Crumpton v. Stephens (In re Northlake Foods, Inc.)

Citation: 483 B.R. 247Docket: No. 8:11-cv-2648-T-33; Bankruptcy No. 8:08-bk-14131-CED; Adversary No. 8:10-ap-00930-CED

Court: District Court, M.D. Florida; September 27, 2012; Federal District Court

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David H. Crumpton, as Distribution Trustee for the Distribution Trust of Northlake Foods, Inc., appealed two orders from the Bankruptcy Court: the first on February 9, 2011, granting Richard Stephens’ motion for judgment on the pleadings, and the second on September 9, 2011, dismissing the amended complaint. Northlake Foods, Inc., a Georgia Subchapter S corporation, operated approximately 150 Waffle House restaurants. A Shareholders Agreement executed in 1991 required the corporation to pay dividends to shareholders if its income became taxable to them, ensuring they could cover their income tax liabilities. In 2006, the corporation paid Stephens a dividend of $94,429.00, reflecting his tax liability for 2005, following a unanimous director resolution.

Northlake Foods filed for Chapter 11 bankruptcy on September 15, 2008, and Crumpton was appointed as Distribution Trustee on January 28, 2009. He initiated an adversary proceeding on September 16, 2010, to recover the 2006 dividend payment, claiming it was a fraudulent transfer under the Bankruptcy Code and the Georgia Uniform Fraudulent Transfers Act. After the Bankruptcy Court granted Stephens’ motion for judgment on the pleadings, Crumpton was allowed to file an amended complaint alleging an illegal dividend claim. However, the amended complaint was subsequently dismissed on September 9, 2011. Crumpton filed his appeal on September 28, 2011, challenging both orders from the Bankruptcy Court. The District Court affirmed the Bankruptcy Court's decisions.

The United States District Court serves as an appellate body for reviewing final orders from the United States Bankruptcy Court, following 28 U.S.C. § 158(a). The court applies a "clearly erroneous" standard for factual findings, meaning it will overturn a finding only if it is left with a strong conviction that a mistake has occurred. Legal conclusions from the bankruptcy court are reviewed de novo. In assessing motions for judgment on the pleadings, the court uses the same standard as a Rule 12(b)(6) motion to dismiss, which requires that all allegations be accepted as true and viewed in the light most favorable to the appellant, along with all reasonable inferences. While detailed factual allegations are not necessary, a plaintiff must provide enough factual content to establish a plausible claim for relief, moving beyond mere labels or conclusions. The "no set of facts" standard from Conley v. Gibson has been replaced by the standards established in Bell Atl. Corp. v. Twombly and Ashcroft v. Iqbal, mandating that a complaint must contain sufficient facts to support a plausible claim.

The Court clarified that the motions in question were not converted to motions for summary judgment, as the Bankruptcy Court limited its consideration to the pleadings, defined under Rule 7(a) to include the complaint and answer, as well as any attached written instruments as per Rule 10(c). The first critical issue on appeal is whether the Bankruptcy Court incorrectly ruled that a pre-petition transfer of $94,429 to a former shareholder, under a Shareholders Agreement, was not an avoidable fraudulent transfer under 11 U.S.C. §§ 544, 548, 550 and the Georgia Uniform Fraudulent Transfers Act. According to 11 U.S.C. § 548, a trustee can avoid transfers made within two years of a bankruptcy filing if the debtor received less than a reasonably equivalent value and was insolvent at the time of the transfer or became insolvent due to it. The parties agree that the transfer occurred within the two-year window and that the debtor was insolvent when the transfer was made. The appeal centers on the Bankruptcy Court's February 9, 2011 ruling, which granted the Appellee's Motion for Judgment on the Pleadings, concluding that the Debtor received reasonably equivalent value due to the satisfaction of an antecedent debt owed under the Shareholders Agreement.

The Bankruptcy Court also noted that the Debtor's Subchapter S election allowed it to pay Appellee's share of income tax liabilities incurred due to the Debtor's operations, which contributed to finding that the Debtor received reasonably equivalent value. The Appellant disagreed with this finding but the Court affirmed the Bankruptcy Court's decision, explaining that under federal tax law, corporations generally face double taxation unless they elect Subchapter S status, which allows income to be reported directly by shareholders, thereby avoiding such taxation.

The Debtor elected Subchapter S status, allowing it to pass tax liabilities to shareholders instead of paying taxes directly. According to the Shareholders Agreement, the Debtor was required to reimburse shareholders for additional income taxes resulting from this pass-through. The 2006 Transfer involved the reimbursement for the tax liabilities related to the Appellee’s share of the Debtor’s taxable income. The Appellant argued that the Debtor received no value from this arrangement, benefitting only the shareholders, and asserted that the creditors were not advantaged by the 2006 Transfer. The Court rejected this argument, stating that a fraudulent transfer does not occur as long as the debtor's unsecured creditors are not worse off due to receiving reasonably equivalent value for what has been transferred. The Court reasoned that, had the Debtor not elected Subchapter S status, it would have been liable for income taxes, and thus, reimbursing shareholders did not negatively impact the Debtor or its creditors. The Court concluded that the Debtor received reasonably equivalent value from the tax payments made by the Appellee, supported by the precedent set in In re Kenrob Information Technology Solutions, which found that payments made to cover shareholders' taxes did not constitute fraudulent transfers, as they were part of the beneficial tax structure of Subchapter S.

Appellee's complaint does not claim that the 2006 Transfer exceeded Appellant's pass-through tax liability. The attached Director's Resolution indicates that the 2006 Transfer was solely for the tax attributable to Appellee’s share of the Debtor’s taxable income, negating any argument that it exceeded the liability. Following the precedent set in In re Kenrob, the Court concludes that the 2006 Transfer was not fraudulent, as the Debtor received reasonably equivalent value due to its Subchapter S status. Consequently, the Bankruptcy Court's decision is upheld. 

In the September 9, 2011 Order, Appellant was allowed to file an amended complaint for recovery of illegal dividends under O.C.G.A. 14-2-640, which forbids distributions to shareholders when a corporation is insolvent. However, the Bankruptcy Court dismissed this amended complaint, determining that Georgia law permits actions against directors who approve illegal dividends, not against shareholders. Since Appellee was not a director, the motion to dismiss was granted. Appellant's appeal does not present any legal basis for a direct claim against a shareholder for illegal dividends and fails to establish its argument linking the illegal dividend to the fraudulent transfer. The Bankruptcy Court's conclusion that the remedy lies with the directors who authorized the distribution, and that the statute of limitations has expired for such action, is affirmed. The Court orders the affirmation of both the February 9, 2011 and September 9, 2011 Bankruptcy Court Orders and instructs to close the case.

Appellant claims that Appellee acknowledges a specific legal standard in his brief, citing to it; however, Appellee's brief does not recognize or quote this standard, indicating a potential error in Appellant's citation. Under Rule 12(c) of the Federal Rules of Civil Procedure, if external documents are considered, the motion should be treated as one for summary judgment, allowing all parties to present relevant materials. The Board of Directors approved a Tax Distribution totaling $969,829, which includes a cash payment of $94,429 to J. Richard Stephens. The Court agrees with Appellee that the Bankruptcy Court was not required to conduct an evidentiary hearing before ruling on the motions, as the analysis is limited to the complaint's allegations and attached exhibits. Appellee contends that Appellant is barred from relitigating the issue of reasonably equivalent value due to issue preclusion stemming from a prior ruling in a separate adversary proceeding involving another shareholder. However, the Court finds that the issues are not identical, as the previous case did not address whether the transfer to Appellee provided reasonably equivalent value, but rather focused on the fraudulent nature of the transfer to another shareholder. Thus, the Bankruptcy Court's ruling does not prevent Appellant from challenging the transfer to Appellee.