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IN RE OLLAG CONSTR. EQUIP. CORP.

February 14, 1978

In the Matter of OLLAG CONSTRUCTION EQUIPMENT CORP. MANUFACTURERS AND TRADERS TRUST COMPANY, Plaintiff-Appellant,
v.
Karl GOLDMAN, as Trustee of Ollag Construction Equipment Corp., Bankrupt, Defendant-Respondent.



The opinion of the court was delivered by: ELFVIN

MEMORANDUM and ORDER

ELFVIN, District Judge.

 The Manufacturers and Traders Trust Company ("M & T") appeals from the decision and order issued September 9, 1976 and from the post-judgment order issued September 24, 1976 by the Honorable Beryl E. McGuire, Bankruptcy Judge, which denied its reclamation petition. The decision of the bankruptcy court, as amended, held that section 908 of New York's Business Corporation Law ("the BCL") was the applicable statutory provision which governed the purported granting of a security interest by Ollag Construction Equipment Corporation ("Ollag") and that the statutory requirement of shareholder approval was not complied with thus invalidating the security agreement under New York law. Having so determined that the security agreement was invalid for failure to obtain shareholder approval, the bankruptcy judge found it unnecessary to determine whether Leopold Gallo, President of Ollag, had authority to execute and deliver the security agreement in question which pledged all of Ollag's assets. The court below further concluded that, even if the execution of the security agreement complied with the requirements of state law, the security interest created thereby constituted a voidable preference under section 60(a)(1) and (b) of the Bankruptcy Act, 11 U.S.C. § 96(a)(1) and (b).

 On appeal, M & T contends that section 202(a)(7) of the BCL rather than section 908 as held by the bankruptcy judge, governed and that shareholder approval was not required. M & T further asserts that Leopold Gallo had the authority to sign the security agreement on behalf of the corporation whereby all of Ollag's assets were pledged to secure a guaranty previously given to M & T. In addition, M & T maintains that the bankruptcy judge erroneously concluded that the granting of said security interest was a voidable preference. M & T argues that the trustee in bankruptcy failed to meet his burden of proof with respect to three elements necessary to a finding that a voidable preference had been created. M & T alleges that the proof submitted by the trustee failed to show that Ollag was insolvent at the time of the transfer, that M & T then had reasonble cause to believe that Ollag was insolvent, and that the effect of the transfer was to enable M & T to obtain a greater percentage of its debt than some other creditor of the same class. Furthermore, M & T points out that the issue whether the execution of the security agreement was in furtherance of the corporate purposes of Ollage must be divorced from the issue whether Leopold Gallo had the authority to execute such agreement on behalf of Ollag.

 Section 908 of the BCL provides:

 "A guarantee may be given by a corporation, although not in furtherance of its corporate purposes, when authorized at a meeting of shareholders by vote of the holders of two-thirds of all outstanding shares entitled to vote thereon. If authorized by a like vote, such guarantee may be secured by a mortgage or pledge of, or the creation of a security interest in, all or any part of the corporate property, or any interest therein, wherever situated." (Emphasis added.)

 Section 202(a)(7) of the BCL states:

 "Each corporation, subject to any limitations provided in this chapter or any other statute of this state or its certificate of incorporation, shall have power in furtherance of its corporate purposes : * * *

 (7) To make contracts, give guarantees and incur liabilities, borrow money at such rates of interest as the corporation may determine, issue its notes, bonds and other obligations, and secure any of its obligations by mortgage or pledge of all or any of its property or any interest therein, wherever situated." (Emphasis added.)

 In order to decide which of the above statutory provisions applies, it must be determined whether the granting of the security interest by Ollag to secure its previous guaranty of the debt of Deplan Contracing, Inc. ("Deplan") was in furtherance of Ollag's corporate purposes. To make such determination, a review of the particular facts and circumstances must be undertaken. Such inquiry should focus upon the character and business of the corporation, the relationship between the transaction in question (here the granting of a security interest to secure the debt of the parent corporation) and the business engaged in by the corporation, and whether such corporate transaction is expected, directly or indirectly, to benefit and further such business and purpose.

 The Gallo brothers *fn1" owned and managed a family construction business which involved three manifestly interrelated corporations. Deplan was the operating company which negotiated and contracted with governmental bodies and outside private parties and performed the construction work contracts. Ollag was the equipmentowning corporation from which Deplan rented the heavy construction equipment needed to perform the said construction projects. Although Ollag did not rent its equipment exclusively to Deplan, uncontroverted testimony adduced at trial revealed that approximately ninety percent of Ollag's rental business was to Deplan. *fn2" Sheldon Construction, Inc. ("Sheldon") owned the real property and buildings from which Deplan operated.

 The Gallo brothers owned all the stock and also were the officers and directors of the three corporations. At some time prior to February 1973, the common stock of Ollag was transferred to Deplan so that Ollag became a wholly owned subsidiary of Deplan.

 M & T had been financing Deplan for a number of years and in January 1973 there was an outstanding balance of approximately $200,000 of unpaid principal owed to it under notes signed by Deplan. As security for these loans, M & T held perfected security interests in equipment owned by Deplan and a mortgage on the land and buildings owned by Sheldon. In addition, M & T obtained guaranty agreements from both Ollag and Sheldon with respect to the debt owed by Deplan.Ollag executed its guaranty April 18, 1968, but such was not secured with any property originally and remained unsecured until Leopold Gallo's allegedly valid pledge of Ollag's assets February 2, 1973.

 In January 1973, M & T and other creditors of Deplan learned that Deplan was in serious financial difficulty because its bookkeeper had concealed certain accounts payable by failing to enter them on Deplan's books. Deplan's financial situation was discussed at various meetings during that month among representatives of Deplan, M & T and Travelers Indemnity Company ("Travelers"), which had provided certain construction bonds to Deplan and with which Ollag had in such connection signed an indemnification agreement. M & T contends that it was not then aware of this agreement and that such was not mentioned during the discussions.

 After the meetings, M & T initially indicated that further financing would not be forthcoming. Subsequently, however, the possibility that a financing plan could be arranged whereby Deplan could be saved from bankruptcy was discussed by representatives of both M & T and Deplan and, in February 1973, Leopold Gallo, also President of Deplan, was requested by Gerald M. Stoddard, Manager of the Lancaster office of M & T, to discuss the situation at the Lancaster bank office. At such meeting, Gallo signed a security agreement whereby Ollag granted a security interest to M & T in all assets owned by Ollag to secure its previously unsecured April 1968 guaranty of the debt of Deplan. Testimony adduced at trial demonstrated that Gallo believed it would have been unwise not to accede to the bank officer's request as he wished to retain M & T's good will during ongoing discussions about possible further financing by M & T to save Deplan from bankruptcy. *fn3" Thereafter, up-to-date financial statements indicated that, even with the additional input of borrowed and investor funds, Deplan would probably be bankrupt in six months. Therefore, instead of jeopardizing the additional monies of new investors, Deplan voluntarily filed a petition in bankruptcy March 20, 1978 under Chapter 11 of the Bankruptcy Act. On May 30, 1973, Travelers as surety on several of Deplan's construction projects and holder of Ollag's guaranty of the indebtedness of Deplan filed an involuntary petition in bankruptcy against Ollag.

 The first issue which must be decided on this appeal is whether the court below correctly concluded that section 908, and not section 202(a)(7), of the BCL governed the execution of the security agreement by Leopold Gallo on February 3, 1973, pledging the assets of Ollag. The answer to this inquiry will hinge upon a determination whether the pledge of Ollag's assets was "in ...


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