Appeals from the District Court of the United States for the Northern District of Illinois, Eastern Division; John P. Barnes, Judge.
Before EVANS, SPARKS, and KERNER, Circuit Judges.
In this case the Money Corporation and the United Finance Corporation are appealing from an order of the district court, finding the corporate appellants insolvent and adjudicating them bankrupt. 30 Stat. 545, 44 Stat. 662, 11 U.S.C.A. § 11. The involuntary petitions in bankruptcy alleged that inter alia the corporate appellants, while insolvent, consented to state receiverships and made preferential transfers. The special master, to whom the case was referred, found that they were solvent, and the court, sustaining the exceptions to the master's report, entered the order above mentioned.
The United Finance Corporation, incorporated in 1919 under the name of Commercial Guaranty Corporation and authorized in 1930 to change its name to Money Corporation and in 1936 to its present name, was engaged primarily in the business of making personal loans. An audit by Baumann, Finney, and Co., Certified Public Accountants, for the period from August 1, 1924 to September 30, 1935, indicates the existence of an operating deficit amounting to $634,092.82 and reveals a total net worth of $264,973.12. In addition, this audit shows that the corporation operated at a $10,796.99 loss in 1934 and a $17,652.47 loss in 1935.
In 1936 the corporation continued its operations at a loss of $76,282.18 and it was imperative that something be done. On April 28, 1936 the corporation, operating then as the (old) Money Corporation, obtained approval from the Federal Housing Administration to act as mortgagee for FHA mortgages. National Housing Act, 48 Stat. 1246, 12 U.S.C.A. § 1701 et seq. On July 3, 1936 the United Acceptance Corporation was organized, and the United Finance Corporation, operating then as the (old) Money Corporation, transferred some assets to it in exchange for the capital stock. On July 27, 1936 the directors of the United Finance Corporation (old Money Corporation) passed a resolution authorizing its president to employ an attorney to file a petition for reorganization under Section 77B of the Bankruptcy Act, 11 U.S.C.A. § 207, but this was not done. On September 2, 1936 the United Finance Corporation changed its name of Money Corporation to its present name and reduced its stated capital. On September 4, 1936 the present Money Corporation was organized, and the United Finance Corporation transferred assets to it in exchange for its capital stock.
In this connection it is interesting to note the testimony of Nelson, president of the United Finance Corporation, concerning the orgarization of the second Money Corporation. Nelson testified that "the only reason for organizing the Money Corporation was to handle the mortgages (FHA) * * *, because the Small Loan Act of Illinois will not permit a company doing business as a small loan office to operate in any other line, so we had to form a separate organization." See Sec. 30, Chap. 74, Ill. Rev. Stats., State Bar Association Ed., (1937). The old Money Corporation received FHA permission in April of 1936, although the Small Loan Act had been approved on July 10, 1935. Moreover, the audits reveal clearly that after the incorporation of the second Money Corporation, the United Finance Corporation immediately transferred its small loans business, having a book value of $113,350.73, to the new corporation, which was incorporated, according to Nelson, to handle the FHA mortgages, separate and distinct from the small loans business. If Nelson's testimony is correct, he was doing with Money Corporation what he contends he could not do with United Finance Corporation (the old Money Corporation).
It is also interesting, at this time, to notice the effect that the change in the capital structure, made September 2, 1936, had on the huge operating deficit that had accumulated. The stated value of the capital stock was reduced or scaled down $751,593.67, credited to surplus, and then applied against the deficit.In the meantime, the audits show that from September 30, 1935 to September 30, 1936 the assets had decreased from $284,901.27 to $184,448.58, and the liabilities had increased from $19,928.15 to $88,916.86, while the net worth had fallen from $264,973.12 to $95,531.72. Moreover, the operating loss for this period was $76,282.18, making an operating loss of $104,731.64 for the years 1934, 1935, and 1936. The balance sheet as of September 30, 1936, after the transfers of assets by the United Finance Corporation to the United Acceptance Corporation*fn1 on July 3, 1936 and to the Money Corporation on September 4, 1936, indicate that of the net book value of $184,448.58 given to all the assets, the United Finance Corporation retained only $6,909.37, although the net book value of its liabilities remained at $79,927.68. It is true that the United Finance Corporation carried the new Money Corporation's capital stock with a book value of $101,000, yet it is imaginable that the creditors might have preferred the assets to the capital stock.
The financial statements as of March 31, 1937 and July 12, 1937 show that the corporations had continued to operate at a loss. The United Finance Corporation had operated at a loss of $24,817.56 from September 30, 1936 to March 31, 1937 and at a loss of $35,908.31 from March 31, 1937 to July 12, 1937. The Money Corporation, which had hardly begun to do business, operated at a loss of $4,694.64 from March 31, 1937 to July 12, 1937. Moreover, the net worth, book valued on September 30, 1935 at $264,973.12, had steadily fallen until on July 12, 1937 it stood at $29,389.39.
There is an abundance of evidence tending to show that the long continual losses from operations had begun to take their heavy toll. The net worth had suffered a huge impairment. The normal demands of creditors could no longer be satisfied adequately. Credit had failed. Lawsuits had begun, and the services of attorneys had become imperative. What little convertible assets remained were utilized to pay off the most pressing creditors, those who threatened to sue or to go to the District Attorney's office. This distressing situation culminated finally, by July 12, 1937, with consent receiverships in the state courts, and on August 7, 1937 the involuntary petitions in bankruptcy were filed.
At the hearing before the special master, much evidence was adduced on values bearing on the pertinent issue of insolvency. Appellees introduced in evidence a consolidated balance sheet of the two corporations as of July 12, 1937. This balance sheet, prepared by White and Co., Certified Public Accountants, revealed combined assets of $87,048.94 and combined liabilities of $57,659.55. Of course, an audit report is usually based on conventional accounting practices and indicate not so much values as statements of cost, and, in this particular case, the cost figures were discounted to a certain extent to allow for the failing condition of the debtors. In addition to these discounted book values, appellees offered evidence showing that the fair value of the combined assets was $50,957.12. In turn the corporations adduced evidence that controverted these values. For example, their evidence as to the value of three groups of assets (Notes Receivable, Real Estate Equities, and Accounts Receivable from Applicants and Mortgagors) of the Money Corporation alone totalled over $90,000., which amounts to more than the auditor's figure for all the assets of both corporations.
Appellees' main witness, one Pearce, Certified Public Accountant, stated that the assets looked to him like the "tail end of a business that had been slipping for many years." His theory of valuation was to adopt the "amount that can be collected within a reasonable period of time and at a reasonable amount of expense." Let us take the Notes Receivable group of assets as an example, to which appellees attached a fair value of $5,198.92.Pearce gave a $100 value to the Equipment Finance notes, bearing a book value of $52,568.90. His conclusion was based on the fact that most of these notes went back to the year 1920 and upon which only $176 had been collected in 1937. In this connection, it is to be noted that the White audit placed a book value of $135,127.37 on the Notes Receivable group of assets, but reserved $114,092.55 as a loss. Pearce admitted that he had not independently investigated any of the co-makers and guarantors, placing greater reliance on the ages of the notes and on the lack of collection from maker or co-maker.
As to the batch of judgments in the Notes Receivable group of assets, to which a book value of $41,658.68 was given, the White audit reserved the entire amount at a loss. Pearce, on the other hand, attached a value of $500. to them, saying that his "valuation of judgments is based on the ages of the judgment" and that he considered a "note reduced to judgment worth less than a note that has not been reduced to judgment, * * *, that is, if the judgment is not paid within a reasonable time." Other witnesses for the appellees also testified as to values of certain assets, corroborating Pearce in these instances.
The witnesses for the corporations, on the other hand, valued the assets much higher than appellees' witnesses and the White audit. Most of these witnesses were corporate employees or officers and persons who had contracted to do special services for the corporations. Let us take the Notes Receivable group of assets for an example, to which appellants attached a fair value of around $50,000. This figure is much higher than appellees' figure of $5,198.92 and the auditor's figure of $21,034.82. One Bernsten, who had been a corporate employee for many years, testified that in his opinion the small loans alone in this group of assets were worth $2,500. Pearce's value as to the small loans was $1,200. Bernsten testified that he could collect $2,500 in six or eight months, although he admitted that "all the loans that I have testified to today that were good are in default for some time; have several years default on some of them. All of them had been in default for more than a year before the receivership and I was trying to collect on all the money I could." In the main, the evidence adduced as to the value of the Notes Receivable group of ...