In re Francis
Citation | 252 BR 143 |
Decision Date | 23 August 2000 |
Docket Number | Bankruptcy No. 97-31344M. Adversary No. 99-3050. |
Parties | In re Mark FRANCIS d/b/a Tech Glass and Body Parts. James C. Luker, Trustee, Plaintiff, v. Lewis Auto Glass, Inc. and Midwest Auto Body Panels, Inc., Defendants. |
Court | United States Bankruptcy Courts. Eighth Circuit. U.S. Bankruptcy Court — Eastern District of Arkansas |
Warren Dupwe, Jonesboro, AR, for debtor.
Harry Hurst, Jonesboro, AR, for Midwest Auto Panels, Inc.
William C. Ayers, West Memphis, AR, for trustee.
Mark Francis ("Debtor") filed a voluntary petition for relief under the provisions of chapter 7 of the United States Bankruptcy Code on November 20, 1997, and the plaintiff, James C. Luker, was appointed Trustee. On September 15, 1999, the Trustee filed a complaint against Midwest Auto Body Panels, Inc., ("Midwest") to recover an alleged preferential transfer of $15,000.00.1 Midwest filed a timely answer. Trial on the merits was held in Jonesboro, Arkansas, on April 18, 2000, and the matter was taken under advisement.
The proceeding before the Court is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(F) (1994), and the Court has jurisdiction to enter a final judgment in this case. The following shall constitute the Court's findings of fact and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052.
The facts are not in dispute. The Debtor was engaged in the automobile glass business as an individual proprietorship. In the fall of 1997, his business was losing money, and by September, he had accounts payable totaling $161,000.00. Among his accounts payable was a debt owed to Midwest in the sum of approximately $15,000.00. The Debtor had written four postdated checks to Midwest which failed to clear the bank by the time he closed the business in September 1997.
In October 1997, the Debtor, fearful of criminal prosecution because of the returned checks, obtained a personal loan from a family member in the sum of $15,000.00. The loan proceeds were placed in the Debtor's personal account on October 10, 1997, and on the same day, the Debtor used the loan proceeds to purchase a cashier's check for $15,000.00 payable to Midwest.
The Trustee argues in his brief that the payment made by the Debtor in the sum of $15,000.00 is a voidable preference under the Bankruptcy Code. Midwest contends that the earmarking doctrine applies to this case and, therefore, that the payment was not a transfer of an interest of the Debtor's property as required by the preference statute.
The Bankruptcy Code provides in relevant part that the trustee may avoid as a preference any transfer of an interest of the debtor in property:
11 U.S.C. § 547(b) (1994).
Midwest argues that the transfer of the sums in question was not a transfer of an interest in the Debtor's property because of the earmarking doctrine and, therefore, no preference occurred. Midwest does not dispute that all of the other elements of a preference have been established.
The earmarking doctrine is a court-made doctrine first appearing under the Bankruptcy Act of 1898. Gray v. Travelers Ins. Co. (In re Neponset River Paper Co.), 231 B.R. 829, 834 (1st Cir. BAP 1999) ( ); David Gray Carlson & William H. Widen, "The Earmarking Defense to Voidable Preference Liability: A Reconceptualization," 73 Am.Bankr.L.J. 591, 592 (Summer 1999) (a case decided under the Act) that Judge Learned Hand invented earmarking in . See, e.g., Smyth v. Kaufman, 114 F.2d 40, 42-43 (2nd Cir. 1940) ( ); Grubb v. General Contract Purchase Corp., 94 F.2d 70, 72 (2nd Cir.1938) ( ).
Generally, the doctrine applies when a third party lends money to the debtor for the specific purpose of paying a selected creditor. The transfer from the debtor to the selected creditor is deemed "earmarked." In re Smith, 966 F.2d 1527, 1533 (7th Cir.1992) (citing McCuskey v. National Bank of Waterloo (In re Bohlen Enters., Ltd.), 859 F.2d 561 (8th Cir.1988)).
The rationale for the creation of the earmarking doctrine under the Bankruptcy Act was that a transfer cannot be a preference if the transfer does not diminish the estate. New York County Nat'l Bank v. Massey, 192 U.S. 138, 148-49, 24 S.Ct. 199, 48 L.Ed. 380 (1904); National Bank of Newport v. Herkimer County Bank, 225 U.S. 178, 185, 32 S.Ct. 633, 56 L.Ed. 1042 (1912) (citing Rector v. City Deposit Bank Co., 200 U.S. 405, 419, 26 S.Ct. 289, 50 L.Ed. 527 (1906); Western Tie and Timber Co. v. Brown, 196 U.S. 502, 509, 25 S.Ct. 339, 49 L.Ed. 571 (1905)). For example, a transfer does not diminish the estate when a surety pays his principal's debt. Grubb, 94 F.2d at 72 (citing National Bank of Newport, 225 U.S. at 178, 32 S.Ct. 633; Bielaski v. National City Bank, 68 F.2d 723 (2d Cir.1934)). This is so because in the case of a surety who pays his principal's debt, the principal (or debtor) has no control of the property transferred and, thus, the transfer did not involve the debtor's property. Grubb, 94 F.2d at 72.
The concept was first named in Smyth v. Kaufman when the court remarked that this doctrine would apply if the funds transferred were proceeds of a loan made for a specific purpose or "earmarked" by the lender. Smyth, 114 F.2d at 43. From these early cases, the earmarking doctrine has developed.
The 8th Circuit Court of Appeals has recognized this doctrine, stating:
If payment to a creditor is made by one liable as an indorser . . . out of his own funds, the creditor has not received a preference . . . It does not matter that in the course of the transaction the party secondarily liable may have paid the money to the debtor . . . for in such a case the debtor took the money charged with a fiduciary obligation to employ it toward extinguishment of the particular debt, and the money the creditor received was never a general asset of the debtor.
Brown v. First Nat'l Bank of Little Rock, 748 F.2d 490, 492 n. 6 (8th Cir.1984) citing Grubb v. General Contract Purchase Corp., 18 F.Supp. 680, 682 (S.D.N.Y.1937) (citations omitted), aff'd, 94 F.2d 70 (2d Cir.1938).
In the case of In re Bohlen Enterprises, Ltd., the Court of Appeals for the Eighth Circuit directly considered the applicability of the earmarking doctrine. The court observed that earmarking has been extended beyond the guarantor situation and now applies when "the new creditor is not a guarantor but merely loans funds to the debtor for the purpose of enabling the debtor to pay the old creditor." In re Bohlen Enters., Ltd., 859 F.2d at 566. The rationales for the extension of the doctrine were "that the debtor did not have `control' of the new money and that the transaction did not diminish the debtor's estate." In re Bohlen Enters., Ltd., 859 F.2d at 566.
The court held that a transaction must meet three requirements before earmarking applied. These include:
In re Bohlen Enters., Ltd., 859 F.2d at 566.
In dictum, the court condemned the extension of earmarking to non-guarantor situations but nevertheless applied the doctrine in holding that in the case before it, the agreement was not performed according to its terms. Thus, the second requirement under the earmarking analysis was not fulfilled. In re Bohlen Enters., Ltd., 859 F.2d at 567.
In 1992, the Eighth Circuit Court of Appeals revisited the applicability of the earmarking doctrine. See, Buckley v. Jeld-Wen, Inc. (Interior Wood Products Co.), 986 F.2d 228 (8th Cir.1993). The court observed that the earmarking doctrine is applicable In re Interior Wood Products Co., 986 F.2d at 231 (citing In re Bohlen Enters., Ltd., 859 F.2d at 564-65; In re EUA Power Corp., 147 B.R. 634, 642 (Bankr.D.N.H.1992); In re Grabill, 135 B.R. 101, 109 (Bankr. N.D.Ill.1991)).
The court also observed that although there is no statutory requirement that a preference diminish the estate under the Bankruptcy Code, many courts have determined such a requirement implicit in the language of the statute. In re Interior Wood Products Co., 986 F.2d at 231 (citing In re Abramson, 715 F.2d 934, 938 (5th Cir.1983); Palmer v. Radio Corp. of America, 453 F.2d 1133, 1135 n. 3 (5th Cir.1971)). The court held that the earmarking defense did not apply in the case before it because there was no third party loan made to the debtor such that one creditor was substituted for another. In re Interior Wood Products Co., 986 F.2d at 232.
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