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HENDERSON v. ROUNDS & PORTER LUMBER CO.

August 2, 1951

HENDERSON ET AL.
v.
ROUNDS & PORTER LUMBER CO.



The opinion of the court was delivered by: John E. Miller, District Judge.

Detailed findings of fact and conclusions of law, separately stated, have been filed in this case, but the court feels in deference to the able attorneys for the respective parties that they are entitled to be apprised of the reasons that prompted the court's conclusions of law. Only those facts necessary to a reasonably clear presentation of the issues will be repeated here.

This action was originally commenced in the Chancery Court of Bradley County, Arkansas, by the plaintiffs, George H. Henderson and J.T. Haley, Jr., the latter being Trustee in Bankruptcy of the Taylor Oak Flooring Company. In their complaint it is alleged that the plaintiff, Henderson, had sold certain quantities of lumber to Manning Taylor and the Taylor Oak Flooring Company for which he had not been paid in full; that the Taylor Oak Flooring Company was duly adjudicated bankrupt, and plaintiff, J.T. Haley, Jr., appointed Trustee; and that the estate of the Oak Flooring Company is about to be closed, and there will be no money for the payment of the claims of common creditors, of which plaintiff, Henderson, is one. Plaintiffs seek to place liability for the unpaid balance directly upon the defendant, alleging "as a result of the fraud of Rounds and Porter Lumber Company in the domination and manipulations of the affairs of Taylor Oak Flooring Company, its agency, and converting all of its current assets, both money and lumber, to its own use, Rounds and Porter Lumber Company should be held to account".

Defendant removed the case to this court, upon grounds of diversity of citizenship and jurisdictional amount, and thereafter filed a motion to quash service. Service was had under the appropriate Arkansas "doing business" statute, and it appearing that the disposition of the motion would entail a full hearing and development of facts, later to be duplicated at the trial if the motion to quash was overruled, the court postponed disposition of the motion until the trial on the merits. Thereafter defendant answered, reasserting its motion to quash, alleging that the complaint failed to state a claim upon which relief could be granted and denying the material allegations of the complaint.

Subsequently the court permitted W.C. Partee and Chrystelle Partee, partners, d/b/a Partee Lumber Company, R.S. Foster, T.S. Grayson and J.B. Lee, partners, d/b/a Foster-Grayson Lumber Company, and J.T. Haley, Jr., Trustee in Bankruptcy, on behalf of all common creditors, to intervene as parties plaintiff, and are hereinafter designated as plaintiffs. These plaintiffs likewise seek to place liability directly upon the defendant, Rounds and Porter Lumber Company. Defendant's answer to their complaint is essentially the same as that filed to the original complaint.

Defendant is a Kansas corporation owned by Ralph M. Rounds, his wife, and two sons. It and its subsidiaries, Rounds and Porter Company, the wholesale department, and Rounds and Palmer, a Texas corporation, operated seven wholesale and thirty retail lumber yards during the period here involved. In December, 1947, Ralph M. Rounds, President of the defendant, agreed with Manning Taylor, of Warren, Arkansas, to form a corporation for the manufacture of Oak Flooring. Mr. Rounds furnished $30,000 in cash and Taylor furnished machinery and equipment valued approximately at $30,000. For their contributions, each received 50%, or 300 shares, of the capital stock. It was disputed whether Ralph M. Rounds individually or the defendant, Rounds and Porter Lumber Company, was the stockholder, but from the evidence the court has found that the defendant was the actual owner of the stock. Ralph M. Rounds was elected President of the new corporation, W.O. Palmer Vice President, Roy W. Elliott Assistant to the President (all of the preceding being officers in the defendant company), Manning Taylor Secretary-Treasurer and General Manager, and Charlene Kight Assistant Secretary. It was agreed from the beginning that Taylor Oak Flooring Company (hereinafter referred to as Flooring Company) would sell its product to the defendant at the prices listed by the E.L. Bruce Company, referred to as Bruce's Price List. These prices were consistently $20 to $40 below the prevailing market price during the period involved.

The Flooring Company was in financial trouble from the beginning. Various factors contributed to this result. Manning Taylor remained as General Manager with authority to issue checks until May 11, 1948, when he resigned under pressure. By that time he had drawn checks aggregating $17,296.19 on the Flooring Company's funds. Part of this included checks written to himself covering equipment already owned by the corporation, and part of it included funds used for the payment of personal obligations. For this sum he gave notes and pledged 210 shares of his stock as security. The other 90 shares of his stock were transferred to one Murray B. McLeod to cover a personal indebtedness to the latter. In addition considerable trouble was experienced with the equipment. However, from all the evidence, the court has found that the principal and determinative factor in the failure of the Flooring Company was the practice of selling lumber to defendant at a loss. During the entire period of its operation defendant purchased 827,606 feet of lumber and paid therefor $76,442.92, whereas all others purchased 720,383 feet and paid therefor $132,868.62.

During this period there was a critical shortage of hardwood flooring. The Flooring Company was not permitted to take advantage of the abnormally high market price, at times referred to at the trial as "gray market" price, but actually the result of an overwhelming demand and a limited supply. It appears that defendant's purpose from the beginning and during the entire course of the transactions involved was to obtain for itself a supply of hardwood lumber at low prices. It should be added that in addition to the profit realized from the purchase at below market prices, defendant made the usual retail profit, variously estimated at from 25% to 50%, on sales through its retail outlets.

While Manning Taylor was occupying the position of General Manager defendant exercised close supervision of the Flooring Company. Roy W. Elliott, Treasurer of defendant, and Assistant to the President of the Flooring Company, visited Warren and supervised the setting up of the books. Defendant's auditors made periodic checks of the records. Manning Taylor was called in to explain the application by him of the funds hereinbefore mentioned, of which defendant was fully advised. And, although it had such knowledge, including the fact that the Flooring Company was steadily losing money, it continued its practice of purchasing flooring at prices below the cost of manufacture. After Taylor's resignation in May, 1948, Roy W. Elliott took over as General Manager. Mr. Elliott apparently made an effort to straighten things out, but was unable to do so, and after two months resigned. In a letter to a creditor concerning his resignation, he commented: "It became evident to me after two months here that at the prices for flooring, at which I am required to sell to the Rounds and Porter Lumber Company, I can neither make a profit nor pay off any creditors. And for that reason, I protested to the Rounds and Porter Lumber Company and resigned." Elliott went to the Flooring Company under an agreement with defendant that he would remain on defendant's payroll while there. Ralph M. Rounds later repudiated this agreement and cut Elliott off, after which, for this and other reasons, Elliott resigned. Calvin Johnson, another employee of defendant, followed Elliott as General Manager and continued as such until involuntary bankruptcy proceedings were instituted in August, 1948.

On June 8, 1948, defendant and the Flooring Company entered into a contract whereby defendant would purchase air dried rough oak lumber and furnish it to the Flooring Company. The latter would manufacture the same into flooring and sell it to defendant at Bruce prices, less 5% and 2% discounts and the cost of the rough lumber to defendant. Thereafter operations were conducted under this agreement, but the Flooring Company was not permitted to make a profit and its loss continued at the same rate as it was when the rough lumber was purchased in its name. Its total expenses in handling and manufacturing the lumber exceeded the price at which it was required to sell to defendant, both before and after the contract of June 8, 1948. It appears that this agreement was suggested by Murray B. McLeod, who, after having acquired the 90 shares of stock from Manning Taylor, had been made a director on March 12, 1948. In this regard, it is interesting to note that later Mr. McLeod also purchased flooring at Bruce prices.

In addition to the original $30,000, defendant made various advances or loans to the Flooring Company. On January 7, 1948, defendant loaned $10,000 as additional operating capital and shortly thereafter paid for a Ross Carrier which cost $6,829.49. Later, on May 11, 1948, defendant loaned the Flooring Company $35,000. The latter sum was principally used to retire certain bank overdrafts and notes, the major portion of which were with the Fourth National Bank of Wichita, Kansas, which were made with the assurance of Mr. Rounds, also a director in the bank, that the bank wouldn't lose any money.

On June 16, 1948, Mr. W.O. Palmer, then Secretary and later President of the defendant, wrote Mr. Elliott at Warren that the time had arrived when Mr. Rounds should get something in return for his investment in the Flooring Company, stating, "The best and quickest way to do this would be to take a retail profit on the production of the Taylor Oak Flooring Company." That same day he sent out a communication to all wholesale warehouses operated by defendant, advising, "In the future we are going to adopt a plan of distribution on oak flooring which will be more favorable to Rounds and Porter Lumber Company", giving specific instructions on how to handle future transactions, and concluding, "There are particular reasons why this decision has been reached and we ask that you do not question our judgment in authorizing such a plan".

An audit was made of the Flooring Company records by an independent accountant as of April 30, 1948, and rechecked as of June 30, 1948, from which it appears that current assets declined from $56,445.28 to $19,008.59. It also reveals that the lumber inventory decreased from $52,318.62 to $11, 128.30 and the amount due for lumber increased from $40,396.02 to $55,147.11. The audit tends to show that the defendant stripped the Flooring Company of its liquid assets. For most discrepancies defendant, and Stanley in the testimony concerning certain necessary adjustments, has offered an explanation. Without detailing this explanation, the substance of it is that the audit cannot be interpreted to show a "stripping of assets" by defendant. However, it is clear from exhibits attached that during this period, when defendant was in unquestioned control of the Flooring Company, it continued to take its products at prices below cost to the latter, inflicting an additional loss on every thousand feet sold, and without any regard for creditors whose claims had accrued prior to May 11, 1948, and subsequent to the date of incorporation of Taylor Oak Flooring Company.

Defendant, in its brief, challenges the right of the plaintiffs, other than the Trustee, to maintain this action, contending that the action should have been brought by the Trustee in the first instance.

Generally, the trustee alone has the power to sue on a claim belonging to the estate, but "the trustee, however, stands in the shoes of the bankrupt corporation in prosecuting a cause of action belonging to the bankrupt, and where the applicable state law makes such obligations or liabilities run to the corporate creditors personally, rather than to the corporation, such rights of action are not assets of ...


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