The bankrupt was largely indebted to a corporation whose
laborers purchased supplies from him; periodically he rendered the
corporation a statement of amounts due from its laborers which it
deducted from their wages and remitted to him in a lump sum. Prior
to, and within four months of, the filing of the petition, the
corporation several times deducted from its payroll amounts
aggregating over $2,000, so due by its laborers, but did not pay
them over, and, on filing its claim, it embodied as an integral
part thereof the amounts so deducted and retained as a proper
credit or offset. The circuit court of appeals found that the
corporation retained the amounts with the knowledge of the
bankrupt's insolvency and with the intention to secure a preference
to that extent thereby, but that the bankrupt had no such
intention, and ordered that the entire claim be expunged unless the
corporation paid the amount so retained to the trustee. On appeal,
objections were taken to the jurisdiction of this Court.
Held that
As the claim to setoff is controlled by and is necessarily based
on the provisions of § 68 of the Bankrupt Act, and its construction
is necessarily involved, and the question is one which might have
been taken to this Court on appeal or writ of error from the
highest court of a state, this Court has jurisdiction of the
appeal.
Under the facts as found below, the deductions from payroll did
not give rise to a voidable preference, nor was the corporation
entitled to credit them as a setoff, as they were not mutual debts
and credits within the setoff clause of the Bankrupt Act, but were
collections made independently
Page 196 U. S. 503
of other transactions and as trustee for the bankrupt. The
corporation was entitled to prove its gross debt with the alleged
setoff eliminated and was a debtor to the bankrupt for the amount
of such deductions, and the court below has power to protect the
bankrupt's estate in respect to dividends to the corporation in
case it should not discharge its obligations.
This is an appeal from a decree of the Circuit Court of Appeals
for the Eighth Circuit, affirming, as modified, an order of the
District Court of the United States for the Eastern District of
Arkansas directing that the claim of the Western Tie & Timber
Company against the estate of S. F. Harrison, a bankrupt, be
expunged unless the company paid to the trustee in bankruptcy a
specified sum, found to have been transferred to the company by the
bankrupt, and decided to have operated a voidable preference. 129
F. 728.
The facts were thus found by the circuit court of appeals:
"1. On February 24, 1903, a petition to procure an adjudication
that S. Frank Harrison was a bankrupt was filed in the District
Court of the United States for the Eastern District of Arkansas,
and Harrison was then adjudged a bankrupt."
"2. The Western Tie & Timber Company was a corporation and a
creditor of Harrison. It presented a claim against his estate in
bankruptcy of $24,358. The trustee moved to expunge this claim on
the ground that the tie company had secured a voidable preference.
The district court ordered the claim expunged unless the tie
company should pay to the trustee $2,210.73, and an appeal from
this order was taken."
"3. For some years prior to February 24, 1903, the tie company
and Harrison had been engaged in removing timber from land of the
former, and converting it into ties, which the company received and
sold. For many months prior to October, 1902, Harrison had owned
and conducted stores in the vicinity of the places where the work
of cutting and hauling the ties was carried on, and had furnished
the laborers engaged in that work with groceries and other
supplies. These laborers and Harrison were paid by the tie company
in this way: once in two or four weeks, an inspector sent to the
tie company a payroll,
Page 196 U. S. 504
on which the name of each laborer, the amount he had earned, and
the value of the supplies he had received from Harrison appeared.
The company deducted from the earnings of each laborer the value of
the supplies the laborer had received, and sent him a check for the
balance. At the same time, it sent to Harrison a check for the
aggregate amount of the supplies which he had furnished to the
laborers."
"4. Four months before the filing of the petition in bankruptcy,
or October 24, 1902, Harrison owed the tie company more than
$20,000."
"5. Between December 27, 1902, and February 24, 1903, the
company refused to pay to Harrison, retained and credited on its
claim against him $2,210.73, which was due him for supplies he had
furnished to the laborers subsequent to November 30, 1902."
"6. At all times when the amounts which aggregate $2,210.73
became due and were retained by the company, Harrison was
insolvent, the tie company knew that fact, and it intended, by
retaining these amounts, to secure to itself a preference over the
other creditors of the insolvent, but Harrison had no such
intention."
"7. After the company had retained several hundred dollars of
the amount due Harrison for the supplies, it advanced to him $75
under a new and further credit."
An appeal to this Court was allowed by the presiding circuit
judge of the circuit court of appeals.
Page 196 U. S. 506
MR. JUSTICE WHITE, after making the foregoing statement,
delivered the opinion of the Court.
Before coming to the merits, we dispose of an objection to the
jurisdiction.
The appeal was prosecuted under clause
b(1) of section
25 of the Bankrupt Act of July 1, 1898, 30 Stat. 544, 553,
providing that from any final decision of a court of appeals
allowing or rejecting a claim under the act, an appeal may be
had
"where the amount in controversy exceeds the sum of two thousand
dollars and the question involved is one which might have been
taken on appeal or writ of error from the highest court of a state
to the Supreme Court of the United States."
The provision of the Revised Statutes regulating the revision of
judgments and decrees of state courts which is relied upon, in
conjunction with the portion of the Bankruptcy Act just quoted, is
that portion of section 709 which authorizes the reexamination of a
final judgment or decree in any suit in the highest court of a
state in which a decision in the suit can be had
"where any title, right, privilege, or immunity is claimed under
. . . any . . . statute of . . . the United States, and the
decision is against the title, right, privilege, or immunity
specially set up or claimed, by either party, under such . . .
statute. . . ."
The appellee does not question that this appeal is from a decree
rejecting a claim, within the meaning of the statute, and that the
requisite jurisdictional amount is involved, but the particular
objection urged is that a right was not claimed under an act of
Congress, nor was a right of that nature denied by the lower
courts.
The objection is not tenable. It clearly appears from the record
that, in the claim filed on behalf of the tie company, there
Page 196 U. S. 507
was embodied, as an integral part thereof, as a proper credit or
setoff, the sum retained from the wages of employees for supplies
furnished by the bankrupt, and the rejection of the claim was based
upon the denial of the right to setoff. As the right of setoff is
controlled by the provisions of section 68 of the Bankrupt Act, the
assertion of such a right, in a proceeding in bankruptcy, as was
the case here, is necessarily based upon those provisions of the
act of Congress, and in this case, the construction of such
statutory provision was undoubtedly involved. That the circuit
court of appeals understood that reliance was had by the tie
company upon the setoff clauses of the act is shown by its opinion,
where, after sustaining the claim of the trustees that the credits
in question constituted a preference, it prefaced a particular
discussion of the contention as to a right of setoff by the
following statement:
"Finally, it is said that this $2,210.73 was a credit to
Harrison, and that the company should be permitted to set it off
against his debt to it, and should be allowed to prove its claim
for the balance remaining without restriction on the ground that
these claims were mutual debts and credits under section 68 of the
bankrupt law."
The record, we think, sufficiently presented a claim of federal
right,
Home for Incurables v. New York, 187
U. S. 157, and the objection to the jurisdiction is
therefore overruled.
Passing to the merits of the controversy:
We must, at the outset, in the light of the facts found below,
determine the exact relation existing between the bankrupt and the
tie company in order to fix the true import of the transactions by
which the tie company, in making its claim against the bankrupt
estate, asserted a right to retain and set off the sums which, in
its proof of claim, it described as "deductions from payrolls."
We think the findings establish that Harrison sold the goods not
to the tie company, but to the laborers, and therefore the result
of the sale was to create an indebtedness for the price
Page 196 U. S. 508
alone between Harrison and the employees. This is not only the
necessary consequence of the facts stated, but likewise
conclusively flows from the nature of the proof of claim made by
the tie company, since that proof, so far as the items concerning
the price of the goods sold to the employees are concerned, based
the indebtedness by the tie company to Harrison not upon any
supposed original obligation on the part of the tie company towards
Harrison to pay for the goods, but upon the "deductions from
payrolls" made by the tie company in paying its employees. The
effect of this was to trace and limit the origin of the debt due by
the tie company to Harrison solely to the fact that the tie company
had deducted, in paying its employees, money due to Harrison by the
employees which, from the fact of the deduction, the tie company
had become bound to pay to Harrison. We think also the facts found
establish that the course of dealing between Harrison and the tie
company concerning the deductions from payrolls was that the tie
company, when it made the deductions, was under an obligation to
remit the money collected from the laborers for account of Harrison
to him, irrespective of any debt which he might owe the tie
company. This follows from the finding that, although there was a
debt existing between Harrison and the tie company, the course of
dealing between them was that, when the tie company made deductions
from the wages of the laborers of sums of money due by them to
Harrison, the tie company regularly remitted the proceeds of the
deductions to Harrison. This conclusion, moreover, is the result of
the finding that Harrison had no intention to give the tie company
a preference, for if Harrison, being insolvent, to the knowledge of
the company, within the prohibited period, gave to the tie company
authority to collect the sums due to him by the laborers for goods
sold them, with the right, or even the option to apply the money to
a prior debt due by Harrison to the company, the necessary result
of the transaction would have been to create a voidable preference.
And if the inevitable result of the transaction would have been
to
Page 196 U. S. 509
create such a preference, then the law would conclusively impute
to Harrison the intention to bring about the result necessarily
arising from the nature of the act which he did.
Wilson
v. City Bank, 17 Wall. 486. To give effect,
therefore, to the finding that there was no intention on the part
of Harrison to prefer, we must consider that the authority given by
him to the tie company to collect from the laborers did not give
that company the right, or endow it with the option, when it had
collected, to retain the money for its exclusive benefit and to the
detriment of the other creditors of Harrison.
The result of the facts found, then, is this: Harrison sold his
goods to the laborers, and agreed with the tie company that that
company, when it paid the laborers, should deduct the amount due by
the laborers from the wages which the tie company owed them, and,
after making the deduction, should remit to Harrison the amount
thus deducted, irrespective of any indebtedness otherwise due by
Harrison to the tie company. Did this give rise to a voidable
preference within the intendment of sections 57
g and
60
b of the Bankrupt Act?
In view of the necessary result of the findings which we have
previously pointed out, it is, we think, beyond doubt that the
agreement was not voidable preference within the meaning of the
statute, since, considering the agreement alone, it brought about
no preference whatever. This leaves only for consideration the
question whether the tie company was entitled to prove its claim,
as it sought to do, for the balance owing, after crediting as a
setoff the "deductions from payrolls," to which we have referred.
Now, as we have seen, from the facts found, it must be that the
agreement between Harrison and the tie company obligated the
latter, when it made the deductions from payrolls, to remit to
Harrison the amount of such deductions, irrespective of the account
between itself and Harrison. It follows that as to such deductions
the tie company stood towards Harrison in the relation of a
trustee, and therefore the case was not one of mutual credits and
debts, within the meaning of the setoff clause of the Bankrupt
Law.
Page 196 U. S. 510
Libby v. Hopkins, 104 U. S. 303.
And, irrespective of the trust relation which the findings
establish, it is equally clear from the general considerations that
the right to setoff did not exist. To allow the setoff under the
circumstances disclosed would violate the plain intendment of the
inhibition contained in clause
b(2) of section 68 of the
Bankrupt Act, which forbids the allowance to any debtor of a
bankrupt of a setoff or counterclaim which
"was purchased by or transferred to him after the filing of the
petition, or within four months before such filing, with a view to
such use, and with knowledge or notice that such bankrupt was
insolvent, or had committed an act of bankruptcy."
That is to say, whether or not the trust relation was
engendered, the result would still be that the tie company, within
the prohibited period, and with knowledge of the insolvency of
Harrison, acquired the claims of the latter against the laborers
with a view to using the same by way of payment or setoff, so as to
obtain an advantage over the other creditors, which it was not
lawfully entitled to do.
As we have concluded that, under the findings, there was no
voidable preference, we think the court below erred in refusing to
allow the tie company to prove its claim unless it surrendered the
sums which it owed Harrison and his bankrupt estate. Section
57
g of the Bankrupt Act, as amended by the act of February
5, 1903, 32 Stat. 797, 799, empowering the court to compel
creditors to surrender preferences as a prerequisite to the proof
of claims against the estate of the bankrupt, relates only to those
creditors "who have received preferences voidable under section
sixty, subdivision
b." But it also is demonstrated from
what we have said that the tie company was not entitled to prove
its claim as it sought to do, embracing as it did, the assertion of
a right to setoff, and thus extinguish the sum which it owed to the
bankrupt estate resulting from the deductions from payrolls.
Whilst, therefore, because of the error in imposing the condition
of prerequisite surrender of the alleged preference, the judgment
below was erroneous, nevertheless the court was correct in
refusing
Page 196 U. S. 511
to allow the alleged setoff, and in refusing to permit proof to
be made which embraced and asserted such setoff. It follows that,
although the judgment below must be reversed for the reasons
stated, the case should be remanded with directions to disregard
the alleged claim of setoff, to reject any proof of claim asserting
the same, and to permit a claim to be filed for the gross
indebtedness to the tie company, with the alleged setoff
eliminated. The result will be that the tie company will be a
creditor of the estate for the whole amount of its claim, and will
be at the same time a debtor to the state for the amount of the
deductions from the payrolls collected by it, the court below, of
course, having power to take such steps as may be lawful to protect
the estate in respect to the payment of dividends to the tie
company, in the event that company does not discharge its
obligations to the bankrupt estate.
The decree of both courts are reversed, and the case is
remanded to the district court with directions to allow the proof
of claim, rejecting the alleged setoff, and for further proceedings
in conformity with this opinion.
