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MILLER v. WELLS FARGO BANK INTL. CORP.

December 22, 1975

Alan B. MILLER, as Trustee in Bankruptcy of American IBC Corp., Bankrupt, Plaintiff,
v.
WELLS FARGO BANK INTERNATIONAL CORP., Defendant


Pollack, District Judge.


The opinion of the court was delivered by: POLLACK

OPINION AND FINDINGS

POLLACK, District Judge.

 This is a plenary suit by a trustee in bankruptcy to recover, as voidable preferences, two loan repayments made by the bankrupt to the defendant bank in November 1973. Jurisdiction is conferred on the Court by 11 U.S.C. § 46 and 28 U.S.C. § 1331. The case was presented at a bench trial and has been fully briefed by the parties.

 The plaintiff, a Trustee in Bankruptcy of American IBC Corporation (hereafter "AIBC"), was appointed on April 2, 1974. AIBC is a Delaware corporation which, among other activities, engaged in international currency transactions and other overseas investment. Its principal offices were in New York City. The defendant Wells Fargo Bank International (hereafter the "New York Bank"), an international bank which is a wholly owned but independently operated subsidiary of Wells Fargo Bank, N.A., of San Francisco, also maintains its principal office in New York City.

 In April 1973 AIBC wished to engage in currency arbitrage involving dollars and Swiss Francs. It approached the New York Bank with whom it had a relationship and two loan transactions resulted. The New York Bank made two six-month loans of $1,000,000 each to AIBC on May 3 and 17, 1973, respectively, which were to be repaid in full in November of that year. AIBC used the funds in two separate currency arbitrage transactions with the Swiss Credit Bank in Zurich (hereafter, the "Swiss Bank") in which the dollars were first exchanged into Swiss Francs, the latter were held in interest-bearing time deposits in Europe, and on maturity thereof six months later the Swiss currency was exchanged back into dollars at a rate of exchange which was fixed initially and was favorable to AIBC. *fn1"

 The arbitrage transactions proceeded according to plan, and the New York Bank received repayment of the two loans, with interest, on the maturity dates of November 2 and November 19, 1973. Within four months thereafter, however, an involuntary petition in bankruptcy was filed against AIBC, on January 29, 1974, and the company was adjudicated bankrupt on February 14, 1974.

 The New York Bank has put forward a number of different legal theories to support its contention that the two loan repayments are beyond the reach of the bankruptcy statutes, and did not constitute preferential transfers voidable by the Trustee. The Bank argues, alternatively, that (1) it was a secured party in that the two loans were secured by pledges of the Swiss Franc time deposits and the repayments were merely the liquidation of the collateral; (2) that it became an assignee in May of either the Swiss Franc time deposits or AIBC's right to receive dollars under the foreign exchange contracts with the Swiss Bank; (3) as to the second loan, the November 19 repayment was not a transfer of the bankrupt's property because AIBC had already assigned those funds in August to the Swiss Bank, which forwarded them to New York by mistake in November; and (4) without regard to the pledge or assignment theories, the satisfaction of the loans by debits to AIBC's account in November constituted a valid set-off by the New York Bank beyond reach of the Trustee. The defendant also denies the Trustee's contention that it had reasonable cause to believe AIBC was insolvent at the times of the loans and repayments.

 On the basis of the record, the Court finds that the two repayments to the defendant Bank, on November 2 and 19, 1973, constituted preferential transfers under § 60 of the Bankruptcy Act, 11 U.S.C. § 96; and since the Court also finds that the defendant Bank had reasonable grounds to believe AIBC was insolvent in November 1973, the funds may be recovered by the Trustee for the benefit of the bankrupt's estate. As is discussed hereinafter, none of the Bank's legal theories is supported in the evidence; they are in the nature of ex post facto rationalizations which are neither persuasive nor tenable.

 I. The Elements of a Preference

 A transfer is preferential under § 60(a)(1) of the Bankruptcy Act, 11 U.S.C. § 96(a)(1), only if it satisfies all the elements of that statute. It must (1) transfer the property of the debtor, (2) to or for the benefit of a creditor, (3) for or on account of an antecedent debt, (4) at a time when the debtor is insolvent, (5) within four months before the filing of a bankruptcy petition, and (6) enable one creditor to obtain a greater percentage of his debt than some other creditor of the same class. In addition, the trustee may void a transfer deemed preferential under § 60(a)(1) only if, under § 60(b), the creditor receiving it had reasonable cause to believe the debtor was insolvent at the time the transfer was made.

 It is apparent that, if the defenses of the defendant Bank fall, all six elements of a preferential transfer are present in the facts of this case. The repayments on November 2 and 19 were made from the bankrupt's assets *fn2" for the benefit of the New York Bank, its creditor, in order to extinguish the antecedent debts incurred by the bankrupt the preceding May. Furthermore, the parties have stipulated that AIBC was insolvent at all times on and after June 1, 1973; the payments in November took place within four months of the filing of the bankruptcy petition in January, and the defendant Bank, by receiving payment in full of the bankrupt's obligations, clearly received a greater percentage of its debt than similarly-situated bankruptcy claimants. All that remains for the Trustee to prove is that the defendant Bank had reasonable cause to believe AIBC was insolvent at the time the payments were made.

 This analysis of the facts must be altered considerably, however, if any of the defendant's defenses mentioned previously are sustained. The New York Bank's pledge and assignment theories affect the dates on which the transfers of AIBC's property would be deemed to have occurred under the Bankruptcy Act, for § 60(a)(2) of the Act defines the time a transfer occurs as "the time when it became so far perfected that no subsequent lien upon such property obtainable by legal or equitable proceedings on a simple contract could become superior to the rights of the transferee." *fn3" Thus, the transfers at issue here would not be deemed to have taken place within four months of bankruptcy if a valid pledge or assignment had been furnished to the defendant and had become enforceable against third parties prior to that time. See Bachner v. Robinson, 107 F.2d 513, 515 (2d Cir. 1939). As to the New York Bank's other defenses, a valid set-off is accorded statutory protection from preference attack; and the allegation that the second loan repayment came from the assets of the Swiss Bank, not the bankrupt, rebuts the existence of the first element of a preferential transfer.

 Consequently, in order to determine whether the two November payments constituted a voidable preference, this Court must first decide whether the defendant Bank had reasonable cause to believe that the bankrupt was insolvent in November 1973; if it did, the Court must then evaluate each of the defenses asserted by the New York Bank. Since the details of the two loans vary, the analysis of the defendant's pledge and assignment theories will be undertaken separately for each loan.

 II. Reasonable Cause to Believe AIBC Insolvent

 The Trustee need not prove that the New York Bank had actual knowledge of the bankrupt's insolvency in order to defeat a preferential transfer under § 60(b) of the Bankruptcy Act. Instead, the plaintiff need show only that the transferee had "reasonable cause to believe that the debtor [was] insolvent" at the time the transfer was made. Section 60(b), 11 U.S.C. § 96(b) (1970); 3 Collier on Bankruptcy P 60.36, at 913 (14th ed. 1975) (hereafter " Collier ").

 A "mere suspicion" that the transferor is insolvent does not constitute "reasonable cause." Grant v. First National Bank, 97 U.S. 80, 24 L. Ed. 971 (1878); In re Hygrade Envelope Corp., 366 F.2d 584 (2d Cir. 1966). Reasonable cause is established, however, where the creditor has notice of "such a state of facts . . respecting the affairs and pecuniary condition of the transferor as would lead a prudent business person to the conclusion that the transferor is insolvent." Robinson v. Commercial Bank of North America, 320 F.2d 106, 107 (2d Cir. 1963). Moreover, the creditor may not "close his eyes" to preserve his ignorance of the debtor's true condition, and is chargeable with notice of all facts which a reasonably diligent investigation would have disclosed, where a person of ordinary prudence would have made inquiry. Id. The New York Bank may not be absolved from a duty of inquiry because, believing itself a secured creditor, it did not need to look to the bankrupt's financial standing as the basis for its decision to extend credit. See Clower v. First State Bank, 343 F.2d 808, 811 (5th Cir. 1965) (bank held to reasonable cause standard, including duty of inquiry, despite its reliance on solvent accommodation endorser of debtor's note). See also G. F. Wertime, Inc. v. Turchick, 358 F.2d 802 (2d Cir. 1966). The Bankruptcy Act makes no exception to its reasonable cause requirement in favor of creditors who do not rely on the credit standing of their debtors. See Clower v. First State Bank, supra.

 The defendant Bank emphasizes that it received its loan repayments precisely as had been scheduled six months earlier, and that it did conduct a general credit check of AIBC in the fall of 1973 which produced no adverse reports from the other banks with whom the bankrupt did business. The Bank submitted in evidence a Dunn & Bradstreet business information report on AIBC dated October 3, 1973 which listed the company's "record" as "clear". Finally, while the documentary evidence shows that the New York Bank was aware in the summer of 1973 that the Banco de la Republica in Bogota, Colombia, was suspicious of AIBC and had severed relations with it in a dispute over an international currency transaction, the defendant has demonstrated in the record that it was advised in September 1973 that the problem had been resolved and the whole matter settled by AIBC.

 Nonetheless, there is no doubt that the New York Bank had notice of facts which would have led a prudent business person to the conclusion that AIBC was insolvent, or which at the very least would have incited a man of ordinary prudence to make inquiry of AIBC's affairs. In re Hygrade Envelope Corp., supra, 366 F.2d at 586-587.

 We start with the undeniable fact that the Bank did not regard AIBC as generally creditworthy and anticipated obtaining full security in any transactions with it. The New York Bank was aware that AIBC was very thinly capitalized -- according to the financial information in the Bank's possession, the company had a net worth of $105,000 and a tangible net worth of $84,000. *fn4" It seems incontrovertible that if the Bank were to learn that AIBC had suffered a serious financial reverse and had not made any off-setting improvement in its capitalization, the Bank would have reasonable cause to believe AIBC was insolvent under the balance sheet test of the Bankruptcy Act, § 1(19), 11 U.S.C. § 1(19) (1970). That is precisely what the Bank did learn.

 AIBC acquired a number of assets in Colombia in 1972 which were reflected in its financial statement at a valuation of approximately $3,000,000. In order to maintain a low profile as a foreign investor, AIBC apparently arranged to have the assets managed as Colombian entities by its two Colombian vice presidents, Luis Lara and Gonzalo Ospina. At some point in late 1972 or early 1973 Lara and Ospina allegedly misappropriated AIBC's Colombian investments; they ceased to be employed by the company in February 1973. Negotiations began regarding the disputed assets, and a settlement was reached, though not consummated, on April 25, 1973. The New York Bank was entirely aware of the proposed settlement since it was to act as escrow agent in connection with the fulfillment of the settlement's terms.

 Although the effect the settlement would have had on AIBC had it been consummated is not entirely clear on the record before the Court, *fn5" no implementation of the provisions of the settlement ever took place. The New York Bank was also aware of that fact, since it had been instructed that the arrangement would be terminated on a given date unless it had been advised, as escrow agent, that a subsequent agreement had been reached; the Bank was never so advised. *fn6"

 Thus, the Bank was aware that AIBC was in jeopardy of losing -- and indeed might already have lost -- up to $3,000,000 of its assets. *fn7" Moreover, the very terms of the proposed agreement, of which the Bank was clearly aware, provided that in the event the settlement were terminated Lara and Ospina were to be released from a pre-existing debt to AIBC of $1,250,000. Given AIBC's net worth, the Bank's awareness of those facts constituted more than "mere suspicion." At the very least it gave rise to a duty to investigate AIBC's financial affairs, which investigation would have disclosed the uncontroverted fact that AIBC was insolvent, at least after June 1, 1973. Indeed, when the Bank eventually did conduct an inquiry in December 1973, it concluded that AIBC's insolvency was attributable in large part to the "fiasco in Colombia" through which it "lost lots of assets."

 The Bank also ignored other signals, apart from the Colombian episode, which suggested the seriousness of AIBC's condition. AIBC was not responsive to the Bank's requests for financial statements for the 1973 fiscal year; indeed, the very Dunn and Bradstreet report the Bank relies upon indicated that the bankrupt had "declined all financial information." Moreover, AIBC did not answer the Bank's belated request, in August 1973, for a signed promissory note in connection with the second loan which had been granted the preceding May. Finally, while relevant only to the second loan payment, the Bank learned on November 9 and 11, 1973 in the course of its general credit check that Chemical Bank had closed AIBC's account and that National Bank of North America refused to comment on its relationship with the company.

 Although these items alone are not dispositive, in conjunction with the evidence concerning the loss of AIBC's Colombian assets they support the inference and conclusion that the Bank's failure to obtain prompt explanations of the omissions and unresponsiveness mentioned and to conduct a diligent inquiry into AIBC's financial affairs represented an inexcusable indifference to what could be ascertained and to the truth, which may not be condoned at the expense of other creditors in bankruptcy.

 In view of the foregoing analysis, there is no need to reach the argument of the Trustee that the New York Bank had actual knowledge of AIBC's insolvency at the time the second payment was made on November 19. This assertion hinges on the testimony of Sheldon Silverston, the president of AIBC, that he met with an officer of the New York Bank on the morning the second loan repayment was due and informed him that AIBC was in serious financial difficulty. The Bank officer, William Boland, testified that he met Silverston for lunch that day but denied that any meeting took place in the morning or that Silverston advised him of AIBC's reverses. Silverston's testimony does not appear sufficiently trustworthy to support a finding of fact in favor of the Trustee on this matter, and no reliance will be placed upon it. *fn8"

 Since the Court finds that the defendant Bank did have reasonable cause to believe that AIBC was insolvent on November 2 and 19, 1973, it is necessary to examine the Bank's contentions that the two loan repayments should not be characterized as preferential transfers.

 III. The Affirmative Defenses of the New York Bank

 A. Set-Off: Both Loans

 The Bank asserts that, wholly apart from its status as a secured creditor, its receipt of funds on November 19 constituted a legitimate set-off of the debt owed it by AIBC and was not a transfer subject to recovery by the Trustee as a preference. While the Bank does not make the point, its set-off argument is also applicable to the repayment of the first loan on November 2 and shall be considered in regard to both loans here.

 Section 68 of the Bankruptcy Act, 11 U.S.C. § 108, provides that "[in] all cases of mutual debts or mutual credits between the estate of a bankrupt and a creditor," the debts shall be set off against one another. Such a set-off may not be recovered as a preferential transfer under § 60 by the bankruptcy trustee. See New York County National Bank v. Massey, 192 U.S. 138, 147, 24 S. Ct. 199, 48 L. Ed. 380 (1904). Section 68 is applicable where the bankrupt makes a deposit in his bank account in good faith and in the due course of business, and where the deposit is subject to withdrawal at the will of the depositor. See Joseph F. Hughes & Co. v. Machen, 164 F.2d 983, 987 (4th Cir. 1947), cert. denied, 333 U.S. 881, 68 S. Ct. 912, 92 L. Ed. 1156 (1948).

 If the deposit is accepted by the bank with an intent to apply it "on a pre-existing claim against the depositor rather than to hold [it] subject to the depositor's checks in ordinary course," however, the deposit is viewed legally as a transfer in payment of the debt. As such, it may be recovered by the trustee where the elements of a voidable preference are otherwise satisfied. Goldstein v. Franklin Square National Bank, 107 F.2d 393, 394 (2d Cir. 1939); Mayo v. Pioneer Bank & Trust Co., 270 F.2d 823, 836 (5th Cir. 1959), cert. denied, 362 U.S. 962, 80 S. Ct. 878, 4 L. Ed. 2d 877 (1960); 4 Collier P 68.18[2] at 919-920.1.

 The deposits to AIBC's account on November 2 and 19 were clearly made and accepted by the New York Bank as payments of AIBC's debts, not as ordinary deposits. Thus, the Bank's internal documents record the credits made to AIBC's account and the subsequent debits in favor of the Bank as "Repayment of ...


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