Merchants National Bank v. Sexton

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 advancés, it was agreed, should be evidenced by negotiable notes of the company in such amounts and to be fúrnished 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, whén 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 be-y tween the agreement of July, 1904, and the adjudication in bankruptcy, in 1907, Kessler & Company advanced a

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 merchan

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

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 transferror, 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

“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 seized 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 , 18 L. Ed. 572 .

“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 hpld, 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

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 section 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 Fed. Rep. 244 ) and that court, in affirming the action of the trial court taken in this case, also approved and adopted the

Although it be conceded for the sake of argument that the power conferred upon Kessler & Company to control the sales of merchandise, did not coperate to take this case out of the rule as to delivery, which was upheld in the cases- 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 agreernent 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; 6, 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.

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

Affirmed.