Decree setting aside as fraudulent per se a preferential payment by an insolvent corporation to a bona fide creditor who was also its controlling person, affirmed; in personam judgment vacated and remanded for ratable distribution of the amount paid among the two unpaid creditors.
Creditors' Rights — Statutory Construction — Insolvency — Close Corporations — Controlling Persons — Preferential Payments — Fraudulent Conveyances (Code Sec. 55-80) — Burden of Proof — Remedies — Judgments
Defendant was president, sole stockholder and a director of a corporation experiencing financial difficulties. He deferred payment of his own salary and the company subsequently became insolvent. On advice of counsel, defendant closed the business, paid himself $3,888.20 in deferred accrued salary and paid all other creditors in full except for one, plaintiff. Plaintiff and defendant were both unsecured general creditors. Plaintiff sued to set aside the payment to defendant as a fraudulent conveyance under Code Sec. 55-80.
1. An insolvent debtor, individual or corporate, may generally prefer some bona fide creditors to the exclusion of others.
2. Absent clear and convincing proof that the debtor made the preference with intent to defraud other creditors and the knowledge of the preferred creditor, a fraudulent conveyance under Code Sec. 55-80 is not established.
3. When an insolvent corporation prefers a creditor who is in complete control of the corporation's affairs over other creditors, the preference is fraudulent per se. Darden v. Lee Company, Inc., 204 Va. 108, 129 S.E.2d 897 (1963), applied.
4. Cases where the preferred creditors are not in complete control or are not directly paid are outside the rule of per se fraudulence. Bank of Commerce v. Rosemary and Thyme, 218 Va. 781, 239 S.E.2d 909 (1978) and Planters Bank of Farmville v. Whittle, 78 Va. 737 (1884), distinguished.
5. The statute, Code Sec. 55-80, contains no authority for award of an in personam judgment when a fraudulent conveyance is set aside and it was error for the trial court to enter such a judgment.
6. Where the validity of the preferred creditor's claim is unchallenged, the appropriate remedy for the preferential payment is submission of the amount of the payment, plus interest, to the court for ratable distribution between the two creditors. Darden v. Lee Company, Inc., construed.
STEPHENSON, J., delivered the opinion of the Court.
Miller Harness Company, Inc. (Miller), sued Carroll C. Mills to set aside certain payments made to Mills by Stombock's Fine Riding Apparel Ltd. of Virginia, Inc. (Stombock), on the ground that the payments constituted a fraudulent conveyance in violation of Code Sec. 55-80. The trial court set aside the payments and awarded Miller an in personam judgment against Mills.
"Code Sec. 55-80 reads as follows:
Every gift, conveyance, assignment or transfer of, or charge upon, any estate, real or personal, every suit commenced or decree, judgment or execution suffered or obtained and every bond or other writing given with intent to delay, hinder or defraud creditors, purchasers or other persons of or from what they are or may he lawfully entitled to shall, as to such creditors, purchasers or other persons, their representatives or assigns, be void. This section shall not affect the title of a purchaser for valuable consideration, unless it appear that he had notice of the fraudulent intent of his immediate grantor or of the fraud rendering void the title of such grantor.
The primary question in this appeal is whether a corporation's preferential payment of a bona fide debt to a creditor who is in complete control of the corporation's affairs is, as a matter of law, a fraudulent conveyance in violation of Code Sec. 55-80. If we answer the primary question affirmatively, the secondary question is whether the court erred in granting the in personam judgment rather than directing that the total payments be distributed ratably among the corporation's creditors.
The facts are undisputed. Mills was president, sole stockholder, and a director of Stombock. He, alone, controlled the management of Stombock's business. When Stombock began to experience financial difficulties, Mills deferred receipt of his salary payments from Stombock. Subsequently, Stombock became insolvent.
On the advice of Stombock's attorney, Mills closed the business, liquidated the corporation's assets, and paid all Stombock's creditors except Miller. Miller's unpaid claim was $5,983.97. Mills, himself, was among the creditors paid. He received $3,888.20 in deferred accrued salary. Both Mills and Miller were unsecured general creditors.
[1-2] Generally, an insolvent debtor, whether an individual or a corporation, may prefer some bona fide creditors to the exclusion of others. Absent clear and convincing proof that a debtor made the preference with intent to defraud the other creditors and that the preferred creditor had notice thereof, the unpaid creditors cannot successfully attack the preference as a fraudulent conveyance under Code Sec. 55-80. Surratt v. Eskridge, 131 Va. 325, 108 S.E. 677 (1921). See also Beck v. Semones' Admr., 145 Va. 429, 134 S.E. 677 (1926).
This general rule, however, is subject to an exception. When an insolvent corporation prefers a creditor who is in complete control of the corporation's affairs over other creditors of the corporation, the preference is fraudulent per se. Darden v. Lee Company, Inc., 204 Va. 108, 129 S.E.2d 897 (1963).
Mills contends that the present case is governed by the general rule and that, because his debt was valid and there is no evidence of actual fraud, Stombock's payments were simply a permissible preference and not a fraudulent conveyance proscribed by Code Sec. 55-80. He relies upon Bank of Commerce v. Rosemary and Thyme, 218 Va. 781, 239 S.E.2d 909 (1978), and Planters Bank of Farmville v. Whittle, 78 Va. 737 (1884). His reliance is misplaced.
These cases are readily distinguishable from the instant case. In neither Bank of Commerce nor Planters Bank was the preferred creditor in complete control of the corporation's affairs. 218 Va. at 787, 239 S.E.2d at 913-14; 78 Va. at 738. Moreover, while the corporate directors in both cases were indirectly liable for payment of the preferred debt as endorsers, the direct creditor was an innocent third party. 218 Va. at 787, 239 S.E.2d at 913-14; 78 Va. at 738.
The present case, on the other hand, is factually similar to Darden. Here, as in Darden, the preferred creditor completely controlled the corporation's affairs. Further, the corporate manager was himself the creditor of the corporation and not merely an endorser for a third party. Thus, applying the Darden exception, the court correctly ruled that the preference was fraudulent as a matter of law.
The remaining question is whether the court erred in awarding Miller an in personam judgment against Mills for the money fraudulently paid rather than directing that the money be distributed ratably to Miller and Mills. We find nothing in the statute authorizing a court to award an in personam judgment when a fraudulent conveyance is set aside. We conclude, therefore, that this was error.
We believe that the amount fraudulently paid should be returned for a ratable distribution to Miller and Mills. This is consistent with the remedy fashioned in Darden. In Darden, as here, two general creditors remained unpaid, and we implicitly approved a ratable distribution. 204 Va. at 113-14, 129 S.E.2d at 900-01. Because the validity of Mills' claim is unchallenged, we will remand the cause with directions that Mills pay $3,888.20, plus interest, into court for a ratable distribution to both of Stombock's creditors.
Summarizing, we will affirm that portion of the court's decree setting aside the fraudulent conveyance. However, we will reverse that part of the decree granting Miller an in personam judgment and remand the cause for a distribution of the funds.
Affirmed in part, reversed in part, and remanded.
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