The opinion of the court was delivered by: KNAPP
In this plenary action, Winthrop J. Allegaert, trustee in bankruptcy of duPont Walston Incorporated ("Walston") alleges that through a series of fraudulent transactions beginning in July 1973, the various defendants brought about Walston's insolvency by causing Walston's assets to be transferred to defendant duPont Glore Forgan Incorporated and others, and causing duPont Glore Forgan's liabilities to be transferred to Walston. Accordingly, the trustee charges the various defendants with breaching their fiduciary duties and with violating the Federal Securities Laws, the Bankruptcy Act, the New York Debtor and Creditor Law, and the Delaware Corporation Law.
In answer, the various defendants, seeking a set-off under Section 68 of the Bankruptcy Act, allege that Walston, through misrepresentations, caused them to purchase Walston securities from the company at a time when it was actually failing. They charge Walston with violating the Federal Securities Laws, and Walston officers with misconduct. The trustee in bankruptcy moves to dismiss these set-offs and to strike the defense of officer misconduct.
In support of its motion to dismiss, the trustee makes three principal arguments. First, that those who are charged with the breach of a fiduciary duty to a bankrupt may not receive the benefits of set-off. Second, that the debts underlying the defendants' claims are subordinated and therefore do not satisfy the mutuality requirement of Section 68, and finally that the defendant's 10B-5 claims in set-off are claims sounding in tort and therefore are not provable under Section 63. We will discuss these arguments Seriatim, and then turn to the motion to dismiss the claims and strike the defenses of officer misconduct.
This motion to dismiss focuses upon Section 68 of the Bankruptcy Act. That provision provides that "in all cases of mutual debts or mutual credits between the estate of a bankrupt and a creditor the account shall be stated and one debt shall be set off against the other, and the balance only shall be allowed or paid." Bankruptcy Act § 68, 11 U.S.C. § 108.
The trustee correctly points out that a creditor invoking Section 68 gains a preferred position over other creditors in that he receives full recovery on his debt, whereas other creditors are relegated to satisfaction of their claim from those assets remaining in the bankrupt's estate. In other words, Section 68 works as a statutorily created preference.
Because of the great potential for abuse, Section 68(A) provides that the debts involved must be mutual, and Section 68(B) provides that the debts must be provable and allowable. Two of the trustee's arguments on this motion go to the lack of mutuality. The third argument alleges nonprovability.
Mutuality in the context of Section 68 means that the debt or credit must be "in the same right and between the same parties, standing in the same capacity." 4 Collier on Bankruptcy § 68.04(2)(1) (14th Ed.1977) For example, a claim against a bankrupt as an administratrix could not be set off against a debt owing to the bankrupt as an individual, Matter of Tietje, 263 F. 917 (E.D.N.Y.1920), and likewise, a claim against a creditor for damages to property belonging to the bankrupt's assignee could not be set off against the creditor's claim against the bankrupt estate. In re Bevins (2d Cir. 1908) 165 F. 434.
Courts have also held that when the liability of the party seeking set-off arises from either a fiduciary duty or a trust, there is a lack of mutuality, and set-off will not be permitted. Western Tie and Timber Co. v. Brown (1904) 196 U.S. 502, 25 S. Ct. 339, 49 L. Ed. 571, Bayliss v. Rood (4th Cir. 1970)
424 F.2d 142. The trustee points out that on motion, courts will prevent defendants charged with breaching a fiduciary duty from pleading set-off, citing three cases for this proposition, Palmer v. Doull Miller Co. (S.D.N.Y.1916) 233 F. 309, Walker v. Man (Sup.Ct.1931) 142 Misc. 288, 253 N.Y.S. 472 and Putnam v. Handy (1965) 251 Mass. 196, 146 N.E. 264. While some have labeled these cases "hoary," we accept their continued validity. However, we also agree with the defendant that these cases are not here determinative.
In all three cases the defendant's potential liability to the bankrupt was based Solely on the breach of fiduciary duties. As a result, defendant's liability, if established, would necessarily arise from his fiduciary duty, and the attempted set-off of his personal claim would not satisfy the mutuality requirement. On the other hand, if plaintiff failed to prove liability, there would be no debt against which to set anything off. In such a situation there can be no purpose in permitting the defendant to prove his claim. That is not the case here.
Here, the trustee in bankruptcy has charged the defendants not only with the breach of fiduciary duties, but with violations of the Bankruptcy Act, Securities Acts, New York Debtor and Creditor Acts and the Delaware Corporation Law. In other words, the trustee could successfully establish liability without proving the breach of any fiduciary duty. The rationale of judicial economy underlying Palmer, Walker and Putnam, therefore, is without application.
The trustee also argues that since the debt underlying defendants' claims is based on a contract providing for its subordination, it fails to satisfy the mutuality requirement of Section 68.
As we have indicated, the purpose of the Section 68 requirement of mutuality is to insure that a claim asserted by the bankrupt against a party in one capacity is not set off against a claim asserted by the party in a different capacity. The requirement does not speak to subordinated claims and priority of distribution. While application of the set-off provision may appear inequitable from the point of view of the creditor since "the operation of this privilege of set-off has the effect to pay one creditor more than another", Cumberland Glass Mfg. Co. v. DeWitt and Co. (1915) 237 U.S. 447, 35 S. Ct. 636, 59 L. Ed. 1042, Congress has chosen to view the problem through the eyes of the creditor who, without the Section 68 provision, would be compelled to pay in full any liability the estate might prove, while receiving only partial, if any, dividends on any claim he might establish. 4 Collier on Bankruptcy, § 68.02. Obviously, this court does not have the power to disregard Congress' mandate. In a recent case, the Second Circuit, speaking through Judge Friendly, reversed a bankruptcy court and district court which had denied set-off on equitable grounds, stating: "The rule allowing set-off, both before and after bankruptcy, is not one that courts are free to ignore when they think application would be "unjust.' " In re Applied Logic Corporation (2d Cir. 1978) 576 F.2d 952.
The trustee has cited several Second Circuit cases in supposed support of the proposition that subordinated debts may not be set off. See, e.g., In re Stirling Homex Corp., 579 F.2d 206 (2d Cir. 1978); In re Weis Securities, Inc., 605 F.2d 590(2d Cir. 1978), petition for rehearing pending; In re Cartridge Television, Inc., 535 F.2d 1388 (2d Cir. 1976); In re Credit Industrial Corp., 366 F.2d 402 ...