In re Clinton Centrifuge, Inc.

• Citation: 85 BR 980
• Decision Date: 17 May 1988
• Docket Number: Bankruptcy No. 86-03950G.
• Parties: In re CLINTON CENTRIFUGE, INC., Debtor.
• Court: United States Bankruptcy Courts. Third Circuit. U.S. Bankruptcy Court — Eastern District of Pennsylvania

85 B.R. 980 (1988)

In re CLINTON CENTRIFUGE, INC., Debtor.

Bankruptcy No. 86-03950G.

United States Bankruptcy Court, E.D. Pennsylvania.

May 17, 1988.

Lewis Kaitz, Kaitz & Mazzocone, and Paul B. Maschmeyer, Lashner, Victor & Maschmeyer, Philadelphia, Pa., for the movants, Aaron M. Lavin, and A.M. Lavin Mach. Works, Inc.

Lewis Kaitz, Kaitz & Mazzocone, Philadelphia, Pa., for movant, Lavin Centrifuge, Inc.

Jonathan H. Ganz, Pincus, Verlin, Bluestein, Hahn & Reich, Philadelphia, Pa., for debtor, Clinton Centrifuge, Inc.

MEMORANDUM OPINION

BRUCE I. FOX, Bankruptcy Judge:

Before me is the motion of Aaron M. Lavin, A.M. Lavin Machine Works, Inc. and Lavin Centrifuge, Inc. requesting the appointment of a trustee to operate or manage this chapter 11 debtor, pursuant to 11 U.S.C. § 1104. Movants contend that the prepetition and postpetition activities of the debtor's principal and sole shareholder, in both establishing the corporation Equipco, Inc. and in the dealings between Equipco and the debtor, justify the appointment of the trustee. The debtor, through current counsel, possibly concedes some small failure to follow all bankruptcy code provisions but argues that the appointment of a trustee is unwarranted.

To place this dispute in context, I must first review an earlier decision rendered in this case.

I.

These same three movants filed a previous motion to dismiss this bankruptcy case which I denied, 72 B.R. 900 (Bankr.E.D.Pa. 1987) appeal pending, and for which I made various factual findings. For purposes of understanding the current dispute, I shall summarize those findings.

Aaron M. Lavin established and is the sole shareholder of A.M. Lavin Machine Works, Inc. ("Machine Works"). The business purpose of Machine Works was the assembly, manufacture, sale and repair of basket-type centrifuges and other equipment. During 1980, Lavin decided to sell his business to William D. Clinton, sole shareholder of the debtor. Rather than simply selling the stock of Machine Works, Lavin entered into an agreement whereby Clinton would form another corporation called Lavin Centrifuge, Inc. and this corporation would purchase some of the assets of Machine Works. In relevant part, this agreement called for payments of $100,000.00 at settlement; $1,000,000.00 in ten years; minimum royalty payments of $120,000.00 per year for ten years (payable monthly); and excess royalties of 3% if "net sales" exceeded $1,000,000.00 per year. In addition, Lavin agreed to rent his plant to Clinton for a monthly payment of $2,000.00; other assets of Machine Works were to be sold for $85,403.00; and Lavin agreed to lend up to $100,000.00 to Lavin Centrifuge as operating capital. As security for this agreement the Lavin Centrifuge stock, though titled in Clinton's name, was placed in escrow. Upon default, the stock would be transferred to Lavin, subject to Clinton's defined right to cure the default.

By April 1983, Lavin Centrifuge was unable to meet its financial obligations to Lavin and Machine Works. Clinton then formed a second corporation, Clinton Centrifuge, Inc., and in early April 1983 transferred all of the assets of Lavin Centrifuge to Clinton Centrifuge in exchange for $135,787.00 evidenced by a five year note. This transfer followed a bulk transfer notice to Lavin and Machine Works—to which they objected. Suit then followed in state court which resulted in judgment in favor of movants, as the bulk asset transfer was found to violate the Pennsylvania Fraudulent Conveyances Act, 39 P.S. § 360. The Court of Common Pleas ordered inter alia:

a. that the bulk transfer of assets on April 6, 1983 from Lavin Centrifuge to Clinton Centrifuge be set aside as fraudulent pursuant to section 360 of the Fraudulent Conveyances Act, 39 P.S. Section 360;

b. that the transferred assets or their equivalent be returned to the control and dominion of Lavin Centrifuge;

c. that the profits generated by Clinton Centrifuge, as a result of its possession of the transferred assets, be returned to Lavin Centrifuge;

d. that ownership of all authorized and outstanding capital stock of Lavin Centrifuge be transferred and delivered to Lavin; and

e. that Lavin and Machine Works failed to prove that Clinton, Lavin Centrifuge and Clinton Centrifuge fraudulently misrepresented any facts concerning the agreement of sale among Lavin, Machine Works, Lavin Centrifuge and Clinton or concerning the April 6, 1983 bulk transfer.

72 B.R. at 903.

When the state court defendants could not post a supersedeas bond to protect assets from execution pending appeal, Clinton Centrifuge filed this chapter 11 petition.¹ However, Clinton did more. Fearing that the Lavin plaintiffs might ultimately execute upon Clinton Centrifuge assets, he formed a third corporation, Equipco, Inc. in October 1985. Clinton is the sole shareholder of Equipco, which has no employees; its books and records are located at the debtor's premises. Equipco's sole business is the leasing of equipment, machinery and automobiles to the debtor, and it purchases these items from capital contributed by William Clinton or through financing guaranteed by William Clinton. In other words, rather than contributing new capital to the debtor which might be reached by Lavin, the debtor meets its equipment needs by lease arrangement with Equipco. Lavin, who was troubled by Clinton's formation of a new corporation in 1983 (Clinton Centrifuge, Inc.), is no less troubled by the formation of this third corporation.

Evidence at trial discloses that Equipco has a single lease with the debtor which was entered into in October, 1985. Items such as equipment leased to the debtor are listed on separate schedules. Originally, the term of the lease was for one year; however, Equipco and the debtor have extended the lease term to a three year period with some reduction in monthly payments resulting. Not only have prepetition leases been extended postpetition, but additional items have been leased postpetition. In fact, far more items have been leased postpetition than prepetition. (See Exhibit P-19). The debtor concedes that all post-petition lease agreements were entered into without any notice to creditors and without court approval.²

As a practical matter, all lease terms have been determined by William Clinton who is the sole shareholder of both the debtor and Equipco. Although Mr. Clinton testified that he selected the rental payments based upon written surveys he reviewed, there is no dispute that Equipco has been profitable since its inception. Using a fiscal year ending November 30, (which is the same fiscal year the debtor employs), Equipco has filed tax returns disclosing that: between October 1, 1985 and November 30, 1985, it had taxable income of $16,677.00 on rental receipts of $20,679.00; between December 1, 1985 and November 30, 1986, it had taxable income of $27,225.00 on rental receipts of $66,643.00. No figures were given for 1987, but Clinton acknowledged that rental income had increased for 1987. Similarly Equipco's asset value listed on its tax returns had increased from $63,743.00 in 1985 to $149,242.00 in 1986. All revenues of Equipco were derived from its lease agreement with the debtor. Moreover, it is unclear how much Clinton himself has invested in Equipco beyond his initial capital investment of approximately $42,000.00.³

While Equipco's fortunes have improved postpetition, the debtor's financial picture is mixed. Looking first at pretax profit figures, the debtor made a pretax profit of approximately $83,000.00 in 1983, $93,000.00 in 1984 and $27,000.00 in 1985. In August 1986, the debtor filed its voluntary bankruptcy petition. In 1986, it suffered a pretax loss of $9,000.00. (No information for 1987 was offered). Shareholder equity (defined in the debtor's unaudited yearly financial statements as assets less liabilities)⁴ has shown a fairly steady increase, from $64,000.00 in 1983 to $199,000.00 as of June 1987.

Movants argue that Equipco is just another example of Clinton's misuse of a corporate vehicle. Unless a trustee is appointed, they contend Equipco will continue to be used as a vehicle for Clinton to siphon cash from the debtor for his own uses; moreover, they believe that only a trustee can take the necessary steps to recover prepetition and postpetition funds wrongfully paid to Equipco. In movants' view, these factors, taken together with the debtor's alleged failure to comply with 11 U.S.C. § 363(b)(1), warrant the imposition of a trustee. Of course, the debtor argues otherwise. It maintains that the lease agreements were in the ordinary course of its business so as to be governed by § 363(c)(1) and thus that no notice was required. It argues that lease terms were fair and beneficial both to the debtor and Equipco. Finally, it argues that any errors committed by Mr. Clinton were done unintentionally, on the advice of prior counsel, and do not support the appointment of a trustee, which is an "extraordinary" remedy.

II.

Movants seek the appointment of a trustee pursuant to the provisions of 11 U.S.C. § 1104(a), which states

(a) At any time after the commencement of the case but before confirmation of a plan, on request of a party in interest or the United States trustee, and after notice and a hearing, the court shall order the appointment of a trustee—

(1) for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case, or similar cause, but not including the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor; or

(2) if such appointment is in the interests of creditors, any equity security holders, and other interests of the estate, without regard to the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor.

In sum, section 1104(a) "provides for the appointment of a trustee...