Roco Corp., In re, 82-1581

• Citation: 701 F.2d 978
• Decision Date: 02 March 1983
• Docket Number: No. 82-1581,82-1581
• Parties: 8 Collier Bankr.Cas.2d 457, 10 Bankr.Ct.Dec. 275, Bankr. L. Rep. P 69,088 In re ROCO CORPORATION, d/b/a Standard Supply Company, Debtor. Edward CONSOVE, Plaintiff, Appellant, v. Avram COHEN, Defendant, Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (1st Circuit)

Page 978

701 F.2d 978

8 Collier Bankr.Cas.2d 457, 10 Bankr.Ct.Dec. 275,

Bankr. L. Rep. P 69,088

In re ROCO CORPORATION, d/b/a Standard Supply Company, Debtor.

Edward CONSOVE, Plaintiff, Appellant, v. Avram COHEN, Defendant, Appellee.

No. 82-1581.

United States Court of Appeals,

First Circuit.

Argued Dec. 10, 1982.

Decided March 2, 1983.

John F. Bomster, Providence, R.I., with whom Russell D. Pollock, and Adler Pollock & Sheehan Incorporated, Providence, R.I., were on brief, for plaintiff, appellant.

Robert J. McGarry, Providence, R.I., with whom Edward J. Regan, and Tillinghast, Collins & Graham, Providence, R.I., were on brief, for defendant, appellee.

Before COFFIN, Chief Judge, BOWNES, Circuit Judge, and SMITH, ^* Senior District Judge.

BOWNES, Circuit Judge.

Appellant Edward Consove (Consove) appeals from a judgment of the United States Bankruptcy Appellate Panel, 21 B.R. 429, which affirmed a decision of the United States Bankruptcy Court, 15 B.R. 813 for the District of Rhode Island. This decision concerned two transfers of funds to Consove from Roco Corporation (Roco), a corporation subject to an involuntary proceeding under chapter 7 of the Bankruptcy Code. Consove maintains that the bankruptcy court erred in finding that a $300,000 note and security interest he received from Roco in exchange for stock constituted a fraudulent transfer and in finding that $26,158.95 he received from Roco was a voidable preference. For the reasons discussed below we affirm the bankruptcy court's judgment as affirmed by the appellate panel.

I. Facts and Proceedings Below

Consove and his partner Arthur Rosen incorporated Roco in 1946; each one owned fifty percent of the company's outstanding stock. Roco, doing business as Standard Supply Company, operated a hardware supply business. Consove was the "inside man" who took care of purchases and accounts receivable while Rosen handled sales. The company appears to have been a marginal one, but generally paid its bills as they came due and provided reasonable salaries for Consove and Rosen.

Rosen died in February 1978 and Roco redeemed his stock for approximately $130,000, funded in part by insurance proceeds. ¹ As a result of this redemption Consove became the sole shareholder of Roco. Soon thereafter Consove and his son Gerald discussed the possibility of Gerald taking over the business and Consove retiring. Gerald had been a full-time employee of Roco since 1970 and a part-time employee before that. During these years Rosen had displayed little confidence in Gerald's ability to manage the company and Gerald had not been given any position of responsibility or ownership.

The discussions between Consove and Gerald resulted in a series of transactions executed on November 1, 1979. Consove sold his 100 shares of Roco, representing all of the company's outstanding stock, back to the company in exchange for a $300,000 note. The note provided for interest at ten percent annually payable on a monthly basis or, at Roco's option, on a weekly basis at $600 per week plus a year-end adjustment. This weekly amount approximated Consove's salary and expense benefits before retirement. During the first five years only interest was due on the note, with principal to be amortized thereafter over fifteen years by monthly payments. Along with the note Consove took a security interest in all of Roco's personal property, including inventory, accounts receivable, and equipment; ² a financing statement was filed with the Rhode Island Secretary of State. Roco also executed a secured note to Consove for $29,558.13 to cover an earlier loan Consove had made to the company. ³ On the same date Gerald became the sole shareholder of Roco by purchasing a single share for $3,000 and also became the sole officer and director; Consove resigned as director and president. Consove and his wife signed a letter to Gerald stating that they would not transfer the $300,000 note and that any outstanding balance would be given to Gerald at the death of the surviving parent.

Consove and his wife then retired to Florida. He apparently had little contact with Roco, other than receiving $600 weekly interest payments, until January 1980 when Gerald telephoned to request a $15,000 loan to cover the company's cashflow shortfalls caused by slow collections of accounts receivable. Consove loaned Roco the amount requested. Apparently this situation was not unusual: Consove had made such loans to the company during the years he had managed it. He cashed a check in full payment of this latest loan on June 13, 1980.

A fire in June 1980 forced Roco to close its warehouse. Consove returned to Rhode Island in July when his weekly payments of $600 stopped; up to this point he had received interest payments totalling $21,600. Consove took back control of the business from Gerald and soon confirmed his suspicion that his son had been mismanaging Roco and diverting its funds for personal use. ⁴ Consove confronted Gerald about this diversion of funds and had him execute a personal note of $27,000 to the order of Roco. In his capacity as Roco's president Gerald endorsed this note to Consove. It has not been paid.

Between the time Consove reassumed control of Roco and September 23, 1980, the date an involuntary bankruptcy petition was filed, he caused the corporation to issue him six checks totalling $36,886.69. According to Roco's books, $26,159.95 of this amount was applied to the balance due Consove for officer loans and the remaining $10,727.74 was applied to reduce the principal balance on the $300,000 note to $289,272.26.

After the filing of the bankruptcy petition, Consove filed a complaint to modify the 11 U.S.C. Sec. 362 automatic stay to permit him to continue exercising his rights as a secured creditor, specifically to reclaim Roco's assets. In his answer the Trustee asserted several affirmative defenses and counterclaims. The bankruptcy court rendered a judgment for the Trustee based on the affirmative defense of fraudulent transfer and on his counterclaim seeking avoidance of preferential transfers under 11 U.S.C. Sec. 547. The appellate panel affirmed the bankruptcy court's findings and conclusions on the issues of the fraudulent transfer and preferences. The panel vacated the court's order that Consove turn over to the Trustee Gerald's $27,000 note because there was no support for it in the record and remanded that issue for appropriate proceedings. ⁵ The Trustee has conducted a public auction of Roco's hardware inventory and is holding the proceeds as well as the estate's remaining assets pending the outcome of this case.

II. Fraudulent Transfer

The bankruptcy court held that the transfer by Roco of the $300,000 note and security interest in redeeming its stock was a fraudulent transfer under 11 U.S.C. Secs. 548(a)(1) & (a)(2) (Supp. V 1981). ⁶ Section 548(a)(1) enables a trustee to avoid any transfer that the debtor made with "actual intent to hinder, delay, or defraud" creditors. Section 548(a)(2) in relevant part provides a standard of constructive fraud which enables the trustee to avoid any transfer in which the debtor "received less than a reasonably equivalent value in exchange for such transfer" and "was insolvent on the date [of such transfer] or became insolvent as a result of such transfer."

The clearly erroneous standard of review provided by Rule 16 of the First Circuit Rules Governing Appeals from Bankruptcy Judges to District Courts, Appellate Panels and Court of Appeals (effective Mar. 1, 1980) seems to apply to our review of the bankruptcy court's findings with respect to both sections 548(a)(1) and 548(a)(2). Consove concedes that there is clear authority for the proposition that the court's finding of actual fraud is a factual finding. See Collier on Bankruptcy p 548.02, at 548-26 (15th ed. 1982) ("The approach under section 548(a)(1) is to be purely factual." (footnote omitted)). The review standard under section 548(a)(2) is not quite as straightforward; that section and its predecessors have been analyzed as intending to provide "a test of a fraud in law as distinguished from fraud in fact." 4 Collier on Bankruptcy, supra, p 548.03, at 548-43. At least one court has treated the issue of fair equivalent value as one of law, see Durrett v. Washington National Insurance, 621 F.2d 201, 203 (5th Cir.1980). The court stated, however, that it would have reached the same result under the clearly erroneous standard. Id. at 204. There is support for viewing the less than reasonably equivalent value and insolvency determinations required by section 548(a)(2) as factual determinations. See, e.g., Klein v. Tabatchnick, 610 F.2d 1043, 1047-48 (2d Cir.1979) ("Fairness of consideration is generally a question of fact" and "[i]nsolvency is also a factual question."); Braunstein v. Massachusetts Bank & Trust, 443 F.2d 1281, 1284 (1st Cir.1971) (insolvency on date of transfer a question of fact); 4 Collier on Bankruptcy, supra, p 548.09, at 548-96 to -97 ("Whether the transfer is for 'reasonably equivalent value' in every case is largely a question of fact, as to which considerable latitude must be allowed to the trier of the facts."). In this case the question of reasonably equivalent value appears to us to be a factual issue to be reviewed under the clearly erroneous standard and the question of insolvency appears at best to be a mixed question. In any event, we would affirm the bankruptcy court's finding on these two issues under either standard of review.

In finding that the redemption of Consove's shares of Roco was a fraudulent transfer under section 548(a)(2), the bankruptcy court held that Roco received less than reasonably equivalent value for the $300,000 note and security interest it gave Consove. Indeed, Roco received nothing but all of its outstanding stock. We agree with the bankruptcy court that this stock was virtually worthless to Roco. ⁷ Under generally accepted accounting...