtor pursuant to Section 510(c)(1) of the Bankruptcy Code; (3) transfer of Nelson's liens to the Debtor's estate pursuant to Section 510(c)(2) of the Bankruptcy Code; and (4) recovery against Nelson for alleged breaches of his fiduciary duties owing to the Debtor, its creditors and its shareholders. This Adversary relates to the pending Chapter 11 Bankruptcy case filed by RTI.

The evidence admitted also relates to Debtor's pending objections to Nelson's Claim No. 6, which were asserted to rest on the issues asserted by RTI in the Adversary. These Findings and Conclusions therefore dispose of that claim objection.

Nelson filed a Dismissal Motion seeking dismissal of this Chapter 11 case, or, alternatively, relief from the automatic stay ("Stay Motion"). The trial on the Debtor's Adversary Complaint was ordered to be consolidated with trial on the Stay Motion.

Shortly before commencement of trial. Defendant Nelson filed a Motion for Summary Judgment with respect to issues presented by the Adversary Complaint. After briefing by the parties on the eve of trial, and there appearing to be some triable issues of fact and even some relief that Plaintiff might obtain (and indeed some partial relief is allowed to Plaintiff by this ruling), Nelson's Motion for Summary Judgment was taken along with trial evidence for ruling after the parties rested without delaying to prepare a complete analysis of the motion.

At the start of trial, counsel for Debtor and Nelson agreed that facts identified by Nelson in his Statement of Uncontested Facts offered in support of his Motion for Summary Judgment, and the facts identified by Debtor in its Statement of Additional Facts offered in opposition to Nelson's Motion for Summary Judgment would be admitted into evidence as uncontroverted to the extent not objected to by the parties.¹

After Debtor rested, Nelson moved for entry of judgment under Fed. R. Bankr.P. 7052. Ruling on Nelson's Motion was deferred until completion of trial. Again, there appeared to be some partial relief due Plaintiff, and the completion of trial was warranted. That Motion will now be stricken as mooted by the Final Judgment that will now be entered.

All of Debtor's Exhibits 1 through 30 were admitted into evidence. Nelson's Exhibits 1 through 20 and 25 through 33 were admitted into evidence. Nelson's Exhibits 21 through 24 and 34 were withdrawn by Nelson. Nelson's Exhibit 35, which was objected to by the Debtor, was never offered into evidence.

At the close of the trial evidence, both parties rested and the parties presented their final arguments in writing.

FINDINGS OF FACT

THE PARTIES

1. The Debtor ("RTI") is a Delaware corporation, with a principal place of business in Lisle, Illinois. RTI markets, supplies, and maintains software pursuant to the terms of various software licensing agreements with its customers.

2. Mr. Nelson is an individual with a principal residence located in Pennsylvania. Since 1996, Mr. Nelson has been a shareholder of RTI. In addition, Mr. Nelson served as Chief Executive Officer of RTI, and has served on RTI's Board of Directors from 1996 and as its Chairman through April 11, 2006, when he resigned.

3. After April 11, 2006, when Mr. Nelson resigned all formal positions with RTI, he only held positions as a shareholder and lender.

4. Since 1996, RTI's Board of Directors had between three and five directors and Mr. Nelson had only one seat on the Debtor's Board of Directors while the principal shareholders, E. James Emerson ("Mr.Emerson") and Kathleen Emerson ("Mrs.Emerson"), had two seats, so Mr. Nelson was never in control of the Board of Directors.

THE BUSINESS OF REPOSITORY TECHNOLOGIES, INC.

5. RTI obtains revenue from three primary sources: (a) new sales of software licenses ("Licenses"); (b) upgrades of prelicensed software to customers with specialized needs ("Services"); and (c) maintenance and customer support of existing software licenses ("Maintenance"). RTI currently has six full-time and two part-time employees. RTI currently has two corporate officers: Mr. Emerson and Mrs. Emerson.

6. Mr. Emerson, RTI's President, is responsible for keeping the books and records of RTI, including payroll and the tracking of employee reimbursements and expenses. Mr. Emerson and Mrs. Emerson own 37.02% and 29.82% of the equity interests in RTI, respectively, for a combined 66.84% of the equity interests.

7. In 2000, RTI had gross income of $2,132,562, and a net loss of $129,835. In 2001, RTI had gross income of $1,913,823, and a not loss of $273,368. In 2002, RTI had gross income of $1,586,897, and a net loss of $701,780. In 2003, RTI had gross income of $1,630,691, and a net loss of $791,771. In 2004, RTI had gross income of $1,406,835, and a net loss of $148,647, without taking into account any interest that might have been due and owing to Mr. Nelson on his loans to RTI. In 2005, RTI had gross income of $1,321,523, and a net gain of $159,967, without taking into account any interest on loans that might be due and owing to Mr. Nelson.

8. Mr. Emerson did not testify as an expert, but in his testimony stated his belief that RTI has a going concern value of a little less than $3,500,000, with actual going concern value most likely determinable based upon a multiple of RTI's earnings. No expert testimony established that value. However, sufficient evidence was received at a contested cash collateral hearing to enable the Court's finding on December 5, 2006, that the value of property securing Nelson's pre-petition claim is less than those claims.

THE NELSON CLAIM

9. On July 31, 2006, Mr. Nelson filed its secured proof of claim in the Debtor's bankruptcy case in an amount in excess of $2,346,072 (the "Nelson Claim"). The Nelson Claim arises from both loans Mr. Nelson made to RTI personally, and from the outstanding balance on a note which Mr. Nelson purchased for face value from West Suburban Bank (the "Bank").

A. Loans and Advances by Nelson to RTI

10. On July 10, 2002, a Special Meeting of Directors was held by conference call, at which time all the directors of the corporation discussed whether RTI should enter into a credit agreement with Mr. Nelson wherein Mr. Nelson would provide financing to RTI. July 10, 2002, RTI Board Meeting Minutes, (the "July 2002 Minutes"). Other issues discussed at that meeting included:

a. Increased compensation to Nelson to pay for his increased day-to-day participation in RTI management;

b. The requirement that Nelson spend at least 50% of his time on RTI business; and

c. Granting of options to Nelson for 1,200,000 more shares of RTI common stock at about $.23 cents per share.

11. Mr. Nelson left the conference call to allow the other directors to discuss and vote on the issues discussed, and, as the prospective lender, Mr. Nelson did not vote on whether or not RTI should borrow the funds, July 2002 Minutes. Thereafter, all remaining directors, including Mr. and Mrs. Emerson, voted in favor of entering into a line of credit to be advanced by Mr. Nelson. July 2002 Minutes.

12. On August 30, 2002, RTI, through its president, Mr. Emerson, executed a Revolving Credit Note (the "Nelson Note") with Mr. Nelson, which granted Debtor a line of credit up to $500,000, at an interest rate of 15%, with interest only to be paid each month until August 1, 2007, when the entire balance is scheduled to become due.

13. On August 30, 2002, RTI, again through its president, Mr. Emerson, executed a Commercial Revolving Loan And Security Agreement (the "Nelson Security Agreement"), which granted Mr. Nelson "a security interest in all assets of the Debtor ... to secure payment to [Mr. Nelson] of the Obligations ..." Nelson Security Agreement, p. 1. See also, J. Emerson Dep. Tr. 111:10-113-6. Nelson did not record a UCC-I financing statement perfecting his security interests until October 29, 2004 (more than two years after execution of the Nelson Note and Nelson Security Agreement).

14. In the Nelson Security Agreement, "Obligations" is defined as

[T]he loan and any and all other advances made hereunder, together with interest thereon, and any and all other indebtedness, liabilities and obligations of whatever nature of the Debtor to [Mr. Nelson], no matter how or when arising and whether under this Agreement, the other Loan Documents, or under any other agreements, guarantees, instruments, or documents executed and delivered by Debtor to [Mr. Nelson] past, present, or future, and the amount due on any notes, or other obligations of Debtor given to, received by or held by [Mr. Nelson] ... for or on account of any of the foregoing, whether, in each case,, direct or indirect, absolute or contingent, due or to become due, not existing or hereinafter arising.

As of the date of the filing of Debtor's related bankruptcy case, the Nelson Security Agreement...