Multiponics, Inc., Matter of

• Decision Date: 16 July 1980
• Docket Number: No. 77-2534,77-2534
• Citation: 622 F.2d 709
• Parties: In the Matter of MULTIPONICS, INCORPORATED, Bankrupt. MACHINERY RENTAL, INC. and Carl Biehl, Appellants, v. William W. HERPEL, Trustee, et al., Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 709

622 F.2d 709

6 Bankr.Ct.Dec. 735

In the Matter of MULTIPONICS, INCORPORATED, Bankrupt.

MACHINERY RENTAL, INC. and Carl Biehl, Appellants, v. William W. HERPEL, Trustee, et al., Appellees.

No. 77-2534.

United States Court of Appeals, Fifth Circuit.

July 16, 1980.

George W. Pigman, New Orleans, La., Thad Grundy, Houston, Tex., for appellants.

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

William M. Meyers, New Orleans, La., George J. Wade, New York City, Stephen Victory, New Orleans, La., Mark Zeichner, New York City, for Citibank, N. A.

Laszlo Kormendi, New York City, amicus curiae, for appellee.

Appeals from the United States District Court for the Eastern District of Louisiana.

Before BROWN, TJOFLAT and GARZA, Circuit Judges.

JOHN R. BROWN, Circuit Judge:

Today we conclude, or at least hope we do, a complex Chapter X reorganization involving Multiponics, Inc. The bankruptcy has engendered lengthy proceedings, sizeable records, and long hours by the parties, their counsel and the federal courts, culminating in three separate appeals. Here, in Multiponics I, we affirm the equitable subordination of a director's claims but reverse the subordination of a corporation's claim. Multiponics II, 622 F.2d 725 at 727 (5th Cir. 1980) ¹ involves the propriety of a bank to set off funds held in its accounts, while in Multiponics III, 622 F.2d 731 at 733 (5th Cir. 1980), we review the validity of an award of attorneys' fees. With these three opinions, we hope to close this case which has spanned nearly a decade, bringing a respite to debtor, creditors and courts alike.

The Dawn And Dusk Of Multiponics

Multiponics, Inc. ("Multiponics" or the "Company"), the debtor corporation, was incorporated on January 9, 1968. The Company was initially organized under the name of Ivanhoe Associates, Inc. to engage in the business of large-scale farming. Multiponics' founders transferred their interests in certain farming properties and the outstanding stock of two businesses to capitalize the Company. ² After only three short years, the Company commenced a Chapter X bankruptcy reorganization.

There are two appellants and two appellees involved in this appeal. Appellants Carl Biehl and Machinery Rental, Inc. were claimants below. Biehl was a founding stockholder of the Company and served as a director from the Company's first meeting throughout its existence. At the outset he owned 13.6% of the stock, although his percentage of ownership decreased to under 7% over the three years. His claims include his payment of $1,000,000 as personal guarantor of a loan to Multiponics and $212,500 paid by him on a note. ³ Machinery Rental is a Texas Corporation whose capital stock is wholly owned by Biehl. Its claim consists of notes guaranteed by Biehl which it purchased from certain banks. ⁴ The appellees are First National City Bank ("Citibank"), trustee under a $3,500,000 debenture issued by Multiponics in 1968, and William W. Herpel, bankruptcy trustee. They objected to the claims of Biehl, Machinery Rental and the other claimants below.

The Days In Court And The Changing Of The Guard

On February 8, 1971, Multiponics filed its Chapter X petition. Numerous proofs of claim were filed before Judge Christenberry. A trustee was appointed who filed a plenary suit against all directors and officers of Multiponics, asserting six causes of action. The first five counts sought damages while the last the subject of this appeal asserted that proofs of claim, including those of Biehl and Machinery Rental, should be subordinated to claims of all other creditors. The plenary suit and objections were referred by Judge Gordon (who took the case following the death of Judge Christenberry) to Bankruptcy Judge T. H. Kingsmill, Jr., as Special Master.

Special Master Kingsmill heard evidence for approximately three weeks, reviewed numerous proposed findings of fact and conclusions of law, and ingested extensive briefs. On December 3, 1976, in a lengthy report, the Special Master denied the first five causes of action. In the Matter of Multiponics Inc., No. 71-218 (E.D.La. Dec. 6, 1976). On the sixth count, however, the Master found that the officers and directors failed to capitalize adequately Multiponics and disregarded the debenture agreement. He ruled that the claims of Biehl and others be subordinated. As to Machinery Rental, however, the Master denied subordination. Id.

Then District Judge, now Circuit Judge, Alvin B. Rubin, who succeeded to the case, upheld the Master as to Biehl but ruled the Master clearly erroneous as to Machinery Rental. Matter of Multiponics Inc., 436 F.Supp. 1065 (E.D.La.1977). ⁵ Thus, Judge Rubin subordinated the claims of Machinery Rental as well as those of Biehl. Not surprisingly, both Biehl and Machinery Rental appeal.

I. Biehl's Appeal

A. The Claim

Biehl's claim against Multiponics consists of two elements totaling $1,212,500. First, in December of 1969, Multiponics obtained a $4,500,000 loan from Lehman Paper Company. Due to Multiponic's poor financial health, Multiponics could draw only $3,500,000 of the lines of credit, and was required to pay one year's interest in advance at 91/2% interest rate and to obtain the personal guarantees of Biehl and other shareholders as security for the loan. When the Company defaulted on the loan, Biehl paid $1,000,000 to Lehman under his guarantee and received an assignment from Lehman in that amount. Second, also in December of 1969, Biehl personally guaranteed payment by Multiponics of a $400,000 note payable to Floyd L. McCalip. When the Company went into bankruptcy, Biehl paid McCalip $212,500 in satisfaction of his personal guaranty and obtained an assignment of McCalip's claim.

B. Our Standard

Equity, Fairness and Fiduciaries

It is well established that a bankruptcy court has the authority to subordinate claims on equitable grounds. See Pepper v. Litton, 308 U.S. 295, 306, 60 S.Ct. 238, 245, 84 L.Ed. 281, 289 (1939); Benjamin v. Diamond (In re Mobile Steel Co.), 563 F.2d 692 (5th Cir. 1977). A Court's conclusions of law are freely reviewable on appeal. United States v. Mississippi Valley Generating Co., 364 U.S. 520, 526, 81 S.Ct. 294, 297, 5 L.Ed.2d 268, 275 (1961); North Texas Production Credit v. Lee (In re Lee ), 570 F.2d 1301, 1302 (5th Cir. 1978). As to all findings of fact, however, a reviewing court of a bankruptcy decision must accept the findings as found, unless they are clearly erroneous. F.R.Civ.P. 52, 53(e); Costello v. Fazio, 256 F.2d 903, 908 (9th Cir. 1958). Reversal may be particularly difficult where both a Special Master and a District Court concur in the findings. Comstock v. Group of Institutional Investors, 335 U.S. 211, 214, 68 S.Ct. 1454, 1456, 92 L.Ed. 1911, 1915 (1948) ("A seasoned and wise rule of this Court makes concurrent findings of two courts below final here in the absence of very exceptional showing of error." (Citations omitted)).

Only recently we have rearticulated the proper test of error in subordination cases:

(i) The claimant must have engaged in some type of inequitable conduct.

(ii) The misconduct must have resulted in injury to the creditors of the bankrupt or conferred an unfair advantage on the claimant.

(iii) Equitable subordination of the claim must not be inconsistent with the provisions of the Bankruptcy Act.

In the Matter of Mobile Steel Co., 563 F.2d at 700 (citations omitted). In connection with (i), as in this case, the inequitable conduct which must be shown need not necessarily be related to the acquisition or assertion of the claim. Id.

Our three part test may be a rewording of the proper legal standard, but is not a dramatic departure from our prior decisions. Thus, we reject Biehl's argument that the District Court's decision cannot stand as to him because it was rendered before Mobile Steel. Although neither the Special Master nor the District Court had the benefit of the precise holding and language of Mobile Steel, the rulings of both are wholly consistent with that case. Moreover, as we suggested in Mobile Steel regarding another case on which one party attempted to rely as precedent, bankruptcy cases are highly factual. Beyond their specific circumstances, their reach is limited. 563 F.2d at 703-04.

As to the conduct of fiduciaries, special scrutiny must be given their dealings with the debtor. The bankruptcy court has the equitable power and the duty "to sift the circumstances surrounding any claim to see that injustice or infairness is not done in administration of the bankrupt estate." Pepper v. Litton, 308 U.S. at 308, 60 S.Ct. at 246, 84 L.Ed. at 290. This duty is "especially clear" when the claim would accrue to the benefit of an officer, director or stockholder. Id.; Spach v. Bryant, 309 F.2d 886, 888 (5th Cir. 1962). See also Herzog & Zweibel, The Equitable Subordination of Claims in Bankruptcy, 15 Vand.L.Rev. 83, 101 (1961) ("the bankruptcy court will regard such a transaction (between a fiduciary and the corporation), if not with distrust, then certainly with a large measure of watchful care in order to be satisfied that the transaction was entered into in good faith and not solely with a view to his own benefit." (Footnote omitted)). While the mere "opportunity to do wrong" is not proscribed, the "unconscionable use" of such an insider opportunity may suffice to deprive the wrongdoer of the fruits of his wrong. Comstock v. Group of Institutional Investors, 335 U.S. at 229, 68 S.Ct. at 1463, 92 L.Ed. at 1923. The presence or absence of the "earmarks of an arm's length bargain" may be significant, Pepper v. Litton, 308 U.S. at 306-07, 60 S.Ct. at 245, 84 L.Ed. at 289, and the conduct of a small rather than large number of directors may be subject to even greater scrutiny for indicia of fair dealing and candor. Twin-Lick Oil Co. v. Marbury, 91 U.S. 587, 590, 23 L.Ed. 328, 330 (1875), quoted with approval in Pepper v. Litton, 308 U.S. at 307 n. 14, 60 S.Ct. at 245 n. 14, 84 L.Ed. at...