In re Pajaro Dunes Rental Agency, Inc.

Citation174 BR 557
Decision Date19 October 1994
Docket NumberBankruptcy No. 91-53976-ASWCZ. Adv. No. 92-5006.
PartiesIn re PAJARO DUNES RENTAL AGENCY, INC., a California Corp., dba Monterey Bay Caterers, Debtor. PAJARO DUNES RENTAL AGENCY, INC., a California Corp., dba Monterey Bay Caterers, Plaintiff, v. Laurence L. SPITTERS, Trustee for Eight Irrevocable Trusts of Children of Laurence L. Spitters; Laurence L. Spitters, an Individual, Defendants.
CourtUnited States Bankruptcy Courts. Ninth Circuit. U.S. Bankruptcy Court — Northern District of California

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Craig K. Welch (argued), of Welch, Olrich & Mori, San Francisco, CA, for Pajaro Dunes Rental Agency, Inc.

James R. Stillman and Louis J. Grimmelbein, IV (argued), of Murphy, Weir & Butler, San Francisco, CA, for Laurence L. Spitters.

DECISION

ARTHUR S. WEISSBRODT, Bankruptcy Judge.

This action involves a complaint to avoid allegedly fraudulent and preferential transfers, under 11 U.S.C. §§ 544(b), 547 and 548. Plaintiff/Debtor, Pajaro Dunes Rental Agency, Inc. ("PDRA"), claims that a $1 million note against it in favor of Defendants, Laurence Spitters, et al. ("Spitters"), supposedly used to finance construction of a new office building and conference center, is void as a fraudulent transfer. PDRA also claims that the interest payments made on this note within one year of its bankruptcy petition are avoidable both as fraudulent and preferential transfers. PDRA was represented by Craig Welch, Esq. of the firm of Welch, Olrich & Mori.1 Spitters is represented by James Stillman, Esq. and Louis Grimmelbein, Esq. of Murphy, Weir & Butler.

Trial witnesses included William Cox, James Maggio, Ryland Kelley, Randall Sugarman, Hurle Fugitt, Jun Delacruz, Anita Sandee, Deborah Hagerman, Lawrence Spitters and Dr. Bruce Ricks. Briefing and oral arguments followed the trial.

This case has had a long and complex history. The factual background to follow covers the nearly thirty years of development at Pajaro Dunes, an exclusive beachfront development on Monterey Bay. PDRA's bankruptcy petition was filed over three years ago, and since then it has undergone a change of ownership and two changes in management.2 Recently, on September 22, 1994, David Bradlow was appointed Chapter 11 trustee for the estate.3 The seven-day trial featured sophisticated expert witnesses who were knowledgeable about litigation as well as accounting and valuing businesses and/or real property. However, the parties, while elaborately outlining their legal arguments, occasionally failed to present sufficient evidence to answer questions raised by the Court. Examples of this absence will be evident at several locations within this Decision.

The following represents the Court's findings of fact and conclusions of law, issued pursuant to Fed.R.Bankr.P. 7052.

I. FINDINGS OF FACT
A. THE EARLY YEARS

Hare, Brewer and Kelley ("HBK") is a California corporation, founded in 1925. The sole current shareholders are brothers, William and Ryland Kelley. Ryland Kelley ("Kelley") joined HBK in 1948, and has served as its president for over 25 years. HBK was primarily involved in developing residential real estate until the 1960's, when it began to involve itself in commercial properties. Much of modern downtown Palo Alto, California is the product of HBK projects.

During the 1960's, HBK developed a planned community, called "Pajaro Dunes," on the Pacific coast of California west of Watsonville. The property was originally acquired by the Kelleys in 1963. They transferred it to Triad, a limited partnership in which HBK was a general partner.4 After receiving the appropriate permits from the County of Santa Cruz, Triad began construction in 1965.

Pajaro Dunes is a very affluent community, populated by many business executives working in the nearby Santa Clara valley, otherwise known as "Silicon Valley." It features beachfront property and exposure to considerable amounts of wildlife, as well as man-made attractions such as golf and tennis.

Pajaro Dunes is organized into several separate homeowners' associations, including but not limited to Pajaro Dunes Homeowners' Association ("PDA") and Pelican Point Homeowners' Association ("Pelican"). Many homeowners in Pajaro Dunes do not live there year-round. Instead, they rent out the dwellings, often using the rental payments to service the indebtedness of their houses. To facilitate this practice, in 1969 HBK created a rental business to find short-term tenants for the homeowners. This business was entitled PDRA, but was still often referred to as HBK.

The 1965 county permit for Pajaro Dunes was succeeded by another issued in 1974, which was amended in 1976. According to this 1976 permit, Triad was authorized to conduct meetings, seminars and similar activities in various common and private facilities. The common facilities, such as the recreation hall, were owned by PDA, and HBK, as Triad's agent, arranged such seminars and meetings in conjunction with the above-mentioned rental business.

However, in 1979, the County of Santa Cruz began to question whether holding such meetings at the PDA-owned recreation hall violated the County's fire and safety ordinances. After extensive negotiations, PDA obtained a new permit (in December 1981) entitling it (or its assignee) to maintain offices and facilities at Pajaro Dunes for the purposes of selling and renting property, providing food service and arranging seminars, including in the recreation hall.

On April 26, 1982, HBK negotiated a license from PDA assigning it PDA's rights under the 1981 permit. This agreement enabled PDRA to remain in business (catering and renting residential and meeting premises). In return, HBK began paying a monthly licensing fee to PDA, and promised to expand and upgrade PDRA's offices. At the time, PDRA was operating out of a building known as the "Cottage house," and many of the homeowners were concerned about its unsightly appearance.

B. PDRA AND ITS CORPORATE STRUCTURE

PDRA was incorporated on January 1, 1983. The primary purpose of this change was so that PDRA could obtain financing based on its own credit, separate from that of HBK. HBK held 87.5% of PDRA's stock. The remaining 12.5% was held by Porter Drive Properties, a limited partnership, of which William and Ryland Kelley were general partners. Following incorporation, Kelley was the sole member of the board of directors of PDRA.5 No significant changes occurred in its day-to-day operations.6 Despite its newly-independent status, PDRA continued to operate as a division of HBK with regard to the licensing agreement with PDA. PDA did not complain about this new arrangement.

During the intervening years between PDRA's incorporation and the transfer at issue in this case, Triad divested itself of many of its holdings at Pajaro Dunes. The house at 143 Puffin Lane ("House 143") was deeded to the Kelley brothers in 1972, and in 1975 a site upon which would eventually be built the "office building," to be discussed infra, was similarly transferred.7

Authority at PDRA was split during the 1980's. Kelley made all of the important decisions, such as acquiring property and the like. Day-to-day operations were controlled by James Maggio ("Maggio"), PDRA's general manager. Maggio was experienced in the hotel and entertainment industry, and ran PDRA, with its residential, meeting and catering services, much like a large hotel. Maggio was the highest-ranked employee who routinely worked at PDRA's offices in Pajaro Dunes.

A practice developed during the 1980's of "upstreaming" cash from PDRA to HBK.8 PDRA is a seasonal business, with most annual income accruing during the months from April through September, and operating losses being incurred throughout the winter. Several times annually, when PDRA had cash surpluses, Kelley would order Maggio to send the surplus to HBK's accounting department. These requests occurred when HBK was short of cash on its own, usually several times each year. Maggio testified that these transfers often left PDRA very short of cash, as HBK did not allow PDRA to retain minimum levels of cash reserves immune to upstreaming.

The upstreamed cash was recorded as an obligation of HBK to PDRA in the accounting records of both corporations. At one point during early 1986, these obligations (accumulated since the late 1960's) were written off. William Cox, HBK's Chief Financial Officer, testified at trial that as no audit was performed prior to that point, it was (and is) impossible to ascertain the net value of those deleted transfers.

A new agreement was reached between PDA and HBK in 1986.9 PDRA officials (not Maggio) were involved in the negotiations, but PDRA was not a party to the contract. By this time, PDRA had left the Cottage House (which was then demolished) and was operating from several portable trailers. Despite landscaping work and other attempts to disguise these structures, homeowners at Pajaro Dunes were still complaining about the appearance of the PDRA premises.10 HBK and PDA therefore agreed to construct a new office building on land owned by the Kelleys ("the Office Building") to house the rental business.11

An additional element of the 1986-1988 agreement between PDA and HBK called for the construction of a new conference center to host seminars and meetings at Pajaro Dunes. This building would become known as the Sandpiper Conference Center ("Conference Center"). Kelley testified at trial that at this time PDRA often had to turn away conference business due to lack of available facilities.

The terms of the agreement included an extension of HBK's license from PDA to operate its rental/meeting/catering business (PDRA) at Pajaro Dunes through 2008. HBK would maintain ownership of the Office Building through that time, but the property would then be deeded to PDA. The Conference Center would be immediately transferred to PDA upon completion, but HBK would enjoy the use...

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