In re Wills, Bankruptcy No. 89-01374-AB

• Decision Date: 11 April 1991
• Docket Number: Bankruptcy No. 89-01374-AB,90-52-AB.
• Citation: 126 BR 489
• Parties: In re Joseph Eugene WILLS, Debtor. Thomas A. SCHULTZ, Jr. and Rex L. Sturm, in their capacities as trustees and substitute trustees, Plaintiffs, v. Joseph Eugene WILLS, et al., Defendants.
• Court: U.S. District Court — Virgin Islands, Bankruptcy Division

126 B.R. 489 (1991)

In re Joseph Eugene WILLS, Debtor Thomas A. SCHULTZ, Jr. and Rex L. Sturm, in their capacities as trustees and substitute trustees, Plaintiffs, v. Joseph Eugene WILLS, et al., Defendants.

Bankruptcy No. 89-01374-AB, 90-52-AB.

United States Bankruptcy Court, E.D. Virginia, Alexandria Division.

April 11, 1991.

Joseph W. O'Malley, Bethesda, Md. and Roy B. Zimmerman, Alexandria, Va., for debtor.

Kurt C. Rommel, Thomas E. Helf, Frank, Bernstein, Conaway & Goldman, Tysons Corner, Va., for William L. Walde.

Malcolm M. Mitchell, Jr., Ross, Marsh, Foster, Myers & Quiggle, Alexandria, Va., for Thomas L. Swarek, D. Cecil Culbertson, Doyle C. Culbertson, Jr. and Nancy F. Culbertson.

MEMORANDUM OPINION

MARTIN V.B. BOSTETTER, Jr., Chief Judge.

This matter arises out of objections filed by Joseph Eugene Wills (the "Debtor"), a Northern Virginia real estate developer, to three proofs of claim. The first claim, filed by Thomas L. Swarek ("Swarek"), relates to two promissory notes, each dated November 10, 1988, made by the Debtor and payable to the order of Swarek 30 days after issuance in the aggregate principal amount of $2,171,459.40 (collectively, the "Notes"). The second proof of claim was filed by D. Cecil Culbertson, Doyle C. Culbertson, Jr. and Nancy F. Culbertson (collectively, the "Culbertsons") who claim to have a beneficial interest in the Notes. The third proof of claim was filed by William L. Walde ("Walde") who contends that he is the holder in due course of the Notes entitling him to the amounts evidenced thereby free and clear of any defenses asserted by the Debtor. Swarek and the Culbertsons, who concede that Walde is the holder in due course of the Notes, filed their proofs of claim to protect their interests in the Notes in the event Walde's claims are satisfied and there is an additional amount owing by the Debtor under the Notes. The three claims are not intended to be duplicative. On July 17, 1990, the parties agreed to have the validity of the three proofs of claim determined within this adversary proceeding.

All three claims arose from a written contract entered into in June 1988 between the Culbertsons and the Debtor (the "Purchase Agreement") whereby the Culbertsons agreed to sell, and the Debtor agreed to buy, certain real property located in Loudoun County, Virginia known as Bluff Farm and Harrison Island (collectively, the "Properties") for $4,500,000 in cash. Prior to the closing of the transaction, the Debtor informed Doyle Culbertson that the Debtor was having cash flow problems and that, instead of paying all cash for the Properties, he wanted to finance part of the purchase price by issuing the Notes.

During discussions over the payment of the purchase price, the Culbertsons advised the Debtor that the Culbertsons were negotiating with Swarek to purchase farm land in Mississippi as part of a tax free exchange to shelter the Culbertsons' capital gain resulting from the sale of the Properties. The Culbertsons determined that, by naming Swarek as the nominal seller of the Properties, they could effect a tax free exchange. This arrangement was acceptable to the Debtor and on November 9, 1988, the parties amended the Purchase Agreement to reflect that Swarek would be the seller of the Properties and that at the closing the Debtor would be required to pay $250,000 in cash and deliver the Notes for the remainder of the purchase price. With documents naming Swarek as the seller, the Culbertsons, Swarek and the Debtor met at the Debtor's home office on November 10, 1988, for the closing on which date the Debtor delivered the Notes to Swarek. On the morning of November 11, 1988, the Culbertsons, Swarek and the Debtor took the closing documents to a hotel in Arlington, Virginia, where they had their signatures on some of the closing documents acknowledged by a notary public.

On November 23, 1988, the Culbertsons and Swarek sought and received a $1,700,000 loan from Walde and pledged the Notes and the liens securing the Notes as collateral to secure their loan. The Debtor defaulted on his obligation to pay the Notes in full on their due date, December 10, 1988, thereby causing the Culbertsons and Swarek to default on their loan from Walde.

In July 1989, the Debtor filed a voluntary petition under Chapter 11 of the Bankruptcy Code. In November 1989, Walde filed a proof of claim based on his contention that he is the holder of the Notes. In January 1990, the plaintiffs filed a motion seeking, inter alia, relief from the automatic stay to foreclose certain real property. In May 1990, the Debtor filed an answer which asserted that the "alleged transfer of property . . . was void by reason of the fact that the Debtor was inebriated and had been so for an extended period of time and incapable of entering into a contract."

In September 1990, Walde, asserting that he is a holder in due course with respect to the Notes and therefore not subject to the defense raised by the Debtor, filed a motion for summary judgment. In response, the Debtor asserted that the Debtor was

mentally and physically incompetent to enter into, form or consummate a contract and that he was further subject to a court order . . ., which barred him from entering into the transaction contemplated by the Purchase Agreement. It is further the Debtor\'s position that the Culbertsons, Swarek and Walde knew, were put on notice, or should have known of these disabilities (which rendered the entire transaction and particularly, the . . . Notes, void or voidable) and that therefore the . . . Notes are invalid as to the Debtor.

Memorandum in Support of the Debtor's Opposition to Motion for Summary Judgment at 2.

After affording the parties extensive opportunity for discovery, this Court conducted a hearing on Walde's summary judgment motion where this Court examined the parties' pleadings, affidavits, depositions, answers, interrogatories and admissions on file. On October 17, 1990, this Court granted Walde summary judgment. Motions for reconsideration of the summary judgment were filed by the Debtor, the Official Committee of Unsecured Creditors and Gloria H. Wills. Such motions were denied.

On October 17 and 18, 1990, this Court heard evidence from the Debtor relating to his affirmative defense of incapacity to the proofs of claim filed by the Culbertsons and Swarek. After the close of the Debtor's evidence, the Culbertsons and Swarek filed a motion to dismiss pursuant to Rule 41(b) of the Federal Rules of Civil Procedure. The Culbertsons and Swarek contended that the Debtor failed to prove by clear and convincing evidence that the Debtor's intoxication or manic depression rendered the Debtor unable to understand the nature and consequences of his acts in purchasing the Properties from the Culbertsons and Swarek. On November 14, 1990, this Court granted their motion to dismiss. This Memorandum Opinion supplements the findings and conclusions set forth in the record of the hearings held on October 17, 1990, and November 14, 1990.

In order to grant Walde's motion for summary judgment, this Court must determine that there is no genuine issue as to any material fact and that Walde is entitled to a judgment as a matter of law. See Fed.R.Civ.P. 56(c); Celotex Corp. v. Catrett, 477 U.S. 317, 322-23, 106 S.Ct. 2548, 2552-53, 91 L.Ed.2d 265 (1986). Although several facts in this matter are in dispute, to determine whether those facts are material we must examine the substantive law governing the holder in due course doctrine. See Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 2510, 91 L.Ed.2d 202 (1986).

The effect of achieving holder in due course status is that the holder takes an instrument free from certain defenses, such as the defenses asserted by the Debtor. See Va.Code Ann. § 8.3-305(2) (1965) ("To the extent that a holder is a holder in due course he takes the instrument free from . . . all defenses of any party to the instrument with whom the holder has not dealt. . . ."). To attain holder in due course status, a person must be a holder who takes a negotiable instrument for value, in good faith and without notice of any defense or claim to it. Va.Code Ann. § 8.3-302(1) (1965). The parties in this matter do not dispute that the Notes are negotiable instruments and that Walde is a holder who took the Notes for value. However, the Debtor contends that Walde did not take the Notes in good faith and without notice of any defense. The Debtor further contends that even if Walde is a holder in due course, a state court decree allegedly prohibiting the Debtor from executing certain contracts, including the Notes, relieves the Debtor from its obligations thereunder.

The issue of whether one is a holder in due course of a note does not arise until it is first determined that the maker has a defense to payment that would be good against a mere holder. See Comment 3, Va.Code Ann. § 8.3-307(3) (1965) ("Until it is shown that a defense exists the issue as to whether the holder is a holder in due course does not arise."); J & B Schoenfeld Fur Merchants, Inc. v. Kilbourne & Donohue, Inc., 704 F.Supp. 466, 470 (S.D.N.Y. 1989) ("The issue of whether plaintiff is a holder in due course does not arise until it is shown by defendants that a defense exists which would be good against a mere holder.").¹ The Debtor has the burden of establishing all defenses by a preponderance of the evidence. See Comment 3, Va.Code Ann. § 8.3-307 (1965). Although in ruling on the Culbertsons' and Swarek's motion to dismiss this Court found that the Debtor was not legally incompetent at the time he executed the Notes and therefore has no defense to payment, our conclusion that Walde is a holder in due course does not depend solely on such a finding.

In Virginia, to constitute notice of a claim or defense, a person taking a negotiable instrument must have knowledge of such claim or defense or knowledge of such facts as would...