Opinion
No. 33219.
May 23, 1938. Suggestion of Error Overruled August 27, 1938.
1. BANKRUPTCY.
To constitute a "voidable preference" under Bankruptcy Act, it is unnecessary that bankrupt should have intended to prefer person receiving or benefited by transfer, and it is only necessary that bankrupt was then insolvent and that transferee had good cause to believe that enforcement of transfer would, in fact, effect a preference (Bankr. Act of 1898, section 60b, 11 U.S.C.A., section 96(b)).
2. BANKRUPTCY.
What constitutes "reasonable cause to believe," within provision of Bankruptcy Act authorizing recovery by trustee of a voidable preference, depends on circumstances of each particular case, but actual knowledge is not necessary, and it is sufficient if there is knowledge or notice of facts such as would lead person of reasonable prudence to believe that debtor is insolvent, or would put a person of ordinary caution on inquiry which would lead to knowledge of insolvency (Bankr. Act of 1898, section 60b, 11 U.S.C.A. section 96(b)).
3. BANKRUPTCY.
Where bank within four months prior to depositor's bankruptcy had reasonable cause to believe, because of fact that numerous checks of depositor were being returned unpaid, that depositor was insolvent, and substantial deposits were made by depositor, while insolvent, on same days on which checks were drawn by him in favor of bank, to which he owed money, for sole purpose of creating balance out of which checks could be paid, bank's right of set-off as a creditor did not exist as to funds so deposited, and as to those funds it received a "voidable preference" (Bankr. Act of 1898, section 60b, 11 U.S.C.A., section 96(b)).
APPEAL from the chancery court of Lauderdale county; HON. A.B. AMIS, SR., Chancellor.
Lyle V. Corey, of Meridian, for appellant.
As a general proposition, an offset is to be distinguished from a voidable preference in that one of the elements of a voidable preference is lacking. One of the important elements of such a preference is a voluntary action on the part of the bankrupt. Such action is completely missing from an offset unless it could be shown that the bankrupt made deposits for the purpose of making such offset possible. So, if, in the instant case, the bankrupt had carried a substantial amount on deposit at all times with the defendant bank and the bank had then exercised its right of offset, we concede that there would have been no voidable preference. But such were not the facts here. The bank did not make any offset, nor did the bankrupt carry a balance on hand which would permit any offset.
In passing upon the payment made in January, 1936, the Chancellor recognized the correct rule of law that the making of a payment under such circumstances as existed in this case constituted a voidable preference. There was no showing as to how that January payment was made. Presumably, it was made by cash, the checking account having been closed eight days prior thereto. If the making of such payment by cash constituted a voidable preference, does not the making of such payment by check, when it is necessary to immediately deposit the cash to pay the check, constitute the same? Where, we ask, is the distinction between the two? The procedure is slightly different but the ultimate result is identical. We respectfully submit that, if one is voidable preference, both are.
Counsel for the defendant bank relied, in the court below, upon the decision of the United States Supreme Court in the case of Studley v. Boylstone National Bank, 229 U.S. 523, 57 L.Ed. 1313, 33 S.Ct. 806, 30 A.B.R. 161. That case is to be distinguished from the case at bar in several particulars. First, the defendant bank in that case did on several occasions exercise its right of offset. Second, the bankrupt carried a substantial balance on hand in its checking account with the defendant bank, and it was unnecessary to make deposits on the same day to cover the checks given to the defendant bank. Third, the entire opinion in that case was predicated upon the finding that the defendant bank did not have reasonable cause to know of the bankrupt's insolvency.
In the case at bar, the money actually changed hands on the very days that the notes were paid. There was no offset and no opportunity for offset of any substantial amount. There was no mutual indebtedness except for very small balances ranging from two to five percent of the amount of one note. There can be an offset or a right of offset only where there is a mutual indebtedness, and except as to those small balances, no such right ever came into existence in this case. The bankrupt transferred the money at the very time that the payments were made. We respectfully submit that the opinion in the Studley case falls far short of being authority for the Chancellor's finding in this case.
The authorities seem to be unanimous that where the deposits are made for the purpose of enabling the bank to obtain payment of its debt, there is a preferential transfer.
4 Remington on Bankruptcy, sec. 1720; Bank of California v. Brainard, 3 F.2d 3, 5 A.B.R. (N.S.) 545.
Since the bankrupt was insolvent at the time the payments were made and since the defendant bank had reasonable cause to know of such insolvency, the making of these payments constituted voidable preferences within the meaning of Section 60-b of the Bankruptcy Act, and the trustee is entitled to recovery therefor.
Chambers Trenholm, of Jackson, for appellant.
The principal question is whether under all of the circumstances the deposits made with the defendant bank by the bankrupt during the four months period, and particularly those which enabled the bank to collect the checks payable to it, were made in the usual course of business. The secondary question is the effect of the giving of checks to the bank by the bankrupt, rather than an exercise by the bank of the right of off-set, if it had such right.
As far back as 1910 the Supreme Court of New Mexico, in Schmidt v. Bank of Commerce, 110 P. 613, 25 A.B.R. 904, held that a bank was not entitled to off-set, where the deposits were made on its inducement for the purpose of permitting an off-set. Certainly, the paying of its own checks in preference to those of others was, under the facts here, more than the equivalent of inducing the deposits for that purpose.
Ernst v. Mechanics and Metals National Bank, 201 Fed. 664, 29 A.B.R. 298; Walsh v. First National Bank, 201 Fed. 522, 29 A.B.R. 118; In re Starkweather Albert, 30 A.B.R. 743; Mechanics Metals National Bank v. Ernst, 231 U.S. 60; Matter of National Lbr. Co., 212 Fed. 928, 32 A.B.R. 389; Knoll v. Commercial Trust Co., 94 A. 750, 35 A.B.R. 379; Johnson v. Gratiot County State Bank, 160 N.W. 544, 38 A.B.R. 518; Fourth National Bank v. Smith, 240 Fed. 19, 38 A.B.R. 771; Merrimack Natl. Bank v. Bailey, 289 Fed. 468, 5 A.B.R. (N.S.) 633; Bank of California v. Brainard, 3 F.2d 3, 5 A.B.R. (N.S.) 545; Ingram v. Bank of Cottage Grove, 29 F.2d 86, 13 A.B.R. (N.S.) 198.
The test was well stated by District Judge Watson, Middle District of Pennsylvania, in 1931, in the case of McGuigan, Trustee, v. Dime Bank T. T. Co., 47 F.2d 760, 17 A.B.R. (N.S.) 764, in this language: "The right of set-off is given by the bankruptcy act itself, and the test in cases where the right of set-off by a bank is questioned is always whether, after insolvency, the money was deposited for the purpose of enabling the bank to secure a preference." We ask the question here: Is it not manifest from the whole record that the deposits were made by Watson for the purpose of permitting the bank to pay the checks given it, not the checks held by others? The bank evidently thought so, for it gave itself the preference, as admitted by the cashier.
Bank of Commerce Trust Co. v. Hatcher, 50 F.2d 719, 18 A.B.R. (N.S.) 126.
We respectfully submit that the Chancellor erred in finding that the deposits were made in the usual course of business, and that the bank was within its right in accepting payment as it could have set-off the bankrupt's notes against his account. Neville Minniece, of Meridian, for appellee.
We call the court's attention to the case of Studley, Trustee, v. Boylston National Bank of Boston, 229 U.S. 523, 57 L.Ed. 1313. In this case the bank had within four months of bankruptcy received checks from the debtor and also had charged notes held by the bank against the bank account of the debtor. In reply to the argument on behalf of the trustee in the Studley case that the giving of checks constituted an unlawful preference, the court said: "These were mutual debts, and if, on the date the first note became due, the Collver Company had failed to pay it, the bank could have enforced its banker's lien or its right of set-off, by applying $5,000 of the deposits in payment of the note which matured that day, and so on as each of the other notes became due. It cannot have been illegal for the parties on September 12, 20, 30, October 3 and 14, to do what the law would have required the trustee to do in stating the account after the petition was filed on December 16, 1910. No money passed in either instance; for, whether the checks for $5,000 were paid or notes for $5,000 were charged was, in either event, a book entry equivalent to the voluntary exercise by the parties of the right of set-off.
"The bankruptcy act recognizes this right, and it cannot be taken away by construction because of the possibility that it may be abused. The remedy against that evil is found in the fact that the trustee is authorized to sue and recover if it is shown that after insolvency the money was deposited for the purpose of enabling a bank or other creditor to secure a preference. But to deny the right of set-off in cases like this, would in many cases make banks hesitate to honor checks given to third persons, would precipitate bankruptcy, and so interfere with the course of business as to produce evils of serious and far-reaching consequence."
American Bank Trust Co. v. Coppard, 227 Fed. 597; Jandrew v. Guaranty State Bank, 294 Fed. 530; Grant v. First National Bank of Monmouth, 97 U.S. 81, 24 L.Ed. 971.
We submit that the Chancellor was correct in holding that the payments made by the bankruptcy to the bank by check did not constitute unlawful preference. The Chancellor found from the evidence that the deposits made by the bankrupt were made in the usual course of business, and in this finding he is amply supported by the evidence.
The Supreme Court of the United States in the case of Grant v. First National Bank of Monmouth, 97 U.S. 81, 24 L.Ed. 971, said "It is not enough that a creditor has some cause to suspect insolvency of his debtor, but he must have such a knowledge of facts as to induce a reasonable belief of his debtor's insolvency in order to invalidate, under the Bankruptcy Act, a security taken for a debt."
4 Remington on Bankruptcy (4 Ed.), sec. 1825.
Creditor cannot be charged with knowledge of bankrupts' financial condition merely because bankrupts have not paid, although urged to do so.
Stark v. White, 245 N.W. 337; Miceli v. Morgano, 36 F.2d 507.
The burden of proof of the existence of a reasonable cause of belief is on the trustee, as well as of that of each element of the preferences.
4 Remington on Bankruptcy (4 Ed.), sec. 1829; Sec. 60, par. b, of the Bankruptcy Act; Grant v. First National Bank of Monmouth, 97 U.S. 81, 24 L.Ed. 971.
Argued orally by Lyle V. Corey and E.L. Trenholm, for appellant, and by Geo. B. Neville, for appellee.
As trustee in bankruptcy of the estate of Simon K. Watson, formerly doing business as Klein's Family Shoe Store, at Meridian, Miss., the appellant filed his bill of complaint against the appellee, First National Bank, Meridian, Miss., to recover as a voidable preference, under section 60b of the Act of Bankruptcy of 1898, as amended 11 U.S.C.A. section 96(b), the sum of $2,382.88; also, any further sums that might be shown by a discovery to have been paid such bank by the bankrupt within the period of four months prior to the adjudication in bankruptcy on January 8, 1936. Upon the final hearing of the cause the chancellor found in his decree that the bankrupt made certain transfers of money to the bank on the 10th day of September, 1935, and on other dates thereafter, until and including the 4th day of January, 1936; that the bankrupt was insolvent at the time each of the transfers was made; that the bank, in receiving such transfers of money, had reasonable cause to believe that the bankrupt was insolvent on said dates; but further found that, inasmuch as each of the said transfers of money was made by check drawn on the account of the bankrupt with such bank, made up of deposits "made in the usual course of business, and not with intent to prefer the bank as a creditor," the bank was only exercising its legal right of off-set, and these transfers did not constitute voidable preferences except as to a payment made of $102 in cash on January 4, 1936, after the account at the bank had been closed, and for which latter amount a decree was rendered against the bank in favor of the appellant. From the adverse portion of this decree the appellant appeals, and the appellee bank prosecutes a cross-appeal.
Section 60b of the Act of Bankruptcy of 1898, as amended in 1910, 11 U.S.C.A. section 96(b), provides in part as follows:
"If a bankrupt shall . . . have made a transfer of any of his property, and if, at the time of the transfer . . . and being within four months before the filing of the petition in bankruptcy . . . the bankrupt be insolvent and the . . . transfer then operate as a preference, and the person receiving it or to be benefited thereby, or his agent acting therein, shall then have reasonable cause to believe that the enforcement of such . . . transfer would effect a preference, it shall be voidable by the trustee and he may recover the property or its value from such person."
It will thus be seen that it is not necessary, in order to constitute a voidable preference under the Act of Bankruptcy as amended, that the bankrupt shall intend to prefer the person receiving, or to be benefited by, the transfer. It is only necessary that he be then insolvent, and that the transferee shall have good cause to believe that the enforcement of the transfer would, in fact, effect a preference. The change in the wording of the statute, 30 Stat. 562, section 60b, from "reasonable cause to believe that it was intended thereby to give a preference," to "reasonable cause to believe that the enforcement of . . . [the] transfer would effect a preference," 11 U.S.C.A. section 96(b), is significant. What constitutes "reasonable cause to believe" depends on the facts and circumstances of each particular case. Actual knowledge or belief is not necessary; it is sufficient if there is knowledge or notice of facts or circumstances such as would lead a person of reasonable prudence to believe that the debtor is insolvent, or as would put a person of ordinary caution, or of reasonable prudence, on inquiry which would lead to knowledge of insolvency. This view is fully sustained in the recently published Corpus Juris Secundum, vol. 8, on the subject of Bankruptcy, pp. 705-719, section 215, inclusive, which is in accord with the other texts and the decisions of the courts on this question.
The finding of the chancellor as to the insolvency of the bankrupt on the dates that the transfers of the money in question were made to the appellee bank within the prohibited period, and his finding that the bank had reasonable cause to believe that the bankrupt was insolvent on said dates, together with the fact that he held one of such transfers of money to be a voidable preference within the meaning of the Act of Bankruptcy, on the ground alone that this one transfer was paid in cash, instead of by check on his bank account, at a time when the bank could not have exercised its legal right of set-off, was equivalent to a finding that the other transfers in question would likewise be voidable, except for the fact that the chancellor concluded, as a matter of law, that the bank, in receiving the transfers as payments on notes of the bankrupt held by the bank, was exercising its legal right of set-off on account of the fact that the payments were made by check on his bank account. In his conclusion as to these transfers not being voidable on the ground thus stated, we think the chancellor was in error. Where all the other essential elements of a voidable preference are present, as in the case at bar, and checks are drawn by the bankrupt in favor of a bank on his funds deposited on the day the checks are given, in order to create a balance for that purpose, the right of set-off as to the funds so deposited does not exist. In Remington on Bankruptcy, vol. 4, section 1720, the rule is announced as follows:
"The correct test is the purpose and intent of the depositor in making the deposits on which the check is drawn, that is to say, if the deposits were not made in the usual course of business subject to withdrawal, but were made with the purpose of enabling the bank to exercise its right of offset, then the deposits were, in effect, indirect payments, and as such were preferential transfers."
In the case of Bank of California v. Brainard, 3 Cir., 3 F.2d 3, 5 A.B.R. (N.S.) 545, the bankrupt made a deposit of checks, and at the same time gave the defendant bank his check in payment of a note. Prior to making the deposit the bankrupt had a balance in his account of $5.74. The bank accepted the check in payment of the note, and when sued by the bankrupt's trustee relied upon the case of Studley v. Boylston National Bank, 229 U.S. 523, 33 S.Ct. 806, 57 L.Ed. 1313, 30 A.B.R. 161, as authority for its contentions, as does the appellee here. The Circuit Court of Appeals, in holding that the transfer constituted a voidable preference, said (page 4):
"The deposit of checks on that date was obviously made for the purpose of paying the bankrupts' notes to the bank. It was in effect a transfer of the checks for that purpose. It was parting with so much of the bankrupts' assets to pay one of [his] debts, and it operated to diminish by that much the bankrupts' estate. . . . We find nothing in the cases cited by the plaintiff in error, such as Studley v. Boylston National Bank, 229 U.S. 523, 33 S.Ct. 806, 57 L.Ed. 1313, to sustain its contention that the right of offset exists under the facts presented in the present case. Those cases go no further than to hold that the Bankruptcy Law recognizes the right of set-off of mutual accounts between a bank and a depositor, and does not deprive the bank of the rights of any other creditor taking money without reasonable cause to believe that a preference will result. But here there were no mutual accounts. There was but a payment of a note to the bank, under circumstances which, if the bank had knowledge of the bankrupts' insolvency, made the payment preferential."
In the Studley Case, supra, the opinion of the court states that (page 808): "The bank was indebted to the Collver Company as a depositor some $54,000 for money deposited in good faith in the usual course of business, and with no purpose of enabling the bank to secure the right of set-off. The Collver Company, on the other hand, was indebted to the bank $25,000 on notes maturing at various dates. These were mutual debts, and if, on the date the first note became due, the Collver Company had failed to pay it, the bank could have enforced its banker's lien or its right of set-off, by applying $5,000 of the deposits in payment of the note which matured that day, and so on as each of the other notes became due. It cannot have been illegal for the parties on September 12, 20, 30, October 3 and 14, to do what the law would have required the trustee to do in stating the account after the petition was filed on December 16, 1910. No money passed in either instance; for, whether the checks for $5,000 were paid or notes for $5,000 were charged was, in either event, a book entry equivalent to the voluntary exercise by the parties of the right of set-off."
But it has been held that a bank is not relieved from liability to refund as a preference a payment received on notes from a bankrupt while insolvent, under such circumstances that it had reasonable grounds to believe that a preference would be effected, by the fact that the payment was made by a check on the debtor's deposit in the same bank, which, if it had remained until the debtor's bankruptcy, the bank might have retained as a set-off. Heyman v. Jersey City Third National Bank D.C., 216 F. 685; In re Starkweather Albert, D.C., 206 F. 797; Ridge Avenue Bank v. Studheim, 3 Cir., 145 F. 798. However, in the Studley Case, supra, the court seems to have been of the opinion that there was no difference in principle between a set-off by the bank and the same result reached by the giving of a check by the depositor. The decision in this case is, however, rendered somewhat uncertain on this point by reason of the fact that it was expressly found in that case that the bank, when it received the checks, had no reasonable cause to believe that a preference would result. Moreover, it was held in the case of Ernst v. Mechanics' Metals Nat. Bank, 2 Cir., 201 F. 664, that a deposit in a bank by a depositor, after the bank had knowledge of his insolvency, or at least after the bank is put on inquiry, to repay a loan, is a voidable preference under section 60b of the Act of Bankruptcy of 1898, as amended, 11 U.S.C.A. section 96(b).
Conceding, however, that there is no difference in principle between a set-off by the bank, and the same result reached by the giving of a check by the depositor, as to a mutual indebtedness between them, we find that the Studley Case is not controlling in the case at bar for two reasons: First, the bank had reasonable cause to believe, as found by the chancellor, that at the time of receiving the checks from the bankrupt depositor in payment of his notes he was insolvent, the bank then knowing that numerous accounts held by out-of-town creditors were being collected by local attorneys at Meridian on checks paid at the bank on their endorsements, and that numerous checks were being returned to such creditors unpaid on account of insufficient funds, together with a check for his light bill, and one to the state tax commissioner, while on the same days that the checks were being given by the bankrupt to the bank in payment of his notes there were numerous other checks being returned unpaid; and, second, the mutual indebtedness existing between the bank and the bankrupt at the beginning of each day's business on the days when checks were given to the bank as payments on the notes of the bankrupt was insubstantial in amount, and it clearly appears that substantial deposits were made on those days for the sole purpose of creating a balance out of which his checks to the bank on the notes could be paid. For instance, during the month of December, 1935, the average daily balance in the bank account of the bankrupt was $16.73, and on the morning of December 9th, when his bank balance was only $29.07, he gave the bank a check in payment of his note for $451, and on that same day made a deposit to cover the check; on the morning of the 16th his bank balance was only $24.36, and he gave the bank a check for $400 on a note, and made a deposit to cover the check; on the morning of the 21st his bank balance was $54.86, and he gave the bank a check for $107.60 on a note, and made a deposit which, when added to the balance on hand, was nearly sufficient to cover the check; on the morning of the 23rd his bank balance was $3.97, and he gave the bank a check for $102.50 on a note, and made a deposit to cover the check; on the morning of the 24th his bank balance was $1.38, and he gave the bank a check for $102.50, and made a deposit to cover the check; and on the morning of the 26th his bank balance was $3.09, and he gave the bank a check for $204 on a note, and made a deposit to cover the check. During this period the bankrupt knew that his trade accounts payable as of December 1, 1935, amounted to $6,822.18; that they were increasing to such an extent that on the date of his adjudication in bankruptcy on January 8, 1936, they amounted to $10,756.13; and that his total assets to be applied thereon, as well as for expense of his then inevitable bankruptcy, would not not exceed 15 per cent. in value of his liabilities. During the thirty days prior to adjudication he paid the appellee bank $1,467 in full payment of his notes, against which indebtedness the bank was entitled to offset the small balances above mentioned, which were carried forward into the day's business on each of the dates that the additional deposits in the bank, hereinabove mentioned, were made for the purpose of paying the notes; and which small balances, so carried forward, and not shown to have been deposited for the special purpose of creating a balance for the payment of the notes, amounted to the aggregate sum of $116.73, leaving a voidable preference of $1,350.27 received by the bank, and for which amount of preference, plus 6 per cent. interest per annum thereon from January 8, 1936, a decree is here rendered, it being conceded by the appellant that he is not entitled to recover the payments made by the bankrupt to the bank during the four-month period prior to the adjudication of bankruptcy, other than those made during the month of December, 1935.
Reversed and decree here on direct appeal, and affirmed on cross-appeal.