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IN RE HYGRADE ENVELOPE CORP.

August 8, 1967

In the Matter of HYGRADE ENVELOPE CORP., Bankrupt


The opinion of the court was delivered by: WEINSTEIN

WEINSTEIN, District Judge.

 Review is sought of the determination of the Referee in Bankruptcy following remand by the Court of Appeals for further findings and conclusions. See In re Hygrade Envelope Corp., 366 F.2d 584, 589 (2d Cir. 1966). The question posed is whether the $101,000 proceeds of an insurance policy - on the life of Jack Wohl, vice-president, general manager and "key man" of the bankrupt, Hygrade - assigned by Hygrade to Gibraltar Factors Corp. at a time when Hygrade was known to be insolvent, is a voidable preference. For the reasons indicated below, this Court concludes, as did the Referee, that Gibraltar may retain the proceeds.

 I. RELATIONSHIP OF HYGRADE AND GIBRALTAR

 For a period of some years Hygrade, an "under-capitalized" firm, was financed by Gibraltar. The parties did not have an "oldline" or classical factoring relationship in which the factor purchases accounts outright and assumes the risk of loss. Steiner & Shapiro, Money and Banking, p. 237 (3rd Ed. 1953); Guthmann & Dougall, Corporate Financial Policy, pp. 470-473 (4th Ed. 1962). Rather, the financing arrangement involved loans of up to 75% of the net amount of the accounts receivable secured by the accounts, and loans secured by inventory liens. Such loans on inventory and other assets are part of the general services offered by modern factors. Phelps, The Role of Factoring in Modern Business Finance, p. 16 (1956); Bradley, Fundamentals of Corporation Financing, pp. 426-427 (1959).

 At the initiation of their relationship, Gibraltar had required Hygrade to take out and assign to it insurance on Wohl's life in the sum of $100,000. Because one of the policies was a reducing one, it had a face value of only $72,000 in November of 1962.

 On November 26, 1962, Hygrade was indebted to Gibraltar for $385,000. This debt was well in excess of the reliable security then held by Gibraltar. Gibraltar held security assignments of $61,000 in chattel mortgages and $273,000 in accounts receivable. Some $144,000 of the assigned accounts were over 120 days old and considered by a court-appointed auditor to be "doubtful." An additional $62,000 of security in a fire loss claim and in inventory was available to pay loans on the accounts receivable because of cross-collateral agreements.

 A few days before November 26, 1962, Gibraltar, in a routine spot check of selected accounts, discovered that Hygrade's second largest account indicated a "discrepancy." Confronted, Wohl revealed that these accounts included "prebilled" goods not yet ordered.

 At this point, Gibraltar sought further protection. It demanded an additional $100,000 insurance policy on the life of Wohl. Hygrade, not wishing to pay an estimated $1,000 necessary to purchase a new $100,000 policy on Wohl's life, assigned to Gibraltar, on November 26, 1962, such a policy owned by it with a cash surrender value of $393. From November 26, 1962 to February 8, 1967, the date Hygrade was adjudicated a bankrupt, Gibraltar continued to finance Hygrade. The loans and security assignments - listed below - indicate a narrower margin of security than the "up to 75% of the Net Amount of the Accounts assigned as security for each loan" provided by the Accounts Receivable Agreement. There was an obvious reliance on the continued managerial skill of Wohl, at least until he died "suddenly" on December 5, 1962 beneath the wheels of a train. Dealings Between Hygrade & Gibraltar 11/26/62-2/8/63 Security Taken Loans Made 11/26/62 Insurance policy (cash surrender value $ 393; Proceeds on death $ 101,000) Chattel Mortgage - $15,000 $ 12,500 11/27/62 Accounts Receivable - $5,951.12 Chattel Mortgage - $ 8,500 6,200 11/28/62 2,000 11/29/62 Accounts Receivable - $8,042.49 4,000 12/1/62 Accounts Receivable - $8,038.23 13,000 12/5/62 (Death of Wohl) 12/17/62 Accounts Receivable - $12,426.65 8,484 12/21/62 Accounts Receivable - $3,590.03 2,700 1/2/63 Accounts Receivable - $2,711.14 2,033 1/23/63 (petition in bankruptcy filed) 1,500 Total $ 64,259.66 (exclusive of life insurance policy) $ 52,417

 During this two-month period there were substantial collections against assigned accounts receivable so that, despite additional loans, the net debt was reduced to $210,000. After collection of $101,000 on the insurance policy in question and other adjustments, there is still a deficit of some $50,000 in the account due from Hygrade to Gibraltar.

 II. LITIGATION INVOLVING PROCEEDS OF POLICY

 The trustee in bankruptcy counterclaimed for the proceeds of the insurance policy as a voidable preference. The Referee, finding a failure of proof that "at the time of the assignment of the insurance policy Gibraltar knew or had reasonable cause to believe that the bankrupt was insolvent," denied relief. Decision of Referee, September 30, 1965. This order was confirmed by Bruchhausen, J. Unpublished opinion, December 13, 1965.

 The Court of Appeals reversed because "the result does not jibe with the applicable rule of law" and "was infected by a misreading of the record." In re Hygrade Envelope Corp., 366 F.2d 584, 588-589 (2d Cir. 1966). The case was remanded to the Referee to determine the following issues:

 
"* * * whether the transfer was for or on account of an antecedent debt, § 60a(1), and whether, if the transfer was preferential, Gibraltar is entitled to a set off under § 60c. He may also consider the claim, first advanced in Gibraltar's petition for rehearing, that the trustee is not entitled to recover because the insurance policy was exempt property under New York Insurance Law § 166(1) if that point remains relevant in the light of his other findings and conclusions." Id. at 589-90.

 Upon remand, the Referee concluded "as a matter of law that the insurance policy in question is exempt property covered by Sec. 166(1) of the Insurance Law of the State of New York [McKinney's Consol.Laws, c. 28] and that the trustee cannot void the assignment thereof as a voidable preference under any of the applicable sections of the Bankruptcy Act." Referee's Decision, April 17, 1967, p. 18. The Referee made the following additional findings - relevant only if his finding regarding the exempt status of the insurance policy is reversed: "the transfer of the insurance policy, from Hygrade to Gibraltar, was a preference within the purview of Section 60B of the Bankruptcy Act and was not made for a new and present consideration but was additional security for a past indebtedness." Id. at p. 19. The Referee further concluded that inasmuch as "Gibraltar, had security of another kind for the additional advances and that the additional advances were not made in good faith * * * I conclude as a matter of law that Gibraltar is not entitled to a set-off against the claim of the trustee to the proceeds of the insurance." Id. at p. 27.

 III. EXEMPT STATUS OF INSURANCE POLICY

 The Federal Bankruptcy Act itself contains no exemptions for the property of bankrupts. Instead, section 6 (11 U.S.C. § 24) grants "bankrupts * * * the exemptions which are prescribed by the laws of the United States or by the State laws in force at the time of the filing of the petition." Since federally created exemptions are not relevant here, the "Bankruptcy Law * * * makes the state laws * * * the measure of the right to exemptions" of the bankrupt. White v. Stump, 266 U.S. 310, 312, 45 S. Ct. 103, 69 L. Ed. 301 (1924). "Whether the exemption claimed * * * should or should not have been allowed must, therefore, be determined by the laws of [the] state." Turner v. Bovee, 92 F.2d 791, 793 (9th Cir. 1937). But, of course, even if the state law permits the exemption, it also must be one allowable under the federal law.

 Paragraph 1 of section 166 of the Insurance Law of New York grants an assignee [Gibraltar] of a life insurance policy the "proceeds or avails" [$101,000] "as against" a trustee in bankruptcy of the "person effecting the insurance" [Hygrade]. It provides as follows:

 
"§ 166. Exemption of proceeds and avails of certain insurance and annuity contracts.
 
1. If any policy of insurance has been or shall be effected by any person on his own life in favor of a third person beneficiary, or made payable, by assignment, change of beneficiary or otherwise, to a third person, such third person beneficiary, assignee or payee shall be entitled to the proceeds and avails of such policy as against the creditors, personal representatives, trustees in bankruptcy and receivers in state and federal courts of the person effecting the insurance. If any policy of insurance has been or shall be effected by any person upon the life of another person in favor of the person effecting the same or made payable, by assignment, change of beneficiary or otherwise, to such person, the latter shall be entitled to the proceeds and avails of such policy as against the creditors, personal representatives, trustees in bankruptcy and receivers in state and federal courts of the person insured; if the person effecting such insurance shall be the wife of the insured, she shall be entitled to the proceeds and avails of such policy as against her own creditors, trustees in bankruptcy and receivers in state and federal courts. If any policy of insurance has been or shall be effected by any person on the life of another person in favor of a third person beneficiary, or made payable, by assignment, change of beneficiary or otherwise, to a third person, such third person beneficiary, assignee or payee shall be entitled to the proceeds and avails of such policy as against the creditors, personal representatives, trustees in bankruptcy and receivers in state and federal courts of the person insured and of the person effecting the insurance. * * * The person insured in a case under the first sentence of this subsection or the person effecting the insurance other than the wife of the insured in a case under the second sentence, and the person effecting the insurance under the third sentence thereof, or the executor or administrator of any such persons, or a person entitled to the proceeds or avails of such policy in trust for such persons shall not be deemed a third person beneficiary, assignee or payee. * * *"

 The exemption provided by state law does not apply in this case for two independent and sufficient reasons. First, the Bankruptcy Act requires that the property be exempt when in Hygrade's hands; under the state statute it is exempt, if at all, only in Gibraltar's. ...


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