In re Carolina Acoustical and Flooring, Inc.

• Citation: 415 B.R. 186
• Decision Date: 03 March 2009
• Docket Number: Adversary No. 07-2032.,Bankruptcy No. 05-13236C-7G.
• Court: United States Bankruptcy Courts. Fourth Circuit. U.S. Bankruptcy Court — Middle District of North Carolina
• Parties: In re CAROLINA ACOUSTICAL AND FLOORING, INC., f/d/b/a The Tile Shop, Debtor. Charles M. Ivey, III, Trustee for Carolina Acoustical and Flooring, Inc., f/d/b/a The Tile Shop, Plaintiff, v. Hunter Acquisitions, Inc., Defendant.

415 B.R. 186

In re CAROLINA ACOUSTICAL AND FLOORING, INC., f/d/b/a The Tile Shop, Debtor.

Charles M. Ivey, III, Trustee for Carolina Acoustical and Flooring, Inc., f/d/b/a The Tile Shop, Plaintiff, v. Hunter Acquisitions, Inc., Defendant.

Bankruptcy No. 05-13236C-7G.

Adversary No. 07-2032.

United States Bankruptcy Court, M.D. North Carolina, Greensboro Division.

March 3, 2009.

COPYRIGHT MATERIAL OMITTED

John M. Blust, Ivey, McClellan, Gatton, & Talcott, LLP, Greensboro, NC, for Plaintiff.

Emily Jeffords Meister, Forman, Rossabi & Black, P.A., Amiel J. Rossabi, Greensboro, NC, for Defendant.

MEMORANDUM OPINION

WILLIAM L. STOCKS, Bankruptcy Judge.

This adversary proceeding came before the court on January 21, 2009, for trial. John M. Blust appeared on behalf of the plaintiff and Emily J. Meister and Amiel J. Rossabi appeared on behalf of the defendant. Having received and considered the evidence offered at the trial and the arguments presented on behalf of the parties, the court makes the following findings of fact and conclusions of law pursuant to Rule 52 of the Federal Rules of Civil Procedure and Rule 7052 of the Federal Rules of Bankruptcy Procedure.

JURISDICTION

The court has jurisdiction over the subject matter of this proceeding pursuant to 28 U.S.C. §§ 151, 157, and 1334, and the General Order of Reference entered by the United States District Court for the Middle District of North Carolina on August 15, 1984.

NATURE OF CONTROVERSY

This proceeding involves a suit by the plaintiff as chapter 7 trustee for Carolina Acoustical & Flooring, Inc. ("debtor") to recover on two promissory notes issued by the defendant, one in the principal sum of $30,000 and the other in the principal sum of $50,000. Both notes arose out of the defendant's purchase of the assets of the debtor in July of 2004.

The defendant admits the issuance of the two promissory notes, but denies any liability on the notes on the grounds that defendant is entitled to a complete setoff based upon indemnity provisions contained in the purchase agreement between the debtor and the defendant.

Defendant's indemnification claim is based upon debtor's failure to pay its vendors and a business broker following the closing as allegedly required under the purchase agreement. The damages alleged by the defendant include a $50,000 settlement with the broker and attorneys' fees incurred by the debtor in defending against the claims asserted by the broker. The defendant contends that the purchase agreement obligated the debtor to indemnify the defendant as to the settlement payment, the attorneys' fees and certain other damages allegedly incurred by the defendant, and that the defendant is entitled to setoff the entire amount due under the two promissory notes against the debtor's obligation to indemnify the defendant.

FACTS

Prior to the events giving rise to this proceeding, the debtor operated a business located in Greensboro, North Carolina, known as the Tile Shop, which involved the sale and installation of various types of flooring. In June of 2003, the debtor entered into a Listing Agreement for Sole and Exclusive Right to Sell ("Listing Agreement") with VR Business Brokers ("VR") under which the debtor engaged VR "to broker the sale, lease, trade or other disposition of all or any part" of the assets of the debtor. Under the listing agreement, the debtor agreed to pay VR the greater of 12% of the selling price or $50,000 if, during the term of the listing agreement, VR procured a purchaser ready, willing and able to purchase assets of the debtor on the terms specified in the listing agreement. Following the execution of the Listing Agreement, VR began efforts to find a buyer for debtor's business. These efforts included listing the debtor on an internet website maintained by VR.

In early 2004, the defendant had become interested in the flooring business and was exploring various alternatives for getting into that business. One of the alternatives under consideration was the purchase of an existing business. At some point prior to July of 2004, the defendant accessed VR's website and learned that one of VR's listings was the debtor's flooring business. The defendant contacted VR in order to obtain more information regarding the debtor. Discussions ensued between representatives of the defendant and representative of VR during which information regarding the debtor's business and assets was provided by VR. These discussions were followed by direct discussions between the defendant and the debtor during which the parties began to negotiate regarding a purchase of the debtor's assets by the defendant.

After several weeks of negotiations, the defendant and the debtor signed an asset purchase agreement on July 9, 2004, under which the debtor agreed to sell all of its inventory, equipment, contracts, records, and two motor vehicles to the defendant for a purchase price of $330,000. As a part of the transaction, the defendant also agreed to pay the debtor the sum of $50,000 over a period of 36 months as consideration for a consulting agreement under which the debtor would be available for consulting services following the closing.

Following the execution of the asset purchase agreement, a closing was held on July 9, 2004. After a $165.38 adjustment for the defendant's share of ad valorem taxes, the balance due on the purchase price was $329,834.62, which was further reduced by payments totaling $157,552.11 which were disbursed directly to creditors of the debtor who held liens that encumbered the purchased assets, leaving the net amount of $172,282.51 payable to the debtor. From that amount the debtor made a loan of $30,000 to the defendant with the result that the debtor received a check for $142,282.31 plus a promissory note for $30,000 evidencing the loan extended to the defendant. The debtor also received a promissory note for $50,000 as consideration for the consulting agreement called for under the asset purchase agreement.

One result of the negotiations that preceded the execution of the asset purchase agreement was that the price to be paid for the debtor's assets was reduced substantially below the initial asking price of $590,000 specified in the listing agreement. Apparently, as a result of this reduction and also dissatisfaction on the part of the debtor regarding VR's performance, VR and the debtor were still discussing a possible reduction in VR's fee when the sale closed. As a consequence, VR was not paid a fee at the closing. Although a number of vendors were paid by the debtor following the closing, VR also was not paid at that time, apparently as a result of the continuing disagreement regarding the amount of VR's fee. Although VR apparently was willing to accept a fee of $48,000, which was less than the $50,000 minimum provided for in the listing agreement, the debtor contended that the fee should be less than $48,000. When no agreement was reached and no payment was made, VR filed suit against both the debtor and the defendant in January of 2005 seeking to recover a fee of $48,000, plus interest and attorneys' fees. The claims asserted against the debtor were for breach of the listing agreement and quantum meruit. The claims against the defendant alleged a violation of the North Carolina statutes dealing with bulk transfers, N.C. Gen.Stat. §§ 25-6-101, et seq., and an allegation that the transfer of the debtor's assets to the defendant constituted a fraudulent transfer.

On September 28, 2005, the debtor commenced a chapter 7 proceeding in this court. Thereafter, VR voluntarily dismissed the civil action which was still pending when the debtor filed its chapter 7 petition. Following the dismissal of the first action, VR filed a second action in the Superior Court of Guilford County on February 3, 2006.

In the second action, VR sued the defendant as well as the principals in the defendant, Britt C. Holcomb and Stacy D. Holcomb. The complaint in the second action contained twelve claims for relief and sought recovery of the $48,000 broker's fee plus compensatory damages in excess of $10,000, interest and attorneys' fees, punitive damages and treble damages. The defendant and the Holcombs filed an answer in the second civil action denying liability. In September of 2007, shortly before the second action was scheduled to be tried, the parties entered into a settlement in which VR received a cash payment of $50,000 and gave a general release to the defendants in the second action.

ANALYSIS

The plaintiff established a prima facie case for recovery on the $30,000 and $50,000 promissory notes by offering the defendant's admissions that it issued and delivered the promissory notes and that no payments have been made on the promissory notes. This left the defendant with the burden of establishing its setoff defense. For the reasons that follow, the court has concluded that the setoff defense has been established by the defendant.

If a right of setoff exists under applicable state law, then section 553 of the Bankruptcy Code preserves the "right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case...." 11 U.S.C. § 553. Thus, in order to exercise a right of setoff under section 553, there are four conditions that must exist: (1) the creditor must hold a "claim" against the debtor that arose before the commencement of the case; (2) the creditor must owe a "debt" to the debtor that also arose before the commencement of the case; (3) the claim and debt must be "mutual"; and (4) the claim and debt each must be valid and enforceable. 5 Collier on Bankruptcy ¶ 553. 01[1] (15th ed. rev.2008). The party asserting setoff must show that setoff is available under applicable state law, as well as each of the requirements under section 553. In re Krause, ...