Opinion
No. 39/624.
02-20-1918
SHOENTHAL v. NEW JERSEY GARDENS CO. et al.
Coult & Smith, of Newark, for receiver. Edward T. Magoffin, of East Orange, and Martin Conboy, of New York City, for defendants Harrison G. McFaddin and Walter E. Murdock. William A. Dolan, of Newton, and Robert H. Southard, of New York City, for defendant Merchants' Nat. Bank.
Bill for instructions between Isaac Shoenthal, as receiver, and the New Jersey Gardens Company and others. Receiver instructed.
Coult & Smith, of Newark, for receiver. Edward T. Magoffin, of East Orange, and Martin Conboy, of New York City, for defendants Harrison G. McFaddin and Walter E. Murdock. William A. Dolan, of Newton, and Robert H. Southard, of New York City, for defendant Merchants' Nat. Bank.
FOSTER, V. C. The receiver of the defendant corporation has applied for instructions regarding the distribution of the balance of its assets in hand amounting to $9,800, and in connection therewith he asks that two judgments recovered by the defendant directors against the company be denied their legal priority, and that the claims based thereon be permitted to participate in the distribution of such assets only as general unsecured claims.
The judgments brought in question are: One obtained by default against the company by William D. Ackerson, a defendant director, for $3,844.10, in the Supreme Court on December 30, 1914, and assigned on January 4, 1915, to the defendant, the Merchants' National Bank of Newton (as security for two promissory notes of the same date). This assignment was made subject to a prior right, or assignment, in favor of one Seth A. Crone for $1,500. The second judgment was also obtained by default against the company on January 12, 1915, by the defendant Walter E. Murdock, admittedly acting for the defendant director Harrison G. McFaddin, for $13,249.10. About four months later, on April 20, 1915, the defendant company was adjudged insolvent and a receiver was appointed, who immediately took possession of the company's assets, consisting of about 420 acres of land situated in Sussex county, and some personal property, including accounts receivable. He has sold the same, and the net proceeds realized from the sale of all the company's assets amounted to $15,274.36. At the time of the sale of the real and personal property, there was a mortgage on the realty for $4,500, and unsatisfied judgments against the company, including the two in question, amounting to $21,751.95, not including interest, and there were in addition unsecured claims amounting to about $1,800, making total liabilities of the company of about $23,600.
The company had been formed to do intensive farming on black muck land which it owned, and from the time of its incorporation in 1911 it was never in good financial condition, due largely to insufficient capital, heavy development expenses, and unsatisfactory market conditions. Both Mr. Ackerson and Mr. McFaddin were officers and directors of the company, and at different times had the active management of its affairs; and the financial condition and credit of the company was such at times that Mr. Ackerson was frequently obliged to borrow money on his own credit to meet the payroll and other operating expenses, and to allow his salary of $3,000 to remain unpaid. When Mr. McFaddin became president in 1914 he continued to loan money to the company to meet its expenses and obligations until the company in December, 1914, owed him about $13,000; these loans had been made by him under the promise of the directors that they would, at the end of the year, when the amount of his advances had been ascertained, secure the payment of the same to him by a mortgage on the company's real estate. At a stockholders' meeting held in December, 1914, some of the stockholders refused to have this mortgage given until Mr. McFaddin, as the president of the company, submitted a statement showing the company's actual financial condition. This statement was not furnished. Instead, McFaddin assigned the notes representing his loans to the company to the defendant Murdock, who brought suit and recovered judgment thereon against the company. As soon as Ackerson learned that McFaddin, through Murdock, had brought suit, he brought his action, and his judgment was entered before the Murdock-McFaddin judgment.
The receiver claims that at the times these judgments were obtained, and for some time prior thereto, the company was insolvent; that McFaddin and Ackerson as directors and its active managers knew of its insolvency, and that they took advantage of their position and knowledge, to obtain their judgments, in order to obtain priority over the general unsecured creditors of the company, of whose claims against the company they were well aware, and that they also well knew of the company's inability to pay these or any other claims against it.
The proofs are convincing that the company never had sufficient money, or credit, to properly and fully develop its property and carry on its operations. Only a small portion of its property was drained and suitable for cultivation. Its operations in 1914 resulted in a serious loss, due to unfavorable market conditions, and at the end of that year the company owed judgment and other creditors nearly $7,000, exclusive of the two judgments in question, which it could not pay from its assets or by securing credits. Both McFaddin and Ackerson knew these facts, as most of this indebtedness had been incurred under their management. The whole situation of the company's affairs shows that for a considerable period prior to the entry of the two judgments in question the company was unable to meet its pecuniary liabilities as they matured by means of other valuable assets or by an honest use of credit. There was no reasonable prospect that the company, if left alone, would soon be placed,by the efforts of its managers, in a condition of solvency, and its actual assets were not, as claimed, equal to or in excess of its liabilities.
Applying to this situation the test adopted by our courts, it is apparent that the company was insolvent when these two judgments were obtained. National Bank of Metropolis v. Sprague, 21 N. J. Eq. 530; Ft. Wayne Electric Corp. v. Franklin Electric Light Co., 57 N. J. Eq. 13, 41 Atl. 217; Skirm v. Eastern Rubber Mfg. Co., 57 N. J. Eq. 179, 40 Atl. 769; Empire State Trust Co. v. Fisher & Co., 67 N, J. Eq. 602, 60 Atl. 940, 3 Ann. Cas. 393; Russell & Erwin Mfg. Co. v. Faitoute Hardware Co., 62 Atl. 42"3; Regina Music Box Co. v. Otto, 65 N. J. Eq. 582, 56 Atl. 715, affirmed 68 N. J. Eq. 801, 64 Atl. 1134; Bernhardt v. Inter-State Telephone Co., 71 N. J. Eq. 78, 63 Atl. 1097. The suits brought by McFaddin (Murdock) and Ackerson were not contested by the officers or directors of the company. The judgments were allowed to be entered promptly by default; and apparently the other directors of the company by their inaction at least were willing to assist their codirectors in obtaining priority for the payment of their claims over the other creditors of the company.
The official relation of these judgment creditors to the company and its creditors was such that in their attempt to obtain the prior payment of their respective claims from the company's assets they violated the duty which they as trustees of the company's property owed to the company's creditors, and they cannot be permitted to use the trust property for their own benefit, to the disadvantage of the other creditors.
It is well settled in our state that independent of section 64 of the Corporation Act (C. S. p. 1638) the directors of an insolvent corporation are trustees of its funds for its creditors, and are subject to the rule that a trustee cannot use the trust property for his own benefit to the disadvantage of the cestui que trust. Montgomery v. Phillips, 53 N. J. Eq. 203, 31 Atl. 622; Savage v. Miller, 56 N. J. Eq. 432, 36 Atl. 578, 39 Atl. 665; Schmidt v. Perkins, 74 N. J. Law, 785, 67 Atl. 77, 11 L. R. A. (N. S.) 1007, 122 Am. St. Rep. 417. It follows, therefore, that the receiver must be instructed not to allow the present holders of the McFaddin and Ackerson judgments any priority over the other judgment and general creditors of the defendant company.
Regarding the contention of the defendant bank, which holds the Ackerson judgment as collateral, that it is a bona fide holder for value without notice of the latent equities in favor of the company's general creditors, I do not find the facts to support this claim. The facts show that the bank when it accepted the assignment of this judgment on January 4, 1915, had both actual and constructive notice of the company's financial condition and difficulties—other judgments against the company were a matter of record at the time—and of its inability to presently pay or to provide for the payment of its matured and maturing obligations. Part of the indebtedness secured by the assignment had been contracted by Ackerson on a note indorsed by Taylor, another director, prior to the assignment, and renewed on that day, and the balance represented a loan made to him by the bank on the date of the assignment, on another indorsed note; and it is clear that to grant the' bank the priority it claims would simply be to aid Ackerson to indirectly obtain a priority over other creditors that the law will not permit him to directly obtain.
I am likewise unable to adopt the view of the bank that between it and McFaddin should have priority over McFaddin's share of the assets, or failing that, then it should have contribution from McFaddin. To my mind both judgments are equally tainted with a breach of trust. Both directors violated their duty as trustees, with the same object in view, viz. to obtain the preferential payment of their respective claims from the company's assets. The standing of one is as good, or bad, as that of the other, and neither is entitled to nor should receive preference over the other. They will receive all that is equitably due them by being permitted to participate as general creditors of the company in the distribution of its assets.
It developed at the hearing that there appears to be at least $2,500 balance owing by Mr. McFaddin on stock purchased by him from the company; and it is expected that the receiver will, of course, take appropriate action to recover this and any other indebtedness that may be due on the purchase of stock from the company.