Moody v. Security Pacific Business Credit, Inc.

• Decision Date: 07 August 1992
• Docket Number: No. 91-3544,91-3544
• Citation: 971 F.2d 1056
• Parties: , 23 Bankr.Ct.Dec. 467, Bankr. L. Rep. P 74,792 James MOODY, Trustee of the Estate of Jeannette Corporation and the Committee of Unsecured Creditors of Jeannette Corporation v. SECURITY PACIFIC BUSINESS CREDIT, INC., the Coca-Cola Bottling Company of New York, Inc., KNY Development Corp., J. Corp., John P. Brogan, John J. Brogan, Hanley Dawson, III, James A. McLean, James R. Winoker, Robert M. Janowiak, Alan MacLachlan, Interdyne, Inc., Muench-Kreuzer Candle Company v. Frank W. STOREY, Calvin MacCraken, Individuals, James Moody, Trustee of the Estate of Jeannette Corporation, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

Page 1056

971 F.2d 1056

61 USLW 2142, 23 Bankr.Ct.Dec. 467, Bankr.

L. Rep. P 74,792

James MOODY, Trustee of the Estate of Jeannette Corporation

and the Committee of Unsecured Creditors of

Jeannette Corporation v. SECURITY PACIFIC BUSINESS CREDIT, INC., the Coca-Cola

Bottling Company of New York, Inc., KNY Development Corp., J. Corp., John P. Brogan, John J. Brogan, Hanley Dawson, III, James A. McLean, James R. Winoker, Robert M. Janowiak, Alan MacLachlan, Interdyne, Inc., Muench-Kreuzer Candle Company v. Frank W. STOREY, Calvin MacCraken, Individuals, James Moody, Trustee of the Estate of Jeannette Corporation,

Appellant.

No. 91-3544.

United States Court of Appeals, Third Circuit.

Argued Feb. 25, 1992.

Decided Aug. 7, 1992.

Robert J. Cindrich (argued), David B. Mulvihill, Cindrich & Titus, Douglas A. Campbell, Campbell & Levine, Pittsburgh, Pa., for appellant.

William F. Lloyd (argued), Michael J. Sweeney, Sidley & Austin, Chicago, Ill., James D. Morton, Buchanan Ingersoll Professional Corp., Pittsburgh, Pa., for appellee Security Pacific Business Credit, Inc.

George E. McGrann (argued), David J. Armstrong, Dickie, McCamey & Chilcote, Pittsburgh, Pa., Philip M. Halpern, Collier, Cohen, Shields & Bock, New York City, for appellees The Coca-Cola Bottling Co. of New York, Inc. and KNY Development Corp.

Robert B. Sommer (argued), H. Woodruff Turner, Terry Budd, Kirkpatrick & Lockhart, Pittsburgh, Pa., for appellees J. Corp., John P. Brogan, John J. Brogan, Hanley Dawson, III, James A. McLean, James R. Winoker, and Muench-Kreuzer Candle Co.

Before: SLOVITER, Chief Judge, and SCIRICA and NYGAARD, Circuit Judges.

OPINION OF THE COURT

SCIRICA, Circuit Judge.

This bankruptcy case requires us to address, once again, the application of the fraudulent conveyance laws to a failed leveraged buyout. In United States v. Tabor Court Realty Corp., 803 F.2d 1288, 1297 (3d Cir.1986), cert. denied sub nom. McClellan Realty Corp. v. United States, 483 U.S. 1005, 107 S.Ct. 3229, 97 L.Ed.2d 735 (1987), we established that the Pennsylvania Uniform Fraudulent Conveyance Act (UFCA) extends to leveraged buyouts. This case raises several questions about the application of this Act to the failed leveraged buyout of Jeannette Corporation.

On July 31, 1981, a group of investors acquired Jeannette in a leveraged buyout. Less than a year and a half later, Jeannette, which had been profitable for many years, was forced into bankruptcy. The bankruptcy trustee brought this action to set aside the advances made and obligations incurred in connection with the acquisition. The trustee alleges that the leveraged buyout constitutes a fraudulent conveyance under the UFCA and is voidable under the Bankruptcy Code. After a bench trial, the district court entered judgment for defendants. Moody v. Security Pac. Business Credit, Inc., 127 B.R. 958 (W.D.Pa.1991). We will affirm.

I

A

Founded in 1898, Jeannette Corporation manufactured and sold glass, ceramic, china, plastic, and candle houseware products in the United States and Canada. ¹ For many years, Jeannette was a profitable enterprise. From 1965 to 1978, its annual net sales grew on a consolidated basis from $9.6 million to $61.7 million and its annual gross profit margin ranged from 18% to 32.9%. In each of those years, Jeannette earned a net profit. From 1975 to 1977, Jeannette's sales increased annually by 16%. Its consolidated pre-tax profit was $3.4 million in 1977 and $6.1 million in 1978.

In 1978, the Coca-Cola Bottling Company of New York, Inc. acquired Jeannette for $39.6 million. Shortly thereafter, Coca-Cola increased the total net book value of Jeannette's property, plant, and equipment (PP & E) by $5.7 million after a manufacturer's appraisal valued these assets at $29 million. From 1978 to 1981, Coca-Cola invested $6 million in Jeannette for capital expenditures, and $5 million for maintenance and repair of its physical plant.

At first, Jeannette was not as profitable under Coca-Cola's ownership. It suffered a consolidated $5 million pre-tax loss in 1979, in part because of the adoption of new valuation procedures for inventory, and net sales fell by $4 million. However, Jeannette's performance rebounded in 1980. Net sales increased by $9 million and the company's gross profit margin doubled. Although 1980 was a break-even year before recognition of acquisition costs, Jeannette reported a $1.3 million pre-tax profit and had a $3 million positive cash flow.

Jeannette projected that this trend would continue into 1981. Although Jeannette had an operating loss of $1.1 million in the first half of 1981, because its business cycle produced stronger cash flows in the latter half of the year, the company projected a pre-tax profit of $500,000 before interest expenses.

B

In late 1979, Coca-Cola decided to sell Jeannette and focus attention on its core bottling business. In June 1981, John P. Brogan expressed an interest in acquiring Jeannette. Brogan was affiliated with a small group of investors in the business of acquiring companies through leveraged buyouts, the hallmark feature of which is the exchange of equity for debt. ² On July 22, 1981, Coca-Cola agreed to sell Jeannette for $12.1 million on condition that Brogan complete the transaction by the end of the month.

Brogan contacted Security Pacific Business Credit Inc., a lending group that had financed one of his prior acquisitions, about obtaining financing. He submitted one year of monthly projections, based in large part on Jeannette's 80-page business plan for 1981, which showed that Jeannette would have sufficient working capital under the proposed financing arrangement in the year following the acquisition. Before agreeing to finance the transaction, however, Security Pacific undertook its own investigation of Jeannette.

Security Pacific assigned this task to credit analyst Stephen Ngan. Based on his discussions with Jeannette personnel and a review of the company's financial records, Ngan made his own set of projections. He concluded that Jeannette would earn a pre-tax profit of $800,000 after interest expenses in its first year of operation, and recommended that Security Pacific finance the acquisition. He thought Jeannette was a "well-established" company with "a good track record for growth and earnings."

After reviewing Ngan's recommendation, together with an inventory report, the 1978 appraisal of Jeannette's PP & E, Brogan's projections, and a 55-page report on Jeannette prepared by another bank, Security Pacific decided to finance the acquisition. At that point, Coca-Cola formally approved the sale of Jeannette to J. Corp., which had been incorporated for the purpose of acquiring Jeannette.

C

The acquisition of Jeannette was consummated on July 31, 1981. J. Corp. purchased Jeannette with funds from a $15.5 million line of credit Security Pacific extended Jeannette secured by first lien security interests on all Jeannette's assets. J. Corp. never repaid Jeannette any portion of, or executed a promissory note for, the amount ($11.7 million) Security Pacific initially forwarded to J. Corp. on behalf of Jeannette to finance the acquisition. Other than new management, the only benefit Jeannette received was access to credit from Security Pacific. ³

As with most leveraged buyouts, the acquisition left Jeannette's assets fully encumbered by the security interests held by Security Pacific. Jeannette could not dispose of its assets, except in the ordinary course of business, without the consent of Security Pacific, and was prohibited from granting security interests to anyone else. As a result, Jeannette's sole source of working capital after the transaction was its line of credit with Security Pacific.

Although Jeannette's total outstanding balance never exceeded the amount of the initial advance ($11.7 million), the total credit advanced Jeannette was many times this amount because of the "revolving" nature of its line of credit with Security Pacific. Jeannette's accounts receivable were forwarded to Security Pacific by way of the Mellon Bank, and were credited against its outstanding loan balance. As this balance was paid down, more credit was made available, which Jeannette drew on to finance operations and generate sales.

Although the initial advance was payable on demand, Jeannette carried this obligation as long-term debt. This reflected the parties' understanding that the transaction would give rise to a long-term lending relationship in which the balance on the revolving credit facility would be paid down over several years. Security Pacific obtained no up-front fees and stood to profit by earning interest on the line of credit at 3 1/4% above prime (at that time about 20%).

D

Jeannette operated as a going concern from the latter half of 1981 into 1982. From August through December 1981, its net sales exceeded $31 million and the company realized a $6 million gross profit. During the same period, Jeannette had a positive cash flow of $3 million. Part of Jeannette's success during this period is attributable to its business cycle, which produced stronger cash flows in the latter half of the year.

By the end of 1981, Jeannette had received over $43 million in credit advances from Security Pacific, and had $4 million of available credit. A year after the leveraged buyout Jeannette had received $77 million in advances, and had $2.3 million in available credit. Jeannette never exhausted its credit and Security Pacific never refused a request for funds, although on several occasions it suggested that Jeannette withdraw smaller amounts.

Although Jeannette's performance initially tracked expectations, its financial condition deteriorated steadily in 1982. Jeannette experienced a shrinking domestic glassware market, a marked increase in foreign competition, dramatic price slashing and inventory dumping by its domestic competitors, and a continued nationwide recession. In January 1982, orders for...