In re Kelton Motors, Inc.
| Decision Date | 31 March 1993 |
| Docket Number | Bankruptcy No. 89-00255,Adv. No. 90-00024A. |
| Citation | 153 BR 417 |
| Court | U.S. Bankruptcy Court — District of Vermont |
| Parties | In re KELTON MOTORS, INC., Debtor. Gleb GLINKA, Trustee for the Estate of Kelton Motors, Inc., Plaintiff, v. BANK OF VERMONT, Defendant. |
Gleb Glinka, Law Offices of Gleb Glinka, Cabot, VT, for Gleb Glinka as Trustee for the Estate of Kelton Motors, Inc.
D. Weiss, Saxer, Anderson, Wolinsky & Sunshine, Burlington, VT, for Bank of Vermont.
Bank of Vermont's Renewed Motion for Summary Judgment1 presents two issues of first impression in this jurisdiction, namely, whether the judicially created "earmarking doctrine" has survived recodification in the Bankruptcy Code and whether the earmarking doctrine is a defense to a preference action commenced under 11 U.S.C. § 547(b) when the new creditor does not directly pay the old creditor.
We hold that the earmarking doctrine survived recodification in the Bankruptcy Code and provides a valid defense to a preference action where the debtor maintains no actual or meaningful control over the earmarked funds and the transfer does not diminish the debtor's estate. The earmarking doctrine is not a complete defense, however, where property of the debtor is used as collateral for a new loan, and therefore the trustee may avoid the transfer to a new lender, but only to the extent that a new lender's lien encumbers an interest of the debtor in property.
In the Memorandum of Decision that follows, we deny Bank of Vermont's motion for summary judgment in all respects, and grant partial summary judgment in favor of Trustee concerning the inapplicability of the earmarking defense to $1,500,000.00 of the $3,000,000.00 at issue.
On October 27, 1988, creditors filed an involuntary petition against Debtor under 11 U.S.C. § 101, et seq. The case was converted to a voluntary one under chapter 11 and shortly thereafter converted to a case under chapter 7. Trustee filed this adversary proceeding against Bank of Vermont on March 3, 1990 to avoid certain fraudulent and preferential transfers.
Bank of Vermont filed a motion for summary judgment regarding the preferential transfer claim on October 11, 1991. In a hearing held on December 11, 1991, we orally denied summary judgment on the basis that two material facts remained in dispute. These two material facts related to Debtor's control of the borrowed funds in reference to Bank of Vermont's assertion of the earmarking defense.
Bank of Vermont renewed its motion for summary judgment on December 23, 1992. Attached to the renewed motion for summary judgment was an affidavit signed by Mr. Kelton concerning the key issues left unresolved after the first summary judgment motion. Trustee submitted response papers and additional supporting materials. In a hearing held on January 14, 1993, we reserved decision on the renewed motion for summary judgment.
This adversary proceeding arose from a criminal check-kiting scheme perpetrated by Carl E. Kelton ("Mr. Kelton")2 under the guise of Kelton Motors, Inc. ("Debtor") and several related corporations. The issue now before us concerns two loans that Debtor obtained within the 90-day preference period to remedy an overdraft at Bank of Vermont. The following facts are substantially undisputed.
On July 26, 1988, Bank of Vermont filed an action in Vermont Superior Court against Debtor, Debtor's related corporate entities, and Mr. Kelton3. In its complaint, Bank of Vermont alleged that account number XXXXXXXXX was overdrawn in the amount of $3,679,427.18 and that Mr. Kelton used the Bank of Vermont account to deposit and clear revenues payable to his other related corporate entities, including Debtor. Bank of Vermont also obtained an ex parte writ of attachment against Charlie Kelton's Chrysler Plymouth Dodge of Brattleboro, Inc. ("the Brattleboro dealership") concerning an overdraft on the Brattleboro Dealership's account.
Shortly after Bank of Vermont brought suit, Mr. Kelton sought a $3,000,000.00 loan from Lyndonville to pay the overdraft at Bank of Vermont. Following negotiations involving Lyndonville's board of directors and Mr. Kelton, Lyndonville agreed to make the loan, subject, however, to a blanket lien on Mr. Kelton's and Debtor's property and an agreement from Bank of Vermont that it would voluntarily dismiss its overdraft action against Debtor and its related entities.
On August 1, 1988, Bank of Vermont, Debtor, and Mr. and Mrs. Kelton agreed in writing that in return for payment of the overdraft and expenses amounting to $2,948,255.52, Bank of Vermont would withdraw its lawsuit against Debtor, its related corporations, and Mr. and Mrs. Kelton. The agreed payment represents $2,926,169.82 to cover the overdraft and $22,085.70 to compensate Bank of Vermont for costs and attorneys' fees.
In two separate loan agreements, Lyndonville agreed to provide the funding necessary for Debtor and its related corporations to pay the agreed settlement amount to Bank of Vermont. First, on July 28, 1988, Debtor guaranteed a promissory note to Lyndonville for $1,500,000.00 (the "Kelton Note" or "Kelton Loan"). Mr. Kelton and his spouse, Carol Kelton, signed the promissory note. The note was secured by a blanket chattel mortgage ("the Chattel Mortgage") on Debtor's property, its related entities, and mortgages on certain real estate. The Chattel Mortgage also secured various unpaid loan obligations owed to Lyndonville by other Kelton businesses or individuals. The original principal amounts of the notes specifically secured by the Chattel Mortgage totaled $4,700,000.00.
All of the security for the Kelton Note described in the Chattel Mortgage, except the contract and franchise rights and inventory, had previously been pledged by Debtor to secure a $1,000,000.00 note of Vernon and Doreen Kelton dated November 12, 1987. The Kelton Note was guaranteed by Debtor, seven of Debtor's related corporations, and Carl and Shirley Kelton. Debtor did not sign the Kelton note. The parties dispute the value of the Debtor's collateral used to secure the Kelton Note.
On July 29, 1988, Peter, Raymond, and Janice Jasmin ("the Jasmins") borrowed an additional $1,500,000.00 (the "Jasmin Note" or "Jasmin Loan") from Lyndonville that was paid to Debtor. Debtor did not sign or guaranty the Jasmin Note. Instead, the Jasmin note was secured by a commercial mortgage on the Jasmins' premises and real property, including property leased to Jasmin Auto Sales and 19 acres in Hartford, Vermont. Also on July 29, 1988, the Jasmins authorized Lyndonville to pay the proceeds of the loan "as directed by Carl E. Kelton, Sr." The Jasmins placed no written restrictions on Mr. Kelton's use of the funds.
The closing for the two $1,500,000.00 loans was held at the Kelton corporate headquarters in White River Junction, Vermont on August 1, 1988. At the closing, Lyndonville issued two checks totaling $2,948,255.52 payable to Debtor. The first check, written for the amount of $30,973.88, was drawn on the Lyndonville account of Charlie Kelton's Chevrolet Oldsmobile, Inc. The second check, written for $2,917,281.64, was drawn from Lyndonville and included both the Jasmin and Kelton loans.
At the closing — eighty-seven days prior to the petition date — the Debtor endorsed two checks payable to Debtor to Bank of Vermont as payment for overdrawn or dishonored checks. Mr. Kelton endorsed the checks as Debtor's president and handed them to A.R. Field, an attorney representing Lyndonville. Field then handed the checks to Bank of Vermont's attorney, G.E. Westgate. These two checks were the sole source of the funds for the $2,948,255.52 payment to Bank of Vermont.
After receiving payment of $2,948,255.52 at the loan closing on August 1, 1988, Bank of Vermont delivered a dismissal of the Vermont Superior Court lawsuit and a release of the ex parte attachment obtained in connection with the overdraft.
Bank of Vermont bases its position on two simple conclusions: first, that Debtor had no control over the borrowed funds, and two, that the security interest pledged in exchange for the Kelton Note had little or no value and therefore did not deplete Debtor's estate. In support of its position, Bank of Vermont refers to Mr. Kelton's affidavit dated August 28, 1992 ("the Kelton Affidavit"). Mr. Kelton states in the affidavit that "the only reason he requested the Lyndonville loan was to pay the Bank of Vermont," and that he and Lyndonville "agreed that the funds from the loan would be used to pay the debt owed to the Bank of Vermont" in exchange for the dismissal of the overdraft suit commenced against the various Kelton corporations. Kelton Affidavit, ¶¶ 3-5. Moreover, Mr. Kelton states that "there was never any intention or agreement to pay these funds to Kelton Motors, Inc. for its use" and that "neither he nor any representative of Kelton Motors, Inc., exercised any control whatsoever over the loan proceeds." Kelton Affidavit, ¶¶ 8, 9.
Bank of Vermont also submits supporting materials concerning the value of Debtor's collateral that was pledged to secure the Kelton Note. Bank of Vermont argues that the collateral was worth, at a maximum, $18,645.60—the amount Lyndonville received from the auction sale of Debtor's assets that were encumbered in the chattel mortgage.4
Trustee disputes both of Bank of Vermont's conclusions. Trustee argues that Debtor maintained control over the two loans and that the security pledged to secure the Kelton Loan depleted the estate. Specifically, regarding Debtor's control over the Lyndonville loans, Trustee lists several facts that tend to show that Debtor maintained control over both the Kelton and Jasmin Loans. First, no written agreements between Lyndonville and Debtor limited Debtor's use of the funds, and the loan checks were...
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