Finch v. Constar et al

UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF NEW MEXICO
In re:
NEWCO AGGREGATE COMPANY, LLC,
Debtor. 	No. 7-03-11787 SF
ROBERT L. FINCH, et al.,
Plaintiffs,
v. 	Adv. No. 05-1065 S
CONSTAR, et al.,
Defendants.
FINDINGS OF FACT AND CONCLUSIONS OF LAW
AFTER TRIAL ON THE MERITS
This matter came before the Court for trial on the merits on
May 16 and 17, 2007. 	Plaintiff appeared through his attorney
Robert L. Finch. 	Defendants Constar, Geoff McMahon and Raymond
W. White appeared through their attorney Gary B. Ottinger.
Defendant Greg Thompson has never been served with process and
has never appeared either in person or through counsel. 	This is
a core proceeding. 	28 U.S.C. § 157(b)(2)(A), (B), (E), (H) and
(K). 	This bankruptcy case was filed before the effective date of
the Bankruptcy Abuse Prevention and Consumer Protection Act of
2005, so those amendments do not apply.
The complaint has five counts: 1) to avoid a promissory note
and security interest for violation of the Limited Liability
Company Act, 2) to avoid intentional fraudulent transfer under
the Uniform Fraudulent Transfer Act, 3) to avoid a constructive
fraudulent transfer under the Uniform Fraudulent Transfer Act, 4)
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for breach of fiduciary duty, and 5) to recover property of the
estate.
FACTS
1. 	Duane Hamblin (“Hamblin”) and Curtis Slade (“Slade”) formed
AAA Construction (“AAA”) in mid-1998. 	AAA was in the rock
crushing business. 	By 1999 it was in financial trouble and
needed cash. 	Hamblin agreed to sell his interest in AAA to
Geoff McMahon (“McMahon”) in late 1999. 	This deal “went
through,” and Hamblin received $100,000 plus partial payment
of some past debts. 	Hamblin understood that the plan was
for McMahon was to contribute capital to AAA and eventually
to form a new company with Slade and transfer AAA’s assets
to it. 	Hamblin believed that he was dealing with McMahon.
The check he received in payment, however, came from Andrea
Corporation. 	Exhibit F also contradicts Hamblin’s belief
that he was dealing with McMahon; Exhibit F is the purchase
agreement between Andrea Corporation and Hamblin.
2. 	Newco Aggregate Company, L.L.C. (“Debtor”) was organized in
the state of New Mexico on November 23, 1999. 	Slade was a
49% owner, and Slade believed that McMahon was a 51% owner.
In fact, Andrea Corporation was the 51% owner. 	Debtor is a
member-managed LLC. 	The Debtor had no operating agreements
or by-laws. 	The Articles of Organization were offered but
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not admitted into evidence, so the Court can make no
findings on what they contain.
Exhibit 3 shows the various ownerships and
relationships of other entities that are involved in this
case. 	Although Slade testified that he was the general
manager of the Debtor, the Court finds that while Slade did
have control over day to day operations, the real control
was always in Andrea Corporation. 	Slade had no signature
authority for the accounts and had no access to the books of
account, and his only control over the finances consisted of
approving bills.
3. 	On December 1, 1999, Slade, for AAA, and McMahon, for Andrea
Corporation, transferred all of the assets into Debtor.
Exhibit 2.
4. 	Greg Thompson was president of Andrea Corporation. 	Andrea
Corporation was a subsidiary of Morningstar Corporation.
Morningstar Corporation was the sole property of McMahon.
McMahon sold Morningstar Corporation to Constar Company
(“Constar”); the date of this sale is not in the record.
Constar is a Nevada common law business trust. 	No
individual defendants own, control, manage or direct
Constar. 	No evidence was presented on who the beneficiaries
of the trust are. 	White testified that the trustee is
Venture Charters Association, a Nevada corporation, that
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acts through its agent Mr. Barrett. 	According to White,
Constar has never made a profit, so there has not been an
issue of what to do with the profits.
5. 	From the beginning of Debtor’s existence, Andrea Corporation
and/or Morningstar funded its operations. 	The testimony of
various parties indicated that Debtor almost broke even the
first year, but then began a series of years of operating
losses. 	Exhibit 26 shows that by June 1, 2004, Debtor had a
net equity of -1.3 million dollars, representing operating
losses over the life of the Debtor. 	Debtor was insolvent on
June 1, 2004, but a balance sheet would not show when the
Debtor became insolvent.
6. 	The parties exerted much effort attempting to prove why
there were operating losses, with various accusations going
back and forth. 	However, the Court finds the reasons not
relevant.
7. 	Exhibits 5, 6 and 7 are a promissory note, security
agreement, and UCC1 filing with the state of New Mexico.
The promissory note, which is undated, indicates that
Debtor, as maker, owed Constar $1.0 million dollars, with
interest accruing at 12% per annum. 	The promissory note is
signed “Newco Aggregate Company, LLC, by Greg Thompson, ___
President.” 	Plaintiff argues that because Debtor is an LLC
without an operating agreement or bylaws it has no position
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of president, and, even if it did, Thompson was not it.
Therefore, Plaintiff seeks to set aside this note as
unauthorized and incorrectly executed. 	The Court finds,
however, that Thompson was signing as president of Andrea
Corporation, and simply forgot to (or did not know he was
supposed to) fill in Andrea Corporation on the blank line.
Andrea Corporation was 51% owner of Debtor and in control.
It was acceptable for Thompson to sign the note on behalf of
Debtor. 	The security agreement pledges all assets, tangible
and intangible of Debtor, and the proceeds thereof. 	The
same signature block appears on the Security Agreement, and
the Court finds that it was properly executed as well. 	The
UCC1 filing shows that it was filed on September 5, 2002.
The Court also finds that these three documents were
prepared at or around the same time in late August or early
September, 2002. 	An earlier promissory note appears at
Defendants’ Exhibit A-1. 	This note was for $500,000, dated
January 21, 2000, and stated that it was to be secured by
“granting the primary secured position in the real and
chattel assets of NewCo Aggregate Company LLC.” 	Slade
denies signing this document, and testified that anyone who
claimed he signed it was a liar. 	However, it was notarized
and White testified that Slade did voluntarily sign it in
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his presence. 	Exhibit A-1 was executed at the same time as
Exhibit A-2, which Slade admitted signing.
8. 	Exhibit 8 is a ledger of amounts due to Constar from Debtor.
As of August 16, 2002, Debtor owed Constar $1,324,484.65.
This exhibit was prepared by White, who testified that it
was a complete and accurate record of the checks written,
internal invoices and internal charges. 	The Court finds
that Plaintiff did not rebut Exhibit 8 as a substantially
correct statement of amounts owed to Constar. 	Slade
testified that the ledger was materially incorrect and that
in fact Constar owed $ 2.0 million to Debtor. 	Aside from
his statements, Slade had no documents or other evidence to
prove this, however.
9. 	Plaintiff provided no evidence that Debtor was insolvent in
late August or early September, 2002 when Exhibits 5, 6 and
7 were executed or that Debtor became insolvent as a result
of Exhibits 5, 6 and 7. 	Plaintiff provided no evidence that
Constar knew or should have known of Debtor’s financial
condition when Exhibits 5, 6 and 7 were executed. 	Exhibit
5, the note, did not increase Debtor’s liabilities; it just
documented an existing debt.
9. 	Debtor filed its Chapter 11 proceeding on March 6, 2003.
10. 	On April 1, 2004, the case was converted to Chapter 7 and
Plaintiff was appointed Trustee.
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1Section 546(a)(1)(A) generally requires that an action
under 547 or 548 be commenced no later than 2 years after the
entry of the order for relief.
2That section provides, in part: “[T]he trustee may avoid
any transfer of an interest of the debtor in property or any
obligation incurred by the debtor that is voidable under
applicable law by a creditor holding an unsecured claim that is
allowable under section 502 of this title or that is not
allowable only under section 502(e) of this title.”
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11. 	Neither the Debtor-in-possession or the Trustee filed an
action to recover a preference under § 547 or fraudulent
transfer under § 548 from Constar by March 6, 2005. 1
12. 	Plaintiff proved no damages flowing from the alleged
breaches of fiduciary duty. 	Plaintiff claims that the
breaches of fiduciary duty led to all assets being
encumbered and that if the note and security agreement were
set aside the assets would be free of liens. 	As discussed
below, however, the note and security agreement cannot be
set aside.
CONCLUSIONS OF LAW
1. 	There are no grounds under the Limited Liability Company Act
to avoid the promissory note and security agreement. 	Debtor
is a member-managed LLC. 	The note and security agreement
were properly executed by the President of Andrea
Corporation, the majority member of Debtor.
2. 	Bankruptcy Code section 544(b) 2 allows the trustee to avoid
any transfer of an interest of the debtor that is voidable
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under applicable law by a creditor holding an unsecured
claim that is allowable under Bankruptcy Code section 502.
This subsection is read to incorporate the forum state's law
of fraudulent conveyance. 	Grochocinski v. Miller (In re
Miller), 175 B.R. 969, 975 (Bankr. N.D. Ill. 1994). 	Counts
2 and 3 are therefore governed by New Mexico’s version of
the Uniform Fraudulent Transfer Act, § 56-10-14 et seq. NMSA
1978 (1996 Repl.), hereafter “UFTA”.
3. 	Under the revised Act [Uniform Fraudulent Transfer
Act], fraudulent transfers are broadly separated into
two classifications: actual fraud and constructive
fraud. ... A fraudulent transfer may be attacked under
either theory. 	Actual or intentional fraud requires a
showing of intent while constructive fraud requires a
showing of inadequate consideration coupled with
insolvency.
Farstveet v. Rudolph ex rel. Eileen Rudolph Estate, 630
N.W.2d 24, 30 (N.D. 2001).
4. 	Under the UFTA, “value is given for a transfer or an
obligation if, in exchange for the transfer or obligation,
property is transferred or an antecedent debt is secured or
satisfied.” 	UFTA § 56-10-17.
5. 	The Court finds that Debtor received reasonably equivalent
value when it granted a lien on its assets to secure the
$1.0 million note, considering that over $1.3 million had
previously been advanced directly to Debtor or for Debtor’s
benefit. 	See Applied Theory Corp. v. Palladin Overseas
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Fund, Ltd. (In re Applied Theory Corp.), 323 B.R. 838, 841
(Bankr. S.D. N.Y.), aff’d, 330 B.R. 362 (S.D. N.Y. 2005):
Here the debtor granted the security interest to
the Lenders to secure antecedent debt, which arose
from $30 million in funds that the Lenders had
advanced to the debtor in the form of unsecured
debentures. 	The security interest did not provide
the Lenders with a right to receive anything more
than the amount of the money they had provided,
and the debtor's liabilities did not increase due
to the security interest. 	The security interest
was granted in respect of an antecedent debt-debt
that arose by reason of the Lenders having
provided the debtor with actual cash in the amount
of the debt. ... [T]his Court must here hold, and
does hold, that the debtor received reasonably
equivalent value in exchange for its granting the
security interest.
6. 	UFTA § 56-10-18 deals with transfers that are fraudulent as
to present and future creditors of a debtor. 	UFTA § 56-10-
18 provides:
A. A transfer made or obligation incurred by a
debtor is fraudulent as to a creditor, whether the
creditor's claim arose before or after the
transfer was made or the obligation was incurred,
if the debtor made the transfer or incurred the
obligation:
(1) with actual intent to hinder, delay or defraud
any creditor of the debtor; or
(2) without receiving a reasonably equivalent
value in exchange for the transfer or obligation,
and the debtor:
(a) was engaged or was about to engage in a
business or a transaction for which the
remaining assets of the debtor were
unreasonably small in relation to the
business or transaction; or
(b) intended to incur, or believed or
reasonably should have believed that he would
incur, debts beyond his ability to pay as
they became due.
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B. In determining actual intent under Paragraph (1) of
Subsection A of this section, consideration may be
given, among other factors, to whether:
(1) the transfer or obligation was to an insider;
(2) the debtor retained possession or control of the
property transferred after the transfer;
(3) the transfer or obligation was disclosed or
concealed;
(4) before the transfer was made or obligation was
incurred, the debtor has been sued or threatened with
suit;
(5) the transfer was of substantially all the debtor's
assets;
(6) the debtor absconded;
(7) the debtor removed or concealed assets;
(8) the value of the consideration received by the
debtor was reasonably equivalent to the value of the
asset transferred or the amount of the obligation
incurred;
(9) the debtor was insolvent or became insolvent
shortly after the transfer was made or the obligation
was incurred;
(10) the transfer occurred shortly before or shortly
after a substantial debt was incurred; and
(11) the debtor transferred the essential assets of the
business to a lienor who transferred the assets to an
insider of the debtor.
(Emphasis added.) 	Subsection (B) lists what are commonly
called the “badges of fraud.” 	Wooten v. Kreischer, 162 Ohio
App.3d 534, 541, 834 N.E.2d 35, 39 (2005).
Subsection (A)(2) does not apply in this case because
Debtor received reasonably equivalent value. 	Under
Subsection (A)(1), the transfer would be fraudulent only if
it were made with the actual intent to hinder, delay or
defraud any creditor of the Debtor. 	The burden of proof is
on the Plaintiff to show that the transfer was made with
this actual intent. 	Houser v. Rodgers, 204 S.W.3d 836, 842
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(Tex. Ct. App. 2006)(“The ... creditor has the burden to
prove the fraudulent transfer by a preponderance of the
evidence.”)(Citations omitted.); Sharp Intern. Corp. v.
State Street Bank and Trust Co. (In re Sharp Intern. Corp.),
403 F.3d 43, 56 (2 nd Cir. 2005) (The burden of proving
actual intent is on the plaintiff.); Wooten, 162 Ohio App.3d
at 541, 834 N.E.2d at 39 (“The issue concerning fraudulent
intent is to be determined based upon the facts and
circumstances of each case, and the burden of proof in an
action to set aside a fraudulent conveyance must be
affirmatively satisfied by the complainant.”)(Quotation and
citation omitted.) 	Plaintiff has not met this burden of
proof. 	Based on the testimony and exhibits presented at
trial the Court finds that there was no intent to hinder,
delay or defraud Debtor’s creditors.
First, the Court will discuss the badges of fraud. 	As
discussed below, the Plaintiff did not prove that Constar
was an insider. 	There was no property to retain possession
of after the transfer - the transfer was a lien to secure an
antecedent debt; alternatively, Debtor had no control over
the lien after the transfer. 	There is no evidence of
whether the obligation was disclosed or concealed generally;
Slade testified that he did not know about it until later.
There is no evidence that Debtor had been sued or threatened
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with suit. 	The lien did encumber all Debtor’s assets. 	The
Debtor did not abscond, and there is no evidence that Debtor
removed or concealed assets. 	The consideration received by
the Debtor was reasonably equivalent to the amount of the
obligation incurred. 	There is no evidence of Debtor’s
solvency at the time of the transfer, or of the transfer
occurring shortly before or after a substantial debt was
incurred. 	The business assets were not transferred to a
lienor. 	Altogether, the Court does not find that
consideration of the badges of fraud leads to a conclusion
of fraudulent intent.
Second, the testimony of Gary Risley, the attorney that
drafted Exhibits 5, 6 and 7, tells that they were done on
his recommendation to document the cash advances to Debtor
and the security agreement that the parties “had a handshake
on.” 	He further testified that when the Debtor “discovered”
that Slade had allegedly stolen over $600,000 from Debtor,
he insisted on finally getting the documents together. 	The
Court finds that the transactions documented by Exhibits 5,
6 and 7 were long-anticipated and prepared in the normal
course of business. 	The January 21, 2000 promissory note
further supports this finding because it demonstrates that
the debtor-secured creditor relationship existed, or was at
least anticipated, from the beginning.
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Third, Michael Daniels, chapter 11 counsel for the
Debtor testified that he had been aware of Constar’s lien
during the case, but saw no reason to avoid it; it was
obvious that Constar had funded the entire operation of
Debtor and had a lien on all assets.
7. 	UFTA § 56-10-15 provides:
G. 	“insider” includes:
...
(2) if the debtor is a corporation:
(a) a director of the debtor;
(b) an officer of the debtor;
(c) a person in control of the debtor;
(d) a partnership in which the debtor is a general
partner;
(e) a general partner in a partnership described in
Subparagraph (d) of this paragraph; or
(f) a relative of general partner, director, officer or
person in control of the debtor;
...
K. 	“relative” means an individual related by
consanguinity within the third degree as determined by
the common law, a spouse or an individual related to a
spouse within the third degree as so determined, and
includes an individual in an adoptive relationship
within the third degree;
Plaintiff did not prove that Constar is an insider.
Debtor is a corporation with 2 members, Slade and Andrea
Corporation. 	Exhibit 3 shows that Andrea Corporation was a
subsidiary of Morningstar, but also shows that it was sold
to Andrea Thompson, McMahon’s daughter. 	The Exhibit and
other evidence does not show when the sale took place.
Exhibit 3 also shows that Morningstar Corporation, which was
the sole property of McMahon, was sold to Constar, but not
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3Plaintiff has the burden of proving insolvency, which must
be determined at the time of the alleged fraudulent transfer.
See Prarie Lakes Health Care System, Inc. v. Wookey, 583 N.W.2d
405, 414 (S.D. 1998).
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when. 	It is possible that at the time Exhibits 5, 6 and 7
were executed Constar had no connection at all with Debtor
other than being a creditor.
8. 	UFTA § 56-10-19 deals with transfers that are fraudulent as
to present creditors. 	UFTA § 56-10-19 provides:
A. 	A transfer made or obligation incurred by a debtor
is fraudulent as to a creditor whose claim arose before
the transfer was made or the obligation was incurred if
the debtor made the transfer or incurred the obligation
without receiving a reasonably equivalent value in
exchange for the transfer or obligation and the debtor
was insolvent at that time or the debtor became
insolvent as a result of the transfer or obligation.
B. 	A transfer made by a debtor is fraudulent as to a
creditor whose claim arose before the transfer was made
if the transfer was made to an insider for an
antecedent debt, the debtor was insolvent at that time
and the insider had reasonable cause to believe that
the debtor was insolvent.
(Emphasis added).
Subsection (A) does not apply in this case because the
Debtor received reasonably equivalent value. 	Plaintiff has
not met the requirements of Subsection (B) because there is
no proof that 1) Debtor was insolvent at the time 3, 2) that
Constar was an insider, or 2) that Constar had reasonable
cause to believe that Debtor was insolvent.
9. 	Damages is an element of a cause of action for breach of
fiduciary duty. 	See Moody v. Stribling, 127 N.M. 630, 638,
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985 P.2d 1210, 1218 (Ct. App.), cert. denied, 127 N.M. 389,
981 P.2d 1207 (1999). 	Plaintiff proved no damages, so the
Court need not consider whether any of the Defendants were
in a fiduciary capacity with Debtor or whether they breached
any duty.
10. 	Count 5 sought to recover property of the estate on which
liens were avoided. 	Because no liens are avoided, Count 5
will be dismissed without prejudice.
CONCLUSION
For the reasons set forth above, the Court finds that counts
1 through 4 of Plaintiff’s complaint should be dismissed with
prejudice, and Count 5 should be dismissed without prejudice. 	A
judgment in favor of Defendants will be entered by separate
document.
Honorable James S. Starzynski
United States Bankruptcy Judge
copies to:
Gary B Ottinger
PO Box 1782
Albuquerque, NM 87103-1782
Robert L Finch
555 E. Main Street
Farmington, NM 87401-2742
Office of the United States Trustee
421 Gold Avenue SW, Room 112
PO Box 608
Albuquerque, NM 87103-0608
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