In re Cumberland Farms, Inc.

• Decision Date: 27 March 2002
• Docket Number: No. 01-1344.,01-1344.
• Citation: 284 F.3d 216
• Parties: In re CUMBERLAND FARMS, INC. Debtor. Demetrios B. Haseotes, Appellant, v. Cumberland Farms, Inc., Appellee.
• Court: U.S. Court of Appeals — First Circuit

284 F.3d 216

In re CUMBERLAND FARMS, INC. Debtor.

Demetrios B. Haseotes, Appellant, v. Cumberland Farms, Inc., Appellee.

No. 01-1344.

United States Court of Appeals, First Circuit.

Heard November 5, 2001.

Decided March 27, 2002.

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Whitton E. Norris, III, with whom Carol R. Cohen and Davis, Malm & D'Agostine, P.C. were on brief, for appellant.

Patrick P. Dinardo, with whom Pamela Smith Holleman, Sullivan & Worcester LLP, and Mark G. Howard were on brief, for appellee.

Before SELYA, Circuit Judge, COFFIN, Senior Circuit Judge, and LIPEZ, Circuit Judge.

LIPEZ, Circuit Judge.

In 1992, Cumberland Farms, Inc. ("Cumberland"), a close corporation owned by the six siblings of the Haseotes family, filed a petition for reorganization under Chapter 11 of the Bankruptcy Act. Demetrios B B. Haseotes — one of Cumberland's directors and the appellant here — filed claims against the corporation for roughly $3 million of prepetition indebtedness owed on certain promissory notes. In response, Cumberland asserted a set-off claim of approximately $5.75 million, arguing that Haseotes breached his duty of loyalty when he caused his wholly-owned company to pay down a debt owed to him, while ignoring a much larger debt owed to Cumberland. The bankruptcy court agreed, and disallowed Haseotes's claims against Cumberland. On appeal, the district court affirmed. Haseotes then appealed to this court. We affirm.

I.

A proper understanding of this case requires a somewhat detailed recitation of the facts, as found by the bankruptcy court. Haseotes is the oldest of six children who together own all of the shares of Cumberland. The family business began in 1938, when Haseotes's parents bought a dairy farm in Cumberland, Rhode Island. Cumberland now owns more than one thousand convenience stores and gas stations, conducts wholesale operations in dairy and other products, owns and manages real estate, and delivers refined petroleum products to its own gas stations and those of third parties. Through these various endeavors Cumberland enjoys a gross annual income of more than $1 billion.

The undisputed family leader, Haseotes became Cumberland's CEO and chairman of its board of directors in 1960. At that time, the corporation was just beginning the gradual process of growth and diversification. Cumberland opened its first gas station in the mid-1960s, linking together its existing food and gas operations. By the early 1970s, Cumberland owned roughly 150 gas stations up and down the east coast. However, the gas crisis of the 1970s nearly crippled the growing company, forcing it to close the majority of its new gas stations.

In the wake of the gas shortage, Haseotes became convinced that Cumberland needed greater security in its gas supply. In 1986, Cumberland entered into a petroleum supply agreement with Chevron U.S.A., Inc. But Haseotes was not satisfied with relying on an outside source for gas; he wanted to ensure a supply of his own. Thus, when he learned of a dormant refinery located in Newfoundland, Canada, he saw a valuable opportunity for expansion.

Having no experience in refining, Haseotes sought advice on the possibility of purchasing the refinery. One source told him that he would need to spend at least $25 million to get the refinery up and running; another estimated that the cost would be closer to $100 million. Haseotes's consultant William Gorden, who recently had retired from Sun Oil Company, urged Haseotes not to buy the refinery. He told Haseotes that Sun Oil had lost money in its refinery operations, and that Cumberland's deal with Chevron provided it with an adequate source of refined petroleum products. Finally, Cumberland's legal counsel advised Haseotes that Cumberland could not own the refinery itself because certain states prohibit a company that operates a refinery from selling petroleum products at retail.

Undeterred, Haseotes decided to go ahead with the purchase. Based on the advice from counsel, he chose to own the refinery through his own wholly-owned entities. Thus, the refinery's physical assets were taken in the name of Newfoundland Processing, Limited, which was formed to conduct the oil refining operations. Haseotes also organized a separate corporation — Cumberland Crude Processing, Inc. ("CCP") — which would purchase crude oil transfer it to the refinery, and sell the refined product to Cumberland and other third parties.

Notwithstanding Haseotes's nominal ownership of the refinery, the family had an unwritten (and somewhat vague) agreement that any profits from the refinery would accrue to Cumberland, and to the family as its shareholders. Based on that sense of common purpose, the family promptly loaned large sums of money to the refinery and to CCP, hoping to bring the refinery to working order. Those loans came from the family members individually, but also — and crucially for this case — from Cumberland. From 1986 through 1988, Cumberland loaned more than $50 million to CCP, and another $20 million to the refinery itself. Cumberland's loans to CCP eventually were represented by a promissory note in the amount of $52,049,437, payable to Cumberland on demand, and no later than December 31, 1989. Some time later, that note was replaced by a new one in the same amount, but payable no later than October 10, 1990.

Throughout the relevant time period, Cumberland's largest lender was the Industrial Bank of Japan Trust Company ("IBJ"). Its agreement with IBJ specified that Cumberland would put no more than $20 million into the refinery entities. Not surprisingly, then, IBJ was not pleased to learn that Cumberland had loaned a total of roughly $70 million to the refinery and CCP. As the CEO of Cumberland and the owner of CCP and the refinery, Haseotes bore the brunt of IBJ's displeasure. In 1988, IBJ forced him to step down as Cumberland's CEO and to loan most of his share of Cumberland's profit distributions (payable to Haseotes as a shareholder) back to the corporation. Those loans form the basis for most of Haseotes's present claim against Cumberland. IBJ also demanded that Donald Holt — who was an officer of both CCP and Cumberland — resign from his post as chief financial officer at Cumberland. Finally, IBJ insisted that under no circumstances was Cumberland to loan any more money to either CCP or the refinery.

In order to ensure that Cumberland's loans to the refinery entities would be repaid, IBJ arranged for CCP and Cumberland to enter into a subordination agreement. In the agreement, CCP recognized its large debt to Cumberland, as well as the smaller debts owed to Haseotes and the other family members, then totaling $14,906,311. The latter debt was referred to in the agreement as "Subordinated Debt." The agreement provided generally that CCP would not allow the balance of the Subordinated Debt to drop below its current level, so that most of the company's resources could be allocated to the Cumberland loan. In the event of a default on that loan, CCP agreed to cease all payments on the Subordinated Debt, concentrating only on repaying its debt to Cumberland.

After IBJ put an end to any additional loans from Cumberland, Haseotes was forced to look elsewhere for funding for the refinery. His original estimates of the cost of bringing the refinery up to speed had proven to be well short of the mark, and by the end of the 1980s the refinery was in dire need of money. Haseotes saw an opportunity for a much-needed infusion of cash in his separate shipping operations. In 1987, Haseotes had purchased three oil tankers in the belief that they could be wedded profitably to his ownership of the refinery. He owned and operated the tankers through several companies; for the sake of simplicity, we will refer to those companies, and the ships themselves, as Haseotes's "shipping operation." Unlike the refinery, the shipping operation quickly became profitable, and in 1990 Haseotes had the opportunity to sell it for $71 million — roughly $50 million more than the purchase price and outstanding loan on the ships.

Haseotes's sister Lily Bentas ("Bentas"), who then was the president and CEO of Cumberland, urged him to sell the shipping operation. However, wary of the tax consequences of an outright sale, and anxious to maximize his available cash flow, Haseotes chose instead to take out a second loan on the shipping operation. In September of 1990, he obtained a $50 million loan from Chemical Bank. Haseotes personally guaranteed payment of the loan, thus linking the fate of the shipping operation to that of the refinery. If the refinery failed, Haseotes would be unable to repay the loan to Chemical Bank. And if the shipping operation defaulted on that loan, Chemical Bank could reach the refinery.

From September, 1990, until April, 1991, Haseotes loaned roughly $20 million from the shipping operation to CCP. Nevertheless, the refinery continued to struggle. CCP was unable to repay its loan to Cumberland, which was in default as of October, 1990. That failure had devastating consequences for Cumberland. By 1991, the corporation was teetering on the brink of bankruptcy.

Hoping to avert a financial crisis, Bentas and other members of the Cumberland board pressured Haseotes to sell the refinery so that CCP could repay its debt to Cumberland. Haseotes had received an offer from J. Aron & Company ("J.Aron") to purchase a 51% interest in the refinery for $70 million. At the Cumberland board meeting on July 10, 1991, the directors voted unanimously (with Haseotes abstaining) to approve and support the "concept" of the proposed sale to J. Aron. At a second meeting on August 8, 1991, Bentas expressed her "very strong interest" in having Cumberland assist in the consummation of a sale to J. Aron or any other entity "in order to stabilize economic circumstances" at Cumberland. IBJ also favored the sale. After a particularly...