Opinion
No. 168.
January 23, 1945.
Appeal from the United States District Court for the Southern District of New York.
Proceeding in the matter of New York, Ontario Western Railway Company, debtor, from orders of the United States District Court for the Southern District of New York in favor of Frederick E. Lyford as trustee of the debtor and Westmoreland Coal Company, a creditor, the Chase National Bank of the City of New York appeals.
Orders modified.
On May 20, 1937, the New York, Ontario Western Railway Company, as debtor, filed a voluntary petition under § 77 of the Bankruptcy Act, 11 U.S.C.A. § 205, in the court below. On the same day the court entered an order approving the petition, which order contained the following provisions: "That all persons, firms and corporations whatsoever, and wheresoever situated, located or domiciled, be and they hereby are restrained and enjoined from interfering with, seizing, converting, appropriating, attaching, garnisheeing, levying upon, or enforcing liens upon, or in any manner whatsoever disturbing any portion of the assets, goods, money, deposit balances, credits, choses in action, interests, railroads, properties, or premises belonging to or in the possession of the Debtor, or from taking possession of, or in any way interfering with the same, or any part thereof, or from interfering in any manner with the operation of its railroad or properties or the carrying on of its business by the Debtor under the orders of this Court * * * That all persons and corporations holding collateral, including deposit balances or credits, heretofore pledged by the Debtor as security for its notes or obligations be and each of them hereby is restrained and enjoined from selling, converting or otherwise disposing of such collateral, deposit balances or other credits, or any part thereof, until further order of this Court."
This order was, on the same day, served on appellant, the Chase National Bank. On May 20, the bank wrote the debtor's treasurer that, in view of the filing of the petition, "we have exercised our right of set-off of the balances in your accounts with us against your indebtedness to us." The set-off entries on the books of Chase had been made on May 20, after it had knowledge of the existence of the order. The bank balances were in the amount of $140,791.52 in an account entitled "General Corporate Account," and $1,960 in an account entitled "General Mortgage Bond Account." The indebtedness of the debtor of Chase then amounted to $1,000,000, so that, if the set-off was valid, the net amount which remained owing to Chase was $857,248.48. The $1,000,000 indebtedness was evidenced by demand collateral promissory notes which were secured by certain bonds of the debtor and certain other collateral. The note contained the following provisions: "The term `Security' as herein used shall include the balance of every deposit account, now or at any time hereafter existing, of the undersigned [the Debtor] with the Bank or any other claim of the undersigned against the Bank * * * As security for the payment of this * * * the undersigned hereby pledge(s) to the Bank all such Security capable of pledge and * * * give(s) it a general lien upon, and/or right of set-off of, all right, title and interest of the undersigned in and to any thereof incapable of pledge * * *, such * * * right of set-off being made or created for the protection and security of the Bank * * * If at any time * * * a petition in bankruptcy shall be filed by or against the undersigned, * * * under any bankruptcy or insolvency laws or any laws relating to the relief of debtors, readjustment of indebtedness, reorganization, compositions or extensions, * * * thereupon, unless the Bank shall otherwise elect, any and all of the Liabilities [`Liabilities' includes the Debtor's demand notes] shall become and be due and payable forthwith."
On May 28, 1937, the court below entered an order as to the filing of claims which provided, inter alia, that "each claim shall set forth * * * the nature of the claim, the dates of accrual and the amounts of the various items, with such details as shall definitely advise the Debtor of the particulars thereof * * * and shall describe any security for such claim, partial payments, offsets, counter-claims or other credits due or accruing to the Debtor, and if any lien, priority or other preferential classification is claimed, the facts respecting the same shall be fully stated."
Thereafter, the Chase Bank filed proof of a claim for $857,248.48 with interest on the sum of $1,000,000 to May 20, 1937. The proof of claim stated the action of the Chase Bank on May 20 in applying the balances in reduction of the $1,000,000 indebtedness; that "there are no set-offs or counterclaims to the" claim "nor has any part thereof been paid"; and that "this proof of claim is made without prejudice to any other claim or claims which The Chase now has or may hereafter have against the Debtor either in an individual or fiduciary capacity, and shall not be deemed a waiver of any other claims or of any right in respect of any security hereinabove mentioned." The debtor and its trustee in bankruptcy filed objections to the claim on the ground that the claim was understated; that its correct amount was $1,000,000; and that the action of the bank in applying the bank balances was unlawful, contrary to the court's order of May 20, 1937, and an infringement of the rights of "six months" claimants whose claims aggregated an amount in excess of the bank balances. The trustee, reporting on claims, pursuant to a court order, filed a report recommending that the Chase's claim be allowed in the principal amount of $1,000,000. The Chase, appearing specially and objecting to the "jurisdiction" of the court on the ground that proceedings with respect to the balances must be plenary and not summary, filed exceptions to this report. The court referred the matter to a special master to hear and report. Chase appeared before the Master specially, for the sole purpose of objecting to the "jurisdiction." When the Master overruled this objection, Chase petitioned the court for an order restraining the Master from proceeding further in respect of its right of setoff or to deal otherwise with the subject of the bank balances. The court, by an order of January 27, 1939, denied this petition without prejudice.
The Master, after hearing the evidence, made a report recommending that the claim be allowed as filed and that the objections thereto be dismissed. He found, as a fact, that the bank had applied the balances "with knowledge of the existence" of the injunction order. He made, inter alia, these findings: "Up to December 31, 1938, the Trustee paid $949,709.33 to six-months creditors granted priority by Orders of the Court. The aggregate amount of the claims of six-months creditors granted priority by Court Orders * * *, not yet paid by the Trustee, is $218,181.72. These sums, together with the wage assignments held by the Bank in the amount of $43,403.46, represent total claims of six-months creditors of $1,211,294.51. The indebtedness of $218,181.72, including the claim of the Westmoreland Coal Company in the amount of $63,036.74, represents the purchase of services, materials and supplies within the six months immediately preceding May 20, 1937. The services, materials and supplies were essential to the operation of the Debtor's railroad as a going concern during that period. Without taking into consideration the mortgaged assets of the Debtor and the balance of $142,751.52 in the Debtor's two-bank accounts with the Bank, the funds available for the six-months creditors, both paid and unpaid, whose claims aggregate $1,211,294.51 are $847,228.15 after deduction of taxes accrued to May 20, 1937. This sum is made up of cash on hand on May 20, 1937; gross operating income of the Debtor produced or earned in the last six months of corporate operation which ultimately came into the hands of the Trustee; diversions of gross income (payments of gross operating revenue for purposes other than the actual operation of the railroad during the period of six months prior to May 20, 1937) less off-sets; and unmortgaged assets. The amount of unmortgaged assets includes an item of $25,000 as the value of the stocks and bonds owned by the Debtor and unpledged, but this amount is only an estimate. A financial statistician and security appraiser testified that the assets valued by the Trustee at $25,000 were worth less than that sum. The operation of the property of the Debtor from May 21, 1937 to December 31, 1938 resulted in a deficit in net railway operation, after the payment of taxes but without payment of any interest on obligations, of $818,560.46. There have been no diversions of net railway operating income during the period of Trusteeship. The Court reserved to itself for future determination the questions as to the time of payment of the claims of the six-months creditors still unpaid and as to the fund or funds out of which such payments may properly be directed to be made."
In an accompanying opinion, the Master summarized certain of his other findings thus: "The record leaves little doubt that the Bank was aware of the precarious financial condition of the Debtor months before the petition was filed. No interest had been paid on the Debtor's notes held by the Bank since February 28, 1937. A vice-president of the Bank knew of the failure to pay the interest on the refunding mortgage bonds on March 1, 1937. It cannot be presumed that the Bank was taken completely by surprise by the suspension of interest payments. Its employees who had been assigned to follow the Debtor's loan need not have realized six months before Section 77 was invoked that bankruptcy was inevitable, but they may be taken to have known that the situation was serious and their knowledge is imputed to the Bank. Nor is there any doubt that the Bank was aware of the reliance of wage and current supply creditors on payment from the current income deposited in the general corporate account. And in the event of appointment of a receiver or a trustee these creditors were relying on a prior lien on the income of the Railroad, deposited in this same general corporate account, under the six-months preferred claims rule. Yet knowing this the Bank sat back ever conscious that in the event of appointment of a trustee or a receiver it was prepared to exercise its contractual right of set-off against the very deposits on which the creditors were relying to be paid. All the time as a large creditor, the Bank profited in the Railroad's being kept operating by the labor and supplies furnished by these creditors. Were it established that funds out of which these six-months creditors could be paid were not available, equity might rise up * * *, deny the Bank's claim to exercise a legal right of set-off, and make it possible to reduce to possession for the benefit of the six-months creditors the chose in action which the Debtor held against the Bank for the balance of its general corporate account * * * The proper inquiry is whether the action of the Bank so misled and confused the six-months creditors to their detriment as to estop the Bank in equity from setting forth its right of set-off, whether the Bank (which with eloquent silence in effect said to the creditors `Lend; you are protected as six-months creditors. You have a first lien on operating income.') is precluded from now standing forth and contradicting the tacit representation, by asserting a set-off against the very fund on which the recent creditors relied. Before an estoppel can be set up — even one of an equitable flavor — reliance to detriment by the one to whom the representation was made must be shown. The question of reliance we need not consider further for we are of the opinion that detriment is not positively shown by the record in the proceedings before us, because even if the six-months creditors are not allowed access to the chose in action which the Debtor has against the Bank relative to the bank accounts aggregating $142,751.52, there may be funds available for their payment because they may be entitled even apart from diversion to go against the corpus of the Debtor's property." Stating that, to deny the set-off, it would be necessary to find "special circumstances," the Master continued: "We cannot say definitely from the record before us that there are no such special circumstances present here. On the question of payment out of the corpus the record is scanty, if not bare. Only slight attention was given to it by counsel in their briefs. If on this record we cannot find that the six-months creditors, or some of them, can be satisfied from the corpus, neither can we say that as a matter of law these creditors, or any of them, cannot reach that property. We cannot therefore say as a matter of law that in the event this set-off is allowed the six-months creditors will have no further possibility of payment in full. Estoppel cannot be grounded on assumptions. To establish an estoppel, it was part of the Trustee's case to show positive detriment which has resulted from reliance on the Bank's implied representation."
Exceptions to the Master's report were filed by the trustee in bankruptcy, by Westmoreland Coal Company, as intervenor, and (as to certain matters) by Chase.
The court confirmed and adopted the Master's finding of fact but differed with his legal conclusions, and on December 9, 1943, made an order disallowing the set-off, holding that the bank's claim was in the principal amount of $1,000,000 without a right of priority of payment, and concluding thus: "That said bank balance of $142,751.52, less the sum of $43,403.46, leaving a net balance of $99,348.06 hereby is determined to be due and payable from said Bank to said Trustee, or his duly authorized representative, who is hereby directed to withdraw said funds from said bank and invest the same in interest-bearing bonds to be first approved by this Court, or to deposit said funds in a special bank account to the credit of said Trustee to be withdrawn therefrom only on the further order of this Court."
From the orders of January 27, 1939, and December 9, 1943, Chase appeals.
Milbank, Tweed Hope, of New York City (A. Donald MacKinnon, of New York City, of counsel), for Chase Nat. Bank.
Elbert N. Oakes, of New York City, for Frederick E. Lyford.
Flynt Sully, of New York City (Wilberforce Sully, Jr., of New York City, of counsel), for Westmoreland Coal Co.
Before SIMONS, CLARK, and FRANK, Circuit Judges.
1. The bank contends that, under section 23 of the Bankruptcy Act, 11 U.S.C.A. § 46, no summary proceedings as to the bank balance can be brought against the bank over its objection, because it is, in that respect, an adverse claimant. That contention (which of course relates not to "jurisdiction" but to venue) we consider untenable.
The bank's effort to obtain an order from the court restraining the Master from conducting the hearing we regard as improper practice. But we need not consider the bank's appeal from the order of January 27, 1939, denying that relief; for the bank preserved its objection to the summary character of the proceedings and can therefore properly raise that question on its appeal from the order of December 9, 1943.
In Alexander v. Hillman, 296 U.S. 222, 56 S.Ct. 204, 210, 80 L.Ed. 192, directors and officers, who had dominated a corporation, filed claims in an equity receivership of the corporation. The receiver then began an ancillary suit in the receivership court against them for funds and property alleged to have been improperly taken by them from the corporation before the receivership. The Supreme Court reversed a decision that (1) the suit could be maintained only as a defense to the claims filed in the receivership and (2) that, because of the venue provisions contained in section 51 of the Judicial Code, 28 U.S.C.A. § 112, must, on objections by the defendants, be dismissed so far as it sought recovery in excess of their filed claims. The Court said: "By presenting their claims respondents subjected themselves to all the consequences that attach to an appearance, section 51 to the contrary notwithstanding." We think that the doctrine of that case is not limited to a case where claims are filed by wrong-doing officers and directors (or the like). And we see no reason why that doctrine is not applicable to proceedings under section 77, no reason why the venue provisions of section 23 were not waived when the bank filed its claim against the debtor here.
The claims were for advances, services and as holders of stock.
The court said that the ancillary bill should be considered as a pleading in the receivership action "to put respondents to proof of their claims and to assert the right to affirmative relief."
Cf. Brooklyn Trust Co. v. Kelby, 2 Cir., 134 F.2d 105, 111 note 13.
Moreover, here the very claim of the bank, since it disclosed the application of the balance and was for the net amount remaining after such application, presented to the court the issue of the validity of the bank's conduct in applying the balance.
In addition, we have the fact that, since the bank knew of the injunction order when it applied the balance, it acted in violation of that order. Accordingly, the court could, in a summary proceeding, direct the bank to restore the status quo, with the result that the bank's claim stood just as it would have if the bank had not taken that action; consequently, the court could properly deal with the matter just as if the bank had merely filed a claim for $1,000,000 and had asserted a right of set-off.
In Re Chicago N.W. Ry. Co., 7 Cir., 86 F.2d 508, is significantly different on its facts. There a bank, the day before the filing of a section 77 petition, applied to a debt owing it by the debtor part of the debtor's balance, the total balance being larger in amount than that debt; the bank filed no claim. The court held that the trustee in bankruptcy could not proceed by summary action against the bank for restoration of the balance thus applied, as the bank was an adverse claimant.
2. But to say that the court could properly consider the matter in a summary proceeding is not to say that, on the merits, the bank has no valid right of set-off. It has that right unless it has lost it because it is estopped as against the "six-months" claims. As the record now stands, no such estoppel has as yet been proved. To the extent that the bankruptcy court's order indicates otherwise it must be modified. That order, as modified, should go no further than to recreate the situation as it would have been if the bank, without attempting to apply the bank balance, had filed a claim on its notes including a claim of set-off. The court below may postpone decision on the validity of the set-off until the ascertainment of further facts as to detriment to the six-months' claimants. Pending that ascertainment and decision (which the court below in its discretion may postpone until it approves a plan of reorganization), the bank is not to be required to pay, or set apart for payment to the trustee, any part of the bank balance. We see no need for us now to decide whether or not, if detriment is shown, the bank will be estopped.
Cf. Dudley v. Mealey, 2 Cir., 147 F.2d 268.
The bank's violation of the injunction does not affect the merits of the bank's set-off.
The order of December 9, 1943, is modified in conformity with this opinion.