Matter of Multiponics Inc.

• Decision Date: 09 June 1977
• Docket Number: No. 71-218.,71-218.
• Citation: 436 F. Supp. 1065
• Parties: In the Matter of MULTIPONICS INCORPORATED, Debtor.
• Court: U.S. District Court — Eastern District of Louisiana

436 F. Supp. 1065

In the Matter of MULTIPONICS INCORPORATED, Debtor.

No. 71-218.

United States District Court, E. D. Louisiana.

June 9, 1977.

George A. Kimball, Jr., George W. Pigman, Jr., Peter A. Feringa, Jr., New Orleans, La., Charles Seligson, for Carl Biehl and Machinery Rental, Inc.

Raymond Salassi, New Orleans, La., Sherwin Rodin, New York City, for Citibank.

Peter J. Butler, New Orleans, La., for trustee.

IN PROCEEDINGS FOR THE REORGANIZATION OF A CORPORATION

ALVIN B. RUBIN, District Judge:

This phase of a complicated corporate reorganization case involves the ranking of debts claimed to be due by the corporation to some of its former directors and corporations controlled by them. For reasons set forth below, the debts are subordinated to the claims of other creditors.

I.

Multiponics, Inc.¹ ("Multiponics") was organized and incorporated under the laws of Delaware on January 9, 1968, to engage in the business of large-scale farming. Carl Biehl and six other persons² became its first directors. These founder-directors initially capitalized the company by transferring to it their interests in certain farming properties and the outstanding stock of two companies.³

Approximately three years after the corporation was formed, on February 8, 1971, Multiponics filed a petition for a corporate reorganization pursuant to Chapter X of the Bankruptcy Act. 11 U.S.C. § 501 et seq. By the end of 1974, a trustee had been named,⁴ all proofs of claim were filed, and Judge Herbert Christenberry (succeeded, after his death by Judge Jack M. Gordon, and later by this court)⁵ referred all objections to the claims to Judge T. H. Kingsmill, Jr., one of the district's referees in bankruptcy, as Special Master to make findings.

He has made a full report, and objections have been taken to a number of his findings of fact and conclusions of law. These concern his recommendation that the debt due Carl Biehl be subordinated and that the debt due Machinery Rental, Inc., a Texas corporation wholly owned by claimant Biehl, not be subordinated. The objections to this report are the subject of this opinion. The unchallenged remainder of the Special Master's findings are adopted by the court, and judgment will be entered accordingly.⁶

II. The Claim of Carl Biehl

Carl Biehl objects to the Special Master's subordination of his claim. That subordination is based on Biehl's conduct as a director of the debtor and is premised on the equitable principle that directors who mismanage corporate assets should not benefit when the corporation becomes bankrupt.

The mere fact that an officer, director, or stockholder has a claim against his bankrupt corporation or that he has reduced that claim to judgment does not mean that the bankruptcy court must accord it pari passu treatment with the claims of other creditors. Its disallowance or subordination may be necessitated by certain cardinal principles of equity jurisprudence. A director is a fiduciary. . . citations omitted Their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the director or stockholder not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein. . . . citations omitted While normally that fiduciary obligation is enforceable directly by the corporation, or through a stockholder's derivative action, it is, in the event of bankruptcy of the corporation, enforceable by the trustee.

Pepper v. Litton, 1939, 308 U.S. 295, at 306-307, 60 S.Ct. 238, at 245, 84 L.Ed. 281.

Biehl is a sophisticated investor. He has a master's degree in business administration from the Harvard Business School and was an active businessman. Throughout the events in question, he was capable of understanding not only Multiponics' financial condition but the effect of each of Multiponics' intricate financial transactions. The Special Master's finding was not clearly erroneous and the court upholds it.⁷

The Special Master found that the debtor corporation was inadequately financed at its inception and improperly financed subsequently, and that these inadequacies were attributable to the conduct of the directors, including Biehl.⁸ Specific examples, sketched in brief since the details may be found in the Special Master's Report, follow:

A. The Acquisition of Stock in the Lisbon Development Corporation.

One of the original directors, Carpenter, owned all of the stock in the Lisbon Development Corporation ("Lisbon"), a farming enterprise. At the first meeting of the Board on January 10, 1968, the Board, including Biehl, voted to purchase Lisbon in exchange for 100,000 shares of the company's stock. The purpose of this purchase was ostensibly to acquire Lisbon's farms for the company's enterprise. However, the directors were "advised repeatedly before the closing of the Lisbon acquisition that Lisbon had incurred substantial liabilities . . .." In spite of this knowledge, and the need of the embryonic company for equity capital, the directors determined to close the sale. After the sale was made, no adjustments were made in Carpenter's shares, issued to him in exchange for Lisbon, to reflect more recent appraisals of Lisbon's value.

In order for Lisbon to plant its crops in 1968, Carpenter had to make loans to it. These loans or advances were reimbursed by Multiponics, which borrowed $600,000 for that purpose. Soon after Multiponics acquired Lisbon, Carpenter sold 100,000 shares, received in exchange for Lisbon, to director Moran, at a profit of $1.00 per share. The Lisbon acquisition was imprudent, even if no self-dealing by Carpenter were shown, because Lisbon had substantial liabilities and could add nothing beneficial to the company's financial status. The purchase is an example of mismanagement by the directors because of their approval of a non-arm's length transaction with no financial benefits for the company.

B. The Purchase of Shares by Director Orbe.

In February of 1969, Lawrence F. Orbe, another of the Multiponics directors, purchased 50,000 shares of its stock at $4.00 per share. The stock was issued and paid for with two 7% promissory notes payable on demand aggregating $200,000. Orbe borrowed $200,000 from Hibernia National Bank in order to pay the note, but the bank required the company to invest the $200,000 in a time certificate of deposit until Orbe paid his debt to the bank. By doing this, the company effectively pledged its assets as security for Orbe's personal loan. When it became evident this state of affairs imperiled the company's registration statement with the Securities and Exchange Commission and its chances for a public offering, the company liquidated its $200,000 certificate of deposit at Hibernia and thereby redeemed Orbe's shares. In effect, the company bailed him out.

While Orbe did not ultimately profit by this series of transactions, the purpose of the sale of shares to him was to compensate him for his services to the company by giving him an opportunity to gain an interest in the corporation. By redeeming his shares, the directors acted improperly in that they caused the corporation to discharge the obligation of one of their fellow directors. They deprived the company of the benefit of the $200,000 it had received from its initial sale. They also violated Section 7.07 of the debenture instrument which, for the protection of the debenture holders, forbade repurchase of its shares except under certain circumstances. The Special Master found that Biehl was aware of this situation or would have known of it because he received copies of minutes of Board meetings he did not attend. The Special Master concluded that Biehl voted for the repurchase out of neglect, and that conclusion is supported by the facts.

C. CBK Industries Transactions.

The directors, including Biehl, resolved on May 10, 1968, to issue 200,000 of the company shares in exchange for 100,000 shares of the common stock of CBK Industries, Inc. ("CBK"). The purpose of this exchange was to bolster the value of the company's stock with what was believed to be the stock of a strong company. When it was discovered that CBK was not financially sound, the directors voted to repurchase the stock.

During the initial negotiations concerning the stock, CBK had insisted upon a promise by the company to include in the company's public offering the 100,000 CBK shares or, if the public offering were delayed, a promise by director Orbe to place the shares privately. (This promise was a condition of CBK's agreement to eliminate from the stock purchase agreement the right to reexchange the shares. The company did not want the right of re-exchange because, with that right, it could not carry the CBK stock as an asset on its balance sheet and could not use the stock as collateral.) By repurchasing the shares, the company relieved Orbe of his promise to place the shares. In order to repurchase the shares, because the re-exchange provision had been deleted from the original agreement, the company had to borrow $400,000 from ICB, a loan that was never paid.

Not only were the CBK transactions financially injurious to the company, they also violated the debenture indenture previously mentioned in this opinion. The Special Master found that the directors, including Biehl, knew or should have known that the debenture indenture was being violated, and his conclusion is not clearly erroneous. The court is satisfied that the Special Master's conclusion that Biehl was negligent in voting for the repurchase of the CBK stock is correct.⁹

D. Undercapitalization of the Company.

The company was formed by the transfer to it of the founders' encumbered farm properties in exchange for stock and cash. Each of these farms was either operating at a loss or not being operated at all. A value of $4.00 per share was set on...