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In re Bankruptcy

decided: May 7, 1987.

IN RE BANKRUPTCY, KORS, INC. DAVID D. ROBINSON, TRUSTEE, PLAINTIFF-APPELLANT,
v.
THE HOWARD BANK, RUTLAND INDUSTRIAL DEVELOPMENT CORPORATION, AND SMALL BUSINESS INVESTMENT CORPORATION OF VERMONT, INC., DEFENDANTS-APPELLEES



Appeal from a judgment of the United States District Court for the District of Vermont, James S. Holden, Senior Judge, ordering the bankruptcy court to enforce a subordination agreement.

Timbers, Van Graafeiland, and Pierce, Circuit Judges.

Author: Pierce

PIERCE, Circuit Judge:

David D. Robinson, trustee for the bankrupt corporation, Kors, Inc. ("Kors"), appeals from a judgment of the United States District Court for the District of Vermont ordering the proceeds of a sale of the debtor's machinery to be paid in accordance with a subordination agreement among the Rutland Industrial Development Corporation ("RIDC"), the Small Business Investment Corporation of Vermont, Inc. ("SBIC"), and the Howard Bank ("Bank"). Appellant contends that, under §§ 544 and 551 of the Bankruptcy Code ("Code"), 11 U.S.C. §§ 544 and 551 (1982), the trustee may avoid a subordination agreement for the benefit of the estate. We disagree.

BACKGROUND

We summarize only the facts believed necessary to an understanding of the issues on appeal. In 1977, Kors entered into negotiations with SBIC, RIDC and the Bank to obtain financing for the operation of a plastics manufacturing business. RIDC, a non-profit local development corporation, agreed to lease equipment to Kors. The Bank agreed to loan funds to Kors and RIDC to purchase the equipment and SBIC agreed to lend Kors working capital.

On July 12, 1978, RIDC, Kors, and the Bank executed a security agreement ("Security Agreement"), wherein RIDC proposed the purchase of new equipment and machinery from Rietenhauser USA Sales Corp. ("Rextrusion") which RIDC would lease to Kors.*fn1 For this purpose, the Bank loaned $1,510,000 to RIDC and Kors as joint debtors. The collateral for the Security Agreement was described as the equipment and machinery to be purchased from Rextrusion by RIDC including "all additions, accessories and substitutions thereto, and all proceeds of their disposition." The Security Agreement required that Kors and RIDC "not permit any other security interest to attach to the Collateral," but acknowledged a subordinate security interest of SBIC, described below, in a loan to Kors of $400,000. On July 13, 1978, the Bank, as secured party, filed financing statements with the Rutland City Clerk and the Vermont Secretary of State, signed only by RIDC, as the debtor, but not by Kors.

Earlier, on June 19, 1978, SBIC loaned working capital in the amount of $400,000*fn2 to Kors pursuant to a loan and security agreement ("Loan and Security Agreement"), wherein Kors agreed to secure its indebtedness to SBIC through its accounts receivable, inventory and all of Kors "machinery, equipment and tangible property of every kind and nature now and hereafter acquired, including all such property as may be leased to [Kors] by Rutland Industrial Development Corporation." However, also contained in this Loan and Security Agreement, which RIDC agreed to execute, was a clause in which SBIC and RIDC agreed to subordinate their respective interests to the Howard Bank, or any other lender financing the purchase by Kors of additional machinery and equipment. Specifically, SBIC and RIDC agreed to be "subject and subordinate to the effect given to any prior security interests therein required to be given to the Howard Bank . . . and to subordinate its security interests to any other Lender as may hereinafter finance the purchase by [Kors] of additional machinery and equipment." Apparently, this clause was included to encourage banks to lend Kors funds to promote its production capacity.

SBIC filed financing statements for the $400,000 loan to Kors on July 19, 1978. SBIC's financing statements were "subject however to the effect given a previous security interest granted to the Howard Bank."*fn3 Thus, both the Security Agreement among RIDC, Kors and the Bank, and the Loan and Security Agreement among RIDC, SBIC and Kors identify an obligation by SBIC and RIDC to subordinate their security interests to the Bank's security interest.

Kors filed a voluntary bankruptcy petition on November 24, 1980 under Chapter 11 of the Code, which was converted to a Chapter 7 liquidation proceeding on August 14, 1981. The appellant, David D. Robinson, was appointed trustee and on April 22, 1982, with the consent of the parties and pursuant to a court order, the trustee sold all of Kors' equipment for a total of $1,100,000.

The bankruptcy court determined, inter alia, that the Bank did not properly perfect its security interest in any collateral; that the trustee, pursuant to § 544 of the Code, preserved the unperfected security interest for the benefit of the estate; and that the estate was subrogated to the Bank's rights under its subordination agreement with SBIC for the benefit of all the creditors of the estate. On appeal to the district court, 64 Bankr. 163, the latter reversed so much of the bankruptcy court determination as held that the trustee stood in the position of the Bank with respect to the subordination agreement, and ruled instead that the proceeds of the sale should be distributed in accordance with the subordination agreement. In all other respects, the judgment of the bankruptcy court was affirmed by the district court.

On appeal to this court, appellant urges that the rights and powers of the trustee under §§ 544 and 551 are superior to the rights of parties to a subordination agreement. Appellee argues that § 510(a) of the Code requires that the subordination agreement be enforced among the parties.

We affirm the judgment of the district court for the ...


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