Adrian Tabin Corp. v. Climax Boutique, Inc.

| NY | May 15, 1974

Lead Opinion

Jasen, J.

The plaintiff, Adrian Tabin Corporation, is a creditor of the defendant L. D. J. Dress, Inc., a New York corporation engaged in the retail sale of dresses. L. D. J. (transferor) sold its business in bulk to one Paul War man, who in turn resold to defendant Climax Boutique, Inc. (transferee), in which he is a principal. At the closing, the transferor furnished a bill of sale, which was preserved by the transferee, containing a schedule of the property transferred, together with an affidavit averring that the business was ‘ ‘ free arid clear of any and all liens, mortgages, security interests, levies, debts, taxes or other claims ” and “ that the Transferor is not indebted to anyone and has no creditors.” In addition, before consummation of the sale, the transferee’s attorney made a lien search, which disclosed no liens, and inquired of the transferor’s attorney as to creditors and was assured that there were none.

Upon learning of the sale, the plaintiff brought an action to have it declared ineffective because the transferee had failed to give notice to it as a creditor, as required by section 6-105 of the Uniform Commercial Code. The trial court voided the sale holding that the transferee had a duty to inquire carefully as to the existence of creditors, intimating that a review of the seller’s books and questioning of the transferor as to the source of the merchandise was required. Lacking such an inquiry, the court held the sale was ineffective. The Appellate Division, by a divided court, reversed, holding that under the Uniform Commercial Code a transferee of a bulk sale who lacks knowledge of creditors of his transferor may rely on an affidavit of no creditors and need not make a careful inquiry. The court was further of the view that, even if the careful inquiry requirement of the former law (Personal Property Law, § 44) were superimposed on the Uniform Commercial Code, the transferee’s actions were in sufficient compliance..

We affirm and hold that the transferee of a bulk sale who has no knowledge of creditors of the transferor may rely on an affidavit of no creditors furnished by the transferor and that the Uniform Commercial Code imposes no duty of careful inquiry as existed under former law.

The language of section 6-104 is simple and unambiguous. In pertinent part, subdivision (1) provides that a bulk transfer is ineffective as against creditors of the transferor unless the transferee requires the transferor to furnish a list of creditors and the transferee preserves the list for six months and allows reasonable inspection thereof. Subdivision (3) places upon the transferor the responsibility for the accuracy and completeness of the list and provides that the transfer is not ineffective because of errors or omissions in the list unless the transferee had knowledge. “ Knowledge ”, as carefully defined by . the code draftsmen, means actual knowledge (Uniform Commercial Code, § 1-201, subd. [25]), not constructive knowledge. And as the official comment to subdivision (3) above makes clear, the sanction for the accuracy of the list of creditors is the false swearing statute of the State.

Concededly, cases interpreting the pre-Uniform Commercial Code New York Bulk Sales Act (former. Personal Property Law, § 44) stand for the proposition that before ,a transferee may rely on an affidavit of no creditors, he must make careful inquiry and otherwise have no knowledge of such creditors of the transferor. (Klein v. Schwartz, 128 N. Y. S. 2d 177; Willner Butter & Egg Corp. v. Roth, 192 Misc. 970" court="N.Y. Sup. Ct." date_filed="1948-06-21" href="https://app.midpage.ai/document/willner-butter--egg-corp-v-roth-5429519?utm_source=webapp" opinion_id="5429519">192 Misc. 970; Carl Ahlers, Inc. v. Dingott, 173 Misc. 873" court="N.Y. Sup. Ct." date_filed="1940-01-24" href="https://app.midpage.ai/document/carl-ahlers-inc-v-dingott-5425748?utm_source=webapp" opinion_id="5425748">173 Misc. 873; Marcus v. Knitzer, 168 Misc. 9" court="N.Y. Sup. Ct." date_filed="1938-02-07" href="https://app.midpage.ai/document/marcus-v-knitzer-5424831?utm_source=webapp" opinion_id="5424831">168 Misc. 9; Heilmann v. Powelson, 101 Misc. 230" court="N.Y. Sup. Ct." date_filed="1917-09-15" href="https://app.midpage.ai/document/heilmann-v-powelson-5416297?utm_source=webapp" opinion_id="5416297">101 Misc. 230.) But on the face of section 6-104 of the Uniform Commercial Code, there is no requirement of careful inquiry.¹ Notwithstanding the commentary accompanying subdivision (3) of section 6-104 that it is declarative of precodé New York law (see McKinney’s Cons. Laws of N. Y., Book 62%, Uniform Commercial Code, § 6-104, p. 735), in our view, the judicial gloss on the former law has not been carried over. As the report of the New York Law Revision Commission more accurately states, subdivision (3) of section 6-104 is merely in “ general accord ” with precode law. (1955 Report of N. Y. Law Rev. Comm. [Study of the Uniform Commercial Code], p. 1747.) Although at first reading this provision may seem harsh oh the transferor’s creditors, a requirement of careful inquiry might, on the other hand, tend to restrain the free alienation of property. Hence, it is in this situation that the code protects the innocent transferee because “ the desirability of allowing transfers to go forward outweighs the value of protecting the omitted creditor.’:’ (Hogan, The Highways and Some of the Byways in the Sales and Bulk Sales Articles of the Uniform Commercial Code, 48 Cornell L. Q., 1, 37.)

Although the Supreme .Court of New .Jersey has not yet passed upon the precise issue before, us, we note two decisions from the intermediate appellate court of that State in accord with this analysis. In Federal Ins. Co. v. Pipeco Steel Corp. (125 N. J. Super. 563), the defendant imported three shipments of steel from Japan, each of which was subject to import duty. Federal Insurance Co. furnished bpnds in favor of the United States to secure payment of the same. Ultimately, Federal was compelled to pay. on the bpnds. Thereafter, Pipeco made a bulk transfer omitting Federal and the United States from the list of creditors furnished to the transferee. Federal then brought an action against the transferor and the transferee seeking to recover the sums paid to the United States and alleging that the bulk sale was ineffective as to it because notice of the transfer had not been given as required by the bulk sale provisions of the New Jersey Commercial Code. (N. J. S. A. 12A:6-10,5.) There was nothing in the record to suggest that the transferee had actual knowledge of the claim of the United States or Federal. The trial court agreed that the bulk sale was ineffective for .failure to give notice and granted summary judgment for Federal. On appeal, it was urged that since Pipeco wa,s partly engaged in importing, the transferee had constructive knowledge that an import duty might be owing to the United States and should have inquired into that possibility. The appellate court disagreed and reversed, stating: “ The statute does not render a transfer ineffective unless the transferee is shown to have had knowledge that the list of creditors was incomplete. This statutory language does not embrace the concept of constructive notice or constructive knowledge. Actual knowledge is required.” (125 N. J. Super. 563.) (Accord Silco Automatic Vending Co. v. Howells, 102 N. J. Super. 243, affd. 105 N. J. Super. 511; Hansell, Bulk Transfers Under Article 6 of the Iowa Uniform Commercial Code, 19 Drake L. Rev. 275, 284; Shkolnick, The Nebraska Uniform Commercial Code : Article 6 — Bulk Transfers, 43 Neb. L. Rev. 760, 766; White & Summers, Handbook of the Law Under the Uniform Commercial Code, § 19-3, pp. 650, 651.)

This is not to say, however, that the omitted creditor is entirely without remedy. The Uniform Fraudulent Conveyance Act (Debtor and Creditor Law, § 270 et seq.) was not repealed by the enactment of the Uniform Commercial Code. Under section 276 of that law, if a transferee knowingly participates in a conveyance made with actual intent to “ hinder, delay, or defraud * * * present and future creditors ” of the transferor, the goods may be recovered from the transferee by the transferor’s creditors notwithstanding literal compliance with the bulk transfer provisions of the Uniform Commercial Code. (See, generally, Hawkland, Remedies of Bulk Transfer Creditors Where There Has Been Compliance with Article 6, 74 Commercial L. J. 257; 1 Glenn, Fraudulent Conveyances and Preferences, § 313.) Also, section 60 of the Bankruptcy Act (U. S. Code, tit. 11, § 96) proscribing preferential transfers may apply in a given context. Conceivably, a preferential transfer could occur in a bulk sale triggering the filing of a petition for involuntary bankruptcy against the transferor. Upon adjudication of the transferor as a bankrupt, the transferee could be required to turn the property over to the trustee if, at the time of the conveyance, the transferee had reasonable cause to believe the transferor was insolvent.

Optional section 6—106² of the official text of the Uniform Commercial Code, not yet adopted in New York and to which legislative attention is invited, provides additional protection for the omitted creditor. This section obligates the transferee to apply the proceeds of the transfer to the debts of the transferor. In practical effect, optional section 6-106 provides an additional 30 days, from the date when the notice to creditors (Uniform Commercial Code, §§ 6-105, 6-107) would ordinarily be given, for unlisted or omitted creditors to assert their claims. (See Hawkland, Remedies of Bulk Transfer Creditors Where There Has Been Compliance with Article 6, 74 Commercial L. J. 257, 262.) Adoption of this expedient provision would go far toward furnishing additional protection for the simple, unsecured creditor.

We recognize, as is so ably stated in the dissenting opinion, that strong reasons grounded in public policy and in the. equities of the situation can be raised as a basis for imposing a duty of careful inquiry upon the transferee of a bulk sale. Nevertheless, it is our view that the simple and unambiguous language of section 6-104 and the precise and careful definition of knowledge as used in the code (§ 1-201, subd. [25]) preclude such a construction.

For the reasons stated, the order of the Appellate Division should be affirmed, with costs.

1 . Indeed, there was none in former section 44 of the Personal Property Law. The requirement was of judicial creation and; it has been suggested, resulted from mistaken application of precedent. (See Note, 52 North Carolina L. Rev. 165, 167-168.)

2 . “ § 6-106, Application of the Proceeds. In addition to the requirements of the two preceding sections: (1) Upon every bulk transfer subject to this Article for which new consideration becomes payable except those made by sale at auction it is the duty of the transferee to assure that such consideration is applied so far as necessary to pay those debts of the transferor which are either shown on the list furnished by the transferor (Section 6-104) or filed in writing in the place stated in the notice (Section 6-107). within thirty days after the mailing of such notice. This duty of the transferee runs to all the holders of' such debts, and may be enforced by any of them for the benefit of all.”

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Dissenting Opinion

Gabrielli, J. (dissenting).

The question presented is whether subdivision (3) of section 6-104 of the Uniform Commercial Code has obviated the rule established by case law in New York that the buyer of a going, business in a bulk sale transaction must make adequate inquiry concerning the seller ’s undisclosed creditors or be subject to the claims of those creditors. We conclude that such an inquiry is required to be made.

On January 9, 1970, L. D. J. Dress, Inc. sold its dress shop to one Warman who, in turn, sold it to defendant, Climax Boutique, Inc., as a going business in a bulk sales transaction. The seller gave the defendant buyer an affidavit that it had no creditors. Plaintiff in this action, however, had sold dresses to the seller L. D. J. for which there was a balance due. The affidavit of no creditors was supplied defendant at the closing. Prior to that defendant’s attorney had made a lien search which disclosed nothing, was informally told by L, D. J.’s attorney that there were no creditors (even including the landlord and utilities), and inspected L. D. J.’s checkbook seeing that indeed checks had been written to certain of L. D. J.’s creditors. Defendant, through its attorney or otherwise, however, never attempted to review L. D. J.’s books; nor was the source of the merchandise included in the bulk sale ever questioned. The parties stipulated that the defendant had no knowledge of the plaintiff’s claim prior to the sale.

The Trial Judge held that the'affidavit of no creditors furnished by the seller was not such a list of creditors as was contemplated under the Bulk Sales Act (Uniform Commercial Code, art. 6) to save the defendant harmless from claims of the seller’s creditors; and that defendant failed to make the sort of thorough inquiry which the law required. As a consequence of these findings he enjoined the sale and ordered the appointment of a receiver unless the defendants should pay the plaintiff the amount due together with costs and disbursements. (On the appeal to the Appellate Division the action was discontinued as to defendant L. D. J.)

The Appellate Division majority reversed and dismissed the complaint. After first noting the case law in New York interpreting former section 44 of the Personal Property Law, to the effect that in addition to taking the required list of creditors from the seller, the buyer was under a duty to make careful inquiry as to the possible existence of creditors, the majority held such law to be inapplicable in light of new subdivision (3) of section 6-104 of the Uniform Commercial Code, which places responsibility on the seller for the accuracy of the list and preserves the effectiveness of the sale even though there might be errors or omissions in the list, unless the buyer be shown to have had the knowledge of the list’s accuracy. A literal interpretation of that section was said to obviate any duty on the buyer to make inquiry. Besides, said the majority, the inquiry that was made, i.e., the lien search, the conversation and the inspection of check stubs, would have satisfied the old rule in any event. The two dissenters could not agree that the old rule regarding inquiry had been overcome by the statute and noted that the defendant should have been put on notice the affidavit of no creditors was false since it would be unlikely that á going business would have no outstanding debts.

Section. 6-104 provides generally that a bulk transfer is ineffective against any creditor of the seller unless the buyer requires the seller to furnish a list of his existing creditors. Sections 6-105 and 6-107 then confer upon the buyer the duty of notifying the seller’s creditors of the sale at least 10 days in advance of the sale. These provisions are as stated in the Official Comment following section 6-105 (McKinney’s Cons. Laws of N. Y., Book 62%, Uniform Commercial Code, p. 738) “ the heart of the Article,” the whole purpose of which is (pp. 716-717) “ to deal with two common forms of commercial fraud, namely:

“ (a) The merchant, owing debts, who sells out his stock in trade to a friend for less than it is worth, pays his creditors less than he owes them, and hopes to come back into the business through the back door some time in the future.

“ (b) The merchant, owing debts, who sells out his stock in trade to any one for any price, pockets the proceeds,, and disappears leaving his creditors unpaid.”

With these salutary aims in mind, how do we deal with subdivision (3) of section 6-104 which seems calculated, as applied by the court below in the instant case, to defeat the whole purpose and intent of article 6? Subdivision (3) states: “ Responsibility for the completeness and accuracy of the list of creditors rests on the transferor, and the transfer is not rendered ineffective by errors or omissions therein unless the transferee is shown to have had knowledge.” The inclusion of this subdivision may very likely have been due to legislative oversight. The purpose of article 6 is to safeguard creditors while at the same time providing for the smooth and relatively uninterrupted flow of the sale transaction (see Hogan, The Highways and Some of the Byways In the Sales and Bulk Sales Articles of the Uniform Commercial Code, 48 Cornell Law Quarterly 1, 37; Levit, Bulk Transfers — Stepchild of the Uniform Commercial Code, 46 Notre Dame Lawyer, 694, 706, 707). The model article 6 of the Uniform Commelrcial Code, in addition to carrying section 6-104 also carries section 6-106. As explained by former Dean William D. Hawkland (Remedies of Bulk Transfer Creditors Where There Has Been Compliance With Article 6, 74 Commercial L. J. 257) prior to the drafting of the Uniform Commercial Code many States followed the New York law which did not require the buyer to apply consideration to the debts of the seller. The idea was that the seller’s creditors were adequately protected if they knew that he was about to realize funds as-the result of the bulk sale. This notice was sufficient to safeguard the creditors. Other States, however, followed the Pennsylvania law and provided that creditors were not adequately protected unless the buyer was obligated to apply the consideration for the sale to the debts of the seller. Thus, when the Uniform Commercial Code draftsmen came to article 6 they wrote in a section 6-106 adopting the Pennsylvania approach which, in effect, requires the buyer to wait 30 days before paying over the considerátion during which time claims of the seller’s creditors could be satisfied out of this fund. Section 6-106 was labeled “ optional ”. Nineteen jurisdictions have accepted section 6-106 and 31, including New York, have rejected it. In New York we consider the list and buyer’s notice adequate protection to the creditor as we did before the Uniform Commercial Code was adopted. But at that time we had no provision which saved the buyer harmless upon the seller’s furnishing a list. At that time the case law required the buyer to make thorough inquiry (Klein v. Schwartz, 128 N. Y. S. 2d 177; Willner Butter & Egg Corp. v. Roth, 192 Misc. 970" court="N.Y. Sup. Ct." date_filed="1948-06-21" href="https://app.midpage.ai/document/willner-butter--egg-corp-v-roth-5429519?utm_source=webapp" opinion_id="5429519">192 Misc. 970; Heilmann v. Powelson, 101 Misc. 230" court="N.Y. Sup. Ct." date_filed="1917-09-15" href="https://app.midpage.ai/document/heilmann-v-powelson-5416297?utm_source=webapp" opinion_id="5416297">101 Misc. 230). Thus, the creditor would have been adequately protected.

Hawkland notes á relationship between subdivision (3) of section 6-104 and section 6-106¹ and from this we can see that where the statute covering bulk sales contains both subdivision (3) of section 6-104 and section 6-106, the consequences to a creditor omitted frojn the list would not be as onerous as they are in New York where there is no section 6-106. At least the odds are that prior to the expiration of the 30. days’ waiting period carried in section 6-106, a creditor would get wind df the sale and have time to lay claim to a portion of the proceeds. At the same time, the buyer would be spared the necessity of making the inquiry required under our case law. However, where, as in New York, there is no section 6-106, there should probably be no subdivision (3) of section 6-104 which acts to cut off the omitted creditor’s rights irrevocably as of the time of the closing as interpreted by the court below, a result in complete and total derogation of the aims of, article 6. As stated by yet another writer: “ If the purpose of article 6 is to give creditors who extend credit on the faith of a stock of merchandise advance notice so that they can take such steps as are necessary to protect themselves against a bulk transfer, the Code and pre-existing law simply afford no adequate protection in the absence of sectidn 6-106 ” (Barkin and Gilbert, Bulk Transfers In Florida — The Creditor Protected, 20 Univ. of Florida L. Rev. 158, 167). It appears, then, that without section 6-106, there is no salutary purpose to be served by the inclusion of subdivision (3) of section 6-104.

We are disposed to conclude that despite the inclusion of subdivision (3) of section 6-104 in the New York statute the pre-existing case law regarding the duty of the buyer to investigate the seller’s creditors persists. If such a case law rule is not superimposed on subdivision (3) the whole purpose of article 6 is subverted. Thus, responsibility for the accuracy of the list of creditors rests on the seller unless the buyer has actual knowledge which must be arrived at through reasonable investigation, i.e., at the very least an inspection of the seller’s books together with a search for liens.² In other words, the part of subdivision (3) which preserves the creditors’ rights if the buyer has knowledge subsumes that the buyer has acted to acquire that knowledge. We are aided in this analysis by three factors. First, the New York Annotations state that subdivision (3) of section 6-104, although new to the statute, is “ but declaratory of the New York law,” citing those cases' which imposed the investigatory duty on the buyer.³ Second, an absurdity would be formulated into legal doctrine were it to be held that, as in this case, a buyer would not actually know (even without investigating) that a going mercantile establishment would have to have at least some current creditors. Third, as before stated, a decision to allow the seller to have the final word as to whether or not there are any creditors and if there are, their identities, would frustrate the express purpose of the article. His responsibility extends to furnishing a list. The buyer must verify that list through his own investigation so as to give him a basis for the acquisition of actual knowledge.

We emphasize that adherence to the position and concept adopted by the majority will permit a buyer to be entirely free of any liability despite even his own reckless disregard of the natural consequences of his failure or refusal to make any inquiry of the liability status of the business being purchased — all to the damage and loss of innocent creditors of the seller. Such a concept -— permitting a buyer to completely ignore the realities of the business world and, further, to cavalierly brush aside any inquiry as to the status of the seller’s business debts — destroys one of the prime aims of article 6, to, wit, to safeguard creditors.

We would not rest our view for reversal, as we might, on the ground that an affidavit of no creditors is not a list contemplated under section 6-104. (See the Commentary of Donald J. Bap-son, McKinney’s Cons. Laws of N. Y., Book 62%, Uniform Commercial Code, § 6-101, p. 711.) To do this would be to postpone the inevitable question of the construction to be given subdivision (3) of section 6-104 when a list is furnished which turns out to be incomplete. The proper ruling is and should be that either where a list is furnished, or where an affidavit of no creditors is furnished, the buyer must investigate, and that a reckless disregard of what might be uncovered by an investigation is tantamount to knowledge within the meaning of the statute. This is not a substitute of constructive knowledge for actual knowledge, but a recognition that willfull or reckless avoidance of knowledge should be and is the equivalent of knowledge.

The order of the Appellate Division should be reversed and the judgment of the trial court reinstated.

Judges Jones, Wachtler and Stevens concur with Judge Jasen ; Judge Gabrielli dissents and votes to reverse in a separate opinion in which Chief Judge Breitel concurs; Judge Rabin taking no part.

Order affirmed.

1 . “ Although creditors, by and large, have applauded section 6-106, its enactment has caused difficulties for transferees because it imposes on them the enormous responsibility of correctly applying the proceeds. * " * Although optional section 6-106 (4) resolves a major difficulty in the administration of - the application of proceeds rule, two troublesome problems remain. One involves the relationship between section 6-104 (3) and section 6-106. Under section 6-104 (3) a transferee may rely on the accuracy of the list of creditors given by the transferor unless he has knowledge that this list is inaccurate. On the other hand, section 6-106 apparently gives protection to creditors who file their claims within thirty days after the notice of transfer is mailed. These two provisions come into play where the transferor delivers to the transferee an affidavit of ‘no creditors’. In that case, assuming the transferee has no knowledge of any creditor of the transferor, may the transferee safely pay the new consideration to the transferor, or must he wait thirty days to see if any creditors file! ‘ The prudent answer seems clear enough. He must wait thirty days. This answer makes section 6-106 impopular with transferors who are forced to wait thirty days after the transaction is closed to get their money ’ [citing himself] A Transactional Guide to the Uniform Commercial Code, 855-6 [1964].” (74 Commercial L. J. 257, 262).

2 . The cheeking for liens and an inspection of checks "written by the seller in this case did not amount to an adequate investigation.

3 . Klein v. Schwartz, 128 N. Y. S. 2d 177; Carl Ahlers, Inc. v. Dingott, 173 Misc. 873" court="N.Y. Sup. Ct." date_filed="1940-01-24" href="https://app.midpage.ai/document/carl-ahlers-inc-v-dingott-5425748?utm_source=webapp" opinion_id="5425748">173 Misc. 873; Marcus v. Knitzer, 168 Misc. 9" court="N.Y. Sup. Ct." date_filed="1938-02-07" href="https://app.midpage.ai/document/marcus-v-knitzer-5424831?utm_source=webapp" opinion_id="5424831">168 Misc. 9; Willner Butter & Egg Corp. v. Roth, 192 Misc. 970. (McKinney’s Cons. Laws of N. Y., Book 62%, Uniform Commercial Code, § 6-104, p. 735.)