Wm. Filene's Sons Co. v. Weed

BROWN, District Judge. We all agree that the judgment of the court below should be affirmed, though there is a difference of opinion as to the precise grounds upon which the affirmance should rest. A majority of the court agree with the reasoning of the court below, and adopt its opinion as the opinion of this court. In view of the argument for the appellant, it may be useful to state certain reasons which seem to support the judgment of the District Court. The nature of the covenant was explained in Slocum v. Soliday, 183 Fed. 410, 412, 106 C. C. A. 56. It has no operation, except from the time when the lessor entered upon the premises as provided therein. The recording of the lease, with the implied notice to other creditors of its terms, does not assist the appellant. On the contrary, it. informed other creditors that, so long as the lease was in effect, either because the lessee had a right to prevent a cancellation, or because the lessor, though having the right to cancel, did not exercise it, any claim under the covenant for indemnity was nonexistent, and did not affect the lessee’s solvency. Other creditors could not have counted the appellant as a creditor for the purpose of showing that the lessee’s debts exceeded its assets, or for instituting proceedings in bankruptcy or insolvency, and were entitled to give credit in reliance upon the fact that, so long as the relation of lessor and lessee continued, the lessor could be a creditor only for installments of rent as tiiey fell due. They were also, in giving credit, entitled to rely, not only upon the fact that the claim had no existence, but upon the fact that a debt first arising after bankruptcy proceedings could not share with them in a distribution of assets, and that, so far as the covenant attempted to create a debt to which bankruptcy was a condition precedent, it contravened the bankruptcy laws and was wholly ineffective against them. Courts of bankruptcy and of equity alike recognize the fundamental equity of equality between creditors, in the distribution of assets, which arises when assets have become insufficient to pay ¿11 in full. Both enforce this equity by assuming the control of assets and by stopping, from the time their aid is invoked, the creation of new debts to be paid out of assets. Credit'upon the faith of assets is-stopped by the filing of a bankruptcy petition or a petition in equity which seeks either primarily or in the alternative a pro rata distribution of assets. The covenant for payment after bankruptcy or insolvency, upon which appellant now relies, was not, as is contended, entered into upon the faith of the lessee’s assets. The lease may have been entered into with more or less consideration of solvency and reliance upon assets, [38] though insolvency was guarded against by reservation of a right to cancel, but the covenant for indemnity was no part of the lease proper, but a substitutional contract, to take effect, if ever, only after termination of the lease, and only after the realization of a loss. While there was a possibility of its application during the lessee’s solvency, we are not in this case concerned with that aspect, but with tire covenant as a provision intended to become effective after the lessor had canceled the lease, not for a voluntary breach during the lessee’s solvency, but because of bankruptcy, insolvency, or a receivership. In this aspect the lessor has in substance only a personal promise to pay after personal ability to pay is gone. Persons doing business with a corporation trust it, not, as the appellant contends, upon the faith of its assets, but upon the faith of an excess of assets over its existing obligations. Knowledge of the amount of indebtedness is as important as knowledge of assets. Persons were entitled to give credit to the lessee regardless of the mere possibility"of a future.debt, and if credit was given in ordinary course until their debts exceeded assets, this fact gave rise to an equitable right to distribution among them of the assets upon which they relied for payment, for the enforcement of which they might resort to the bankruptcy court or to a court of equity. This right, after it is once asserted by petition or bill, cannot be impaired or diminished by a debt which did not come into being until the assets were insufficient to pay those creditors who had contracted with the lessee upon the assumption of solvency. As rent was paid up to the filing of the creditors’ bill, the creditors were entitled to assert that no brea.ch occurred by act of the lessee before they asserted their right to the assets. For a breach after this time the lessor must look to the personal responsibility of the lessee at the time of breach. The reason for the rule is the same in bankruptcy and in equity. The claim arises too late. It is not true that the lessor has a claim for damages for a breach of contract for the entire term of the lease, for it terminated the lease and cut off the future term by its own election. The substitu-tional covenant, which takes effect after the relation of landlord and tenant is terminated, is what the former lessee has not performed, and upon this rests the appellant’s claim. The former lessee has lost its control over its assets, since those creditors who trusted it on the faith of its assets, and with knowledge that the covenant had created no debt, have asserted their right to the assets. Exactly what was contemplated as one condition precedent to the right of cancellation has happened; custody of the assets for the benefit of creditors who are, as the appellant is not, entitled to say: “We trusted tlie lessee upon the assumption of solvency, and ability to apply its assets in payment of our claims.” The covenant is inherently weak and insufficient to give a claim to share in assets, for it is a provision for a time when the assets of the lessee are gone from its hands. The lessor, however, still has all that it contracted for in this event — the personal obligation of the lessee. [39] In substance the covenant is one of indemnity or insurance — a covenant to indemnify the lessor against loss occasioned by the lessee’s bankruptcy or insolvency. The lessee insures the lessor for the loss occasioned by the lessee’s own inability to pay the agreed rent for the full period. ’ A claim based upon a promise to pay “after I have become a bankrupt or insolvent the' loss occasioned by my bankruptcy” cannot be permitted to share equally with other claims merely on the ground that those, who give credit on the faith of assets should be permitted to share in the pro rata distribution of those assets. / This ground upon which the appellant bases its argument for an equitable right to a share in the assets is, however, a good ground .for preferring the claims of other creditors. As it is obvious that in framing the provision for bankruptcy or insolvency and for a cancellation of the lease the lessor did not rely upon the lessee’s possession of assets to pay with at the time when the debt might arise, this is a sufficient reason for holding that the claim cannot compete equitably with the claims of ordinary creditors. As a device for the creation of a debt which it is not expected that the lessee can pay, but which, as the lease in terms clearly indicates, is to be used in competition with other prior creditors in sharing assets —as a device to become a creditor ex post facto — it is wholly ineffective. V The claim was rightly disallowed, because the appellant did not become legally or equitably a creditor before other creditors had become entitled, both under the Bankruptcy Act and upon equitable principles to all the assets for pro rata distribution, and because the appellant did not rely upon the assets of the lessee for the performance of the covenant of indemnity, as appears by the covenant itself, which contemplates both the creation and payment of a debt after all the lessee’s assets are required to pay prior creditors. The decree of the District Court is affirmed, and the appellees recover their costs of appeal.