Chittenden Trust Co. v. Sebert Lumber, Co. (In Re Vermont Toy Works, Inc.)

MEMORANDUM DECISION

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DENYING DECLARATORY RELIEF AND RELIEF FROM STAY, AND DIRECTING MARSHALING OF ASSETS

FRANCIS G. CONRAD, Bankruptcy Judge.

This proceeding began with Chittenden’s complaint for a declaratory judgment. Chittenden requests that we determine the collateral it repossessed from Vermont Toy Works, Inc. prepetition is not property of the Debtor’s estate. In the alternative, Chittenden moves for relief from the automatic stay of the Bankruptcy Code, and approval of its repossession.

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Based upon the litigated evidence, pleadings, and the voluminous and competent briefings by counsels, we hold: that the Trustee has standing as a hypothetical judicial lien creditor to affirmatively raise the equitable doctrine of marshaling

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of assets; that an unsecured creditor’s attorney may prosecute on behalf of the Trustee a contested matter with the Trustee’s consent and the Court’s approval; that the inequitable conduct of Debtor’s director, officer, and shareholder is sufficient to warrant the piercing of the corporate veil and the application of the marshaling of assets doctrine; that Chittenden may seek satisfaction of its secured claim from the personal guarantees of Debtor’s president and vice president; that Chittenden may use the securities hypothecated by Debtor’s director, officer, shareholder, and his spouse, and pledged by the Debtor for its loans in the unlikely event the guarantees are insufficient; that the proceeds from the repossessed collateral are property of the Estate; and, after marshaling, that Debt- or’s director, officer, and shareholder’s inequitable conduct requires equitable subordination of his subrogated guarantor relationship under 11 U.S.C. § 510 (c).

PROCEDURAL POSTURE

On December 31, 1985, Sebert, an unsecured creditor, with other unsecured creditors filed an involuntary Chapter 7 petition against Vermont Toy Works, Inc. (Debtor). 11 U.S.C. § 101 et seq.

Sebert concomitantly filed an ex parte motion for an order staying Debtor from disposing of some or all of its assets at a private sale, scheduled for the morning of December 31, 1985, between Chittenden and Vermont Wood. We denied Sebert’s motion by our Order Denying Motion for A Specific Stay, filed December 31, 1985, holding that 11 U.S.C. § 303 (f)

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permits a Debtor to operate its business and conduct its affairs as if a petition had not been filed during the “involuntary gap” period, (between the date of the filing of the involuntary petition and the order of relief), and that Sebert failed to “satisfy the legislatively suggested reasons” for judicial curtailment of Debtor’s financial affairs.

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In addition to Sebert’s failure to establish the exception to the general rule of permitting the Debtor to operate its business within the “gap period,” we said:

We also deny the relief requested because other subsequent relief may be available, if the movant herein, makes a case under 11 USC Section 362 (a)(6) or (7), or if an Order for relief is subsequently entered and the trustee moves under 11 USC Section 547 .

Order Denying Motion for A Specific Stay, page 3, filed December 31, 1985. (Emphasis supplied).

Chittenden perceived the December 31, 1985 Court Order, as placing a “cloud” on its title to the pre-petition repossessed collateral. On January 17, 1986, Chittenden filed a “Complaint For Declaratory Judgment Or Motion For Relief From Automatic Stay”

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to remove the alleged “cloud” so

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Chittenden and Vermont Wood could complete their pre-petition contract for the sale and purchase of the disputed collateral. For some reason, discernable only to it, Chittenden’s complaint named Sebert as Defendant. Sebert answered the complaint on January 30, 1986.

Sebert filed, on January 28, 1986, a motion for an appointment of interim trustee and, on January 29, 1986, we entered an Order for Relief Under Chapter 7 and Order Appointing Interim Trustee.

At a February 21, 1986 hearing, the Trustee, Chittenden, and Sebert consented, with conditions, to allow Chittenden to sell the disputed pre-petition repossessed equipment and machinery collateral to Vermont Wood. On March 7, 1986, we entered an Order Authorizing Sale of Property which approved the conditions and permitted Chit-tenden, as agent of the Trustee, to sell the pre-petition repossessed collateral, for the amount of the outstanding balance of Chit-tenden’s and the Vermont Industrial Development Authority’s notes, to Vermont Wood free and clear of all liens, encumbrances, and interests of any party. We also Ordered that Chittenden's security interest attach to the proceeds and that the proceeds were to be held in an interest bearing account pending the outcome of this adversary proceeding.

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Within 60 days of the Trustee’s appointment and the Court’s Order for relief, 11 U.S.C. § 108 (b)(2), the Trustee filed a petition to marshal assets and moved in Open Court, during the first of a five day bench trial, to intervene as a matter of right, Rules of Practice and Procedure in Bankruptcy, Rule 7024,

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in this adversary proceeding. Chittenden initially objected to the Trustee’s intervention motion; however, it withdrew its objection and the Court granted the Trustee permission to intervene. (April 1, 1986 transcript, page 55). We then ordered that the Trustee’s petition to marshal assets, as a hypothetical judicial lien creditor under 11 U.S.C. § 544 ,

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consolidated with the instant adversary proceeding.

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Sebert, as the named defendant in Chittenden’s declaratory action, also timely raised the doctrines of marshaling and piercing the corporate veil as affirmative defenses.

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After the Trustee’s intervention, however, Sebert’s attorney assumed the role of pursuing these affirmative defenses on behalf of the Trustee for the benefit of Debtor’s estate.

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(June 27,1986 transcript, pages 36-39). Chittenden timely preserved its objections to the Trustee’s standing to marshal and pierce Debtor’s veil, albeit through Sebert’s attorney’s prosecution. (April 1,1986 transcript, page 57; June 18, 1986 transcript pages 2-3; June 26, 1986 transcript page 50; June 27, 1986 transcript pages 32-39).

This proceeding was tried, briefed, and reserved for decision.

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FINDINGS OF FACT

1. Debtor, Vermont Toy Works, Inc., filed its Articles of Incorporation with the Vermont Secretary of State. Debtor’s Certificate of Incorporation was issued by that Office on May 31, 1979, (Sebert’s Exhibit #37, page 1; June 19, 1986 transcript, page 32), and stated as some of its corporate purposes:

(a). To design, develop and manufacture products and sell such products and other products made by others and to engage in distribution of items to wholesale and retail trade....,

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(e). To borrow money without limitation as to amount of corporate indebtedness or liability.

(Exhibit 37, page 2).

2. Debtor, a closed family Sub-Chapter S corporation, (June 18, 1986 transcript, pages 104-105; June 27, 1986 transcript, page 83), engaged in the manufacturing of finished wood products, and had three directors who also served as its officers: Gordon Winer, Chairman of the board of directors, and president, (April 1,1986 transcript, page 16); David Winer, Gordon Win-er’s father, vice president, (Exhibit C-4; April 1, 1986 transcript, page 12); and, Janet Winer, David Winer’s spouse, treasurer, (Exhibit 37, page 11).

3. David Winer is Debtor’s sole shareholder. David Winer’s total equity (capital) contribution to the Debtor is $10,000.00. (June 18, 1986 transcript, page 59; Exhibit 37, pages 13-14; Exhibit C-3).

4. On November 15, 1984, Debtor executed two demand collateral notes: a $98,-562.00 purchase money note for additional equipment; and, a $50,000.00 working capital note. (April 1, 1986 transcript, page 13). Both notes were in favor of Chitten-den. (Exhibit 1, pages 6, 7).

5. The $98,562.00 demand note pledged the following described property as collateral:

MORTGAGE DEED DATED 11/15/84

and Security Agreement dated 11/15/84 including all machinery and equipment and any attachments or replacements thereof, all inventory, accounts receivable, contracts entered into or contract rights, etc., assigned STOCKS AND BONDS AND life insurance policy.

(Exhibit 1, page 6) (emphasis ours).

The above emphasized words, “Mortgage Deed dated 11/15/84 and,” and, “stocks and bonds and,” were struck and initialed by Debtor’s president and Chittenden’s in-house attorney. (Exhibit 1, page 6).

6. The $50,000.00 demand note pledged the following described property as collateral:

Security Agreement dated 11/15/84 including all machinery and equipment and any attachements (sic) or replacements thereof, all inventory, accounts receivable, contracts entered into or contract rights, etc., ASSIGNED STOCKS AND BONDS AND life insurance policy.

(Exhibit 1, page 7) (emphasis ours).

The above emphasized words, “assigned stocks and bonds and,” were struck and replaced with the word “assigned” and initialed by Debtor’s president and Chitten-den’s in-house attorney. (Exhibit 1, page 7).

7. At Chittenden’s request, the two original notes were subsequently replaced by two new notes, which were then back dated to November 15, 1984 and with the same principal amounts as the original notes. (Exhibits A & B; June 26, 1986 transcript, page 180). The new notes were not executed on November 15, 1984, but were executed several months after the original notes.

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(June 18, 1984 transcript, page 26). The collateral described in the new notes is different from the original notes. (June 18,1986 transcript, pages 27-28; June 26, 1986 transcript, pages 163-165). The two new notes each contain identical descriptions of the security:

Security Agreement dated 11/15/84 including all machinery, equipment, all inventory, accounts receivable, contracts entered into or contract rights, etc., and any attachments or replacements thereof, stocks and bonds in (sic) the current market value of not less than $200,000, as hypothecated to the Bank and described more particularly in a Hypoth-ecation Agreement of even date herewith from David A. Winer and Janet R. Win-er, and life insurance policy in the amount of $250,000 on the life of Gordon E. Winer.

(Exhibits A & B).

8. The Debtor executed with Chittenden a security agreement dated November 15,

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1984 for the two notes. The security interest describes the collateral as follows:

All of Debtor’s interest in accounts receivable and/or contract rights, past, present and future of the manufacturer of wooden products known as Vermont Toy Works, Inc., and all goods and inventory, past, present and future, equipment, improvements, fixtures, machinery, special tools, and all additions, accessions, renewals and replacements for all or any part thereof, and all other intangible, or mixed personal property of Debt- or of any type or class, and all products and proceeds of all the foregoing (all hereinafter called ‘Collateral’). The ‘Collateral’ shall further include, without limitation, any personal property of Debtor which may come into the Bank’s possession or control in any manner or for whatever purpose.

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The Collateral shall remain personal property regardless of the manner in which it is attached to realty.

(Exhibit C) (parenthetical in original; emphasis ours).

The above emphasized words “the collateral assignment of certain marketable securities and/or municipal bonds in an amount of not less than $200,000” were also struck and initialed by Debtor’s president and Chittenden’s in-house attorney from this security agreement. No evidence was,, introduced on when these changes were made. (Exhibit C). Chittenden filed financing statements for both notes, ($98,-562.00, “Note # 75,” Exhibit A; $50,000.00, “Note # 83,” Exhibit B), with the Town Clerk for Bristol, Vermont on November 16, 1984, and with the Vermont Secretary of State on November 27, 1984. (Exhibit D). ' On their face, the financing statements incorporated the November 15, 1984 security agreements. No evidence was introduced, however, on whether the financing statements were filed before or after the changes were made to the security agreements and no new or relevant amended financing statements were filed. Chit-tenden later filed an amended financing statement with the Town Clerk for Bristol, Vermont on April 25, 1985 and with the Vermont Secretary of State on April 29, 1985. The amendment expressed that Chit-tenden agreed to subordinate $50,000 of its security interest in certain machinery and equipment to VIDA’s November 15, 1984 security agreement and interest. (Exhibits D; G).

9. The $98,562.00 note, “Note #75,” (Exhibit A), was used by Debtor to acquire certain additional machinery and equipment for Debtor’s expansion, (April 1, 1986 transcript, page 13), and subject to the security agreement. (Exhibit C). There was no formal vote of approval on this loan by Debtor’s board of directors prior to its consummation. (June 18, 1986 transcript, pages 51-52; Exhibit 10). Debtor already had pre-expansion machinery and equipment in place that was not acquired from the $98,526.00 note proceeds. (April 1, 1984 transcript, page 13).

10. The $50,000.00 note, “Note #83,” (Exhibit B), was used by the Debtor for working capital purposes. (April 1, 1984 transcript, page 13).

11. Chittenden required the personal guarantees of David and Gordon Winer as additional collateral for Debtor’s two notes, ($98,562.00, “Note # 75,” Exhibit A; $50,-000.00, “Note # 83,” Exhibit B). (Exhibit J; April 1, 1986 transcript, pages 18-19). The guaranty, (one document with two guarantors), was executed on or about November 15, 1984 in the amount of $148,-562.00 and provided in part:

IN CONSIDERATION of and as an inducement to financial accommodations given and/or further and continued extension of credit by said Chittenden ... to Vermont Toy Works, Inc. ... (hereafter ‘Borrower’) ... we, Gordon E. Winer and David A. Winer (hereafter ‘Guarantors’), hereby jointly and severally unconditionally guarantee ... all indebtedness ... from said Borrower to the Chitten-den ... to the amount in the aggregate

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of ... ($148,562.00)_ This Guaranty shall continue until all of Borrower’s indebtedness referred to hereunder and all other sums due from Borrower are paid. Guarantors hereby waive notice of the acceptance of this Guaranty, and hereby also waive notice of presentment, demand, nonpayment, or protest of any such note or other obligation representing an indebtedness or liability of Borrower to said Bank, covered by this Guaranty ... This Guaranty shall be deemed to be a guaranty of payment and not of collection.

(Exhibit J) (parentheticals in original).

12. Janet Winer is not a party to the guaranty. (April 1, 1986 transcript, pages 20, 51; June 26, 1986 transcript, page 38).

13. On or about November 15, 1984, David Winer and Janet Winer executed a “Hypothecation Agreement,” which authorized Debtor, as “Borrower,” to:

[P]ledge as collateral security for the payment of any and all loans now or hereafter made by you (Chittenden) to the Borrower (Debtor) ... and for the payment of any direct or indirect liability of the Borrower’s to you, due or to become due ... and for the payment of any note or notes now or hereafter given by the Borrower to you, and upon the terms stated therein, the following securities

Chittenden Corporation Cert. #34240 22 shares

” ” ” #18345 1000 shares

” ” ” #25386 21 shares

” ” ” #37508 110 shares

Southern California Edison Co. Cert. # RJJUT7130 $25,000

The Pacific Telephone & Telegraph Company Cert. # R22928 $50,000

and all additions or replacements thereof. Also any securities ... which the Borrower may hereafter deposit with you for the purposes aforesaid; and ... hereby give you the same powers with respect to said securities as is contained in any note or notes given you as aforesaid by said Borrower, hereby authorizing you to deal with said securities in the same way and with the same force and effect as if said securities pledged by said Borrower as collateral security therefor had belonged to said Borrower.... [Authorize you to deliver to said Borrower the said securities ... whenever you may wish ... meaning and intending to authorize said Borrower to act with said securities as if the Borrower were the absolute owner thereof.

(Exhibit K) (parentheticals supplied). The hypothecation agreement is a Chittenden standard form. It was changed to reflect the intentions of David and Janet Winer, Debtor, and Chittenden that Debtor be given the right to use the Winer’s hypothecat-ed securities as collateral for Debtor’s loans with the Chittenden. The hypothe-cated securities appreciated to approximately $125,000,000 as of June 26, 1986. (June 26, 1986 transcript, pages 153-154).

14. Debtor pledged the hypothecated securities to Chittenden as collateral for the two replacement notes. Chittenden accepted the securities after it was satisfied that David and Janet Winer had hypothe-cated the securities to Debtor. (June 26, 1986 transcript, page 165).

15. The securities hypothecated to Debtor, used to secure Debtor’s replacement notes, were also used to secure personal promissory notes of David and Janet Winer to the Chittenden:

a). $80,000.00 “Demand Collateral Note”, signed by David and Janet Winer, dated April 30,1985, (Note # 133, Exhibit L); and,

b). $156,000.00, “Commercial Real Estate Mortgage Note” by David Winer, dated November 15, 1984, (Mortgage note # 141, Exhibit LI).

(June 26, 1986 transcript, pages 144-148).

16. The intended purpose of the loan proceeds from personal Note # 141 was for the construction of improvements to Debt- or’s leased manufacturing premises. (June 26, 1986 transcript, page 147).

17. David Winer and Janet Winer “lent” Debtor the proceeds from their personal note # 133 to provide the Debtor with working capital. (Exhibits L; April 1,1986 transcript, page 20).

18. Debtor is in default on its notes # 75 and # 83. (June 26, 1986 transcript,

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page 148). As of March 18, 1986, the outstanding balances on the notes were: a). Note #75, $98,470.55 with a per diem of $28.96880; and, b). Note # 83, $51,540.91 with a per diem of $14.38356. (Exhibit E).

19. The Winers’ notes, (Notes # 133, 141), are not in default. Chittenden is prepared to “roll over” these personal notes at the conclusion of this adversary proceeding. (June 26, 1986 transcript, pages 146, 174-175; June 27, 1986 transcript, pages 73-74).

20. David Winer is the owner in fee simple of the premises on which the Debtor conducted its wood manufacturing business. (Exhibit P; June 26, 1986 transcript, page 147).

21. On November 15, 1984, David Win-er, as lessor, and Debtor, as lessee, entered into a “Lease Agreement.” (Exhibit W; April 1,1986 transcript, pages 73-74). The pertinent provisions of this lease include:

2. The term of this Lease shall be three (3) years, commencing on November 15, 1984 and ending on November 14, 1987. The Tenant (Debtor) shall have an option to extend this lease for an additional three-year term by giving written notice to Landlord (David Winer) sixty (60) days prior to the expiration of the then current term....

3. Tenant (Debtor) shall pay rent of THREE THOUSAND DOLLARS ($3,000.00) per month during the initial three-year term of the Lease. Rental for the renewal period of an additional three years shall be FOUR THOUSAND DOLLARS ($4,000.00) per month.

8. Landlord (David Winer) agrees that any personal property or fixtures brought upon the premises by Tenant (Debtor) may be removed upon the termination of this Lease Agreement. Tenant (Debtor) shall make any repairs required as a result of such removal.

(Exhibit W) (parentheticals supplied for clarity).

22. Debtor never made any rental payments to David Winer. (April 1, 1986 transcript, pages 73-74).

23. Despite the absence of rental payments, David Winer never provided Debtor with either a written demand notice for rental payments or with a written termination notice of default. (April 1, 1986 transcript, pages 73-75). After David Win-er was sure that Debtor was insolvent and, in what he characterizes as an effort to keep the Debtor “going,” David Winer, individually, and Gordon Winer, as Debtor’s president, agreed that the Debtor would execute a $48,000.00 “Demand Note” on July 31, 1985, (Exhibit U), to David Winer for unpaid rent for the period from November 15, 1984 through November 15, 1985. (Exhibit U; June 19, 1986 transcript, page 13).

24. Between 1979. and 1985, David Win-er “lent” Debtor approximately $466,000.00 from the personal loans he or he and Janet Winer had obtained from the Chittenden or from other sources not disclosed to us. (Exhibit C — 1; Exhibit C-3, Debtor’s 1984, 1983, 1982 Federal Income Tax Returns, page 4, line 18 “Loans from shareholders;” June 19, 1986 transcript page 12; June 26, 1986 transcript pages 16-19).

25. David Winer “lent” Debtor monies for the purpose of providing working capital to maintain Debtor’s operations, (June 18, 1986 transcript, pages 37, 62), since the Debtor’s financial condition was woefully inadequate to borrow money on its own. (April 1, 1986 transcript, pages 21-22).

26. The three directors of Debtor did not formally meet or vote their approval for the personal loans from David Winer to the Debtor prior to the loan transactions. (June 26, 1986 transcript, page 125; Exhibits C — 1, 37). David Winer, an interested party to the personal loan transactions with Debtor, testified that he and the other two directors, his spouse and their son, had weekly informal discussions concerning personal loans and repayments. (June 26, 1986 transcript, pages 125, 131). David Winer also testified that Debtor’s directors might have had meetings every few months, but not every meeting or discussion was constituted as a meeting and, they might have acted without corporate minutes. (June 18, 1986 transcript, pages 33-34; June 26, 1986 transcript, page 27).

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27. At the same time David Winer caused Debtor to execute the demand note for the unpaid past and future rent, (finding 23), David Winer also caused Debtor to execute promissory notes for his personal loans to the Debtor. Debtor’s promissory and demand notes to David Winer were not contemporaneous with the personal loans, and may have been made several months to a year after the actual loans were made. (June 18, 1986 transcript, pages 13, 19, 41; Exhibits C — 1, U, and Y; June 19, 1986 transcript, page 13). We are not told of the actual dates.

28. Debtor’s promissory notes to David Winer were made at David Winer’s request, (June 18, 1986 transcript, page 41; June 19, 1986 transcript, page 13), and at a time when he knew that Debtor was hopelessly insolvent. (June 18, 1986 transcript, pages 56-57).

29. David Winer never requested that Debtor make payments on any of the loans because he knew that Debtor’s financial condition would not permit it to do so, and, as he stated: “I would be asking it of myself.” (June 18, 1986 transcript, page 37).

30. On July 31, 1985, David Winer and Debtor entered into a “Settlement Agreement,” (Exhibit C-2), which required Debt- or to execute the two demand notes, (Exhibits U; V), to David Winer for the unpaid and future rents, (November 15, 1984 through November 15, 1985), of $48,000.00 and the $132,580.00 consolidated personal loans from David Winer, (for the period of January 1, 1985 through July 31, 1985). (June 26, 1986 transcript, pages 22-23; 134).

31. David Winer intended the “Settlement Agreement” to provide him with a mechanism to make the leased premises available if Debtor failed. (June 26, 1986 transcript, page 23). The “Settlement Agreement” also provided for a “Security Agreement” and described the following collateral:

All of Debtor’s interest in accounts receivable and/or contract rights, past, present and future of Vermont Toy Works, Inc., and all goods and inventory, past, present and future, equipment, improvements, fixtures, machinery, special tools, and all additions, accessions, renewals and replacements for all or any part thereof, and all other tangible, intangible, or mixed personal property of the Debtor of any type or class, and all products and proceeds of all the foregoing (all hereinafter called “Collateral”). The Collateral shall remain personal property regardless of the manner in which it is attached to realty.

(Exhibit C-2). Financing statements (UCC-1) from the transaction were filed with the Vermont Secretary of State on November 8, 1985 and the Bristol Town Clerk on November 14, 1985. (Exhibit D). The UCC-l’s were filed several months after the “Settlement Agreement,” but shortly before Debtor’s demise. We also find that the date on the Bristol UCC-1, (there was no date on the State UCC-1), was changed, altered, or backdated from a November date to “7/31/85,” leaving us to conclude that the UCC-ls were not contemporaneous with the “Settlement Agreement,” and to further conclude that this was a blatant attempt on the part of David Winer to overcome his insecurities about his unsecured position.

32. Gordon Winer, Debtor’s president, personally lent over $25,000.00 to Debtor. (June 19,1986 transcript, page 3). Barbara Winer, Gordon Winer’s spouse, personally lent Debtor approximately $30,000.00. (June 19, 1986 transcript, page 14). Like the loans from David Winer, these loans were not formally approved by a disinterested quorum of Debtor’s directors, nor did Debtor execute contemporaneous promissory notes. (Exhibits 37, C — 1; June 19, 1986 transcript, pages 4, 14-15).

33. By the middle of 1985, Chittenden was well aware of Debtor’s insolvent condition. (Exhibits 13; 14). A Chittenden internal “Memorandum” entitled “Loan Review and Audit on David Winer d/b/a Vermont Toy works, Inc.,” dated July 11, 1985, reveals:

... Gordon Winer’s experience with running this type of facility is indeterminable. It is known that his father, David

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Winer, came to the aid of his son in the winter months in an attempt to help him with the financial aspects of the corporation ...

Misdirection of construction loan funds further show the company’s cash flow problems. The construction loan was written for $156,000 on November 15, 1984. Two of the initial drawdowns paid off two previous notes_ The misdirecting of these funds apparently left the customer short of cash during the renovation period for the building ... (See, finding #15, supra)

The corporate checking account has been overdrawn 36 times since it was opened on July 31, 1984. The overdrafts occurred regularly at least once a month since November of 1984. The overdrafts ranged from $267.25 on February 15, 1985, to $38,619.72 on December 12, 1984. This further evidences the poor cash flow position of the company.

As of May 19, 1985, the customer had only six clients. This is based on an unsigned workpaper developed by Vermont Toyworks and submitted to Vice President Ronson on May 15, 1985 ... Also noted during the closing interview ... was that the company was attempting to phase out their largest purchaser, Creative Woodcraft, because of differences with their management. Creative Woodcraft was responsible for 77.8% of accounts receivable for Vermont Toy-works ...

To summarize, there is a strong possibility that the bank will lose an indeterminable amount of money if Vermont Toy-works is unable to solve its financial problems ...

(Exhibit 13, pages 1-5) (parenthetical supplied).

34.Chittenden’s auditor recommended that Chittenden “Require additional collateral prior to any further advances.” (Exhibit 13, page 6). The auditor’s “Memorandum” also contained “Exceptions Notes,” which stated under “General Exceptions: 'Corporate Resolution must be signed by another corporate officer other than Vice President, David Winer.’ ” (Exhibit 13, page 7).

35. David Winer used funds intended for Debtor’s working capital to pay off his pre-November 1984 personal loans from Chittenden. (Exhibit 13, pages 3, 8; June 26, 1986 transcript, pages 160-62).

36. During May of 1985, David Winer consented to a $60,000.00 transfer of Federal National Mortgage Association bonds from his Smith Barney account to Chitten-den’s custody account at First of Boston. (Exhibit 12; June 18,1986 transcript, pages 53-54). David Winer testified that he and Chittenden had an understanding that these bonds were to be added to Chitten-den’s collateral pool for his loans. (April 1, 1986 transcript, pages 65-66). Later in the trial he contradicted this statement. (June 18, 1986 transcript, pages 53-54). Chitten-den’s internal auditor noted that these bonds, as of July 11,1985, had not yet been assigned to Chittenden. (Exhibit 13, page 5). The auditor recommended in a July 11, 1985 “Memorandum” regarding the “Subject: Loan Review and Audit on DAVID WINER D/B/A VERMONT TOYWORKS, INC.” that Chittenden: “f. Have customer, (David Winer d/b/a Vermont Toyworks, Inc.), immediately assign the RMS (we were not informed what “RMS” means) held portfolio to the CTC (Chittenden) to increase the value of the collateral.” (Exhibit 13, pages 1, 6) (parentheticals and emphasis supplied). Contrary to David Winer’s testimony, (June 18, 1986 transcript, pages 53-54), that the bonds were not intended to be pledged as additional security to Chittenden, we find his earlier testimony is corroborated by the auditor’s report which states:

Regarding recommendation ‘F’ that deals with the immediate assignment of readily marketable securities currently held in portfolio by the Chittenden, it should be noted that David Winer has agreed that this can be done and that we can cross-collateralize the readily marketable securities to all of his personal obligations at the bank. By so doing, we will increase our collateral position by approximately $60,000.00. Additionally, in a recent discussion with David Winer, he has further agreed to provide us with another $100,-

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000.00 worth of marketable securities in two (2) $50,000.00 increments which should be available to us within the next 30-45 days. Consequently, we are looking at being able to improve our collateral position as to the David Winer and David Winer and Janet Winer debt by approximately $160,000.00.

(Exhibit 14, page 2, August 14,1985 “Memorandum” by Chittenden’s auditor regarding the subject “Review and audit on David Winer and Vermont Toy Works, Inc.;” Exhibit 15, page 4, August 20, 1985 “Problem Loan Status Report” of David and Janet Winer by Chittenden).

37. During the summer of 1985, David Winer, Debtor’s attorney, and Chittenden had frequent discussions:

[A]s to whether or not the company is liquidated, placed in bankruptcy, or the assets are voluntarily surrendered to the Chittenden. The only event which would forestall these activities would be if they are able to find an outside investor who is willing to come up with the necessary capital to keep the company going.

(Exhibit 14, page 2; June 18, 1986 transcript, pages 57-58; Exhibit 15, page 1).

38. David Winer admits to the receipt of a Chittenden “demand letter,” which gave Debtor until August 31, 1985 to be current on its loans with Chittenden. (June 18, 1986 transcript, page 56).

39. Chittenden was unwilling to provide additional capital funds when Debtor repeatedly demonstrated its inability to carry its current debt load. (June 18, 1986 transcript, page 59). Chittenden placed one of Debtor’s notes on “interest only” status in an effort to make Debtor more attractive to potential outside investors and to preserve Debtor’s working capital. (June 18, 1986 transcript, pages 60-61). Some of David Winer’s personal loans from Chitten-den, “lent” to Debtor to provide working capital, were also put on an “interest only” status. (June 18, 1986 transcript, pages 61-62; Exhibit 16).

40. David Winer was unsuccessful in finding outside investors who were interested in the Debtor as an investment opportunity. (June 18, 1986 transcript, pages 57-58).

41. Debtor was the owner of a wood toy patent. David Winer acquired ownership of this patent from Debtor during March or April of 1985. (June 19, 1986 transcript, page 5). He paid $25,000.00 for it. None of Debtor’s officers or directors estimated the patent’s value, voted by a disinterested quorum, or approved its transfer to David Winer. (June 19, 1986 transcript, pages 6-7).

42. During the fall of 1985, David Win-er, Debtor’s attorney, and Chittenden met and discussed the possibility of forming a new corporation which would acquire Debt- or’s personalty. (June 18, 1986 transcript, pages 64-65, 72). An October 28, 1986 memorandum by a Chittenden officer, Mr. Burnell, of a meeting among himself, a Chittenden employee, Chittenden’s in-house attorney and Debtor’s attorney, reveals that Mr. Burnell had problems with the passing of Debtor’s personality to a new corporation and that Chittenden’s in-house attorney and Debtor’s attorney were to pursue and devise the legal aspects for the pass through of Debtor’s personality:

Gable — (Patricia Gable, Esq., Debtor’s and Vermont Wood’s attorney) pursuing various ways of possibly transferring personality to a new corp. I have problems with this. Mark (Mark Scribner, Esq., Chittenden’s in-house attorney) and pat (sic) Gable to pursue legal aspects and get back to us.

(Exhibit 18, parentheticals supplied for clarity; June 26, 1986 transcript, pages 175-77). The formation of a new corporation was devised by David Winer and Chit-tenden to carry on Debtor’s business prior to Debtor’s demise because:

With the growing difficulties of Vermont Toy and the lack of success of our (sic) developing investors for Vermont Toy, we thought it would be a good idea to have a company that would be available to continue producing items similar to those at Vermont Toy that would use the facility and might be able to be favorably considered for investment on the part of

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a businessman interested in going into this kind of business.

(June 26, 1986 transcript, page 99).

Through efforts on behalf of Vermont Wood Industries, sales of products were generated, and these were products that were going to be produced in the facilities of Vermont Toy Works. There was growing concern that Vermont Toy Works would not survive. We were unable to bring in investment from others, and the thought that perhaps a new company that would generate investment, new investment, from others might be able to carry on. The customers were unwilling to consider certain placement of orders with Vermont Toy in the event that the company would not be able to survive. So discussions were held to assure (sic) the fact that these customer requirements could be satisfied.

(June 18, 1986 transcript, page 67).

43. During the summer of 1985, Debtor was introduced to Mr. Bruce Brosler, president of Tech Furnishings, Inc., a potential furniture customer for Debtor. (June 26, 1986 transcript, pages 93-94). Debtor contemplated that Tech Furnishings, Inc. would purchase within a year as much as $40,000.00 of finished furniture from it. (June 26, 1986 transcript, page 94). Mr. Brosler submitted a detailed cost estimate, dated September 27, 1985, for a “Brosler C206” case to be produced by Debtor. (Exhibit 33; June 18, 1986 transcript, pages 71-72).

44. Mr. Brosler, on behalf of Tech Furnishings, Inc., placed an order with Debtor on October 17, 1985, (June 18, 1986 transcript, page 84); however, Debtor lacked working capital to purchase the wood inventory to fill the order. (June 26, 1986 transcript, page 95). Neither Mr. Brosler nor David Winer, like Chittenden, were willing to advance any further funds to Debtor. (June 18, 1986 transcript, pages 84-85). Mr. Brosler then introduced a Mr. Jacobson to David Winer as a potential investor of much needed capital for the necessary raw material to fill Tech Furnishings, Inc.’s order. Mr. Jacobson was unwilling to invest directly in Debtor, because of its precarious financial condition, and the “Tech Deal” collapsed. (June 26, 1986 transcript, page 95).

45. Vermont Wood Industries, Inc., (Vermont Wood), “Certificate of Incorporation” was issued by the Vermont Secretary of State on October 30, 1985. (Exhibit 19, page 1; June 26, 1986 transcript, page 96-97). Vermont Wood’s “Articles of Association” listed David Winer as the sole initial director, and listed Debtor’s attorney as the incorporator of Vermont Wood. Vermont Wood’s “Articles of Association” stated specific corporate purpose is:

Engaging in the business of designing, manufacturing, distributing, selling, buying, repairing, exporting, importing and otherwise dealing in and with, at wholesale and retail, all kinds of furniture, furnishings, decorative fixtures and products constructed out of wood and/or out of other building materials, as well as in and with all raw materials and replacement parts therefor.

(Exhibit 19, pages 2, 3).

46. There was a six week overlap between Vermont Wood’s incorporation, October 30,1985, and Debtor’s cessation. (June 18, 1986 transcript, pages 65-67).

47. David Winer became Vermont Wood’s president, chairman of the board, treasurer, fifty percent shareholder, and one of three directors (April 1, 1986 transcript, page 24) as a result of a November 12, 1985 “Shareholders Agreement” with Mr. Jacobson. (Exhibit T). In consideration for Jacobson’s financial investment in Vermont Wood, David Winer agreed to relinquish his sole shareholder interest and directorship position in Vermont Wood and share control of Vermont Wood with Mr. Jacobson. Mr. Jacobson was made a fifty percent shareholder in Vermont Wood on November 12, 1985, and was given the right to name two of Vermont Wood’s three directors. (April 1, 1985 transcript, page 24; June 26,1986 transcript, page 42). Mr. Jacobson named himself and Tech Furnishings, Inc.’s president, Mr. Brosler, as Vermont Wood’s second and third Directors. (April 1, 1986 transcript, page 24; June 26, 1986 transcript, page 96). Under

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the November 12, 1985 “Shareholders Agreement,” Mr. Brosler has the right to purchase stock (price unknown) in Vermont Wood, (Exhibit T; June 18, 1986 transcript, page 68), but David Winer’s ownership could not be less than fifty (50) percent of all issued shares.

48. Before Debtor’s cessation, Mr. Jacobson and David Winer agreed to salvage the aborted Tech Furnishing contract, and to provide Vermont Wood with the necessary capital to fund Debtor’s manufacturing of Tech Furnishings, Inc.’s order. (June 26, 1986 transcript, page 95). Vermont Wood then entered into a contract with Mr. Brosler for the original furniture order with Debtor. (June 26, 1986 transcript, page 95).

49. On November 12, 1985, David Win-er, on behalf of Vermont Wood, and Gordon Winer, on Debtor’s behalf, entered into a consignment “Agreement.” (Exhibit Y). The consignment agreement was designed to protect Vermont Wood in the event that Debtor failed. (June 18, 1986 transcript, page 84). Under the consignment agreement and in furtherance of its contract with Tech Furnishing, Inc., Vermont Wood agreed to purchase lumber, (inventory), and pay Debtor for the manufacturing of finished product. (June 26,1986 transcript, pages 93-96; June 27, 1986 transcript, page 100).

50. Mr. Jacobson and David Winer also agreed to commit Vermont Wood to purchase Debtor’s machinery and equipment in order to discharge David Winer’s and Gordon Winer’s personal guarantees on Debt- or’s loan obligations with Chittenden. Thus, as early as November 12, 1985, Vermont Wood, David Winer, and Mr. Jacobson were committed on an option basis to purchase Debtor’s equipment and machinery for the amount required to discharge Debtor’s obligations to Chittenden. (April 1, 1986 transcript, pages 33-34; June 26, 1986 transcript, pages 42-43).

51. In mid-November, 1985, and after Debtor had defaulted on its loan obligations to Chittenden, David Winer on behalf of Vermont Wood entered into negotiations with Chittenden to enable Vermont Wood to obtain Chittenden’s collateral in Debtor’s machinery and equipment. (This was ultimately consummated on December 9, 1985 in an agreement entitled “Equipment Lease Agreement;” finding 59). Vermont Wood’s consideration was the payoff figure on Vermont Toy’s debts to Chitten-den. (June 26, 1986 transcript, page 100).

52. Also, by mid-November, David Win-er and Mr. Jacobson agreed that Vermont Wood would pay off Debtor’s rent arrear-age owed to David Winer and enter into a real estate lease with David Winer after David Winer terminated Debtor’s lease.

53. After Vermont Wood was created and Mr. Jacobson was committed to invest in Vermont Wood: Debtor, ceased doing business on December 7, 1985; stopped making payments on its loans to Chitten-den; and, Chittenden declared Debtor in default of its notes # 75 and #

83.

(April 1, 1985 transcript, pages 22-23; June 26, 1986 transcript, page 148).

54. On December 6, 1985, Gordon Win-er, Debtor’s president, and Chittenden entered into a “Repossession Acknowledgement,” (Exhibit M), which provided in part:

1. On November 15, 1984, Debtor executed the following notes payable to the Chittenden Trust Company:

(a) Demand Collateral Note in the amount of $98,562.00; and

(b) Demand Collateral Note in the amount of $50,000.00 ...

5. Debtor is in default under the terms of the promissory notes described above.

6. The collateral described herein does not constitute a going concern. Debtor consents to the peaceable repossession of the collateral by the secured parties without the necessity of instituting legal proceedings, and voluntarily surrenders said collateral to the possession of secured parties ...

8. Debtor waives its right to redeem the collateral prior to any disposition.

9. Debtor agrees that if the secured parties lease the machines and equipment to a third party and thereafter sell the collateral to said Lessee, the secured parties shall be deemed to have used

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reasonable care in the custody and preservation of said collateral and to have kept collateral identifiable so long as (1) debtor receives a copy of the proposed lease and signs its written consent to the terms thereof and (2) said lease is hereafter entered into without modification, followed by a private sale to said Lessee.

(April 1, 1986 transcript, page 23; June 26, 1986 transcript, page 38).

55.Before the December 6, 1985 “Repossession Acknowledgement,” Chittenden held meetings with David Winer where David Winer agreed to become Chitten-den’s agent:

In addition to calling me, I met with the people at the bank in the days immediately preceding the December 6th or 7th date. I was aware that the bank had made a demand for payment on the debts that were due, and I was aware that the company (Debtor) was unable to make those payments, and I was instructed by the bank (Chittenden) during meetings at the bank that I was to make certain that all machinery and equipment which is identified on an inventory list be maintained on the premises and maintained in good working condition and preserved. I was instructed to segregate all Vermont Toy Works inventory; and in order to save administrative costs and expenses which would be generated, I was instructed as to how the pallets were to be assembled and segregated and marked; and I presented to the bank that that (sic) was done as it was done. I provided them with complete lists of documentation as to the pallet identifications and the machinery and equipment.

(April 1, 1986 transcript, pages 85-86) (par-entheticals supplied for clarity). Chitten-den’s counsel, on re-direct, tried to establish that Chittenden gave David Winer instructions after the “Repossession Ac-knowledgement” was signed: “Q. Did the Chittenden Bank give Vermont Toy any instructions after the repossession agreement was signed on December 6, 1985? A. They did.” (June 26, 1986 transcript, page 38). In our view, this attempt at rehabilitation bears no fruit. It is clear Chittenden instructed David Winer, prior to the “Repossession Acknowledgement,” how to handle the collateral owned by the Debtor. It is equally clear that Chittenden, David Win-er and Debtor’s successor, Vermont Wood, had Debtor’s business death as an agen-dum long before the ink of the “Repossession Acknowledgement” was dried.

56. Chittenden never took actual or direct physical possession of Debtor’s machinery and equipment. (April 1, 1986 transcript, pages 80-81). Neither did it obtain the keys to Vermont Toy’s business premises, nor did it personally mark or otherwise identify the alleged repossessed collateral. (April 1, 1986 transcript, pages 84-85).

57. Prior to the “Repossession Ac-knowledgement,” David Winer was instructed orally by Chittenden to act as its repossession agent and to preserve, segregate and identify Debtor’s equipment, machinery, inventory and accounts receivable. (June 26, 1986 transcript, page 39). David Winer instructed Debtor’s employees to verify Chittenden’s collateral according to Chittenden’s pre-existing list of Debtor’s machinery and equipment. (April 1, 1986 transcript, page 86). Chittenden instructed David Winer to separate the Debtor’s inventory on a “pallet-by-pallet basis and to make sure it was properly labelled so that it was identified as property of the bank.” (April 1, 1986 transcript, page 47). David Winer and Debtor’s employees prepared approximately 120 pallets of corrugated boxes, finished goods, toys, and parts. The bulk of the pallets were “fall off” wood. This “fall off” wood is part of the work in process from certain raw material that was too good to throw out and yet not good enough to use in on-going product. (April 1, 1986 transcript, page 47). David Winer estimated that of the 120 pallets, there were approximately 70 to 80 pallets of “fall off” material. (April 1, 1986 transcript, page 48).

58. On December 6, 1985, Gordon Win-er, Debtor’s president, executed a written “Consent to Lease of Equipment,” (Exhibit O), whereby Debtor consented “to the terms, execution and performance of the Equipment Lease Agreement,” not yet con

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summated, pursuant to paragraph nine (9) of the December 6, 1985 “Repossession Ac-knowledgement.” (Exhibits M; 0; Q). David Winer and Gordon Winer decided, during a director’s meeting, that Debtor would execute the “Consent to Lease of Equipment.” Janet Winer was absent from this meeting. (April 1, 1986 transcript, pages 109-110). There is no evidence that Debtor, on or prior to December 6, 1985, independently approved of the December 9, 1985 Chittenden’s “Equipment Lease Agreement,” (Exhibit N), with Vermont Wood.

59. On December 9, 1985, David Winer, on behalf of Vermont Wood, and Chitten-den executed a Chittenden prepared document entitled “Equipment Lease Agreement.” (Exhibit N; April 1, 1986 transcript, page 103). Chittenden proclaimed itself “lessor” of Debtor’s machinery and equipment under its alleged acquired possession of Debtor’s collateral (Exhibit N, page 1), and paragraphs 6 and 9, (Exhibit M) of the “Repossession Acknowledgement.” (June 26, 1986 transcript, page 39).

60. The “Equipment Lease Agreement” provides that the machinery and equipment are to remain Debtor’s property. (Exhibit N, page 3, paragraph 5.1; April 1, 1985 transcript, pages 104-105). The term of • the “Equipment Lease Agreement” was for one year. The rental payments were calculated to maintain Debtor’s loan payment schedule with Chittenden. (Exhibit N, page 3, para. 4; June 26, 1986 transcript, pages 39-40). Vermont Wood pays Chit-tenden approximately $2,400.00 a month under this “Equipment Lease.” (April 1, 1986 transcript, pages 106-108).

61. Findings 59 and 60 are examples of the quagmire Chittenden and David Winer planned and created for the Debtor. Chit-tenden proclaims both itself and Debtor as owners of the machinery and equipment. David Winer also claims an interest

vis a vis

his “Settlement Agreement” and his belatedly filed UCC-1. (finding 31). Mercifully, we do not have to resolve who is on first because our holding does not require it.

13

62. The “Equipment Lease Agreement” also provides Vermont Wood with an option to purchase Debtor’s machinery and equipment, (Exhibit N, page 4), from Chittenden, (lessor), for “[T]he principal balance owed to Lessor by Vermont Toy Works, Inc. or the debt incurred to purchase the equipment.” (Exhibit N, page 4; June 26, 1986 transcript, page 40; April 1, 1986 transcript, pages 32-33).

63. Although no written termination or notice to vacate the real estate lease was given by David Winer, lessor, to Debtor, lessee, David Winer considered the lease terminated when Debtor ceased doing business on December 7, 1985. (April 1, 1986 transcript, page 75).

64. The original real property lease between Debtor and David Winer, (Exhibit W), did not express when Debtor was to make its monthly rental payments. The “Settlement Agreement” between Debtor and David Winer, stated, inter alia: “3. The Corporation (Debtor) shall, commencing on November 15, 1985, make all rental payments when due under the Lease Agree

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ment.” (Exhibit C-2). Because of the November 12, 1985 agreement between David Winer and Mr. Jacobson, David Winer intended that Vermont Wood would become the successor lessee to Debtor prior to Debtor’s cessation.

65. On December 9, 1985, Vermont Wood, Lessee, and David Winer, lessor, executed a real estate “Lease Agreement” for the same land and building premises (the Bristol property) as David Winer had leased to Debtor. (Exhibit Q; April 1,1986 transcript, page 31). The term of Vermont Wood’s lease is for five years from December 9, 1986 through December 31, 1990, with an option to extend the term of the lease for two additional five year terms. (Exhibit Q, page 1). In the event that Vermont Wood purchased Debtor’s equipment and machinery under the “Equipment Lease Agreement,” then the term “shall be deemed a month to month tenancy.” (Exhibit N, page 1). Vermont Wood’s rent for the five year term is $4,000.00 a month with the exception that:

... [N]o rent shall be required to be paid during any month that Lessee’s (Vermont Wood’s) revenues, less returns, do not exceed $35,000. Rent for these months shall be accrued. When such gross revenues, less returns, exceed $35,-000 for any month, the rent paid during that month shall equal eight (8) percent of such revenues, and shall be applied first to rent accrued for prior months and then to the month in question; PROVIDED, HOWEVER, that under no circumstances shall rent paid exceed $4,000 per monthduring (sic) the first five year term....

(Exhibit Q, pages 1-2, para. # 4) (parenthetical supplied for clarity).

66. As a result of Vermont Wood’s “Shareholders Agreement,” (Exhibit T), David Winer became a “minority” director and could be “overruled” by the other two directors on matters of Vermont Wood’s operations. David Winer could, however, overrule the other two directors of Vermont Wood on matters which concerned David Winer’s interests, such as Vermont Wood’s building and real estate rental payments to David Winer, because these matters required the Directors’ unanimous votes. (April 1, 1985 transcript, page 25).

67. Vermont Wood commenced its wood manufacturing business on December 9, 1985. (April 1, 1986 transcript, pages 83-84).

68. On December 17, 1985, Debtor’s new attorney sent a letter to Debtor’s creditors to inform them that Chittenden had taken possession of Debtor’s assets and:

... As of October 81, 1985, the principal amount of loans owed to the Bank (Chit-tenden) and VIDA exceeded $190,000.00 Unsecured trade debt exceeded $237,-000.00 The principal amount of shareholder and insider loans to the Corporation (Debtor) exceeded $400,000.00, of which over $135,000.00 was loaned to the Corporation by shareholder David Winer within the last ten months ... Consequently, the amount of the debt to the secured parties exceeds the value of collateral. We do not anticipate that any assets will be available to satisfy the $237,000.00 debt owed to unsecured creditors or the debt of over $380,000.00 in loans and $36,000.00 in unpaid rent which is owed to shareholder David Winer.

... We have been advised that the Bank intends to foreclose the machinery and equipment at a private sale on December 27, 1985 ... The buyer is expected to be Vermont Wood Industries, Inc., which is controlled.by a businessman from Massachusetts who had no previous affiliation with Vermont Toy Works, Inc. or David Winer. David Winer, who, as guarantor of the Debt to the Chittenden and VIDA, remains personally liable for any deficiency on such debt, is also a stockholder in Vermont Wood Industries, Inc.

Vermont Wood Industries, Inc. is expected to lease the building previously rented by Vermont Toy Works, Inc. and to hire some of the individuals previously employed by Vermont Toy Works. Associates of the Massachusetts investor in Vermont Wood Industries, Inc. bring with them a new market for the wood products to be made by the new company.

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The management of Vermont Toy Works, Inc. ... has been assured by Vermont Wood Industries, Inc. (it) will use its best efforts to do business with the creditors of Vermont Toy Works Inc

(Exhibit 35, parenthetical supplied for clarity; June 18,1986 transcript, page 88; June 19, 1986 transcript, page 12). This letter contains many misstatements. For example, it did not disclose: that David Winer’s insider shareholder loans are unsecured; that David Winer is the original sole shareholder and director of Vermont Wood; and, that the “businessman from Massachusetts” and David Winer are each presently fifty (50%) percent owners of Vermont Wood. Nor did this letter disclose that Chittenden, Debtor, Vermont Wood and David Winer had already negotiated contracts for: Vermont Wood to lease and purchase Debtor’s machinery and equipment for an amount calculated to discharge Debtor’s debt to Chittenden; the rental of the premises with an option to purchase to Vermont Wood; the discharges of David Winer’s guaranty to Chittenden as well as Debtor’s rental arrearage owed to David Winer; and, that Chittenden and Debtor both claimed ownership of the Debtor’s assets.

69.David Winer testified that Vermont Wood was not established as Debtor’s successor and that Vermont Wood was different from Debtor because:

In the first place, the ownership and control would be different. The customer basis would be different. The products would be different. The markets would be different.

(June 18, 1986 transcript, pages 67-68). We disagree.

69(a). Vermont Wood’s corporate purpose is similar to Debtor’s, i.e., to produce wood products. (April 1, 1986 transcript, pages 89-90). With minor differences in type of wood and style, (June 26, 1986 transcript, pages 100-101) both Vermont Wood and Debtor manufactured wood furniture products with the same machinery and equipment. Indeed, on November 12, 1985, Vermont Wood contracted with Debt- or for the latter to produce certain wood products for Vermont Wood. (Exhibit Y; Exhibit C-6; June 26, 1986 transcript, pages 89-93; April 1, 1986 transcript, pages 90-91; June 18, 1986 transcript, pages 78, 80).

69(b). Vermont Wood continues to service many of the same customers, (Exhibit 21; June 18, 1986 transcript, pages 73-74), that Debtor had at the time it had closed. (June 26, 1986 transcript, pages 100-101, 2 to 3 customers carryover; Exhibit 13, page 3, para. 5, as of May 19, 1985, Debtor only had 6 customers).

69(c). Vermont Wood’s key personnel are the same as those of Debtor: David Winer, Debtor’s vice president, is Vermont Wood’s president; Gordon Winer, Debtor’s president, is Vermont Wood’s “plant manager.” (June 18, 1986 transcript, page 64); Barbara Winer, Gordon Winer’s wife and Debtor’s office manager, is Vermont Wood’s “business manager.” (June 27, 1986 transcript, pages 4, 58); and, Debtor’s corporate former counsel is now Vermont Wood’s counsel, (June 18, 1986 transcript, page 65; June 26, 1986 transcript, pages 8-10).

70. David Winer testified that he calculated the value of the “fall off” (finding 57) by factoring into the value, the gaps between the material on the pallet, the current market price of the material, and the likely yield that would result if the “fall off” materials were to be used. (April 1, 1986 transcript, pages 48-49). David Win-er’s opinion established the fair market value of Debtor’s “fall off” as approximately $13,000.00. (April 1,1986 transcript, pages 48-49). In Debtor’s December 17, 1985 letter to creditors, (finding 68) however, this inventory’s value was between $15,-000.00 and $20,000.00: “Inventory consists largely of ‘fall off’ lumber and custom design boxes and is estimated not to exceed a value of $15,000.00 to $20,000.00.” (Exhibit 35). We find the value of the “fall off” inventory is $15,000.00.

71. David Winer testified that Debtor had uncollected accounts receivable of approximately $52,000.00 at the time of Debt- or’s demise. (April 1,1986 transcript, page

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49). He also testified that two of Debtor’s major customers, Creative Woodcraft, ($45,000.00), and Enrico Bartellini, ($3,000.00), represented approximately $48,-000.00 of the total uncollected accounts receivable, and that Debtor would be “fortunate to get $15,000.00 from them in total.” (April 1,1986 transcript, pages 49, 51). No evidence was produced as to the collectability or uncollectability of the $4,000.00 balance of the Debtor’s total accounts receivable. Thus, the value of the Debtor’s accounts receivable is $15,000.00.

72. The parties agreed that the value of Debtor’s machinery and equipment ranges from $90,000.00 to the $141,800.00 sales price to Vermont Wood. (April 1, 1986 Stipulation; Exhibits H, I). Vermont Wood is willing to offer $141,800.00 for Debtor’s machinery and equipment because the machinery and equipment is in place and fully operational. (April 1, 1986 transcript, pages 27, 29; June 26, 1986 transcript, page 42). In addition to the going concern value, Vermont Wood is also willing to offer the $141,800.00 sales price in order to discharge Debtor’s two notes by assuming Debtor’s obligation (April 1, 1986 transcript, page 32) and to release David and Gordon Winer from their personal guarantees of Debtor’s obligations. (April 1, 1986 transcript, pages 31-32; June 26, 1986 transcript, pages 41-42). With no other evidence before us, the $141,800.00 sales price is the fair market value of Debtor’s machinery and equipment.

73. Sebert Lumber, Inc. (named Defendant in this proceeding) was a major supplier of raw materials to Debtor and a purchaser of finished product. (April 1, 1986 transcript, pages 37-38). During July and August of 1985 David Winer approached Se-bert’s president with a request to invest in Debtor. He provided Sebert with Debtor’s financial data and information about potential customers such as Tech Furnishings, Inc. (April 1, 1986 transcript, pages 40, 59-60; June 27, 1986 transcript, page 98). There was no competent evidence that Se-bert or any of Debtor’s other unsecured trade creditors were informed about Debt- or’s under-capitalization or that the proceeds from Chittenden’s personal loans to David Winer were used by David Winer for his shareholder loans to the Debtor. Se-bert declined David Winer’s offer to invest in Debtor. (June 18, 1986 transcript, page 69).

74. David Winer never requested that Mr. Sebert invest in Vermont Wood. (June 27, 1986 transcript, page 88). David Winer never told Sebert, or any other unsecured creditor, about Vermont Wood, and Sebert did not know of Vermont Wood’s existence (June 27,1986 transcript, page 97; June 18, 1986 transcript, page 81) until the first disclosure of Vermont Wood was made through the Debtor’s December 17, 1985 attorney’s letter. (June 27,1986 transcript, pages 88, 97). In rebuttal to Sebert’s testimony regarding nondisclosure of Vermont Wood or of David Winer’s intentions of forming a new company, David Winer testified that during late October or early November of 1985 he discussed with Sebert’s president and/or Sebert’s vice president about the possibility of forming a successor corporation to Debtor. (June 27,1986 transcript, pages 102-103). On this point, we perceive Sebert as credible and not David Winer. When testifying in response to questions from Chittenden’s counsel, David Winer had a rather remarkable memory, not unlike a picture from a camera; however, when questioned by Sebert’s counsel, David Winer’s memory was as if the negative had been underdeveloped.

75. Sebert, with others, initiated the involuntary bankruptcy proceeding against Debtor to stop the December 27, 1985 private sale, disclosed in Debtor’s December 17, 1985 attorney’s letter, between Chitten-den and Vermont Wood. (June 27, 1986 transcript, pages 95-96).

76. Debtor’s outstanding loan obligations with Chittenden are summarized as follows:

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Note #_Date_Borrower Payoff_Collateral_

75 11/15/84 Debtor $99,400.00 Debtor’s machinery; equipment; accounts receivables; inventory; hypothe-cated securities; personal guarantees

83 11/15/84 Debtor $51,600.00 Debtor’s machinery; equipment; accounts receivables; inventory; hypothe-cated securities; personal guarantees

(Exhibit C — 7; June 26, 1986 transcript, pages 149-150).

77. A summary of the outstanding per- David Winer and Janet Winer with Chitten-sonal loan obligations of David Winer or of den is as follows:

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78. David Winer’s Bristol property, leased by Debtor and Vermont Wood for wood manufacturing, was appraised on September 18, 1984 at a fair market value of $213,000.00, and was subject to increase to $355,000.00 if certain proposed improvements were made to the subject property and surrounding non-subject property. (Exhibit C-10; June 26, 1986 transcript, page 64).

78(a). The appraiser of the Bristol property testified that substantial improvements have been made to the subject premises since his 1984 appraisal: the subject premises have been surveyed; an operational septic system, an expanded electrical system to meet the needs of the machinery and equipment, a heating system, including a new boiler, and an outside and an inside cyclone and sawdust collection systems have been installed; and, an office, employee lounge, and fire protected storage areas have been constructed in the subject premises. (June 26, 1986 transcript, pages 64-69). The appraiser observed that a fire in the boiler room caused some damage and was informed that the boiler room leaked and was not operational. (June 26, 1986 transcript, page 70).

78(b). The Bristol property appraiser also testified that a number of contemplated improvements on the premises had not been made, i.e., a thirty-foot by thirty-foot addition and an eighteen-foot high door with a loading dock facility attached to the front of the subject building. (June 26, 1986 transcript, pages 69-70). When performing the appraisal, the appraiser also considered potential improvements on adjacent property, not owned by David Winer, in his 1984 final value. The following contemplated improvements to the adjacent property were not made: removal of approximately ten truckloads of debris; two steel frame buildings were to have been repaired and put into good appear-

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anee; and, a 2,000 square foot concrete building was to be leveled. (June 26, 1986 transcript, pages 65-67).

78(c). The appraiser testified that the present market value, as of June 26, 1986, of the Bristol premises was approximately $250,000.00, (June 26, 1986 transcript, page 64); however, the appraiser failed to conduct any sale comparisons with other comparable manufacturing sites for his updated appraisal. (June 26, 1986 transcript, pages 71-72). Based on the appraiser’s testimony and other evidence at trial, we find the fair and present market value of David Winer’s Bristol premises to be $300,-000.00.

79. David Winer submitted a “Personal Statement” of his financial affairs to Chit-tenden which indicated that as of June 11, 1984, his net worth was $1,212,000.00. (Exhibit 38; June 26,1986 transcript, pages 171-173). David Winer listed on “Schedule A — U.S. Governments and Marketable Securities” of his “Personal Statement” the following deposits, accounts and corresponding market values:

Smith Barney Account $125,000.00

Merrill Lynch Account 20,000.00

IRA/Keough Account 25,000.00

$50,000 PT & T 2016 Bonds 34,000.00

1215 Shares Chittenden Bank Stock 26,000.00

Mise Stock 30,000.00

Total $260,000.00

(Exhibit 38, page 2; June 26, 1986 transcript, page 173).

79(a). David Winer testified that part of his June 1984 “Personal Statement” was no longer accurate as of June of 1986, (June 27, 1986 transcript, page 68), and, as required by his loan agreements with Chit-tenden, he never provided Chittenden with the required written notice of a change in his financial status. (June 27, 1986 transcript, page 80).

79(b). David Winer testified that the current values of the deposits and accounts listed on the “Schedule A — U.S. Governments and Marketable Securities” on his “Personal Statement,” had changed as follows:

Smith Barney Account $ 45,000.00

Merrill Lynch Account 0.00

IRA/Keough Account 0.00

$50,000 PT

&

T 2016 Bonds 50,000.00

1215 Shares Chittenden Bank Stock 48,000.00

Mise Stock 65,000.00

Total $208,000,00

(June 27, 1986 transcript, page 69).

79(c). David Winer testified that Chit-tenden never requested that he set forth, in his 1984 “Personal Statement,” which properties were held individually by him or jointly with Janet Winer, however, he had a “long history” of discussions with Chitten-den on this subject and had always included jointly held properties in the many statements he had provided to Chittenden. (June 27, 1986 transcript, page 78).

79(d). David Winer’s “Personal Statement” discloses that, as of June 11, 1984, his Barnard property was appraised at a market value of $325,000.00 with a Chitten-den mortgage of $60,000.00. (Exhibit 38, page 2). David Winer has placed several more Chittenden mortgages against the Barnard property, (finding 77). David Winer, however, testified that the current value of the Barnard property was approximately $150,000.00, since a substantial portion of the land and a dwelling has been sold. (June 27, 1986 transcript, pages 70, 76).

80. On Chittenden’s direct examination, David Winer testified that his present net worth was approximately $300,000.00 (June 27, 1986 transcript, page 72); however, on cross examination, he admitted that this estimate did not include: his $180,000.00 of antiques and arts, (June 27, 1986 transcript, page 81); his $250,000.00 home in Shelburne, Vermont (June 27, 1986 transcript, page 75) (we were not told if there are any mortgages on this property and assume there are none); his $40,000.00 equity in North Carolina property (June 27, 1986 transcript, page 76); his approximate $22,000.00 net loan receivable from property in Storrs, Connecticut (June 27, 1986 transcript, pages 80-81); and, he also omitted the toy patent worth at least $25,-000.00. (Finding # 41).

80(a). Based on David Winer’s own testimony, we find that his present net worth is approximately $817,000.00:

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Winer’s Estimate $300,000.00

Increases to Winer’s Estimate

Antiques and Arts $180,000.00

Shelburne Home 250,000.00

North Carolina 40,000.00

Storrs’ Receivables 22,000.00

Toy Patent 25,000.00 _

Total Assets Forgotten $517,000.00

Total Present Net Worth $817,000.00

80(b). This 1986 net worth of $817,-000.00 compares with David Winer’s 1984 net worth of $1,212,000.00, a reduction of $396,000.00. Additionally, we find David Winer’s testimony that over $912,000.00 of his assets had disappeared between his 1984 net worth and his original 1986 estimates as inconsistent with the evidence and doubtful at best. We find that he is financially capable of paying his guarantee of Debtor’s loans from Chittenden.

80(e). We also find that David Winer has sufficient assets to meet his and/or his and his wife’s personal loan obligations.

81.Chittenden acknowledges that the hypothecated securities were also used, at Chittenden’s request, as collateral for David Winer’s or David Winer’s and Janet Winer’s personal notes # 133 and # 141 (finding 15; June 26, 1986 transcript, pages 149-150, 166) which are not in default. (Finding 19). Chittenden’s in-house attorney testified that if the hypothecated securities were to be used to discharge Debtor’s notes #75 and # 83, then Chittenden would lose its collateral on the Winers’ personal note # 133 (June 26, 1986 transcript, pages 151) and the Winers would be in default unless they pledged additional sufficient securities within twenty-four hours of the Chittenden’s request. (June 26, 1986 transcript, pages 152, 174-175). Chittenden, however, is well aware of the prior hypoth-ecation of these securities for Debtor’s notes.

81(a). Chittenden’s in-house attorney also testified that the Winer’s personal note # 141 would be less secure if the hypothecated securities were to be utilized for Debtor's notes #75 and #83. (June 26, 1986 transcript, page 151). In that event, Chittenden would be secured by the first mortgage on the Bristol property, which is also collateral for the Winers’ personal notes #117 and # 125. (June 26, 1986 transcript, pages 151-152). Chitten-den can, as it has done with other notes, (see, finding # 7), demand that David Win-er and Janet Winer provide substitute collateral at the time notes # 141 and # 133 are rolled over. (Finding 19).

81(b). If either Debtor’s hypothecated securities or the personal guarantees of David Winer and Gordon Winer are to be utilized to discharge Debtor’s Chittenden debt, rather than Debtor’s machinery and equipment, Chittenden concedes it will not suffer a financial loss on Debtor’s notes # 75 and # 83. (June 26, 1986 transcript, pages 165, 174).

82. We find that Chittenden’s admitted mismanagement of Debtor’s and Winers’ loans and its knowing contribution to Debt- or’s financial crises, as demonstrated by its dominant participation in Debtor’s so called “loan workouts,” has caused the extensive cross-collateralization between the Debtor and the Winers.

83. David Winer testified that he never received a salary or any form of remuneration from Debtor (June 26, 1986 transcript, page 32); however, David Winer testified that Debtor has repaid approximately $20,-000.00 of his loan. (June 26, 1986 transcript, page 20).

83(a). Debtor’s general ledger (Exhibit C — 1, page 8) reveals that David Winer was paid $14,000.00 by the Debtor in 1985: $5,000.00 during February; $4,000.00 during May; and, $5,000.00 in September of 1985. David Winer admitted that the September 1985 $5,000.00 payment was made when he knew Debtor was in serious financial trouble and insolvent. (June 26, 1986 transcript, pages 132-133).

83(b). Debtor’s general ledger (Exhibit C — 1) reveals that a number of loans were made by “WNB,” Woodstock National Bank, and were recorded as “Stockholder Loans.” A Woodstock National Bank’s Officer testified that none of the loans, from Woodstock National Bank to Debtor, listed in Debtor’s ledger appeared in any of their loan records. (June 26, 1986 transcript, pages 79-81, 86-88). Debtor’s general ledgers, however, incorrectly reflected the

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Woodstock National Bank loans as “stockholder loans” from David Winer. (June 26, 1986 transcript, page 120; June 27, 1986 transcript, pages 26-31). The Woodstock National Bank loans are unauthorized corporate loans (Exhibit C-ll) and reflect, at worst, sloppy accounting and Debtor’s failure to observe corporate formalities. In this specific finding, although Sebert would like us to find otherwise, we do not find any inequitable conduct or wrongdoing on the part of David Winer other than his failure to observe the corporate formalities as Debtor’s director.

CLAIMS OF THE PARTIES

A. STANDING

Chittenden claims that the Trustee lacks standing to raise the equitable doctrine of marshaling of assets. It urges us to hold that only a secured creditor may invoke the doctrine, and that the Trustee’s position as a hypothetical lien creditor, under the “strong arm” clause 11 U.S.C. § 544 (a)(1),

14

does not rise to the requisite secured party status necessary to summon the marshaling doctrine into application in this proceeding.

The Trustee’s response

15

to Chittenden’s standing argument is that: this is a “no asset” case without a successful application of the doctrine of marshaling of assets; a successful marshaling defense would create a dividend, which would not otherwise exist, from which Sebert and other unsecured creditors would share; it has a secured party status under 11 U.S.C. § 544 (a)(1) and Vermont law; and, in the alternative, the doctrine of marshaling does not require two secured creditors, but rather two creditors.

B. DOCTRINE OF MARSHALING

In the event we hold that the Trustee may properly invoke the doctrine of marshaling of assets, Chittenden argues that the requirements of marshaling had not been met because: there is no “common debtor;” the Debtor, the guarantors, and the hypothecators are separate legal entities; Debtor does not have an interest in two funds subject to the secured claims of both Chittenden and the Trustee since the machinery and equipment was lawfully repossessed and Debtor waived its redemption; the guarantees of David Winer and Gordon Winer are not funds but only invitations for a lawsuit; and, finally, the hy-pothecated securities are not owned by the Debtor, but rather, are owned by David Winer and Janet Winer.

The Trustee’s response is that there are three funds from which Chittenden may satisfy the Debtor’s notes: fund 1, the personal guarantees of David Winer and Gordon Winer that waive notice, demand, nonpayment, or protest of any such note or other obligation representing an indebtedness or liability of the Debtor to the Chit-tenden. These guarantees incur liability which is indistinguishable from that of the Debtor; fund 2, the securities, hypothecat-ed to the Debtor by David Winer and Janet Winer; and, fund 3, Debtor’s machinery, equipment, inventory, and accounts receivable.

Alternatively, the Trustee claims that the facts and circumstances of this case and adversary proceeding give rise to certain exceptions to the “common debtor” element of marshaling, namely, the doctrines of piercing the corporate veil, alter ego, equitable contribution of capital, and the doctrine of substantive consolidation.

1.

Piercing the Corporate Veil and Equitable Contribution of Capital

In the context of piercing the corporate veil and equitable contribution of capital, the Trustee asserts that David Winer is the

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true alter ego of Debtor and, thus, the guaranty and hypothecated securities ought to be deemed in equity as contributions to Debtor’s capital.

The Trustee parades (paraphrased for brevity) the following examples of inequitable conduct for these exceptions to the “common debtor” rule of marshaling:

a. David Winer and Chittenden knew or should have known that Debtor was grossly undercapitalized and,.even with the personal financial contributions from David Winer and Debtor’s officers, was unable to meet its debts as they became due;

b. The hypothecated securities, used by Debtor to obtain working capital, gave the appearance to Debtor’s suppliers and unsecured creditors that Debtor was a solvent concern;

c. Appropriate corporate formalities, such as duly constituted director’s meetings and disinterested quorums, were disregarded when shareholder loans were executed without contemporaneous promissory notes or without approved repayments of shareholder loans;

d. David Winer forced Debtor to execute certain transactions in an attempt to create a secured status for himself during Debtor’s insolvency;

e. David Winer diverted Debtor’s corporate opportunities and customers. Specifically, by refusing to loan additional working capital for the Tech Furnishing’s order, he diverted opportunities to Vermont Wood, a corporation owned 50% by him, and of which he is its president. Instead, David Winer invested the necessary operating capital in Vermont Wood to acquire Debtor’s opportunities; and,

f. David Winer caused the Debtor to transfer its toy patent to him without any prior independent evaluation of its worth or value or prior approval by a disinterested quorum of Debtor’s directors.

The Trustee also claims that David Win-er, Debtor’s corporate officers and Chitten-den schemed to form Vermont Wood to become a depository for the contemplated transfer of Debtor’s assets and Chitten-den’s secured debts without prior notification to Debtor’s creditors. This scheme (paraphrased for brevity) was implemented when:

a. They refused to advance any additional operating funds and abruptly closed the Debtor;

b. David Winer unilaterally terminated the real estate lease with Debtor and subsequently leased the premises to Vermont Wood;

c. David Winer agreed to act as Chit-tenden’s agent to repossess Debtor’s machinery, equipment, inventory, and accounts receivable;

d. Chittenden, as lessor, agreed to lease Debtor’s machinery, equipment, inventory, and accounts receivable to Vermont Wood as the lessee;

e. The personal property rental payments were calculated to pay off the outstanding interest on the two Chitten-den notes, and were designed to result in a discharge of David and Gordon Winer’s personal guaranties and a release of the hypothecated securities; and,

f. The released hypothecated securities would then be used by David and Janet Winer for an expanded base of collateral for their personal loans to Chittenden.

Chittenden responds (paraphrased for brevity) to the piercing doctrine and alter ego exceptions with:

a. Debtor was not undercapitalized when David Winer paid $10,000.00 for his stock and personally loaned over $450,-000.00 to Debtor for its working capital;

b. The lack of corporate formalities and contemporaneous promissory notes for the shareholder loans is excused by the fact that Debtor was a closely-held or family corporation;

c. David Winer borrowed funds, pledged his own assets as security, and then advanced those funds to Debtor as working capital because of Debtor’s inability to secure additional financing;

d. Admits that Vermont Wood was created as a successor to Debtor by Chitten-den and the Winers, because of the latter’s inability to attract subsequent investors, but denies that this “workout”

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was an attempt to defraud Debtor’s unsecured creditors; and,

e. That although David Winer and others provided Vermont Wood with the working capital, Vermont Wood did not divert Debtor’s corporate opportunities because Debtor lacked the necessary capital to fill the Tech Furnishings’s order.

Chittenden also claims that the doctrine of equitable contribution of capital is not applicable in this proceeding. Since Janet Winer is not a shareholder of Debtor, and did not guarantee Debtor’s debt, this Court cannot reach their jointly owned hypothe-cated securities or property. Additionally, Chittenden argues there is no evidence that any of Debtor’s unsecured creditors were induced to extend credit based on the hy-pothecated securities or guarantees.

2.

Prejudice

The Trustee’s goal is to have us apply the doctrine of marshaling of assets and order Chittenden to obtain satisfaction of Debtor’s notes from the guarantees of David and Gordon Winer. Moreover, he argues, the hypothecated stocks and bonds, and Debtor’s machinery and equipment should also be marshaled and made a part of Debtor’s estate for a dividend to Debt- or’s unsecured creditors.

Chittenden’s responds, arguendo, even if the Trustee meets the requirements of marshaling, nevertheless, this doctrine may not be applied if the application might result in an economic detriment to its status as Debtor’s senior lienholder. For support, Chittenden says that if the guaranties are marshaled, this would increase the risk of loss because it would be forced to initiate a lawsuit, obtain judgment, and execute against the guarantors’ assets in order to realize payment. Furthermore, although David Winer is not in default on his personal notes with the Chittenden, an application of marshaling increases its risk of loss on the personal notes of David Winer, thus further prejudicing it. Chittenden also claims that if the hypothecated securities are marshaled, it would lose its partial security on David Winer’s note # 133 and David Winer would be required to provide replacement security within twenty-four hours, otherwise that personal note would be in default. Similarly, David Winer’s personal note # 141 would lose the hy-pothecated securities since those securities were also pledged by David Winer as partial collateral and the remaining collateral, Bristol property, was cross collateralized with other personal notes.

The Trustee counters: Prejudice to a secured creditor may only be determined by an examination of that creditor’s status with Debtor, and not of other debts with other debtors; the Chittenden actively participated in the scheme to pass Debtor’s assets and Chittenden’s secured status to Debtor’s successor, Vermont Wood; finally, that Chittenden invited the risk of losing partial collateral for David Winer’s personal notes by its own gross mismanagement in permitting extensive cross collateralization between Winer’s and Debtor’s notes. Alternatively, the Trustee advances that the alleged harm or prejudice is highly speculative. Even if the Court were to accept David Winer’s testimony that his personal net worth is in excess of $300,-000.00 and that over $900,000.00 of his net worth disappeared in two years, David Winer’s personal net worth is more than sufficient to pay back his personal notes. The only harm which would result to the Chittenden would be that the Bank would have to notify the Winers that their note # 133 was in default, and the Winers would then have 24 hours to pledge adequate collateral for that loan. Additionally, Chit-tenden has in its possession bonds worth over $66,000.00, which the Winers transferred to Chittenden, and these bonds could be pledged as collateral for loan # 133. Since loan # 133 has matured, if Chittenden follows the same procedure that was utilized when Debtor’s notes were replaced, Chit-tenden may demand supplemental collateral prior to rewriting. Lastly, Chittenden created its own peril when note # 133 was executed six months after Debtor’s notes and Chittenden failed to increase its collateral base for the personal notes at that time.

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Chittenden’s final position is: that if the doctrine of marshaling is applied by this Court, and the Debtor’s machinery and equipment becomes part of the estate, then Vermont Wood threatens to not purchase the machinery and equipment for the amount required to discharge Debtor’s notes with the Chittenden. Instead, Vermont Wood will simply await the Trustee’s auction. (We do not address this argument in our discussion, infra, because the machinery, equipment, etc., has already been sold to Vermont Wood).

C. SUBSTANTIVE CONSOLIDATION

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The Trustee raises the doctrine of “substantive consolidation” upon the Court’s inquiry early in the trial on the doctrine’s efficacy to the present proceeding. While the Trustee admits that the doctrine should be used sparingly because of the significant effect on the rights of debtors and creditors, the Trustee argues (paraphrased for brevity) that the doctrine is appropriate here as among Debtor, Vermont Wood, and David Winer for the following reasons:

a. Chittenden relied upon David Winer’s financial statements to determine the appropriateness of loans to Debtor, Vermont Wood, and to David Winer personally;

b. David Winer is the sole shareholder of Debtor and a 50% shareholder of Vermont Wood and has guaranteed loans from the Chittenden to Debtor and Vermont Wood;

c. David Winer has sufficient assets to pay off the liabilities of Debtor, Vermont Wood, and his own liabilities;

d. Examples of transfers of assets among David Winer, Debtor, and Vermont Wood without the observance of corporate formalities include shareholder loans, payments to shareholders on outstanding loans, transfer of an interest in a toy patent, and transfer of a leasehold interest to Vermont Wood without a termination of this interest with Debtor; and,

e.Assets and business functions between Debtor and Vermont Wood were confused and commingled, and that corporate opportunities were diverted from Debtor to Vermont Wood.

Chittenden says (paraphrased for brevity) to the Trustee the facts do not support equitable consolidation:

a. The relationship of David Winer to the Debtor is that of a shareholder to a corporation, not that of a parent to a subsidiary;

b. All transactions between David Win-er, Debtor, and Vermont Wood were at arm’s length and were subsequently documented by promissory notes, corporate resolutions and entered on the corporation’s ledgers;

c. David Winer’s and Debtor’s financial affairs were kept separate;

d. No corporate opportunities were usurped by David Winer or Vermont Wood from Debtor;

e. There is no difficulty in segregating the respective assets and liabilities of Debtor and Vermont Wood and no assets have been commingled; and,

f. Appropriate corporate formalities were followed in the transfer of assets from Debtor to Vermont Wood.

ISSUES PRESENTED

1. Does the Trustee have standing as a hypothetical lien creditor under 11 U.S.C. § 544 to raise the doctrine of marshaling of assets and alter ego against a secured creditor and the Debtor’s sole shareholder?

2. If the Trustee has standing to assert marshaling and the alter ego doctrines, are they causes of action under Vermont law?

3. If allowed under Vermont law, are the actions of marshaling and alter ego property of the Estate?

4. If the doctrine of marshaling applies, does the conduct of Debtor’s sole

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shareholder require the application of equitable subordination, 11 U.S.C. § 510 (c) to prevent his guaranty from assuming the position of the marshaled senior creditor?

DISCUSSION

I. Introduction

A.

Federal and State Law

Courts have generally held that in the absence of a Congressionally expressed exercise the substantive nature of a creditor’s property rights in bankruptcy is defined by reference to state law.

Butner v. United States,

440 U.S. 48, 54-55 , 99 S.Ct. 914, 917-18 , 59 L.Ed.2d 136, 141-42 (1979):

Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interest should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests by both State and federal courts within a state serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving ‘a windfall merely by reason of the happenstance of bankruptcy.’

Id. 440 U.S. at 55 , 99 S.Ct. at 918 , 59 L.Ed.2d at 141-42 , (1979) (citing,

Lewis v. Manufactures National Bank,

364 U.S. 603, 609 , 81 S.Ct. 347, 350 , 5 L.Ed.2d 323, 327 (1961)). Reference to State law, to the extent of the absence of controlling Federal law, will also define the nature of a debtor’s interest as well as the extent of the bankruptcy estate’s interest in property.

Robinson v. U.S. Small Business Administration (In re Catamount Dyers, Inc.),

50 B.R. 788, 789 (Bkrtcy.D.Vt.1985). Similarly, a creditor’s property rights are also defined by State law.

Kors, Inc. v. Howard Bank,

819 F.2d 19, 22 , 16 B.C.D. 162, 164 (2d Cir.1987);

Purcell v. STN Enterprises, Inc. (In re STN Enterprises, Inc.),

47 B.R. 315, 318 (Bkrtcy.D.Vt.1985).

Where Congress has acted, however, (see e.g., 11 U.S.C. §§ 547 , 548), this Court’s equitable and Federal powers will supersede conflicting State law to properly administer and enforce the provisions of the bankruptcy laws.

What claims of creditors are valid and subsisting obligations against the bankrupt at the time a petition in bankruptcy is filed is a question which, in the absence of overruling federal law, is to be determined by reference to state law. In determining what claims are allowable and how a debtor’s assets shall be distributed, a bankruptcy court does not apply the law of the state where it sits_ But bankruptcy courts must administer and enforce the Bankruptcy Act as interpreted by this Court in accordance with authority granted by Congress to determine how and what claims shall be allowed under equitable principles.

Vanston Bondholders Protective Comm. v. Green,

329 U.S. 156, 161-62 , 67 S.Ct. 237, 239 , 91 L.Ed. 162, 165-66 (1946) (citations and footnotes omitted). See also,

Butner v. United States,

supra, 440 U.S. at 55, n. 10 , 99 S.Ct. at 918, n. 10 , 59 L.Ed.2d at 142, n. 10 (1979) (dicta, Federal statutory basis for voiding preferential and fraudulent transfers as examples where Federal law modifies State defined property interest);

Lewis v. Manufactures National Bank,

364 U.S. 603, 609 , 81 S.Ct. 347, 350 , 5 L.Ed.2d 323, 327 (1961) (instances where the trustee has Federal rights which existing creditors may not have).

B.

Doctrine of Marshaling

There is no doubt that we possess equitable jurisdiction to entertain a proper application for marshaling of assets.

Moody v. Century Savings Bank,

239 U.S. 374, 377 , 36 S.Ct. 111, 113 , 60 L.Ed. 336, 340 (1915).

The Doctrine of marshaling concerns itself with an effect on the property interests of liens, thus, State law governs .its application.

Meyer v. United States,

375 U.S. 233, 239 , 84 S.Ct. 318, 321 , 11 L.Ed.2d 293, 299 (1963);

Moody v. Century Savings Bank,

supra, 239 U.S. at 377-78 , 36 S.Ct. at 113 , 60 L.Ed. at 340 (1915);

In re C & B Oil Co., Inc.,

72 B.R. 228, 230 (Bkrtcy.N.D.Ohio 1987).

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We do not, however, mean to imply that Vermont’s property law of liens and contracts, as opposed to equity, will provide our rule of decision:

In considering the relevance of the doctrine here it is well to remember that marshaling is not bottomed on the law of contracts or liens. It is founded instead in equity, being designed to promote fair dealing and justice. Its purpose is to prevent the arbitrary action of a senior lienor from destroying the rights of a junior lienor or a creditor having less security. It deals with the rights of all who have an interest in the property involved and is applied only when it can be equitably fashioned as to all of the parties.

Meyer v. United States,

375 U.S. 233, 237 , 84 S.Ct. 318, 321 , 11 L.Ed.2d 293, 297 (1963).

Marshaling in Vermont may occur: When one man holds security on two funds, with perfect liberty to resort to either for his pay, and another party has security upon only one of the same funds, equity will compel the first to exhaust the fund upon which he alone has the security, before taking any part of the other, and thereby depriving the other party of his security.

Warren v. Warren,

30 Vt. 530, 535 (1858).

The doctrine of marshaling of assets developed as an equitable principle to benefit junior secured creditors. Traditionally, it is applied when two or more secured creditors claim against one debtor and the senior secured creditor can reach two or more of a debtor’s property interests or funds while the junior secured creditor may reach only one. By forcing the senior secured creditor to elect the fund which is not subject to satisfaction by the junior secured creditor, both the junior and senior secured creditors may realize satisfaction of their respective claims against their common debtor.

There are three elements to marshaling: 1). a senior creditor with rights to two or more funds in which a common debtor has an interest; 2). a common debt- or with an interest in two funds; and, 3). a junior creditor with a lien on or interest in only one of the funds in which the common debtor has an interest.

Warren, supra,

30 Vt. at 535 (1858);

Poole v. Tyler “The Edith,

” 94 U.S. (4 Otto) 518, 522, 24 L.Ed. 167, 168 (1877). See, 53 Am.Jur.2d, Marshaling Assets, §§ 7 et seq. (1970); 55 C.J. S. Marshaling of Assets and Securities, § 1 et seq. (1948); Annot. Doctrine of Marshaling Assets Where the Two Funds Governed by the Paramount Lien are Subject Respectively to Subordinate Liens in Favor of Different Creditors, 76 A.L.R.3d 326 (1977) (Supp.1987).

Before a Court invokes the equitable doctrine of marshaling, either the funds on which marshaling may be impressed, or all of the parties must be subject to the Court’s jurisdiction:

And in marshalling (sic) assets strictly, it is always regarded as indispensable that all the parties in interest should be before the court, so that the decree shall be final and conclusive upon their rights; or at the very least, that the fund should be so before the court that the judgment might operate in rem.

Shedd & Co. v. Bank of Brattleboro,

32 Vt. 709, 717 (1860).

Bankruptcy Courts are Courts of equity. They are the gatekeepers of the fair allocation of assets to creditors. As such, when faced with facts which demand a remedy for inequitable conduct they have fashioned various exceptions to marshaling’s technical requirements of two or more funds, one of which would otherwise be considered a non-estate asset.

II. Standing

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The Supreme Court in

Sowell v. Federal Reserve Bank,

268 U.S. 449 , 45 S.Ct. 528 ,

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69 L.Ed. 1041 (1925), held that ordinarily a debtor may not invoke the marshaling doctrine:

The equitable doctrine of marshaling rests upon the principle that a creditor having two funds to satisfy his debt may not, by his application of them to his demand, defeat another creditor, who may resort to only one of the funds. The debtor may not ordinarily invoke the doctrine, for by doing so he would disregard the express provisions of his contract on which the creditor is entitled to rely.

Sowell v. Federal Reserve Bank,

supra, 268 U.S. at 456-57 , 45 S.Ct. at 530-31 , 69 L.Ed. at 1049 (1925).

Although Chittenden sued Sebert and has conceded Sebert’s prosecution of the action on behalf of the intervening Trustee, it did not concede the Trustee’s standing, nor Sebert’s for that matter, to assert the doctrine of marshaling of assets.

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We are compelled to examine the fundamental precept of standing to determine whether the Trustee is a cognizable and real party in interest, Rules of Practice and Procedure in Bankruptcy Rule 7017,

19

with power to prosecute the affirmative and equitable defense of marshaling.

Standing requires a personal stake in the outcome of a controversy adequate to ensure that the matter will be presented in an adversarial context and will be amendable to judicial resolution. See,

Allen v. Wright,

468 U.S. 737, 751 , 104 S.Ct. 3315 , 82 L.Ed.2d 556, 569 (1984);

Sierra Club v. Morton,

405 U.S. 727, 731-32 , 92 S.Ct. 1361, 1364-65 , 31 L.Ed.2d 636, 640-41 (1972). The standing issue: “[I]s whether the plaintiff has ‘alleged such a personal stake in the outcome of the controversy’ as to warrant HIS invocation of federal court jurisdiction and to justify exercise of the court’s remedial powers on his behalf.”

Simon v. Eastern Kentucky Welfare Rights Organization,

426 U.S. 26, 38 , 96 S.Ct. 1917, 1924 , 48 L.Ed.2d 450, 460 (1976) (quoting,

Warth v. Seldin,

422 U.S. 490, 498-99 , 95 S.Ct. 2197, 2204-05 , 45 L.Ed.2d 343, 354 (1975)) (emphasis in original).

We hold that the Trustee’s status as a hypothetical lien creditor under 11 U.S.C. § 544 (a) satisfies the first element of marshaling, i.e., that there be two secured creditors; next, the marshaling action and the Trustee’s use of the alter ego exception to the “common debtor” element of marshaling constitutes § 541(a)(1),

20

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property of the estate; lastly, the Trustee has the prerequisite standing to invoke the marshaling doctrine and the related actions of breach of fiduciary duty, piercing the corporate veil, and alter ego under Vermont law.

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A.

“Strong Arm,” 11 U.S.C. § 544

In opposing marshaling, Chittenden claims that the Trustee is not a junior secured creditor within the penumbra of the marshaling doctrine and, hence, has no standing to raise it. The Trustee claims that the “Strong Arm” clause of 11 U.S.C. § 544 provides the necessary standing since his status under State law is that of a judgment lien creditor holding an execution duly returned unsatisfied as of the date of Debtor’s petition. We accept the Trustee’s argument and hold that he is entitled to the status of a secured creditor under the facts present in this case.

The legislative history of § 544 indicates: Subsection (a) is the “strong arm clause” of current law, now found in Bankruptcy Act § 70c. It gives the trustee the rights of a creditor on a simple contract with a judicial lien on the property of the debtor as of the date of the petition; of a creditor with a writ of execution against the property of the debtor unsatisfied as of the date of the petition; and a bona fide purchaser of the real property of the debtor as of the date of the petition. “Simple contract” as used here is derived from Bankruptcy Act § 60a(4). The third status, that of a bona fide purchaser of real property, is new. (H.Report. No. 95-595 to accompany H.R. 8200, 95th Cong., 1st Sess. (1977) p. 370).

Reprinted in 4

Norton Bankruptcy Law and Practice, Annotated Legislative History,

page 442, (parenthetical supplied for clarity).

The Supreme Court in

Lewis v. Manufacturers National Bank of Detroit, 364

U.S. 603, 81 S.Ct. 347 , 5 L.Ed.2d 323 (1961), held, under a predecessor

22

to 11 U.S.C. § 544 , the trustee acquired the status of an existing or hypothetical lien creditor as of the date of the bankrupt's petition:

We think that one consistent theory underlies the several versions of § 70c which we have set forth, viz., that the rights of creditors — whether they are existing or hypothetical — to which the trustee succeeds are to be ascertained as

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of “the date of bankruptcy,” not at an anterior point of time. That is to say, the trustee acquires the status of a creditor as of the time when the petition in bankruptcy is filed. We read the statutory words “the rights ... of a creditor [existing or hypothetical] then holding a lien” to refer to that date.

Lewis v. Manufacturers National Bank of Detroit,

364 U.S. 603, 607 , 81 S.Ct. 347, 349 , 5 L.Ed.2d 323, 326 (1961) (Footnotes omitted).

Once the Trustee assumes the status of a hypothetical lien creditor under § 544, State law is used to determine what a lien creditor’s priorities and rights are.

Kors, Inc. v. Howard Bank,

819 F.2d 19, 22 , 16 B.C.D. 162, 164 (2d Cir.1987). As eloquently noted by Colliers on the interaction of Federal status and State rights on the trustee’s standing:

Whether the trustee is entitled to such status and the conditions under which he may attain it, are federal questions governed by the Bankruptcy Code. But the extent of the trustee’s rights, remedies and powers as a lien creditor are measured by the substantive law of the jurisdiction governing the property in question. It is not for the state law to determine what rights conferred on lien creditors are transferred to the trustee under the Code. Nor, on the other hand, does section 544(a)(1) or (2) confer on the trustee any greater rights than those accorded by the applicable law to a creditor holding a lien by legal or equitable proceedings. These are fundamental concepts in the application of the strong-arm clause of section 544(a) which must not be forgotten.

4

Collier on Bankruptcy,

§ 544.02, pages 544-8, 544-11 (15th Ed.1987) (emphasis in original). Simply stated, Federal law bestows the hypothetical lien status, State law determines its parameters.

The leading case within the Second Circuit which addresses the scope of a trustee’s § 544(a) powers, in a marshaling context, is

Balaber-Strauss v. Reichard (In re Tampa Chain Co., Inc.),

53 B.R. 772 , 13 B.C.D. 792 (Bkrtcy.S.D.N.Y.1985). In

Tampa,

supra, a perfected and secured creditor, Fundex, had made a $194,760.00 working capital loan to the debtor, Tampa, secured by Tampa’s inventory, receivables, and other assets. The loan was not based on the strength of Tampa’s collateral or ability to repay since Tampa had no assets, no operating history, no capital, and a meager $2,500.00 bank account. Rather, the loan was made on the protection afforded by certain collateral, a $300,000.00 interest in a cooperative apartment (Co-op), provided by guarantors of Tampa’s debt. An involuntary Chapter 7 was filed against Tampa and an Order for relief was entered. The Chapter 7 trustee ultimately realized $200,000.00 from a liquidation of Tampa’s assets. Fundex then sought an 11 U.S.C. § 725

23

Order directing the trustee to turn over certain inventory proceeds to satisfy its secured claim, attorney’s fees, costs and Section 506(b) charges. The trustee countered with a marshaling request which would require Fundex to first proceed against the guarantors, and then the Co-op.

The

Tampa

Court found, inter alia, that: Fundex had made its loan to debtor without monitoring the debtor’s operations; within the first four months of Tampa’s brief life the guarantors had spent all of the loaned money; the guarantors had contributed $216,000.00 to Tampa, but, up to $315,-000.00 had been spent on a separate in-family company which operated on Tampa’s premises and used Tampa’s inventory.

In response to the secured creditor’s and the guarantors’ argument that the trustee was not a junior secured creditor within the contemplation of the marshaling doctrine, the

Tampa

Court held that 11 U.S.C. § 544 (a)(2) was the exception to the Code’s policy of leaving creditors in the status

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they enjoyed under State law, although the application of marshaling had the effect of enriching unsecured creditors over secured creditors:

In providing a trustee with “the rights and powers of” an unsatisfied execution creditor as of the commencement of the bankruptcy case, however, § 544(a)(2) of the Code is a principal exception to that policy and not so limited. Neither the language of the statute nor its legislative history gives the slightest indication that Congress contemplated that such “strong arm” rights and powers are not to apply in a marshaling context. By stepping into the “overshoes” of such a creditor,

In re Leichter,

471 F.2d 785 , 787 n. 4 (2d Cir.1972), whether or not one exists, the trustee enjoys whatever rights and powers that status conveys under state law.

Balaber-Strauss v. Reichard (In re Tampa Chain Co., Inc.),

supra, 53 B.R. at 777 , 13 B.C.D. at 794 (citation in original) (footnote omitted). The

Tampa

Court then concluded the standing issue by noting that under the applicable State law, (New York), the trustee was deemed a secured creditor and thus entitled to raise the doctrine.

Balaber-Strauss v. Reichard (In re Tampa Chain Co., Inc.),

supra, 53 B.R. at 777-78 , 13 B.C.D. at 794 . See,

In re C & B Oil Co., Inc.,

72 B.R. 228, 229-30 (Bkrtcy.N.D.Ohio 1987) (held trustee had standing under § 544(a) to bring the marshaling issue before the Court);

Committee of Creditors of Ludwig Honold Manufacturing Company, Inc., (In re Ludwig Honold Mfg. Co.,),

34 B.R. 645, 646 (Bkrtcy.E.D.Pa.1983) (senior lien holder’s contention that unsecured creditors lacked standing was moot since the trustee was a joined party in the adversary proceeding and the trustee had standing as a secured party to bring marshaling under § 544(a)).

Representative of the rationale of the Courts’ holdings that a trustee may not invoke marshaling by virtue of its § 544 status is

Federal Land Bank of Columbia v. Tidwell (Matter of McElwaney),

40 B.R. 66 , 10 C.B.C.2d 820 (Bkrtcy.M.D.Ga.1984):

To allow the Trustee to invoke the marshaling doctrine, by virtue of his status as a hypothetical lien creditor, would be a use of the strong-arm clause not contemplated by Congress. In this Court’s opinion, the Trustee’s construction would frustrate the Code’s policy by enriching unsecured creditors over secured creditors.

Federal Land Bank of Columbia v. Tidwell (Matter of McElwaney),

supra, 40 B.R. at 70-71 , 10 C.B.C.2d at 826 (Bkrtcy.M.D.Ga.1984) (citation omitted).

In

McElwaney,

supra, the Court was faced with a marshaling request by a trustee which would have recovered certain Federal Land Bank stock for the benefit of the debtor’s unsecured creditors; forced a senior lienholder, Federal Land Bank, to seek full satisfaction from a farmland sale proceeds instead of the stock; and, a junior lienholder, FmHA, would have received less satisfaction on its claim then it would have if the senior lienholder first looked to the stock for a reduction of the latter’s claim. Under these circumstances, the

McElwaney

Court found the application of marshaling would have resulted in a detriment to a perfected junior secured creditor of the debtor, a result not intended by marshaling or § 544:

Section 544 was intended to protect the estate from secret, unperfected liens, and it was not intended to benefit the Trustee over a perfected junior secured creditor. Because the marshaling, as the Trustee requests, would harm the FmHA’s (junior secured creditor’s) position, the Trustee’s request for marshaling must be denied.

Id., 40 B.R. at 72 , 10 C.B.C.2d at 828 (Bkrtcy.M.D.Ga.1984) (parenthetical supplied for clarity). See,

Owens Corning Fiberglas Corp. v. Center Wholesale, Inc. (In re Center Wholesale, Inc.),

788 F.2d 541, 544 (9th Cir.1986) (citing, inter alia, its prior decision,

Owens Corning Fiberglas Corp. v. Center Wholesale, Inc. (In re Center Wholesale, Inc.),

759 F.2d 1440 , 1447 (9th Cir.1985) and

Duck v. Wells Fargo Bank (In re Spectra Prism Industries, Inc.),

28 B.R. 397, 399 (9th Cir. BAP 1983), for the proposition that the imposition of marshaling must avoid a prejudicial result

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to third persons, and denied a trustee’s authority to apply reverse marshaling; i.e., a trustee may not require a senior lienor to satisfy its claim out of a junior lienor’s collateral);

Canal National Bank v. Larry’s Equipment Service, Inc. (In re Larry’s Equipment Service, Inc.),

23 B.R. 132, 134 (Bkrtcy.D.Me.1982) (Court has equitable power to order marshaling, however, it will not be applied at the request of a trustee to the detriment of a senior and junior lien creditor).

Actually, few Courts squarely address the trustee’s standing under § 544 to marshal. They usually seek to avoid the issue by jumping ahead to the other elements of marshaling, such as common debtor, two funds or prejudice. Finding one or more of the elements missing or lacking, they declare marshaling is not available. Arguably,

McElwaney,

supra, also falls into this “ducking the issue” camp since its decision was controlled by the fact that prejudice would have resulted to a non-trustee junior secured creditor. We question whether

McElwaney

would have treated the standing issue in this manner if prejudice to a secured junior creditor was absent and demonstrable inequitable conduct was present.

We chose to follow the lead of

BalaberStrauss v. Reichard (In re Tampa Chain Co., Inc.),

53 B.R. 772 , 13 B.C.D. 792 (Bkrtcy.S.D.N.Y.1985) and hold that if applicable State law permits, the Trustee has standing under § 544 to raise marshaling.

Our next step is to determine whether under Vermont law the Trustee is a secured creditor by virtue of his § 544 status; and, whether both marshaling and alter ego actions belong to the bankrupt corporation, and hence, constitute § 541(a)(1) property of the Estate.

B.

Applicable State Law

(1)

Vermont law

Vermont law tells us that the Trustee is a secured creditor armed with the status of a judicial lien creditor with an execution returned unsatisfied.

Under Vermont’s U.C.C., 9A Vt.Stat. Ann. §§ 9-105(2) and 9-301(3), a lien creditor is defined as:

A “lien creditor” means a creditor who has acquired a lien on the property involved by attachment, levy or the like and includes an assignee for the benefit of creditors from the time of assignment, and a trustee in bankruptcy from the date of the filing of the petition or a receiver in equity from the time of appointment. Unless all the creditors represented had knowledge of the security interest such a representative of creditors is a lien creditor without knowledge even though he personally has knowledge of the security interest.

9A Vt.Stat.Ann. § 9-301(3).

9A Vt.Stat.Ann. § 9-301(3) was derived, in part, from the 1933 Uniform Trust Receipts Act, (See, Comment 6, 9A Vt.Stat. Ann. § 9-301 (“Subsection (3) defines ‘lien creditor,’ following in substance the provisions of the Uniform Trust Receipts Act”), which contained, in Section 1 therein, the following definition of “lien creditor:”

‘lien creditor’ means any creditor who has acquired a specific lien on the goods, documents or instruments by attachment, levy, or by any other similar operation of law or judicial process, including a distraining landlord.

Volume 9C

Uniform Laws Annotated,

Uniform Trust Receipts Act, pages 231-32 (Thompson 1957).

The 1962 Code was adopted in Vermont by Act No. 29, § 1, March 12, 1966. We note that the 1972 Uniform Commercial Code eliminated the “knowledge” provision,

24

of the 1962 version of § 9-301(3) to avoid a possible conflict between the U.C.C. and the Bankruptcy Act. The “knowledge” aspect of 9A Vt.Stat.Ann. § 9-301 was derived, in part, from Section 5 of the Uniform Conditional Sales Act which provided:

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§ 5.

Conditional sales void as to certain persons.

Every provision in a conditional sale reserving property in the seller, shall be void as to any purchaser from or creditor of the buyer, who, without notice of such provision, purchases the goods or acquires by attachment or levy a lien upon them, before the contract or a copy thereof shall be filed as hereinafter provided, unless such contract or copy is so filed within ten days after the making of the conditional sale.

Book 2

Uniform Laws, Annotated,

Uniform Conditional Sales Act, page 6 (Thompson 1922). See,

McPhail & Co. v. Gerry,

55 Vt. 174, 176-77 (1882) (held that an attaching creditor who had notice of the conditional nature of the buyer’s rights could not maintain a claim against the vendor under an 1872 Act relating to liens reserved on property sold). To the extent that § 544(a) renders such knowledge immaterial and Vermont’s adoption of the 1962 version of 9-801(3), 9A Vt.Stat.Ann. § 9-301(3), appears to be in conflict, § 544(a) will control. See,

Vanston Bondholders Protective Comm. v. Green,

supra, 329 U.S. 156, 161-62 , 67 S.Ct. 237, 239 , 91 L.Ed. 162, 165-66 (1946).

Thus, the Trustee is a secured party as a “lien creditor” under Vermont law without regard to his or any other creditor’s knowledge of Chittenden’s interest.

We need not only rest the Trustee’s secured status as a lien creditor solely on § 9-301. Since the Trustee is also armed as a judicial lien creditor with an execution returned unsatisfied, he also has the right under Vermont law to institute a creditor’s bill.

Marshaling is nothing more than an alternate expression of a “creditors’ bill,” which is defined as:

A creditor’s suit or bill is generally defined as an equitable proceeding brought by a creditor to enforce the payment of a debt out of property or interests of his debtor which cannot be reached by ordinary legal process.

21 Am.Jur.2d,

Creditors’ Bills,

§ 1, page 6 (1981).

When a creditor seeks a creditor’s bill, a Court of equity will not ordinarily interfere on behalf of a creditor unless he has established his claim so far as he can at law.

Rice v. Barnard,

20 Vt. 479, 484 , 50 Am.Dec. 54 (1848). As noted by the United States Supreme Court, a creditor must show that an execution has been issued in the form and manner required by law and has been returned unsatisfied before an action on a creditors’ bill may be maintained.

The true rule in equity is that under usual circumstances a creditor’s bill may not be brought except by a judgment creditor after a return of ‘nulla bona’ on execution.

Harkin v. Brundage,

276 U.S. 36, 52 , 48 S.Ct. 268, 274 , 72 L.Ed. 457, 464 (1928).

As Collier points out, § 544(a) is much broader than its predecessor § 70(c) of the Bankruptcy Act:

If the description of the trustee's position under former Section 70c was apt, it is even more so under the broader language of section 544(a). It is evident that this hypothetical status depends for meaning upon a substantive law that is not explicitly indicated but is incorporated by reference. Therefore, the trustee’s powers, in every case governed by section 544(a), are those which the state law would allow to a supposed or hypothetical creditor of the debtor who, as of the commencement of the case, had completed the legal (or equitable) processes for perfection of a lien upon all the property available for the satisfaction of his claim against the debtor.

4

Collier on Bankruptcy,

§ 544.02, pages 544-5, 544-6 (15th Ed.1987) (footnotes omitted).

A more apt description of the creditor’s bill is found in

Bean v. Parker,

89 Vt. 532, 541 , 96 A. 17 (1915). In

Bean ,

the debtor, as mortgagor, had executed a note to his mother and the note was later secured by a new note and several chattel mortgages. Later, the debtor, his mother, and another person executed several notes to a bank, and the debtor executed a mortgage for his mother. The bank later called upon the

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mother for payment. Debtor’s mother then caused her son’s notes and mortgages to be placed in the hands of her attorney who, in turn, placed the same in the hands of a deputy sheriff, a defendant in the action, with instructions to foreclose on the debtor. The defendant sheriff eventually realized proceeds from a sale of property after the debtor had filed bankruptcy but prior to the trustee’s suit to recover the proceeds. In the State proceeding, the bankruptcy trustee maintained that this sale was in fraud of the rights of the creditors, whose claims were established in bankruptcy. The

Bean

Court found no fraud and affirmed the lower Court’s judgment for the sheriff since the mortgage was given for the indemnity of the mother against her liability as a surety for the debtor.

Bean

is important because it addressed the trustee’s status, in reference to § 544’s 1910 predecessor, as a

judgment creditor holding an execution duly returned unsatisfied:

The trustee in bankruptcy stands in these proceedings with all the rights, remedies, and powers of a judgment creditor holding an execution duly returned unsatisfied.

This is in accordance with the provisions of the Federal Bankruptcy Act as amended by the Act of 1910. It is said in Collier on Bankruptcy, 9th Ed. 942, that this amendment disposes of any doubt which may have existed as to the rights of the trustee to proceed as a judgment creditor against conveyances invalid for failure to record or file, or because of fraud as against creditors. It is upon the last named ground that the plaintiff (trustee in bankruptcy) has proceeded in this case. But as we have seen neither fraud in fact nor intent by either the bankrupt or his mother, to defraud creditors, has been found, and on the findings there was no fraud in law.

Bean v. Parker,

89 Vt. 532, 541 , 96 A. 17 (1915) (parenthetical and emphasis supplied).

25

In Vermont, an action on a judgment is not dependent upon the exhaustion of a judgment creditor’s ability to collect on a prior judgment by execution, since a judgment creditor has two independent means of satisfaction of its judgment: “The judgment creditor not only can maintain execution proceedings for the enforcement of the judgment, but also can maintain an action upon the judgment.”

Koerber v. Middlesex College,

136 Vt. 4, 7 , 383 A.2d 1054 (1978).

26

Marshaling does not require fraud, but merely a demonstration that its application will prevent an otherwise inequitable result to a junior creditor or is necessary to correct inequitable conduct.

The remedy of marshaling under Vermont law appears to be available to all lien or judicial creditors of a debtor so long as the other requisite elements are established. We perceive no impediment under Vermont law to the Trustee’s request for marshaling as a secured creditor.

Thus, under § 544(a)(2) and Vermont law, the Trustee is a secured party either as a lien creditor or as a judicial lien creditor with an execution returned unsatisfied and has met Vermont’s jurisdictional prerequisite to invoke the equitable remedy of marshaling in the form of a creditors’ bill.

(2)

Marshaling as a Cause of Action Within § 5jl(a)(l) Property of the Estate

We also hold that under Vermont law marshaling is a cause of action which is

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part of the Debtor’s Estate within § 541(a)(l)’s “all legal or equitable interests of the debtor in property.”

Vermont law on the doctrine of marshaling of assets is sparse and ancient. Nevertheless, an examination of those few cases which discuss it supports our determination that under modern circumstances equity can invoke this tool of natural justice in Vermont.

Despite the absence of fraud, in

Warren v. Warren,

30 Vt. 530 (1858), the Vermont Supreme Court adopted the following marshaling rule:

When one man holds security on two funds, with perfect liberty to resort to either for his pay, and another party has security upon only one of the same funds, equity will compel the first to exhaust the fund upon which he alone has the security, before taking any part of the other, and thereby depriving the other party of his security. And this principle is founded upon so plain an equity, that parties will sometimes be compelled to follow it, without the direct interposition of the power of the court in advance, and especially when the party was bound by contract to do so.

Warren v. Warren,

supra, 30 Vt. at 535 (1858).

27

The case of

Edgerton v. Martin,

35 Vt. 116 (1862) involved an application of marshaling in a trustee process context and is particularly illustrative of the powers of a judicial lien creditor to summon marshaling. In

Edgerton, id.,

the trustee was a recipient of certain property that was subject to pre-judgment attachments against the principal defendants. The trustee also received a right to, but not actual possession of, certain accounts and notes from the defendants as security for indemnification of liabilities which might result from his receipt of the property. The defendants retained possession of the accounts and notes. The trustee then purchased other property from the principal defendants and executed his own notes and retained his own notes as security for all liabilities which he had contracted for with them. Plaintiffs, after reducing their claims against the principal defendants to judgment, then served the trustee with their trustee process. Afterwards, the trustee assumed new liabilities for the principal defendants and pledged the accounts and all prior notes as security. At this point, the trustee received possession of the accounts and notes (which were previously in the defendants’ possession subject to the trustee’s rights) from the principal defendants and realized certain sums from his collection. Thus, at the time of the service of the trustee process, the trustee had acquired two means of indemnity by which he could rely on for his security against the liabilities he had incurred on account of the principal defendants: one being his own notes to the principal defendants, which were retained by the trustee; and the other being the contract concerning the notes and accounts and the monies collected from the demands which belong to the principal defendants but were turned over to the trustee as security.

The Vermont Supreme Court, in

Edgerton v. Martin,

id., 35 Vt. at 122 (1862), upheld plaintiffs’ request that the sums received and collected by the trustee be applied in satisfaction of the liabilities incurred by the trustee prior to the service of the plaintiffs’ trustee process, and expressed as an alternate ground for its holding that this case was a proper one for the application of marshaling:

The general principles of equity law in respect to the marshalling (sic) of securities (1 Story Eq. Jurisp., by Redfield, §§ 633, 645,) may well be applied in this case to the extent of the money collected by the trustee. For his liabilities for the principal defendants assumed prior to the commencement of this suit, he had a lien on, or interest in, two means of indemnity, viz.: on his own notes which he had executed to them, and on the money collected on demands belonging to them,

*299

which, by their agreement, were “turned out” to him for the express purpose of securing these liabilities. The plaintiffs by their attachment acquired an interest in or lien upon only one of these funds.

Edgerton v. Martin,

35 Vt. 116, 122 (1862) (citation in original).

28

The

Edgerton

Court defined the nature of the paramount and junior parties’ status as either a “lien” on or an “interest in” the proposed funds. Though the

Edgerton

Court dealt with lien creditors, arguably, “interest in” would broaden the class of parties entitled to raise marshaling to not only include secured and unsecured creditors, but also, under appropriate circumstances, non-creditors:

In some cases the doctrine is defined strictly in terms of lien or secured creditors. In other cases the doctrine is defined in terms of “interests” which are not limited to secured creditors or even to creditors.

53 Am.Jur.2d Marshaling Assets § 1, page 6 (1970) (footnotes omitted).

The Vermont Supreme Court has not addressed marshaling since the 1862 case of

Edgerton,

supra, consequently, it has not provided us with an evolved view of marshaling under today’s modem equitable principles.

The principle of marshaling assets had its origin in a desire on the part of the chancellor to protect junior creditors, and its early application was considered solely with regard to the respective rights of creditors. The debtor was not given a hearing or allowed a voice in the matter. While assets are ordinarily marshaled, not at the suit of the debtor, but only at the instance of one creditor against another, modem equitable principles have extended the doctrine in many instances to include debtors. There is no sound reason why a court of equity should not marshal assets in favor of the debtor if, in the circumstances, it can do justice to the other parties concerned and at the same time accomplish a more nearly just result.

53 Am.Jur.2d, Marshaling Assets, § 30, page 29 (1970) (footnotes omitted).

We believe the Vermont Supreme Court applying equitable principles

29

would allow an insolvent debtor, as well as a trustee standing in debtor’s shoes as a secured party representative of the debt- or’s estate, a hearing as a party with an “interest in” funds sought to be marshaled among creditors of its estate.

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(3)

Fiduciary Duty, Alter Ego and Piercing the Corporate Veil as Causes of Action Within § 541(a)(1) Property of the Estate

We turn now to the Trustee’s utilization of alter ego theory cause of action as property of the estate, an exception to marshaling’s “common debtor” requirement, and thereby hold Debtor’s sole shareholder accountable.

30

Piercing the corporate veil and alter ego actions against a corporation’s sole shareholder-director and guarantor are actually constituents of the larger cause of action for breach of fiduciary duty since each of these actions involves an equitable infraction of the duty owed toward the corporation, and, in some eases, others.

The issue of fiduciary law involving corporate directors and stockholders must be resolved by reference to State law, since corporations are creatures of the State,

Cort v. Ash,

422 U.S. 66, 84 , 95 S.Ct. 2080, 2090 , 45 L.Ed.2d 26, 40 (1975), in the absence of otherwise controlling Federal law.

As we said in the past, the first place one must look to determine the powers of corporate directors is in the relevant State’s corporation law.

Burks v. Lasker,

441 U.S. 471, 478 , 99 S.Ct. 1831, 1837 , 60 L.Ed.2d 404, 412 (1979) (citations omitted).

As we examine fiduciary law, we are mindful of Justice Frankfurter’s observations concerning a court’s inquiry into fiduciary law:

But to say that a man is a fiduciary only begins analysis; it gives direction to further inquiry. To whom is he a fiduciary? In what respect has he failed to discharge these obligations? And what are the consequences of his deviation from duty?

SEC v. Chenery Corp.,

318 U.S. 80, 85-86 , 63 S.Ct. 454, 458 , 87 L.Ed. 626, 632 (1943).

Although there is a presumption in Vermont that every man has conformed his private and official duty according to the demands of law and equity,

Morse v. Bruce’s Estate,

70 Vt. 378, 380 , 40 A. 1034 (1898), and the Court will not presume an agent has profited at the expense of its principal,

Noyes v. Landon,

59 Vt. 569, 574 , 10 A. 342 , 343 (1887), nevertheless, the

*301

law demands the utmost good faith and undivided loyalty from agents for the furtherance and advancement of the interests of their principals,

Capital Garage Co. v. Powell,

96 Vt. 145, 149 , 118 A. 524 (1922);

Leno v. Stewart,

89 Vt. 286, 289 , 95 A. 539 (1915), especially between a shareholder-director and his corporation since such transactions are not at arms-length:

[D]ealings between a majority stockholder and director and the corporation he controls are not arms-length transactions. They are subject to close scrutiny at the instance of persons having an interested relationship to the operation, such as a stockholder. The relationship of a director-stockholder to his corporation binds him to use utmost good faith and loyalty for the furtherance and advancement of the interest of that corporation. He is not permitted to make profit for himself in the transaction of the business of the corporation, against its interest.

Lash v. Lash Furniture Co. of Barre, Inc.,

130 Vt. 517, 522 , 296 A.2d 207, 211 (1972) (citations omitted).

Fiduciary duty requires that directors cannot let competing interests interfere with their undivided loyalty and duty to further the interests of the corporation they represent. This competing interest might be the representative director’s ownership in another corporation where it might have interfered with the fiduciary corporation since:

The directors of the defendant company would, in effect, be selling the property to themselves. The right to do this is denied to all persons acting in a fiduciary capacity. The directors of a corporation cannot represent it in transactions with another corporation in which they are shareholders, if their interest in the latter company might induce them to favor it at the expense of the company whose interests have been intrusted to their care.

Corry v. Barre Granite & Quarry Co.,

91 Vt. 413, 418 , 101 A. 38 (1917).

As stated by the United States Supreme Court in

Twin-Lick Oil Company v. Marbury,

91 U.S. (1 Otto) 587, 23 L.Ed. 328 (1876), the degree of judicial scrutiny of a fiduciary will increase proportionately according to the status of control held by that fiduciary:

It is very true, that as a stockholder, in making a contract of any kind with the corporation of which he is a member, is in some sense dealing with a creature of which he is a part, and holds a common interest with other stockholders, who, with him, constitute the whole of that artificial entity, he is properly held to a larger measure of candor and good faith than if he were not a stockholder. So, when the lender is a director, charged, with others, with the control and management of the affairs of the corporation, representing in this regard the aggregated interest of all the stockholders, his obligation, if he becomes a party to a contract with the company, to candor and fair dealing, is increased in the precise degree that his representative character has given him power and control derived from the confidence reposed in him by the stockholders who appointed him their agent. If he should be a sole director, or one of a smaller number vested with certain powers, this obligation would be still stronger, and his acts subject to more severe scrutiny, and their validity determined by more rigid principles of morality, and freedom from motives of selfishness.

Twin-Lick Oil Company v. Marbury,

supra, 91 U.S. at 589 , 23 L.Ed. at 330 (1876) (not all transactions between a director or stockholder and his corporation are void

ab initio

as where an honest director openly makes a fair loan to his corporation secured by a deed of trust).

The competing interest might also be the representative’s personal interest which may be set aside by a Court of equity,

Lash v. Lash Furniture Co. of Barre, Inc., supra,

130 Vt. at 521-22 , 296 A.2d 207 even if the consideration was fair or there was no injury to the corporation,

Hooker, Corser & Mitchell Co. v. Hooker,

88 Vt. 335, 353-54 , 92 A. 443 (1914), since the director’s duty is to exercise his inde

*302

pendent judgment from the standpoint of an ultimate benefit to the corporation:

In short, the business management of a corporation is confided to its directors and they must act in behalf of the corporation. They represent all the stockholders and creditors and cannot enter into agreements, either among themselves or the stockholders, by which they abrogate their independent judgments.

Creed v. Copps,

103 Vt. 164, 168 , 152 A. 369 (1930) (citations omitted).

See, Norlin Corp. v. Rooney, Pace, Inc.,

744 F.2d 255, 264-65 (2d Cir.1984) (applying New York law held that directors as corporate fiduciaries owe two duties, loyalty and care, and once self-dealing, self-interest, or bad faith is demonstrated, then the burden shifts to the director to show the transaction was in the best interest of the corporation).

Vermont’s statutory law requires full disclosure and formal approval by disinterested quorums concerning the subject of a director’s contract with the corporation:

A contract may be made between a corporation and one or more of the directors, if the contract is approved by a quorum of the board of directors, the contracting director not being present. In entering into such contract, the directors shall act in good faith, and, if their good faith is attacked, the burden shall be upon them to prove it. Subject to these provisions, such contract shall be voidable by the corporation only in case it would have been voidable if made with a stranger. The term ‘contract’ as used herein is intended to include loans, and corporation guarantees of personal obligations.

11 Vt.Stat.Ann. § 1888.

A director is a fiduciary who possesses by virtue of trust and t;his duty is owed to and enforceable by the corporation as well as the corporation’s shareholders.

Hooker, Corser & Mitchell Co. v. Hooker,

supra, 88 Vt. at 353 , 92 A. 443 .

In the event of the corporation’s bankruptcy, the trustee of the bankrupt corporation may pursue an action against the offending fiduciary:

Their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the director or stockholder not only to prove the good faith of the transactions but also to show its inherent fairness from the viewpoint of the corporation and those interested therein ... The essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm’s length bargain. If it does not, equity will set it aside. While normally that fiduciary obligation is enforceable directly by the corporation, or through a stockholder’s derivative action, it is, in the event of bankruptcy of the corporation, enforceable by the trustee. For that standard of fiduciary obligation is designed for the protection of the entire community of interest in the corporation — creditors as well as stockholders.

Pepper v. Litton,

308 U.S. 295, 306-07 , 60 S.Ct. 238, 245 , 84 L.Ed. 281, 289-90 (1939) (citations omitted).

Accord, S.I. Acquisition, Inc. v. Eastway Delivery Service, Inc. (In the Matter of S.I. Acquisition, Inc.),

infra, 817 F.2d 1142 (5th Cir.1987);

Koch Refining v. Farmers Union Central Exchange, Inc.,

infra, 831 F.2d 1339, 1346 (7th Cir.1987);

Delgado Oil Co., Inc. v. Torres,

785 F.2d 857 (10th Cir.1986) (reversed and remanded with directions to dismiss District Court’s ruling of lack of subject matter jurisdiction over a creditor’s Colorado common law fiduciary action in federal district court against director of insolvent corporation in bankruptcy since it was the trustee’s cause of action which could only be maintained in Bankruptcy Court);

Mitchell Excavators Inc. by Mitchell v. Mitchell,

infra, 734 F.2d 129 (2d Cir.1984);

American National Bank of Austin v. MortgageAmerica Corp. (In re MortgageAmerica Corp.),

infra, 714 F.2d 1266 , 1276 n. 9 (5th Cir.1983);

Bayliss v. Rood (Matter of West Virginia Industries Development Corp.),

infra, 424 F.2d 142 , 146 (4th Cir.1970).

See,

3

Fletcher Cyclopedia Corporations

§ 849 (M. Wolf perm. ed. revised 1986); 3A

id.

§§ 1180-84.

*303

But see,

In re Morgan-Staley Lumber Co., Inc.,

70 B.R. 186 (Bkrtcy.D.Or.1986) (Court dismissed adversary proceeding on grounds that the Chapter 7 trustee lacked standing to prosecute a shareholder’s or creditor’s derivative action for direct harm to corporation under applicable State law); 4

Collier on Bankruptcy

§ 541.10[8] (15th ed. 1986) (trustee cannot enforce, under 11 U.S.C. § 541 (a), State created obligations which run personally to corporate creditors, rather than to the corporation).

In

Unsecured Creditors Committee of Debtor STN Enterprises, Inc. v. Noyes (In re STN Enterprises),

779 F.2d 901, 905 (2d Cir.1985) the Second Circuit ordered a reversal and a remand to the District Court for its failure to consider whether, under Vermont law, creditors of an insolvent corporation in bankruptcy had an implied right to maintain an action, on behalf of and for the benefit of the bankrupt corporate debt- or, against its directors for,

inter alia,

breach of fiduciary duty:

The district court’s ruling failed to take into account that, although in most states directors of a

solvent

corporation do not owe a fiduciary duty to creditors, quite the reverse is true when the corporation becomes insolvent ... Thus, the ‘majority rule’ permits recovery by creditors of an insolvent corporation for mismanagement as if the corporation itself were the plaintiff ... while the ‘minority rule’ precludes suit by injured creditors of an insolvent corporation ... although a suit for misappropriation or diversion of corporate property may stand on different and more solid footing ...

In re STN Enterprises,

supra, 779 F.2d at 904-05 (2d Cir.1985) (Emphasis in original, citations omitted). Upon Order of Referral from the District Court, we held,

inter alia,

that we had jurisdiction and the unsecured creditors’ committee had standing to sue debtor’s corporate officers and directors when the debtor in possession unreasonably failed to do so:

It is our opinion that Vermont would follow the “majority rule” to allow creditors a “qualified right” to sue, on behalf of the debtor corporation under circumstances presented in this adversary proceeding, for breach of fiduciary duty, fraudulent conveyances, and director negligence against directors or officers.

Unsecured Creditors Committee of Debtor STN Enterprises, Inc. v. Noyes (In re STN Enterprises, Inc.),

73 B.R. 470, 490 (Bkrtcy.D.Vt.1987).

Cf. Murdock v. Allina (In re Curtina Int’l),

15 B.R. 993, 995 (Bkrtcy.S.D.N.Y.1981) (Bankruptcy Court held that it did not have jurisdiction to adjudicate a creditor’s

personal

claim of alter ego against non-debtor defendants, debtor’s officers and stockholders, when that creditor sought a

personal

recovery which was not for the benefit of the debt- or’s estate, and the trustee had asserted no interest in the otherwise private controversy).

31

Upon proper proof, equity will not only enforce this loyalty and trust, but also will apply the doctrine of unjust enrichment when fiduciaries “[H]ave yielded to the temptation of self-interest ...,”

Manufacturers Trust Co., Trustee v. Becker,

338 U.S. 304, 312 , 70 S.Ct. 127, 132 , 94 L.Ed. 107 , 114 (1949), where:

The fact stands out in unmistakable clearness that they (directors) evolved and carried out plans to benefit themselves at the expense of the corporation of which they were the directors. Equity will not suffer them to withhold from the corporation the benefits so obtained.

Hooker, Corser & Mitchell Co. v. Hooker,

supra, 88 Vt. at 357 , 92 A. 443 (1914). See, Restatement of Restitution, §§ 123, 150, 168, 178, 204 (1936).

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In

Assoc., Haystack Property Owners v. Sprague,

145 Vt. 443 , 494 A.2d 122 (1985), the Vermont Supreme Court reversed and remanded a trial court’s order granting defendant’s Vermont Rules of Civil Procedure Rule 12(b)(6) motion to dismiss class action plaintiffs’ amended complaint for failure to state a claim upon which relief may be granted. Plaintiffs alleged that: defendants, as directors of a corporation, owed members of the plaintiffs’ class, creditors, a fiduciary duty; defendants breached that duty; and, plaintiffs were entitled to damages caused by the director’s breach. After ruling that a novel legal theory should be explored by facts developed by evidence at trial, the Vermont Supreme Court acknowledged the “qualified right” of creditors to maintain an action against the directors of an insolvent corporation:

It is true, as the lower court pointed out, that while corporate directors do owe fiduciary duties, the duties are not owed to the world at large. Also it may be generally true that those duties are owed to the corporation and to its stockholders but

not

creditors of the corporations. Nevertheless, some courts have held that corporate directors do owe a fiduciary duty to creditors ... partieulary when the corporation becomes insolvent ...

Haystack,

supra, 145 Vt. at 448 , 494 A.2d 122 (1985) (emphasis in original). See,

In re STN Enterprises,

supra, 779 F.2d at 904-05 (2d Cir.1985).

In

Lash v. Lash Furniture Co. of Barre, Inc.,

supra, 130 Vt. at 522 , 296 A.2d at 211 (1972), the Vermont Supreme Court held:

[Dealings between a majority stockholder and director and the corporation he controls are not arms-length transactions. They are subject to close scrutiny at the instance of persons having an interested relationship to the operation, such as a stockholder.

id.,

(citations omitted).

In

Haystack,

supra, the Court seized on the just quoted language in

Lash,

supra, to preserve the corporate creditors’ (plaintiffs’) “novel” theory of recovery against the directors of an insolvent and dissolved corporation and held:

This language suggests that parties other than stockholders,

may,

under certain circumstances, also subject corporate director’s dealings to close scrutiny. Again, however remote the possibility or novel the claim may be, we cannot say as a matter of law at this point that there is no possibility that plaintiffs could present sufficient evidence to establish a fiduciary duty and a breach thereof; a dismissal based on V.R.C.P. 12(b)(6) was at least premature in this case.

Haystack,

supra, 145 Vt. at 448 , 494 A.2d 122 (1985) (emphasis in original).

The rationales of the corporate fiduciary cases decided by the Vermont Supreme Court, including

Haystack,

supra, which permitted corporate creditors to sue a director for breach of fiduciary duty, and of the United States Supreme Court in

Pepper,

supra, which held a trustee may enforce a cause of action against a bankrupt’s director or stockholder, are applicable in this proceeding. The transactions and conduct of Debtor’s sole shareholder and director with the corporate Debtor are in issue. Moreover, it is quite unlikely that the sole shareholder or his fellow family directors would cause their corporation to scrutinize such matters against him. We hold that a corporation under Vermont law may sue a director for breach of fiduciary duty, and upon the event of bankruptcy the action becomes property of the estate. Thus, the Trustee may prosecute a cause of action for breach of fiduciary duty against an offending director-sole shareholder on behalf of the insolvent corporate Debtor for the benefit of the Debtor’s Estate and its creditors.

We turn now to the components of fiduciary law; namely, piercing the corporate veil and alter ego.

The rule that a corporation is separate and distinct entity from the identity of its shareholders,

Eureka Marble Co. v. Windsor Manufacturing Co.,

47. Vt. 430, 447 (1874), or its agents,

Wheelock v. Moulton,

15 Vt. 519, 512-22 (1843), is elementary to corporation law. This legal fiction was de

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signed as a privilege by the legislature for the furtherance of convenience and promotion of commerce, 18 Am.Jur.2d, Corporations §§ 42-43, pages 840-43 (1985), and it is axiomatic that a corporation has no other power than those conferred upon it by the sovereignty which creates it.

Vermont Acc. Ins. Co. v. Burns,

114 Vt. 143 , 40 A.2d 707 (1944).

Equity, however, will not blindly accept mere corporate form over the actual substance of the transactions involved,

Chicago, M. & St. P.R. Co. v. Minneapolis C. & C. Assn.,

247 U.S. 490, 501 , 38 S.Ct. 553, 557 , 62 L.Ed. 1229, 1237 (1918), and will scrutinize such a privilege “where it otherwise would present an obstacle to the due protection or enforcement of public or private rights,”

New Colonial Ice Co. v. Helvering,

292 U.S. 435, 442 , 54 S.Ct. 788, 791 , 78 L.Ed. 1348, 1353 (1934), to serve the ends of natural justice,

Bangor Punta Operations v. Bangor & A.R. Co.,

417 U.S. 703, 713 , 94 S.Ct. 2578, 2584 , 41 L.Ed.2d 418, 427 (1974), or to correct inequitable conduct which demands an individual be held responsible for the abuse of this privilege to the injury of the corporation or its creditors. See e.g., Annot. Stockholder’s Persona] Conduct of Operations or Management of Assets as Factor Justifying Disregard of Corporate Entity, 46 A.L.R.3d 428 (1972) (Supp.1987).

It has long been established in Vermont and elsewhere, contrary to the position taken by Chittenden in its briefs, that actual fraud is not a requirement for piercing the corporate veil.

In

Roberts v. W.H. Hughes Co.,

86 Vt. 76, 88 , 83 A. 807, 812 (1912) the Vermont Supreme Court held that the absence of actual or intended fraud was immaterial where mere implied fraud may be imputed to an insolvent sole shareholder who conveyed, as an individual, property to his corporation in exchange for stock. After a recital of the general rule that corporations are distinct from the individuals who comprised it and the exception that courts will not permit the general rule to become a shield for the “contrivers of fraudulent schemes,” id., the

Roberts

Court stated:

It has even been said that in an appropriate case, and in furtherance of the ends of justice, a debtor corporation and the individual owning all its stock and assets will be treated as identical, independent of any question of fraud. But cases of this class, in which the individual is held liable merely because he owns all the stock of the corporation, have been spoken of as of doubtful authority. However this may be, there is ample authority for saying that in cases of fraud the courts will look behind the corporation to the individuals composing it. The business of an individual or partnership is often continued through the formation of a corporation, and the transfer to it of the property of the individual or partnership in exchange for the stock of the corporation. A fraud upon creditors may be effected by this process as well as by a conveyance to an individual, and when the one who makes use of it is insolvent the corporation issuing the stock for the property will not be treated as a bona fide purchaser.

Roberts v. W.H. Hughes Co.,

supra, 86 Vt. at 88 , 83 A. at 812 (1912) (citations omitted). The

Roberts

Court’s dicta implies that the corporate shield ought not be lowered merely because a sole stockholder is involved. We agree. This is simply another statement of the basic principle of separate identities as between a corporation and its stockholder.

On the other hand, equally as well settled as is (sic) the principle that plain fraud is not a necessary prerequisite for piercing the corporate veil is the rule that the mere fact that all or almost all of the corporate stock is owned by one individual or a few individuals, will not afford sufficient grounds for disregarding corporateness.

DeWitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co.,

540 F.2d 681, 685 (4th Cir.1976) (footnote omitted).

The

Roberts’

Court cited

Wilson v. Spear,

68 Vt. 145 , 34 A. 429 (1894) for the distinction between actual and implied fraud: “[mjerely the fraud which the law imputes to him from the condition of his

*306

estate and the necessary consequence of his act.”

Roberts v. W.H. Hughes Co.,

supra, 86 Vt. at 88 , 83 A. at 812 . This distinction rests on the principle that: “It is only in cases where no actual fraud appears that the conveyance can be sustained on the ground that the grantor retained sufficient property to satisfy his debts.”

Wilson v. Spear,

supra, 68 Vt. at 148 , 34 A. 429 .

Roberts

does not require fraud for the invocation of the piercing the corporate veil doctrine, rather

Roberts

requires looking at the factual circumstances of the transaction and:

Upon these facts we think it must be considered that the corporation was but an instrumentality for enabling Hughes (insolvent grantor) to hold his property and continue his business in another name and a different manner; that in conveying his property to the corporation he was in effect deeding it to himself; and that the corporation, in exchanging its stock for his property, was but returning his property in a different form. The property which he at first held by title he afterwards held through stock. In this situation, the defendant company is not entitled to be treated as a purchaser for value.

Roberts v. W.H. Hughes Co.,

supra, 86 Vt. at 90 , 83 A. 807 (parenthetical supplied for clarity).

Fraud is merely one of the many circumstances from which the equitable exceptions to the general rule of limited liability may arise. Inadequate capitalization is another:

But there are occasions when the limited liability sought to be obtained through the corporation will be qualified or denied.... The cases of fraud make up part of that exception. But they do not exhaust it. An obvious inadequacy of capital, measured by the nature and magnitude of the corporate undertaking, has frequently been an important factor in cases denying stockholders their defenses of limited liability.

Anderson v. Abbott,

321 U.S. 349, 362 , 64 S.Ct. 531, 538 , 88 L.Ed. 793, 802-03 (1944) (citations and quote omitted), reh’g. denied, 321 U.S. 804 , 64 S.Ct. 845 , 88 L.Ed. 1099 (1944). Accord,

S.I. Acquisition, Inc. v. Eastway Delivery Service, Inc. (In the Matter of S.I. Acquisition, Inc.),

infra, 817 F.2d 1142, 1152 (5th Cir.1987) (the doctrine of alter ego does not require a showing of fraud on a particular creditor, nor does it rest upon a particular creditor’s dealings with or reliance on a controlled entity);

32

DeWitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co.,

infra, 540 F.2d 681, 684 (4th Cir.1976) (citing,

Anderson v. Abbott,

supra).

As explained by the United States Supreme Court in the context of the “instrumentality rule,” of which breach of fiduciary duty, piercing the corporate veil and alter ego actions are likened, these actions are actually remedies:

Petitioners invoke the so-called instrumentality rule, — under which they say, Deep Rock (subservient entity) is to be regarded as a department or agent of Standard (dominant entity), — to preclude the allowance of Standards claim in any amount. The rule (instrumentality) was much discussed in the opinion below. It is not, properly speaking, a rule, but a convenient way of designating the appli

*307

cation, in particular circumstances, of the broader equitable principle that the doctrine of corporate entity, recognized generally and for most purposes, will not be regarded when so to do would work fraud or injustice.

Taylor v. Standard Gas & Elec. Co.,

306 U.S. 307, 322 , 59 S.Ct. 543, 550 , 83 L.Ed. 669, 676 (1938) (parentheticals supplied for clarity). In

Taylor ,

the Supreme Court, using the “Deep rock” doctrine, held that loans from a controlling shareholder to his corporation may be deemed capital contributions if the corporation was initially under-capitalized or thereafter ineligible for a loan from a disinterested source.

The following non-exhaustive list contains some of the collective equitable factors utilized by various Courts for their inquiry into the factual circumstances concerning alter ego:

(1) The corporate fiction is used as a means of perpetrating fraud;

(2) A corporation is organized and operated as a mere tool or business conduit of another corporation;

(3) The corporate fiction is employed as a means to the end of avoiding existing legal or moral obligations;

(4) Failure to observe proper corporate formalities or there is an absence of corporate records or meetings;

(5) Gross undercapitalization or thin capitalization;

(6) Non-functioning of other officers or directors;

(7) Corporation is a mere facade for the operations of the dominant stockholders);

(8) Insolvency of the debtor corporation;

(9) Siphoning or commingling of corporate funds by the dominant stockholder; and,

(10)The corporate fiction is used to achieve or perpetrate monopoly.

See,

Valdes v. Leisure Resource Group, Inc.,

810 F.2d 1345, 1352-53 (5th Cir.1987) (discussed Texas law,

Castleberry v. Branscum,

721 S.W.2d 270, 272 (Tex.1986), on alter ego);

United States v. Pisani,

646 F.2d 83, 88 (3d Cir.1981);

DeWitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co.,

supra, 540 F.2d at 685-87 (4th Cir.1976) (excellent case for authorities on the various factors throughout the jurisdictions);

Lowen v. Tower Asset Management, Inc.,

653 F.Supp. 1542, 1552-53 (S.D.N.Y.1987) (New York criteria) affirmed,

Lowen v. Tower Asset Management, Inc.,

829 F.2d 1209, 1220 (2d Cir.1987);

Solomon v. Klein,

770 F.2d 352, 353-54 (3d Cir.1985) (dicta, listed factors not used in its decision, citing, inter alia,

DeWitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co.,

540 F.2d 681 (4th Cir.1976));

In re BDW Associates, Inc.,

75 B.R. 909, 912-13 (Bkrtcy.W.D.Pa.1987) (factors within the Third Circuit). See also, 18 Am.Jur.2d, Corporations, Disregarding Corporate Entity, In General, §§ 43-54 (1985).

Although some facts are entitled to more weight than others, it is important to keep in mind that no one factor will be determinative, with the possible exception of actual fraud. Rather, the collective facts and circumstances aid the Court’s equitable determination:

The conclusion to disregard the corporate entity may not, however, rest on a single factor, whether undercapitalization, disregard of corporation’s formalities, or what-not, but must involve a number of such factors; in addition, it must present an element of injustice or fundamental unfairness.

DeWitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co.,

supra, 540 F.2d at 687 (4th Cir.1976). See, Gelb, Piercing the Corporate Veil-the Undercapitalization Factor, 59 Chicago Kent Law Review 1 (1982).

Vermont has few cases where, based upon equitable concerns, an alter ego remedy was applied. These involved facts where there was such identity between the corporation and a control individual or dominant entity that the Court felt bound to disregard the corporate entity.

In

Administratrix of Bigelow v. Congregational Society of Middletown,

11 Vt. 283 (1839), the Vermont Supreme Court permitted a judgment creditor, with a writ re

*308

turned unsatisfied, to levy upon the individual members of the corporation for satisfaction of a judgment against the corporation, a congregational society. The society had hired the administratrix’s husband as it’s minister, and at his death, the society was indebted to him for unpaid salary. Members of the society had taken the available funds of the society, consisting principally of notes for money lent, and transferred it to a new corporation where it appears to have been used to pay the salary of a new minister and finance resistance to the administratrix’s claims. Before the transfer, the available funds were earmarked to pay the deceased’s salary and would have satisfied the administratrix’s judgment. The only other asset of the society consisted of their meeting house, which was exempt from process. On the first appeal to the Supreme Court, (citation unknown), and after the society had successfully presented a request for an off-set of their claims against the deceased as their treasurer, the Court upheld the Commissioners’ allowance of a balance due the estate, on the estate’s claim for the unpaid salary and entered judgment against , the society.

On the second appeal to the Supreme Court,

Administratrix of Bigelow v. Congregational Society of Middletown,

Id., the Court noted the general rule of confining liability to the corporation was not without exceptions and permitted the ad-ministratrix to pierce the society’s veil and hold the individual members liable for the society’s debt in the absence of fraud:

... There may be a difficulty in ascertaining what remedy should be afforded in the case of a corporation, and in applying the remedy so as to not to do injustice to individual interests, but still, if individuals have not done all they mght (sic) or could do to fulfil their legal and moral duties, the consequences are their own ...

... The individuals composing the society are not personally liable, unless they have made themselves so by some act or default. An execution against the society cannot be levied on the separate property of the individual members ...

... It was the duty of the society, on the death of Mr. Bigelow, to appropriate this fund for that purpose, and what was the duty of the society was the duty of the individual members, and if they have suffered the fund to be wasted and lost, through carelessness, negligence, or misfeasance, it must be their loss ...

Administratrix of Bigelow v. Congregational Society of Middletown,

Id., 11 Vt. at 286-88 (1839). The

Bigelow

Court held the society’s members responsible and decreed that a receiver be appointed to collect whatever remained of the funds and a master be appointed to determine both the amount of the funds at the time the deceased died, prior to the funds transfer to the new corporation, as well as the identity of the society’s members to be held accountable for the funds short-fall. See,

Administratrix of Bigelow v. Congregational Society of Middletown,

15 Vt. 370 (1843) (third appeal, upholding the Chancellor’s decree adopting the Master’s report).

Public policy may require that a corporation’s veil be pierced in order to protect a public interest:

Public policy dictates that the veil of Bushey’s and Spentonbush’s (parent and subsidiary corporations respectively) separate corporate entities be pierced, since these corporations wholly own, control, manage, operate and in all ways supervise the operations of the many subsidiaries of Bushey. The subsidiaries are mere corporate shells established for purposes of avoiding tort liability to the parent for the acts of the subsidiaries which are alter egos of Bushey and Spen-tonbush.

United States v. Ira S. Bushey & Sons, Inc.,

363 F.Supp. 110, 119 (D.Vt.1973) affirmed 487 F.2d 1393 (2d Cir.1973) cert. denied 417 U.S. 976 , 94 S.Ct. 3182 , 41 L.Ed.2d 1146 (1974) (citations omitted) (parenthetical supplied for clarity). The District Court in

Bushey

held that the public interest in preserving the environmental integrity of Lake Champlain and preventing future oil spills was paramount to that of the corporate fiction of separate identities and enjoined the parent and all of its

*309

subsidiaries from making further oil deliveries on the “sixth largest lake in the country and a jewel of nature.” Id. 363 F.Supp. 110, 119 (D.Vt.1973).

Vermont law, beyond

Bigelow

and

Bush-ey,

supra, has not provided us with a litmus test to aid our determination of the factual circumstances which will allow the corporate form to be disregarded. This failure is not due solely to the absence of cases on the subject, rather its absence is partially explained by the requirement that the facts of each case be individually examined on its own merits to ascertain whether the particular circumstances fall within the general principles of public convenience, fairness and equity. As the Court in

Brunswick Corp. v. Waxman,

459 F.Supp. 1222 (E.D.N.Y.1978) noted:

The circumstances under which the court should disregard the corporate fiction are not always clear and it is difficult, if not impossible, to formulate a precise and categorical definition applicable to all situations, each case being sui generis.

Brunswick Corp. v. Waxman,

supra, 459 F.Supp. at 1229 (E.D.N.Y.1978), (citation omitted), aff’d 599 F.2d 34 (2d Cir.1979) (New York law in the area of piercing the corporate veil and the disregard of the corporate fiction “[i]s hardly as clear as a mountain lake in springtime,” Id. 599 F.2d at 35, and cited with approval, Cary, Corporations 110 (4th ed. 1969) that: “[n]o concept of separate corporate personality will suffice to solve an actual problem.” Id. 599 F.2d at 36.

Another explanation why Vermont has not provided us with much guidance on the full reach of equity to pierce a corporate veil and to hold accountable the alter ego(s) who have misused the corporate entity lies in the inherent conflict of interest which arises when a corporation’s facade is sought to be lowered. As explained earlier, dominant directors or shareholders are unlikely to cause their corporation to institute an action for breach of fiduciary duty against themselves. They are even less likely to direct their corporate victim to properly inquire whether the latter ought to hold the former responsible for the corporate obligations to creditors. When viewed in this light, the absence of Vermont precedent on the ability of the injured corporation to pierce its own veil, is quite understandable:

The corporation may be thought of as a separate legal entity which has an interest of its own in assuring that it can meet its responsibility to its creditors, while at the same time allowing it to argue that it should be deemed to be identical to its alleged alter ego for purposes of paying those creditors. There is only a practical — not a legal or logical— difficulty in a corporation’s bringing an alter ego action in its own name: The defendants who so completely dominate the corporation as to constitute its alter ego are not likely to institute an action to determine their own liability for corporate debts. Therefore, it is not surprising that the parties can produce no such case. The corporation needs an independent voice, such as a trustee in bankruptcy, in order to act to protect its creditors.

Henderson v. Buchanan (In re Western World Funding, Inc.),

infra, 52 B.R. 743, 783 (Bkrtcy.D.Nev.1985) (citations omitted). The Fifth Circuit recently reached the same conclusion in the absence of Texas precedent and under the general policy of holding alter egos accountable for corporate obligations held:

Since the corporation has an independent existence at law, we do not believe it is inconsistent in light of the above policy to say that a corporation may pierce its own corporate veil and hold accountable those who have misused the corporation in order to meet its corporate obligations.

S.I. Acquisition, Inc. v. Eastway Delivery Service, Inc. (In the Matter of S.I. Acquisition, Inc.),

infra, 817 F.2d 1142, at 1152 (5th Cir.1987).

We, therefore, conclude that the Trustee has standing under Vermont law to pursue the alter ego and piercing the corporate veil actions.

C.

Proyerty of the Estate, 11 U.S.C. $ 541(a)

The third aspect of standing is whether the Trustee’s cause(s) of action is

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property of the Estate. A bankruptcy trustee must not only possess a sufficie

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