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Jerome Fried and Nazareth Fairgrounds & Farmers Market Inc. v. Margolis

November 9, 1961

JEROME FRIED AND NAZARETH FAIRGROUNDS & FARMERS MARKET, INC., APPELLANTS,
v.
BENJAMIN MARGOLIS, IDA MAE MARGOLIS, SARAH KASON, BERNARD L. UNGAR AND WILLIAM MCK. SHONGUT, APPELLEES. ARNOLD A. WEINSTEIN, JEROME FRIED AND IRVING J. WOLF, ET AL., APPELLANTS, V. NAZARETH FAIRGROUNDS & FARMERS MARKET, INC., ET AL., APPELLEES.



Author: Moore

Before MOORE, FRIENDLY and SMITH, Circuit Judges.

MOORE, Circuit Judge.

The two cases (Nos. 26962 and 27000) consolidated on this appeal both involve the resolution of stock claims in Nazareth Fairgrounds & Farmers Market, Inc. (the Debtor), a corporation being reorganized under Chapter X of the Bankruptcy Act, 11 U.S.C.A. § 501 et seq. No. 26962 involves five stock claimants (54 shares) and is an appeal from an order of the District Court which reopened the proceedings on a petition to review a decision of the Referee denying the stock claims of the five claimants therein. No. 27000 is an appeal from an order of the District Court settling and allowing the stock claims of the thirty-six claimants (262 shares) therein.

The Debtor was organized on August 7, 1951, as part of a plan to transfer the ownership of a farmers' market in Nazareth, Pennsylvania, a parcel of some 32 acres and buildings, from a group consisting of Edward Malakoff, Maurice Malakoff, Milton Zoloth and Morris Soble (the Philadelphia Group) to John Malakoff (Malakoff). Prior thereto on April 17, 1951, the Philadelphia Group through a controlled corporation, Richard Realty Co., purchased this property from its then owner, Nazareth Fairgrounds, Inc., for $66,000. John Malakoff had one-quarter interest in the original purchase of the property by the Philadelphia Group. On May 14, 1951, for corporate and tax reasons Richard Realty Co. conveyed the property subject to mortgages to Kipling Realty Co. (also a Philadelphia Group controlled corporation) for $100.

In July, 1951, John Malakoff orally agreed (so found by Examiner and trial court) to purchase the Philadelphia Group's interest in the property for $66,000 plus an undetermined amount, alleged to have been $30,000. The Articles of Incorporation of the Debtor which were executed on August 1, 1951, provided for an authorized capital of 200 shares with a stated capital applicable thereto of $120,000. The first meeting of the directors of the Debtor authorized the purchase of the Nazareth property from Zoloth and Soble for twenty shares of the corporation's stock and the assumption of all obligations by the corporation, including amounts shown as loans payable to the Philadelphia Group. About August 8, 1951, stock certificate #1 for 10 shares was issued to Milton Zoloth and certificate #2 for 10 shares was issued to Morris Soble. On October 17, 1951, a contract was executed between John Malakoff and Zoloth and Soble whereby Malakoff purchased their 20 shares of stock for $32,853.08; $2,853.08 was paid on execution of the contract and the remaining $30,000 was to be paid in 10 monthly installments of $3,000. Title to the stock was to pass on the execution of the contract but the stock was to be held in escrow until the payment of the $30,000. On October 17, 1951, Zoloth, endorsed stock certificate #1 over to Malakoff and on October 22, 1951, Soble endorsed certificate #2 to Malakoff. On June 17, 1953, Malakoff endorsed these certificates over to the Debtor, and executed a release of all claims against the Debtor.

The certificates and corporate books were not turned over to Malakoff until December, 1952, although he had been managing the business since October, 1951.

In April, 1951, Malakoff started to solicit investments in the Nazareth enterprise, promising investors a 20% return on their capital. Generally, shares were offered at a rate of $1,000 a share, although some investors paid only $600 a share.

Between April 1, 1951, and February 15, 1952, Malakoff received from investors in the Nazareth venture $79,025 and paid to the Philadelphia Group $77,010.84; the latter figure includes $11,032.84 received in payment of an insurance claim for windstorm damage. However, at no time did the amount that John Malakoff paid to the Philadelphia Group exceed the amount which he had already collected from investors. Until he became insolvent in June, 1953, Malakoff paid monthly "dividends" to the investors based on a 20% annual return on their original investments. These "dividends" were paid in Ponzi-like*fn1 manner out of new money received from investors in the Nazareth Market. The corporation did not have a profit from which dividends could have been paid during this period. Shares of stock were issued to the claimants herein on and after February 2, 1953, and none can be said to have been issued in a regular manner, that is, upon receipt of consideration passing directly to the Debtor. Moreover, the consideration for which the stock in Nazareth was issued was not the same in all cases: some investors gave Malakoff cash or checks; others received their interest in Nazareth by releasing funds which Malakoff held for them as proceeds from other ventures; others accepted Nazareth stock from Malakoff in exchange for stock in other Malakoff ventures that had proved worthless; and some of the claimants received interests in Nazareth in satisfaction of Malakoff's personal debts to them. In substantially all cases the certificates were not issued to the stock claimants at or about the time they allegedly gave consideration to Malakoff as an investment in Nazareth. Altogether 316 shares were issued, 116 more than were authorized, to the 41 claimants herein. On September 28, 1953, the Debtor filed a voluntary petition for reorganization under Chapter X of the Bankruptcy Act. To achieve a reorganization of the Debtor which, insofar as stock issuance and ownership are concerned, never had been properly organized, the trial court had to determine as a basic issue: who, if any, were entitled to participate in the stock of the reorganized Debtor. The Court referred the task of making this investigation to an Examiner (Bankruptcy Act of 1898, §§ 167, 168; 11 U.S.C.A. §§ 567, 568). Testimony (some 10,000 pages) was taken concerning the circumstances under which the stock claimants had purportedly invested in the Nazareth Market or claimed to be entitled to participate as stockholders of the Debtor. In a detailed and painstaking report (236 pages), the Examiner carefully sifted the issues fundamental to the resolution of stock participation.

In summary, he found that every claimant had acquired his or her stock by means of transactions with Malakoff or his agents; that none of the consideration therefor passed directly to the Debtor; that Malakoff and the claimants "ascribed little or no importance to the legal form which the venture took, or to the observance of the legal and other formalities and requisites of its corporate form"; that not one of the claimants "has a clear legal right to any of the shares which he or she claims"; and that he (the Examiner) should "apply equitable principles in the determination of who are the stockholders of the debtor and what proportions of its stock they hold."

Since the problem for the reorganization court is to decide upon the capitalization necessary to do equity in the light of the various claims before it, this court need pass only upon the immediate question of who should be stockholders of the reorganized debtor and in what proportions. With these basic principles determined, the solution becomes more clearly defined. One group of investors paid Malakoff by check, credit or cash various sums to purchase an interest in the Nazareth Market. The money was solicited for this purpose by Malakoff as the promoter of the enterprise and was not intended to be loans to Malakoff personally or to be used generally by him in his many business operations. The funds should have reached the Debtor's treasury and have been the consideration required by Pennsylvania law*fn2 to support the valid issuance of the Debtor's shares. The other group consists of persons to whom Malakoff issued shares for antecedent personal debts, in exchange or substitution for shares of other ventures or for other obligations personal to Malakoff. From these persons the Debtor did not receive and was not intended to receive anything of value, either from them or from Malakoff. These shares as a matter of Pennsylvania law could have had no validity as an original issue. In many instances, however, Malakoff gave by assignment to persons in this group shares purportedly issued to him. Had these shares been validly issued to Malakoff then, but only then, would the principles of the Uniform Stock Transfer Act*fn3 in force in Pennsylvania at the time of the transactions here involved as to consideration and "value" apply. But no such shares were ever validly issued to Malakoff. The 20 shares originally issued to Zoloth and Soble, although subsequently assigned to Malakoff and still later by him to the Debtor, did not come into the hands of any claimant. After the shares had been issued to the claimants from and after February 2, 1953, corporate minutes in May or June, 1953, were fraudulently prepared and pre-dated as of July 2, 1952 (or post-dated as of July 2, 1953) purporting to evidence the issuance of the remaining 180 shares to Malakoff for $75 a share. There is no proof that Malakoff ever paid for these shares or that they were legally issued. Thus no claimant can derive any rights by assignment from Malakoff on the theory that he was the owner of the Debtor's stock. The purported issuance was both fraudulent and invalid.

Despite the cloud of illegality obscuring any stock issuance, the Debtor came into corporate being and did acquire a valuable property which it still holds. The Market property is sufficient to support a valid stock issue to those entitled thereto. The sellers (Philadelphia group) have been paid for that property by Malakoff. Malakoff in turn obtained the money for this purpose from those who thought that they were to receive an interest in the Nazareth Market. Malakoff as the promoter must be regarded as a trustee, fiduciary, agent, promoter or syndicator (the terminology is unimportant - the facts create the rights) for those who gave him their funds for investment in the project. They should in equity receive that for which they paid.

Although the findings of fact of the Examiner may be accepted almost in their entirety, his conclusions are at variance with the equitable principles applicable here. The Examiner treated Malakoff as the owner and operator of the Debtor and each claimant as having purchased his interest from Malakoff. This erroneous assumption made it possible for the Examiner to accept the stock claims of all claimants who had received stock from Malakoff on the theory that stock transfers from Malakoff rested upon adequate consideration if the Stock Transfer Act's definition of "value" were satisfied. This,however, is not the problem. The Debtor's stock for all practical purposes has never been legally issued. Such stock as is to be issued in the reorganization should be based upon the requirements of Pennsylvania law with respect to the issuance of stock.*fn4

Malakoff received the moneys put into his hands by the investors for the specific purpose of the allotment of shares in the Nazareth Market property. He used some of this money to acquire that property. Title thereto now is in the Debtor. The court upon reorganization is in a position to give to the investors that which they were originally entitled to receive.

At the time Malakoff obtained the investors' funds, he spoke in terms of the issuance of shares. To some he promised shares at $600; to others at $1,000. Although shares were purportedly issued, the "dividends" of 20% were paid and accepted on the basis of the amount invested. Greater equity will be achieved by calculating the allowed claims in terms of dollars rather than in invalidly issued shares. The "investors" had a right to expect that the sums delivered to Malakoff would represent their shares in the enterprise and would be delivered to the corporation. Therefore, in determining their interests the entire amount paid, undiminished by any so-called "dividends," must control their participation.

As to the stock claimants, with few exceptions they fall into two distinct categories: (1) those investors who paid for a participation in the Nazareth Market by cash, check or credit, and (2) those who did not make any payment but who rely upon antecedent indebtedness of Malakoff and other transactions with him unrelated to the Nazareth venture as consideration.

In the first category are the claimants listed below whose claims should be allowed in the amounts indicated. As to these claimants, the findings of the Examiner and the trial court relating to the amounts paid to Malakoff and the circumstances under which they were paid are affirmed.

Name Amount

Charles Kanter $4,000.00

Morton Samet 2,000.00

Gertrude Klein 14,000.00

Dorothy Holober Clark 3,000.00

Barry Clark 4,000.00

Harold Q. Masur 4,000.00

Louis Como ...


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