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In re Weis Securities Inc.

UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT


decided: September 15, 1976.

IN THE MATTER OF WEIS SECURITIES, INC., DEBTOR. STOCK CLEARING CORPORATION INC., PLAINTIFF-APPELLANT,
v.
WEIS SECURITIES, INC., AND EDWARD S. REDINGTON, AS TRUSTEE OF WEIS SECURITIES, INC., DEFENDANTS-APPELLEES, SECURITIES INVESTOR PROTECTION CORPORATION, APPLICANT-APPELLEE

Appeal from an order of the United States District Court for the Southern District of New York, Izner B. Wyatt, Judge, affirming an order of the Bankruptcy Court which dismissed Stock Clearing Corporation, Inc.'s complaint for reclamation.

Lumbard, Hays and Gurfein, Circuit Judges.

Author: Hays

HAYS, Circuit Judge:

Plaintiff-appellant, Stock Clearing Corporation Inc. ("SCC"), appeals from an order of the district court which affirmed an order of the Bankruptcy Court dismissing SCC's complaint. By its complaint SCC sought reclamation of securities delivered to the bankrupt, Weis Securities Inc. ("Weis"), by SCC for which SCC has not received payment. We find that SCC has not demonstrated a sufficient possessory interest in the securities to support reclamation.*fn1

SCC, a New York corporation and wholly-owned subsidiary of the New York Stock Exchange ("NYSE"), is a clearing corporation which provides a central facility for the clearing and settling of security transactions among its members. Weis was a broker-dealer and member in good standing of SCC.

SCC facilities greatly simplify the physical transference of stock certificates between member brokers and the payment therefor. In lieu of making individual delivery and payment for each of the multitude of transactions a broker engages in daily, a member of SCC can make all deliveries through SCC, receive all purchases through SCC, and make a single payment to, or receive a single payment from, SCC representing the net credit or debit balance on a day's transactions.

At the end of a trading day SCC matches the trades in each security for each of its members and issues a "balance order." Thus, if a broker purchased a particular stock through five different brokers for five different customers and sold that same stock for other clients through still other brokers, the balance order would represent the net of these multiple transactions so that only a single delivery or receipt is necessary to clear all of them. The balance order directs the member to deliver to, or receive from, another member a specified number of shares of that security on the "settlement day," the fifth business day after the date of trade.

Deliveries for a settlement day commence the preceding evening and are timely up to 11:30 A.M. that day. A delivering member brings the securities to SCC in envelopes with the receiving member and total dollar amount of the contents within identified on the outside of the envelope. An SCC clerk sorts the envelopes into the cubicles of the receiving members without inspecting or in any way confirming the contents of the envelopes. Receiving members may pick up delivered envelopes between 8:00 A.M. and 11:30 A.M. on the settlement day. If the contents of any of the envelopes are irregular, the receiving member may return the envelope to SCC up until 2:00 in the afternoon that day. All payments are due at 3:00 P.M. on settlement day and are made directly to or from SCC - not between brokers. Thus, if a broker has received more securities than he has delivered he must pay SCC the difference by 3:00 P.M.; conversely, if a broker has delivered more securities than he has received SCC makes payment to that broker by 3:00 P.M.*fn2

On the morning of May 24, 1973, the day the contested securities were delivered to Weis, reports of financial trouble at Weis appeared in the newspaper and were widely discussed at SCC and the NYSE. Nevertheless, SCC employees were directed to conduct business in the normal manner. After Weis received from SCC all items directed to it from other brokers and delivered all items to SCC pursuant to the balance orders, Weis' SCC settlement account, as calculated in accordance with applicable SCC rules, reflected a net debit balance of $1,135,459.87. Under the SCC By-Laws and Rules*fn3 which together with the Clearing Member's Agreement governed the transactions between SCC and Weis, a member with a net debit balance must draw a check to SCC for the amount owed before 3:00 P.M. If that amount is $5,000 or over the check must be certified unless certification is waived by SCC. (Rule 7.)*fn4 At approximately 12:30 on May 24, the Securities Investor Protection Corp. commenced liquidation proceedings against Weis pursuant to its authority under the Securities Investor Protection Act, 15 U.S.C. § 78aaa et seq. (1970). At approximately 4:00 P.M. that day SCC accepted an uncertified check from Weis for the amount of Weis' net debit balance. The uncertified check was accepted upon the authorization of an officer of SCC after SCC was informed by Weis that certification was not possible because its bank account had been frozen. Weis' uncertified check was duly deposited by SCC but was returned by the bank upon which it was drawn for insufficient funds.

The SCC By-Laws and Rules clothed SCC with protections additional to that of requiring a certified check from a member. Under Rule 13 SCC was accorded a lien upon any securities held by it for the account of a member for all amounts owed SCC by that member; Rule 6, § 1(6) provided that delivery of securities to a receiving member by SCC is subject to SCC's right to retain such property as security for the member's obligation to SCC; Rule 6, § 1(11) accorded SCC a lien on any property of a member in SCC's possession for any debit balance due SCC by that member. The lien interest provided SCC by these Rules was extinguished when SCC voluntarily turned the securities over to Weis without restriction. National City Bank v. Hotchkiss, 231 U.S. 50, 57, 58 L. Ed. 115, 34 S. Ct. 20 (1913). Additionally, Rule 7 allowed SCC the right to demand such assurances as it deemed necessary of a member's ability to finance commitments, to impose further conditions for its protection, and to accelerate the time at which any payments are due.

Before the Bankruptcy Court SCC argued that the securities were delivered to Weis on the condition that they would be paid for in cash and Weis' failure to fulfill this condition precluded the securities from passing into Weis' estate. The case was heard on a stipulated record containing the basic facts which governed transactions between SCC and Weis, the dollar amounts of the transactions due for settlement on May 24, 1973, a copy of the SCC By-Laws and Rules, a copy of the Clearing Member's Agreement between SCC and the bankrupt, and deposition testimony of five witnesses which counsel agreed could be used by any party for any purpose. Briefs were filed and a hearing held. The bankruptcy court determined that SCC was never the owner of the contested securities and, never having acquired title to the securities, failed to assert a right to possession which is superior to the prima facie right of the Trustee, see National Silver Co. v. Nicholas, 205 F.2d 52, 55 (5th Cir. 1953), and thus failed to sustain the burden a petitioner for reclamation must bear. See 4A Collier on Bankruptcy P70.39[3], at 476-77 (14th ed. 1976). Because the court found the requisite title absent it never reached the issue of whether the transactions were for cash or credit and dismissed SCC's complaint.

SCC appealed to the District Court. That court, characterizing the Bankruptcy Court's rationale as "sound," held that even if SCC had title it could not reclaim the securities because it had parted with such title in a credit transaction.*fn5 See National City Bank v. Hotchkiss, 231 U.S. 50, 58 L. Ed. 115, 34 S. Ct. 20 (1913). When a debtor engages in a cash transaction, payment for the fair value of the goods received is not a preference under section 60 of the Bankruptcy Act, 11 U.S.C. § 96(a); 3 Collier on Bankruptcy § 60.23 (14th ed. 1975); In re Perpall, 271 F.466 (2d Cir. 1921). When, however, a transaction is one which contemplates payment at a later time such that there is an extension of credit, subsequent payment would be on an antecedent debt and, if the other elements of section 60 are present, therefore a preference. The District Court found that the clearing transactions accomplished through SCC are analogous to intra-day extensions of credit because SCC rules allow a broker to receive securities several hours (at least 3 1/2 hours and as much as 7 hours) before payment is due. Thus finding a credit transaction, satisfaction of which would constitute a preference, the District Court affirmed the dismissal of SCC's complaint.

On appeal to this Court SCC argues that it is entitled to reclamation as a matter of law because SCC Rule 7, quoted note 3, supra, unambiguously provided for delivery against payment in cash. SCC further contends that if any ambiguity be found, a remand is necessary to develop a full factual record on the intent of the parties. We reject these contentions.

Both courts below proceeded to decision on the understanding that the entire case was submitted on the basis of the stipulated record and deposition testimony. The Bankruptcy Judge specifically asked counsel if there were any other material facts as to which evidence should be taken and the attorney for the Trustee answered in the negative without contradiction by SCC's counsel. Indeed, if SCC believed that the Bankruptcy Judge erred by dismissing the complaint without making further factual explorations, it is suprising this claimed error was not advanced before the District Court. To the contrary, counsel for SCC advised the District Court that "[the] parties have entered into a stipulation of facts and there is no dispute as to the facts in this case." Moreover, the District Court specifically questioned whether remand to the Bankruptcy Court would be appropriate if the court found a decision on the credit-cash nature of the transaction necessary or whether it should go ahead and decide the case on the merits. Counsel for SCC responded: "I think it would be appropriate because we are up in a stipulation of facts, as I indicated in my brief, that the entire issue be decided." SCC's belated contention that a remand is necessary is thus belied by its own invitation below that the case be decided on the facts as stipulated. Even at oral argument counsel for SCC was unable to inform this Court what, if any, relevant evidence would be developed at a further hearing.

SCC's claim that the courts below erred in dismissing its complaint for reclamation raises the problem of applying traditional legal doctrine concerning passage of title in cash and credit transactions to the hybrid of roles a stock clearinghouse performs. The usual legal terminology - owner, bailee, subrogee - does not appear adequately to characterize SCC's relationship to the securities it processes. We, however, leave the accommodation of these legal concepts to the unique functioning of a securities clearinghouse to another day and affirm the dismissal below on the limited grounds that the particular facts of this case evidence an extension of credit by the clearinghouse to the bankrupt broker.

For purposes of our decision we assume, arguendo, that SCC held title to the securities at the time of delivery to Weis. We further assume, arguendo, that the arrangement between SCC and its members contemplates cash transactions.*fn6 Even with these issues resolved favorably to SCC the complaint must fail because acceptance by SCC of an uncertified check on an account it knew to be frozen rendered the transaction a credit transaction.

Payment by an uncertified check, without more, does not ordinarily convert a cash sale to one for credit if a cash sale is intended. Engstrom v. Wiley, 191 F.2d 684, 686 (9th Cir. 1951). Normal commercial practice requires the use of checks in lieu of cash and, in fact, in sales of goods transactions specific provision is made by statute that payment by any means in the ordinary course of business is sufficient unless the seller demands cash and allows a reasonable extension of time for the buyer to procure it. Uniform Commercial Code § 2-511 (McKinney 1964). In the instant case, however, there was reason to believe that the check would not be honored and consequently could not be immediately converted into cash. Under these circumstances it cannot be said that the check was taken as the equivalent of cash. Moreover, acceptance of an uncertified check is a deviation from SCC's ordinary course of business with its members, particularly when that acceptance is with knowledge that the account upon which it is drawn is frozen. In waiving its right to certification and failing to exercise any of the other panoply of rights it enjoyed under the Rules, SCC was relying on the credit of Weis. Thus, irrespective of whether the clearing system contemplates cash transactions, the conduct of SCC converted the particular transaction at issue here into a credit sale. As such, SCC cannot successfully maintain an action for reclamation and the dismissal of its complaint is affirmed.*fn7

Disposition

Affirmed.


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