In re Roco Corp.

• Citation: 21 BR 429
• Decision Date: 25 June 1982
• Docket Number: Bankruptcy No. 81-9055.
• Parties: In re ROCO CORPORATION, d/b/a Standard Supply Company, Debtor. Edward CONSOVE, Appellant, v. Avram COHEN, Trustee, Roco Corporation, d/b/a Standard Supply Company, Appellee.
• Court: Bankruptcy Appellate Panels. U.S. Bankruptcy Appellate Panel, First Circuit

21 B.R. 429 (1982)

In re ROCO CORPORATION, d/b/a Standard Supply Company, Debtor.

Edward CONSOVE, Appellant, v. Avram COHEN, Trustee, Roco Corporation, d/b/a Standard Supply Company, Appellee.

Bankruptcy No. 81-9055.

United States Bankruptcy Appellate Panel for the First Circuit.

June 25, 1982.

COPYRIGHT MATERIAL OMITTED

John F. Bomster and Russell D. Pollock, Adler, Pollock & Sheehan, Providence, R.I., for appellant.

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

Before LAWLESS, Chief Judge, and GLENNON and LAVIEN, Bankruptcy Judges.

OPINION

LAVIEN, Bankruptcy Judge.

This is an appeal from the Decision of the Bankruptcy Court for the District of Rhode Island, 15 B.R. 813, relating to two transfers from the Debtor to the Appellant. The Appellant, Edward Consove, claims that the Bankruptcy Court erred in finding that a $300,000 note and security interest granted to him by the Debtor in exchange for his stock was a fraudulent conveyance. Appellant further claims as error the Bankruptcy Court's finding that $26,158.95 transferred from the Debtor to Appellant from July 24, 1980 to September 17, 1980 was a voidable preference. For the reasons below, we affirm the Bankruptcy Court's decision.

I. FACTS AS FOUND BELOW

Appellant, Edward Consove, was a shareholder, officer and founder of Roco Corporation, the Debtor. Roco Corporation (Roco) was in the hardware supply business doing business as Standard Supply Company. Roco was established in 1946 and up until February, 1978, Edward Consove and his partner, Arthur Rosen, each owned 50% of the outstanding stock of the company. When Arthur Rosen died in February of 1978, Roco Corporation redeemed his stock for approximately $130,000, funded in part by insurance proceeds and Edward Consove became the sole shareholder. At that time, Edward Consove began having discussions with his son, Gerald, about the possibility of Gerald's taking over the business. During Rosen's lifetime, he had displayed little confidence in Gerald's ability to manage the company. Gerald had been a full-time employee of the business since 1970 and a part-time employee prior to 1970. After some discussion between father and son, the following transactions took place. On November 1, 1979, Edward transferred his 100 shares, which was all of Roco's outstanding capital stock, to the corporation in exchange for a $300,000 note secured by a security interest in all of Roco's personal property, including inventory, accounts receivable and equipment. Financing statements were filed on October 30, 1979. The note provided for interest at 10% per annum, payable in monthly installments, or, at Roco's option, weekly installments of $600 with a year end adjustment. Six hundred dollars per week was substantially equivalent to Edward's salary and expense benefits prior to retirement. For the first five years only interest was due on the note. Thereafter the principal was to be amortized over 15 years by monthly payments. Edward also received a second note in the amount of $29,558.13 which represented an earlier loan to the company.¹

After all of the stock was transferred to Roco, Gerald Consove purchased one share for $3,000^1A and became the sole shareholder of the company. Edward Consove resigned as director and president. Contemporaneously, Edward and his wife, Irene, directed a letter to Gerald which stated that the promissory note and any balance due thereunder would be given to Gerald at the time of the death of the surviving parent unless the note had been paid in full. Edward and his wife then moved to Florida.

In January, 1980, Gerald requested a $15,000 loan from his father because the company was having cash flow problems due to a slow collection of accounts receivable. Edward testified that when he was running the company it was not unusual for him to loan the corporation money to assist the cash flow when turnover of accounts receivable was slow. In response to Gerald's request, Edward and his wife loaned the corporation $15,000 which was eventually repaid on June 13, 1980.

In June of 1980, there was a fire in the corporation's warehouse and Roco was forced to close. Up until this time, Edward had been receiving weekly interest payments of $600. When these payments stopped Edward returned to Rhode Island. He discovered that his son had been mismanaging the corporation and diverting corporate funds for personal use. Edward took control of the company.² When Gerald was confronted about the diversion of corporate funds, he executed a personal note in the amount of $27,000 to the order of Roco and then, in his capacity as President of Roco, Gerald endorsed this note to Edward.

From July 24, 1980 until an involuntary bankruptcy petition was filed on September 23, 1980,³ six checks were issued by Roco to Edward Consove in the total amount of $36,886.69. The books of Roco show that the six checks were applied to pay off the officer loan of $26,158.95 from Edward, and the balance of $10,727.74 was applied to reduce the principal balance on the $300,000 note to $289,272.26.

II. PROCEEDINGS BELOW

After the bankruptcy petition was filed, Edward Consove brought a complaint to modify the 11 U.S.C. § 362 stay and to permit him to continue to exercise his rights as a secured creditor. The Trustee answered raising several affirmative defenses and counterclaims. The Bankruptcy Court entered a judgment for the Trustee based on his affirmative defense of fraudulent transfer and his counterclaims seeking avoidance of preferential transfers under 11 U.S.C. § 547.

III. DISCUSSION

A. Fraudulent Conveyance

The Bankruptcy Court found that the transfer of the common stock in exchange for the $300,000 note and security interest was fraudulent within the meaning of 11 U.S.C. § 548(a)(1) and § 548(a)(2).⁴ Section 548(a)(1) provides an actual fraud standard, which requires that a court find actual intent to hinder, delay or defraud creditors. Section 548(a)(2) establishes a standard based upon objective criteria from which fraud can be implied. We will consider each finding separately.

The Bankruptcy Court initially found that the transfer was fraudulent under § 548(a)(2)(A) and (B)(i). The court found that Roco had received less than a reasonably equivalent value when the $300,000 note was exchanged for the stock and that Roco was rendered insolvent as a result of the transfer. If both "less than reasonably equivalent value" and insolvency or resulting insolvency are present, there is a conclusive presumption of fraud. See 4 Collier on Bankruptcy ¶ 548.03 (15th ed. 1981).

Both the finding of insolvency and the finding of "less than a reasonably equivalent value" are questions of fact. See Klein v. Tabatchnick, 610 F.2d 1043 (2nd Cir. 1979) (fairness of consideration is generally a question of fact); Braunstein v. Massachusetts Bank & Trust Co., 443 F.2d 1281 (1st Cir. 1971) (insolvency is an issue for the trier of fact). Findings of fact by a bankruptcy judge can only be reversed if clearly erroneous. See Rule 16, First Circuit Rules Governing Appeals From Bankruptcy Judges to District Courts, Appellate Panels and Court of Appeals (effective date March 1, 1980); In re Garland Corp., 6 B.R. 456, 460-61 (Bkrtcy. 1st Cir. 1980). A finding is clearly erroneous if "the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed." United States v. United States Gypsum Co., 333 U.S. 364, 395, 68 S.Ct. 525, 542, 92 L.Ed. 746 (1948).

The Bankruptcy Court found that Roco received less than a reasonably equivalent value in the exchange of the $300,000 note for the stock. Appellant argues that it was not the economics of the redemption transaction that caused Roco's decline. He points out that the transaction did not materially change the operation of Roco and that since Edward received approximately $600 per week in salary prior to retirement, the interest payments did not cause an extraordinary burden on the cash flow of the corporation. While Appellant may be responding to the Bankruptcy Court's statement that the effect of the transaction on the company was catastrophic, none of Appellant's arguments address the issue of value received by the corporation. By arguing that the going concern or asset value of Roco did not decline, Appellant is trying to persuade this Court that the value received by Roco was whatever the corporation was worth on November 1, 1979. This premise is not correct. The Court had to determine the value Roco received when it acquired its own stock. The Bankruptcy Court found that the stock was virtually worthless to Roco. This finding is not clearly erroneous. The purchase by the corporation of its own stock is a form of shareholder distribution from which the corporation receives nothing. B. Manning, A Concise Textbook on Legal Capital, at 130 (1977).

Appellant's argument that he gave up substantial value when he relinquished his sole ownership interest in Roco is misguided. Section 548 does not apply to the value Edward Consove allegedly relinquished. Section 548 looks only to the value received by a corporation. The corporation received 100 shares of its own stock and then may have received $3,000 for one share of stock. Regardless of whether Edward's ownership interest had any tangible or intangible value to him,⁵ the stock was worthless to the corporation. "Treasury stock is not generally considered an asset, because it is widely held that a corporation cannot own a part of itself." M. Miller, Comprehensive GAAP Guide, at 38.04 (1979). The Bankruptcy Court was correct in concluding that Roco received less than a reasonably equivalent value when it exchanged the $300,000 note for its own stock.

Having concluded that the Court was correct in finding that the corporation received less than a reasonably equivalent value, we must also determine whether the Bankruptcy Court was...