Sampsell v. Imperial Paper & Color Corp.

Background

An individual businessman, Downey, transferred his stock of goods and business operations into a small family corporation controlled by himself, his wife, and his son. After Downey was adjudged a voluntary bankrupt, the bankruptcy referee found that the transfer was made in bad faith to keep assets away from Downey’s creditors. A creditor of the corporation (the respondent) had an unsecured claim against the corporation and later sought priority to funds realized from liquidation of the corporation’s assets.

Reasoning

The Court addressed whether that corporate creditor could take ahead of Downey’s individual creditors. The referee found the corporation was essentially a sham and that the transfer was fraudulent. The Court explained that where a family corporation was formed to hide a bankrupt’s assets and the creditor knew of or helped the scheme, the creditor cannot claim priority. The bankruptcy court properly used summary proceedings to absorb the corporate assets into Downey’s estate. Because the respondent was not an innocent purchaser or a lienholder and had knowledge of the fraud, it failed to show any superior right to the funds.

Real world impact

The decision means creditors who knowingly lent to or participated in a scheme to move a debtor’s assets into a family corporation may lose priority and share equally with the debtor’s other creditors. Trustees can marshal such corporate assets for the bankrupt estate through summary procedures when fraud is shown. If a creditor is a bona fide lienholder or an innocent purchaser, different results might still be possible.