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June 28, 1968

Milton R. ACKMAN, as Trustee of American Foam Rubber Corporation, Bankrupt, Plaintiff,

Wyatt, District Judge.

The opinion of the court was delivered by: WYATT

WYATT, District Judge.

This is an action by the Trustee in Bankruptcy of American Foam Rubber Corporation ("Foam"), a New York corporation, on account of a preference alleged to have been received by defendant Walter E. Heller & Company, Inc. ("Heller"), a Delaware corporation. The Trustee relies on Section 60a(1) and b of the Bankruptcy Act (Act of July 1, 1898, 30 Stat. 544, c. 541, as amended; the "Act"; 11 U.S.C. § 96(a)(1)) and on Section 15 of the New York Stock Corporation Law (in effect during the relevant period but since repealed) applicable under Section 70e(1) of the Act (11 U.S.C. § 110(e)(1)). There is jurisdiction in this Court under the cited sections of the Bankruptcy Act.

 No jury having been demanded, the action was tried to the Court.

 Foam made and (through subsidiaries) sold foam rubber and foam rubber products, such as pillows, mattresses, and furniture cushioning. The foam rubber was made from latex bought from suppliers.

 Foam had the following subsidiaries:

 1. Burlington Holding Corp. ("Burlington"), which owned land and a plant in Burlington, New Jersey, and leased this land and plant to Foam (Burlington is on the Delaware River a few miles northeast of Philadelphia);

 2. Burlington Workshops, Inc. ("Workshops"), which had a workshop, a "service organization";

 3. Mirafoam Industrial Sales, Inc. ("Industrial"), which sold foam rubber products to industrial users, principally manufacturers;

 4. Mirafoam Industrial Sales of Illinois, Inc. ("Illinois") which likewise sold to industrial users;

 5. Mirafoam, Inc. ("Mirafoam"), which sold foam rubber products to the retail trade, including big department stores; and

 6. Riverside Industries, Inc. ("Riverside"), which made cloth covers for the foam rubber products sold at retail; its plant was located in Riverside, New Jersey, about five to ten miles from the Burlington plant, and also on the Delaware River.

 All these subsidiaries were New York corporations except Illinois and Riverside which were Delaware corporations.

 Foam and its subsidiaries had their principal offices in the Empire State Building in New York City. They operated as an integrated business and, except where significant, no distinction is made herein between Foam and its subsidiaries.

 Heller is in the business of lending money and supplying related financial services as a factor; its principal offices are in Chicago but it has an active office in New York City, located in the relevant period at 342 Madison Avenue.

 Beginning about October 1959, there was a relationship between Foam and Heller. Between December 3, 1959 and January 17, 1961, Foam borrowed money from Heller.

 Foam on January 17, 1961 filed a petition for an arrangement under Chapter XI of the Act (11 U.S.C. § 701 and following). On February 23, 1961, Foam was adjudicated a bankrupt on its own written consent. Plaintiff was thereafter appointed Trustee and, although he was not required to obtain authorization from the bankruptcy court (2 Collier on Bankruptcy (14th ed., cited hereafter as "Collier") 1746-47), he followed the better practice and obtained authority from a Referee to bring this action.

 The period of time within which a bankruptcy preference can take place is four months before the filing of a petition initiating a proceeding under the Bankruptcy Act (11 U.S.C. § 96(a)(1)). Since the petition in this case was filed on January 17, 1961, the relevant period for determining whether there was a preference is from September 17, 1960 to January 17, 1961. Events occurring prior to this period are relevant to an understanding of the problems. Under Section 15 of the New York Stock Corporation Law, a preference could take place at any time; there was no limitation to a four months period. The Trustee here, however, in his complaint (para 7), in the pre-trial order (p. 13) and elsewhere has confined his claim to the same four months period of the Bankruptcy Act.

 September 17, 1960 was a Saturday. Since no business was transacted on Saturday or Sunday, the figures would be the same at the opening of business on September 19 as at the close of business on September 16.

 The answer of Heller contains two counterclaims. It was explained for Heller at trial (SM 663) that these were in fact "setoffs" and had been pleaded under Section 60c of the Act.

 The three shareholders of Foam were Alexander Pathy, his wife Suzanne, and Marie Louise de Montmollin. Pathy was President and the chief figure for Foam in the events in suit.

 Foam kept its books on the basis of a fiscal year of exactly thirteen periods of four weeks each, the weeks always ending on a Sunday. Its fiscal year ended on Sunday, January 3, 1960. The new fiscal year began on Monday, January 4, 1960, and ended on Sunday, January 1, 1961.

 The accountants for Foam were Edward Isaacs & Company (Isaacs). They made an audit as of January 3, 1960, and an examination (not an audit) at the end of the first four periods of 1960 (April 24, 1960) and thereafter at the end of each three periods (July 17 and October 9, 1960 and January 1, 1961).

 Before December of 1959 Foam had been financed by loans from two banks - First Philadelphia Company and Irving Trust Company - and by a factoring arrangement with Hubshman Factors Corporation.

 In October 1959, Foam applied to Heller for financial accommodation.

 The background for the application by Foam is of interest.

 Foam rubber is made by one or the other of two patented processes, Dunlop and Tallalay. Foam itself had built a modern plant, ready in 1956, using the Dunlop process.

 Serious competition to foam rubber began to be felt about 1955 from cheaper plastic foam made from polyurethane. This plastic competition affected sales to industrial users.

 In December 1958, a competitor of Foam (B. F. Goodrich Co.) developed a new process, called "pincore", for producing foam rubber more cheaply and thus enabling foam rubber better to compete with polyurethane.

 It was difficult to use the pincore technique with the Dunlop process and as the competitive situation evolved in 1959 Foam lost industrial sales to such an extent that its production for such sales, normally about two-thirds of total production, was sharply reduced. As part of meeting polyurethane competition, there was also a 20% price drop in foam rubber on July 15, 1959.

 In the fall months of 1959 Foam was operating at about one-third normal production, nearly all for retail sales. Foam was trying to find a way of adapting the pincore technique to the Dunlop process.

 In this situation, the shareholders of Foam increased their equity by putting in about $150,000 more capital. It was also decided to concentrate financing with Heller.

 It was agreed in October 1959 that Heller would make an examination of the books and records of Foam, which was done. Heller in October 1959 had an independent appraisal made of the real estate at Burlington and the equipment at Burlington and Riverside. The value of the real estate was reported as $170,000, the value of equipment at Burlington as $581,000 and at Riverside $45,000. Heller questioned two large equipment items - one of $65,000 (for mold conveyor) and the other (for molds) of $295,650 - and was assured by the appraiser that the values were "auction", a "knock down appraisal", that the items had "an indefinite life and would have great value * * * in the industry". Heller further questioned the valuation of the molds and received from the appraiser information in writing, among other things, that the molds "will remain in excellent condition for years", that they were "standard throughout the foam rubber industry", that the value was placed on them "after a thorough investigation", and that the 'same line of reasoning' was used to state a value for the mold conveyor". The writing from the appraiser said that they "would lend themselves best to a negotiated sale within the industry".

 Heller looked at the list of accounts receivable assigned to Hubshman for a month and found them "desirable", "reasonably well rated", and should "make up a sound receivable portfolio".

 It appeared that Foam would suffer a loss in 1959 (for the reasons already given), that the loss was "temporary" so far as the price drop of 20% on July 15, 1959 was concerned, and that prices were going up and by "spring" of 1960 the 20% decrease would be eliminated. Heller felt that, without the financing then planned, working capital of Foam would be "practically nothing" but that with the financial plan working capital would improve by $300,000. Heller felt that Foam was "strong enough and has a standing in the field so that it can weather the temporary loss and that it would be exceptional if anything drastic should happen to them" in the year following November 1959.

 By agreements of December 3, 1959, Heller agreed to make three types of collateral loans to Foam: (1) a time loan of $500,000 secured by mortgages of the real estate, plant and equipment at Burlington and Riverside and further secured by pledge of warehouse receipts for inventory of $150,000 value; (2) demand loans against pledge of accounts receivable up to 80% of the face amount of such accounts; and (3) demand loans of not more than $450,000 against warehouse receipts for inventory deposited in a field warehouse up to 2/3 the value of such deposited inventory.

 The $500,000 time loan was duly made on December 29, 1959, and the proceeds delivered to Foam. This time loan was agreed to be repaid, $100,000 on November 15, 1960 and the rest in monthly installments beginning January 15, 1961.

 Foam transferred its factoring from Hubshman to Heller and began pledging accounts receivable and inventory ...

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