Per-Co, Ltd. v. Great Lakes Factors, Inc.

Decision Date26 April 2007
Docket NumberNo. 3:06CV00979.,3:06CV00979.
Citation509 F.Supp.2d 642
PartiesPER-CO, LTD., et al., Plaintiff, v. GREAT LAKES FACTORS, INC., et al., Defendant.
CourtU.S. District Court — Northern District of Ohio

Patricia B. Fugee, Stephen W. Funk, Roetzel & Andress, Patrick B. Cavanaugh, Kitch Drutchas Wagner Valitutti & Sherbrook, Toledo, OH, for Plaintiff.

Howard B. Hershman, Gressley, Kaplin & Parker, Janine T. Avila, Reginald S. Jackson, Jr., Timothy P. Nackowicz, Connelly, Jackson & Collier, Toledo, OH, M. Colette Gibbons, Schottenstein, Zox & Dunn, Bryan J. Farkas, Vorys, Sater, Seymour & Pease, Cleveland, OH, David S. Blocker, Jonathan T. Hyman, Mary K. Whitmer, James W. Ehrman, Kohrman Jackson & Krantz, Kimberly A. Brennan, McCarthy, Lebit, Crystal & Liffman, Cleveland, OH, Ralph Denune, III, Lydy & Moan, Sylvania, OH, for Defendant.

ORDER

JAMES G. CARR, Chief Judge.

This suit for declaratory and other relief involves conflicting claims to the assets of Great Lake Factors, Inc. [Factors], a factoring business presently in bankruptcy. The principal parties to the dispute are the RFC Banking Company, which is a successor to the Peoples Banking Company [jointly, the "bank"], and entities owned or controlled by James Perry [Perry].

The dispositive issues are: 1) whether Factors obtained all or substantially all of the assets of Great Lakes Funding, Inc. [Funding], also a factoring business, to which the bank had extended a secured line of credit, and 2) if so, whether Factors is a successor to Funding, so that the bank's secured interest in Funding's assets attaches to Factors' assets. Perry claims to be an unsecured creditor of Factors.

If the bank prevails on its claim that Factors is a successor to Funding, then the bank's status as a secured creditor of Funding will give the bank priority over Perry, an unsecured creditor, in Factors' bankruptcy.

Following a nonjury trial, filing of post-trial briefs, and oral argument, the case is decisional.

For the reasons that follow, I find that Factors: 1) acquired substantially all the assets of Funding; and 2) is a successor to Funding. The bank, accordingly, has a secured interest in the assets of Factors.

Background

Thomas Bielski [Thomas] and Jeffrey Bielski [Jeffrey] are, respectively, father and son. Together they run a factoring business. Factoring companies provide financing to their customers, who, as a result of their credit ratings, might otherwise be unable to obtain the cash flow needed to run their own businesses.

The factor pays its customers a percentage of the face value of the customers' accounts receivable. In exchange for this cash, the customers assign to the factor their rights to those accounts receivable. The third parties who owe money on the accounts receivable ("invoice debtors") make payments directly to the factor instead of the creditor (the factor's customer) listed on the invoice. After the factor receives full payment of an invoice, the customer receives whatever amount remains (if any) minus interest and a factor's fee. By selling its invoices at a discount, a factor's customer receives cash immediately: it does not have to wait for the invoice debtors to pay the invoices.

For factoring to work, a factoring company needs funds to pay its customers for the invoices.

In this instance, the bank, beginning sometime in 1998 or 1999, made funds available to the Bielskis. Through a Loan and Security Agreement [Loan Agreement] dated February 21, 2001, the bank extended a $3.5 million line of credit to Funding, secured by an interest in all of Funding's accounts, accounts receivable, inventory, general intangibles, and proceeds. Both Jeffrey and Thomas personally guaranteed the bank's extension of credit to Funding.

The Bielskis used the money from the bank to buy invoices from their customers. The Loan Agreement required the Bielskis to instruct the invoice debtors to send their payments to a lockbox — a post office box to which the bank had sole access. As the payments came into the lockbox, the bank would be repaid for the monies it provided to Funding under the Loan Agreement. At this point, the flow of cash from the bank to Funding, from Funding to Funding's customers, and from the invoice debtors to the bank (via the lockbox) would be complete.

The circulation of that flow depends, ultimately, on the ability and willingness of the invoice debtors to pay their bills. If they do not do so, money doesn't go into the lockbox. If, in the meantime, the factor has continued to use the line of credit to buy more invoices, the line of credit may eventually become exhausted.

That occurred in early 2002: Funding was, as Thomas told Perry, whom Thomas met at an investment seminar, "maxed out" on its line of credit with the bank. Though cash was coming in from some of the invoices, others were over-aged [i.e., several months delinquent], and were thus unlikely to be paid.

This was not the first time in the course of its existence that the Bielskis' business had had credit problems. When Thomas started the factoring business in 1989, he operated it as a sole proprietorship. By 1992, because, for reasons not explained at trial, Thomas could not get credit in his own name, he incorporated Funding and issued 100% of its shares to Jeffrey.

By the Spring of 2002, the bank had notified Funding that the bank would not extend to Funding any additional credit. By this time, Thomas and Perry had met, and Perry had expressed an interest in lending money to the Bielskis at a 20% interest rate.

Perry did not want his loan to the Bielskis to be to be subordinate to the bank's line of credit to Funding, which was secured by an interest in nearly everything Funding owned. To satisfy Perry that his loan would be repaid, the Bielskis decided to form another corporation. This led to the incorporation of Factors as an LLC on May 22, 2002.

Shortly thereafter, the Bielskis learned that the LLC form would not accomplish the fundamental objective of preventing Perry's loan from being subordinate to that of the bank. On consultation with counsel, the Bielskis learned that creation of an Employee Stock Option Plan [ESOP] within a new corporation would render any assets held for employees by the ESOP "creditor proof': i.e., free of any claim by the bank for the debt Funding owed to the bank.1

The plan to establish an ESOP within a new corporation began to take shape as of June 18, 2002, when Factors LLC was dissolved and Factors Inc. was incorporated.

As envisioned, the shares held by the ESOP were to be owned jointly by: 1) Jeffrey and Thomas, who would share ownership of 79% of the company's stock; 2) the company's two other employees, who would have 11% of the shares; and 3) the company's attorney, who was to receive 10% of the shares. No stock in Factors in these or any other percentages was, however, ever issued.

Nor does the ESOP appear to have been implemented. There is no evidence that the Bielskis shared any profits generated by Factors with anyone else.

The Bielskis' efforts, which stalled when no Factors stock was issued, to manipulate the corporate structure of their business, had no meaningful effect on its operations. Jeffrey and Thomas continued to perform the same work that they had been doing for several years, their two other employees likewise continued to do the same jobs, both Funding and Factors were located in the same premises, and both shared the same phone and fax lines.

There were, to be sure, some differences between Funding and Factors: there were separate business records, files, computers, and checking accounts.

As time passed, there was, as well, a division of the company's principal asset: its accounts receivable. During the Summer and Fall of 2002, the Bielskis caused Funding to transfer its collectible accounts receivable to Factors, while having Funding retain invoices that, at least during the period of the inter-company transfers, had, or appeared at the time to have, no meaningful value.

In addition, at one point, Factors sold to Funding invoices of marginal, if any, value. In the meantime, the Bielskis conducted the affairs of both companies in a way that, in essence, looted Funding of cash that had come to it from Factors when Factors acquired Funding's collectible invoices. To the extent that Funding generated cash, Thomas and Jeffrey used the money to underwrite the expenses of running the overall factoring business and to compensate themselves. The Bielskis otherwise spent this money as they saw fit. As a result, money that, should have gone to the bank under the Loan Agreement went, for the most part, elsewhere, and it did so at the Bielskis' direction and for their benefit.

As noted at the outset of this opinion, the issues in this case are: 1) whether the Bielskis' actions caused Factors to acquire "all, or substantially all" of the assets of Funding; and 2) if so, whether Factors is a "successor corporation" to Funding, so that Factors acquired Funding's debt to the bank in addition to Funding's assets. If Factors is a successor corporation, its assets are encumbered by the bank's security interest under the Loan Agreement, and that security interest takes priority over Perry's unsecured claim against Factors.

1. Factors' Acquisition of Funding's Assets

Normally, a company that acquires the assets of a second company does not inherit the liabilities of the second company. See, e.g., Welco Indus., Inc. v. Applied Cos., 67 Ohio St.3d 344, 346, 617 N.E.2d 1129 (1993) (citations omitted) ("The well-recognized general rule of successor liability provides that the purchaser of a corporation's assets is not liable for the debts and obligations of the seller corporation.").

If, however, Factors acquired "all or substantially all" of Funding's assets, Factors may be liable under Welco for Funding's debts: "A corporation that purchases the assets of another is not liable for the contractual...

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    • United States
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    ...transactions fraudulently for the purpose of escaping liability to the debtor's creditors. See Per-Co, Ltd v. Great Lakes Factors, Inc., 509 F. Supp.2d 642, 653-54 (N.D. Ohio 2007). The defendants' motion to dismiss the alternative cause of action in paragraph 56 is, therefore, Counts I thr......

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