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Willcox v. Goess

July 19, 1937

WILLCOX
v.
GOESS (FIRST NAT. BANK & TRUST CO. OF ROCHESTER, INTERVENER)



Appeal from the District Court of the United States for the Southern District of New York.

Author: Hand

Before L. HAND, AUGUSTUS N. HAND, and CHASE, Circuit Judges.

L. HAND, Circuit Judge.

These appeals are from decrees in a consolidated suit to recover upon a bank account, and to set aside a number of transfers alleged to have been preferential, not under the Bankruptcy Act -- since all were more than four months before petition filed -- but under section 15 of the New York Stock Corporation Law (Consol.Laws, c. 59). The plaintiff is the trustee of a corporation called, "J.A.M.A. Realty Corporation," of which Harriman, the president of the Harriman National Bank and Trust Company, and his wife, Augusta, owned all the twenty thousand shares except eight held by their daughter, Miriam. This corporation was originally organized to hold real estate, but gradually its activities were enlarged and at the time of the events here in question Harriman used it among other things as a conduit for his operations in the Bank's shares. He treated it substantially as his own, and much of the resulting confusion arises from the extent of the powers which he so assumed. The Bank, as its name implies, was a national banking association, over which Harriman also exercised almost as absolute a control, with a corresponding entanglement of legal relations. The Comptroller declared the Bank insolvent and appointed the defendant its receiver on October 16, 1933; the plaintiff was later appointed trustee in bankruptcy of J.A.M.A. and brought seven separate suits against the receiver, later consolidated and tried together; it will be more convenient to deal with the facts in each when we take them up seriatim. The First National Bank & Trust Company of Rochester intervened in Suit No. 3, claiming a lien upon the property there in dispute; it has no other interest in the litigation. The judge gave the trustee a decree in Suit No. 1, but dismissed all the other bills against the receiver, including the claim of the Rochester bank in Suit No. 3. The trustee has appealed in all seven suits, though in Suit No. 1 from that part only of the decree which held that J.A.M.A. owed the note which had been preferentially secured. The receiver has appealed in Suit No. 1 from the decree declaring the transfer there involved a preference. The Rochester bank has appealed from the decree in Suit No. 3.

Suit No. 1.

This suit is to set aside the preferential transfer of miscellaneous property by J.A.M.A. to the Bank on July 25, 1932, made as security for a note of $100,000. This collateral consisted of a miscellaneous assortment of works of art, valued by the judge at $100,000; the "High Farm property," $6,900; the "West Orange mortgage," $15,000., and two hundred of the Bank's shares. Two questions arise: whether the transfer was a preference under section 15 of the New York Stock Corporation Law; and whether J.A.M.A. owed the Bank the debt for which it was security. First, as to the debt. On December 7, 1931, Harriman wanted to get cash into the hands of the Harriman Securities Corporation in order to pay the coming dividend on its shares. Burke, the Bank's comptroller, on behalf of Harriman, got one Levin to sign a note for $100,000, with the proceeds of which Levin was to buy from Harriman two hundred of the Bank's shares, which should be used as security for the note. Harriman was to take these back at the same price after six months, and give Levin five shares as a bonus. Levin cashed the cheque, and Harriman deposited the proceeds in J.A.M.A.'s account with the Bank to pay loans which he owed to it. The shares were apparently set aside for Levin, and perhaps used as security for the loan, though this is not clear, and is immaterial anyway. J.A.M.A. at once paid the same sum to the Securities Corporation, in discharge of its own debts, and the Securities Corporation used this and other money to pay its dividend. The note was pretty clearly a sham. In December, 1931, the shares were being quoted for about $1,400, and two hundred would have cost nearly $300,000. It is incredible that Harriman should have really meant to give them to Levin, a stranger, at one-third their value with a boot of five shares thrown in. Harriman was engaged in "boosting" the shares, and the transaction was surely not a sale at five hundred dollars. On the other hand, if it was not, it is improbable that Levin should have borrowed $100,000 from the Bank merely to let Harriman have the use of it on Harriman's personal undertaking, even though backed by the shares as security and with the bonus. At least it was a very curious transaction, which lent itself much more readily to the interpretation that Harriman, who had exceeded his borrowing limit with the Bank, adopted this means of misappropriating its funds. Moreover, the parties always treated the note as a sham. J.A.M.A. paid the interest upon it, and Burke told Levin to disregard the notice sent to him when the principal fell due. As soon as Cooper, the new president, who had come in in July because of Harriman's misconduct, learned the facts, he at once assented to Levin's disclaimer of liability, returned it and marked it "paid" on the Bank's books. We agree with the finding below that it was void.

If so, Harriman having misappropriated the Bank's funds and paid his debts to J.A.M.A. with them, J.A.M.A. became liable to it under the docrine of Munroe v. Harriman, 85 F.2d 493 (C.C.A.2). We there held that, although a principal is not charged with his agent's knowledge while engaged in a fraud upon him, if the principal must avail himself of a transaction entered into by the agent on his behalf, the guilty agent's knowledge will be imputed to him. In that case Harriman had stolen Munroe's securities and pledged them with the Bank; we held that, as the Bank could keep them only as a purchaser, and as Harriman had acted as its agent in taking them as security, it was charged with his knowledge of his own theft. So here J.A.M.A. can keep the money which Harriman embezzled from the bank only if it was a bona fide purchaser. A purchaser it was, because Harriman used the money to pay his debts; but bona fide it was not, for it must resort to the payment to be a purchaser at all, and it was Harriman who directed how the funds deposited should be used. Thus J.A.M.A. was under an antecedent obligation of which its own note was merely a new form, and it is a valid claim.

J.A.M.A. was insolvent on July 25, 1932, in the sense that its assets were less than its liabilities; so much is now conceded. But that sort of insolvency will not answer the requirements of section 15; the debtor must have defaulted upon its obligations in due course, or default must be "imminent." Brouwer v. Harbeck, 9 N.Y. 589; Abrams v. Manhattan Consumers' Brewing Co., 142 App. Div. 392, 126 N.Y.S. 844; Childs v. County Trust Co. (D.C.) 6 F.Supp. 821, affirmed 70 F.2d 1012 (C.C.A.2). The drop in value of the Bank's shares had been such that J.A.M.A. could not conceivably hope to keep out of bankruptcy or some other insolvency proceeding, though just when it must default, might still be uncertain. Indeed, strictly speaking, it had already defaulted, because, although Cooper did not demand payment of the underlying obligation, the note was not properly a renewal of Levin's note; it was tabula in naufragio. This is shown by the character of the collateral, and by the fact that it was made up of all J.A.M.A.'s unencumbered assets except the Bank's own shares. Perhaps Cooper did not know the last, but he knew that the collateral was most unusual for a bank; moreover he must have known that J.A.M.A. was a family company of Harriman's; he had just learned that Harriman had in this very transaction misappropriated the Bank's funds; he knew of the collapse in the shares. And aside from that he knew that J.A.M.A. could not pay at the time, which was the important information under section 15, because the insolvency and the notice of insolvency must be parallel.

Indeed, the receiver's main reliance is not that the Bank was not charged with notice of insolvency, but that there were other debts which J.A.M.A. owed the Bank, the dividends on which may be set-off against any recovery, though they were not proved in J.A.M.A.'s bankruptcy and are now barred. We cannot agree. It is true that a creditor will be allowed to prove on the preferred debt after the statute has run against it, even though surrender of the preference has been forced. Keppel v. Tiffin Savings Bank, 197 U.S. 356, 25 S. Ct. 443, 49 L. Ed. 790. Moreover, the result will be worked out by setting off the dividend in the preference suit itself. Page v. Rogers, 211 U.S. 575, 581, 29 S. Ct. 159, 53 L. Ed. 332; Larkin v. Welch, 86 F.2d 442 (C.C.A.7). But we know of no decision holding that when the creditor has allowed the bar of section 57 (n), Bankr. Act (as amended, 11 U.S.C.A. ยง 93 (n), to fall against other debts, he may set off the dividends upon these also against the recovery of the preference. Nor can we conceive that it is any reason, legal or equitable, why he should be relieved of the bar, that he has tried to take an unfair advantage over his fellows and has been compelled to disgorge. We may assume that a creditor must surrender all preferences in order to prove on any debts whatever which exist at the time of the preference (In re Dix [D.C.] 267 F. 1016); but that does not affect the scope of section 57 (n). The only excuse for allowing the creditor to prove at all upon the claim which has been preferred, is the injustice of compelling him to choose between forfeiting his dividend and trying out his right to keep the security. It was not inevitable that he should have that choice; section 57 (n) does not clearly require it; but there is no justice in extending it beyond the preferred claim, as to which alone the predicament exists. In the case at bar we do not forget that J.A.M.A.'s note pledged the property not only for itself -- $100,000 -- but for "all other liabilities," and that it then owed the Bank $345,000 more; or that the judge has found the value of the security on August 2, 1934, the last day to prove claims, as about $122,000 -- made up of $100,000 for the works of art; $6,900 for the "High Farms" property; and $15,000 for the "West Orange" mortgage. But it is absurd to suppose that the Bank failed to prove claims of over $600,000 because it relied upon this supposititious surplus of $22,000, which in fact turned out to be a deficiency anyway.

Finally, it is true that at times when the debtor and the creditor have had a running merchandise account, begun after the debtor is insolvent, and ending in an enrichment of the estate, payments made upon the account are not treated as preferences. Jaquith v. Alden, 189 U.S. 78, 23 S. Ct. 649, 47 L. Ed. 717; Yaple v. Dahl-Millikan Grocery Co., 193 U.S. 526, 24 S. Ct. 552, 48 L. Ed. 776; Wild v. Provident Trust Co., 214 U.S. 292, 29 S. Ct. 619, 53 L. Ed. 1003; In re Fred Stern & Co., 54 F.2d 478 (C.C.A. 2). The doctrine is somewhat anomalous at best, and can be defended in principle only by the fiction of treating all items of the account as one and the payment as therefore subject to set-off of the dividends payable on all. Even that will not serve unless the dividends exhaust the preference. Whatever the explanation of the doctrine, there is no room for its application here. In Ely v. Greenbaum, 85 F.2d 501 (C.C.A. 2), we treated the payment as in fact made upon all the debts, whose dividends were set off.

Suit No. 2.

This suit concerns a transfer made by J.A.M.A. on October 13, 1931, of three pieces of property: (1) the "Brookville mortgage" (of the face amount of $325,000 at 5 1/2%, valued by the court at $275,000); (2) some shares of stock in a cooperative apartment corporation -- 1170 Fifth Avenue; (3) the lease of an apartment in the same building. Neither of the last two had any value. The question is whether the transfer was voidable under section 15 of the Stock Corporation Law. The trustee's argument is that Harriman never meant finally to part with the property, but only to use the assignment as a screen. Also that if he intended to make it definitive, neverthless it was a preference, because J.A.M.A. was then insolvent, or its insolvency was imminent. The assignment was formal, regular and absolute; so far as appears, it was always kept in the bank's files, though no entry was ever made of it in J.A.M.A.'s books, and it was not recorded for a year. It secured a present advance of $195,000, and an earlier loan of $150,000, on which the national bank examiners had demanded some collateral. In support of the argument that it was a sham assignment it is to be noted that it was never entered in the Bank's collateral loan register until it was recorded, that the mortgagor was never notified, and that the fire insurance policies were never changed. These were certainly suspicious circumstances. Moreover, a bank examiner, one Francis, in December, 1931, made a report in which the "Brookville mortgage" appeared as primarily pledged to the Securities Corporation, the Bank having only an equity in it; though Francis could not remember why he had so reported it. On the other hand, a memorandum of collateral in the possession of the Bank's discount clerk dated November 17th, and another dated January 13th, both declared that the mortgage was security for the notes. (Although these memoranda were initialled "J.W.H.," that need not have meant that the securities were pledged on Harriman's loan, and the discount clerk denied that it did.) Again, the Bank's appraiser appraised it on October 22nd; and on November 14th, J.A.M.A.'s bookkeeper, Hughes, wrote a letter to the Bank about it, stating the outstanding insurance policies. The auditors for the Bank's directors reported that they found it attached to the note for $150,000; the Clearing House examiner, Hanna, reported the same thing. Finally, Francis in a report of June 20, 1932, showed that the loans were then at any rate so secured. It is of course possible that Harriman secretly wished to withhold any irrevocable record, so as to be able to shuffle the assignment about as he pleased; but in order successfully to question a document fair on its face, there must be more than that. The intent of the parties is to be found in their expressions, and these were unequivocal enough. Such flotsam and jetsam as we have to the contrary are too dubious to justify our upsetting a finding based upon appearances formally invulnerable. If it was what it purported to be, the much overworked decision in Benedict v. Ratner, 268 U.S. 353, 45 S. Ct. 566, 69 L. Ed. 991, did not invalidate it. J.A.M.A. was not authorized to collect and disburse any of the principal, and it is well settled in New York that a mortgagor may collect the rents -- even when as here the mortgage assigns it -- until the mortgagee has taken possession or got a receiver. Sullivan v. Rosson, 223 N.Y. 217, 119 N.E. 405, 4 A.L.R. 1400; In re Prudence Co., 88 F.2d 420 (C.C.A.2).

The mortgage or pledge was therefore valid, unless it was a preference under section 15 of the Stock Corporation Law. J.A.M.A.'s insolvency was not "imminent" on October 13, 1931; none of its obligations were due until December and they were then renewed until the summer. Moreover, it could pay; its assets were enough to meet its debts; we are not to judge it by what happened during the next nine months. The trustee insists that its creditors had been misled by a statement issued to them at the end of December, 1931, with the connivance and complicity of the Bank. But that was no more than a balance sheet of assets and liabilities, and as such it was correct; it did not profess to distinguish between free and ...


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