In re Eljay Jrs., Inc., Bankruptcy No. 87-B-10094 (HCB)

• Decision Date: 27 October 1989
• Docket Number: Adv. No. 88-5366A.,Bankruptcy No. 87-B-10094 (HCB)
• Parties: In re ELJAY JRS., INC., Debtor. Bruce S. SCHERLING, Trustee of Eljay Jrs., Inc., Plaintiff, v. Joel S. EHRENKRANZ and Andrea Boles Mallas, Executors of the Estate of Louis J. Mallas, Defendants.
• Court: United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York

106 B.R. 775 (1989)

In re ELJAY JRS., INC., Debtor Bruce S. SCHERLING, Trustee of Eljay Jrs., Inc., Plaintiff, v. Joel S. EHRENKRANZ and Andrea Boles Mallas, Executors of the Estate of Louis J. Mallas, Defendants.

Bankruptcy No. 87-B-10094 (HCB), Adv. No. 88-5366A.

United States Bankruptcy Court, S.D. New York.

October 27, 1989.

COPYRIGHT MATERIAL OMITTED

Scherling, Davidson & Rech, P.C., New York City by Gustav Rech, for Trustee.

Skadden, Arps, Slate, Meagher & Flom New York City by Michael Cook, Julie L. Miller, and Kayalyn Marafioti, for Joel S. Ehrenkranz, Co-Executor of the Estate of Louis J. Mallas.

HOWARD C. BUSCHMAN, III, Bankruptcy Judge.

This adversary proceeding was commenced by Bruce S. Scherling (the "Plaintiff" or the "Trustee"), Chapter 7 trustee of Eljay Jrs., Inc. (the "Debtor" or "Eljay"), against Joel S. Ehrenkranz and Andrea Boles Mallas (the "Defendants"), Co-Executors of the Estate of Louis J. Mallas (the "Mallas Estate"), to avoid, pursuant to žž 544(b), 547 and 548(a) of 11 U.S.C. (the "Bankruptcy Code" or the "Code"), transfers of insurance proceeds alleged to be property of Debtor, to the Mallas Estate approximately two months prior to the Debtor's filing for relief under the Bankruptcy Code, at a time when it was insolvent.¹ The principal issues are (i) whether an inter vivos life insurance trust was established in 1980, when there is no proof of insolvency, having as its res the right to collect the proceeds from existing and after acquired policies and (ii) whether, if so, the transfer of the insurance proceeds violated ž 513(a) of the New York Business Corporation Law and are therefore avoidable pursuant to ž 544(b) of the Code. Trial was held on June 13 and 16, 1989. Post-trial submissions were completed on October 10, 1989.

I

Eljay is a New York corporation. It was incorporated in 1977. June 16, 1989 Trial Transcript (the "6/16/89 Tr."), pp. 12-13. Louis J. Mallas was a shareholder and officer of the corporation from its inception until his death in 1986. Eljay commenced the business of selling domestically manufactured ladies' garments upon acquiring a division of Lou Mallas, Inc. in exchange for a demand obligation in the principal amount of $2,000,000. 6/16/89 Tr., pp. 12-13.

Eljay obtained from Phoenix Mutual Life Insurance Company of Hartford, Connecticut ("Phoenix") two insurance policies on Mallas' life on June 7, 1977 and September 6, 1977. The policies, Nos. 2,011,175 and 2,021,244, were in the face amounts of $1,500,000 and $500,000, respectively (the "Phoenix Policies"). The Phoenix Policies named Eljay as owner and provided that "the owner controls the policies while the insured is living." Exh. 12 and Exh. 13,  3. Eljay retained the rights to receive all amounts payable during the insured's life, to change the beneficiary and the interest of any owner, and to assign, release or surrender the policies. Exh. 12 and Exh. 13,  3 and  4.

Beneficiary Designations, dated June 16, 1977 and October 5, 1977 were filed with Phoenix by Eljay in 1977. They stated that the proceeds of the policies would be

"payable on account of the death of the insured . . . to Lou Mallas, Inc., a New York corporation, its successors or assigns, creditor, as such creditor\'s interest may appear . . . The amount payable on account of the death of the insured, less the amount paid as hereinbefore provided, shall be payable to El Jay Jrs., Inc., a New York corporation, its successors or assigns." Exh. 14 and Exh. 15.

Eljay also assigned, by virtue of Assignments of Policy as Collateral dated June 28, 1977 and October 5, 1977 (the "Assignments"), its rights and interests in the Phoenix Policies to Louis Mallas, Inc. Exh. 17 and Exh. 18. It reserved, however, the right to designate and change the beneficiary. Exh. 17 and Exh. 18, Â B.

Some three years later, Mallas and his fellow shareholders, Laurence Korman and Lee Blumenthal, and Eljay executed an agreement dated as of May 3, 1980 (the "Agreement," Exh. 1). The Agreement provided, inter alia, for Eljay to repurchase shares held by the estate of any deceased shareholder and the estate to sell those shares. Exh. 1, Â 1.4. The Agreement further provided that the purchase price of each share of stock of a deceased shareholder was to be the value of each share on the date of the shareholder's death and that the proceeds of any life insurance policies on the life of the deceased shareholder shall be applied to the purchase price. Exh. 1, Â 1.8.2(c).

The policy proceeds were to be held in trust to satisfy Eljay's obligation to purchase the shares held by the deceased shareholder and excluded from the calculation of Eljay's net worth. The Agreement further provided for assignment of the proceeds by Eljay if it had not received them when it purchased the stock and for return of that portion of the proceeds if it overpaid for the stock. It stated:

. . . there shall not be included in any such calculation of net worth per share any of the life insurance proceeds received or receivable by the Corporation upon the death of a Stockholder. The Corporation shall pay over the full amount of such life insurance proceeds, to the extent received to the estate of the deceased Stockholder when the sale takes place as provided in Section 1.4. Such payments shall be applied against the purchase price for the shares. If the amount of life insurance proceeds received at any time as a result of the death of the Stockholder whose shares are being purchased is greater then what the purchase price for such shares would be, based upon the value calculated as set forth above, then the amount of insurance proceeds so paid over shall be deemed to be the purchase price. If the insurance proceeds are less than the value so calculated then the purchase price shall be the value so calculated. The proceeds of such life insurance shall be kept separate and apart from all other funds of the Corporation and shall be held by the Corporation, in trust, to be applied to its obligation to purchase the shares owned by the deceased Stockholder in accordance with the terms and provisions of this Agreement. If all of the insurance proceeds have not been received when the sale takes place, then the Corporation shall assign to said estate the right to receive such proceeds. If the amount so assigned when received by the estate, is, together with all other amounts of purchase price received by the estate in excess of the total amount of purchase price to which the estate is entitled, then the estate promptly shall return to the Corporation the full amount received by the estate in excess of said purchase price.

Exh. 1, Â 1.8.3 (Emphasis added).

Eljay's purchase of shares of stock was subject to the restrictions imposed by law on New York corporations with respect to the purchase of their own shares of stock. If such restrictions would prevent either the purchase of any shares by Eljay or the payment of any installment of purchase price, then the parties agreed to vote for a reduction in the capital of Eljay in order to enable it to make any purchase or payment required under the Agreement. Exh. 1, Â 7. However, "if the amount of any insurance proceeds received by the Corporation in respect of the death of the Stockholder whose shares are being purchased exceeds the price which would be paid based upon such value, then the price shall be an amount equal to the amount of such insurance proceeds." Exh. 1, Â 1.8.1(ii).

Prior to the execution of the Agreement, Howard Bernstein, of the Joseph S. Herbert Company, Eljay's accountant, attended, as consultant to Korman and Blumenthal, a meeting of the Eljay shareholders convened to discuss the instrument. He testified that it was intended by Mallas that "all matters contained in the Agreement were to be effective on the date of signing," subject to further "embellishment," i.e., purchase of additional insurance, so as to have sufficient proceeds to

cover in the largest amount funds to pay out the decedent\'s estate on the buyback provision . . . From time to time usually at year end the various stockholders were to meet with me, formally or informally, most of the times informally, to discuss whether the life insurance ought to be embellished to be greater than they were originally based on the new values of the company that might pertain on the audit date.

6/16/89 Tr., pp. 11-12.

To this Korman added that he understood that there was to be insurance on the lives of the three shareholders pursuant to the Agreement, that "the expressed purpose of this insurance was for the benefit of, God forbid, whoever passed away, that their family would retain the money," that "there was mention of a trust, but again it was his understanding that the trust was basically holding the money for the beneficiary if somebody was deceased," and that the Agreement was to be effective "at the beginning of the shareholders' agreement, May of 1980." 6/16/89 Tr., p. 35.

On November 2, 1983, Connecticut Mutual Life Insurance Company ("Connecticut") issued life insurance policy No. 4271128 (the "Connecticut Policy") for the face amount of $400,000 on the life of Mallas, with Eljay named as owner and beneficiary. Compl., Â 7; Ans., Â 6.

A Standard Confirmation Inquiry dated May 25, 1984 and submitted to Phoenix by Bernstein on behalf of the corporation named Eljay as the owner and "Lou Mallas Inc., Corp. creditor as their interest may appear. Balance same as owner" as beneficiaries of the Phoenix Policies. Exh. 41, 6/16/89 Tr., pp. 18-19. Note 2 of Eljay's certified financial statement dated April 28, 1984, Exh. 40, stated that the Debtor was the owner and beneficiary of the Phoenix Policies and the Connecticut Policies.² Bernstein averred that such information was confirmed by the insurer and inscribed on the policies. 6/16/89 Tr., pp. 10, 16. Although the audit note makes no mention of the Agreement, Bernstein claimed that the note was consistent with his...