Meredosia Harbor & Fleeting Service, Inc., Matter of

• Decision Date: 08 November 1976
• Docket Number: No. 76-1018,76-1018
• Citation: 545 F.2d 583
• Parties: In the Matter of MEREDOSIA HARBOR & FLEETING SERVICE, INC. and River Road Marine Repair, Inc. FARMERS & TRADERS STATE BANK OF MEREDOSIA, Lien Claimant-Appellant, v. Robert M. MAGILL, Trustee-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 583

545 F.2d 583

In the Matter of MEREDOSIA HARBOR & FLEETING SERVICE, INC.

and River Road Marine Repair, Inc.

FARMERS & TRADERS STATE BANK OF MEREDOSIA, Lien Claimant-Appellant, v. Robert M. MAGILL, Trustee-Appellee.

No. 76-1018.

United States Court of Appeals, Seventh Circuit.

Argued Sept. 17, 1976.

Decided Nov. 8, 1976.

Duane D. Young, Mervin L. Beil, Springfield, Ill., for lien claimant-appellant.

James L. Magill, John B. Hendricks, Springfield, Ill., for trustee-appellee.

Before FAIRCHILD, Chief Judge, and CUMMINGS and TONE, Circuit Judges.

CUMMINGS, Circuit Judge.

This case arises from the denial of two Illinois banks' petitions to reclaim two vessels, allegedly subject to a maritime mortgage, or the proceeds from their sale in the hands of the bankruptcy trustee of the corporate mortgagor.

In 1970, John D. Rasco formed two companies, viz., Meredosia Harbor & Fleeting Service, Inc. and River Road Marine Repair, Inc., its wholly owned subsidiary, to build and repair boats. During that year, the corporations were building the Mary Ann, a river towboat, and the Anita Marie, a harbor towboat.

In early 1970, Rasco engaged upon a fraudulent scheme to obtain funds from appellant Farmers & Traders State Bank of Meredosia (Meredosia Bank) and its subrogor, Schuyler State Bank of Rushville (Rushville Bank). Rasco opened checking accounts in the corporate names and in his own name in those banks and in another Illinois bank and an Oklahoma bank. During the summer of 1970, he commenced kiting checks among the various banks. The kite was discovered by bank examiners in auditing the Meredosia Bank in early September 1970. Because of the check kite and Rasco's own unsecured borrowings on his account and on each corporation's account from the Meredosia and Rushville Banks, the Meredosia Bank lost $170,000 and the Rushville Bank $130,000.

Neither of Rasco's corporations ever had any paid-in capital, and neither issued any stock. Both corporations were insolvent in early September 1970. The Meredosia Bank was aware of Rasco's check kiting as early as July 1970, and the Rushville Bank realized in early September 1970 that Rasco was insolvent and in an overdraft position. There was evidence of connivance between some of the bank officers and Rasco.

On October 1, 1970, River Road Marine Repair, Inc., pursuant to the banks' demand, mortgaged the Mary Ann and the Anita Marie to the banks to secure the indebtedness of $300,000, consisting of $170,000 cash previously advanced by the Meredosia Bank and $130,000 cash previously advanced by the Rushville Bank. Attached to the mortgage was Rasco's October 1, 1970 affidavit stating that the mortgage was made by Rasco as president of River Road Marine Repair, Inc.,

"in good faith without any design to hinder, delay or defraud any existing or future creditor of the mortgagor (shipowner) or any lienor of the vessel mortgaged; and that this affidavit is made pursuant to the order of the Board of Directors of said corporation."

Both vessels were incomplete on October 1.

On November 6, 1970, the mortgagor River Road Marine Repair, Inc. and Rasco's other corporation, Meredosia Harbor & Fleeting Service, Inc., filed reorganization petitions under Chapter XI of the Bankruptcy Act. On the same day, they filed petitions to consolidate their Chapter XI proceedings. Consolidation orders were entered the same day by the bankruptcy referee and Alonzo Sargent was appointed as their receiver.

On November 20, 1970, the receiver sent a notice to all the creditors listed in the debtor's schedule of creditors, fixing the time and place for the first meeting of creditors and for various subsequent hearings. As sent out, the notice specified that the last date to file claims was June 14, 1971. The final paragraph of the notice referred to the fact that River Road Marine Repair, Inc.'s petition for arrangement had been consolidated with that of Meredosia Harbor & Fleeting Service, Inc. and that the cases were to proceed under one title, viz., In the Matter of Meredosia Harbor & Fleeting Service, Inc., No. S-BK-70-1365. The receiver's summary of liabilities and assets of the consolidated debtors attached to the notice unrealistically valued the Mary Ann at $450,000 and the Anita Marie at $135,000. The debtors' personal property schedule filed by Rasco on December 14, 1970, listed the Mary Ann's incomplete value as "unknown" and the Anita Marie's incomplete value as $80,000. Rasco listed corporate debts of $504,350.08 and $59,132.65, or a grand total of $563,482.73.

In the consolidated proceeding, an adjudication of bankruptcy was entered on January 4, 1971, and receiver Sargent was appointed as trustee. Ten days thereafter, the trustee petitioned for leave to sell both unfinished vessels and other property of the consolidated bankrupts. On the following day, the referee in bankruptcy sent a notice to the creditors to show on or before January 25, 1971, why the property should not be sold. On June 25, 1971, he authorized the sale of the bankrupts' property, there having been no contest to the January 15 show cause order. On December 14, 1971, he approved the trustee's sale of the Anita Marie for $21,500. A month thereafter, he approved the sale of the Mary Ann and other miscellaneous personal property of the bankrupt for $25,000.

On February 7, 1973, the Meredosia Bank filed an objection to the trustee's January 2, 1973, final report, indicating that it had a maritime mortgage on the two vessels for $300,000, and stating that the trustee's counsel had previously advised the bank that the proceeds of the sale of the two vessels would not be expended until it was determined whether the mortgage was a valid lien. In March 1973, the Meredosia Bank filed a petition to reclaim the vessels or the proceeds of their sale, and a similar reclamation petition was filed in June 1973 by the Rushville Bank.

On May 1, 1974, the bankruptcy referee overruled the Meredosia Bank's objections to the final account of the trustee ¹ and denied both banks' reclamation petitions. At the same time, he entered supporting findings of fact, conclusions of law and an opinion. In his opinion, the referee noted that the October 1, 1970, mortgage was given for an antecedent debt of $300,000 caused by Rasco's check-kiting scheme. He observed that the bankrupts were hopelessly insolvent at the time of the mortgage transaction. He held that the mortgage on the towboats was void as a preference. He also held that the mortgage was invalid for want of a proper supporting affidavit and because each boat was incomplete when the mortgage was executed. Consequently, both banks' claims were only allowed as general claims.

On October 23, 1975, the district court rendered a thorough opinion affirming the referee's order. Judge Wood held that the banks never possessed a valid preferred ship's mortgage because the supporting affidavit was not made in good faith. He also held that the banks had only a voidable preference because they had reasonable cause to believe that the mortgagor River Road Marine Repair, Inc. was insolvent at the time of the mortgage. Other contentions of the banks were overruled. We affirm.

The Meredosia bank insists that the bankruptcy court had no jurisdiction to consider the preferred mortgage the banks assertedly obtained on the two vessels under the Ship's Mortgage Act of 1920 (46 U.S.C. § 911 et seq.). The bank maintains that only a federal district court, a court with original jurisdiction in admiralty, may question the validity of a preferred ship's mortgage. ² However, in the consolidated proceedings involving the mortgagor River Road Marine Repair, Inc., the consolidated debtor was adjudicated bankrupt on January 4, 1971. By that act, the property of the bankrupt passed into the custody of the bankruptcy court. 2 Collier on Bankruptcy P 23.04 (14th ed. 1974). Having first secured custody of the vessels, the bankruptcy court was entitled to retain possession and determine all lien claims asserted against the vessels. 1 Collier on Bankruptcy P 2.10 at 180-181 (14th ed. 1974). ³ Thus the referee in bankruptcy properly reached the validity of the maritime mortgage.

An otherwise valid ship's mortgage is granted the preferred status given by 46 U.S.C. § 953 ⁴ only if the conditions of 46 U.S.C. § 922(a) ⁵ are met. Here the bankruptcy court refused to give preferential status to the banks' maritime lien because Rasco's accompanying affidavit that the mortgage was "made in good faith and without any design to hinder, delay, or defraud any existing or future creditor of the mortgagor or any lienor of the mortgaged vessel", as required by Section 922(a)(3), was itself made in bad faith. The banks would have us construe Section 922(a)(3) in a pro forma manner, viz.: once the affidavit is made the Section's requirement is met without more. If the affidavit is fraudulent, the appellants argue that recourse should be had against the affiant rather than the mortgage. We disagree. The Section 922(a) (3) affidavit requirement demands assurance that the "mortgage is made in good faith." The good faith requirement applies to the mortgage transaction. This creates, in turn, a derivative good faith requirement for the mortgagee. Upon a showing that the mortgagee knew of the mortgagor's bad faith, such knowledge will trigger Section 922(a)(3). Since each of the requirements of Section 922(a) is independently necessary for a ship's mortgage to attain preferred status, the mortgagee's bad faith will defeat a mortgage's aspiration towards preferred status.

The district judge marshalled nine factors based on the evidence that negated this good faith requirement:

Representatives of both banks agreed on the mortgage.

At the time the mortgage was arranged, bankruptcy was contemplated by all parties.

The mortgage was agreed upon after the large overdraft developed.

Rasco paid off officers of both banks to help get loans...