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In re Plymouth Dyeing Co.

September 25, 1963


Author: Mclaughlin

Before BIGGS, Chief Judge, and McLAUGHLIN and GANEY, Circuit Judges.

McLAUGHLIN, Circuit Judge.

This is an appeal from an order of the district court affirming an order of the referee in bankruptcy. The referee's order, issued in summary proceedings, extended the bankruptcy proceedings of Plymouth Dyeing Co., Inc. (Plymouth) to include the assets of P.A.C. Realty Company (P.A.C.). P.A.C. and its officers have at all times asserted their status as a substantial adverse claimant and have strenuously objected to the exercise of summary jurisdiction by the bankruptcy court.

The sole matter raised in this appeal is a question of jurisdiction: whether the issue below was properly tried in summary proceedings or whether the trustee should seek his remedy by way of plenary suit. More precisely, the question is whether the referee exceeded his jurisdiction in the process of his preliminary inquiry as to the character (colorable or substantial) of P.A.C.'s claim. We believe that the exercise of summary jurisdiction was warranted by the facts in this case.

The applicable principles of law are not in dispute. "A bankruptcy court has the power to adjudicate summarily rights and claims to property which is in the actual or constructive possession of the court. * * * If the property is not in the court's possession and a third person asserts a bona fide claim adverse to the receiver or trustee in bankruptcy, he has the right to have the merits of his claim adjudicated 'in suits of the ordinary character, with the rights and remedies incident thereto.' * * * But the mere assertion of an adverse claim does not oust a court of bankruptcy of its jurisdiction. * * * It has both the power and the duty to examine a claim adverse to the bankrupt estate to the extent of ascertaining whether the claim is ingenuous and substantial. * * * Once it is established that the claim is not colorable nor frivolous, the claimant has the right to have the merits of his claim passed on in a plenary suit and not summarily. Of such a claim the bankruptcy court cannot retain further jurisdiction unless the claimant consents to its adjudication in the bankruptcy court."*fn1 An adverse claim is said to be "substantial" "when the claimant's contention 'discloses a contested matter of right, involving some fair doubt and reasonable room for controversy,' * * * in matters either of fact or law; and is not to be held merely colorable unless the preliminary inquiry shows that it is so unsubstantial and obviously insufficient, either in fact or law, as to be plainly without color of merit, and a mere pretense."*fn2 In applying the Harrison test to a particular set of facts "[the] referee must proceed to determine whether the adverse claim is 'plainly without color of merit and a mere pretense' on a proper weighing of the testimony considered in the light of the claimant's self-interest and a due consideration of existing law." (Emphasis supplied).*fn3

The undisputed facts disclosed by the referee's preliminary inquiry may be briefly summarized.

In 1937 Plymouth Dye Works was formed by Paul Manton (50% interest), Alfred Gellene, Sr. (25%) and Charles Rosenberg (25%) to engage in the textile dyeing business. The corporation enjoyed substantial yearly profits until 1951 when it sustained a loss of $237,881. The following year appellant P.A.C. Realty was formed by Manton, Gellee and Rosenberg. The stockholders and officers of P.A.C. were identical with the stockholders and officers of Plymouth Dye Works. To this new corporation Plymouth Dye Works transferred its real estate, machinery and equipment and other minor items, with the exception of some office furniture and equipment. There is also testimony that P.A.C. additionally assumed and paid certain liabilities of Plymouth Dye Works amounting to $32,184. The net value of the transfer is placed at $705,140. In exchange therefor, Plymouth Dye Works received from P.A.C. all of its capital stock. This transfer of assets from Plymouth Dye Works to P.A.C. was carried out pursuant to the "spin off" provisions of the Internal Revenue Code.

Plymouth Dye Works then distributed all of the P.A.C. capital stock to its stockholders, Manton, Gellene and Rosenberg, who, as noted above, were also the stockholders of Plymouth Dye Works. Nothing was paid to Plymouth Dye Works for this distribution. The accountant for Plymouth Dye Works (and P.A.C.) testified that P.A.C. was formed at his suggestion in order to minimize Federal income taxes through utilization of the spin-off provisions of the Code. According to the testimony of Gellene, Sr. it was Manton's idea to form P.A.C. and he (Gellene) never asked why substantially all the fixed assets were to be transferred out of Plymouth Dye Works to P.A.C.

In any event, P.A.C. and Plymouth Dye Works thereafter entered into a written lease agreement on June 20, 1952 whereby P.A.C. leased the premises and machinery to Plymouth Dye Works for a term of one year. The lease, which was signed by Manton and attested to by Gellene, Sr. as president and secretary, respectively, of both corporations, called for an annual rental of $42,000 payable in monthly installments of $3,500. For the six months period of June 20, 1952 to December 31, 1952 Plymouth Dye Works paid P.A.C. $36,000, or an overpayment of $15,000. In that year Plymouth Dye Works had a profit of $12,801. During the calendar year 1953 Plymouth Dye Works paid P.A.C. $72,000 for rent, an overpayment of $30,000, and in the same year had a loss of $79,041. In the calendar year 1954 the rental of $42,000 called for in the original lease was paid by Plymouth Dye Works, while it sustained a loss of $105,785.

On February 17, 1955 a new corporation known as Hood Dye and Print Works, Inc. was organized with stockholders of record consisting of Charles Rosenberg's son Alvin (99 shares); Alfred Gellene, Jr. (50 shares); Leo Bohl (attorney for Plymouth Dye Works - 50 shares), and Louis Green (1 share). Its name was changed to Plymouth Dyeing Company, Inc. (hereinafter referred to as Hood-Plymouth) on March 10, 1955 and it commenced operation on April 13, 1955. The testimony indicates that the original 1937 corporation, Plymouth Dye Works, operated in January and part of February 1955 and then stopped doing business under that corporate name for the remainder of year. Although the corporation, Plymouth Dye Works, did not continue business under that name after February 1955, the evidence revealed that there was a continuity of business function under the several corporate names throughout the year. HoodPlymouth was dissolved on December 30, 1955 and Plymouth Dye Works was "reactivated" in order to take advantage of the loss carryback provisions of the Internal Revenue Code. Book entries were made transferring the assets and liabilities of Hood-Plymouth to Plymouth Dye Works and the latter then changed its name to Plymouth Dyeing Co., Inc. (Plymouth). Plymouth operated from January 1, 1956 until its present adjudication as bankrupt in April 1961.

In May 1955 a new written lease agreement was executed between P.A.C. and Plymouth, which provided for a six month term commencing April 15, 1955 with a rent of $18,000 plus 30% of the profit before taxes. In February of that year Gellene, Sr. and Charles Rosenberg had bought out Manton's interest in Plymouth Dye Works and P.A.C. for $76,000. Accordingly, the new P.A.C.Plymouth lease was now signed by Gellene, Sr. and Rosenberg as president and secretary, respectively, of both corporations. In 1955 P.A.C. was paid $41,000 (or $41,200) as rent when only $38,000 was due under the applicable leases. Plymouth lost $81,640 in 1955. During the subsequent years Plymouth paid as rent $52,400 in 1956 (an excess payment of $16,400); $50,800 in 1957, $54,000 in 1958 and 1959, an excess of $18,000 in both years) and $45,351 in 1960 (excess of $9,351). In the corresponding years Plymouth sustained losses of $24,281 in 1956, $12,526 in 1958, $115,546 in 1959, $219,844 in 1960 and had a $59,356 profit in 1957.

Although there was no written lease in existence between P.A.C. and Plymouth after 1955, P.A.C. does not dispute the accuracy of the above figures. P.A.C. alleges that the basic rental sums were provided for by oral leases agreed upon by the principals (Gellene, Sr. and Rosenberg) of Plymouth and P.A.C. No explanation is given for the payments in excess of either the written or oral leases. Thus, from June 20, 1952 to December 31, 1960 P.A.C. received a rental of $109,900 in excess of the total amount called for by the applicable leases. During this same period of excess rental payments Plymouth sustained a total loss of $577,352.

The testimony further showed that in the fall of 1960 P.A.C. issued a distraint on the remaining fixed assets held by Plymouth (primarily office furniture and equipment) for nonpayment of the September rent. These assets, having a cost value of approximately $18,000, were sold to P.A.C., but remained at the same premises and continued to be utilized solely by the tenant Plymouth. At the time of the distraint Plymouth had a substantial bank account and subsequent to the sale it continued paying rent as before to P.A.C.

Against this background of the divestiture of tangible assets and the Plymouth-P.A.C. rental arrangements, additional undisputed facts appear. From 1952 to 1960 P.A.C.'s expenses of approximately $84,500 were attributable to taxes, insurance and repairs. The balance of the total rental payments - apprxvimately $363,219 - was spent for the acquisition of new equipment and fixed assets to be used by Plymouth in its dyeing operation. These rental payments were the sole source of income for P.A.C. P.A.C. shared the office space with Plymouth and had no separate designated office space of its own; P.A.C.'s books were kept by Plymouth's bookkeeper, her salary was paid by Plymouth; and P.A.C. never declared any dividends and at most paid its officers a nominal salary. The uncontradicted testimony of Gellene, Sr., one of the principals in both Plymouth and P.A.C., is especially illuminating. When asked what the sole function of P.A.C. was he replied, "We had no function, we just had real estate and machinery." And later he agreed that the sole function of P.A.C. was to collect rent from ...

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