In re Kirchoff Frozen Foods, Inc.

• Decision Date: 15 May 1972
• Docket Number: No. B-70-131 Phx.,B-70-131 Phx.
• Parties: In the Matter of KIRCHOFF FROZEN FOODS, INC., Bankrupt. Barnet DEXTER, as Trustee in Bankruptcy of Kirchoff Frozen Foods, Inc., Petitioner, v. Frank H. GILBERT and Beverly L. Gilbert, husband and wife, Respondents.
• Court: U.S. District Court — District of Arizona

375 F. Supp. 156

In the Matter of KIRCHOFF FROZEN FOODS, INC., Bankrupt.

Barnet DEXTER, as Trustee in Bankruptcy of Kirchoff Frozen Foods, Inc., Petitioner, v. Frank H. GILBERT and Beverly L. Gilbert, husband and wife, Respondents.

No. B-70-131 Phx.

United States District Court, D. Arizona.

May 15, 1972.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Henry Jacobowitz, Phoenix, Ariz., for Barnet Dexter, Trustee.

Robert H. Green, Phoenix, Ariz., for respondents.

OPINION^* AND ORDER

COPPLE, District Judge.

Respondents, Frank and Beverly Gilbert, have filed a petition for review of the Referee's findings of fact and conclusions of law and a petition for review of his order allowing costs. The Trustee has filed a cross-petition for review. Both parties have filed memoranda in support of their motions and in opposition to the other party's.

After an extensive hearing in bankruptcy court the Referee ordered respondents to turn over $111,460.16, together with Trustee's costs and interest, to the Trustee. The following is a summary of the Referee's findings of fact.

Kirchoff Frozen Foods, Inc., had been in financial trouble some time before Donald Kirchoff, Frank Gilbert¹ and Richard Mitchell, an attorney, went to Los Angeles on April 2, 1969, to meet with several of the corporation's major creditors. These creditors were advised on an individual basis that the Gilberts were interested in investing new capital in Kirchoff Frozen Foods, Inc. This proposal was later included in the general plan for extension which was sent to all the corporation's creditors.

On May 2, 1969, Mr. Kirchoff and Mr. Gilbert made another trip to Los Angeles in an attempt to persuade the corporation's creditors to accept the plan for extension. When queried as to the nature of his investment, Mr. Gilbert was evasive as to its precise nature.² He said nothing about a secured loan.

As a condition for the creditors accepting the plan of extension, Frank Gilbert was required to personally guarantee payment for all shipments during the ninety days following the acceptance of the plan of extension dated April 17, 1969.³ The creditors then accepted the plan either formally, informally or by inaction.

On June 6, 1969, the Gilberts deposited into a new account, under the name of "Gilbert Foods" the sum of $50,000. An additional $20,000 was deposited in this account on August 4, 1969, by Beverly Gilbert by a check drawn on her personal account. Frank Gilbert had complete control of that account.

In the early part of August Richard Mitchell drew up notes, security agreements and financial statements which purported to give the Gilberts a security interest in the corporation's accounts receivable for all moneys advanced by the Gilberts. (Exhibits A-4 through A-9.) Although some of the documents bear the date June 3, 1969, they were all signed on August 20, 1969, at a board of director's meeting. No consideration was given the corporation on the date the documents were signed.

At the same meeting on August 20, Frank Gilbert was elected Secretary and a Director on the Board and Beverly Gilbert was elected Vice President of the corporation. Donald Kirchoff, as President, was voted a $1,500 per month salary and Frank Gilbert was voted a $1,000 monthly salary. The amount of salary each was to receive was agreed upon prior to the meeting. Frank Gilbert did little for the corporation. It was also agreed prior to the meeting that the Kirchoffs could keep their two leased Cadillacs at the corporation's expense. This private agreement between the Kirchoffs and the Gilberts was not brought before the board for approval.

Things went badly for the corporation and on November 18, 1969 Frank H. Gilbert made available to the corporation another $25,000. On January 7, 1970, at a point when the corporation was hopelessly insolvent, the Kirchoffs relinquished to the Gilberts all the corporation's stock and resigned as officers and directors of the corporation.

Shortly thereafter, the Gilberts reached an agreement with Alvin De Frates, who was still the treasurer and a member of the board, that for a "bonus" of $3,000 the latter would sign all documents put before him and turn over to the Gilberts all incoming sales proceeds of the corporation. Between January 8, 1970 and February 13, 1970 the corporation was almost completely liquidated and the proceeds turned over to the Gilberts. The day-to-day business activities of the corporation were carried out but none of the corporate debts accumulated during that period were, with few exceptions, paid. During that period Alvin De Frates turned over to the Gilberts the sum of $93,866.69.

The Gilberts also received funds by surrendering a life insurance policy on the life of Donald L. Kirchoff, which was promised to creditors originally but later promised to them. They received $3,623.00 from this policy.

On January 26, 1970 a petition for involuntary bankruptcy was filed.

The Referee in the decision under review categorized the funds diverted from the corporation by the Gilberts and ordered the respondents to turn over the following amounts:

1. $92,531.17—withdrawal of sales proceeds and accounts receivable, less a credit of $1,335.52.

2. $3,000.00—"salary" withdrawals.

3. $11,105.99—corporate funds expended to pay Donald L. Kirchoff's personal obligations, with the permission and consent of Frank H. Gilbert.

4. $3,623.00—cash surrender value of Paul Revere Life Insurance Company policy on the life of Donald L. Kirchoff.

5. $1,200.00—lease payments on one of the Kirchoff Cadillacs during the period of June to December, 1969.

The Gilberts have filed a petition for review largely on the ground that the Referee lacked jurisdiction to order them to turn over funds in their possession. Essentially, they argue that even though they were officers of the bankrupt corporation at the time they acquired the funds, they liquidated the corporate assets pursuant to valid security agreements they had with the corporation (Exhibits A-4 and A-7) and are third parties to the bankruptcy and thus entitled to a plenary suit to determine their rights under the security agreements.

Referee's Conclusion of Law No. 7 sets forth two bases for the Referee's finding that summary jurisdiction exists: (1) actual and constructive possession of the funds in the court, and (2) consent to jurisdiction by the Gilberts.

The Referee's finding that the money in question was in the actual and constructive possession of the court will be treated first.

The power of the bankruptcy court to proceed summarily as to controversies over property rests largely upon whether or not the subject matter of the controversy is in its possession, either actually or constructively. 2 W. Collier, Collier on Bankruptcy ¶ 23.05 1 (14th ed. 1971).

Where possession is found to be in a third person, then the question becomes one of the substantiality of the claim under which possession is held, and the bankruptcy court has constructive possession and may exercise its jurisdiction over that property where the claim asserted is a mere pretense or is merely colorable. 2 W. Collier, Collier on Bankruptcy ¶ 23.05 1 (14th ed. 1971).

While it is a general rule that property found to be in the possession of directors or officers of the bankrupt corporation will be deemed to be in possession of the bankrupt, there is an exception where the officer or director has shown an adverse claim. Ford v. Magee, 160 F.2d 457 (2d Cir.), cert. denied, 332 U.S. 759, 68 S.Ct. 58, 92 L.Ed. 345 (1947); Wisconsin Banking Commission v. Van Steenwyck, 81 F.2d 337 (7th Cir. 1936); Brenner v. Sawyer, 24 F.2d 167 (1st Cir. 1928); In re Franklin Brewing Co., 263 F. 512 (2d Cir. 1920); In re Marquette, Inc., 254 F. 419 (2d Cir. 1918); 2 W. Collier, Collier on Bankruptcy ¶ 23.06 3, at 503-04 & n. 27 (14th ed. 1971).

An adverse claim is substantial and sufficient to deprive the bankruptcy court of summary jurisdiction if there is a contested matter of right, involving some fair doubt and reasonable room for controversy. American Mannex Corporation v. Huffstutler, 329 F.2d 449 (5th Cir. 1964); In re Carburetor Corp., 202 F.2d 75 (2d Cir. 1953); Atlanta Flooring & Insulation Co., Inc. v. Russell, 146 F.2d 884 (5th Cir. 1945); 2 W. Collier, Collier on Bankruptcy ¶ 23.07 2 (14th ed. 1971) and cases cited. If its validity depends upon disputed facts as to which there is a conflict of evidence or question of law, there must be a plenary action. Harrison v. Chamberlin, 271 U.S. 191, 46 S.Ct. 467, 70 L.Ed. 897 (1926); In re California Paving Co., 95 F.Supp. 909 (N.D.Cal.1951), aff'd sub nom. California Paving Co. v. L. C. Smith, 193 F.2d 647 (9th Cir. 1952), cert. denied, 343 U.S. 957, 72 S. Ct. 1052, 96 L.Ed. 1357 (1953); In re Marquette, Inc., supra; In re Midtown Contracting, 243 F. 56 (2d Cir. 1917); 2 W. Collier, Collier on Bankruptcy ¶ 23.07 2 (14th ed. 1971).

The exercise of summary jurisdiction is especially inappropriate when it is necessary to weigh the testimony of third parties before determining the substantiality of the person's claim. In re Wire Corporation of America, 131 F. Supp. 586 (D.N.J.1955); see In re Silver, 2 F.Supp. 628 (S.D.Fla.1933).

In all cases where the summary power of the bankruptcy court is disputed, a preliminary inquiry is necessary to ascertain the nature of the possession. If it is ascertained that a substantial claim exists as to the property adversely held, even though it is probable that such claim can be defeated, the bankruptcy court must desist and proceed no further in the summary proceedings; a plenary suit is the only proper remedy. 2 W. Collier, Collier on Bankruptcy ¶ 23.07 3 (14th ed. 1971).

The Ninth Circuit follows the above-articulated test. Suhl v. Bumb, 348 F. 2d 869 (9th Cir. 1965); Martoff v. Elliott, 326 F.2d 204 (9th Cir. 1963); Cadwell v. Elliott, 319 F.2d 598 (9th Cir. 1963); Bank of California v. McBride, 132 F.2d 769 (9th Cir. 1943); ...