Before MEDINA and MOORE, Circuit Judges, and GALSTON, District Judge.
This is an appeal by the Trustee in Bankruptcy of Stanton Togs, Inc. from an order of the District Court for the Southern District of New York, reversing an order of a Referee in Bankruptcy which denied the motion of Samuel Breiter & Co. (referred to as "Breiter") to reclaim certain chattels under a chattel mortgage.
On June 1, 1956 Stanton Togs executed and delivered to Breiter a chattel mortgage on certain of its machinery and equipment as security for an indebtedness of $7,800 (consisting of a loan of $6,700 and various charges, such as interest, bonus and fees totalling $1,100) repayable in monthly installments evidenced by twelve promissory notes of $650 each, the first note due on July 15, 1956. Upon execution of the chattel mortgage Stanton Togs received from Brieter $6,700. This transaction was typical of the business conducted by Breiter and in the regular course of its business it was the lender in many such transactions.
Stanton Togs made no monthly payments, petitioned for an arrangement under Chapter XI, 11 U.S.C.A. § 701 et seq., on June 19, 1956, and on August 26, 1956 was adjudicated a bankrupt. Thereafter the trustee sold the chattels secured by mortgage and now holds the net amount realized, $6,582.90, pending final determination of this proceeding.
In opposition to the petition to reclaim the chattels the sole defense raised by the Trustee was that the notes were discounted and that therefore the entire transaction was void under section 131 of the New York Banking Law*fn1 and section 18 of the New York General Corporation Law*fn2 prohibiting the discounting of loans by non-banking corporations. The Referee upheld this defense but the District Court reversed holding that section 18 allowed a nonbanking corporation to make a loan secured by a chattel mortgage and rendered the prohibition of section 131 inapplicable even assuming a discount.
The question here presented is of considerable importance to the business world because many companies (particularly the small or medium size) are frequently financed by secured loans from non-banking companies.
For its defense, the Trustee primarily relies upon the recent case of Miller v. Discount Factors, Inc., 1 N.Y.2d 275, 152 N.Y.S.2d 273, 135 N.E.2d 33, to support its contention that Breiter cannot reclaim the chattels given to it as security. That case was decided by the New York Court of Appeals in May 1956 and "staggered the financial and commercial mechanism - and the executives and lawyers who are responsible for its operation -" (Kupfer, Prohibited Discounts Under the Banking and General Corporation Laws: The impacts of Miller v. Discount Factors, Inc. Vol. 12, No. 1, The Record, Association of the Bar of the City of New York). Another author has described the Miller case as "a time bomb that had lain dormant in the statutes of New York for over a hundred years" (Kripke, Illegal "Discounts" by Non-Banking Corporations in New York, 56 Col.L.R. 1183).
To account for, and in explanation of, this reaction, the law of New York on the subject must be reviewed.
The purpose of section 131 was obviously to confine banking functions to government chartered, regulated and inspected institutions and to avoid the possible chaos which might arise were every uncontrolled corporation allowed to act in such a capacity.
Passing by earlier decisions, in 1880 the New York Court of Appeals (Pratt v. Short, 79 N.Y. 437) decided that although the discounted note was unenforceable the lender might recover the amount actually loaned as money had and received because "[If] the defendants avoid their endorsement it is the plainest equity that they shall restore the money which they received on the faith of it" (79 N.Y. at page 449). On the same day the Court of Appeals in Pratt v. Eaton, 79 N.Y. 449, held the discounted note to be unenforceable, but permitted foreclosure of the mortgage securing it.
In 1931 in Williams-Dexter Co. Inc. v. Dowland Realty Corp., the trial court granted a foreclosure of a $33,000 real estate mortgage given to secure a loan of $25,000. The Appellate Division, affirming three to two, sent the case on without opinion for final disposition on certified questions as to the validity of the defenses (234 App.Div. 827, 253 N.Y.S. 987). The Court of Appeals answered the questions in the negative, affirmed the judgment of foreclosure but wrote no opinion (259 N.Y. 581, 182 N.E. 189).
In 1935 the State legislature amended section 18 by adding the exception "that engaging in the business of loaning money in this state on bonds, notes or other evidences of indebtedness, secured by deeds of trust or mortgages upon real property or personal property situated in, upon or appurtenant thereto, * * * and the holding of the same, or the endorsing, selling, assigning, transferring or disposing of the same to another corporation, by a domestic business corporation, or by a foreign corporation * * * shall not be deemed or construed to violate any of the provisions of the banking law" (Laws of 1935, Chapter 905).
Thereafter in 1954 in a bankruptcy proceeding the District Court (Leibell, D.J., S.D.N.Y.) upheld both the validity of notes on which the interest was deducted in advance and a chattel mortgage securing the notes (Wolf v. Aero Factors ...