Custom Fuel Services, Inc. v. Lombas Industries, Inc.

• Citation: 805 F.2d 561
• Decision Date: 09 December 1986
• Docket Number: No. 85-3605,85-3605
• Parties: , 55 USLW 2352 CUSTOM FUEL SERVICES, INC., Plaintiff-Appellant and Todd Shipyards Corporation, Intervenor-Appellant, v. LOMBAS INDUSTRIES, INC., et al., Defendants, First Mississippi National Bank, Intervenor-Defendant-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)

Page 561

805 F.2d 561

1987 A.M.C. 1321, 55 USLW 2352

CUSTOM FUEL SERVICES, INC., Plaintiff-Appellant and Todd Shipyards Corporation, Intervenor-Appellant, v. LOMBAS INDUSTRIES, INC., et al., Defendants, First Mississippi National Bank, Intervenor-Defendant-Appellee.

No. 85-3605.

United States Court of Appeals, Fifth Circuit.

Dec. 9, 1986.

Rehearing and Rehearing En Banc Denied Jan. 8, 1987.

Charles M. Steen and Don K. Haycraft, New Orleans, La., for Custom fuel.

G. Edward Merritt, New Orleans, La., for Todd Shipyard.

W.E. Noel, New Orleans, La., for First Miss. Nat. Bank.

Appeals from the United States District Court for the Eastern District of Louisiana.

Before WISDOM, JOHNSON, and HIGGINBOTHAM, Circuit Judges.

WISDOM, Circuit Judge:

This case is one of first impression. The question this appeal presents is whether a parent corporation can insulate its vessel from maritime liens by transferring title to its wholly-owned subsidiary as a nominal owner and taking back a preferred ship mortgage in an amount equal to the value of the vessel. The transaction was innocuous until the vessel's charterer became unable to pay its suppliers. When the suppliers seized the vessel and asserted their maritime liens, the true owner intervened to enforce the priority of its "mortgage". Because the vessel owner had acted lawfully in transferring the vessel to its subsidiary and had followed the statutory requirements for perfecting a ship mortgage, the district court upheld the priority of its mortgage. We decline to give effect to this sham and reverse the judgment of the district court.

I.

Lombas Offshore No. 3, Inc., a corporation controlled by Anthony Lombas, owned the M/V TON LOMBAS, an oceangoing tug. First Mississippi National Bank ("the Bank") had lent the money for the vessel's purchase and took a preferred ship mortgage on the vessel. When Lombas Offshore was unable to pay its debt, the Bank foreclosed on its mortgage and purchased the vessel at the marshal's sale. Holding an unwanted vessel, the Bank searched unsuccessfully for a purchaser.

Later, Anthony Lombas approached the Bank with an offer to lease the M/V TON LOMBAS from the Bank. Mr. Lombas was negotiating with Continental Milling Corporation, which wanted to hire the vessel to tow grain barges between Louisiana and Puerto Rico. When it appeared that Lombas and Continental Milling would reach an agreement, the Bank agreed to lease the vessel to Lombas.

The lease was arranged through a step-transaction involving First Continental Leasing Corp. ("the Subsidiary"), a wholly-owned subsidiary of the Bank. The Subsidiary was created in August 1980 to allow the Bank to finance the leasing business of its sister corporation, Continental Leasing Corporation. Continental Leasing is an active leasing company, acquired earlier by the Bank's parent holding company. The Bank capitalized the Subsidiary with $1,000 and extended it a $2,500,000 line of credit. The Subsidiary could then borrow money from the Bank to purchase property for leasing. The Subsidiary had no employees and did not manage its own portfolio or seek new business. Instead, it "hired" Continental to manage its portfolio of leased property. ¹

To accomplish the lease, the Bank first "sold" the M/V TON LOMBAS to its Subsidiary for $2,600,000, the vessel's book value on the Bank's records. The Subsidiary borrowed the full amount of the purchase price from the Bank and gave a demand note and a preferred ship mortgage in return. ² The Subsidiary then leased the vessel under a bareboat charter to Louisiana-Mississippi Carribean Corporation ("LMCC"), a corporation set up by Mr. Lombas. LMCC assigned its interest in the towage contract to the Subsidiary as security for the charter payments. The Subsidiary then assigned its interest in the towage contract and the charter party to the Bank as security for the demand note. Continental Milling was directed to pay its towing fees directly to the Bank. The Bank had permission to retain these payments to satisfy the charter hire due the Subsidiary and to deposit the balance in LMCC's account. After completion of these transactions on November 26, 1980, the Subsidiary withdrew from an active role. The Bank maintained contact with the other parties, collected and applied the payments made under the towing contract, and supervised Mr. Lombas's operation of the vessel.

The vessel operated successfully until the expiration of the towing contract and the untimely death of Mr. Lombas. On July 19, 1983, Custom Fuel Services brought this action against the M/V TON LOMBAS in rem and LMCC, Lombas Industries, Inc., ³ and the Subsidiary in personam to recover $73,254.67 for fuel and lubricants that it had supplied to the vessel. Todd Shipyards Corporation intervened to enforce its maritime lien against the vessel in the amount of $81,384 for repairs and supplies that it had furnished to the vessel. ⁴ 4] The Bank intervened to enforce its preferred ship mortgage on the vessel. ⁵ Custom Fuel Services and Todd Shipyards then sued the Bank, requesting that the court deny the preferred status of the Bank's mortgage so that it would lose its priority over the maritime liens of Custom Fuel and Todd Shipyards. The parties reached an agreement by which the Bank was allowed to purchase the vessel at the marshal's sale, without the necessity of paying cash, and to substitute a letter of undertaking in place of the vessel pending trial on the parties' claims.

The district court held a bench trial on the claims. The parties stipulated to most of the facts. Other evidence was submitted by exhibit and deposition. The court held that Custom Fuel Services and Todd Shipyards had valid maritime liens for necessaries. The court denied their in personam claims of unjust enrichment against the Subsidiary. ⁶ The parties do not appeal these holdings. The court held also that the Bank had a valid preferred ship mortgage, which has priority over the maritime liens. Custom Fuel Services and Todd Shipyards appeal from this holding.

II.

The lienors contend that the mortgage should not be given preferred status under the Ship Mortgage Act. This Act specifies the conditions under which a ship mortgage will take preference over all other maritime liens except those arising before the perfection of the mortgage. ⁷ One of the requirements for preference under the Act is that the mortgage must be made in good faith and "without any design to hinder, delay, or defraud any existing or future creditor of the mortgagor or any lienor of the mortgaged vessel". ⁸ The liens of Custom Fuel Services and Todd Shipyards arose after the creation of the Bank's mortgage. Therefore, the Bank is entitled to a preference if its mortgage is upheld. In this case, recognition of the validity of the mortgage would mean that Custom Fuel Services and Todd Shipyards take nothing, because the Bank bid barely more than the amount due on the mortgage. ⁹

The lienors do not contend that the Bank's mortgage is per se invalid. They admit that the Bank followed the necessary procedures to obtain a preferred ship mortgage. ¹⁰ They argue, however, that the priority of the Bank's mortgage should be denied because of its contrived nature. In response, the Bank argues that there is no authority that prohibits a subsidiary corporation from granting a preferred ship mortgage to its parent. Therefore, absent proof of bad faith or fraud, this Court should respect the priority of the Bank's mortgage. To resolve this controversy, we must determine the power of an admiralty court to deny priority to an otherwise valid mortgage lien and the conditions in which denial of priority is appropriate.

The Ship Mortgage act is not a complete statute. It provides certain recording procedures, but not much more. Therefore, merely following the recording procedures does not automatically create a valid preferred mortgage entitled to priority. ¹¹ Instead, the admiralty court must turn to other sources to determine the underlying validity of a ship mortgage. ¹² Admiralty courts have turned to state law, ¹³ other federal laws, ¹⁴ and general principles of equity. ¹⁵

Generally, courts will respect the separate personalities of a parent and its subsidiary. ¹⁶ A shareholder may lend money to a wholly-owned corporation and become a bona fide creditor. Such transactions, however, are subject to scrutiny for fraud, unfair dealing, or other inequitable conduct. ¹⁷ Admiralty is no stranger to these principles. Admiralty courts have not been hesitant to scrutinize preferred ship mortgages granted to related entities and, in appropriate cases, deny their priority. ¹⁸

The power of an admiralty court to scrutinize the underlying validity of liens and mortgage claims is of ancient origin and derives from the court's historic equity jurisdiction. In Florida Bahamas Lines v. Steel Barge "Star 800" of Nassau, ¹⁹ this Court denied the priority of a maritime lien for wharfage on equitable grounds. The wharfinger was the sister corporation of the corporate vessel owner, both of which were wholly-owned by Joe Brown. Mr. Brown granted a foreign ship mortgage on his vessel and then allowed the vessel to accumulate wharfage debts in favor of his wharfage company for almost four years. When the vessel corporation defaulted on the mortgage and the mortgagee foreclosed, the wharfage company intervened to enforce the priority of its wharfage claim. ²⁰ We denied the claim of the wharfage company, holding:

The nature of the facts in this case--which need no embellishment--"make the entire transaction subject to the sharpest scrutiny". After such scrutiny we conclude that to deny priority to the mortgagee--pecuniarily "keel hauled" by the practices and manipulations of Joe Brown--would be to exalt the corporate form and to constitute a denial of justice. Indeed, the circumstances of this case are peculiarly attuned to the gentle strains of admiralty's equity jurisdiction...