Iin re Cotton Manufacturers' Sales Co.

THOMPSON, District Judge. In the careful and painstaking report of the learned referee he has so fully stated the history of the case and so thoroughly discussed the evidence upon which his findings of fact and conclusions of law are based that a detailed reference thereto would be superfluous. The evidence sufficiently supports the ref-' eree’s finding tha.t the bankrupt was insolvent on August 26, 1910, when the original agreement between the parties was made and the statement of the bankrupt’s condition as of May 1, 1910, was presented, and that its excess of liabilities over its assets continued to increase from that date to the’time of the filing of the petition in bankruptcy, and his finding that the statement of the bankrupt’s condition and the circumstances under which the agreement of August 26, 1910, was made were such as to put the petitioner upon inquiry as to the bankrupt’s financial condition. [1]- The referee did not err, in my opinion, in finding that ,Mr. Nattress, the president and general manager of the bankrupt company, the agent of the petitioner in the collection of the assigned accounts, is legally chargeable with knowledge of the condition of the company during the period covered by the transactions, and that the bank is legally chargeable with its agent’s knowledge of the insolvency of the company. It is argued on behalf of the petitioner that it is not bound by the knowledge of its agent because the authority of the agent was limited to the collection of the accounts and their payment to the bank. Even so, the authority of Mr. Nattress covered everything which it was necessary should'be done in the transaction except the credit of the receipts upon payment of the assigned accounts and the payment of the money to the bankrupt upon its checks, and it appears that he — 654 — did transact all of the other business in connection with the assignment and collection of the accounts. To hold that the bank may appoint the principal officer of the bankrupt its agent in the transactions and thereby preclude knowledge of the transactions being obtained by the customers of the bankrupt and not be bound ,by the knowledge of the agent as to the bankrupt’s condition of insolvency would enable parties intending to effect preferences to render nugatory the provisions of the Bankruptcy Act as to the conditions under which a preference may be set aside. The bank’s consent that Mr, Nattress should act as agent for both parties prevents its escape from the general rule that notice to the agent is notice to the principal. A principal who knows that his agent.is also acting as agent for the party adversely interested in a transaction with him, and yet consents that he may act as his agent, is estopped from denying the notice and knowledge which the agent has during the transaction. Pine Mountain Iron & Coal Co. v. Bailey, 94 Fed. 260, 36 C. C. A. 229. [2] Counsel for the bank contends that the agreement of August 26, 1910, operated as an assignment in prsesenti of all the accounts to come into existence in futuro,= and that therefore the assignment of the accounts did not create a preference because all the collateral passed more than four months prior to the filing of the petition in bankruptcy. The referee has found that the agreement of August 26th was without consideration between the parties, that nothing passed thereby to the bank, and that no accounts passed until specific assignments were made as provided in the agreement. The final paragraph of the agreement is as follows: “It is mutually agreed that this contract may be canceled by tile second party (the' bank) at any time without notice, and >by the iirst party at any time by payment of the amount of all advances, with interest, according to the terms of the notes given in evidence thereof, and thereupon the second party agrees to reassign all unpaid accounts.” ' No account was assigned to the bank until September 7, 1910, and no advances were made to the bankrupt until the advance of 80 per cent, was made upon the accounts assigned at,that date. Prior to September 7th the agreement could have been terminated by either party with nothing further to be done to put both parties in the same position they held prior to the execution of the agreement. Neither party could have enforced specific performance because no consideration had passed and the other party could have canceled the contract at once. There were no previous dealings between the parties by way of extension of credit and assignment of accounts as collateral, and the referee has found from the conduct of the parties, as shown by the testimony of Mr. Nattress and the officials of the bank, that each assignment wás considered by the parties as a separate and independent transaction and treated as such. It is apparent that the agreement of August 26th did not operate as an equitable assignment of the accounts, and that it is properly construed in accordance with the referee’s opinion as merely providing for a future course of dealing in case specific assignments of accounts were thereafter made. — 655 — The case is clearly distinguishable from Young v. Upson (C. C.) 115 Fed. 182, and In re Schwab-Kepner Co., 203 Fed. 475, 121 C. C. A. 597, as pointed out by the learned referee, and he was clearly right in holding that by the assignments during the four months.’ period preferences were created except for the amounts advanced at the time of the respective assignments, and that, the bank having reasonable cause to believe that preferences were thereby created, the assignments are valid only as security for the amounts advanced at the time of the respective assignments. AS was held by the referee, the position of the bank is not helped by the collateral note. In so far as the bank attempted to secure collateral for indebtedness other than that created by the individual assignments, the collateral note cannot be said to have created any additional obligations on the part of the bankrupt, and its obligations therefore can be enforced only in so far as it is for a present fair consideration in good faith. [3] As to the four accounts assigned before the commencement of the four months’ period, the referee holds that the assignments are valid, and no exception is taken to that finding. As to the accounts assigned within the four months’ period, the referee finds that those assigned between September 25, 1910, and November 1, 1910, are valid assignments as security for the amounts advanced at the time of the said assignments respectively, but that the accounts assigned between November 1, 1910, and December 30, 1910, are void under section 67e because they were made with intent on the part of the bankrupt to hinder, delay, and defraud its creditors, and that the bank cannot retain the security even for the aihounts advanced at the time of the i'espective assignments, because it sought to profit by the fraud, and therefore is not a purchaser in good faith. -As to the accounts assigned after November 1st, the refe'ree finds that upon that date the bankrupt was hopelessly insolvent; that it knew of its insolvency; that Mr. Nattress knew of its insolvency, and that it continued to create debts it could-not, hope to pay; and that the bank, being bound by the knowledge of Mr. Nattress and the information it could have obtained from the books, committed a fraud upon other creditors by continuing to receive assignments of the accounts and to make advances thereon at a time when the bankrupt actually and the bank constructively knew that the bankrupt could not hope to pay its creditors. The referee bases his finding of fraud as to the bank upon the fact that the bank knowing that the bankrupt was hopelessly insolvent and unable to pay its debts nevertheless continued, through its advances and the credit its funds afforded the bankrupt, to help it create new book accounts, which were to be assigned to it as collateral security for advances to the bankrupt by which the bankrupt was to be further enabled to cremate new debts, which it would be unable to pay, and new book accounts for the purpose of further assigning them to the bank for further advances; and he concludes that, if the bank had refused to continue its advances, the creditors who sold to the bankrupt from and after November 1, 1910, would not have done any business with the bankrupt and incurred any loss, and that therefore the bank was responsible for the creation of the liabilities to these creditors and in the same — 656 — position legally as though it had induced them to give credit upon the faith of statements made by it directly to them, or by withholding information it was under a duty to give to other creditors. The referee in reaching his conclusion applies to the bankrupt the rule as laid down in Gillespie v. Piles Co., 178 Fed. 886, 102 C. C. A. 120, holding that a bankrupt is guilty of a fraud upon creditors if, being in a condition of hopeless insolvency, it fails to disclose that condition and continues to obtain merchandise on credit at a time when it. could not have had any intention of paying for the same or any hope of its ability to do so, and applies to the bank the principles underlying the decision in the case of Boyd ,v. Browne, 6 Pa. 310, where, in an action on the case for deceit, the Supreme Court of Pennsylvania held: “The ground of action is the deceit practiced upon the injured party; and this may be either by the positive statement of a falsehood, or the suppression of material facts, which the inquiring party is entitled to know. The question always is: Did the defendant knowingly falsify, or willfully suppress the truth, with a view of giving a third party a credit to which he was not entitled?” In the case of Gillespie v. Piles Co., certain creditors of the bankrupt obtained an order upon the trustee to return to them the proceeds of property bought by the bankrupt while insolvent and when he knew that it was impossible for him to pay for it. I quote from the syllabus by the Circuit Court of Appeals in that case: “An insolvent buyer, who knows at the time of his purchase that his financial condition is such that it is and will be impossible for him to pay, is conclusively presumed to have bought the goods with an intention not to pay for them. “A presumption to that effect arises from the fact that such a purchaser’s affairs were in such a condition at the time of the purchase of the property that he could have had no reasonable expectation of paying for them. “But insolvency is insufficient to establish such an intent.” It appeared that the bankrupt had entered upon the business of buying and selling hogs in the spring of 1905_, with a capital of $1(30 and. a debt of $2,000, and continued in this business until on June 26, 1908, he had accumulated property worth $20,000 and debts exceeding $100,-.000. During the spring and summer of 1908 he owed to vendors from $75,000 to $100,000 and had no way to pay any of them except by buying more hogs of others and using the money derived from the sales of their hogs for the purpose of paying earlier vendors. He knew this condition of things perfectly, and strove to increase his purchases and his sales in order to get money to use in this way. It appeared that, when his assets to his knowledge were not more than 20 per cent, of his liabilities for his purchases, he continued to purchase from the interveners in the bankruptcy proceeding, and the trustee was ordered to pay back the proceeds of these later sales because, as stated by the Circuit Court of Appeals: “In tbis state of tlie case it is incredible that be intended to pay for these bogs when be bought them. He knew it was impossible for him to pay for them, and the human mind is so constituted that it cannot harbor a serious intent that the being it directs shall do that which it knows it is impossible for it to accomplish.” — 657 — Upon the facts in that case it was held that the trustee had no right to retain the funds derived from the hogs sold by the interveners to the bankrupt, as the court found from the evidence that the purchases were made with an actual fraudulent intent. In the present case the referee has found that on October 21, 1910, the excess of the bankrupt’s liabilities over its assets was at least $7,-370.38; that on November 30, 1910, it was $10,990.59, and on December 31, 1910, it was $16,749.50. There is no finding as to the amount of assets and liabilities on these respective dates, but the expert accountant’s statement shows on December 30, 19Í0, assets of $39,205.28 and liabilities of $55,954.86. I am unable to agree with the referee in his inference from these facts that from November 1 to December 30, 1910, the bankrupt was in such a condition of hopeless insolvency, that it knew when it made purchases during that period that it would be impossible for it to pay for them and that it did not intend to pay for them. The most that can be said of its condition is that it was insolvent at that time, and that its excess of liabilities was continuing to increase within those two months; but it does not follow that at any time during that period it knew that it could not recoup its losses and continue to carry on its business. To quote from the referee’s report: “Tbe basis of tbis contention (of tbe trustee) is fraud practiced by tbe bankrupt on its creditors. There is-no positive direct evidence of fraud, and tbe’ trustee’s contention rests upon tbe theory that the bankrupt, by failing to disclose its hopeless insolvency and by continuing to obtain merchandise on credit at a time when it could not have had any intention to pay for the same or any hope in its ability to do so, was guilty of such a fraud.” There is not shown in the present case so great a preponderance of liabilities over assets as, in my opinion, to warrant the presumption of bad faith, which was drawn by the court in the case of Gillespie v. Piles; nor is there any evidence to show that the loans from the bank upon the security of the accounts .receivable were obtained for any other purpose than to furnish the bankrupt with funds with which to continue to pay its creditors with the hope of making sufficient profit out of its business to enable it to extricate itself from its insolvent condition. The fact that the bank’s money was used tp pay some creditors to the exclusion of others and thereby to create preferences is not by any means conclusive evidence of actual fraud upon the part of the bankrupt. My conclusion is that, in the absence of evidence to the contrary, the assignments of accounts to the bank must b.e presumed to have been made for the purpose of obtaining funds to continue the business of the bankrupt, and that there is no presumption arising from the evidence that they were made with intent to hinder, delay, or defraud creditors. Unless the assignments were fraudulent on the part of the bankrupt, they cannot be set aside under section 67e under the authority of Coder v. Arts, 213 U. S. 223, 29 Sup. Ct. 436, 53 L. Ed. 772, 16 Ann. Cas. 1008. _ [4] The most that can be said of the assignments to the bank is that, in so far as they were not for a present fair consideration, they constituted an attempt to prefer under section 60b. Without citing at large from Coder v. Arts, I think the referee has failed to recognize — 658 — the distinction therein' laid ’ down between an attempt to prefer and an attempt to defraud and the necessity of showing an actual intent on the part of the bankrupt to hinder, delay, and defraud creditors where it is attempted to void a transfer under section 67c as fraudulent. The judgment of the bankrupt’s officers upon the question of continuing the business may not have been prudent, and in view of the event it would no doubt have been wiser to have discontinued the transactions with the bank and ceased doing business at . a time when more Pould have been realized for creditors; but the fact that the bankrupt was insolvent and that its business conducted while knowing that it was insolvent proved a failure is not evidence of actual fraud upon its part. As was said in Re Maher (D. C.) 144 Fed. 503, cited with approval by the Supreme Court in Coder v. Arts: “In a preferential transfer tlie fraud is constructive or technical, consisting in the infraction of that rule of equal distribution among all creditors, which it is the policy of the law to enforce when all cannot be fully paid. In a fraudulent transfer the fraud is actual, the bankrupt has secured an advantage for himself out of what in law should belong to his creditors, and not to him." In so far as the bank advanced money at the time of the assignments without actual notice of insolvency, I do not think the trustee has sustained the burden of proof that the transactions were fraudulent and that the bank was not a purchaser in good faith and for a present fair consideration. In Boyd v. Browne, upon which the referee relies to sustain his conclusion as to the want of good faith upon the part of the bank, it appeared that Boyd knowingly and intentionally misrepresented the credit of one Miller, whom he had induced to buy a store and stock from him upon a long term of credit, and that he not onfy knowingly made false representations, but knowingly suppressed facts within his knowledge when vouching for Miller’s credit, and thereby enabled him to obtain from the plaintiffs in the action merchandise for which he was unable to pay. In the present case the bank had no actual knowledge of the bankrupt’s insolvent condition. It neglected to make inquiries which would have put it in possession of that knowledge, and hence, being bound by the knowledge of its agent and by the information it could have obtained from the books of the bankrupt, may properly be held to come within the provisions of section 60b as having received an unlawful preference except for the amounts actually advanced at the time of the assignment of any account within the four months’ period. The knowledge of the bank as to the bankrupt’s condition is an inference which the law permits to be drawn by reason of its relations with the bankrupt and its opportunities to acquire actual knowledge. Upon that inference the learned referee bases a further inference that by advancing money to the bankrupt, and thereby enabling it to obtain credit to continue business and pay some of its creditors, it was perpetrating a fraud upon other creditors because, if it had discontinued its advances at the time when the inference of knowledge is found against it, they would have learned its true condition and ceased deab ing with it and thereby have forced it into bankruptcy; that its fail — 659 — ure in this duty to the other creditors of refusing to make further loans places it in a position of having fraudulently suppressed a fact within its knowledge and therefore, having caused the losses to creditors, it did not receive the collateral for its loans in good faith. With great respect for the opinion of the learned referee, I am unable to agree with a conclusion which would put a bank loaning money to an insolvent upon collateral without notice to other'creditors, but without actual knowledge of its insolvency, in the position of being liable for losses to creditors whom it or its representatives did not know, had never seen, or had never communicated with in any manner, because a result of such loans is to enable the insolvent to continue to carry on business. I must hold that the referee was in error in his finding that the assignments made between November 1st and December 30th were void. I am unable to agree that the inference of fraud based upon an inference of knowledge is sufficient to invalidate these assignments and hold that they are valid to the same extent as those made between September 25th and November 1st. [5] As to the proceeds of the merchandise returned by purchasers from the bankrupt to the bank after bankruptcy, the referee, for the reasons set out in his report and upon the authorities cited, was clearly right in holding that, under the lav/ of Pennsylvania, the assignment of the accounts did not operate as an assignment of the merthandise upon which the accounts were based. Guarantee Title & Trust Co. v. First National Bank of Huntingdon, 185 Fed. 373, 107 C. C. A. 429. The petitioner’s contention is that the merchandise was intended to pass under the language of the assignment wherein the bankrupt gave to the bank “the right to stoppage in transit of the goods and merchandise covered and described therein” (that is to say, in the account). A sufficient answer to the contention is. that no right of stoppage in transit was exercised, nor is the claim based upon that right. I discover no error in the referee’s rulings as to the assignment of the book accounts on January 5 and January 9, 1911. In accordance with the foregoing views, the order of the referee is affirmed, with the exception of the third paragraph thereof, which is reversed, and it is ordered that the assignments of book accounts made by the Cotton Manufacturers’ Sales Company to the First Mortgage Guarantee & Trust Company between November 1, 1910, and December 30, 1910, are valid assignments as security for the amounts advanced by the First Mortgage Guarantee & Trust Company to the said Cotton Manufacturers’ Sales Company at the time of the said assignments respectively.