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December 16, 1965


The opinion of the court was delivered by: TENNEY

TENNEY, District Judge.

 The trustees and respondent Leo B. Levin, separately petition to review the order of the Honorable Asa S. Herzog, Referee in Bankruptcy, dated January 21, 1965, pursuant to Section 39(c) of the Bankruptcy Act as amended, 74 Stat. 528 (1960), 11 U.S.C. § 67 (Supp.1964) (hereinafter referred to as "Act" and cited to the appropriate section of the Bankruptcy Act.)

 The trustees of Credit Industrial Corporation, the bankrupt, moved before Referee Herzog for an order subordinating the claims of certain noteholders to the claims of the institutional creditors (hereinafter referred to in the alternative as the "banks") on the basis of an alleged subordination provision contained in the notes entered into between the bankrupt and the noteholders, but to which the banks were not a contracting party.

 Six answers were filed by seventeen noteholders, (including Levin) alleging fifteen defenses, and two asserting counterclaims demanding affirmative relief.

 The trustees moved to dismiss the defenses and counterclaims for insufficiency or failure to state a claim upon which relief could be granted and Levin cross-moved for summary judgment.

 Referee Herzog, in his decision, dismissed all the defenses and counterclaims asserted in the various answers, except the defense of "non-reliance" which was held to raise a triable issue. Levin was granted leave to amend his answer by asserting as an affirmative defense that the bank creditors did not rely upon the subordination provisions of the subordinated notes as an affirmative defense. His motion for summary judgment was also denied.

 Levin (the only noteholder seeking review) petitions for review of the denial of his motion for summary judgment as well as the dismissal of the following affirmative defenses:

 (1) That the trustees are not the real parties in interest;

 (2) That the trustees' application and claims fail to state claims against Levin upon which relief can be granted;

 (3) Fraud by reason of material misrepresentations, false financial statements, sale of unregistered securities by the bankrupt, giving rise to the right to rescind the loan transaction (3d, 4th and 5th affirmative defenses);

 (4) That the subordination clause does not apply to bankruptcy; and

 (5) That the bank creditors, by their conduct, waived the subordination provisions of the notes and are estopped from taking advantage of said provisions in this proceeding.

 The bankrupt herein was engaged in the business of commercial financing and, as is the general business practice, borrowed large portions of its working assets from banks.

 Levin's first defense in part questions whether the trustees are the proper parties to bring this application, as opposed to the creditor banks. Section 47a(8) of the Act explicitly states that it is the trustee's duty to "examine all proofs of claim and object to the allowance of such claims as may be improper." It is proper for the trustees to take a position on whether allowable claims should be treated on an equal footing. See In re Royce Dry Goods Co., 133 F. 100 (W.D.Mo.1904).

 Since the trustees represent all creditors, they clearly have the right to raise this point. First Nat. Bank of Bay City v. Young's Estate, 41 F.2d 8, 9 (6th Cir. 1930); see 3 Collier, Bankruptcy Para. 57.17[2.3] (14th Ed. 1964); Nadler, The Law of Bankruptcy §§ 573, 579 (2d ed. 1965).

 The notes, which are the basis of the claims which the trustees seek to subordinate to the bank claims, are substantially alike and in pertinent part provide:

"Until the Corporation shall pay and satisfy in full all of its obligations and each and every one of its present or future loans * * * now in existence or hereinafter incurred from any bank * * * or other institutional organization * * * the Corporation will not make * * * any payment of the whole or any part of this note. * * *"

 The notes also provide that no noteholders will receive security and that any payment or security given prior to satisfaction of the obligations to the banks will be received and held in trust for, and as agents of, the banks.

 Provision is also made that so long as there be no default in the obligations to the banks, installments of interest may be paid on the notes. Finally, it is provided that the noteholders waive notice "of the acceptance of this subordination provision" by the banks or of reliance by them "upon the subordination herein contained."

 Levin, in his seventh affirmative defense, asserts that the subordination provision in his note fails to refer to its applicability in the case of bankruptcy or other insolvency proceedings, and therefore it does not have the effect of subordinating his dividends in this proceeding to the claim for priority of the institutional creditors.

 "In determining the question of subordination the courts are guided by cardinal principles of equity jurisprudence to the end that injustice and unfairness is not done in the administration of the bankrupt estate." Opinion per Referee Herzog, Matter of: Credit Industrial Corp., 63 B 394 at 11 (January 8, 1965) (hereinafter cited as "Referee's decision").

 The power of the bankruptcy courts to subordinate claims or to adjudicate equities arising out of the relationship between creditors is complete. Sampsell v. Imperial Paper & Color Corp., 313 U.S. 215, 219, 61 S. Ct. 904, 85 L. Ed. 1293 (1941).

 Thus, for example, it has been held that subordination will result from the conduct of the parties where equity required it, even though no consensual subordination is involved. Pepper v. Litton, 308 U.S. 295, 60 S. Ct. 238, 84 L. Ed. 281 (1939).

 The language utilized in the notes in question clearly indicates that the noteholders will assume an inferior position as far as receiving payment on their notes is concerned. In addition, the last sentence of each note refers specifically to the waiver of notice of acceptance of the "subordination provision" by any institutional creditor of the corporation.

 It has long been my understanding that the parties are not prohibited from making contracts for a priority or subordination insofar as they do not impinge upon statutory priorities. In re Aktiebolaget Kreuger & Toll, 96 F.2d 768 (2d Cir. 1938).

 While undoubtedly it might be the better practice to provide for the applicability of the subordination provision under conditions of insolvency, including any proceeding under the Bankruptcy Act (Herzog & Zweibel, The Equitable Subordination of Claims in Bankruptcy, 15 Vand.L.Rev. 83, 93 (1961)), I do not find its absence fatal.

 The subordination clauses such as the one involved herein are important in obtaining credit, and their attractiveness or appeal is in part due to the superior status obtained by those extending credit in reliance on the said clause - a superior status which becomes most important when the debtor is unable to pay its debts and under circumstances similar to those existent herein. Cf., In re Aktiebolaget Kreuger & Toll, supra, 96 F.2d at 770.

 Neither the Referee nor I have been referred to any cases, nor has my research revealed any, which hold that a subordination provision similar to the one at bar will not be enforced in the bankruptcy court in the absence of express language in the contract alluding to bankruptcy proceedings.

 The language used in providing for subordination is in broad terms and all encompassing, and in no respect excludes or prohibits application in bankruptcy proceedings.

 Accordingly, I find that the Referee's decision, in finding the subordination provision applicable to bankruptcy dividends, proper. *fn1"

 Levin, as part of his first defense, asserts that neither the institutional creditors in the additional proofs of claim nor the trustees in their application allege, directly or indirectly, that the loans which the institutional creditors made to the bankrupt, for which proofs of claim have been filed in this proceeding, were in fact made in reliance upon or induced by the subordination provisions of his (Levin's) note or others like it. Levin, assuming the correctness of the aforementioned point, goes on to assert that no other basis has been shown or alleged for departing from the underlying policy of equity and the bankruptcy statutes favoring equality of distribution among unsecured creditors in the absence of a compelling showing that the denial of priority would work an injustice.

 Levin, then, in his second defense, states that the trustee's application and the claims filed by the banks fail to state claims against him upon which relief can be granted.

 I will initially discuss the latter portion of the above-cited first defense and the second defense, leaving the balance for subsequent consideration.

 As was pointed out by the Referee in his decision, express agreements to subordinate are uniformly enforceable in proceedings under the Bankruptcy Act. "Section 64b of the Bankruptcy Act, as amended, 11 U.S.C.A., § 104(b), for reasons of public policy, creates priorities regardless of the parties' contracts and overrides inconsistent covenants. But this does not mean that the parties are prohibited from making contracts for a priority or subordination insofar as they do not impinge upon statutory priorities. Section 65a of the act, 11 U.S.C.A. § 105(a) means no more than that dividends paid to creditors shall be pro rata except where there is a priority given by law or by lawful contractual arrangement between the parties. Bird & Sons Corporation v. Tobin, 8 Cir., 78 F.2d 371, 100 A.L.R. 654." In re Aktiebolaget Kreuger & Toll, 96 F.2d 768, 770 (2d Cir. 1938); see also, Wyse v. Pioneer-Cafeteria Feeds, Ltd., 340 F.2d 719, 722-723 (6th Cir. 1965).

 Agreements to subordinate in favor of a specific creditor or group of creditors are so enforceable. Bird & Sons Sales Corp. v. Tobin, 78 F.2d 371, 100 A.L.R. 654 (8th Cir. 1935); Matter of Dodge-Freedman Poultry Co., 148 F. Supp. 647 (D.N.H.1956), aff'd sub nom. without opinion, Dodge-Freedman Poultry Co. v. Delaware Mills, Inc., 244 F.2d 314 (1st Cir. 1957); Matter of Handy-Andy Community Stores, Inc., 2 F. Supp. 97 (W.D.La.1932). See also Wyse v. Pioneer-Cafeteria Feeds, Ltd., supra.

 Thus, for example, subordination agreements have been enforced for the benefit of groups or classes; various combinations have been sustained, such as the claims subordinated to all other obligations, present and prospective, in Bank of America Nat. Trust & Sav. Ass'n v. Erickson, 117 F.2d 796 (9th Cir. 1941). In Bird & Sons Sales Corp. v. Tobin, supra, a creditor group subordinated their existing claims to all future indebtedness or liabilities of the bankrupt; debentures were subordinated to all other debts in In re Aktiebolaget Kreuger & Toll, supra; and the debentures were subordinated to all bank debts, notes and other commercial paper of certain maturity and renewals, certain other short-term indebtedness and future debentures in Matter of Nat'l Discount Corp., 212 F. Supp. 929 (W.D.S.C.), aff'd sub nom. Austin v. National Discount Corp., 322 F.2d 928 (4th Cir. 1963). See generally, 3 Collier, Bankruptcy Para. 65.06 (14th ed. 1964); Annot. 100 A.L.R. 660 (1936).

 Since I have already indicated that the instant subordination provision is applicable for enforcement in bankruptcy proceedings, I find Levin's defense of legal insufficiency untenable. *fn2"

 I now proceed to the crux of the case presented herein, namely, the issue of whether reliance on the subordination provisions must be shown by banks extending credit subsequent to the execution of these subordination clauses, and, if so, upon whom the burden of pleading and/or proving reliance and/or non-reliance falls.

 The trustees petition to review that portion of Referee Herzog's Order which failed to dismiss the defense of non-reliance upon the subordination provisions of the notes by the institutional creditors, asserted by noteholders Rose Friedman, Edith Keller, Beverly Keller, Pauline Goldstein, Fannie Winnick, and Samuel Coslow.

 The trustees also petition to review that part of the Referee's Order which permitted amendment of their answers to allege non-reliance as a defense by noteholders Leo B. Levin, Florence Schwartz, Milton Schwartz, Lawrence S. Kryle and Flora Haltenbach; and Benjamin Fried, Marcus Fried, Arthur A. Hilton, Gertrude L. Hilton and Edward H. Bottner.

 As set forth in their third counterclaim, it was the position of noteholders Rose Friedman, Edith Keller, Beverly Keller, Pauline Goldstein, and Fannie Winnick (who are not seeking review herein) that most of the loans had been obtained from the institutional creditors prior to the execution of their notes containing subordination provisions; further, that the bank loans were not predicated upon, based upon or made in reliance upon any alleged subordination agreement made by them with the bankrupt, since the said subordination agreements were not in being at the time said bank loans were made to the bankrupt, and that as to said outstanding bank loans and advances which were in existence on the dates of the execution of their respective loans, such advances are not subordinated to the institutional creditors who were creditors of the bankrupt as of those dates.

 In addition, claimant Samuel Coslow (who also is not seeking review herein), in his third affirmative defense made the broad assertion that there was no proof of reliance by the ...

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