Stone v. Morton Cmty. Bank (In re Int'l Supply Co.)

• Decision Date: 28 July 2021
• Docket Number: Adv. No. 17-8051,Case No. 15-81467
• Citation: 631 B.R. 331
• Parties: IN RE: INTERNATIONAL SUPPLY CO., Debtor. Sheldon Stone, as Creditor Trustee of the International Supply Co. Creditor Trust, Plaintiff, v. Morton Community Bank and Rebecca Hofman, Defendants.
• Court: U.S. Bankruptcy Court — Central District of Illinois

631 B.R. 331

IN RE: INTERNATIONAL SUPPLY CO., Debtor.Sheldon Stone, as Creditor Trustee of the International Supply Co. Creditor Trust, Plaintiff,

v.Morton Community Bank and Rebecca Hofman, Defendants.

Case No. 15-81467

Adv. No. 17-8051

United States Bankruptcy Court, C.D. Illinois.

Signed July 28, 2021

Daniel Curth, Goldstein & McClintock LLLP, Sean P. Williams, Levenfeld Pearlstein, LLC, Chicago, IL, for Plaintiff.

Charles E. Covey, Peoria, IL, for Defendant Rebecca Hofmann.

Michael Kraft, Jeffrey Alan Ryva, Quinn Johnston Henderson Pretorius & Cer, Peoria, IL, for Defendant Morton Community Bank.

OPINION

Thomas L. Perkins, United States Chief Bankruptcy Judge

This matter is before the Court on a motion for summary judgment filed by one of the Defendants, Morton Community Bank (MCB). The Plaintiff, Sheldon Stone, is the Trustee of the International Supply Company Creditor Trust, having been appointed as Trustee by this Court as part of the Chapter 11 Plan of Liquidation filed by the Debtor, International Supply Company (ISCO), and confirmed on May 26, 2016. Under the terms of the confirmed plan, the Trustee was granted authority to exercise the avoiding powers under Chapter 5 of the Bankruptcy Code.

The Complaint filed by the Trustee on September 22, 2017 names as Defendants MCB, E. Lee Hofmann (individually, "Lee") and Rebecca Hofmann (individually, Rebecca). The Hofmanns, husband and wife, at all relevant times were officers, controlling shareholders and paid employees of ISCO, a closely held corporation. The first three counts of the eleven-Count Complaint seek avoidance of loan payments totaling $180,617.65 made by ISCO to MCB within two years before bankruptcy, alleging that the payments benefitted Lee, personally, and not ISCO, and that the absence of reasonably equivalent value makes the transfers avoidable as constructively fraudulent. The statutory bases for avoidance include Section 548(a)(1)(B) of the Bankruptcy Code and two sections of the Uniform Fraudulent Transfer Act as adopted in Illinois, 740 ILCS §§ 160/5(a)(2) and 160/6, actionable via Section 544 of the Bankruptcy Code. Counts IV, V and VI, seeking avoidance of two obligations owed to MCB evidenced by promissory notes executed by ISCO as maker, are also brought on theories of constructive fraud under the same three statutory provisions.

Lee, named as a Defendant in Counts I, II, III, VIII, IX and X, filed a personal Chapter 7 case in 2019 and was dismissed as a Defendant in this Adversary Proceeding by Order entered December 20, 2019. Rebecca has not sought bankruptcy relief.

FINDINGS OF FACT

Prior to 2010, Lee was involved with a business and commercial real estate development in Peoria known as InPlay that ultimately failed, causing him to incur substantial personal liability, separately, to both MCB and to CEFCU, a Peoria-based credit union. In January 2011, he entered into a settlement agreement to resolve his liability to MCB under which he paid MCB a cash payment of $415,000 and agreed to pay an additional $800,000 over seven years, signing a promissory note on January 5, 2011 in that amount. ISCO was not obligated on the note.

In 2011, CEFCU obtained two judgments against Lee totaling in excess of $3.0 million. To collect on the judgments, CEFCU garnished the salary he was earning as President of ISCO. In an effort to avoid the garnishment, a portion of Lee's compensation was surreptitiously diverted and recharacterized as wages earned by and paid to Rebecca. CEFCU eventually became aware of the scheme, brought suit and obtained a judgment entered January 11, 2013 against Rebecca and ISCO in the amount of $261,800, determined to be the amount that CEFCU would have received had Lee's earnings been correctly reported and garnished. ISCO appealed the judgment and posted a Certificate of Deposit in the amount of $330,000 with the Peoria County Circuit Clerk to stay enforcement of the judgment during the appeal process.

In June 2013, the Hofmanns and ISCO entered into a settlement agreement with CEFCU to resolve their liability on the three judgments. Under the agreement, Lee was to pay CEFCU $2,010,000 by August 1, 2013, in exchange for which CEFCU would release the three judgments and the related appeals would be dismissed. Under the terms of the settlement, neither ISCO nor Rebecca was required to separately pay CEFCU any amount. After Lee failed to make payment by the August 1 deadline, the agreement was amended to increase the settlement amount to $2,020,000 with $1,400,000 due on August 2, 2013 and the balance of $620,000 due on August 15, 2013. The $1,400,000 payment was timely made on August 2, 2013 with funds loaned by Heartland Bank to ISCO and Lee. An additional $320,000 was paid to CEFCU on August 15, 2013, also with funds loaned by Heartland Bank to ISCO and Lee. The remaining $300,000 was paid on August 16, 2013, which is the crux of the dispute.

The final $300,000 needed to complete the CEFCU settlement was obtained with a loan from MCB evidenced by a promissory note in that amount, dated August 16, 2013, with a maturity date of February 16, 2014, executed by ISCO and Lee as co-borrowers. The note was secured by a security interest in all of ISCO's personal property assets. Prior to this loan, ISCO had not been indebted to MCB. Lee had continued to make payments on his January 2011 note, executed in settlement of the InPlay indebtedness, until March 2012. The $300,000 loan proceeds were disbursed by a check from MCB payable to CEFCU.

According to CEFCU's attorney, who testified in a deposition, the $261,800 judgment CEFCU had obtained against ISCO and Rebecca was subject to increase for interest, attorney fees and court costs. The attorney testified that unpaid attorney fees were incurred by CEFCU in the amount of $81,947.50. As part of the settlement CEFCU agreed to release that judgment including its claim for additional interest, attorney fees and costs. The attorney testified that a cashier's check in the amount of $300,000 was personally delivered to her at her law office on August 16, 2013 by Lee and a representative of MCB, but she was not aware at that time that the source of the funds was a loan from MCB to ISCO. Upon receipt of the cashier's check, CEFCU's attorney delivered to the Hofmanns' and ISCO's attorney the executed release called for by the settlement agreement that released, among other things, CEFCU's claims under the January 11, 2013 judgment against ISCO.

According to the deposition testimony of Robert Dittmer, MCB's executive vice president and chief lending officer, as a condition of making the $300,000 loan, MCB required the accrued interest due on Lee's $800,000 note be paid current. On August 13, 2013, ISCO paid $47,741.08 by corporate check to MCB, which funds were credited to the interest due on Lee's $800,000 note, which had previously been charged off by MCB and removed as a performing loan from MCB's general ledger. When the $300,000 note dated August 16, 2013 was added to MCB's general ledger as a new loan, the January 2011 note was not restored to the general ledger and retained its charged off status.¹

MCB generates a quarterly Watch List memo for each loan that is graded substandard, for the purpose of regularly updating MCB's loan review group as to the status of such loans and to set loss reserves if warranted. The record contains eight Watch List memos that identify "Lee Hofmann/International Supply Co." as the customer, covering the period from September 11, 2013 through June 4, 2015. The September 11, 2013 memo lists the $300,000 loan and the $800,000 loan (with a remaining balance of $750,000) and references the fact that the $800,000 note was charged off and is "no longer on the books." It also notes that "Lee also paid $47M in accrued interest on our charged-off note, which is being held in a suspense account at this time as we do not want to take a recovery while loaning additional funds."

The December 11, 2013 Watch List memo states that a potential sale of ISCO fell through and the company is "off the market." With respect to the $300,000 note, the memo states that full principal and interest is due at maturity on 2/16/2014.

The March 14, 2014 Watch List memo notes that the matured $300,000 note and the charged off $800,000 note (current balance $712,699 plus attorney fees) will be restructured and combined into one new note on an eight-year amortization with a balloon after 24 months. It further states the expectation that ISCO would make the monthly payments. Mr. Dittmer testified that the restructuring was done at Lee's request. A promissory note dated March 26, 2014 in the amount of $1,025,392 payable to MCB was executed by ISCO and Lee as co-makers and was secured by a security interest in all of ISCO's personal property assets. The note called for twenty-three monthly payments of $13,018.87 beginning April 28, 2014 with a final payment of $819,631.87 due on March 28, 2016. Lee arranged for the payments to MCB to be automatically deducted from ISCO's bank account at Heartland Bank. ISCO made thirteen full monthly payments through April 2015. In May, June and July 2015, ISCO made three additional partial payments of less than $4,000 each. ISCO's payments on the March 26, 2014 note total $180,617.65. Lee made no payments himself.

The June 10, 2014 Watch List memo, the first one after the March 26, 2014 note, continued to reflect the separate status of the two loans on MCB's books, showing a current obligation balance of $282,176.51 and a previous charge-off balance of $725,974. Mr. Dittmer, who holds a master's degree in accounting and is a CPA, testified that ISCO's payments were still being accounted for on MCB's books as a credit against the same debt evidenced by the $300,000 note of August 16, 2013, on which ISCO was a co-maker. He testified it is a standard industry practice when new funds are advanced to a borrower who has an earlier charged off loan, to credit payments...