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In re Reliable Manufacturing Corp.

decided: March 18, 1983.

IN RE RELIABLE MANUFACTURING CORPORATION, DEBTOR. LIBCO CORPORATION, APPELLANT,
v.
CHARLES W. LEIGH AND ERVIN F. DUSEK, APPELLEES



Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 81 C 828 -- Prentice H. Marshall, Judge.

Richard D. Cudahy, Circuit Judge, John L. Coffey, Circuit Judge, William H. Timbers, Senior Circuit Judge.*fn*

Author: Cudahy

This case involves the enforceability of a security interest under Section 9-203(1) of the Uniform Commercial Code, Ill. Rev. Stat. ch. 26, § 9-203(1) (1981), and under Section 160 of the Delaware Corporation Law, Del. Code Ann. tit. 8, § 160 (1978). The appellees, Charles W. Leigh and Ervin F. Dusek, assert a lien upon the proceeds of the sale of collateral of the bankrupt, Reliable Manufacturing Corporation ("Reliable"). Both the bankruptcy judge and the district court granted summary judgment for Leigh and Dusek and against the appellant, Libco Corporation ("Libco"), of which Reliable is a wholly owned subsidiary. We affirm the judgment of the district court, although on grounds which are in some respects different from those on which its decision was based.

I.

Appellees, Charles W. Leigh and Ervin F. Dusek, are the former owners of Reliable Manufacturing Corporation, the bankrupt corporation involved in this case. On April 5, 1977, the appellant, Libco, bought Reliable from Leigh and Dusek in a transaction which has given rise to the litigation here. Libco, as buyer, signed a Stock Purchase Agreement in which it agreed to pay a total of $1,750,000 in exchange for all of the shares of Reliable stock. The money was to be paid in four installments, the last two of which, totaling $940,000, were due on January 31, 1979 and on January 31, 1980. The Stock Purchase Agreement specified that these two installments were to be secured by a security interest in all of the equipment, dies and molds of Reliable and that a Security Agreement to that effect was to be attached to the contract of sale. The transaction up to this point was straightforward, with the sellers financing the purchase of the Reliable stock, and securing their extension of credit by an interest in Reliable's collateral.

Apparently in fulfillment of the agreement that the last two installments of the stock purchase price be secured, both a Guarantee and a Security Agreement were attached to the Stock Purchase Agreement. The Guarantee of Libco's obligation, whereby Reliable undertook to guarantee the debt of Libco to Leigh and Dusek, was executed by Leigh and Dusek, as officers of Reliable, to themselves, as individuals, for the last two installments. The Security Agreement which was also attached to the Stock Purchase Agreement secured this Guarantee. The Security Agreement was signed by Leigh on behalf of Reliable and granted to Leigh and Dusek a lien on all the machinery, equipment, tools and dies owned by Reliable as of the date of the Agreement. This Security Agreement was apparently the one referred to in the Stock Purchase Agreement, and it specified that it was intended to secure performance of the Guarantee by Reliable of the obligations of Libco. The security interest was perfected by filing a financing statement with the Illinois Secretary of State on April 8, 1977.

In sum, the sales transaction entered into on April 5, 1977 consisted of a Stock Purchase Agreement between Libco, on the one hand, and Leigh and Dusek, on the other, a Guarantee running from Reliable to Leigh and Dusek, and a Security Agreement, granting a lien on Reliable's equipment, to secure the Guarantee to Leigh and Dusek. On the same day, Leigh and Dusek each entered into a written employment contract with Reliable and Libco; each contract contained a covenant not to compete with Reliable. Leigh also, together with one Marvin Green, executed a lease and option to buy with respect to the premises on which the company was located, Leigh again signing in a dual capacity -- both as landlord and on behalf of the tenant, Reliable.

The amounts due under the Stock Purchase Agreement were never paid. In March of 1979, in response to a creditors' petition, Reliable filed for bankruptcy under Chapter 11 of the Bankruptcy Act. On September 18, 1979, Reliable filed a complaint to sell its machinery and equipment free of all liens; the appellees responded by asserting their security interest in that equipment and moved for summary judgment. Leigh and Dusek's claim was contested by Reliable, the trustee, Libco, and the Creditors' Committee. The bankruptcy court ordered that the machinery and equipment be sold; and it is the proceeds of that sale -- $407,000 -- which are the subject of this lawsuit.

Leigh and Dusek supported their motion for summary judgment with copies of the Stock Purchase Agreement, the Guarantee, the Security Agreement and the financing statement with respect to it filed with the Illinois Secretary of State, the lease and employment contracts, a Libco filing with the S.E.C. describing its purchase of Reliable and two statements of audits of Reliable. On this basis, the bankruptcy judge granted the motion for summary judgment in an order and opinion of November 21, 1979. Upon motions for reconsideration, the court again granted summary judgment on December 9, 1980, holding, despite Libco's arguments to the contrary, that the Guarantee and Security Agreement were supported by adequate consideration, that they served a valid corporate purpose of Reliable and that they did not unlawfully impair Reliable's capital. In re Reliable Manufacturing Corp., No. 79 B 2152 (Bankr. N.D. Ill. Dec. 9, 1980).

Libco appealed the decision of the bankruptcy court to the district court, arguing that 1) the Guarantee and security interest were invalid since they were not supported by consideration to Reliable, and 2) that Reliable's Guarantee and grant of a security interest constituted a purchase of its own stock which impaired its capital and was therefore invalid under Section 160 of the Delaware Corporation Law. Del. Code Ann. tit. 8, § 160. Judge Marshall upheld the granting of summary judgment for the appellees, but on grounds different from those which formed the basis for the decision of the bankruptcy court. In re Reliable Manufacturing Corp., 17 Bankr. 899 (N.D. Ill. 1981). First, he held that the value required by Ill. Rev. Stat. ch. 26, § 9-203(1) for the enforceability of a security interest need not flow to the debtor; thus the security interest was valid, despite the fact that the value given did not flow directly to Reliable. Second, Judge Marshall, assuming arguendo that Delaware Section 160 applied, held that Libco was estopped to attack the validity of a transaction which it had freely undertaken in order to purchase Reliable's stock. In response to this estoppel ruling, Reliable has intervened in the appeal to this court, arguing that it, unlike Libco, is not estopped to raise Section 160. Libco in its appeal challenges both the estoppel holding and the finding that the security interest was a valid and enforceable one.

Since the procedural posture of this case is that of a challenge to a motion granting summary judgment, we may uphold the judgment of the district court only if we find that the parties are entitled to judgment as a matter of law and that the opponents of the motion for summary judgment have failed to show that there is any genuine issue of material fact. Fed. R. Civ. P. 56(c). Given this posture, the issues for decision by this court may be summarized as follows: 1) Does the Security Agreement executed by Reliable and Leigh and Dusek (as to which a financing statement was duly filed) fulfill the requirements prescribed by Ill. Rev. Stat. ch. 26, § 9-203 for the enforceability of a security interest, when the value given under the Agreement flowed to a party other than the debtor? 2) Was the Guarantee given by Reliable to Leigh and Dusek illegal under Section 160 of the Delaware Corporation Law as a purchase of its own stock which impaired its capital? and 3) Was the Guarantee otherwise void as being ultra vires?

II.

Section 9-203(1) of the Uniform Commercial Code establishes the requirements for the enforceability of a security interest as follows:

(a) the collateral is in the possession of the secured party pursuant to agreement, or the debtor has signed a security agreement which contains a ...


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