In re Joy Recovery Technology Corp.

286 B.R. 54

In re JOY RECOVERY TECHNOLOGY CORPORATION, Debtor Noel Daley, not individually, but solely as Trustee for the Joy Recovery Technology Corporation Liquidation Trust, Plaintiff, v. Mark J.F. Chang and Cathy C.H. Chang, Defendants.

Bankruptcy No. 97 B 36491.

Adversary No. 98 A 02044.

United States Bankruptcy Court, N.D. Illinois, Eastern Division.

November 20, 2002.

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Christopher J. Horvay, Esq., Gould & Ratner, Chicago, IL, for Plaintiff.

Scott N. Schreiber, Esq. Much, Shellist, Freed, Denenberg, Ament & Rubenstein, P.C., for Defendants.

Stephen Wolfe, Esq., U.S. Trustee.

FINDINGS OF FACT AND CONCLUSIONS OF LAW

JACK B. SCHMETTERER, Bankruptcy Judge.

In the related Chapter 11 Bankruptcy of Joy Recovery Technology Corporation ("Joy"), its liquidating Plan was confirmed on September 24, 1998. Joy liquidated its assets and established a Liquidating Trust (the "Trust") to pursue the present Adversary, over which the confirmed Plan retained jurisdiction in this Court. Noel H. Daley ("Trustee") was appointed as Trustee of the Trust. In that capacity he filed the present Adversary proceeding seeking to recover moneys borrowed by Joy for use by Nick Young ("Young"), president and 50% shareholder of Joy, to purchase Joy stock from Mark Chang ("Chang"), chairman of the board, director, and alleged joint owner of 50% of the company's shares with his wife, Cathy Chang.

The Trustee charges that Chang looted his former company Joy by selling his 50% stock interest to Young in a leveraged buyout ("LBO") which left the company insolvent, and that he thereby constructively defrauded Joy's creditors. The Adversary Complaint also avers that Chang breached his fiduciary duty to Joy's creditors and misappropriated company assets. Accordingly, the Trustee invoked the "strong-arm" powers of Section 544 and 550 of the Code as well the Illinois Uniform Fraudulent Transfer Act to recover $2.1 million from the Changs.

The Complaint is pleaded in five counts: Counts I and II averred fraudulent transfers under Section 544 of the Code and 740 ILCS §§ 160/5(a)(2) and 160/6(a), respectively; Counts III and V alleged that the Changs' owed a fiduciary duty to Joy's creditors as officers and sole shareholders and that they breached that duty by causing the subject transaction; and Count IV charged misappropriation of corporate assets under 805 ILCS § 5/8.60. The Trustee also objects to Changs' claim against Joy under 11 U.S.C. § 510. The charges against Nick Young were settled, and the case went to trial on the remaining allegations against the Changs. After both sides rested, the parties presented their closing arguments in writing. Following trial, the Findings of Fact and Conclusions of Law set forth below are now made and entered.

The Findings and Conclusions are based on consideration of the evidence at trial and written arguments. In an earlier opinion denying summary judgment, the Court made findings of undisputed facts applicable to trial. In re Joy Recovery Technology Corp., 257 B.R. 253 (Bankr.N.D.Ill.2001), which are incorporated in the Findings set forth below. For reasons stated below, Judgment will be entered for the Changs on Count I, but will separately enter for the Trustee on Count II against Mark and Cathy Chang¹ (collectively "Chang"), and individually against Mark Chang on Counts III, IV, and V. Further, the Changs' claim will be subordinated under § 510 of the Bankruptcy Code.

JURISDICTION AND VENUE

Jurisdiction lies under 28 U.S.C. §§ 1334(b) and 157(a). The matter is referred here under the standing referral of District Court Internal Operating Procedure 15(a). This is a core proceeding pursuant to 28 U.S.C. §§ 157(b)(2)(B) and (B)(2)(H). Venue lies here under 28 U.S.C. §§ 1409(a) and (c).

FINDINGS OF FACT

1. In 1981, Chang incorporated Joy Metal, Inc. In 1992, Joy Metal Inc. changed its name to Joy Recovery Technology Corporation.

2. Joy's business was the recovery of various metals from industrial telecommunications wiring and computers. Joy's recovery operation benefitted its customers in two ways: it reduced acquisition costs by recycling metals, and it minimized potential environmental disposal problems. Initially, Chang held the bulk of Joy's shares and his wife held forty-nine shares of a Joy subsidiary, but Young eventually became a 50% shareholder of the company with the Changs holding the other shares. Chang and Young shared responsibility for operating Joy's business until mid-1995.

3. In addition to being an employee, director, and president of one of Joy's divisions, Chang was Chairman of the Board of Directors.

4. On June 25, 1994, Chang agreed to increase Joy's Board of Directors from two members (formerly only Chang and Young), to five members. This step effectively eliminated Chang's veto power over corporate proposals that he did not like.

5. During 1995, Chang and Young had heated arguments over Joy's future business strategy. Young wanted to invest in a new technology being developed in China. Chang thought the new venture was too risky and wanted to concentrate on Joy's core business. At a board meeting in April 1995, Chang suggested that Young should buy him out or he would buy Young's shares. Young asked Joy's vice-president, Lee Riegler, to explore how he might purchase Chang's stock. Riegler consulted with the law firm of Holleb & Coff which produced a memorandum outlining several possibilities including an Employee Stock Option Plan ("ESOP"), a cross-purchase, a stock redemption, or a combination of all three.

6. Chang rejected the various proposals and insisted on a stock buyout for $2.6 million. Young thought that price was high, but eventually agreed to resolve the impasse between him and Chang. In June of 1995, Chang retained Michel Shelist ("Shelist") as legal counsel regarding the sale of his stock, and Young retained Edward Salomon ("Salomon") as his counsel for the transaction.

7. After returning from a trip to China, Chang became ill.

8. On August 16, 1995, Chang was taken to Lutheran General Hospital where he was diagnosed with anoxia/carbon monoxide poisoning. As a result of his illness, Chang experienced difficulty for several months in short-term memory, speech problems, lethargy, slower ambulation, fluctuating lucidity, and changes in personality.

9. Chang did not participate in Joy's day-to-day decision making between July 1995 and the end of 1995, while he was recuperating.

10. Because of Chang's illness, Young did not believe that Chang was physically capable of executing Joy's strategic business plan.

11. Young agreed to prepare weekly memoranda and operating reports regarding Joy's day-to-day activities for Chang.

12. On August 18, 1995, senior management of Pioneer Bank (the "Bank" or "Pioneer") prepared an internal document offering new credit terms to Joy ("August Loan Recap."). Joy had previously been financed by LaSalle Bank, but it accepted Pioneer's offer. Part of the funds received from Pioneer was to be used to pay off loans made by LaSalle. Pioneer offered to Joy three loans in all, including one totaling $2.1 million to be used to fund the purchase by Young of Chang's stock.

13. In late September, Young sent Chang a letter-of-intent and a handwritten memo offering that he would personally purchase the Changs' 50% interest in Joy for $2,600,000. The letter-of-intent did not contain a financing contingency. Young told his counsel, Salomon, who drafted the letter-of-intent, that the deal between him and Chang was to be a "cross-purchase."

14. The September memorandum from Young indicated that he had secured a potential party to invest by August 24, 1995. In fact, Young did not actually have an investor, but, he was negotiating with several potential investors in Taiwan. Young testified that he needed an investor because he could not afford to finance the deal himself.

15. No investor ever committed to purchase Joy's stock.

16. To raise the money for the purchase, Young decided that Joy should borrow $2,100,000 ("the Loan") from Pioneer Bank ("Bank").

17. On September 20, 1995, senior management at the Bank revised the August Loan Recap and proposed that the Bank increase its proposed commitment and agree to make four rather than three loans to Joy, these four loans totaling $4.1 million (the "September Loan Recap.") included one loan for $2.1 million to pay for the purchase of Chang's stock.

18. On September 29, 1995, Joy applied for an account at the Bank. On or about October 2, 1995, the Bank sent Joy four commitment letters regarding the four loans. Those commitments totaled $4.1 million.

19. Shortly thereafter, Joy changed its banking and lending relationship from LaSalle Bank to Pioneer Bank & Trust Company.

20. On October 13, 1995, Joy entered into a secured credit agreement with the Bank.

21. The Bank made three of the four loans set forth in the September loan recap. The $2.1 million loan for stock acquisition was not made at that time. Chang was not involved in negotiations with Pioneer Bank, but the switch from LaSalle Bank and payoff of the LaSalle debt meant that Chang no longer had personal responsibility on loans to Joy which he had earlier guaranteed.

22. Pioneer Bank knew that the $2.1 million credit facility would fund the purchase of Chang's stock. The Loan Recap from the Bank stated that the $2.1 million buyout price for that stock was "relatively low ... given [Joy's] current projected growth patterns."

23. Joy provided the Bank with a copy of Joy's business Plan.

24. The Pioneer Bank required Young to personally guarantee repayment of the Loan.

25. Young provided the Bank with his personal financial information. According to his personal financial statement, Young had a personal net worth of $1,171,000. However, he only had $350,000 in liquid assets. Therefore, the...