In re Roco Corp.

• Decision Date: 10 December 1981
• Docket Number: Adv. No. 800239.,Bankruptcy No. 8000718
• Citation: 15 BR 813,8 BCD 582
• Parties: In re ROCO CORPORATION d/b/a Standard Supply Company, Debtor. Edward CONSOVE, Plaintiff, v. Avram COHEN, Trustee, Defendant.
• Court: U.S. Bankruptcy Court — District of Rhode Island

15 B.R. 813 (1981)

In re ROCO CORPORATION d/b/a Standard Supply Company, Debtor Edward CONSOVE, Plaintiff, v. Avram COHEN, Trustee, Defendant.

Bankruptcy No. 8000718, Adv. No. 800239.

United States Bankruptcy Court, D. Rhode Island.

December 10, 1981.

John F. Bomster, Russell D. Pollock, Adler, Pollock & Sheehan Inc., Providence, R.I., for plaintiff.

Edward J. Regan, Robert J. McGarry, Tillinghast, Collins & Graham, Providence, R.I., for Trustee.

DECISION

ARTHUR N. VOTOLATO, Jr., Bankruptcy Judge.

Heard on the Plaintiff's complaint to modify the automatic stay, 11 U.S.C. § 362 (1979), and on the Trustee's counterclaim seeking to avoid certain transfers of the Debtor's property to the Plaintiff.

On September 23, 1980, an involuntary petition for relief under Chapter 7 of the Bankruptcy Code, 11 U.S.C. §§ 701, et seq. (1979), was filed against the Debtor, Roco Corporation, d/b/a Standard Supply Company, and an order for relief was entered on September 26, 1980.

Since 1932, Roco had been engaged in the business of selling hardware and related supplies. The Plaintiff, Edward Consove, is a former shareholder, officer, and one of the founders of Roco. From the inception of the business through February, 1978, Edward Consove and Arthur Rosen each owned fifty percent (50%) of the shares of Roco. According to Louis Adler, Roco's own accountant during most of that time, Roco was a "marginal" business, but one which generally paid its bills as they became due.

Prior to 1970, the Plaintiff's son, Gerald Consove, was a part-time employee of the company, and thereafter he worked full time. The record indicates that Gerald Consove was never held in very high regard by Arthur Rosen, and that he was not considered for any position of responsibility until after Rosen's death. When Rosen died in February, 1978, the corporation purchased his interest for approximately $130,000, and at the conclusion of those negotiations with Rosen's estate, Edward Consove and his son began talking about Gerald buying Roco. These father/son discussions culminated in a number of transactions which were executed on November 1, 1979. On that date, Edward sold his 100 shares, which represented all the issued and outstanding capital stock of Roco, to the corporation. The consideration was a promissory note in the amount of $300,000. This note provided for interest at the rate of ten percent (10%) per annum, payable in monthly installments, or, at Roco's option, weekly installment payments of $600, with a year-end adjustment. Only interest, in the amount of $30,000 per year was payable for the first five years, and thereafter the monthly installments were to be increased to provide for amortization of the principal within fifteen years. Edward received a second note at the same time for $29,558.13,¹ which represented an old loan that he had made to the company. As collateral for both notes, Edward Consove took a security interest in the following items:

Receivables, Inventory and Equipment; All ledger sheets, files, records, documents and instruments . . . evidencing an interest in or relating to the Collateral; and All Instruments, documents, securities, cash, property and the proceeds of any of the foregoing, owned by Borrower or in which Borrower has an interest,. . . .

Security Agreement, Plaintiff's Exhibit 3. A financing statement was properly filed with the Rhode Island Secretary of State on October 30, 1979. Edward's loans to the business had been unsecured prior to November 1, 1979.

On the same date as Edward's transfer of all of the outstanding shares of stock of Roco back to the corporation, Gerald purchased one share of the common stock of Roco for $3,000 and, thereupon, became the sole stockholder of the company. Gerald also became the sole officer and director, with Edward Consove resigning as director and President effective November 1, 1979. Also on November 1, 1979, Edward Consove and his wife Irene (Gerald's mother), directed a letter to Gerald requesting that Gerald allow Roco to redeem the stock owned by Edward. This letter

. . . put in writing the agreement of the Consoves, which agreement is the consideration for your allowing the Company to enter into the transaction and your willingness to acquire a stock interest in the Company and to operate it, that the promissory note and any balance due thereunder shall be given to you at the time of the death of the survivor of the Consoves, unless, of course, the promissory note has been paid in full by that time.

Defendant's Exhibit G.

Through these transactions, the Consoves expected to receive a steady stream of income during their retirement and then to make a testamentary gift of the unpaid balance of the note to Gerald. After these matters were concluded, Edward and his wife moved to Florida. It was not long before problems began to appear.

In January, 1980, Gerald telephoned his father, told him the receivables were slow coming in, and asked for $15,000. Edward Consove testified that it was not unusual when he was running the company to advance funds to assist cash flow when business was slow. In response to Gerald's request, Edward and Irene Consove sent checks for $5,000 and $10,000, respectively, both payable to Gerald S. Consove and Standard Supply. A check in the amount of $15,000 was drawn by Roco's bookkeeper and sent to Edward Consove, with the understanding that Edward would hold it until he was notified that Roco had sufficient funds in its account to cover the check. On May 22, 1980 Roco issued a new check to Edward Consove to replace the first check which had grown "stale." Defendant's Exhibit W. Edward cashed this check on June 13, 1980 in full payment of the January loan.

Between November 9, 1979 and July 11, 1980, Roco paid Edward Consove 36 weekly interest payments of $600, totalling $21,600. In June, 1980, there was a fire and Roco was forced to close its warehouse. When payments to Edward stopped the next month, he returned from Florida to "take over the operation" from his son who he had reason to believe "was mismanaging" the company. After reassuming control of the company, Edward confirmed his suspicion that Gerald had been using corporate funds for his personal use. When he was confronted about this, Gerald executed a personal note in the amount of $27,000 to Edward. This note has not been paid.

From July 24, 1980 until the filing of the bankruptcy petition on September 23, 1980, Edward Consove caused Roco to issue six checks to himself totalling $36,886.69.² The six checks were applied to pay off the $26,158.95 debt to Consove for advances he had made to Roco in prior years. The remaining $10,727.74 was applied to reduce the principal balance on the $300,000 note to $289,272.26.

In the present complaint, the Plaintiff asks that the automatic stay be modified to permit him to continue to exercise his rights under the security agreement dated November 1, 1979. The Trustee denies that Roco is indebted to the Plaintiff in the amount the Plaintiff alleges, and asserts as affirmative defenses that (1) the notes executed in favor of the Plaintiff were fraudulent transfers, (2) that the alleged obligations of Roco to the Plaintiff in fact constituted contributions to capital, (3) that the transactions in question took place while Roco was insolvent, with Roco receiving less than reasonably equivalent value, and (4) that the November 1, 1979 notes constituted an illegal contribution from Roco's capital surplus in violation of R.I.Gen.Laws § 7-1.1-41, and that therefore the security agreement between Edward Consove and the corporation is void. The Trustee also asserts a number of counterclaims in which he seeks to avoid transfers of Roco's property to the Plaintiff, and asks that the Plaintiff be ordered to turn over any such property in his possession. Since the Trustee's affirmative defense of fraudulent transfer and counterclaims seeking avoidance of preferential transfers under § 547 are dispositive of this case, his other defenses need not be considered.

I FRAUDULENT TRANSFER

The Trustee argues that the November 1, 1979 security interest acquired by Edward Consove should be declared void pursuant to § 548 of the Bankruptcy Code which provides, in part, that

(a) The trustee may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within one year before the date of the filing of the petition, if the debtor —

. . . .

(2)(A) received less than a reasonably equivalent value in exchange for such transfer or obligation; and

(B)(i) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation;

In this case, the petition was filed within one year of the November 1, 1979 transaction. Based on the record, I conclude that all the requirements of § 548(a)(2)(B)(i) have been satisfied, that the transfer is fraudulent, and is hereby set aside and avoided.

A. Roco received less than a reasonably equivalent value in exchange for obligating itself to pay $300,000.

The events of November 1, 1979 must be viewed as a single transaction. This was the intention of the Consoves and of Roco, through the Consoves. The object of these dealings was to transfer 100 percent of the stock ownership of Roco from Edward Consove to his son, Gerald Consove, and at the same time, to provide a retirement income to Gerald's parents. The net result of the bargain was that Gerald replaced Edward Consove as the sole stockholder of Roco, and that Edward was to receive his retirement income. With a capital investment of only $3,000, Gerald Consove acquired exactly the same ownership of the business that was previously held by Edward Consove. The effect on the company, however, was catastrophic. Roco became obligated to the Consoves for $300,000, payable at ten percent (10%) interest per annum, in exchange for...