Jefferson Bank v. Devault Manufacturing Co. (In re Devault Manufacturing Co.)
Docket: Bankruptcy No. 79-620EG
Court: United States Bankruptcy Court, E.D. Pennsylvania; August 25, 1982; Us Bankruptcy; United States Bankruptcy Court
The court determined that the creation and perfection of Jefferson Bank's security interest shortly before Devault Manufacturing Company filed for bankruptcy was not a voidable preference under section 60 of the Bankruptcy Act. The creditors’ committee and the debtor failed to demonstrate that Jefferson had reasonable cause to believe the debtor was insolvent when the security interest was established. The timeline reveals that Devault filed for bankruptcy on April 10, 1979, after an ongoing business relationship with Jefferson, which included a $200,000 loan in default. Jefferson agreed to extend the loan in exchange for a security agreement signed by Devault on March 13, 1979, and subsequently perfected its interest by filing financing statements on March 21 and 22, 1979. The debtor claimed Jefferson's security interest constituted a voidable preference, arguing it was a transfer made while insolvent to benefit a creditor. However, the court found insufficient evidence of the debtor’s insolvency at the time of the transfer or that Jefferson was aware of any insolvency. Consequently, the court ruled in favor of Jefferson and granted its reclamation complaint. The creditors’ committee later sought to intervene and reconsider the ruling, which the court allowed on June 5, 1980.
Jefferson conceded the debtor's insolvency at the time of a March 1979 transfer, with the trial focused on Jefferson's awareness of this insolvency. After the creditors’ committee presented its case, Jefferson moved for a directed verdict, arguing insufficient evidence to show it knew or should have known of the debtor's insolvency. The committee claimed the totality of circumstances indicated Jefferson's awareness, citing a $200,000 loan made in 1976 and 1977 without security until shortly before the debtor's bankruptcy filing. However, Jefferson's vice president testified that efforts to obtain a security agreement were ongoing since 1976, with the agreement finally executed in March 1979.
The court found that Jefferson's acquisition of security did not alone demonstrate knowledge of insolvency. The creditors' committee argued that Jefferson had access to an audited financial statement from 1976 showing a $20,000 equity deficit, but under cross-examination, Jefferson’s vice president stated he did not review that statement until late 1978, instead relying on a summary indicating the debtor was solvent. The court deemed Jefferson's reliance on this summary, which was based on audited statements and other sources, as reasonable, especially since the 1976 statement was outdated by over two years.
The creditors’ committee posited that the summary’s inclusion of "capitalized expenses," not recognized as a proper accounting practice, indicated inaccuracies that should have prompted further inquiry from Jefferson. While the court acknowledged this created a duty to investigate, it concluded that Jefferson had fulfilled that duty adequately.
Jefferson's vice president testified that he inquired about the capitalized expenses item on the debtor’s summary statement and was informed that it included costs for developing new products, which he found satisfactory due to recent sales increases. The conclusion drawn was that Jefferson acted reasonably in their inquiry and reliance on this information. Although the creditors’ committee pointed out discrepancies between the summary statement and the 1976 audited statement, Jefferson was still considered to have acted reasonably in relying on the summary statement, as no circumstances raised suspicion regarding its accuracy.
The creditors’ committee argued that an incident in January 1979, where a trade creditor attached the debtor’s bank account for $3,000, should have raised red flags for Jefferson. However, Jefferson's vice president testified that such attachments were not unusual and that he had no reason to question the debtor's solvency based on the debtor's explanation and other favorable financial indicators, including a previously approved line of credit and a repaid loan secured by a letter of credit.
Ultimately, the evidence did not support the creditors’ committee's claim that Jefferson knew or had reasonable cause to suspect the debtor's insolvency in March 1979. Jefferson fulfilled its inquiry duty, leading to the conclusion that a directed verdict in favor of Jefferson was warranted, with the creditors' committee's motion for summary judgment being denied.
Findings of fact and conclusions of law are provided in accordance with Rule 752 of the Rules of Bankruptcy Procedure. The Bankruptcy Act, though superseded by the Bankruptcy Code on October 1, 1979, continues to apply to petitions filed prior to that date. Notably, in the case of In re Devault Mfg. Co., the court determined that a transfer occurred on March 22, 1980, when Jefferson perfected its security interest, and the debtor was deemed insolvent on that date. Following the trial, the creditors’ committee’s motion for summary judgment was denied, as the court ruled in favor of a directed verdict for Jefferson. The excerpt references In re Cruft, which established that a creditor's initiation of garnishment proceedings alone does not demonstrate knowledge of the debtor's insolvency without further evidence. Additionally, discrepancies in financial statements arose from the debtor's inclusion of a 'capitalized expenses' category, leading to differences in reported equity between the 1976 audited statement and the summary statement.
