Rubin v. Manufacturers Hanover Trust Co.

• Decision Date: 01 October 1981
• Docket Number: D,No. 344,344
• Citation: 661 F.2d 979,8 B.C.D. 297
• Parties: Herbert RUBIN, as Trustee of U.S.N. Co., Inc., Bankrupt, and Eliot H. Lumbard, as Trustee of Universal Money Order Co., Bankrupt, Plaintiffs-Appellants, v. MANUFACTURERS HANOVER TRUST CO., Defendant-Appellee, and John M. Trent and Eugene Skowron, Defendants. ocket 80-7468.
• Court: U.S. Court of Appeals — Second Circuit

Page 979

661 F.2d 979

8 Bankr.Ct.Dec. 297

Herbert RUBIN, as Trustee of U.S.N. Co., Inc., Bankrupt, and Eliot H. Lumbard, as Trustee of Universal Money Order Co., Bankrupt, Plaintiffs-Appellants, v. MANUFACTURERS HANOVER TRUST CO., Defendant-Appellee and John M. Trent and Eugene Skowron, Defendants.

No. 344, Docket 80-7468.

United States Court of Appeals Second Circuit.

Argued March 11, 1981.

Decided Sept. 21, 1981.

Order Filed Oct. 1, 1981.

Terry Myers, New York City (Morrell I. Berkowitz, Herzfeld & Rubin, P.C., New York City, on the brief), for plaintiffs-appellants.

Rolon W. Reed, New York City (John F. Cambria, Don D. Grubman, Simpson Thacher & Bartlett, New York City, on the brief), for defendant-appellee.

Before FRIENDLY, MANSFIELD and KEARSE, Circuit Judges.

KEARSE, Circuit Judge:

This appeal arises from the collapse and ultimate bankruptcy of two affiliated firms, U.S.N., Inc. ("USN"), and Universal Money Order Co., Inc. ("UMO"), companies in the business of issuing money orders. Plaintiffs Herbert Rubin and Eliot H. Lumbard, bankruptcy trustees of USN and UMO, respectively, appeal from a judgment of the United States District Court for the Southern District of New York, 4 B.R. 447, Milton Pollack, Judge, dismissing their claims to recover the value of certain funds and securities of the bankrupts from defendant Manufacturers Hanover Trust Co. ("MHT"). The trustees contend that MHT took these assets pursuant to fraudulent conveyances within the meaning of § 67(d) of the Bankruptcy Act of 1898, former 11 U.S.C. § 107(d) (1976), ¹ in satisfaction of debts arising from defaulted loans made, at the behest of the bankrupts, to companies that acted as sales agents for the bankrupts. The district court held, after a bench trial, that the loans against which MHT applied the bankrupts' property were supported by fair consideration and did not render the bankrupts insolvent, so that the transactions could not be set aside pursuant to § 67(d). Because we conclude that the district court did not apply the proper legal standards in considering the issues of fair consideration and insolvency, we vacate its judgment and remand the matter for further proceedings.

I. HISTORY OF THE BANKRUPTS' BUSINESS

The bankruptcy of UMO and USN was part of the collapse of a sort of private banking empire controlled by Messrs. John M. Trent and Eugene Skowron. The Trent/Skowron companies were a major factor in what the plaintiffs have termed the "auxiliary banking system," a group of businesses that provide banking-type services primarily to lower-income persons who do not maintain ordinary checking accounts. As part of this system UMO and USN (sometimes referred to as "issuers") engaged in the business of issuing money orders. Defendant MHT was the principal banker for the Trent/Skowron network and, as detailed below, made loans to various members of the network and held as collateral assets owned by UMO and USN. As a result of the collapse of the Trent/Skowron network, an as yet undetermined, but undoubtedly quite large, number of money orders issued by UMO and USN became unredeemable and worthless. In the present litigation, the trustees of the issuers seek to recover for the benefit of purchasers of unredeemed UMO and USN money orders the value of certain collateral pledged by the issuers and applied by MHT to debts of other companies, most of which were Trent/Skowron affiliates. Resolution of the difficult legal questions raised by the trustees' appeal requires a fairly detailed recounting of the history of the Trent/Skowron enterprises.

A. Basic Organization of the Enterprise

UMO, USN, and their parent corporation, International Express Co. ("International"), were apparently the central elements of the Trent/Skowron network. USN, a New York corporation formed by Trent and Skowron in 1962, sold money orders primarily in New York State. UMO, incorporated by Trent and Skowron in New Jersey in 1970, sold money orders primarily in California, Colorado, Massachusetts, New Jersey, Ohio, and West Virginia. Although the two firms had different sales territories, they were run as a single enterprise. Each was wholly owned by International; 89% of the stock of International was owned by Trent and Skowron. ² UMO, USN, and International had the same principal officers and directors, including Trent as president and Skowron as secretary-treasurer. The funds of UMO and USN were mingled in a single bank account and were used fungibly to redeem either firm's money orders as they were presented. Although the companies' accounts were so "jumbled together" that their monthly sales rates could not be stated separately, their combined monthly sales volume amounted to about 900,000 money orders, having an average daily face value of about $1,850,000.

UMO and USN did not sell their money orders directly to the public. Instead, each firm enlisted a number of small businesses in its sales territory to act as sales agents. Although a variety of retail stores, particularly drug stores, acted as sales agents in smaller communities, the firms' principal sales agents were check cashing establishments located in large cities. ³ These check cashing "stores" were well situated to sell money orders, for they were equipped for the safe handling of large amounts of money, and their check cashing services provided customers with the cash needed to buy the bankrupts' money orders. By the same token, the sale of money orders aided the check cashers in their principal business by reducing the cash outlays associated with it. This symbiotic relationship with the check casher sales agents was vital to the money order issuers. Robert Sparago, an officer and former general counsel ⁴ of both UMO and USN, testified that the check cashers did "the major part of the money order business of USN" and that "(w)ithout the check cashers there was no USN." UMO was similarly dependent upon its check casher sales agents.

At some point in the development of their businesses, Trent and Skowron sought to expand into the check cashing business. Toward this end they formed Empire Small Business Investment Corp. ("Empire"), ⁵ which they used as a holding company to acquire a controlling 50% interest in National Payroll Services Ltd. ("National"), itself a holding company that owned eleven check cashing corporations that operated at 18 locations, and to acquire a controlling 331/3% interest in TWO Check Cashing Corp. ("TWO"), another holding company that owned four check cashing outlets. All of the check casher subsidiaries of National and TWO were located in New York City, and all were sales agents of USN.

Thus, for the period relevant to this appeal, the relationships between Trent and Skowron and the principal businesses they controlled can be summarized schematically as shown below: ⁶

NOTE: OPINION CONTAINS TABLE OR OTHER DATA THAT IS NOT VIEWABLE

B. The Banking Arrangements and the System of Guarantees

Because their check cashing business required continuous outlays of currency, the check cashers who served as sales agents for UMO and USN experienced a constant need for cash, a need that the inflow of funds from the sale of money orders could never wholly satisfy. The resulting imbalance posed obvious problems for both the check cashers and the money order issuers. If the cashers ran out of currency, they could not conduct their principal business; if the cashers became unable to cash checks, then many prospective customers of UMO and USN would be unable to obtain the cash needed to purchase money orders.

In addition, the currency shortfalls of the check cashers presented a somewhat more fundamental problem for the money order issuers. To the extent that a check casher ran low on cash, he would be tempted to retain the proceeds of his money order sales for use in his own business rather than remit them promptly to the issuer. Such foot-dragging could have disastrous consequences for the issuer, whose profit depends largely on his freedom to exploit the "float" inherent in his business-i. e., on his ability to use and invest the proceeds of money order sales between the time of purchase and the time when the money orders are presented for collection. Any delay in the remittance of sales proceeds to the issuer necessarily diminishes the "float," and therefore the profitability of the issuer's business. ⁷

As a means of resolving these problems Trent and Skowron settled on short-term bank financing for the check cashers. In 1964, the two entrepreneurs caused USN to arrange for certain of its check casher sales agents to receive loans from MHT, with which USN maintained an account. Under the initial 1964 arrangement, MHT opened a "loan line" against which USN's check casher sales agents were permitted to borrow for three-day periods. Each month, Trent and Skowron submitted to MHT a schedule of requested loans to each check casher for each day of the month; the daily loans were based on estimates of each casher's varying daily needs for cash. After reviewing and approving the schedules, MHT would extend the specified credit for each day to each of the listed check cashers. This three-sided financing arrangement, whereby MHT loaned money to the check cashers according to the schedules submitted by Trent and Skowron, remained an essential operating procedure until the Trent/Skowron network collapsed in January 1977.

The initial 1964 loan line for the check cashers was provided by MHT on the basis of the check cashers' own credit. In 1966, Trent and Skowron obtained from MHT a second, supplementary line of credit for the check cashers. Under this arrangement, Trent and Skowron pledged certain securities, owned by them, as collateral, and MHT extended credit to the check cashers, in accordance with monthly schedules submitted by Trent and Skowron as described above, in a total amount that was fixed as a varying multiple of the value of the collateral. Thus, under...