In re McKnew
| Citation | 270 BR 593 |
| Decision Date | 02 November 2001 |
| Docket Number | Bankruptcy No. 00-51364-S. Adversary No. 01-5005. |
| Court | United States Bankruptcy Courts. Fourth Circuit. U.S. Bankruptcy Court — Eastern District of Virginia |
| Parties | In re William C. McKNEW, Debtor. KMK Factoring, L.L.C., Diversified Investments, L.P., Plaintiff, v. William C. McKnew, Defendant. |
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David K. Spiro, Cantor Arkema & Edmonds, P.C., Richmond, VA, for debtor.
Peter V. Chiusano, Willcox & Savage, P.C., Norfolk, VA, for creditor.
STEPHEN C. ST. JOHN, Bankruptcy Judge.
This matter comes on for trial of the Complaint of KMK Factoring, L.L.C. and Diversified Investments, L.P. to determine the dischargeability of certain indebtedness the debtor, William C. McKnew, allegedly owes them, respectively. This opinion constitutes the Court's findings of fact and conclusions of law pursuant to Federal Rule of Bankruptcy Procedure 7052.
KMK Factoring, L.L.C. ("KMK") is a limited liability corporation formed to own and operate "Commission Express" franchises. Commission Express National, Inc. of Fairfax, Virginia sells "Commission Express" franchises and provides a system in which licensed real estate brokers and agents can factor their real estate commissions. The operation of a Commission Express franchise involves purchasing a real estate agent's right to collect his or her full commission at closing of the real estate transaction. The franchisee purchases the right prior to the closing at a discount rate. The difference between what a franchisee pays for the commission receivable purchased and the amount collected at closing, constitutes the gross profit of the franchisee.
The debtor, William C. McKnew ("McKnew") first became aware of Commission Express in 1995 when he, as a customer, utilized the factoring services of a franchisee.1 In the Spring of 1997, McKnew approached Robert C. Kidd ("Kidd") and Walter D. Kelley, Jr. ("Kelley") about the possible business opportunity of acquiring a Commission Express franchise. Kidd, an ordained minister who is presently self-employed in the area of mortgages, building and development, met McKnew in 1996. Kelley is an attorney who previously represented McKnew in certain litigation unrelated to KMK. After experiencing a favorable outcome in such litigation, McKnew and Kelley continued their relationship.2 Kidd and Kelley had not met prior to the formation of KMK.
The original plan made Kidd and Kelley primarily "outside" investors who supply the necessary capital while relying on McKnew to manage the business operation. Initially, Kidd invested $10,000.00 in the venture. Despite the initial pro forma budget for this new business requiring approximately $100,000.00 in venture capital, Kelley committed himself to invest $125,000.00 because of his belief "that some of the projections were a little bit ambitious." (Tr. at 173.) Operating a Commission Express franchise requires two types of capital, venture capital and factoring capital. Venture capital consisted of the monies invested for the purpose of funding normal business operations or as Kelley described it, the monies "necessary to keep the lights on, pay Mr. McKnew, things like that." Id. The second source of capital, known as "factoring capital," serves as the basis to permit the Commission Express franchise to purchase receivables and is maintained in a segregated account. Specifically, the company utilized factoring capital to purchase real estate commissions from real estate agents. Two sources supplied the factoring capital for KMK Factoring. Tom Carr, an attorney in Richmond, Virginia, who also owned a Commission Express franchise, operated initially as a lender of factoring capital. KMK had a loan agreement with Tom Carr restricting the use of monies advanced by him to the purchase of receivables. (Tr. at 303, 370.) Diversified Investments, L.P., a partnership composed of Kelley and other family members ("Diversified"), also supplied factoring capital.3 McKnew understood monies advanced by Diversified were earmarked for purposes of purchasing receivables.4
KMK was incorporated in July 1997 as a Virginia limited liability company. The plan made Jennifer J. Kelley, the wife of Kelley ("Mrs. Kelley"), a member owning fifty percent (50%) of KMK; McKnew was to own forty-five percent (45%) and Kidd owned five percent (5%). The plan further stated McKnew was co-manager of the venture along with Kelley. (Tr. at 297.) Prior to the formation of KMK, the Commission Express business operated through Colony Holdings, Ltd. ("Colony Holdings"), a corporation owned by McKnew and conducted business from his home office, with monies of this business passing through a Colony Holdings' bank account to the KMK owners.
Kidd, Kelley and McKnew, addressed the issue of compensation to McKnew early in the formation of KMK. They agreed McKnew could receive $10,000.00 per month so long as the initial venture capital existed or KMK's net profits could fund such a salary.5 McKnew prepared an operating pro forma and promulgated it to Kelley and Kidd. (Pls.Ex. 27.) The pro forma listed $10,000.00 a month as compensation for management starting in June 1997 until January 1998, when the monthly amount increased to $10,417.00. Id. The pro forma continued this amount until January 1999, when the listed management salary increased to $12,500.00, which continued until the end of three years of operation.6 Consistent with the plan to segregate venture capital from factoring capital, McKnew, Kidd and Kelley also agreed to limit monies borrowed by KMK to the purchase of commission receivables and not for the payment of any operational expenses. They further agreed to maintain these funds in two separate categorical items. (Tr. at 57.) The agreement between Kelley, Kidd and McKnew as to the payment of expenses at the outset of KMK's operations was less clear. McKnew initially paid some legitimate business expenses from the monies KMK paid him, but apparently KMK would have reimbursed McKnew for expenditures which benefitted the company. McKnew did not submit expense reports until after September 1998. (Tr. at 140-41.)
KMK commenced operations in early July 1997. On July 28, 1997, McKnew prepared and forwarded to Kidd and Kelley a memorandum providing financial information concerning the first twenty-seven days of operations of the Commission Express franchise. (Pls. Ex. 28.) McKnew's memoranda urges finalization of the organizational documentation and attaches a "CE of Tidewater Funding Request" indicating pending total expenditures of $15,010.00, cash available of $2720.00, and the necessity of injecting $12,290.00 into the business. The pending expenditures, in addition to items relating to office occupancy, printing and marketing, included for August 1997 "consulting" in the amount of $10,000.00. Attached also was a "CE Tidewater-Expense Statement (Cash) 6/1/97 through 7/26/97." Id. This expense statement shows that from June 9, 1997 through July 1, 1997 McKnew received $20,000.00 in compensation for consulting.7 During the month of June 1997, McKnew actually paid himself $8,725.89. (Pls.Ex. 3, 15.)
The business operations of KMK continued and McKnew provided to Kelley and Kidd a "CE/Tidewater-Income Statement (cash) 6/1/97 through 9/9/97," which detailed monies invested into KMK and monies expended by KMK for the relevant time period. This document, prepared by McKnew, listed his paid compensation as $30,000.00 from June 6, 1997 through July 30, 1997. (Pls.Ex. 14.)8 Kelley and Kidd reviewed this document and found the compensation consistent with their agreement with McKnew, that is, $10,000.00 a month. In his own handwriting, McKnew further noted on the document an extension of the expense listings through a later period, which indicated that McKnew had received $40,000.00 at that point in time.9 However, these listings of McKnew's salary payments from KMK were incomplete.10 In July 1997, McKnew paid himself a total of $21,480.87. (Pls.Ex. 3, 22.)11 In August 1997, McKnew paid himself a total of $16,000.00. (Pls.Ex. 3, 30.)12 In September 1997, McKnew paid himself through checks to Colony Holdings, a total of $14,250. (Pls.Ex. 3, 36.)13 Thus, while McKnew had represented to Kelley and Kidd that he received $30,000.00 through July 30, 1997 and $40,000 through September 1997, McKnew actually paid himself $30,206.76 through July 30, 1997, $46,206.76 through August 31, 1997 and $60,456.76 through September 30, 1997. Stated another way, by September 30, 1997, McKnew paid himself $20,456.76 more than he represented to Kelley and Kidd, and $20,456.76 more than authorized by his agreement with Kelley and Kidd.
McKnew ran the business operations of KMK throughout the fall of 1997 and into 1998. Financial reporting on the business operations was scarce. KMK then engaged Carter, Corbin and Company, a public accounting firm, to prepare financial statements. They prepared a draft Balance Sheet as of December 31, 1997. (Def.Ex. Z.) Kidd recalls seeing this statement some time in early 1998. The profit and loss portion of this draft Balance Sheet, under the Expense section, contained an entry under professional fees identified as "Consulting — Other 121,136.00." Kidd understood the figure represented fees to McKnew, other consulting fees, some national consulting fees and franchise fees.14 Kelley did not recall reviewing this draft balance sheet and profit and loss statement. (Tr. at 208.)15
During its first year of operations, KMK attempted to expand its business. In May 1998, KMK obtained a line of credit from Cenit Bank, which provided up to $350,000.00 to fund the purchase of commission receivables. In November 1997, KMK, while still not profitable, increased its volume more rapidly in the Hampton Roads area than the pro formas from the national franchiser suggested would occur. (Tr. at...
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