In re Waddell-Entz Co.

| Conn. | Feb 21, 1896

Hamersley, J.

When the law takes possession of the property of an insolvent debtor, that property becomes a trust fund to be divided among such creditors as may present their claims in the prescribed manner; and the respective interests of the creditors in the fund are, as between themselves, of an equitable nature, to be determined on a basis of equality. This is true of the property of an insolvent corporation when it is taken possession of by a receiver under the statute providing for the winding up of a corporation, as truly as when it is taken possession of by a trustee under the statute regulating insolvent estates. New Haven Wire Co. Cases, 57 Conn., 352" court="Conn." date_filed="1888-12-31" href="https://app.midpage.ai/document/new-haven-wire-co-cases-6582537?utm_source=webapp" opinion_id="6582537">57 Conn., 352, 387.

The questions submitted by this reservation present little difficulty when it is remembered that the real question is, not what remedies each creditor may have had against the solvent corporation, but simply what is the amount of actual debt due from the insolvent estate to him; such debt and such only can be proved, as the basis for an equitable distribution of the trust fund.

A consideration of the disputed claims of William A. Procter and Knauth, Nachod & Kiihne, will dispose of all the' others.

Procter’s claim (aside from the thirteen bonds Nos. 32 to 44, about which no question arises) is based on a loan to the Waddell-Entz Company of $4,500. As evidence of the debt he received a demand note for that amount (Ex. “ C ”) ; he also received ten notes or bonds (in the form of Ex. “ D ”) for $1,000 each, and claims that the debt on which he is entitled to a proportionate dividend from the trust fund is $14,500. If he had received a demand note for $14,500, or if he had received 145 notes under seal for $100 each, it would hardly be claimed that he could prove more than his actual debt of $4,500; whatever advantages possession of evidences of debt in such form might secure to him in enforcing his rights against his debtor, the possession of such advantages does not alter the fact that his real debt is $4,500, and that fact must control his right to a dividend from the insolvent estate. The amount of his debt is not altered because in the demand note the ten bonds delivered to him are called “ collateral security.” They are not col-' lateral security for the payment of the original debt. The demand note itself is in a sense a security dependent for its value on the credit and property of the borrower; another note or fifty other notes furnish a similar security; they might aid the creditor in enforcing speedy payment bjr the debtor, but in case of insolvency it is the actual debt and not the multiplication of evidences of debt that defines the creditor’s interest in the trust fund. “ Collateral security ” necessarily implies the transfer to the creditor of an interest in some property or lien on property, or obligation which furnishes a security in addition to the responsibility of the debtor. The law regulating this subject rests on the assumption of such transfer to the creditor of property in some form, on which property he relies for security, and which he is entitled to apply instead of resorting to the debtor’s own property towards the satisfaction of his debt, by virtue of a contract implied or express as the case may be, but collateral to the contract of indebtedness. A debtor’s additional promises to pay cannot, from the very nature of the case, be treated as collateral security for his debt, unless such additional promises are themselves secured by a lien on property or by the obligations of third persons; under such circumstances they may be treated as collateral security so far as is necessary to obtain the benefit of the lien or obligation. This self-evident proposition has rarely been discussed in reported cases. The principle, however, has been clearly stated by the courts of New York and Massachusetts. People v. Remington, 54 Hun, 480, affirmed, 121 N.Y., 675" court="NY" date_filed="1890-03-09" href="https://app.midpage.ai/document/matter-of-obyrne-3591071?utm_source=webapp" opinion_id="3591071">121 N. Y., 675; Third Nat. Bank v. Pastern R. R. Co., 122 Mass., 240" court="Mass." date_filed="1877-03-07" href="https://app.midpage.ai/document/third-national-bank-v-eastern-railroad-6418862?utm_source=webapp" opinion_id="6418862">122 Mass., 240; see also 124 id., 518. In the case of In re Litchfield Bank, 28 Conn., 575" court="Conn." date_filed="1859-10-15" href="https://app.midpage.ai/document/in-re-the-litchfield-bank-6577710?utm_source=webapp" opinion_id="6577710">28 Conn., 575, it was apparently conceded by all parties that the currency of a State bank, pledged as security for the payment of its promissory notes, is pledged as money; the case turned on a claim of tort in selling the money so pledged, and the question now at issue was not considered.

The amount of Mr. Procter’s debt is not altered by the sale from himself to himself of the bonds. Such bonds were not “collateral security” for the demand note, and their sale to himself or others would not be governed by the law peculiar to the disposition of such security. Whether or not they might constitute a debt for their face value in the hands of a third party who had purchased them from Procter, would depend upon the circumstances of such purchase. Their standing, in such case, as a debt against the insolvent estate, would not depend on their sale as “ collateral security,” but on their valid assignment to an innocent third party. Mr. Procter by purchasing these bonds from himself, after he had been advised of the insolvency of the company and the appointment of a receiver, and after he had presented his debt of $4,500, did not put himself in the position of, nor in a position analogous to that of, an innocent third party.

One claim of Knauth, Nachod & Kuhne raises a different question, although its solution is 1 argel}' controlled by the same principle, i. e., the equality of the creditors in respect to their equitable interests in the trust fund. These claimants held collateral security for their debt; they have sold that security through proper legal proceedings, and have received the proceeds. The fact that they themselves were purchasers at the sale is immaterial. They now insist that for the purposes of a division of the trust fund, the amount or value of the proceeds received by them from the sale of their security cannot be deducted from the original amount of their debt.

It is undoubtedly true that a creditor holding collateral security may, in case of non-payment of the debt, pursue all his remedies at the same time, or either one before having recourse to the other. He is not bound to apply the collateral security before enforcing his direct remedy. He has a legal property interest in the security as well as in the debt; to deprive him of either might be in the nature of a violation of the obligation of a contract; his rights, however, are limited to the satisfaction of his debt, and if he gains more, a trust arises which equity will enforce. But when the debtor is insolvent, and his property is taken into the custody of the law as a trust fund to be distributed among the creditors on the basis of equality under direction of a court exercising equity powers, the right of a secured creditor to a share of that fund stands on the same footing as the right of every other creditor who presents a claim; and the amount upon which he is entitled to a dividend must be determined on the same principles. He cannot be deprived without consent, of the property which he holds as security, he cannot be deprived of his right to sue the debtor for any unpaid balance (unless by force of a discharge in insolvency or bankruptcy) ; but his share of the trust fund must be determined by the same rule which determines the share of every other creditor, and that is a rule of equity for securing equality of treatment. Whether this rule of equity will permit a secured creditor to proceed against the fund in the hands of the trustee, as he might have proceeded against his debtor, without applying his collateral security to the reduction of his claim, and so to receive a dividend from the property of the insolvent, sequestered by operation of law for the equal benefit of all creditors, on that portion of his debt which the property of the debtor, sequestered by his own act for that special purpose, has paid or will pay in full, — is a question as to which courts in different jurisdictions have differed. The cases are reviewed in People v. Remington, 121 N.Y., 328" court="NY" date_filed="1890-06-03" href="https://app.midpage.ai/document/people-v-e-remington--sons-3603073?utm_source=webapp" opinion_id="3603073">121 N. Y., 328. It may be doubtful whether in this State, prior to the Act of 1853 relating to insolvent debtors, this question had been conclusively settled, although Findlay v. Hosmer, 2 Conn., 350" court="Conn." date_filed="1817-11-15" href="https://app.midpage.ai/document/findlay-v-hosmer-6573216?utm_source=webapp" opinion_id="6573216">2 Conn., 350, and some subsequent eases, indicate an approval of the rule contended for by counsel for Knauth, Nachod & Kuhne. It is unnecessary, however, to discuss the question, for we are satisfied that legislation on that subject has settled the doubt in favor of a different rule.

The insolvent Act of 1853 contained a provision (now found in §590 of the General Statutes) requiring a secured creditor who presented his claim against the estate, to elect between the surrender of such security and a dividend from such estate only upon the excess of such claim above the value of such security. In Mechanics' Farmers' Bank, Appeal from Probate, 31 Conn., 63" court="Conn." date_filed="1862-09-15" href="https://app.midpage.ai/document/mechanics--farmers-bank-of-albany-appeal-from-probate-6578049?utm_source=webapp" opinion_id="6578049">31 Conn., 63, 70, it was held that this statute placed all the property of the insolvent in the custody of the law, to be disposed of according to law; that the creditor has no .vested interest in such property; and that the statute was “strictly remedial, providing for the appropriation of the debtor’s property, on principles of equity and justice among all his creditors.” The provision in relation to secured creditors was extended to insolvent estates of deceased persons; so that this equitable rule applied to the distribution by law of all insolvent estates, including insolvent corporations. In 1869 a law was passed for the winding up of corporations, and under that law the property of the insolvent corporation could be taken possession of for division among all creditors in equal proportions, by a receiver appointed by the Superior Court as a court of equity, as well as by a trustee appointed by the Court of Probate under the insolvent Act. New Haven Wire Co. Cases, supra. The present- proceeding is brought under this Act, which is still in force substantially unchanged.' General Statutes, § 1942. The Act confers on the court full equity powers to make such orders as to the doings of the receiver “ and as to the payment of debts and distribution of the effects of said corporation, as may be just and comformable to law.” We think the property of an insolvent corporation is in the custody of the law to the same extent and for the same purposes when transferred to a receiver under § 1942, as when transferred to a trustee under the insolvent Act, and that the principle of the rule in respect to the participation of secured creditors in the distribution of such property, which is obligatory in the latter case, ought to be applied in the former. This is just and required by the insolvent Act.

The Superior Court is advised:—

First: William A. Procter is entitled to a dividend only on the original indebtedness of $4,500 and the thirteen coupon obligations numbered 32-44.

Second: John C. Brown and Mrs. Smith are entitled to dividends only upon the amount of their demand notes.

Third: Knauth, Nachod & Kuhne are entitled to a dividend on the excess of their claim of $12,336 above the amount received by them from the sale of their collateral security. They are not entitled to a dividend upon the eight coupon obligations.

In this opinion the other judges concurred.