Lippi v. City Bank

• Decision Date: 23 January 1992
• Docket Number: Nos. 89-15891,90-15907,s. 89-15891
• Citation: 955 F.2d 599
• Parties: Robert O. LIPPI, Trustee for Pacific Industrial Distributors, Inc., Plaintiff-Appellant, v. CITY BANK; Edward F. Plant; United States National Bank of Oregon, Personal Representative of the Estate of Robert E. Hamilton, Deceased, Defendants-Appellees. Robert O. LIPPI, Trustee for Pacific Industrial Distributors, Inc., Plaintiff-Appellant, v. CITY BANK, Defendant, and Linda R. Russell, as Personal Representative of the Estate of Shirley M. Russell, Deceased; Edward F. Plant, Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 599

955 F.2d 599

Robert O. LIPPI, Trustee for Pacific Industrial

Distributors, Inc., Plaintiff-Appellant, v. CITY BANK; Edward F. Plant; United States National Bank of

Oregon, Personal Representative of the Estate of

Robert E. Hamilton, Deceased,

Defendants-Appellees.

Robert O. LIPPI, Trustee for Pacific Industrial

Distributors, Inc., Plaintiff-Appellant, v. CITY BANK, Defendant, and Linda R. Russell, as Personal Representative of the Estate

of Shirley M. Russell, Deceased; Edward F. Plant,

Defendants-Appellees.

Nos. 89-15891, 90-15907.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Feb. 15, 1991.

Decided Jan. 23, 1992.

H. William Burgess, Honolulu, Hawaii, for plaintiff-appellant.

James A. Agena, George W. Playdon, Jr., Reinwald, O'Connor & Marrack, James Duca, Honolulu, Hawaii, for defendants-appellees.

Appeal from the United States District Court for the District of Hawaii.

Before FLETCHER, NORRIS and TROTT, Circuit Judges.

FLETCHER, Circuit Judge:

Robert O. Lippi, the trustee in bankruptcy for the debtor, Pacific Industrial Distributors, Inc. ("PID"), appeals grants of summary judgment to the two selling stockholders and one of the financing banks of a failed leveraged buy-out of PID. The trustee seeks to recover money he alleges was obtained through fraudulent and/or

                illegal transfers.   He also appeals post-judgment orders declining to hold the transfers null and void as to the stockholders and bank
                

BACKGROUND

PID is a Hawaii corporation which did business in the State of Hawaii from 1973 through sometime in 1986 as a wholesaler of construction materials. In April, 1981, the outstanding capital stock of PID consisted of 375 shares owned by Edward F. Plant, Robert E. Hamilton and Earl C. Russell, who were also the three directors of the corporation. Russell was both the President and Secretary and was primarily responsible for running PID since both Hamilton and Plant resided on the mainland. However, there was evidence in the record that Hamilton and Plant maintained close contact with Russell. In addition, they regularly drew "consulting fees" from PID which amounted to close to $100,000 between them annually in 1979 and 1980.

PID had operated profitably for several years. Its audited financial statement for the fiscal year ending September 30, 1980 showed a total stockholders' equity of $195,450. Early in 1981 PID began an expansion into new operations in Alaska and other west coast locales. The directors asked the accounting firm of Peat Marwick Mitchell & Co. (Peat Marwick) to undertake a review of the proposed expansion. The resulting report listed as a disadvantage that the proposed expansion would require "the assumption of significant additional financial risks." The report also noted at several points that PID was undercapitalized and recommended that "[m]easures should be taken immediately to increase working capital." By August, 1981, however, PID had advanced approximately $64,000 to PID-Alaska.

During roughly the same period, Russell decided to buy out the stock of Plant and Hamilton, and offered them $500,000 for their 250 shares. Russell and City Bank (one of the lending banks) assert that the motivation for the buy-out was Russell's belief that as sole shareholder he could make PID more profitable than it was with three shareholders, in part by eliminating Plant and Hamilton from the corporate payroll and consolidating their functions in a single new Hawaii employee, Jack Simpson, who was a certified public accountant. It is that buy-out, structured as a leveraged buy-out (with the assets of PID pledged as security for some of the money borrowed to purchase the shares), which underlies the claims presently before us on appeal.

Documents drafted by attorney E. Gunner Schull indicate that he structured the original transaction to have PID and Russell purchase the stock of Plant and Hamilton. At the time that he sent the initial proposed agreement to the parties, Schull wrote a letter informing them that by law the shares could be purchased by PID "only out of earned or paid-in surplus and thus, to the extent that the purchase price exceeds the corporate surplus, the balance of the shares should be purchased by [Russell] personally." The initial proposed agreement contained a clause providing that PID and Russell

hereby represent and warrant that the consideration for the shares purchased by the Corporation shall be made from earned or paid-in surplus of the Corporation, and the Corporation shall provide evidence of the existence of such surplus satisfactory to the selling shareholders at the closing date.

That version of the agreement was never executed, however, although Plant and Hamilton both signed stock powers in mid-May transferring their shares to PID.

Ultimately the transaction was structured so that Russell and a shell corporation formed by him, ECR Ltd., at least on paper, purchased the 250 shares. ECR was incorporated with $1,000 of capital, and was owned 87% by Earl C. Russell and 13% by his father, Earl R. Russell. ECR never had any employees and the only significant activity through its bank account during the relevant period consisted of receipt of money from PID "dividends" and various loans, and payments out to Plant and various lenders. Only $12,500 of the $500,000 The remaining $250,000 was obtained from a Small Business Administration (SBA) loan through City Bank to PID. ³ PID signed a promissory note for $250,000, and gave City Bank a security interest in all of PID's assets. The $250,000 of loan proceeds was in turn "lent" to Russell and ECR for purchase of Hamilton's stock. ⁴ In fact, the SBA loan portion of the transaction ended up being somewhat more complicated. Because the SBA processing was not complete at the time of closing on June 23, 1981, City Bank lent $250,000 to Russell and his wife, Linda, personally, secured by a fourth mortgage on their home, with a provision that "[r]epayment [was] to come from funding of a 90% SBA Guaranty loan in the amount of $250,000." Thus, at the closing of the transaction, the source of the $250,000 payment to Hamilton was a personal loan to the Russells. However, when the SBA loan came through on August 24, 1981, it was immediately applied on the Bank's books to pay off the interim advance to the Russells, leaving only PID liable on the loan.

                purchase price was provided by Russell himself.   ECR and Russell borrowed $37,500 from an individual named Joseph Cochran;  they borrowed an additional $100,000 from Carlinville National Bank structured as a loan to Russell's parents, Earl R. and Shirley Russell.   Plant agreed to defer receipt of $100,000 of the $250,000 purchase price owed him. 1  The $100,000 deferred payment was secured by a pledge of the shares of stock purchased from Plant;  it was not guaranteed by PID directly or secured by PID assets.   The promissory note was executed by ECR Ltd. and Earl C. Russell. 2
                

The trustee asserts that PID's liability for the $250,000 loan had the immediate effect of shifting PID's net worth from positive to negative. ⁵ He also contends that PID's negative net worth was shielded from potential creditors' view by structuring the transaction so that PID did not buy treasury stock. Potential creditors were thus unaware of the significant outflow of payments from PID to meet the various loan obligations. Defendants assert, to the contrary, that nothing about the transaction Ultimately PID paid out $667,000 either directly to City Bank in repayment of the $250,000 loan or in dividends to ECR which ECR used to make payments to Russell, Cochran, Plant and Carlinville National Bank. All of the lenders who financed the LBO were eventually paid in full. ⁶ In pretrial depositions Russell, Simpson and Michael Kawamoto, the City Bank loan officer, all stated that it was their understanding at the time of the transaction that money for repayment of the various obligations was all to come from profits from operations of PID. All three of them were aware that PID was directly liable for the $250,000 loan and that its assets were pledged as security for that loan.

was concealed, that financial statements fully disclosed the various parts of the transactions, and that City Bank properly recorded its security interest in PID's assets.

Plant also indicated in his deposition that:

[i]t was [his] expectation that, after the June 1981 closing, PID would continue to generate substantial income and profits for its new shareholder ECR, that would enable that shareholder to meet its obligations to [him] and to any other entity from whom funds were borrowed in order to finance the acquisition of the PID shares owned by [him] and Mr. Hamilton.

Despite this expectation that repayment would come--indirectly at least--from profits generated by PID, Plant stated in deposition and affidavits that he was unaware of how ECR obtained the financing to purchase his and Hamilton's shares, that he had nothing to do with the structure of the transaction, that he had no knowledge that PID assets were being encumbered, and that he believed that Russell personally held sufficient assets to obtain financing for the transaction. There was no direct evidence presented to the court on summary judgment that Plant or Hamilton had knowledge of how the transaction was structured or that PID was liable to repay some of the obligations related to the buy-out. They received all of their payments by way of City Bank cashier's checks or checks drawn on ECR. Although they remained directors and officers of PID as a technical, legal matter until December of 1981 and January of 1982, Russell and Plant both testified in deposition that it was the clear understanding of all parties that Plant's and Hamilton's roles as officers, directors and consultants would terminate at the time of the stock buy-out. There was no evidence in the record to indicate that Plant or Hamilton took any role in...