Wan Ho Indus. Co. v. Hemken (In re Hemken)

Citation513 B.R. 344
Decision Date16 July 2014
Docket NumberBankruptcy No. 13–25399–svk.,Adversary Nos. 13–2550,13–2546.
PartiesIn re John D. HEMKEN and Kathleen A. Hemken, Debtors. Wan Ho Industrial Co., Ltd., Plaintiff, v. John D. Hemken and Kathleen A. Hemken, Defendants. Towsley's, Inc., Plaintiff, v. John D. Hemken, Defendant.
CourtUnited States Bankruptcy Courts. Seventh Circuit. U.S. Bankruptcy Court — Eastern District of Wisconsin

OPINION TEXT STARTS HERE

Kyle B. Hanson, Hanson Law Group LLP, Barrington, IL, Scott B. Fleming, Milwaukee, WI, for Wan Ho Industrial Co., Ltd.

Lawrence G. Vesely, Green Bay, WI, for Defendants.

Michele M. McKinnon, Law Firm of Conway, Olejniczak & Jerry, Green Bay, WI, for Towsley's, Inc.

MEMORANDUM DECISION

SUSAN V. KELLEY, Bankruptcy Judge.

John Hemken (the Debtor) paid a lot of money for a business selling promotionalmodel equipment such as pint-sized cranes, bulldozers and fire trucks. The business failed, leaving at least two unhappy creditors in its wake. When the Debtor filed bankruptcy, Towsley's, Inc. (Towsley's) filed a complaint to except the Debtor's debt from discharge under 11 U.S.C. § 523(a)(4) and (a)(6). Wan Ho Industrial Co., Ltd. (Wan Ho) also filed a dischargeability complaint against the Debtor and his spouse, Kathleen Hemken, 1 under Bankruptcy Code § 523(a)(2)(A), (a)(4) or (a)(6) and sought to deny the Debtor's discharge under § 727(a)(2), (a)(3), (a)(4)(A), or (a)(6)(A). The adversary proceedings were consolidated for the purpose of trial. The parties stipulated to many of the facts and exhibits.

The Court has the authority to enter a final order as these cases involve the Debtor's discharge, a matter which is designated as a “core proceeding” and is at the center of the adjustment of the debtor-creditor relationship. See28 U.S.C. § 157(b)(2)(J); Stern v. Marshall, ––– U.S. ––––, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011). This Memorandum Decision constitutes the Court's findings of fact and conclusions of law.

I. Statement of Facts

Between 2003 and 2007, the Debtor was the president and an owner of Towsley's. (Stipulated Facts (“Stip.”) ¶ 1.) One division of Towsley's (the Model Division) contracted with manufacturers to produce die cast models that Towsley's sold to distributors for resale. (Stip. ¶ 2.) The models are “museum quality die cast replicas used primarily for marketing by manufacturers of construction, mining and specialty trucking equipment and fire and rescue vehicles.” (Pls.' Ex. 36.) In 2007, the Debtor decided to purchase the Model Division, and on May 7, 2007, he formed TWH Acquisition Co. (“Acquisition Co.”) for this purpose; shortly thereafter TWH Acquisition Co. changed its name to TWH Collectibles, Inc. (“Collectibles, Inc.”).2 (Stip. ¶¶ 4, 9.)

To finance the purchase, Acquisition Co. obtained a loan in the amount of $2,600,000 from Nicolet National Bank (the “Bank”) secured by a general business security agreement. (Stip. ¶ 8; Testimony of Debtor.) Although the Bank's security interest included a lien on the tooling used to manufacture the models, the Bank never perfected its security interest on the tooling, as it was located in China. (Testimony of Bank vice-president Michael Vogel.) The financing from the Bank was insufficient to complete the sale, and Acquisition Co. also financed a portion of the purchase price with a promissory note and general business security agreement in favor of Towsley's. (Pls.' Ex. 2, 3.) To confirm their respective lien priorities, the Bank and Towsley's executed a subordination agreement under which Towsley's security interest was subordinated to the Bank's interest. (Def.'s Ex. 2.) On the date of the sale, the Debtor's company took possession of Towsley's model inventory and acquired ownership of the tooling used to manufacture the models. (Stip.¶ 5.) However, Wan Ho, the manufacturer of the models, at all times retained physical possession of the tooling in China. ( Id.)

The Debtor lacked legal training and financial expertise, and he traveled often, including to China. Accordingly, he relied on Patricia Roth, a co-owner and chief financial officer of the business, as well as Karen Monfre, a certified public accountant with Wipfli LLP, Inc., in making and carrying out the financial decisions for the business. On the advice of Ms. Monfre, and with the assistance of Ms. Roth and Attorney Adrian Ulatowski, on March 24, 2008, the Debtor engaged in a corporate restructuring for tax savings purposes. 3 The corporate restructuring created a new entity, TWH Collectibles, LLC (“Collectibles LLC”), for the purpose of owning and operating the Model Division purchased from Towsley's. (Stip. ¶ 15.) Despite the name change, the Debtor testified that he and all of the creditors continued to deal with the business as if nothing had changed, and, thus, he did not understand the significance of the name change at the time. Other than the change from Acquisition Co. to Collectibles, Inc., neither the Bank nor Towsley's was notified of the corporate name changes at the time they took place.4 (Stip. ¶¶ 13, 20.)

In 2008, Collectibles LLC began to experience financial distress, and the company was unable to remain current on all its debts. (Stip. ¶ 19.) Testimony at the trial revealed that a large order was returned, causing a significant cash flow shortage. Despite these problems, the Debtor testified that at the end of 2008, the business made a scheduled $600,000 loan repayment to Towsley's. This stretched the company's finances to the limit, and the company defaulted on its loan covenants with the Bank. As a result, pursuant to the subordination agreement, the Bank informed the Debtor orally and by letter dated June 26, 2009, that the company was to discontinue payments to Towsley's. (Def.'s Ex. 51.) The Debtor testified at trial that the correspondence and discussions with the Bank led him to believe that the Bank required him to focus all repayment efforts toward the Bank.

Collectibles LLC was also having problems paying Wan Ho's invoices. (Stip. ¶ 21.) On December 31, 2010, Collectibles LLC and Wan Ho entered into a Settlement Agreement and Mutual Release of Claims, and Collectibles LLC granted Wan Ho a security interest in the tooling in Wan Ho's possession. (Pls.' Ex. 30.) In the settlement agreement, Collectibles LLC represented to Wan Ho that Collectibles LLC owned the tooling (except for certain items that were expressly excluded as “customer owned tooling”), and that it was free from any liens. (Stip. ¶ 22; Pls.' Ex. 30.)

After the December 2010 settlement agreement, Collectibles LLC made some payments to Wan Ho, and Wan Ho continued to manufacture and sell models to the business. (Stip. ¶ 23.) However, Collectibles LLC was unable to maintain the scheduled payments to Wan Ho, and on January 17, 2012, the parties entered into an Assignment and Forbearance Agreement. (Pls.' Ex. 31.) Under the forbearance agreement, Collectibles LLC assignedownership of the tooling to Wan Ho, and Collectibles LLC warranted that the tooling “is free from any and all liens and encumbrances.” ( Id. ¶ 2.)

By the fall of 2012, Collectibles LLC was in severe financial distress. The Debtor, Ms. Monfre, and Ms. Roth all testified that they were focused on working through the financial hurdles so that Collectibles LLC could emerge as a profitable entity. Wan Ho was demanding cash for any future orders. The Debtor was regularly meeting with a group of consultants to come up with ideas to save the business. In September 2012, three of these individuals, Mark Radtke, Tim Weyenberg, and Gerald Sevick (the “Investors”), advanced $102,000 to fund Wan Ho purchase orders. (Pls.' Ex. 36.) Pursuant to agreements signed by Collectibles LLC, the Bank, and the Investors, the Investors deposited $102,000 in an account at the Bank, and the Bank provided a letter of credit to Wan Ho. ( Id.) Collectibles LLC granted the Investors a lien on the models covered by the purchase orders, and the Bank agreed to subordinate its lien on those models to the lien of the Investors. ( Id.)

Under pressure from the Bank, Collectibles LLC applied for other sources of financing, but the applications were rejected. Ms. Monfre testified about a six-step plan put in place for refinancing the business. One of the steps, which Ms. Monfre testified was her suggestion, was for Collectibles LLC to sell its model inventory. According to Ms. Monfre, maintaining the inventory was a monthly drain, and if Collectibles LLC could switch to a direct sale plan, the business may have been able to turn a profit. Ms. Monfre also testified concerning her numerous meetings and discussions with Towsley's and the Bank. As the CPA for the business, her efforts were directed at achieving debt reductions necessary for the business to survive.

On December 31, 2012, after other marketing efforts failed, Collectibles LLC sold the majority of its model inventory in a bulk sale to MTN Marketing, LLC (“MTN”) for $280,000. (Def.'s Ex. 6.) The Debtor, Ms. Monfre, and Ms. Roth all discussed the terms of the proposed sale with the Bank, and the Bank agreed to the sale. ( id.) Even though the Bank was owed in excess of $2,500,000 at the time, the Bank agreed to take $180,000 in exchange for releasing its lien on the model inventory. ( Id.) The remaining $100,000 from the sale was paid to the Investors. (Stip. ¶ 35.) The parties stipulated that the Investors held security interests in assets of Collectibles LLC, but not specifically in the inventory sold to MTN. ( Id.) The purchase money finance agreements suggest that the Bank agreed that the Investors could be repaid for advancing the money to complete the purchase orders. (Pls.' Ex. 36.) Testimony at trial from both the Debtor and Mr. Weyenberg indicated that the Investors were paid because they were owed money, and the Investors had committed to helping the business move forward in the future. The Debtor testified that he was under the impression that Towsley's could not be paid from the sale, due to the subordination agreement and the Bank's...

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