Court Opinion

ID: 8746820
Source: CourtListenerOpinion
Date Created: 2022-11-26 11:10:52.665248+00
Date Added: 2024-06-11T17:00:43.152996
License: Public Domain

After the foregoing statement, the opinion of the court was delivered by
GROSSCUP, Circuit Judge.
The facts rightly settled, this case involves no controverted questions of law. The evidentiary facts are voluminous, but the findings upon which the case turns, including what seems necessarily prefatory, may be summed up as. follows:
In 1890 the Northwestern Shoe Company of Chicago entered into negotiations with-certain citizens of Beividere, Illinois,, looking toward the transfer of the shoe company from Chicago to Beividere. As a result of these negotiations, a public meeting was held in Beivi-dere, and a committee consisting of three of its citizens, John Hannah, Levi Murch, and James Cook, was appointed to visit the factory of the shoe company at Chicago, and investigate the standing of the concern and its management.
The committee proceeded to Chicago; made an examination of the machinery, books, and stock in trade of the company; had conversations with Barnett Graff, its then president, and Frank Harris, its then secretary, respecting the profits, assets and business of the company; and, upon returning to Beividere, submitted a report favoring the transfer.
In reliance upon .this report, the citizens of Beividere accepted a proposition submitted to them by Barnett Graff, asking, as a consideration for the transfer, that the capital stock of the company — then five thousand dollars — be increased to fifty thousand dollars; that twenty-five thousand dollars of this stock be issued to Barnett Graff, Frank Harris and Jacob Graff, in return for tools, machinery and merchandise to be transferred; that the citizens of Beividere subscribe for fifteen thousand dollars; leaving ten thousand dollars of the stock in the treasury. It was asked, also, that a donation should be made to the company of seven thousand five hundred dollars for the purchase of a site upon which to erect a factory; the shoe company, on its part, to employ, for a certain period of years, a minimum number of men in such factory; and to give a mortgage *27upon the land and buildings so purchased and erected as security therefor.
In pursuance of the above arrangement, the citizens of Belvidere named Allen C. Fuller, John Hannah, Ezra May, W. D. Swail, S. S. Whitman and E. L. Lawrence, a committee to secure the cash bonus of seven thousand five hundred dollars, and to sell the fifteen thousand dollars stock of the company. This committee selected the site and erected the factory, at a total cost of thirteen thousand five hundred dollars, and turned the balance, nine thousand dollars, over to the treasury of the company.
Accordingly, Barnett Graff, Jacob Graff, and Frank Harris, shipped to Belvidere the machinery, tools, fixtures, etc., belonging to the Northwestern Shoe Company in Chicago, which were appraised at the instance of the committee, by Samuel C. Tribou (general manager and superintendent of the Rockford Shoe Company of Rockford, Illinois) at twenty-five thousand dollars; and thereupon stock to that amount was issued to Barnett Graff and his associates, certificates amounting to fifteen thousand dollars being issued to the Belvidere stockholders.
February 13, 1891, having completed the work intrusted to it, the committee submitted a written report to the stockholders of the reorganized Northwestern Shoe Company, and were discharged; and F. R. Smiley, Ezra May, Barnett Graff, Jacob Graff, and Frank Harris were thereupon elected directors of the new company, Barnett Graff being elected president and treasurer, and Frank Harris secretary. January 11, 1892, Allen C. Fuller, D. D. Sabin, Barnett Graff, John Hannah, and Frank Harris were elected directors. January 20, 1892, E. E. Lawrence succeeded Frank Harris as director. March 9, 1892, John J. Foote succeeded Allen C. Fuller as director. No further change took place on the board until August 9, 1892, when John J. Foote was succeeded by Irving Terwilliger.
The shoe company continued doing business until September 2, 1892. In the meantime the ten thousand dollars treasury stock was issued at par, and the money therefor received; and June 28, 1892, a further issue of twenty-five thousand dollars of stock was made— ten thousand being taken by Graff, and the balance by the Belvi-dere stockholders and directors — the avails being used to pay off the indebtedness to the First and Second National Banks of Belvi-dere and Allen C. Fuller. July 1, 1892, bonds were issued to the amount of fifty thousand dollars, secured by trust' deed upon the entire property, and were used to take up the indebtedness then due to the First and Second National Banks of Belvidere. Additional to these transactions, during this interval, Graff, in the name of the shoe company, contracted debts with other parties, on account of goods purchased, to the amount of some twenty-eight thousand dollars, inclusive of the indebtedness due to the complaining creditors. But only a small amount of this appeared on the books of the company. When the crash came in September, 1892, the available assets did not exceed thirty-one thousand dollars; it being found, among other things, that of the outstanding accounts and bills receivable, amounting in all to some ninety thousand dollars, *28as shown by the books to be due the company, only about five thousand dollars were collectible, the balance being largely fictitious.
There is no doubt that these transactions concealed and carried out a monstrous fraud; but it is not insisted that the appellees were purposely parties to the fraud; indeed, they were, to a large degree, victims, for they continued putting into the company, from time to time, fresh money. The deception that was practiced upon the complaining creditors, and also upon the appellees, was brought about principally by, (a) a gross overvaluation of the assets, at Chicago, upon which the twenty-five thousand dollars par value stock was issued to the Graffs and Harris; (b) the imposition upon the banks, and the shoe company of fictitious notes, said by Graff to be in payment by customers of goods previously sold; (c) a continuation, after removal to Belvidere, of this practice of bringing forward and discounting fictitious notes upon the pretense that they were in payment of goods sold to various customers; (d) the removal from the factory of manufactured' goods ostensibly shipped to designated consignees, but, in fact, sold for cash, and the proceeds appropriated by Graff; and (e) omission from the books of the company of the greater part of purchases made (including those from cofnplaining creditors) whereby a large portion of the indebtedness of the company was concealed from the stockholders and directors.
There is nothing in the record showing that the appellees, either as individuals, or directors, actually knew that the company was insolvent when the dividend complained of was declared; or that, prior to June, 1892, the indebtedness of the company exceeded the capital stock. The contention, at most, is that, owing to their negligence in taking note of the affairs of the company, they constructively had such knowledge. The whole question of liability in these respects seems to center around the inquiry, Should the ap-pellees, in the exercise of the diligence required of them by law, have known, at the time of the transactions, the true state of the company’s affairs.
After a careful study of all the evidence, our conclusions respecting the general questions of fact involved may be stated as follows:
First, taking into consideration everything that would naturally influence the committee, including a reasonable confidence in the statements of Graff, and doubtless some anxiety to obtain for their town the industry represented by the shoe company, it is not clear that men of ordinary carefulness, acting in their place, would have discovered that the company’s Chicago assets were overvalued.
Second, it is not satisfactorily shown that, until near the culmination of the company’s career, and after the indebtedness due to the co°mplaining creditors had been contracted, the appellees had the means of knowing, without the exercise of unusual acuteness and diligence, that the notes said by Graff to have been in payment of goods sold to various customers were, in fact, fictitious.
Third, it is not satisfactorily shown that there came to the directors, prior to the failure, evidence to put them upon notice that *29the goods shipped from the factory to the consignees named on the books were, in fact, never delivered to such consignees.
Fourth, there is not evidence sufficient to justify a finding that, until near the culmination of the company’s career, and after the indebtedness to the complaining creditors had been contracted, the appellees ought, in the exercise of ordinary diligence, to have known that the books were falsely kept, and that there existed, from time to time, indebtedness that was not,shown there.
Upon the basis of these findings, we cannot hold the appellees-chargeable on account of the dividend declared, for, at the time the dividend was so declared, they had no means, sufficient to put them on notice, of knowing the insolvency of the company; nor can we hold the appellees to have assented to indebtedness in excess of the capital stock, for, at the time the indebtedness was created, they had no means, sufficient to put them upon notice, of knowing that such indebtedness was being created; nor can we hold them liable, upon any common-law obligation, to the complaining creditors, for negligent discharge of their duties, for, at the time the debts due the complaining creditors were contracted, the appellees had no means, sufficient to put them on notice, of knowing that the affairs of the company were not being honestly managed, and that the company was not financially sound.
Upon the remaining question — the preference given to Fuller and the banks — the members of the court entertain a difference of opinion.
The majority of the court are of the opinion that the mortgage or trust deed of July i, 1892, securing fifty thousand dollars of bonds, was authorized in good faith to retire that amount of bona fide corporate indebtedness to the banks, and so used and accepted in like good faith, and that the mortgage was executed by a going concern, to secure its indebtedness, after the stockholders had put in their capital for the undoubted purpose of continuing the business; which was so continued up to the failure of September, 1892.
Upon this finding of fact — not concurred in, however, by the writer of this opinion — the transaction would not be within the condemnation of Sutton Mfg. Co. v. Hutchinson, 24 U. S. App. 145, 11 C. C. A. 320, 63 Fed. 496, or any case cited, but is upheld in all material features by the authorities, both federal and state. Hollins v. Iron Co., 150 U. S. 371, 14 Sup. Ct. 127, 37 L. Ed. 1113; Sandford Fork & Tool Co. v. Howe, Brown & Co., 157 U. S. 312, 13 Sup. Ct. 621, 39 L. Ed. 713; Rockford Wholesale Grocery Co. v. Standard Grocery & Meat Co., 175 Ill. 89, 51 N. E. 642, 67 Am. St. Rep. 205, and cases cited. In the Sutton Case, the insolvent corporation mortgaged all its property to another corporation to secure its over-drafts, with the intention and effect of closing all further prosecution of its business immediately thereupon; and this when both corporations, debtor and creditor, were managed by the same officers and directors and the capital stock owned substantially by the same persons. On the contrary, in the finding of fact arrived at by the majority of the Court, the mortgage under consideration was executed by a going concern to secure its indebtedness for the *30purpose of continuing the business, and was reinforced by fresh money contributed by the stockholders in good faith to the same end. This unquestionably would bring this case clearly within the distinctions pointed out in Sandford Fork & Tool Co. v. Howe, Brown & Co., supra, as sustaining the mortgage there in question.
In addition to this, the majority of the Court are of the opinion that the fact that two of the five directors of the shoe company, or that certain of its stockholders, were likewise either directors or stockholders of one or the other bank, receiving the security — all being free from knowledge of the true state of affairs as heretofore indicated — cannot in any view operate to invalidate the security in favor of the banks, accepted in good fáith, where a large proportion of the banks’ shareholders are not shareholders in the shoe company; nor, can the further fact, that directors or stockholders of the shoe company were guarantors of any part of the indebtedness of that company to the banks impugn that security thus given, as the case is not thus within the rule against the preference of corporate indebtedness to a director. Rockford Wholesale Grocery Co. v. Standard Grocery & Meat Co., 175 Ill. 89, 93, 51 N. E. 642, 67 Am. St. Rep. 205; Sandford Fork & Tool Co. v. Howe, Brown & Co., supra. As held in Hollins v. Iron Co., 150 U. S. 371, 382, 14 Sup. Ct. 127, 37 L. Ed. 1113 (approved in Manufacturing Co. v. Hutchinson, supra), the doctrine is well settled in the federal courts “that the property of a private corporation is not burdened with any specific lien or direct trust in favor of general creditors” and prior to the Bankrupt Act of 1898 it was the established rule in Illinois that an insolvent corporation is at liberty to prefer creditors not officers of the company. Blair v. Steel Co., 159 Ill. 350, 364, 42 N. E. 895, 31 L. R. A. 269, and cases cited. In this judgment the writer of this opinion would concur were he able to see that the directors and stockholders of the bank receiving the security were at the time free from knowledge of the shoe company’s true state of affairs.
I cannot, however, bring myself to see the facts, centering around the preference transaction, as the majority of the Court have seen them, and feel that it may be excusable to state my own conclusions in this respect.
July 1, 1892, the board of directors of the shoe company consisted of John J. Foote, Barnett Graff, John Hannah, E. L. Lawrence and D. D. Sabin. On this date Foote was a stockholder in both banks, and a director of the First National Bank; and Sabin was a stockholder, director and vice-president of the Second National Bank. Allen C. Fuller, a director of the shoe company from January 11, 1892, until March 8, 1892, was, during that period, and until after the failure of the company, the largest stockholder in both banks. Ezra May, director of the shoe company from February 13, 1891, until January 11, 1892, was, during this period, and on July 1, 1892, a stockholder and director in both banks, and president of the Second National Bank. All the stockholders in both banks were stockholders in the shoe company, at different times. Fuller was the holder approximately of twenty-two thousand dollars of the cap-*31itai stock of the two banks, or a little less than one seventh. His subscription to the twenty-five thousand dollar increase stock was six thousand two hundred and fifty dollars, which, after deducting something over thirty-five hundred dollars paid to himself, left two thousand seven hundred and fifty dollars to go upon the payment of the debts — or a little over one ninth of the whole stun paid in as increase capital stock. Foote was the owner of thirty-eight hundred dollars of the capital stock of the two banks, or about one thirty-ninth, and his subscription to the increase capital stock was four hundred dollars, or about one sixtieth. Sabin was the holder of the stock of the two banks to the amount of two thousand one hundred dollars, or about one seventy-first thereof, and his subscription to the increase capital stock was one hundred dollars, or about one two hundred and fiftieth thereof. May was the holder of stock in the two banks to the amount of six thousand five hundred dollars, or about one twenty-third thereof, and his subscription to the increase capital stock was six hundred and seventy-five dollars, or about one thirty-seventh thereof. It is thus apparent that if the avails of the increase capital stock went to the banks to pay off the liability on the fictitious notes, each of these men, considering the notes as otherwise worthless, received from the subscription a benefit considerably greater than his contribution.
The testimony shows that the bond issue of fifty thousand dollars, and the avails of the twenty-five thousand dollars increase capita] stock, (except the thirty-five hundred going to Fuller) went to the two banks, to lift the so-called customer’s notes, and certain notes of the shoe company itself, then held by the banks; that, after March 25, 1892, the First National Bank discounted no further paper of the shoe company, and that, after June 5, 1892, the Second National Bank discounted no further paper of the company. It is not clear what business was done by the shoe company from July 1, 1892, until the failure in September. The question is whether these transactions show that on July 1, 1892, the appellees were apprised of the insolvency of the company, and took these steps — the execution of the mortgage and the increase of stock- — to obtain lor their banks an advantage over the other creditors.
The fact that the banks, largely owned by these officers, directors, and stockholders of the shoe company, were the beneficiaries of the mortgage, covering every species of the shoe company’s property, is in my opinion a circumstance sufficient to put the court upon inquiry. “Courts of equity” say the Supreme Court, considering a transaction similar to this, (Richardson v. Green, 133 U. S. 30, 10 Sup. Ct. 280, 33 L. Ed. 516), “regard such personal transactions of a party in either of these positions, not perhaps with distrust, but with a large measure of watchful care; and unless satisfied by the proof that the transaction was entered into in good faith, with a view to the benefit of the company as well as of its creditors, and not solely with a view to his own benefit, they refuse to lend their aid to its enforcement.” The circumstances of the transaction, in my opinion, put the burden of explanation, upon the ap-pellees.
*32The explanation is that the rapidly increasing business of the shoe company made it desirable that the pending indebtedness to the banks should be liquidated, so,that the banks could, in the future, carry the shoe company’s current financial needs, including the discounting of customers’ paper. This might be satisfactory, if it were not in conflict with the sequel. Either the shoe company had further financial needs, in which case, contrary to the explanation, the banks did not, in fact, come to its help, or, what seems more probable, the business of the shoe company was already collapsing, in which case, the explanation is shown to have been false. The explanation, indeed, is no explanation. It only intensifies the suspicion aroused by the circumstances of the transaction.
The judgment of the Circuit Judge, hearing the case below, and of the majority of this Court, seems to have been influenced by the fact that the stockholders and directors of the shoe company, at the time the mortgage was executed, subscribed and paid for the increased capital stock; and that this constituted satisfactory evidence that they did not then realize or suspect the failing condition of the shoe company. But this argument is shorn of its force, when it is remembered that the money thus going out of their pockets, as stockholders of the shoe company, came back, with increase, into their pockets, as stockholders of the banks; and that on the whole, not even taking into account the fifty thousand dollars bond transaction, that was wholly for the benefit of the bank, this transfer from one pocket to the other was to their financial advantage.
I cannot escape the conviction — looking at their conduct both preceding and following the transaction of July, 1892 — that the parties above named, directors or stockholders of the bank, had reason to know at the time of the execution of the mortgage of July 1, 1892, that the shoe company was insolvent. I cannot bring myself to believe that the mortgage was given in good faith by a going concern to obtain financial assistance to keep the company upon its feet. It seems much more probable to me that the whole transaction was a device, in view of coming failure — a failure that came in fact without any further attempt to keep going — to enable the banks to obtain a preference in the distribution of the company’s assets. Nor does the fact that Ruller and May, the chief stockholders in the First and Second National Banks, ceased to be directors of the shoe company in January, 1892, prevent the rule stated from applying. They continued directors and officers of the bank. Foote and Sabin, small stockholders and officers in the banks, were put upon the directory of the shoe company. The rule that creditors thus situated shall not be permitted to obtain a peculiar advantage to themselves over others goes to. the core of the transaction, and is not intended to be defeated by a mere technical alignment of officers. I have no doubt, in view of this record, that Foote and Sabin, directors of the shoe company, were controlled in this transaction by Fuller and May, their associates and superior officers in the bank. Nor is this view changed by the fact that there were other stockholders of the bank. For the purposes of this transaction the men named were the representatives of the others.
*33In this view of the facts, this case is, in all material respects, simi-' lar to Manufacturing Co. v. Hutchinson, supra. In that case, the Hopper Lumber and Manufacturing Company, being insolvent, and having no purpose to further continue its business, executed a mortgage to the Sutton Manufacturing Company, covering its entire stock, and every article and thing used in its business, to secure the payment of drafts to the amount of eighteen thousand dollars, drawn at different times during the preceding two' months by the Hopper Company upon the Sutton Company. Of the six hundred shares capital stock of the Hopper Company at the time of the mortgage, five hundred and ten shares were held by James S. Hopper, the president; thirty shares by Henry S. Hopper, secretary and treasurer, and a director; twenty shares by Fannie K. Hopper, a director; and forty shares by Elizabeth Sutton, mother of Fannie E., and mother-iu-law of James S. Hopper.
Of the one thousand shares of the Sutton Manufacturing Company, one share was held by_ James S. Hopper; two hundred and fifty-nine shares by Fannie K. Hopper; one hundred and twenty shares by Henry S. Hopper; two hundred and four shares by Benjamin F. Sutton (a director in the Hopper Company); seventy-six shares by Mary J. Adams; one hundred and twenty shares by Walter A. Hopper; and two hundred and twenty shares by Elizabeth Sutton. Neither of the last three were officers or directors in the Hopper Company, and had no relation to the Hopper Company, other than that Mary J. Adams was his sister, and Fdizabeth Sutton the mother, of Fannie E. Hopper, and Walter A. Hopper was the son of James S. Hopper by a former wife.
The court held the mortgage void, laying down the rule that when a corporation becomes insolvent, and does not expect to make further effort to accomplish the objects of its creation, its managing officers and directors came under a duty to distribute its property or its proceeds ratably among the creditors; and that, because of the existence of this duty, the law will not permit them, although creditors, to obtain any peculiar advantage for themselves to the prejudice of others.
Recognizing the fact that the mortgagee was a corporation, and not the individual directors, of the Hopper Company, and that some of its stockholders had no pecuniary relation with the Hopper Company, the rule is, notwithstanding, applied, because, as stated, two of the directors of the insolvent Hopper Company owned nearly four hundred shares out of the one thousand shares of the Sutton Company; wherefore, the mortgage had the effect to protect their interest, and to withdraw the property mortgaged from its primary liability for the debts of the mortgagor company. “The case presented” say the court “is consequently one in which an insolvent corporation, recognizing its inability to further prosecute its business, and with no hope of recovering from its financial embarrassments, gives a preference by mortgage of its property to some of its directors, being also creditors. According to the principles we have announced this could not be rightfully done.”
The Illinois cases (Gottlieb v. Miller, 154 Ill. 44, 39 N. E. 992; *34Blair v. Steel Co., 159 Ill. 350, 42 N. E. 895, 31 L. R. A. 269; State Nat. Bank of St. Joseph v. Union Nat. Bank of Chicago, 168 Ill. 519, 48 N. E. 82), in essence, are not in conflict with this ruling. In all these cases it is held that creditors of an insolvent corporation, who are, also, directors, can not secure preference of their claims, at the expense of other creditors; that in such a case, as distinguished from a case where the directors apply the assets of the insolvent corporation to the payment of a debt due a third person, there is a trust.
The mortgage, in my judgment, comes under the ruling of Manufacturing Co. v. Hutchinson, supra, and should, as to the complaining creditors, be declared void, and the estate should be administered according to that theory; but overruled in'this particular phase of the case, as I am, by the judgment of my associates, the decree of the Circuit Court must be affirmed.