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BUCHMAN v. AMERICAN FOAM RUBBER CORP.

October 25, 1965

Samuel BUCHMAN, Plaintiff,
v.
AMERICAN FOAM RUBBER CORPORATION, Milton R. Ackman, as Trustee of American Foam Rubber Corporation, Bankrupt, Marie Louise deMontmollin, Alexander F. Pathy and Suzanne M. Pathy, Defendants



The opinion of the court was delivered by: COOPER

COOPER, District Judge.

 Motion for summary judgment in their respective favor by trustee Ackman and the individual defendants on the Trustee's second counterclaim and cross claim. *fn1"

 Briefly stated, by his second counterclaim and cross claim, the trustee seeks to recover for the benefit of bankrupt's creditors under Section 70, sub. e of the Bankruptcy Act, 11 U.S.C. § 110, sub. e, certain moneys paid by the bankrupt at a time it was solvent to its retired president under a "severance agreement" on the theory such payments violated an antidividend provision contained in debentures then outstanding.

 BACKGROUND

 Assigned to this Court under local Rule 2 for all purposes (S.D.N.Y. Civil Rule 2), this litigation involves the affairs and transactions of American Foam Rubber Corporation (hereinafter AFR), and those who at various times were its officers, directors and stockholders. *fn2"

 In June, 1960 plaintiff Samuel Buchman filed suit against AFR and the individual defendants, Marie Louise deMontmollin, Alexander F. Pathy and Suzanne M. Pathy. For many years and until May 17, 1957, Buchman was a substantial stockholder of AFR and served as its president and a director. On that date, plaintiff and his son sold their stock interests to the individual defendants who thereby became sole owners of AFR's common stock; further, plaintiff resigned as director and president of AFR. AFR's business (manufacture and distribution of foam rubber products) was thereafter conducted by Alexander Pathy as president and the other individual defendants as officers and directors. In February, 1961 it was adjudicated a bankrupt and Milton R. Ackman was appointed and qualified as Trustee in bankruptcy of AFR. *fn3"

 Plaintiff's complaint, based on diversity jurisdiction, sets forth two causes of action. The first, against AFR, alleges that it defaulted in payments of principal amounts of debentures held by plaintiff; the second, against the individual defendants, alleges conduct violating an agreement made on or about May 17, 1957 under which Alexander Pathy and Marie Louise deMontmollin were to subordinate certain debentures issued to them by AFR and its subsidiary to the rights of holders of certain debentures issued by AFR to plaintiff.

 The answers of AFR (filed July 13, 1960) and the individual defendants (original answer filed December 1, 1960) denied certain material allegations and interposed various affirmative defenses.

 After AFR was adjudicated a bankrupt in 1961, the individual defendants were given leave to file an amended and supplemental answer setting forth certain counterclaims. Further, on his own motion, the Trustee was added as a defendant, permitted to defend on behalf of AFR and serve and file an answer setting forth (a) a "first counterclaim" against plaintiff and (b) a "second counterclaim" against plaintiff and cross claim against the individual defendants (see order dated December 19, 1961). *fn4"

 THE TRUSTEE'S SECOND COUNTERCLAIM AND CROSS CLAIM

 The Trustee's second counterclaim and cross claim alleges that AFR, a New York corporation, was organized in March, 1950 by plaintiff who served from that time until May 17, 1957 as its president and a director; during that period, plaintiff and his son together owned capital stock of AFR in amounts varying from 40% to 33%; on May 17, 1957, plaintiff and his son sold to the individual defendants all of the issued and outstanding stock of AFR then held by them, plaintiff thereupon resigned from AFR and its subsidiaries, remaining however until December 31, 1958 as consultant in matters of business policy, to render services as such when called upon by AFR (Para. 15).

 Until the stock sale and resignations, plaintiff and defendants Alexander F. Pathy and deMontmollin were all of the directors and principal executive officers of AFR; between May 17 and May 20, 1957, defendants Alexander F. Pathy and deMontmollin were such; and from May 20 until May 31, 1957, the same was true as to the individual defendants. After May 31, 1957, the individual defendants were three of five persons who constituted all of AFR's directors and principal executive officers (Para. 16).

 The pleading, in detail, further alleges that the individual defendants, acting as directors and officers, caused AFR to make certain payments to plaintiff under his "Severance Agreement" with AFR of May 17, 1957; the agreement and payments were made without consideration; the payments constituted: (1) a conversion of AFR's assets; (2) an unjust enrichment of plaintiff at AFR's expense; and (3) a dividend forbidden by provisions of certain debentures (Paras. 17-26). As a result, AFR and the Trustee were damaged in the sum of $73,700, that being the aggregate amount of payments claimed to have been made to plaintiff (Para. 27).

 The cause of action for the damages claimed is alleged to arise under Section 70, sub. e of the Bankruptcy Act, 11 U.S.C. § 110, sub. e. (Para. 28).

 THE REPLIES

 Plaintiff's reply to the Trustee's second counterclaim denies material allegations of fact and asserts, as affirmative defenses, that the counterclaim fails to set forth a claim on which relief can be granted; in any event, it is barred by the applicable statute of limitations (Para. 8-17). It demands judgment dismissing the counterclaim.

 The reply of the individual defendants denies material factual allegations of the Trustee's cross claim and interposes as affirmative defenses that the cross claim fails to set forth a claim upon which relief can be granted and that the cause is barred by the applicable statute of limitations (Paras. 1-6). It prays for judgment dismissing the cross claim.

 CONTENTIONS OF THE PARTIES AND ORAL ARGUMENT

 After a preliminary hearing and the filing of reply briefs, the Court entertained oral argument on July 2, 1965. *fn5" In addition to the challenging legal issues, it appeared the Trustee had modified the grounds upon which he urged relief. In his memorandum filed March 25, 1965 in support of summary judgment, the Trustee stated at page 1:

 
Ackman's cause * * * is against [the individual defendants] * * * for causing it [AFR] to pay, improperly, dividends to themselves.
 
The payment of the dividends was forbidden by virtue of the provisions of bonds of A.F.R., held by two infants, Laurent deMontmollin and Edmee deMontmollin. Impropriety because of impairment of capital or other statutory ban is not claimed.

 On oral argument, the Trustee, in response to the Court's question whether he relied solely upon the debenture provisions, responded affirmatively (pp. 5, 7). An ultimate issue, therefore, is whether the payments to plaintiff by AFR under the May 17, 1957 "Severance Agreement" can be said to be, as a matter of fact or law, "dividends" paid by AFR in violation of certain debenture provisions. If not, the Trustee's claim must fall.

 Preliminary matters, however, are the subject of conflicting contentions by the parties. *fn6" Plaintiff and individual defendants challenge the Trustee's cause as time-barred and, in any event, as failing to set forth a claim upon which relief can be granted. They assert that those in whose shoes the Trustee seeks to stand are not, and have not the capacity to become creditors of the bankrupt; if they did, there would be no provable claim; if such a claim exists, there being an adequate legal remedy, the broad equitable relief here sought would be inappropriate. The Trustee relies upon Section 70, sub. e of the Bankruptcy Act to establish his claim and applicable state law, incorporated therein, to demonstrate its timeliness.

 THE STATUTE

 The Trustee's claim is predicated upon Section 70, sub. e of the Bankruptcy Act, 11 U.S.C. § 110, sub. e. It provides in part:

 
§ 70. Title to Property
 
* * *
 
e. (1) A transfer made or suffered or obligation incurred by a debtor adjudged a bankrupt under this Act which, under any Federal or State law applicable thereto, is fraudulent as against or voidable for any other reason by any creditor of the debtor, having a claim provable under this Act, shall be null and void as against the trustee of such debtor.
 
(2) All property of the debtor affected by any such transfer shall be and remain a part of his assets and estate, discharged and released from such transfer and shall pass to, and every such transfer or obligation shall be avoided by, the trustee for the benefit of the estate * * *. The trustee shall reclaim and recover such property or collect its value from and avoid such transfer or obligation against whoever may hold or have received it * * *.
 
(3) For the purpose of such recovery or of the avoidance of such transfer or obligation, where plenary proceedings are necessary, any State court which would have had jurisdiction if bankruptcy had not intervened and any court of bankruptcy shall have concurrent jurisdiction.
 
* * *

 Under the Act, a trustee may acquire rights of action he could not possess as a successor to the bankrupt and may avoid transfers the bankrupt itself could not have avoided. Stellwagen v. Clum, 1918, 245 U.S. 605, 38 S. Ct. 215, 62 L. Ed. 507; Knapp v. Milwaukee Trust Co., 1910, 216 U.S. 545, 30 S. Ct. 412, 54 L. Ed. 610; Re Progressive Wall Paper Corp., 2 Cir., 1916, 229 F. 489, L.R.A. 1916E, 563. Subrogated to rights of creditors as of the time of the filing of the bankruptcy petition, a trustee is vested with title to property transferred by the bankrupt in fraud of its creditors. § 70, sub. a(4), 11 U.S.C. § 110, sub. a(4). In substance, as against a trustee in bankruptcy, a transfer which ...


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