This Court does not assent to the principle that one who takes
an assignment of part of a claim secured by a common fund can, in
the absence of a special agreement or necessary implication arising
from particular circumstances, acquire more than a proportional
right to the common security or the power to exclude his assignor
in the event of a deficiency from participating therein to the
extent of the portion retained.
The effect of bankruptcy is to so fix the relative rights of the
different classes of creditors that it is not in the power of any
class to set aside or frustrate as against the other rights fixed
by the adjudication in the assets of the estate, and it is the duty
of the trustee to conserve and administer such rights.
A trustee, acquiring by purchase with assets of the general
estate some of a series of notes on all of which the bankrupt is
liable as endorser but which are all secured
pro rata by a
special fund with other notes of the same series and held by third
parties, is subrogated by operation of law, as well as by subd.
c and
f of § 67 of the Bankruptcy Act, to all the
rights of the parties from whom he purchased the notes, and is
entitled to share
pro rata in such special fund as a
holder of such notes.
The effect of a bank's setting off against the bankrupt's credit
balance a debt for which it holds collateral is to subrogate the
trustee to all the rights of the bank in such collateral.
The facts, which involve the power of the trustee in bankruptcy
to use the funds of the estate on behalf of the general creditors
to properly administer it and to conserve their rights, and the
proportions in which the trustee and creditors specially secured by
a special fund shall share in such fund, are stated in the
opinion.
Page 228 U. S. 635
MR. CHIEF JUSTICE WHITE delivered the opinion of the Court.
In July, 1904, Kessler & Company, bankers, contracted to
give the R. B. McLea Company, engaged in business as importers and
jobbers of dry goods, a line of credit up to $50,000, and in
addition to advance money on the invoice price of goods imported,
and for the purpose of paying the duties thereon. The advances, it
was agreed, should be evidenced by negotiable notes of the company
in such amounts and to be furnished at such times as desired by
Kessler & Company. It was also agreed that the company would
hold its stock in trade as a security for all the advances to be
made, with interest charges and commissions, and that the company,
when required to do so, would execute any assignments or deeds
reasonably necessary to the accomplishment of the purpose in view.
It was moreover agreed that all sales of merchandise made by the
company should be subject to approval by Kessler & Company,
and, when approved, Kessler & Company would guarantee the
amount, and that the account sales should be transferred to them as
security, the accounts, when collected, to be applied to the
extinction of the debt. On October 30, 1907, Kessler & Company
made a general assignment, and were adjudicated bankrupts on
November 6 following, when Lawrence E. Sexton was designated as
receiver, and was appointed trustee on December 30. In the nearly
three and one half years which elapsed between the agreement of
July, 1904, and the adjudication in bankruptcy in 1907, Kessler
& Company advanced a
Page 228 U. S. 636
large amount of money to the company, and at the date of the
bankruptcy, there were outstanding notes to the amount of $96,000,
given by the company under the agreement. Only one note for $7,000
was then held by Kessler & Company, the other notes having been
used by the firm in the course of its business as collateral
security for money by it borrowed, as follows: with the Merchants
Bank of New York City, notes for $30,000; with the Bank Commerciale
de Bale, notes for $15,000; with the National City Bank of New York
City, notes for $39,000, and a note for $5,000 with Kessler &
Company, Limited, Manchester, England.
It is not disputed that, at the time Kessler & Company
delivered the notes as collateral, or when the arrangements were
made for obtaining the credit to secure which the collaterals were
given, the nature and character of the contract with the company
was as stated, and it is not controverted that, as the result of
these statements and the delivery of the collateral notes, holders
of the notes became entitled to participate in the security. After
the appointment of the receiver, pending a rule taken by him
against the company for the purpose of asserting his rights to the
accounts and stock of merchandise securing the notes, an agreement
was made between the receiver and the company which was sanctioned
by the court and put in the form of an order in substance providing
as follows: first, directing the receiver to collect any unpaid
account sales of the company assigned under the contract of 1904 to
Kessler & Company and forbidding the company from interfering
with the discharge by the receiver of this duty; second, directing
the company to pay over to the receiver the proceeds of any
assigned account sale which had been collected by the company after
the service upon them of the rule to show cause on November 16,
1907, and third, providing that an inventory be taken by the
receiver and the company, of all merchandise
Page 228 U. S. 637
purchased "during the life of the contract" between the company
and Kessler & Company, the possession of which was in
controversy between the parties, without prejudice to the right of
the trustee, when appointed, to enforce any claims as such trustee,
arising from sales or deliveries of merchandise by the McLea
Company prior to November 16, 1907. The McLea Company was
authorized to deliver any of the inventoried merchandise in
fulfillment of orders theretofore received, and to make further
sales and deliver goods so sold, all, however, with the approval of
the receiver. Provision was made for the deposit by the receiver of
the proceeds of the accounts, and by the McLea Company of the
proceeds of the merchandise, to await further action, it being
specially declared that the making of the order was without
prejudice to any of the rights of the McLea Company as against
Kessler & Company, the receiver or trustee in bankruptcy when
appointed, and that the consent of the McLea Company to the order
should not be construed as an admission against its interests or
waiver of its rights. The trustee realized from the accounts a sum
slightly in excess of $32,000, and the McLea Company, acting under
the agreement approved by the court, realized from the stock of
goods a sum slightly in excess of $12,000, making about $44,000
held as security under the contract of 1904 for the payment of the
McLea notes. The Merchants Bank and the Commercial Bank of Bale, by
proceedings not necessary to state, acquired for a small price,
which was credited on the debt due them by Kessler & Company,
the collateral notes of the McLea Company. On some or all of these
notes, judgments were obtained and execution issued or threatened
to be issued against the stock of the McLea Company. That company
and the two banks thereupon entered into an agreement by which the
stock of merchandise was assigned to a named trustee with the duty,
as the stock was realized on, to turn over the
Page 228 U. S. 638
proceeds for the purpose of paying the two banks. As this
agreement was made after the rule to show cause, issued on behalf
of the receiver, and the order of the court consequent thereon, it
was expressly provided in the agreement that it was not intended to
violate the order of the court, but that it was subject to the
approval of the court.
At the time of the adjudication in bankruptcy, Kessler &
Company had a deposit account in the National City Bank to which
there was a credit balance of $27,000. Although it is not
controverted that the bank held as collateral the McLea notes to
the amount of $39,000, there is a contention as to the adequacy of
the proof, showing the amounts due that bank, back of which the
notes were held as collateral. We content ourselves, however, on
this subject with saying that we think it is not subject to be
controverted on the record that the National City Bank had a claim
for $39,000 and that it set off the deposit of $27,000 against this
claim of $39,000, and that the trustee, in order to protect the
bankrupt estate, paid the additional $12,000, and received from the
National City Bank the $39,000, of McLea collateral notes, along
with some other collaterals, the nature and amount of which is not
disclosed.
The Merchants Bank and the Commercial Bank of Bale, having made
a claim to a special right to the proceeds of the stock of
merchandise, concerning which they had made the agreement above
stated with the McLea Company, their claim was referred for
consideration to a special master. The receiver, the two banks, and
Kessler & Company, Limited, of Manchester, being before the
master, an agreement was entered into by which it came to pass that
the master was called upon to consider and determine upon the
facts, as we have stated them, the special rights of the parties in
and to the fund derived from the stock of merchandise of the McLea
Company,
Page 228 U. S. 639
and the amount which had been collected from the account sales
of merchandise.
Prior to the arising of the controversy now before us, it seems
that a somewhat similar contest had arisen in the Kessler &
Company bankruptcy, and had been decided by the district court. The
facts in such prior case were these: Kessler & Company had made
an agreement with the firm of Milne, Turnbull & Company, to
give financial assistance and take charge of the collection of
account sales, etc., upon terms and conditions substantially like
those embraced in the contract with the McLea Company which is now
under consideration. Under that contract, Kessler & Company had
received notes, had transferred some of the notes as collateral to
the Merchants National Bank and to Kessler & Company, Limited,
of Manchester, and had retained the remainder. Under these
circumstances, the question which arose was how should a sum of
money derived from the account sales or stock of Milne, Turnbull
& Company, which was a security for the outstanding notes, be
distributed among the holders of the notes? That is, it being
insufficient to pay all the notes, should it be ratably applied, or
was Kessler & Company, as assignor, to be excluded from the
distribution until the assignees had been paid? Considering that
the question was open and not settled, under the local law of New
York, the court came to determine it by its appreciation of
principles of general law, and held that as Kessler & Company,
as transferor, occupied a trust relation, that firm could not be
allowed to violate its trust by diminishing the security which
otherwise would be attributable to the transferred notes.
Considering the relation of the transferees between themselves, it
was decided that, although the Act of Kessler & Company, after
having transferred some of the notes, in transferring others, was a
breach of trust, the second transferee was unaffected thereby, and
therefore the fund was subject to be distributed between
Page 228 U. S. 640
the two transferees
pro rata, to the exclusion of
Kessler & Company, or its trustee. T he court said:
"It seems to me that that is exactly the situation here: Kessler
was solely entitled to receive the proceeds of the accounts payable
pledged by Milne, and he so remained down to the time of these
bankruptcies. These accounts were, to be sure, security for all the
notes that Kessler had, but when he assigned some of the notes, he
became a trustee for his assignee to the extent of the face value
of the notes in question."
"It can hardly need authority to show that, in a court of
equity, the
cestui que trust is actually seised of the
trust property; he may alien it, and any legal conveyance by him
will have the same operation in equity upon the trust as it would
have had at law upon a legal estate.
Croxall v.
Shererd, 5 Wall. 281."
"It can make no difference that a holder of collateral securing
several notes assigns them successively, and thereby diminishes the
value of each note in the event of deficiency. Each
cestui que
trust takes his chances of that; but if (in this case) Kessler
became a trustee for the bank by the Act of assignment, no act of
his, nor any change in his circumstances, can change his relation
to the
cestui que trust he himself created. To the extent
of his ability, he is at all times bound to account for the trust
he had himself created, and that duty has, by operation of law,
descended to his trustee in bankruptcy."
In the light of this ruling in the previous case, the special
master, in deciding this controversy, concluded that the receiver
of Kessler & Company, as assignor, was not entitled, as to the
$7,000 or the $39,000 of McLea notes which he held, to participate
in the distribution, and therefore the fund should be ratably
distributed between the Merchants Bank, the Bank of Bale, and
Kessler & Company of Manchester. Under this view, the master
concluded that it was unnecessary to consider the claim made
Page 228 U. S. 641
by the two banks that, because of the agreement with the McLea
Company subsequent to the bankruptcy, they were exclusively
entitled to the proceeds of the stock of merchandise.
When the district court came to consider a motion to confirm the
report, its previous decision in the Milne, Turnbull & Company
case was pending undetermined on appeal in the circuit court of
appeals. While adhering to the ruling made in that case, it was
nevertheless decided that the master had erred in considering that
case as decisive of the right of the trustee as the holder of the
$39,000 of collateral notes, to participate in the security to the
extent that the general funds of the bankrupt estate had discharged
the principal debt of the National City Bank, on the ground that,
to the extent of such payment, the trustee, as the representative
of the general creditors, was by operation of law subrogated to the
rights of the bank. In addition to this general right of
subrogation, it was held that the right of the trustee to
participate to the extent stated was secured by the provisions of
subdivisions
c and
f of § 67 of the Bankruptcy
Act. Disposing of the right asserted against the proceeds of the
stock of merchandise, it was decided that, whatever might have been
the infirmity, for want of delivery, if any, of the agreement
constituting the stock as a security, it was too late to raise such
question on behalf of the Merchants Bank and the Bank of Bale after
the trustee had virtually, as a result of the agreement, sanctioned
by an order of the court, taken possession of the stock for the
purpose of carrying out the agreement. Thereafter, the ruling made
in the Milne, Turnbull & Company case was affirmed by the
circuit court of appeals upon substantially the reasoning which
controlled the court below (
In re Milne, 185 F. 244), and
that court, in affirming the action of the trial court taken in
this case, also provided and adopted the
Page 228 U. S. 642
reasoning which caused the trial court to permit the trustee to
participate, to the extent stated, in the fund held by him as
security for the payment of the collateral notes. The court,
however, while referring to the right asserted by the Merchants
Bank and the Bank of Bale, to exclusively participate on special
grounds in the proceeds of the stock, made no ruling on the
subject, and error with reference to that matter, as well as with
regard to the ruling permitting the trustee to participate to the
extent allowed in the funds securing the collateral notes, are the
subjects which we are called upon to consider on this appeal taken
by the Merchants Bank and the Bank of Bale.
Although it be conceded for the sake of argument that the power
conferred upon Kessler & Company to control the sales of
merchandise did not operate to take this case out of the rule as to
delivery, which was upheld in the case relied upon, we nevertheless
put out of view the contention of the two banks concerning their
particular right to the merchandise fund, for the following
reasons: (a) because we think the trial court was clearly right in
holding that, after the trustee had virtually exerted, under the
sanction of the court, with the assent of the McLea Company, the
power to take legal possession of the stock, it was too late for
the two banks, as a result of an agreement with the McLea Company
thereafter made, to raise the question of whether the original
agreement as to the stock between Kessler and the McLea Company was
ineffective to operate a lien as to creditors because of the want
of delivery; (b) as the two banks were seeking to enforce the
contract and the lien arising therefrom so far as the avails of the
account sales were concerned, we do not think they could be heard
to disintegrate the contract by enforcing rights given under one
provision, and repudiating another provision, the two being, under
the contract, indissolubly associated, the one being the complement
of the other.
Page 228 U. S. 643
Underlying the question of the right of the trustee to
participate to the extent of the general estate absorbed in
acquiring the $39,000 of collateral notes in the fund securing all
such notes is the ruling made by the court below in
In re
Milne, supra. As, however, no appeal was taken in the
Milne case, and the trustee has not here appealed, and it
is possible to dispose of the case upon the grounds upon which it
was rested below without reexamining the broader and fundamental
ruling involved in
In re Milne, we shall confine our
attention to the narrower question here arising. In doing so,
however, in view of the importance of the subject and of its
far-reaching effect, we do not desire, even by implication, to be
understood as giving our assent to the principle that one who takes
an assignment of part of a claim secured by a mortgage or other
lien upon a common fund thereby, in the absence of special
agreement or necessary implication arising from particular
circumstances, acquires anything more than a proportional right to
the common security, or the power to exclude his assignor, in the
event of a deficiency, from participating in such fund to the
extent of the portions of the claim held by him. Moreover, for the
same reason which causes us to make the reservation just stated, we
also desire to expressly exclude any inference that our opinion is
that, under the contract here involved and the facts here
disclosed, there was either an express agreement or anything
justifying an implication which would take the case out of the rule
of proportional distribution if that rule were otherwise
applicable.
By the effect of the bankruptcy, the rights of the parties
became fixed. The collateral note holders had a fund specially
applicable to the payment of their debt, and the general creditors
had the general fund, to which alone they could look for the
discharge of what was due them. It was in the power of neither
class to set aside or frustrate, as against the other, the rights
fixed by the adjudication,
Page 228 U. S. 644
and which it was the duty of the trustee to conserve and
administer. The fund on deposit to the credit of the general estate
was an asset of that estate. True, it was subject to be set off --
that is, compensated -- by the debt due to the National City Bank.
But the exercise by that bank of the right of setoff did not change
the character of the two funds, and could not confer upon the
National City Bank the power to pay its debt out of the general
fund, and thereby diminish the general estate, and increase the
share of the security fund distributable among those entitled to
participate in that fund. The impossibility, legally, of bringing
this result about at once demonstrates the application to the
situation of the elementary principle of legal subrogation which,
for the protection of the general fund, gives to that fund and to
its representative, the trustee, the right to exercise against the
special fund, recourse to the extent necessary to prevent the
inequality and destruction of right which otherwise would result.
To suppose that that principle here finds no application, because
Kessler & Company itself, the bankrupt, if it had held the
collateral notes, could not enforce them under the principle
decided in
In re Milne, ubi supra, as lucidly pointed out
by the court below, is but to disregard the situation resulting
from the adjudication in bankruptcy and to destroy the equality of
distribution which it was the purpose of that act to secure.
Nothing could more clearly demonstrate this conclusion than a
consideration of the result to be brought about by taking the
opposite view, since, if that is done, the situation existing at
the time of the adjudication would be seriously changed, the rights
of the general creditors would be lost, and those of the secured
creditors would be greatly enlarged. But resort to the principle of
legal subrogation is not here necessary, as the subject is fully
covered by subdivisions
c and
f of § 67 of the
Bankruptcy Act, especially as elucidated by
First National Bank
v. Staake, 202 U. S. 141.
Moreover,
Page 228 U. S. 645
even though it be admitted that there would be a possibility, if
the text were narrowly considered, to take this case out of the
operation of the section, its obvious spirit and intent, as
illustrated and make cogent by the entire text of the act, by the
purpose which it was intended to subserve, the distinction between
secured and unsecured creditors which it draws, all conclusively
demonstrate the correctness of the principle which the court below
applied, and by which it held this case was not controlled by the
doctrine by it announced in
In re Milne.