Bank of Commerce v. Rosemary & Thyme, Inc.

• Decision Date: 13 January 1978
• Docket Number: No. 761502,761502
• Citation: 218 Va. 781,239 S.E.2d 909
• Parties: BANK OF COMMERCE v. ROSEMARY AND THYME, INC., et al. Record
• Court: Virginia Supreme Court

Page 909

239 S.E.2d 909

218 Va. 781

BANK OF COMMERCE v. ROSEMARY AND THYME, INC., et al.

Record No. 761502.

Supreme Court of Virginia.

Jan. 13, 1978.

Jon Marsh Worden, Richmond (Cantor & Cantor, Richmond, on briefs), for appellant.

Edward T. Caton, Virginia Beach (Barry Randolph Koch, Richmond, on brief), for appellees.

Before I'ANSON, C. J., and CARRICO, HARRISON, COCHRAN, HARMAN and COMPTON, JJ.

COMPTON, Justice.

In this creditors' rights suit, we consider whether a fraudulent conveyance has been made by an insolvent corporation.

In March of 1976, appellant Bank of Commerce, the plaintiff below, filed a bill in equity against appellees Rosemary and Thyme, Inc., Edmund C. Ruffin, Nabil D. Kassir and Khalid A. Kassir seeking relief under Code § 55-80. ¹ Plaintiff, a creditor of Rosemary and Thyme, Inc., alleged that the corporate defendant, acting through the individual defendants, its directors, made a payment to another creditor-bank, the Peoples Bank of Virginia Beach, with intent to hinder, delay and defraud defendant's creditors. The defendants demurred on the grounds that (1) the plaintiff had a "full, adequate and complete remedy at law for money damages" and (2) the payment to Peoples Bank "was not, in law, a fraudulent conveyance."

The trial court overruled the demurrer as to ground one and sustained it as to ground two, dismissing the suit in a September 1976 decree from which we granted plaintiff an appeal. Defendants assigned cross-error to the action of the chancellor in overruling the demurrer on ground one, but in the view we take of the case, it is necessary to discuss only the correctness of the trial court's action in sustaining the demurrer.

The plaintiff's bill of complaint states the following case, the effect of the demurrer being to admit as true all material facts which are well-pleaded. From November of 1973 to August of 1974, the defendant corporation, engaged in the retail sale of women's clothing, became indebted to the plaintiff for $1,805.05. Judgment in that amount was obtained on some unspecified date and remains unsatisfied.

On April 17, 1975, "and prior thereto," defendant corporation "was unable to pay its trade indebtedness to creditors and was insolvent". In March of that year, the said defendant "was indebted" to Peoples Bank in the amount of $7,215.17 "by virtue of a promissory note" on which the individual defendants, "officers, directors and the controlling stockholders" of the defendant corporation, "were endorsers or co-makers". On March 15, 1975, the corporate defendant "used $7,215.17 of its assets for the purpose of applying it to the indebtedness to the Peoples Bank" thereby releasing, it is alleged, the individual defendants from liability in that amount.

The plaintiff further asserted that the payment to Peoples Bank "had the effect of preferring (the individual defendants) with respect to their secondary liability on said promissory note and was accomplished in order to hinder, delay and defraud creditors of (the corporate defendant) including this Plaintiff."

In its prayer for relief, plaintiff asked, inter alia, that the defendants be required to "restore" all funds which were paid to satisfy the Peoples Bank indebtedness; that defendants be forced to account for all sums received from debtors of the corporate defendant and for the application of such funds; that a receiver be appointed for the corporate defendant; that the claims and priorities of all creditors of the defendant corporation be established; and that a money judgment be entered against the individual defendants "to the extent that they may be liable by reason of the fraudulent acts complained of."

Upon consideration of the pleadings the chancellor, in sustaining the demurrer, determined "that the facts as alleged do not show an unlawful preference."

The demurrer, of course, tests the legal sufficiency of the bill of complaint. The question presented is whether this payment of a promissory note, upon which the controlling officers, directors and stockholders were secondarily liable as endorsers, which note evidenced a debt of the insolvent corporation incurred before insolvency, was an invalid preference which constituted a fraudulent conveyance as to the corporation's unsecured creditors.

Preliminarily, settled principles should be reviewed. In Virginia, not all preferential transfers are invalid. At common law and under Code § 55-80, supra, an insolvent debtor may generally make a valid transfer of a portion or the whole of his assets to a bona fide creditor on account of an existing indebtedness, if that is the sole purpose of the debtor and the transfer is for full value. Surratt v. Eskridge, 131 Va. 325, 335, 108 S.E. 677, 680 (1921). This is true even though such transfer may and is intended by the debtor and creditor to give such creditor a preference to the exclusion of others in the distribution of the debtor's assets. Id. This rule applies to corporations, Beck v. Semones' Adm'r, 145 Va. 429, 436, 134 S.E. 677, 679 (1926), ² which are not banks or trust companies. ³ But if the purpose to make a bona fide preference is merely incidental to the transaction and is used as a cloak for some other purpose which is fraudulent in actual intent, the transfer is invalid. 131 Va. at 335, 108 S.E. at 680.

In order to set aside a preference, the plaintiff must not only prove that the debtor intended to delay, hinder or defraud his other creditors, he must also show that the preferred creditor had notice of such intent. Hutcheson v. Savings Bank, 129 Va. 281, 291-92, 105 S.E. 677, 681 (1921). Under the last sentence of the statute, supra, the transfer to an innocent grantee who has given value will be sustained. But proof of actual knowledge of the debtor-grantor's fraudulent intent is not necessary, it being sufficient to show that the grantee had "knowledge of such facts and circumstances as would have excited the suspicion of a man of ordinary care and prudence, and put him upon such inquiry as to the bona fides of the transaction as would necessarily have led to the discovery of the fraud of the grantor . . . ." Crowder v. Crowder, 125 Va. 80, 87-88, 99 S.E. 746, 748 (1919).

Against this background, we examine the arguments of the respective parties. Plaintiff relies on Darden v. George G. Lee Co., 204 Va. 108, 129 S.E.2d 897 (1963). In that case, Darden personally advanced $22,500 to the Ricks Company during a 1958 creditors' arrangement under the federal bankruptcy act. In return for that loan, Darden took promissory notes from the company and also received 50 percent of its common stock. He was then elected a director and secretary-treasurer of the corporation. The company continued in business, but in 1960 became insolvent and Darden decided to liquidate it. At that time, there were only two creditors of the Ricks Company Darden to the extent of the $22,500, as evidenced by the notes, and George G. Lee Co. in the amount of $20,000, for materials and supplies purchased by the Ricks Company. When it was ascertained that the assets of Ricks were insufficient to satisfy both debts, Darden took an assignment of all the company's accounts receivable. These accounts constituted the sole remaining assets of the insolvent corporation and left nothing from which the Lee Company could satisfy the sum due it.

This court held the transfer to Darden amounted to a fraudulent conveyance. We noted that the transferor's intent was to delay and hinder the creditor Lee Company from satisfying its claim and because Darden the preferred creditor, was in complete control of the financial affairs of the debtor corporation, he was chargeable with that intent. We said:

"The weight of authority seems to be that the directors of an insolvent corporation, who are also creditors of the corporation, have no right to grant themselves a preference or an advantage over other creditors in the payment of their claims. This rule is based upon simple justice. (Citations omitted)" 204 Va. at 112, 129 S.E.2d at 900.

The plaintiff thus contends that the effect of the payment of the note in this case, in which the corporate officers were in control of the corporation, was exactly the same as if the corporation had made the payment directly to the officers. Plaintiff argues that in view of the insolvency of the defendant corporation, the individual defendants would ultimately be called upon individually to pay the note as endorsers. Therefore, the plaintiff urges, it is immaterial how the funds were transferred from the corporation to pay the note because the result is the same, i. e., the defendant corporate officers have been released from their individual obligation to pay the indebtedness of the sinking corporation, and thus have created a preference for themselves.

The defendants contend, however, that the preference was valid and primarily rely on Planters Bank v. Whittle, 78 Va. 737 (1884), in which this court sustained the right of a director to grant himself a preference if such preference was made in good faith and without fraud. In that case, Planters Bank of Farmville discounted for the Farmville Insurance and Banking Company certain negotiable notes upon which one or more of the directors of the company were accommodation endorsers, the company having agreed to indemnify the endorsers. All but one of the notes were from time to time renewed and the amount of indebtedness to the bank on account of the notes became $23,529.52. To satisfy this debt, the directors ordered that the company assign to the bank certain bonds, which were...