Bayliss v. Rood
| Decision Date | 13 April 1970 |
| Docket Number | No. 13212.,13212. |
| Citation | 424 F.2d 142 |
| Parties | J. M. Howard BAYLISS, Appellant, v. Norman E. ROOD, Trustee in Bankruptcy, Appellee. In the Matter of WEST VIRGINIA INDUSTRIES DEVELOPMENT CORPORATION, a West Virginia corporation, Bankrupt. |
| Court | U.S. Court of Appeals — Fourth Circuit |
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Paul N. Bowles, Charleston, W. Va. (Stone, Bowles, Kauffelt & McDavid, Charleston, W. Va., on the brief), for appellant Bayliss.
Robert H. Burford, Huntington, W. Va., for petitioner Rood.
Raymond D. Battocchi, Atty., Civil Division, Dept. of Justice (William D. Ruckelshaus, Asst. Atty. Gen., Robert V. Zener, Atty., Dept. of Justice, and Milton J. Ferguson, U. S. Atty., on the brief), for respondent Small Business Administration.
Paul M. Friedberg, Charleston, W. Va., on the brief for respondent B & L Furniture Co.
Before BOREMAN, BRYAN and BUTZNER, Circuit Judges.
The sole appellant, J. M. Howard Bayliss, appeals from the judgment of the district court, which essentially approved and affirmed the holding by the Referee in Bankruptcy (hereafter Referee) that Bayliss and one Rolfe Lee were obligated to the Trustee in Bankruptcy (hereafter Trustee) in the amount of $77,266.50 plus interest,1 representing funds improperly withdrawn from the now bankrupt West Virginia Industries Development Corporation (hereafter Development or corporation).
The findings of fact by the Referee were adopted by the district court and we shall do no more than state briefly the highly pertinent facts necessary to an understanding of this opinion.
Development was organized in 1961 for the purpose of constructing resort motels, its lone project being located near Point Pleasant, West Virginia. Lee was its president, both Bayliss and Lee served as directors during its existence, and both were among its top five shareholders from the date of its organization.
Development obtained an authorization from the Area Redevelopment Administration on May 11, 1964, for a loan to be made by the Small Business Administration (hereafter SBA) in the amount of $1,041,500, upon certain terms and conditions to be met by the corporation. Construction of the motel was begun in June of 1964, and a $400,000 loan to the corporation from Huntington Trust & Savings Bank was closed in September 1964. Between the beginning of construction and the closing of the $400,000 loan Development had exhausted its cash capital obtained through sale of its stock and further funds were required to meet payments due the contractor. In July and August of 1964, Bayliss furnished $95,000 and Lee $55,000 to Development with which to meet the contractor's demands and these advancements were evidenced by notes of the corporation.
The SBA loan of $1,041,500 was closed near the end of October of 1964, but prior to this closing and the making of the initial disbursement thereunder representatives of the SBA insisted that the corporation obtain working capital of $125,000 (required under the Area Redevelopment Administration's authorization of the SBA loan) as well as an additional $25,000 to meet possible overruns necessary to the completion of the project. In order to comply with these requirements Development obtained an agreement (hereafter tripartite agreement) by Bayliss and Lee that the $150,000 which they had previously advanced would remain in the project on a permanent basis in order to complete facilities and provide working capital. This agreement was reduced to writing in the form of letter agreements from Bayliss and Lee, dated November 2, 1964, and October 30, 1964, respectively. In this tripartite agreement, Bayliss and Lee reserved three options: (1) they could treat the $150,000 advancement as a loan to the corporation and receive a subordinated note; (2) they could treat the $150,000 advancement as a purchase of capital stock of the corporation; or (3) they could procure purchases of capital stock of the corporation by others in a like amount so as to permit the release of their $150,000.
Thereafter, without the knowledge of SBA and in violation of their agreement to leave the funds in the corporation on a permanent basis, Bayliss and Lee maneuvered the return of $125,000 of the $150,000 which they had advanced. Bayliss received his entire advancement of $95,000 and Lee received $30,000 of the $55,000 which he had advanced. Subsequently, Bayliss and Lee obtained an agreement from SBA that they might temporarily withdraw the $150,000 provided that Bayliss and Lee would restore any withdrawn funds upon demand by Development or by SBA. This agreement as to temporary withdrawal was evidenced in part by a letter agreement executed by Bayliss, Lee and Development dated December 14, 1964, and in part by a demand note of the same date executed by Bayliss and Lee payable to the corporation in the amount of $150,000.
In early May 1965, the corporation became insolvent in the sense that it was unable to pay its debts as they matured, and it became insolvent in the sense that its liabilities exceeded the fair value of its assets on June 4, 1965. Although the resort was opened for business on June 4, 1965, Development was without sufficient funds to pay the full cost of the project or to operate the resort which eventually closed on February 15, 1966.
In July and August of 1965, the SBA made demand upon Bayliss and Lee to restore the withdrawn $125,000 pursuant to the terms of the tripartite agreement, but they notified SBA that they did not intend to repay that amount. Development made no formal demand on Bayliss and Lee for payment. Litigation ensued, the Referee and the district court ruled that Bayliss and Lee were liable to the Trustee for the funds withdrawn from the corporation, and Bayliss alone prosecutes this appeal.
Bayliss now asserts that the district court erred in the following particulars: (1) in finding that the $125,000 recovered from Development by Bayliss and Lee was impressed with a trust in favor of Development or its creditors; (2) in failing to hold that the tripartite agreement constituted an executory contract which has since become unenforceable; and (3) in failing to allow Bayliss and Lee to set off Development's obligation to them which would have arisen immediately upon Bayliss' and Lee's tender to the corporation of the withdrawn $125,000.
In passing upon the asserted error (1) above the district court said:
"In view of this fiduciary relationship betwen Lee and Bayliss and the corporation and the circumstances surrounding the transactions at issue in this proceeding, it is our opinion that the Referee was justified in finding that under such circumstances equity would impose a trust so as to bind Bayliss and Lee as trustees with an obligation to restore the unremitted funds."
It is well established that a controlling stockholder, director or officer of a corporation occupies a fiduciary relationship to the corporation.2 As such fiduciaries, their powers are powers in trust, their dealings with the corporation are subject to rigorous scrutiny, and they must bear the burden of proving the good faith and inherent fairness of their transactions with the corporation. Pepper v. Litton, 308 U.S. 295, 60 S.Ct. 238, 84 L.Ed. 281 (1939). The record clearly shows that Bayliss and Lee agreed to leave their cash advancement of $150,000 with Development on a permanent basis. Their surreptitious...
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