Colonial Discount Corp., In re

• Decision Date: 05 December 1986
• Docket Number: 85-2308,Nos. 85-2298,s. 85-2298
• Citation: 807 F.2d 594
• Parties: Bankr. L. Rep. P 71,552 In re COLONIAL DISCOUNT CORPORATION, Debtor. James C. COURTNEY, Trustee, Plaintiff-Appellee and Cross-Appellant, v. OCTOPI, INC. and Joe McNeal, Defendants-Appellants and Cross-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 594

807 F.2d 594

Bankr. L. Rep. P 71,552

In re COLONIAL DISCOUNT CORPORATION, Debtor.

James C. COURTNEY, Trustee, Plaintiff-Appellee and Cross-Appellant, v. OCTOPI, INC. and Joe McNeal, Defendants-Appellants and Cross-Appellees.

Nos. 85-2298, 85-2308.

United States Court of Appeals, Seventh Circuit.

Argued Feb. 18, 1986.

Decided Dec. 5, 1986.

Sidney Mishkin, Mishkin, Cromer, Eaglesfield & Maher, Indianapolis, Ind., for debtor.

Jon B. Abels, Dann, Pecar, Newman, Talesnick & Kleiman, Indianapolis, Ind., trustee.

Before COFFEY and RIPPLE, Circuit Judges, and WILL, Senior District Judge. ^*

WILL, Senior District Judge.

Colonial Discount Corporation ("CDC"), the debtor in this bankruptcy action, filed for reorganization under chapter eleven of the Bankruptcy Code. In the bankruptcy court, the trustee argued that certain transactions between CDC and appellants/cross-appellees Joe McNeal and Octopi, Inc. constituted avoidable preferences under 11 U.S.C. Sec. 547 (1982 & Supp. II). On the trustee's motion for summary judgment, the bankruptcy court ruled that some of the transactions were preferential and that others were not. The district court affirmed. On appeal, both sides challenge the lower court's conclusions. We affirm in part and reverse in part.

I.

Prior to filing its chapter eleven petition, CDC was engaged in the business of buying and selling real estate. On October 23, 1981, CDC borrowed $150,000 from a lender known as Silvertown, Inc. In return, CDC gave Silvertown a promissory note and a mortgage on property located at 40-42 Virginia Avenue ("Virginia Avenue property"). The mortgage was never recorded. In exchange for Joe McNeal's agreement to act as surety on the loan, Silvertown assigned the promissory note and mortgage to him.

On November 13, 1981, CDC made a payment of $50,000 on the loan to McNeal who in turn forwarded it to Silvertown. At this time, the due date of the note was extended from November 15, 1981 to December 7, 1981. When December 7 arrived, CDC failed to make payment and McNeal as surety paid Silvertown the balance of $102,560.

On January 13, 1982, McNeal incorporated Octopi, Inc. with himself as its president and sole shareholder. The same day, CDC executed a new note ("Octopi note"), evidencing its agreement to pay Octopi $110,000. In his affidavit and deposition, McNeal stated that the $110,000 figure represented the unpaid principal and interest on the original loan plus an additional cash advancement of "approximately $7,000" from McNeal to CDC. The trustee in his affidavit stated that the books and records of CDC contained no documentation of any cash advancement.

To secure the Octopi note, CDC granted mortgages to Octopi on the Virginia Avenue property and on real estate known as the Westman Glen Apartments in Hamilton County, Indiana ("Octopi mortgage"). Both mortgages were recorded on January 14, 1982.

CDC filed for bankruptcy on February 4, 1982. Its estate consisted of hundreds of separate real estate parcels, including the properties subject to the Octopi mortgage. After an auction at which the highest bid was rejected, the trustee abandoned the Westman Glen Apartments property to the senior mortgage holder, who then proceeded to foreclose on the property. On April 7, 1983, McNeal approached the trustee about obtaining a quitclaim deed for the apartments property. The trustee agreed to quitclaim his interest in the apartments property in exchange for $10,000 cash and a $25,000 credit on CDC's debt under the Octopi note and the mortgage on the Virginia Avenue property.

In September, 1983, McNeal offered to purchase the Virginia Avenue property from the trustee. Upon investigating the mortgages on the property, the trustee learned for the first time of the original loan from Silvertown to CDC and the subsequent transactions by which Octopi was substituted as obligee. The trustee promptly advised McNeal of his position that the Octopi mortgage on the Virginia Avenue property and the November 13, 1981 payment of $50,000 to McNeal on the original debt were preferential transfers. Subsequently, the trustee commenced this action.

In the bankruptcy court, the trustee moved for summary judgment, arguing that on the uncontradicted record the Octopi mortgage on the Virginia Avenue property and the $50,000 payment must be set aside as preferences. The bankruptcy court agreed with the trustee as to the Virginia Avenue mortgage, but disagreed as to the $50,000 payment. On appeal to the district court, the bankruptcy court's conclusions were affirmed. ¹

II.

Rule 56 of the Federal Rules of Civil Procedure, which applies in bankruptcy proceedings by virtue of Rule 7056 of the Bankruptcy Rules, provides that summary judgment will be granted if there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law. Fed.R.Civ.Pro. 56(c). On appeal, we apply the same standard, for the existence of a genuine issue of material fact is a legal determination subject to de novo review. See, e.g., In re Brass Kettle Restaurant, 790 F.2d 574 (7th Cir.1986).

The courts below found that there was no genuine issue as to each of the following material facts: (1) that CDC was insolvent when it granted the Octopi mortgage; (2) that McNeal gave no new consideration for the Octopi mortgage; (3) that the trustee was not estopped from asserting the invalidity of the Octopi mortgage; and (4) that the original $150,000 loan and $50,000 payment on the loan were made in the ordinary course of business of CDC and McNeal. After briefly discussing the relevant provisions of the Bankruptcy Code, we consider each of these issues in turn.

Section 547 of the Code sets forth the rules governing avoidability of preferential transfers. Under subsection (b), the trustee may avoid any transfer of property of the debtor that is:

(1) to or for the benefit of a creditor;

(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;

(3) made while the debtor was insolvent;

(4) made--

(A) on or within 90 days before the date of the filing of the petition; or

(B) between ninety days and one year before the date of the filing of the petition if such creditor at the time of such transfer was an insider;

(5) that enable such creditor to receive more than such creditor would receive if--

(A) the case were a case under chapter 7 of this title;

(B) the transfer had not been made; and

(C) such creditor received payment of such debt to the extent provided by the provisions of this title.

11 U.S.C. Sec. 547(b). Subsection (c), in turn, "excludes certain specified transfers from the trustee's preference avoiding power even though they literally fall within the definition of a preference contained in section 547(b)." 4 Collier on Bankruptcy p 547.37 (15th ed. 1979). Under subsection (g), added to the Code by the amendments of July 10, 1984, Pub.L. 98-353, Title III, Sec. 462(g), 98 Stat. 355, the trustee has the burden of proving avoidability under subsection (b), while the creditor has the burden of proving an exception to avoidability under subsection (c). 11 U.S.C. Sec. 547(g). Subsection (f) creates a presumption that the debtor was insolvent during the ninety days immediately preceding the filing of the petition. 11 U.S.C. Sec. 547(f).

A.

McNeal and Octopi contend that a genuine issue of material fact exists as to whether CDC was insolvent under section 547(b)(3) on the date of the Octopi mortgage. Recognizing that CDC granted the mortgage well within the ninety day period in which, under subsection (f), they are presumed to be insolvent, the appellants maintain that they brought forth evidence sufficient to rebut the presumption. Specifically, they rely on CDC's financial report for the year ending September, 1980 and the two sets of balance sheets contained therein. The first set of balance sheets, which was prepared in accordance with generally accepted accounting principles, showed a positive net worth of $7,387. The second set used an experimental method of measuring "current value" and revealed a positive net worth of over five million dollars.

The evidence contained in the financial report is not sufficient to rebut the presumption of insolvency contained in section 547(f). First, although notes regarding litigation pending against CDC were appended to the report as late as September 1981, the report does not purport to reflect CDC's financial condition as of any date later than September, 1980. ² The relevant period is in January, 1982, over a year later, when CDC made the Octopi mortgage. The fact that CDC's assets exceeded its liabilities by a mere $7,387 in September, 1980 does not tend to rebut the presumption that CDC was insolvent over a year later; if anything, it tends to support the presumption.

Second, the current-value balance sheets raise no genuine issue as to CDC's insolvency. As the independent auditors who examined the financial report noted, the current-value balance sheets "differ significantly from, and are not in accordance with, generally accepted accounting principles." Financial Report, Exh. 1 to McNeal's Affidavit, at 2. The auditors further observed:

Because current-value accounting is presently in an experimental stage, uniform criteria for the preparation and presentation of current-value financial information has not yet been established and acceptable alternatives exist as to the nature and content; accordingly, as experimentation proceeds, the principles followed in the accompanying current-value financial statements may be modified.

Given these caveats, and the additional fact that again the current-value balance sheets reflect CDC's financial condition only as of September 1980, we think it clear that this evidence would not have been admissible at trial and is therefore not properly considered on a motion for summary judgment. See Fed.R.Civ.Pro. 56(e) (supporting materials "shall set forth...