An insolvent debtor, making an assignment for the benefit of his
creditors, cannot reserve to himself a beneficial interest in the
property assigned, or interpose any delay, or make provisions which
would hinder and delay creditors from their lawful modes of
prosecuting their claims.
In this case, the deed of assignment, which forms the subject of
controversy, has the obvious purpose of enabling the insolvent
debtors who made it to continue in their business unmolested by
judicial process, and to withdraw everything they had from the
effect of a judgment against them. Though this bill is not
sustainable under the provisions of the Bankrupt Act against a
preference of creditors in fraud of the act, because the
proceedings were not commenced within the time prescribed by that
act as necessary to avoid a preference, yet a right is shown to
relief on the ground that the instrument was made to hinder and
delay creditors.
This is an appeal from a decree of the Circuit Court of the
United States for the Western District of North Carolina dismissing
a bill brought by Paul B. Means, assignee in bankruptcy of Charles
G. Montgomery and Charles D. Dowd, partners, composing the firm of
Montgomery & Dowd, against Clement Dowd, A. B. Davidson,
Charles G. Montgomery, and Charles D. Dowd.
On and prior to the 24th day of April, 1876, the firm of
Montgomery & Dowd carried on a mercantile business in the Town
of Concord, North Carolina. About that time they became
embarrassed, and on that date made a conveyance in writing of all
their goods and personal property to A. B. Davidson and Clement
Dowd, of Charlotte in the same state, which instrument is variously
called a "deed of trust," an "assignment," or a "mortgage."
Although the grantors asserted that they did not consider
themselves as being insolvent at the time, it is very evident now,
in the light of subsequent circumstances, that they were entirely
so. They had a very considerable stock of goods, which does not
seem to have
Page 128 U. S. 274
been inventoried in reference to this transfer, and a large
amount relatively to their business was outstanding debts due them
growing out of that business. The stock of goods was old and needed
replenishing. The notes and accounts due them were in many cases
worthless, and never have been paid. They were also indebted in a
large amount (quite as much, probably, as they were worth) to
certain banks in Charlotte upon promissory notes endorsed by A. B.
Davidson and Clement Dowd, sometimes jointly, and in other cases
separately.
Davidson was the father-in-law of Charles G. Montgomery, and the
vice-president of the Merchants' & Farmers' National Bank, one
of the creditors secured by this conveyance. Clement Dowd, the
other grantee, was a brother of Charles D. Dowd, one of the
grantors, and also president of the Commercial National Bank, a
preferred creditor. W. J. Montgomery was a brother of Charles G.
Montgomery, and he and Davidson and Clement Dowd appear as
endorsers upon some of the notes set forth in the instrument
referred to.
This conveyance, although made in April, was not placed on
record until the 12th day of July, 1876, thereafter, and the
grantors, Montgomery & Dowd, remained in possession and had
absolute control of the property until shortly after that period.
The instrument itself is filed as "Exhibit A," and reads as
follows:
"
EXHIBIT A"
"This indenture, made this 24th day of April, 1876, by Chas. G.
Montgomery and Chas. D. Dowd, partners, trading under the firm and
style of Montgomery & Dowd of Concord, North Carolina, parties
of the first part, and A. B. Davidson and C. Dowd, of Charlotte, in
the state aforesaid, parties of the second part, witnesseth that
whereas the parties of the first part are indebted as follows: by a
certain promissory note of even date with these presents, given to
the Commercial National Bank of Charlotte, N.C., for three thousand
dollars, and endorsed by the said A. B. Davidson and C. Dowd; also
by a certain other note to the said bank for one thousand dollars,
dated the ___ day of _____, 1876, due
Page 128 U. S. 275
at sixty days and endorsed by W. J. Montgomery; also by another
note of five hundred dollars to the said bank, of even date
herewith, endorsed by C. Dowd, and due at sixty days; also by
another note to said bank of thirty-four hundred dollars, secured
by customers' notes in the hands of Montgomery & Everitt,
att'ys, bearing date the ___ day of _____, and due at sixty days;
also by two other notes, of one thousand dollars each, to the First
National Bank of Charlotte, endorsed by A. B. Davidson, dated,
respectively, on the 25th March and 5th April, 1876, and running to
maturity at sixty days; also by a note to the Merchants' &
Farmers' National Bank of Charlotte for one thousand dollars, dated
the ___ day of _____, 1876 at sixty days and endorsed by A. B.
Davidson; also by another note to the last-named bank for five
hundred dollars, endorsed by W. H. Lilly; also by another note to
said M. F. National Bank for one thousand dollars, endorsed by J.
R. Neisler, and by another note to said bank for five hundred
dollars, endorsed by R. S. Harris; also by a note to Martin Boyer,
Jr., _____ dollars, and note to D. P. Boger for _____; also by a
note to J. A. Lilly for four hundred dollars,"
"Now, in order to provide for the payment of the said debts and
to indemnify and save harmless the said endorsers, the parties of
the first part do hereby bargain, sell, convey, and transfer unto
the said A. B. Davidson and C. Dowd the following property, to-wit
the entire stock of goods, wares, and merchandise of every kind and
description now in the possession of the parties of the first part
and in and about their store in Concord, together with all the
fixtures and personal property used in connection with the said
store and business; also such goods, wares, and merchandise as the
parties of the first part may purchase to renew or replenish the
said stock; also all the notes, accounts, mortgages, judgments, and
other evidences of debt due and belonging to the parties of the
first part, from whomsoever and howsoever the same may be due."
"To have and to hold the said property, and the said choses in
action and evidences of debt, to the said A. B. Davidson and C.
Dowd, their executors and assigns, in special trust, as follows:
"
Page 128 U. S. 276
"The said parties of the first part are to remain in the
possession of the said property and choses in action and continue
to sell the goods for cash only, and to collect, under the
direction and control of the parties of the second part, the
proceeds to be deposited weekly in the Commercial National Bank of
Charlotte, N.C., and applied, under the direction of the parties of
the second part, to replenish the stock by such small bills as may
be agreed upon, and to the payment of the debts of the said firm,
as follows:"
"First, after deducting and retaining the commissions and other
expenses of this trust, to the payment of the note of three
thousand dollars to the Commercial National Bank of Charlotte, of
even date herewith, endorsed by the said A. B. Davidson and C.
Dowd, the same being given for money this day borrowed for the
exclusive use and benefit of the said firm, and also to the payment
of any renewal or substitution of the said note, and of any other
note or notes that may hereafter be given by said firm, and
endorsed by the said parties of the second part, or either of them,
not being renewals of the notes endorsed by them, or either of
them, mentioned and provided for in the next class."
"Secondly, to the payment of all the debts hereinafter
mentioned, except the debt of three thousand dollars, and other
possible indebtedness hereafter to be incurred, as provided for in
the first class above named."
"Thirdly, to the payments of all the other indebtedness of the
said firm, howsoever and to whomsoever the same may be due, any
surplus to be paid over to the parties of the first part, or their
legal representatives or assigns."
"And it is further the understanding and agreement that if any
of the said debts, or any renewal or substitution of them, or any
of them, shall not be paid when the same shall become due, or if,
for any other cause, the parties of the second part may so elect,
then and in that case it shall be lawful for the parties of the
second part, and they are hereby expressly authorized, to take
possession of the said goods and merchandise, and all the property
and choses in action conveyed herein, and dispose of the same at
public or private sale, as they may deem best, applying the
proceeds as hereinbefore directed. "
Page 128 U. S. 277
"In witness whereof the parties of the first part do hereto set
their hands and seals the day and year aforesaid."
"[S'g'd] CHAS. G. MONTGOMERY [Seal]"
"[S'g'd] CHAS. D. DOWD [Seal]"
"Witness: W. P. SIMPSON"
"Probated July 11, 1876. Registered same day."
It appears that at the term of the Concord Superior Court held
in July, 1876, a suit was pending against the bankrupts in favor of
Calvin Chestnut, one of the unsecured creditors, which had been in
the hands of an attorney for collection since some time during the
preceding April. Several of the New York creditors also commenced
proceedings, during the autumn of that year, against the insolvent
firm, and obtained judgments at the October term of the United
States circuit court against Charles G. Montgomery and the firm of
Montgomery & Dowd. After executions issued thereon had been
returned
nulla bona, these creditors filed a bill to set
aside the deed executed by the firm as fraudulent and void.
In December, 1876, proceedings were instituted by which the firm
of Montgomery & Dowd were adjudicated bankrupts, and the
appellant Means was duly appointed their assignee in bankruptcy.
Very soon afterwards, he commenced the present suit in the circuit
court to set aside the conveyance above recited as being fraudulent
and void under the statute of 13 Eliz. and the United States
Bankrupt Act. After the filing of this bill, the complainants in
the first one, the New York creditors above referred to, proved
their debts in bankruptcy and asserted their lien upon the assets
created by the bill in equity filed in December, 1876, and the
first suit has been considered in abeyance ever since, and treated
as merged in the proceeding instituted by the assignee in
bankruptcy. To the bill brought by the assignee, both of the
grantors and the grantees in the deed of assignment were made
defendants, and each of them filed answers. There is the usual
denial of any fraudulent purpose in the transaction, and
allegations that the practices were doing the best they could,
under the circumstances, to secure a proper distribution of
their
Page 128 U. S. 278
property among their creditors. After considerable testimony was
taken, in which all the parties to the deed were sworn, the circuit
court dismissed the bill, and it is from that decree that the
assignee has taken the present appeal.
Page 128 U. S. 280
MR. JUSTICE MILLER delivered the opinion of the Court.
We are of the opinion that whether the case be decided upon the
face of the instrument itself or in view of the testimony as to the
conduct of the parties, that the decree should be in favor of the
complainant. The principles, if not the exact language, of the
statute of 13 Eliz. have been accepted in the equitable
jurisprudence of nearly all the states of common law origin, and
they are the law of North Carolina, with a modification which is
attempted to be applied to this case -- that is, that where the
question of the validity of an instrument of this kind, or any
other conveyance of property, depends upon its fraudulent
character, it must be shown that the grantee participated in the
fraud, and the fact that the
Page 128 U. S. 281
grantor alone is guilty of it is not sufficient to invalidate
the instrument. Conceding this to be the doctrine of the State of
North Carolina, we are of opinion that it can have no important
application to the case before us, because the fraud here is one in
law, as distinguished from actual fraud -- that is to say that
while the parties to this transaction, either grantors or grantees,
probably never had in view the ultimate loss of the debts of the
unsecured creditors by their acts, and may really have supposed
that they were taking the best means to insure payment to them all,
yet the law has said that the means which they took is to be
regarded as a fraud in law by necessary application.
All experience has shown how very common it is for failing or
insolvent debtors who have any considerable means on band, and
especially in cases where a mercantile business of considerable
value is still going on, to delude themselves with the idea that if
they can get time, they can pay their debts; that if their
creditors will delay until they can make such arrangements as they
believe themselves capable of, that they will be able to pay
everybody, and even to save a very considerable surplus out of
their business. This delusion leads them to undertake to obtain
this delay by means which the law does not sanction. If the
creditors refuse to extend time on their obligations and thus give
them the delay which they deem necessary, or if they fear to expose
their condition to their creditors, they adopt, in many instances,
the principle of making an absolute sale to certain friends who
will settle up their affairs and return to them any surplus, or
they make assignments or deeds of trust, conveying the title to all
their property to some trustee or assignee and vesting it in them,
thus opposing an obstruction to the efforts of creditors at law to
collect the amounts which may be due to them. In this manner they
frequently take the law into their own hands and attempt to secure
that delay which can only be obtained by the consent of the
creditors, or by such a conveyance as leaves the creditors in no
worse condition than they were before. It has always been held that
whatever transfer of this
Page 128 U. S. 282
character -- that is, of the title to property by a failing or
insolvent debtor -- may be valid, any instrument which secures to
the assignor an interest in or an unlimited control over the
property conveyed and which has the effect of hindering or delaying
creditors is void as being a fraud upon those creditors.
A very similar case to the one before us was that of
Griswold v. Sheldon, 4 N.Y. 581, in which the court
decided that the mortgage, which, besides permitting the mortgagor,
by its terms, to retain possession of the goods, and on its face
conferred on him the power to sell and dispose of them as his own,
was therefore fraudulent and void in law as to creditors.
Another decision of like character was made in
Nicholson v.
Leavitt, 6 N.Y. 510, the headnote of which correctly expresses
what was decided in the following words:
"An assignment by insolvent debtors of their property to
trustees for the benefit of their creditors, authorizing the
trustees to sell the assigned property upon credit, is fraudulent
and void as against the creditors of the assignors."
This is founded upon the ground that such a provision has the
effect of hindering and delaying creditors.
A very instructive case, and very like the one before us, is
that of
Davis v. Ransom, 18 Ill. 396. A chattel mortgage
of a stock of goods had been made, reciting the indebtedness of the
mortgagor but with an agreement that he should keep possession of
the goods and sell them in the usual course of trade. Out of the
proceeds he was to pay certain preferred creditors, dividing the
remainder
pro rata among the others, with the right in the
mortgagee to take possession of the property under certain
contingencies. This mortgage was held void upon the principles
already cited.
To the same effect is the case of
Bank
v. Hunt, 11 Wall. 392, which cites with approval
the case of
Griswold v. Sheldon, supra.
But this whole subject has been so frequently discussed in the
American courts that it would be an immense labor to go very
extensively into the authorities. The prevailing doctrine, however,
is unquestionably that which we have stated,
Page 128 U. S. 283
and its fundamental essence is that an insolvent debtor making
an assignment, even for the benefit of his creditors, cannot
reserve to himself any beneficial interest in the property
assigned, or interpose any delay, or make provisions which would
hinder and delay creditors from their lawful modes of prosecuting
their claims.
In the case before us, the whole face of the instrument has the
obvious purpose of enabling the insolvent debtors who made it to
continue in their business unmolested by judicial process and to
withdraw everything they had from the effect of a judgment against
them, for it is shown that except the goods in this place of
business transferred by the conveyance, they had nothing of value
but one or two pieces of real estate, encumbered by mortgage for
all they were worth. It specifically provides that the grantors
shall remain in possession of the said property and choses in
action, with the right to continue to sell the goods and collect
the debts under the control and direction of the grantees. The
collections were to be deposited weekly in the Commercial National
Bank of Charlotte, N.C., and applied, under the direction of the
assignees, "to replenish the stock by such small bills as may be
agreed upon, and to the payment of the debts of the said firm,"
specifically mentioned therein, being principally notes held by the
banks, endorsed by the grantees, Davidson and Dowd. It also
contained a provision for the renewal of these notes, without
limitation as to time, and authorizing the trustees,
"if any of the said debts, or any renewal or substitution of
them or any of them shall not be paid when the same shall become
due, or if, for any other cause, the parties of the second part may
so elect, then and in that case it shall be lawful for the parties
of the second part, and they are hereby expressly authorized, to
take possession of the said goods and merchandise, and all the
property and choses in action conveyed herein, and dispose of the
same at public or private sale as they may deem best, applying the
proceeds as hereinbefore directed."
It is difficult to imagine a scheme more artfully devised
between insolvent debtors and their preferred creditors to enable
the former to continue in business, at the same time
withdrawing
Page 128 U. S. 284
their property used in its prosecution from the claims of other
creditors which might be asserted according to the usual forms of
law. So long as these debtors were able to pay the interest and
keep the trustees satisfied that they were not going to lose
anything by the delay, the business could go on, and the property
of the insolvent firm be safe from execution and attachment.
The interest paid on these renewals was twelve percent, and as
the endorsers on the notes were officers of the banks who held the
paper, as well as trustees under this assignment, to say nothing of
the fact that they were closely related to the bankrupt debtors, it
is easy to be seen that,= as long as they had security, they would
be willing to renew these notes and endorse them on each renewal.
So that, by the mere expedient of paying the interest on this
indebtedness, Montgomery & Dowd had it in their power to
continue in their business, whether profitable or otherwise, with a
large stock of goods on their shelves, and defy the creditors who
were not protected. The authority to take possession of the goods,
even when the trustees should deem such action proper, is
accompanied by no direction for an immediate sale or winding up of
the business, but, on the contrary, their discretion as to whether
they shall take possession or not and as to how or upon what terms
they shall sell seems to be absolute, and intended even then to be
controlled for their own benefit and that of the debtors, without
regard to the unsecured creditors.
The case before us is almost precisely like that of
Robinson v.
Elliott, 22 Wall. 513. In that action, it appeared
that John and Seth Coolidge were partners in the retail drygoods
trade in Evansville, Indiana; that they owed the First National
Bank $7,600, and a Mrs. Sloan $3,174 for money previously borrowed
of her to aid them in their business. To secure to Mrs. Sloan the
payment of what was due her and to indemnify Robinson, who was an
endorser, they made to them a chattel mortgage upon their stock of
goods then in a rented store. The mortgage, after reciting the
liability of the firm to Robinson on the notes endorsed by him,
stated that it was contemplated that it might become necessary to
renew the
Page 128 U. S. 285
notes or to discount other notes. It was also stated that the
note to Mrs. Sloan might be renewed at maturity if it was not
convenient for the firm to pay it. The mortgage then proceeded in
the following language:
"And it is hereby expressly agreed that until default shall be
made in the payment of some one of said notes or some paper in
renewal thereof, the parties of the first part may remain in
possession of said goods, wares, and merchandise, and may sell the
same as heretofore, and supply their places with other goods, and
the goods substituted by purchase for those sold shall, upon being
put into said store or any other store in said city where the same
may be put for sale by said parties of the first part, be subjected
to the lien of this mortgage."
Although the mortgage was duly recorded, it was held by this
Court to be void under the statute of frauds of Indiana. Section 10
of that act declared that no such assignment or mortgage should be
valid unless acknowledged
"as provided in cases of deeds of conveyance, and recorded in
the recorder's office of the county where the mortgagor resides,
within ten days after the execution thereof."
Section 21 makes the further provisions:
"The question of fraudulent intent in all cases arising under
the provisions of this act shall be deemed a question of fact; nor
shall any conveyance or charge be adjudged fraudulent as against
creditors or purchasers solely upon the ground that it was not
founded on a valuable consideration."
This Court, in a lengthy review of the effect of recording acts
and of the doctrine of the statute of 13 Eliz., held that the
recording of the mortgage contemplated by the statute was intended
as a substitute for possession, but "was not meant to be a
protection for all the other stipulations contained in it." It was
also held that the court was the proper party to say whether on its
face the mortgage was void, and that it was so void.
It was argued in that case that there could be no such thing as
constructive fraud, because under this statute the question of
fraudulent intent was one of fact; but this Court, following the
Supreme Court of Indiana, said that those provisions of
Page 128 U. S. 286
the statute of that state had not changed the law on the
subject, and that the court must in the first instance determine
upon the legal effect of the written instrument, and, if that be to
delay creditors, it must be rejected.
In the opinion, the Court said:
"But there are features engrafted on this mortgage which are not
only to the prejudice of creditors, but which show that other
considerations than the security of the mortgagees, or their
accommodation even, entered into the contract. Both the possession
and right of disposition remain with the mortgagors. They are to
deal with the property as their own, sell it at retail, and use the
money thus obtained to replenish their stock. There is no covenant
to account with the mortgagees, nor any recognition that the
property is sold for their benefit. Instead of the mortgage's being
directed solely to the
bona fide security of the debts
then existing and their payment at maturity, it is based on the
idea that they may be indefinitely prolonged. As long as the bank
paper could be renewed, Robinson consented to be bound, and in Mrs.
Sloan's case it was not expected that the debt would be paid at
maturity, but that it would be renewed from time to time, as the
parties might agree. It is very clear that the instrument was
executed on the theory that the business could be carried on as
formerly by the continued endorsement of Robinson, and that Mrs.
Sloan was indifferent about prompt payment. The correctness of this
theory is proved by the subsequent conduct of the parties, for the
mortgagees remained in possession of the property, and bought and
sold and traded in the manner of retail drygoods merchants, from
July 7, 1871, to August 7, 1873. . . . It hardly need be said that
a mortgage which, by its very terms, authorizes the parties to
accomplish such objects is, to say the least of it, constructively
fraudulent. Manifestly, it was executed to enable the mortgagors to
continue their business, and appear to the world as the absolute
owners of the goods, and enjoy all the advantages resulting
therefrom. . . . This conduct is the result of trust and
confidence, which, as Lord Coke tells us, are ever found to
constitute the apparel and cover of fraud. . . . Whatever may have
been the motive which
Page 128 U. S. 287
actuated the parties to this instrument, it is manifest that the
necessary result of what they did do was to allow the mortgagors,
under cover of the mortgage, to sell the goods as their own and
appropriate the proceeds to their own purposes, and this too for an
indefinite length of time. A mortgage which in its very terms
contemplates such results, besides being no security to the
mortgagees, operates in the most effectual manner to ward off other
creditors, and where the instrument on its face shows that the
legal effect of it is to delay creditors, the law imputes to it a
fraudulent purpose. The views we have taken of this case harmonize
with the English common law doctrine, and are sustained by a number
of American decisions."
Other authorities sustain this view of the subject, and the
instrument now under consideration, in the opinion of the Court,
contains all the elements denounced in the case, above quoted, of
Robinson v. Elliott as proof of constructive fraud.
If we examine into the acts of the parties in connection with
this transfer, we shall see that they were in accordance with this
purpose of hindering and delaying creditors. There was but one
witness to the instrument, and he was the confidential bookkeeper
of the bankrupts. He states that he put his name to it as a witness
on the day that is bears date, but that he did not read it, nor was
he informed of its contents, and, although it is said by some
witness that the conveyance was delivered at or about the time it
is dated, the grantees were not present when this witness put his
name to it.
The law of North Carolina, like that of all other states,
provides for the recording of such instruments as this, and that
until so recorded, they are not valid as against creditors and
purchasers without notice. In the present case, it was kept from
record from the time of its date, the 24th of April, until the 11th
day of July thereafter. This was undoubtedly the act of the
grantees in the deed, the parties whose obligations for the
bankrupts were secured by it, and who were the trustees appointed
by it for its execution. The period it was thus kept secret was as
long as it could be with safety to the purpose of hindering and
delaying creditors, for as soon
Page 128 U. S. 288
as it was known that Calvin Chestnut was about to procure a
judgment, which either by virtue of the judgment itself or by a
levy of an execution upon the goods would become a lien, the paper
was recorded for the undoubted purpose of preventing this result.
The bankrupts were permitted for several months to continue in the
possession and control of these goods, and to deal with them as
their own, and even when the trustees did seem to consider it
necessary to interpose and take the matter into their own hands,
the manner in which they did it is open to animadversion. It does
not appear that they went in person to the building, and took
possession of it or of the goods. On the contrary, they made no
change in its appearance or in the manner of conducting the
business. No sign was put up indicating that any change of
ownership had taken place. The same books were currently kept by
the same bookkeeper, and entries were made in the same manner as
before. The two bankrupts were also employed by the assignees to
conduct the business at a salary of $100 per month each, and they
continued it in precisely the same manner as it had been
previously, with the exception of depositing the moneys arising
therefrom, as they allege, in bank according to the directions of
the trustees. In fact, so far as the outside public was concerned,
the whole affair was conducted before the recording of this
assignment and until the appointment of the assignee in bankruptcy
in the same manner that it had always been before the conveyance
was executed. Then it seemed to occur to the trustees that the time
had come to wind up this business, and although it was not done
with any extraordinary expedition, it is not necessary to hold that
there was anything actually fraudulent in the manner in which it
was finally accomplished.
These are circumstances which, taken in connection with the
provisions of the deed itself, show very clearly that in the minds
of the assignors and the assignees, one of the effects of this
instrument and of the operations conducted under it was undoubtedly
to hinder and delay creditors. Indeed it is impossible to believe
that this effect was not intended by all the parties to the
deed.
Page 128 U. S. 289
The suit in this case is not sustainable under the provision of
the Bankrupt Act against a preference of creditors in fraud of the
law, because the bankruptcy proceedings were not brought within the
time prescribed by that act as necessary to avoid such preference.
But a right is shown to relief on the ground that the instrument
was made to hinder and delay creditors.
The decree of the circuit court is therefore reversed, and
the case remanded to that court with instructions to refer the case
to a master, before whom the defendants, the trustees, must account
for the property conveyed to them by the instrument.
In this accounting, all the creditors, secured and
unsecured, must be brought into a concourse and held to an equal
right in distribution of the funds arising from the sale of the
goods and the choses in action assigned to the trustees. But in
accounting with the trustees, they must be credited with what they
have paid to any of the creditors, so far as those creditors would
be entitled on an equal and pro rata distribution among all the
creditors of all the assets conveyed to them by the deed of
trust.
