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December 4, 1964


The opinion of the court was delivered by: Campbell, Chief Judge.

  This matter is before me on the petition of A.J. Armstrong Co., Inc., (hereinafter referred to as Armstrong) seeking review of two orders entered by the referee, one on November 27, 1963, and the other on December 2, 1963. The order of November 27(1) overruled the motion of Armstrong challenging the summary jurisdiction of the Court; (2) invalidated a chattel mortgage and trust deed executed as part of a transaction entered into on December 14, 1961 by Armstrong and the bankrupt securing a loan of $2,500,000; (3) subordinated the claim of Armstrong (asserted to exceed $3,750,000) to the claims of all general creditors herein filed and allowed (in an approximate amount of $1,181,000); and (4) directed a sale of all of the assets of the bankrupt free and clear of the liens asserted by Armstrong. The order of December 2, implemented the sale portion of the order of November 27, by fixing the date of sale and by authorizing the trustee to employ an auctioneer to sell the assets. The dates set for the sale were February 11 through February 16, 1964. The sale was not held, however, by reason of the objection of Armstrong thereto and by the compliance by Armstrong with conditions of stay of said orders imposed by the referee and affirmed, in turn, by this Court and the Court of Appeals. The stay conditions were that Armstrong post two corporate surety bonds totaling $3,000,000, one in the amount of $2,000,000, securing the trustee and the unsecured creditors herein, and one in the amount of $1,000,000, securing the reclamation petitioners claiming under conditional sales contracts or leases. The corporate surety bonds were posted by Armstrong on February 7, 1964, three days before the first sale date.

The key order under review is, therefore, the order of November 27, 1963. This order, containing detailed findings and conclusions of the Referee, is 66-pages and was entered after many months of hearings before the Referee. Both the trustee and Armstrong filed lengthy briefs before the Referee prior to the entry of this order, and both parties have likewise filed lengthy, detailed briefs before me. I have just concluded my review of the orders of the Referee under challenge, the pleadings, the transcript of the testimony and the exhibits upon which the orders were based, the petition for review by Armstrong and the briefs of the parties.

Armstrong's contentions here are basically the same as they were before the Referee, namely, that the Court does not have summary jurisdiction to adjudicate the claim of Armstrong on the merits. In addition, Armstrong now asserts that the findings of the Referee are not supported by competent evidence in the record. Armstrong also asserts that the Referee should have made additional or contrary findings upon the conflicting evidence before him. Armstrong also contests the order of the Referee on the merits, i.e., the holding that the transfers of December 14, 1961, were fraudulent conveyances under Sections 67, sub. d and 70, sub. e of the Bankruptcy Act and the holding that Armstrong's entire claim should be subordinated to the claims of all general creditors filed and allowed herein.

A review of the pertinent facts necessary for an understanding of the legal issues is hereinafter set forth.

The Key Participants

The three key participants involved are Process-Manz Press, Inc., the bankrupt; Process Lithographers, Inc., and A.J. Armstrong Co. Inc.

Process-Manz Press, Inc. (hereinafter referred to as "Manz" or "the bankrupt") was engaged in the printing business and had been so for approximately 90 years. It occupied a large building situated on more than one-half of a city block in Chicago at the date of bankruptcy, November 23, 1962. It had formerly been known as Manz Corporation but had changed its name to Process-Manz Press, Inc. in May, 1962.

Process Lithographers, Inc., (hereinafter referred to as "Lithographers") is a New York corporation which was engaged in the printing business in New York City. It has now been adjudicated a bankrupt in New York.

Armstrong is engaged in the finance business in New York. It is successor to City Industrial Company, a partnership formerly engaged in the finance business.

The Contract of March 20, 1961 for the Sale of the Major Part of the Manz Stock

Lithographers immediately on March 20, 1961 assumed full ownership and control of Manz, subject to a restriction against the sale or hypothecation of the assets of Manz stipulated in the contract. The restriction, in effect, prohibited the sale or hypothecation of the assets of the bankrupt unless one-half of the proceeds of the sale or loan were paid to the selling shareholders in part pre-payment of the sale price of their stock.

The new officers of the bankrupt were the same as the officers of Lithographers, and to all intents and purposes Lithographers was the parent of the bankrupt. The contract of March 20, 1961 vested full voting rights of shareholders in Lithographers.

Monthly payments as provided in the contract were made by Lithographers to the shareholders until August 1, 1961. At this time and prior thereto, Lithographers was in financial difficulty and was not paying its debts in the regular course of business. It was unable to pay the full installment of $172,833.33 due to Neumann on August 1, 1961 and paid only $50,000 on account. The balance of this installment was not paid to Neumann until October 16, 1961.

The Loan of October 4, 1961

On October 4, 1961 the new officers of Manz (Roskin and Young) entered into an agreement with Armstrong for a secured loan of $1,000,000 in behalf of Manz. Of this, $500,000 was to be advanced to Manz, and $500,000 was to be held by the lender in escrow pursuant to special permission granted by two of the selling shareholders (Neumann and Moss) for the mortgaging of the assets of the bankrupt. The $500,000 withheld was to be turned over to the selling shareholders by Armstrong in the event of nonpayment of the loan by a designated date.

From the proceeds of the loan of $500,000, the bankrupt advanced $289,231.75 to Lithographers, which the latter used to pay the balance due to Neumann in the sum of $122,833.33 for the installment of August 1, 1961.

Negotiations with Armstrong for $2,500,000 Loan

After the loan of October 4, 1961 negotiations were conducted between Armstrong and the bankrupt for a loan of approximately $2,500,000 to be made upon the property of the bankrupt. During said negotiations Armstrong required as conditions to the making of the loan (1) 100% of the shares of stock of Manz to be deposited with it as collateral; and (2) an exclusive contract for all of the accounts receivable financing, which would continue in effect so long as the bankrupt was indebted to Armstrong.

On October 31, 1961 the bankrupt signed a contract for the assignment of all of its accounts receivable to Armstrong. Under this arrangement Armstrong received copies of all invoices and received all the income generated by Manz and in return made advances to Manz in amounts solely determined by Armstrong.

On November 6, 1961 Manz, Lithographers and Armstrong entered into a written agreement whereby Lithographers assigned to Armstrong all of its interest in and to the contract of March 20, 1961 with the selling shareholders of Manz as collateral for the proposed loan. On November 6, all shares of stock of Manz paid for and acquired by that date were delivered to Armstrong by Lithographers. Armstrong thereby acquired all the interest and rights of Lithographers under the contract of March 20, 1961 and in the shares of stock of Manz covered by that contract. Armstrong also acquired the right to make the payments due on the contract of March 20 in the event of any default by Lithographers.

The Loan of December 14, 1961

On December 14, 1961 Manz executed and delivered to Armstrong a trust deed transferring its real estate, a chattel mortgage transferring certain of its personal property (exclusive of inventory and work-in-progress) and a promissory note for $2,500,000 with interest at 12% per annum.

In consideration of these transfers and the delivery of the promissory note, Armstrong on the same date disbursed the proceeds of the $2,500,000 loan as follows: (1) it repaid itself the sum of $500,000 borrowed from it by Manz on October 4, and released to itself the balance of that loan held in escrow pursuant to the loan agreement; (2) it paid itself $11,666.67 in interest on the loan of October 4; (3) it paid $2,525 to Melvin Hirsch, its Vice President and General Counsel, for title expenses and attorney's fees; (4) it delivered two checks — one for $814,432.58 and one for $624,122.49, or a total of $1,438,555.07 — payable to the order of Schwartz, Nathanson and Frank, attorneys for Manz, to George Schwartz; and (5) it issued a check for $547,253.26, payable to Manz (representing the net cash proceeds actually received by Manz). The two checks delivered to Schwartz were delivered with directions and on condition stipulated by Armstrong that the amount of the first check be paid over to Moss and the amount of the second check be paid over to Neumann to prepay to Moss and Neumann the respective total balances due to them on the contract of March 20, 1961 and that George Schwartz receive in return from Moss and Neumann (or their escrow agent) the balance of the shares of stock of Manz, covered by these payments and deliver them to Armstrong as collateral for its loan in accordance with the terms of the loan.

Upon receipt of the two checks Schwartz exchanged them for two certified checks in amounts identical thereto, payable respectively to Moss and Neumann. Schwartz then delivered these certified checks to Moss and Neumann from whom he had already obtained the remaining balance of stock (both preferred and common) and for whom he was acting as escrow agent. Schwartz then certified to Armstrong that he had "this day made payment to the selling shareholders under the agreement of March 20, 1961 of the sums which we computed to be the balance provided for under said agreement", and further, that in his opinion, "there is no prohibition or restriction of any nature under the terms of said agreement which would prevent Manz * * * from mortgaging its assets or assigning its accounts receivable." Schwartz delivered to Armstrong the shares of Manz stock which he had received from Moss and Neumann. These shares were, as were all other shares of Manz stock previously delivered to Armstrong, endorsed in blank with blank signed powers of attorney. Of the net cash proceeds of the loan actually received by it — $547,000 — Manz transferred $200,000 to Lithographers.

On December 14, 1961 several creditors of Manz had claims against Manz which have never been paid and are still due and owing.

Stock Redemption

On December 5, 1961 Melvin Hirsch, Vice President and General Counsel of Armstrong, arranged with local counsel for Armstrong in Chicago, for the Articles of Incorporation of Manz to be amended so as to authorize the redemption of preferred stock (Trustee's Ex. 87). Said authorization was given by the officers of the bankrupt at the direction of Armstrong. At the same time, counsel for Armstrong drafted a statement of redemption and cancellation of 282,000 shares of preferred stock. This statement was signed on December 22, 1961 and filed with the Secretary of State of Illinois on December 29, 1961 at the direction of Armstrong. The Certificate of Redemption reflects the amount of $1,979,640 paid by Manz to Lithographers for these shares. The books of Manz, however, show the transaction as follows: Manz redeemed 282,000 shares of its preferred stock from Lithographers at $7.23 per share or a total of $2,038,860. The bankrupt subsequently made a correcting entry of $59,220 on its books to adjust the redemption price down to $7.02 per share. This made the final redemption price for the 282,000 shares $1,979,640. Of this amount $1,438,555.07 represents the amount paid to Moss and Neumann. This amount was treated as an advance to Lithographers. The difference between the two amounts — $541,084.93 — was credited to the cancellation of indebtedness owing to Manz in an equivalent amount by Lithographers for cash advances made to Lithographers and for printing jobs done by Manz for the account of Lithographers.

Financial Condition of Bankrupt Before and after the Commencement
    of Its Relationship with Armstrong

Prior to its dealings with Armstrong, Manz had no mortgages on any of its property except for balances due on conditional sales contracts for purchase of specific items of property. Manz did not discount its accounts receivable but relied entirely upon bank financing at the usual and customary rates charged by banks. The annual volume of Manz' business was $6,000,000. However, since January, 1961 Manz had been slow in paying its bills to trade creditors. Moreover, it had sustained losses in the calendar years 1958 through 1960 inclusive. The combined amount of the loss in 1959 and 1960 was $468,953.21.

The obligations of Manz to its unsecured creditors on December 14, 1961 were approximately $588,000.

Following the transaction of December 14, 1961 the financial condition of Manz grew progressively worse from month to month. Within 11 months from that date, accounts payable, exclusive of taxes, wages and indebtedness to Armstrong, aggregated approximately $1,181,000. Within 30 days from the date of the loan, Manz was in default among other reasons by its failure to maintain the required ratio of net working capital of a minimum of $400,000 and by its failure to maintain a minimum net worth of $1,300,000 as required by the loan agreement. Additional defaults under the loan agreement thereafter accrued. Manz made payments on the loan in March, April and May, 1962 and defaulted entirely on the payment due in June, 1962.

  Armstrong made advances to Manz on accounts receivable in round
figures without reference to the accounts receivable financial
contract of October 31, 1961. The contract which provided
originally for a 70% advance was amended on December 14, 1961 to
provide for an 80% advance. During the early months under the
contract Armstrong advanced substantially less than the agreed
percentage, while in the later months Armstrong advanced
substantially in excess of the agreed percentage. Manz assigned
to Armstrong all of its receivables, including rents from tenants
and miscellaneous claims. Included in the miscellaneous claims
was a claim for an inventory adjustment (against the selling
shareholders) which Armstrong learned about at the last moment,
and in the language of its Vice President and General Counsel,
"grabbed, in its usual course of grabbing everything." Manz was
thereafter dependent solely upon Armstrong for its financial
needs and Armstrong supplied to Manz the funds required for
payroll and other ...

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