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In re Ollag Construction Equipment Corp.

June 26, 1978


Appeal and cross appeal from an order of the Western District of New York, John T. Elfvin, Judge, affirming a judgment of the Bankruptcy Court that appellant's security interest in the bankrupt's property is void as against appellee. Reversed and remanded to the Bankruptcy Court on appeal of Manufacturers and Traders Trust Co. Affirmed on cross appeal of Karl Goldman.

Kaufman, Chief Judge, Feinberg, Circuit Judge, and Werker, District Judge.*fn*

Author: Kaufman

KAUFMAN, Chief Judge:

When financial storms rage, unsecured creditors take on collateral as ballast. The security thus gained is often tenuous, however, for if bankruptcy is involved, it may be dissolved by the trustee's challenge. In this case, we are called upon to decide whether Manufacturers & Traders Trust Company ("the Bank") may enforce a security interest in the property of the bankrupt Ollag Construction Equipment Corp. ("Ollag"), or whether, as Ollag's trustee contends, the Bank's claim is a voidable preference under § 60 of the Bankruptcy Act.*fn1 Since we believe that the courts below inadequately considered the crucial issue of Ollag's solvency when the security interest was created, we reverse and remand to the bankruptcy court for further findings.


Ollag's financial demise was triggered when the construction business operated in Lancaster, New York, by the four Gallo brothers - Leopold, Anthony, Michael, and James - fell on hard times. An equipment leasing firm, Ollag was but one of the three corporate constituents of this family enterprise. It was a wholly-owned subsidiary of Deplan Contracting Inc. ("Deplan"), a construction firm that accounted for more than ninety percent of Ollag's rentals. The third Gallo corporation, Sheldon Builders Supply Corp. ("Sheldon"), owned the real estate quartering the Deplan and Ollag facilities.

In late 1972, the Gallos learned that Deplan's financial condition was grave because approximately $300,000 in accounts payable had not been recorded in the company's books. Deplan's creditors became aware of this state of affairs in January 1973, as Deplan began to default on a number of construction projects. Meetings were held to discuss refinancing the stricken business. The principal creditor participants were the Bank and the Travelers Indemnity Company ("Travelers"). The Bank held Deplan's note in the sum of $200,000, collateralized by a security interest in equipment Deplan owned separately from Ollag. It had also obtained a mortgage on Sheldon's real estate, and payment guaranties from Ollag and the Gallos and their wives. Travelers had written performance and payment bonds for Deplan's projects, and Ollag, Sheldon, and the Gallos had also agreed to indemnify Travelers against liability on these bonds,*fn2 a fact of which the Bank claims ignorance.

While the discussions continued, the security interest at issue in this case came into being. In February 1973, Leopold Gallo, Ollag's president, executed at the Bank's request a chattel mortgage on Ollag's inventory and equipment to serve as security for Ollag's guaranty of Deplan's note.*fn3 The proposed refinancing never occurred. By March 1973, it was readily apparent that, even with an infusion of new funds, Deplan would soon be insolvent again. Although Deplan attempted to avert disaster by filing a petition under Chapter XI to rearrange its debts, even that maneuver failed. To no one's surprise, Deplan was adjudicated a bankrupt.

In June, Travelers, having undertaken to finish Deplan's construction projects after the latter's default, filed an involuntary petition against Ollag. The Bank, without delay, submitted a reclamation petition asserting its security interest in Ollag's equipment. The trustee counterclaimed, seeking an avoidance of the Bank's claim.*fn4 The rather complex issues presented by these stratagems are now before us. Bankruptcy Judge McGuire decided that the Ollag security interest was invalid both under New York law and as a voidable preference under § 60 of the Bankruptcy Act. On review by the district court, Judge Elfvin reversed the determination that the security interest transgressed New York law, but affirmed the judgment on the basis of § 60. Both the Bank and the trustee appealed.


We have little difficulty in disposing of the trustee's contention on his appeal that the security agreement was void because it did not further any of Ollag's corporate purposes and had not been ratified by Ollag's shareholders in accordance with N.Y. Bus. Corp. Law § 908.*fn5 It is clear that the security agreement did in fact serve a valid corporate purpose by attempting to avert the bankruptcy of Ollag's parent and principal customer, Deplan.*fn6 Accordingly, under N.Y. Bus. Corp. Law § 202(a)(7), shareholder ratification of the agreement was unnecessary.*fn7

Nevertheless, the trustee argues that even if shareholder approval was not required, the security agreement is without force because Leopold Gallo, president of Ollag, did not have authority to execute it on its behalf. But Leopold's right to act for Ollag was conclusively established by a resolution adopted by Ollag's board of directors before any suggestion of trouble in the Gallo enterprises. It granted any one officer of Ollag authority to execute security agreements with the Bank on behalf of Ollag. Accordingly, we have no hesitation in finding that the security agreement complied with New York law.*fn8


We now turn to the trustee's assertion that the Bank's security interest in Ollag's inventory and equipment is a voidable preference. The Bank argues that of the seven prerequisites for voidability under § 60 of the Act,*fn9 the trustee has failed to establish two. It asserts that Ollag was not insolvent when the security interest was taken and, moreover, that the Bank did not have ...

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