In re Otis & Edwards, PC

• Decision Date: 02 January 1990
• Docket Number: Bankruptcy No. 82-03508-G,Adv. No. 83-1310.
• Citation: In re Otis & Edwards, PC, 115 BR 900 (Bankr. E.D. Mich. 1990)
• Parties: In re OTIS & EDWARDS, P.C., f/k/a Otis, Peters, Becker & Pietsch, P.C., f/k/a Peter R. Barbara & Associates, P.C., f/k/a Barbara, Ruby, Domol, Bowerman, Miller and Aaron, P.C., Debtor. Robert B. WEBSTER, Trustee, and United States of America, Plaintiffs, v. Peter R. BARBARA, Defendant.
• Court: U.S. Bankruptcy Court — Eastern District of Michigan

115 B.R. 900 (1990)

In re OTIS & EDWARDS, P.C., f/k/a Otis, Peters, Becker & Pietsch, P.C., f/k/a Peter R. Barbara & Associates, P.C., f/k/a Barbara, Ruby, Domol, Bowerman, Miller and Aaron, P.C., DebtorRobert B. WEBSTER, Trustee, and United States of America, Plaintiffs, v.Peter R. BARBARA, Defendant.

Bankruptcy No. 82-03508-G, Adv. No. 83-1310.

United States Bankruptcy Court, E.D. Michigan, S.D.

January 2, 1990.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Wallace M. Handler, Snyder & Handler, P.C., Birmingham, Mich., for defendant.

Robert B. Webster, Hill, Lewis, Adams, Goodrich & Tait, Detroit, Mich., Trustee.

Peter A. Jackson, Hill, Lewis, Adams, Goodrich & Tait, Detroit, Mich., for plaintiff-trustee.

David S. Grossman, Dept. of Justice, Tax Div., Washington, D.C., for U.S.

MEMORANDUM, FINDINGS OF FACT AND CONCLUSIONS OF LAW

RAY REYNOLDS GRAVES, Bankruptcy Judge.

The trustee objects to allowance of the secured claim Peter R. Barbara filed against chapter 7 debtor Otis & Edwards, P.C. based upon a February 5, 1981 promissory note and security agreement executed by Peter R. Barbara & Associates, P.C.¹This adversary proceeding is before the court following a trial on the trustee's complaint to avoid the secured obligation to Peter Barbara under 11 U.S.C. § 544(b) or to subordinate his claim under 11 U.S.C. § 510(c).The trustee also seeks to recover $93,972.67 transferred to or on behalf of Peter R. Barbara under the terms of the February 5, 1981 promissory note and monies transferred by Peter R. Barbara & Associates, P.C. to Peter R. Barbara as shareholder loans. Adv.Pro.No. 83-1310, Complaint.

The trustee claims that the obligation incurred by Peter R. Barbara & Associates, P.C. and its contemporaneous grant of a security interest in the firm's assets to secure that obligation to repurchase Peter R. Barbara's shares of stock in the law firm are voidable under state law as constructive and intentionally fraudulent conveyances.Alternatively, the trustee argues that a pro rata payment of Peter Barbara's claim would be contrary to equitable principles established under federal law and that the court should subordinate his claim to those of all other claimants.Peter Barbara admits owing $1,641,868 under a shareholder loan arrangement with the law firm on February 5, 1981.

After consideration of the testimony and exhibits introduced at trial, the legal arguments advanced on brief, and an independent review of the applicable law, this court makes the following findings of fact and conclusions of law.

I.FINDING OF FACTS

Between 1977 and February 5, 1981, Peter Barbara owned the 750 issued and outstanding shares of Peter R. Barbara & Associates, P.C., a law firm engaged almost exclusively in a plaintiff's personal injury practice.The firm had serious financial problems during the late 1970s and 1980.

Trial exhibits as well as testimony of clerical staff and of senior attorneys establish that the law firm's problems resulted in failure to pay trade creditors, clients, and taxing authorities on a timely basis.Severe cash-flow problems forced removal of a long-established computerized docketing system in 1979, and the firm became dilatory in removing closed-case files from its manual filing system.²

Exhibits establish the financial condition of the law firm on February 5, 1981, the date of the challenged transaction.A February 5 balance sheet prepared by the firm's accountant shows that the firm had only $29,414 in cash assets in late January 1981.³Among its liabilities the firm listed single business tax arrearages for 1979 through 1981 amounting to $81,995, federal tax arrearages of $684,017, and trade credit payables of $569,111.⁴Further, the firm had negotiated agreements⁵ to pay $577,058 owed to the former clients whose claims provide the basis for this proceeding.Simultaneously, Peter Barbara had increased the amount he owed on a "loan" account with the firm to $1,641,868.⁶

Testimony of the trustee's accounting expert further establishes the firm's financial condition.He calculated that the firm had a five-year weighted average net realization rate of twenty percent, evidencing availability of approximately one-half the amount of revenue generally recognized as available to partners in well-run and successful personal injury law firms.⁷In response, Peter Barbara pointed to the firm's growth pattern and necessary expenses, explaining that he had paid $20,000 per week for television advertising during the late 1970s.⁸He did not attribute the problems to his maintaining a substantial personal "loan" receivable account⁹ on the law firm's books, to the significant amounts he took as salary during those years,¹⁰ or to taking cases of little merit.¹¹

Personal legal problems occupied the time of Peter Barbara for several years prior to February 1981.Indeed, his withdrawal from the firm on February 5, 1981 preceded his suspension from the practice of law by just a few days.¹²Then, in July 1981, he pled guilty to a three-count Criminal Information charging him with mail fraud and interstate transportation of forged securities.¹³Following the plea, the court sentenced him to a 2½ year term of incarceration.

By 1980,¹⁴Peter Barbara knew that his suspension from practice was imminent and that he must sell his interest in the firm or close his practice and obtain substitute counsel for his clients.¹⁵He also knew that he had personally guaranteed many of the law firm's obligations.¹⁶In addition, he knew he had a $1,641,868 loan payable¹⁷ to the law firm and probable responsibility for accumulated tax arrearages approaching $750,000.¹⁸

Peter Barbara explored several ways to terminate his relationship with his law firm.¹⁹He failed in an attempt to sell his interest in the firm to an out-of-state attorney;²⁰ the firm's "senior" attorneys, admitted to practice less than five years, were unable or unwilling to assume ownership and management of the law firm.²¹Furthermore, Detroit area attorneys accepted referrals of contingent-fee cases on a file-by-file basis and only after careful evaluation of each file.²²Finally, referral of a contingent-fee case would result in income to Peter Barbara only when and if the substituted attorney's efforts resulted in a settlement or favorable judgment.²³

Against this factual background, Peter Barbara proposed²⁴ that Sheldon Otis acquire sole ownership of the firm by purchasing one share of stock in Peter R. Barbara & Associates, P.C. for $5,000.²⁵Peter Barbara devised a "fair arrangement"²⁶ and structured the transfer of ownership and control to Sheldon Otis,²⁷ assuming that Sheldon Otis's combined criminal defense experience and exposure to the firm's clients and their cases during his participation in Peter Barbara's criminal defense qualified him to manage the firm.²⁸According to former employees, however, Sheldon Otis demonstrated his inability to perform soon after the transfer of ownership.²⁹

On February 5, 1981, Peter R. Barbara & Associates, P.C., acting through its president Peter R. Barbara, repurchased Peter Barbara's remaining 749 shares of stock for $3,365,000.Peter Barbara, as firm president, also granted himself a security interest in firm assets³⁰ to assure the firm's performance under a ten-year payment schedule.As consideration, Peter R. Barbara agreed to return his share certificates and reaffirmed his long-standing loan obligation to the firm.³¹

Peter Barbara and his attorney tailored the stock purchase agreement to accomplish Peter Barbara's personal agenda.³²First, the parties bound their successors and assigns to the agreement.Second, Peter Barbara received an option³³ to regain a controlling interest in the law firm, contingent only upon his obtaining a license to practice law in Michigan between February 16, 1984 and February 1991.Under the agreement, Peter Barbara had twenty years to buy into the firm.Third, the parties conditioned payment of each installment to Peter Barbara upon the existence of adequate surplus as defined by Michigan statute.However, the law firm also agreed to increase the surplus by revaluing the firm assets or by changing the stated capital of the corporation at any time an insufficient surplus should prevent a full payment to Peter Barbara.³⁴

In addition, the parties agreed that a formula set forth in "Exhibit C"³⁵ to the purchase agreement established the method for determining "fair market value" of the shares of Peter R. Barbara & Associates, P.C. for purposes of the 749 share repurchase, the one-share purchase by Sheldon Otis, and any exercise of the contingent option in favor of Peter R. Barbara.

Peter Barbara admits structuring the stock transfer transaction in a way that would allow him to "maintain a firm hand in a similarly structured" law firm upon his return to practice and to secure for himself one-third of the gross fees contained in the files at his departure.³⁶He also planned that the successor firm would pay his former clients in accordance with the agreements he had executed in mid-1980, would pay doctors for past-due charges for services on settled cases, and would satisfy past-due tax obligations.³⁷Finally, he planned to repay his personal debt to the corporation through a setoff in 1991.³⁸

II.APPLICABLE LAW

The trustee"steps into the shoes" of a creditor in order to nullify transfers voidable under state law and to obtain control of property of the estate for pro rata distribution to creditors.11 U.S.C. § 544(b);N.L.R.B. v. Martin Arsham Sewing Co.,873 F.2d 884, 887(6th Cir.1989);In re Xonics Photochemical, Inc.,841 F.2d 198, 202(7th Cir.1988);American National Bank of Austin v. Mortgageamerica Corp.(In re Mortgageamerica Corp.),714 F.2d 1266(5th Cir.1983).Property that has been fraudulently conveyed should be subject to equitable distribution under the Bankruptcy Code.Martin Arsham Sewing Co.,873 F.2d at 887.

CONSTRUCTIVE FRAUD

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