Boyer v. Crown Stock Distribution

Facts

D was a designer and manufacturer of machinery for cutting and bending tubes. Most of the machinery it made was custom-designed to the buyer's specifications, and only two other companies manufactured custom-designed machinery of that type. Ds agreed to sell for $6 million all of Crown's assets to Kevin E. Smith, the president of a company in a similar line of business. D agreed to employ Smith until the closing so that he could assure himself of the value of the business before committing to buying it. At the closing, on January 5, 2000, D received from a new corporation, formed by Smith, $3.1 million in cash and a $2.9 million promissory note. The new corporation was also named Crown Unlimited Machine, Inc. borrowed the $3.1 million from a bank. The loan was secured by all of Crown's assets, the annual interest rate (a floating rate) initially exceeded 9 percent. The promissory note was payable on April 1, 2006, with interest at an annual rate of 8 percent. The new corporation would be required to pay only $100,000 a year on the note, with the first payment due in April 2001, unless new Crown's sales exceeded a specified high threshold. The note was secured by all of Crown's assets but was subordinated to the bank's. Smith contributed $500 of his own money toward the purchase. Crown transferred $590,328 from its corporate bank account to a separate bank account so that it could be distributed to Crown's shareholders as a dividend. After the closing, Crown distributed the entire $3.1 million in cash that it had received to its shareholders and ceased to be an operating company. New Crown declared bankruptcy in July 2003, and its assets were sold for $3.7 million. The buyer was a new company of which Smith is now the president. Most of the money was paid to the bank. New Crown's unsecured creditors, who were owed some $ 1.6 or $1.7 million were screwed. P brought a section 544 avoidance action and ta section 550 action to recover improperly transferred funds. The bankruptcy judge ruled that $6 million paid had been paid 'without new Crown's receiving a reasonably equivalent value in exchange.' It held that D and its shareholders could neither enforce the promissory note nor keep either the $3.1 million in cash received at the closing or the two $100,000 interest payments made on the note. It held that the $ 590,328 dividend was legitimate because it had been paid out of cash that belonged to D rather than to the debtor (new Crown). The court rejected P's argument that the purchase of D's assets had been an LBO (a leveraged buyout), that it should be 'collapsed' and the sale thus recharacterized as a sale by the shareholders of D, and that once it was collapsed in this fashion the $590,328 'dividend' would be seen as an asset of the debtor's estate and thus would be available to help satisfy the claims of the unsecured creditors. Both parties appealed. If the asset sale is recharacterized as a sale of D by its shareholders, as is implicit in our characterization of the sale as an LBO, the shareholders lose the protection of section 550(b) because they then are initial rather than subsequent transferees and the 'dividend'--the retention of cash by old Crown--becomes an adjustment in the purchase price. The initial transferee was D and the second-stage transferees were the shareholders. But they gave no 'value' in the transfer and so are not protected by section 550(b). They gave nothing in exchange for their distributions from D Stock. Ds argue that even if the transaction was voidable, they shouldn't have to return any of it because that would give P a windfall. D sold new Crown assets that new Crown later sold in bankruptcy for $3.7 million. If D gets no credit for the initial transfer, the debtor's estate will have received in excess of $7.6 million, consisting of the amount of the judgment ($3.295 million) plus the proceeds of the sale of the assets ($3.7 million), plus the dividend money (almost $ 600,000)--all to pay (besides administrative expenses) total debts of only $5.2 or $ 5.3 million: $ 3.6 million to the bank (the original bank loan, plus an additional $500,000 that the bank lent new Crown, all of which has been repaid to the bank), and $1.6 or $1.7 million to the unsecured creditors. Should all the unsecured creditors of new Crown be paid in full the only other potential claimants to any surplus money in its estate will be the original shareholders. The LBO was fraudulent only with respect to the unsecured creditors. If and when they are paid in full, the wrong committed by the shareholders will have been righted and there will be no reason to deny their claims to whatever money is left over. Only a creditor can set aside a fraudulent conveyance. P is entitled to the judgment awarded by the bankruptcy judge, plus the $ 590,328 dividend. Any money remaining in the hands of P must be returned to Ds. Affirmed in part, reversed in part, and remanded.

Issues

Rule of Law

Holding and Decision

Legal Analysis

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