In re Humphreys Pest Control Franchises, Inc., Bankruptcy No. 82-05540K.

• Decision Date: 22 June 1984
• Docket Number: Bankruptcy No. 82-05540K.
• Parties: In re HUMPHREYS PEST CONTROL FRANCHISES, INC., Debtor.[*]
• Court: United States Bankruptcy Courts. Third Circuit. U.S. Bankruptcy Court — Eastern District of Pennsylvania

40 B.R. 174 (1984)

In re HUMPHREYS PEST CONTROL FRANCHISES, INC., Debtor.^*

Bankruptcy No. 82-05540K.

United States Bankruptcy Court, E.D. Pennsylvania.

June 22, 1984.

Joseph S.U. Bodoff, Philadelphia, Pa., for debtor.

Melvin Lashner, Philadelphia, Pa., for creditors' comm.

Louis W. Fryman, Philadelphia, Pa., Trustee.

OPINION

WILLIAM A. KING, Jr., Bankruptcy Judge.

Humphreys Pest Control Franchises, Inc. ("debtor") filed a Chapter 11 petition for reorganization on November 17, 1982. The debtor is a wholly-owned subsidiary of Humphreys Pest Control Company, Inc. ("parent corporation"). A Chapter 11 petition was also filed by the parent corporation on November 17, 1982.

The parent corporation operates an insect extermination business. The debtor was formed for the purpose of selling franchises in the insect extermination business to passive investors. Both corporations have remained in operation as debtors-in-possession under § 1108 of the Bankruptcy Code ("Code"). The officers and principals of the parent corporation are the same as the officers and principals of the debtor corporation.

A Creditors' Committee has been appointed in each case. The Creditors' Committee of the debtor, Humphreys Pest Control Franchises, Inc., has moved for the appointment of a trustee pursuant to § 1104(a)(2) of the Code for the following reasons:

(1) that alleged improper transfers of assets from debtor corporation to parent corporation have occurred;

(2) that these transfers constitute a commingling of debtor\'s assets with those of the parent corporation which is harmful to creditors of debtor corporation; and

(3) that the officers and principals of the debtor corporation have breached their fiduciary duties to the debtor because of conflicting interests.

On the basis of the evidence presented, we conclude that the appointment of a trustee is in the best interests of creditors.¹

Section 1104(a)(2) provides:

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

(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 securities of the debtor or the amount of assets or liabilities of the debtor.

The debtor's assets consist of revenues received from the sale of franchises and royalty payments received from operation of the franchises. The debtor has no tangible assets.² On May 3, 1983, due to the debtor's failure to register the franchises as securities with the Pennsylvania Securities Commission, the Commonwealth Court of Pennsylvania prohibited the debtor from continuing to sell franchises without proper registration. Currently, the income received from monthly royalty payments is the only source of assets because the debtor is no longer selling franchises.

The evidence before us shows that over $650,000.00 was transferred from the debtor's assets to the parent corporation during the year preceding the bankruptcy filing.³ Subsequent to the filing of the Chapter 11 petition, in excess of $125,000.00 has been transferred to the parent corporation.⁴ The amounts transferred represent a significant portion of the debtor's monthly receipt of royalty payments. The net result of the cash transfers is that the debtor often has a negative cash flow at the end of each month.

The propriety of the transfers is challenged by the Creditors' Committee. The Committee asserts that the transfers violate the fiduciary duties owed to creditors by the debtor-in-possession⁵ and leave the debtor with no assets for reorganization.

The debtor's response is that a management agreement exists between the debtor and its parent corporation. Testimony was offered at the hearing by Rosamond Humphreys, a principal and officer of the debtor, to show that the transfers were proper and supported by adequate consideration. When asked to explain the reasons for the transfers, Mrs. Humphreys testified as follows:

"They had a management agreement that was written up where Humphreys Pest Control would do certain things for the franchise corporation, such as handle their payroll, their—the housing of the operations, pay for that, all the computer and software that—of our systems, all of our training background and professional background that we have, and office expenses, auto expenses, travel—there were certain things that the franchise corporation—that the Humphreys Pest Control Corporation was doing for the Franchise Corporation, and they had this agreement, and in turn the Pest Control Company received 20 percent of the royalties received."⁶

Although Mrs. Humphreys testified as to the terms of the written management agreement, she was unable to support her testimony by producing either the original agreement or a copy of it at the hearing. Assuming, arguendo, that a management agreement does exist and that services were performed and expenses incurred on the debtor's behalf by the parent corporation, the debtor, nevertheless, was unable to provide an adequate accounting for the amounts transferred.

The Creditors' Committee offered into evidence "Cash Flow Statements" reflecting cash receipts and cash disbursements by the debtor on a month-to-month basis from November, 1982, the date the Chapter 11 petition was filed, until December, 1983.⁷ The amounts listed as "Transfers" by the debtor to its parent corporation under the category of cash disbursements varied from month to month. No explanation was provided either on the statements themselves or at the hearing as to how the amounts transferred related to the alleged expenses incurred on behalf of the debtor or the payment of twenty (20%) percent of royalty receipts to the parent corporation under the terms of the management agreement. For example, in March of 1983, the amount transferred to the parent corporation represented forty-eight (48%) percent of the debtor's cash receipts for the month of March. In April of 1983, the amount transferred was eighty-one (81%) percent of cash receipts. In October of 1983, the amount transferred was one hundred and six (106%) percent of cash receipts.

The "Cash Flow Statements" also show that the debtor was paying many of its own expenses. For example, costs of advertising, insurance, utilities, rent, telephone, etc. are listed as cash disbursements. Yet, the parent corporation was allegedly incurring expenses on behalf of the debtor.

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