Court: United States Bankruptcy Court, D. Connecticut; December 10, 1979; Us Bankruptcy; United States Bankruptcy Court
On June 27, 1977, an involuntary bankruptcy petition was filed against C. S. Mersick, Co., which was adjudicated on July 19, 1977. Prior to the adjudication, Mersick held a 25-year lease for a building located at 458 Sackett Point Road, North Haven, Connecticut, with a monthly rent of $10,140.61 and a security deposit of $22,500. The lease included a clause allowing the lessors to terminate it with six months’ notice in the event of bankruptcy. A modification to the lease in February 1977 stipulated that if rent was unpaid for ten days after the due date, the lessors could notify Mersick by certified mail, granting a ten-day period to cure the default. This notice was never sent.
Steven M. Zelman, the trustee for Mersick, filed a complaint against lessors G. E. Esher, Jr., Joseph U. Labov, and Allan I. Sheppard, seeking the return of $27,121.40 in rental payments claimed as preferential payments and the return of the $22,500 security deposit as a fraudulent transfer. An evidentiary hearing was conducted, and the parties submitted a stipulation of additional facts. This stipulation showed that from September 1976 to February 1977, rental payments were received and deposited on various dates, with the rent check for March 1977 being returned for insufficient funds on two occasions before a substituted check was honored. In April and May 1977, Mersick made rent payments, including a check from a sublessee.
Joseph Labov, a lessor, testified he was unaware of Mersick’s insolvency before the bankruptcy petition and recounted a meeting with Mersick’s president, Jordan Friedman, in late March 1977. At that meeting, Friedman expressed a desire to terminate the lease due to inefficiencies at the North Haven location, where Mersick was occupying only 30% of the leased space, with United Liquors Ltd. as a significant subtenant.
On June 16, 1977, Mersick was released from all lease liabilities by the lessors in exchange for Mersick relinquishing claims to a $22,500 security deposit. Simultaneously, United entered into a new lease for the same premises under the original terms, except that United was exempt from paying rent for the last two months, capped at $22,500. Labov testified that Mersick’s security deposit was used to facilitate the deal with United, and no additional deposit was required. There were no discussions about Mersick's financial issues, and the transaction was initiated by Mersick’s president. William J. Shea, Mersick’s treasurer, noted that Mersick had assets of $1,173,000 and over 350 creditors with claims exceeding $3,000,000 during its bankruptcy proceedings. Shea confirmed that Mersick's first dishonored rent check occurred in March 1977. It was established that Mersick was insolvent at relevant times, and the trustee argues that rent payments made in the four months prior to bankruptcy were voidable preferences under §60(b) of the Bankruptcy Act. Additionally, the trustee claims the transfer of the security deposit was a fraudulent conveyance under §67(d)(2). The key legal question is whether the rent payments were made for a present consideration or an antecedent debt, as defined by §60(a)(1). The lessors contend the payments were for current rent, not prior debts. Case law suggests that current rent payments are generally considered present consideration and not preferences. The court concurs, noting that rent payments due within the month are for present consideration, as a lease continues despite a failure to pay on time unless the landlord chooses to terminate it.
The trustee faces a burden to prove that the lessors had reasonable cause to believe the debtor, Mersick, was insolvent when rent payments were made, as outlined in 60b of the Bankruptcy Act. The evidence presented does not support this claim, as the lessors could only reasonably conclude that Mersick was experiencing temporary cash-flow issues. Mersick, a long-established business with a solid history as a tenant, had over 350 creditors, and a creditor cannot be expected to know of a debtor's insolvency without access to the debtor's financial records.
Consequently, the court finds that the rent payments made in the four months prior to the bankruptcy petition do not constitute payment for an antecedent debt, and the trustee cannot recover them due to insufficient evidence of the lessors' constructive knowledge of insolvency.
Regarding the alleged fraudulent transfer under 67d of the Bankruptcy Act, the trustee argues that Mersick's surrender of a $22,500 security deposit for a release from lease obligations lacks fair consideration. However, the court determines that this exchange was reasonable and supported by the circumstances. The lessors' release from future obligations occurred in the context of a lease with an extended term, and the transaction was not characterized by bad faith. The trustee's assertion that the lessors received a windfall is unfounded, as they used the security deposit to cover the last two months' rent for a new tenant. The determination of fair consideration must take into account the entire context of the transaction, leading the court to conclude that the exchange was valid and not void for the trustee.
Finally, the lease language has been interpreted by both parties as creating a “security deposit,” but it does not explicitly label any payments as such, particularly regarding the advance rental payment of $17,250 for the last three months.
The amount in question is legally classified as a payment of rent in advance, not a security deposit, which is a crucial distinction under Connecticut law. This distinction means that if the lease is terminated due to default or abandonment, the advanced rent automatically belongs to the lessor unless the lease states otherwise. Additionally, federal case law supports this state law distinction, particularly in bankruptcy contexts where a trustee challenges a lessor's right to retain advance rent. In these cases, state law is first used to determine the nature of the payment, followed by an assessment of ownership transfer to the lessor upon lease termination or the tenant's payment. This legal principle has been consistently upheld by three Circuit Courts of Appeal.
If the payment made by Mersick to the lessors in 1960 is classified as rent in advance under Connecticut law, ownership of that rent vested with the lessors either at the lease's start or upon its termination, resulting in no property transfer from Mersick on June 16, 1977. The defendants would prevail under both the security deposit and advance rental theories. Judgment is ordered in favor of the defendants on all counts of the complaint.
The document outlines the definition of a preference under the Bankruptcy Act, emphasizing that it involves a transfer of a debtor's property to benefit a creditor for an antecedent debt while the debtor is insolvent, within four months of filing a bankruptcy petition. Historical case law supports this definition, with significant cases from the early 1900s reinforcing the notion that such transfers are generally recognizable and not subject to dispute.
A contrary case, In the Matter of Ailing Sport Shop, Inc., involved late rent payments deemed preferential but limited the ruling to specific factual circumstances. The document also details conditions under which a trustee can avoid a preference if the creditor believed the debtor was insolvent at the time of the transfer. It defines fraudulent transfers made without fair consideration within one year prior to a bankruptcy filing.
The term "fair consideration" is outlined, requiring good faith exchanges or securing present advances comparable in value to the property obtained. Notably, the contested amount of $22,500 is referred to as a “security deposit,” and its classification will be addressed in subsequent sections, alongside an unexplained discrepancy between this amount and what was specified in the lease agreement.
