James Pott & Co. v. Schmucker

McSherry, C. J.,

delivered the opinion of the Court.

This is another of the many cases which have resulted from the failure of the banking house of J. J. Nicholson and Son in January, eighteen hundred and ninety-two ; but it differs widely from those that have preceded it, and involves quite distinct and dissimilar principles and doctrines.

In eighteen hundred and eighty-four Johns H. R. Nicholson, one of the members of the firm of J. J. Nicholson and Son, purchased the assets, the good will and the business of John B. Piet and Company who had recently theretofore failed whilst largely indebted to Johns H. R. Nicholson individually. Mr. Nicholson thereafter continued the business of Piet and Company on his own account, but under the name of the Baltimore Publishing Company, until March, eighteen hundred and eighty-five, when he procured a certificate of incorporation in which the capital stock was fixed at twenty-five thousand dollars. The whole of this stock was taken by Johns H. R. Nicholson, but to effect an organization of the corporation, whose charter name was the Baltimore Publishing Company, he allotted four shares of the stock to four of his employees to be held by them only so long as they remained in his service. He was the treasurer of the company, signed all notes and checks given by it, and furnished all the money needed to conduct its business. He owned the whole of the assets of the concern and the business carried on in its name was his business, confessedly no one else having any interest therein whatever. He was in reality himself -the Baltimore Publishing Company, and this fact was so stated and represented to the various persons who became, on the faith of this assurance, its creditors. When the banking house of J. J. Nicholson and Son failed on January the fourteenth,,eighteen hundred and. ninety-two, it was discovered that there appeared upon its ledgers an overdraft indebtedness of seventy-six thousand. dollars apparently due to it by the Baltimore Publishing Company. The members .of the firm were aware, as this overdraft indebtedness grew, that Johns H. R. Nicholson was overdrawing in the name of the Baltimore Publishing Company. When the. Nicholsons suspended they appointed trustees- under a deed of trust for the benefit of creditors, but being proceeded against under the insolvent law and being adjudged insolvents, a permanent trustee in insolvency was elected who displaced the conventional trustees. • Before, however, the conventional trustees were superseded they filed a bill in equity against, the Baltimore Publishing Company, alleging that the company was insolvent and praying that it be so declared, and asking that receivers-be-appointed .to take charge of its assets and to reduce, them to money for the settlement,of its indebtedness. To this bill an answer was filed, and-subsequently receivers were appointed who converted the assets into money which they now have in the Equity Court for distribution. Later on Nicholson and Son and Johns H. R. Nicholson were adjudged insolvent, as already stated, and Mr. Samuel D. Schmucker was elected their trustee in insolvency. Mr. Schmucker then filed a supplemental bill wherein he made two alternative claims with respect to the funds in the hands of the Publishing Company’s receivers. These claims were, first, that the charter of the Publishing Company was invalid and that therefore the funds belonged, not to the corporation, but to Johns H. R. Nicholson individually, and consequently the title to them passed, upon his being adjudged an insolvent, to his trustee, Mr. Schmucker; and, secondly, if the charter was valid, then Mr. Schmucker as trustee in insolvency of the firm of J. J. Nicholson and Son, claimed to be a creditor of the Publishing Company to the amount of the above-mentioned overdraft, and so claiming, asserted his right to participate pari passu with all other creditors of the Publishing Company in the distribution of the funds in the possession of the receivers. This supplemental bill was answered. At the hearing the evidence taken under the original bill as well as that taken under the supplemental bill was considered and is in the record now before us. This evidence shows that Johns H. R. Nicholson treated this overdraft hot as a debt due by the Publishing Company, but as capital of his own advanced to the company ; and there is nothing in the record to contradict this, apart from the form of the entries on the books of the firm. The Circuit Court of Baltimore City decreed, first, that the Baltimore Publishing Company’s charter was valid; and, secondly, that the insolvent firm of Nicholson and Son, through the trustee, Mr. Schmucker, was entitled as a creditor of the Publishing Company to the extent of the overdraft, to share pari passu in the receivership funds with the creditors of the Publishing Company. From the latter or second clause of this decree the creditors of the Publishing Company have appealed.

The question then is: Are the funds derived from the sale of the Publishing Company’s assets applicable under the facts above stated, to the payment in the first place of the debts due by the Baltimore Publishing Company ex-elusive of the alleged overdraft indebtedness; or does the overdraft stand on the same footing with the undisputed debts of the Publishing Company, entitled to be paid pari passu with them ?

If there had been no corporation, and if the business of the Publishing Company had been conducted openly and ostensibly as the individual business of Johns H. R. Nicholson in his own name, there can be no doubt, according to firmly settled principles, that the creditors of the firm of J. J. Nicholson and Son, of which firm Johns H. R. Nicholson was a member, would not have been entitled to be paid out of the funds arising from the sales of Johns H. R. Nicholson’s individual property until his individual creditors were first paid therefrom in full. And this is so because the individual property of a member of a firm is applicable in the first instance to the payment of his individual creditors, just as the social assets are liable for the firm debts in preference to the debts due by the copartners personally. This doctrine is so generally accepted and so familiar that we need not pause to demonstrate it. McCulloh v. Dashiell’s Admr., 1 H. & G. 96; Hull v. Deering, 80 Md. 424.

The application of this doctrine to varying conditions of facts has logically led to the development of a corollary, with which we are, on this appeal, more immediately and directly concerned. It has often happened in the diversity of business enterprises that one of the partners of a firm has also been engaged in a separate venture of his own, and that in the latter business he became a debtor to his own firm for advances or loans of money made by the firm to him. In other words, as an individual he was a debtor to himself and his copartner, besides being a debtor to others on account of his separate business. Upon becoming insolvent in his individual venture and owing creditors as well as owing his own firm for money advanced to him, the question has arisen as to whether his own firm—the firm of which he was a member and to a portion of the assets of which, including his own debt, he was entitled—could compete or stand on the same footing with his individual creditors in the distribution of his individual assets; and the Courts, certainly since the time of Lord Thurlow, who broke through previous rulings of Lord Hardwicke, have quite uniformly held, when the debt to the firm was not surreptitiously or fraudently created, that until the individual creditors were first paid in full, the firm of which the insolvent was a member, though it was also one of his creditors, could not be permitted to claim satisfaction out of his individual assets. There are two conditions under which the creditor firm of which the insolvent is a member may prove in competition with the individual creditors; and these are: First, where money or effects have been fraudulently abstracted from one estate and applied for the benefit of the other; and secondly, where some of the members of a partnership form an entirely distinct firm carrying on a distinct trade from that of the general partnership, and where the articles of one trade have been furnished by one firm to the other. Collyer on Part., sec. 991. There was no fraudulent abstraction of the funds of J. J. Nicholson and Son by Johns H. R. Nicholson for the benefit of the Publishing Company. The overdraft account was made up of numerous items entered on the firm’s books at various periods, and the transaction as it progressed was known to the other members of the firm and was never objected to or challenged. Much slighter evidence than this will repel an imputation of fraud. For instance: Where one partner puts the other in absolute possession of the partnership funds and leaves to him the sole management of the concern, this is prima facie an implied consent to any measure which the latter may adopt regarding the joint property; and joint creditors must abide by the consequences of such arrangement. Ex parte Assignees of Lodge & Fendall, 1 Ves. Jr. 166. The second of the two conditions above alluded to does not exist in this case. There were no articles of trade furnished by Nicholson and Son to Johns PI. R. Nicholson or the Publishing Company. What was furnished was money, and Lord Eldon, in Ex parte Sillitoe, i Glyn. & Jam. 374, expressly laid down the doctrine that the right of the firm to prove in competition with other creditors arose where articles of one trade had been furnished to another trade; and he stated that there was no-case in which the proof had been allowed where money had been advanced to the partnership by one or more of the partners. This was followed by Lord Brougham in Ex parte Cook, 1 Mont. (Bankr. cas.) 228.

The reason for the general doctrine is obvious. If the firm of which the insolvent debtor fs a member were allowed to compete with that debtor’s individual creditors in the distribution of his. assets, he would, to the extent of his interest in the firm, be in fact competing with his own creditors and would thereby withdraw from them for his own benefit just So much of his own assets as would be necessary to reimburse him his proportion of the very debt due by him personally to himself and his copartners as a firm. In a word he would be repaying himself at the expense of his creditors. That he cannot be permitted to do this is made perfectly clear by Lord Eldon in Ex parte Harris, 2 Ves. & B. 210. He said: “There has long been an end of the law which prevailed in the time of Lord Harwicke, whose opinion appears to have been that, if the joint estate lent money to the separate estate of one partner, or if one partner lent to the joint estate, proof might be made by the one or the other in each case. That has been put an end to-, among other principles upon this certainly, that a partner cannot come into competition with separate creditors of his own, nor, as to the joint estate, with the joint creditors. The consequence is, that if one partner lends one thousand pounds to the partnership, they become insolvent in a week, he cannot be a creditor of the partnership, though the money was supplied to the joint estate; so, if the partnership lend to an individual partner, there can be no proof for the joint estate against the separate estate; that is, in each case no proof to affect the creditor, though the individual partners may certainly have the right against each other.” See Collyer on Part., sec. 990, et seq.

Now, if the firm of Nicholson and Son had not failed but were still solvent, and if Johns H. R. Nicholson alone had become bankrupt, and if the Baltimore Publishing Company as a corporation had never existed but the business conducted in its name were confessedly the individual business of Johns H. R. Nicholson, there can be no possible dispute that the firm of Nicholson and Son would not, under the principles alluded to, be permitted to prove this claim for an overdraft against the separate estate of Johns H. R. Nicholson until all his individual creditors were first paid in full. The insolvency of the firm can in no way alter this legal principle or affect its application. Thus in Ex parte Collinge, 4 De G. Jones & Sm. 533, Holdsworth and Ashburner were partners. The firm became insolvent. A banking company was a creditor of Ashburner for one thousand pounds. His separate estate amounted to six thousand pounds. The assignees of the firm set up a claim against his separate estate for a debt of eleven thousand pounds due by him to the firm; and this claim of the assignees of the firm to compete with the individual creditors of Ashburner was disallowed.

We have on the record now before us practically the same situation that was presented in Ex parte Collinge, unless the fact that Johns H. R. Nicholson conducted the business of the Publishing Company, not in his own name, but in that of the corporation, distinguishes the two cases. We do not pause to discuss the objections made to the validity of the Publishing Company’s charter further than to say we do not consider them tenable. And we do not consider them tenable because the requirements of the general incorporation law under -which the company was formed were “ fairly and substantially complied with.” Hughes v. Antietam Co., 34 Md. 324. But in addition to this the validity of the articles of incorporation cannot be inquired into incidentally and collaterally. Keene & Brady, Trustees, v Van Reuth, 48 Md. 184.

✓ The testimony clearly and incontestably shows that the whole of the capital stock and the entire assets of the Publishing Company belonged to Johns H. R. Nicholson; the corporation having been formed merely for convenience in conducting the enterprise. He and everyone else connected with the concern regarded the business as his business, and the evidence shows without contradiction that he considered the overdraft now made the basis of Mr. Schmucker’s claim, as so much cash contributed to the concern’s capital, and not as a debt due by the Publishing Company to the bank- ' ing house of Nicholson and Son. If this be so, and if it be competent for a Court of Equity to look back of the mere artificial and formal body corporate and upon seeing that Johns H. R. Nicholson was the sole and real owner of its assets and its stock, to treat the debts apparently due by it to the creditors who filled its orders for goods, loaned it money on its notes and supplied it stock in trade, as debts in fact due by Johns H. R. Nicholson on the credit of his ownership of the company’s assets, there can be no difficulty in practically applying to this state of facts the legal principles we have been considering in respect to the inability of the trustee of the insolvent firm to compete with the individual creditors of one of its members. We need not go beyond the limits of Maryland for adjudged cases sustaining the right of a creditor or others in an appropriate case and in furtherance of the ends of justice, to treat the debtor corporation and the individual owning all its stock and assets as identical. Thus in Hoffman Steam Coal Co. v. Cumberland Coal and Iron Co., 16 Md. 456, it appeared that one Sherman, a director of the Cumberland Company, having purchased lands from it united with other persons in forming a new corporation, he subscribing for almost all the capital stock therein and becoming one of its officers and directors. It further appeared that on the next day, in pursuance of one entire plan, he conveyed the same lands to the new company in payment of his subscription for the stock. Upon a bill filed by the Cumberland Comp an against Sherman, Dean and the new company, to set aside the deed made by the Cumberland Company to Sherman and Dean, this Court looked through the disguise of a new corporation in which Sherman and Dean had clothed themselves and said: “ Sherman and Dean becoming the owners of 4996 of the five thousand shares, into which the capital stock was divided, it was, in fact, but a contrivance whereby the same property was held by the same parties, but under a different name;” and the Court proceeded to deal with the case precisely as though the title to the land had not been conveyed by Sherman and Dean to the Hoffman Company, but still stood in their names. And so in Swift v. Smith, Dixon & Co., 65 Md. 428, where one person became the sole owner of all the capital stock of a private corporation and then executed a mortgage upon the corporate property. As a mortgage by the corporation the instrument was defective, but was valid as against the individual who had executed it. This Court looked into the facts and decreed that the mortgage was binding on the corporate property merely because the whole of the capital stock was owned by the person who signed the mortgage. It was said, in effect, that such sole owner might individually make a valid mortgage of all the property of the corporation and that after such a mortgage was recorded it would be binding on all persons thereafter dealing with or trusting the corporation. In both of these cases it was necessary for the'' Court to look beyond and back of mere external appearances, and upon doing this and discovering that one individual owned the whole capital stock, the transactions dealt with as corporate transactions were treated precisely as they would have been treated had the proceedings been against the individual owning all the stock; not because there was necessarily no difference between any of the ulterior consequences that might arise where there was no corporation, and those that might exist where there was a corporation the whole of whose assets and stock were owned by one individual; but because the law will not in any case suffer the corporate name—the mere shadow—to be interposed for the purpose of defeating substantial rights depending for their ultimate vindication not upon the accidental form of a ^transaction, but upon its inherent equity and justice.

Giving heed and credence to the overwhelming and undisputed evidence in the record there is no room to doubt that though the Publishing Company subsisted as k corporation and in its corporate name became ostensibly a debtor to the appellants, it none the less represented the individual business of Johns H. R. Nicholson; and unless we disregard and deliberately depart from the long settled principles to which we have alluded, the creditors whom Johns H. R. Nicholson owes through the agency and under the name of the corporation must be paid first out of the proceeds of the assets individually owned by him and now in the receiver’s hands where they rightfully are for distribution, before the trustee in insolvency of Nicholson and Son can make claim to be paid the overdraft out of those same funds, and before the trustee of Johns H. R. Nicholson can demand any part of these funds under the adjudication declaring Johns H. R. Nicholson individually an insolvent.

But it has been strenuously insisted that against this obvious equity of the appellants, the trustee of Nicholson and Son has, as the representatives of the -firm’s creditors, “ a defensive equity ” sufficient to neutralize or counterbalance that of the creditors. And this defensive equity is founded on the fact that the creditors of the firm were depositors whose money the banking firm took on deposit when the firm itself was hopelessly insolvent and was known by its members to be so. Upon this state of facts it is contended the depositors were grossly defrauded and that they consequently have the right to follow the funds and reclaim them. Whilst it is true that a bank which, being insolvent and knowing it, takes funds on deposit, thereby commits a gross fraud on the depositors; yet it becomes the duty of the depositor to elect whether he will repudiate the transaction and reclaim the money deposited, or affirming, permit the relation of debtor and creditor between him and the bank to stand undisturbed. The relation between a bank and its depositors is that of debtor and creditor, and if a fraud has been perpetrated by the bank in accepting the deposit, the depositor may rescind the contractual relation and recover back the money; but if he affirms the contract he surrenders his right of rescission. Now, all of these depositors have proved their claims in the insolvent proceedings and taken their dividends. They have consequently elected to adhere to the contract and it is too late to rescind it now. These depositors have, therefore, no greater equities than any other contract creditor of Nicholson and Son, and certainly none that is superior to those which the appellants have against the fund realized from the sale of the assets upon the faith of which as being the property of Johns H. R. Nicholson, they credited the Publishing Company.

If the Baltimore Publishing Company was a corporation, and we think it was, then its ostensible assets cannot go into the hands of Nicholson and Son’s, trustee in insolvency, or into the hands of Johns H. R. Nicholson’s trustee; but ares properly in a Court of Equity for distribution ; and if that Court can, as in a proper case it unquestionably may, lookv beyond and back of the charter and discover that the assets belong in reality to one individual, then that individual will not, nor will his trustee, be permitted to compete in the distribution of those assets with the creditors of the corporation who are in fact, though not in form, the individual’s own creditors; and, as a consequence, a firm of which that individual is a member will be likewise forbidden to compete with these same individual creditors in respect to that same^ fund. As such a firm cannot so compete, the trustee of that firm, whether a conventional trustee or a trustee appointed under insolvent proceedings, will occupy no better position (Houseal and Smith's Appeal, 45 Pa. St. 484); and, therefore, until the creditors who contracted with the corporation on the faith of its assets and in the bona fide belief that those assets were owned by Johns H. R. Nicholson individually, are paid in full, the trustee’s claim in behalf of the partnership and of the partnership creditors and his claim as trustee of Johns H. R. Nicholson’s individual estate must be deferred.

(Decided January 5th, 1897.)

But there is another view of this case presented by the record that ought not to be overlooked. The testimony is unequivocal that Johns H. R. Nicholson, though he entered the items of this over-draft account in the books of the banking house as debits against the Publishing Company, regarded the over-draft not as a debt due by the company to the house of Nicholson and Son, but as cash capital advanced by him to the concern for which he and not the company was a debtor to the firm. He allowed his agents and employees to represent to persons from whom they sought credit for the concern that the only debts due by the company were debts for books and materials purchased, not exceeding fifteen thousand dollars; whilst the assets were stated to be at least one hundred thousand dollars. Upon the faith of these representations which necessarily excluded every inference that there was an indebtedness due to the banking house, the very debts due to the present appellants were contracted. Under these circumstances Johns H. R. Nicholson could not, either as surviving partner or individually compete in the distribution of these assets with the creditors who trusted to, and were influenced by the representations referred to ; and if he could not thus compete, it would be inequitable in the extreme to permit the trustee to maintain successfully a claim which Nicholson himself would be absolutely estopped to assert. Devries &c. v. Hiss, 72 Md. 564.

For the reasons we have given the decree appealed from will be reversed and the cause will be remanded for a new decree conforming to the views herein expressed; the costs to be paid out of the funds in Court.

Decree reversed and cause remanded, the costs in this Court and in the Court below to be paid out of the funds in the hands of the receivers.

Case Details

Case Name: James Pott & Co. v. Schmucker

Court Name: Court of Appeals of Maryland

Date Published: Jan 5, 1897

Citation: 84 Md. 535

Court Abbreviation: Md.