Judge rejects trustee lawsuit

Merry-Go-Round overseer alleged banks used `set-offs'

October 01, 1999|By Sean Somerville | Sean Somerville,SUN STAFF

A federal bankruptcy judge yesterday dismissed a lawsuit by the trustee for Merry-Go-Round Enterprises Inc., which alleged that four banks improperly transferred about $10 million between accounts to cut the struggling retailer's debt to them before it filed for bankruptcy protection.

U.S. Bankruptcy Judge E. Stephen Derby ruled that the trustee, Deborah H. Devan, had failed to prove that a reduction in the net amount owed to the banks from $61.3 million to $50.6 million within 90 days before the bankruptcy filing amounted to "set-offs" prohibited by federal law.

"More than one essential element necessary to establish a set-off is missing," Derby said.

Devan, who is overseeing the liquidation of Merry-Go-Round under Chapter 7 of the bankruptcy code, was seeking the recovery of the money. First Union National Bank and Bank of America, now the owners of two of the banks involved in the 1993 transactions, asked the judge Monday to award the banks summary judgment.

The judge sided with the banks yesterday. Under bankruptcy law, he said, such transfers must be made unilaterally with an attempt to satisfy a mature debt to be considered "set-offs" subject to recovery by the trustee.

"Whatever action that was taken was taken with the consent of Merry-Go-Round Enterprises or at the direction of Merry-Go-Round Enterprises," Derby said yesterday.

He also said the amount owed the banks could not be considered a mature debt. "They continued to advance funds [to Merry-Go-Round] during the prepetition period," Derby said.

Joel I. Sher, a lawyer for the firm of Shapiro and Olander who represented Devan, said: "We think the case law supported our claim. The judge doesn't."

"There's always an appeal option," he said, adding that it's too early to say whether he will seek one.

Sher said the decision marked one defeat among hundreds of other actions seeking the recovery of tens of millions of dollars.

The trustee in April won a significant victory for the estate and for lawyers when accounting giant Ernst & Young LLP agreed to pay $185 million to settle a lawsuit claiming that its duplicity and bad advice sank the company, which filed for Chapter 11 bankruptcy protection Jan. 11, 1994 -- a case that was converted to a Chapter 7 liquidation case March 1, 1996.

In her suit against the banks, Devan alleged that Signet Bank, acting as the agent for a four-bank consortium that funded a $100 million revolving line of credit, enacted transfers to reduce Merry-Go-Round's liability.

For example, Devan charged that on Dec. 7, 1993, Signet, now owned by First Union, used $4.1 million from Merry-Go-Round's "cash concentration account" to cut the company's liability to the revolving credit line.

The banks included Signet, Westminster Bank USA, Boatmen's National Bank and Credit Suisse. Boatmen's is now part of Bank of America.

The banks similarly cut Signet's letter-of-credit obligation from $21.6 million Oct. 13, 1993, to $10.5 million Dec. 7, 1993, Devan charged.

In their motion seeking summary judgment, the banks called the complaint baseless. Richard N. Kremen, a Piper & Marbury LLP lawyer who represented First Union National Bank, argued that many of the transfers were made at Merry-Go-Round's request as part of a cash-management system intended to keep the company's interest costs low.

To support his argument, Kremen quoted Frank Peters, the company's comptroller at the time. "Pay off the loans, I don't want to pay the additional interest," Peters said, according to Kremen's motion.

In his motion, Kremen also said that neither "MGRE nor Signet treated the payments as set-offs or understood the payments to be set-offs. Indeed, in the 90-day period preceding the petition filing, the banks advanced to MGRE $4.5 million more than they received as payments on the line of credit."

Kremen said the trustee had a "first-impression theory," contending that "the loan repayments are set-offs, `because I say so.' " After the ruling, Kremen declined to comment in detail, saying only "We're pleased."

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