Delaware

Warning: The following opinion is provided for purposes of discussion only. We have not Shepardized™ this opinion, and do not know the subsequent disposition of this case nor whether the effect of the opinion has been overruled or superceded by other law.

Leo W. Farland v. S. Hayward Wills & Others,
1975 DE 282 (DE 11/12/1975)

COURT OF CHANCERY OF DELAWARE, NEW CASTLE

Civil Action Nos. 4888, 4914

1975.DE.282

November 12, 1975

LEO W. FARLAND (FARLAND)

v.

S. HAYWARD WILLS, RUSSELL E. KEMMERER, JOHN F. RING, PAUL R. STUKEN, JAMES R. POWELL, GAC CORPORATION (GAC), GAC PROPERTIES, INC. (PROPERTIES), GAC RENTAL CORPORATION (RENTAL), AND GAC PROPERTIES CREDIT, INC. (CREDIT), CIVIL ACTION NO. 4888; BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, AS TRUSTEE UNDER AN INDENTURE DATED AS OF NOVEMBER 15, 1970, FROM GAC PROPERTIES CREDIT, INC. (BOA) AND CHEMICAL BANK, AS TRUSTEE UNDER AN INDENTURE DATED AS OF SEPTEMBER 11, 1971 FROM GAC PROPERTIES CREDIT, INC. (CHEMICAL) V. GAC PROPERTIES CREDIT, INC. (CREDIT), GAC PROPERTIES, INC. (PROPERTIES), GAC RENTAL CORP. (RENTAL), GAC CORP. (GAC), S. HOWARD WILLS, RUSSELL E. KEMMERER, JAMES F. RING, PAUL R. STUKEN AND JAMES R. POWELL, CIVIL ACTION NO. 4914;

William E. Taylor, Jr., Esquire, 500 Continental American Building, Wilmington, Delaware 19801.

S. Samuel Arsht, Esquire, 1105 N. Market Street, P. O. Box 1347, Wilmington, Delaware 19899.

Martin I. Lubaroff, Esquire, 4072 DuPont Building, Wilmington, Delaware 19801.

Charles S. Crompton, Jr., Esquire, 350 Delaware Trust Building, P. O. Box 951, Wilmington, Delaware 19899.

Quillen

The opinion of the court was delivered by: Quillen

Letter Opinion on Application by Farland, BOA and Chemical for Preliminary Relief

This letter constitutes the opinion of the Court in applications for preliminary injunctions in two pending cases. In Civil Action No. 4888, Farland, a holder of $25,000 worth of 12% Debentures issued under an Indenture dated November 15, 1970 and maturing on November 15, 1975 (1975 Debentures) has sued Credit and the other defendants in a three count complaint alleging fraudulent transfer of assets, an unconscionable exchange offer for the debentures, and misrepresentations in the September 12, 1975 prospectus covering the Exchange Offer. The plaintiff brings suit on behalf of a class and requests preliminary injunctive relief, including the enjoining of the outstanding Exchange Offer, and appointment of a temporary receiver.

In Civil Action No. 4914, BOA sues the same defendants as trustee under the Indenture dated November 15, 1970 from Credit. The trustee alleges fraudulent conveyances and violations of the Delaware Corporate Law and requests injunctive relief to freeze any property transferred and to prohibit further transfers plus the establishment of a constructive trust.

It is important to understand the GAC corporate structure insofar as it is pertinent here. This is probably most easily shown in graph form:

GAC CORPORATION (Del.)

GAC Properties, Inc. GAC Realty GAC Utilities, Inc.

(Fla.)

GAC Properties Credit, GAC Rental Consolidated Water Company

Inc. (Del.) Corp. (Del.)

I include GAC Utilities, Inc. and Consolidated Water Company because they are involved in the terms of the outstanding Exchange Offer presently pending.

The important fact to bear in mind when discussing the corporate relationships and transactions is that Properties owns Credit. Thus, the position of the debenture holders, the only public investors in Credit, is antagonistic to Properties to the extent that creditor interests and ownership interests clash.

It is necessary to have some understanding of the relationship between Properties and Credit. Properties sells land at retail, primarily in installments. Credit provides financing for Properties by purchasing the installment land contracts. The contracts purchased by Credit are somewhat seasoned by the payment of the down payment and six installments. It had been anticipated that the land sales by Properties and the contract purchases by Credit would be sufficient to move the necessary cash from Credit to Properties.

The nature of the business is such that purchasers have no personal liability on their contract, and in the event of default, the contract is canceled and the monies paid retained. Properties also has obligations for development costs which can exceed the initial cash receipts of the long term purchase contracts (up to fifteen years). Properties is dependent upon Credit for a flow of cash which permits Properties to perform its development obligations which in turn generates new receivables and maintains the collectability of receivables already held.

For a variety of reasons, Properties' business has suffered. Installment land sales netted cancellations in 1971 by $128,457,000. By 1974, this total had declined to $19,489,000. The trend is continuing in 1975. Credit concedes that the transfer transactions, which are challenged in these lawsuits, were made because Properties had a cash shortage and was not generating sufficient cash through the sale of eligible receivables (land sale installment contracts to Credit). The defendants claim that Properties expended approximately $45,000,000 from January 1, 1974 through March 31, 1975 for purposes which, directly or indirectly, maintain collectability of Credit's receivables. Farland, on the other hand, maintains Properties paid GAC and others millions of dollars siphoned from Credit.

Prior to September 30, 1974 Properties owned 50,500 shares of common stock of Credit constituting all of the outstanding shares of Credit. Indeed, under the 1970 Indenture and the operating agreement, Credit is not authorized to issue shares to anyone except Properties and its subsidiaries. The complaints in the cases center on three types of transactions: the purchase by Credit of its own stock from Properties and the purchase of fixed assets by Credit from Properties and the purchase of a lease by Credit from Rental.

As to the first, it is undisputed that on the dates listed below Credit purchased the number of shares listed for the amount of money listed.

Date Shares Price

September 30, 1974 1,000

December 31, 1974 10,146 $17,600,755 (1974 Total)

March 31, 1975 1,582 $2,527,435

June 30, 1975 368 $591,232

September 17, 1975 116 $188,743

(as of July 31, 1975)

October 17, 1975 121 $195,651

(as of August 31, 1975)

These stock purchases were the first undertaken although dividends had been paid previously.

As to the second, as of March 31, 1975, the company Purchased certain real estate, machinery, equipment, furniture and fixtures owned by Properties or its subsidiaries for $12,132,713, representing the net book value of the assets on the books of the affiliates ($14,960,570) net of applicable mortgage debt ($2,827,857). The assets have been rented to the affiliates on a net lease basis whereby all costs of ownership related to the Property are paid for by the lessee. Rental is computed at the rate of 110% of depreciation for depreciable assets which, in turn, is computed principally on a straight-line basis over the estimated useful lives of the assets. The depreciation charges are based upon a continuation of the rates used by the affiliates prior to the sale. Non-depreciable real estate has been rented at the rate of 1.43% of the net book value of the Property per month.

As to the third, Credit purchased a lease from Rental for $1,787,662. In particular, as of March 31, 1975, Properties sold all of its real property and improvements, except for its land inventory and one hotel, to Rental, for the net book value of the property, less mortgage debt assumed, and leased back the property under a net full payout lease. Rental payments provided for in the lease are computed at the rate of 110% of depreciation on depreciable property and at 1.43% of cost per month over 120 months on non-depreciable land. Credit simultaneously purchased the lease from Rental for $1,787,662.

In total, Credit has thus transferred liquid assets in excess of $35,000,000 between September 30, 1974 and the present day. These transfers have been undertaken admittedly as an alternate method of moving cash from Credit to Properties.

There is presently outstanding approximately $35,600,000 principal amount of the 1975 Debentures. On November 15, 1975 Credit will be obligated to pay this principal amount to the holders of the 1975 Debentures and to pay them approximately $4,300,000 in interest on their 1975 Debentures for a total of $39,900,000. The interest figure is evidently in dispute according to the pleadings.

In addition, Credit has outstanding $43,654,000 of 11% Debentures issued under an Indenture dated September 1, 1971 and maturing on September 1, 1977 (1977 Debentures). Chemical as trustee has intervened as a plaintiff and seeks relief similar to BOA.

It is somewhat difficult to get a handle on the case due to the considerable diverse views parties take of the corporate relationships, the operating agreement, and the actions to be taken in the future. But it seems to me that it is best, as a matter of preliminary consideration, to turn first to the second and third causes of action of Farland. His prayer for relief is that this Court "declare the Exchange Offer null and void, . . . and enjoin preliminarily . . . the defendants from proceeding with, making effective, and consummating the Exchange Offer to the 1975 Debenture holders . . .".

I am not satisfied that a case for relief as to the Exchange Offer has been made. The Court believes it inappropriate to take any action to interfere with the debenture holders right to respond to the Exchange Offer. Several reasons support this Conclusion.

In the first place, with the exception of the last two stock purchases not determined by September 12, 1975, the transactions about which complaint is made are described in the prospectus. Even as to the last two transactions, Credit announced its intention to continue the practice. I cannot conclude on this application for preliminary relief that the failure to label the transactions as fraudulent, illegal, or unfair make the representations in the prospectives false and misleading.

In the second place, over 55% of the 1975 Debenture holders have already accepted the Exchange Offer. I see no compelling reason why the matter of acceptance of the offer is not most appropriately left to the judgment and discretion of the holders of the 1975 Debentures as BOA has recommended. Campbell v. Loews, Inc., Del. Ch., 134 A.2d 565, 567 (1957).

In the third place, if the plaintiff Farland does not consent to the Exchange Offer and it is consummated, Farland will have nothing to object to since he will receive one hundred cents on the dollar.

In the fourth place, if the Exchange Offer is not successful, Credit has indicated it will not have sufficient funds to pay the 1975 Debentures making a default in that issue as well as a default in the 1977 Debentures under the cross default provisions. It thus appears that the Exchange Offer may be the only means to avoid bankruptcy.

In the fifth place, the debenture holders are facing a current option and it is not clear to me what the relative benefits of plaintiff's remedy may be as compared to the Exchange Offer.

As to the preliminary relief sought in regard to the Exchange Offer, I conclude that Farland has failed to establish that preliminary relief is justified.

I think it useful secondly to turn to the prayer of Farland which requests this Court to appoint a receiver to take charge of the property of Credit. The Court may in its discretion appoint a receiver pendente lite "if cause therefore be shown". Rule 149. The justification by Farland for the appointment of a receiver is the insolvency of the corporation. 8 Del.C., § 291. The statute of course does permit the Court to appoint a receiver in cases of insolvency. It seems to me the question on the receivership is whether it is necessary for the prevention of manifest wrong and injury and whether the plaintiff, without such an appointment, is in danger of suffering irreparable loss. Gray v. Newark, Del. Ch., 79 A. 735 (1911). Whitmer v. William Whitmer & Son, Inc., Del. Ch., 99 A. 428 (1916).

It is true that the Court of Equity has inherent power to appoint a receiver even for solvent corporation pendente lite so as to preserve property involved in litigation. Lichens Co. v. Standard Commercial Tobacco Co., Del. Ch., 40 A.2d 447 (1944). In Re North European Oil Corp., Del. Ch., 129 A.2d 259 (1957). But, as the defendants argue, the appointment of a receiver would frustrate the present effort of Credit to bring about an agreement among the debenture holders which would enable the company to continue operations. Specifically, the appointment of a receiver would automatically trigger default provisions in both the 1970 Indenture and the 1971 Indenture so that both issues of debentures would become due and payable.

Even with insolvency the appointment remains discretionary. Banks v. Christiana Copper Mines, Inc., Del. Ch., 99 A.2d 504 (1953). Kinney v. Arbington Co., Del. Ch., 151 A. 257 (1930). The utility of a receiver must be demonstrated. Argenbright v. Phoenix Finance Co., Del. Ch., 142 A. 793 (1928). Foster v. Delaware Valley Drug Co., Inc., Del. Ch., 114 A.2d 228 (1955). Boggs v. Belvue, Del. Ch., 156 A. 202 (1931).

In this case, to appoint a receiver on the application for preliminary relief by one debenture holder, might well frustrate not only the goal of Credit but also the hopes and expectations of a majority of the debenture holders. Even if the present situation was produced by the defendants, the debenture holders are facing a current option and, as noted already, it is not clear to me what the relative benefits of the plaintiff's remedy may be as compared to the Exchange Offer. I therefore decline at this time to appoint a receiver because the utility has not been demonstrated and, as trustee argued orally, it could trigger consequences not beneficial to the debenture holders.

In the Farland reply brief, and at oral argument, Farland suggests the Court make use of 8 Del.C., § 102(b)(2) and § 302(b). I do not believe that the case is in a posture for the Court to administer and enforce any compromise or agreement made pursuant to those provisions. The section contemplates a specific proposal and I do not believe the court should move blindly to assert its statutory power. Indeed, the only compromise that has been proposed is the Exchange Offer.

Thus, I reject three specific remedies being sought by Farland as inappropriate but, in so doing, I make no decision on the underlying dispute. The balance of the prayers present the Court with more difficulty and necessarily involve the Court in the merits of the controversy. Since the additional relief sought by Farland is included in the relief sought by the trustee, I find it useful to concentrate on the trustee's lawsuit and to have the relief entered in that proceeding. I will rely, however, on the arguments made by Farland as well.

The main thrust of the plaintiffs' attack is that the property transfers were fraudulent conveyances (6 Del.C., § 1304, 1307) or purchases by the corporation of its own stock while capital was impaired (8 Del.C., § 160).

These alleged statutory illegalities have some problems of proof attached to them. Credit had and continues to have a book surplus. Credit made a timely interest payment of $2,400,000 on the 1977 Debentures as recently as September. Credit says it carries receivables at the estimated collectible amounts unrelated to market. BOA has by a general affidavit indicated present fair salable value [8 Del.C., § 1302(a)] of the receivables would be lower, as it would. But the question is obviously how much lower. Was Credit insolvent at the time of the transactions in question?

The definition of insolvency under the Uniform Fraudulent Conveyance Act (the Delaware Act) is broad. If the Act applies, and I tend to think it does insofar as the stock purchases are concerned (8 Del.C., § 169 makes Delaware the situs of ownership of capital stock of Delaware corporations), the liberal definition of 6 Del.C., § 1302(a) is applicable:

"A person is insolvent when the present fair salable value of his assets is less than the amount that will be required to pay his probable liability on his existing debts as they become absolute and matured."

It has been said that this definition is broader than both insolvency in the bankruptcy sense (deficit net worth) and insolvency in the equity sense (inability to pay debts as they mature). Larrimore v. Feeney, Pa. Supr., 192 A.2d 351 (1963); Cellar Lumber Co. v. Holley, Ohio App., 224 N.E.2d 360 (1967). But there is no precise evidence and the condition of being insolvent within the Uniform Fraudulent Conveyance Act can ultimately be determined only by a fact and figure balancing of assets and liabilities. Hay v. Duskin, Ariz. App., 455 P.2d 281 (1969). Similar evaluation is necessary under the capital impairment standard of 8 Del.C., § 160. The admissions relied on by the plaintiffs relate to cash flow only and therefore it seems to me that they fall short of establishing insolvency, even as a preliminary matter.

Thus, it is very difficult for me to determine on the present record whether Credit was insolvent at the time of the transfers being attacked or thereby was rendered insolvent. It is equally difficult to determine if capital was impaired. I could make a guess but speculation without a record does not justify judicial relief on a theory premised on the speculation. Even for preliminary relief, the Court must be able to find a reasonable probability as to the necessary facts.

It is also somewhat questionable to conclude as a preliminary matter that all these transfers were made with the actual intent to defraud. 8 Del.C., § 1307; Fla. Stat., § 726.01. The plaintiff Farland has argued the point well noting the financial embarrassment of Credit, the nature of the consideration, the related transferees, and the nature of the transactions. But, under the view I take of the case, I do not find, in regard to the stock purchases, it is necessary to Judge the actual intent of the defendants. I feel there is a less severe judgment which justifies the same relief and which is included in the prayers of the plaintiffs and indeed argued by Farland in the brief. I do not believe that this Court is narrowly limited to statutory definitions in the present situation. In my judgment, even as a preliminary matter, the circumstances are such that the transactions here appear so unconscionable as to require some equitable relief. I find in the record a recognized basis for relief. And I might add that this Court's special responsibility in the corporate field supports my Conclusion.

While it is perhaps premature to characterize Credit's behavior in a precise statutory sense, it seems to me probable that the stock purchases, which are continuing, constitute fraudulent conduct, at least in an equitable sense, as to 1975 and the 1977 Debenture holders.

Initially, one cannot help but be struck by the cavalier manner in which Credit acted. Approaching the problem from a corporate law context, our statute, 8 Del.C., § 160, forbids a corporation from purchasing its own capital stock "when the capital of the corporation is impaired or when such would cause any impairment of the capital of the corporation." While a formal appraisal is not required, the directors are "under a duty to evaluate the assets on the basis of acceptable data and by standards which they are entitled to believe reasonably reflect present 'values'." Morris v. Standard Gas and Electric Co., Del. Ch., 63 A.2d 577, 581 (1949). It is clear that no effort was made in this regard although the accounts receivable are discounted 40% for reserves for development costs, cancellations, credits, property taxes and mortgages. As the prospectus says: "Installment land sales contracts are not marketable except at very substantial discounts." If one looks at the nature of the receivables (no credit investigation, no personal liability, long term contracts), the market depression (described at length by defendants on pages 8 and 9 of their opening brief), and percentage of total assets in receivables (92.5% on December 31, 1975 to 81.1% on June 30, 1975 as set forth in BOA's brief), the need for a current market valuation is apparent. It is also apparent to break through the circular nature of the defendants' argument. The high value of the receivables is used to justify a stock purchase made necessary to maintain the high value of receivables. At some point, it seems to me that the receivables need to be related to a market under the circumstances of this case.

While I think it is important to note the manner of corporate operation, I do not believe it is necessary for me to conclude preliminarily that there was an actual impairment of capital. This Court has noted "the obvious dangers and abuses inherent in a corporation's dealing in its own shares" and that "creditors . . . may be prejudiced even though the purchase be made in good faith." Propp v. Sadacca, Del. Ch., 175 A.2d 33, 38 (1961); aff'd sub nom., Bennett v. Propp, Del. Supr., 187 A.2d 405 (1962). A corporation should not be able to become a purchaser of its own stock when it results in a fraud upon the rights of or injury to the creditors. 6A Fletcher Cyclopedia Corporations, § 2854; see In re International Radiator Company, Del. Ch., 92 A. 255 (1914); Pasotti v. United States Guardian Corporation, Del. Ch., 156 A. 255 (1931); Hegarty v. American Commonwealth Powers Corporation, Del. Ch., 174 A. 273 (1934). With these principles of law in mind, I turn to the facts present here as to stock purchases.

Initially, Credit is purchasing its own stock. It is generally true that the acquisition of its own capital stock is not ordinarily an essential corporate function. Brophy v. Cities Service Co., Del. Ch., 70 A.2d 5, 8 (1949).

Second, Credit is legally bound to pay the 1975 Debenture holders on November 15, 1975 and needs cash. Whatever the effect on capital invasion, the stock purchase transaction deprived Credit of liquid assets essential to meet maturing obligations.

Third, Credit not only now admits it will be unable to pay the debentures which mature on November 15, 1975, but Credit also knew at least on yearend analysis of calendar year 1974, when Credit was publicly projecting that only 75% to 80% of the debentures could be retired and the remainder would require refinancing, that it would not be able to pay the 1975 Debenture holders. It was also clear on 1974 yearend analysis, as evidence by public statement, that refinancing was not immediately available. Notwithstanding this situation, largely created by the 1974 stock purchases, Credit continued to purchase its own stock from Properties during 1975 and continued to deplete the liquid assets necessary to pay the debenture holders.

Fourth, Credit is wholly owned by Properties and must so remain. There can be no advantage to Credit as a separate corporate entity in holding treasury stock. The purchase is without any direct material consideration.

Fifth, Credit has announced its intention to continue to purchase stock and has thus demonstrated a wilful disregard for the rights of the debenture holders.

Sixth, since Credit is wholly owned by Properties, there is self dealing. The saving of the interdependent corporate structure is simply using for selfish purposes liquid assets needed to pay creditors.

Just as it is no answer for Credit to say capital is not invaded, it is no answer to such behavior to say the Indenture contract permits such stock purchases by its income formula approach. The Indenture contract provides for repayment as its prime obligation and should not be read to contemplate the wrongful eliminating of Credit's liquidity at the expense on the debenture holders on the part of Properties. The debt of the debentures is senior to any amounts owing the GAC group. Whatever the ultimate pigeonhole, a probable case of equitable fraud has been made by the 1975 Debenture holders as to the stock purchases. Given the cross default provisions, the 1977 Debenture holders also have made a case.

Turning to the purchase of fixed assets and the purchase of the lease, the record lacks evidence in regard to "fair consideration" as well as the previously discussed deficiency concerning "insolvency." Therefore, if preliminary relief on the basis of a fraudulent conveyance is appropriate, under either Delaware or Florida law, it must be based on actual intent to delay, hinder or defraud creditors. It is important to note that these transactions took place at the end of the first quarter of 1975 when the 1974 yearend picture is clear. The conveyances of liquid assets for fixed assets were made under circumstances when the result was necessarily to hinder and delay the 1975 Debenture holders. J. I. Kelly Co. v. Pollack, Fla., 49 So. 934 (1909). As noted before, Credit was financially embarrassed and the transfers were to related transferees. Moreover, the nature of the transactions should be examined.

The 1970 Indenture restricts the business of Credit by providing that Credit will not "engage in any business other than dealing in eligible receivables or activities incidental thereto." In essence, Credit claims that the asset purchases and lease purchases were incidental to dealing in eligible receivables because they permitted Properties to continue sales and development work and thus aided Credit in maintaining its present receivables and in gaining new receivables. Furthermore Credit maintains that the $13,900,000 figure is only a fraction of the total asset figure on the Credit balance sheet.

I cannot agree that the $13,900,000 figure is not material when the transaction involves the transfer of liquid assets by a corporation which will have to meet approximately $39,000,000 of debt and interest less than eight months after the transfer. Nor can I agree that these sales are merely "incidental" to dealings in eligible receivables. They have nothing to do with eligible receivables. They are a wholly separate means of generating cash flow from Credit to Properties and involve Credit in business activities not permitted by the Indenture. The Indenture after all is directly related to the interests of 1975 Debenture holders. Indeed, had the trustee so requested, violation of the Indenture alone might have been an independent basis for relief.

I conclude as a preliminary matter that under either 6 Del.C., § 1307 or Fla. Stat., § 726.01, the transfers of the fixed assets and lease were with the intent to delay, hinder or defraud the 1975 Debenture holders. Given the cross default provisions, the 1977 Debenture holders have a case as well.

As to all the transactions, given Credit's announced intention, without a favorable result of the Exchange Offer, "to seek the Court's protection under the bankruptcy law", it appears that irreparable harm has been established. The debenture holders have the choice of a substituted, less favorable contract or some proceedings in bankruptcy.

In my judgment, the relief sought by BOA in Civil Action No. 4914 is the most appropriate for the present. I therefore intend to enter the order, a copy of which was given to counsel this morning. Before entering the order, counsel will be given a chance to comment upon it at 4:00 p.m. today.

I do not deem it necessary or advisable at this time to enter any order on the Farland complaint in Civil Action No. 4888. The order contemplated in Civil Action No. 4914 is modeled after the proposed order submitted by BOA although not identical with it.

William T. Quillen

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