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Speare v. Consolidated Assets Corp.

decided: October 4, 1966.


Lumbard, Chief Judge, and Moore and Friendly, Circuit Judges.

Author: Lumbard

LUMBARD, Chief Judge:

This is an appeal from a decision of the Southern District Court, Irving Ben Cooper, J., by Adele Speare, as one of the debtors in possession in an arrangement proceeding, exercising the power of a trustee in bankruptcy to void two mortgage liens held by Consolidated Assets Corporation. The parties agree, as the referee and the district court found, that the mortgage liens in question were tainted with usury. The issues before us are whether or not the principal of the usurious loan is forfeited, and whether, if the principal is not forfeited, legal interest must be paid in a proceeding brought by a debtor in possession exercising the power of a trustee in bankruptcy under Section 70(a) (6), 11 U.S.C. § 110(a) (6). We agree with the referee and the district court that, under New York choice of law which the parties have assumed to be applicable, New Jersey law governs this entire transaction and that the lien is valid only to, but to the extent of, the outstanding principal providing that payment is tendered promptly.

On June 13, 1960 George and Adele Speare, New Jersey residents, signed two notes and mortgages in the offices of Consolidated Assets Corporation in Rutherford, New Jersey. The transactions arose out of their need for funds to complete the renovation of a restaurant which they rented from Consolidated in New York City. The mortgages were on land located in Bridgewater, New Jersey. The first note and mortgage was for $43,700, representing $20,000 to be applied to the repairs, $7,200 in accrued rent owing, and $16,500 to discharge a prior mortgage on the New Jersey property, and bore six per cent interest payable quarterly. A second note for $4,370 was given by the Hubbard Operating Co., Inc., a company wholly owned by the Speares, to Consolidated and also secured by a mortgage on the Bridgewater property.

In February 1961, the Speares filed a petition for an arrangement under Chapter XI of the Bankruptcy Act and were authorized to act as debtors in possession with the power of trustee under Section 342, 11 U.S.C. § 742. They sought permission first to sell the tract of land free of encumbrances (which would then attach to the proceeds) and then under § 70(a) (6) to void the two mortgage liens held by Consolidated as tainted by usury.

The referee held that no consideration was received for the $4,370 note; that the transactions of June 13, 1960 were in fact a single transaction and therefore that the second note was a ten per cent bonus on the original loan; and that the "separate bonus as a condition of the $43,700 loan infects the latter with the poison of usury." No appeal was taken from this conclusion, amply supported as it is by the record. The parties, however, earnestly dispute what consequences should flow from it.

The referee, purporting to apply New Jersey law in conformity with New York's conflict of laws rules, voided the $4,370 note and the mortgage, and held that the creditor was entitled to repayment in the amount actually loaned, without interest if tendered by the debtors within 20 days of the order;*fn1 the mortgage remaining a valid lien to that extent.

Upon review, the district court affirmed, but granted the debtor a stay of tender in order to apply to the referee to sell the property and make the tender from the proceeds.*fn2

On appeal the debtor argues that New York law, which he contends would make the creditor forfeit the principal, should apply to this usurious contract, or that, if New Jersey law is applicable, the principal need not be tendered in order to prevent payment of legal interest. The mortgagee cross-appeals the denial of interest. We conclude that (I.) New Jersey law applies and that (II.) the creditor is not entitled to interest provided appropriate tender of principal is made.


Where the question involves the usurious nature of notes and the consequent obligation to pay interest, we will look to the substantive law of the states. See Missouri K. & T. Trust Co. v. Krumseig, 172 U.S. 351, 355, 358-359, 19 S. Ct. 179, 43 L. Ed. 474 (1899). "Where the contract is plainly usurious the applicable state law must be closely followed as to the legal consequences of the defect. State law may, for instance, distinguish between the right of the debtor to plead usury as a defense in bar of the creditor's claim and his right to void the contract by affirmative action (e.g., in suing for return of a security) which may be subject to the condition of tendering capital and legal interest. Where such distinction is drawn by state law it will be carried over into the bankruptcy law." 3 Collier on Bankruptcy para. 63.07 [15] at 1824 (14th ed. 1964); see Matter of Miller, 21 F. Supp. 644 (S.D.N.Y.1937); In re Wilde's Sons, 133 F. 562 (S.D.N.Y.1904), aff'd 144 F. 972 (2 Cir. 1906); In re Worth, 130 F. 927 (D.C.Iowa 1904); also 3 Collier on Bankruptcy para. 63.13 (14th ed. 1964).*fn3

Despite seemingly contrary intimations in Vanston Bondholders Protective Comm. v. Green, 329 U.S. 156, 161-162, 67 S. Ct. 237, 91 L. Ed. 162 (1964) and by commentators, Hill, The Erie Doctrine in Bankruptcy, 66 Harv.L.Rev. 1013, 1046-47 esp. n. 135 (1953); Moore, Commentary on the U.S. Judicial Code 356 (1949); 4 Collier on Bankruptcy para. 70.04 n. 31 at 958-60 (14th ed. 1964), the parties, the referee and the district judge assumed New York choice of law rules to be applicable, and the debtors in possession argue only that the referee misinterpreted the New York law of conflicts in deciding that the substantive law of New Jersey is applicable.

Although New York generally follows the rule that the validity of a contract will be governed by the law of the state having the most significant contact with it, Auten v. Auten, 308 N.Y. 155, 124 N.E.2d 99, 50 A.L.R.2d 246 (1954), it seems to follow a special rule with regard to usury, applying the law of any state connected with the transaction which will validate it, Hawkins v. Ringel, 231 N.Y.S.2d 476 (Sup.Ct.1962), rev'd on other grounds, 19 A.D.2d 649, 242 N.Y.S.2d 616 (2d Dep't 1963); Crylon Steel Co. v. Globus, 185 F. Supp. 757 (S.D.N.Y.1960); see Fahs v. Martin, 224 F.2d 387 (5 Cir. 1955), to give effect to the parties' apparent intention to enter a lawful contract.

Where all of the states connected with the transaction would invalidate a contract as usurious, as here, it would seem doubtful that the "validation rule" would call for the application of the law of the state which is most lenient in penalty, but see Restatement (Second), Conflict of Laws § 334d, comment d (1960), for if this special rule is designed to accommodate the presumed intention of the parties to consummate a lawful contract, inquiry should be made only as to whether or not, under the laws of any related forum, the contract would be held valid.*fn4 Hawkins v. Ringel, supra, nevertheless holds that the usury law of the forum "having relation with the transaction which is most favorable to the transaction" should be applied. 231 N.Y.S.2d at 478 (emphasis added). Thus if, as the parties assume, New York law would not require tender of principal or legal interest under these circumstances, but see New York Credit Men's Ass'n v. Manufacturers Discount Corp., 186 Misc. 756, 60 N.Y.S.2d 2 (Sup.Ct.1945), aff'd mem., 270 A.D. 838, 61 N.Y.S.2d 375 (1st Dep't), motion for leave to appeal dismissed per curiam, 296 N.Y. 615, 68 ...

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