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United States v. Tabor Court Realty Corp.

filed: October 22, 1986.

UNITED STATES OF AMERICA
v.
TABOR COURT REALTY CORP., MCCLELLAN REALTY CO., INC., PAGNOTTI ENTERPRISES, INC., LOREE ASSOCIATES, JAMES J. TEDESCO, HENRY VENTRE, LOUIS PAGNOTTI, II, RAYMOND COLLIERY CO., INC., BLUE COAL COMPANY, GILLEN COAL MINING CO., CARBONDALE COAL CO., MOFFAT PREMIUM ANTHRACITE, NORTHWEST MINING, INC., MAPLE CITY COAL CO., POWDERLY CORPORATION, CLINTON FUEL SALES, INC., GREAT AMERICAN COAL CO., JOSEPH SOLFANELLI, INDIVIDUALLY AND AS TRUSTEE, GENERAL ELECTRIC CREDIT CORP., COMMONWEALTH OF PA. DEPT. OF MINES & MINERAL INDUSTRIES, DEPT. OF ENVIRONMENTAL RESOURCES AND DEPT. OF REVENUE, BOROUGH OF OLYPHANT, JOHN J. GILLEN, THOMAS J. GILLEN, ROBERT W. CLEVELAND & SONS, INC., WILLIAM T. KIRCHOFF, JAY W. CLEVELAND, ROYAL E. CLEVELAND, CITY OF SCRANTON SEWER AUTHORITY, LACKAWANNA RIVER BASIN AUTHORITY, BOROUGH OF TAYLOR, LACKAWANNA COUNTY, WILLIAM R. HENKLEMAN, GLENEAGLES INVESTMENT CO., INC., JEDDO HIGHLAND COAL CO., OLYPHANT PREMIUM ANTHRACITE, INC., OLYPHANT ASSOCIATES, MININDU CORPORATION, GLEN NAN, INC., GILCO, INC., JAY W. CLEVELAND, AS ADMINISTRATOR OF THE ESTATE OF ROYAL E. CLEVELAND; MCCLELLAN REALTY COMPANY, JEDDO HIGHLAND COAL CO., PAGNOTTI ENTERPRISES, INC., LOREE ASSOCIATES, GILLEN COAL MINING CO., CARBONDALE COAL CO., MOFFATT PREMIUM ANTHRACITE, NORTHWEST MINING, INC., MAPLE CITY COAL CO., POWDERLY CORPORATION, CLINTON FUEL SALES, INC., OLYPHANT PREMIUM ANTHRACITE, INC., OLYPHANT ASSOCIATES MININDU CORPORATION, GILCO, INC. AND JOSEPH SOLFANELLI, INDIVIDUALLY AND AS TRUSTEE, APPELLANTS; THE UNITED STATES, APPELLANT; MCCLELLAN REALTY CORPORATION AND OTHER DEFENDANTS, APPELLANTS; JAMES J. HAGGERTY, TRUSTEE IN BANKRUPTCY FOR BLUE COAL CORPORATION AND GLEN NAN, INC., APPELLANT



Appeal from the United States District Court for the Middle District of Pennsylvania - Scranton, D.C. Civil No. 84-1424

Author: Aldisert

Before ALDISERT, Chief Judge, and HIGGINBOTHAM and HUNTER, Circuit Judge.

ALDISERT, Chief Judge.

We have consolidated appeals from litigation involving one of America's largest anthracite coal producers that emanate from a district court bench trial that extended over 120 days and recorded close to 20,000 pages of transcript. Ultimately, we have to decide whether the court erred in entering judgment in favor of the United States in reducing to judgment certain federal corporate tax assessments made against the coal producers, in determining the priority of the government liens, and in permitting foreclosure on the liens. To reach these questions, however, we must examine a very intricate leveraged buy-out and decide whether mortgages given in the transaction were fraudulent conveyances within the meaning of the constructive and intentional fraud sections of the Pennsylvania Uniform Fraudulent Conveyances Act (UFCA), 39 Pa. Cons. Stat. §§ 354-357, and if so, whether a later assignment of the mortgages was void as against creditors.

The district court made 481 findings of facts and issued three separate published opinions: United States v. Gleneagles Investment Co., 565 F. Supp. 556 (M.D. Pa. 1983) (Gleneagles I); 571 F. Supp. 935 (1983) (Gleneagles II); and 584 F. Supp. 671 (1984) (Gleneagles III). We are told that this case represents the first significant application of the UFCA to leveraged buy-out financing.

We will address seven issues presented by the appellants and an amicus curiae, the National Commercial Finance Association, and by the United States and a trustee in bankruptcy as cross appellants:

* whether the court erred in applying the UFCA to a leveraged buy-out;

* whether the court erred in denying the mortgage assignee, McClellan Realty, a "lien superior to all other creditors";

* whether the court erred in "collapsing" two separate loans for the leveraged buy-out into one transaction;

* whether the court erred in holding that the mortgages placed by the borrowers on November 26, 1973 were invalid under the UFCA;

* whether the court erred in holding that the mortgages placed by the guarantors were invalid for lack of fair consideration;

* in the government's cross-appeal, whether the court erred in determining that the mortgage assignee, McClellan Realty, was entitled to an equitable lien for municipal taxes paid; and

* in the government's and trustee in bankruptcy's cross-appeal, whether the court erred in placing the mortgage assignee, McClellan Realty, on the creditor list rather then removing it entirely.

We will summarize a very complex factual situation and then discuss these issues seriatim.

I.

These appeals arise from an action by the United States to reduce to judgment delinquent federal income taxes, interest, and penalties assessed and accrued against Raymond Colliery Co., Inc. and its subsidiaries (the Raymond Group) for the fiscal years of June 30, 1966 through June 30, 1973 and to reduce to judgment similarly assessed taxes owed by Great American Coal Co., Inc. and its subsidiaries for the fiscal year ending June 30, 1975.

The government sought to collect these tax claims from surface and coal lands owned by the Raymond Group as well as from lands formerly owned by it but which, as a result of allegedly illegal and fraudulent county tax sales, were later owned by Gleneagles Investment Co., Inc. In addition, the government sought to assert the priority of its liens held by others. The district court held in favor of the government on most of its claims and concluded the litigation by promulgating an order of priority of liens on Raymond Group lands.

Raymond Colliery, incorporated in 1962, was owned by two families, the Gillens and the Clevelands. It owned over 30,000 acres of land in Lackawanna and Luzerne counties in Pennsylvania and was one of the largest anthracite coal producers in the country. In 1966, Glen Alden Corporation sold its subsidiary, Blue Coal Corporation, to Raymond for $6 million. Raymond paid $500,000 in cash and the remainder of the purchase price with a note secured by a mortgage on Blue Coal's land. Lurking in the background of the financial problems present here are two important components of the current industrial scene: first, the depressed economy attending anthracite mining in Lackawanna and Luzerne Counties, the heartland of this industry; and second, the Pennsylvania Department of Environmental Resources' 1967 order directing Blue Coal to reduce the amount of pollutants it discharged into public waterways in the course of its deep mining operations, necessitating a fundamental change from deep mining to strip or surface mining.

Very serious problems surfaced in 1971 when Raymond's chief stockholders -- the Gillens and Clevelands -- started to have disagreements over the poor performance of the coal producing companies. The stockholders decided to solve the problem by seeking a buyer for the group. On February 2, 1972, the shareholders granted James Durkin, Raymond's president, an option to purchase Raymond for $8.5 million. The stockholders later renewed Durkin's option at a reduced price of $7.2 million.

Durkin had trouble in raising the necessary financing to exercise his option. He sought help from the Central States Pension Fund of the International Brotherhood of Teamsters and also from the Mellon Bank of Pittsburgh. Mellon concluded that Blue Coal was a bad financial risk. Moreover, both Mellon and Central States held extensive discussions with Durkin's counsel concerning the legality of encumbering Raymond's assets for the purpose of obtaining the loan, a loan which was not to be used to repay creditors but rather to buy out Raymond's stockholders.

After other unsuccessful attempts to obtain financing for the purchase, Durkin incorporated a holding company, Great American, and assigned to it his option to purchase Raymond's stock. Although the litigation in the district court was far-reaching, most of the central issues have their genesis in 1973 when the Raymond Group was sold to Durkin in a leveraged buy-out through the vehicle of Great American.

A leveraged buy-out is not a legal term of art. It is a shorthand expression describing a business practice wherein a company is sold to a small number of investors, typically including members of the company's management, under financial arrangements in which there is a minimum amount of equity and a maximum amount of debt. The financing typically provides for a substantial return of investment capital by means of mortgages or high risk bonds, popularity known as "junk bonds." The predicate transaction here fits the popular notion of a leveraged buy-out. Shareholders of the Raymond Group sold the corporation to a small group of investors headed by Raymond's president; these investors borrowed substantially all of the purchase price at an extremely high rate of interest secured by mortgages on the assets of the selling company and its subsidiaries and those of additional entities that guaranteed repayment.

To effectuate the buy-out, Great American obtained a loan commitment from Institutional Investors Trust on July 24, 1973, in the amount of $8,530,000. The 1973 interrelationship among the many creditors of the Raymond Group, and the sale to Great American -- a seemingly empty corporation which was able to perform the buy-out only on the strength of the massive loan from IIT - forms the backdrop for the relevancy of the Pennsylvania Uniform Fraudulent Conveyance Act, one of the critical legal questions presented for our decision.

Durkin obtained the financing through one of his two partners in Great American.*fn1 The loan from IIT was structured so as to divide the Raymond Group into borrowing companies and guarantor companies. The loan was secured by mortgages on the assets of the borrowing companies, but was also guaranteed by mortgages on the assets of the guarantor companies. We must decide whether the borrowers' mortgages were invalid under the UFCA and whether there was consideration for the guarantors' mortgages.

The IIT loan was closed on November 26, 1973. The borrowing companies in the Raymond Group received $7 million in direct proceeds from IIT. The remaining $1.53 million was placed in escrow as a reserve account for the payment of accruing interest. The loans were to be repaid by December 31, 1976, at an interest rate of five points over the prime rate but in no event less than 12.5 percent. In exchange, each of the borrowing companies -- Raymond Colliery, Blue Coal, Glen Nan, and Olyphant Associates -- created a first lien in favor of IIT on all of their tangible and intangible assets; each of the guarantor companies -- all other companies in the Raymond Group -- created a second lien in favor of IIT on all of their tangible and intangible assets. The loan agreement also contained a clause which provided IIT with a propriety lien on the proceeds from Raymond's sales of its surplus lands. Finally, the agreement provided that violations of any of the loan convenants would permit IIT to accelerate the loan and to collect immediately the full balance due from any or all of the borrowers or guarantors.

The exchange of money and notes did not stop with ITT's advances to the borrowing companies. Upon receipt of the IIT loan proceeds, the borrowing companies immediately transferred a total of $4,085,000 to Great American. In return, Great American issued to each borrowing company an unsecured promissory note with the same interest terms as those of the IIT loan agreement. In addition to the proceeds of the IIT loan, Great American borrowed other funds to acquire the purchase price for Raymond's stock.

When the financial dust settled after the closing on November 26, 1973, this was the situation at Raymond: Great American paid $6.7 million to purchase Raymond's stock, the shareholders receiving $6.2 million in cash and a $500,000 note; at least $4.8 million of this amount was obtained by mortgaging Raymond's assets.

Notwithstanding the cozy accommodations for the selling stockholders, the financial environment of the Raymond Group at the time of the sale was somewhat precarious. At the time of the closing, Raymond had multi-million dollar liabilities for federal income taxes, trade accounts, pension fund contributions, strip mining and back-filling obligations, and municipal real estate taxes. The district court calculated that the Raymond Group's existing debts amounted to at least $20 million on November 26, 1983. 565 F. Supp. at 578.

Under Durkin's control after the buy-out, Raymond's condition further deteriorated. Following the closing the Raymond Group lacked the funds to pay its routine operating expenses, including those for materials, supplies, telephone, and other utilities. It was also unable to pay its delinquent and current real estate taxes. Within two months of the closing, the deep mining operations of Blue Coal were shut down; within six months of the closing, the Raymond Group ceased all strip mining operations. Consequently, the Raymond Group could not fulfill its existing coal contracts and became liable for damages for breach of contract. The plaintiffs in the breach of contract actions exercised their right of set-off against accounts they owed the Raymond Group. Within seven months of the closing, the Commonwealth of Pennsylvania and the Anthracite Health & Welfare Fund sued the Raymond Group for its failures to fulfill back-filling requirements in the strip mining operations and to pay contributions to the Health & Welfare Fund. This litigation resulted in injunctions against the Raymond Group companies which prevented them from moving or selling their equipment until their obligations were satisfied. Moreover, Lackawanna and Luzerne counties announced their intent to sell the Raymond Group properties for unpaid real estate taxes. Finally, on September 15, 1976, IIT notified the borrowing and guarantor Raymond companies that their mortgage notes were in default. On September 29, 1976, IIT confessed judgments against the borrowing companies for the balance due on the loan and began to solicit a buyer for the Raymond Group mortgages.

New dramatis personae came on stage and orchestrated additional financial dealings which led to the purchase of the IIT mortgages. These dealings form the backdrop for additional legal issues to be decided here. Pagnotti Enterprises, another large anthracite producer, was the prime candidate to purchase the mortgages from IIT. In December 1976, James J. Tedesco, on behalf of Pagnotti, commenced negotiations for the purchase, Tedesco signed an agreement on December 15, 1976. Pursuant to the mortgage sale contract -- and prior to the closing of the sale and assignment of the mortgages -- IIT and Pagnotti each placed $600,000 in an escrow account to be applies to the payment of delinquent real estate taxes on properties listed for the county tax sales or to be used as funds for bidding on the properties at the tax sale.

IIT and Pagnotti agreed that bidding on the properties at the Lackawanna and Luzerne county tax sales would be undertaken by nominee corporations. Pursuant to their agreement, more new business entities then entered the picture. Tabor Court Realty was formed to bid on Raymond's properties at the Lackawanna County tax sale; similarly, McClellan Realty was formed to bid on Blue Coal's lands in Luzerne County. Pagnotti prepaid the delinquent taxes that predated IIT's mortgages to Lackawanna County. On December 17, 1976, Tabor Court Realty obtained Raymond's Lackawanna lands for a bid of $385,000; yet by this date an involuntary petition in bankruptcy had been filed against Blue Coal, a chief Raymond subsidiary, by its creditors. A similar proceeding was instituted against another subsidiary, Glen Nan. Based on the failure of Tabor Court to pay other delinquent taxes, on December 16, 1980, Lackawanna County held a second tax sale of Raymond's lands. At that sale, Joseph Solfanelli, acting on behalf of Gleneagles Investment, bid and acquired Raymond's lands for $535,290.39. These transactions did not stand up. At trial, the parties stipulated that both county tax sales were invalid and that Raymond's lands purportedly sold to Tabor Court and Gleneagles remained assets owned by Raymond.

On January 26, 1977, the sale and assignment of the IIT mortgages took place. Pagnotti paid approximately $4.5 million for the IIT mortgages; at that time, the mortgage balance was $5,817,475.69. Pagnotti thereafter assigned the mortgage to McClellan, thus making McClellan a key figure in this litigation. On December 12, 1977, Hyman Green, one of Durkin's co-shareholders in Raymond, was told that McClellan intended to sell, at a private sale, many of Raymond's assets encumbered as collateral on the IIT mortgages. McClellan did just that -- it foreclosed. On February 28, 1978, in a private sale, Loree Associates purchased the assets from McClellan for $50,000. This sale was not advertised nor were the assets offered to any other parties. Additionally, the sale was not recorded on the books of either Loree Associates or McClellan until May 1983, six months after the start of the litigation below. Nor was this the only private sale. On October 6, 1978, McClellan foreclosed on the stock of Raymond and sold it at a private sale for $1 to Joseph Solfanelli, as trustee for Pagnotti. Again, the sale was not advertised nor was anyone other than Green informed of the sale. No appraisals were obtained for either the stock or the collateral purportedly sold by McClellan at these sales.

This, then, constitutes a summary of the adjudicative facts that undergird the litigation below and the appeals before us.

II.

The instant action was commenced by the United States on December 12, 1980 to reduce to judgment certain corporate federal tax assessments made against the Raymond Group and Great American. The government sought to assert the priority of its tax liens and to foreclosure against the foreclosure against the property that Raymond had owned at the time of the assessments as well as against properties currently owned by Raymond. The United States argued that the IIT mortgages executed in November 1973 should be set aside under the Uniform Fraudulent Conveyance Act and further that the purported assignment of these mortgages to Pagnotti should be voided because at the inception Pagnotti had purchased the mortgages with knowledge that they had been fraudulently conveyed.

As heretofore stated, after a bench trial, the district court issued three separate published opinions. In Gleneagles I, 565 F. Supp. 556 (1983), the court concluded, inter alia, that the mortgages given by the Raymond Group to IIT on November 26, 1973 were fraudulent conveyances within the meaning of the constructive and intentional fraud sections of the Pennsylvania Uniform Fraudulent Conveyances Act, 39 Pa. Cons. Stat. §§ 354-357. In Gleneagles II, 571 F. Supp. 935 (1983), the court further held that the mortgages to McClellan Realty were void as against the other Raymond Group creditors. In its third opinion, 584 F. Supp. 671 (1984), the court set out the priority of the creditors. The court granted McClellan and Tabor Court an equitable lien ahead of the creditors for the Pennsylvania municipal taxes they paid in Raymond's behalf prior to the 1976 Lackawanna county tax sale of Raymond's properties. However, the court placed McClellan, as assignee of the IIT mortgages, near the bottom of the list of creditors. The trustee in bankruptcy of Blue Coal and Glen Nan argues that McClellan's rights are totally invalidated and that McClellan has no standing whatsoever as a creditor.

The Raymond Group -- four coal mining companies that executed the mortgages (Raymond Colliery, Blue Coal, Glen Nan, and Olyphant Associates) as well as interrelated associated companies that had placed guarantee mortgages and subsidiaries of such associated companies -- has appealed. As heretofore stated, all these mortgages, subsequently invalidated by the district court, had been granted to IIT on November 26, 1973 and assigned to IIT to appellant McClellan. For the purpose of this appeal, we shall refer to the Raymond Group as "appellants", or "McClellan".

Jurisdiction was proper in the trial court. 28 U.S.C. §§ 1340, 1345. We are satisfied that jurisdiction on appeal is proper based on 28 U.S.C. § 1291. Although one or two parties have questioned the timeliness of McClellan's appeal based on a contention that partially defective service of McClellan's motion for a new district court trial failed to toll the running of the 60-day period for filing appeals under Rule 4(a)(1) of the Federal Rules of Appellate ...


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