805 F.2d 719 (7th Cir. 1986), 85-3162, Matter of Prescott

Docket Nº:85-3162, 85-3177 and 85-3203.
Citation:805 F.2d 719
Party Name:In the Matter of John B. PRESCOTT and Janet L. Prescott, Debtors. Appeals of MARINE BANK DANE COUNTY, Gateway Foods, Inc. & Jerry J. Armstrong, Trustee.
Case Date:November 04, 1986
Court:United States Courts of Appeals, Court of Appeals for the Seventh Circuit

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805 F.2d 719 (7th Cir. 1986)

In the Matter of John B. PRESCOTT and Janet L. Prescott, Debtors.

Appeals of MARINE BANK DANE COUNTY, Gateway Foods, Inc. &

Jerry J. Armstrong, Trustee.

Nos. 85-3162, 85-3177 and 85-3203.

United States Court of Appeals, Seventh Circuit

November 4, 1986

Argued June 10, 1986.

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Patricia M. Gibeault, Brynelson, Herrick, Bucarda & Dorschel, Madison, Wis., for Marine Bank Dane County.

Michael J. Collard, Minahan & Peterson, S.C., Milwaukee, Wis., for Gateway Foods.

Deniz N. Gursoy, Murphy & Desmond, S.C., Madison, Wis., for trustee.

Before WOOD, CUDAHY and FLAUM, Circuit Judges.

CUDAHY, Circuit Judge.

John and Janet Prescott (the "debtors") funded their purchase of a Wisconsin grocery store with a loan from appellant Marine Bank Dane County that was secured, inter alia, by the store's inventory and accounts receivable. Appellant Gateway Foods, Inc. held a junior interest in this security. The debtors filed for bankruptcy in the United States Bankruptcy Court for the Western District of Wisconsin. The bankruptcy court found that during the preference period preceding this filing, Marine had received preferential transfers of $40,733.33, resulting from its taking possession of the Prescotts' certificate of deposit, receiving payment for overdrafts in their bank accounts and offsetting debtors' positive balance accounts, 51 B.R. 751. The bankruptcy court found these transfers resulted in an indirect benefit to Gateway of $59,643.71. The United States District Court for the Western District of Wisconsin affirmed the bankruptcy court's findings as to Marine but in part reversed the findings as to Gateway. The district court held that an indirect beneficiary could not be found to have benefited from another creditor's setoff and that the bankruptcy court had erred in not considering Gateway's

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extension of new value in computing the size of its preference. We reverse the judgment of the district court to the extent that its findings depart from the judgment of the bankruptcy court, thus in effect reinstating the bankruptcy court findings.

John Prescott became manager of a Gateway Foods Store in Monona, Wisconsin, in November 1980. One year later, he purchased the Monona store with a $396,000 demand note from Gateway, secured by an interest in all the store's inventory and equipment. Five days later, Prescott purchased a second Gateway store in Stoughton, Wisconsin. Gateway was the sublessor of the Stoughton store and was granted certain security interests in that store's inventory and equipment to secure lease payments and payment for other goods and services it provided to Prescott.

In December 1982, John Prescott purchased a third Gateway store on East Washington Avenue in Madison, Wisconsin (the "East Washington store"). Gateway referred Prescott to Marine Bank, which loaned him $125,000 for the purchase. Marine's loan was secured by a perfected senior security interest in the East Washington store's inventory, equipment and accounts receivable. As additional security for Marine's loan, Prescott agreed to deliver a $45,000 certificate of deposit within 60 days. Marine took possession of the certificate on March 17, 1983. Marine was also secured by any credit balances in Prescott's bank accounts at Marine and by all property secured by future security agreements between Marine and Prescott. Prescott maintained three accounts with Marine--a business savings account and two separate checking accounts for the Monona and East Washington stores. Gateway agreed to guarantee one half of the declining balance of Prescott's $125,000 note to Marine.

As with the Monona store, Gateway was the sublessor for the East Washington store and acted as its primary supplier. As with the Stoughton store, Gateway received a second lien on the store's inventory and equipment. Gateway also performed many other services for Prescott, including providing advance funds for payroll expenses and taxes and providing accounting services. Between March 17, and March 31, 1983, Gateway made advances to Prescott and extended credit totaling $148,474,48. Gateway was reimbursed only $51,990 for these advances. After many of Prescott's checks to Gateway were returned for insufficient funds and after Gateway determined that its security interest in Prescott's stores had decreased, Gateway took over the three Prescott stores on March 31, 1983.

Gateway notified Marine of its actions on April 4, 1983. Thereafter, Marine deemed itself undersecured on its note from Prescott. Marine froze Prescott's three accounts, containing a total positive balance of $18,353.59 and offset this amount against Prescott's indebtedness on his note, which then had a balance of $121,920.49. On June 3, 1983, Marine cashed in the certificate of deposit, receiving proceeds of $34,290.12, and applied this against Prescott's indebtedness.

Prescott filed for relief under Chapter 7 of the Bankruptcy Code, 11 U.S.C. Sec. 701 et seq., on June 14, 1983 in the United States Bankruptcy Court for the Western District of Wisconsin. On November 23, 1983, the trustee of the debtors' estate, Jerry J. Armstrong, brought an adversary proceeding to recover alleged preferential transfers to Marine and indirect transfers to Gateway.

The bankruptcy court determined that on March 16, 1983, the date the preference period began, Marine was owed $172,467.33. This represented the balance of $121,919.73 on the loan and bank account overdrafts of $50,547.60. 1 The bankruptcy court found that after the preference period began, Marine received bank deposits that eliminated the overdraft and left a positive balance of $18,353.59. That positive

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balance was offset on April 4. In June, Marine cashed in the certificate of deposit, receiving proceeds of $34,290.12. The bankruptcy court ruled that the setoff and the cashing of the certificate were preferential transfers to the extent that Marine had been undersecured on March 16. The court determined that as of March 16 Marine was undersecured by $40,733.33--the difference between $172,467.33 owed and the value of Marine's collateral on that date, which the court found to be $131,734. This collateral consisted of inventory and accounts receivable in the East Washington store valued at $130,000 and a positive savings account balance on that date of $1,734.

Gateway as junior lienholder benefited from the improvement in Marine's position. 2 The bankruptcy court found that as Marine's debt secured by the East Washington store inventory decreased, Gateway's security was thereby increased dollar for dollar. This, the court determined, resulted in an indirect preferential transfer to Gateway to the extent the amount transferred to Marine reduced the fund for payment to other creditors with unsecured claims. The court found Gateway to have been indirectly preferred in the amount of $59,643.71--the amount by which Marine's security exceeded its claim. 3

The bankruptcy court entered judgment against Marine and Gateway jointly in the amount of $40,733.33 and against Gateway individually in the amount of $18,910.93.

Both Marine and Gateway appealed the bankruptcy court's decision to the district court. On that appeal, Marine raised three issues. First, it contended that the bankruptcy court abused its discretion in allowing and considering testimony concerning the overdrafts on Prescott's bank accounts during the preference period. Second, Marine argued that the bankruptcy court erred in denying Marine's motion to dismiss because the trustee never proved that Marine received a preference as defined in 11 U.S.C. Sec. 547(b). No preference was shown, Marine argued, because the trustee never established the value of Marine's collateral on March 16, 1983, and thus never showed Marine to be undersecured. Finally, Marine contended that, assuming the value of collateral was established, the bankruptcy court erred in computing the amount of Marine's preference because it failed to consider proceeds of collateral in estimating the value of the March 16 collateral and did not take into account exchanges for new value made during the preference period as is required by 11 U.S.C. Sec. 547(c)(1) and (4). The district court affirmed the bankruptcy court's findings on these points.

Gateway also raised three issues on appeal before the district court. First, it claimed it was not liable for Marine's setoff of Prescott's accounts or for Prescott's payments of overdrafts existing on March 16, 1983. Second, Gateway argued it was not liable for Prescott's transfer of the certificate of deposit. Third, Gateway raised an argument similar to Marine's,

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arguing that because the trustee never established the value of Marine's collateral and thus Marine's undersecurity, he also did not establish that Gateway received an indirect preference; the bankruptcy court therefore erred in finding Gateway liable under 11 U.S.C. Sec. 547(b).

The district court agreed that Gateway was not responsible for Marine's setoff. The court read 11 U.S.C. Sec. 553 to prohibit a trustee from recovering a setoff from an indirect beneficiary. The court also agreed with Gateway that new value had been transferred after March 17, 1983 that offset Gateway's liability for the certificate of deposit. While reversing the bankruptcy court on these points, the district court agreed that Gateway was indirectly benefited by Prescott's repayment of the overdrafts and that Marine's undersecurity was sufficiently established to find Gateway to have received an indirect preference of $50,546.84. The district court found Marine and Gateway jointly liable to the trustee for $31,636.46, Marine individually liable for $9,096.83 and Gateway...

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