Barlow v. Budge

127 F.2d 440, 1942 U.S. App. LEXIS 3896

• Court: Court of Appeals for the Eighth Circuit
• Decided: April 20, 1942
• Docket: 12008
• Status: Published

Opinions

SANBORN, Circuit Judge.

The question for decision is whether the claim of the appellee, who was a director, an officer and a stockholder of The Liberty Poster Company, which has been adjudged a bankrupt, must be subordinated to the claims of other creditors.

The bankrupt is a Minnesota corporation, which was organized in 1919 by C. A. Rose, F. H. Paulsen, W. P. Budge and R. E. Morrissey to do a printing business. Its’ capital stock was $20,000, of which each of its stockholders owned one-fourth. In 1925 Paulsen, who had been Vice-President, withdrew and sold his stock to the other stockholders, each of whom thereafter owned one-third of the stock of the corporation. After 1925 its stockholders were Rose, Budge and Morrissey, and its acting and active directors and officers were Rose and Budge. Rose acted as President and General Manager; Budge, as Secretary and Treasurer. In 1938 Morrissey became a director.

From 1919 to 1930 the bankrupt’s business was reasonably successful, but, like many other corporations, it then fell upon evil days. In 1931 its net profit was $109.-22, and that was the last year in which it made a profit, except for the year 1935 when a net profit of $332.30 was realized. In the years 1930 and 1931 Budge’s salary of $1,040 per annum was not paid. By 1934 the capital of the bankrupt was impaired to the extent of $2,169.97. In 1935 there were occasions when the bankrupt was without sufficient funds to meet the weekly payroll, and at such times Budge made necessary advances. In 1935 the total advances made by Budge were $3,450. In 1936 a new press was purchased for $13,200. An old press, for which $3,-500 was allowed, was exchanged in part payment. Budge advanced $2,000 in cash, and the $8,000 balance of the purchase price was covered by a mortgage. During 1936 the corporation had gross sales of $55,302, hut by the end of the year the impairment of capital was $2,926.63. In February, 1937, Budge advanced $500 to the bankrupt, and in August, 1937, $250. He received from the bankrupt, in part payment of its indebtedness to him, $2,060 by 1932, $1,000 in 1936, and $250 on September 8, 1937. Budge advanced to. the bankrupt a total of $6,200; it owed him for salary for the years 1931 and 1932, $2,080; and it had paid him $3,310, leaving an unpaid balance due him of $4,970. He made no advances after August, 1937, and received no repayments after September 8, 1937. From July 1, 1937, the claims of other creditors of the bankrupt began to accumulate. At the end of 1937 the bankrupt owed creditors other than Budge $4,913.15, and the impairment of capital was $8,932.29. By the end of 1938 additional indebtedness to creditors amounted to $4,374.18 and capital impairment was $14,634.48. The corporation was adjudged bankrupt April 22, 1939. The schedules showed liabilities (including the indebtedness to Budge) of $14,646.22, and assets of $11,748.81.

Budge filed a claim for $4,970. The Trustee objected to the allowance of the claim. A hearing was had before the Referee. Budge testified, in substance, that he had made the loans to the corporation in good faith and to supply necessary funds; that no arrangements were made with other stockholders before the advances were made, but that at times he told Rose lie would put in money; that all of the transactions were shown upon the hooks of the corporation; and that there was no agreement as to the withdrawal of the funds advanced. Budge further testified that he kept the books of the bankrupt and drew its checks. He charged no interest for the advances. He made no charge for his services after 1931. The Trustee conceded that Budge advanced the money he claimed to have advanced and that it was used for corporate purposes. No question was raised as to the reasonableness of Budge’s claim for salary for the years 1930 and 1931, and the Referee evidently treated the salary claim as having been discharged by the repayments made prior to 1935.

The charter of the bankrupt limited the indebtedness to $10,000. The by-laws provided for a board of three directors, who should control and manage the corporation. The by-laws also provided that no contract by the “General Manager” for the purchase of equipment involving more than $200 should be entered into without the approval of the board of directors, and that no dividends should be declared which would impair the capital of the corporation. The by-laws provided that the officers’ salaries should be fixed by the hoard of directors. The last action of the board of directors with reference to salaries, as shown by the minutes, was taken at a meeting of stockholders held July 19, 1921. Meetings of stockholders and of directors were held on July 18, 1922, at which Rose, Paulsen and Budge were elected directors and President, Vice-President, Secretary and Treasurer, respectively. There were no records of any other meetings of stockholders or directors from 1922 until 1938. Rose was the manager of the business and was paid $45 a week from the beginning. Rose and Budge ran the business and on many occasions would get together and discuss its affairs. Income, social security, and unemployment tax returns were made by the bankrupt as a corporation. The creditors dealt with it as a corporation. There can be no doubt that Rose and Budge dominated and controlled the affairs of the. bankrupt and that they did .not observe the formalities of corporate management with respect to holding meetings of stockholders and directors. Neither did they observe the charter requirement that the indebtedness of the corporation should not exceed $10,000, for, in the year 1935 and thereafter, the indebtedness was in excess of that amount. They did not procure the formal approval of the board of directors for the purchase of machinery, and ignored the provision of the bylaws in that regard. It is to be noted, however, that the advisability of purchasing the new printing press in 1936 was discussed and presumably its purchase was informally approved by all of the stockholders of the bankrupt.

The Referee found that Budge had acted in good faith and that his acts and conduct could not be considered even constructively fraudulent as to other creditors and that he was entitled to share in the assets of the estate on a parity with them. The Trustee petitioned for a review of the Referee’s order. The District Court ordered the claim of Budge allowed, saying: “I find nothing here suggesting ‘the history of a deliberate and carefully planned attempt’ on the part of Budge to accomplish a fraud on creditors such as was the situation in Pepper v. Litton, 308 U.S. 295 [60 S.Ct. 238, 84 L.Ed. 281], upon which the Trustee so heavily relies. The controlling features in this case it seems to me are the presence of the conceded good faith of the claimant and that in this good faith the loans were made for the benefit of the corporation. Under such circumstances equity and good conscience suggest the allowance of the claim.”

The appellant contends that the facts compel the subordination of Budge’s claim to the claims of other creditors. He asserts that the domination and control shown to have been exercised by Budge and Rose made them fiduciaries, and that when Budge’s claim was challenged the burden was upon him to show the fairness of his dealings with the assets of the bankrupt on behalf of creditors, and that his evidence shows that the affairs of the corporation were conducted for the benefit of himself and Rose and to the detriment of creditors. The Trustee also asserts that the substance and form of corporate management was disregarded by Budge and Rose, and that they conducted the business as though it were a partnership or joint venture. The Trustee further argues that Budge’s contributions were made to preserve his own investment and should be treated as contributions to capital at least in so far as other creditors are concerned.

It can not be said that appellant’s contentions are without merit. While there can be no doubt of the validity of the claim of Budge against the bankrupt, one can believe that, because of the way in wnich he and Rose managed the business and because of their failure to conduct the affairs of the corporation in accordance with the charter and by-laws, Budge’s rights as a creditor should not be placed upon an equitable parity with the rights of other creditors in a distribution of assets. It is probable, we think, that the Referee and the court below could have subordinated the claim of Budge to the claims of other creditors on a finding that his informal and irregular conduct of the affairs of the bankrupt had prejudiced their rights and was a violation of Budge’s duty toward them. We hesitate to say, however, that, under the evidence, the court of bankruptcy was compelled to subordinate Budge’s claim to the claims of other creditors, believing, as it did, that Budge was guilty of no fraud and of no unfairness in his dealings with the bankrupt. As a practical matter, it is difficult to see in what way the informal manner in which the corporate affairs were handled prejudiced the rights of creditors. There is no claim that any creditor was deceived as to the nature of the bankrupt’s business, as to who was in charge of its affairs, or as to its financial condition. The books of account were properly kept and reflected the assets and liabilities of the bankrupt. It is, of course, evident now that from a creditor’s standpoint it was a mistake to attempt to continue the business of the bankrupt after 1930 or 1931. It is not our understanding, however, that a mere mistake of judgment in continuing a business which is in financial difficulties is in any respect akin to fraud or unfairness. The unfavorable business conditions which prevailed during the 1930’s are a matter of common knowledge. Businessmen were urged to continue operations in the face of adverse conditions, to prevent further unemployment and in the hope that their businesses might survive. Legislation, both state and national, was enacted to prevent individuals and corporations from going to the wall. That Budge and Rose met with failure in their attempts to make the bankrupt’s business successful does not seem to us a sufficient basis to justify penalizing Budge for participating in the attempt. All that Budge and Rose did directly and informally, they could have done indirectly and formally. Whatever was done by the bankrupt in borrowing money from Budge was apparently known to and approved or fully acquiesced in by all of the three stockholders. The evidence does not justify an inference that Budge manipulated the affairs of the corporation for his own personal advantage. The inference which is justified by the evidence is that the advances which Budge made were made in good faith to enable the bankrupt to meet pressing obligations and to remain in business. The advances were made before the creditors, to whose claims it is now contended Budge’s claim should be subordinated, had become creditors.

The rule appears to he that where a claimant is a person or corporation having complete ownership and control of a bankrupt corporation, which the claimant has organized, controlled and operated as a mere agent, adjunct or instrumentality for his own purposes and benefit, the courts will disregard the corporate entity at least so far as other creditors are concerned and deny to the alleged creditor participation on a parity with them.¹ But, while the dealings of an officer, director or stockholder who files a claim against a bankrupt corporation for money loaned to it will be subjected to rigorous scrutiny and the claimant required to prove the good faith of the transaction upon which the claim is based and also its fairness from the point of view of the corporation and those interested in it (Geddes v. Anaconda Copper Mining Co., 254 U.S. 590, 599, 41 S.Ct. 209, 65 L.Ed. 425; Pepper v. Litton, 308 U.S. 295, 306, 60 S.Ct. 238, 84 L.Ed. 281), his relation to the bankrupt will not prevent the allowance of his claim on a parity with other creditors if he can show that the money was needed by the corporation and was used for proper corporate purposes and that the transaction between him and. the corporation was open, honest and free from unfairness or fault.²

We think that the duty and responsibility of determining - whether, under the applicable law, the claim of Budge was upon an equitable parity with the claims of other creditors was primarily that of the bankruptcy court, which was charged with the administration of this insolvent estate, and that this Court would not be justified in setting aside the order appealed from unless convinced that it was clearly erroneous. We are not convinced that it was clearly erroneous.

The order appealed from is affirm.ed.

1 In re H. Hicks & Son, Inc., 2 Cir., 82 F.2d 277; Forbush Co. v. Bartley, 10 Cir., 78 F.2d 805; In re Kentucky Wagon Mfg. Co., 6 Cir., 71 F.2d 802; In re Burntside Lodge, Inc., D.C., 7 F.Supp. 785; In re Mill Run Lumber Co., D.C., 4 F.Supp. 807; Clere Clothing Co. v. Union Trust & Savings Bank, 9 Cir., 224 F. 363; Pepper v. Litton, 308 U.S. 295, 307-311, 60 S.Ct 238, 84 L.Ed. 281; 8 C.J.S., Bankruptcy, § 385, pp. 1217, 1218.

2 Twin-Lick Oil Co. v. Marbury, 91 U. S. 587, 589, 590, 23 L.Ed. 328; Pepper v. Litton, 308 U.S. 295, 306, 307, 60 S.Ct. 238, 84 L.Ed. 281; Finn v. George T. Mickle Lumber Co., 9 Cir., 41 F.2d 676; First National Bank v. Young’s Estate, 6 Cir., 41 F.2d 8; Wheeler v. Smith, 9 Cir., 30 F.2d 59; In re Sassy Jane Mfg. Co., 9 Cir., 4 F.2d 55; In re American Range & Foundry Co., D.C., 22 F.2d 558. See, also, Sanford Fork & Tool Co. v. Howe, Brown & Co., Ltd., 157 U.S. 312, 15 S.Ct. 621, 39 L.Ed. 713. In re Lake Chelan Land Co., 9 Cir., 257 F. 497, 5 A.L.R. 557.