Brooks v. Strategic Funding Source, Inc. (In re Brooks)

619 B.R. 669

IN RE: Anthony D. BROOKS and Amy J. Brooks, Debtors.

Anthony D. Brooks and Amy J. Brooks, Plaintiffs,

v.Strategic Funding Source, Inc. and First Midwest Bank, Defendants.

Case No. 18-80311

Adv. No. 19-08072

United States Bankruptcy Court, C.D. Illinois.

SIGNED THIS: August 14, 2020

Gordon Gouveia, Fox Rothschild LLP, 321 N. Clark Street, Suite 1600, Chicago, IL 60654, for Debtor(s)

Lydia Anne Bueschel, Valentine Austriaco and Bueschel, 105 W. Adams, 35th Floor, Chicago, IL 60603, for Defendant Strategic Funding Source, Inc.

Jeffrey E. Krumpe, 416 Main St. #1125, Peoria, IL 61602, for Defendant First Midwest Bank

OPINION

Thomas L. Perkins, United States Chief Bankruptcy Judge

This matter is before the Court after trial on Count III of the complaint filed by Anthony D. Brooks and Amy J. Brooks, the Debtors, against Strategic Funding Source, Inc. (Strategic) and First Midwest Bank (FMB), and the First Crossclaim asserted by Strategic against FMB. A settlement agreement entered into by the Debtors and Strategic, resolving most of the disputes between them, was incorporated into a Chapter 11 plan which has been confirmed. The only remaining issue between the parties to this proceeding involves the competing claims of Strategic and FMB to the balance of the 2018 grain proceeds in the approximate amount of $235,000 held by the Debtors in a Debtor-in-Possession account.

BACKGROUND

The Debtors, engaged in farming since 2000, reside with their young daughter in Avon, Illinois, where their homestead and farmstead are located. In addition, the Debtors own approximately forty acres of livestock pasture land with a small rental house in nearby Berwick. The Debtors operate a corn and soybean farming business as a sole proprietorship, doing business as Brooks Farm, renting as much as 4,000 acres in some years. Beginning in 2012, the Debtors financed their farming operation through a series of loans with FMB. The loans were secured pursuant to a security agreement dated July 16, 2012, which granted FMB a lien on substantially all of their assets, as well as by mortgages on their real estate. In July 2012, the Debtors borrowed $2,800,000 from FMB. FMB perfected its security interest by filing a financing statement on August 2, 2012.

The Debtors encountered financial difficulties in 2013, which led to additional borrowing from FMB in subsequent years, placing the Debtors in a highly leveraged position. In December 2015, while awaiting FMB's restructuring of their loans, Anthony, with the encouragement of his FMB loan officer, Adam Stonecipher, sought another source of funding for the 2016 crop inputs, in order to qualify for cash discounts offered by input vendors.

On December 29, 2015, Anthony executed a Revenue Based Factoring Agreement with Strategic, a New York company engaged in the business of paying merchants cash for future receivables. Under the Factoring Agreement, the Debtors sold and Strategic purchased all of the Debtors' "future receipts, accounts, contract rights and other obligations arising from or relating to the payment of moneys" from the Debtors' customers, until such time as the "Receipts Purchased Amount," designated to be the sum of $236,250, was paid in full by the Debtors to Strategic. The Receipts Purchased Amount was to be paid over a one-year term, by ACH debit from a bank account designated by the Debtors in 26 bi-weekly payments of $9,086, in exchange for which the Debtors were to receive an immediate cash payment from Strategic in the amount of $175,000.

The Debtors designated their operating account at FMB as the account from which the ACH payments to Strategic were to be debited. The account statements for this account, called a Solutions Checking account, reveal a large amount of activity. In January 2016, the account had over $580,000 in deposits and $616,000 in debits, with an average balance of $57,000. In February, deposits of $205,000 were made against $198,000 of debits, with an average balance of $34,000. In March, deposits of $1,315,000 were made with debits of $1,316,000, and an average balance of $55,000. In April, $626,000 in deposits were made and $572,000 in debits, with an average balance of $94,000.

In connection with the transaction, Anthony executed a related Security Agreement and Guaranty granting Strategic a security interest in all accounts, chattel paper, documents, equipment, general intangibles, instruments, and inventory, including after-acquired property and all proceeds. On January 11, 2016, after deducting $1,205 for certain transaction fees, Strategic caused the cash proceeds under the Factoring Agreement of $173,795 to be deposited into the Debtors' operating account at FMB by wire transfer. Strategic perfected its security interest by filing a UCC financing statement on January 12, 2016.

The Debtors' loans with FMB were restructured in early March 2016. Those loans, totaling $7,079,165, included a line of credit in the amount of $2,250,000; the 2015 grain inventory note with a balance of $1,916,182; the 2015 carryover single pay note at $822,733; the Ag equipment note at $1,268,650; and real estate mortgages at $821,600. In so doing, however, FMB viewed the loans with concern, given the significant amount of debt owed by the Debtors. As a special condition of the restructured loans, FMB required copies of receipts/bills for bank controlled draws from the 2016 line of credit to reconcile with 2016 cash flow projections.

Instead of bi-weekly debits, weekly ACH debits of $4,543 began on January 19, 2016, and continued to be made to Strategic, on a regular basis. In mid-April 2016, however, the ACH debit of $4,543 to Strategic would have resulted in an overdraft of $2,210.33, and thus required special approval by FMB. Following a communication between Mr. Stonecipher and Douglas Slaton, FMB's Vice President, regarding the negative account balance, the ACH payment was not made. Mr. Stonecipher advised Slaton that he was not aware of any business the Debtors had with Strategic and that he would inquire of Anthony. That same day, while responding to a request from Amy Brooks for a transfer of funds to cover certain itemized expenses, Stonecipher advised her that he noticed the Strategic transaction and requested information concerning it, asking whether it should be covered with an advance from the line of credit. She did not answer his inquiry.

On May 17, 2016, Anthony suffered severe injuries when a bull ran over him, breaking his back and pelvis. After spending forty-five days in the hospital, he recovered at home, remaining bed-bound until early to mid-August. At some point while he was recuperating at home, Stonecipher made a farm visit. The date of the visit and the substance of what was discussed is not part of the evidentiary record.

A "Stop Payment" order, bearing a stamped date of August 2, 2016, was placed by FMB on the Debtors' account which halted the ACH debits to Strategic. Mr. Stonecipher denied initiating the order or knowing who did so, although typically an order to stop an ongoing ACH debit is made at the direction of the account holder, according to his testimony. At that point in time, Strategic had been paid $94,028 via ACH debits. By its terms, the Stop Payment would expire on February 1, 2017. Following the Stop Payment order, the Debtors continued to make payments on their own, totaling $17,000, to Strategic by wire transfer. Nonetheless, Strategic declared a default and on October 7, 2016, brought suit against Anthony and Brooks Farm in New York state court, alleging breach of contract, account stated, and breach of guaranty against Anthony. A default judgment was entered against Anthony and Brooks Farms in the amount of $140,074.48.

The Debtors filed a Chapter 11 petition on March 9, 2018. At the time the case was filed, the Debtors' assets included harvested corn valued at $985,500, cattle valued at $101,000 and farm equipment and machinery valued at $583,550. Strategic was listed on Schedule F as holding an unsecured claim for $125,500. FMB filed a claim for $4,941,389.11, representing the combined amounts due on its loans. Eventually, the Debtors ceased managing their own farming business after the filing of the petition, employing Middle Ground Farms, LLC, as sales consultant and embarking on a plan to liquidate certain assets including grain equipment and cattle livestock in order to pay down secured creditors and reorganize their scaled-down farming operation. During the pendency of the proceedings, FMB received interim distributions of $750,000 in September 2018, $194,157.75 (equipment proceeds) on November 14, 2018 and $60,000 on December 21, 2018. With the making of the third distribution, the Debtors retained approximately $400,000 to cover any remaining expenses.

Strategic did not participate in the proceedings until February 28, 2019, after the law firm which had earlier entered its appearance on behalf of Strategic, made a switch in the attorneys handling the case. On that date, a hearing was held on the Debtors' emergency motion for authority to obtain credit for crop financing for 2019. At that hearing, Strategic first raised with the Court the assertion of an ownership interest, rather than a security interest, in the Debtors' future business receivables, a position which the Debtors strenuously opposed. An agreed order entered on March 4, 2019, authorized the financing on an interim basis, reserving the issue of the respective rights and priorities of FMB and Strategic in the remaining proceeds from the sale of the Debtors' assets.

The Debtors filed their disclosure statement and plan on May 13, 2019. Strategic objected to the plan on the basis that it failed to protect its ownership interest in the Debtors' future receivables. On Oct. 11, 2019, after the filing of an amended disclosure statement and plan, the Debtors filed a motion for approval of a compromise reached with Strategic, which was eventually granted on Dec. 9, 2019...