Mountain Iron & Supply Co. v. Jones

• Decision Date: 08 June 1968
• Docket Number: No. 45016,45016
• Parties: MOUNTAIN IRON AND SUPPLY COMPANY, a Corporation, Appellee and Cross Appellant, v. George R. JONES and Albert J. Gebert, III, Appellants and Cross Appellees.
• Court: Kansas Supreme Court

Page 795

441 P.2d 795

201 Kan. 401

MOUNTAIN IRON AND SUPPLY COMPANY, a Corporation, Appellee and Cross Appellant, v. George R. JONES and Albert J. Gebert, III, Appellants and Cross Appellees.

No. 45016.

Supreme Court of Kansas.

June 8, 1968.

Rehearing Denied July 16, 1968. See 443 P.2d 185.

Syllabus by the Court.

1. When a guarantor of an obligation is called upon by the creditor to pay the indebtedness the guarantor is entitled to be subrogated to the rights of the creditor against the principal.

2. A second mortgagee that foreclosed upon its second mortgage and purchased the security cannot, by purchasing the first mortgage note and mortgage upon which there are guarantors, add the indebtedness of the first mortgage note to the indebtedness of the principal on its own note and rely upon the proposition that a guarantor is not entitled to be subrogated to the rights of a creditor until the claim of the creditor has been paid in full. To do so would have the effect of increasing the indebtedness for which the guarantors were secondarily liable beyond the scope of their original endorsement and the terms of the first mortgage.

3. The liability of a shareholder in a corporation for 'watered stock' is controlled by K.S.A. 17-3206.

4. In an action brought by an oil well supply company against the officers, directors and stockholders of a bankrupt corporation for the debts of that corporation, the record is examined and for the reasons stated in the opinion it is held: (a) The trial court erred in ruling as a matter of law contrary to the proposition stated in Syllabus 1; and (b) the findings of fact made by the trial court are supported by substantial competent evidence.

William L. Oliver, Jr., Wichita, argued the cause, and George B. Collins, Robert Martin, K. W. Pringle, Jr., William F. Schell, Robert M. Collins, William V. Crank and Tom C. Triplett, Wichita, and Thomas M. Burns and Peter J. Wall, Denver, Colo., were with him on the brief for appellants and cross appellees.

Richard W. Stavely, Wichita, argued the cause and was on the brief for appellee and cross appellant.

SCHROEDER, Justice.

This is an action brought by Mountain Iron and Supply Company against George R. Jones and Albert J. Gebert, III, as officers, directors and stockholders of Jones-Gebert Oil, Inc., a bankrupt corporation, for the debts of that corporation.

In Court I of the petition the plaintiff seeks to recover from the defendants on their personal guarantee of a corporate note which was secured by a rotary drilling rig owned by the corporation. This note was purchased by the plaintiff after it had acquired title of the drilling rig through foreclosure of its second mortgage on the rig.

In Court II the plaintiff seeks to hold the defendants personally liable for the amount of 'watered stock' which was acquired by the defendants when the corporation was formed. This is based on the allegations that Jones-Gebert Oil, Inc. was undercapitalized at the time of its formation.

In Count III the plaintiff alleges that Jones-Gebert Oil, Inc. was a sham corporation formed to defeat creditors of the defendants, and that the defendants intermingled and commingled their affairs with the affairs of the corporation.

In the petition the plaintiff sought judgment against the defendants in the sum of $16,000 together with interest and costs on its first cause of action; $12,290.97 with interest and costs on its second cause of action; and the sum of $44,075.77 with interest and costs on its third cause of action, 'except that credit should be given on the third cause of action for the recoveries, if any, allowed by the court on the first and second causes of action.'

The case was tried to the court and judgment was entered for the plaintiff on Count I, and for the defendants on Counts II and III. Both sides have appealed from the decisions of the court adverse to them.

The principal issues presented are: (1) Whether on the facts in this case the defendants were released on their personal endorsement of the corporate note; and (2) whether the defendants are liable for the debts of the corporation on either the theory of 'watered stock' or that the corporation was a sham and fraudulent.

In view of the specific issues presented, it will be necessary to state the facts in some detail.

In 1959 George R. Jones and Albert J. Gebert, III (defendants-appellants and cross appellees), together with Jerry E. Shawver and E. B. Shawver, formed a partnership by the neme of Jones-Gebert Oil Co., to engage in the business of producing and exploring for oil and gas. Beginning in the year 1961 the partnership proposed to drill a number of wells, and it was decided that the partnership should purchase a drilling rig instead of contracting for the drilling of wells as it had done in the past. The partners decided to put the drilling rig in a corporation to make use of the limited liability available through a corporate form of business in such a hazardous occupation as drilling oil and gas wells. Therefore, on the 6th day of February, 1961, Jones-Gebert Oil, Inc. was formed and the defendants transferred to the corporation $15,000 in cash from personal sources. In addition, all of the partners in Jones-Gebert Oil Co. transferred to the corporation assets of the partnership valued at $37,436.45, and partnership liabilities of $22,436.45. The assets were transferred by a letter to the corporation from the partners, which was made a part of the minutes of the corporation, and a bill of sale. Included in the assets transferred to the corporation were undeveloped oil and gas leases in McPherson and Sumner Counties, Kansas. These leases were described in the letter but were not contained in the bill of sale. The difference between the value of the assets and liabilities which were transferred was $15,000, which, when added to the cash contribution, made a net capitalization of $30,000. The capital stock of Jones-Gebert Oil, Inc. was issued one-third to George R. Jones; one-third to Albert J. Gebert; one-sixth to Jerry E. Shawver; and one-sixth to E. B. Shawver, which was the same ratio of ownership that the partners had in Jones-Gebert Oil Co. The partnership of Jones-Gebert Oil Co. remained in existence and functioned as a producing company, and the corporation, Jones-Gebert Oil, Inc., functioned as a drilling company.

On the 18th day of October, 1963, the corporation borrowed the sum of $26,000 from the McPherson & Citizens State Bank of McPherson, Kansas, in the form of a promissory note secured by a mortgage on a Brewster N-4 drilling rig. The face of this note was signed by Jones-Gebert Oil, Inc., through Albert J. Gebert, III, as president and secretary-treasurer. The defendants signed the note on the back as personal guarantors of the corporate obligation.

Mountain Iron and Supply Company, a corporation, (plaintiff-appellee and cross appellant) is an oil field supply house with its principal office in Wichita, Kansas. The plaintiff's credit manager, Clyde Niernberger, testified that in February, 1961, when Jones-Gebert Oil, Inc. was formed, the plaintiff's sales department was aware of that fact and obtained routine credit reports on the corporation. These reports contained a statement of the paid-in capital of the corporation. However, it was not until October, 1962, that the plaintiff transacted any subiness with Jones-Gebert Oil, Inc.

In 1962 the corporation requested a line of credit from the plaintiff, which was granted even though the plaintiff had credit reports which showed that the corporation was having difficulty. The plaintiff admits that it knew it was extending credit to Jones-Gebert Oil, Inc. as a corporation and not to Jones-Gebert Oil Co. (the partnership) or to any of the individuals involved. The corporation soon fell behind on its credit line with the plaintiff, which then obtained a second mortgage on the rotary drilling rig heretofore described, which had previously been mortgaged to the McPherson & Citizens State Bank. The promissory note secured by the second mortgage was for $44,329.08. At that time the plaintiff attempted to get the defendants to personally guarantee the second mortgage note, which the defendants unequivocally refused to do. The plaintiff knew there was a first mortgage on the drilling rig.

On the 4th day of October, 1963, the defendants sold their interest in Jones-Gebert Oil Co. (the partnership) to the Shawvers, who in turn assigned their stock in Jones-Gebert Oil, Inc. (the corporation) to the defendants.

On the 8th day of July, 1964, Jones-Gebert Oil, Inc. was put into an involuntary bankruptcy. This was shortly after the plaintiff had taken possession of the drilling rig on June 22, 1964, pursuant to the second mortgage. The plaintiff did not file a claim in the bankruptcy proceeding, but was apparently content to foreclose its second mortgage on the drilling rig which it sold to itself on the 2nd day of October, 1964, for the sum of $17,000.

By this time the first mortgage note to the McPherson & Citizens State Bank had been paid down to approximately $16,000. On the 10th day of November, 1964, the plaintiff purchased this bank note for $16,613.30 and received an assignment of the note and first mortgage. The plaintiff then made a demand upon the defendants for that amount on the 25th day of January, 1965; and on the 1st day of February, 1965, the defendants tendered a certified check in the amount of $16,778.76 for the payment in full of the promissory note upon the condition that the defendants be subrogated to the security for the note and receive an assignment of the first mortgage. This tender was refused by the plaintiff.

This action was filed and discovery commenced during the time that the Jones-Gebert Oil, Inc. bankruptcy proceeding was pending. The plaintiff filed interrogatories requesting information with regard to the formation of Jones-Gebert Oil, Inc. The defendants when...