Costello v. Fazio

256 F.2d 903 (9th Cir. 1958)

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Nature of the Case

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Facts

'Leonard Plumbing and Heating Supply Co.' was organized in 1948. The three partners, P, Ambrose, and B. T. Leonard, made initial capital contributions to the business aggregating $44,806.40. The capital contributions of the three partners, as they were recorded on the company books in September 1952, totaled $51,620.78, distributed as follows: P, $43,169.61; Ambrose, $6,451.17; and Leonard, $2,000. The partners decided to incorporate the business. P and Ambrose, on September 15, 1952, withdrew all but $2,000 apiece of their capital contributions to the business. They were issued partnership promissory notes in the sum of $41,169.61 and $4,451.17, respectively. These were demand notes; no interest being specified. The capital contribution to the partnership business then stood at $6,000 with $2000 for each partner. The closing balance sheet of the partnership showed current assets to be $160,791.87, and current liabilities at $ 162,162.22. There were also fixed assets in the sum of $6,482.90, and other assets in the sum of $887.45. The partnership had cash on hand in the sum of $ 66.66, and an overdraft at the bank in the amount of $3,422.78. Of the current assets, $41,357.76, representing 'Accounts receivable -- was assigned to American Trust Co., to secure $50,000 of its $59,000 in notes payable. Both before and after the incorporation, the business had a $75,000 line of credit with American Trust Co., secured by accounts receivable and the personal guaranty of the three partners and stockholders, and their marital communities. The net sales of the partnership during its last year of operations were $389,543.72 with a net loss of $22,521.34 as compared to a net profit of $40,935.12 in the prior year. The corporation was capitalized for six hundred shares of no par value common stock valued at ten dollars per share. Two hundred shares were issued to each of the three partners. P became president, and Ambrose, secretary-treasurer of the new corporation. Both were directors. The corporation assumed all liabilities of the partnership, including the notes to P and Ambrose. The corporation filed a voluntary petition in bankruptcy. P filed a claim against the estate in the sum of $34,147.55, based on the promissory note given to him when the capital of the partnership was reduced. Ambrose filed a similar claim in the sum of $7,871.17. P asked that these claims be subordinated to the claims of general unsecured creditors. D averred. Three expert witnesses for D expressed the view that, at the time of incorporation, capitalization was inadequate.

The accountant for the partnership and corporation 'testified that in his opinion, the bankrupt corporation was adequately capitalized at the inception of its corporate existence. The court agreed with P and D appealed. The district court affirmed. D appealed.