Boyer v. Crown Stock Distribution, Inc.

• Citation: 587 F.3d 787
• Decision Date: 18 November 2009
• Docket Number: No. 09-1861.,No. 09-1699.,09-1699.,09-1861.
• Parties: R. David BOYER, Plaintiff-Appellee/Cross-Appellant, v. CROWN STOCK DISTRIBUTION, INC., et al., Defendants-Appellants/Cross-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

587 F.3d 787

R. David BOYER, Plaintiff-Appellee/Cross-Appellant, v. CROWN STOCK DISTRIBUTION, INC., et al., Defendants-Appellants/Cross-Appellees.

No. 09-1699.

No. 09-1861.

United States Court of Appeals, Seventh Circuit.

Argued October 9, 2009.

Decided November 18, 2009.

Scot T. Skekloff, Skekloff, Adelsperger & Kleven, Fort Wayne, IN, for Debtor

Daniel J. Skekloff, Skekloff, Adelsperger & Kleven, Fort Wayne, IN, Kevin D. Finger (argued), James G. Richmond, Greenberg Traurig, Chicago, IL, for Plaintiff-Appellee/Cross-Appellant.

Christopher M. Forrest, Matthew M. Hohman (argued), Barnes & Thornburg, Fort Wayne, IN, for Defendants-Appellants/Cross-Appellees.

Before POSNER, ROVNER, and WILLIAMS, Circuit Judges.

POSNER, Circuit Judge.

These appeals arise from the Chapter 7 bankruptcy of Crown Unlimited Machine, Inc. The trustee in bankruptcy filed an adversary action charging the—a defunct corporation and its shareholders, members of a family named Stroup—with having made a fraudulent conveyance in violation of Ind.Code § 32-18-2-14(2) (section 4(a)(2) of the Uniform Fraudulent Transfer Act), a statute enforceable in a bankruptcy proceeding. See 11 U.S.C. § 544(b). After an evidentiary hearing, the bankruptcy judge awarded the$3,295,000 plus prejudgment interest. The district judge affirmed and the defendants have appealed. The trustee has cross-appealed, seeking an additional $590,328.

Crown was a designer and manufacturer of machinery for cutting and bending tubes. Most of the machinery it made was custom-designed to the buyer's specifications, and only two other companies manufactured custom-designed machinery of that type. In January 1999 the defendants agreed to sell all of Crown's assets to Kevin E. Smith, the president of a company in a similar line of business. The price was $6 million. Crown agreed to employ Smith until the closing, so that he could assure himself of the value of the business before committing to buying it.

He decided to go through with the deal. At the closing, on January 5, 2000, Crown received from a new corporation, formed by Smith, $3.1 million in cash and a $2.9 million promissory note. The new corporation (also named Crown Unlimited Machine, Inc., the name being among the assets sold to the new Crown) had borrowed the $3.1 million from a bank. Although the loan was secured by all of Crown's assets, the annual interest rate (a floating rate) initially exceeded 9 percent. The rate suggests—since inflation expectations were low at the time—that the bank considered the risk of default nontrivial.

The promissory note was payable on April 1, 2006, with interest at an annual rate of 8 percent. Although that translates into an interest expense of $232,000 a year, the agreement of sale specified that the new corporation would be required to pay only $100,000 a year on the note, with the first payment due in April 2001, unless new Crown's sales exceeded a specified high threshold. The note, like the bank loan, was secured by all of Crown's assets, but the promisee's (old Crown's) security interest was subordinated to the bank's. Although the interest rate on the note was lower than the interest rate on the bank loan, even though the note was not as well secured, there was, as we'll see, little chance that the note would ever be paid; and after the first two $100,000 interest payments, it wasn't.

Smith's personal assets were meager. He contributed only $500 of his own money toward the purchase.

Just prior to the closing, old Crown transferred $590,328 from its corporate bank account to a separate bank account so that it could be distributed to Crown's shareholders as a dividend. This was done pursuant to an understanding of the parties that, depending on the company's performance between the initial agreement and the closing, the Stroups would be permitted to keep some of Crown's cash that would otherwise have been transferred to the new corporation as part of the sale; the sale, since it was of all of Crown's assets, included whatever money was in the corporation's bank account.

After the closing, old Crown (renamed Crown Stock Distribution, Inc.) distributed the entire $3.1 million in cash that it had received to its shareholders, and ceased to be an operating company.

New Crown was a flop. It declared bankruptcy in July 2003, and its assets were sold pursuant to 11 U.S.C. § 363 (which authorizes a sale, if approved by the bankruptcy judge, of assets of the debtor) for $3.7 million. The buyer was a new company of which Smith is now the president. Most of the money realized in the sale was required for paying off the bank; very little was left over to pay the claims of new Crown's unsecured creditors, who were owed some $1.6 or $1.7 million and on whose behalf the trustee in bankruptcy brought the adversary action. The action was timely, despite the length of time since the alleged fraudulent conveyance, because the bankruptcy petition was filed within the four-year "look back" period of the Uniform Fraudulent Transfer Act, Ind.Code § 32-18-2-19(2), and the trustee initiated this suit within the period specified in 11 U.S.C. § 546 for bringing a section 544 avoidance action and the one-year deadline for bringing a section 550 action to recover improperly transferred funds, a deadline that runs from the date on which the transfer was set aside. 11 U.S.C. § 550(f)(1).

The bankruptcy judge ruled that the $6 million that new Crown had paid (the $3.1 million in cash), or obligated itself to pay (the $2.9 million promissory note), for old Crown's assets had been paid "without [new Crown's] receiving a reasonably equivalent value in exchange." As a result, New Crown had embarked upon "a business . . . for which [its] remaining assets . . . were `unreasonably small in relation to the business,'" in the language of the Uniform Fraudulent Transfer Act. The judge did not think the assets, including intangible assets such as goodwill that made old Crown a going concern and not just a pile of machinery, had been worth more than $4 million tops on the date of the closing. And he thought that new Crown had been so depleted by the debt it had taken on that it had been, in his words, on "life support" from the get-go. So old Crown and its shareholders could neither enforce the promissory note nor keep either the $3.1 million in cash received at the closing or the two $100,000 interest payments made on the note.

But the $590,328 dividend, the judge ruled, was legitimate, because it had been paid out of cash that belonged to old Crown rather than to the debtor (new Crown). In so ruling he rejected the trustee's argument that the purchase of old Crown's assets had been an LBO (a leveraged buyout), that it should be "collapsed" and the sale thus recharacterized as a sale by the shareholders of old Crown, and that once it was collapsed in this fashion the $590,328 "dividend" would be seen as an asset of the debtor's estate and thus would be available to help satisfy the claims of the unsecured creditors. If the transaction was not collapsed—and the bankruptcy judge thought it should not be because he refused to recharacterize the sale of assets as an LBO—the debtor was not entitled to the return of the dividend because, when it was paid, the money out of which it was paid belonged to old Crown.

We begin our analysis with the trustee's argument for recharacterizing the transaction. In a conventional LBO, an investor buys the stock of a corporation from the stockholders with the proceeds of a loan secured by the corporation's own assets. In re Image Worldwide, Ltd., 139 F.3d 574, 580 (7th Cir.1998); In re EDC, Inc., 930 F.2d 1275, 1278 (7th Cir.1991); Mellon Bank, N.A. v. Metro Communications, Inc., 945 F.2d 635, 645-46 (3d Cir. 1991). It follows that if all the assets are still fully secured when the corporation declares bankruptcy, the unsecured creditors cannot satisfy any part of their claims from a sale of the assets. If the trustee loses this suit, the unsecured creditors will have recovered only $150,000—less than 10 cents on the dollar.

Should the acquired company be doomed to go broke after and because of the LBO—if the burden of debt created by the transaction was so heavy that the corporation had no reasonable prospect of surviving—the payment to the shareholders by the buyer of the corporation is deemed a fraudulent conveyance because in exchange for the money the shareholders received they provided no value to the corporation but merely increased its debt and by doing so pushed it over the brink. HBE Leasing Corp. v. Frank, 48 F.3d 623, 635-37 (2d Cir.1995); Moody v. Security Pacific Business Credit, 971 F.2d 1056, 1063-64 (3d Cir.1992); Mellon Bank, N.A. v. Metro Communications, Inc., supra, 945 F.2d at 645-46; United States v. Tabor Court Realty Corp., 803 F.2d 1288, 1297 (3d Cir.1986). A corporate transfer is "fraudulent" within the meaning of the Uniform Fraudulent Transfer Act, even if there is no fraudulent intent, if the corporation didn't receive "reasonably equivalent value" in return for the transfer and as a result was left with insufficient assets to have a reasonable chance of surviving indefinitely. Ind.Code § 32-18-2-14(2); Rose v. Mercantile National Bank, 844 N.E.2d 1035, 1053-54 (Ind.App.2006), vacated in part on other grounds, 868 N.E.2d 772 (Ind.2007); see also Donell v. Kowell, 533 F.3d 762, 770-71 (9th Cir.2008).

Some courts have been reluctant to apply the Act as written to leveraged buyouts. See Kupetz v. Wolf, 845 F.2d 842, 847-50 (9th Cir.1988); United States v. Tabor Court Realty Corp., supra, 803 F.2d at 1297; Wieboldt Stores, Inc. v. Schottenstein, 94 B.R. 488, 503 (N.D.Ill.1988). They sympathize with minority shareholders who have no power to prevent such a deal. They may also agree with the scholars who have argued that many LBOs are welfare-enhancing transactions because by making the managers owners (managers are often the buyers in an LBO)...