American Discount Corp. v. Saratoga West, Inc.

• Decision Date: 14 July 1975
• Docket Number: No. 2486--I,2486--I
• Citation: 537 P.2d 1056,13 Wn.App. 890
• Parties: AMERICAN DISCOUNT CORPORATION, Respondent, v. SARATOGA WEST, INC., a corporation, et al., Defendants, Mission Ridge Estates, a limited partnership, Appellant, James O. Neal, as Trustee in Bankruptcy of Mission Ridge Estates, and Central Washington Bank, a Washington Banking Corporation, Defendants.
• Court: Washington Court of Appeals

Page 890

13 Wn.App. 890

537 P.2d 1056

AMERICAN DISCOUNT CORPORATION, Respondent, v. SARATOGA WEST, INC., a corporation, et al., Defendants Mission Ridge Estates, a limited partnership, Appellant James O. Neal, as Trustee in Bankruptcy of Mission Ridge Estates, and Central Washington Bank, a Washington Banking Corporation, Defendants.

No. 2486--I.

Court of Appeals of Washington, Division 1.

July 14, 1975.

Rehearing Denied Sept. 29, 1975.

Whitmore & Warren, David J. Whitmore, Wenatchee, for appellant.

A. J. Westberg, Seattle, for respondent.

WILLIAMS, Chief Judge.

This action was commenced by American Discount Corporation against Saratoga West, Inc., to foreclose a real-estate mortgage. After the action was instituted, Mission Ridge Estates, a limited partnership, filed a complaint in intervention based upon unsecured promissory notes issued by Saratoga West. Following a hearing, judgment was entered denying such complaint and foreclosing the mortgage. Mission Ridge's appeal, in which it was successful is reported in American Discount Corp. v. Saratoga West, Inc., 81 Wash.2d 34, 499 P.2d 869 (1972).

When the case was returned to the Superior Court, American Discount answered the complaint in intervention, and the cause went to trial on the issue of whether the notes and mortgage of Saratoga West to American Discount should be subordinated to the claim of Mission Ridge on Saratoga West's unsecured notes, which totaled $77,839.85, plus $35,008.52 interest. The trial court found for American Discount, entering judgment confirming the foreclosure decree and dismissing the complaint of Mission Ridge with prejudice. This appeal followed.

Although some of the facts are recited in the earlier report, the evidence introduced at the trial on behalf of Mission Ridge gives a clearer understanding of the situation. Essentially, it appears that American Discount is a corporation owned by Edward F. Stern, Sr., and Sol Esfeld, which, for a number of years, has engaged in the loan business. Saratoga West is a corporation formed by Stern, Esfeld and two others, Elmer C. Hovik and Don Minor, for the purpose of developing a parcel of real estate located on Whidbey Island. It commenced business with paid-in capital of $60,000. Most of this was used to make the down payment on a contract for the purchase of the land to be developed. To finance the initial stages of the enterprise, American Discount agreed to advance $100,000 to Saratoga West, to be secured by a first mortgage (subject to the vendor's interest in the real-estate contract) upon the real estate of Saratoga West. It was anticipated by all concerned, that once the development got under way, the flow of cash arising from the sale of lots would supply the remaining financial requirements.

American Discount loaned a total of $130,000 to Saratoga West before calling a halt. Saratoga West then borrowed $77,839.85 from Mission Ridge, as evidenced by a series of unsecured notes bearing interest as 12 percent per annum. This proved to be insufficient, Saratoga West defaulted on its obligations to American Discount, and the proceeding to foreclose the mortgage was instituted. By its complaint in intervention, Mission Ridge seeks to have American Discount's mortgage subordinated to the unsecured notes, on the theory that Saratoga West was undercapitalized, and that the money loaned to it by American Discount, which was secured by the mortgage, was in reality a contribution to capital by Stern and Esfeld. The rationale for the theory is best expressed by Judge Learned Hand in In re V. Loewer's Gambrinus Brewery Co., 167 F.2d 318, 320 (2d Cir. 1948), as follows:

Both the shareholders and the creditors in any enterprise assume some risk of its failure, but their risks are different. The shareholders stand to lose first, but in return they have all the winings above the creditors' interest, if the venture is successful; on the other hand the creditors have only their interest, but they come first in distribution of the assets. Beneficially considered, the same persons are both creditors and shareholders, when they have organized into two corporations under a single control. If in such a case they are allowed to prove in insolvency on a parity with other creditors, as shareholders of the debtor they can use their control to take all the winnings which may be made on their advances while the company is successful, yet they will expose themselves only to creditors' risks, if it fails. That is unfair to other creditors regardless of whether they know that the shareholders of the debtor corporation have this power through their common ownership; for every creditor rightly assumes that his risk is measured by the collective claims of other creditors, and by creditors he understands those alone, who like him, have only a stipulated share in the profits. To compel him to divide the assets in insolvency with those who at their option have all along had power to take all the earnings, is to add to the risk which he accepted.

This reasoning only applies however to cases in which, as here, the shareholders are the same in both corporations, and in which the shares in each are divided so nearly alike that the majority in each can lawfully act for all in any dealings between the two. It may be asked why the same principle does not apply to a loan made by a single shareholder, at least to so much of any advance he may make as his shares represent of all the shares outstanding. My answer is that, unless he also controls the debtor corporation, he cannot decide whether his loan shall be paid, or whether it shall remain as a part of the capital of the debtor contributing to profits in which he will share as one of the debtor's shareholders. Even to that limited extent he does not therefore enjoy the advantage of the ambivalent position of the shareholders collectively of two corporations under a common control.

Mission Ridge strenuously argues that the court should 'pierce the corporate veil' of American Discount and thereby disclose that Stern and Esfeld defrauded the general creditors of Saratoga West by supplying it with insufficient initial capital and then securing their investment by the device of the first mortgage from Saratoga West to American Discount, which they own. It does seem that Stern and Esfeld placed themselves in the position of having 'all the winnings' if the venture succeeded and all of the assets if the venture failed, as it did. The applicable...