HIJ Indus., Inc. v. Roy (In re Roy)

565 B.R. 820

IN RE: Jeremey C. ROY, Debtor

HIJ Industries, Inc., formerly known as JOMCO, Inc., Plaintiff

v.Jeremey C. Roy, Defendant

CASE NO. 15–51217

ADV. NO. 15–5084

United States Bankruptcy Court, E.D. Kentucky, Lexington Division.

January 26, 2017

Tricia A. Shackelford, Lexington, KY, for Plaintiff.

John M. Simms, Lexington, KY, for Defendant.

MEMORANDUM OPINION AND ORDER DENYING MOTION TO REOPEN PROOF

Tracey N. Wise, Bankruptcy Judge

This matter is before the Court following the conclusion of a trial on the merits of the causes of action that Plaintiff HIJ Industries, Inc., formerly known as JOMCO, Inc.,¹ asserted against Debtor/Defendant Jeremey C. Roy, seeking to bar Debtor's discharge under § 727(a)(2) and/or to except HIJ's claims from Debtor's discharge under § 523(a)(6).² Both Plaintiff and Debtor appeared at trial and were represented by counsel. Having heard the evidence, the Court finds HIJ did not satisfy its burden to prove an entitlement to relief on its claims. In addition, the Court denies HIJ's motion to reopen proof filed on October 10, 2016. [ECF No. 119.]

FACTUAL BACKGROUND

The parties stipulated to many facts relating to HIJ's claims, rendering them undisputed for purposes of the trial. [ECF No. 99.] The following recitation derives from the stipulations, testimony and evidence presented at trial.

A. The Sale of HIJ's Business to EMS, and EMS's Subsequent Collapse.

HIJ's principal, Jeffrey O'Brien, formed HIJ in 1990. HIJ operated a fabrication and machining shop ultimately located in Versailles, Kentucky. HIJ made custom-built machinery; essentially, HIJ built machines that made machines to be used in factories. Mr. O'Brien testified that HIJ had gross sales in a wide range, varying from $350,000 to $525,000, in the last several years that he owned the business. He also testified that HIJ had a history of strong annual earnings under his leadership.

Mr. O'Brien decided that he wanted to sell his business in 2007, and so he had the company appraised and engaged a business broker to help him find a buyer. The broker brought several potential purchasers to Mr. O'Brien, including both Debtor and non-party Robert Fleming, a journeyman with a certificate in tool-making and on-the-job training as a junior engineer. Neither Debtor nor Mr. Fleming had the expertise or financial wherewithal to acquire the business by himself.

Debtor Jeremey Roy holds a Master's Degree in Business Administration and is a Certified Management Accountant. When he first investigated acquiring HIJ in or around early 2008, Debtor had worked for several employers as an accountant and was interested in becoming his own boss. He also wanted to own a company to help finance the education of his three small children. Debtor found the opportunity to acquire HIJ online and had interest, in part, because it was located close to his home in Lexington, Kentucky. Debtor did not attempt to acquire HIJ initially because he thought it unlikely that he could run the business (he had no manufacturing experience) or obtain financing. Months later, another broker introduced Debtor to Mr. Fleming to explore whether they could acquire HIJ's business together as business partners. Mr. Fleming had experience in the operational aspects of the machining business, while Debtor had the expertise to handle accounting and related financial matters.

On November 11, 2009, Debtor formed Elite Machining Services, LLC ("EMS") for the purpose of purchasing HIJ's assets. Debtor held a 65% membership interest in EMS and Mr. Fleming owned the remaining 35% interest. On December 11, 2009, EMS purchased HIJ's assets (the "Assets") for a total of $855,000 (the "Purchase Price") via an Asset Purchase Agreement (the "Agreement"). The Assets included furniture, fixtures, and equipment, valued at $150,000, and tooling valued at $50,000. Mr. Roy contributed $70,000 in cash toward the Purchase Price. EMS funded most of the Purchase Price, $641,500, via a small business association ("SBA") loan serviced by Huntington National Bank ("HNB"). EMS issued two promissory notes to HIJ to pay the remainder of the Purchase Price, one for $42,000 and another for $131,500 (the "Notes"). Debtor personally guaranteed the SBA loan and both Notes.

EMS continued HIJ's business after acquiring the Assets. Mr. Fleming ran EMS's day-to-day operations, including making bids, managing labor, buying materials, and making product, while Debtor, who maintained other employment, handled bookkeeping and invoicing for EMS. Mr. Roy and Mr. Fleming were EMS's only officers.

HIJ introduced evidence regarding executive compensation at EMS. The EMS tax returns for 2010 and 2011 reflect that officer salaries increased from $89,000 in 2010 to about $117,000 in 2011, even though revenue decreased in that time frame. When asked about this fact, Debtor explained that he and Mr. Fleming did not look at the EMS financials when setting their salaries because Mr. Fleming expected the business to grow substantially. Debtor stated "Rob told me how much he needed to make, so that's how we set the salary." Debtor testified that Mr. Fleming earned a salary of about $80,000 and his own salary was roughly $30,000 to $35,000. Debtor also testified that distributions were made to officers in 2010 because EMS had cash at the time to make the distributions.

The Agreement required Mr. O'Brien to provide training and consulting services to EMS after the acquisition. Mr. O'Brien introduced Mr. Fleming to customers post-acquisition. Mr. O'Brien also worked at EMS for about a month and a half after the transition, until Mr. Fleming told Mr. O'Brien that his services no longer were required. While he provided the consulting services, Mr. O'Brien perceived that Mr. Fleming and Debtor were not receptive to his critiques.

Debtor testified that problems arose at EMS almost immediately after it took over HIJ's business. Within a few weeks after the acquisition, HIJ's primary customer, United Glass, stopped sending business to EMS. Debtor and William Dray, a long-time employee for HIJ who then worked for EMS, described United Glass as providing 50–80% of HIJ's business; Mr. O'Brien called United Glass a "very big customer." Debtor was told that United Glass had moved its production work from Versailles, Kentucky to another location and thus no longer needed EMS's services. Mr. O'Brien stated that he did not know that United Glass was going to stop sending work to EMS within weeks of the asset sale. Not only did United Glass stop ordering from EMS, it also failed to pay a significant receivable to EMS for about 75–90 days, which adversely affected EMS's cash flow.

When EMS management asked Mr. O'Brien about declining sales with United Glass, Mr. O'Brien advised them to "pick up the phone and ask what's going on." EMS management also asked Mr. O'Brien to call another customer with falling sales, but the customer refused to speak with him. Debtor stated that, in addition to these problems, another EMS customer failed to pay on its account, and EMS never was able to collect on that receivable.

When EMS became desperate for work with the loss of United Glass's business, it tried to procure work as a bulk parts manufacturer even though HIJ historically had operated as a custom parts business. According to Debtor, the decision to take on large, bulk projects required EMS to devote significant cash to buy raw materials. Mr. O'Brien testified that margins are high in custom manufacturing, whereas bulk manufacturers must have a high-volume business to make money. Mr. O'Brien questioned the swift change in the business model, but offered no evidence to support his view that the decision to make the change somehow was nefarious.

As time progressed, the problems worsened for EMS. Although Mr. Fleming's role was to handle operations, he fell ill for a long period and could not work. While Debtor had procured disability insurance for this possibility, the policy lapsed, resulting in a significant set-back for EMS. In addition, Debtor testified that Mr. Fleming purchased equipment for EMS with cash without consulting him, which further hindered the business and EMS's liquidity.

HIJ explored numerous alternatives to address its financial challenges. Debtor left a full-time position with Nestle so that EMS could bid for work from Nestle, as discussed below. In 2011, Debtor searched for new investors or a potential purchaser for EMS to no avail. In July 2011, Debtor met with a bankruptcy attorney to explore the viability of EMS filing bankruptcy and/or reorganizing, but EMS did not have the funds necessary to go through the bankruptcy process. In August or September 2011, Debtor contacted Second Wind Consulting, a company that specializes in debt restructuring, turnaround consulting, and capital formation. EMS retained Second Wind Consulting to help negotiate a settlement on the default of its SBA loan, as Debtor could not see a way for EMS to continue in business. In September 2011, EMS defaulted on its SBA loan and the Notes.

While EMS made payments to HIJ on the smaller Note, it never made payments on the bigger Note. The last Note payment to HIJ came in September 2011 and, in October 2011, Mr. O'Brien was told that no further payments would be made on the Notes, though he never was asked about whether there was a way to work out another payment plan.

B. Other Corporate Activity Involving Debtor.

After EMS's customer base began to erode, Debtor saw an opportunity for EMS to bid on work for Nestle, his then-current employer; however, EMS could not bid on such work while Debtor remained a Nestle employee. To enable EMS to bid on Nestle work, Debtor resigned from his job as the Head of Factory Finance at Nestle, which paid about $130,000 per year, and found employment as an accounting manager with Precision Castparts in West Virginia. Debtor commuted from Lexington, Kentucky, each week for this job.

Debtor met fellow Precision Castparts employees Jim Dome and William...