In re Southern Textile Knitters,
No. 01-2369 (4th Cir. 01/16/2003)
UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT
No. 01-2369, No. 02-1365
January 16, 2003
IN RE: SOUTHERN TEXTILE KNITTERS, DEBTOR.
ANDERSON & ASSOCIATES, PA, APPELLANT, AND ROBERT F. ANDERSON, TRUSTEE,
SOUTHERN TEXTILE KNITTERS DE HONDURAS SEWING INCORPORATED, PARTY IN
INTEREST-APPELLEE, AND SAMUEL H. SIMCHON; LEVY SIMCHON; REBECCA SIMCHON;
ODED SIMCHON; OLD FORT INDUSTRIAL PARK LLC; [Sister]; BAY ISLAND SPORTSWEAR
INCORPORATED, CREDITORS-APPELLEES, AND SOUTHERN TEXTILE KNITTERS OF
GREENWOOD, INCORPORATED, DEBTOR-APPELLEE.
Appeals from the United States District Court for the District of South Carolina, at Anderson.
Margaret B. Seymour, District Judge. (CA-00-3426-8-24, BK-98-7203-W, CA-01-312-8-24)
Argued: Henry Flynn Griffin, III, Anderson & Associates, P.A., Columbia, South Carolina, for
Appellants. Robert L. Widener, Mcnair Law Firm, P.A., Columbia, South Carolina, for Appellees.
ON Brief: Michael M. Beal, Mcnair Law Firm, P.A., Columbia, South Carolina, for Appellees.
Before Wilkinson, Chief Judge, Traxler, Circuit Judge, and Claude M. Hilton, Chief United States
District Judge for the Eastern District of Virginia, sitting by designation.
The opinion of the court was delivered by: Per Curiam
Argued: September 23, 2002
Affirmed in part, reversed in part, and remanded by unpublished per curiam opinion.
Unpublished opinions are not binding precedent in this circuit. See Local Rule 36(c).
Anderson & Associates, P.A. and Robert F. Anderson (collectively "Trustee") filed suit as Trustee
in bankruptcy against Samuel Simchon and multiple related parties (collectively "Defendants") who
had all been connected to Southern Textile Knitters, Inc. ("Debtor") before its bankruptcy.
Trustee argued that Defendants had fraudulently misappropriated large sums of cash and inventory
from Debtor while they were in control of its activities. The bankruptcy court rejected Trustee's
major substantive claims, found in favor of Trustee on certain minor counts, and sanctioned
Trustee's counsel for improperly maintaining certain claims without sufficient foundation. The
district court upheld the bankruptcy court's decision. We affirm in part and reverse in part.
Debtor was incorporated in October 1988. Its principal business was the manufacture and sale of T-
shirts. From the date of incorporation, it was a closely held corporation with the sole ownership
stake split between the company's president, Samuel Simchon, his father Levy Simchon, his mother
Rebecca Simchon, and his brother Oded Simchon; those four also made up the Board of Directors.
Samuel's sister [Sister] was a commission salesperson but did not serve as an officer or
Historically, Debtor was a very successful company. During FY 1995, Debtor had a net income of
$2.3 million on $20.8 million in revenues, with assets exceeding liabilities by $2.8 million. In
the wake of NAFTA, however, Debtor's competitors began to move offshore to take advantage of
cheap labor. By 1996, virtually all of them were offshore, and the resulting shift in industry
cost structure led to a serious downturn in Debtor's financial situation. After an attempt in
late 1995 to subcontract some operations to a Mexican manufacturer failed, Debtor's shareholders
decided, on the advice of American and Honduran counsel, to create a Honduran corporation which
would sew cut parts into finished goods. Southern Textile Knitters de Honduras, Inc. (STKH) was
formed in March 1997, with Samuel owning 99% of the shares and Levy owning the remaining 1%.
Debtor paid all of STKH's operating costs and also shipped sewing equipment and inventory to
STKH, retaining title to both. In return, STKH provided sewing services to Debtor at cost. STKH
was contractually obliged to pay Debtor $3,000 per month for the sewing equipment, but that rent
was never paid. Debtor saved at least $600,000 by using STKH, lowering its net sewing costs by
In October 1997, Debtor transferred its 1/3 equity interest in Excel Dyeing and Finishing, Inc.
("Excel") to Samuel as a bonus. The Excel shares had been purchased for $75,000 and were valued
in September 1997 at $107,000. In addition to the bonus, Samuel also received $141,000 in salary
during Debtor's final year of solvency.
Debtor's financial situation continued to deteriorate, however. By FY 1997, its revenues had
fallen to $13 million and it was operating at essentially no profit. In June 1998, Debtor's
principal lender, SouthTrust Savings, terminated Debtor's line of credit because of continued
deterioration in Debtor's financial condition. Bay Island Sportswear, Inc. (a corporation 100%
owned by Samuel) subsequently purchased SouthTrust's outstanding claim on Debtor's assets, which
Samuel had personally guaranteed. And Samuel began to personally infuse cash into Debtor so that
it could continue to operate. Relying on the advice of counsel, Samuel purchased products from
Debtor and resold them to Debtor's customers when he was able to do so. However, Debtor did not
reduce the inventory listed on its books to reflect these sales, so the inventory remained listed
as an asset on Debtor's books. Samuel then formed Southern Textile Knitters of Greenwood, Inc.
(STKG) with himself as sole shareholder. He transferred all the inventory he purchased from
Debtor to STKG and used STKG as the vehicle to sell the purchased products to Debtor's existing
customers. The inventory that Samuel purchased was identified and physically segregated from
Debtor's remaining inventory, but was not moved from Debtor's warehouses. STKG closed down soon
after it sold all of the products Samuel purchased from Debtor. In total, this maneuver gave
Debtor an $850,000 cash infusion essentially straight from Samuel's pockets.
Despite these maneuvers, Debtor was unable to reverse its financial position. After negotiations
for debt restructuring failed, creditors filed an involuntary petition for relief under Chapter 7
of the Bankruptcy Code. Debtor consented to the relief sought in September 1998. Schedules filed
by Debtor during the bankruptcy proceedings indicate that Debtor was insolvent at that time by
roughly $2 million. Debtor also had $2.4 million less inventory on hand than Trustee's analysis
of the books suggested should be present.
Robert F. Anderson was appointed as Trustee in September 1998 and has served as Trustee since
that time. In January 1999, Trustee filed this lawsuit. After being amended twice, Trustee's
complaint named the following defendants: Samuel, Levy, Rebecca, Oded, [Sister], Renee Simchon
(Samuel's wife), STKG, STKH, Excel, Center Pointe Construction (a corporation 100% owned by
Renee), Old Fort Industrial Park (a corporation 96% owned by Samuel), and Bay Island. Trustee
sought the following relief: (1) turnover of assets pursuant to 11 U.S.C. § 542; (2) avoidance of
preferential transfers under 11 U.S.C. § 547; (3) avoidance of fraudulent transfers under 11
U.S.C. § 548; (4) avoidance of post-petition transfers pursuant to 11 U.S.C. § 549; (5) damages
for breach of fiduciary duty; (6) piercing the corporate veil; (7) damages for aiding and
abetting; ( damages for conversion; (9) avoidance of fraudulent transfers under S.C. Code § 27-23-
10; (10) damages for civil conspiracy; (11) subordination of claims; (12) accounting of assets;
(13) payment of rent due by STKH; and (14) payment of money owed by [Sister].
The charges against [Sister] were tried separately, and the bankruptcy court granted judgment in
favor of [Sister] in March 2000. In January, March, and April 2000, the bankruptcy court
dismissed all causes of action against Levy, Rebecca, Oded, Renee, Center Pointe, Old Fort, and
Bay Island. On July 19, the bankruptcy court dismissed all remaining causes of action which
required Debtor to have been insolvent before July 31, 1998. On July 29, the bankruptcy court
granted judgment under Rule 52 in favor of the remaining defendants -- Samuel, STKH, and STKG --
on all remaining charges except three. It found in favor of Trustee on the claims for turnover of
the equipment used by STKH, conversion of the equipment used by STKH, and rent due for the
equipment used by STKH. It therefore required Defendants to return the sewing equipment from STKH
and pay the accrued rent. The district court affirmed the bankruptcy court on all counts, holding
that the bankruptcy court's application of the wrong legal standard on some of the claims was
On August 18, the bankruptcy court fined Trustee's counsel $1,000 for failing to withdraw
Trustee's claim against Old Fort. On November 21, the bankruptcy court fined Trustee's counsel
$750 for pursuing claims that required insolvency before July 31, 1998 as a necessary element.
The district court upheld these sanctions in two separate rulings.
The district court's decision is reviewed de novo. In re Weiss, 111 F.3d 1159, 1166 (4th Cir.
1997). We review the bankruptcy court's findings of fact for clear error and its conclusions of
law de novo. Id.
Trustee brings claims against Samuel, Levy, Rebecca, Oded, Renee, STKG, and STKH under several
causes of action involving fraud or unfairness, including breach of fiduciary duty, aiding and
abetting a breach of fiduciary duty, and fraudulent transfer under S.C. Code § 27-23-10 and 11
U.S.C. § 548(a)(1)(A). As discussed by the bankruptcy court, all of these claims involve at their
core the allegation that Defendants' behavior in this case was improper. See In re Southern
Textile Knitters, Inc., 2000 WL 33709685 (Bankr. D.S.C. July 27, 2000). Thus, if the bankruptcy
court was correct that none of Defendants defrauded Debtor or dealt with it in even an arguably
improper fashion, none of these claims can stand. We therefore review that finding.
Trustee's contentions of fraud and unfair dealing center on his characterization of a series of
transactions between Debtor, Samuel, STKG, and STKH as fraudulent or bad-faith transfers from
Debtor to insiders. Trustee points specifically to the transfer of inventory and operating funds
to STKH, the sale to Samuel and STKG of inventory from Debtor's warehouses, and the payment of a
salary and stock bonus to Samuel.
Trustee contends that these transfers must be avoided as fraudulent. See 11 U.S.C. § 548(a)(1)(A)
(2002) (transfers completed within one year of the bankruptcy petition may be avoided if
made "with actual intent to hinder, delay, or defraud any entity to which the debtor was . . .
indebted"); S.C. Code § 27-23-10(A) (2002) ("Every . . . transfer . . . [made] for any intent or
purpose to delay, hinder, or defraud creditors . . . must be deemed . . . to be clearly and
utterly void"). He also argues that they constituted a breach of fiduciary duty. See S.C. Code §
33-8-300(a) ("A director shall discharge his duties . . . in good faith . . . [and] in a manner
he reasonably believes to be in the best interests of the corporation and its shareholders.").
And he contends that the fraudulent nature of these transfers justifies piercing the corporate
veil so that creditors can pursue their claims directly against the individual Defendants. See
Parker Peanut Co. v. Felder, 20 S.E.2d 716, 720 (S.C. 1942) ("Where . . . the corporate fiction
is urged for fraudulent or perverted purposes, the courts may properly disregard it and look to
the responsible human beings . . . who compose the corporation and are hidden behind the juristic
screen.") (citations omitted).
The bankruptcy court, however, held that the key decisions challenged by Trustee were made by
Defendants as part of a bona fide effort to save Debtor in the face of rapidly changing market
conditions. The bankruptcy court's finding was based on a careful, extensive, credibility-based
review of testimony and evidence presented by the parties. We see no clear error in this finding
and therefore affirm the trial court's rejection of the fraudulent transfer and breach of
fiduciary duty charges, as well as its refusal to pierce the corporate veil.
The court found that Debtor temporarily transferred inventory to STKH for assembly into salable
finished goods and sent equipment and cash to STKH to cover the local costs of that assembly.
This was simple and straightforward production outsourcing; as the bankruptcy court noted, "[t]he
transfer of inventory and operating funds to STKH appear[s] to be a result of Debtor's attempt to
move its sewing operation off-shore to reduce its costs" and stay competitive with other Tshirt
manufacturers. In re Southern Textile Knitters, 2000 WL 33709685, at *20. Indeed, STKH lost
$180,000 on $635,000 in revenues during 1998, and its liabilities were greater than its assets at
the end of that year. It was not clearly erroneous for the bankruptcy court to hold that these
transactions were proper.
Similarly, the bankruptcy court did not commit clear error in holding that the sale of inventory
to Samuel and STKG was a stopgap effort to generate cash to keep the company afloat. The
bankruptcy court specifically held that "the transfer of inventory to [Samuel] and STKG [was] an
attempt [to] pay down SouthTrust's loan . . . and to aid Debtor during its financial downturn,"
and further that "STKG ultimately purchased the inventory and sold it to third parties at no
profit." (emphasis added). In re Southern Textile Knitters, 2000 WL 33709685, at *20. And like
STKH, STKG also "lost considerable amounts of money during its short existence." Id. at *11.
These findings were sufficient to justify the bankruptcy court's conclusion that the inventory
sales were not improper.
Finally, the court did not clearly err in its conclusion that Samuel's yearly salary and bonus --
less than $250,000 for the head of a $13 million company which had historically been very
profitable -- represented good faith "compensation and bonus for his services." Id. at *20.
Trustee claims that, even failing a finding of fraudulent behavior with respect to any of the
specific challenged transactions, there is nonetheless a smoking gun proving that major
impropriety took place: $2.4 million in inventory vanished from Debtor's books without
explanation. That this inventory was misappropriated is apparent, he claims, from the application
of simple arithmetic. On July 31, 1998, there was $3.7 million of inventory listed on the books.
But after Trustee was appointed in September 1998, he found only $1.3 million of inventory on
hand when he liquidated the stock. Thus, Trustee argues, Defendants misappropriated roughly $2.4
million in inventory that simply vanished from the books without a trace.
The bankruptcy court's careful analysis of the facts, however, demonstrates that Defendants
sufficiently explained the $2.4 million discrepancy. See In re Southern Textile Knitters, 2000 WL
33709685, at *12-15. The bankruptcy court noted that $200,000 of the alleged gap was attributable
to the fact that Defendants' accounting method valued some categories of inventory differently
than did the accounting method used by Trustee in September. Trustee's misidentification of some
of the inventory as yarn or griege goods rather than as individual piece goods which have a
higher value accounted for $205,000 of the discrepancy. A further $1,790,000 of the inventory gap
was due to the fact that the inventory actually sold to Samuel had erroneously been left on the
books even after Debtor actually received payment for that inventory. Between $100,000 and
$200,000 more of the gap was accounted for by a collection of damaged inventory left in the
warehouse but not included in the September accounting. And any remaining discrepancy was
accounted for by the fact that some 20,000 pounds of yarn had not yet been liquidated when the
September accounting took place, and also by the fact that Debtor made some sales of inventory
after the July 31 accounting.
Defendants have thus adequately accounted for the discrepancy between their figures and Trustee's
figures. There is no inventory gap, and no smoking gun.
Trustee further claims that the bankruptcy court used the wrong burden of proof in resolving the
claims of breach of fiduciary duty and fraudulent transfer. Trustee argues that the findings
discussed above should therefore not be insulated by the "clearly erroneous" standard of review.
See In re K & L Lakeland, Inc., 128 F.3d 203, 206 (4th Cir. 1997); Pizzeria Uno Corp. v. Temple,
747 F.2d 1522, 152627 (4th Cir. 1984).
Ordinarily, the plaintiff bears the burden of proof with claims such as those brought by Trustee.
Under S.C. Code § 33-8-310, however, the burden of proving the fairness of a conflict of interest
transaction (one in which a director of the corporation has a direct or indirect interest) lies
on the party seeking to defend the transaction. The burden of proof can be shifted back to the
party challenging the transaction in one of two circumstances: if the transaction was ratified by
a majority of the disinterested directors, or if it was ratified by a majority of the
disinterested shareholders. S.C. Code § 33-8-310 (2002). Since Debtor's directors ratified the
transfers challenged here, the bankruptcy court held that the burden was shifted back to Trustee
to prove that the transfers were fundamentally unfair.
This ruling was incorrect. By the terms of S.C. Code § 33-8-310, the transfers challenged in this
case were not approved by a disinterested board because the members of that board were Samuel's
immediate family. See id. at comment 5 (stating that a director should be viewed as interested if
he or his family members have a financial interest in the transaction). Under South Carolina law,
the burden should therefore have remained on Defendants. This means, Trustee asserts, that the
bankruptcy court's findings of fact are not insulated from review by the clearly erroneous
standard, since the court did not actually find by a preponderance of the evidence that
Defendants' actions were fundamentally fair.
With respect to the transfers to STKG, the transfers to STKH, and Samuel's compensation, however,
the bankruptcy court did in fact put the burden on Defendants to prove the underlying fairness of
the transactions. It is true that, in its analysis of the breach of fiduciary duty claim, the
court erroneously placed the burden on Trustee. However, in its separate analysis of the
fraudulent transfer claims, the bankruptcy court clearly put the burden on Defendants. It
specifically noted that the "burden of proof rests with Defendants to meet the requirements" of
proving the bona fides of these transactions. In re Southern Textile Knitters, 2000 WL 33709685,
at *19. And the fraudulent transfer claims hinged on precisely the same underlying factual events
as the fiduciary duty claims: the STKG transfers, the STKH transfers, and Samuel's compensation.
On each of these counts, placing the burden on Defendants to prove their case, the bankruptcy
court found that their behavior was fair and in good faith. Id. at *2022 (holding that
conveyances "were [not] intended to defraud creditors"). Thus, the court did make the factual
findings critical to its fiduciary duty analysis under the correct burden of proof -- even if
only in another section of its opinion.
We are also satisfied that a different burden of proof would not have affected the lower court's
rejection of Trustee's allegation that $2.3 million dollars of inventory is unaccounted for.
To begin with, it is certain that the court would have found that $1.8 million of that alleged
gap was appropriately accounted for under either burden of proof. In its separate Findings of
Fact, applicable to every section of its opinion, the court found that "the sales of inventory
from Debtor to [Samuel] were not reflected in Debtor's books and records by a respective
reduction in inventory" even though Debtor received full payment from Samuel for those transfers.
Id. at *8. Its subsequent discussion of the alleged $2.3 million gap explicitly relied on that
earlier and separate finding: since the inventory sold to Samuel "had not been removed from the
inventory numbers carried on Debtor's books and records," the July 31 figures on which Trustee
relies are overstated by the amount at which that inventory was valued -- roughly $1.8 million
dollars. *fn1 Id. at *12.
With respect to the remaining $500,000 in allegedly missing inventory, it is apparent from both
the logic of Defendants' explanation and from the overall context of the bankruptcy court's
rulings that the bankruptcy court would have given equal credence to Defendants' careful and
logical explanation of the facts under any burden of proof. In more than five lengthy rulings on
charges relating to Defendants' behavior during Debtor's final year of existence, the bankruptcy
court judge rejected every single specific allegation of fraud or unfair dealing. It did so both
when the burden was on Defendants and when the burden was on Trustee. It did so with heavy
reliance on judgments about witness credibility and demeanor, an aspect of fact finding which
appellate courts are particularly ill equipped to second-guess. If the bankruptcy court had
harbored questions about the alleged $2.3 million gap, it is difficult to imagine that it would
have found Defendants credible in their arguments on every single other count, as it obviously
did. Ultimately, it is clear to this court that the bankruptcy judge believed Defendants to have
been motivated by a sincere desire to save their family business from ruin; this sense pervades
the Findings of Fact as well as the court's specific Findings of Law.
Trustee further brings a claim of constructive fraud under both S.C. Code § 27-23-10(A) and 11
U.S.C. § 548(a)(1)(B), challenging the transfer of inventory and operating funds to STKH, the
transfer of inventory and business to STKG, and the transfer of a salary and bonus to Samuel. We
address each statutory ground in turn.
Under § 27-23-10, more commonly known as the Statute of Elizabeth, an action lies for
constructive fraudulent transfer if (1) debtor makes a transfer but does not receive "valuable
consideration" in return; (2) debtor was indebted to the plaintiff at the time of transfer; and
(3) debtor does not have sufficient property to pay his debt to plaintiff in full. Future Group,
II v. Nationsbank, 478 S.E.2d 45, 4849 (S.C. 1996). If all three conditions are met, the transfer
will be set aside as a fraudulent conveyance. Id. Since the transfers at issue here were made to
members of the family, Defendants have the burden to establish "both a valuable consideration and
the bona fides of the transaction by clear and convincing testimony." Windsor Props., Inc. v.
Dolphin Head Constr. Co., 498 S.E.2d 858, 860 (S.C. 1998) (citations omitted).
Noting that the "burden of proof rests with Defendants" to meet these requirements, the
bankruptcy court held that Defendants had established by clear and convincing evidence that each
transfer was reciprocated with valuable consideration. In re Southern Textile Knitters, 2000 WL
33709685, at *19 (citing Windsor Props., 498 S.E.2d at 861). That conclusion was sufficiently
supported by the evidence. As discussed above, Debtor received $850,000 in desperately-needed
emergency capital in exchange for the inventory it sold to Samuel. The fact that Samuel then sold
this inventory at no profit to Debtor's existing customers is sufficient to support the
conclusion that the price he paid was the market price. Similarly, the shipments of money and
inventory to STKH were compensated by STKH's sewing those goods into finished parts. Indeed, the
STKH outsourcing saved Debtor roughly half of what its costs would have been in the United
States -- a profitable exchange for Debtor by any measure. Id. at *9. And the district court's
conclusion that Samuel's services as President of Debtor were consideration for his salary and
stock bonus was also reasonable in light of Samuel's position with the company, Debtor's size,
and Debtor's historic success.
Thus, since these transfers were supported by valuable consideration, they may not be set aside
under the Statute of Elizabeth.
Under 11 U.S.C. § 548(a)(1)(B), a transfer by Debtor of any interest in property may be avoided
if two elements are satisfied. First, Debtor must have "received less than a reasonably
equivalent value in exchange for such transfer." 11 U.S.C. § 548(a)(1)(B) (2002). Second, the
transfer must either have been made while Debtor was insolvent, or have itself rendered Debtor
insolvent. Id. The district court rejected Trustee's claims under this statute because it held
that Debtor had been solvent through July 31, 1998.
Because this finding was not clearly erroneous, we affirm. The evidence presented by George
DuRant, Trustee's expert witness, tended to establish that Debtor was solvent as of July 31,
1998. He cited Debtor's internal financial statements from June 30, 1998 which showed Debtor to
be solvent at that time, and he did not suggest that anything happened during July to change that
status. This was sufficient evidence to support the bankruptcy court's finding.
Trustee also seeks to avoid the transfers of inventory and business to Samuel and STKG as
preferential transfers under 11 U.S.C. § 547(b). That statute is intended to promote the "prime
bankruptcy policy of equality of distribution among creditors" and to "discourage[ ] creditors
from attempting to outmaneuver each other in an effort to carve up a financially unstable
debtor." In re Barefoot, 952 F.2d 795, 797-98 (4th Cir. 1991) (citations omitted). It allows a
trustee in bankruptcy to avoid any transfer:
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(A) on or within 90 days before the date of the filing of the petition; or
(B) between ninety days and one year before the date of the filing of the petition, if such
creditor at the time of such transfer was an insider; and
(5) that enables such creditor to receive more than such creditor would receive if-
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the provisions of this
title. 11 U.S.C. § 547(b) (2002).
The district court rejected this claim based on its finding that Debtor had been solvent until at
least July 31, 1998. We affirm on different grounds.
Section 547(c)(1) provides an exception to this general rule of preferential transfers. Courts
may not use § 547 to avoid any transfer which was intended to be part of a "contemporaneous
exchange for new value given to the debtor" and which actually was "in fact a substantially
contemporaneous exchange." 11 U.S.C. § 547(c)(1) (2002). "New value" is defined as any "money or
money's worth in goods, services, or new credit." 11 U.S.C. § 547(a)(2) (2002). This rule makes
sense for two reasons: it encourages business partners to continue doing business with troubled
debtors (potentially enabling them to avoid bankruptcy altogether), and it does not adversely
affect other creditors because Debtor's estate receives new value in exchange for the money or
property it gives up. In re Jones Truck Lines, 130 F.3d 323, 326 (8th Cir. 1997).
This exception applies to the inventory transfers from Debtor to Samuel. The bankruptcy court
explicitly found that Samuel "purchase[d] products from Debtor for cash in an effort to alleviate
Debtor's cash flow problem." In re Southern Textile Knitters, 2000 WL 33709685, at *6. It held
that Samuel and Debtor, on the advice of corporate counsel, intended the cash purchases to be
payments for an immediate property exchange rather than temporary loans. Id. at *68. This finding
was based on the trial court's assessment of witness credibility, and it was not clearly
erroneous. The transfers of inventory to STKG and Samuel therefore may not be avoided under 11
U.S.C. § 547(b).
Trustee further challenges the bankruptcy court's ruling that payments made to [Sister] did not
violate the Statute of Elizabeth's prohibition on transfers made "for any intent or purpose to
delay, hinder, or defraud creditors." S.C. Code § 27-23-10(A) (2002). *fn2 He argues that the
bankruptcy court should have required [Sister] to prove by clear and convincing evidence that she
gave valuable consideration in exchange for her salary. We agree, and therefore remand this issue
to the bankruptcy court for a determination of that issue under the proper burden of proof.
When considering transfers to a family member under the Statute of Elizabeth, "the burden of
proof shifts to the transferee to prove both that valuable consideration was exchanged between
the parties and the bonafides of the transaction." In re Haddock, 246 B.R. 810, 816 (Bankr.
D.S.C. 2000). Furthermore, "[e]ach must be established by clear and convincing evidence, not mere
preponderance of the evidence." Id.; see also Windsor Props., 498 S.E.2d at 860. In this case,
the bankruptcy court stood this cause of action on its head and placed the burden of proof on
Trustee to prove his case rather than on [Sister] to disprove it by clear and convincing
evidence. This was reversible error.
Defendants respond that the court would have reached the same result under the correct burden of
proof. We decline to make that assumption, particularly because of the very large gap between the
burden of proof that should have been applied and the burden of proof that was actually applied.
Our hesitation to do so is reinforced by the existence of evidence which, depending on the
bankruptcy court's credibility assessment, could have supported a verdict for Trustee on this
In particular, [Sister]'s pre-trial deposition could give rise to the inference that she did not
do any real work for Debtor during the years that she was receiving a paycheck. For example, the
following exchange took place during her deposition:
Q: [D]uring 1997, I guess, was the last full year that
Southern Textile Knitters was in the business; how many presentations would you say you made?
A: I don't recall.
A: I don't recall.
Q: Was it less than 10?
A: I don't recall.
Q: Could it be less than 10?
A: I don't recall.
Q: And do you recall how many telephone contacts you made during 1997?
A: I do not recall.
A: I have no idea.
Q: Was it less than a hundred?
A: I do not recall.
Q: All right, who was your supervisor during 1997?
A: I believe it was Al Bollinger, but I'm not a hundred percent sure."
Q: All right, and during 1997, how many times did you talk to Mr. Bollinger, if at all?
A: I do not recall.
Q: Well, would you generally talk to him once a month, or once a week or every day; how -- how
frequently would you talk to him?
A: I don't recall.
Q: Do you know any of the other salesmen that worked at Southern Textile Knitters during 1997?
A: I think Jean Price, but she's the only one that I recall.
Q: All right, during 1997, how many sales meeting [sic] would you say you attended?
A: I don't recall.
Q: In 1997, how many clients did you have, how many customers?
A: I don't recall.
A: I don't recall.
Q: Would you say it's more than 10 or less than 10?
A: I don't recall.
Q: Who was your best customer during 1997?
A: I don't recall.
Q: Do you know the names of any of your customers during 1997?
A: I don't recall.
Similar concerns apply to the bankruptcy court's assessment of other evidence and testimony at
[Sister]'s trial. At the time her employment was terminated, it appears that [Sister] had
received advances on future commissions larger than any other sales representative -- arguably a
year and a half of as-yet unearned pay. Testimony from that trial could support the conclusion
that [Sister] was one of only two sales representatives who even received any advances on future
commissions. She apparently kept no paper records of her daily activities as sales representative
for Debtor. And her highly specific testimony on direct examination at trial about her
responsibilities, customer connections, and activities as sales representative could be seen as
inconsistent with her earlier inability to remember even the most basic details about her job.
On remand, the bankruptcy court may well still decide in favor of [Sister]. This issue, after
all, turns on questions of credibility, intent, and other subjective factors which the trial
court is in a far better position to assess than we are. But the gap between requiring clear and
convincing evidence from [Sister] that she acted properly and requiring Trustee to prove that she
acted improperly is too large for us to ignore.
Trustee further contends that the bankruptcy court was wrong to dismiss on summary judgment the
contention that Bay Island's claim on Debtor's assets should be equitably subordinated. We
decline to reverse the bankruptcy court on this ground.
A creditor's claim can generally be subordinated under 11 U.S.C. § 510(c) if three circumstances
are satisfied: (1) the claimant engaged in inequitable conduct; (2) that conduct injured other
creditors; and (3) subordination is consistent with other bankruptcy law. In re ASI Reactivation,
Inc., 934 F.2d 1315, 1320 (4th Cir. 1991); see also U.S. v. Noland, 517 U.S. 535, 538-39 (1996)
(holding that § 510(c) was intended to incorporate existing doctrine of equitable subordination
as exemplified by In re Mobile Steel Co., 563 F.2d 692 (5th Cir. 1977)).
Trustee suggests three grounds on which Bay Island's claim should be equitably subordinated. We
reject each of them. First, he argues that Bay Island initially submitted an excessive claim on
Debtor's estate before revising it downwards to an acceptable figure. But the bankruptcy court
held that the reduction of Bay Island's claim did not demonstrate prior inequitable behavior,
since Bay Island had openly explained that the higher figure included certain funds in which STKG
had a claim. In re Southern Textile Knitters, Inc., No. 9807203-W, slip op. at 3 (Bankr. D.S.C.
Jan. 5, 1999). Second, Trustee argues that because Samuel had personally guaranteed the
SouthTrust claim, giving equal priority to Bay Island's claim would grant Samuel a windfall. In
support of this argument, Trustee cites In re Psychiatric Hosp. of Hernendo, Inc., 207 B.R. 276
(Bankr. M.D. Fla. 1997). The insider's claim was partially subordinated in that case, however,
because he had purchased a creditor's claim for 25% of its value and sought to collect on the
entire claim -- not because he had also purchased the creditor's separate claim on his own
assets. Id. at 281-82. South Bay, by contrast, seeks only to recover what it actually paid.
Third, Trustee argues that Samuel's conversion of sewing equipment to STKH qualifies as
inequitable conduct sufficient to justify subordination. However, the bankruptcy court did not
view Samuel's conduct as sufficient to support a finding of inherent unfairness under fiduciary
duty analysis. We are not inclined to disturb its judgment.
In the final analysis, there simply is no injury to Debtor's other creditors here. Bay Island
merely stands in the shoes of SouthTrust: it can receive only what SouthTrust could have
received. We decline to reverse the bankruptcy court's refusal to equitably subordinate Bay
Trustee argues that Samuel should be personally responsible for the unpaid rent on the sewing
equipment that was temporarily transferred from Debtor to STKH. Trustee, however, does not
contend that Samuel was a party to the rental contract between STKH and Debtor; indeed, the trial
court's order makes it clear that "the rent [is] owed by STKH." In re Southern Textile Knitters,
2000 WL 33709685, at *17 (emphasis added). And for the reasons discussed in Part III, we decline
to pierce the corporate veil with respect to any of the companies involved in this case. We
therefore hold that Samuel may not be held personally liable for the unpaid rent.
The bankruptcy court also sanctioned Trustee's counsel for two separate aspects of his conduct
during the litigation. Trustee appeals those rulings. We review each ruling in turn.
A bankruptcy court's order of sanctions may be overruled if it is an abuse of discretion. It is
an abuse of discretion for a trial court to "base[ ] its ruling on an erroneous view of the law
or on a clearly erroneous assessment of the evidence." Cooter & Gell v. Hartmax Corp., 496 U.S.
384, 405 (1990).
The bankruptcy court sanctioned Anderson & Associates for its failure to withdraw Trustee's
claims against Old Fort under 11 U.S.C. § 547, 11 U.S.C. § 548, and S.C. Code § 27-23-10. The
sanctions were based on the court's holding that Rule 9011 of the Federal Rules of Bankruptcy
Procedure requires affirmative, formal withdrawal of any claims which, though proper when made,
later turn out to have no evidentiary basis.
Rule 9011(b)(3) requires all "representations to the court" either to "have evidentiary support"
or to be "likely to have evidentiary support after a reasonable opportunity for further
investigation." Fed. R. Bankr. P. 9011(b)(3). The bankruptcy court noted that Trustee's claims
against Old Fort were "not initially frivolous" and that Trustee "refrain[ed] from making any
arguments or presenting any evidence" about those claims at any point during the trial. In re
Southern Textile Knitters, Inc., 2000 WL 33709686, at *8 (Bankr. D.S.C., Aug 18, 2000). Indeed,
apparently the only representation made by Trustee after he discovered that his fraudulent
transfer claims against Old Fort had no basis was the following: "We're not aware of any
transfers to Old Fort . . . . The only [claim] that's left [to be litigated], as far as I know,
as far as Old Fort, is the accounting." And the only claim against Old Fort listed in Trustee's
Pre-Trial Order was a request for an accounting. Trustee's Jan. 12, 2000 Pre-Trial Order at 6-13,
In re Southern Textile Knitters, Inc., No. 98-07203-W (Bankr. D.S.C. 2000).
Thus, the claims were neither improper when filed nor affirmatively reiterated once their lack of
evidentiary support became clear. Rather, the sanctions were levied because Defendants "fail[ed]
to withdraw the allegations despite a knowledge of a lack of evidentiary support." In re Southern
Textile Knitters, 2000 WL 33709686, at *10. Imposition of sanctions therefore hinges on the
theory that Rule 9011 requires litigants to formally withdraw claims which were proper when made,
but turn out during the course of litigation to have an insufficient evidentiary basis. The plain
text of the rule forecloses this theory. *fn3 "Presenting to the court" is carefully defined in
the rule; it includes "signing, filing, submitting, or later advocating" a meritless position.
Fed. R. Bankr. P. 9011(b). It does not include failing to formally withdraw a meritless position.
The trial court also sanctioned Trustee's counsel for its pursuit of claims against Samuel for
preferential transfer under § 547 and fraudulent transfer under § 548(a)(1)(B). Specifically, it
sanctioned Trustee's decision to pursue those claims despite the fact that a necessary element of
each is Debtor's insolvency at the time of the challenged transfers. The trial court based this
ruling on two findings: first, that Trustee's counsel knew and conceded that Debtor had been
solvent at least through July 31, 1998; second, that the challenged transfers all took place
before that date.
The bankruptcy court stated that George DuRant, Trustee's expert witness, unequivocally and
directly testified that he believed Debtor had been solvent up to at least July 31, 1998. If this
were accurate, it might provide sufficient basis for the court's discretionary decision to
sanction Trustee's counsel. However, it is not. DuRant explicitly stated that he did not prepare
a report on insolvency. His exchange with Defendants' counsel on cross-examination is instructive
in this regard:
Q: And in this case it was your intent to prepare a report to the trustee that dealt with
solvency, wasn't it?
A: I was asked to.
Q: And you looked at the solvency issue, didn't you?
A: There you go, he asked me to, but I didn't do that.
Q: You didn't look at it?
A: No, I didn't prepare a report on insolvency.
Q: Okay. You are an expert on insolvency but you are not going to tell the Court whether or not
this company was solvent at any time, is that correct?
A: That's correct.
DuRant's testimony is straightforward: whatever his subsequent discussion of assumptions
surrounding his calculations of misappropriated inventory, he took no position on the specific
date that Debtor became insolvent. The bankruptcy court was clearly erroneous to hold otherwise.
The bankruptcy court also stated that "the parties [both] reported that there was no dispute as
to the fact that the transfer of the salary and Excel stock to [Samuel] took place while Debtor
was still solvent." In re Southern Textile Knitters, Inc., No. 98-07203-W (Bankr. D.S.C. Nov. 21,
2000), slip op. at 20. This was also error. Defense counsel did represent to the court
that "there is no dispute that [these two transfers] occurred before July 31st." And Trustee's
counsel did state at the same hearing that "all the salary payments were made prior to July
31st, . . . as was [the transfer of] Excel stock." But the parties' agreement that the transfers
occurred before July 31st is in no sense equivalent to a concession by Trustee that Debtor had
been solvent up until that date. Trustee agreed that bankruptcy court was correct about the date
of the transfer, but did not concede that Debtor had been solvent on that date. *fn4 The
bankruptcy court erred in holding otherwise.
Since the sole basis for these sanctions was the erroneous conclusion that Trustee's counsel knew
(or should have known) and conceded that Debtor was insolvent prior to July 31, 1998, we reverse
the bankruptcy court's order and dismiss Defendants' motion for sanctions with prejudice.
In sum, we reverse the district court's order dismissing the claims of fraudulent transfer under
S.C. Code § 27-23-10(A) against [Sister]. We also reverse the imposition of sanctions against
Anderson & Associates. We affirm the district court's dismissal of all other claims.
The judgment of the district court is affirmed in part, reversed in part, and remanded for
further proceedings consistent with this opinion.
AFFIRMED IN PART, REVERSED IN PART, AND REMANDED
*fn1 Trustee argues that Samuel's payment of $850,000 for this inventory demonstrates fraud in
itself. However, the bankruptcy court noted that the discrepancy between the two values was due
to the average cost basis of Debtor's accounting on its books. In re Southern Textile Knitters,
2000 WL 33709685, at *12 n.11. More important, the bankruptcy court also found (in a section of
its opinion where it had clearly placed the burden on Defendants) that Samuel resold the
inventory to Debtor's existing customers "at no profit." Id. at *20 (emphasis added). This was
sufficient evidence for the court's conclusion that Samuel's purchase of the inventory was not
made in bad faith. Id.
*fn2 Trustee does not challenge the bankruptcy court's ruling that, in the absence of fraud,
South Carolina law does not require employees to repay unearned commissions unless they have
specifically agreed to do so. See McConnell v. Banker, 169 S.E. 842, 843 (S.C. 1933).
*fn3 Nor do the cases decided under revised Rule 9011 that were cited by the bankruptcy court
support this theory. Both involved litigants who affirmatively argued positions which they knew
or should have known to be meritless at the moment they argued them. See Turner v. Sungard Bus.
Sys., 91 F.3d 1418, 1420, 1422 (11th Cir. 1996) (lawyer explicitly "told the court that he had
evidence to support" plaintiff's only claim even though he "knew from the moment he began
representing Plaintiff that his claim was meritless"); Young v. Corbin, 889 F. Supp. 582, 586
(N.D.N.Y. 1995) (plaintiff "defaulted on his obligation under Rule 11 by submitting to the court
a frivolous lawsuit").
*fn4 It is notable in this regard that Defendants do not even contest this point on appeal.