Hammond v. Lyon Realty Co.

On October 8th, 1927, the Milburn Realty Company, a Maryland corporation, purchased from Caroline V. Richardson a tract of land known as "Glenleigh" containing about twenty-one acres on Glen Avenue near Park Heights Avenue in Baltimore City for $60,000, of which it paid in cash $20,000, and executed to the vendor a mortgage on "Glenleigh" to *Page 444 secure the payment of the balance of the purchase price. The mortgage was in the form ordinarily employed under the Public Local Laws of Baltimore, matured in three years, contained provisions for a consent decree, and the usual covenants for the payment of taxes, charges, assessments, interest, and principal. On January 6th, 1923, Joseph Berman, the Lyon Realty Company, and the Druid Realty Company, of the first part, and the Milburn Realty Company, of the second part, executed an agreement under which Berman, for himself and as president of the Lyon Realty Company, and the Druid Realty Company, agreed to furnish the Milburn Realty Company "at the rate of six per cent. per annum, such sums of money and at such times as I may deem necessary for the carrying on of the business of The Milburn Realty Company." In the same agreement the Milburn Company undertook to execute on demand a mortgage or mortgages pledging any of its property which Berman deemed adequate to secure such loans or advances. On July 29th, 1930, in response to a demand made under that agreement, the Milburn Realty Company executed to the Lyon Realty Company a mortgage for $124,564.38 on its entire assets for loans or advances made to it from time to time by the Lyon Realty Company or the Druid Realty Company.

And, on February 20th, 1931, in consideration of the release of certain land covered by that mortgage, the Milburn Realty Company executed to the Lyon Realty Company another mortgage for $35,000 (the portion of the first mortgage released) on two pieces of fee simple property included in that mortgage. Caroline V. Richardson having been adjudicated a lunatic, and Nathaniel G. Grasty and Peter E. Vale having been appointed a committee of her estate, and the mortgage from the Milburn Realty Company to her being in default, on November 14th, 1930, that committee instituted in Baltimore City foreclosure proceedings to enforce the payment of a balance due under that mortgage "in excess of $38,000." *Page 445 A sale of the property was in due course reported and ratified in that proceeding, and a deficiency decree entered therein in favor of the committee for $29,209.28 on July 29th, 1931. On July 18th, 1931, petitions were filed for the foreclosure of the two mortgages from the Milburn Realty Company to the Lyon Realty Company, the case referring to the earlier being designated as case B and that referring to the later mortgage as case A. A sale was reported to the Beta Realty Company in case A of the property therein described for $705 subject to a first mortgage of $30,000, and in case B a sale was reported to the same purchaser of the property described in the mortgage filed in that case for $5,000, "subject to prior mortgages of $38,501.73." On August 8th, 1931, the committee of Richardson filed in Circuit Court No. 2 of Baltimore City a bill of complaint against the Milburn Realty Company, in which it prayed that that corporation be dissolved, a receiver appointed, and its affairs wound up. As a result of further proceedings, Edward H. Hammond and Abraham Davidson were appointed receivers for the company, and on October 1st, 1931, it was dissolved and the receivers continued in charge of its assets, with authority "to institute any and all proper suits and actions, or to appear in any suits already pending in order to prosecute their rights as Receivers or on behalf of said corporation to any and all preferences, or to any and all claims or choses in action to which they as Receivers, or to which the said corporation have been or is or are now entitled." On September 15th, 1931, the receivers filed exceptions to the sales reported in cases A and B, and on the following day similar exceptions were filed by the committee, both sets of exceptions being grounded on the proposition that the two mortgages to the Lyon Realty Company constituted an unlawful preference and were void.

After the testimony and a hearing, those exceptions were overruled and the sales ratified. The appeals from those decrees were entered by the receivers and the committee, and after that, the Milburn Company *Page 446 having been adjudicated a bankrupt, the appeals were prosecuted by the trustee in bankruptcy. The questions growing out of the appeals may be thus stated: (1) Whether at the time the Milburn Company executed its B mortgage to the Lyon Realty Company it was in fact insolvent; (2) whether the mortgage to the Lyon Realty Company was in effect and for the purposes of this case a mortgage to Berman; (3) whether, if in fact it was insolvent, it could validly prefer Joseph Berman, one of its stockholders, who was also an officer and a director in it, over its general creditors; and (4) whether such preference can be avoided in this proceeding. Since any consideration of those questions involves to some extent the relation in which Berman stood to each of the several corporations to which reference has been made, and as there is no dispute as to just what that relation was, that will be first stated.

The Milburn Realty Company was a Maryland corporation which conducted a real estate and construction business in Baltimore City, in the course of which it bought, sold, leased, mortgaged, and developed real estate. It issued fifty shares of stock, of which sixteen and one-half stood in the name of Joseph Berman, sixteen and one-half in the name of Harry M. Berman, his son, and seventeen in the name of Isaac Rosenberg, his son-in-law. Isaac Rosenberg was its president, Harry M. Berman, its secretary and treasurer, and they with Joseph Berman its board of directors. The Lyon Realty Company was a corporation which was engaged in the business of operating the Riviera Apartments at Lake Drive and Linden Avenue in Baltimore, Md. It issued 500 shares of stock, 498 to Joseph Berman, and 1 each to Harry M. Berman and Isaac Rosenberg.

Joseph Berman was its president and Harry M. Berman its secretary and treasurer, and they with Isaac Rosenberg its directors. Harry M. Berman was merely a nominal officer and the shares of stock which he and Rosenberg owned were mere qualifying shares indorsed "in blank back to Joseph Berman," so that *Page 447 in fact he was the actual owner of all of the stock of that corporation. The Beta Realty Company, a Maryland corporation, was also in the real estate business. It issued to Joseph Berman 248 shares of its stock, and to Harry M. Berman and Isaac Rosenberg, 1 share each.

Harry M. Berman was its president, Isaac Rosenberg its secretary, and they with Joseph Berman its directors. The Druid Realty Company, also a Maryland corporation, issued 189 shares of its stock to Joseph Berman, 10 shares to Harry M. Berman, and 1 share to Isaac Rosenberg. Joseph Berman was president of that company and Harry M. Berman its secretary and treasurer. Reverting to the question first stated, the evidence permits no reasonable inference other than that on July 29th, 1930, the Milburn Realty Company was insolvent within any definition of that term by this court.

Within the meaning of bankruptcy and insolvency statutes, insolvency has been held to mean the inability of a debtor to pay his debts when they accrue in the ordinary course of business. Castleberg v. Wheeler, 68 Md. 277 , 12 A. 3 . In Strouse v. Amer. Credit Indemnity Co., 91 Md. 260 , 46 A. 328 , 330, 1063, an action on an indemnity bond, where liability depended upon the insolvency of debtors, it was said: "The insolvency designated is the usual legally defined `insolvency,' which is an inability of the debtor to pay his debts as they fall due in the ordinary course of business, and this is dependent neither upon a formal adjudication, nor on an actual insufficiency of assets to meet liabilities." In U.S. Fid.

Guar. Co. v. Williams, 148 Md. 304 , 129 A. 660 , an action on an automobile casualty indemnity policy, it was held equivalent to "general financial irresponsibility." And it has been held to mean the insufficiency of the insolvent's assets when fairly appropriated and sold at their fair market value to pay his just debts. 3 Words Phrases, First Series, 2648. The term is not therefore one of precise legal significance, but its meaning varies within somewhat narrow limits according to the facts to which it is applied. But whether it means inability to pay *Page 448 debts as they accrue in the ordinary course of business, or the deficiency of the assets of the insolvent if sold at their fair market value to discharge his liabilties, the evidence in this case leads inevitably to the conclusion that on July 29th, 1930, the Milburn Realty Company was insolvent.

On November 7th of that year that company wrote Messrs. Mullen and Hammond in reference to an extension of the mortgage as follows: "We are desirous of having this mortgage amounting to $37,079.00 extended for a period of two years. Due to present economic conditions, particularly with reference to real estate, we are unable at present time to pay the unpaid taxes for 1929 and 1930, and the six months interest which fell due on October 8th. We propose to pay the 1929 taxes at this time and the 1930 taxes during the year 1931, and further to pay the sum of $200.00 per month on account of the interest.

"We regret that we are unable to do better, but feel that the estate of Miss Richardson would be benefited if our proposition is accepted, rather than resorting to foreclosure proceedings." At that time it owed the Lyon Realty Company $124,564.38, the committee of Caroline V. Richardson an amount which with accumulated interest on November 14th, 1930, exceeded $38,000; it was also indebted to different creditors in amounts aggregating a substantial sum on notes and accounts payable, and its financial condition appears from these extracts from the testimony of Harry M. Berman, its secretary and treasurer: "Q. At that time you owed large sums that you were not able to pay? A. In the ordinary course of business, no, sir. Q. You did not owe a cent? A. No, I say we were not able to pay in the ordinary course of business, that is right.

Q. That is what I am trying to get at. On October, 1930, you owed quite a large sum of money which you were unable to pay in the ordinary course of business? A. That is right. Q. Isn't the same thing true on July 29th, 1930?

A. Approximately, yes. * * * Q. Let me *Page 449 change my question; as I understood you to say, on July 29th, 1930, you did owe large sums of money. When I say `you' I mean the Milburn Realty Company owed large sums of money which you were unable to pay in the ordinary course of business? A. That is partially true, yes, sir. * * * Q. Now, then, Mr. Berman, when the receivers took charge of the Milburn Realty Company, the only assets that they received — or, at least, were available, I won't say `received,' were some furniture which, I believe the State Tax Commission appraised at $450 and which your company claimed was worth $250. That is one asset, isn't that so?

A. That is correct. Q. There was not a cent in bank, the bank account was overdrawn, wasn't it? A. There wasn't anything in there; I don't know about being overdrawn. Q. And there are no accounts receivable, are there, that are any good?

A. No, sir. Q. There is no physical property of the company at all? A. No, sir." All the property covered by the Lyon Realty Company mortgage was sold for $5,705, and the "Glenleigh" property sold under foreclosure of the Richardson mortgage for $29,209.28 less than the sum needed to pay that mortgage, accrued charges, and costs of foreclosure. So that the Milburn Realty Company was on July 29th, 1930, in financial distress, heavily indebted, unable to meet such immediate and pressing debts as taxes due on the Glenleigh property, with assets which proved wholly inadequate to pay the debts which it then owed, and was, within any accepted definition of the term, insolvent.

The second question is whether the mortgage to the Lyon Realty Company is to be regarded as a mortgage to Joseph Berman. Berman was the nominal owner of 498 of the 500 shares of the capital stock of the Lyon Realty Company and the actual owner of the entire issue. He therefore derived the identical benefit from the mortgage to the company that he would have derived had it been made directly to him, and, in fact, in the following extract from his testimony, he speaks of the Lyon Company and himself indifferently as signifying *Page 450 the same person, when he said: "Most of the money the Milburn Company used to borrow was furnished through you and your companies? A. At times.

In the first few years there was very little money I had to put up or lend to them. At times that I know of the books summed up to 1929, I believe, or 1930, they owed me at one time $30,000. They owed the Lyon Realty Company $30,000, and after that — that was, I think, in 1927 or 1928, I would have to refer to the statement — after that, in fact, one time they paid us over and above the amount that we had lent to them, and then later when times got hard, then I had — the Lyon Company had to lend them larger sums to pay their bills, and so forth and so on." And, while for all corporate functions a corporation is to be regarded as separate and distinct from its stockholders, yet where it is used as a mere device or contrivance to effect some personal purpose or design of a stockholder who controls it, the fiction of a distinct identity will not, in a court of equity at least, be permitted to defeat a just claim which could have been enforced against the stockholder had he stood in the place of the corporation. For a court of equity will look through the form to the substance beneath, and will not permit a mere fiction to validate a transaction which but for such fiction would be illegal, when recognition and acceptance of the fiction would result in injustice or would confer upon one relying upon the transaction an unfair advantage over others.

In Swift v. Smith, 65 Md. 428 , 5 A. 534 , it was intimated that ownership by one person of all the stock in a corporation virtually suspends its operations as a corporation until the election of new officers through new stockholders purchasing from that person. Whether in the light of more recent developments in the law the principle thus announced would be accepted now ( Dollar Dry Cleansers and Dyers, Inc., v. MacGregor, 163 Md. 105 , 161 A. 159 ), need not be decided, because the question here is not whether a one man corporation could as to all matters within the sphere of its legitimate corporate operations function as a corporation, but whether such a corporation can be used by its owner to escape the application *Page 451 of legal rules and principles which would reach and control him as a natural person. And in reference to that question it was said in Bauernschmidt v. Bauernschmidt, 101 Md. 162 , 60 A. 437 , 442: "In Anthony v. American Glucose Co., 146 N.Y. 407 , 41 N.E. 23 , the court said, `We have of late refused to be always and utterly trammeled by the logic derived from corporate existence, when it only serves to distort or hide the truth;' and in Seymour v. Spring [ 144 N.Y. 333 , 39 N.E. 365 ], supra, `The abstraction of the corporate entity should never be allowed to bar out and prevent the real and obvious truth.' This principle was recognized and applied in a different situation in Pott v. Schmucker, 84 Md. 535 , 36 A. 592 , in which it was held that `it was competent for a court of equity to look back of the mere artificial and formal body corporate, * * * and to treat the corporation and the individual owning all its stock and assets as identical.'" In Fletcher's Cyclopedia of Corporations, sec. 44, it is said: "It is idle to promote a corporation for the purpose of endeavoring to accomplish fraud or other illegal acts under the cloak of the corporate fiction. Where this is attempted, courts of law, equity, or bankruptcy, do not hesitate to tear aside the veil of corporate entity and to look beyond it and through it at the actual and substantial beneficiaries.

A notable instance is found in cases where it is sought to delay, hinder and defraud creditors by means of `dummy' incorporations. The courts have uniformly held that there is no magic in incorporation and refuse to apply the doctrine of corporate entity to enable such schemes to be successful." In 14 C.J . 61, the same principle is expressed in this language: "Thus it has repeatedly been held that the courts, both at law and in equity, will disregard the fiction of corporate entity apart from the members of the corporation when it is attempted to be used as a means of accomplishing a fraud or an illegal act." The rule thus stated is generally accepted, and cases illustrating its application may be found collected in Donovan v. Purtell, 216 Ill. 629 , 75 N.E. 334 ; 14 C.J. "Corporations," secs. 5, 20, 21, 22, 25; Fletcher's *Page 452 Cyclopedia of Corporations, secs. 43, 44; Carozza v. Federal Finance Co., 149 Md. 223 , 131 A. 332 . In considering the facts referred to above in connection with the third and controlling question, it will be assumed for the purposes of this case that, at the time the Milburn Realty Company mortgaged its entire assets to the Lyon Realty Company, it was insolvent, and that Joseph Berman and the Lyon Realty Company may be regarded as identical.

The third question in the case, which is whether the Milburn Realty Company, being insolvent, could lawfully prefer one of its directors over its general creditors in the distribution of its assets, is academic and moot unless the appellants are entitled to attack that preference in this proceeding. That it would have been unlawful upon a seasonable application to avoid it appears settled by Clark Co. v. Colton, 91 Md. 195 , 46 A. 386 , 391. In that case a banking corporation, insolvent at the time, for the purpose of discharging obligations of certain of its directors who had notice of its insolvency, paid on the day before it closed its doors a certain promissory note which they had indorsed, and also paid another note due to a corporation in which the president of the bank owned nearly all the stock. In the course of the opinion filed in that case it was said: "In our opinion, fairness and justice require that the officers should be placed on an equality, and no more than an equality, with the other creditors of the corporation.

And so, in the case of Sutton Mfg. Co. v. Hutchinson [(C.C.A.) 63 F. 496 ], supra, Harlan, J., says: `It is, we think, the result of the cases that, where a private corporation is dissolved, or becomes insolvent, and determines to discontinue the prosecution of business, its property is affected by an equitable lien or trust for the benefit of creditors. The duty in such cases of preserving it for creditors rests upon the directors or officers to whom has been committed the authority to control and manage its affairs. Although such directors and officers are not technical trustees, they hold, in respect of the property under their control, a fiduciary relation to creditors; and, necessarily, in the disposition of the property of an insolvent corporation, *Page 453 all creditors are equal in rights, unless preference or priority has been legally given by statute or by the act of the corporation to particular creditors.' * * * Certainly one of the interests of every corporation is that, while solvent, all its creditors should be fully paid, and, when insolvent, that all its assets should be equally divided, and not awarded by the president and directors or other officers to themselves and their friends." That statement of the law agrees with the rule which Fletcher, in the following statement from his Cyclopedia of Corporations (Rev. Ed.), secs. 7468, 7469, says is supported by the "great weight of authority": "When a corporation becomes insolvent and can no longer continue in business, the directors and other managing officers occupy a fiduciary relation towards creditors by reason of their position and their custody of the assets, and they cannot, by conveyance, mortgage, pledge, confession of judgment, or otherwise secure to themselves, as creditors, any preference or advantage over other creditors, but the most that they can claim is the right to come in and share pro rata with the other creditors in the distribution of the assets.

This is the rule sustained by the great weight of authority, and the fiduciary relation occupied by the officers results from their duty to wind up the affairs of an insolvent