Opinion
Civ. No. JFM-98-1218.
October 15, 1998.
MEMORANDUM
This is an appeal from an order entered by the bankruptcy court denying a motion filed by Mercantile-Safe Deposit Trust Co. ("Mercantile") for relief from the automatic stay entered in involuntary Chapter 7 proceedings instituted against The Art Works Corporation ("Debtor"). Mercantile is seeking to set off approximately $606,000, said to be owed by Debtor under a guarantee of a revolving line of credit extended by Mercantile to Debtor's principals, Jeffrey and Penelope Gilbert, against approximately $157,900 in bank accounts maintained by Debtor with Mercantile.
In the bankruptcy court Mercantile sought a set off of approximately $224,000, representing the balance of funds in Debtor's Mercantile bank accounts when the accounts were frozen after Mercantile learned of the Chapter 7 petition. Mercantile now concedes, at least implicitly, that its set-off rights are limited to $157,869.20, the lowest post-petition balance in Debtor's accounts.
The bankruptcy court rested its rulings on five separate grounds. Since the first four grounds raise issues that I believe it would be prudent not to decide and since I find that the bankruptcy court's finding on the fifth ground — equitable marshaling — was correct, I will affirm on that ground alone.
Under the circumstances here presented, in order for the doctrine of equitable marshaling to apply the Trustee must establish four things: (1) the secured creditor (Mercantile) has a right to look to two assets in satisfaction of outstanding obligations; (2) the Trustee, standing in the position of a hypothetical judgment lien creditor, has a right to look to only one of the assets for satisfaction of his debts; (3) an insider is guilty of inequitable conduct; and (4) there will be no harm to the other secured creditor. See Berman v. Green (In Re Jack Green's Fashions For Men Big and Tall, Inc.), 597 F.2d 130, 132-33 (8th Cir. 1979) (citing Meyer v. United States, 375 U.S. 233 (1963)); In Re R.L. Kelly and Sons, Millers, 125 B.R. 945, 954 (Bankr. D. Md. 1991).
Three of these elements clearly are met. The first is undisputed. According to the record established in the bankruptcy court, Mercantile has the right to look not only to the funds in the subject bank accounts but also to the Gilberts' MPM Enterprises stock. Likewise, it is undisputed that the Trustee does not have the right to look to the MPM Enterprises stock, but only to the bank accounts, for satisfaction of his debt. Further, although Mercantile does not concede the issue, it is evident that Mercantile will not be harmed by requiring it to look to the stock to recover what is owed on Debtor's guarantee of the Gilberts' line of credit. Litigation over the valuation of the stock is presently pending in the Delaware Chancery Court, but it is undisputed that the value of the stock is not less than 4.6 million dollars. It may take some time for the Delaware litigation to be resolved, but there is nothing at all inequitable about making Mercantile wait to satisfy its debt since, as the bankruptcy court found from overwhelming evidence, in making the loan to the Gilberts, Mercantile did not rely upon Debtor's guarantee but on the Gilberts' wealth. Moreover, as the bankruptcy court also found, Mercantile knew from the outset that Debtor was undercapitalized.
Thus, the only remaining question is whether the "inequitable conduct" prong of the equitable marshaling doctrine was met. Mercantile first argues that the bankruptcy court erred by failing to make any finding on the issue. It points to the "Discussion" section of the court's opinion in which the court simply stated that "[t]he Trustee argues that it presented evidence of inequitable conduct by showing that Mercantile allowed Mr. Gilbert to make personal draws on the revolving notes, to direct advances to other entities, and to make extraordinary expenses in the name of [the Debtor]." The court's finding perhaps could have been more explicit. However, when setting forth the facts earlier in its opinion, the court had stated "[t]he Trustee's evidence showed numerous and substantial advances on the line in excess of those acknowledged by Mercantile that were for the benefits of entities other than The Art Works."
The evidence referred to by the court was fully sufficient to support a finding that Gilbert had been guilty of inequitable conduct. The Trustee testified that his review of the records disclosed that (1) Debtor paid $105,000 to Baraka Art and Frame Company (a firm of which Mrs. Gilbert was the principal); (2) $76,000 in charges on the Debtor's credit cards appeared not to have been for the benefit of Debtor; and (3) $105,000 of a $150,000 certificate of deposit supplied by the Gilberts was paid by Debtor. On cross-examination, the Trustee admitted that it is possible that despite what the records showed, the expenditures might have been for Debtor's benefit. However, as the maxim known by all trial lawyers states, "all things are possible." Mercantile did not produce either of the Gilberts or present other evidence to rebut what the Trustee testified his examination revealed, and that testimony established a prima facie case that loans proceeds that had been repaid by Debtor had benefitted persons other than Debtor.
Mercantile's final argument is that, assuming that the transactions identified by the Trustee did not benefit Debtor, they do not give rise to a finding of inequitable conduct. Mercantile correctly asserts that in In re Tampa Chain Co., Inc., 53 B.R. 772 (Bankr. S.D.N.Y. 1985), a leading case applying the equitable marshaling doctrine, the principals of the debtor were found to have stolen 50% of the loan proceeds from the creditor bank and to have transferred almost all of the debtor's inventory, for no consideration, to another company they operated. This misconduct certainly was far more egregious than the conduct revealed by the evidence here upon which the bankruptcy court relied. However, "inequitable conduct" need not amount to "massive, wholesale fraud and theft" as Mercantile suggests. Rather, it should be measured by purposes of the equitable marshaling doctrine — to protect the interests of unsecured (or less secured) creditors where (1) assets or revenues of the debtor have been used for the benefit of others, (2) the interests of a more secured creditor can be adequately protected by recourse to an asset not in the bankruptcy estate, and (3) the equities warrant requiring the more secured creditor to follow that course. The wrong may have been small, but the remedy is modest. The bankruptcy court properly granted that remedy here.
ORDER
For the reasons stated in the memorandum entered herewith, it is, this 15th day of October 1998.
ORDERED that the order entered by the Bankruptcy Court on March 16, 1998 denying the motion for relief from automatic stay filed by Mercantile-Safe Deposit Trust Company is affirmed.