In re USA Motel Corporation

• Decision Date: 21 October 1971
• Docket Number: No. 24074,24075.,24074
• Citation: 450 F.2d 499
• Parties: In the Matter of U. S. A. MOTEL CORPORATION, a California corporation, Debtor. CARUSO ENTERPRISES, INC., et al., Appellants, v. U. S. A. MOTEL CORPORATION, a California corporation, Curtis B. Danning, Trustee, Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

450 F.2d 499 (1971)

In the Matter of U. S. A. MOTEL CORPORATION, a California corporation, Debtor CARUSO ENTERPRISES, INC., et al., Appellants, v. U. S. A. MOTEL CORPORATION, a California corporation, Curtis B. Danning, Trustee, Appellees.

Nos. 24074, 24075.

United States Court of Appeals, Ninth Circuit.

October 21, 1971.

George Treister (argued), Bruce H. Spector, of Quittner, Stutman, Treister & Glatt, Sulmeyer, Kupetz & Alberts, Stephen P. Feldman, Los Angeles, Cal., for appellees.

Nathan Markowitz (argued), of Gendel, Raskoff, Shapiro & Quittner, Robert W. Driscoll, Los Angeles, Cal., for appellants.

Before ELY, CARTER and TRASK, Circuit Judges.

ELY, Circuit Judge:

U.S.A. Motel Corporation (hereinafter USA) petitioned for reorganization under Chapter X of the Bankruptcy Act, 11 U.S.C. §§ 501-676. USA's petition was approved, a trustee and a special master were appointed, and a hearing date was set. 11 U.S.C. §§ 517, 541, 556, 561. Two stockholders of USA, Henry Caruso and Caruso Enterprises, Incorporated (hereinafter CEI), filed two pleadings controverting the allegations of USA's petition and urging dismissal of the Chapter X proceedings.¹ After USA responded to these pleadings, hearings were held before the special master, who sustained the Chapter X petition. CEI and Caruso objected to the special master's report and recommendations, but after a brief hearing, the district judge confirmed the report, overruled the objections, and adopted the special master's Findings of Fact and Conclusions of Law. Caruso, CEI, and the intervenors appeal.

Factual Background

USA's principal asset is a twenty-one room motel. It also has a 25% interest in a joint venture, the Gaslight Venture, which owns a parcel of real estate. USA has some 501 stockholders, with 20% of its stock being publicly held. The decision to file the Chapter X petition stemmed principally from an apparent dispute between Caruso and USA's president, one Fallon. This dispute arose partially from a repudiation by Caruso of partnership with Fallon in another enterprise which was a debtor in a separate Chapter X proceeding. Fallon asserts that Caruso was bleeding USA by forcing it to invest substantially in the Gaslight Venture, of which CEI owns 75%. Caruso claims that Fallon's objective was to liquidate USA under Chapter X by placing USA's real property in a block with three pieces of adjoining property, which are also involved in Chapter X proceedings.

On the morning of January 8, 1968, USA's Board of Directors, consisting of president Fallon, secretary Manion, and treasurer Merwin, met to discuss the corporation's financial condition. Although Caruso and a Mr. Leavy, attorney for Merwin, Caruso, and CEI, were not invited to do so, they also attended the meeting. Fallon had orally requested Merwin to bring the corporation's books and records to the meeting, but Merwin, claiming that he feared a disruption of the corporation's business, failed to comply with the request. Fallon and Manion voted to adjourn and reconvene that afternoon at Fallon's home because, according to them, attorney Leavy and Caruso were interfering with the meeting. Fallon asked Merwin to bring the books to the afternoon meeting, but Merwin stated that he could not attend. At the reconvened meeting, Fallon and Manion, as two-thirds of the Board of Directors, voted to remove Merwin as treasurer and to file the Chapter X petition. The petition was filed later in the day. Appellants Caruso and CEI, together with two intervenors, Day and Brown Insurance Company and Mr. Guccione, now question (1) the validity of the corporate resolution authorizing the Chapter X filing, (2) the finding that on January 8, 1968, USA was insolvent or unable to pay its debts as they matured, (3) the finding that the Chapter X proceeding was filed in "good faith," and (4) the district judge's fulfillment of the role required of him in a Chapter X controversy.

Insolvency

An essential allegation of every Chapter X petition is, of course, that "the corporation is insolvent or unable to pay its debts as they mature." 11 U. S.C. § 530(1). If the petition is challenged, the burden rests upon the petitioner to prove this and all other material allegations of the petition. Marine Harbor Properties, Inc. v. Manufacturer's Trust Co., 317 U.S. 78, 85, 63 S.Ct. 93, 87 L.Ed. 64 (1942); 6 Collier on Bankruptcy ¶ 6.05, at 1014 (14th ed. 1969) (hereinafter Collier). USA alleged insolvency and inability to pay its debts as they matured, and the special master found that on January 8, 1968:

(1) The fair market value of USA's motel property was $467,000.

(2) USA owed undisputed unsecured obligations of approximately $1300.

(3) There was a statement from a law firm for $11,408.83 which was addressed to and owing jointly and severally by CEI, Caruso, and USA, which was not carried on USA's books, and which Caruso had agreed to satisfy.

(4) A first deed of trust on the motel property secured an obligation to the City National Bank in the amount of $171,000.

(5) The bank had offered on January 8, 1968, to Caruso, on behalf of the principal stockholders of the corporation, to extend the note for one year under the same terms and conditions, but Fallon and Manion were unaware of this. The bank would renew the note only if the Chapter X proceeding were dismissed.

(6) A second deed of trust, evidencing an obligation of $70,000 in favor of the Roxbury Fund had not yet matured, was current, and was guaranteed by Caruso.

(7) The book net worth of USA as of December 31, 1967, was $220,240.20.

(8) The book net profit of USA from May 1, 1967, to December 31, 1967, was $13,962.17, without reference to a probable estimated loss of $11,751.00.

(9) "The Debtor was * * * able to meet its unsecured obligations as they matured, and the Debtor was not * * * insolvent, but two Directors, Manon Manion and James L. Fallon, were not aware of this fact."

(10) "Debtor corporation was not able to meet its operating expenses and its unsecured obligations, including the * * * legal bill, as they matured, the payments on the first deed of trust as extended for an additional year, as they matured, and the second deed of trust payments as they matured."

Section 1(19) of the Bankruptcy Act defines insolvency: "A person shall be deemed insolvent within the provisions of this title whenever the aggregate of his property * * * shall not at a fair valuation be sufficient in amount to pay his debts." 11 U.S.C. § 1(19). This definition is applicable to Chapter X. Meyer v. Dolan, 145 F.2d 880 (2d Cir. 1944), cert. denied, 324 U. S. 867, 65 S.Ct. 916, 89 L.Ed. 1422 (1945). Clearly the special master's finding that USA was not insolvent and that USA enjoyed a book net worth of some $220,000 negates any possibility that USA was insolvent in the bankruptcy sense. Thus, the question is confined to whether USA was insolvent in the equity sense, i. e., that it could not pay its debts as they matured.²

As we have previously noted, the master found that on January 8, 1968, USA could meet its unsecured obligations and was not insolvent, but that two directors were unaware of this. This lack of knowledge by the corporate directors at the time the petition was filed is relevant to the issue of good faith, but it has no bearing on the issue of equity solvency resolved at the later hearing. In his Finding XI, the master determined that on January 8, 1968, USA could not meet its operating expenses, its unsecured obligations, including the legal bill which he had found was guaranteed by Caruso,³ its payment on the extended first deed of trust, and its payments on the second deed of trust, as they matured. With the first deed of trust being treated as extended⁴ and the unsecured obligations met or guaranteed, the only obligations which could create the necessary equity insolvency appear to be current operating expenses and the payments on the two deeds of trust. We can discover little evidence on the amounts of these impending debts or the alleged inability to pay them. While the statutory requirement of inability to meet debts as they mature is not limited to debts which have already matured, if a Chapter X petition is granted on the basis of inability to meet debts in the future, such inability must be proved to be imminent and certain, not merely a possibility or speculation. First Nat'l Bank of Cincinnati v. Flershem, 290 U.S. 504, 54 S.Ct. 298, 78 L. Ed. 465 (1934) (equity receivership reorganization); In re Hudson & Manhattan R.R. Co., 138 F.Supp. 195, 200 (S.D.N.Y.1955). But cf. In re Kelly-Springfield Tire Co., 10 F.Supp. 414 (D.Md.1935) (equity receivership reorganization). Over the last eight months of 1967, USA had a book net profit of some $13,000, and the special master found that on the date it filed the Chapter X petition it could meet its minor unsecured debts. USA had regularly made the previous payments on the two deeds of trust, along with its other maturing obligations, and a possible foreclosure on the second trust deed was not imminent or certain.

Furthermore, the master failed to delineate which debts, if any, he believed to be of such significance that they could not be currently retired from the proceeds of the debtor's regular operations. In all of the circumstances, we have therefore concluded that the petitioner did not meet the burden which should fairly rest upon it. The required allegations of a Chapter X petition, if challenged in a hearing, must be adequately established by a preponderance of the evidence, and in this case, such was not done.⁵

Our scope of review in a case such as this is narrow. Rule 52(a), Fed.R.Civ.P.⁶ We recognize the expertise of the special master and the need for judicial restraint in reviewing his findings. See Olympic Finance Co. v. Thyret, 337 F.2d 62, 68 (9th Cir. 1964), cert. denied, 380 U.S. 963, 85 S.Ct. 1106, 14 L.Ed.2d 153 (1965); Costello v. Fazio, 256 F.2d 903 (9th Cir. 1958). But...