In re M. Paolella & Sons, Inc.

• Decision Date: 11 May 1988
• Docket Number: Adv. No. 87-1007F.,Bankruptcy No. 86-00495F
• Citation: 85 BR 965
• Parties: In re M. PAOLELLA & SONS, INC., Debtor. The AMERICAN CIGAR COMPANY, the American Tobacco Company, Lorillard, Inc.; Philip Morris Incorporated; and R.J. Reynolds Tobacco Company, Plaintiffs, v. MNC COMMERCIAL CORP., Maryland National Bank, and Larry Waslow, Trustee, Defendants.
• Court: U.S. Bankruptcy Court — Eastern District of Pennsylvania

85 B.R. 965 (1988)

In re M. PAOLELLA & SONS, INC., Debtor The AMERICAN CIGAR COMPANY, the American Tobacco Company, Lorillard, Inc.; Philip Morris Incorporated; and R.J. Reynolds Tobacco Company, Plaintiffs, v. MNC COMMERCIAL CORP., Maryland National Bank, and Larry Waslow, Trustee, Defendants.

Bankruptcy No. 86-00495F, Adv. No. 87-1007F.

United States Bankruptcy Court, E.D. Pennsylvania.

May 11, 1988.

COPYRIGHT MATERIAL OMITTED

Arthur E. Newbold, Kathleen Milsark, Jennifer M. Anderson, Dechert, Price & Rhoads, Philadelphia, Pa., for plaintiffs, The American Cigar Co., Lorillard, Inc., The American Tobacco Co., Philip Morris, Inc., and R.J. Reynolds Tobacco Co.

Richard M. Jordan, Jack B. Justice, Paul A. Patterson, White and Williams, Philadelphia, Pa., for defendants, MNC Commercial Corp. and Maryland Nat. Bank.

Kevin Walsh, Adelman Lavine Gold & Levin, Philadelphia, Pa., for defendant/trustee, Larry Waslow.

MEMORANDUM OPINION

BRUCE I. FOX, Bankruptcy Judge:

Plaintiffs in this adversary proceeding have filed a five count complaint against three defendants, one of whom is the trustee. Two of the defendants, MNC Commercial Corporation and Maryland National Bank have filed a joint motion to dismiss, pursuant to Bankr.Rule 7012(b), raising questions concerning subject matter jurisdiction as well as standing. This motion has been thoroughly briefed and argued and, for the reasons set forth below, must now be denied.

I.

In considering this motion to dismiss, plaintiffs' factual allegations set out in their complaint are accepted as true, solely for the purpose of deciding this motion. See Ingersoll-Rand Financial Corp. v. Callison, 844 F.2d 133 (3d Cir.1988); D.P. Enterprises, Inc. v. Bucks County Community College, 725 F.2d 943 (3d Cir.1984); In re Stephen W. Grosse, P.C., 68 B.R. 847 (Bankr.E.D.Pa.1987).

Those facts are as follows:

The debtor, M. Paollela & Sons, Inc., was, for many years, a large wholesaler of cigarettes, cigars and candy. The plaintiff tobacco companies sold tobacco products to the debtor on credit—although plaintiffs limited the amount of credit allowed. Financing for the debtor's operation came from defendant MNC; in return, MNC took a security interest in all of the debtor's assets, including inventory and accounts receivable. Financing was obtained pursuant to a lending formula which was based upon a percentage of outstanding accounts receivable and inventory. Formula compliance was monitored, inter alia, by the debtors sending daily business reports to MNC and by the debtor's depositing the proceeds of sales into a bank account controlled by MNC. (MNC also conducted inventory audits.) The debtor would obtain operating funds through a checking account at defendant Maryland National Bank into which MNC would deposit loan funds.

Plaintiffs allege that they had a practice of informing customers, such as the debtor, of upcoming price increases and of raising their credit limits so that wholesalers could purchase greater amounts of inventory at the pre-increase price. On January 1, 1983 there was to be such a price increase. MNC allowed the debtor to participate in buying more than their normal amount of inventory from plaintiffs even though the debtor would be exceeding the formula prescribed borrowing limits. Plaintiffs allege that MNC permitted the debtor to be continuously "out of formula" beginning approximately January 1983 (rather than modifying the formula) in order to insure that the debtor was in perpetual loan default.

Sometime in 1985, the debtor decided to liquidate all of its assets outside of bankruptcy. The process was to be orderly with all creditors paid and MNC was informed of this decision and indeed received the proceeds from the sale of various subsidiaries of the debtor. The debtor though was still operating. In December 1985, the debtor was informed of another tobacco price increase and of its right to purchase above normal amounts of tobacco products from plaintiffs prior to the implementation of this increase. Plaintiffs aver that MNC agreed to allow the debtor to make higher than normal inventory purchases and agreed to provide funds for payment.

In January 1986, MNC began a detailed physical audit of the debtor's inventory. Sometime during January 1986, defendant Maryland National informed various plaintiffs that it would continue to honor checks written by the debtor. Subsequently, plaintiffs shipped more inventory to the debtor; however, the checks were not honored. On January 30, 1986, MNC declared the debtor to be in loan default and seized all of its assets. On January 31, 1986, plaintiffs filed an involuntary chapter 7 petition against the debtor, and an order for relief was entered. Since this involuntary filing, all of the debtor's business assets have been liquidated. MNC, which claims to be a secured creditor owed in excess of $11 million, has received $6,606,678.37 from the sale proceeds. Unsecured creditors, such as plaintiffs, have received no distribution and, (absent this litigation and litigation brought by the trustee), are highly unlikely to receive any funds under 11 U.S.C. § 726.

II.

In order to resolve this motion to dismiss, it is necessary to review the various claims contained in the complaint. Counts I and II involve claims of equitable subordination under 11 U.S.C. § 510(c). The first count is brought by plaintiffs Lorillard, Philip Morris, and Reynolds against defendant MNC and the trustee. The second count is brought by plaintiffs American Cigar and American Tobacco against the same two defendants. Oversimplifying slightly, both counts contend that defendant MNC embarked upon a studied plan to reduce the debtor's prepetition obligation to it at the expense of the plaintiffs. It is alleged that MNC deliberately allowed the plaintiffs to ship inventory to the debtor knowing that it would not advance funds to pay for such inventory and with the intention of seizing the inflated inventory pursuant to its security agreement. Plaintiffs believe that if they prove these allegations, MNC's secured claim must be subordinated to their unsecured claims pursuant to 11 U.S.C. § 510(c).

The trustee, of course, was not a party to any of this prepetition conduct, but is named as a defendant solely because the plaintiffs seek to recover from MNC the full amount of their unsecured claims. They request that this sum be paid to the trustee who would then be directed to pay the plaintiffs. In sum, the relief sought would subordinate MNC's secured claim to plaintiffs claims only, but leave MNC with a secured claim entitled by virtue of 11 U.S.C. § 725 to payment prior to unsecured creditors other than plaintiffs.¹

Counts III and IV are brought by some plaintiffs against either MNC and Maryland Bank or against the Bank alone and are based solely upon a common law cause of action for misrepresentation. Plaintiffs in these counts contend that the defendant(s) intentionally misstated both the debtor's financial condition as well as defendant's own willingness to fund the debtor's purchases and honor the debtor's checks. Count V is brought by all plaintiffs against the trustee and MNC seeking reclamation under 11 U.S.C. § 546(c).

In reviewing defendant's motion to dismiss as to all counts for lack of subject matter jurisdiction, I note a common premise underlying the motion. Defendants view this dispute as solely involving creditors of the estate, in which the trustee is a nominal party, concerning funds already distributed to MNC and which involve causes of action based upon state law. In defendant's view, the outcome of this proceeding will have no affect upon this estate, can be completely resolved in a nonbankruptcy forum and so should be dismissed. My basis for denying the motion stems from my conclusion that defendants are both misapplying and overlooking certain jurisdictional principles.

III.

Bankruptcy proceedings may now be grouped into three categories:

(1) core proceedings, which may be heard and resolved by the bankruptcy court, see 28 U.S.C. § 157(b)(1); (2) noncore, related proceedings, which the bankruptcy court may hear and submit proposed findings of fact and conclusions to the district court, see 28 U.S.C. § 157(c)(1); and (3) noncore, unrelated proceedings, over which the bankruptcy court lacks any jurisdiction.

In re Malone, 74 B.R. 315, 318 (Bankr.E.D. Pa.1987) recommendation approved C.A. 86-361 (E.D.Pa. September 30, 1987). Accord e.g., In re Globe Parcel Service, Inc., 71 B.R. 323 (E.D.Pa.1987); In re Bowling Green Truss, Inc., 53 B.R. 391 (Bankr.W. D.Ky.1985). While defendants argue that counts I, II, and V are noncore, unrelated claims, they have cited no decisions supporting this view. To the contrary, there are a number of reported cases holding that proceedings brought pursuant to 11 U.S.C. § 510(c) and § 546(c) are not merely related but are core proceedings. In re Osborne, 42 B.R. 988, 993 (W.D.Wis.1984) (subordination is core); In re Wheeling-Pittsburgh Steel Corp., 74 B.R. 656, 658 (Bankr.W.D.Pa.1987) (reclamation is core); In re Atlas Fire Apparatus, Inc., 56 B.R. 927, 934 (Bankr.E.D.N.C.1986) (subordination); In re Western World Funding, Inc., 52 B.R. 743, 762 (Bankr.D.Nev.1985) (subordination). See also 1 Collier on Bankruptcy ¶ 3.01, at 3-37 (15th ed. 1987) (subordination is core). Such a conclusion, that these counts are core matters, is supportable by two disparate approaches.

Although 28 U.S.C. § 157(b)(2) does not expressly mention either equitable subordination or reclamation among its list of core proceedings, this list was never intended by Congress to be exclusive. See 1 Collier ¶ 3.01 at 3-36. Both equitable subordination and reclamation proceedings establish the respective rights of creditors to participate in the distribution of the estate. Resolution of these matters affects both the size as well as the priority of claims. Thus, a court may easily conclude that proceedings under 11...